CNI

Business Context and Reporting Period

Company: Canadian National Railway Company (CN)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: Third quarter and nine months ended September 30, 2010
Business Overview: CN operates a rail network spanning Canada and mid-America, connecting the Atlantic, Pacific, and Gulf of Mexico coasts. The company transports a diversified portfolio of commodities including grain, coal, intermodal, automotive, and forest products.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Q3 revenues increased 15% and 9M revenues increased 13%, driven by higher freight volumes across almost all markets, increased fuel surcharges, and freight rate hikes. This was partially offset by the negative translation impact of a stronger Canadian dollar.
• Profitability: Net income rose 21% in Q3 and 26% for the nine-month period. The operating ratio improved by 2.0 points in Q3 and 4.4 points for the nine-month period.
• Volume Increases: Carloadings increased 18% in Q3. Specific commodity highlights include a 75% increase in Canadian coal traffic (9M), a 25% increase in overseas intermodal traffic (9M), and record grain volumes approaching 1996/1997 levels.
• Unusual Items:
  • 2010: Included a $152 million pre-tax gain ($131 million after-tax) from the sale of the Oakville subdivision in Q1.
  • 2009: Included a $157 million pre-tax gain from the sale of the Weston subdivision, $49 million in EJ&E acquisition costs, and a $58 million deferred income tax recovery.
• Foreign Exchange: The strengthening Canadian dollar negatively impacted reported net income by $12 million in Q3 and $61 million for the nine-month period.

Guidance, Outlook, and Risks

2010 Outlook: Management remains comfortable with guidance issued in July 2010.

• Adjusted Diluted EPS: Expected to increase approximately 25% over 2009 (targeting ~$4.05 vs. 2009's $3.24).
• Free Cash Flow: Expected to be in the range of C$1.1 billion.
• Capital Spending: Approximately C$1.6 billion planned for 2010.

Key Assumptions: Outlook assumes 5% growth in North American industrial production, U.S. housing starts of ~675,000 units, mid-teens carload growth, 3.5% pricing improvement, and crude oil prices between US$75-$80/barrel.

Risks and Contingencies:

• Regulatory: Ongoing oversight of the Elgin, Joliet and Eastern (EJ&E) acquisition by the Surface Transportation Board (STB), including mitigation conditions and potential challenges to the Environmental Impact Statement.
• Labor: Active negotiations with various unions in Canada and the U.S. (e.g., TCRC, CAW). While tentative agreements were reached with some groups, strikes or lockouts remain a risk.
• Environmental: Liability for remediation at approximately 300 sites; aggregate accruals of $161 million as of Sept 30, 2010.
• Market: Sensitivity to fuel price volatility, foreign exchange fluctuations, and general economic conditions affecting customer demand.

Investor Verification Checklist

• Adjusted vs. GAAP: Verify the impact of the $152 million Oakville subdivision gain on Q1 2010 results when analyzing core operating performance.
• Foreign Exchange Sensitivity: Monitor the CAD/USD exchange rate, as a one-cent change can impact net income by $5-$10 million annually.
• Labor Agreements: Track the ratification status of tentative agreements with the TCRC-CTY and CAW to assess strike risk.
• Regulatory Compliance: Review updates on the STB's five-year monitoring of the EJ&E acquisition and any new conditions imposed.
• Pension Funding: Note the $300 million voluntary contribution made in 2010 to strengthen the CN Pension Plan and monitor future actuarial valuation requirements.