CNI

Business Context and Reporting Period

Company: Canadian National Railway Company (CN)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: First Quarter ended March 31, 2010
Business Overview: CN operates a rail network spanning Canada and mid-America, connecting the Atlantic, Pacific, and Gulf of Mexico coasts. The company manages its operations as a single business segment, focusing on freight transportation across seven commodity groups.

Key Financial Metrics

Liquidity and Debt:

• Cash and Cash Equivalents: $748 million (March 31, 2010) vs. $352 million (Dec 31, 2009).
• Working Capital: $610 million.
• Long-term Debt: $6,189 million (excluding current portion).
• Debt-to-Total Capitalization: 35.4% (Adjusted: 37.3%).

Material Changes vs. Prior Period

• Revenue Growth: Driven by a 16% increase in carloadings and a 14% increase in revenue ton-miles across all commodity groups due to improving economic conditions. Automotive (+48%), Coal (+28%), and Intermodal (+10%) saw significant revenue increases. Petroleum/Chemicals (-6%) and Forest Products (-5%) declined.
• Operating Expenses: Decreased 1% to $1,362 million. This was primarily due to the positive translation impact of a stronger Canadian dollar on U.S.-denominated expenses, the absence of one-time EJ&E acquisition costs recorded in Q1 2009, and reduced equipment rents. These savings were partially offset by higher fuel costs and increased labor expenses.
• Unusual Items:
  • Q1 2010: Included a one-time after-tax gain of $131 million ($0.28 per share) from the sale of the Oakville rail-line subdivision to a Toronto-area transit agency.
  • Q1 2009: Included a gain on the sale of the Weston subdivision ($135 million after-tax) and one-time EJ&E acquisition costs ($28 million after-tax).
• Foreign Exchange: The stronger Canadian dollar reduced Q1 2010 net income by approximately $41 million ($0.09 per share) on a constant currency basis.

Guidance, Outlook, and Risks

Revised 2010 Outlook: CN has revised its 2010 earnings estimate upward, targeting solid double-digit growth in adjusted diluted EPS over the 2009 level of $3.24. The company expects full-year 2010 free cash flow to be in the order of $1 billion (previously $700 million).

• Key Assumptions: North American industrial production growth of ~5%; U.S. housing starts of ~675,000 units; low double-digit carload growth; pricing improvement of ~3.5%; Canadian-U.S. exchange rate near par; crude oil price of ~$85/barrel; and capital investment of ~$1.6 billion.

Management Commentary: CEO Claude Mongeau highlighted strong winter operating performance and improved service levels allowing the company to accommodate increased freight volumes at low incremental cost. The company is focused on operational excellence and network velocity.

Risks and Contingencies:

• Regulatory: Ongoing Surface Transportation Board (STB) oversight regarding the EJ&E acquisition, including a five-year monitoring period and potential challenges to environmental impact statements.
• Labor: Collective agreements for various unionized groups (locomotive engineers, conductors, clerical staff) are expiring or under negotiation, posing risks of work stoppages.
• Environmental: Liability for remediation at approximately 310 sites; aggregate accruals of $99 million.
• Legal: Reserves for personal injury and other claims total $354 million.

Investor Verification Checklist

• Adjusted EPS: Verify the reconciliation of reported EPS ($1.08) to adjusted EPS ($0.80) to understand the impact of the $131 million rail-line sale gain.
• Constant Currency Impact: Assess the sensitivity of future earnings to the Canadian dollar, noting the $41 million negative impact in Q1 2010.
• Capital Expenditures: Confirm the $1.6 billion capital program plan, specifically the $1 billion allocation for track infrastructure and $300 million for equipment.
• Share Repurchases: Note the new program allowing repurchase of up to 15 million shares; 2.3 million shares were repurchased in Q1 2010 for $129 million.
• Debt Maturity: Review the contractual obligations table for long-term debt and interest payments due in 2010 and beyond.
• Regulatory Status: Monitor the outcome of the STB audit regarding the EJ&E acquisition and any potential additional mitigation costs.