Business Context and Reporting Period
Company: Canadian National Railway Company (CN)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: Second Quarter ended June 30, 2009 (Three and Six Months)
Business Overview: CN operates a rail network spanning Canada and mid-America, connecting the Atlantic, Pacific, and Gulf of Mexico. The company manages its operations as a single business segment, focusing on "precision railroading" to optimize asset utilization and service reliability.
Key Financial Metrics
| Metric (C$ Millions) | Q2 2009 | Q2 2008 | 6M 2009 | 6M 2008 |
|---|---|---|---|---|
| Revenues | 1,781 | 2,098 | 3,640 | 4,025 |
| Operating Expenses | 1,198 | 1,391 | 2,576 | 2,795 |
| Operating Income | 583 | 707 | 1,064 | 1,230 |
| Net Income | 387 | 459 | 811 | 770 |
| Diluted EPS | $0.82 | $0.95 | $1.72 | $1.59 |
| Operating Ratio | 67.3% | 66.3% | 70.8% | 69.4% |
| Free Cash Flow | 256 | 164 | 463 | 225 |
Liquidity and Debt:
- Cash and Cash Equivalents: $431 million (June 30, 2009) vs. $161 million (June 30, 2008).
- Total Debt: Long-term debt was $7,093 million plus a current portion of $506 million.
- Adjusted Debt-to-Total Capitalization: 42.7% (June 30, 2009).
- Adjusted Debt-to-Adjusted EBITDA: 2.33 times (Trailing twelve months ended June 30, 2009).
Material Changes vs. Prior Period
Revenue and Volume Declines:
- Revenues declined 15% in Q2 2009 and 10% for the six-month period, driven by depressed North American and global economies.
- Carloads fell 22% to 928,000 in Q2 2009; Revenue Ton-Miles (RTM) declined 14%.
- Significant volume drops occurred in Metals and Minerals (-34%), Automotive (-26%), and Forest Products (-21%). Coal was the only segment to show growth (+4%) due to the EJ&E acquisition.
- Operating expenses decreased 14% in Q2 2009, primarily due to a 56% drop in fuel costs (average price fell to $2.00/gallon from $3.82) and cost-containment measures.
- Despite lower expenses, the Operating Ratio worsened by 1.0 percentage point to 67.3% due to the steeper revenue decline.
- Q2 2009: Included a $28 million deferred income tax recovery (lower provincial tax rates and foreign investment recapitalization) and $2 million after-tax costs related to the EJ&E acquisition.
- 6M 2009: Included a $157 million gain on the sale of the Weston subdivision (Toronto) and $49 million in EJ&E acquisition costs.
Guidance, Outlook, and Risks
Management Commentary:
- CEO E. Hunter Harrison noted continued weakness in most commodity groups due to the recession, with double-digit declines in all groups except coal.
- Management sees signs of stabilization in several markets and hopes for an economic recovery in the second half of 2009.
- Capital spending for 2009 is targeted at approximately $1.5 billion, with $1 billion allocated to track infrastructure.
- Economic Conditions: Deep recession in North America and global contraction continue to suppress demand.
- Regulatory (EJ&E Acquisition): The acquisition of Elgin, Joliet and Eastern Railway (EJ&E) is subject to a five-year monitoring period by the U.S. Surface Transportation Board (STB). Challenges to the Environmental Impact Statement (EIS) by local communities could result in further mitigation costs or operational restrictions.
- Environmental Liabilities: Aggregate accruals for environmental costs were $112 million. Unknown future liabilities related to contamination cannot be reasonably estimated.
- Legal Claims: Reserves for personal injury and other claims totaled $424 million. Final outcomes of pending litigation are uncertain.
- Labor: Ongoing negotiations with Canadian and U.S. unions; potential for strikes or lockouts if agreements are not reached.
Investor Verification Checklist
- Adjusted Earnings: Verify the reconciliation of GAAP Net Income to Adjusted Net Income ($361 million for Q2 2009), excluding the tax recovery and acquisition costs, to assess core operational performance.
- Volume Trends: Monitor the stabilization of carloads in key segments (Metals, Automotive, Forest Products) as a leading indicator of economic recovery.
- EJ&E Integration: Track the operational integration of the EJ&E lines and any updates regarding STB regulatory challenges or additional mitigation costs.
- Weston Subdivision Proceeds: Confirm the receipt of the remaining escrow funds ($50 million balance) from the Weston subdivision sale by December 31, 2009.
- Debt Maturity: Review the contractual obligations table for debt maturities and interest payments, noting the $350 million principal due in 2009.
- Foreign Exchange: Assess the impact of the weaker Canadian dollar, which provided a $15 million benefit to Q2 net income but increased U.S.-denominated expenses.