Business Context and Reporting Period
Company: Canadian National Railway Company (CN)
Filing Type: Form 6-K (Report of Foreign Issuer)
Date: October 26, 2009
Reporting Period: The filing announces the release of the 2009 Investor Fact Book, containing unaudited financial and statistical data for the fiscal years ended December 31, 2006, 2007, and 2008, with operational updates for 2009.
CN is a Class I railroad operating a tri-coastal network spanning Canada and the mid-United States. The company operates under a "Precision Railroading" model focused on scheduled service, asset utilization, and cost control. In 2009, the company is navigating a severe North American recession, adjusting resources to reduced demand while integrating the Elgin, Joliet and Eastern Railway (EJ&E) acquisition.
Key Financial Metrics (2008 vs. 2007)
| Metric (CAD Millions) | 2008 | 2007 | Change |
|---|---|---|---|
| Revenues | $8,482 | $7,897 | +7.4% |
| Operating Income | $2,894 | $2,876 | +0.6% |
| Net Income | $1,895 | $2,158 | -12.2% |
| Adjusted Net Income | $1,778 | $1,725 | +3.1% |
| Diluted EPS | $3.95 | $4.25 | -7.1% |
| Free Cash Flow | $794 | $828 | -4.1% |
| Net Capital Expenditures | $1,424 | $1,387 | +2.7% |
Financial Ratios (2008)
- Operating Ratio: 65.9% (vs. 63.6% in 2007)
- Debt-to-Total Capitalization: 42.8% (vs. 35.6% in 2007)
- Adjusted Debt-to-Adjusted EBITDA: 2.4 times (vs. 1.9 times in 2007)
- Dividend Per Share: $0.92 (vs. $0.84 in 2007)
Material Changes and Operational Highlights
- Economic Impact: The 2008 results reflect a strong year prior to the deepening 2009 recession. Revenue increased due to freight rate hikes and volume growth in Intermodal, Coal, and Petroleum/Chemicals. However, Net Income declined primarily due to a $117 million deferred income tax recovery in 2008 compared to a $328 million recovery in 2007, alongside higher fuel costs.
- Commodity Performance (2008):
- Intermodal: Revenues up 14% ($198M) driven by Prince Rupert terminal volumes and rate increases.
- Coal: Revenues up 24% ($93M) due to new mine operations and strong Western U.S. volumes.
- Forest Products: Revenues down 7% ($116M) due to the U.S. housing market decline.
- Automotive: Revenues down 7% ($35M) due to production curtailments.
- Strategic Acquisition: CN completed the $300 million acquisition of the EJ&E on January 31, 2009. This 198-mile line encircles Chicago, providing a critical bypass to reduce congestion and improve network velocity. CN plans to invest an additional $100 million in upgrading the EJ&E over three years.
- Capital Expenditures: 2008 CapEx was $1.54 billion. For 2009, CN plans to invest approximately $1.5 billion, with roughly $1 billion targeted at track infrastructure, including EJ&E improvements and siding extensions.
Guidance, Outlook, and Risks
Management Commentary: Management acknowledges the "most challenging economic conditions in decades." The focus for 2009 is on cost management, reducing train starts, and carefully managing headcount to match reduced volumes. Despite the downturn, CN remains committed to long-term structural growth opportunities, including the EJ&E integration, Prince Rupert expansion, and oil sands development in Western Canada.
Outlook by Segment:
- Intermodal: International segment expected to recover with the global economy; domestic segment expected to benefit from truck-to-rail conversion.
- Grain & Fertilizers: Optimistic about long-term growth driven by global population and food demand, despite short-term market weakness.
- Coal: Demand deteriorated in 2009 due to economic conditions, but long-term outlook remains positive for thermal and metallurgical coal.
- Automotive: Volumes expected to decline in 2009 due to the credit crisis and reduced consumer confidence.
Risks and Contingencies:
- Labor Relations: Ongoing negotiations with Teamsters Canada Rail Conference (TCRC) regarding locomotive engineers and traffic controllers. A Canada Industrial Relations Board inquiry is underway to determine essential services in the event of a strike. No disruption is currently foreseen, but the risk of work stoppages remains.
- Regulatory: Compliance with the U.S. Railway Safety Improvement Act of 2008, requiring Positive Train Control (PTC) implementation by 2015.
- Market Volatility: Exposure to fuel price fluctuations (mitigated by surcharges), foreign exchange rates (50-55% of revenue in USD), and general economic recession.
Investor Verification Checklist
- 2009 Earnings Trajectory: Verify Q3 and Q4 2009 earnings reports to assess the full impact of the recession on volume and pricing power, as 2008 data is pre-recession.
- EJ&E Integration Progress: Monitor operational metrics (train speed, yard dwell) to confirm the anticipated efficiency gains from the Chicago bypass are materializing.
- Labor Negotiation Status: Track the outcome of the CIRB inquiry and TCRC negotiations to assess the risk of potential service disruptions.
- Capital Discipline: Confirm that 2009 capital expenditures remain near the $1.5 billion guidance, particularly regarding the $100 million EJ&E upgrade commitment.
- Free Cash Flow: Analyze the ability to maintain dividend payouts and debt service given the decline in Free Cash Flow from $828M (2007) to $794M (2008) and the projected 2009 volume declines.