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 transcontinental railway network spanning Canada and the mid-section of the United States, connecting the Atlantic and Pacific oceans to the Gulf of Mexico. The company serves major ports and metropolitan areas, facilitating freight transport across North America.

Key Financial Metrics

Liquidity and Debt:

• Cash and Cash Equivalents: C$748 million (March 31, 2010) vs. C$352 million (Dec 31, 2009).
• Long-term Debt: C$6,189 million (March 31, 2010).
• Debt-to-Total Capitalization: 35.4% (March 31, 2010) vs. 43.4% (March 31, 2009).

Material Changes vs. Prior Period

• Unusual Items: Reported Net Income included a C$131 million after-tax gain (C$152 million pre-tax) from the sale of the Oakville subdivision rail-line to a Toronto-area transit agency. Excluding this gain, Adjusted Net Income was C$380 million.
• Volume Growth: Carloadings increased 16% and Revenue Ton-Miles increased 14%, driven by higher freight volumes across all commodity groups due to improving economic conditions.
• Revenue Mix: Automotive revenues surged 48%, Coal 28%, and Intermodal 10%. Petroleum/Chemicals and Forest products declined 6% and 5% respectively.
• Yield Impact: Rail freight revenue per revenue ton-mile decreased 7% primarily due to the negative translation impact of a stronger Canadian dollar, partially offset by higher fuel surcharges and rate increases.
• Expense Management: Total operating expenses declined 1% year-over-year, aided by the positive translation impact of the stronger Canadian dollar on U.S.-denominated expenses and reduced equipment rents, despite higher fuel costs.

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 C$3.24. The company expects full-year 2010 free cash flow to be in the order of C$1 billion (previously C$700 million), driven by strong Q1 performance and proceeds from the rail-line sale.

Key Assumptions:

• North American industrial production increase of ~5%.
• U.S. housing starts of ~675,000 units.
• Low double-digit carload growth with ~3.5% pricing improvement.
• Canadian-U.S. exchange rate near par.
• Crude oil price (WTI) of ~US$85/barrel.
• Capital investment of approximately C$1.6 billion.

Risks and Contingencies:

• Currency: A stronger Canadian dollar reduced Q1 net income by C$41 million (C$0.09 per share) on a constant currency basis.
• Legal and Environmental: The company maintains C$354 million in reserves for personal injury and other claims, and C$99 million for environmental costs. Future liabilities related to environmental remediation or litigation could be material.
• Operational: Risks include severe weather, labor negotiations, fuel price volatility, and regulatory changes.

Investor Verification Checklist

• Adjusted vs. Reported Earnings: Verify the sustainability of earnings by analyzing the C$131 million gain from the rail-line sale, which significantly boosted reported Q1 net income.
• Currency Sensitivity: Assess the impact of the Canadian dollar strengthening on future U.S.-denominated revenues and expenses, as this reduced Q1 net income by C$41 million.
• Free Cash Flow Quality: Confirm the C$493 million free cash flow figure, noting it includes proceeds from the asset sale and excludes the C$129 million share repurchase program initiated in Q1.
• Debt Reduction: Review the decline in the debt-to-total capitalization ratio from 43.4% to 35.4% and the reduction in long-term debt.
• Environmental Liabilities: Monitor the C$99 million environmental accrual and the potential for additional costs from the 310 identified sites with contamination concerns.