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, 2015 (and six months ended June 30, 2015)
Business Overview: CN operates a rail network spanning Canada and mid-America, connecting the Atlantic, Pacific, and Gulf of Mexico coasts. The company transports over C$250 billion worth of goods annually across seven commodity groups.
Key Financial Metrics
| Metric | Q2 2015 | Q2 2014 | 6 Months 2015 | 6 Months 2014 |
|---|---|---|---|---|
| Revenues | C$3,125 million | C$3,116 million | C$6,223 million | C$5,809 million |
| Operating Income | C$1,362 million | C$1,258 million | C$2,425 million | C$2,078 million |
| Net Income | C$886 million | C$847 million | C$1,590 million | C$1,470 million |
| Diluted EPS | C$1.10 | C$1.03 | C$1.96 | C$1.77 |
| Adjusted Diluted EPS | C$1.15 | C$1.03 | C$2.01 | C$1.68 |
| Operating Ratio | 56.4% | 59.6% | 61.0% | 64.2% |
| Free Cash Flow (6mo) | C$1,051 million (vs. C$1,270 million prior year) | |||
| Total Debt (Carrying Amount) | C$9,344 million (as of June 30, 2015) | |||
| Cash and Cash Equivalents | C$86 million (as of June 30, 2015) |
Material Changes vs. Prior Period
- Profitability: Net income increased 5% in Q2 and 8% for the six-month period. Operating income rose 8% in Q2 and 17% for the six months, driven by efficiency gains and lower fuel costs.
- Operating Ratio: Improved by 3.2 points in Q2 (56.4% vs. 59.6%) and 3.2 points for the six months (61.0% vs. 64.2%), reflecting record efficiency.
- Revenue Drivers: Q2 revenues were flat year-over-year. Growth in automotive (+17%), forest products (+8%), and petroleum/chemicals (+4%) was offset by declines in coal (-26%), grain/fertilizers (-7%), and metals/minerals (-5%).
- Volume Trends: Carloadings decreased 3% and revenue ton-miles declined 7% in Q2. However, rail freight revenue per revenue ton-mile increased 7% due to rate increases and currency translation.
- Foreign Currency Impact: The weaker Canadian dollar provided a positive translation impact on U.S.-denominated revenues. On a constant currency basis, Q2 net income would have been lower by C$64 million.
- Unusual Items: Q2 2015 included a deferred income tax expense of C$42 million due to a higher provincial corporate income tax rate. Q2 2014 included a C$80 million gain on the disposal of the Deux-Montagnes subdivision.
Guidance, Outlook, and Risks
- 2015 Outlook: Management reaffirmed guidance for double-digit adjusted EPS growth for the full year 2015 compared to 2014's adjusted diluted EPS of C$3.76.
- Capital Program: CN plans to invest approximately C$2.7 billion in 2015, with C$1.4 billion targeted for network safety and integrity.
- Revised Assumptions:
- North American industrial production growth revised down to ~1% (from 3%).
- Total carloads expected to be generally comparable to 2014 (revised down from 3% growth).
- No longer counting on growth in energy-related commodities (crude oil, frac sand).
- Assumed CAD/USD exchange rate of ~0.80 and crude oil price of ~US$50/barrel.
- Key Risks:
- Regulatory: Implementation of Positive Train Control (PTC) in the U.S. and new safety regulations in Canada (Bill C-52).
- Market: Weakness in coal and grain markets; volatility in energy commodity shipments.
- Operational: Labor negotiations (though several agreements were ratified in early 2015); environmental liabilities; and currency fluctuations.
Investor Verification Checklist
- Constant Currency Performance: Verify the impact of the weaker Canadian dollar on reported earnings versus underlying operational performance.
- Volume vs. Yield: Confirm the sustainability of revenue growth given the 7% decline in revenue ton-miles and 3% decline in carloadings.
- Coal and Grain Exposure: Assess the long-term impact of the 26% decline in coal revenue and 7% decline in grain revenue on future guidance.
- Capital Expenditure: Review the C$2.7 billion capital program allocation, specifically the C$100 million increase for safety and the Western Canada feeder rail upgrades.
- Debt Levels: Monitor the adjusted debt-to-total capitalization ratio (41.7% at June 30, 2015) and the impact of the weaker CAD on U.S.-denominated debt.
- Regulatory Compliance Costs: Evaluate the financial impact of upcoming PTC implementation and new Canadian safety regulations (Bill C-52).