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, 2014
Business Overview: CN operates a rail network spanning Canada and mid-America, transporting goods across three coasts. The company reported solid results despite operational challenges caused by an unusually harsh winter that impacted network capacity.
Key Financial Metrics
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Revenues | C$2,693 million | C$2,466 million | +9% |
| Operating Income | C$820 million | C$780 million | +5% |
| Net Income | C$623 million | C$555 million | +12% |
| Diluted EPS | C$0.75 | C$0.65 | +15% |
| Adjusted Diluted EPS | C$0.66 | C$0.61 | +8% |
| Operating Ratio | 69.6% | 68.4% | -1.2 pts |
| Free Cash Flow | C$494 million | C$151 million | +227% |
| Carloadings | 1,239 thousand | 1,231 thousand | +1% |
| Revenue Ton-Miles | 53,334 million | 50,576 million | +5% |
Material Changes vs. Prior Period
- Revenue Growth: Driven by a 9% increase in total revenues, primarily due to the positive translation impact of a weaker Canadian dollar, freight rate increases, and higher volumes in energy markets and intermodal traffic.
- Expense Increases: Operating expenses rose 11% to C$1,873 million. This was attributed to the negative translation impact of the weaker Canadian dollar on U.S.-denominated expenses, increased fuel costs, and higher purchased services/material expenses due to harsh winter conditions.
- Operating Ratio Deterioration: The operating ratio worsened by 1.2 points to 69.6%, reflecting the disproportionate rise in operating expenses relative to revenue growth.
- Unusual Items:
- Q1 2014: Included a C$80 million pre-tax gain (C$72 million after-tax) from the sale of the Deux-Montagnes subdivision.
- Q1 2013: Included a C$40 million pre-tax gain (C$36 million after-tax) from the sale of the Lakeshore West segment.
- Currency Impact: The fluctuation of the Canadian dollar provided a positive impact of C$26 million to net income.
Guidance, Outlook, and Risks
- 2014 Outlook: CN reaffirmed its 2014 financial guidance, targeting double-digit EPS growth over 2013 adjusted diluted EPS of C$3.06 and free cash flow in the range of C$1.6 billion to C$1.7 billion.
- Capital Spending: Increased the 2014 capital spending envelope to C$2.25 billion (up from C$2.1 billion), with approximately C$1.2 billion targeted for network safety and integrity.
- Key Assumptions: Forecasts include 3% North American industrial production growth, mid-single digit carload growth, and a Canadian dollar range of US$0.90-$0.95.
- Risks and Contingencies:
- Weather: Severe winter weather previously reduced capacity; recovery is underway.
- Regulatory: Ongoing inquiries regarding grain movement mandates in Canada and Positive Train Control (PTC) implementation in the U.S.
- Labor: Collective agreements with Canadian unions (Teamsters Canada Rail Conference) are subject to binding arbitration expected in June 2014.
- Environmental: Exposure to liabilities from approximately 275 sites with potential contamination; aggregate accruals of C$118 million.
Investor Verification Checklist
- Adjusted EPS: Verify the reconciliation of reported EPS (C$0.75) to adjusted EPS (C$0.66) to understand the impact of the C$80 million property sale gain.
- Winter Impact: Assess management's commentary on the recovery of network capacity and service metrics following the "harshest winter in decades."
- Currency Sensitivity: Review the C$26 million positive currency impact and the company's exposure to CAD/USD fluctuations given significant U.S. operations.
- Capital Allocation: Confirm the rationale for the C$150 million increase in the 2014 capital spending budget.
- Labor Arbitration: Monitor the outcome of the binding arbitration with the Teamsters Canada Rail Conference expected in June 2014.