Business Context and Reporting Period
Company: Canadian National Railway Company (CN)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: Second Quarter and Six Months ended June 30, 2014
Business Overview: CN operates a rail network spanning Canada and mid-America, transporting goods across three coasts. The company reported a strong operational recovery from Q1 2014 winter weather challenges, delivering record volumes driven by a record Canadian grain crop and strength in energy and intermodal markets.
Key Financial Metrics
| Metric | Q2 2014 | Q2 2013 | 6M 2014 | 6M 2013 |
|---|---|---|---|---|
| Revenues (C$ millions) | 3,116 | 2,666 | 5,809 | 5,132 |
| Operating Income (C$ millions) | 1,258 | 1,042 | 2,078 | 1,822 |
| Net Income (C$ millions) | 847 | 717 | 1,470 | 1,272 |
| Diluted EPS (C$) | 1.03 | 0.84 | 1.77 | 1.49 |
| Operating Ratio (%) | 59.6% | 60.9% | 64.2% | 64.5% |
| Free Cash Flow (C$ millions) | 776 (Q2) | 637 (Q2) | 1,270 (6M) | 788 (6M) |
| Total Debt (C$ millions) | 7,661 (Carrying amount as of June 30, 2014) | |||
| Cash and Cash Equivalents (C$ millions) | 127 (as of June 30, 2014) |
Material Changes vs. Prior Period
- Revenue Growth: Q2 2014 revenues increased 17% year-over-year, driven by a 14% increase in revenue ton-miles and an 11% increase in carloadings. Key growth drivers included a record Canadian grain crop, strong energy markets, and market share gains in intermodal.
- Profitability: Net income rose 18% in Q2 2014. Adjusted diluted EPS increased 24% to C$1.03, excluding a one-time gain in the prior year. The operating ratio improved by 1.3 points to 59.6%.
- Foreign Currency Impact: The weaker Canadian dollar provided a positive translation impact on U.S.-denominated revenues. On a constant currency basis, Q2 2014 net income would have been C$28 million lower.
- Unusual Items:
- 2014: Included a C$80 million pre-tax gain (C$72 million after-tax) from the disposal of the Deux-Montagnes subdivision in Q1 2014.
- 2013: Included a C$29 million pre-tax gain from an exchange of easements and a C$5 million tax expense from higher provincial corporate income tax rates.
Guidance, Outlook, and Risks
Revised 2014 Outlook
Management revised its 2014 financial outlook positively:
- Earnings Per Share: Expects solid double-digit EPS growth over adjusted 2013 diluted EPS of C$3.06.
- Free Cash Flow: Revised range to C$1.8 billion to C$2.0 billion (previously C$1.6 billion to C$1.7 billion).
Key Assumptions
- North American industrial production growth of 3-4%.
- U.S. housing starts of approximately 1 million units.
- Canadian dollar trading in the range of US$0.90 to US$0.95.
- Crude oil (WTI) prices in the range of US$95-US$105 per barrel.
- Capital spending of approximately C$2.25 billion for 2014.
Risks and Contingencies
- Regulatory: Ongoing legislative reviews in Canada (Bill C-30) regarding grain movement minimums and U.S. Surface Transportation Board proceedings on competitive switching and rate complaints.
- Safety & Environment: Implementation of Positive Train Control (PTC) by Dec 31, 2015, with estimated costs of US$335 million. Exposure to environmental liabilities at approximately 270 sites.
- Labor: Several collective agreements in Canada expire in late 2014, with negotiations expected to commence in September 2014.
- Market: Volatility in fuel prices and foreign exchange rates.
Investor Verification Checklist
- Constant Currency Performance: Verify organic growth by reviewing constant currency metrics, as the reported results were significantly boosted by the weaker Canadian dollar.
- Grain Supply Chain Status: Confirm the sustainability of the record grain volumes and the status of port line-ups and car wait-lists as the crop year progresses.
- Capital Expenditure Execution: Monitor the C$2.25 billion capital program, specifically the C$1.2 billion allocated to track infrastructure and the C$350 million for equipment.
- Labor Negotiations: Track the outcome of upcoming collective bargaining agreements in Canada expiring in December 2014.
- PTC Implementation: Assess progress and potential cost overruns related to the U.S. federal mandate for Positive Train Control.