Business Context and Reporting Period
Company: Canadian National Railway Company (CN)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: Third quarter and nine months ended September 30, 2014
Business Overview: CN operates a rail network spanning Canada and mid-America, transporting approximately C$250 billion worth of goods annually. The company manages its operations as a single business segment, focusing on seven commodity groups including petroleum, grain, intermodal, and automotive.
Key Financial Metrics
| Metric (C$ Millions) | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Revenues | 3,118 | 2,698 | 8,927 | 7,830 |
| Operating Income | 1,286 | 1,084 | 3,364 | 2,906 |
| Net Income | 853 | 705 | 2,323 | 1,977 |
| Diluted EPS | $1.04 | $0.84 | $2.81 | $2.33 |
| Operating Ratio | 58.8% | 59.8% | 62.3% | 62.9% |
| Free Cash Flow (9M) | N/A | 2,045 | 1,307 | |
| Total Debt (Long-term + Current) | N/A | 7,841 | 7,498 |
Note: All figures are in Canadian dollars unless otherwise noted. Free cash flow is a non-GAAP measure defined by the company.
Material Changes vs. Prior Period
- Revenue Growth: Q3 2014 revenues increased 16% to a record C$3,118 million, driven by an 11% increase in carloadings (1,475 thousand) and a 13% increase in revenue ton-miles. Key drivers included a record Canadian grain crop, strong energy markets (crude oil and frac sand), and new intermodal business.
- Profitability: Net income rose 21% to C$853 million in Q3 2014. Adjusted diluted EPS increased 21% to C$1.04, excluding a C$19 million income tax expense in Q3 2013 related to higher provincial tax rates.
- Operating Efficiency: The operating ratio improved by 1.0 percentage point to 58.8% in Q3 2014. Operating expenses increased 14% due to higher fuel costs, labor, and purchased services, but were outpaced by revenue growth.
- Foreign Currency Impact: The weaker Canadian dollar provided a positive translation impact on U.S.-denominated revenues. On a constant currency basis, Q3 2014 net income would have been C$22 million lower.
- Unusual Items: The nine-month 2014 results included a C$80 million gain (C$72 million after-tax) from the disposal of the Deux-Montagnes subdivision. The nine-month 2013 results included gains from the exchange of easements and disposal of the Lakeshore West subdivision.
Guidance, Outlook, and Risks
Management Commentary and Outlook
Management maintains its 2014 financial outlook, expecting solid double-digit EPS growth over adjusted 2013 levels and free cash flow in the range of C$1.8 billion to C$2 billion (excluding major asset sales). Key assumptions for the full year include:
- North American industrial production growth of 3-4%.
- U.S. housing starts of approximately 1 million units.
- U.S. motor vehicle sales of approximately 16 million units.
- Canadian grain crop in-line with the five-year average; U.S. grain crop above average.
- Canadian dollar trading between US$0.90 and US$0.95.
- Crude oil (WTI) averaging US$95-US$105 per barrel.
Capital Program: CN plans to invest approximately C$2.25 billion in 2014, with C$1.2 billion targeted for track infrastructure safety and integrity.
Risks and Contingencies
- Regulatory: Ongoing regulatory reviews in Canada (grain movement mandates) and the U.S. (Surface Transportation Board proceedings on rates and service). Potential delays in Positive Train Control (PTC) implementation deadlines.
- Labor: Collective agreements with several Canadian unions expire December 31, 2014. Negotiations are underway, with potential risks of strikes or work stoppages.
- Environmental: Liability for remediation at approximately 260 sites. Aggregate accruals for environmental costs were C$118 million as of September 30, 2014.
- Market: Exposure to fuel price volatility, foreign currency fluctuations, and general economic conditions affecting commodity demand.
Investor Verification Checklist
- Constant Currency Performance: Verify the impact of the weakening Canadian dollar on reported earnings versus constant currency results to assess organic growth.
- One-Time Gains: Confirm the exclusion of the C$80 million gain from the Deux-Montagnes disposal when analyzing core operating performance for the nine-month period.
- Labor Negotiations: Monitor the status of collective bargaining agreements expiring in late 2014, particularly in Canada, for potential operational disruptions.
- Regulatory Compliance: Track progress on Positive Train Control (PTC) implementation costs and potential regulatory penalties regarding grain movement volumes in Canada.
- Capital Expenditures: Review the execution of the C$2.25 billion capital program, specifically the allocation toward track maintenance versus growth initiatives.