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, 2013
Business Overview: CN operates a rail network spanning Canada and mid-America, transporting goods ranging from resources to consumer goods. The company serves major ports and metropolitan areas across North America.
Key Financial Metrics
| Metric | Q2 2013 | Q2 2012 | YTD 2013 | YTD 2012 |
|---|---|---|---|---|
| Revenues | C$2,666 million | C$2,543 million | C$5,132 million | C$4,889 million |
| Operating Income | C$1,042 million | C$985 million | C$1,822 million | C$1,778 million |
| Net Income | C$717 million | C$631 million | C$1,272 million | C$1,406 million |
| Diluted EPS | C$1.69 | C$1.44 | C$2.98 | C$3.18 |
| Operating Ratio | 60.9% | 61.3% | 64.5% | 63.6% |
| Free Cash Flow (YTD) | C$437 million (vs. C$703 million YTD 2012) | |||
| Total Debt | C$7,463 million (Carrying amount as of June 30, 2013) | |||
| Cash and Equivalents | C$87 million (Unrestricted) + C$497 million (Restricted) |
Material Changes vs. Prior Period
- Revenue Growth: Q2 revenues increased 5% year-over-year, driven by a 5% increase in revenue ton-miles and a 2% increase in carloadings. Growth was supported by freight rate increases, strong energy markets, and a weaker Canadian dollar.
- Profitability: Q2 Net Income rose 14% to C$717 million. Adjusted diluted EPS increased 11% to C$1.66, excluding a C$13 million net gain from a non-monetary transaction with another railway.
- Operating Efficiency: The operating ratio improved by 0.4 points to 60.9% in Q2, reflecting cost management despite a 4% increase in operating expenses (driven by purchased services, fuel, and depreciation).
- Commodity Performance: Petroleum and chemicals revenues surged 18%. Conversely, automotive revenues declined 3%, and coal revenues were flat.
- Cash Flow: Free cash flow for the first half of 2013 was C$437 million, a significant decrease from C$703 million in the same period of 2012, primarily due to higher capital expenditures and pension contributions.
Guidance, Outlook, and Risks
- 2013 Outlook: CN is maintaining its full-year 2013 financial outlook issued in January. Capital investment plans were revised upward to approximately C$2 billion (from C$1.9 billion), with C$1.1 billion targeted for track infrastructure.
- Market Assumptions: Management forecasts North American industrial production growth of ~2%, U.S. housing starts of ~950,000 units, and carload growth of 2-3% (revised down from 3-4%). The assumed CAD/USD exchange rate is C$0.95-C$1.00.
- Unusual Items: Q2 results included a C$29 million pre-tax gain from an exchange of easements and a C$40 million pre-tax gain from the disposal of the "Lakeshore West" rail segment. These were excluded from adjusted earnings.
- Risks: Key risks include economic conditions, fuel price volatility, currency fluctuations, regulatory changes (including Positive Train Control implementation), and environmental liabilities. The company noted a solvency deficit of approximately C$2.1 billion in its Canadian pension plans, though it holds C$675 million in prepayments to offset future payments.
Investor Verification Checklist
- Adjusted vs. GAAP Earnings: Verify the impact of the C$69 million in gains from asset disposals and easement exchanges on reported net income versus adjusted net income.
- Free Cash Flow Decline: Investigate the drivers behind the 38% year-over-year drop in free cash flow, specifically the increase in capital expenditures and pension contributions.
- Pension Obligations: Review the C$2.1 billion solvency deficit in Canadian pension plans and the company's funding strategy using accumulated prepayments.
- Debt Structure: Confirm the composition of the C$7.46 billion total debt, including the C$554 million in commercial paper and C$270 million in securitized accounts receivable.
- Volume Trends: Monitor the divergence between strong energy sector volumes and declining automotive volumes to assess exposure to specific economic cycles.