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, 2013
Business Overview: CN operates a Class I railroad network spanning Canada and mid-America, connecting the Atlantic, Pacific, and Gulf of Mexico. The company manages its operations as a single business segment, focusing on freight transportation across seven commodity groups.
Key Financial Metrics
| Metric | Q1 2013 | Q1 2012 |
|---|---|---|
| Revenues | C$2,466 million | C$2,346 million |
| Operating Income | C$780 million | C$793 million |
| Net Income | C$555 million | C$775 million |
| Diluted EPS | C$1.30 | C$1.75 |
| Adjusted Diluted EPS | C$1.22 | C$1.18 |
| Operating Ratio | 68.4% | 66.2% |
| Free Cash Flow | (C$20 million) utilized | C$48 million generated |
| Total Debt | C$7,411 million | C$6,900 million |
| Cash and Cash Equivalents | C$128 million | C$182 million |
Material Changes vs. Prior Period
- Revenue Growth: Revenues increased 5% year-over-year, driven by freight rate increases and higher volumes in petroleum/chemicals (+17%), intermodal (+7%), and metals/minerals (+3%). This was partially offset by a 1% decline in coal revenues.
- Profitability Decline: Reported Net Income decreased 28% to C$555 million. This decline is primarily attributable to a significantly smaller gain on the sale of rail line segments compared to the prior year (C$36 million after-tax in 2013 vs. C$252 million after-tax in 2012).
- Adjusted Performance: Excluding gains on rail line sales, Adjusted Net Income increased to C$519 million (C$1.22 EPS), representing a 3% increase in Adjusted EPS compared to Q1 2012.
- Operating Ratio Deterioration: The operating ratio worsened by 2.2 points to 68.4%. Operating expenses rose 9% due to higher labor costs, fuel expenses, and operational challenges caused by extreme cold and heavy snow in Western Canada.
- Volume Metrics: Carloadings increased 2% and Revenue Ton-Miles (RTM) increased 3%.
Guidance, Outlook, and Risks
Management Commentary and Outlook
- Operational Challenges: Management cited extreme weather in Western Canada as a constraint on volume growth and service levels in Q1. Improvements in train velocity and reduced dwell times were noted post-quarter.
- Capital Spending: CN increased its 2013 capital spending plan to approximately C$2.0 billion (up C$100 million from the original C$1.9 billion plan). Approximately C$1.1 billion is targeted for track infrastructure to enhance network resilience.
- Financial Outlook: The company maintained its 2013 financial outlook issued in January, assuming 2-4% carload growth and pricing improvements above inflation. Assumptions include a Canadian-U.S. exchange rate near parity and crude oil prices between US$90-$100 per barrel.
Risks and Contingencies
- Legal and Executive Matters: The company recorded a C$20 million reduction in stock-based compensation liability due to the forfeiture of awards by a former Executive Vice-President and COO who resigned to join a competitor, breaching non-compete agreements.
- Environmental Liabilities: CN has identified approximately 300 sites with potential remediation costs. Aggregate accruals for environmental costs were C$118 million as of March 31, 2013.
- Pension Obligations: The company expects a solvency deficit of approximately C$2.0 billion in its Canadian pension plans based on the upcoming actuarial valuation. It expects to make total contributions of C$235 million in 2013.
- Regulatory: Ongoing regulatory scrutiny includes Surface Transportation Board (STB) oversight of the Elgin, Joliet and Eastern Railway acquisition and potential impacts from new safety regulations regarding Positive Train Control (PTC).
Investor Verification Checklist
- Adjusted vs. Reported Earnings: Verify the impact of the C$36 million after-tax gain on the sale of the "Lakeshore West" rail segment on Q1 2013 results versus the C$252 million gain in Q1 2012.
- Weather Impact: Assess the extent to which Western Canada weather conditions impacted Q1 operating ratios and whether service recovery is on track for Q2.
- Capital Expenditure Increase: Review the justification for the C$100 million increase in 2013 capital spending and its impact on future free cash flow.
- Pension Funding: Monitor the upcoming June 2013 actuarial valuation for Canadian pension plans and the resulting solvency deficit funding requirements.
- Executive Turnover: Evaluate the operational impact of the COO's resignation and the associated forfeiture of compensation.