CNI

Business Context and Reporting Period

Company: Canadian National Railway Company (CN)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: Year ended December 31, 2013
Business Overview: CN operates a single business segment spanning Canada and mid-America, connecting the Atlantic, Pacific, and Gulf of Mexico coasts. The company transports a diversified portfolio of commodities including petroleum, chemicals, grain, coal, metals, forest products, intermodal, and automotive goods. The financial statements are prepared in accordance with U.S. GAAP and expressed in Canadian dollars.

Key Financial Metrics (Year Ended Dec 31, 2013)

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 7% ($655 million) driven by freight rate increases, higher volumes (particularly in energy markets), and a positive translation impact from the weaker Canadian dollar.
• Net Income Decline: Net income decreased 3% ($68 million) primarily due to a significant reduction in "Other income" from lower gains on the disposal of rail assets compared to 2012. This was partially offset by higher operating income.
• Operating Expenses: Increased 7% ($467 million) due to higher labor and fringe benefits, increased purchased services/materials, and negative foreign exchange translation impacts on U.S. dollar-denominated expenses.
• Operating Ratio: Deteriorated by 0.5 percentage points to 63.4%.
• Debt Levels: Total debt increased due to new issuances ($1.85 billion) and the implementation of an accounts receivable securitization program, partially offset by repayments ($1.41 billion).

Guidance, Outlook, and Management Commentary

• 2014 Capital Expenditures: CN plans to invest approximately $2.1 billion in 2014. Over $1.2 billion is targeted for track infrastructure to ensure safety and network fluidity. Equipment capital expenditures are targeted at $300 million, and facilities/IT spending is expected to be approximately $600 million.
• Dividends: The Board approved a 16% increase in the quarterly dividend to $0.250 per share for 2014 (from $0.215 in 2013).
• Share Repurchases: A new share repurchase program was approved in October 2013, allowing for the repurchase of up to 30.0 million shares through October 2014.
• Pension Funding: The company expects 2014 cash contributions for pension plans to be approximately $130 million, utilizing accumulated prepayments to satisfy solvency deficit requirements.
• Outlook: Management expects North American industrial production to increase by approximately 3% in 2014, with continued improvements in U.S. housing starts and automotive sales. Growth is expected to be led by energy-related commodities, overseas container traffic, and offshore grain exports.

Risks and Contingencies

• Regulatory & Safety: The company faces significant regulatory oversight regarding safety (e.g., Positive Train Control implementation by 2015) and economic regulation in both Canada and the U.S. Recent derailments have led to enhanced emergency directives and potential new regulations on tank cars and crew size.
• Environmental Liabilities: CN has identified approximately 280 sites with potential remediation costs. While provisions are considered adequate, future costs related to unknown contamination or new regulations could be material.
• Labor Negotiations: As of February 2014, a tentative agreement with the Teamsters Canada Rail Conference (TCRC) had not been ratified by the membership, posing a risk of work stoppages.
• Foreign Currency: A significant portion of revenues and expenses is denominated in U.S. dollars. Fluctuations in the CAD/USD exchange rate materially impact reported results.

Key Facts for Investor Verification

• Asset Disposal Gains: Verify the sustainability of earnings by noting that 2012 included a $281 million gain on the Bala-Oakville disposal, whereas 2013 included only $69 million in gains from easement exchanges and the Lakeshore West disposal.
• Pension Funded Status: Review the impact of the discount rate increase (from 4.15% to 4.73%) which significantly improved the funded status of pension plans, resulting in a $1.66 billion pension asset on the balance sheet in 2013 compared to a liability in 2012.
• Capital Intensity: Confirm the company's ability to fund the planned $2.1 billion capital expenditure program for 2014 alongside its dividend and share repurchase obligations.
• Stock Split: Note that all share and per-share data reflect a two-for-one stock split effected in November 2013.