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, 2012
Business Overview: CN operates a transcontinental railway network spanning Canada and the mid-section of the United States, connecting the Atlantic, Pacific, and Gulf of Mexico. The company reported solid third-quarter performance driven by operational excellence and revenue growth across all business segments.
Key Financial Metrics
| Metric | Q3 2012 | Q3 2011 | 9M 2012 | 9M 2011 |
|---|---|---|---|---|
| Revenues | C$2,497 million | C$2,307 million | C$7,386 million | C$6,651 million |
| Operating Income | C$985 million | C$938 million | C$2,763 million | C$2,457 million |
| Net Income | C$664 million | C$659 million | C$2,070 million | C$1,865 million |
| Diluted EPS | C$1.52 | C$1.46 | C$4.71 | C$4.08 |
| Operating Ratio | 60.6% | 59.3% | 62.6% | 63.1% |
| Free Cash Flow (9M) | C$1,036 million (vs. C$1,328 million in 9M 2011) | |||
| Total Debt (Long-term + Current) | C$6,448 million (as of Sept 30, 2012) | |||
| Cash and Cash Equivalents | C$175 million (as of Sept 30, 2012) |
Material Changes vs. Prior Period
- Revenue Growth: Q3 revenues increased 8% year-over-year, driven by a 7% rise in revenue ton-miles and a 3% increase in carloadings. Petroleum and chemicals led segment growth with a 15% revenue increase due to higher crude oil shipments from western Canada.
- Earnings Per Share: Diluted EPS increased 10% to C$1.52 compared to the adjusted diluted EPS of C$1.38 in Q3 2011 (which excluded a one-time gain on asset sales).
- Operating Expenses: Increased 10% to C$1,512 million in Q3, primarily due to higher labor and fringe benefits, purchased services, and volume-related fuel costs.
- Operating Ratio: Deteriorated by 1.3 points to 60.6% in Q3 2012 compared to 59.3% in Q3 2011, though it improved to 62.6% for the nine-month period compared to 63.1% in the prior year.
- Foreign Currency Impact: The weaker Canadian dollar provided a positive translation impact on U.S.-denominated revenues. On a constant currency basis, Q3 net income would have been C$8 million lower.
Guidance, Outlook, and Risks
Management Commentary and Guidance
- 2012 Outlook: Management remains comfortable with guidance issued in July 2012, expecting up to 15% growth in adjusted diluted EPS for the full year 2012.
- Free Cash Flow: Expects to generate approximately C$1 billion in free cash flow for 2012, contingent on a potential additional C$250 million voluntary pension contribution in Q4.
- Capital Investment: Plans to invest approximately C$1.8 billion in capital programs in 2012, with over C$1 billion targeted at track infrastructure.
- Share Repurchase: The Board approved a new share repurchase program for up to C$1.4 billion (maximum 18 million shares) to be executed through a normal course issuer bid.
Risks and Contingencies
- Legal Proceedings: CN is involved in legal proceedings against its former CEO regarding the forfeiture of approximately C$18 million in RSU payouts and C$21 million in retirement benefits due to alleged breaches of non-compete and non-disclosure agreements. No gain has been recorded pending resolution.
- Environmental Liabilities: The company has identified approximately 300 sites with potential remediation costs. Aggregate accruals for environmental costs were C$126 million as of September 30, 2012.
- Pension Funding: While voluntary contributions of C$450 million were made in Q1 2012, the company is reviewing the merits of an additional C$250 million contribution in 2012 due to uncertainty in plan returns and interest rates.
Investor Verification Checklist
- Adjusted EPS Reconciliation: Verify the reconciliation of reported net income to adjusted net income, specifically the exclusion of the C$281 million gain on the Bala-Oakville property disposal in the nine-month period.
- Constant Currency Impact: Review the constant currency adjustments to understand the true organic growth rate, as the reported results benefited from the weaker Canadian dollar.
- Pension Contribution Timing: Confirm the timing and amount of the potential additional C$250 million pension contribution in Q4, as this will impact full-year free cash flow.
- Former CEO Litigation: Monitor the status of the legal proceedings regarding the former CEO's benefits, as a resolution could result in a non-recurring gain or loss.
- Share Repurchase Execution: Track the execution of the new C$1.4 billion share repurchase program approved in October 2012.