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, 2012
Business Overview: CN operates a transcontinental railway network spanning Canada and the mid-section of the United States, connecting the Atlantic and Pacific oceans to the Gulf of Mexico. The company serves major ports and metropolitan areas, transporting commodities including intermodal, automotive, coal, petroleum, chemicals, metals, minerals, forest products, and grain.
Key Financial Metrics
| Metric (CAD Millions) | Q2 2012 | Q2 2011 | YTD 2012 | YTD 2011 |
|---|---|---|---|---|
| Revenues | $2,543 | $2,260 | $4,889 | $4,344 |
| Operating Income | $985 | $874 | $1,778 | $1,519 |
| Net Income | $631 | $538 | $1,406 | $1,206 |
| Diluted EPS | $1.44 | $1.18 | $3.18 | $2.63 |
| Adjusted Diluted EPS | $1.50 | $1.26 | $2.67 | $2.16 |
| Operating Ratio | 61.3% | 61.3% | 63.6% | 65.0% |
| Free Cash Flow (YTD) | $703 | $823 | $703 | $823 |
| Total Debt (Long-term + Current) | $6,775 | $6,576 | $6,775 | $6,576 |
| Cash and Cash Equivalents | $345 | $175 | $345 | $175 |
Note: Adjusted figures exclude net income tax expenses related to provincial rate changes and gains on the disposal of rail lines.
Material Changes vs. Prior Period
- Revenue Growth: Q2 revenues increased 13% to $2,543 million, driven by higher freight volumes (8% increase in revenue ton-miles), freight rate increases, fuel surcharges, and a favorable foreign exchange impact from a weaker Canadian dollar.
- Profitability: Net income rose 17% to $631 million in Q2. Adjusted diluted EPS increased 19% to $1.50.
- Operating Efficiency: The operating ratio remained stable at 61.3% in Q2, though YTD improved to 63.6% from 65.0% in the prior year.
- Commodity Performance: Double-digit revenue ton-mile gains were recorded in intermodal, automotive, coal, petroleum/chemicals, and metals/minerals. Grain and fertilizers revenues declined 1% due to lower volumes.
- One-Time Items: Q2 2012 included a $28 million net income tax expense due to higher provincial tax rates. YTD 2012 included a $281 million gain on the sale of the Bala-Oakville rail segment, which was excluded from adjusted metrics.
- Cash Flow: YTD free cash flow decreased to $703 million from $823 million in 2011, primarily due to $450 million in voluntary pension plan contributions made in Q1 2012.
Guidance, Outlook, and Risks
Revised 2012 Financial Outlook
CN has revised its 2012 outlook upward based on strong first-half performance and positive economic assumptions:
- Adjusted Diluted EPS: Targeting up to 15% growth over 2011 (previously 10%), despite an additional $100 million pension expense.
- Free Cash Flow: Projected at approximately $1 billion, accounting for a potential additional $250 million voluntary pension contribution in Q4 (totaling $700 million for the year).
- Capital Investment: Planned investment of approximately $1.8 billion, with over $1 billion targeted for track infrastructure.
Key Assumptions
- North American industrial production growth of ~3.5%.
- U.S. housing starts of ~750,000 units and motor vehicle sales of ~14.5 million units.
- Canadian-U.S. exchange rate slightly below parity.
- Crude oil prices (WTI) in the range of US$85-US$95 per barrel.
Risks and Contingencies
- Legal Proceedings: CN is involved in legal proceedings against its former CEO regarding alleged breaches of non-compete and non-disclosure agreements. The company has forfeited approximately $18 million in RSU payouts and $1.5 million in annual retirement benefits, pending final resolution. No gain has been recorded yet.
- Environmental Liabilities: Aggregate accruals for environmental costs are $120 million. The company identifies approximately 310 sites with potential remediation liabilities.
- Foreign Exchange: A significant portion of revenues and expenses is denominated in U.S. dollars. On a constant currency basis, Q2 and YTD net income would have been lower by $13 million and $17 million, respectively.
- Operational Risks: Includes labor negotiations, fuel price volatility, and potential disruptions from severe weather or natural events.
Investor Verification Checklist
- Adjusted vs. GAAP: Verify the impact of the $281 million gain on the sale of the Bala-Oakville rail segment on YTD net income and the exclusion of this item in adjusted EPS calculations.
- Pension Contributions: Confirm the timing and impact of the $450 million voluntary pension contribution in Q1 and the potential for an additional $250 million in Q4 on free cash flow.
- Foreign Exchange Sensitivity: Assess the impact of the weakening Canadian dollar on reported results versus constant currency performance.
- Legal Contingency: Monitor the status of the legal proceedings against the former CEO regarding the forfeiture of benefits and potential recovery of amounts paid.
- Debt Structure: Review the increase in current portion of long-term debt to $784 million (from $135 million at year-end 2011) and the utilization of the revolving credit facility.