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, 2012
Business Overview: CN operates a rail network spanning Canada and mid-America, connecting the Atlantic, Pacific, and Gulf of Mexico coasts. The company transports a diversified portfolio of commodities including petroleum, metals, forest products, coal, grain, intermodal, and automotive goods.
Key Financial Metrics
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Revenues | C$2,346 million | C$2,084 million | +13% |
| Operating Income | C$793 million | C$645 million | +23% |
| Net Income | C$775 million | C$668 million | +16% |
| Diluted EPS | C$1.75 | C$1.45 | +21% |
| Adjusted Diluted EPS (Excluding asset sale gains) |
C$1.18 | C$0.90 | +31% |
| Operating Ratio | 66.2% | 69.0% | -2.8 pts |
| Free Cash Flow | C$48 million | C$445 million | -89% |
| Revenue Ton-Miles | 49,049 million | 46,153 million | +6% |
| Carloadings | 1,205 thousand | 1,146 thousand | +5% |
Material Changes vs. Prior Period
- Revenue Growth: Driven by higher freight volumes (6% increase in revenue ton-miles), a milder winter, and improved economic conditions. Yield (revenue per ton-mile) increased 6% due to freight rate increases and higher fuel surcharges.
- Commodity Performance: Significant revenue increases were seen in Metals and Minerals (+31%), Coal (+18%), Intermodal (+17%), and Petroleum and Chemicals (+15%). Grain and Fertilizers declined 2% due to lower export volumes.
- Operating Expenses: Increased 8% to C$1,553 million, primarily due to higher fuel costs and labor expenses. This was partially offset by lower casualty and other expenses.
- Asset Sales: Q1 2012 included an after-tax gain of C$252 million from the sale of the Bala-Oakville rail line segments. Q1 2011 included a similar after-tax gain of C$254 million from the sale of the Lakeshore East segment.
- Cash Flow Impact: Free cash flow dropped significantly to C$48 million (from C$445 million in Q1 2011) due to voluntary pension plan contributions totaling C$450 million.
Guidance, Outlook, and Risks
Revised 2012 Financial Outlook
CN has revised its 2012 outlook positively based on strong Q1 results and improved economic assumptions:
- Adjusted Diluted EPS: Targeting full-year growth of 10% over 2011 (C$4.84), despite an estimated C$100 million headwind from additional pension expense.
- Free Cash Flow: Revised guidance to approximately C$950 million (previously C$875 million).
- Capital Expenditures: Planned investment of approximately C$1.8 billion, with over C$1 billion targeted for track infrastructure.
- Legal Proceedings (Former CEO): CN is pursuing legal action against its former CEO regarding alleged breaches of non-compete and non-disclosure agreements. The company has forfeited approximately C$18 million in RSU payouts and C$1.5 million in annual retirement benefits, though these gains have not been recorded pending final resolution.
- Regulatory Environment: Ongoing oversight by the Surface Transportation Board (STB) regarding the Elgin, Joliet and Eastern Railway (EJ&E) acquisition, including grade separation projects and mitigation conditions.
- Operational Risks: Exposure to fuel price volatility, labor negotiations (both Canadian and U.S. unions), and environmental liabilities (C$113 million accrued).
- Adjusted Earnings: Verify the reconciliation of GAAP Net Income (C$775M) to Adjusted Net Income (C$523M) to understand the impact of the C$252M after-tax gain on asset sales.
- Pension Contributions: Confirm the impact of the C$450 million voluntary pension contribution on Q1 free cash flow and the total expected 2012 contribution of C$575 million.
- Former CEO Litigation: Monitor the status of the legal proceedings regarding the forfeiture of the former CEO's benefits (approx. C$18M RSUs and C$21M retirement liability gain) to determine if these amounts will be recognized in future periods.
- Constant Currency: Review constant currency metrics, as the weakening Canadian dollar provided a positive impact of C$3 million to Q1 net income.
- Debt Levels: Note the increase in the adjusted debt-to-total capitalization ratio to 39.9% (from 35.9% in 2011) driven by pension actuarial losses and debt levels.