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, 2012
Business Overview: CN operates a single business segment spanning Canada and mid-America, connecting the Atlantic, Pacific, and Gulf of Mexico. The company transports a diversified portfolio of commodities including petroleum, 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, 2012)

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 10% to $9.92 billion, driven by higher freight volumes (7% increase in revenue ton miles), freight rate increases, and a higher fuel surcharge. The weaker Canadian dollar provided a positive translation impact on U.S. dollar-denominated revenues.
• Profitability: Net income rose 9% to $2.68 billion. Diluted earnings per share increased 13% to $6.12. The operating ratio improved by 0.6 percentage points to 62.9%.
• Unusual Items:
  • 2012: Included a $281 million gain on the disposal of the Bala-Oakville rail segments (after-tax impact: $252 million). Also included a net income tax expense of $28 million due to higher provincial corporate tax rates.
  • 2011: Included gains on the disposal of IC RailMarine ($60 million) and Lakeshore East ($288 million).
• Expense Trends: Operating expenses increased 9% to $6.24 billion, primarily due to higher labor costs, fuel expenses, and purchased services. Fuel expenses rose 8% due to higher volumes and prices.

Guidance, Outlook, and Management Commentary

• 2013 Outlook: Management expects North American industrial production to increase by approximately 2%. U.S. housing starts and automotive sales are expected to continue growing. Grain production is expected to be in-line with 5-year averages.
• Capital Expenditures: CN plans to invest approximately $1.9 billion in 2013. Over $1.0 billion is targeted for track infrastructure to ensure safety and fluidity. Equipment capital expenditures are targeted at $200 million.
• Shareholder Returns:
  • Dividends: The Board approved a 15% increase in the quarterly dividend to $0.430 per share for 2013.
  • Share Repurchases: A new program approved in October 2012 allows for the repurchase of up to $1.4 billion in common shares (not exceeding 18.0 million shares) through October 2013.
• Pension Funding: The company made voluntary contributions of $700 million in 2012. Expected cash contributions for 2013 are in the range of $135 million to $335 million, including potential voluntary contributions.
• Risks: Key risks include economic conditions, fuel price volatility, labor negotiations, regulatory changes (including Positive Train Control implementation costs of ~$220 million), and environmental liabilities.

Investor Verification Checklist

• Unusual Gains: Verify the sustainability of earnings by excluding the $281 million one-time gain from the Bala-Oakville disposal in 2012.
• Pension Assumptions: Review the sensitivity of pension liabilities to changes in the discount rate (4.15% in 2012) and the expected long-term rate of return (reduced to 7.00% for 2013).
• Debt Maturities: Assess the debt maturity schedule, noting $398 million in debt obligations due in 2013 and $320 million in 2014.
• Environmental Liabilities: Monitor the provision for environmental sites ($123 million at year-end) and potential future costs related to unknown contamination or regulatory changes.
• Legal Contingencies: Track the status of proceedings against the former CEO regarding the forfeiture of retirement benefits and RSU payouts, which could result in a gain of approximately $18 million if resolved favorably.
• Foreign Exchange: Monitor the impact of the Canadian/US dollar exchange rate on reported results, as a significant portion of operations is US-denominated.