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, 2011
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 record carloadings and revenues for the quarter, driven by improved service, market positioning, and modest economic growth.
Key Financial Metrics
| Metric | Q3 2011 | Q3 2010 | 9M 2011 | 9M 2010 |
|---|---|---|---|---|
| Revenues | C$2,307 million | C$2,122 million | C$6,651 million | C$6,180 million |
| Operating Income | C$938 million | C$834 million | C$2,457 million | C$2,250 million |
| Net Income (GAAP) | C$659 million | C$556 million | C$1,865 million | C$1,601 million |
| Diluted EPS (GAAP) | C$1.46 | C$1.19 | C$4.08 | C$3.39 |
| Adjusted Net Income | C$621 million | C$556 million | C$1,613 million | C$1,470 million |
| Adjusted Diluted EPS | C$1.38 | C$1.19 | C$3.53 | C$3.11 |
| Operating Ratio | 59.3% | 60.7% | 63.1% | 63.6% |
| Free Cash Flow (9M) | C$1,328 million (vs. C$938 million in 9M 2010) | |||
| Carloadings (Q3) | 1,261,000 | 1,216,000 | 3,641,000 (9M 2011) vs. 3,506,000 (9M 2010) |
Material Changes vs. Prior Period
- Revenue Growth: Q3 revenues increased 9% year-over-year, driven by a 4% increase in carloadings and a 6% increase in revenue ton-miles. All commodity groups posted revenue gains, with Metals and Minerals up 21% and Intermodal up 12%.
- Profitability: Operating income rose 12% to C$938 million. The operating ratio improved by 1.4 percentage points to 59.3%, reflecting rigorous cost control and operational efficiency.
- Unusual Items: GAAP results included a C$38 million after-tax gain (C$60 million pre-tax) from the sale of IC RailMarine Terminal Company assets. Excluding this gain, adjusted net income grew 12%.
- Expense Drivers: Operating expenses increased 6% primarily due to higher fuel costs (average price rose to $3.37/gallon from $2.56), purchased services, and depreciation. These were partially offset by lower labor costs due to reduced incentive compensation.
- Currency Impact: A stronger Canadian dollar negatively impacted reported results. On a constant currency basis, Q3 net income would have been C$22 million higher.
Guidance, Outlook, and Risks
- 2011 Outlook: CN reaffirmed its guidance for double-digit adjusted diluted EPS growth of up to 15% for the full year 2011 (targeting C$4.83 based on 2010 adjusted EPS of C$4.20). Free cash flow is expected to be approximately C$1.2 billion, accounting for an additional C$350 million pension contribution.
- Share Repurchase: The Board approved a new program to repurchase up to 17 million common shares, commencing October 28, 2011. A prior program of 16.5 million shares was completed in September 2011.
- Capital Investment: CN plans to invest approximately C$1.7 billion in capital programs in 2011, with over C$1 billion targeted at track infrastructure.
- Risks and Contingencies:
- Legal/Environmental: The company maintains C$353 million in reserves for personal injury claims and C$158 million for environmental remediation costs across approximately 310 sites.
- Operational: Risks include fuel price volatility, currency fluctuations, labor negotiations, and regulatory changes (e.g., Positive Train Control implementation costs estimated at C$210 million).
- Economic: Outlook assumes North American industrial production growth of 3.5% and crude oil prices between US$90-US$100 per barrel.
Investor Verification Checklist
- Adjusted vs. GAAP: Verify the impact of the C$60 million gain on disposal of IC RailMarine Terminal on Q3 earnings; adjusted metrics exclude this non-recurring item.
- Currency Sensitivity: Review the constant currency reconciliation, as the strengthening Canadian dollar reduced reported net income by C$22 million in Q3.
- Free Cash Flow Definition: Note that CN's free cash flow calculation includes adjustments for restricted cash and dividends, differing from standard GAAP operating cash flow.
- Pension Obligations: Confirm the C$350 million additional pension contribution expected in 2011 and its impact on the C$1.2 billion free cash flow guidance.
- Share Count: Monitor the execution of the new 17 million share repurchase program and its effect on diluted EPS.