CNI

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 Class I railroad network spanning Canada and mid-America, connecting the Atlantic, Pacific, and Gulf of Mexico. The company transports a diversified portfolio of commodities including petroleum, metals, forest products, coal, grain, intermodal, and automotive goods.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Q3 revenues increased 9% year-over-year, driven by a 4% rise in carloadings and a 6% increase in revenue ton-miles. All seven commodity groups posted revenue gains, with Metals and Minerals up 21% and Intermodal up 12%.
• Profitability: Net income rose 19% to C$659 million. Operating income increased 12% to C$938 million. The operating ratio improved by 1.4 percentage points to 59.3%.
• Unusual Items: Q3 results included a C$38 million after-tax gain on the sale of IC RailMarine Terminal Company assets. Nine-month results also included a C$254 million after-tax gain on the sale of the Lakeshore East rail property and a C$40 million net deferred income tax expense.
• Adjusted Performance: Excluding gains on asset sales, adjusted Q3 net income increased 12% to C$621 million, with adjusted diluted EPS up 16% to C$1.38.
• Expense Drivers: Operating expenses increased 6% primarily due to higher fuel costs (up 41% in Q3), purchased services, and depreciation. Labor costs decreased due to lower incentive compensation.

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. Free cash flow is expected to be approximately C$1.2 billion, accounting for an additional C$350 million pension contribution.
• Capital Allocation: The Board approved a new share repurchase program to buy back up to 17 million common shares. The company also increased its quarterly dividend by 20% to C$0.325 per share.
• Capital Expenditures: Planned 2011 capital investment is approximately C$1.7 billion, with over C$1 billion targeted for track infrastructure.
• Key Risks:
  • Foreign Currency: A stronger Canadian dollar negatively impacted reported revenues and net income; constant currency results would have been higher.
  • Regulatory: Ongoing Surface Transportation Board (STB) oversight regarding the Elgin, Joliet and Eastern Railway (EJ&E) acquisition, including grade separation commitments.
  • Operational: Labor negotiations with Canadian and U.S. unions; potential disruptions from severe weather or natural disasters.
  • Environmental: Liabilities related to remediation of contaminated sites and compliance with evolving environmental laws.

Investor Verification Checklist

• Adjusted vs. GAAP: Verify the impact of the C$348 million pre-tax gain on asset disposals (IC RailMarine and Lakeshore East) on the reported net income and EPS.
• Currency Impact: Review the "constant currency" reconciliation to understand the true operational performance excluding the negative translation effect of the stronger Canadian dollar.
• Debt Structure: Confirm the status of the new C$800 million revolving credit facility and the repayment of the 6.38% Notes in October 2011.
• Pension Obligations: Monitor the C$350 million additional pension contribution expected in 2011 and its impact on free cash flow.
• Share Repurchases: Track the execution of the new 17 million share buyback program approved in late October 2011.