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 First Half ended June 30, 2010
Business Overview: CN operates a transcontinental railway spanning Canada and mid-America, connecting the Atlantic and Pacific oceans to the Gulf of Mexico. The company reported strong results driven by improving economic conditions, higher freight volumes, and the execution of its Precision Railroading model.
Key Financial Metrics
| Metric (C$ Millions) | Q2 2010 | Q2 2009 | YTD 2010 | YTD 2009 |
|---|---|---|---|---|
| Revenues | 2,093 | 1,781 | 4,058 | 3,640 |
| Operating Income | 813 | 583 | 1,416 | 1,064 |
| Net Income | 534 | 387 | 1,045 | 811 |
| Diluted EPS | $1.13 | $0.82 | $2.21 | $1.72 |
| Operating Ratio | 61.2% | 67.3% | 65.1% | 70.8% |
| Free Cash Flow (YTD) | 958 (vs. 463 in YTD 2009) | |||
| Cash and Equivalents (End of Period) | 896 | |||
| Long-Term Debt | 6,345 |
Material Changes vs. Prior Period
- Revenue Growth: Q2 revenues increased 18% year-over-year, driven by a 27% increase in carloadings and a 15% increase in revenue ton-miles. Key growth areas included coal (+40%), automotive (+39%), and metals/minerals (+33%).
- Profitability: Net income rose 38% in Q2. Operating income increased 39% to C$813 million.
- Efficiency: The operating ratio improved by 6.1 percentage points to 61.2% in Q2, despite a 7% increase in operating expenses (primarily due to higher fuel costs).
- Unusual Items: The first half of 2010 included a C$152 million pre-tax gain (C$131 million after-tax) from the sale of the Oakville subdivision rail property. Excluding this, adjusted diluted EPS for the first half was C$1.93.
- Currency Impact: A stronger Canadian dollar negatively impacted reported results. On a constant currency basis, Q2 net income would have been higher by approximately C$35 million.
Guidance, Outlook, and Risks
Revised 2010 Guidance
Based on strong first-half performance and expectations of continued economic recovery, CN raised its 2010 outlook:
- Adjusted Diluted EPS: Expected to increase approximately 25% over 2009 adjusted diluted EPS of C$3.24.
- Free Cash Flow: Expected to be in the range of C$1.1 billion for the full year.
Key Assumptions
- North American industrial production increasing ~5%.
- U.S. housing starts of ~675,000 units.
- Carload growth in the mid-teens with pricing improvement of ~3.5%.
- Canadian-U.S. exchange rate between C$0.95 and par.
- Crude oil (WTI) price range of US$75–US$80 per barrel.
- Capital investment of approximately C$1.6 billion.
Risks and Contingencies
- Legal and Environmental: Aggregate reserves for personal injury and other claims were C$375 million. Environmental accruals totaled C$106 million across approximately 315 sites.
- Operational: Risks include severe weather, labor negotiations, fuel price volatility, and regulatory changes.
- Pension Contributions: The company expects to make an additional voluntary pension contribution of approximately C$250 million in 2010.
Investor Verification Checklist
- Adjusted vs. Reported EPS: Verify the impact of the C$152 million gain on the Oakville subdivision sale on first-half earnings.
- Constant Currency Performance: Assess underlying operational growth by reviewing constant currency metrics, which exclude the negative translation impact of the stronger Canadian dollar.
- Free Cash Flow Sustainability: Confirm the C$1.1 billion full-year free cash flow guidance, noting it includes proceeds from the rail-line sale and assumes a C$250 million voluntary pension contribution.
- Debt and Liquidity: Review the C$6.3 billion long-term debt balance and the C$896 million cash position to assess leverage and liquidity coverage.
- Commodity Mix: Analyze the shift in revenue mix, specifically the significant growth in coal and automotive sectors versus the slight decline in grain and fertilizers.