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 Class I railroad network spanning Canada and the mid-United States, connecting the Atlantic, Pacific, and Gulf of Mexico coasts. The company manages its operations as a single business segment, focusing on freight transportation across seven commodity groups.
Key Financial Metrics
| Metric | Q2 2010 | Q2 2009 | YTD 2010 | YTD 2009 |
|---|---|---|---|---|
| Revenues (C$ millions) | 2,093 | 1,781 | 4,058 | 3,640 |
| Operating Income (C$ millions) | 813 | 583 | 1,416 | 1,064 |
| Net Income (C$ millions) | 534 | 387 | 1,045 | 811 |
| Diluted EPS (C$) | 1.13 | 0.82 | 2.21 | 1.72 |
| Operating Ratio (%) | 61.2% | 67.3% | 65.1% | 70.8% |
| Free Cash Flow (C$ millions) | 465 | 256 | 958 | 463 |
| Cash and Equivalents (C$ millions) | 896 | 431 | 896 | 431 |
| Total Debt (C$ millions) | 6,555 | 6,461 | 6,555 | 6,461 |
Note: Debt figures represent carrying amounts of long-term debt including current portion. Free cash flow is a non-GAAP measure defined by the company.
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. YTD revenue growth was 11%.
- Profitability: Net income rose 38% in Q2 and 29% YTD. Operating income increased 39% in Q2 and 33% YTD.
- Efficiency: The operating ratio improved by 6.1 points in Q2 (to 61.2%) and 5.7 points YTD (to 65.1%), reflecting strong volume growth against a 7% increase in operating expenses.
- Commodity Performance: Significant revenue increases were reported in Coal (+40%), Automotive (+39%), Metals and Minerals (+33%), and Intermodal (+25%). Grain and fertilizers declined 1% in Q2.
- Unusual Items:
- 2010: Included a C$152 million pre-tax gain (C$131 million after-tax) from the sale of the Oakville subdivision in Q1.
- 2009: Included a C$157 million pre-tax gain from the sale of the Weston subdivision and C$49 million in acquisition-related costs for the Elgin, Joliet and Eastern Railway (EJ&E).
- 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 results 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 approximately 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 to US$80 per barrel.
- Capital investment of approximately C$1.6 billion.
Risks and Contingencies
- Foreign Exchange: Significant portion of revenues/expenses in U.S. dollars creates volatility.
- Environmental Liabilities: Approximately 315 sites identified for potential remediation; aggregate accruals of C$106 million.
- Legal Claims: Aggregate reserves for personal injury and other claims of C$375 million.
- Labor: Ongoing negotiations with various unions in Canada and the U.S.; potential for strikes or work stoppages.
- Regulatory: Subject to economic and safety regulations by the Canadian Transportation Agency, Surface Transportation Board (STB), and Federal Railroad Administration (FRA).
Investor Verification Checklist
- Adjusted EPS Reconciliation: Verify the exclusion of the C$131 million after-tax gain on the Oakville subdivision sale from the reported YTD net income to understand core operating performance.
- Constant Currency Impact: Assess the C$35 million (Q2) and C$76 million (YTD) negative impact of the stronger Canadian dollar on reported earnings.
- Capital Expenditures: Confirm the C$1.6 billion capital program plan, specifically the C$1 billion allocation for track infrastructure.
- Pension Contributions: Note the expected C$250 million voluntary pension contribution in 2010 to improve funded status, impacting free cash flow.
- Debt Structure: Review the C$6.555 billion total debt carrying amount and the C$1 billion revolving credit facility availability.
- Share Repurchases: Verify the C$446 million spent on share repurchases YTD under the new 15 million share program.