Business Context and Reporting Period
Company: Canadian National Railway Company (CN)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: Third quarter ended September 30, 2009 (Q3 2009) and nine months ended September 30, 2009 (YTD 2009).
Business Overview: CN operates a transcontinental railway network spanning Canada and the mid-section of the United States. The reporting period was characterized by significant weakness in freight volumes due to depressed North American and global economic conditions.
Key Financial Metrics
| Metric (in millions, except per share) | Q3 2009 | Q3 2008 | YTD 2009 | YTD 2008 |
|---|---|---|---|---|
| Revenues | $1,845 | $2,257 | $5,485 | $6,282 |
| Operating Expenses | $1,156 | $1,413 | $3,732 | $4,208 |
| Operating Income | $689 | $844 | $1,753 | $2,074 |
| Net Income | $461 | $552 | $1,272 | $1,322 |
| Diluted EPS | $0.97 | $1.16 | $2.69 | $2.74 |
| Operating Ratio | 62.7% | 62.6% | 68.0% | 67.0% |
| Free Cash Flow (YTD) | $657 | $483 | $657 | $483 |
| Cash and Equivalents (Sep 30, 2009) | $233 | $288 | $233 | $288 |
| Total Debt (Current + Long-term) | $6,600 | $7,911 | $6,600 | $7,911 |
Material Changes vs. Prior Period
- Revenue Decline: Q3 revenues fell 18% year-over-year, driven by lower freight volumes across all commodity groups (Metals/Minerals -32%, Automotive -25%, Forest Products -24%) and reduced fuel surcharges.
- Volume Reductions: Carloads declined 15% to 1,032 thousand, and revenue ton-miles (RTM) dropped 11% to 40,487 million. However, the RTM decline was a sequential improvement from the 14% drop in Q2 2009.
- Expense Management: Operating expenses decreased 18% to $1,156 million, primarily due to significantly lower fuel costs (average price $2.19/gallon vs. $3.84/gallon in Q3 2008) and cost-containment measures.
- Profitability: Net income decreased 16% to $461 million. Adjusted net income (excluding tax recoveries) was $446 million, a 12% reduction in diluted EPS compared to the prior year.
- Productivity Gains: Despite volume declines, the operating ratio remained essentially flat at 62.7%. System train speeds improved 11% year-over-year, and average dwell time declined 9%.
Guidance, Outlook, and Risks
Management Commentary: CEO E. Hunter Harrison noted that while Q3 was challenging, several markets may have "hit bottom." The company focused on cost containment and productivity, positioning itself for eventual traffic recovery. No specific numerical guidance for future periods was provided in this filing.
Unusual Items and Adjustments:
- Tax Recoveries: Q3 2009 included a $15 million deferred income tax recovery. YTD 2009 included a total $58 million recovery related to tax rate changes and prior year adjustments.
- Asset Sale: A $157 million gain on the disposal of the Weston subdivision (Toronto) was recorded in YTD 2009.
- Acquisition Costs: $49 million in acquisition-related costs for the Elgin, Joliet and Eastern Railway (EJ&E) were expensed in YTD 2009.
Risks and Contingencies:
- Economic Conditions: Continued recession in North America and global economic contraction remain primary risks.
- Regulatory Oversight: The EJ&E acquisition is subject to a five-year monitoring period by the Surface Transportation Board (STB), with required infrastructure spending of ~$100 million and potential challenges to environmental impact statements.
- Legal and Environmental: The company maintains reserves of $381 million for personal injury claims and $109 million for environmental costs. Future liabilities related to unknown environmental concerns or litigation outcomes cannot be predicted with certainty.
Investor Verification Checklist
- Volume Recovery: Monitor subsequent quarters for stabilization or growth in revenue ton-miles and carloads to confirm management's view that markets have bottomed.
- Operating Ratio Stability: Verify if the operating ratio can remain flat or improve as volumes recover, given the fixed cost structure of the railroad.
- Debt Reduction: Confirm the trajectory of debt reduction; total debt decreased from $7,911 million (Dec 2008) to $6,600 million (Sep 2009) via repayments and new issuances.
- Non-GAAP Reconciliations: Review the impact of the $157 million Weston subdivision gain and $49 million EJ&E acquisition costs on YTD adjusted earnings to understand core operational performance.
- Environmental and Legal Reserves: Track changes in the $381 million personal injury and $109 million environmental reserves for potential future adjustments.