Business Context and Reporting Period
Company: Canadian National Railway Company (CN)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: Second Quarter ended June 30, 2009 (Three and Six Months)
Business Overview: CN operates a major railroad network spanning Canada and the mid-United States. The reporting period was characterized by a deep recession in North America and global economic contraction, leading to significant declines in freight volumes across most commodity groups.
Key Financial Metrics
| Metric (C$ Millions) | Q2 2009 | Q2 2008 | YTD 2009 | YTD 2008 |
|---|---|---|---|---|
| Revenues | 1,781 | 2,098 | 3,640 | 4,025 |
| Operating Expenses | 1,198 | 1,391 | 2,576 | 2,795 |
| Operating Income | 583 | 707 | 1,064 | 1,230 |
| Net Income | 387 | 459 | 811 | 770 |
| Diluted EPS | $0.82 | $0.95 | $1.72 | $1.59 |
| Operating Ratio | 67.3% | 66.3% | 70.8% | 69.4% |
| Free Cash Flow (YTD) | 463 | 225 | - | - |
Liquidity and Debt:
- Cash and Cash Equivalents: C$431 million as of June 30, 2009 (up from C$413 million at Dec 31, 2008).
- Long-term Debt: C$7,093 million (excluding current portion of C$506 million).
- Debt to Total Capitalization: 40.6%.
Material Changes vs. Prior Period
- Revenue Decline: Q2 revenues fell 15% year-over-year due to depressed economic conditions and lower fuel surcharges. YTD revenues declined 10%.
- Volume Contraction: Carloads dropped 22% in Q2 (928,000 vs. 1,188,000) and 19% YTD. Revenue ton-miles declined 14% in Q2.
- Commodity Performance: Metals and minerals saw the steepest decline (-34% revenue in Q2), followed by automotive (-26%) and forest products (-21%). Coal was the only segment with revenue growth (+4% in Q2), driven by the EJ&E acquisition.
- Expense Management: Operating expenses decreased 14% in Q2, primarily due to significantly lower fuel prices (average price dropped from $3.82 to $2.00 per gallon) and cost-containment measures.
- Profitability: While Net Income declined in Q2, YTD Net Income increased 5% to C$811 million, driven by a one-time gain on the sale of the Weston subdivision.
Guidance, Outlook, and Unusual Items
Management Commentary:
- CEO E. Hunter Harrison noted continued weakness in most commodity groups due to the recession but observed signs of stabilization in several markets.
- Management expressed hope for an economic recovery in the second half of 2009.
- Cost structure and operational expertise are cited as key strengths to navigate the downturn.
Unusual Items and Adjustments:
- Weston Subdivision Sale: A gain of C$157 million (C$135 million after-tax) was recognized in Q1 2009 from the sale of the Weston subdivision in Toronto. This significantly boosted YTD net income.
- EJ&E Acquisition: CN acquired the Elgin, Joliet and Eastern Railway Company (EJ&E) on January 31, 2009, for C$373 million. Acquisition-related costs of C$49 million were expensed in the first half of 2009.
- Tax Recovery: A deferred income tax recovery of C$28 million was recorded in Q2 2009 due to lower provincial tax rates and foreign investment recapitalization.
- Adjusted Net Income: Excluding the above items, Adjusted Net Income for Q2 2009 was C$361 million ($0.76 diluted EPS), compared to C$436 million ($0.90 diluted EPS) in Q2 2008.
Risks and Contingencies:
- Regulatory Oversight: The EJ&E acquisition is subject to a five-year monitoring period by the U.S. Surface Transportation Board (STB), including conditions for infrastructure improvements and community mitigation.
- Environmental Liabilities: Aggregate accruals for environmental costs were C$112 million. The company faces potential liabilities at approximately 325 sites.
- Legal Claims: Reserves for personal injury and other claims totaled C$424 million.
Investor Verification Checklist
- Volume Recovery: Verify if the "stabilization" mentioned by management translates into volume growth in Q3 and Q4, particularly in metals, automotive, and forest products.
- Adjusted vs. Reported Earnings: Analyze the sustainability of earnings by focusing on Adjusted Net Income, which excludes the one-time Weston sale gain and EJ&E acquisition costs.
- Fuel Price Sensitivity: Monitor the impact of rising fuel prices on operating expenses, as the Q2 results benefited significantly from low fuel costs.
- EJ&E Integration: Assess the operational efficiencies and revenue contribution from the EJ&E acquisition against the C$100 million infrastructure commitment and regulatory conditions.
- Capital Allocation: Review the status of the share repurchase program (expired July 2009) and future dividend sustainability given the economic environment.