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, 2008
Business Overview: CN operates a rail network spanning Canada and mid-America, connecting the Atlantic, Pacific, and Gulf of Mexico coasts. The company manages its operations as a single business segment, focusing on "precision railroading" to improve velocity, reliability, and asset utilization.
Key Financial Metrics
| Metric (C$ Millions) | Q3 2008 | Q3 2007 | 9M 2008 | 9M 2007 |
|---|---|---|---|---|
| Revenues | 2,257 | 2,023 | 6,282 | 5,956 |
| Operating Income | 844 | 768 | 2,074 | 2,140 |
| Net Income | 552 | 485 | 1,322 | 1,325 |
| Diluted EPS | $1.16 | $0.96 | $2.74 | $2.59 |
| Operating Ratio | 62.6% | 62.0% | 67.0% | 64.1% |
| Cash from Operations | 957 | 446 | 1,531 | 1,475 |
| Free Cash Flow (Non-GAAP) | 258 | 142 | 483 | 193 |
Liquidity and Debt:
- Cash and cash equivalents: $288 million (Sept 30, 2008).
- Total long-term debt: $6,264 million.
- Current portion of long-term debt: $449 million.
- Debt-to-total capitalization ratio: 39.5% (Sept 30, 2008) vs. 36.8% (Sept 30, 2007).
- Adjusted debt-to-adjusted EBITDA: 2.2 times (12 months ended Sept 30, 2008).
Material Changes vs. Prior Period
- Revenue Growth: Q3 revenues increased 12% to $2,257 million, driven by freight rate increases (approx. two-thirds due to fuel surcharges) and higher volumes in intermodal, metals/minerals, and coal. This offset weakness in forest products and grain.
- Expense Increases: Operating expenses rose 13% to $1,413 million, primarily due to higher fuel costs (up 55% year-over-year) and purchased services/materials. Labor costs decreased slightly.
- Operating Ratio: The operating ratio increased by 0.6 points to 62.6% in Q3 and 2.9 points to 67.0% for the nine-month period, reflecting the impact of higher fuel costs and a stronger Canadian dollar reducing the value of U.S. dollar-denominated revenues.
- Deferred Tax Impact: Q3 2008 net income included a $41 million deferred income tax recovery ($0.09 per share) from resolved tax matters. Q3 2007 included a $14 million recovery.
- Foreign Exchange: The stronger Canadian dollar reduced net income by approximately $55 million for the nine-month period compared to 2007.
Guidance, Outlook, and Risks
Management Commentary: CEO E. Hunter Harrison cited "outstanding" operational execution and gains in network fluidity. However, he noted the "uncertain economic landscape" and recessionary conditions in North America pose challenges. Management believes CN is well-positioned due to its unique business model and growth prospects in intermodal, bulk commodities, and Western Canadian energy developments.
Strategic Initiatives: - Acquisition: Pending acquisition of Elgin, Joliet and Eastern Railway Company (EJ&E) for approx. $300 million. Approval by the U.S. Surface Transportation Board (STB) is delayed due to an Environmental Impact Statement (EIS). CN has petitioned the U.S. Court of Appeals for an expedited ruling to close by Dec 31, 2008.
Risks and Contingencies: - Economic Conditions: Recessionary conditions and global economic slowdown may reduce freight volumes. - Fuel Prices: Volatility in fuel prices remains a significant risk, though mitigated by fuel surcharges. - Regulatory: Ongoing regulatory reviews regarding grain revenue caps in Canada and safety regulations (e.g., Positive Train Control) in the U.S. - Environmental: Potential liabilities for environmental cleanup at approx. 19 Superfund sites; aggregate accruals are $118 million. - Labor: Several collective agreements in Canada and the U.S. are expiring or under negotiation, with potential for work stoppages.
Investor Verification Checklist
- Deferred Tax Recoveries: Verify the sustainability of earnings by excluding the $41 million Q3 and $75 million 9M deferred tax recoveries to assess core operating performance.
- Fuel Surcharge Effectiveness: Monitor the ability to pass through rising fuel costs to customers via surcharges, given the 55% increase in fuel expenses.
- EJ&E Acquisition Status: Track the STB's final decision on the EJ&E acquisition, as delays could impact strategic growth plans.
- Foreign Exchange Sensitivity: Assess the impact of the Canadian dollar's strength on future U.S. dollar-denominated revenues and expenses.
- Labor Negotiations: Review the status of expiring collective agreements in Canada and the U.S. for potential strike risks.
- Capital Expenditures: Confirm adherence to the $1.5 billion capital program plan for 2008, focusing on track infrastructure and strategic initiatives.