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, 2008
Business Overview: CN operates a transcontinental railway network spanning Canada and the mid-United States, serving key ports and metropolitan areas. The company reported financial results based on U.S. GAAP.
Key Financial Metrics
| Metric | Q2 2008 | Q2 2007 | H1 2008 | H1 2007 |
|---|---|---|---|---|
| Revenues | C$2,098 million | C$2,027 million | C$4,025 million | C$3,933 million |
| Operating Income | C$707 million | C$811 million | C$1,230 million | C$1,372 million |
| Net Income | C$459 million | C$516 million | C$770 million | C$840 million |
| Diluted EPS | C$0.95 | C$1.01 | C$1.59 | C$1.63 |
| Operating Ratio | 66.3% | 60.0% | 69.4% | 65.1% |
| Operating Expenses | C$1,391 million | C$1,216 million | C$2,795 million | C$2,561 million |
| Free Cash Flow | C$164 million | C$227 million | C$225 million | C$51 million |
Liquidity and Debt: As of June 30, 2008, cash and cash equivalents totaled C$161 million. Long-term debt stood at C$6,389 million, with a debt-to-total-capitalization ratio of 39.0%. The company maintained a C$1 billion revolving credit facility and a commercial paper program with total borrowings of C$345 million.
Material Changes vs. Prior Period
- Profitability Decline: Q2 Net Income declined 11% and Operating Income declined 13% year-over-year. The Operating Ratio worsened by 6.3 points in Q2 and 4.3 points in H1.
- Fuel Cost Surge: Fuel costs rose 60% year-over-year in Q2 to nearly C$400 million, significantly impacting operating expenses.
- Currency Impact: A stronger Canadian dollar reduced Q2 net income by approximately C$25 million and H1 net income by C$55 million due to the translation of U.S. dollar-denominated revenues and expenses.
- Revenue Mix: While total revenues increased 4% in Q2, this was driven by freight rate increases (two-thirds due to fuel surcharges) and volume growth in Intermodal (+14%), Coal (+8%), and Petroleum (+7%). These gains were offset by declines in Forest Products (-14%) and Automotive (-13%).
- Volume Trends: Revenue ton-miles declined 2% in Q2 but were relatively flat for the first half of 2008 compared to 2007.
Guidance, Outlook, and Risks
Management Commentary: CEO E. Hunter Harrison noted that operations performed well despite spiraling fuel costs and economic uncertainties. The company maintained its full-year 2008 guidance for diluted EPS growth in the mid-single-digit range over 2007 adjusted diluted EPS of C$3.40.
Guidance Assumptions: The outlook assumes a Canadian-U.S. dollar exchange rate at or around parity, crude oil prices around US$135 per barrel, and North American economic growth of approximately 1%.
Risks and Contingencies:
- Acquisition: CN is pursuing the acquisition of Elgin, Joliet and Eastern Railway Company (EJ&E) for approximately US$300 million, pending Surface Transportation Board approval and an Environmental Impact Statement.
- Legal and Environmental: The company holds C$450 million in reserves for personal injury claims and C$108 million for environmental costs. Future liabilities related to environmental remediation and litigation cannot be predicted with certainty.
- Market Conditions: Risks include industry competition, regulatory developments, labor disruptions, and adverse economic conditions.
Investor Verification Checklist
- Fuel Hedging and Pricing: Verify the extent of fuel cost pass-through to customers via surcharges and the company's exposure to future oil price volatility beyond the US$135/barrel assumption.
- Currency Sensitivity: Assess the impact of continued Canadian dollar strength on future earnings, given the significant translation headwinds in 2008.
- Commodity Exposure: Monitor the recovery or continued weakness in the Forest Products and Automotive sectors, which drove significant revenue declines.
- Acquisition Timeline: Track the regulatory progress of the EJ&E acquisition, specifically the Environmental Impact Statement process, to determine closing feasibility in late 2008.
- Share Repurchase Program: Note the completion of the previous 33.0 million share repurchase program and the initiation of a new 25.0 million share program approved on July 21, 2008.