CNI

Business Context and Reporting Period

This Form 6-K filing by Canadian National Railway Company (CN) reports financial results for the fiscal year ended December 31, 2008. The filing includes audited consolidated financial statements prepared in accordance with U.S. GAAP, along with Management's Discussion and Analysis (MD&A). CN operates as a single business segment providing rail and related transportation services across Canada and the United States.

Key Financial Metrics

Material Changes Versus Prior Period

• Revenue Growth: Revenues increased 7% to $8.482 billion, driven by freight rate increases (including fuel surcharges) and higher volumes in metals, minerals, intermodal, and coal. This was partially offset by lower volumes in forest products and automotive sectors due to economic weakness and harsh weather in Q1 2008.
• Profitability Decline: Net income decreased 12% to $1.895 billion. The decline was primarily due to a significant reduction in deferred income tax recoveries compared to 2007 (which included $328 million in recoveries) and higher operating expenses.
• Operating Expenses: Expenses rose 11% to $5.588 billion. The primary driver was a 37% increase in fuel costs ($1.403 billion). Labor and fringe benefits decreased slightly, while casualty and other expenses increased 19%.
• Debt Levels: Total debt increased by $2.294 billion to $7.911 billion. This increase was due to new issuances of notes, capital leases, and commercial paper, as well as foreign exchange translation losses on U.S. dollar-denominated debt, partially offset by repayments.
• Foreign Exchange: The fluctuation of the Canadian dollar had a net negative impact of approximately $10 million on 2008 net income, though Q4 weakness in the CAD offset earlier Q1-Q3 translation impacts.

Guidance, Outlook, and Risks

• Capital Expenditures: CN plans to invest approximately $1.5 billion in capital programs for 2009, with nearly $1 billion targeted for track infrastructure to ensure safety and improve network fluidity.
• Acquisitions: The company completed the acquisition of the Elgin, Joliet and Eastern Railway Company (EJ&E) on January 31, 2009, for approximately U.S. $300 million. In 2008, it acquired three short-line railways in Quebec for $50 million.
• Economic Outlook: Management notes that the global financial crisis and recession have negatively affected several commodity groups (forest products, automotive, intermodal). The company is redeploying assets and reducing costs to reflect reduced volumes.
• Key Risks:
  • Competition: Intense competition from other rail carriers and trucking, potentially leading to reduced rates.
  • Regulation: Ongoing regulatory reviews in Canada (grain revenue caps) and the U.S. (fuel surcharge methodology, safety regulations).
  • Environmental: Liability for remediation at approximately 345 identified sites; potential for unknown future liabilities.
  • Labor: Several collective agreements expired or are under negotiation in both Canada and the U.S., posing a risk of work stoppages.
  • Pension Funding: Adverse market conditions could increase future pension contribution requirements.

Investor Verification Checklist

• Verify the impact of the $117 million deferred income tax recovery in 2008 versus the $328 million recovery in 2007 on normalized earnings.
• Monitor the progress of labor negotiations in Canada and the U.S., specifically regarding the Teamsters Canada Rail Conference (TCRC) and potential strikes.
• Assess the integration and operational impact of the EJ&E acquisition completed in early 2009.
• Review the company's ability to maintain the fuel surcharge program amidst regulatory scrutiny and economic downturns.
• Track the funded status of pension plans given the reduction in the expected long-term rate of return assumption from 8.00% to 7.75% for 2009.