Business Context and Reporting Period
Company: Canadian National Railway Company (CN)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: First Quarter ended March 31, 2008
Release Date: April 21, 2008
CN operates a transcontinental railway network spanning Canada and the mid-section of the United States. The first quarter of 2008 was characterized by severe winter weather conditions, particularly in Western Canada, which disrupted operations and increased costs. Additionally, the company faced headwinds from a stronger Canadian dollar and weakness in specific commodity markets, notably forest products and automotive sectors.
Key Financial Metrics
| Metric | Q1 2008 | Q1 2007 | Variance |
|---|---|---|---|
| Revenues | C$1,927 million | C$1,906 million | +1% |
| Operating Income | C$523 million | C$561 million | -7% |
| Net Income | C$311 million | C$324 million | -4% |
| Diluted EPS | C$0.64 | C$0.63 | +2% |
| Operating Ratio | 72.9% | 70.6% | +2.3 pts |
| Operating Expenses | C$1,404 million | C$1,345 million | +4% |
| Cash from Operations | C$165 million | C$263 million | -37% |
| Free Cash Flow (Non-GAAP) | C$61 million | (C$176 million) | Improvement |
| Total Debt | C$6,333 million | C$5,856 million | +8% |
| Cash & Equivalents | C$334 million | C$106 million | +215% |
Note: Total Debt includes current portion of long-term debt (C$269 million) and long-term debt (C$6,064 million) as of March 31, 2008.
Material Changes vs. Prior Period
- Revenue Growth: Driven by freight rate increases (including fuel surcharges), improved traffic mix, and volume growth in grain, fertilizers, and intermodal. These gains were partially offset by the negative translation impact of the stronger Canadian dollar and lower volumes in forest products and automotive sectors.
- Operating Expenses: Increased 4% primarily due to higher fuel costs (average price rose to $3.02/gallon from $2.18/gallon) and purchased services. This was partially mitigated by the positive translation impact of the stronger Canadian dollar on U.S. dollar-denominated expenses.
- Currency Impact: The stronger Canadian dollar reduced Q1 2008 net income by approximately C$30 million (C$0.06 per diluted share).
- Comparability Factors: Q1 2008 included a C$11 million deferred income tax recovery. Q1 2007 was negatively impacted by a conductors' strike in Canada, estimated to have reduced net income by C$35 million.
- Commodity Performance:
- Increases: Intermodal (+12%), Coal (+11%), Grain and Fertilizers (+10%), Petroleum and Chemicals (+5%), Metals and Minerals (+4%).
- Decreases: Forest products (-20%), Automotive (-12%).
Guidance, Outlook, and Risks
Revised 2008 Outlook
Based on difficult Q1 operating conditions and market weakness, CN revised its full-year 2008 guidance:
- Diluted EPS Growth: Now expected in the mid-single digit range over 2007 adjusted diluted EPS of C$3.40 (previously mid-to-high single digit).
- Free Cash Flow: Now expected to be in the order of C$650 million (previously C$750 million).
- Revenue Growth: Maintained forecast of 6% to 8%.
Key Assumptions: Outlook assumes a Canadian-U.S. dollar exchange rate at or around parity, crude oil prices around US$105/barrel, and North American economic growth of approximately 1%.
Management Commentary
CEO E. Hunter Harrison noted that extreme cold and snow in Q1 delayed trains and disrupted cycles, necessitating a suspension of most operations in the West for nearly two days in January. While the U.S. economy may be in a recession, management expects a gradual recovery in the second half of 2008. Growth opportunities are identified in container trade via the Port of Prince Rupert and commodities associated with oil and gas development in Western Canada.
Risks and Contingencies
- Acquisition: CN is pursuing the acquisition of Elgin, Joliet and Eastern Railway Company (EJ&E) for approx. US$300 million. Closing is subject to Surface Transportation Board (STB) approval and an Environmental Impact Statement, expected by late 2008.
- Legal & Environmental: The company maintains reserves of C$458 million for personal injury/claims and C$109 million for environmental costs. Future environmental liabilities cannot be reasonably estimated but are not currently expected to have a material adverse effect.
- Guarantees: Maximum potential liability for standby letters of credit and other guarantees is C$470 million.
Investor Verification Checklist
- Weather Impact Duration: Verify the extent to which Q1 weather disruptions persist into Q2 and the timeline for full network fluidity recovery.
- Forest Products & Automotive Trends: Monitor volume trends in these declining sectors to assess if the weakness is cyclical or structural.
- FX Sensitivity: Track the CAD/USD exchange rate, as parity is a key assumption for the revised EPS and cash flow guidance.
- Fuel Price Volatility: Assess the impact of oil prices deviating from the US$105/barrel assumption on operating expenses.
- EJ&E Acquisition Status: Monitor STB regulatory progress and the Environmental Impact Statement timeline for the EJ&E deal.
- Share Repurchases: Note that CN repurchased 7.3 million shares for C$367 million in Q1; verify remaining authorization under the 33.0 million share program.