CNI

Business Context and Reporting Period

Company: Canadian National Railway Company (CN)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: Fiscal Year Ended December 31, 2007
Filing Date: February 12, 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, transporting a diversified portfolio of commodities including petroleum, chemicals, grain, coal, metals, forest products, intermodal, and automotive goods.

Key Financial Metrics (Year Ended Dec 31, 2007)

Material Changes vs. Prior Period

• Revenue: Decreased slightly by $32 million (0.4%) to $7.897 billion. The decline was primarily driven by the translation impact of a stronger Canadian dollar on U.S. dollar-denominated revenues (approx. $220 million negative impact), weakness in forest products markets, and operational disruptions from a first-quarter union strike and adverse weather. These were partially offset by net freight rate increases.
• Operating Expenses: Increased by $122 million (2.5%) to $5.021 billion. The increase was mainly due to higher fuel costs (up 15%) and equipment rents (up 25%), partially offset by lower labor costs and the favorable translation impact of the stronger Canadian dollar on U.S. expenses.
• Net Income: Increased by $71 million (3.4%) to $2.158 billion. This growth occurred despite lower operating income, driven significantly by a $328 million deferred income tax recovery (due to Canadian tax rate changes) and one-time gains from asset sales.
• Operating Ratio: Worsened by 1.8 percentage points to 63.6%, reflecting the combination of flat revenues and rising operating costs.

Guidance, Outlook, and Management Commentary

• 2008 Outlook: Management expects economic growth in North America to slow in 2008 but does not anticipate a recession. Capital spending for 2008 is projected at approximately $1.5 billion, with over $1 billion targeted for track infrastructure.
• Strategic Initiatives:
  • Acquisitions: CN agreed to acquire the Elgin, Joliet and Eastern Railway (EJ&E) for approx. $300 million (pending regulatory approval) and acquired the Athabasca Northern Railway (ANY) for $25 million.
  • Asset Sales: Sold the Central Station Complex in Montreal for $355 million (recognizing a $92 million gain) and sold its 32% stake in English Welsh and Scottish Railway (EWS) for $114 million (recognizing a $61 million gain).
• Capital Allocation: The company repurchased 30.2 million shares for $1.584 billion in 2007 and increased the quarterly dividend to $0.21 per share.
• Risks: Key risks include labor negotiations (recently resolved via back-to-work legislation for the UTU), environmental liabilities, fuel price volatility, and foreign exchange fluctuations. A one-cent change in the CAD/USD exchange rate impacts net income by approximately $10 million annually.

Investor Verification Checklist

• Deferred Tax Impact: Verify the sustainability of net income growth, as 2007 results included a $328 million non-cash deferred tax recovery.
• One-Time Gains: Assess the impact of $153 million in pre-tax gains from the sale of the Central Station Complex and EWS investment on "Other Income."
• Union Stability: Monitor the status of labor agreements, particularly the recently arbitrated UTU settlement and upcoming expirations for other unions in 2008.
• Regulatory Approval: Track the U.S. Surface Transportation Board (STB) decision on the EJ&E acquisition, which is subject to an Environmental Impact Statement.
• Foreign Exchange Sensitivity: Evaluate the exposure to CAD/USD fluctuations, which significantly impacted 2007 revenue and expense comparability.