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, 2003
Filing Date: February 11, 2004
Accounting Basis: U.S. GAAP and Canadian GAAP (U.S. GAAP figures used for primary analysis)
Business Overview: CN operates a rail network spanning Canada and mid-America, connecting the Atlantic, Pacific, and Gulf of Mexico. Revenue is derived from a diversified portfolio including petroleum, chemicals, metals, forest products, coal, grain, intermodal, and automotive freight.
Key Financial Metrics (U.S. GAAP)
| Metric (in millions, except per share) | 2003 | 2002 |
|---|---|---|
| Total Revenues | $5,884 | $6,110 |
| Operating Income | $1,777 | $1,469 |
| Net Income | $1,014 | $800 |
| Basic EPS | $5.30 | $4.07 |
| Diluted EPS | $5.23 | $3.97 |
| Operating Ratio | 69.8% | 76.0% |
| Cash from Operating Activities | $1,976 | $1,612 |
| Free Cash Flow | $578 | $513 |
| Total Assets | $20,337 | $21,738 |
| Total Long-Term Debt | $4,175 | $5,003 |
| Cash and Equivalents | $130 | $25 |
Material Changes vs. Prior Period
- Revenue Decline: Total revenues decreased 4% to $5,884 million. This was primarily driven by the appreciation of the Canadian dollar against the U.S. dollar (reducing translated U.S. revenue by approx. $380 million), weakness in coal shipments, and a slowdown in the automotive sector. Volume (revenue ton miles) increased 2%.
- Profitability Improvement: Net income increased 27% to $1,014 million. Operating income rose 21% to $1,777 million. The operating ratio improved significantly from 76.0% to 69.8%.
- Expense Reduction: Operating expenses decreased 11% to $4,107 million. This was largely due to the absence of the $281 million U.S. personal injury charge and $120 million workforce reduction charge recorded in Q4 2002. Fuel costs increased slightly due to higher prices, but were offset by hedging gains.
- Accounting Changes: A cumulative benefit of $48 million (after tax) was recorded in 2003 due to the adoption of SFAS No. 143 regarding asset retirement obligations, which reduced depreciation expense.
- Shareholder Returns: The company completed a share repurchase program, buying back 13.0 million shares for $859 million. Dividends increased to $1.00 per share in 2003 from $0.86 in 2002.
Guidance, Outlook, and Risks
- Acquisitions: CN announced agreements to acquire BC Rail ($1 billion) and Great Lakes Transportation LLC ($380 million). Both transactions are subject to regulatory approval and are expected to close in Q2 2004. Financing will be a mix of cash and debt.
- Stock Split: A 3-for-2 common stock split was approved on January 27, 2004, to be effected as a stock dividend in February 2004.
- Foreign Exchange Risk: Management notes that a one-cent change in the Canadian dollar relative to the U.S. dollar impacts net income by approximately $8 million. The strong Canadian dollar in 2003 negatively impacted reported results.
- Personal Injury Claims: A significant risk factor remains U.S. personal injury claims under FELA. While 2003 expenses were lower than 2002 (which included a large accrual), the company maintains a $590 million reserve. A 5% change in claim assumptions could alter annual expense by $5 million.
- Environmental Liabilities: The company has $83 million in accruals for environmental costs but notes that future liabilities from unknown sites or new regulations cannot be reasonably estimated.
- Labor Negotiations: Approximately 97% of Canadian union agreements expired Dec 31, 2003. Tentative agreements were reached with the CAW, but negotiations with other unions were ongoing as of the filing date.
Investor Verification Checklist
- Adjusted Performance: Verify "Adjusted Net Income" ($1,045 million) which excludes the 2003 Ontario tax rate enactment ($79 million expense) and 2002 one-time charges, to better assess core operational trends.
- Acquisition Integration: Monitor the regulatory approval status and integration costs for the BC Rail and GLT acquisitions, which are expected to close in Q2 2004.
- FX Sensitivity: Assess the impact of the Canadian dollar's strength on future earnings, as a significant portion of revenue and debt is U.S. dollar-denominated.
- Debt Maturities: Review the debt maturity schedule; $483 million is due in 2004, with significant refinancing needs in subsequent years.
- Personal Injury Reserves: Track the adequacy of the $590 million reserve for U.S. personal injury claims, given the volatility of FELA litigation outcomes.