Business Context and Reporting Period
Company: Canadian National Railway Company (CN)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: Third quarter and nine months ended September 30, 2006
Release Date: October 19, 2006
Business Overview: CN operates a transcontinental railway spanning Canada and mid-America, serving key ports and cities from the Atlantic and Pacific oceans to the Gulf of Mexico. The company reported exceptional third-quarter results driven by revenue growth, asset utilization, and cost control.
Key Financial Metrics
| Metric | Q3 2006 | Q3 2005 | 9M 2006 | 9M 2005 |
|---|---|---|---|---|
| Revenues | C$1,981 million | C$1,810 million | C$5,774 million | C$5,354 million |
| Operating Income | C$844 million | C$665 million | C$2,274 million | C$1,904 million |
| Net Income | C$497 million | C$411 million | C$1,588 million | C$1,126 million |
| Diluted EPS | C$0.94 | C$0.74 | C$2.95 | C$1.99 |
| Operating Ratio | 57.4% | 63.3% | 60.6% | 64.4% |
| Free Cash Flow (9M) | C$1,131 million | C$1,058 million (2005) | ||
| Long-term Debt | C$5,164 million (Sep 30, 2006) | C$4,608 million (Dec 31, 2005) | ||
| Cash & Equivalents | C$56 million (Sep 30, 2006) | C$119 million (Dec 31, 2005) |
Material Changes vs. Prior Period
- Revenue Growth: Q3 revenues increased 9% and 9M revenues increased 8%, driven by rate increases, higher fuel surcharges, and volume growth in grain, intermodal, and metals/minerals. This was partially offset by a C$65 million (Q3) and C$220 million (9M) unfavorable translation impact from the stronger Canadian dollar.
- Profitability: Q3 Net Income rose 21% and 9M Net Income rose 41%. The 9M increase included a one-time C$250 million deferred income tax recovery due to lower Canadian corporate tax rates.
- Cost Control: Q3 operating expenses declined 1% despite higher fuel costs, aided by lower casualty expenses and favorable currency translation on U.S. dollar-denominated expenses. 9M operating expenses increased 1% primarily due to fuel and depreciation.
- Operating Ratio: Achieved a record quarterly operating ratio of 57.4% in Q3, an improvement of 5.9 percentage points. The 9M operating ratio improved 3.8 percentage points to 60.6%.
- Volume: Freight volume (revenue ton-miles) increased 6% in Q3 and 4% for the nine-month period. Carloadings improved 2% in Q3 and 1% for the nine-month period.
Guidance, Outlook, and Risks
Guidance and Outlook
- 2006 Full-Year: CN revised its adjusted diluted EPS guidance upwards to approximately C$3.40 (excluding the C$250 million tax recovery). Full-year free cash flow is expected to be approximately C$1.3 billion.
- 2007 Outlook: Management expects diluted EPS to grow in the 10%+ range. Free cash flow is projected at approximately C$800 million, reduced by higher Canadian income tax payments.
- Assumptions: 2007 outlook assumes 2.6% North American economic growth, crude oil at US$65/barrel, and a CAD/USD exchange rate of US$0.89.
Risks and Contingencies
- Currency: Continued appreciation of the Canadian dollar reduced Q3 net income by C$15 million and 9M net income by C$50 million.
- Legal and Environmental: The company maintains C$647 million in reserves for personal injury and other claims and C$131 million for environmental costs. Future environmental liabilities cannot be reasonably estimated.
- Operational: Risks include industry competition, regulatory changes, severe weather, fuel price volatility, and labor disruptions.
Investor Verification Checklist
- Adjusted EPS: Verify the C$3.40 full-year 2006 adjusted EPS guidance excludes the C$250 million non-recurring tax benefit.
- Currency Impact: Monitor the sensitivity of future earnings to the Canadian dollar exchange rate, which negatively impacted 2006 results.
- Debt Structure: Review the C$5,164 million long-term debt balance and the recent issuance of U.S. dollar-denominated notes to reduce commercial paper.
- Share Repurchases: Confirm the execution of the new C$393 million share repurchase program in Q3 and the total C$1.1 billion repurchased in the first nine months.
- Free Cash Flow Definition: Note that CN's free cash flow calculation excludes changes in accounts receivable sold under securitization programs, which may differ from standard GAAP definitions.