CNI

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, 2009
Business Overview: CN operates a transcontinental railway network spanning Canada and the mid-section of the United States, connecting the Atlantic, Pacific, and Gulf of Mexico coasts. The company reported results during a period of significant economic contraction in North America and globally.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Revenues decreased 4% to $1,859 million, driven by a 16% drop in carloadings (954k vs. 1,132k) due to the global economic downturn. This was partially offset by a 12% increase in revenue per revenue ton-mile (yield) and favorable currency translation.
• Expense Management: Operating expenses declined 2% to $1,378 million. This reduction was primarily due to lower fuel costs (average price dropped from $3.02 to $1.98 per gallon) and reduced labor costs, offset by acquisition-related costs for the Elgin, Joliet & Eastern Railway (EJ&E).
• Profitability: While operating income fell 8% to $481 million, Net Income increased 36% to $424 million. This increase was largely due to non-operating items, including a $157 million gain on the sale of the Weston subdivision and a $15 million deferred tax recovery.
• Adjusted Performance: Excluding special items, Adjusted Net Income was $302 million ($0.64 per share), a slight increase from the adjusted $300 million ($0.62 per share) in Q1 2008.
• Debt Levels: Total debt increased significantly to $8,363 million from $6,333 million in the prior year, reflecting the $373 million cash acquisition of EJ&E and new debt issuances to manage liquidity.

Guidance, Outlook, and Risks

• Management Commentary: CEO E. Hunter Harrison highlighted the "challenging" economic conditions but emphasized the company's ability to reduce expenses quickly using the "Precision Railroading" model. Management remains focused on long-term growth opportunities beyond the current business cycle.
• Strategic Acquisitions: CN completed the acquisition of the EJ&E for $300 million (U.S.) to create a route-around-Chicago, expected to improve transit times and productivity. The company committed to spending approximately $100 million on infrastructure improvements for this line over the next few years.
• Asset Sales: The sale of the Weston subdivision in Toronto generated $110 million in cash proceeds (with $50 million in escrow) and a $157 million gain, while retaining perpetual freight operating rights.
• Risks and Contingencies:
  • Economic Uncertainty: Forward-looking statements are subject to risks regarding the depth and duration of the North American and global recession.
  • Regulatory Challenges: The EJ&E acquisition faces potential legal challenges from communities regarding environmental impact statements, which could delay or alter the transaction's benefits.
  • Environmental Liabilities: CN has identified approximately 340 sites with potential remediation costs. Aggregate accruals for environmental costs were $125 million as of March 31, 2009.
  • Legal Claims: Aggregate reserves for personal injury and other claims totaled $461 million.

Investor Verification Checklist

• Non-GAAP Reconciliation: Verify the impact of the $122 million in special items (Weston sale gain, EJ&E costs, tax recovery) on reported Net Income versus Adjusted Net Income.
• Debt Servicing: Review the increase in total debt to $8.36 billion and the company's ability to service this debt given the 16% decline in traffic volumes.
• Acquisition Integration: Monitor the progress of the EJ&E integration and any regulatory or legal hurdles that could impact the projected efficiency gains.
• Environmental Provisions: Assess the adequacy of the $125 million environmental accrual against the 340 identified sites and potential future regulatory changes.
• Currency Impact: Note the $30 million positive impact on net income from the strengthening U.S. dollar and monitor future currency fluctuations.