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, 2003
Business Overview: CN operates a network of approximately 17,500 route miles spanning Canada and mid-America, connecting the Atlantic, Pacific, and Gulf of Mexico. The company transports a diversified portfolio of goods including petroleum, metals, forest products, coal, grain, intermodal, and automotive freight.
Key Financial Metrics (U.S. GAAP)
Financial results are reported in Canadian dollars (C$) unless otherwise noted.
| Metric | Q3 2003 | Q3 2002 | 9M 2003 | 9M 2002 |
|---|---|---|---|---|
| Revenues | $1,413 million | $1,503 million | $4,372 million | $4,563 million |
| Operating Income | $454 million | $484 million | $1,265 million | $1,380 million |
| Net Income | $294 million | $268 million | $790 million | $778 million |
| Diluted EPS | $1.53 | $1.32 | $4.06 | $3.86 |
| Operating Ratio | 67.9% | 67.8% | 71.1% | 69.8% |
| Free Cash Flow | $105 million | $88 million | $455 million | $444 million |
| Long-Term Debt | $4,473 million | $5,003 million | $4,473 million | $4,699 million |
| Cash & Equivalents | $122 million | $24 million | $122 million | $24 million |
Material Changes vs. Prior Period
- Currency Impact: A significant appreciation of the Canadian dollar (13% in Q3, 10% in 9M) negatively impacted reported results. This reduced Q3 revenues by approximately $100 million and net income by $14 million. For the nine-month period, revenues were reduced by $235 million and net income by $37 million.
- Revenue Drivers:
- Declines: Coal revenues fell 33% in Q3 due to mine closures and reduced production. Automotive revenues dropped 21% in Q3 due to weaker North American sales and production. Petroleum and chemicals, metals, and forest products also saw declines primarily due to currency translation.
- Increases: Intermodal revenues rose 3% in Q3 and 8% in 9M, driven by increased import volumes and new traffic through the Port of Vancouver. Grain and fertilizer revenues increased 1% in Q3 due to a recovery in Canadian grain shipments following the previous year's drought.
- Expense Management: Operating expenses decreased 6% in Q3 and 2% in 9M. This was driven by the currency impact on U.S.-denominated expenses, lower purchased services, and reduced equipment rents. These savings were partially offset by higher casualty and other expenses (personal injury claims) and higher fuel costs in the nine-month period.
- Accounting Change: The adoption of SFAS No. 143 regarding asset retirement obligations resulted in a cumulative after-tax benefit of $48 million ($75 million pre-tax) recorded in the nine-month period, increasing net income by $2 million for the period.
Guidance, Outlook, and Risks
- Management Outlook: CEO E. Hunter Harrison noted that while the strong Canadian dollar remains a challenge, the company anticipates continued strength in Canadian grain shipments and a gradual improvement in North American economic output. Management expects to benefit from an economic rebound through cost control and service levels.
- Capital Expenditures: Gross capital expenditures for 2003 are anticipated to be approximately $1,100 million (U.S. GAAP).
- Acquisition: On October 20, 2003, CN entered an agreement to acquire Great Lakes Transportation LLC's railroad and related holdings for approximately $500 million (U.S. $380 million). The transaction is subject to regulatory approval (STB) and is expected to close by mid-2004.
- Share Repurchase: CN completed its 2002-2003 share repurchase program, buying back 13.0 million shares for $859 million at an average price of $66.06 per share.
- Key Risks:
- Labor: Labor agreements covering 97% of the Canadian unionized workforce expire December 31, 2003. No legal strikes are possible before January 2004, but negotiations are ongoing.
- Competition: Significant competition from trucking, barges (particularly for Illinois Central Railroad), and other railroads.
- Environmental & Legal: Ongoing exposure to environmental liabilities and personal injury claims. Reserves for personal injury and other claims were $613 million as of September 30, 2003.
- Regulatory: Subject to new homeland security regulations and potential legislative changes in Canada (Bill C-26).
Investor Verification Checklist
- Currency Sensitivity: Verify the impact of the Canadian dollar's strength on future earnings, as a one-cent change in the exchange rate impacts net income by approximately $7 million annually.
- Coal Segment: Monitor the trajectory of coal shipments given the 33% Q3 decline and ongoing mine closures in western Canada.
- Acquisition Status: Track the regulatory approval process for the Great Lakes Transportation acquisition and its integration timeline.
- Labor Negotiations: Watch for updates on Canadian labor contract renewals expiring end of 2003 and potential work stoppages in 2004.
- Accounting Adjustments: Distinguish between organic growth and the one-time $48 million after-tax benefit from the SFAS No. 143 accounting change when analyzing nine-month profitability.