The positive pricing environment coupled with modest volume gains has significantly aided Canadian National Railway Company’s (CNI) financial performance in the third quarter and we expect the trend to continue.
However, we believe Canadian National’s industry leading operating ratio will remain challenged in the fourth quarter and beyond by rising fuel prices, increased depreciation charges, unfavorable currency translation, higher taxation and a competitive railroad market in Northern America.
Additionally, the company’s utility coal volume is expected to be affected by higher inventories and cheaper natural gas prices. Coal mine operations will also face weather hindrances in Canada, affecting volume growth and compelling our cautious stance on the company.
Despite the strong Canadian dollar, surging fuel prices and a volatile economic outlook, the company expects double-digit earnings growth of up to 15% for2011. We believe the company’s key business segments, particularly Coal and Intermodal will fuel the earnings growth this year and beyond. Canadian National remains well positioned to benefit from the growing demand of export coal.
The company registered higher coal shipments from West Coast and Port of Prince Rupert, which serves PRB (Powder River Basin) mines. The ports are also emerging as the new hubs for coal exports. Intermodal is also expected to remain a key growth driver in fiscal 2011.
The company provides Intermodal services to mainly three coasts (Vancouver, Prince Rupert and North American West Coast) and is looking forward to expand its network to the neighboring areas.
The company is focusing on train productivity by accelerating the purchase of locomotives equipped with distributed power capability that allows the company to run longer haul trains efficiently.
In order to support these development projects, the company to invest C$1.7 billion toward track and infrastructure improvement as well as productivity initiatives in 2011. Approximately C$1 billion is dedicated toward track infrastructure that includes the replacement of rail, ties, and other track materials and bridge improvements, as well as rail-line improvements for the Elgin, Joliet and Eastern Railway Company property acquired in 2009.
Canadian National’s strong financial performance has strengthened its balance sheet position. As a result, the company maintains a free cash flow expectation of C$1.2 billion for 2011,including voluntary pension contribution of approximately $350.0 million for pension plans. Further, Canadian National seeks to deliver increased returns to its shareholders via dividends and share buybacks.
However, the company is prone to volatility in fuel prices due to changes in the economy or supply disruption. Rising fuel prices could adversely affect the company’s expenses. In an effort to forestall this risk, Canadian National has implemented a fuel surcharge program. However, rising fuel prices have forced the company to raise its crude oil estimate to the range of $90–$100 per barrel for 2011.
Additionally, increased depreciation charges and taxation will hurt the cost component of the company. We believe these near-term headwinds will lead to reduced profits, affecting the financial position of the company.
Canadian National operates its business in both Canada and the U.S. and is, thus, affected by currency fluctuations. The company expects the Canadian dollar exchange rate to remain similar to the third quarter level i.e., 98 cents to $1.00 for fiscal 2011. Changes in the exchange rate makethe company more or less competitive in the world market and thereby affect its revenue.
Going forward, Canadian National faces significant competition from rail carriers and other modes of transportation. Specifically, the company faces competition from Canadian Pacific Railway (CP), which operates other major rail systems in Canada and service areas similar to Canadian National. It also faces intense competition from trucking companies in eastern Canada.
Consequently, we maintain our long-term Neutral recommendation on Canadian National, supported by a Zacks #3 Rank (Hold).
CDN NATL RY CO (CNI): Free Stock Analysis Report
CDN PAC RLWY (CP): Free Stock Analysis Report
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