The gradual recovery in the North American economy has significantly aided Canadian National Railway Company’s (CNI) financial performance in the first quarter through accelerated volume growth and pricing improvements, and we expect the trend to continue.
However, we believe Canadian National’sindustry leading operating ratio will remain challenged in the upcoming quarter and beyond due to skyrocketing fuel prices, increased depreciation charges, unfavorable currency translation, higher taxation and a competitive railroad market in Northern America.
Though we believe the company has the potential to improve its operating ratio over the long term by improving network fluidity and an above-inflation pricing strategy, we have a cautious stance on the company for the near term given the above-stated potential headwinds.
Canadian National remains well positioned to benefit from the ongoing economic improvements, supporting favorable supply chain dynamics for coal, grain and terminal service agreements along with strength in import and export traffic.
Additionally, market share gains, solid execution, a turnaround in automotive productionand gradual improvements in housing and related segments will generate strong financial results in 2011.
Given continued volume expansion, we believe double-digit earnings growth expectation of up to 15% for 2011 remains a feasible target for the company. Further, In light of improving service metrics, we believe company’s target of achieving operating ratio in the mid-60s in the long run is highly achievable.
Canadian National posted a 7% increase in operating income and 30 basis points improvement in operating ratio despite record high snow fall, frequent avalanches, frigid sub-zero temperatures, surging fuel prices and a strong Canadian dollar dominating U.S. currency. This depicts a commendable operating efficiency by the company.
Canadian National represents a key holding given its long-term investment plans for business expansion. Over the last five years, Canadian National spent almost C$8 billion on capital improvements.
The company plans to invest approximately C$1.7 billion on capital programs in 2011, of which approximately C$1 billion is targeted toward infrastructure and rail line improvements. The rest will be dedicated toward growth and productivity initiatives including investments in Calgary logistics center, Chicago network, positive train control systems, upgrading and overhauls of locomotives, railcar mix and information technology.
Canadian National’s strong financial performance has strengthened its balance sheet position. As a result, the company has raised its free cash flow expectation to C$1.2 billion from C$850 million for 2011. 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 disruptions. 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 has forced the company to raise its crude oil estimate to the range of $100–$110 per barrel in 2011. Additionally, increased depreciation charges and taxation will further 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 Canadian dollar exchange rate in the range of C$1.00 to C$1.05. Changes in the exchange rate makes the company more or less competitive in the world market and thereby affect the company’s 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 the other major rail systems in Canada and services almost similar areas in which Canadian National serves. 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
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