Tuesday, January 26, 2016

For CN, strong, solid financials in a tough year

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CN President and CEO Claude Mongeau CN President and CEO Claude Mongeau

Despite decreases in carloadings and revenue ton-miles, CN on Jan. 26, 2015 posted solid financials for fourth-quarter and full-year 2015. Significant in its results are record free cash flow and full-year earnings, and an operating ratio well below 60. The strength of the U.S. dollar figured in.

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For the fourth quarter, CN’s net income increased 11% to C$941 million, while diluted EPS increased 15% to C$1.18, compared to the prior-year period. Operating income increased 7% to C$1.35 billion. The operating ratio improved by 3.5 points to 57.2%. Revenues decreased by 1% to C$3.17 billion. Carloadings declined 8% to 1.33 million, and revenue ton-miles (RTM) declined 5%, but revenue per RTM, a measurement of yield defined as revenue earned on the movement of a ton of freight over one mile, increased by 5%.

Fourth-quarter revenues increased for automotive (13%), forest products (12%), intermodal (5%), and grain and fertilizers (1%). Revenues declined for metals and minerals (21%), coal (16%), and petroleum and chemicals (4%). CN said the decrease in total revenues “was mainly attributable to reduced shipments of energy-related commodities due to a reduction in oil and gas activities, lower volumes of semi-finished steel products and short-haul iron ore, decreased shipments of coal due to weaker North American and global demand, and lower U.S. grain exports via the Gulf of Mexico; as well as a lower applicable fuel surcharge rate. These factors were partly offset by the positive translation impact of the weaker Canadian dollar on U.S.-dollar-denominated revenues, freight rate increases, and solid overseas intermodal demand.”

Operating expenses for the quarter decreased by 7% to C$1.81 billion. CN said the decrease “was primarily due to lower fuel expense, lower accident-related costs and cost-management efforts, partly offset by the negative translation impact of the weaker Canadian dollar on U.S.-dollar-denominated expenses.”

For full-year 2015, CN’s net income increased 12% to C$3.54 billion, with diluted EPS rising 14% to C$4.39. Adjusted net income increased 16% to C$3.58 billion, while adjusted diluted EPS increased 18% to C$4.44. Operating income rose 14% to C$5.27 billion. The operating ratio for 2015 improved by 3.7 points to 58.2%. Revenues increased 4% to C$12.61 billion. Free cash flow was a record C$2.38 billion, compared with C$2.22 billion for 2014. Carloadings declined 2% to 5.49 million, and revenue ton-miles decreased 3%.

Full-year revenues increased for automotive (16%), forest products (13%), intermodal (5%), grain and fertilizers (4%), and petroleum and chemicals (4%). Revenues declined for coal (17%) and metals and minerals (3%). “The rise in total revenues was mainly attributable to the positive translation impact of the weaker Canadian dollar on U.S.-dollar-denominated revenues; freight rate increases; and solid overseas intermodal demand, higher volumes of finished vehicle traffic, and increased shipments of lumber and panels to U.S. markets,” CN said. “These factors were partly offset by a lower applicable fuel surcharge rate; and decreased shipments of energy-related commodities including crude oil, frac sand and drilling pipe, lower volumes of semi-finished steel products and short-haul iron ore, reduced shipments of coal due to weaker North American and global demand, as well as lower U.S. grain exports via the Gulf of Mexico.”

Rail freight revenue per RTM increased 8% over 2014, “driven by the positive translation impact of the weaker Canadian dollar and freight rate increases, partly offset by a significant increase in the average length of haul, particularly in the second half of the year, and a lower applicable fuel surcharge rate,” CN said. Operating expenses for 2015 decreased by 2% to C$7.35 billion, “mainly due to lower fuel expense and cost-management efforts, partly offset by the negative translation impact of a weaker Canadian dollar on U.S.-dollar-denominated expenses.”

“CN generated strong fourth-quarter and full-year 2015 results despite the weak volume environment,” said President and CEO Claude Mongeau, who just a few days ago returned from a health-related absence. “Our solid performance is testament to the strength of CN’s franchise and diversified portfolio of businesses. I am particularly proud that CN’s team of railroaders quickly recalibrated resources to respond to weaker volumes, while protecting customer service. Although the economic environment remains challenging, CN will continue to leverage its franchise strength and industry-leading efficiency. For 2016, we expect to deliver mid-single-digit EPS growth over adjusted diluted 2015 EPS of C$4.44. We will continue to invest in the safety and efficiency of our network, with a 2016 capital investment program of approximately C$2.9 billion, including the negative impact of foreign exchange and increased spending for Positive Train Control technology.”

CN’s Board of Directors approved a 20% increase in the company’s quarterly cash dividend. With this increase, CN’s dividend on an annualized basis is C$1.50 per common share. “We are pleased to uphold our track record of consistently returning cash to shareholders,” said CN Executive Vice President and CFO Luc Jobin. “This dividend increase is testimony to our confidence in the strong cash flow generation capacity of CN throughout business cycles, and reaffirms our objective of gradually increasing the dividend payout ratio toward 35%."

A quarterly dividend of C$0.375 per common share will be paid on March 31, 2016, to shareholders of record at the close of business on March 10, 2016. CN has declared annual increases to its dividend 20 consecutive times, averaging 17% per year, since its initial public offering of shares in 1995.

“CN delivered an EPS beat to our and consensus forecasts partly driven by widespread operational improvements and a lower-than-expected tax rate,” observed Cowen and Company Managing Director and Railway Age Wall Street Contributing Editor. “The company's guidance for mid-single-digit EPS growth is largely in line with the street and slightly ahead of our projection. While headwinds persist in first-half 2016, CN remains one of the best-positioned railroads to weather the macro challenges longer term.”

“In the absence of favorable demand dynamics, the railroads have sharpened their focus on improving operating metrics, and CN has once again proven that it is the best operator in the space,” said Seidl. “The improvements achieved in the first three quarters of 2015 continued, and in most cases intensified, in 4Q15, with just about every key operating metric improving year over year, including train speed, up 5% in 4Q15 and 2% for the full year, and terminal dwell, down 15% in 4Q15 and 11% for the full year. These improvements, along with 3%-plus expected price increases, share repurchases, and favorable foreign exchange, should more than offset a slight anticipated volume decline and negative mix to produce mid-single-digit earnings growth in 2016.”

Based on these results, “We are fine-tuning our 2016 EPS estimate from C$4.55 to C$4.60, which reflects roughly 3.5% growth,” Seidl concluded. “We are also introducing our 2017 EPS estimate of C$5.10 (U.S. $3.83). Our U.S.-dollar-denominated price target of $61.50 remains intact as we begin to value the shares based on our new U.S. 2017 EPS estimate of $3.83 while lowering the multiple by two turns to 16x, which is just below the midpoint of the company’s valuation range in the past five years.”

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