Tuesday, April 22, 2014

CN toughs out a challenging first quarter

Written by  William C. Vantuono, Editor-in-Chief
CN President and CEO Claude Mongeau CN President and CEO Claude Mongeau
“The winter of a lifetime,” as described by CN President and CEO Claude Mongeau, bumped up CN’s first-quarter 2014 operating expenses and ratio compared to the year-ago quarter, but despite these challenges, the railroad posted gains in revenues, operating income, and net income.

CN’s net income was C$623 million, or C$0.75 per diluted share, compared with net income of C$555 million, or C$0.65 per diluted share, for the year-earlier quarter. Excluding gains on rail line sales in both the 2014 and 2013 periods, first-quarter 2014 adjusted diluted earnings per share (EPS) increased 8% to C$0.66 from adjusted diluted EPS of C$0.61 in Q1-2013. Adjusted net income of C$551 million increased 6% over adjusted net income of C$519 million for the first quarter of 2013. Operating income increased 5% to C$820 million. Revenues increased 9% to C$2.7 billion million, revenue ton-miles grew by 5%, and carloadings increased 1%. Free cash flow was C$494 million, compared with C$151 million for the year-earlier quarter.

CN’s operating ratio for the quarter deteriorated by 1.2 points to 69.6% from 68.4% the year before. Operating expenses for the quarter increased by 11% to C$1.87 billion, “mainly attributable to the negative translation impact of a weaker Canadian dollar on U.S.-dollar-denominated expenses, operational challenges due to an unusually harsh winter resulting in increased purchased services and material expense, increased fuel costs, and higher casualty and other expense,” the railroad said.

“Although we report our earnings in Canadian dollars, a large portion of our revenues and expenses is denominated in U.S. dollars,” CN said. “The fluctuation of the Canadian dollar relative to the U.S. dollar, which affects the conversion of our U.S.-dollar-denominated revenues and expenses, resulted in a positive impact to net income of C$26 million (C$0.03 per diluted share) in the first quarter of 2014.”

Revenues increased for petroleum and chemicals (23%), intermodal (12%), metals and minerals (7%), coal (7%), and grain and fertilizers (6%). Forest products revenues were flat, and automotive revenues declined by 4%. “The increase in revenues was mainly attributable to the positive translation impact of the weaker Canadian dollar on U.S.-dollar-denominated revenues; freight rate increases; higher freight volumes due to strong energy markets and market share gains, particularly in intermodal; and the impact of a higher fuel surcharge as a result of higher volumes,” CN said. “Revenues were negatively affected by operational challenges due to an unusually harsh winter that reduced our capacity to serve our customers.”

Revenue ton-miles increased by 5% over the year-earlier quarter. Rail freight revenue per revenue ton-mile, a measurement of yield defined as revenue earned on the movement of a ton of freight over one mile, increased by 4% over the year-earlier period, “driven by the positive translation impact of the weaker Canadian dollar and freight rate increases, partly offset by an increase in the average length of haul,” CN said.

CN reaffirmed the 2014 financial guidance that it announced on Dec. 10, 2013: “We are aiming to deliver double-digit EPS growth in 2014 over adjusted diluted 2013 EPS of C$3.06, as well as free cash flow in the range of C$1.6 billion to C$1.7 billion.” In addition, the railroad said it is now targeting 2014 capital spending of C$2.25 billion, an increase of C$150 million over its previous spending forecast of C$2.1 billion announced on Dec. 10, 2013, and C$250 million higher than 2013 capital spending of C$2.0 billion.

“CN delivered solid first-quarter results thanks to a dedicated team of railroaders who labored long and hard to keep us rolling through the harshest winter in decades,” Mongeau said. “The winter of a lifetime took its toll on network capacity and affected all of our customers, but I’m pleased that CN’s recovery is now well under way, with key safety, operating and service metrics returning to pre-winter levels. With continued focus on supply chain collaboration and solid execution, CN is reaffirming its 2014 financial outlook and increasing its capital envelope to C$2.25 billion in support of its commitment to growth, efficiency, and safety.”

In CN’s earnings call, Mongeau was peppered with questions regarding Canada’s contentious grain situation, and looming new regulations. Here’s what he had to say:

“We are going to have a record year in terms of overall grain throughput, and people will have to step back and look at what they’ve done during the winter when emotion went high. I believe the Canadian government effectively gave super priority to the grain business. . . . I am hopeful that some will be wise enough to engage in the debate so that it’s not just the railroad talking; that customers from all sectors will be saying, [we’re] trying to make trade-offs, manage priorities, and use our normal commercial incentives.

“It broadly aligns with what we are trying to do in the commercial system, not just a super priority for grain. So I think that hopefully it will get people to think through and be wise about how they interact with governments over the next few months and years as the dust settles. . . . With the regulation, the government also introduced a new regime for service level arbitration, for instance: penalties—things of that nature. . . . Certain customers that are more regulatory-bent use the regulatory leverage and jump the queue, get in the line and get a better deal, try to make the railroad become a taxi as opposed to a bus service.

“I think [non-grain] customers are going to see the government allowing others to jump the queue and get a better deal by going to Ottawa. That also should get people who understand the logic of a [balanced regulatory] system to engage in the debate. . . . I believe this was not a good decision. I think it was made in the heat of the moment for the wrong reasons and we are going to explain to stakeholders, our other shippers, and the regulators that there is a much better approach: to encourage supply chain collaboration to have the sound policy that builds on commercial incentive.

“I can understand the grain grower side being concerned about the grain not moving as fast as they would have hoped. But you also had private sector companies that control a big part of the supply chain doing a lot of grain shifting and a lot of self-serving regulatory advocacy. . . . [In] Vancouver this weekend there were 500 hopper cars sitting there not being unloaded while [terminals] were taking a break for Easter weekend.

“So we are going to go back to the government and we are going to say, it’s one of two things: You either align the supply chain on an incentive basis or you regulate, and if you regulate, you should regulate it all—grain elevators, railroads. . . . You tell people what they are supposed to do and do it on a regulatory basis. I am hopeful that cooler heads will prevail and that we can sustain the supply chain collaboration and the sound policy framework that we worked so hard to build.

“We have the best railway system in the world, period. We have the lowest rates, the best service. Before we [tamper] with success, we should think it through. And so it’s either supply chain collaboration or it’s a regulatory approach, and if it’s regulatory, we are going to be arguing that we should regulate the grain elevators and the railroads . . . .”