CN 2Q2020 Results “Demonstrate Resiliency”

CN, the second North American Class I railroad to report second-quarter 2020 financial and operating results, was, as expected, adversely affected by the falloff in business related to the COVID-19 pandemic. Nevertheless, there are some bright spots, among them an increase in free cash flow, a decision to acquire 1,500 additional high-capacity grain hoppers, approval from the railroad’s Board of Directors to pay a third-quarter 2020 dividend, and re-affirmation of its C$2.9 billion capital plan.

Looking at CN’s hard numbers, compared to 2Q2019, revenues decreased by C$750 million or 19% to C$3.21 billion. CN said the decrease in revenues was mainly due to lower volumes across most commodity groups caused by the COVID-19 pandemic, and lower applicable fuel surcharge rates, which were partly offset by increased shipments of Canadian grain, higher Canadian coal exports via West Coast ports and freight rate increases. RTMs (revenue ton-miles) declined by 18%. Freight revenue per RTM decreased by 1.0%.

Diluted earnings per share (EPS) decreased 59% to C$0.77. On an adjusted basis, diluted EPS declined 26%, to C$1.28. The operating ratio (OR) increased 1,800 basis points (BPS) from 57.5% to 75.5%. On an adjusted basis, the OR increased 290 BPS points, from 57.5% to 60.4%. Operating income fell 53% to C$785 million; 24% to C$1.27 billion on an adjusted basis.

Free cash flow increased C$495 million to C$1.01 billion.

Operating expenses increased by 6% to C$2.42 billion, partly offset by lower fuel and labor costs. The rise in expenses was “mainly driven by a loss on assets held for sale” resulting from the decision to market for sale, for ongoing rail operations, certain “non-core” lines in Wisconsin, Michigan and Ontario that were legacy lines from its acquisition of Wisconsin Central in 2001. The decision to sell these lines resulted in a one-time charge of C$486 million, or C$363 million after-tax (C$0.51 per diluted share). Excluding this one-time charge, operating expenses were down 15% vs. last year.

“By being adaptable, we were able to swiftly right-size our resources and continue to provide our essential transportation services to our customers, the economy and the communities we serve,” said CN President and CEO JJ Ruest. “I could not be prouder of our railroaders as they never stopped working to keep our customers’ goods and the North American economy moving safely and efficiently throughout this pandemic. The decisive actions we took early on in March, well before the pandemic impacted the North American economy, allowed us to deliver more than C$1B of free cash flow during this recessionary quarter. I’m pleased to reaffirm our commitment in encouraging the economic recovery through our C$2.9B capital investment plan for 2020, as well as our new investment announcement of the purchase of approximately 1,500 new, efficient, high-capacity covered hopper cars to expand our grain export business for delivery starting in January of 2021. Our strategic long-term approach to investments, together with our continued focus on cost and deployment of innovative technology, as well as our commitment to enabling trade, position us to keep delivering long-term value to our stakeholders.”

CN’s acquisition of 1,500 high-capacity grain covered hopper cars “will encourage the economic recovery through job creation in the North American manufacturing sector, and help CN continue to meet the growing needs of grain farmers and grain customers,” Ruest said. “This investment, combined with our 2020 C$2.9 billion capital investment program, will help us move more grain. We are confident in the future of the grain business and its key role in CN’s long-term growth. By investing in the construction of these new cars, we want to help quickly stimulate the North American economy by supporting manufacturing and agriculture related jobs.”

The car order comes roughly two years after an initial order of 1,000 units from National Steel Car to replace aging equipment and accommodate increasing annual Western Canadian crop yields. The 2018 order closely followed the Canadian government’s passing of Bill C-49, the Transportation Modernization Act. The 55-foot, 8-inch jumbo hopper cars offer 5,431 cubic feet of capacity.

“CN’s Canadian grain movements continue to break records, month after month, and these new hopper cars will help perpetuate our growth in this key sector of the North American economy,” said CN Senior Vice President, Rail Centric Supply Chain James Cairns. “By purchasing new hopper cars for the second time in two years, we are continuing to deliver on our commitment to grain farmers, grain customers and the overall supply chain to expand our collective capacity through fleet renewal. Through this investment, we will be able to support and expand our movements of grain to international markets as demand continues to increase.”

This year, 4,000 CN workers have been furloughed, 3,000 of whom can be recalled if business improves. “We unfortunately had to do quite a few layoffs,” said Ruest. “The good news is we’re starting to recall some people back to work.”

On July 21, CN’s Board of Directors announced that the company will pay, on Sept. 30, 2020, a third-quarter 2020 dividend of C$0.575 per common outstanding share, to shareholders of record at the close of business on Sept. 9, 2020.

THE COWEN INSIGHT: CN “SET FOR GROWTH”

“CNI has historically been one of the best-run North American railroads,” said Cowen and Company analysts Jason Seidl (Managing Director and Railway Age Wall Street Contributing Editor), Matt Elkott and Adam Kramer. “The company’s strong track record of execution and effective cost management have resulted in one of the lowest operating ratios in the industry. Our base case assumptions: Economic growth continues, and the company maintains its ability to achieve solid pricing and industry-best margin. On the upside, there is potential for more customer wins from competitors. We rate CNI shares Outperform.”

“CNI posted an adjusted 2Q EPS beat relative to Cowen and Street estimates,” the analysts noted. “Permanent closures of some yards and shops along with the planned sale of U.S. rail assets should aid margins going forward. Recent record grain volumes are set to continue with sustained demand and CNI purchasing 1,500 new grain cars next year.

“CNI’s 2Q20 r adjusted EPS of C$1.28 was 26% below last year’s result but above our and Street expectations of C$1.14 and C$1.26, respectively. The adjusted operating income decrease of24% y/y to C$1.27 billion was above our C$1.15 billion estimate and in line with the Street. The adjusted OR of 60.4% was significantly better than our estimate, ~50 BPS better than consensus’ expectation, but ~290 BPS worse than a year ago.

“We note that the adjusted results this quarter reflect the company’s decision to market for sale certain non-core rail lines in Wisconsin, Michigan and Ontario, which were legacy lines from CNI’s Wisconsin Central purchase. Management stated that it previously rationalized the Canadian portion of its network, but had yet to rationalize the U.S. network in the same way. We take this as a positive sign that, even though CNI implemented PSR more than 20 years ago, the company remains committed to continual improvement.

“Revenue was 19% lower y/y at C$3.21 billion, just C$5 million below our estimate but below the Street’s expectation of C$3.25 billion. Carloads decreased 15.9% in the quarter, just 10 BPS worse than our expectation and 20 BPS better than the Street’s estimate. That said, the 3.9% decline in average revenue per carload was worse than our expectation of a 2.4% decline. On a carload by carload basis, Petroleum & Chemicals, Forest Products, Grain & Fertilizers and Automotive beat the Street’s estimates, while Metals & Minerals, Coal and Intermodal missed. Other revenue was in line with the Street. Pricing in each of CNI’s business units was ahead of rail cost inflation. CNI is ordering 1,500 new grain hopper cars to take advantage of increasing export grain demand, even after setting monthly grain records recently

“As volumes have recovered since the late-May trough, CNI has selectively called back employees, but not on a one-to-one basis with volumes. Cost reductions, including the closure of shops and yards, will help keep costs down in the future. Similarly, selling track that was likely a drag on the overall company margin is a CNI-specific reason for why the reduced cost basis is potentially repeatable, even as traffic comes back. Additionally, traffic from these rail lines will likely remain with CNI for its long-haul move.”