CN 3Q20: Making ‘Sequential Improvements’ (UPDATED)

CN, the second North American Class I to report third-quarter 2020 financial and operating results Oct. 20, saw “sequential improvements” through the pandemic.

According to the railroad, revenues for the third quarter were C$3.41 billion (US$2.59 billion), a decrease of C$421 million (US$319 million) or 11%, when compared with the 2019 period. The decrease in revenues was “mainly due to lower volumes across most commodity groups caused by the ongoing effects of the COVID-19 pandemic and lower applicable fuel surcharge rates, partly offset by freight rate increases as well as increased shipments of Canadian grain,” CN reported.

CN experienced a 7% decline in revenue ton miles (RTM) from the year-earlier period. Freight revenue per RTM fell by 3% over the year-earlier period.

Operating expenses, too, fell—8% to C$2.04 billion (US$1.55 billion)—mainly driven by lower fuel and labor costs, as well as decreased purchased services and material expense, according to the railroad. “The decrease in the first nine months was partly offset by a loss on assets held for sale in the second quarter, resulting from the company’s decision to market for sale for on-going rail operations, certain non-core lines,” CN noted.

Demand During the Pandemic

CN provided details on demand in the third-quarter report. It noted: “Starting in late March 2020, the spread of the COVID-19 pandemic resulted in significantly weaker demand for freight transportation services. During the third quarter of 2020, demand partially recovered, with sequential improvements in volumes relative to the second quarter of 2020, but overall demand remained below 2019 levels. By the end of the third quarter of 2020, demand for certain commodities had recovered at or close to 2019 levels, including intermodal, driven by increased online consumer spending on imported goods as well as consumer staples, particularly the grocery sector, which CN was well-positioned to capitalize on, leveraging the acquisitions of TransX and H&R; and strong demand for lumber and panels used in home renovations and construction of new homes, as a result of accumulated demand during the pandemic lockdown phase in the second quarter. The demand for less economically-sensitive products, such as export grain and fertilizers continued to remain positive compared to last year. The demand for other commodities that CN transports remained below pre-pandemic levels, including finished vehicles, industrial products used or produced by manufacturing, petroleum and chemical products, coal, and frac sand used in energy exploration as a result of ongoing economic uncertainty.”

CN’s Investor Relations page provides further details.

Business Outlook

“As we look at the fourth quarter and beyond, we continue to see sequential improvements and momentum leading us to have a cautious optimism about the future,” CN President and CEO JJ Ruest concluded. “We remain confident in our ability to continue delivering long-term shareholder value.”

Cowen Insight: ‘3Q Light But 4Q Has Some Momentum’

“CN posted light 3Q results, like their Canadian peer yesterday, with certain businesses fully recovering from the pandemic and others taking longer,” said Cowen and Company analysts Jason H. Seidl (Managing Director and Railway Age Wall Street Contributing Editor), Matt Elkott and Adam Kramer. “CN is seeing the export market recover, which should help rectify network balance issues which have been discussed by the IMCs. We fine tune our 2020 and 2021 estimates, roll our model forward to 2022, and raise our PT to $116.”

The analysts’ takeaways from the railroad’s 3Q results include:

• “CN’s 3Q20 results saw adjusted EPS of C$1.38, 17% below last year’s result and below our and Street expectations of C$1.53 and C$1.45, respectively. Adjusted operating income decreased 15% y/y to C$1.366 bn, below our C$1.508 bn estimate and the Street’s $1.442 bn expectation. The adjusted operating ratio (OR) of 59.9% was 200bps worse than a year ago, 260bps worse than our estimate, and 110bps worse than consensus’ expectation.
• “Revenue was 11% lower y/y at C$3.409 bn, also below our $C3.534 estimate and the Street’s expectation of C$3.500 bn. Carloads decreased 5.9% in the quarter, 70bps better than our expectation and 240bps better than the Street’s estimate. Conversely, the 4.5% decline in average revenue per carload was worse than our expectation for a 1.1% decline and worse than consensus’ rev/carload expectation.
• “On a carload by carload basis, revenues in each of CN’s segments missed Street expectations. Relative to our estimates, Forest Products and Grain & Fertilizers revenues beat while the remaining carload types missed. CN’s pricing was again ahead of rail cost inflation. On the demand side, CN has seen strong recoveries in certain areas of their business, with other areas still lagging.
• “Emerging from the pandemic, there has been a divergence between rising imports and exports remaining stagnant. Per CN, this divergence is beginning to normalize, with exports nearing normal levels again. Intermodal carriers, including JBHT [J.B. Hunt Transport Services, Inc.] most recently, have discussed disruptions in their networks with boxes stuck in the interior of the U.S. and needed on the West Coast. Perhaps CN’s commentary can be taken as a sign that the worst is behind.
• “We adjust our 2020 EPS estimate to C$5.43 or [US]$4.03 from C$5.51 or [US]$4.10. Our 2021 estimate goes to C$6.75 and $5.00 in USD from C$6.82 or $5.05 in USD. Like we did with fellow Class I’s, we roll our model forward to 2022 and establish an initial 2022 EPS estimate of C$7.45 or $5.52 in USD. We lower our multiple a turn to 21x as a result (as we also did with peers). Using this 2022 estimate and 21x multiple, our price target goes to $116 from $111.”