CN: “Solid First Quarter, Despite Network Disruptions”

Reporting on its financial and operating results for the first quarter ended March 31, 2020, CN said it “demonstrated resiliency with solid performance amid month-long illegal blockades and impacts of the COVID-19 pandemic.”

Compared to 1Q19, revenues of C$3.55 billion remained flat. Diluted earnings per share (EPS) of increased 31% to C$1.42, and adjusted diluted EPS increased 4% to C$1.22. The operating ratio (OR) improved 380 basis points to 65.7%, 150 bps points on an adjusted basis. Operating income increased 13% to C$1.22 billion, 4% on an adjusted basis. Operating expenses decreased by 5% to C$2.23 billion, mainly driven by lower labor costs, depreciation expense and fuel expense.

“Inclusion of TransX within the domestic market of the intermodal commodity group, freight rate increases, higher volumes of petroleum crude and increased shipments of Canadian grain were offset by lower volumes across all other commodity groups mostly due to the impacts of the illegal blockades in February 2020 and the COVID-19 pandemic in late March,” CN noted. “RTMs (revenue ton-miles) declined by 1% from the year-earlier period. Freight revenue per RTM increased by 2% over the year-earlier period, mainly due to the inclusion of TransX in the intermodal commodity group and freight rate increases.”

CN provided a revised 2020 financial outlook, liquidity, and scenario analysis: “The COVID-19 pandemic is having an unprecedented and extraordinary impact on the economy. The economic outlook, and therefore overall demand for transportation services, are highly correlated with the duration of containment measures and the impacts on businesses and consumers, which at this point remain uncertain. As a result, CN is withdrawing its 2020 financial guidance and three-year targets provided at the 2019 Investor Day. CN has a solid track record of resiliency in periods of economic weakness. Our strong investment grade credit rating, top-tier among all companies and the best in the rail industry, has once again proven its strategic value, providing CN with robust low-cost liquidity. CN will continue to pause share repurchases in these economic circumstances and will reassess on an ongoing basis. While it is clear that no one can predict the ultimate impact of the current global economic environment, based on what we know today, we are still working to generate a minimum of approximately C$2.5 billion of free cash flow. We are committed to maintaining our previously announced 2020 dividend increase of 7%.”

“CN’s team of dedicated railroaders has demonstrated our ability to overcome difficult situations and keep the economy moving,” said President and CEO JJ Ruest. “I am very proud of how we recovered quickly in March from the service disruptions in February. Our network is very fluid, and we are continuing the temporary right-sizing of our resources to match the weaker demand caused by the global recession. We are committed to providing long-term shareholder value by delivering on our strategic capacity investments for growth and by deploying technological innovations.

“CN’s 2020 key assumptions are withdrawn and can no longer be relied upon given the high degree of business uncertainty caused by the COVID-19 pandemic, its severity, magnitude and duration, including impacts of the pandemic and of businesses’ and governments’ responses to the pandemic on our business, financial position, results of operations and liquidity. In 2020, CN now plans to invest approximately C$2.9 billion in its capital program, of which C$1.6 billion is still targeted toward track and railway infrastructure maintenance. A reduction of C$0.2 billion in CN’s capital program reflecting lower volumes was partly offset by approximately C$0.1 billion due to the negative impact of foreign exchange, resulting in a net C$200 million reduction.

“As we look back to the quarter, my first message is that despite the unusual challenge we were faced with, the men and women of CN produced solid financial results. I also believe it is important to look ahead. My second message is that the resiliency of CN that we demonstrated last quarter was serviced well to this challenging time and positioned us for the recovery. Our investors know we manage the business to deliver long-term performance, and we continue to build for 2021 and beyond. We will balance the need to manage through the short term with the focus on long-term performance of the business. The network is currently in full operation and very fluid.

“We have the capacity to move goods and enable the eventual recovery of the economy. We also continue to build on our technology such as automating track and train inspection, and fully enabling a connected and paperless train crews and increasing train automation. Our financial strength will also service well in the near to long term. We have a very robust balance sheet and a proven track record of dealing with any type of business disruption. Our 2020 capex will further enhance capacity in the strategic and maintain the Prince Rupert growth corridor, as well as the infrastructure required for our growth in and around the Port of Vancouver.”

COWEN INSIGHT

“CN dealt with blockades on its main line early in the quarter and then the start of the pandemic at the end of the quarter, but still managed to beat estimates top through bottom,” says Cowen and Company Managing Director and Railway Age Wall Street Contributing Editor Jason Seidl. Like its Class I peers, 2Q2020 volumes will be challenged, with management believing that May will be the COVID-19 bottom. CN has historically been one of the best-run North American railroads. The company’s strong track record of execution and effective cost management have resulted in one of the lowest operating ratios in the industry.

“CN’s 1Q2020 results saw adjusted EPS of C$1.22, 5% above last year’s result and above our and Street expectations of C$0.93 and C$1.09, respectively. Operating income increased 4% y/y to C$1.22 billion, also above our and consensus estimates of C$956 million and C$1.12 billion, respectively. The OR of 65.7% was significantly better than our estimate, ~210 bps better than consensus’ expectation, and ~150 bps better than last year. Revenue was roughly flat y/y at C$3.55 billion, but outpaced our estimate of C$3.41 billion and the Street’s expectations of C$3.49 billion. Carloads decreased 5.9% in the quarter, better than our expectation for a 6.5% decline but worse than the Street’s 4.7% decrease estimate, while the increase in average revenue per carload was above our estimate and in line with the Street. On a carload by carload basis, every carload type beat Street revenue estimates, other than coal, which missed by ~C$10 million. “Other Revenue” missed consensus by ~$6 million

“Relative to its U.S. peers, the Canadian Class I’s volumes have trended better thus far in 2Q2020, and we believe that this geographic volume differential will continue. That said, management believes it hasn’t yet seen the bottom of this COVID-19-induced bottom, with that likely to occur sometime in May. Automotive, currently –88.5% in 2Q2020, has likely seen its bottom, but for energy and other carload types, the worst is probably yet to come.

“Though our pre-1Q2020 earnings Rail Shipper Survey showed that shippers expect a steep pricing decline in the coming 6 months, management still believes CN will price above rail inflation. In another encouraging sign, management only slightly trimmed the 2020 capex expectation. As a result, we believe CN will be well-positioned to handle increased traffic on the railroad once we are on the other side of the pandemic.

“We adjust our 2020 EPS estimate to C$5.20 or US$3.76 from C$5.60 or US$4.20. Our 2021 estimate goes to C$6.40 from C$6.49, or US$4.74 from $4.95, the result of models updates and updating our currency exchange rate. Continuing to use an 18x multiple and our new 2021 USD EPS estimate, our price target goes to $85 from $89. We continue recommending CN and believe that strong management will help it weather the COVID-19 storm. We continue recommending shares, and rate CN Outperform.”