CN: Off to a strong start

CN’s first-quarter 2017 financial and operating results reflect a strong start to the year and have prompted an upward revision to its 2017 financial outlook.

Net income increased 12% to C$884 million, while diluted EPS increased 16% to C$1.16, compared with the first quarter of 2016. Adjusted net income increased 11% to C$879 million, with adjusted diluted EPS increasing 15% to C$1.15. Operating income increased 7% to C$1.3 billion. Revenues increased by 8% to C$3.2 billion. Carloadings increased 9% and revenue ton-miles increased 14%. Operating expenses increased 9% to C$1.9 billion, mainly due to higher fuel prices and higher costs due to increased volumes of traffic. The operating ratio of 59.4%, was an increase of 0.5 of a point from the prior-year quarter. Free cash flow was C$848 million, up from C$584 million in the year-earlier quarter.

Revenues increased for coal (39%), grain and fertilizers (16%), metals and minerals (16%), automotive (10%), intermodal (7%), and petroleum and chemicals (1%). Revenues declined for forest products (–3%). CN said its increase in revenues was mainly attributable to higher volumes of Canadian and U.S. grain, frac sand, coal exports, overseas intermodal traffic, and finished vehicles; freight rate increases; and higher applicable fuel surcharge rates. These factors were partly offset by the negative translation impact of a stronger Canadian dollar on U.S.-dollar-denominated revenues. Rail freight revenue per carload decreased by 1%.

Under a revised outlook, CN now says it aims to deliver 2017 adjusted diluted EPS in the range of C$4.95 to C$5.10, vs. last year’s adjusted diluted EPS of C$4.59, and compared with its Jan. 24, 2017 financial outlook , which clled for mid-single-digit growth this year.

CN has also increased its 2017 capital program by C$100 million to C$2.6 billion, of which C$1.6 billion is still targeted toward track infrastructure. The additional capital investment will go toward the purchase of 22 high-horsepower locomotives and other projects to support growth.

“Although CN reports its earnings in Canadian dollars, a large portion of its revenues and expenses is denominated in U.S. dollars,” the company said. “The fluctuation of the Canadian dollar relative to the U.S. dollar affects the conversion of the company’s U.S.-dollar-denominated revenues and expenses. On a constant currency basis, CN’s net income for the first quarter of 2017 would have been higher by C$22 million, or C$0.03 per diluted share.”

Luc Jobin, CN President and CEO, said: “I am very proud of the solid response from our team of railroaders in accommodating the strong demand during the quarter. We delivered record first-quarter volumes, including a 14% increase in Western Canadian grain tonnage moved over our network, despite a return to more demanding winter conditions versus last year. Our ongoing investments in people, equipment and infrastructure continue to position us well to leverage CN’s industry-leading operational performance and superior customer service.”

“We remain onboard with CN,” said Cowen and Company Managing Director and Railway Age Wall Street Contributing Editor Jason Seidl. “Results and core pricing were solid, although mix affected yield negatively. CN raised its EPS guidance, but we do not see a compelling reason to change our estimates, which were already above guidance and consensus. Our price target rises modestly on a multiple boost that reflects strong execution and an improved rail environment.

“CN reported another solid quarter, with adjusted EPS of C$1.15 in line with consensus and above our C$1.11 estimate. Operating income came in at $1.30 billion, compared to our and the Street forecast of $1.28 billion. Revenue was C$3.20 billion, largely in line with our and consensus expectations. The operating ratio (OR) of 59.4% represented a 50 bps y/y deterioration, primarily due to fuel. The OR was 20 bps better than our assumption and 70 bps better than the implied consensus OR.

“Core pricing came in at 2.7%, in line with 4Q16. However, due to mix and other factors, revenue/carload declined 0.8% y/y (up 1.9% sequentially), and revenue/revenue ton-mile declined 5.5% y/y (up 0.2% sequentially). Some of the negative mix appears to be related to a higher component of freight not moved on CNI equipment. The company does not provide a specific breakout of such freight, but we are not too concerned about pricing overall and believe it will be stable in coming quarters, with upside possible later in the year as the rail recovery continues.

“CN achieved broad-based improvements in service metrics even as volumes increased 9% and GTMs were up 12% while weather was more severe than last year’s somewhat mild weather. The service improvements included an 11% rise in train velocity, a 16% rise in yard productivity, and an 8% improvement in terminal dwell.

“Management guided for 2017 EPS in a range of C$4.95 to C$5.10. The C$5.03 midpoint is just a penny below the consensus estimate at the time of the earnings release and below our C$5.15 estimate. CNI had previously guided for mid-single-digit EPS growth.

“We continue to believe CN’s guidance may be a bit conservative (something the company is known for). We do not see a compelling reason to change 2017 and 2018 EPS estimates, which were already ahead of the street before the company’s guidance raise. Our USD price target rises from $77 to $81 based on our USD EPS estimate of $4.17 and a 19.5x multiple. This is up one turn from our prior multiple as the company continues to demonstrate solid execution, and as rail industry fundamentals improve. We maintain our Outperform rating.”