CN 2Q 2017: Volume growth generates record revenues

Continued strong volume growth led to record revenues and a 21% increase in adjusted diluted earnings per share (EPS), CN reported for its financial and operating results for the second quarter ending June 30, 2017.

In the second quarter, net income increased 20% to C$1. 03 billion, while diluted EPS increased 24% to C$1.36, compared with second-quarter 2016. Adjusted net income increased 17% to C$1.01 billion, with adjusted diluted EPS increasing 21% to C$1.34. Operating income increased 16% to C$1.50 billion.

Revenues increased by 17% to a quarterly record of C$3.33 billion. Revenues increased for metals and minerals (33%), coal (33%), grain and fertilizers (23%), automotive (20%), intermodal (17%), petroleum and chemicals (12%), and forest products (6%). Carloadings increased 14% to 1.4 million. Revenue ton-miles (RTMs), measuring the relative weight and distance of rail freight transported by CN, increased by 18% from the year-earlier quarter. Rail freight revenue per RTM decreased by 1% over the year-earlier period.

The increase in revenues was mainly attributable to higher volumes across several sectors, such as Canadian grain and fertilizers, overseas intermodal traffic, frac sand, coal and petroleum coke exports, crude oil, and finished vehicles. Higher applicable fuel surcharge rates, freight rate increases, and the positive translation impact of a weaker Canadian dollar contributed to the revenue increase. These factors, which partly offset an increase in the average length of haul, drove the decrease in revenues per RTM.

CN’s operating expenses increased 18% to C$1.83 billion. The operating ratio of 55.1% was an increase of 0.6 points over the prior-year quarter. Free cash flow for second-quarter 2017 was C$811 million, up from C$585 million in the 2016 quarter.

CN said it aims to deliver 2017 adjusted diluted EPS in the range of C$4.95 to C$5.10 compared to last year’s adjusted diluted EPS of C$4.59.

Although CN reports its earnings in Canadian dollars, a large portion of its revenues and expenses is denominated in U.S. dollars. “The fluctuation of the Canadian dollar relative to the U.S. dollar affects the conversion of our U.S.-dollar-denominated revenues and expenses,” CN said. “On a constant currency basis, our net income for second-quarter of 2017 would have been lower by C$28 million, or C$0.04 per diluted share.”

Once again, CN delivered solid quarterly performance with strong volume growth across most commodity groups, building on the momentum started in the fourth quarter of 2016,” said President and CEO Luc Jobin. “Our team of railroaders remained focused on balancing operational and service excellence while efficiently adjusting to the growing demand. The North American economic outlook continues to be positive, and we remain committed to delivering on our 2017 financial outlook. However, volume comparisons in the second half of the year will be more challenging, and the strengthening of the Canadian dollar will constitute a headwind.”

“CN’s 2Q17 results were in line with our estimate, but better than consensus expectations,” said Cowen and Company Managing Director and Railway Age Wall Street Contributing Editor Jason Seidl. “There was no change to guidance, but our estimate remains slightly above the high end. Pricing growth moderated from 1Q17 as the OR deteriorated y/y a bit as well.”

The railroad’s operating income of C$1.50 billion matched Cowen’s forecast and beat the Wall Street consensus estimate of C$1.4 billion. Revenue of C$3.30 beat both Cowen’s C$3.20 billion estimate and the consensus of C$3.25 billion. The 55.1% OR was 200 basis points better than Cowen’s assumption. Core pricing came in at 2.3%, a deceleration from 2.7% in 1Q17.

“CN has lost a few front line supervisors to CSX as CSX implements Hunter Harrison’s Precision Railroading initiatives,” Seidl noted. “CN does not view the losses as significant to their business. And while we’ve heard from public truckers and private contacts that the U.S. TL (truckload) industry picked up in 2Q17, CN is not seeing a tightening within its footprint. Management continues to expect tighter capacity, which should drive the company’s domestic intermodal business later this year. Intermodal margins are at the company’s average, whereas some of the U.S. railroads have lower than average margins on that business.”

CN management “is reiterating the company’s focus on attracting the right kinds of business,” Seidl said. “CN wants to make it clear it is not afraid to turn away unprofitable opportunities. We continue to believe CN guidance may be a bit conservative—something the company is known for, and we do not see a compelling reason to change our 2017 and 2018 EPS estimates of C$5.15 and C$5.55, respectively.”

Cowen’s stock price target for CN remains at US$83, based on an unchanged USD EPS estimate of $4.17 and a 19.5x multiple. “The stock is approaching our price target,” Siedl added.