CN: Strong quarter, full-year financial and operating performance

CN’s fourth-quarter and full-year 2016 financial and operating results “demonstrated once again our ability to perform well in a mixed economic environment, despite facing difficult winter conditions in December,” President and CEO Luc Jobin said on Jan. 24.

“We saw weaker volumes during the year, but quickly adjusted as our dedicated team of railroaders maintained its focus on operational efficiency, while continuing to provide quality service to our customers and improve our safety performance,” Jobin said.

In fourth-quarter 2016, net income increased 8% to C$1.02 billion, while diluted EPS increased 12% to C$1.32, compared with the fourth quarter of 2015. Adjusted net income increased 1% to C$952 million, with adjusted diluted EPS increasing 4% to C$1.23. Operating income increased 3% to C$1.39 billion. Revenues increased by 2% to C$3.22 billion. Carloadings increased 3% to 1,37 million, and revenue ton-miles (RTMs) increased 4%. The operating ratio improved by 0.6 points to 56.6%.

Fourth-quarter revenues increased for grain and fertilizers (14%), automotive (four%), and intermodal (1%) and declined for metals and minerals (6%), coal (6%), petroleum and chemicals (5%), while revenues for forest products remained flat. The revenue increase was mainly attributable to higher volumes of Canadian grains and U.S. soybeans, refined petroleum products, finished vehicles, and petroleum coke; as well as freight rate increases. These factors were partly offset by lower volumes of crude oil, U.S. thermal coal, and drilling pipe; and lower applicable fuel surcharge rates.

Though RTMs, measuring the relative weight and distance of rail freight transported, increased 4%, rail freight revenue per RTM, a measurement of yield defined as revenue earned on the movement of a ton of freight over one mile, decreased by 3%.

Operating expenses for the quarter increased by 1% to C$1.82 billion, primarily due to higher casualty and other expenses, and higher depreciation and amortization expense, partly offset by lower pension expense and lower costs resulting from operating productivity gains, including cost-management initiatives.

For full-year 2016, net income increased 3% to C$3.64 billion, with diluted EPS rising 6% to C$4.67. Adjusted net income remained essentially flat at C$3.58 billion, while adjusted diluted EPS increased 3% to C$4.59. Operating income rose 1% to C$5.31 billion. Revenues decreased by 5% to C$12.04 billion. Carloadings and revenue ton-miles both declined by 5% in 2016. The operating ratio for 2016 improved by 2.3 points to 55.9%. Free cash flow was a record C$2.52 billion, compared with C$2.37 billion in 2015. The operating ratio was 55.9% in 2016, an improvement of 2.3 points over the 2015 operating ratio of 58.2%.

Annual revenues increased for automotive (6%), forest products (4%), and grain and fertilizers (1%), but were more than offset by revenue declines for coal (29%), metals and minerals (15%), petroleum and chemicals (11%), and intermodal (2%). The decrease in total revenues was mainly attributable to lower volumes of crude oil, coal and frac sand, as well as lower applicable fuel surcharge rates. These factors were partly offset by the positive translation impact of the weaker Canadian dollar and freight rate increases.

Rail freight revenue per RTM remained flat compared to 2015, driven by lower applicable fuel surcharge rates and an increase in the average length of haul; offset by the positive translation impact of a weaker Canadian dollar and freight rate increases.

Operating expenses for 2016 decreased by 8% to C$6.73 billion. The decrease was mainly due to lower costs resulting from operating productivity gains, including cost-management initiatives and decreased volumes of traffic; lower pension expense; and lower fuel prices, partly offset by the negative translation impact of a weaker Canadian dollar on U.S.-dollar-denominated expenses.

“Overall, the economy remains challenging, but we remain optimistic and expect to see moderate volume growth in 2017.” Jobin said.”

CN said it expects to deliver EPS growth in the mid-single-digit range in 2017 over adjusted diluted EPS of C$4.59 in 2016. It will “continue to invest in the safety and efficiency of its network, with a 2017 capital investment program of approximately C$2.5 billion, which includes increased spending for Positive Train Control technology in the U.S.

CN’s Board of Directors approved a 10% increase to CN’s 2017 quarterly cash dividend.

Although CN reports its earnings in Canadian dollars, a large portion of its revenues and expenses is denominated in U.S. dollars. “As such, our results are affected by exchange-rate fluctuations,” CN said. “On a constant-currency basis, that excludes the impact of fluctuations in foreign currency exchange rates, CN’s net income for the three months and year ended Dec. 31, 2016 would have been lower by C$3 million (unchanged per diluted share) and C$85 million (C$0.11 per diluted share), respectively.”

CN said it “has made a number of economic and market assumptions in preparing its 2017 outlook. The company is assuming that North American industrial production for the year will increase in the range of 1% to 2% and assumes U.S. housing starts in the range of 1.25 million units and U.S. motor vehicle sales of approximately 17.5 million units. For the 2016/2017 crop year, the grain crops in both the U.S. and Canada were above their respective five-year averages. The company assumes that the 2017/2018 grain crops in both Canada and the U.S. will be in line with their respective five-year averages. With these assumptions, CN assumes total RTMs (revenue ton-miles) for all freight categories in 2017 will increase in the range of 3% to 4% vs. 2016. CN expects continued pricing improvement above inflation. CN assumes that in 2017, the value of the Canadian dollar in U.S. currency will be in the range of $0.75, and that the average price of crude oil (West Texas Intermediate) will be in the range of US$50 to US$60 per barrel. In 2017, CN plans to invest approximately C$2.5 billion in its capital program, of which C$1.6 billion is targeted toward track infrastructure.”

“We are revising our 2017 EPS estimate from C$5.36 to C$5.10, which is about 6% above the implied midpoint of the company’s guidance,” said Cowen and Company Managing Director and Railway Age Contributing Editor Jason Seidl. “We are also introducing our 2018 estimate of C$5.55. Our USD-denominated price target rises from $75.00 to $77.00 based on our USD 2018 EPS estimate of $4.17 and the same 18.5x multiple. We maintain our Outperform rating.

“Our new 2017 EPS estimate reflects a modest OR improvement and is 6% above the midpoint of guidance, which we believe may prove conservative. Our newly established 2018 EPS estimate represents 9% growth. CNI remains the best operator and is likely to target some more market share. We remain constructive.

“CN reported adjusted 4Q16 EPS of C$1.23, up 4% y/y and modestly above our and consensus estimates of C$1.20 and C$1.21, respectively. Operating income increased 3% to C$1.4 billion, largely in line with our and consensus forecasts. Revenue grew 2% to C$3.2 billion, also largely in line with our and street projections. The top line growth occurred via a 3% volume increase, which offset a 2% decline in revenue per carload. Other revenue contributed positively through a 9% y/y increase. The revenue per carload decline occurred as negative mix and fuel impacts more than offset a 2.7% core price increase. The OR was a fourth-quarter record at 56.6%, in line with our assumption, and 70 bps better than the implied consensus OR. The company achieved these solid results despite severe weather in December and was able to improve train productivity, yard productivity and locomotive utilization. On the other hand, terminal dwell, car velocity, and train velocity deteriorated somewhat.

“CN guided for 2017 EPS growth in the mid single digits, compared to the roughly 8% growth reflected in the consensus estimate at the time of the earnings release. We believe this guidance may be somewhat conservative. Indeed, with volumes likely to grow moderately (3% in our model), pricing expected to exceed rail inflation, and share repurchases projected to be roughly C$2 billion, the company’s guidance seems to imply some OR deterioration. We believe that is unlikely and are modeling for a 70 bps OR improvement. Pricing could improve progressively throughout the year as freight demand rebounds gradually while freight capacity, including in the truckload market, has been somewhat curtailed.

According to our proprietary 4Q16 Rail Shipper Survey, respondents expect rail pricing to increase 2.7% on average in the next 6-12 months, up from the 2.1% recorded in our 3Q16 survey. This improved pricing outlook, coupled with the aforementioned volume growth and CN’s operational excellence, is what gives us confidence in our projection for a modest OR improvement despite somewhat tough weather comps and the potential for some business wins at a slightly higher OR.”