The largest rail network in Canada, Canadian National Railway Company (CNI) reported adjusted earnings per share of C$1.19 ($1.14) in the third quarter of 2010, easily surpassing the Zacks Consensus Estimate of $1.12.
Adjusted earnings increased 27% from the year-ago earnings of 94 Canadian cents. Higher-than-expected earnings were led by solid revenue growth, effective cost-control measures and improved productivity.
Total revenue climbed 15% year over year to C$2,122 million ($2,042 million) but was below the Zacks Consensus Estimate $2,068 million. The year-over-year improvement was driven by higher volumes across all commodity segments. Growth across all commodity segments can be attributable to improving economic conditions in North America and internationally, a higher fuel surcharge as well as an increase in freight rate. These factors were partly offset by a negative currency translation.
Carloads (volume) rose 18% year over year and revenue ton miles, which measures the relative weight and distance of rail freight transported by Canadian National, grew 9% from the year-ago quarter.
On an annualized basis, revenues increased 28% from Coal, 24% from Metals and Minerals, 22% from Automotive, 19% from Intermodal, 10% from Petroleum and Chemicals, 7% from Grain and Fertilizers and 4% from Forest Products.
Operating expenses increased 11% year over year. Higher fuel costs, increased labor and fringe benefit expenses as well as higher casualty and other expenses were partially offset by the positive impact of currency translation. Operating ratio (defined as operating expenses as a percentage of revenue) improved 200 bps year over year to 60.7% from 62.7% in the year-ago quarter.
Liquidity
The company generated negative free cash flow of C$20 million in the reported quarter compared with positive free cash flow of C$194 million in the year-ago quarter. Cash and cash equivalents increased to C$548 million at the end of the third quarter from C$233 million in the year-ago quarter.
Long-term debt decreased to C$6.1 billion from the year-ago level of C$6.5 billion. Debt-to-total capitalization ratio was 34.4%, down from 36.7% in the year-ago quarter. The low debt-to-total capitalization ratio implies that the company has enough liquidity in its balance sheet and is favorably positioned for long-term opportunities.
Dividend
On December 31, Canadian National is scheduled to pay a quarterly dividend of 27 cents per share to shareholders of record on December 10.
Outlook
Canadian National continues to expect adjusted earnings per share to increase 25% in 2010 over C$3.24 in 2009. The Zacks Consensus Estimate for 2010 is $4.09, showing a whooping 32.7% increase from the year-ago quarter.
The company also expects to achieve free cash flow of approximately C$1.1 billion for 2010.
Our Analysis
Based on continued recovery in North American and global economies, we believe increased traffic, solid execution, effective cost-control measures, carload growth, improved pricing, rise in North American industrial production and gradual improvements in housing and related segments will generate strong financial results for the remainder of 2010 and beyond. However, the railindustry may create potential headwinds by increasing regulations, which may weigh on efficiency gains and earnings growth of the company. In addition, strong Canadian dollar, competitive threats and a highly unionized labor might limit the upside potential of the stock.
We are currently recommending our long-term Neutral rating with Zacks #3 (Hold) Rank on Canadian National.
