Canadian National (CNI) started the year with the consolidation of its corporate structure, namely the merging of its subsidiaries DMIR (Duluth, Missabe and Iron Range Railway Company) and DWP (Duluth, Winnipeg and Pacific Railway Company) into the existing Wisconsin Central Ltd. subsidiary.
Canadian National initiated the merger process last year and received the requisite authorisation from the U.S. Surface Transportation Board in April. However, the merger could not be completed until December due to pending approvals from various labor unions representing workers at Canadian National.
Following the merger, Canadian National is expected to see significant synergies resulting from a streamlined operating structure. The improvement in processes would eliminate inefficiencies and thereby enhance the quality of its services.
The main advantage is of course cost optimisation, since the merger would enable better utilization of assets. This is a significant positive for a railroad company, which typically depends on heavy capital investment.
This is not the first time that Canadian National has taken measures to improve its return on assets. The company has implemented several productivity initiatives in the recent past that could reduce costs and leverage its assets. For instance, Canadian National initiated operations like “first mile-last mile” that focused on improving customer services. It also made significant investment in the purchase of locomotives equipped with distributed power capability that has allowed longer and more efficient train operations, particularly in cold weather conditions.
The company has also been focusing on infrastructure developments like rail-line improvements for the Elgin, Joliet and Eastern Railway Company (EJ&E) property acquired in 2009, the expansion of the Calgary logistics centre, and the upgrading of positive train control (PTC) systems for maintaining better railroad safety.
We believe that these initiatives coupled with a stronger volume outlook and favourable pricing trends in the railroads segment will support Canadian National’s growth in the near-term and also enable it to achieve its long term growth targets.
However, Canadian National is prone to volatility in fuel prices due to changes in the economy or supply disruption. Rising fuel prices could adversely affect the company’s expenses. In an effort to forestall this risk, Canadian National has implemented a fuel surcharge program, wherein it added incremental charges (currently 18% of the net charges) to freight rates to reimburse fuel cost. However, rising fuel prices have forced the company to raise its crude oil cost estimate to the range of $90-$100 per barrel for fiscal 2011. Additionally, increased depreciation charges and taxation are also expected to hurt impact earnings in the near term.
Going forward, Canadian National faces significant competition from rail carriers and other modes of transportation. Specifically, the company faces competition from Canadian Pacific Railway (CP), which operates other major rail systems in Canada and service areas similar to Canadian National. It also faces intense competition from trucking companies in Eastern Canada.
We maintain our long-term Neutral recommendation on Canadian National. However, the stock holds a short-term (1-3 months) #4 (Sell) Rank.
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