(The following article by Eric Vanden Bussche was posted on the Globe and Mail website on August 3.)
TORONTO — Canadian National Railway Co. has continued to roll in with strong year-over-year results, propelled by recent acquisitions, a rise in Asian imports and efficient management.
The Montreal-based company, which boasts the highest profit margin among North American railways, recently raised its annual profit forecast after second-quarter profit climbed 28 per cent on gains in rates and shipments.
Analysts attribute CN’s strong results to its ability in integrating their recent acquisitions of two ore-hauling railways, BC Rail Ltd. and Great Lakes Transportation.
Contrary to other railway companies, CN’s acquisitions have added length to their system instead of duplicating the same string of track. This has spared the company from the troublesome issues associated with the integration of corporate cultures.
“If you look at the mergers that occurred between Southern Pacific and Union Pacific or Santa Fe and Burlington in the U.S., for instance, there was a lot of duplications of track infrastructure in systems,” said Randy Cousins, an analyst at BMO Nesbitt Burns Inc. “When they tried to eliminate excess track and create a new graded system, they ran into all kinds of problems in terms of network operations.”
CN’s aggressive expansion across the border over the past few years has included the purchase of companies such as Wisconsin Central Ltd. and Illinois Central Railroad. Through these mergers, CN carved a “NAFTA route,” enabling it to move freight as far south as the Gulf of Mexico.
Analysts associate part of CN’s success to the company’s efficiency in running its railways and cutting costs. For instance, CN is spending to improve its tracks so that it can run longer trains, thus reducing the costs per car.
Despite the company’s intensive cost control, CN’s operating expenses rose 3 per cent in the past quarter, propelled by a 46-per-cent year-over-year increase in fuel costs. CN’s labour expenses, however, fell $30-million or 6.2 per cent.
“This company has gone from being a government-owned entity with the highest operating ratio in the industry to a railroad with now the lowest operating ratio in the industry,” Mr. Barnes said.
CN has also reaped benefits from the shift in pricing power in favour of the railways. For many years rail rates fell almost on a continuous basis, and the only way the railways stayed ahead of the game was to drive productivity growth. But with the growth in demand triggered by the increase of global trade, railways are recognizing the value of their service product in their pricing. This loops into CN’s ability to offset higher fuel costs by charging rising fuel surcharge recoveries.
The climbing trade figures with Asia continue to boost revenue for CN. The company expects a surge in business at Halifax when China Shipping (North America) Holding Co. Ltd. begins a new cargo service between Asia and North America later this year.
Analysts at Virginia-based BB&T Capital Markets raised their 12-month price target for the company to $94.34 after the company reported that second-quarter profit beat Wall Street’s estimates. BB&T predicted a share profit estimate of $1.33 for the third quarter. Since reaching a 52-week low of $58.10 last August, CN’s shares rose steadily, closing at a 52-week high of $82.89 in late July. The shares closed at $81.37 yesterday on the Toronto Stock Exchange.
“CN’s core merchandise businesses, including forest products, metals and minerals, and petroleum and chemicals continued to register solid gains,” chief executive officer Hunter Harrison recently said in the statement.
In the past quarter, shipments increased 5.2 per cent and cargo that moves by a rail-truck combination rose 9 per cent to $313-million. Forest products shipments climbed 22 per cent, petroleum and chemicals sales 5 per cent and metal shipment, including ore, 16 per cent.
Meanwhile, grain fell 5 per cent as farmers held back for higher prices and auto revenue dropped 3 per cent.
Adding to the favourable business climate, analysts foresee an opportunity for railways to take business from the trucking industry. They note that railways are more efficient relative to trucks because of fuel and labour costs, particularly in long haul (more than 1,600 kilometres). Some trains, for instance, can carry the same quantity of products as 220 trucks.
Looking into the third quarter, analysts at Bear Stearns & Co. Inc. forecast that a stronger U.S. dollar will boost CN’s profit. Last quarter, the depreciation of the U.S. currency cut the company’s profit by about $15-million.
The company’s forest products franchising, which corresponds to about 24 per cent of its revenue, could experience a decline if higher interest rates cool off the booming housing market, analysts warn.
While a majority of analysts still rate the company’s share as “buy,” having raised their 12-month price target after the company forecast a higher full-year share profit on July 20, some analysts warn business could slow down in the long run.
“It’s more about pricing power and who can drop that to the bottom line,” said National Bank Financial Inc. analyst David Newman. “CN has been the most efficient in the industry, but there are some emerging players such as Norfolk Southern.”
Gathering steam
Canadian National Railway Co. has posted strong second-quarter results on gains in rates and shipments. The company has raised its annual profit forecast and a majority of analysts rate CN a ‘buy.’