(The following story by Tian Huang appeared at news.medill.northwestern.edu on December 2, 2008)
CHICAGO, Il – The economy may be weakening, but that hasn’t stopped Canadian National Railway Co., known for pioneering the “precision” or “scheduled” railroad that emphasizes traffic volume over car capacity, from acquiring new railways as it pursues higher efficiency. Right now its most-wanted acquisition is the Elgin, Joliet and Eastern Railway encircling Chicago from Waukegan to Gary, and it hopes for government approval by Jan. 31.
Obtaining the EJ&E would give the Montreal-based company significant efficiency advantages over the six Class 1 freight companies (out of seven in the U.S.) that operate through the heart of Chicago.
Analysts like the stock, predicting better earnings for the company next year.
Canadian National is one of this country’s seven biggest freight haulers, connecting to the Gulf of Mexico via its Illinois Central route. It has major operations in Chicago, and has had industry-leading free cash flow of 17 percent of revenue for the past five years. The company, according to Keith Schoonmaker, an analyst with Chicago-based Morningstar Inc., is “far and away the most profitable large North American railroad.”
“I have a very favorable opinion of Canadian National,” Schoonmaker said. “It is enjoying a wave of pricing power right now.”
With its fluid operations, Canadian National’s earnings jumped to C$552 million, or C$1.16 per diluted share, in the quarter ended Sept. 30, compared with C$485 million, or 96 Canadian cents per diluted share, for the year-earlier period. The company beat the analysts’ consensus estimate of C$1.02 compiled by Bloomberg LP.
Canadian National has seen a steady advancement in its quarterly revenues, rising 88 percent to C$552 million in the third quarter ended Sept. 30 from C$294 million in the five-years-earlier period. But the company’s growth in net income hasn’t been as smooth. It’s still recovering from a steep fall in the first quarter of 2008. (See accompanying graphs.)
“Canadian National says that there’s been times when it takes the same time to operate from Winnipeg, Canada to Chicago as it does to go from the north to the south end of Chicago,” said Schoonmaker. “Canadian National is certainly looking at [EJ&E] as an opportunity to speed up velocity.”
Canadian National and U.S. Steel Corp., which owns the EJ&E, announced a $300 million agreement on the 198-mile track on Sept. 26, 2007.
The contract needs the approval of the Surface Transportation Board, the division of the U.S. Department of Transportation that rules on railroad mergers and acquisitions. Canadian National contends that the acquisition is not anti-competitive, a factor the STB will consider. But the railroad admits its presence in the suburbs will bring in the train whistles and air pollution from increased railway traffic that have long plagued inner-city residents who live near Chicago’s railroad tracks.
Affected communities and Canadian National are negotiating over who should pay for the over- and underpasses the trains would need to travel through the region without causing undue traffic congestion at grade crossings. The STB says it must evaluate the full impact of the acquisition, so the company may have to wait until Jan. 31 for a decision though U.S. Steel said it wanted to finalize the agreement by the end of this year.
“The only issue has become the, quote, mitigation of the environmental issues,” said E. Hunter Harrison, president and CEO of Canadian National, in an earnings conference call Oct. 21. “We’re perfectly willing, and we have said to the court and to the STB that we would…not change any operation until they feel like and are comfortable that the environmental issues have been dealt with.”
As Canadian National awaits the decision, it is actively pursuing voluntary mitigation agreements with cities to establish quiet zones and implement noise mitigation measures. Joliet, Ill., and Crest Hill, Ill., so far are the only two municipalities that have reached such an agreement with Canadian National.
The company also has developed a $60 million comprehensive voluntary mitigation plan and will spend another $100 million on infrastructure improvements on the EJ&E. These include reducing crossing blockages, a commitment from Canadian National that a public crossing will not be blocked longer than 10 minutes unless it cannot be avoided, accelerated implementation of the Environmental Protection Agency’s locomotive emissions reduction efforts, adoption of efficient fuel saving practices, and implementation of dust suppression controls.
“It’s inevitable for Canadian National to provide some sort of compensation to placate the communities,” Schoonmaker said. “Can they complete the deal without providing some sort of relief? Sure, but it’s not good business to do it without the cities’ approval.”
Besides seeking the EJ&E, Canadian National recently reacquired three principal railway subsidiaries in eastern Canada and a rail-ferry operation in Quebec from the Quebec Railway Corp. for C$49.8 million on Nov. 3. Canadian National sold the rail lines to QRC in the late 1990s.
“With Canadian National’s industry-leading operating model and track record of seamlessly integrating acquisitions, we expect to realize meaningful operating efficiencies from the addition of these properties to our network,” Harrison stated in a press release.
Thomas Wadewitz, an analyst with New York-based JPMorgan Chase & Co., wrote in a note that the QRC acquisition “makes sense in terms of gaining full control of some short line traffic coming onto [Canadian National], but we do not expect meaningful impact to earnings.”
The acquisition didn’t change Wadewitz’s earnings per share estimate of C$3.65 for 2009. The analysts’ consensus estimate for the fourth quarter is C$1.04 and of the 23 analysts who cover Canadian National, 13 rate the stock a buy while nine, including Wadewitz, recommend holding, according to Bloomberg.
Wadewitz said that though he expects “solid” earnings per share growth for Canadian National in the future, he believes Canadian National will be “more sensitive to growth within the North American economy compared to the U.S. railroads, which have much greater exposure to the coal segment and which have a somewhat stronger pricing story.” Canadian National’s freight mix is rich in forest products, which makes it exposed to the current financial crisis as the housing market continues to decline.
However, though Canadian National did not give its earnings estimates for the future, company officials said they are confident it will perform well.
“Looking forward, the uncertain economic landscape in North America and around the world will pose challenges to [Canadian National] and its customers,” stated Harrison in a press release Oct. 21. “But we believe [the company] is well positioned to weather the headwinds … We will continue to pursue these opportunities aggressively while maintaining a clear focus on cost control and productivity improvements to keep CN at the forefront of rail industry efficiency.”
Schoonmaker also believes the company has “great long-term potential.”
“Canadian National has long been the best and most profitable of its competitors,” Schoonmaker said. “The railroads get their competitive advantage from their geography and those networks don’t really overlap, so Canadian National should stay profitable.”
CN stock closed at $32.86 Tuesday, up 74 cents. Its 52-week high was $58.50 on May 19; the low was $30.40 on Nov. 21. Nevertheless, the stock is relatively cheap, with a price-earnings ratio of 11.98 compared to19.39 for the S&P 500 stocks