DBRS Confirms CN Ratings at A (low) and R-1 (low), Stable Trend

DBRS has today confirmed the Issuer Rating of Canadian National Railway Company (CN or the Company) at A (low), along with the ratings of its Unsecured Bonds, Debentures & Notes and Commercial Paper at A (low) and R-1 (low), respectively. The trends are Stable. The Company continues to benefit from its position as a leading Class I carrier in the North American railway industry. The business profile remains above average, complemented by the Company’s unique rail network, industry-leading profitability and relatively diversified revenue mix. The financial profile and credit metrics remains commensurate with the currently assigned rating, despite steadily increasing debt balances and shareholder-friendly activities, due to strong earnings and cash flow generation.

Throughout 2013, CN’s total revenue expanded 6.6% relative to 2012, due to price and volume improvements, in line with the overall positive economic environment. Broad North American indicators continued to improve, including industrial production, manufacturing and non-manufacturing activity, U.S. housing starts, consumer confidence and unemployment figures. Operating profit was up 5.1%, although below the rate of revenue growth due to a slight deterioration in the operating ratio, as a result of higher labour, pension and purchased material costs. The Company’s performance largely met expectations, although the rate of growth was below the rate seen in prior periods.

Revenue and earnings performance helped to continue generating strong cash flow from operations at $3.8 billion in 2013, compared with $3.7 billion in 2012, despite higher cash taxes of $890 million in 2013, compared to $289 million in 2012. Cash usages including dividends, share repurchase and capital expenditures were higher relative to last year, although this was partially offset by the absence of the large voluntary contribution to pension, which used up cash in 2012. Strong operational performance and improved earnings continued to offset higher debt levels. On the whole, CN’s credit ratios remained stable or slightly worse compared to year-end 2012, although still well in line with the A (low) range.

CN maintained a strong liquidity position at the end of 2013, with approximately CAD 1 billion in available liquidity sources. As at December 31, 2013, CN, short-term debt which came due within a year totalled approximately $1 billion, although approximately $250 million represented its commercial paper program, which CN is expected to renew on an ongoing basis. The Company has good liquidity to meet other short-term needs, also noting that CN’s USD 325 million notes, which matured January 15, 2014, were effectively already pre-funded in November 2013 with the issuance of a USD 600 million note. DBRS notes that CN has begun using commercial paper and securitization financing facilities, effectively shifting towards a higher proportion of floating-rate debt in its capital structure.

CN’s business profile continues to be consistent with the currently assigned ratings. The Company has a distinctive rail network, reaching all three North American coasts, and originates approximately 85% of its traffic. The revenue stream remains well-diversified with the majority of the exposure split among several product groups, including intermodal, petroleum and chemicals, grain and fertilizers and forest products, as well as metals and minerals. CN additionally maintains an industry-leading cost position, with its operating ratio positioned in the low-60% range over recent history. The business profile remained stable during the last year and is not expected to change materially in 2014.

DBRS notes that CN has been shipping increased quantities of petroleum and chemicals, driven by growing energy-related shipments. Unlike most southern competitors, CN primarily hauls southbound heavy crude shipments from northern Alberta to the gulf coast refineries, which can process heavier crude. CN’s presence and expansion in the Manitoba and Saskatchewan portion of the Bakken formation is an additional positive contributor to light crude shipments, although this remains a relatively smaller component. DBRS expects the increase in crude shipments to be material in the next few years, although growth is likely to be more moderate after the pipelines are built. Some further safety regulations on this front are likely to be implemented for the industry in the short-medium term. While the crude-by-rail business represents only approximately 2% of CN’s total shipments, increased regulatory costs could reduce incremental profitability.

In 2014, DBRS expects that CN will likely expand revenue in the single-digit range, due to both higher pricing and increased volume, with some segment-specific factors to support revenue momentum. Similar segment trends are likely to carry over from 2013, including increased petroleum and chemical shipments, as well as higher shipments of forestry products. CN will also likely gain market share in the intermodal segment. The outlook for shipments of coal and fertilizer continues to be uncertain, while grain shipments should increase, due to the strong Canadian grain harvest, although the Company could face some pricing pressures related to revenue cap constraints. The operating ratio will likely stay between 63% and 64%, assuming no disruptive events, as any operating efficiency could be offset by the ongoing heavy winter conditions. Financial metrics will likely remain firm, as stronger earnings and cash flows are expected to offset increasing shareholder-friendly activities and higher debt levels.

DBRS expects the Company’s rating to remain stable in 2014, backed by commensurate business and financial profiles. DBRS expects the Company to be committed to maintaining conservative financial policies; accordingly, the Company will be judicious in its share buyback activity, in order to keep credit metrics at levels commensurate with the rating in the near to medium term.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Companies in the Railway Industry, which can be found on our website under Methodologies.