DBRS Confirms Canadian National Railway Company at “A” and R-1 (low), Stable Trends

DBRS Limited (DBRS) confirmed the Issuer Rating and Unsecured Bonds, Debentures & Notes rating of Canadian National Railway Company (CN or the Company) at “A” and confirmed its Commercial Paper rating at R-1 (low). The trend on all ratings remains Stable. The rating confirmations reflect CN’s continued strong market position, focus on operating efficiency and robust earnings and operating cash flows despite the recent capacity constraints and their impacts. In 2017, both the strong economy and demand surge in some commodities led to robust volume growth across most of the Company’s segments, supporting an earnings increase but affecting network fluidity and inflating costs. The Stable trends reflect DBRS’s expectation that the Company will address its capacity constraints in a timely manner while remaining focused on productivity and maintaining a financial profile consistent with its ratings.

In 2017, operating conditions for the freight railway industry resulted in unexpected volume growth across most of CN’s segments and the commodities it transports, which affected its overall network fluidity, train speed and terminal dwell times. In addition, the combined effects of both a surge in volume for commodities such as frac sand and, most recently, harsh winter conditions caused the Company to not be able to fully accommodate the increased demand from customers in a timely and efficient manner. As a result, CN’s operating ratio modestly deteriorated to 57.4% in 2017 from 55.9% in 2016, and the Q4 2017 operating ratio reached 60.4%, an elevated level compared with historical levels and those of Canadian Pacific Railway Limited, CN’s most direct competitor, at 56.1%. While both the Company’s revenue and EBITDA were up overall in 2017, by 8% and 5%, respectively, and carloads and revenue ton miles (RTMs) increased 10% and 11%, respectively, the capacity constraints and their impact were more acute in the second half of the year and are expected to continue to be felt into H1 2018. CN’s 2018 $3.2 billion capital expenditure plan is expected to address these capacity issues with substantially increased investments in track infrastructure expansion, in yards, in intermodal terminals and in locomotive acquisitions while a significant number of people are being hired and trained to be train conductors. However, the results of these investments are not expected to ramp up and start being visible until the second half of 2018. In 2018, the Company expects freight volume (in RTMs) to grow by approximately 3% to 5% with most of this growth coming during the back end of the year and being driven by higher intermodal volume partly related to port expansions at Vancouver and Prince Rupert; increased demand for commodities such as frac sand, crude oil and coal; strong demand for grain; and an overall healthy North American economy. DBRS believes that, despite the current constraints CN is experiencing across its network, which are putting pressure on costs and decreasing fluidity, the Company is well-positioned to turn these challenges around, owing to a significant capital program increase that will allow it to better accommodate growth, restore fluidity and improve its operating ratio going forward.

The Company’s continued strong cash flow and earnings in 2017 have allowed it to slightly improve its financial metrics, which are consistent with the “A” rating range for the railway industry. Debt levels in 2017 slightly decreased as a result of a favourable foreign exchange fluctuation and despite partly debt-funded share repurchases of close to $2 billion, which was consistent with DBRS’s expectations. In 2018, financial leverage expressed as adjusted cash flow-to-debt and adjusted debt-to-EBITDA is expected to slightly deteriorate to around 45% from 46.9% in 2017 and about 1.75 times (x) from 1.67x in 2017, respectively. While the expected erosion in metrics is not considered significant enough to put pressure on the rating in the near term, a continued deterioration caused by a combination of weaker earnings and higher use of debt to fund shareholder distributions, such that cash flow-to-debt declines below 35% and debt-to-EBITDA increases above 2.0x, could lead to a negative rating action.

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

The principal methodologies are Rating Companies in the Railway Industry, DBRS Criteria: Commercial Paper Liquidity Support for Non-Bank Issuers and DBRS Criteria: Guarantees and Other Forms of Support, which can be found on dbrs.com under Methodologies.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at info@dbrs.com.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

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