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

DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating and Unsecured Bonds, Debentures & Notes rating of Canadian National Railway Company (CN or the Company) at “A” and its Commercial Paper rating at R-1 (low). All trends remain Stable. The rating confirmations reflect CN’s resilient financial performance and continued improvement in operating efficiencies despite the Coronavirus Disease (COVID-19)-related disruptions that started to affect the Company beginning at the end of Q1 2020. Carloads and revenue-ton-miles (RTMs) declined 5.4% and 4.8%, respectively, during 2020, which, along with a 2% decline in revenue per RTM, led to 7.4% lower revenues. CN responded by accelerating its focus on cost reduction and efficiencies and operated using reduced resources throughout the year. Train lengths and weights sustained enhancements, thus leading to more efficient use of crews, locomotives, fuel, and other resources. In addition, CN also benefitted from low fuel prices for part of 2020. Thus, CN’s adjusted operating ratio only increased slightly in 2020.

CN’s activity and volumes bottomed out during Q2 2020 but this was followed by an uneven consumer-based economic recovery in Q3 2020 and a particularly strong recovery during Q4 2020, which surpassed Q4 2019 in carloads and RTMs by 7% and 10%, respectively. The Company carried forward the strong momentum into 2021 with most segments, particularly Grain and Intermodal, gaining volume during the first nine weeks of 2021. Year-to-date 2021 carloads and RTMs grew 7.9% and 9.0%, respectively. Headwinds are expected to continue to be felt in some pockets of the business—such as crude-by-rail; refined petroleum products such as gas, diesel, and jet fuel; and commodities tied to the energy market —where recovery is expected to be uneven. The Stable trends reflect DBRS Morningstar’s expectation that the Company will continue to recover in line with the anticipated rebound in the broader economy while benefitting from some of the cost-cutting and efficiency measures implemented throughout 2020 in a resilient and sustainable manner and while maintaining a financial profile consistent with the ratings, such as adjusted debt-to-EBITDA below 2.00 times (x) and adjusted cash flow-to-debt above 40%.

CN’s operating efficiency continued to be strong in 2020. Despite a year-over-year revenue decline of 7.4%, the Company sustained its adjusted operating ratio at 61.9%, which represented only a small increase compared with 61.7% in 2019 and 61.5% in 2018. Firstly, in 2020 CN achieved a 4% improvement in fuel efficiency, a measurement of how much locomotive fuel is consumed to move 1,000 gross ton miles. Secondly, the Company improved both its overall train length and weights by 4% when compared with 2019. Thirdly, CN operated with almost 11% lower average workforce in 2020 versus 2019. Finally, the Company benefitted from lower fuel prices in 2020. CN has invested substantially and has completed a significant number of projects and initiatives on its network in the last few years in response to strong demand over that period, but in 2020 capital expenditures moderated to levels more in line with historical levels. During 2021, the Company will continue to engage in several ongoing innovative technology projects, such as automated track and train inspection capabilities, which will improve safety, increase network capacity, and contribute to more fluid operations over time. Further, CN will take delivery of 491 new high-efficiency grain hopper cars, part of a larger order of 1,500 new grain hopper cars announced in 2020, the balance of which was put into service in 2020. In 2021, DBRS Morningstar expects CN to grow its revenue, earnings, and volumes at mid-single-digit rates as the remaining sectors of the economy recover.

DBRS Morningstar also expects CN to continue conducting its financial policy such that its financial metrics will support and be consistent with the “A” rating range for the railway industry. In 2020, the Company paused its share repurchases in response to the pandemic, repurchasing only $379 million of its outstanding shares compared with its $1.7 billion share repurchases in 2019. For 2021, CN has announced a $1.5 billion share repurchase program because of higher expected free cash flow that will allow most share repurchases to be internally funded. Financial leverage expressed as adjusted cash flow-to-debt and adjusted debt-to-EBITDA is expected to stay above 40% and trend towards 1.9x, respectively.

DBRS Morningstar expects the Company’s financial metrics to remain commensurate with the rating and does not see any near-term factors that could lead to a positive rating action. However, an erosion in leverage caused by weaker earnings and/or higher debt to fund shareholder distributions, such that cash flow-to-debt declines below 35% and debt-to-EBITDA increases above 2.0x on a sustained basis, could lead to a negative rating action.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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

The principal methodologies are Rating Companies in the Railway Industry (January 26, 2021; https://www.dbrsmorningstar.com/research/372750), DBRS Morningstar Criteria Commercial Paper Liquidity Support for Nonbank Issuers (March 10, 2020; https://www.dbrsmorningstar.com/research/357788), DBRS Morningstar Criteria: Guarantees and Other Forms of Support (January 14, 2021; https://www.dbrsmorningstar.com/research/372344), and DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 2, 2020; https://www.dbrsmorningstar.com/research/369167), which can be found on dbrsmorningstar.com under Methodologies & Criteria. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262).

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883-.

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 [email protected].

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

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at [email protected].

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