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

DBRS Limited (DBRS Morningstar) confirmed Canadian National Railway Company’s (CN or the Company) Issuer Rating and Unsecured Bonds, Debentures & Notes rating at “A” and its Commercial Paper rating at R-1 (low). All trends remain Stable. The rating confirmations reflect CN's continued strong market position and focus on operating efficiencies. The year 2021 was mixed for CN; strong performance in multiple segments somewhat offset weaker Canadian grain volumes and almost five weeks of interruption due to the wildfires in July and the track washout in November (both in British Columbia). Thus, CN ended 2021 with volumes only 1% higher year over year (YOY), measured in revenue-ton-miles, compared with higher guidance. CN also faced headwinds from higher fuel prices, which it was able to pass along to its customers by way of fuel surcharges. This, along with CN’s ability to price above rail inflation, enabled 4.8% YOY revenue growth in 2021. The Company also continued to improve operational efficiencies by increasing train weights and fuel efficiency during the year. This, along with lower YOY expenses (notably purchased services and materials and equipment rentals), led to 4.5% EBITDA growth in 2021. CN’s adjusted operating ratio (OR) of 61.2% was a slight improvement compared with the 61.9% OR in 2020. In 2021, CN also received a USD 700 million merger termination fee that allowed it to reduce debt by $489 million. Thus, higher earnings and lower debt enabled CN to end 2021 at debt-to-EBITDA of 1.8 times (x), lower than approximately 2.0x in 2020 and also well within the target range of 2.0x.

The Company entered 2022 with continued strong demand within most segments, a robust pricing environment, and lower headcount owing to cost-reduction measures that were implemented starting September 2021. However, the first two months of 2022 were challenging because of harsh winter weather conditions leading to lower-than-expected volumes, which have since improved as the weather has normalized (save for Canadian grains, whose volumes are expected to improve in the second half of 2022). CN has guided the market to (1) low-single-digit volume growth in 2022, (2) a lower capital envelope of 17% of revenues, (3) a $5 billion share buyback program for 2022, and (4) its continued commitment to 2.0x target leverage. DBRS Morningstar expects that financial leverage in 2022 will be slightly above 2.0x, mainly due to the softness in volumes in the first two months of the year. This does not change DBRS Morningstar’s view on CN’s credit ratings so long as CN does not deviate from its current financial leverage policy.

DBRS Morningstar 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. For 2022, the Company has announced a $5 billion share repurchase program, compared with $1.6 billion of share repurchases in 2021. CN’s announcement is supported by (1) higher forecast earnings in 2022; (2) CN starting 2022 with 1.8x leverage, lower than its target of 2.0x; and (3) a reduction in CN’s capital envelope to 17% of revenues for 2022, compared with $2.9 billion for 2021. While internally generated cash flows are expected to fund some of the share repurchases, DBRS Morningstar expects that CN will issue incremental debt to fund a greater portion of the share repurchase program. However, DBRS Morningstar also expects financial leverage expressed as adjusted cash flow-to-debt and adjusted debt-to-EBITDA to be close to 40% and 2.0x, respectively. DBRS Morningstar expects the Company’s financial metrics to remain commensurate with the ratings 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 or a change in CN’s target leverage range, 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 20, 2022; https://www.dbrsmorningstar.com/research/390920), DBRS Morningstar Criteria: Commercial Paper Liquidity Support for Nonbank Issuers (March 1, 2022; https://www.dbrsmorningstar.com/research/393065), and DBRS Morningstar Criteria: Guarantees and Other Forms of Support (April 4, 2022; https://www.dbrsmorningstar.com/research/394683), 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).

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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