Despite a lower operating ratio and higher revenue and net profits in the third quarter, Canadian National Railway (NYSE: CNI) said it plans to lower its guidance for 2019 amid sluggish rail volumes and a softer North American economic outlook.
The railroad now expects its adjusted diluted earnings per share (EPS) in 2019 to grow in the high single-digit range, compared with its July outlook of low double-digit growth, “in light of the deterioration in North American rail demand [and] as the economy continues to weaken,” the company said when it released its earnings on October 22. Its adjusted diluted EPS in 2018 was C$5.50. (A Canadian dollar is worth US$0.76.)
The fourth quarter “will be a challenging quarter,” said Chief Executive Officer JJ Ruest. “And if you look just on the volume standpoint, month to-date…our volumes and we do report our volumes both in terms of carloads and [revenue per ton mile], our volumes are down 10%. So, obviously that impacts EPS.”
Third-quarter net profit was C$1.2 billion, compared with C$1.1 billion in the third quarter of 2018. Diluted EPS was C$1.66 in the third quarter, compared with diluted EPS of C$1.54 and adjusted diluted EPS of C$1.50 in the third quarter of 2018. Adjusted diluted EPS takes into account some measures that are not part of generally accepted accounting principles, or GAAP.
Operating ratio in the third quarter fell to 57.9%, compared with 59.5% in the same period in 2018. A lower operating ratio can imply a company’s increased profitability.
Canadian National, known in the industry as CN, pointed to several factors that contributed to its tempered outlook for 2019. The railroad projects North American industrial production to increase between 0.5%-1% in 2019, compared with its July assumption of approximately 1%. Meanwhile, while the 2019-2020 grain crop in Canada is expected to be line line with its three-year average, CN anticipates the U.S. grain crop to be below the three-year average for the same time period.
The railroad also expects revenue per ton mile growth to be “slightly negative” in 2019 when compared with 2018. This is a change from its expectations in July that revenue per ton mile would increase in the mid-single digits.
Third-quarter revenue rose 4% to C$3.8 billion on higher freight rates and increased intermodal revenue, while operating expenses rose 1% to C$2.2 billion on increased purchased services and material expenses.
“The first half might be more challenging than the second half on the overall business environment, the economy,” Ruest said. “But how we manage all these things with cost – we don’t want to be giving guidance today for 2020, but maybe we can give some hint. But I think one of the hints is the first half might be more challenging than the second half.”
Beyond 2020: a focus on consumer economies
Despite the near-term headwinds, Canadian National still plans to keep “increasing [its] exposure to consumer economies” as part of its strategy to build a long-term sustainable business, Ruest said.
“We’re passionate about building, innovating [a] new supply chain for the future of the rail industry,” he explained.
The exposure to consumer economies will come through growing the railroad’s intermodal and automotive segments through efforts such as increasing the number of autoport storefronts, and offering a new container train service with CSX (NASDAQ: CSX), which will connect the ports of New York/New Jersey, Philadelphia and Wilmington to the Montréal and Toronto gateways, The railway hopes the new service will compete with over-the-road trucking for both dry and refrigerated consumer goods, according to Keith Reardon, senior vice president of the consumer product supply chain.
The railway is eyeing several “structural opportunities,” such as a 30% capacity expansion for intermodal at the Port of Prince Rupert by 2022, growth potential related to the purchase of the Ridley Bulk Terminal by the private sector and developing capacity at the Port of Halifax and the new Halterm terminal, according to chief financial officer Ghislain Houle.
“We believe that partnering with select world-class operators and investors in their respective fields of expertise is a very smart approach to create a new model of future rail growth, especially with the increasing very important demand derived freight from the consumer economy,” Ruest said.
Keeping costs reined in
Despite the long-term prospects, Canadian National executives said the railroad was responding to near-term economic softness by taking cost-cutting measures such as “right sizing” the company’s rail fleet to better match existing rail volumes and demand, which in turn lowers expenditures on the fleet. Canadian National plans to return nearly 3,000 leased railcars, scrap another 2,000 railcars and park over 6,000 railcars. It also expects to return the last of its leased railcars in the fourth quarter, and it is aligning resources in its mechanical department to better match traffic volumes.
“These moves will allow us to more proactively scheduled maintenance at the right locations and continue to improve our fleet’s availability while minimizing the amount of inventory we carry at outline locations,” chief operating officer Rob Reilly said.