Canadian National Railway Company

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

Canadian National Railway Company (CNI) is a major transportation company that operates a vast railway network spanning across Canada and into the U.S, primarily engaged in the transport of goods.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

CNI, as a business, relies on a complex interplay of factors that impact its economic standing, and because of this it is not the most easily understood business, but also not too difficult either.

Business Explanation

Canadian National Railway Company (CNI) operates a vast rail network spanning across Canada and the United States. Its primary business involves the transportation of goods, which include a diverse range of commodities and finished products.

  • Revenue Distribution: The company’s revenue is derived from three main commodity groups:

  • Merchandise: This segment includes finished goods transported in intermodal containers as well as bulk products like lumber and steel.
  • Grain and Fertilizers: CNI moves a large amount of grain and fertilizers, critical inputs for the agricultural sector.

  • Other Commodities: The remaining part of their business includes transporting commodities like coal, potash and other ores.

  • Industry Trends: Several trends currently shape the railroad industry:

    • Economic Growth: Economic growth and overall industrial output are direct drivers of revenue for CNI. Strong economic activity tends to increase demand for shipping, while slowdowns lead to reduced volumes and a shift to lower-cost modes of transportation. The recent strength in demand is helping CNI push for higher prices and fuel revenue growth.
  • Supply Chain Disruptions: Supply chain issues have impacted various industries and have increased the demand for rail transport, as it is generally a faster mode of transport compared to sea. These disruptions can also create bottlenecks that hamper fluidity and efficiency of the company and the whole supply chain. It should be noted though that CNI has stated that they are “strategically building capacity” to respond to such issues in the supply chain.
  • Sustainability Concerns: As carbon emissions come under scrutiny, railroads are increasingly favored over trucking because rail is a more environmentally friendly mode of transportation, which is expected to drive demand.

Although it is greener than trucking, rail can still be carbon-intensive.

  • Technological Upgrades: Advancements in technology, such as AI, automation, and data analytics, can improve the efficiency of railway operations and help companies to better analyze business data.

  • Regulatory landscape: There are extensive regulations that railroads have to comply with, especially in the US. Changes in the regulatory landscape are always a constant concern.

  • Competitive Landscape: CNI operates in a competitive environment with other railroads and with other modes of transport like trucking:

    • Intermodal Transportation: Some railroads have invested heavily in intermodal transportation capabilities in recent years, a segment where they directly compete with truckers.
    • Competitive Intensity: While the industry has seen some consolidation in recent decades and has a high barrier of entry, it is still competitive. Competitors include Union Pacific, and CSX which compete in different regions in the USA.

  • What Makes CNI Different:

  • Cross-Border Network: CNI owns a highly valuable cross border railroad network with good access to some main ports and industrial areas which is a significant factor when shipping goods in North America.
  • Focus on Technology: CNI is one of the leaders in using technology and data-driven decision-making in the industry, which has helped improve efficiency and profitability. Their current management structure also places a high emphasis on technological innovation.
  • Strong Operational Metrics: CNI has a track record of consistent operational performance. They are focused on long term growth and they are looking to deploy technology in ways that will help them in areas such as route optimization, and fuel efficiency.

Financial Analysis

Here is an analysis of CNI’s financials with a focus on more recent results:

  • Revenues: CNI’s revenues have seen an increasing trend. They have had a 9% year over year increase in Q2 of 2023. The increase comes from a combination of factors including an increase in prices and volume growth.
  • Operating margins: There has been a slight decrease in their Q2 operating ratio, 58.7% to 60.5% YoY (the lower the better). The decrease can be attributed to higher fuel prices.
  • Return on Invested Capital (ROIC): CNI has had a relatively stable ROIC. 2022 was the first year in five years that CNI managed an ROIC that is over 10%. They have managed to keep their ROIC above 10% in 2023, which shows a slight upward trend. However, it must be kept in mind that some of their new operating contracts are with higher operating costs (e.g. higher fuel prices) which will increase costs if not effectively managed. This is a major trend that could significantly impact returns.
  • Capital Expenditure: CNI has also invested heavily into capital expenditures and they plan to continue to do so going forward. They cite this as key driver for profitability and increasing value for shareholders.
  • Debt: CNI’s debt levels have gone up in recent years but remain at manageable levels. Their main focus is to try to return their debt levels to more manageable levels and they plan to use the large profits in coming periods to do so. However, they will still make use of some debt in the future where applicable. They seem to have an issue with debt, which will be addressed below.

While financial results have shown an improving performance, it’s important to remember that there is potential for future volatility because of external factors such as the broader economy, fuel prices, supply chain disruptions and rising interest rates.

Moat Analysis

Based on our research, here is a moat analysis for CNI:

  • Moat Rating: 3 / 5.
    • Solid Cross Border Network: Their largest moat is their vast and difficult to recreate rail network that connect Canada and the USA. They have a first-mover advantage in a lot of regions in the northern US that are very difficult for competitors to compete with.
    • Regulatory Hurdles: The railway industry is subject to regulatory oversight and requires large sums of investment, which acts as a barrier to entry.
    • Cost Advantage: Their investments in efficiency are expected to keep them at the front of cost leadership compared to competitors, and give them more wiggle room to navigate the uncertainties of the market.
  • Risks:
    • Pricing Wars: Given the nature of their business, price competition can impact profits negatively. The new low cost routes taken by some airlines could also negatively impact CNI, as they compete on price. This would result in lowered revenue as well as higher transit times due to slower speeds for the company. * Industry Consolidation: Any further significant consolidation in the airline, or automotive industries could increase pricing pressure. They could gain more negotiating power which could lead to lower revenues.
    • Environmental Regulations: A stricter regulatory environment could increase operating costs which would lead to lower profits. If governments implement carbon taxes, CNI may be disproportionately impacted because of high transport times of their network.

Understandability

  • Understandability: 3 / 5. CNI’s business model is relatively straightforward as it involves the transportation of commodities. However, a deep understanding of their financial performance, business economics, industry dynamics, regulatory requirements and risk factors requires a moderate understanding of economics and finance. For these reasons I am giving it an average rating when it comes to understandability.

Balance Sheet Health

  • Balance Sheet Health: 4 / 5. The company has a strong balance sheet, and cash flows, but debt needs to be monitored and kept under control.
    • Debt: In the 2023 Q2 earnings call it was noted that the debt levels have increased, they plan on aggressively paying down their debt in the upcoming years. The debt load seems manageable for now, but I do want to keep an eye on their debt and leverage over the coming quarters.

Recent Concerns, Controversies, and Problems

  • Cost Increase and Labor: In their Q2 of 2023 presentation they note that their operating costs have risen due to higher fuel prices. The company also is in negotiations with several labor groups which can have a significant impact on future profits. It is something to keep a close eye on as it progresses further.
  • Inflation: Like many companies, they are seeing inflationary pressures which may negatively impact cost of operation, these effects however, have been minor compared to the effect of fuel prices. They are also seeing pressure on raw materials, which is a concern.
  • Acquisitions: CNI has had many past acquisitions, which seem to cause significant changes in some of their financials. It is hard to understand their previous operating performance because the company has been incorporating many acquisitions into their historical results. Furthermore, one thing to note, is that they have been using pro forma calculations for their historical revenue, which is a management tool to try to make their results look better, when in reality may be far from perfect. The current guidance that the company gives is not for GAAP metrics, but for their adjusted results, which makes transparency questionable.

While the company has a solid business, it has potential risks like macro economic headwinds, high leverage, high capital intensity, and other specific risks that must be considered. These risks make the business volatile and unpredictable, and their effect can sometimes be outsized.