Few railroads are as efficient as CN, even with weakening demand. Image source: Getty Images.
Canadian National Railway (USA) (CNI 0.08%) reported third-quarter financial and operating results on October 25. Even though revenue declined 6% on fewer carloads hauled in key categories, the railroad managed to deliver flat net income and improved cash flows by continuing to leverage its world-class assets and keep costs low.
Here's a closer look at how CN, as the railroad is commonly known, continues to deliver solid results, even in a generally weak demand environment. (Please note: All dollars in this article are Canadian.)
The numbers
| Metric | Q3 2016 | Q2 2016 | Change (YoY) |
|---|---|---|---|
| Revenue | $3,014 | $3,222 | -6.5% |
| Net income | $972 | $1,007 | -3.5% |
| Earnings per share | $1.25 | $1.26 | -0.8% |
| Operating ratio | 53.3% | 53.8% | +50 BPS |
Revenue and net income in millions Canadian. Source: CN.
A look at where CN's business came from last quarter
Weakness in several key categories drove revenue and carloads lower:
- 4% decline in intermodal revenue, to $736 million. Management said global economic weakness was a key driver in this segment.
- 13% decline in petroleum/chemicals revenue, to $532 million. Low oil prices have weighed on this segment, but have largely stabilized at current levels.
- 20% decline in metals/minerals revenue, to $303 million. Similar to oil, this segment has stabilized in recent quarters at current levels.
- 32% decline in coal revenue, to $110 million. A secular decline in thermal coal is likely to keep this a very small part of CN's business going forward.
The declines above more than offset the gains in the following:
- 4% growth in grain/fertilizer revenue, to $497 million. This was expected to be higher, but a delayed Canadian grain harvest shifted demand. CN expects strong demand from a near-record crop will carry into late 2017.
- 2% growth in forest products revenue, to $449 million. Carloads declined 2%, but revenue ton miles increased 3%.
- 3% growth in automotive revenue, to $186 million. CN's ability to connect West Coast terminals to demand markets is helping it leverage growth in this segment, even with "flattish" demand in North America.
Here's how CN kept its costs down and profits steady
CN does a better job than nearly every other North American railroad at flexing its operating costs up and down to match changes in demand. Here's how it performed in key operating expense categories:
- Labor and benefits fell 16%, to $495 million.
- Purchased services and material fell 5%, to $379 million.
- Fuel expense fell 11%, to $261 million.
At the same time, CN continues to operate one of the safest railroads. Its casualty expense fell 7% in the quarter and is down 22% so far in 2016, while its accident rate per million trail miles is well below 2015 levels, and injury frequency rate per 200,000 man hours is essentially flat with last year.
But it's not just about keeping hard costs low. CN has consistently improved key operating metrics related to how efficiently it actually moves goods through its network:
Image source: CN.
As you can see, CN moved the goods it did ship more efficiently and more quickly than in the same period last year. And this was with around 2,000 fewer active employees than the year-ago period.
Looking ahead
Railroads have significant exposure to the broader economy. Because of this, the best investments in this sector are typically the ones that can keep their costs low and operate the most efficiently when business is soft. CN, with one of the best management teams in the industry, has consistently demonstrated it's one of the best at doing just that. At the same time, CN has continued to invest opportunistically to expand its services, a key step that will reduce the downside of weakness in one industry (such as energy, currently) by taking advantage of growth in others (such as grain in coming quarters).
While it's not clear what the greater macroeconomic outlook will be for the foreseeable future, CN continues to deliver by focusing on what it can control: Keeping costs low, while not cutting corners on safety, and investing in areas where long-term demand is likely to grow, thus diversifying industries and markets it can serve. The third quarter was evidence that this strategy continues to pay off.
