Canadian National Railway (CNI 0.27%) released its fourth-quarter and fiscal 2017 numbers on Jan. 23 after market close, and the market doesn't seem too happy with the results. That's despite the railroad giant reporting a whopping 156% year-over-year jump in its fourth-quarter net income. The market has become smarter to not take every number at face value. After all, rival Canadian Pacific Railway (CP -0.62%) also saw a strikingly similar growth in its net profit in the last quarter.

Digging deeper into Canadian National's earnings report gives a feeling that it was a slow quarter, but management's outlook for 2018 and growth plans continue to remind investors that CN, as the company is popularly known, remains a long-term growth story.

CN results: The raw numbers

Below is a snapshot of the key numbers from CN's fourth-quarter earnings report. Note that all numbers in the tables below are in CN's reporting currency, Canadian dollars:

Metric Q4 2017 Q4 2016 Year-Over-Year Change
Revenue $3.29 billion $3.22 billion 2%
Net income $2.61 billion $1.02 billion 156%
Earnings per share (diluted) $3.48 $1.32 164%
Earnings per share (adjusted) $1.2 $1.23 (2%)
Free cash flow (FCF) $457 million $777 million (41%)
Operating ratio 60.4% 56.6% (3.8%)

Data source: Canadian National Railway. Exchange rate as of Jan. 24, 2017: CA$1=$0.81.

Let's drill into those numbers to see what they mean.

A close-up view of railroad tracks.

Image source: Getty Images.

What happened with CN this quarter

The number that stands out in the above table is the sharp jumps in CN's net income and earnings per share (EPS). It was an exceptional quarter as the company benefited from a deferred income tax recovery of CA$1.76 billion, thanks to a lower U.S. corporate tax rate. Canadian Pacific's earnings last quarter also surged for the same reason.

Adjusting for the one-time gain, CN's net profit declined 6% and adjusted EPS dropped 2% year over year. Higher operating expenses, partly because of higher fuel and harsh weather-induced costs, were to blame. That explains why CN's operating ratio -- which measures its operating expenses versus revenue and denotes efficiency -- rose to 60.4% during the quarter. A higher ratio is negative, as the table above reflects. 

From a sales perspective, CN is on a strong footing:

  • CN's carloadings, or the total amount of freight carried, rose 11% year over year.
  • Metals and minerals and intermodal were the strongest markets, delivering double-digit growth in sales on a constant currency basis.
  • While coal, automotive, and forest products saw sales rise single-digit percentages, grain and fertilizers and petroleum and chemicals proved to be the weakest links.
  • CN generated strong operating cash flow during the quarter, and its FCF slipped 41% year over year because of higher capital spending.
  • CN increased its dividend by 10%.

For fiscal 2017, CN's revenue improved 8%, adjusted net income rose 6%, and FCF grew 10%. Its operating ratio stood at 57.4% for the full year, slightly higher than Canadian Pacific's ratio of 56.1%.

What management had to say

President and CEO Luc Jobin lauded CN's performance amid "rapidly changing market demands" and "challenging operating conditions," including harsh weather in the fourth quarter. Jobin remains bullish about 2018: "As the economic backdrop remains favorable in North America, we expect to see continued volume growth in 2018," he said. 

CN is, in fact, witnessing strong demand from end markets, so much so that it's expanding its business to meet rising demand, which is adding to its operating expenses. To give you an example, CN's employee count during the third quarter climbed 7.6% to 23,945. Investors may recall that management had bumped up its capital expenditure target for FY 2017 to CA$2.7 billion during the third quarter.

2018 is expected to be an even bigger year for the company, as Jobin explained:

We remain focused on operational efficiency and providing quality service to our customers. In 2018 we are adding new train crews and increasing our capital program to a record [CA]$3.2 billion as we invest in locomotives and build additional capacity for resiliency.

While the bulk of its capital spending will go toward maintenance of its railway infrastructure, CN plans to spend roughly CA$1.2 billion on new equipment and the expansion of its capacity and track infrastructure.

Looking forward

Investors in CN should keep an eye on the company's operating ratio, though there's nothing to worry as long as the company is incurring costs to expand its business. Management aims to earn an adjusted EPS of CA$5.25-CA$5.40 in fiscal 2018, which represents a growth of 6.7% at the midpoint. That's nothing to sneeze that, as it indicates Canadian National is headed for another strong year.