How do you win back customer and investor confidence in a span of a few months after having irked some of them because you were unable to meet unexpectedly high demand due to operational challenges? Ask Canadian National Railway (CNI -0.20%).
After a challenging first quarter that saw the railroad's costs shoot up and profits slump, CN got back on the track full speed in the second quarter, pumping record investments into infrastructure and equipment and driving its profits high enough to bump up its full-year outlook on July 24.
What's notable is that Q2 also was the first full quarter under the leadership of Jean-Jacques Ruest, who was just confirmed as CN's CEO after serving on an interim basis since March. As Ruest pointed out during the earnings conference call, the CN board asked him to "act with urgency" when he took over in March. That's exactly what he did, to investors' benefit.
CN results: The raw numbers
It's not surprising that CN shares shot up soon after its second-quarter earnings release on July 24. You'll understand why if you look at the table below, which gives a snapshot of the key numbers from the quarter. (Note that all numbers in the table below are in CN's reporting currency, Canadian dollars.)
| Metric | Q2 2018 | Q2 2017 | Year-Over-Year Change |
|---|---|---|---|
| Revenue | $3.63 billion | $3.33 billion | 9% |
| Net income | $1.3 billion | $1 billion | 30% |
| Diluted earnings per share (EPS) | $1.77 | $1.36 | 30% |
| Adjusted EPS | $1.51 | $1.34 | 13% |
| Free cash flow (FCF) | $974 million | $811 million | 20% |
| Operating ratio | 58.2% | 57.5% | (0.7 percentage point) |
Data source: Canadian National Railway. Exchange rate as of July 25, 2018: CA$1 = $0.76.
Solid growth in revenue, profit, and free cash flow sums up CN's second quarter. Remarkably, CN expected a challenging Q2 until some months ago. In fact, management even downgraded its adjusted guidance for the full year in Q1. Fast forward to another quarter, and CN already expects to earn higher profits this year.
What happened with CN this quarter?
To overcome capacity constraints and keep up with demand, CN diligently expanded capacity, improved efficiency, and hired hundreds of workers in Q2. That explains why the company was able to grow revenue by 9% and limit its operating ratio to 58.2% despite a 10% rise in operating expenses. Because operating ratio measures a railroad's operating expenses as a percentage of revenue, a lower ratio is better.
Image source: Getty Images.
Other key highlights from CN's quarterly report worth noting are:
- Carloadings, or the total amount of freight carried, improved 6% year over year.
- Revenue ton miles (RTMs), which measures the relative weight in tons and distance it's transported, climbed 7%.
- Revenue from coal jumped the most, at 39%, followed by 15% growth in metals and minerals and 12% each from petroleum and chemicals, and grains and fertilizers.
- If not for currency headwinds, CN's net income would be higher by 30 million Canadian dollars.
Overall, CN successfully turned around its operational performance to make the most of an exceptionally busy season, driven by strong commodity and grain markets.
What management had to say
Ruest had a tough task at hand when he took charge at CN some months ago, and he clearly delivered. His excitement was evident in his words.
Our entire team pulled together quickly to turn around our operational performance following a challenging winter, delivering a best-in-class operating ratio of 58.2% in the quarter. Record capital investments in new equipment and expanded infrastructure are on schedule, as we advance important projects that will give us the capacity and resiliency to serve the market at the industry-leading standard we and our customers expect.
Ruest further added that CN has the "momentum for a strong second half," backed by the capital investments. The company now plans to invest another CA$100 million this year to purchase new rail cars, taking its total outlined capital expenditure budget for the year to CA$3.5 billion.
Looking forward
Encouraged by a solid second quarter, robust demand from key end markets, and its ongoing capacity expansion program, CN now expects to earn adjusted earnings of CA$5.30-CA$5.45 per share versus its previous outlook of CA$5.10-CA$5.25 per share. That represents strong improvement over last year's adjusted EPS of CA$4.99. With this quarterly report, Ruest just gave investors in CN a strong reason to trust him.
