Canadian National Railway (CNI 0.35%) set itself up for a strong end to 2018 when it pumped record capital investment to improve infrastructure and increase capacity to meet high anticipated demand from key end markets.
Investors got to hear what they expected when the railroad giant reported its fourth-quarter and full-year numbers on Jan. 29 after market close: CN delivered strong numbers for Q4, announced a hefty 18% increase in dividends, and is setting itself up for another good year in 2019 as it further ramps up capital spending. Here's all you need to know about what's fueling CN's growth and management's plans for 2019.
CN results: The raw numbers
A quick look at the table below, which highlights key numbers from CN's fourth quarter, might give you an idea that it was a mixed quarter for the railroad. That's not really so, as CN delivered on all fronts and expects the tailwinds to continue. (Note that all numbers in the table below are in CN's reporting currency, Canadian dollars.)
|Metric||Q4 2018||Q4 2017||Year-Over-Year Change|
|Revenue||$3.81 billion||$3.29 billion||15.8%|
|Net income||$1.14 billion||$2.61 billion||(56.3%)|
|Diluted earnings per share (EPS)||$1.56||$3.48||(55.2%)|
|Free cash flow (FCF)||$633 million||$457 million||38.5%|
|Operating ratio||61.9%||62.7%||0.8 percentage points|
What happened with CN this quarter
The railroad sector overall is witnessing strong demand, and it was no different with CN. CN's Q4 carloadings, or the total amount of freight it carried during the period, improved 5%. Its revenue ton miles, which measures the weight in tons and the distance of rail freight transported, rose 12%.
CN's revenue jumped 16% during the quarter thanks to strong freight volumes across all its key markets, including petroleum and chemicals, intermodal, grain and fertilizers, coal, forest products, metals and minerals, and automotive. Among these, petroleum and chemicals reported a whopping 50% surge in revenue, followed by coal, where sales rose 21% year over year.
Yet despite strong growth on the top line, CN's operating ratio -- defined as operating expenses as a percentage of revenue, hence the lower the better -- improved only marginally to 61.9% because of higher operating expenses. That's not necessarily a bad sign: CN has been on a hiring spree in recent months as it put several expansion projects into service, which drove its labor and material expenses higher. Higher fuel prices were an added headwind.
The sharp drop in CN's GAAP EPS that you see in the table above was primarily because of a large income tax recovery in Q4 2017. When adjusted for that non-recurring item, CN delivered nearly 24% growth in EPS, reflecting the underlying strength of its business right now. Not surprisingly, management is optimistic about 2019 and has some big growth plans lined up.
What management had to say
CN's CEO JJ Ruest believes 2019 will be the year of building on the momentum that CN gained in 2018 through its aggressive growth moves. In fact, 2019 could be an even bigger year in terms of the money the company spends on building upon its infrastructure. As Ruest revealed: "In 2019, our record capital program of CA$3.9 billion will be focused on investing in the renewal of a more efficient and reliable locomotive fleet, adding network capacity to accommodate our solid pipeline of growth in diverse markets and bringing technology to our Precision Scheduled Railroading."
Precision scheduled railroading is the name of the game among railroads right now. Put simply, it's an operating model that strives to improvise on key areas such as train velocity to boost productivity and cost efficiency. CN intends to spend record sums of money this year to the tune of CA$3.9 billion on expanding its locomotive, grass hopper, and intermodal fleet and adding nearly 80 miles of double track rail, among other things.
Ruest has strong expectations for 2019. "With CN-specific growth opportunities, combined with a broadly positive economic backdrop, we expect high single-digit volume growth in 2019 in terms of revenue ton miles (RTMs)," said Ruest.
CN expects to grow adjusted EPS in a low double-digit range in FY 2019, which is an encouraging projection to say the least given that CN grew its adjusted EPS by 10%, to CA$5.50, in FY 2018. CN's just announced dividend increase of 18% -- the company has increased dividends every year since 1996 -- further demonstrates management's confidence in CN's growth potential going forward.
Check out the latest Canadian National Railway earnings call transcript.