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Morningstar | CN Delivers 2% Revenue Ton Mile Growth in a Weak Freight Market; Back to Excellent Operating Ratio

Canadian National has long been the highest-margin railroad, and we don't anticipate it will deviate from its excellent mid-50s operating ratios even as other railroads improve profitability. As recently as the third quarter of 2016, CN set a quarterly record OR of 53.3% (admittedly with a strong fuel benefit). Railroads generate tremendous cash, and CN shines here, generating free cash flow averaging 15% of sales during the past decade and 12% of sales even during a trying 2009. The firm is highly exposed to forest products (12% of 2018 revenue, down from the low 20s in 2002-06) and has a limited 5% revenue reliance on coal; thus, it could benefit from the U.S. homebuilding recovery while losing less revenue than rails with greater dependence on coal. CN's mix is richest in intermodal, agriculture, and chemicals, each of which contributes 17%-24% of total sales. A railroad's competitive advantages are inseparable from its geography, and CN's network is a unique three-coast system spanning Canada coast to coast, then down through the U.S. to New Orleans. The 2009 acquisition of the EJ&E line around Chicago enables CN to better maintain velocity at a choke point as volume grows, benefiting service, reliability, and asset turns. Also, CN may be less exposed to increased U.S. regulatory risk than the U.S. Class I rails because on its U.S. route, the option to ship by barge on the Mississippi River makes CN's clients less captive than those of inland rails.CN is improving its already excellent velocity by installing more distributed-power locomotives (now more half of the fleet) and extending sidings. Running a scheduled railroad requires commitment to on-time train departures from every operating employee and even from customers queuing cars for departure. CN encourages some customers to load and unload cars seven days a week to keep trains moving, and it offers guaranteed cars whereby it pays penalties for late arrivals and customers pay penalties for causing delays. Legendary CEO Hunter Harrison left at the end of 2009, but the firm's unwavering outstanding margins confirm that precision railroading is infused in CN's culture.