Morningstar | What Started as a Struggle, Canadian National Closes in Strength; Solid 2018 Growth and Operations
CN has been a stalwart of railroading excellence for more than a decade. So it was unexpected to observe the congestion, service, and cost challenges CN suffered in late 2017 and early 2018. In last year's first quarter, expenses grew 9% on flat revenue and the rail changed CEO. Now, under new CEO JJ Ruest, mismanagement of capacity and demand seem behind CN, and it is increasing investment in 2019 to boost capacity more via 80 miles of new double track and 140 reliable new locomotives.In its fourth quarter, the rail grew revenue ton miles 12%, expanded sales 16%, and improved its operating ratio 80 basis points to 61.9%. Excluding a charge to reduce its nonunion labor force, the OR was 61.2%; we expect CN will generally fare in the 50s. We maintain our wide moat rating and expect any change to our fair value estimate will be modestly upward as we incorporate actual performance and news of new growth opportunities and capital deployment plans. For the full-year 2018, CN realized broad strength in demand and solid rate increases, with coal revenue up 24% on export strength, petroleum and chemicals up 20%, metals and minerals up 11%, and intermodal up 8%.
Management expects in 2019 high-single-digit growth in revenue ton miles and pricing above inflation, resulting in double-digit growth of normalized EPS over the 2018 adjusted EPS of CAD 5.50. The 2019 capital expenditure budget is CAD 3.9 billion, up from CAD 3.5 billion in 2018. Both are big investment years. Typically CAD 1.6 billion is basic maintenance spending, but the firm is adding 140 locomotives. We might have concern about increasing capital expenditures at other firms, but believe CN is prudently adding capacity to avoid recurrence of year-ago congestion, and returning expensive leased motive power makes sense. We note the Canadian pension accounting reclassification has a 200-220 basis point negative impact on OR compared with prior years, but management guides to a high 50s OR over the long run.
Canadian National Railway, together with its wholly-owned subsidiaries, is engaged in the rail and related transportation business. Co.'s network of approximately 20,000 route miles of track spans Canada and mid-America, from the Atlantic and Pacific oceans to the Gulf of Mexico. Co.'s network and connections to all Class I railroads provide access to all three North American Free Trade Agreement nations. Co. handles and carries cargo, serving exporters, importers, retailers, farmers and manufacturers. Co. is engaged in the movement of a portfolio of goods, including petroleum and chemicals, grain and fertilizers, coal, metals and minerals, forest products, intermodal and automotive.
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