CHALLENGE TO CN'S MARGINS AS ECONOMY RUNS OUT OF STEAM
TORONTO -- There should be some self-congratulation at Canadian National Railway Co. today when it reports fourth-quarter results that are expected to be the best among major railways, the National Post reports.
But for Paul Tellier, the president and chief executive, the euphoria will be short-lived because, as every executive knows, a stock is only as good as the company's next quarter.
Even before the fourth-quarter numbers are served up, analysts are wondering what comes next for CN and other major railways amid a deteriorating economy.
"They will have the strongest performance of any railroad in this quarter," said a rail analyst at Morgan Stanley, who asked that his name not be used.
"It will be interesting to see what they say on the cost side. What will they do to try to maintain that margin? Instead of their revenue growing 5% to 7% a year, they're probably going to grow 2%. What are they going to to do to offset that?"
Across North America, railways are feeling earnings pressure as the economy cools. Because they move everything from raw materials to finished consumer products, railways are especially vulnerable to the economic cycle.
Further compounding their woes are higher fuel costs -- which CN and others have attempted to mitigate with price increases and surcharges -- and winter weather that drives up operating expenses.
Recently, Craig Kloner, an analyst at Goldman, Sachs & Co., downgraded CN along with other railways. He lowered it to "market perform" from "market outperform," citing concerns about the economy, and slightly trimmed his earnings projections for 2001.
CN is the only major carrier to have avoided an earnings estimate downgrade for the fourth quarter, which should come in at $1.18 per share, according to the analyst consensus. The railway earned $1.01 in the final quarter of 1999.
According to carload data, CN's commodity traffic decreased 2.2% in the quarter -- a victim of not only the economy but also the weather, said Ted Larkin, an analyst at HSBC Securities.
On the bright side, intermodal traffic was up 14.8% due to more aggressive marketing. However, noted Mr. Larkin, this type of traffic generates lower margins.
For the year, CN's commodity traffic was up 1.4% and intermodal 15.3%. This is striking contrast to its competitors. Cumulative totals for all 17 reporting U.S. and Canadian railroads show commodities down 0.2% from last year, and intermodal up 3.9% from last year.
As well, CN has the lowest operating ratio -- the percentage of revenue needed to operate and maintain the railway -- and the best productivity.
"They have seen the least falloff in traffic volumes of any railroad which is pretty impressive. The slowing economy is going to impact them-- they can't hide from that -- but they've shown amazing resiliency," said the Morgan Stanley analyst. "We think they have the best management in the industry, we like the results they're getting from their scheduled railway program, and they're the most profitable railroad today."
Others are also confident CN can weather whatever storm may arise.
"We believe the company will perform to expectations in fiscal 2001," James David, an analyst at UBS Bunting Warburg Inc., wrote in a recent report.
Among analysts, Mr. David is calling for earnings of $4.77 per share and has a 12-month target of $55; Mr. Larkin is calling for $4.75 and has a $57 target; while Winnie Siu, an analyst at Salman Partners in Vancouver, expects the company to earn $4.81 and has a $59 target. All have 'buy' ratings on the stock.
CN shares (CNR/TSE), which dipped precipitously in recent weeks on economic concerns but have since recovered, closed at $48.45 yesterday, up 45¢. The 52-week range is $49.90 to $33.25. Apart from the economy the other factor that could have a major impact on the sector this year is industry consolidation.
The 15-month moratorium imposed by U.S. regulators on mergers that quashed the CN's combination with Burlington Northern Santa Fe Corp. expires in June. That could sound the starting gun to more mergers, although it is far from certain there will be any or that the Canadian railways would be part of them.
Dick Davidson, the president, chief executive and chairman of Union Pacific Corp., told analysts recently he does not expect any mergers in the near term because the industry is still grappling with issues from previous mergers.
UP did take a "hard look" at buying Canadian Pacific Railway Co., but believes it can achieve the same benefits through alliances, said Mr. Davidson. That has long been CPR's position. For its part, Mr. Tellier has been coy about CN's plans and has not been overly fretful about tougher new rules for mergers being mooted by the U.S. Surface Transportation Board.
Others note, though, that since 41-year-old Matthew Rose recently replaced
retiring Robert Krebs in the top job at BNSF, there will be less urgency
to merge because the young executive won't want to see his job disappear.
January 23, 2001
© 2001 Brotherhood of Locomotive Engineers