Canadian National Earnings: Intermodal Activity in Retreat, but Network Productivity Gains Solid

Wide-moat railroad Canadian National’s CNI first-quarter revenue grew 12% year over year (removing foreign exchange) on higher fuel surcharges, core rate gains, and slight volume growth. Revenue came in ahead of our forecast because of strong yield improvement (up 12%). Relative to the first quarter of 2022, total volume rose slightly less than 1% on service improvement (hiring progress and less winter-weather disruption), strong Canadian grain (favorable harvest), higher export coal, and recovering auto carloads (increased vehicle production). These factors were largely offset by slowing industrial end markets and pronounced weakness in international intermodal activity rooted in retail sector inventory destocking and loose capacity in the competing full-truckload sector.

CN’s adjusted operating ratio (expenses/revenue) improved materially to 61.5% (versus 66.6%), thanks to more favorable winter weather this year, network service recovery, and the firm’s revitalized focus on precision scheduled railroading principles under new COO and railroading veteran Ed Harris. The OR came in better than our expected run rate. Management did not provide specific guidance, but we will likely continue to bake in modest OR improvement in 2023, despite elevated wage inflation and flattish volume trends, due to solid core pricing conditions and network productivity gains.

We expect to raise our $109 U.S. dollar-denominated fair value estimate by around 3% due to the time value of money and the impact of foreign exchange. However, we see elevated downside risk to our 2023 top-line and margin forecasts due to uncertainty surrounding consumer spending (retail restocking could remain anemic for a protracted period) and slowing industrial production.