The coronavirus has stymied business activity around the globe. For the first 26 weeks of the year, Canadian railroads reported an 8.3% decline in rail traffic. This implies Canadian National (CNI) could face serious headwinds going forward. In Q1 2020, Canadian National reported total revenue of $3.5 billion, flat Y/Y. Total freight volume fell 6%, while average selling price (“ASP”) rose 7%.
Four of the company’s seven product categories experienced revenue declines. Revenue for Forest Products fell 5% due to an 8% decline in volume and 4% increase in ASP. Revenue from Coal fell 12% primarily due to lower exports to the Gulf Coast due to competitive market pricing. Revenue from Metals and Minerals fell in the low single-digit percentage range on lower steel volume and falling shipments of frac sand. Intermodal was flat as volume for international container traffic fell due to the impact of the coronavirus. Automotive revenue fell 9% due to lower volume of domestic vehicles.
Total carloads fell 6% Y/Y. The biggest decliners were Forest Products, Intermodal and Automotive.
Intermodal volume will likely face headwinds until the pandemic subsides. Automotive volume could be particularly vulnerable if consumers shun autos and focus on essential items. Intermodal was the largest segment, representing over 40% of total volume.
The Canadian railroads had previously feasted on price hikes to help offset stagnant rail traffic. Canadian National’s ASP rose 7% Y/Y, as five of its seven product categories realized price hikes.
As the economy’s vital signs are collapsing, it could be difficult for Canadian National to pass through more price increases.
Operating Ratio Ticked Up
Canadian railroads are known for their efficiency vis-a-vis U.S. railroads. Canadian National reported an operating ratio of 66%, down from 70% in the year-earlier period. Total operating expenses were $2.3 billion, down 5% Y/Y. Labor costs fell 7% Y/Y, mainly due to lower incentive compensation and lower headcount. Purchased services rose 4% due to the inclusion of TransX, partially offset by lower material costs. Fuel costs fell by 10% on productivity gains and lower fuel prices. Falling fuel prices could be a knock-on effect of a slowing economy. It could be difficult to drive more efficiency gains if Canadian National’s top line falters.
The fallout was that EBITDA of $1.6 billion, up 6% Y/Y. EBITDA margin was 45%, up about 200 basis points versus the year-earlier period. I expect the company to continue to look for ways to wring costs out of the system. Integrating TransX could present a major opportunity to become more efficient. However, if its rail traffic falls hard like I expect, Canadian National’s EBITDA and margins could still fall. The economy is so uncertain that management did not give forward guidance:
The pandemic is having an unprecedented and extraordinary impact on the global economy. In North America and in Canada in particular, these impacts are being compounded by the drop in oil prices. The economic outlook and therefore overall demand for transportation services is highly correlated to the duration of containment measures and the impacts on businesses and consumers, which at this point remain uncertain. As a result, CN like many companies is withdrawing its 2020 financial guidance.
I felt the economy had peaked prior to the pandemic. The coronavirus likely exposed a weak global economy. That said, Canadian National’s best days could be behind it. CNI has an enterprise value of $99 billion and trades at 13.7x last 12 months (“LTM”) EBITDA. The trading multiple is robust, despite the dismal economy, and may not reflect the economic uncertainty faced by railroads.
CNI is down over 10% Y/Y. In my opinion, its trading multiple does not reflect the stiff headwinds faced by the company. Sell CNI.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.