In the midst of what CN President and CEO Luc Jobin called “a very challenging volume environment” that saw second-quarter declines in revenues and operating income, the railroad posted an operating ratio of 54.5%—a second-quarter record and an improvement of 1.9 points over the prior-year quarter.
Net income was C$858 million, compared with net income of C$886 million for second-quarter 2015. Q2-2016 diluted EPS remained flat at C$1.10. The decrease in net income was mainly due to lower operating income and other income, and higher interest expense; net of related income taxes.
Adjusted diluted EPS of C$1.11 declined 3% from year-earlier adjusted diluted EPS of C$1.15. The adjusted figures exclude the impact of deferred income tax adjustments resulting from higher provincial corporate income tax rates in both years.
Operating income declined 5% to C$1.29 billion. Revenues decreased by 9% to C$2.84 billion. Carloadings declined 12% and revenue ton-miles declined 11%. Operating expenses declined 12% to C$1.55 billion. Free cash flow for the first six months of 2016 was C$1.17 billion, compared with C$1.05 billion for the year-earlier period.
Revenues increased for forest products (4%), but were more than offset by revenue declines for coal (36%), metals and minerals (17%), petroleum and chemicals (16%), grain and fertilizers (12%), intermodal (4%), and automotive (1%). CN said the revenue decline “was mainly attributable to decreased shipments of energy-related commodities including crude oil, frac sand, drilling pipe and semi-finished steel products as a result of declining energy markets; reduced shipments of coal due to weaker North American and global demand; lower volumes of Canadian grain to North American and export markets due to lower available supply; and lower applicable fuel surcharge rates. These factors were partly offset by the positive translation impact of the weaker Canadian dollar on U.S.-dollar-denominated revenues; freight rate increases; as well as increased shipments of lumber and panels to U.S. markets, and increased domestic retail intermodal shipments. Carloadings for the quarter declined by 12% to 1.25 million.
Revenue ton-miles (RTMs) declined by 11% from the year-earlier quarter. Rail freight revenue per RTM increased by 1% over the year-earlier period, driven by the positive translation impact of the weaker Canadian dollar and freight rate increases, partly offset by a significant increase in the average length of haul and lower applicable fuel surcharge rates.
Operating expenses for the second quarter decreased by 12% to C$1.55 billion, “mainly due to lower costs resulting from decreased volumes of traffic, lower fuel prices, lower pension expense and cost-management initiatives, partly offset by the negative translation impact of a weaker Canadian dollar on U.S.-dollar-denominated expenses.”
“CN continued to face a very challenging volume environment in the second quarter and maintained strong discipline in realigning resources to keep them in line with reduced freight demand,” said Luc Jobin. “Service remained solid, key operating metrics advanced, and we continued to improve our safety record. An important product of our cost-management and productivity focus was a record second-quarter operating ratio of 54.5%.
“We expect the second quarter to be the volume trough for the year. For the balance of 2016, we continue to expect some markets to remain strong, including lumber and panels, automotive, and refined petroleum products, and we anticipate a bumper grain crop in Canada. At the same time, international intermodal volumes are expected to remain challenging while shipments of commodities related to oil and gas development, such as crude oil, frac sand and drilling pipe, are expected to decrease relative to last year.
“Given these expectations, we reiterate our April 25, 2016, financial outlook of aiming to deliver 2016 EPS in line with last year’s adjusted diluted EPS of C$4.44.”
Although CN reports its earnings in Canadian dollars, a large portion of its revenues and expenses is denominated in U.S. dollars. The fluctuation of the Canadian dollar relative to the U.S. dollar affects the conversion of the company’s U.S.-dollar-denominated revenues and expenses. On a constant currency basis, CN’s net income for the second quarter of 2016 would have been lower by C$23 million, or C$0.03 per diluted share.
CN has made a number of economic and market assumptions in preparing its 2016 outlook. The company says it “now assumes that North American industrial production for the year will be slightly negative (compared with its April 25, 2016, assumption that North American industrial production would increase by less than 1%) and assumes U.S. housing starts in the range of 1.2 million units and U.S. motor vehicle sales of approximately 17.5 million units. For the 2015/2016 crop year, the Canadian grain crop was in line with the five-year average and the U.S. grain crop was above the five-year average. The company now assumes 2016/2017 grain crops in both Canada and the U.S. will be above their respective five-year averages (compared with its April 25, 2016, assumption that both the Canadian and U.S. 2016/2017 grain crops would be in line with their respective five-year averages). With these assumptions, CN now expects total carloads for 2016 will decrease in the mid-single-digit range (compared with its April 25, 2016, assumption that total carloadings for the year would decline 4% to 5% vs. 2015). CN expects continued pricing improvement above inflation. CN assumes that in 2016 the value of the Canadian dollar in U.S. currency will be in the range of $0.75 to $0.80, and that the average price of crude oil (West Texas Intermediate) will be in the range of US$35 to US$45 per barrel. CN plans to invest approximately C$2.75 billion in its capital program, of which C$1.5 billion is targeted toward track infrastructure.”
CN’s Board of Directors has approved a third-quarter 2016 dividend on the Company's common shares outstanding. A quarterly dividend of thirty-seven-and-one-half cents (C$0.375) per common share will be paid on Sept. 30, 2016, to shareholders of record at the close of business on Sept. 9, 2016.