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Canadian National Remains Neutral

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On Dec 5, we retained our Neutral recommendation on Canadian National Railway (CNI - Free Report) . Despite coal headwinds, the company’s third quarter top and bottom line figures were ahead of the Zacks Consensus Estimate and improved year over year. Currently, the Zacks Consensus Estimate for the company is pegged at 80 cents, representing an annualized growth rate of 13%. The company currently carries a Zacks Rank #2 (Buy).

Why Retained?

Canadian National expects modest economic growth in North America to support around 2% industrial production growth in 2013. The company also expects strong demand across most of its businesses with improvements in wholesale and retail markets, underpinning 2–3% growth in business volumes for the year.

In addition, pricing should also be favorable with growth above cost inflation. We expect operating ratio to remain at the current level of high 60s on enhanced productivity from improving system velocity and fuel efficiency. Given these positive factors, we believe that the company will be able to achieve its projected high single-digit year-over-year earnings growth in 2013.

In the ongoing quarter, the company expects volume to driven by improved housing starts, automotive sale, improved grain crop in Canada and the U.S., ethane and natural gas feedstock and energy consumables like frac sand and crude. In terms of agricultural volumes, the company recently forecasted robust growth of over 60 million tons in West Canadian crop production, which will likely bolster agricultural shipments. In Intermodal, the company expects to gain from the Port of Montréal rail share and its existing business in Port of Vancouver.

Automotives will continue to grow on higher North American auto production and estimated U.S. motor vehicles sale of 15 million units. The company, in the third quarter, contributed approximately 50% in finished vehicle shipment sold in Canada. In terms of fertilizers, management expects the 10-year contract with Canpotex Ltd. for transporting potash to remain accretive to carloads. Profits are also expected from higher metallurgical coal exports and a 7-year contract with Coalspur inked in Feb 2013. The agreement entails thermal coal transport from Coalspur’s Vista Coal Project in Alberta, Canada, to Ridley Terminals as well as railway line construction to serve its mines.

However, Canadian National expects a financial headwind of C$150 million in 2013 due to higher pension expense (approximately C$120 million) and depreciation expenses (C$30 million). Tax expenses are also expected to remain higher in the remainder of the year owing to provincial budgets and corporate income taxes.  In addition, the company expects to incur costs related to stock-based compensation alongside higher employee compensation benefits, representing a headwind of $30 million. Total carloads are also likely to remain subdued in the fourth quarter given weakness in coal, potash, sulphur and pet coke.

Given the above mentioned pros and cons over the near-term future of Canadian National, we continue to have a Neutral recommendation on the stock.

Other Stocks

Other stocks worth considering within this sector are Canadian Pacific Railway Limited (CP - Free Report) , Arkansas Best Corporation and Covenant Transportation Group Inc. (CVTI - Free Report) . CP carries a Zacks Rank #1 (Strong Buy), while ABFS and CVTI currently hold a Zacks Rank #2 (Buy).

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