Canadian National Earnings: Intermodal Continues To Struggle; Wildfires a Headwind

Wide-moat Canadian National’s CNR second-quarter revenue swung negative year over year, falling 9% excluding foreign exchange, on lower volumes and falling fuel surcharges. Revenue came in shy of our forecast due to greater-than-expected intermodal deterioration and network disruption from the Canadian wildfires.

Relative to the second quarter of 2022, total volume fell 7% due in large part to continued intermodal volume declines rooted in retail-sector inventory destocking and sluggish imports. Forest products also fell, partly because of wildfire disruption and soft overall lumber demand. On the other hand, several bulk and merchandise categories remained positive, including metals and minerals, coal, Canadian grain, and automotive (higher vehicle production). Total yield fell 3% on lower fuel surcharges, easing accessorial income, and pressure on intermodal pricing from loose capacity in the competing truckload sector. That said, core pricing remains positive and CN is committed to inflation-plus rate hikes.

Despite solid productivity gains from the firm’s revitalized precision scheduled railroading focus, CN’s adjusted operating ratio (expenses/revenue) deteriorated to 60.6%, from 59%, on lost leverage from lower volumes, wildfire disruption, and wage inflation (including higher headcount). CN’s OR came in worse than our expected run rate because of sluggish intermodal activity and wildfire headwinds.

We will be tempering our 2023 revenue growth and operating margin assumptions, but we don’t expect to materially alter our $111 USD-denominated fair value estimate, save for a slight potential increase from the impact of foreign exchange on our USD valuation. In our view, the shares are appropriately valued relative to our longer-term free cash flow growth forecasts.