Congestion issues delay but won’t derail CN, analysts say
Planned fixes call for patience from investors
Investors appear to have largely shrugged off Canadian National Railway Co.’s weak fourth quarter results and soft 2018 guidance, despite expectations that network congestion problems will hurt performance until the summer or later.
Higher- than- anticipated operating costs, due to ongoing congestion in key corridors, weather- related outages, and higher fuel costs, were the primary culprits behind CN’s fourth- quarter earnings miss. The company plans to significantly increase its operating and capital resources to help resolve the issues, but it acknowledged that additional new capacity likely won’t be available until the second half of 2018.
As a result, investors will probably have to be patient for CN’s results to improve, and may be presented with attractive entry points in the interim.
“There is no quick, cheap, or easy remedy to the prevailing fluidity problems caused by large pockets of concentrated volume growth in 2017 that stressed network resiliency,” said Brian Ossenbeck, an analyst at J. P. Morgan. “Adverse weather was cited as an operating headwind, but we note service metric deterioration accelerated during the second half of 2017.”
Track construction, hiring additional staff, and buying more trains will boost capex and pressure CN’s operating ratio, and until these de- bottlenecking efforts are complete, the company will find it difficult to increase volumes without congestion getting even worse.
Ossenbeck prefers Canadian Pacific Railway Ltd., and believes it can regain market share during CN’s "extended network reset,” but the analyst remains confident that CN can get back on track.
“CN has historically demonstrated industry- leading service levels, and as such we view these as persistent but not permanent issues,” he said, noting that margins and volume growth should normalize in 2019.
Part of the reason for the market’s muted reaction is that CN’s volume- driven operating challenges have been well-telegraphed. The company also raised its dividend by 10 per cent, and maintained its target of approximately 10 per cent average annual earnings per share growth for the next five years.
“CN is making the necessary investments to manage its positive long- term volume outlook,” said Kevin Chiang, an analyst at CIBC World Markets. “CN continues to have the best revenue visibility amongst the Class 1s reflecting its network reach.”
That reach will improve further as CN begins i ts capacity investments at the end of winter, with a focus on regions that experienced significant volume growth, such as Western Canada and Northern B.C. Walter Spracklin at RBC Capital Markets also views the situation at CN as temporary, and remains positive on the stock over the long term.
However, he noted that the company will need to execute in order to remedy the situation.
“While CN has been known for conservatism in its guidance, we believe the forecast provided to be fair given the current congestion issues,” Spracklin said. “Key will be how quickly the company will be able to re- align its resources — with expectation for a meaningfully better second half than first half.”
Benoit Poirier at Desjardins Capital Markets expected the Street to be disappointed by CN’s weaker outlook for 2018, but noted that it was mostly in line with his forecast.
“We expect the stock to react negatively but see any weakness in the name as a buying opportunity,” the analyst said.
CN shares were trading down 1.73 per cent $ 98.39 on Wednesday. The stock is down roughly five per cent so far in 2018.