DBRS Confirms Canadian National Railway Company at A (low)

DBRS has today confirmed the long-term debt and commercial paper ratings of Canadian National Railway Company (CN or the Company) at A (low) and R-1 (low), respectively. CN’s business and financial risk profiles were solid over the past year despite facing sharply weaker freight volumes precipitated by the economic recession in North America. The Company continues to lead the Class 1 rail industry in the majority of credit measures, which most notably include an operating ratio (operating expenses divided by operating revenues) of well below 70%. The ratings are expected to remain stable as CN generates improved operating results over the near term and maintains its relatively conservative balance sheet.

CN’s ability to generate solid free cash flow helped to limit the impact of materially weaker operating results over the past year. Free cash flow was used almost exclusively to reduce debt. In addition, the relative strengthening in the Canadian dollar led to lower leverage, given that the Company’s debt is largely U.S.-dollar denominated. As a result, CN’s financial profile modestly improved, with adjusted debt-to-capital dropping below 40% and adjusted debt-to-EBITDA improving to just over 2.0 times despite the reduction in earnings and cash flow from operations. DBRS expects a modest improvement in CN’s coverage ratios and profitability in the near term, driven by gradual strengthening in operating results.

Growth in volumes related mainly to industrial production and stronger commodity market demand is likely to be a source of near-term earnings growth. While a sharp rebound is not expected, demand should gradually recover in most end-markets, albeit from very weak levels in certain cases (i.e., automotive, forest products).

Base freight rate increases (low single-digits) are largely locked in for 2010, which should exceed cost inflation and contribute to improvement in CN’s operating ratio (to the mid-60% range). In addition, the Company remains focused on improving its cost base through a variety of efficiency initiatives.

CN will continue to generate solid free cash flow, which provides a high degree of financial flexibility, particularly during weak economic conditions. In DBRS’s opinion, cash is likely to be used primarily toward share repurchases, given the lack of debt maturities in 2010 and low likelihood of large acquisitions. While share buybacks are viewed negatively from a financial risk perspective and currently limit upside to the rating, free cash flow will help mitigate the impact on leverage and CN is not expected to have any trouble maintaining its strong balance sheet.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Companies in the Railway Industry, which can be found on our website under Methodologies.

This is a Corporate rating.

The full report providing additional analytical detail is available by clicking on the link under Related Research at the right of the screen or by contacting us at info@dbrs.com.

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