Canadian National Railway Pitch (TSE:CNR)

Canadian National Railway Pitch (TSE:CNR)
November 22, 2014
Prepared for:
University of Waterloo Stock Pitch Competition
MICHAEL KARP
LIAM SMITH
Bachelor of Commerce 2014
Bachelor of Computing 2015
Bachelor of Commerce 2018
Agenda
Section 1
Company Overview
Sub-Sections
Network Map
Business Description
Trading Information
Capitalization
2
Company Overview
Business Description
Management Team

Canadian National Railway is the fourth largest railroad in
North America based on revenue

The company transports $250 billion worth of goods per
year over a network of 20,000 route miles of track
spanning Canada and mid-America, and connecting three
coasts: the Atlantic, Pacific, and the Gulf of Mexico

7 core shipping segments: Intermodal, Petroleum &
Chemicals, Grains & Fertilizers, Forest Products, Metals
& Minerals, Coal, and Automotive
Revenue By Segment
Intermodel
5%
Petroleum & Fertilizers
Grains & Fertilizers
Forest Products
6%
23%
2013 Revenue:
$10,575mm
Metals & Minerals
18%
Coal
Automotive
Other
Claude Mongeau
Luc Jobin, CA
Jim Vena
J.J. Ruest
Position
President & CEO
EVP & CFO
EVP & COO
EVP & CMO
Years of Exp.
20
22
37
18
Background
Prior to CN, Mr.
Mongeau was a
partner with
Groupe Secor
Prior to CN, Mr.
Jobin was an
EVP of Power
Corporation
Prior to being
appointed COO,
Mr. Vena served
as a SVP
Prior to CN, Mr.
Ruest worked at
an international
chemical
company
Network Map
7%
12%
Name
13%
16%
3
Company Overview (cont’d)
Capitalization Table
Business
Price-Volume
Description
Chart
(in C$ millions)
$85.00
Share Price
$80.83
Basic Shares Outstanding
815
'
Market Capitalization
$75.00
5
Add: Debt
7,841
'
-
$70.00
4
73,596
2014E EBITDA
5,543
$65.00
3
2015E EBITDA
6,143
2014E EPS
$3.68
2015E EPS
$4.21
$60.00
2
EV / 2014E EBITDA
13.3x
$55.00
1
EV / 2015E EBITDA
12.0x
P / 2014E EPS
22.0x
P / 2015E EPS
19.2x
$50.00
Nov-13
4
Feb-14
May-14
Aug-14
Volume (millions)
(176)
Enterprise Value
6
65,931
Less: Cash & Equivalents
Add: Minority Interest
$80.00
5
Share Price
Diluted Securities
7
Earnings Release
Agenda
Section 2
Macroeconomic &
Industry Outlook
Sub-Sections
Carload Growth
Renewed Industrial Supply
5
Industry Outlook
Management
Class I North
American Carload Traffic
Management
Financials
Growth Key
and Renewed
Industrial Supply

Revenue among North American Class I rails has grown
10% in the last 12 months

Rail carload traffic has experienced improvement over
the past 5 years surpassing the pre-crisis levels

11,000
10,000
This significant increase is mainly due to renewed supply
in the crude oil, intermodal, and agricultural markets
9,000

8,000
2006



12,000
Crude Oil: As improvements in drilling technology open
up new oil production locations pipelines are slow to
provide service to these areas, rail’s fast transit times,
flexibility, and scalability have enabled them to pick up the
slack; accounting for a 60% of Bakken crude transport
750%
Intermodal: Intermodal traffic increased 7% LTM with all
seven Class I rails experiencing gains
550%
Class I rail carloads reached
an all-time high in Q3
2008
2010
2012
2014
Class I Rail Index vs. S&P 500 Growth
Agriculture: Agricultural carloads increased 11% in the
first half of 2014, a trend that looks to continue with the
USDA predicting increasing corn yields
350%
Since the railroad industry is oligopolistic in nature and
has high barriers to entry, existing rail companies should
be able to capitalize on the U.S.’s ever-growing GDP
S&P 500
S&P 500 Railroad Index
Rail stocks have beat
the S&P 500 by more
than 5x since a
railroad renaissance
began in 2003
150%
(50%)
2003
Source: Bloomberg
6
2005
2007
2009
2011
2013
Agenda
Section 3
Investment Thesis
Sub-Sections
Argument I: Poised to
Benefit from Growing
Demand
Argument II: Productivity
Leader with Growth
Potential
Argument III: Valuation
7
Argument I – Poised to Benefit from Growing Demand
Forestry & Metallic Ore Demand
U.S. GDP Growth

Of all Class I railroads, the western rails have the biggest
market share for the eight main carload types

The rail industry is very cyclical in nature, a positive given
the improving U.S. economy

CNR is especially well positioned to capitalize some of
the fastest growing types - forest products & metallic ores

In 2010 Berkshire Hathaway acquired Class I Rail
Burlington Northern for 26.5 billion USD and Warren
Buffet stated that he intended this to be an, “all-in wager
on the economic future of the United States”

Forestry: Canadian forestry sector revenues and total
exports were $57.8 billion and $28.5 billion last year

Metallic Ores: The global copper and nickel demand is
expected to grow at a CAGR of ~4% and ~6% from
2014 through 2020, respectively


Called “doctor copper” - copper is used as
economic indicator due to its broad industrial
use

YTD Class I Market Share
Forest Products
Metallic Ores
Over half of CNR’s revenue is earned in USD giving
them greater exposure to the benefits of the US
recovery than their direct competitor CP
International demand for forestry products is growing
rapidly, with Canada being a major exporter of forest
products CNR is set to benefit as it is the industry leader
in transportation of forest products
S&P 500 Index
35%
$2,100
31%
$2,000
13%
12%
10%
7%
16%
16%
14% 14%
$1,900
11%
5%
7% 6%
$1,800
3%
-
$1,700
Nov-13
Others
8
Jan-14
Mar-14
May-14
Jul-14
Sep-14
Nov-14
Argument II – Productivity Leader with Growth Potential
Key Financials



Management
Management
Historical Operating Ratio Efficiency
CN is North America’s most profitable railroad sustaining an
industry leading operating ratio for the past decade
CNR
CP
CSX
82%
81%
NSC
KCS
78%
“Precision Railroading”, which is the foundation for CN’s
scheduled railroading system, is the foundation for their
relative outperformance
75%
77%
76%
75%
UNP
81%
73%
71%
72%
71% 71% 71% 71%
71%
71%
72%
CN was an early adopter of the scheduled railroad and has
clearly benefited from the potential efficiency improvements
ahead of its peers while also instilling a culture and
discipline that we believe makes the efficiencies sustainable
70%
71% 71%
69%
68% 68%
67%
66%
64%
2009
64%
2010
Intermodal Revenues
63%
63%
2011
2012
2013
Superior Terminal Dwell Time
(in C$ millions)
(hours idle)
30
2167
26
1994
Average: 24.6 hours
28
25
21
1790
17
1576
1337
2009
2010
2011
2012
2013
The Prince Rupert Terminal, a ship to rail terminal, will provide
CN with growth in intermodal because it offers short transit
times for goods going from Eastern Asia to the U.S. Midwest
CNR heavily peruses expansionary capex regarding efficiency.
One example is their SmartYard technology which produces
ideal sequences for train deployment lessening dwell time
9
Argument III - Valuation
Class I Railroads Comparable Universe
EV /
Price
Equity Value
Enterprise Value
Price /
LTM EBITDA FY1 EBITDA FY2 EBITDA
LTM EPS
FY1 EPS
FY2 EPS
Class I Railroads
Canadian Pacific Railway Limited
$229.60
$35,592
$40,161
14.7x
14.0x
11.6x
29.5x
27.2x
20.6x
Union Pacific Corporation
$120.50
$108,091
$117,709
11.5x
11.2x
10.1x
22.3x
21.4x
18.6x
CSX Corporation
$36.87
$36,753
$45,891
9.8x
9.6x
8.9x
19.7x
19.3x
17.1x
Norfolk Southern Corporation
$115.17
$36,267
$43,754
9.7x
9.5x
8.7x
18.0x
17.8x
15.7x
$122.92
$16,017
$17,602
16.9x
16.0x
13.9x
26.8x
25.7x
22.3x
11.4x
11.1x
9.8x
22.9x
22.1x
18.8x
13.7x
13.3x
12.0x
23.1x
22.0x
19.2x
Kansas City Southern
Overall Adjusted Average
Canadian National Railway
$80.83
$66,746
$73,596
Canadian Universe LTM EV and EPS Multiples
Conclusions

EV to EBITDA Multiples
18x
15x
13x
10x
Nov-13
Canadian National
Canadian Pacific

Avg: 13.77x
Jan-14
Mar-14
May-14
Jul-14
Sep-14

Nov-14
Price to Earnings Multiples
Canadian National
30x
26x
22x
18x
Nov-13

Mar-14
May-14
Jul-14
Sep-14
Nov-14
10
For explanatory purposes, we used the historical
average of both CNR and CP EPS and EV multiples
It is currently trading at a ~0.5% and a ~4.9% discount to
its LTM average on a EV and EPS basis respectively

Canadian Pacific
Avg: 24.26x
Jan-14
Though in the comparables universe above CNR is
valued at a premium to its peers, it is currently trading at
a discount to just its Canadian universe
Implies a $87.63 valuation when using the average of
our two methodologies
We believe the market is not valuing CNR based where it
has been historically positioned in Canada because it is
overreacting to their exposure to China
Argument III - Valuation
Valuation Assumptions

Valuation based on the following assumptions:






5-year forecasted growth phase based on the maturity of the company
Total revenue grows at a compounded annual growth rate (CAGR) of ~9.0% between 2014E
and 2018E based on Street consensus estimates
Operating expenses are based on historical trends; management guidance has indicated that
they do not expect the operational structure of the company to change
Working capital projections are based on turnover and days outstanding ratios
Capital expenditures are forecasted based on Street consensus estimates
WACC: 6.9%
Perp. Growth Rate: 2.0%
FDSO: 820 million
Statutory Tax Rate: 26.5%
Use of the mid-year convention to discount the annual cash flows
DCF Unlevered Cashflow Summary
*All dollar amounts in millions
Total Revenues
Revenue Growth
Operating Expenses
Total EBITDA
EBITDA Margin
Depreciation & Amortization
Total EBIT
EBIT Margin
Cash Taxes
Total EBIAT
EBIT Margin
Add: Depreciation & Amortization
Less: CapEx
Less: Change in Net Working Capital
Unlevered Free Cashflows
2011
9,028
-%
(4,848)
4,180
46.3%
(884)
3,296
36.5%
(899)
2,397
57.3%
884
(1,625)
(27)
1,629
2012
9,920
9.9%
(5,311)
4,609
46.5%
(924)
3,685
37.1%
(978)
2,707
58.7%
924
(1,731)
(198)
1,702
2013
10,575
6.6%
(5,722)
4,853
45.9%
(980)
3,873
36.6%
(977)
2,896
59.7%
980
(1,973)
238
2,141
2014E
11,988
13.4%
(5,541)
6,447
46.2%
(4,407)
2,041
36.8%
(1,709)
332
58.6%
4,407
(2,254)
109
2,594
EV Perpetual Growth Method
Cashflow Forecast
2015E
2016E
2017E
13,031 14,077 15,201
8.7%
8.0%
8.0%
(6,023) (6,506) (7,026)
7,008
7,571
8,175
46.2%
46.2%
46.2%
(4,790) (5,175) (5,588)
2,218
2,396
2,588
36.8%
36.8%
36.8%
(1,857) (2,006) (2,166)
361
390
421
58.6%
58.6%
58.6%
4,790
5,175
5,588
(2,346) (2,393) (2,447)
150
168
189
2,956
3,340
3,751
11
2018E
16,921
11.3%
(7,821)
9,100
46.2%
(6,220)
2,880
36.8%
(2,412)
469
58.6%
6,220
(2,589)
213
4,313
Grown TV FCFF
Terminal Value
Present Value of Terminal Value
Terminal Value as % of Total Value
Present Value of Forecast FCF
Forecast Period as % of Total Value
4,399
89,536
66,276
82%
14,169
18%
Enterprise Value
- Debt
+ Cash
Equity Value (Market Cap)
Diluted Shares Outstanding
Fair Value Share Price
80,444
(7,841)
176
72,779
820
88.76
Agenda
Section 4
Catalysts and Risks
12
Catalysts and Risks
Catalysts

Regulation increases – CN in subject to both Canadian
and American regulation
• The Canadian Transportation Agency currently allows
rails to negotiate prices based on market forces however
the shipping industry argues that this is unjust seeing as
there is very low competition among Class 1 rails and
that they charge excessively high prices in many ports
where only one rail provides service
Intermodal transport is a rapidly growing segment of the
railway industry Increasing 7% LTM, CNR is the most
exposed rail to this segment
Acquisition of EJ&E enables CNR to bypass the
congestion found in Chicago, further improving their
industry leading productivity
•


CNR’s key terminal in Prince Rupert is set to increase
capacity by 67%, growth that they will realize exclusively
as they are the only rail that owns service rights to the
terminal
•

Risks
• Unpredictable derailments can potentially cause
environmental damage and subsequently reintroduce
the idea further safety regulation
As they continue to increase investment in the area, the
gained efficiencies will have an even larger impact
As gas prices trend upwards market share will be gained
from the trucking industry, rails become comparatively
more cost effective
• If .5% intermodal trucking market share is shifted
to rail transport it would represent a 30% increase
in the rail market
13

Unpredictable harsh weather can reduce efficiency,
lowering turnover and profit margin

The US economy could remain stagnant or decline as
oppose to improve, adversely affecting the industry’s
demand and bottom line

Chinese manufacturing could slow down, dampening
CN’s growth prospects within their Intermodal ports on the
West coast
Agenda
Section 5
Recommendations
Sub-Sections
Analyst Recommendations
Recommendation Summary
14
Recommendations
Analyst Recommendations
Buy Recommendation
Hold Recommendation
$92.00
$87.00
$85.24
$85.00
$85.00
$87.00
$85.00
$84.00
$83.00
$82.00
$78.00
$77.00
$81.33
Adj. Average: $82.81
$77.00
$75.65
$71.00
Firm
Date
14-Oct-14 21-Oct-14 21-Oct-14 22-Oct-14 22-Oct-14 22-Oct-14 22-Oct-14 22-Oct-14 22-Oct-14 27-Oct-14 11-Nov-14 12-Nov-14 14-Nov-14 16-Nov-14 16-Nov-14 19-Nov-14
Recommendation Summary
Summary Recommendations
Method
Target Price
Comparables
$87.63
DCF
$88.76
Analyst Avg.
$82.81
Entry Price:
12-mo. Target Price:
Dividend Yield:
All-In Return:
Stop Loss:
15
Market Price
$88.00
1.2%
10.1%
$70.50
Agenda
Section 6
Appendix
16
Appendix A: Operational Performance
Revenue Ton Miles (RTM)
Revenue Per RTM
(in billions)
210
$0.046
201
$0.044
$0.043
$0.043
186
188
184
180
179
178
174
$0.042 $0.041
$0.038
$0.039 $0.039
$0.036
160
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Carloads
Revenue Per Carload
(in millions)
4.8
4.8
4.6
4.7
4.7
4.6
4.9
5.1
1,847
5.2
1,767
1,656
1,664
1,662
1,579
4.0
1,504
1,515
1,426
1,366
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
17
Appendix B: WACC Analysis
Beta Comparables Analysis
Levered Beta
Market Cap Total Debt Raw Adjusted
Canadian Pacific Railway Limited
Union Pacific Corporation
CSX Corporation
Norfolk Southern Corporation
Kansas City Southern
35,592
108,091
36,753
36,267
16,017
4,884
11,505
9,617
8,919
1,871
0.870
0.300
1.110
0.780
1.030
0.913
0.533
1.073
0.853
1.020
B/S
13.7%
10.6%
26.2%
24.6%
11.7%
Unlevered Beta
Tax Rate Raw Adjusted
27%
35%
35%
35%
35%
Overall Adjusted Average
Valuation Assumptions
Assumption
Key Metric
0.830
0.499
0.917
0.736
0.948
0.842
0.858
Unlevered Adjusted Avg. Beta
Target Gearing
Tax Rate
0.858
0.59
27%
Relevered Beta
1.228
WACC Assumptions
Justification
Beta
1.23
Based on the unlevered betas of comparable peers
Risk-free Rate
2.4%
10-year U.S. treasury bill interest rate
Cost of Debt (pre-tax)
4.8%
Weighted average of interest rates based on CNR's debt
structure
2.0%
Conservative assumption which proxies the target inflation rate
in North America
Perpetual Growth Rate
0.790
0.281
0.949
0.672
0.957
18
10-yr US government bond rate
Expected market return
Market risk premium
Beta
CAPM cost of equity
Cost of debt
Tax rate
After tax cost of debt
Target Debt Structure
WACC
2.4%
7.7%
5.3%
1.23
8.9%
4.8%
26.5%
3.5%
37%
6.9%

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