DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating and Unsecured Bonds, Debentures & Notes rating of Canadian National Railway Company (CN or the Company) at “A” and its Commercial Paper rating at R-1 (low). All trends remain Stable. The rating confirmations reflect CN’s continued strong market position and focus on operating efficiency, despite recent headwinds and unforeseen events which negatively affected the Company. While revenues and earnings grew in 2019 overall, volumes were adversely affected, especially during the latter part of the year because of softening economic conditions as well as the eight-day conductors’ strike in Q4. Headwinds are expected to continue to be felt into 2020 because of the rail blockades that occurred in February, most notably on the eastern part of CN’s network. The Stable trends reflect DBRS Morningstar’s expectation that the Company will continue to execute on efforts to grow its business in a resilient and sustainable manner while maintaining a financial profile consistent with the ratings, such as adjusted debt-to-EBITDA below 2.00 times (x) and adjusted cash flow-to-debt above 40%.
In 2019, CN grew both its revenues and its EBITDA about 4% and 5%, respectively, while volumes (as expressed in revenue ton miles) declined about 2.5%. Most segments saw declining volumes except for petroleum and chemicals, which benefitted from strong volumes of crude, natural gas liquids, and refined petroleum products. The rest of CN’s business was affected by various headwinds, including the softening of the economy and the eight-day conductors’ strike in November 2019. Operating efficiency, while still considered to be strong overall, deteriorated slightly in 2019 with a 61.7% operating ratio, a small increase compared with 2018. CN has invested substantially and has completed a significant number of projects and initiatives on its network in the last couple of years in response to strong demand over that period, but in Q4 2019, the Company announced that it is making adjustments to its fleet and resources to adapt to a slowdown in demand. In 2020, DBRS Morningstar expects capital expenditure to moderate to levels more in line with historical levels. The Company is also engaged in several innovative technology projects, such as automated track and train inspection capabilities, which will improve safety, increase network capacity, and contribute to a more fluid operations over time. Finally, CN pursued inorganic growth opportunities with two small and complementary acquisitions in 2019, in the intermodal sector, for a total consideration of $297 million. In 2020, CN faced the adverse effects from the February rail blockades that constrained parts of its network, especially on the strategic Toronto-Montréal corridor, and will have to address the mounting uncertainties in the broader economy. While CN is often considered a reflection of the economy because of the nature and diversity of the goods and commodities it transports, DBRS Morningstar believes the Company’s network and assets are adequately prepared to cope with a slowdown in trade volumes and disruption in supply chains so that its credit quality would not be significantly affected. However, if the economic impact of COVID-19 were to significantly disrupt global supply chains and/or consumer demand, we could revisit the credit within that context. In 2020, DBRS Morningstar expects CN to grow its revenue, earnings, and volumes, albeit at low-single-digit rates. At the same time, the Company’s lower capital envelope will allow free cash flow to grow substantially, compared with 2019.
DBRS Morningstar expects CN to continue conducting its financial policy such that its financial metrics will support and be consistent with the “A” rating range for the railway industry. In 2019, CN partly debt-funded share repurchases of $1.7 billion consistent with DBRS Morningstar’s expectations but, in 2020, higher expected free cash flow will allow for most share repurchases to be internally funded, allowing leverage to slightly moderate. Financial leverage expressed as adjusted cash flow-to-debt and adjusted debt-to-EBITDA is expected to stay above 40% and trend towards 1.9x, respectively.
DBRS Morningstar expects the Company’s financial metrics to remain commensurate with the rating and does not see any near-term factors which could lead to a positive rating action; however, an erosion in leverage caused by weaker earnings and/or higher debt to fund shareholder distributions, such that cash flow-to-debt declines below 35% and debt-to-EBITDA increases above 2.0x on a sustained basis, could lead to a negative rating action.
All figures are in Canadian dollars unless otherwise noted.
The principal methodologies are Rating Companies in the Railway Industry, DBRS Morningstar Criteria Commercial Paper Liquidity Support for Non-Bank Issuers, DBRS Morningstar Criteria: Guarantees and Other Forms of Support, and DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships which can be found on dbrs.com under Methodologies & Criteria.
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The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.
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