A Pipeline on Wheels

06/02/2010 9:18 am EST


Roger Conrad

Chief Analyst/Managing Partner, Capitalist Times

Canadian National is already doing well, and could really clean up on a plan to ship oil sands crude by rail, write Roger Conrad and David Dittman in Canadian Edge.

Canadian National Railway's (NYSE: CNI, Toronto: CNR) first-quarter report drew a mixed response from analysts. The headline earnings number beat expectations, inspiring buy-target increases and quips to the effect that “it’s not too late to hop on the train.”

During the first quarter, CNI’s carload volume—its internal equivalent of railcar loadings—rose 16%. CN posted double-digit volume increases in metals and minerals, coal, automotive, Canadian grain, and fertilizer. Foreign demand for metallurgical coal, in particular, has kept CN busy; the railroad moved record coal volume from mine to vessel for shipment overseas in the first quarter. Strong volume trends continued into the second quarter, as carloads reached 90,000 in April for the first time since fall 2008.

Overall revenue grew 6% (17% adjusted for currency swings). Automotive (48%), coal (28%), intermodal (10%), metals and minerals (6%), and grain and fertilizers (4%) generated increases. Revenues declined 6% for petroleum and chemicals [and] 5% for forest products. CN’s operating ratio—operating expenses as a percentage of revenue—came down to 69.3% from 71.7% a year ago, well below the 80% considered desirable in the railroad industry.

On-the-rail results, as chief executive officer Claude Mongeau noted in his remarks opening the company’s first-quarter conference call, also suggest Canada’s economy is growing faster than most observers anticipated. Based on the first 12 weeks of the year, Canadian National, one of North America’s largest transportation companies, boosted its full-year cash flow guidance from C$700 million to C$1 billion.

More pipeline capacity is needed to transport oil sands production, a growing source of oil supply to the US and still an intriguing prospect for emerging Asian economies such as China, but construction is expensive and time-consuming. Into that perceived breach has stepped CN Rail.

CN has proposed shipping oil sands production south to the US and west to British Columbia’s ports for eventual trans-Pacific delivery; it still hasn’t drawn much attention as the energy exploration industry gets back up to speed following the series of shut-ins and cancellations that marked 2008 and 2009.

CN’s idea is promising; upgraded oil sands output or simple bitumen could be moved more economically than by pipeline—if it can subsequently be exported to Asian markets.

Efficient rail transport could provide immediate cash flow to producers that would otherwise have to wait for the completion of incredibly costly upgraders and/or pipelines—or simply shut in their wells.

Should the oil sands-by-rail plan reach fruition, it will mean major business for the company. But even if it doesn’t, Canadian National is on track for substantial profit gains as the country’s resources increasingly find a market in the Far East. Buy Canadian National Railway up to US $60.  (It closed Tuesday above $57—Editor.)

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