September 2, 2011



Canadian National Railway Co. |(CNI-NYSE) |$95.76 | |

Note: This report contains substantially new material. Subsequent reports will have changes highlighted.

Reason for Report: 1Q13 Earnings Update

Prev. Ed.: Apr 4, 2013; 4Q12 and 2012 Earnings Update

Brokers’ Recommendations: Neutral: 81.0% (17 firms); Positive: 14.3% (3); Negative: 4.7% (1) Prev. Ed.: 16; 4; 2

Brokers’ Target Price: $97.83 (↑$2.69 from the last edition; 19 firms) Brokers’ Avg. Expected Return: 2.2%

Note: A Flash Update was done on May 28, 2013: CNI Ramps Up Wisconsin Venture

A Flash Update was done on Apr 22, 2013: 1Q13 Earnings Release

Portfolio Manager Executive Summary

Canadian National Railway Co. (CNI) is the largest Canadian railroad and the fifth largest North American railroad as measured by carloads. It engages in the rail and related transportation business, including intermodal (containers and trucks) in North America, transporting a portfolio of goods, including petroleum and chemicals, metals and minerals, forest products, coal, grains and fertilizers, and automotive.

Of the 21 firms covering the stock, 17 assigned neutral rating, 3 rendered positive ratings and 1 gave negative ratings. The price target ranges from $84.00 to $112.00, with the average being $97.83

The following is a summarized opinion of the diverse brokerage viewpoints:

Cautious: Neutral or equivalent outlook (17/21 firms): The firms believe that Canadian National has improved on technological innovations and industry consolidation. These improvements have resulted in better service levels to customers, enabling it to hike freight rates, while gaining market share from highway to rail freight conversions. In addition, the company also focuses on cost savings and service, which have consistently improved its profitability. However, with rapid margin expansion over the past decade and operating margins remaining close to peak levels, the firms do not see much scope for expanding margins in the near future unless volume and pricing escalate. As a result, the firms apprehend that despite improved operational metrics, margin growth will be difficult, thus creating roadblocks in earnings expansion. Further, fluctuations in oil prices also create substantial risk in terms of fuel surcharges, which is significant in determining the company’s total revenue.

Bullish: Buy or equivalent outlook (3/21 firms): The brokerage firms remain bullish over the company’s future given its best-in-class operating performance, healthy balance sheet, strong free cash flows, share buybacks, and a management team focused on increasing dividend and improving growth prospects. The company’s volume outlook remains positive, as it aims to tap its pipeline of opportunities in key growth segments. The firms believe the company will be able to realize growth targets through its market share gains, productivity initiatives and pricing strategies. The firms also believe that Canadian National has exhibited solid service capabilities to deliver strong results and maintain network fluidity and productivity despite challenging weather conditions and unfavorable exchange rates.

Bearish: Negative or equivalent outlook (1/21 firms): The firm remains apprehensive about the company’s prospects due to weakness in some of the product lines along with estimated higher expenses, competitive pressures and uncertainties in the market conditions.

The firms believe the following additional factors should also be taken into consideration for investing in the stock:

A) The company is the only railroad that crosses the continent east-west and north-south, serving ports on the Atlantic, Pacific, and Gulf coasts, while linking customers to all three NAFTA nations.

B) Canadian National enjoys a strong competitive position within the North American Class I railway industry, positioned as the largest Canadian operator by both network and size.

C) The company faces significant competition in ground transportation in Canada. It not only competes with the primary Canadian rail carrier, which serves the same regions, but also faces intense competition from trucking companies in eastern Canada.

D) Canadian National consistently leads the Class I railroads relative to several key financial metrics, from its industry best operating ratio, free cash generation relative to revenue, free-cash flow return on equity, and return on invested capital.

E) Canadian National expects a capital investment plan of C$2 billion for the year, up from C$1.9 billion stated previously. Approximately, C$1 billion of this would be spent on developing railway track infrastructure to enhance business networks. Further, the company aims to direct C$700 million of the total budget on market expansion to increase distribution centers and construct intermodal terminals. Moreover, it will spend approximately C$200 million on the purchase of locomotives, intermodal equipment and vehicles. In 2013, Canadian National expects to purchase 40 new and 37 second-hand high-horsepower locomotives. Additional C$100 million expenditure on the upgrade of infrastructure in order to increase network capacity in the Western Corridor is also planned.

F) Canadian National’s strong financial performance has strengthened its balance sheet position. It expects to generate free cash flow of $800–$900 million in 2013. The improved liquidity profile of the company will not only support higher investment, but will also assure shareholder return via dividend payouts and share buybacks. Canadian National maintained dividend hikes for seventeen consecutive quarters since 1995. Following a 15% dividend hike in 2012, the company again raised its dividend by 12% to C$0.43 for 2013. Canadian National also introduced a new share repurchase program worth C$1.4 billion in 2012. The company will fund its dividend and share repurchases through cash generated from operations.

General Outlook

The company expects the improving economy to support North American industrial production growth. Canadian National is poised to benefit from strong pricing as well as volume growth on Intermodal backed by truckload to rail freight conversions. Further, significant gains from automotive shipments and high commodity prices, growing demand for petroleum products will also aid revenue and earnings growth in 2013.

June 25, 2013

Overview

Based in Montreal, Canada, Canadian National Railway Company is engaged in the rail and related transportation business. The company spans Canada and mid-America from the Atlantic and Pacific oceans to the Gulf of Mexico, serving the ports of Vancouver, Prince Rupert, British Columbia, Montreal, Halifax, New Orleans, Alabama, and the cities of Toronto, Buffalo, Chicago, Detroit, Duluth, Minnesota/Superior, Wisconsin, Green Bay, Wisconsin, Minneapolis/St. Paul, Memphis, St. Louis and Jackson, Mississippi, with connections to all points in North America. In addition to its regional structure, the company organized its businesses under seven business units: Petroleum and Chemicals, Metals and Minerals, Forest Products, Coal, Grain and Fertilizers, Intermodal and Automotive. CNI's revenue is derived from the transportation of a diversified and balanced portfolio of goods.

The firms identified the following factors for evaluating the investment merits of CNI:

|Key Positive Arguments |Key Negative Arguments |

|Compelling Fundamentals: Pricing strength and competitive pricing strategy |Fuel Costs: High fuel cost is expected to negatively impact financial |

|combined with strong demand continue to drive the topline results, while |results by slowing the future pace of global and North American economic |

|cost improvement and network optimization also add to higher earnings. |activity. High crude oil prices make it more difficult to offset margin |

|Management provides high-quality customer service. |pressure using fuel hedging and fuel surcharges. |

|Best Track Record: CNI's track record is the best among the major railroads |Currency Risk: Sustained increase in the C$ relative to the US$ has the |

|in terms of EPS growth, free cash flow, stock performance, share buybacks, |potential to slow trade between the countries, negatively impacting |

|and increasing dividends. |carloading growth. For the U.S. investors, currency risks exist if the US$ |

|Market Share Gains: Factors like fuel efficiency, truck driver shortages, |appreciates against the C$. In that case, the translated EPS results in the |

|favorable environmental legislation, new passport legislation, and |US$ could be negatively impacted. |

|increasing costs of trucks bolster the rail share. The company is increasing|Slowdown in Economy: The company’s traffic base is more cyclical in nature |

|capex to support growth and efficiencies. |than its peers. An abrupt North American or global economic slowdown would |

|Low Costs: CNI remains the low cost company and has a long proven record of |impact results. Rising interest rates could contract multiples. |

|creating shareholder value through its dividend increases and share |Revenue Concerns: Lack of volume growth and potential for government |

|buybacks. |intervention may depress revenue growth going forward. |

For more information on CNI, visit its website at:

Note: The company’s fiscal year ends on Dec 31.

June 25, 2013

Long-Term Growth

The firms expect Canadian National’s propspects to be strong on demand across all its businesses with substantial growth in volume and pricing. Despite the strong Canadian dollar and surging fuel prices, the company has exhibited operational excellence that bodes well for its long-term operating ratio in the mid-60s range. These firms expect double-digit earnings per share (EPS) growth upto 15% with mid single-digit volume growth, sustainable price growth above inflation, and capital expenditure as a percentage of sales in the 17%–19% range.

The firms believe the supply chain collaboration for coal, grain and terminal service agreements will boost volume expansion over the long term along with continued strength in its international business. Additionally, market share gains, solid execution, effective cost-control measures, a turnaround in automotive production, and gradual improvements in housing and related segments will generate strong results over the years.

The firms also believe that the company is gaining significant exposure in emerging markets across all its business lines. Export coal will remain a key driver for the company’s long-term growth, particularly due to higher shipment from West Coast and Port of Prince Rupert, which serves to PRB (Powder River Basin) mines. The ports are also emerging as a new hub for coal exports. The company expects mine expansions and new mine openings to support 25 million tons of additional coal shipments per year over the next 3–4 years.

Intermodal is expected to remain a key growth driver. The company has also entered into 10 years contract with Canpotex Ltd. to ship potash in Canpotex's main export terminal in Vancouver, ending Canadian Pacific’s monopoly over potash shipments in Canadian export markets. Other growth opportunities include market share gains in new fractional sand shipments, growth in automotives on higher production in North American light vehicle production, overseas container traffic, wood pulp and lumber offshore metal products, and iron ore in domestic as well as international markets.

The company aims to maintain high railroading (velocity, reliability, lower costs, and asset utilization) standards. The company already has a 20%–25% advantage relative to its peers, in terms of train speed and dwell time. In addition, it is continuously seeking productivity initiatives to reduce costs and leverage its assets. The company focuses on increasing its train productivity by accelerating the purchase of locomotives, which are being equipped with distributed power capability that allows it to run longer and more efficient trains, particularly in cold weather conditions.

The firms believe the company’s potential for strong free cash flow generation provides it with an opportunity to deploy cash in other high-return areas outside its traditional markets. In addition, the company’s higher free cash flow will allow it to enter non traditional markets (ports/3PL) in which its more cash-constrained peers cannot compete. Further, the balance sheet strength makes the company attractive for investors seeking higher returns through dividends and share buybacks.

June 25, 2013

Target Price/Valuation

Provided below is a summary of target price/valuation:

|Rating Distribution |

|Positive |14.3%↓ |

|Neutral |81.0%↑ |

|Negative |4.7%↓ |

|Max. Target Price |$112.00↓ |

|Min. Target Price |$84.00 |

|Avg. Target Price |$97.83↑ |

|No. of Analysts with Target Price/Total |19/21 |

Key risks to target price include a general slowdown in North American or global economic conditions, falling housing starts and lower forest product shipments, foreign exchange, long-term work stoppages, potential disruptions from a highly unionized labor force, potential rising interest rates to contract sector multiples and changes in North American grain production.

Recent Events

On May 28, 2013, is accelerating work on the US$33-million upgrade of its Whitehall Subdivision in Wisconsin to increase car-loading capacity and train velocity for the growing frac sand supply chains of Badger Mining Corporation, Preferred Sands of Wisconsin LLC, Atlas Resin Proppants LLC, and Taylor Frac LLC.

On Apr 22, 2013, Canadian National reported adjusted EPS of C$1.22 (approximately $1.21) missed the Zacks Consensus Estimate of $1.23. The results however increased 3% from the adjusted EPS of C$1.18 ($1.17). Quarterly revenues increased 5% year over year to C$2,466 million (approximately $2,447 million) but failed to match the Zacks Consensus Estimate of $2,512 million.

On Mar 28, 2013, Canadian National has entered into a multi-year agreement with Coalspur Mines Limited. The agreement involves a 7-year contract for transporting thermal coal from Coalspur’s Vista Coal Project in Alberta, Canada, to Ridley Terminals as well as construction of railway lines to serve its mine.

Revenue

Revenues increased 5.0% year over year to C$2,466 million (approximately $2,447 million) in 1Q13. The company gained significantly from growth across most of its commodity segments like Petroleum and Chemicals, Intermodal and Automotive.

Revenue ton-miles (measured by the relative weight and distance of rail freight transported by the company) increased 3.0% in 1Q13.

Carloads (volumes) increased 2.0% in 1Q13. Core pricing gains were 3.5% year over year in 1Q13.

Details of each segment, as per the company press release, are as follows:

Petroleum and Chemicals: Petroleum and Chemicals revenue increased 17.0% to C$457.0 million ($453.5 million) in 1Q13. The growth was driven by higher crude oil shipments and increased volumes of propane and chlorine. In addition, higher freight rate and fuel surcharge due to longer haul crude volumes also aided the growth.

Metals and Minerals: Metals and Minerals revenue increased 3.0% year over year to C$282.0 million (279.8 million) in 1Q13 driven by higher shipments of materials used in oil and gas industry, in particular pipe and sand.

Forest Products: Forest Products revenue increased 2.0% year over year to C$336.0 million ($333.4 million) in 1Q13 backed by freight rate hikes and increased shipments of lumber and panels to the U.S. market.

Coal: Coal revenue dipped 1.0% year over year to C$165 million ($163.7 million) in 1Q13 due to lower shipments of thermal coal largely offset by higher Canadian metallurgical coal shipments and freight rate increases.

Grain and Fertilizer: Grain and Fertilizer revenue increased 1.0% year over year to C$401.0 million ($398.0 million) in 1Q13. The gowrth was byoued by freight rate increases, rise in potash export; higher demand for fertilizers and export soybeans, peas and lentils.

Intermodal: Intermodal revenue increased 7.0% year over year to $492.0 million ($488.3 million), backed by higher volumes from overseas markets as well as improving container traffic in the domestic market.

Automotive: Automotive revenue increased 2.0% year over year to C$132.0 million ($131.0 million) in 1Q13, owing to a rise in freight rates.

Other Revenue: Other Revenue includes those from services such as non-rail transportation and inter-switching, increased 1.0% year over year to C$201.0 million ($199.4 million) due to higher revenues from services like warehousing and distribution, docks and vessels.

Outlook

Canadian National expects modest economic growth in North America to support around 2% growth in industrial production in 2013. It expects strong demand across all its businesses with improvements in wholesale and retail markets, underpinning 3–4% growth in business volumes for the year. In addition, pricing should also be favorable if growth remains above cost inflation.

Management expects Intermodal growth to be driven by international and domestic businesses. International business growth will be backed by increased shipments through the Port of Vancouver and the Port of Halifax as well as the new terminals in Joliet, Illinois and Indianapolis which will start operations in the near term. Domestic Intermodal business will be driven by industrial customers and direct retail programs. New terminals coming up for loading and offloading crude shipments will aid crude business, especially in the North American energy markets. In addition, revenue accretion is expected from the upcoming markets for frac sand, pipe, and construction aggregate.

Management expects Automotives to grow on higher North American auto production. In terms of fertilizers, management expects the 10-year contract with Canpotex Ltd. for transporting potash, to be accretive to carloads. Further, higher metallurgical coal exports and a 7-year contract with Coalspur inked in Feb 2013 will also aid revenue growth. In addition, exports through the Central Gulf region will also aid U.S. coal exports. Further increased lumber and panel shipments, buoyed by the opening of a few Canadian panel mills will support West Coast container import into the U.S. Midwest and export to the Asian markets. However, management expects agricultural revenues to remain subdued owing to low corn and soybean stocks.

The firms believe large oil producers are increasingly looking for crude-to-rail movements to the East Coast. The firms suggest that this news bodes well for the company as it is increasingly looking into grow in the Eastern oil market. Further, the company’s partnership with other railroads in this network well also aid revenue going forward.

Margins

The company’s adjusted operating income declined 2% year over year to C$780 million (approximately $774 million), while operating expenses crept up 9% year over year to C$1,686 million (approximately $1,673 million). Operating ratio (defined as operating expenses as a percentage of revenue) was 68.4%, up 220 basis points.

Outlook

The company expects a financial headwind of C$150 million in 2013 pertaining to higher pension expense (approximately C$120 million) and depreciation expenses (C$30 million). Tax expenses are also expected to remain higher in the remainder of 2013 owing to provincial budgets and corporate income taxes.

Earnings per Share

Canadian National reported pro forma EPS of C$1.22 (approximately $1.21) in 1Q13, up 3.0% from C$1.18 ($1.17) in 1Q12.

Outlook

Management expects EPS to register high single-digit year-over-year growth in 2013.

The firms believe the company continues to lead the industry in terms of top-line growth with volume growth faster than most other railroads. However, the firms fear that the headwinds arising from pension would remain a drag on earnings, limiting growth to only a single digit in 2013.

– The Online Stock Research Community

Discover what other investors are saying about Canadian National Railway company (CNI) at:

CNI profile on

|Research Analyst |Pinky Ghosh |

|Copy Editor |Sudipta Mukherjee |

|Content Ed. |Moutushi Saha |

|Lead Analyst |Moutushi Saha |

|QCA |Nalak Das |

|No. of brokers reported/Total |21/21 |

|brokers | |

|Reason for Update |Earnings |

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Jun 25, 2013

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