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CN Rail shares take a hit as efficiency dips

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Shares of Canadian National Railway Co (CNR-T) "took it on the chin" on Tuesday as quarterly results revealed a surprise weakening in productivity, suggesting performance gains may be getting tougher for North America's most efficient railroad.

The stock skidded nearly 5 percent as Canada's biggest railway also cautioned that a pension cost headwind could cap its earnings per share growth at 10 percent in 2012. In 2011, EPS increased by 15 percent.

Raymond James analyst Steve Hansen said that CN stock is trading at a premium to the broader North American rail sector and is "priced for a bit of perfection" thanks to the railway's top-rated operating efficiency.

"As soon as you get a marginal slip in performance they take it on the chin," Hansen said.

CN said its operating ratio - an important measure of a railroad's productivity - rose 1.3 points to 64.7 percent in the fourth quarter. The lower the ratio, which measures operating costs as a percentage of revenue, the more efficient the railway.

CN has the lowest ratio of North America's "big six" railroads, and it has been rare in recent times for increases in its operating expenses to outstrip revenue growth.

"These guys are so efficient. It is getting more difficult to drive the operating ratio lower," said Edward Jones analyst Brian Yarbrough.

For all of 2011, CN's operating ratio was 63.5 percent, a tiny improvement on its 63.6 percent in 2010. It is still far superior to that of its biggest domestic competitor, Canadian Pacific Railway (CP-T), which last reported a ratio of 75.8 percent.

The efficiency of Canada's two big railroads is at the center of a proxy battle being mounted at CP by activist investor William Ackman and his Pershing Square Asset Management group, which is now CP's biggest shareholder.

Ackman wants to replace CP's chief executive with former CN CEO Hunter Harrison. Ackman says Harrison will be able to drive the same productivity improvements at CP as he did at CN.

Q4 EARNINGS RISE

CN aims to increase diluted earnings per share by up to 10 percent in 2012 and cited "significant headwinds" from a pension expense of about $120 million ($118.72 million US), which analysts said will weigh on its operating ratio.

Earlier, CN reported a 20-percent rise in fourth-quarter earnings to $592 million, or $1.30 a share after adjustments, up from 2010's fourth quarter and ahead of market expectations for earnings of $1.30 a share.

However, analysts said that much of the beat was due to a lower tax rate in the quarter. "The quality of the earnings' beat was low," Yarbrough said.

Quarterly revenue increased 12 percent to a record $2.38 billion as all of CN's commodity groups experienced higher revenues, led by a big increase in metal and minerals hauling, followed by intermodal.

"We were successful in outpacing the economy, but also in outpacing our peers," CN Chief Executive Claude Mongeau said on a conference call.

CN raised its quarterly dividend by 15 percent.

"Although the economic recovery may be affected by global uncertainty, CN believes the gradual improvement in the North American economy will continue in 2012," Mongeau said.

The company, which has tracks across Canada and in the United States, plans to spend $1.75 billion on capital projects in 2012, up from the $1.6 billion spent in 2011.

CN declined to comment during its conference call about the CP proxy battle. It said on Monday it had stopped paying retirement benefits to Harrison as it believes he is breaching his contractual obligations because of his involvement in Ackman's plans for rival CP.

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