DBRS Limited (Morningstar DBRS) confirmed Canadian National Railway Company's (CN or the Company) Issuer Rating and Unsecured Bonds, Debentures & Notes rating at 'A.' Morningstar DBRS also confirmed CN's Commercial Paper rating at R-1 (low).

All trends remain Stable.

KEY CREDIT RATING CONSIDERATIONS

The credit ratings confirmations and Stable trends reflect the Company's sound operating performance in 2023, combined with Morningstar DBRS' expectations that, although key credit metrics will weaken as the Company uses incremental debt for significant share buybacks, key credit metrics will remain commensurate with the current ratings.

In 2023, revenue declined modestly by 1.6% year over year (YOY) to approximately $16.8 billion. This was largely attributable to lower volumes of intermodal, crude oil, U.S. grain, and forest products offset by increased volumes of Canadian grain and potash. In addition, higher freight rates and the positive impact from a weaker Canadian dollar more than offset lower fuel surcharges. In line with the decline in revenue, EBITDA and operational cash flow (as defined by Morningstar DBRS) also modestly declined to approximately $8.4 billion (-1.8% YOY) and $7.0 billion (-0.8% YOY), respectively. Free cash flow also declined to $1.8 billion ($2.6 billion in 2022) largely because of higher capital expenditures (capex) of $3.2 billion in 2023, up from $2.8 billion in 2022. CN used its free cash flow in combination with incremental debt of $3.2 billion to support its share repurchases of more than $4.5 billion in 2023 . Consequentially, debt-to-EBITDA leverage increased to 2.2 times (x) in 2023 from 1.8x in 2022.

CREDIT RATING DRIVERS

Should key credit metrics weaken for a sustained period beyond what Morningstar DBRS deems acceptable for the current rating (i.e., debt-to-EBITDA above 2.5x) as a result of either weaker-than-expected operating performance and/or more aggressive financial management, the credit ratings could be pressured. Furthermore, a sustained period of weaker-than-expected operating performance reflecting a permanent downward shift of the Company's business risk profile would require the Company to maintain stronger credit metrics in order to support the same rating. Although highly unlikely over the near term, any significant improvement of key credit metrics (i.e., debt-to-EBITDA improving toward 1.5x) over a sustained period coupled with management's commitment to maintain key credit metrics at such levels may warrant a positive rating action.

EARNINGS OUTLOOK

Morningstar DBRS expects the Company's earning profile to remain solid, with revenues forecast to grow to above $18 billion in 2024 and above $20 billion in 2025, helped by price increases and recovering volume growth. A recovery in volumes should be helped by a rebounding intermodal growth largely as a result of a stronger than expected U.S. labour market, recovery in home sales, a tight automotive inventory supporting auto volumes, and continued demand for Canadian potash owing to the ongoing Russia-Ukraine conflict. Additionally, CN's Mexico offering in tie-up with Union Pacific (UP) and Ferromex should also help drive volumes. Volume recovery should be complemented with price increases that should remain ahead of inflation. In line with revenue growth, EBITDA should also grow to above $9 billion in 2024 and $10 billion in 2025.

FINANCIAL OUTLOOK

Strong EBITDA should translate to solid cash flow generation with operating cash flow reaching close to $8.0 billion in 2024 and more than $8.5 billion in 2025. As the Company continues to invest in its network, capex is set to remain high with approximate $3.5 billion expected for 2024 and $3.7 billion for 2025. As a result, Morningstar DBRS forecasts free cash flow net of dividends to be more than $2.2 billion in 2024 and above $2.6 billion in 2025. Morningstar DBRS expects the Company to use its free cash flow in combination with incremental debt for shareholder repurchases. As such, in line with Morningstar DBRS' expectations, credit metrics should moderate further, with debt-to-EBITDA increasing toward 2.5x in 2025.

CREDIT RATING RATIONALE

The credit ratings continue to be underpinned by CN's vast network, diversified product and customer base, industry-leading operating efficiency, traditionally strong cash flow generation, and the broad importance of the sector to the broader economy. The ratings also consider the potential for further strengthening of the business risk profile over the medium term helped by planned Port Terminal expansions at Halifax; Contrecoeur, Quebec; Vancouver; Prince Rupert, British Columbia; and New Orleans. Additionally, the potential of future partnerships similar to the Company's partnership with UP and GMXT, which led to the development of the premium intermodal product offering connecting Canada, Mexico, and the U.S., may also positively affect the business risk profile over the medium term. Offsetting these advantages are the high capital intensity of the railway industry, regulatory focus on safety and service, and the overall maturity of the industry with its modest long-term growth relative to other cyclical industries.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://dbrs.morningstar.com/research/427030 (January 23, 2024).

BUSINESS RISK ASSESSMENT (BRA) AND FINANCIAL RISK ASSESSMENT (FRA)

(A)	Weighting of BRA Factors

In the analysis of Canadian National Railway Company, the relative weighting of the BRA factors was approximately equal.

(B)	Weighting of FRA Factors

In the analysis of Canadian National Railway Company, the relative weighting of the FRA factors was approximately equal.

(C)	Weighting of the BRA and the FRA

In the analysis of Canadian National Railway Company, the BRA carries greater weight than the FRA.

Notes:

All figures are in Canadian dollars unless otherwise noted.

Morningstar DBRS applied the following principal methodologies:

Global Methodology for Rating Companies in the Railway Industry (April 15, 2024), https://dbrs.morningstar.com/research/431183

Morningstar DBRS Global Corporate Criteria (April 15, 2024), https://dbrs.morningstar.com/research/431186

Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://dbrs.morningstar.com/research/427030 (January 23, 2024).

Morningstar DBRS credit ratings may use of one or more sections of the Morningstar DBRS Global Corporate Criteria (April 15, 2024), which covers, for example, topics such as holding companies and parent/subsidiary relationships, guarantees, recovery, and common adjustments to financial ratios.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

A description of how Morningstar DBRS analyzes corporate finance transactions and how the methodologies are collectively applied can be found at https://dbrs.morningstar.com/research/431153.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at info-DBRS@morningstar.com.

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS trends and credit ratings are under regular surveillance.

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.

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