Canadian National Railway (CNI)

Background Founded in 1918 by the Canadian gov’t Deregulation of 1980 Headquartered in Montreal, Quebec Largest railway in Canada Only Canadian transcontinental railroad ADR (denominated in CAD)

Industry Overview Railroads operate about 9% of overall U.S. Transportation Market Rails and trucks have gained market share in last 30 years for freight

Industry Overview Railroads can be broken down by region Class I railroads ship a mix of commodities which usually constitutes 50-60% of total carload Rest is intermodal

Business Model Transport goods for profit Must pay for creation and maintenance of tracks and trains Geographic monopolies are common Efficiency is a big revenue driver

Commodity Mix

Freight Mix

Industry Performance Market cap weighted Rail performance vs. XLI and the S&P 500

Industry Overview Tied to demand of products that a railroad hauls High barriers to entry High debt ratios Very asset-intensive

Industry Outlook Gaining momentum over trucking on fuel prices and increases in efficiency Pricing gains outpacing inflation Tied to recovery in economy High debt loads, can be affected by interest rates

Industry Competitive Advantages Incredibly asset-intensive (high barriers to entry) Low geographic competition Diversified by economic demand Market share gains by industry give increased pricing power to rail freight companies 20-25x trucking’s fuel efficiency

Industry Competitive Disadvantages Geographic limitations (U.S. map, overseas growth difficult) Capital structure makes it difficult to generate free cash flows Low scalability (50-60% of CapEx goes to maintenance of tracks and rail cars)

CNI Highlights Market Cap: 38.53Bn Trading around $89.30 (11/28) Beta: 0.99 TTM EPS: % Dividend Yield P/E: 14.73

CNI Freight mix

CNI Performance Performed about in line with its peers on the 1y Outperforming XLI

CNI Competitive Advantages Best in class operating ratio and average velocity Sets the railroad standard for efficiency Has implemented programs that encourages customers to operate more fluidly and charges customers for delays to improve efficiency Using its advantages to focus on top-line growth

Competitive Advantages Industry-best RoA, RoE, TTM Sales Growth

Competitive Advantages Trading around the industry P/E ratio despite very strong competitive advantages and higher profitability

Current Initiatives Moving away from cyclical commodities Thermal coal phased out (metallurgical coal => offshore markets/steel production) Moving crude oil by rail from pipeline constraints “Precision” Railroad, 7 days/week Prince Rupert Crude Oil Carloads , (e) 30, (e) 60,000

Growth opportunities Larger mix of forest products and metals than competition ties CNI more to housing market Industry EV/EBITDA multiples are trading at about a 15% discount to the S&P One of highest industry FCF (w/ positive momentum) allows CNI to grow faster and return profits to shareholders

Housing Market Carloads tied to housing market represents 14% of revenues (down from 25% in 2006), significant upside potential

Growth opportunities Management increasing less cyclical intermodal % of revenues Share buyback program initiated Oct. 22 to buy 3.6% of o/s shares over next 12 months One of highest credit rating among peers allows the company to take out debt more freely

Risks Denominated in CAD so a strong depreciation in the CAD could hurt actual returns Some commodity markets unstable, underinvested in coal Heavy reinvestment requirements

Investment Conditions Investment horizon 18 months - 2 years Sell 20% adjusted earnings (~$105 PT) Sell if housing starts don’t break 1 million by December 2013 (assuming unchanged (+/-5%) revenue mix) Watch for disruptive weather in railroad’s areas