Excess in Grain Revenue Caps Hurts Canadian Railways

Canada's railways will be hit hard in the fourth quarter, says J.P. Morgan analyst Thomas Wadewitz, by a larger-than-expected excess in their respective grain revenue caps for the 2007-2008 grain year ended in August.

Earlier this week, the Canadian Transportation Agency announced that Canadian National Railway Co. (CNI) exceeded its grain by C$26-million and Canadian Pacific Railway Ltd. (CP) exceeded its cap by C$33.8-million.

Mr. Wadewitz told clients in a note:

We believe that the combined overage and penalty are greater than anticipated for both CN and CP. Our sense is that CN and CP expected the total impact to each railroad to be on the order of C$23-million. However, we believe the additional C$7-million for CN and C$16-million for CP (including the penalties) will likely be a drag on 4Q08 earnings, regardless of any appeals that may be filed by January 23, 2009.

The analyst also noted that both railways are experiencing weak volumes in the fourth quarter, with CN down 9.8% and CP down 9.4% year-over-year.

Mr. Wadewitz said the combination of incremental grain penalties and weak volumes puts at risk CN and CP's Q4 earnings, which are expected by the Street to reach C$1.02 andC$1.15, respectively.

He has a "neutral" rating on CN stock and $36.01 price target and a "neutral" rating and $33 price target on CP.