Executive Summary / Key Takeaways

• Margin Expansion Despite Volume Headwinds: CNI delivered a 170 basis point operating ratio improvement to 61.4% in Q3 2025 while volumes grew just 1% in RTMs, demonstrating that precision scheduled railroading and aggressive productivity initiatives are structurally lowering the cost base independent of top-line growth.

• Capital Allocation Inflection Point: Management's decision to reduce 2026 CapEx to $2.8 billion (down $600 million from 2025) signals a strategic pivot from network expansion to harvesting returns, positioning free cash flow to accelerate meaningfully even in a low-growth macro environment.

• Network Advantages Creating Resilient Growth Pockets: The Prince Rupert gateway's 30% volume growth and grain segment's record performance illustrate how CNI's unique Canadian network and service reliability generate market share gains even as tariffs and weak industrial production pressure other segments.

• Macro and Tariff Uncertainty Remains the Primary Risk: With duties on Canadian lumber more than doubling and steel/aluminum tariffs reaching 50%, forest products and metals face sustained pressure, while the broader North American industrial outlook remains weak, limiting volume visibility.

• Valuation Reflects Quality Premium: At $96 per share, CNI trades at 18.25x earnings and 11.79x EV/EBITDA, pricing in its superior operating margins (41.6%) and ROE (22.7%) relative to eastern U.S. peers, though below the multiples of its larger western rival.

Setting the Scene: The Canadian Railway Toll Bridge

Canadian National Railway Company, incorporated in 1919 and headquartered in Montreal, operates one of North America's most strategically positioned freight networks. The company connects Canada's Eastern and Western coasts with the U.S. Midwest and Gulf Coast, creating a unique north-south and east-west artery that serves as a critical backbone for continental trade. CNI generates revenue by transporting freight across this network, with pricing determined by volume, distance, and cargo type across seven core segments: intermodal, petroleum & chemicals, metals & minerals, forest products, coal, grain & fertilizers, and automotive.

This network positioning creates a powerful economic moat. CNI originates over 85% of its book and terminates more than 65% of its business—more than any other Class I railroad—giving it exceptional control over service quality and pricing. The company's reach into Canada's resource-rich interior and its access to multiple ports (Vancouver, Prince Rupert, Halifax, Montreal) provides customers with routing flexibility that competitors cannot easily replicate. In an industry where scale and density drive unit economics, CNI's Canadian duopoly with CPKC (CP) and its extensive U.S. presence create barriers that have sustained profitability through multiple cycles.

The current investment case rests on two interlocking themes: operational excellence that expands margins even without volume growth, and a capital allocation shift that will accelerate free cash flow generation. These themes emerged from a difficult 2024, when labor disruptions and port strikes prevented CNI from capitalizing on its resourced capacity, teaching management hard lessons about agility and cost control that now define its strategy.

Technology, Products, and Strategic Differentiation: The Precision Railroading Advantage

CNI's competitive edge stems from its precision scheduled railroading model, which optimizes asset utilization through disciplined train scheduling, yard management, and predictive maintenance. This operational philosophy delivered tangible results in Q3 2025: car velocity reached 211 miles per day, through dwell improved by 1%, and locomotive availability hit 93% while failures dropped 12% year-over-year. These metrics represent more than operational trivia—they directly translate to lower costs, faster transit times, and superior service reliability that wins market share.

The productivity gains extend beyond equipment. Training and engine labor productivity improved 20% year-over-year through disciplined crew management and accelerated furloughs, while contractor spend was cut by approximately $120 million year-to-date by shifting work in-house. Engineering productivity saw tie gangs become 7% more productive with 5% lower unit costs, and overtime levels reached their lowest point in a decade. These improvements are structural, not cyclical, reflecting management's focus on embedding efficiency into the operating model.

Technology investments amplify these gains. Locomotive fleet modernization and predictive maintenance analytics have reduced parts inventory by 5% while improving reliability. The company's network operating metrics are at their best levels in the last decade, creating a foundation for what management calls "better to best-in-class" operational consistency. This matters because in a capital-intensive industry, small improvements in asset utilization flow directly to the bottom line—each percentage point of OR improvement represents approximately $120 million in annual operating income.

Financial Performance & Segment Dynamics: Evidence of Margin Leverage

CNI's Q3 2025 results provide compelling evidence that the margin expansion thesis is materializing. Despite revenue growth of just 1% and volume growth of 1% in RTMs (5% in carloads), the company grew EPS by 6% and improved its operating ratio by 170 basis points to 61.4%. This decoupling of margin improvement from volume growth is the hallmark of a successfully executed productivity program.

Segment performance reveals a tale of two businesses. Intermodal delivered robust growth with domestic units up 18% and international units up 14%, driven by the new Gemini service through Prince Rupert where volumes surged 30% year-over-year. This 30% growth at Prince Rupert matters because it demonstrates CNI's ability to capture market share from congested U.S. West Coast ports by offering faster, more reliable service. Grain & fertilizers was a "real bright spot" with 12% revenue growth in Q2, setting records for Western Canada shipments. These growth pockets offset significant weakness in forest products, where lumber faced duties that more than doubled on August 1 plus an additional 10% tariff effective October 14, and metals & minerals, where iron ore shipments fell due to mine idlings and frac sand volumes declined from reduced BC drilling.

The mix shift toward higher-growth, higher-margin segments while managing cost declines in weaker areas shows management's agility. Petroleum & chemicals grew RTMs 8% in plastics and chemicals through market share gains, while coal benefited from the Quintette mine restart. This diversification insulates CNI from single-sector downturns—a critical advantage when tariffs target specific Canadian industries.

Cost control was equally impressive. Fuel expense dropped 20% year-over-year due to the Canadian carbon tax repeal, lower prices, and 2% efficiency gains. Purchased services and materials fell 1% through tight management. Even with a 2% increase in labor costs from incentive compensation and wage inflation, headcount declined 5%. The net result: operating leverage that converted modest revenue growth into meaningful earnings expansion.

Outlook, Management Guidance, and Execution Risk

Management's guidance for 2025 and 2026 reveals a company recalibrating for a lower-growth environment while intensifying its focus on shareholder returns. The full-year 2025 volume assumption remains low single-digit RTM growth, with more than 50% expected from CN-specific initiatives rather than macro recovery. This internal sourcing of growth matters because it demonstrates the company's ability to self-generate momentum through service improvements and market share gains, particularly at Prince Rupert and in grain markets.

The most significant strategic shift is the 2026 capital envelope of $2.8 billion, down nearly $600 million from 2025's $3.35 billion. Management describes this as "no regret capital" completion—capacity expansion projects and fleet upgrades are finished, leaving a maintenance-focused program that aligns capital intensity with U.S. peer levels at mid-teens percentage of revenue. This reduction will accelerate free cash flow generation, with management explicitly stating that incremental cash will be returned to shareholders while maintaining the 2.5x debt-to-EBITDA target.

This capital discipline reflects lessons from 2024, when CNI was "resourced for more volumes than we handled" and failed to deliver bottom-line growth. The new approach keeps over 6,000 system cars and approximately 160 high-horsepower locomotives (about 10% of the fleet) parked and ready, allowing rapid response to volume rebounds without carrying excess costs. Management is "intentionally keeping resources tight and driving efficiencies across the organization to deliver better margins," a stark contrast to the previous build-for-growth mentality.

Commercial initiatives support this efficiency focus. Chief Commercial Officer Janet Drysdale's "boots on the ground sales program" generated $35 million in Q3 and is projected to approach $100 million in Q4, targeting share gains in chemicals, plastics, and domestic intermodal where strong service creates pricing power. This proactive sales approach, combined with operational excellence, aims to drive "growth at a low incremental margin" by resizing the resource base.

Risks and Asymmetries: What Could Break the Thesis

The primary risk to CNI's margin expansion story is sustained volume weakness from macroeconomic deterioration and trade policy. Management acknowledges "limited volume growth with a weak outlook for North American industrial production and housing starts" for 2026, with forest products particularly exposed to continued tariff impacts. If the industrial economy contracts more severely than expected, even best-in-class productivity may not offset fixed cost deleverage.

Tariff uncertainty creates specific segment vulnerabilities. The forest products segment has seen duties more than double, with an additional 10% tariff in October 2025, directly causing mill curtailments that reduce both lumber and wood pulp shipments. Metals & minerals faces 50% tariffs on Canadian steel and aluminum shipped to the U.S., forcing CNI to help customers find alternative markets. While management is actively mitigating through intra-Canada and intra-U.S. moves, these trade barriers represent a structural headwind that could persist "through at least the next several quarters."

Canadian exposure introduces currency and policy risks. With approximately 60% of operations in Canada, a stronger Canadian dollar creates a headwind—each $0.01 appreciation represents a $0.05 annual EPS headwind. More concerning is the potential for regulatory intervention, as evidenced by the "unprecedented referral to the Canadian Investor Relations Board" during 2024's labor dispute, which created three months of uncertainty and diverted container volumes.

Competitive dynamics also pose risks. CPKC's Mexico access gives it an edge in Latin American trade lanes that CNI cannot easily replicate. Union Pacific (UNP)'s scale-driven cost advantages and CSX (CSX)'s eastern network density create pressure in overlapping markets. However, CNI's operational metrics currently lead most peers, and its diversification across commodities provides a buffer that more specialized railroads lack.

The key asymmetry lies in volume recovery. CNI has parked assets ready to deploy and a network operating at best-in-class efficiency. If macro conditions improve or tariff resolutions unlock pent-up demand, the operating leverage could be substantial—each 1% volume gain flows through at high incremental margins given the current cost structure. Conversely, if weakness persists, management has demonstrated the ability to extract costs, as shown by the 170 bps OR improvement in Q3.

Valuation Context: Pricing in Operational Premium

At $96 per share, CNI trades at 18.25 times trailing earnings and 11.79 times EV/EBITDA, with an enterprise value of $75.46 billion representing 6.13 times revenue. These multiples reflect the company's superior operating margin of 41.6% and return on equity of 22.7%, both well above eastern U.S. peers CSX (operating margin 35.1%, ROE 22.6%) and NSC (NSC) (operating margin 36.6%, ROE 20.5%). The valuation gap versus Union Pacific acknowledges UNP's larger scale and western network dominance, while the premium to CPKC reflects CNI's current operational outperformance.

Cash flow metrics reinforce the quality story. The price-to-free-cash-flow ratio of 24.39 and price-to-operating-cash-flow of 12.32 position CNI attractively relative to its 2.66% dividend yield and 47.7% payout ratio. With 29 consecutive years of dividend increases and an active buyback program that repurchased 8 million shares for $1 billion in Q3 2025, the company offers a compelling combination of yield and capital return. The balance sheet remains strong with debt-to-equity of 1.02 and leverage at 2.54x, consistent with the 2.5x target that preserves financial flexibility.

The valuation multiple expansion potential hinges on the margin expansion thesis playing out. If CNI can sustain OR improvements while growing free cash flow through reduced CapEx, the market may re-rate the stock closer to UNP's multiple, implying 15-20% upside from current levels. Conversely, if macro headwinds intensify and volume declines overwhelm cost cuts, multiple compression could pressure the stock despite operational excellence.

Conclusion: Execution in a Challenging Environment

Canadian National's investment case centers on its ability to expand margins through operational excellence while pivoting capital allocation toward maximum shareholder returns. The Q3 2025 results provide tangible proof of this thesis: 170 basis points of OR improvement on 1% volume growth demonstrates structural cost takeout, while the $2.8 billion 2026 CapEx plan signals a harvest phase that should accelerate free cash flow.

The company's network advantages—particularly the Prince Rupert gateway's 30% volume growth and grain segment's record performance—create resilient growth pockets that offset tariff-driven weakness in forest products and metals. This diversification, combined with best-in-class operating metrics, positions CNI to navigate macro uncertainty better than more specialized peers.

The primary variables to monitor are tariff resolution and North American industrial production trends. If trade policy stabilizes and volumes recover, CNI's parked assets and lean cost structure will generate substantial operating leverage. If headwinds persist, management has proven it can extract costs and maintain margins. At current valuations, the market prices in operational excellence but not a macro recovery, creating an attractive risk-reward for investors who believe in CNI's ability to execute through the cycle.