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Rating Action:

MOODY'S UPGRADES THE RATINGS OF CANADIAN NATIONAL RAILWAY COMPANY (SENIOR UNSECURED AT A3)

22 Dec 2005
MOODY'S UPGRADES THE RATINGS OF CANADIAN NATIONAL RAILWAY COMPANY (SENIOR UNSECURED AT A3)

Approximately $4.1 billion of debt affected

New York, December 22, 2005 -- Moody's Investors Service upgraded the debt ratings of Canadian National Railway ("CN") -- senior unsecured to A3. The rating outlook is stable. This completes the rating review opened on July 27, 2005.

The rating action takes into account CN's industry-leading financial performance; focused approach to continuous improvement in operations; sizeable free cash flow generation; and, achieving a return on capital consistent with other industrial issuers at the single-A rating level. As well, Moody's expects CN will preserve its strong credit metrics and liquidity, and further improve its return on capital. Also considered are Moody's expectations that the company will continue to use most of the future free cash flow to repurchase shares and the potential for modest-sized acquisitions, in addition to the considerable amount of capital spending necessary in the railway industry to support high service levels.

CN's scheduled railroad continues to set new standards for performance in the rail industry, and the discipline to scheduled railroading as well as consistently strong investment in the network is generating considerable Free Cash Flow. For FY 2005, operating income growth in excess of 20% should produce Free Cash Flow in excess of C$1.2Bn. Moody's expects that the high level of demand for transportation services will continue over the near term and that CN's results will reflect further volume growth and fluidity in its network, as well as the favorable environment for further improving yield.

The stable outlook reflects Moody's expectations that CN is likely to modestly increase leverage near term, and will be aggressive in share repurchases in doing so. CN believes itself as slightly underlevered compared to its relatively conservative target capital structure. As such, Moody's believes that the company will use most of its Free Cash Flow to repurchase shares and not to prepay debt. Nonetheless, CN views investment in its business through capital spending and appropriate acquisitions as its most important use of cash. Should the company engage in acquisitions, Moody's expects that it would greatly limit, or end, share repurchases until the acquisitions are fully integrated and operations are restored to pre-acquisition levels. Moody's notes that the company eliminated share repurchases post the 2004 BC Rail and Great Lakes Transportation acquisitions. Moreover, with CN's strong operating performance, Moody's expects that CN will maintain key credit metrics consistent with similarly rated peers, including Debt to EBITDA ranging between 2.1 and 2.5x and free cash flow to debt in excess of 10% (using Moody's standard adjustments).

The rating could be raised further if CN applies a meaningful portion of expected free cash flow to debt reduction and sustain Debt to EBITDA (using Moody's standard adjustments) at less than 2.0x, and can further improve operations to generate free cash flow to debt approaching 20% and higher return on capital with EBITDA to Assets greater than 12%. The rating could be lowered if CN pursues a sizeable acquisition while continuing its share repurchase program, or accelerates its share repurchases to materially exceed near term free cash flow, or the business weakens such the free cash flow to Debt falls to the mid single digit level.

Capital investment is expected to continue to be substantial, with gross capital expenditures for the year likely in the $1.4 billion range; up approximately $175 million, and largely reflecting the needs of BC Rail and Great Lakes Transportation. In 2006, capital spending is likely to continue to grow, as CN moves increasing volumes and implements programs to improve efficiency and reduce asset intensity. Capital investment is expected to remain at one of the highest levels in the industry, and Moody's expects capital spending to be in the range of 18 to 19% of revenue over time. CN's scheduled railroad and efficiency programs are expected to lead to continued lowered costs and higher revenue potential through better customer service.

Moody's believes that CN will be the operational leader for some time. The company will likely achieve an operating ratio at the low to mid 60% level --the lowest among its competitors. Productivity gains are likely to offset much of the inflationary cost pressures. Elevated fuel costs are increasingly being passed through via fuel surcharges, and Moody's believes that CN has among the highest recovery levels in the industry.

The near-term outlook for each of CN's business segments is favorable, with the exception of its modest exposure to the auto industry. About 60% of CN's revenue is from merchandise traffic, whose shippers require high service levels but are also most receptive to consistent performance. Higher fuel prices and increasing costs within the trucking industry also improve the economics of rail transport, and CN is therefore well positioned to take additional traffic off the highway. Strong demand for rail service and CN's performance also present the opportunity for CN to gradually improve its yield, and the higher volume and better yield should contribute to steady revenue growth over time. While the higher than industry average exposure to merchandise traffic does increase CN's exposure to an economic downturn, Moody's believes that CN's consistent service somewhat offsets the economic risk as shippers will generally prefer the lower cost of rail transport during soft business conditions.

CN is currently seeing the benefit of several years of considerable reductions in its fixed cost structure. Because of this, growth in cash generation will be more reliant on top-line growth, rather than on cost reductions. Price increases and market share gains, therefore, will be most important—pointing further to the need for continued strong service levels. In addition, CN's focus on applying its scheduled railroad approach to Intermodal traffic has considerable potential, particularly since Intermodal is expected to be the fastest growth segment for some time.

Upgrades:

..Issuer: Canadian National Railway Company

....Issuer Rating, Upgraded to A3 from Baa1

....Senior Secured Pass-Through, Upgraded to A1 from A2

....Senior Secured Shelf, Upgraded to (P)A2 from (P)A3

....Senior Unsecured Bank Credit Facility, Upgraded to A3 from Baa1

....Senior Unsecured Regular Bond/Debenture, Upgraded to A3 from Baa1

....Senior Unsecured Shelf, Upgraded to (P)A3 from (P)Baa1

....Subordinated Shelf, Upgraded to (P)Baa1 from (P)Baa2

..Issuer: Illinois Central Railroad Company

....Senior Unsecured Medium-Term Note Program, Upgraded to A3 from Baa1

....Senior Unsecured Regular Bond/Debenture, Upgraded to A3 from Baa1

..Issuer: Wisconsin Central Transportation Corporation

....Senior Unsecured Regular Bond/Debenture, Upgraded to A3 from Baa1

Outlook Actions:

..Issuer: Canadian National Railway Company

....Outlook, Changed To Stable From Rating Under Review

..Issuer: Illinois Central Railroad Company

....Outlook, Changed To Stable From Rating Under Review

..Issuer: Wisconsin Central Transportation Corporation

....Outlook, Changed To Stable From Rating Under Review

Canadian National Railway, based in Montreal Quebec, operates a transcontinental railroad across Canada and also serves the middle U.S.

New York
Michael J. Mulvaney
Managing Director
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Robert Jankowitz
Senior Vice President
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
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