UPDATE 2-Canadian National profit nipped by forex, fuel costs

(Updates with conference call)

VANCOUVER, British Columbia, July 21 (Reuters) - Canadian National Railway (CNR.TO) posted an 11 percent drop in second-quarter earnings on Monday, nipped by a stronger Canadian dollar and higher fuel costs, but still beat expectations.

The railway, with operations in Canada and the United States, said it is was sticking with forecast for 2008 earnings-per-share growth in the mid-single digits, despite the volatile economy.

Fuel surcharges billed to customers traditionally lag the railway's actual fuel costs, but should begin to kick in in the second half of 2008 when CN also expects its fuel bill will stabilize somewhat.

"Even with headwinds (such as fuel costs) I am very very encouraged about the second half of the year in spite of what appears to be a less than robust economy," Chief Executive Hunter Harrison told analysts in a conference call.

Canadian National said its profit dropped to C$459 million ($459 million), or 95 Canadian cents a share, in the quarter ended June 30 from C$516 million, or C$1.01 a share, a year earlier.

The results were boosted about 5 Canadian cents a share by an income tax-related recovery.

Analysts, on average, had expected earnings of 86 Canadian cents a share, with estimates ranging between 93 and 83 Canadian cents a share, according to Reuters Estimates.

Revenues rose 4 percent to C$2.09 billion, in part because of fuel surcharges, but that was offset by fuel costs that were up 60 percent year over year to about C$400 million and helped push up operating expenses 14 percent to C$1.4 billion.

Canadian National's operating income fell 13 percent to C$707 million and its operating ratio -- a measure of efficiency -- deteriorated about 6.3 percentage points to 66.3 percent, with fuel costs responsible for much of that.

CN reported higher revenues for most commodity groups such as intermodal and chemicals, but automobile revenue was off 13 percent and forest products down by 14 percent as customers in both sectors continued to suffer.

The railway said the stronger Canadian dollar, which had an impact on both its revenues and expenses, took a bite of about C$25 million out of its second-quarter profit, or about 5 Canadian cents per share.

Officials said foreign exchange rates will be less of a concern in year-to-year comparisons in the second half of 2008, because the Canadian dollar saw its climb to current levels around parity with the the U.S. dollar in the second half of 2007.

($1=$1 Canadian) (Reporting Allan Dowd, editing by Rob Wilson)