Canadian National Railway Company (CNR) Earnings Call Transcript & Summary

I think we're live here. Good morning, everyone, and I'm Brandon Oglenski, senior transportation and airline analyst here at Barclays. Just want to welcome everyone to 37th Annual Barclays Industrial Select Conference. It's been going on for quite some time. We know you have lots of choices in conferences, so I appreciate you coming to ours and definitely appreciate the support. And I'm definitely delighted to kick off the transportation sector this morning with Canadian National. Honestly, probably the first Precision Scheduled Railroad, which has become a pretty hot topic for railroad investors, and definitely, going to have a good conversation here. So joining us today is Ghislain Houle, Chief Financial Officer; Keith Reardon, Senior Vice President of Consumer Product Supply Chain. I got that right?

Correct.

Okay.

Screen had to be elongated a little bit to fit his title, but...

You're going to hear this a lot today as we go through the presentations. If anyone that's been to this conference before is going to be well aware. But if you look at that old-school Blackberry looking device, we're going to do audience response questions. It is pretty cool for the [ corporates ] too because they see time series of these. So if we can queue up the ARS question one. Do you currently own the stock in the room? Yes, overweight, market weight, underweight or no? And then we'll give a few seconds here to answer. And you'll see these in every presentation today. [Voting]

Do you think they will answer?

Yes, we need some up here. Question number 2, please? What is your general bias towards Canadian National right now: positive, negative or neutral? [Voting]

All right. And then last -- question number three, and then I'm going to turn it over. In your opinion, through-cycle EPS growth for Canadian National will be, above peers, in line or below peers? [Voting]

Probably talk about return to...

Yes. That's a pretty favorable audience, actually.

So just laying in, Keith, I know there's been a lot going on in Canada. You guys want to address some issues that are going on in the network right now? I know I saw an announcement that you've had some disruption in your network so...

Yes, so maybe -- well, first of all, thanks for having us again, Brandon. It's always nice to leave Montreal and come to beautiful Miami. We left actually yesterday with a bit of a snowstorm. So I think we're very pleased to be here. Thanks for people being in the room and people listening on webcast. Yes, Keith and I will give a little bit of update on the context of what we're seeing now for CN. I'll be more short term, Keith will be a little bit more long term. We'll take a few minutes. And then after that, we can dig into your questions. So obviously, there is quite a bit happening. If you look at Q1 to date, there is quite a bit of happening for CN and in Canada. Typically, Q1 is always a quarter where there's more noise, obviously, due to the weather mostly. And when you look in January, I think that hit us, not unusual. We had 8 days of deep frost in Western Canada that impacted our network. But frankly, after, we were pretty lucky on the weather. The weather in Canada, across the board, has been relatively good. Unfortunately, when we think about weather in Canada, we think about the cold, but there's been some torrential rains west of Vancouver on our main line that caused some landslides and caused some washouts, 2 washouts, actually, Keith, one before tunnel and another one in the tunnel. So we had our engineering forces working very, very, very diligently, very safely to fix this. And again, this is the rain where it's a bit tough to work on, but we're glad that we fixed the network. And then came the -- some of you that are reading the Montreal news and Québec news and Canada news, the First Nation blockage that started in February 6. So we had one in Western Canada, which was east of Terrace and west of the Smithers. So that's right in the middle of the Rockies, actually blocking our mainline going to Rupert. That blockage has been lifted. So now we're back to business in moving our -- the customers' precious goods are going to Rupert. But there's another one in the Eastern Canada on our Kingston Sub, which is the subdivision between Montreal and Toronto. The blockage is actually east of Belleville, it's still going on, as we speak. The Canadian government is involved in negotiating with First Nations to peacefully get it lifted. This has nothing to do, by the way with CN. We're a bit taken hostage, we're a bit victim out of this, but we're working with the Canadian government and cooperating with them, and we're very hopeful that this blockage on our eastern network will be lifted any time soon in the next day or 2, but it's still going on, as we speak. And then there was a ministerial order that was given to both Canadian railroads on February 6, that essentially was limiting speed on what we call key trains. Key trains, just to keep it simple for people, is trains that have loaded hazmat product. That ministerial order has been amended on February 16. And that will really allow us to get our network back fluid in Western Canada. So that's going to be very helpful. When you look at 2020, again, you and I were talking before the conference, we still remain cautiously optimistic. This is what we said in our call a few weeks ago, on our Q4 call. Again, yes, there's a little bit more noise on the first quarter than what we're used to. But again, it's only 1.5 months. So there's still 10.5 months in front of us, and we feel cautiously optimistic going forward. When you look at our CapEx, at CN, we do what we said we're going to do. We said we're going to normalize our CapEx back to historical levels in terms of percentage of revenues, we are doing this. Our CapEx now or envelope came from $3.9 roughly billion in '19 to $2 billion or $3 billion. And that will obviously help free cash flow and free cash flow conversion. We do -- and we did give some visibility on cost headwinds that are specific to CN in 2020, namely pension. There's some incentive compensation. Our tax -- effective tax rate is going up from 25% to 26%. When you total these cost headwinds, it's roughly about $400 million that we have to deal with. And then, obviously, we continue on our consistent shareholder distribution and you've all heard our dividend increase and our share buyback that we've announced on January's Q4 call. For 2021 and beyond, we still remain quite bullish. We do have -- and Keith will touch upon some of those, we do have some very CN specific structural growth opportunities that are ahead of us. We're extremely as well pleased with the advancements we're doing on technology. And Keith, I'll let you cover some of those.

Sure. So we are very excited, and we're very confident in a lot of these mid- to long-term structural infrastructure projects that are going to be located on our lines, many of them exclusive. We'll start off maybe in Rupert and talk about the propane terminals that have been built or being built. You have AltaGas, which was established last year in May, and they're doing about 40,000 barrels a day through that facility. Second half of this year, a new terminal built by Pembina will be open, and they will be doing roughly 25,000 barrels per day. And that will -- in 2023, that will expand an additional 15,000 barrels per day. When we look towards coal, a new facility or new mine was opened up last year in May, the -- near Hinton, Alberta, Coalspur, and they start off roughly a 3 million ton per year clip, expanding into, we feel this year, they'll be upwards of 6 million tons. And they've got some plans to going to 10 million tons. And that's -- a lot of that's going through Prince Rupert. And so in Rupert, the previously Crown Corporation owned Ridley terminals, which is the coal terminal, but they're also doing -- looking to do some other products as well, that facility put in a second dumper and the tonnage throughput there has gone from 14 million tons per year to 16 million tons per year. And they also have plans to put in a second berth. It will take that to 34 million tons per year. When we stay on the coal side of the house, we're very, very pleased with the new partnerships that we've signed with Teck Coal, where in 2021, we will start moving their product to their new -- newly expanded facility at Neptune terminals, which is on the North Shore. They've gone -- they're putting in additional capacity there, going from 12 million tons to 18 million tons, they're 18.5 million tons. So the product that we move out of their mines will not only go to the Neptune to fulfill their own terminal, but will also go to Rupert as well. We stay in the west a little bit. There's some capacity improvements also at the container terminals, near and dear to my heart. In Prince Rupert, in 2021, there will be expansion there of an additional 250,000 TEUs, and in 2022, it will take that up another 200,000 TEUs, taking the terminal to 1.8 million TEUs. If you listen to my friend, Shaun Stevenson, at the Port of Prince Rupert, they also have plans for a second terminal there, and they feel that over the next 15, 20 years, they could take that anywhere between 6 million and 7 million TEUs total throughput for Prince Rupert on a container basis. Let's not leave out Vancouver, though. Deltaport, they finished their expansions of loading rail there last year, an additional 600,000 TEUs of rail loading capabilities. At Centerm, they've got a 2-year project going on right now to take that terminal to a 1.5 million TEU terminal. And this year, there will be a completion of Vanterm, taking them to a little over 1 million TEUs there. So we see a lot of capacity on the west -- on our western front to be increased, but that doesn't leave out the east. As many of you probably have heard, PSA has purchased the Halterm container terminal in Halifax from Macquarie. And they have plans this year of extending a berth there where we could get 2 post-Panamax vessels alongside at one time. They also have another post-Panamax crane coming in and being commissioned this summer. When we go back to talk a little bit more about bulk on the grain side of the house, as the farmers keep getting better and better at producing crops and the yield increases, there's been a move to increase the number of elevators in the country. And with 32 new elevators being built in Canada from 2015, not all of them are complete yet, but I can tell you that over 70% of them are on CN lines. So we have a good footprint to handle more grain. And this year, the second half of the year, there'll be the first loop track to loop track total supply chain of grain put in place in Canada on the North Shore at the new G3 terminal. Again, we service the North Shore in Vancouver. All of those things have us very, very excited. And what that means is, for us, is we want to take it to the next level of, as Brandon mentioned earlier, we were kind of the initial PSR folks. We want to take it to -- we feel we're in PSR 2.0 right now. We've been in the growth mindset for the last 10 years. And we want to take it to 3.0 and JJ has tasked all of us to take the stuff that we were looking at in the lab, a lot of its innovative technologies that will make us a safer railroad, a more efficient railroad, and one that can create even more capacity with the same network that we have today. So we have 2 really coal projects that are ongoing. One is automated or autonomous track inspection. So we have 8 boxcars that have been fitted with a very, I guess, a high level of technology. And these cars are going around the network in regular train service and their inspection, the health and the integrity of the track, the ties and the ballast, and those are going around in this regular train service, and we do not have to stop the railroad for track inspectors to go out on the railroad, which is the traditional method. And so we're working through with the regulators on that to make that part of our process is moving forward. And that's -- we have that in our game plan to build an additional 2 of those cars this year. So we're very, very excited about what we see happening there. One more last point is the -- on the railcar inspections or train inspections, we've created 7 portals, 5 in Canada, 2 in the U.S., and these portals take high-resolution, thousands-per-second pictures of the integrity of the railcar, and we have 9 of the algorithms in place that are finding these defects and reporting in a real-time basis back to headquarters, where then people are then looking and planning the next work order for those railcars to be inspected. One key proof point is, is this stuff working? Yes, it's working. We did a 45-day test in Winnipeg where we had regular railcar inspectors testing trains and then we ran the -- ran several trains through the portals. We found 3,000 more defects with the portal than we did with the naked eye of our inspectors. So our inspectors are probably better to repair the railcars then to find out what's going wrong in some of these very tough to find places inside of a railcar. So we're very excited about all of these things, and it's going to differentiate us moving forward, for sure.

Well, you guys gave me so much to talk about.

Yes.

But I've got to put it in my short-term hand on Ghislain. You're still sticking by the annual guidance right now for...

Yes, I think, as I said, we're not -- it's early on. At this time, I would say, stay tuned. We are recovering right now, our western franchise. So we're working hard on that, and we have some backlog that we're moving. So -- and then if you look at March, March is typically a very big month for us. It's -- from a seasonality standpoint, the biggest 2 month is March and it's October. So at this point, we're going as she goes. We'll see, hopefully, like these blockades in Western Canada and Eastern Canada, which, again, most of our volumes, as you know, Brandon, is west and going to Chicago. This is where we have some of our capacity issues that we've resolved in the last 2 years with quite a bit of investments in CapEx. So our eastern franchise is actually underutilized. So I don't want to undermine the impact of the blockades that are on our Eastern network, and we're hoping that it's going to be resolved. But at this point, we're not panicking. There's business out there. There's opportunities to move more crude. Keith talked a little bit about long-term grain, but grain is good as well. I mean, when you look at the Rupert, where Keith and I were comparing notes yesterday, even with the blockade that we have, I think, Rupert's volumes in terms of RTM, month -- year-to-date, Keith, I think they're up like 29%?

Yes.

So -- and DP World is continuing to expand. So listen, at this point, when you look as well because one of your questions was, how do you see trade this year? And I think that the trade is more positive this year than it was last year. I think when you look at the tone, with the U.S. and China, I think, when you look at the USMCA agreement, that's going to be ratified or close to be ratified. I think we're hopeful that trade is going to be much better, maybe not, much better is a big word, but at least the tone is much more positive than last year. And I think that's going to be good for the railroad and for CN.

I think the -- a lot of uncertainty is taken out of the equation, and it allows folks like us and our customers to plan a little bit more about what we're going to do moving forward. And that uncertainty, out of the equation, is helping people start to plan for some second half improvements.

And I guess along that point, though, we do have some uncertainty in China, right? And what Apple said yesterday, what are your customer base telling you about activity in China and manufacturing and expectations for volumes?

Well, as you know, Brandon, we have boots on the ground in China. With our business development folks and our freight forwarding arm there, and talking directly with our guy that heads that up, Gabriel Lagunes, they're slow to start ramping back up the manufacturing production. And part of that is also the -- just the logistics and the -- what they need to get those products from the plants to the ports. So the trucking is slowly get cranked up. I would not be surprised if we see another 2, 3, 4 weeks of ramp up before that we start to see it get to the point where maybe we were 4 months ago or so.

Okay. But this could be a significant because the way we track it, inventory levels, at least in the U.S., have been relatively elevated. Could this actually be somewhat of a blessing in disguise, such that the channel gets a little bit lighter?

Yes, we actually see the inventories coming down and talking to a lot of our retail customers, the inventories are being depleted. So I think depending upon when this gets resolved or when this gets to the point where they're able to start ramping back up, it could fit quite nicely with where the inventory levels are. We're hopeful for this.