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

Wanted to kick off on time as we have one of the original scheduled railroaders here with us. We want to make sure we start on time for day 2 of the transportation track. We're very pleased to be joined by Canadian National Railway. And from CN, we have a number of executives here that we're very pleased to host. So to my left is JJ Ruest, who is the CEO of the company; we also have Ghislain Houle, who's the CFO; Keith Reardon, who's the Consumer Product Supply Chain, SVP; and Paul Butcher, who runs the IR efforts for the company. So we're very pleased to have all of you here. So thanks very much for joining us. We're going to -- I'm going to turn it over to JJ. He's going to run through some opening comments. He's got a few slides to get through. And then we'll dive into Q&A. We certainly want the conversation to be interactive. So certainly feel free to jump in with questions, just raise your hand, and we'll get you on. But again, gentlemen, thanks so much for joining us. We really appreciate having you here.

Thank you, Chris, and good morning, everyone. Good morning to those who are joining us on the webcast. Yes, I'm on a short 24-hour trip joining my team here who's here during the conference season. And we're working hard on getting the railroad back on track with some of the help of our customers and customers association. So maybe a few comments first on some of the comments we have on this slide. It's some of the comments that we've put out when we had the fourth quarter result. We just want to update that a bit. Our volume year-to-date, as those of you who follow, our RTM are down 2%. It's not a reflection of demand. It's the reflection of some of the operating challenges that we've had. We had a bit of a cold week in mid-January. It affected both Canadian railroad. Then we had a piece of a mountain that kind of came down on our Southern BC Fraser Canyon railroad. We lost that railroad for 6 days, in and out of Vancouver. But more impactful, really much more impactful are the First Nations blockade, it started February 6. We're now into week 2, basically. This thing started February 6 on the Thursday afternoon, and we're Thursday, again. We're -- we lost the main line between Québec and Ontario between basically, East of Toronto and going East. And then also, we had, I think, some of you who may be more inclined to follow some of the more technical issues of railroad, we also had following the CP derailment of February 6, the Minister of Transport on that morning issued, what you call, a ministerial order, where he restricted the speed of train of -- so-called, hazmat train. Any train that was more than x number of railcars with hazmat. He was really targeting propane and crude, mostly crude. And that has definitely a negative impact on any railroad if you can -- if you have to run your train at 25 miles an hour because it's hazmat. And as you know, railroads are typically a single track, so it slows everything behind them. Good news is, after a week of working with the Minister of Transport and his team, he lift the order, ministerial order, last Sunday. So we also lift the embargo with the permit that we had issued the week before. So as of early this week, we're back to running at regular -- what we call regular speed on the mainline. Mainline for CN is all CTC network. So from that point of view, we're in a recovery or slow recovery from Toronto West, Toronto to West Canadian West Coast, Toronto to the U.S. because with -- the blockade in Northern BC has been removed after 5 days. That was the line to Rupert. That line is reopened. And then we had these on and off blockade, one in Winnipeg for one day, one in Edmonton for one day, some East of Montreal. So we had to adapt the operating plan back and forth. So I want to thank some railroads who have allowed us to do some detour train, which is more likely in the last week. So we've been moving some freight to try to maintain some level of activities. We're very concerned about our customers and the ability to keep running their plant, especially those who are east of Toronto. They are the one in more challenging area. And definitely, we would believe that the other Canadian Railroad will allow us to do some detour on their underutilized track between Montreal and Toronto. On the 2020, we are targeting volume growth. The -- there's opportunities out there with port business with energy, crude is a topic that comes regularly. And definitely, the province of Alberta has reassigned their crude contract to the private sector. I met the CEO of the company who bought the contract, which are running on CN, and he's keen to ramp up the commitment that he's -- that he took over from the Alberta government. Our CapEx is focused on safety, growth, technology. This year, it will be about $3 billion or roughly 20%. We're managing cost headwinds. The cost headwinds that we have this year is an increase in cost and pension. There's also -- we have to fill back the bonus system or the compensation. And depreciation is higher at CN because we've increased the capital in the last 2 years. And therefore, obviously, that finds its way into depreciations. But at the same time, we do have much more capacity than we used to have so when these blockade are removed, we should be able to make good use of that through remaining of the year. We've increased dividend 7%. We have a share buyback program. And we have a good solid pipeline of opportunities. I think some of that maybe we can discuss during the Q&A, Chris. So if we go back on the next slide there, Paul?

So back to the basic. And when you see that density map, you also see where our most important book of business is. So definitely, West Coast trade is very key to CN, short term, long term. Definitely, natural resource, mostly from the Canadian Prairies, from the Great Lakes system to the West Coast is very key to CN's future as well as the U.S. Midwest. We're very focused on the consumers, what can we do as an industry or as a railroad to participate even more on the freight nearby by consumers consumptions. And we target the U.S. Midwest and Central Canada from both coasts, in fact, from the 3 coasts, but especially from the West Coast and also on the East, we have an effort that I call the Rupert of the East. And why I call it Rupert of the East? Because I think it's image that people understand that is you go to a port, which has a very small population, Halifax or Québec city. And then you make that port a prime supply chain ship to terminal to rail, you make it rail, mostly ocean operation. And then you want to ship long, heavy train, low-cost train to where people live. In our -- in the case of CN, it's more Central Canada, Southern Ontario and the U.S. Midwest. U.S. -- let's call it the broad U.S. Midwest, Michigan, Illinois, Minnesota, maybe all the way down to Memphis in some cases, yes or no. Energy is a big factor. Crude by rail was very strong for CN at some point. And we have the capacity to move as much as 200,000 barrels, so that's going to be another area of opportunity for us short-term and midterm. So maybe on that, I can stop and then we can cover questions that you may have or question from the audience.

Great. Well, thanks very much for the prepared comments. Let's just talk about sort of the short-term stuff right up front, and think about, particularly -- first the blockages. I don't know if there's any ability to sort of put a time line on maybe getting things cleared out to the potential to operate more seamlessly across the network, but what's happening now from a government intervention perspective? And what are sort of the next steps that hopefully get you clear to run smoothly?

Yes. So we do, as blockade are being put up or taken down, every time we go and quickly get a court injunction. Court injunction, basically, is a legal process to get people off your property, especially when they're in the way of operation. Then we serve these court injunction to the people on site. And then after that, we rely on the provincial police of each of these province to take action to -- ask people to leave. So the issue here is that how that is done? In the case of British Columbia, with the help of the Premier and Mr. Horgan in British Columbia. He got involved and after 5 days, people left the blockade and the law was respected, if you wish. In the Canadian province like Alberta, where we had one in Edmonton. It lasted one day. We had one in Winnipeg. It lasted about one day. It's about whether or not the involvement of province and the feds and what are the police authority feel that it's -- how to go about doing that. The issue in Belleville, which has been going on for 2 weeks is the concern of the federal government as to the ripple effect of what would happen. But truly here, we've reached a point where there's a need for leadership, need for leadership in each province, need for leadership at the federal level. We see that leadership in some of the province, and we need leadership at the federal level because CN customers can no longer really put up with this for very much longer. We can't just have an ad hoc offering plan that we kind of reshuffle every day based on who's coming up unannounced in our track. It's also very unsafe. We don't get a heads up when people do a blockade. It's just the train crew that reports, there's a blockade ahead of them. So there's a lot of good reason why this needs to stop. And -- so how long will it last? I don't know but it has to be a short period of time because we have huge number of customer support to ask for a conclusion and the pain, financial pain for some of the factories that depend much more on us. And now, right now, they're mostly West -- I'm sorry, the port business is slow. And in the Eastern Canada, some of the factories are -- they're in need of raw material in and be able to ship out. So this will have to come to a head fairly shortly.

So what -- so when we get resolution to the issue, how quickly can the network get back up to speed? And is there going to be any carryover volume that's sort of sitting, waiting? Presumably some stuff that's very urgent, ultimately probably you lose to truck. But I'm guessing there's also some pieces of the business that stays and waits for the service to resume. So how do you think about, sort of, getting the network to where it needs to be? How quickly? And then will there be that sort of catch-up?

So definitely. Well, for example, we are in that phase of getting the network back on shape west of the -- West of Belleville. We had, unfortunately, a blockade of 24 hours in Edmonton as part of that. But -- and that -- we've actually moved a lot of locomotive West of Toronto. We're in full gear of putting the network back in shape. We are working hard to deal with the pent-up demand for Prince Rupert, Port of Vancouver. There's a lot of demand that will need to be filled as we regain control of our network container business at all the ports, import and export. Coal export from BC, where the coal mine have a lot of clean coal ready at their mine that they want to ship to Prince Rupert. Propane, we have a propane export terminal in Rupert since last spring. There's a backlog. There's also a pent-up demand for how much propane is scheduled to be in ships in Rupert. So if you look at -- one way to look at that would be the number of ships at anchor in Vancouver and the number of ships at anchor in Rupert, and it typically, grain, coal, probably some potash and some containership. And that's basically the revenue ton-mile that's waiting to be handled. Some of that has to find its way all the way to Montreal. That's not going to be possible at this point. What needs to find its way to Chicago and Toronto, we're working on that right now. And we can't afford to have any other of these 24-hour blockade, surprise blockade, like we had in Edmonton yesterday. So when a network is reopened, you will see the revenue ton-mile in CN ramping up, and that may be a couple of weeks before everything is back to normal.

Okay. Okay. That's helpful. And since you mentioned the West Coast ports, obviously, a topic at the conference over the last couple of days has been the coronavirus and the potential impact on particularly containerized imports, but just general sort of trade. What's your take? Obviously, there's always a lull through Chinese New Year. I think right around now, we begin to see volumes ramp back up as the manufacturing capacity, kind of, would've come online a week or plus or so ago. So how do we think about the impact? And what are you expecting or hearing from your customers, particularly the steamship lines?

Yes, so to answer that properly, I need to put all the pieces back in motion related to, kind of, where we're at right now. So if we start in China, and we also -- we have a group of people who work for us in China, roughly about 50 people, roughly. And so they've extended the shutdown of the holiday by 1 week. So whether you're working in the factory or working in a freight-forwarding office, like in the case of CN, you had a 1 more week of holidays. And coming back from the holidays, most people actually don't quite work in their office yet. They work from home, which is what -- how we do it for the freight forwarding business. And so the factories will have as many employees as it would have otherwise. So you lost 1 week of production. The production is restart, but it's spotty, depending on which factory, which province and to what rate they're running up. So what we have right now, we have the lull of the usual Chinese New Year. The vessels are coming in, there's a lot of blank sailing vessels. That was to be expected. That lull will last longer, maybe a month longer. It all depends when China really gets back on its feet. And what that lull is done, then obviously, because the supply chain will be empty, both in China and on this side, for those who buy raw material or finished goods from China, there should be a pent-up demand some time in April. So already through that, in the case of CN, because of the work -- the illegal blockade that we have right now will end eventually, and the port of West Coast is quite high. So at this point, the fact that vessel -- there's is less vessels coming in may just be part of how we are able to recover more quickly because we'll have a chance to maybe evacuate the port faster than the stuff is coming in, and there may be a lull in March. And in April, all based on the recovery at which the factory really starts to produce at a good pace, then we'll see that freight coming in. You got to put that also in perspective that in North America, the consumption is still good, right? Whoever makes a product, if it's not China, it may be somebody else, but consumption is there. If you're running out of -- first, you deplete your inventory in Canada and United States. So when you run out of that, it may be that for a quarter, the consumer may have to buy something different, another brand, another different product. As long as they consume and as long as they consume tangible goods, then there's freight to be moved. So I think also, remember, when we had the meltdown of the nuclear plant in Japan, I know it's many years ago, but at that point, and as an example, the world ran out of white pigment for paints for cars. So there was a time there was shortage of white pigment. The consumer kept buying cars, but there was not as many car available with white paint. And I think in the case of freight, that's the same thing is as long as the consumer in United States and Canada has a job, and he feels positive about the economy, and he keeps consuming, he might be consuming something somewhat different if some of these supply chain are disrupted, but it doesn't matter for us. What matters is consumption over here as opposed to where it's coming from.

Okay. And if you were to, sort of, make your best guess about what maybe all of this does to sort of 2020's outlook from an RTM perspective? Is it too early to say because there is opportunity for catch-up, but how do you just sort of broadly think about it?

Yes. So our guidance remains the same that we had put out early this year. It was -- we're only 1.5 months into the year, so there's still lots of time to recover. And I think -- what has happened is -- I'm not so much worried about the coronavirus because that might just mean the displacement from one quarter to another. The blockade, that may be tougher to make it back. So what that needed -- I guess, it consumed a bit of our conservative buffer, if you wish. But because these things are happening early in the year, it still gives us time to use the network. And we have good capacity in the network. And to that point, for example, I'll give you an example of how I feel bullish, for example, in the potential of Prince Rupert as a gateway. We have -- we are in the process right now this week to reshuffle some of our money in our capital plan, to add 2 signings on the rail line between Prince George and Prince Rupert because we feel very confident that there's even a better prospect on the export of natural resource, namely coal and import of container and propane in that corridor that we'll take some of our capital that we were going to deploy somewhere else, and we'll deploy it to Rupert because we see a great future over there.

Yes, absolutely. So let's talk a little bit about the pipeline, kind of get out of that sort of lens of the first quarter and the short-term, but think maybe more about the year and maybe even beyond in terms of what you see is interesting. There's a lot of different pieces of it. You mentioned crude by rail, so let's maybe get that one out of the way first. In terms of activity, it seems like there has been some incremental demand. How do you sort of see the year shaping up? And then maybe thinking a little bit more broadly, the sustainability in the context of maybe at some point, pipelines coming online?

Yes. Pipeline -- actually, this whole blockade that we have right now, it's not about CN, it's about pipeline. In that case, it's natural gas pipeline. So pipeline, there's always money to build a pipeline because it's getting them done -- is actually the -- always so much more difficult and lengthy than one would expect or one would think logically, could happen. So crude by rail is a growth opportunity for CN in 2020 and '21. We have a company like Cenovus, who're now ramping up because they now have a much bigger fleet. They actually have the rail equipment to be able to meet their commitment. Commitment, obviously, which is always -- they've always intended to do. We have some other customers also who are very well equipment from a rolling stock and places to load and offload rail cars. In the province of Alberta, they had -- it was a challenge for them to reassign all these contracts from themselves to the private sector, but as this is all done. So it's all taking place right now. And the equipment that was a purchased -- or leased from Trinity railcars will come in as supposed to, and it will be put in hand of that private company. So crude by rail, the environment is that there should be a decent environment for crude by rail this year. Short term, this is where we go back to blockade. Our network is not really working the way it should. And as I said, for one week, there was a ministerial mandate to slow down train of the likes of crude by -- from 50 miles to 25 miles. So obviously, it has a drastic impact. But we're going to go -- we get all these things resolved some time over the next few weeks. The blockade hopefully, next few days and get the network back in shape next few weeks. And then crude by rail will be one of the good story. If you look at that long-term, pipeline takes time to build, and there's a number of crude company also who are now looking at the rail business as a long-term solution for them. And this is where there's going to be some capital investment by a producer of crude into making a different product, a rail product as opposed to a pipeline product. A pipeline product is diluted 30% with diluent in the summertime and 40% diluent in the wintertime when it's very cold. When you do it by rail, you don't really need -- you could get away with only a few percent of diluent as long as your product is loaded hot, and as long as your railcar is coiled and insulated, so you can make it hot at destination. So there's -- this is a process called DRU, to remove the diluent from the product, to take it out of the pipeline spec, make it rail spec. It makes for a safe product, as now -- it's not flammable. Also, you save 20% to 25% of freight because you're not moving diluent. And also, you might get a slight premium on your selling price of that crude because now you're selling, you're already selling heavy crude. Which is really why the refinery in the Gulf, they really want heavy crude. They don't want diluent. So if you can bring that crude directly to the refinery as is, very heavy, you will also not only save on freight and move a product, which is safe, safer but you also probably get a bit of a premium on your selling price. So I think the -- some of the refiners are on the verge of making decisions by year-end to invest some capital, was $500 million or close to $1 billion, to put these units in place to do crude by rail over the long term. And when I say long term, we're talking 10-years type contract.

Yes, absolutely. Okay. So the contract on your side could be 10 years? Okay.

Yes.

And when you think about the DRU, that differential relative to pipeline, meaning the cost to move by rail relative to pipeline really does narrow. Can you talk a little bit about sort of what those economics might look like?

Yes. It does narrow. It may not quite meet the pipeline economics. But at the same time, it also gives diversity in supply chain and a better -- to the seller because now he has a better opportunity to be able to avoid these months where he has to sell some of his crude at distressed price because he can't get pipeline capacity. So when you take these months or these weeks, where pipe -- where crude is sold at a discount FOB back in Edmonton because you can't get in the pipeline. Therefore, you have to bid your price down to be able to get in, there's definitely a return. But we talked about crude -- coal, at least for 2020, is a significant opportunity for CN. I was in Vancouver 2 weeks ago and I met at all of our -- I met the new owner of the coal terminal at Rupert and I also met Conuma and Teck and the Vista group, and they are all very keen in using a coal terminal in Rupert. This will be a growth opportunity for CN in 2020 and '21. It will offset our shrinking coal business in the U.S., which is mostly Illinois based for export. And I think if it started first part of 2020, beyond the first part of 2020, we should be able to show revenue growth in our portfolio on the back of a very strong Western Canada coal, partly some of the decision of Teck and how they manage their flow between Westshore and Neptune, partly Conuma, partly Vista. And also partly the fact that the new owner of the coal terminal in Rupert, maybe is a better operator and he will run this. Their goal is to set record with output, and our goal is to set record for them. That's why I'm actually looking to redeploy some of the capital plan of this year into putting more 2 sidings on the BC north, because I could see that we have a very solid partner here with. I like to invest behind my partners. So if one of our partners is willing to invest into his terminal, whether coal terminal, grain terminal. Like in Vancouver, we had G3, he was putting -- signing up this huge grain terminal this summer or the one in the Fraser River. When we invest, then we feel -- it gives us a lot of confidence to invest behind them in the same supply chain that -- good efficiencies, capacity and obviously, top line growth.

Got it. And how do we think about sort of the ramp-up in coal and the timing of it? Obviously, there's the big Teck contract, but that's not until next year, so how do we think about between now and then?