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

Great. Good morning, everyone, and again, thank you, and welcome back to our 27th Annual Transportation and Industrials Conference. I'm Ken Hoexter, BofA's airfreight and surface transportation and marine shipping analyst. And we welcome next, Canadian National, JJ Ruest, President and CEO; and as well as Paul Butcher, Investor Relations, on the phone with us. So we welcome JJ back for the fourth time for our BofA conference. And CN has been our participant in every 1 of the 19 years we've been hosting the conference. So truly appreciate the dedication to us and the firm. JJ, your first time here, if you can recall, was back in 2007, in your role as SVP of Marketing. So your willingness, first of all, to step-up in tough times is clearly evident to be the speaker for CN. So appreciate you doing that. And we did a great tour with Canadian National at the Port of Vancouver, back in October. We hosted management, down in Australia and also at our Stars Conference in March. So this is truly a top-notch organization. Happy to have them here with us. JJ, I know you wanted to open with a few minute update. Before I do turn it over to you, let me just mention one quick thing for investors. If you do want to ask a question on the line, on the Webex, you can submit those questions to me right on the Webex screen. Alternatively, of course, you also can e-mail me or Bloomberg ID me, through the morning. But JJ, you obviously, recently withdrew the 2020 and 3-year targets provided at the Analyst Day, suspended the share repurchases and noted a revised CapEx target. So we're going to have a lot of things to hit on, given the incredible changes going on in the market right now just given this unprecedented time. But let me go ahead and throw it over to you to start. And again, appreciate your willingness to contribute here.

Well, thank you, Ken, and thanks for having us. As you said, we've been participating in your conference for a long time and we will definitely continue to do that. Before we start the Q&A, I'd like to maybe take 5, 7, 8 minutes of intro comments to cover some of the point, which I think are of interest to most. Let's start briefly on the financial health of CN. We have a really strong balance sheet. We have best credit rating of the industry. We continue to access the commercial paper market at rate below the LIBOR. We had a recent bond offering of USD 600 million through the years at 2.45%, lowest coupon rate ever for a Class 1 railroad. So I think it says a lot. We are considering the pause on the share repurchase that we announced just before the earning call in April and then we'll revise at some point as the economy eventually get back on its feet. And we're also very committed to maintaining the previously announced 2020 dividend increase of 7%. So the one thing that we've signaled clearly as we pull out the guidance for 2020 and the next 3 years is the company is working to generate a minimum of approximately $2.5 billion free cash flow in 2020. 2020 is a year to really focus on cash flow. Let's go to page -- Slide 4 for those of you who are looking at the slides and talk briefly about the pause of the volume in the rail industry and at CN. The way I looked at myself is on a rolling 7-days revenue that I look at everyday. When you look at this page, each bar is the revenue -- average revenue for 1 day for the last 7 days rolling. So it gives -- really gives you a short-term pause. So where we're at in month of May, month of May after 11 days, revenue is down 25%. In April, you would -- I think we -- the prior conference, we did say that April revenue was down 16%. So as we had talked on the call, the month of March was a fairly good month from a cost point of view, but also decent enough on revenue, except maybe the last 7 days of March. April came down because of the pandemic. And May is turning out, probably going to be our worst month for the quarter and that -- based on the run rate right now of 25% of revenue reduction. And June might become a -- I wouldn't say a bounce back, but it could be or should be better than April, partly because the automotive industry will start to come back in the next 10 days. And I think, Paul is sending you the list of the automotive plants on CN who are restarting next week and the week after. So automotive went from basically almost no revenue -- no daily revenue at all in the last 10 days to plant restarting. So the market which have strength is the bulk. So when you look at the chart, when you said bulk, you could see that Canadian grain is solid. Actually, year-over-year positive. Canadian coal is solid. It's actually a year-over-year positive. And the Canadian coal that CN does is mostly just about only over Port of Prince Rupert. It's thermal coal and met coal. We have some new mine on CN. And then merchandise, which is really manufacturing, it still hasn't reached its bottom. You could see the trend that when you -- if you talk about whether petrochemical industry or Forest Products or met coal or steelmaking, all of the likes, the -- those industries are still waiting for the demand to sort of restart a bit. The crude-by-rail and the frac sand, both together in that graph, even though the graph shows fairly high bar, those revenue right now are very, very weak. So we are probably near the bottom on the energy side or at the bottom, but I don't really expect an improvement from that bottom in June. We might be kind of a run rate here waiting to see how this market happen. And then on the left side, the consumer product, which is at CN is international container, domestic container and automotive, and that's probably a more exciting prospect for the -- when you talk about the long-term. So short-term, on the port business, the wave of product coming from the port after the closure of the Chinese factory is in now. So now we're into a phase where the retailers in North America and some of the manufacturers have slowed down the order from China. So therefore, the vessel coming in right now are lighter during the month of May and might be lighter also in the month of June. We do have a contract that's moving from one railroad to another that will help us on that run rate. Domestic intermodal at CN is a positive story. And as you remember, last year, we bought 2 intermodal company. One is TransX, we bought the company. H&R, we only bought the intermodal business. And H&R and TransX, 70% of what they move is food, food related. It's all temperature-controlled freight. So that's a segment that's doing well during the pandemic and will also do well, long time, obviously. And the automotive market, which basically went to a hard stop and will start to restart between now and the end of June. And the first thing that OEM producers wants to restart are SUVs. There is a good demand for SUVs, not too sure about the demand for the sedan there, short term. Let's look at -- on the cost side, we had a quick review of the revenue. On the cost side, if you go on Page 5, it's really about asset, productivities and labor. So at this point, this slide was prepared and updated yesterday. We have 22% of our active fleet in storage, 20,000 railcars. 650 locomotive also in storage. We've idled a couple of merchandise yard, some automotive related. So they will restart. That's namely -- and at some point, Battle Creek will restart. Some others are more industrial product related. So they might only restart late summer. Some of them actually may never restart because as we look at the new world or the new economy, some of the efficiencies that we're creating right now, I will try to see if we can preserve them post-pandemic. We also have -- we've configured our footprint on the mechanical and shop point of view. Some of them also might become permanent. On the labor side, 20% reduction year-over-year. So right now, CN has about -- I think the precise number is 5,500 people less on the payroll than last year. So these are, the way Hunter used to call them, paycheck. Most of these paycheck are full-time employee paycheck, but some of them were consultants who were working at CN on a full-time basis. So we're 20% below last year in terms of the workforce, and of that, about 27% is train-related, which is a very -- an indication of how fast we adjust our cost versus the GTM. If you go on Page 6, that's really what the graph on the left is all about. It's showing you that even though -- I mean, it is unprecedented time. Volume is coming down at a pace that we've never seen before or haven't seen in a long, long time. And you could see that we're also adjusting the workforce at the same pace than the GTM reduction. I think, as I said, May should probably be -- hopefully will be the bottom. And then when you look on the right side of the chart, this is where you get into productivity. So at a time where you're on the PSR railroad and your network is not as busy because it's very fluid, it has less volume on it, the thing that we pick that we want to drive the hardest to work on to get our cost where it needs to be is train weight, train length and crew start. So we had very drastic reduction in crew start. That's mostly people-related. And we made sure that as volume weaken, that we actually set the new record or new high for train length and train weight. So a lot of service design had to be taken in the background to do that. And as we do that, we've decided to sacrifice short term total dwell because obviously, we have excess fleet, we have excess capacity, terminal dwell is not as much of a driver in our cost right now. So we really -- let's make sure we run long -- even longer train, even more heavier train, and we reduce as many crew start as possible because the crews are directly in labor. If we go on Page 7, there will be a post-pandemic, and this is what -- this is kind of a list of commercial initiative that we have for 2021, '22 and '23, and some of these things will be long-lasting. So if you start on the left of the mark -- the map, Prince Rupert, obviously. And this year, we've actually slightly increased our capital program between Edmonton and Prince Rupert to add 3 signings to be able to make -- thing -- that network really fluid and also to make sure we can deal with any growth coming at us in '21, '22 with activities related to Port of Prince Rupert with its bulk of containers. I think you should see that as a sign of confidence that this is a long-term gateway for CN to serve North America. Propane terminal, which is on the same -- was also in Rupert. There's one of them operating. There will be another one that eventually starting up on the construction, Pembina. Propane in North America is selling for peanuts. When you sell out to Asia, you have a much better netback. So that's why Pembina and AltaGas investing capital to have access to better paying market in Asia than there is in North America. The Ridley Coal Terminal, I mentioned, is one of our positive stories for this year. We have an agreement with Teck Coal who will now do, I guess, dual -- have 2 large supplier to move their coal to the coast. And it will be coming to Rupert for some volume and it will also be -- they are also expanding their terminal in Vancouver, a terminal called Neptune, which they own. And they will do -- they will share that business between CN and the other railroad from an interchange point called Kamloops. We also have grain investment from our customers, G3 and Fraser Terminal in Vancouver, particularly closer by [ year-end ]. G3 is coming in operation this summer. And in the country, 70% of the country -- new country elevators in Canada have been built on CN. And in 2020 and 2021, we will continue to expand -- invest capital money in the renewal of our grain fleet for higher-payload cars, which are even more cost-effective. So that we can continue to that participate in the year-after-year increase in the size of the Canadian grain crop. If you go in the middle of the continent, this spring, this summer, we will open an auto port facility near Minneapolis. We made an acquisition, as I said earlier, of TransX and H&R, which allow us to do retail intermodal, retail as in from warehouse to warehouse, which has been a very solid performing product for CN because it's all temperature-controlled. As I mentioned, 70% of that is fully related. And as you go to the East Coast, we have some long-term project. One of them is a new container port in Québec City, which is aimed to participate in the trade via the Suez Canal. That's a joint venture between CN and Hutchinson, that's 2024. And then we have the Interline service that we started last year with CSX. We now have a service between the Port of New York and New Jersey into the island and Montreal and downtown Toronto. So we can connect those supply chain by rail, a market that used to be 100% truck. And we also have initiative with Halterm, the new owner of the terminal in Halifax. Halterm is -- PSA is a very solid Singapore-owned terminal operator. But at the same time, when you look long-term, during the pandemic, as we speak, we're also looking at our network and what we may need or not need to be in the best of shape possible in '21, '22, '23. So we're looking well enough. We should look at our branch line, some of our branch line, whether or not we need all of them, whether we need all of our shop. And also, we're looking at technology because we really like to automate every -- as much as we can in operations and get the positive benefit of all that, which is safety, capacity, cost and obviously, efficiency. So I think on that, Ken, I will turn it back to you and cover item, which would be of the most interest to your clients and to your investors.

Wonderful. JJ, that's a great rundown. And I guess, begs a couple of questions just for me to start with. When you think about, as CEO, and given the gyrations you've gone through, I mean, whether it was the illegal blockades last year, but there have been so many other issues, whether -- even going back to just weather and avalanches, you've got to be prepared for different things. So how do you think about balancing out -- reducing labor 20% and on 21% reduction in crew starts, amazingly aligned with how volumes are doing, right? So the speed with which you've acted is amazing, right, especially after what we -- what you confronted last quarter. But when you think about that -- and it looked like on both those charts, the GTM start to inflect a little bit here. You mentioned kind of seeing some of the autos, some of the auto business. In intermodal, you're preparing for an intermodal win. So how do you prepare for that and also take the cost down? So maybe just talk about variability of costs and how quickly you can bring back those resources as well.

Yes. So it is -- in the rail industry and at CN, especially in the last 12 months and maybe up to a point when I took leadership, where we had to deal with the issue of the network or shorter capacity, you have to act very quickly. And whether we had the labor shortage, the labor strike and then we have to recover quickly, they're very unforeseen, very disappointing. First Nation blockade where we couldn't quite get the -- all of the laws of the land and of course, to enforce quickly enough. And then after that, recover quickly and then the pandemic. You have -- because it's a very high cost business -- and we try very hard to make as much of these costs viable costs, including the call -- the cost that historically we may have designed -- defined as fixed, we work hard to make them more viable and act quickly. The thing I keep telling my people, especially in time like this, is, time is not on our side. As revenue falls, we have to act as quickly on the cost side and resource side. And when thing -- this thing turn -- and I don't think we're looking at a V-turn. I would be some kind of a U or a U with maybe an extended bottom, then we need to also act as quickly. So we need the signal. To get the signal, this is where we look at these 7-days rolling revenue down by specific commodity, it's much more granular than what I show on this chart, and then make the decision right away on the easiest part, we're running trade, and then into the maybe not as easy part, assuming mechanical, the network, and then even more not as easy, the headquarter function. So that we adjust these costs and make them more viable and then hope for the business -- in some cases, hope, in some cases, gain the business or make the business happy, make our own luck, but eventually, we can call these people back and give them a paycheck. The silver lining of that for people short term is that they do have a paycheck. It's coming from these new social system net that the government regulators have put in. They're getting more than just a usual unemployment insurance. So that's one thing that will keep them -- give them a financial support, but we have to act very quickly. But at the same time, as I said, we are also already working on '21, '22, '23 in terms of what commercial opportunities we have, rethinking or reassessing our strategy, what will be the new normal, the new market. We might have a rebase of the economy and we start from that lower base. So what does that mean, in term of the network I need? Should I relook at some of my branch line which are less performing and more dependent on some industrial activities that may -- that was already struggling before the pandemic? Should I focus even more than in the past on the consumers? The consumer in the U.S. and Canada is even a greater portion of the total GDP. So what does the consumer generate in terms of freight? How does that freight move? Who moves it? How do I get closer to that freight? How do I get this price increase from that freight that it's a little more sticky to see into the rail industry, as opposed to fall in the pocket of a wholesaler or a broker? And then how do I follow what I would call the China plus 1, which is that China, with the issues that we've had between -- the geopolitics issues, that producing in China to supply in North America has some amount of risk, but producing in North America is probably too expensive. So China plus 1 is the product. It will still come from Asia, but maybe 20% of it -- 25% of it, will come in from a non-Chinese factory and then that might mean some of that business might come by at East Coast. So we want to be sure that as things start to slowly trip towards India, Suez Canal, Malaysia, Philippines, that we're in position to follow that freight as opposed to lose that freight because it's on a different coast. So a lot of focus on the long term. For the long term, start with the short term. And in the month of May, May is a very soft revenue so we have to really bring the cost down as hard as we can, protect our balance sheet, protect our financial health. And then after that, wait to see what the 2 government will be able to give the consumers the confidence to leave their house, start to consume again and restart the whole economy. And so I'm not taking anything for granted when it comes to Q3 and Q4, and that's why we had to put out our financial guidance for 2020.

So JJ, I think it's been a while. I can't remember even, I'd have to really go back and look at the details. But with the operating ratio, one of the highest in the groups at Canadian National, a lot of things out of your control and yet the speed with which you're making these moves says, hey, those onetime things happen and look how quickly we can fix things and given the PSR and our background, we get up and back up and running. Maybe given that you were the kind of the leader in launching present schedule railroading and you kind of hit that seeming wall in the upper 50s, right? And is that kind of the level that you say, hey, at that, when we get to that level, that's where we can maximize our growth potential. You've given a great outlook on some of these growth projects that you're working on. And I guess -- or do you look at it as, say, these are temporary things, they're still structural. You mentioned that during this down period, we can step back and look at some opportunities where we can more permanently fix that cost base, given things are slow right now. So how do you look at that from your seat in terms of more structural on the cost side?

Yes. So we are focused on the operating ratio. I mean, it's not the only point of optimization, but it is one of the point of optimization, especially in a weak economy. So in a weaker economy, definitely, we're focused on cost. And then in a better economy, say, 2 or 3 years from now, we will and we are going to be remaining focused on costs. So we have some of the costs that we're taking out right now, which are meant to be way beyond the pandemic. That's why some of these things I've mentioned -- some of them we've already mentioned, some of them, we eventually we will mention, but we are focused on the operating ratio. The challenge that we had in the -- from 2010 to basically 2020 or 2008 -- 2008, yes -- 2018, I'm sorry, we did reduce the operating ratio a bit. And at some point, maybe we lost sight of that when you grow business, you need capacity and the CapEx has to stay in line and then, at some point, a good deal of our CapEx or more than we thought was going to PTC. It may not be in -- having at that time that we were spending CapEx, but not as much CapEx was going to capacity in the network. Too much of it was going to PTC because we started PTC a little late in the game. Having learned from that, that's why we're continuing to expend some capacity CapEx right now, especially, as I mentioned, at the Port of Vancouver, Port of Rupert and the corridor for the Port of Rupert. But make no mistake, we're very focused on the operating ratio. We may not be striving to be the lowest operating ratio of the industry, but operating ratio matter and operating ratio matter for a railroad who wants to be best-in-class in domestic, intermodal and port business and a railroad who wants to be sure that we can capitalize on the freight derived by the consumers, especially when there's large cities or while we can create interline service with other railroad who's other railroad are serving large cities. So costs does matter. We have a headwind on pension, a little unique to CN because pension in Canada is not an industry pension. And also, we have a little unique short-term headwind on depreciation because of our elevated CapEx in the last 2 years. But any other aspect of our costs, we're very focused to see if we can shrink those during the pandemic, but also a number of item post-pandemic as well.

JJ, let me -- I know you ran through some of the top line stuff real quick. Maybe we can just dig into some of those a little bit more, right? So if I think about intermodal, you mentioned the near-term benefits from ONE. Is that something we need to wait until June to see that rebound? Do you still expect kind of the flipping of the switch and seeing maybe perhaps intermodal continuing to show some more -- better growth as we go forward? Or do you think the demand side is down so much it outweighs the benefits of the contract gain?

So the ONE is showing in our statistics, the Port of Vancouver. The Port of Vancouver in total is weaker right now because of the -- as I said, there was a backlog of business coming from China because the Chinese factory were closed. When they reopened, they got caught up with their backlog. And now the issue is more on the demand side, the people on this side have canceled a lot of orders coming from China, from Asia. So the Port of Vancouver business overall is down, but ONE has started to transfer some of their business from one railroad to CN. I think, I asked the team this week, they said we're about 20% of the transfer and that we will go from 20% of what they have when you bring in Vancouver to, call it, 100% by late May or first week of June. So we actually are in the beginning of the transition. We're 1 quarter into it. And the transition will be completed by end of May or first week of June. But the Port of Prince Rupert and Port of Vancouver right now, the West Coast intermodal business is down. I think it's down for all the ports in this phenomenon. I mentioned that we have a team in China freight hoarders. The ports are open. Most of the factories are operating. Most of the province are sort of mostly aback on their feet, at least from a manufacturing point of view, but the demand from retailers and the manufacturers in North America is down. So we're -- the month of May and June for the industry are going to be slow. We're not too sure also whether or not we will have a fall peak, whether or not we will have a back-to-school peak. If there is a peak this summer on overseas business, it might be a bit of a mute -- kind of a small peak. So that's all demand-related and it has to do with -- you're living in New York, when will cities like New York kind of revive and people start to consume again, that's really what will drive that port business.

So let me switch over to -- thanks for that, JJ. Switching over to crude, you kind of mentioned crude and frac kind of thrown in together. You had done about 200,000 barrels a day in the first quarter. You talked about 50,000 of that being just the heavy stuff. What has -- obviously, pricing has changed so dramatically since then. Does that mean the non-heavy goes to 0 still in your view, given where spreads are, the 50,000, heavy still moving? Maybe just some thoughts on crude.

Yes. So Ken, our view on that hasn't changed and we're now testing that view, if you wish. So there's not that much crude we're moving right now and what's moving is the heavy crude. On the sand, there's not much sand moving. And sand, at some point, sand might be increment. So both commodities, at this point, especially in May, they might be at the increment run rate of what -- the only crude moving is heavy crude. So that would be like 1.5% of our revenue about. And the sand is moving very slowly. So that end up being only 0.5% of our revenue. And these might be the run rate for crude and frac sand for the month of May, the month of June. And the price of crude is so low that the numbers don't add up, right? So you drill or you have more costs in drilling than you have in the value of the product. So the energy sector is not a sector that we are banking on between now and the end of the year unless something drastic happens to the price of natural gas and the price of crude. So that's -- no change on energy situation than what we said in April, Ken.

And JJ, since you gave such a detailed intro, maybe I'll just ask specifically as questions have come in. I know you pulled your target, but did you give any thoughts on your operating ratio in terms of thoughts of staying in the 50s from the levels you were at last year versus being in the 60s in terms of given the decline of volumes and the speed with which you've cut costs? Or are you still not prepared to kind of give an outlook for OR?

Yes. We don't want to give an outlook for the OR because I think the rail industry right now is facing -- the drop in revenue in April and May has been so drastic, it is quite a challenge to keep up with the cost reduction that match it on -- without having any time line. If you're following what I mean is you have a reduction of ex-volume revenue but now you got to do your layoff and you trigger the layoff on the Friday and it takes a few days to trickle in. And so this pace at which the revenue is falling and the pace at which you park equipment and rolling stock and you do your layoff, there is a bit of a lag. So it is challenging to maintain the best of the best operating ratio at a time when things are falling that fast. I think, on the other side, when this thing eventually turn, unfortunately, it will not be a V-shape. The potential for industry is very solid, even better operating ratio, what might be better because now the time -- the lag will work with you on the other side. It might create some tension in terms of the recovery on the freight as you call the people back and bring the resource back, there is some time lag on that, too, but then it might be -- the volume leverage at that point might be more useful. So I think, at this point, again, we're working very hard on our costs. We want to keep up with the GTM reduction. There is a bit of a lag between GTM reduction and when the costs disappear in the following 7, 10, 14 days. And some of these costs that we're taking -- cost action that we're taking, we're taking them with -- in mindset that we would like them to last beyond the pandemic. I think that's as much I would say as the operating ratio specifically. We don't have a target to offer for this year.

That's helpful. Just, I think, people are just trying to grasp how the impact happens maybe even more near-term. And I get the view is always kind of preparing for the longer-term. So just to sum up, JJ, if I can, real quick, as we approach the half hour here. Your volume is down kind of mid-teens and -- but you've taken moves to adjust the costs. It doesn't happen at the same speed, but moving to adjust cost, your access to liquidity. You've got the cheapest fundraising for the rails ever. By the way, congratulations on that phenomenal job. Looking -- you're still looking for structural cost reductions, but you still want to be prepared for that long-term growth. You're matching that capital side to that with your capital dollars you're spending. JJ, is there anything else you want to throw out there in kind of a quick sum up?

Yes. So as you said, very strong financial health, the best of the rail industry. The short-term volume is came down very fast. Mid-month here, we might be at the bottom or close to bottom. We did the same thing on cost. We slammed the brake on costs, whether it's people, rolling stock or fixed asset. Some of the things we do on cost is with the view that we want them to -- these things to last beyond the pandemic. And we've continued to work very hard on our midterm, long-term strategy for commercial growth. And I don't know what the new base will be, but CN intend to be inflation plus pricing, outperforming the industry in terms of volume growth, whatever growth or what or may be the least negative growth of the industry, if you wish. And even this year, we are investing capital for growth, namely the West Coast port and our rail lines to Rupert. So we're very much focused on 3 years plus as well. So thank you for having us today.

Wonderful. Thank you, J.J. Thank you, Paul. Next up, we're going to have Kansas City Southern at 10:40. So if you want to disconnect from the Webex and log back into that one. But J.J. and Paul, thank you very much for taking the time and for your commitment to be here. I appreciate the time. Thank you.

Thank you, Ken.

Thank you, Ken.