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

Hi. Good morning to everyone on the webcast. Welcome back for Day 2 of Deutsche Bank's 11th Annual Global Industrials and Materials Summit. My name is Seldon Clarke, and I'm responsible for coverage of transportation as well as the building products and materials sectors here at Deutsche Bank. Starting things off for us this morning, we have an incredibly high-quality company and one of North America's preeminent railroads, Canadian National. Speaking today from CN, we have Chief Financial Officer Ghislain Houle; as well as Paul Butcher from Investor Relations. So I'd like to welcome them as well. And Ghislain, I believe you're going to kick us off with some prepared remarks, and then we'll jump into the Q&A.

Yes. Thank you, Seldon, and thank you to have us, and thank you for people listening on webcast. I do have some prepared remarks, so I'll go through a couple of slides. And then after that, we'll be happy, Paul and I, to take your questions. So first of all, I would like to thank the team and all of CN's employees. During this pandemic, everyone has stepped up and have pulled together as one team, and I couldn't be prouder. We have exceptional railroaders in this organization, and it's more evident than ever right now as we navigate through these unprecedented times. Our priorities have been and continue -- to protect our employees, ensure the continuity of our railroad as an essential service and rightsize our resources to the decreasing demand. We are well-positioned to continue to operate safely and efficiently throughout this pandemic. If you turn to Page 3 of the small presentation, we continue to feel that we've hit bottom in May with volumes in terms of revenue ton-miles down 20% versus last year. June month-to-date volumes are down 17% in terms of RTMs. On a sequential basis, last week, we saw volumes up 4% week-to-week. However, this week, volumes are down 3% week-to-week. This tells us that the recovery will be slow, probably choppy, and it will take a while for the improvement in demand to stick. The economy is slowly reopening. If you look at the market drivers on the right-hand side of the slide, we have record shipments of Canadian grain and Canadian coal. On the Canadian grain side, June month-to-date volumes are up 24%, and this is always in terms of RTMs. And quarter-to-date, volumes are up 10%. Canadian coal, June month-to-date volumes are up 23%, and quarter-to-date, they're up 40%. The reopening of manufacturing, construction and retail stores is happening. However, when you look at lumber, June month-to-date volumes are down 10%. Quarter-to-date, they're down 30%, but in May, they were down as much as 34%. In terms of retail stores and its impact on intermodal international, June month-to-date volumes were down 8%. Quarter-to-date, they were down 7%, and May volumes were down 9%. As many of you know, automotive production is back up. Started from the very low, almost -- volumes were down about 90% when you look at it in May. June month-to-date volumes are down 50% on a year-to-year basis, but sequentially, on a week-to-week, volumes are up 50%. And last week, as I mentioned, in the UBS conference, they were up again. So it's the second week in a row that volumes are up on the automotive but starting from a very, very low base. Consumer essential goods are still flowing, and intermodal domestic volumes in June month-to-date are up 21%, and quarter-to-date, they're down 3%. We're quite pleased with our grocery products segment of intermodal domestic. June month-to-date volumes are up 20%. Quarter-to-date, they're up 60%, which is another proof point that the acquisition that we've made of TransX and H&R is delivering benefits. Low oil prices are impacting, obviously, crude-by-rail and frac sand shipments. I mean, June month-to-date volumes of crude-by-rail are down 100%. Quarter-to-date, they're down 75%. On the frac sand side, June month-to-date volumes are down 77%, and quarter-to-date, they're down 70%. If you turn on Page 4, what are we doing as a response to this pandemic? Well, as many of you know, we're aggressively rightsizing our resources, and I'll give a few statistics in a minute. We're quite pleased with the record train weight. Our average June month-to-date train weight is 10,500 tonnes. That's up 12%. I've been with CN for 22 years, and I've -- had not seen this on a consistent basis. And our average train length, June month-to-date, is close to 900 feet, which is up 12% as well. From an asset standpoint, we had 20,000 cars in storage at the end of May. June month-to-date, we're now at 17,000 cars in storage because we took out auto racks to -- for the service of the automotive sector that's back on production. We have 710 locomotives in storage. And we did idle switching yards in Battle Creek and Garneau in Quebec. And we did reduce mechanical activities in more than 20 locations. And I can assure you that some of these changes are structural and will be permanent in nature. In terms of productivity, we had 23% reduction in crew starts with 21% reduction in workload or gross ton miles. That's at the end of May. When you look at June month-to-date, GTMs are down 17% and crew starts are down 22%. Our network speed is up June month-to-date 4%. And we're very pleased and proud of our all-time record fuel productivity in May, up 4% year-over-year. That's after having delivered 6% year-over-year fuel efficiency in Q1 that resulted in $20 million of savings. In terms of labor, we have 21% year-over-year reduction in workforce, and that includes full-time consultants. That equates to about 6,000 people. And we currently have about 4,000 people on layoffs. If you turn on Page 5. Again, we're quite bullish on our strategic pipeline of CN-specific growth opportunities that are in front of us. And I'm very pleased -- I'm happy to report that these are all advancing even during the pandemic. There's a lot of boxes on this slide, so I'll touch just upon a few of them. And I cannot start by, of course, talking about Prince Rupert container expansion with our friends, DP World, that are continuing to expand the terminal's capacity and still continuing to plan to deliver 250,000 TEUs in 2021 and 200,000 TEUs in 2022. And if you listened to the Port of Prince Rupert Authority that was public a couple of months ago, they told publicly that there's space for another terminal -- another container terminal in Rupert that would bring the overall capacity to 6 million to 7 million TEU. We're quite pleased with the Ridley Coal Terminal. As you know, used to be owned by the Canadian government. Now it's owned by the private sector. Ridley, last year, did 10 million tonnes of coal with a capacity of 14 million tonnes. But a new dumper was installed at the end of the year last year that brought the capacity to 16 million tonnes, and there's an opportunity for a second berth that would bring Ridley Terminal to 34 million tonnes. Ridley Terminal is a multicommodity terminal, and I'm proud to report we have a propane export terminal without the gas. As we speak, that's 45,000 barrels a day capacity. And Pembina is looking to install its own terminal early 2021 at 25,000 barrels a day, but they're already planning to increase the capacity to 45,000 barrels a day. We're very, very pleased and proud of our strategic partnership with Teck Coal, and this is a long-term partnership that we believe will bring about an over $1 billion of business to CN over the next 5 years. There's a lot of the new grain elevators being built in the country in Canada. And I'm proud to report that there's 70% of these new high-throughput grain elevators that are or will be built on our lines. We are working with Hutchison Port, which is one of the biggest port operators in the world, to open a brand-new container port terminal in Quebec City. That's planned to be opened in 2024. And lastly, we're very pleased with all term -- this is the terminal in Halifax, and the fact that PSA, Port of Singapore Authority, a strategic buyer, now owns the terminal. And we're pleased to work in partnership with them to grow that terminal. And this is business and market share that would be taken from the port of New York and the port of New Jersey and would come on -- in Halifax in our underutilized Eastern network business and containers that would go to the mid-U.S. And we believe that we will be able to support that business and that growth at 0 or very little CapEx. If you turn on Page 6. We are continuing to advance our technology deployment, and we do have proof points that we are in the right direction. When you look at the automated train inspections, we currently have 7 portals that are operational. We aim to develop about 100 algorithms by 2021. And we have found 30,000 defects that have been detected by the portal that would not have been found by the human eye. And this is with only 17 algorithms that have been built. And as I said, we plan on building 100. So this is a solid proof point that this thing is working and will deliver a lot of the benefits, including improving safety significantly. Same thing on track inspection. We have 8 ATIP cars in service. We're doing test program between Chicago and New Orleans. We are finding a lot of defects that would not have been found by the human and by the visual inspection. And we are able to inspect the track more often than we would have done at the same period last year, 16 times more often. And then finally, we have and we are deploying 11,000 handheld tablets to our crews and mechanics. We have -- we will have and have the rulebook, which is typically a big binder in the tablet that will make it much easier for train crews to find specific rules. And this is -- again, will allow us to provide more accurate information than in the past. And it's a big step towards paperless operations and reducing our environmental footprint. So on the last slide, Page 7. We do have a solid team in place, and we have the best investment grade credit rating, continuing to have access to commercial paper market at rates that are lower than LIBOR to weather this current storm. We continue to work on our strategic pipelines of growth opportunities going forward. As I've said, we continue to pursue a technology deployment, and we continue to drive ESG strategy, including our fuel strategy even harder than ever. And on this, Seldon, I will -- Paul and I will take your questions.

Great. Thanks for all that. So I promised Paul I wasn't going to ask for second quarter revenue guidance. But I do just want to ask about mix and how that sort of has trended through the quarter. It feels like right now you're at a bit of an inflection point in some of your volume categories. And I realize these are fairly fluid situations, and the recovery is not necessarily straight line, but if we just sort of walk through some of the moving parts, autos obviously have been under significant pressure with the production shutdowns, but you have seen a couple weeks of improvement. You do expect production to continue coming online. Fuel has been pretty volatile. So when we just try to think about the impact from mix in the quarter, how do you sort of balance all these dynamics going forward as we think about auto ramping back up and whether, from our perspective, there's anything to glean from a productivity standpoint in June with carload declines being a lot softer than -- or just being a lot less bad than maybe your RTM declines?

Yes. I mean I can open up and let Paul jump in here. I think, as I said, the recovery will be slow, and I think it will be choppy. To your point, I think the auto sector is starting. I think there's a lot of word out there that OEMs may not take a shutdown as they typically do in the summer. I think when you look at the consumer products, again, with intermodal, it is a bit -- like it's not -- I don't think it's sticking yet to your point, Seldon. I think June, I wouldn't say better, but I would say June, we believe, will be less bad than May. And I think that Q3 on a year-over-year basis will still be down but will be less bad than Q2. And I think that Q4 will be better. So -- but I think that, again, it'll be slow. And when you look at some of our commodities, and I've referenced them a little bit, Canadian grain is continuing to hit records. I mean when you look in May, I mean we've delivered a record of 2.52 million metric tonnes of Western Canadian grain versus a previous record that dates back to 2014 of 2.4 million metric tonnes. And that's even over 20% of the 3-year average. So we're quite proud of that. And when you go back, March and April were records as well. So May -- so grain is continuing to be strong. Fertilizer, although it's seasonal, is strong. I mean, RTMs, I didn't mention fertilizer in my remarks, but fertilizer RTMs are up 7% Q2-to-date. Canadian coal is strong. But the places where -- again, the very weakest crew, I mentioned that in my opening remarks, frac sand, the auto sector is improving but starting from a very low base. From a productivity standpoint, I think, as I said, some of the changes that Rob and -- and I must commend Rob and the team -- the operating team are doing a hell of a job rightsizing and pushing on productivity in these unprecedented times. Some of these changes that they're doing will be structural, will be permanent in nature. As the recovery happens, we will be patient in putting back assets and/or calling back people. We will be patient because, as much as when volumes were going down very quickly, there was always a lag in terms of cutting costs because, by the time you tell someone that you're going to lay them off, by the time that you go through the bumping process with the union, you can lose 1 week, 1.5 weeks, 2 weeks. Well, that same lag will happen on bringing and calling these people back as the recovery happens. So we will be patient. And I'm very confident that, when we do add back resources, we will not add them back on a one-to-one basis. Paul, anything you want to add?

No. I think you answered it very, very well. Thank you.

Okay. So I want to get back to the cost side in a second. But if we take a little bit of a closer look within each commodity group, I think you've talked in the past about grain being supported by some excess -- just supply out there from last year's crop, and it seems like this year's crop is shaping up okay. Do you think there's enough excess supply to sort of support grain growth until you start to move next year's crop?

I think there is. I think there is. I mean, to your point, there is excess supply, and I think that there is. And I think at this point, we're looking at an average crop for next year. And the average crop, Seldon, as you know, because you follow us quite closely, it increases with the technology of agriculture. With the technology and the improvement in fertilizer, it naturally increases by 2% to 3%. So in the past, when we used to talk about an average crop of 65 million, 67 million metric tonnes, today, the average crop is in the range of 72 million metric tonnes. So it naturally increases. So we're quite pleased with that. And we're quite pleased with the high grain throughput elevators. I mean there's 24 of them that are being or will be built, 23 will be exclusive to CN and 17 are actually operational. And maybe, Paul, you want to talk about the grain -- the new grain terminal on the North Shore of Vancouver, that, again, we haven't seen this in many, many years. That will be on our line that's quite exciting.

Yes. I think to Ghislain's point, if you look over the years how much the grain production in Canada has increased, and that's definitely led to more elevators getting built in the country but also, as you need to move that grain to offshore markets, we have seen a new terminal that's getting built to G3 just on the North Shore Vancouver, so served by CN. And it is the first terminal -- export terminal on the coast that will have a loop track capability. So basically, it will be the first loop-track-to-loop-track supply chain here that we're going to see. So it's going to be very, very efficient. So we're very pleased that that's going to come. It's going to -- it's being commissioned right now. So we would expect that to be operational for the next crop that's coming here in the fall so very excited about that. So that, with the inland new facilities that are opening are going to be definitely a positive. And as Ghislain said, I think right now, we're thinking that the crop will be pretty much average -- an average crop at this point.

And what's exciting because we're a long-term business, Seldon, is -- I mean these opportunities and the ones that I've touched upon that are CN-specific, I mean CN, we've been around for 100 years. We celebrated our 100-year anniversary, and we will be around for the next 100 years. And we've seen recessions come, recessions go. So these opportunities are not only going to feed the network for the next quarter or 2 but more so is going to feed the network for the next 10, 15, 20 years. This is what's exciting. When you build a high grain throughput elevator on our lines, highly efficient, then that elevator is with you for the next 30, 35 years. So this is long term very exciting. And this is why we're very comfortable to say that we can grow more than the economy because of these -- because of all these lines in the water. It's like going fishing. I mean if you have only one line in the water, maybe lucky to catch a fish. But if you've got 10 or 15 of them, then you will probably catch 1 or 2 or 3. So this is what we have in front of us.

And do these new high-throughput grain elevators or these -- the new loop-to-loop tracks, so to speak, do those have implications for train length as well?

Yes. They do. Actually, they typically have 2 loop tracks of 105 cars. So -- and they have -- they're equipped with air, which means that when we come in with our big locomotives -- high-horsepower locomotives, the train, which is the cars, have already been -- the brakes have already been tested because you need to test it with air. So we just hook and haul the first part of 105 cars, double up to the other 105, and we bring that grain with a 210-car train to the West Coast. It's a beautiful thing.

And is there any idea what the average train length is today of a grain car or what you're moving on some of these older nonloop tracks or older grain elevators, just to get a sense of what the change is?

Well, as I said in my opening remarks, and just not grain, but if you look at the average overall train length of CN, we're close to 10,000 feet. So obviously, the grain -- these new high-throughput elevators, the unit trains are 210 cars, so...

Okay. I'll have to do my math on that one. So one more just short-term question, and you can answer it as quickly as possible. And I know you don't want to give a lot of detail on it -- or you can't give a lot of detail on this. But is there any way just from RC to think about how to just guess on what liquidated damages could be in the quarter? Or could you give us a sense of maybe what crude volumes were last year that -- or revenue was in 2Q of last year that won't show up in 2Q of this year? Anything along those lines?

No. Listen, we -- I think to your point, we're not going to give a whole lot of detail. All to say is that most, if not all, of our business, all of our business in crude do have liquidated damage. We are charging those liquidated damage, and we are collecting them. And again, I think these are not the same as pipeline liquidated damage where if -- whether you use or whether you don't use the pipeline, you have to pay. In terms of railroads, the liquidated damage is a kind of an amount per car of volume that have not been moved. And frankly, crude is a very volatile business. As you know, Seldon, I mean crude-by-rail, railroads were not moving any crude-by-rail in 2010, and we build that business for us at CN to $1 billion. This is crude-by-rail and frac sand in 2014. And very quickly in '16, in the second quarter, we hit the trough with that business, fell by half to $500 million. So again, when you look back in '18 -- in December of '18, Paul, we were moving crude-by-rail in December at an all-time high on an annualized basis of 140,000 carloads. And we thought going into '19 was going to be very robust. And then the Alberta government got in into the market, and we barely did 100,000 carloads. And now this thing is close to very little, as we speak, as you know, Seldon, now. What we're moving, as we speak, is the heavy undiluted bitumen that doesn't have or has very little diluent. And that business, we believe, will continue to be on the railroad for a couple of reasons. Number one, because you removed the discount of diluent, now the economics of moving it by rail is very, very similar to moving it by pipeline. And second, because this is like [ heavy molass ], it's not a dangerous good, so -- and this is in light of, if DRU, diluent recovery unit, are being built, that's exactly what it would do. We are -- I mean last year, Paul, out of the 100,000 carloads that we moved, I would say, about 1/3...

1/3. Yes.

Yes. About 1/3 was this undiluted bitumen. So listen, we at CN believe that crude will want to go by pipeline if pipeline capacity opens up. We're not counting on the long term on crude, but we believe that crude will remain a niche business for us and for the railroad. That's our thesis on crude.

Okay. That's really helpful. And then just switching to the cost side for a second. In your prepared remarks, you cited you have a 21% reduction in workforce and 30% decline in T&E employees. Is that where you stand today or an average number?

That's where we are today.

That's where we are today.

Okay. In a couple of your previous slides or presentations, you had some really insightful productivity metrics. And obviously, this is quite an unprecedented situation, and the dropoff in volumes is obviously tough to catch up immediately. But it looks like, in June, just based on all the productivity metrics you've sort of provided, it looks like the network is a lot more balanced than it was in, say, May or April. And you talked about a lot of these things helping you on the way out of Q3 or when volumes do start to rebound. So I guess just from a decremental margin standpoint, can you help parse out maybe what you've been able to do with your fixed cost base relative to your variable cost base as we move through the quarter and maybe how that should look in Q3 and on the other side, maybe when we return to growth in Q4 or Q1 of next year?

Yes. I would say that most of our costs are somewhat variable. I mean when you look at labor, that's variable. And you can see at what we're doing with our labor as we speak, when you look at fuel, when you look at purchasing services, the one that's fixed is depreciation. And we've said, Seldon, as you know, early in the year, with our 2 years of high investments, which we needed to invest for capacity in Western Canada, and again, we may not need these investments this year because of the significant reduction of volumes, but we will eventually need them. I mean, as I said, Rupert continues to expand. Ridley continues to expand. So we will need those investments and -- but depreciation is fixed, and depreciation this year is a headwind of about $130 million. The other piece -- the other cost that sticks is pension. And we have a pension. We have a defined benefit pension plan at CN in Canada. And as you know, some of the expense is determined by the discount rate that's exactly on December 31 of the year. And because the discount rate of last year was 3.11 versus 3.77 the year before, every point of discount rate is about $1 million of expense. So that creates another $65 million to $67 million of pension headwind that's basically fixed. So we have $200 million of costs that are fixed, but everywhere else, Paul, I would say it's mostly variable. Now there is some lag. For example, when you return cars, and we've seen that very well in center beams, where we've leased cars because we know that the lumber market can be choppy and volatile, and we've seen that in 2008/2009, which I was there, so I've seen it, so what we do is we lease cars, and we pay a little bit of a premium to lease it, but at least it gives us the opportunity. And what we do when we lease is we have staggered expiry dates, so that when, in fact, there's a downturn, like we've seen, then we're able to turn around and park these cars and send them to lessors and reduce our expense. But again, the lease has to expire, so there will be a little bit of a lag. Same thing when you lay off people. By the time you announce it, by the time you provide the notice, by the time that there's a bumping effect, there's a bit of a lag as well. But as I said in my opening remarks, that lag will happen on the recovery. So again, on the recovery, and I've talked many times with my friend, Rob Reilly, our COO, and his team, and we will be patient before we call back people, making sure that it's there, making sure that it sticks. And we're going to use it to really push the organization, and that's what we're going to do. So that's what I have to say on that. I don't know, Paul, if there's anything else you want to add.

Yes. Maybe just very quickly, I can add from an efficiency and cost perspective. I think Ghislain highlighted earlier but really the focus right now is when you're in a market like we are, we are focusing a lot on the operating side, on train length, train weight. And I know from an investor perspective, a lot of you look at data, which is car velocity, terminal dwell and train speed. And some of them -- some of those have deteriorated a bit, but that's really a decision on our part. As we focus on train length, train weight, it does -- it can impact some of the other operating metrics. But at the end of the day, it's the right decision to do from an efficiency perspective. And I do want to highlight that Rob and the operating team have done a really, really good job of making sure our network is fluid and also making sure we are prepared when the volumes do return.

Yes.

Got it. Okay. And just a quick public service there. We have a couple of minutes left. If anyone has a question from the webcast, please feel free to submit that online. I want to ask just a longer-term question real quick. In 2017 -- or 2019, sorry, when you had your last Investor Day, the focus of that Investor Day was largely these IT investments that you were making. And you called out $200 million to $400 million of cumulative savings from these IT investments from beginning in 2020 through 2022. So could you give us an update kind of where you stand today with those cost initiatives. You talked about being at 30 algorithms. Is that sort of in line with what you initially thought? And then just expanding on that, I'm obviously not a railroader, but I still do wear my steel-toed boots every once in a while. But just standing in front of the automated inspection terminal and comparing it to a manual inspection process, I thought the dividends were incredibly obvious with pretty significant implications for asset utilization and capital deployment down the road. So it's now a year later -- exactly 1 year later from your Investor Day. So could you just give us an update on those $200 million -- $400 million of cost savings targets? And maybe what else you've gleaned in terms of better asset utilization or any structural change in capital deployment longer term?

Yes. I think that we're still very much in line to deliver the benefits that we've said at the Investor Day. I think as I said in my opening remarks, we do have proof point that we're in the right direction. I think that the algorithms -- 100 algorithms, we were shooting to have them mostly all done by 2020. Now they push back a little bit to 2021 with the COVID, but we're still advancing. My view, Seldon, I think that, in the benefits that we quantified, there's some of the things that we were not able to quantify, like the capacity, to your point. Today, the train may sit in the yard for 1, 1.5 hours to have a -- what we call a certified car inspection by a mechanical person. It takes about 2 minutes to inspect every car. And they kick the wheels and they go on their knees looking down underneath the box car. Tomorrow, that train goes right away. And it takes 2 minutes to inspect the train in the portal. And I don't think we've done a very good job quantifying the benefits of the additional capacity that, that will provide. My view is that, at the end of the day, these things will change the way we operate. I mean, again, when you look at -- you've just talked about the portal. If you look at the way we inspect track today, and this is not just us, this is all the railroads. Somebody, in our case, needs -- goes into a pickup truck. In our case, it's a white pickup truck with a CN logo. They need a track warrant. They get on a track, therefore use track capacity, and they inspect track. Some of it technology. They have some technology on their pickup truck, but some of it visual at 10 miles an hour. If you can imagine the world where, one day, you have a box car equipped with all this technology, that box car attached to a regular revenue train that has to go through the track anyway, inspecting track at track speed and avoiding having these people, now hundreds of people, that we have in our railroad, going and visually inspect. Today, the train that needs to use the track does it automatically. Not about -- this is not about downsizing, by the way. This is about -- this is -- like these people will be repurposed, and this is a side benefit. But the real benefit is you get a better inspection. Better inspection, you've got better preventive maintenance, better preventive maintenance, better safety record, lower accidents, lower accidents cost, and therefore, solidifying our social license to operate. This is what this is about. Same thing on the portal. So I think this will fundamentally change the way that we operate. And I think that this is the way for us to do PSR 2.0 or JJ sometimes called it 3.0. Let's call it, whatever we want. We have the foundation of PSR at CN that we've built 15 years ago. And our strategy is working, and that foundation remains intact. Now the next leg of efficiency has to be through the effective deployment of technology. Not technology for the sake of technology, technology to deliver value, to deliver long, sustainable value, become more efficient, have better inspection, have better safety. This is what's about. This is our next leg. And we're extremely proud about it, and we're very pleased, and we're excited because we've seen now proof points. We're out of the lab. I mean, you remember, we talked about this technology, Seldon, in 2017. And when JJ became CEO, he got us out of the lab, and now we're deploying, and we're learning way more. And now we're starting to see the proof point that this will change fundamentally the way we operate. We're quite excited about this.

Okay. That was really helpful. I can tell -- I can definitely tell you are. We're about 3 minutes over. So unfortunately, we have to end it there. But Ghislain and Paul, thank you so much for coming on today.

Thank you for having us, and thanks to everyone for listening to us.

Yes. Thank you, Seldon. Thank you very much.

Thank you.

Bye.

Bye.