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

Greetings, and welcome to the Scotiabank Canadian National Railway Conference Call. [Operator Instructions] As a reminder, this conference is being recorded for distribution purposes on Wednesday, September 2, 2020. I would now like to turn the conference over to Konark Gupta from Scotiabank. Please go ahead.

Thank you, operator. Good morning, and thanks, everyone, for joining us today's 9 a.m. investor call with the management team of Canadian National Railway. My name is Konark Gupta. I'm a Scotiabank's transportation sector analyst. It's been interesting times for the global and North American economy as well as Class 1 railroads over the past several quarters with the pandemic, labor actions, blockades, trade noise, energy market volatility, et cetera, all posing challenges for the railroads. Yet CN is navigating its way through with the help of intermodal, grain and some other segments. So joining us this morning to discuss how CN is faring in this environment, we are pleased to have JJ Ruest, President and CEO; Keith Reardon, Senior Vice President, Consumer Product Supply Chain; and Paul Butcher, Vice President, Investor Relations. We will start the call off with some opening remarks by the management team before I host a fireside chat with them. So everyone should have a copy of the presentation they have put together for us. And with that, JJ, Keith and Paul, over to you.

Good morning, everyone, and thank you, Konark, for having us today. What I will do is I will do some opening comments using the first 2 slides that you have on your deck, for those of you who are watching -- listening to us on the webcast. And Keith will give us his viewpoint and what's happening in the world of intermodal right now. So let me start on Page 3, which is a slide that we show roughly the RTM recovery. RTM, meaning measure of volume in the rail industry. So as you could see, the volume, the month of May was the low point, and things have been improving since then. The segment which have the -- probably the better resiliency have been domestic intermodal and domestic international. Just simply, people are spending more money at home or near home. And that's really the world of intermodal. Canadian grain has been extremely strong. In fact, for example, in the month of August, you know that we set a record in July, and we also have set a record month of August. We will have moved roughly 2.3 million ton of grain in Canada. Canadian coal has been good. At intermodal, I'd say intermodal is back. So just look quickly, if you look on the right side of the slide, just a bit of a sense of sequential gain. In the month of June, we were up on volume-wise, as measured by RTM, 5%. The Port of Prince Rupert got quite busy, meaning that early in the spring, we had blank sailings, which means that they were taking ships out of rotation. We had less blank sailings in July, and the business was coming back from Asia. Frac sand was also decent because of resumed trading activities, mostly in Western Canada. U.S. grain is also picked up. And as you know, the U.S. grain crop looks good for this fall. There should be a good story for railroad and CN as well. And when we talk about grain, we also talk about ethanol. And ethanol is made out of corn. And ethanol, the main use of ethanol is to be blended with gasoline. So as people start to drive again, the demand for ethanol and diesel and gasoline came back. Obviously, jet fuel did not came back. It's not about to come back, but activities on the road is resuming. A bit of an improvement in crude. And automotive, which was at a hard stop in May, came back and has reopened. When we got to -- so broadly speaking, in the month of July, we met demand that was available to us, and that's an important point as we talk to August. So the month of August, we were up 4% sequentially from the month of July. We did not quite meet all of the demand in the month of August as it relate to calling back crews that we didn't call back in the month of July, but now they're finally all in to start the month of September. So the month of August, the demand for domestic intermodal and international intermodal was also strong. There was less blank sailings in the shipping rotation. But also, in some cases, there were extra loaders because there's product in Asia that was waiting to be able to get on ship. There's a backlog. There's still today a bit of a backlog of containers back in Asia to make it to North America. Lumber, I think those of you who follow what's happening in the housing starts and renovation and at-home spending know that lumber industry is extremely strong. The sawmill, running at capacity, and they can't quite meet capacity. Therefore, the price of lumber is up. The demand for center beam is also strong. We're not meeting all the demand. The demand is strong. And the export to China probably slowed down because the price of China is nothing like the price in the United States. Canadian grain has remained strong, unusually strong all summer. And as I said, we actually set a company, CN company record, all-time record in the month of August at roughly 2.3 million ton. And then now that our crews, most of them are back, I'm talking train crews, we should have a very, very solid month of September. In the month of August, there's probably $15 million, $20 million of business that we could not move because we -- the resource were coming back, but not quite all there at that time. If we go to the next page, which is specifically talking to operation. We have rightsized our resource. You remember that we had significant layoff at CN since the beginning of the pandemic. The peak of people being on unemployment insurance was the month of May. At that time, we had 2,800 of our crews which were furloughed. We're now down to only 1,000 of our crews being furloughed, 1,800. These employees have been recalled. A lot of them have been recalled during the month of July. Just as a reminder, in Canada, when you recall an employee, union employee, train crews, from the time you pick up the phone and call them, it's 2 weeks before they come back to work. Because of the pandemic and the nice summer, just about all of them have taken the 2 weeks before coming back. And because they've been out of work for long enough, we need to provide them with some training, safety training refresher, which is an extra week. So from the time you recall a person back to work and the time they become productive, there's about a 3 to 4 weeks lag in Canada, and it's about 4 to 5 weeks lags in the U.S. So right now, we're down to about 1,000 employees to call back, and we hope that we can do it, we can recall most of them some time in the fall as business come back. Just on that point, yesterday, I was talking to a top executive of one of the global container terminal operator in the world, as well as a big infrastructure fund. And when you look at the container business in the world, as one of the indicator of where the economy is all that, the international movement of container right now, it only seems to be about 5%, 6% below last year same time. So what that means is, I mean, broadly speaking, obviously, you have different geographic pocket. But broadly speaking, the economy is on its way back in terms of trade activities, at least on the container side. And the part which is really, really stalled is the part -- -- is very concentrated. Like airport, obviously, are not doing well at all. Airline are not doing well at all. Restaurant, mall, shopping centers, park, et cetera, et cetera. But many other sectors are really doing much better and on their way to be able to have a decent end of the year. On the other aspect, on the cost side, that we focus to make sure that we come out of the pandemic with better cost than what we came in, as obviously like other companies, we have a number of employees who are now going to be working from home permanently, not so much between now and year-end, but we've identified a number of jobs that will be done at all time permanently from home. And other people who are working, sort of office workers, sort of what we call the A and B team concept have started to come back to work at the office in terms of 1 week on, 1 week off. One week at the office, one week at home and rotating that way. So this way, we diminish the density of the office workers in our building at the same time as reconnecting employees with their team members and the company's strategy in a way that is, in many ways, somewhat better than what you could do just by using the video conference. Operation. On the operations side, there is some yard and some activities on mechanical side, mechanical shops and the way we do work in engineering that will be permanent cost savings. You look at our train length and train weight. Obviously, you could see the red bar, our train length, train weight are up, and that's a testament to basically managing costs. Although, as I said, in the month of August, we were a little tight on resource. So in the month of September, we'll be in better shape to meet most or all of the demand. And our focus on the ESG remained very, very strong. For a company like CN in the supply chain, our carbon footprint is obviously top of mind. In the month of July, we set another company record in terms of fuel efficiencies. We were 3% better than July of last year. And July last year was actually extremely strong, saving 14,000 tons of CO2, but also saving money. Diesel is not free, and every time you save on diesel, you save money. And we feel confident that these fuel efficiencies will stay with us and, over time, improve. And another tidbit of item, we have placed an order to buy 50 electric truck. They will only be delivered in the fall of 2021. And that's also in the mindset of innovating in the space of our intermodal network and starting to use other technologies than just regular Class A truck to do the local delivery of our container. And finally, on that point, we have our new CITO, Chief Technology Officer, who joined CN on September 1. He actually comes from a very strong technology background. He was at the GE Transportation and at Wabtec, building locomotive and been involved in the PTC implementation. So Dominique will be a very strong contributor to our technology push to automate everything that we can in the rail operation and in the rail industry, with a very strong engineering background for the last 20 years in the space of rail automation and rail technology. At that point, I'm going to pass it on to Keith to talk specifically about intermodal.

Sure. Thank you, JJ. We're going to break down my piece on intermodal into 3 different parts: one, international intermodal; the next, domestic; and then we'll talk about the future of intermodal and our facilities. So on the first, the unique 3 coast access to North America that we have with our network. We're very, very pleased and honored, and we feel very confident that this network is something that's a differentiator for us. It's our gateways of trade. And it's very relevant now with what's going on in the consumer economy, what's going on in the world trade as supply chains move from different parts of Asia to Southern Asia. And as people discuss near-shoring those types of things, we think that our network is still relevant, will continue to be relevant and the structural advantages that we have will be there for the long term. And to strengthen that, to bolster that, we work with our partners, the terminal operators, the port authorities to increase the capacity. And as you see in the Port of Prince Rupert, there's expansion plans. Port of Vancouver has been and will continue to expand. Port of Halifax and PSA, they are making expansion plans. And we also have plans with Hutchison to build a new terminal, Port of Québec City. But when you go down south, there's also expansion plans in New Orleans, and there's been a new port built for the Port of Mobile with APMT. So the 3 coasts are covered. We have the ability to move with the changes in supply chains, to react quickly as our carriers and the customers that they haul business from all over the world through these gateways, we're able to react quickly. In fact, when the Montreal strike occurred at the port here in Montreal, we were able to react and use the Port of Saint John, the Port of Halifax as additional ways to get into the gateway of Montreal, Toronto and the U.S. Midwest. So again, just another proof point to show that our network is advantaged, and we have the ability to react very quickly. I want to move to the next page where we talk about domestic intermodal. We've seen, with the changes in the economy, the reaction to COVID and a lot of the things that JJ mentioned earlier about people staying at home but changing their purchasing habits, purchasing more, purchasing more of the home items. So we have worked very closely with all of our multiple sales channels that we have to find out the changes that are happening in the supply chain, who the partners are, what changes they need to make in order to be successful as these changes occur. And so we are blessed that we have multiple products and services to be able to be used in those various supply chains. And we also have multiple sales channels to be able to participate in those supply chains. We saw this coming several years ago. This is not -- we're not able to react as quickly as we are because of luck, it's been great planning. It's why we made the acquisitions of TransX and H&R. As we see, the refrigerated products, the temperature-controlled segment is growing very, very rapidly this year. And because of our acquisitions, we've been able to participate in that new supply chain, that the growth that's happening in that supply chain. That's one of our sales channels. Another sales channel is our own CN retail product, where we have our own cold supply chain business. And we've been participating in that. They're different customers, for the most part, in those various supply chains, and the different multiple sales channels allow us to participate in all of them. When we look at the other sales channels that we have, we have the EMP, so that's more of the IMCs that are crossing the border from the U.S. Southwest with the UP and coming into Canada; and then the U.S. Southeast with the NS coming into Canada. That's another sales channel that we participate in. And then we work very, very closely with our wholesale partners in Canada. Our -- we're very unique in our intermodal business that we have a retail channel, and we also have wholesale partners that we work with. And some of the ones that we work very closely with, with these different supply chains that are evolving are M-O, TFI, Kleysen. There's multiple others. And we work independently with each one of them as they deepen their hooks and their grasp of these different supply chains. We work with them on their cost structures to make them win in the market. And it's just another product, another service and another sales channel that we use. Finally, on the domestic repositioning. What that is, is working with our steamship lines to take their boxes that have made it into the hinterland as they are coming across our network with the 40-foot container or the 20-foot container. And we work with them to get that box back to the coast in an economical fashion for them. We use that box to move domestic goods. It's a win-win situation. It increases our capacity, it reduces their cost and it gets the boxes to where they need to be to get an export for overseas. And then finally, the CSX partnership that we've developed over the Port of New York, New Jersey and Philadelphia has been very, very successful. Again, with what's changing in the economy and with the different supply chains that are evolving over the last 5, 6 months, because we had this planning, we've been able to participate in this. In fact, some of the vessels that were diverted off of Montreal during the strike actually went through New York, New Jersey or Philly, and we were able to participate in those movements back into Canada based upon that partnership that we've developed. The last piece that I'd like to talk about is the building the intermodal of the future. We know that in order to compete down the road with the truck, that we have to not only be safer, more efficient, but we also have to be more customer-centric. And that's our thinking and as we develop our terminals of the future, we're using our Brampton Intermodal Terminal as our mini sandbox to play in to find out how do we evolve our terminal structures, how to evolve our processes to be safer, more efficient and more customer-focused. The first thing that we did was yard design. If we redesign our yards to be more productive, have more capacity and be able to provide higher service levels, then we're going to be much more successful. We redesigned our yard using some help from some industrial engineers. We actually are able to put more containers in our yard. We're able to decongest the movements of trucks and our equipment through the yard, which means we have more capacity, we also are safer and we provide a better service for our customers or their surrogates, their truckers that come in and out of our terminals. As we want to be lower cost, always working on our cost structure, we've put telematics. So we put devices on all of our cranes and all of our shunt trucks. Anything that we move around the yard, we put telematics on those. So now we know where everything is. We're able to backtest some of the events of a day or a week, learn who's more productive. And we're taking all of that data and we're using that to evolve how we operate our terminals to be traveling less. We view our terminals as an outdoor distribution center. And by having these telematics, with all of this rolling stock, we can be better planners and better operators moving forward. As the demographics of our workers are changing, we must change with the times as well. That's why a lot of the technology that we're implementing in our terminals with our smart screens and our smart maps, they're more geared towards the newer generation of operators that we have. And where we -- we're fearful that bringing on more technology was going to negatively influence our workforce, it's actually the reverse. They're screaming out for it. They're asking us why we waited so long to implement them. So the change, the process change, the behavioral changes have been very, very easy compared to what we initially thought. These types of devices are also giving our frontline supervisors more tools to manage better, to be safer, more efficient and actually provide a better experience for our customers. And finally, by building all of those foundational aspects to this intermodal of the future, we're going to be implementing new operating systems that will help us with decision-making. It will take out wasteful movements of our cranes and our shunt trucks and ultimately, someday, will lead to the ability for us to do new and adventurous things with how we operate these terminals, maybe autonomously or with different types of operating mechanisms, different cranes. We ultimately want to get to do things like our partners are doing that we see overseas with the way that they operate their terminals in these large ocean terminals. So with that, Paul and Konark?

Okay. So we'll -- we go back with you, Konark.

Yes. Yes. That was a great update on the overall, the business and intermodal, Keith. So maybe we can kick off with something that you touched upon, JJ, before we go into kind of in-depth Q&A. So on the T&E employees that you are recalling, I just wanted to kind of understand better, with the peak season upon us here, how prepared are you for that with the recalls of these employees? And what else needs to be done to get -- to have supply and capacity in line with demand that you expect for the peak season?

Yes. Thank you. A very good question, because we are focused on growth, we're focusing on pivoting to growth and helping the economy to restart. So we have recalled quite a number of our employees in the month of July, and they're rolling in, in the month of August. And as I said, as they roll in here mid-August and late August, they're becoming requalified after the 5 trips to be on their own with running extra train. We are, in some places, re-adding frequency of local service from say 2 days a week to 3 days a week or 3 days a week to 5 days a week to be able to meet the demand. On the grain side, our fleet of hopper cars have been inspected. It's coming out of storage. It's going in preposition. Our orders with National Steel will -- they're going to be making most of the cars in the fall. We'll take most of them, possession of them in the first 2 weeks of January. We might actually advance delivery of some of those in December. We'll make that decision later in a couple of weeks as to whether how much of that we do. Locomotive fleet. We still have locomotive in storage, but we're rolling back equipment. So it's really 3 things. One is we're careful about how many railcars we bring back in service. We don't want to create congestion. So the first thing that we call back is crews, making sure that we have crews to run the train. Second thing is that we deploy some more locomotive as the crews are coming back and being requalified. And then the other thing is on the rolling stock. So the -- as much -- as we had a good month of July, we're very happy with July. The month of August was actually a little better than what we thought. That's what I said, that the resource gain were a little tight. Western Canadian business, for example, is our areas of most promising short-term results. Intermodal is part of that because there's quite a bit of business coming at us at the port. Quarter-to-date, week 35, CN -- on the Canadian railroad side, CN is only down 3% on total intermodal business. That's domestic and international, and the other railroad is down about 10%. So we've got good demand coming in for both Canadian cities and U.S. cities. In fact, I think I was looking at the stat this morning, intermodal port business going to U.S. cities is almost at par to last year, what it was last year at this time, and it's only down a bit on the Canadian cities. So we are getting set up for a good fall peak. Business mix, obviously, is a little different, but the mix of business is different every year. So this year, energies and crude is way down and other commodities are picking it up. So we're getting set up for continued improvement and sequential growth, and that's why we're deploying the resources to be able to do that.

Perfect. So maybe we can dig into the intermodal. You mentioned about the international and domestic trends there. If we were to think about the mix between domestic and international intermodal with respect to, let's say, revenue and margins, how does that compare to the prior years? And what have you learned in this pandemic about the cyclicality or resiliency of this segment based on the footprint you have?

Keith, do you want to take that?

Sure. If you're looking at what's changed this year from others, I would say that we're dealing, in our intermodal business, less with the industrial business that we have in the past. We're not maybe moving as much of the manufacturing in intermodal equipment as we have in the past. However, on the consumer side, whether it's grocery products or whether it's retailers or e-tailers, the e-commerce commerce business, we're moving more than ever. And it's again one of those things that we planned for. JJ -- I mean, my title is SVP of Consumer Products. It's why we split the CMO role in the first place, to give myself and James some room to move in, to strategize about how we're going to play in the new economies. So we've been prepared for it. We're able to extract the value out of these changes now because of being prepared for it. The acquisitions of TransX and H&R have accentuated or accelerated this. And we also are working very closely with all of our partners, whether they're the wholesalers in Canada or the IMCs in the states to participate in this. And then as I said before, the network that we have is unique. It is structurally advantaged over others. And we don't take that lightly. And these multiple gateways, multiple optionality that customers have to get into North America, to the U.S. Midwest, we make sure that we use it and don't abuse it.

Great. You mentioned, Keith, about TransX and H&R, obviously, and how they have sort of benefited you guys during this kind of time frame for high demand for consumer products. If you can help us understand, to what extent have you already seen the benefits of TransX and H&R that you were expecting? And is there room for further growth or margin expansion from here?

Yes. Thank you very much for the question. The -- we had an investment thesis, and it was that we wanted to grow our rail business in intermodal, which we've been able to do. We've taken a lot of the truck business, the traditional truck business that TransX may have done and converted that to rail. We also said that we wanted to add talent value to CN. We've done that. Numerous people inside of TransX are participating in other parts of CN business, whether it's strategy or whether it's, interestingly enough, community affairs, those types of things. So the second piece of adding talent into CN has done very well for us, too. We also said that we wanted to take TransX and make it the best in the business from an operating ratio standpoint of its like businesses, whether it's a TFI or J.B. Hunt. At that point, we have done that as well. They are on par with those businesses that are like and similar in the products and services that they deliver. Is there room for improvement? Yes, there is. We have just begun to kind of integrate our fleet of assets between H&R, TransX and our traditional CN fleet, taking out empty miles as they move across the network. As we get better and better and better at that, we'll see margin improvement. But we're also going to see gains on the revenue side as we get deeper and deeper with the customers that they have and deeper and deeper with the blue-chip customers that we have at CN, who maybe we don't provide the level of service that they need. We will be -- we're giving the TransX and the H&R folks a lot of leeway to come in and provide those higher levels of more touch points, more white glove-type service with those customers so that we can get into the additional revenue streams that maybe we have not been able to.

Okay. And then just moving on to -- switching gears to international intermodal, perhaps, I don't know if JJ or Keith, do you want to take it? So we have learned recently that imports on the West Coast are surging this quarter, both in California and B.C., which is kind of causing port congestion and higher dwell times. So how are you managing operations on the West Coast and your customer expectations through this period of high demand?

Yes. Maybe I can take that one, Konark. So as you mentioned -- as we mentioned earlier, there was a time there was a lot of blank sailings in the rotation on the trans-Pacific trade. And then eventually, we went from a lot of blank sailings to no blank sailings, to eventually no blank sailings and some extra orders. So there was a slowdown then of surge on the West Coast. And that surge has caused some -- because they came fairly quickly, in a matter of a couple of weeks, from less than 2 months from bottom to peak. So there has been some congestion, broadly speaking, in the West Coast. And that's partly why also our ethanol business in total is only down 3% from last year quarter-to-date, because there's good business in the West Coast. On the import side, the retailers, brick and mortars, but especially e-commerce are stocking up. As a consumer yourself, probably you have noticed that if you were shopping in the month of late June and July, there were many stores which had some -- not all the shelf were full. So -- but that situation is resuming itself. But it is part of the reason why we are recalling crews and pulling local Nevada storage is to handle the businesses available to us. And as I said, there was a couple of weeks lag in terms of crew recall. We've been recalling quite a few crews, but maybe we could have recalled them 2 weeks earlier. And then in the month of September, I think you will see that we will deal with that surge in intermodal September, October, November in a way that we maintain the port very fluid. Our freight forwarding team in China tell us that right now, when they try to book containers to go from China to Canada, basically all the vessels are sold-out or most of them sold-out between now and early October. So that gives you a sense that the vessel arriving in September and October, till all the way to end October, are probably going to be quite busy and quite full. And so it bodes well. And it's the reason why we feel confident about the recall of our crews, that we're going to be able to keep them busy. Thank you.

Great. That's great, JJ. And if I can follow up maybe with respect to the West Coast. So like we have seen congestion in Vancouver, obviously, in California as well, how has Prince Rupert fared during this time? Have you seen similar congestion issues at Rupert? Or have you seen any benefits there? And then if you can help us understand. Obviously, over time, Prince Rupert has gained a lot of market share from the West ports, Vancouver and others in the U.S. Do you expect to see more of that going forward as well?