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

Good afternoon, everyone. Welcome back to the transportation track here. And we're very happy to have with us Canadian National Railway. We are joined today by JJ Ruest, President and CEO; James Cairns, Vice President, Senior, Rail Centric Supply Chain; as well as Paul Butcher from Investor Relations. Gentlemen, thank you so much for joining us. Before I turn it over to JJ, James and Paul for some opening remarks, please note that this webcast is for Morgan Stanley's clients and appropriate Morgan Stanley employees only. This webcast is not for members of the press. If you're a member of the press, please disconnect and reach out separately. For important disclosures, please read the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. And please, the audience, send me your questions via the webcast, and I can pass those along to the management team. And with that, JJ and James, the floor is yours.

Just on the covering page -- I'm assuming you can hear me now. Just on the covering page, if you look at the picture, it's a picture of the grain terminal at Prince Rupert, which is, obviously, when we talk about the reason why James is with me today, we want to talk about also carload, grain and bulk, and that's the reason for that picture. So if we go on page -- what is it, Page 3, it says volume. Business is coming back nicely, especially the port business, that is the container business out of Port of Vancouver, Rupert, but also Halifax is busy. The grain business is very solid, has been solid all summer, and it's also good in the United States. Lumber business have been very strong in July, August. It's been basically outpacing where we can move. So port business, grain business, lumber business have been very strong. And it's a strong late summer, strong fall peak, especially for the port and the grain business. We've been bringing back train crews and rolling stock back to work for all of the month of August. And as a result of demand on one end and bringing back people to work, we had capacity snug in August and still currently are not fully [ earnest ]. We're meeting most of the demand, but not all of the demand. The operating team of Rob Reilly and Doug Ryhorchuk is doing a very nice job of [ ranking ] back up capacity, but doing so under cost control. At a time where rail infrastructure capacity is becoming precious again because we may have forgotten the value of rail capacity and rail infrastructure during the COVID, but we're one of the segments in the economy that has recovered from the pandemic very quickly. And we want to make sure that this rail capacity, which will be even more valuable in 2021 and 2022, is priced fairly, and James will expand on the trade-off of volume and price. So on that point, I think I'd like to pass it on to James, since we have him today and he's very close to the carload and the bulk market, and I'm looking forward to your question later in 5, 10 minutes.

Yes. Thank you, JJ. Thank you for inviting us, Ravi. We really do appreciate that. If you look at the next slide, we're really zeroing in on grain. And the way it is for our business, a very diversified portfolio of commodities, we go with the opportunity that's in front of us. So we ride the wave. And one of the ways we're going to ride for the balance of this year and well into next year is grain, both U.S. grain and Canadian grain. U.S. grain, looking at a very, very robust crop and very strong buys from the Chinese down in the U.S. Gulf Coast. That's going to be very well for CN. But Canadian grain is going to be a star. It's going to be an all-star. We're looking at, some may say, a record crop of this year coming off right in time to match up with our investments in new assets, new equipment and our customers' investments in new assets and new equipment and infrastructure to support this new business. So we're very excited to test this new capacity out here as we go into this record grain crop season. In particular, our good friends at G3 have completed their terminal on the West Coast, and they will have the only loop track to loop track grain supply chain in Canada. Between us and G3, we'll have 5 dedicated sets of 150 cars that will run like a conveyor basis, origin to destination, never breaking apart, consistently running all with new high capacity grain cars. I think we've all seen that we acquired, last season, 1,000 new high-capacity grain cars. And we have an order in for additional 1,500. We're going to start taking delivery of those new cars as early as October. By the end of Q1, between CN and our customers, recall that CN's strategy on the fleet side is a little different than our Canadian competitor. We have our own fleet, plus we have partner fleet. Between us and our customers, we should have about 4,100 new high capacity grain cars in service end of Q1 of 2021. Really bullish on grain, good news story. If you look at CN -- next slide there I'm on, guys -- and the long-term opportunities, it's a deep, deep well of new opportunities on CN. One of our focuses is always, always to try and find ways to grow the size of the rail pie, looking at new projects to bring new carloads to rail that weren't part of rail before. I'll give you an example. If you think about the wood pellet business, wood pellets is something that was fairly small or insignificant in the marketplace just as little as 5 years ago. Now it's a fairly stable, growing business for CN. Year-to-date, our volumes for wood pellets is up about 50%. This is a very, very high demand commodity for international markets, and we see several new projects coming online that's going to continue to grow our wood pellets business moving forward. And the only last one I want to talk about on this slide are our deep well of projects is around propane. AltaGas has just been an outstanding, outstanding opportunity for CN for AltaGas and for Canadian propane producers. The AltaGas has been ramping up here steadily the last 18 months, and now we're seeing a run rate closing in on 50,000 barrels a day. And I think public information is out there that they’d look to expand their capacity and doubling it moving forward and they have the permit to do so. Coming online, early in 2020, probably beginning of Q2, is going to be Pembina's new propane facility at Prince Rupert, increasing them out of propane that we export to that gateway. Clearly, we're seeing that the export gateway that we’ve worked hard with our customers to develop over Prince Rupert gives customers the best netback opportunity for propane shipping off to West Coast. So very excited about that one. We see capacity tightening up here across our network and specific lanes. And as JJ said on pricing, we've been very careful not to chase down a declining market with price, to leave our options open. And as we see this capacity get to be a little bit constrained, it is going to create for us, moving forward, some pricing opportunities as we allocate that capacity into 2021. So some very exciting times in the carload business, recovering much, much quicker than we expected with more of a V shape than a U shape, and we're excited and ready to grow here.

Very good. So I know business is coming back nicely. So as we said, Ravi, we wanted to leave time for precious -- your questions, so we'll do that now at your convenience.

Wonderful, JJ and James, and thanks so much for the opening remarks. Maybe if I can follow-up on that. I mean, candidly, I haven't been kind of following you guys forever. I've been tracking CN in this sector for about 5 years now. And I feel like for each of the last 5 years, you guys have been telling us that it's going to be a record Canadian grain crop this year. So either I'm a really good omen for you guys and kind of bring you a lot of good luck or something is happening structurally with this business that just the crop keeps increasing every year. So for those who are not as close to the Canadian grain story, can you just help us understand kind of what is structurally changing with this business? Not so much on the rail and transportation side as much on the kind of yield and the crop size side and kind of how much visibility do you have on where this is going in the next 3 to 5 years?

Yes. So you do bring us good luck. And there is something fundamental happening in the science of growing in Western Canada. So James, you want to share about why things are looking good and looking better in the years to come in terms of the yield per acre basically?

Yes. I got to tell you, I grew up in Winnipeg. And I spent my summers on my grandfather's farm as a kid. And farming on the prairies is not like it used to be when I was a kid. It's a very highly automated, mechanized and there's a lot of science put to it. We're seeing average yield grow up -- go up kind of in the range of 2% every year. It's about better technology in the cabs of the tractors, better application of fertilizers, and it's really about getting more out of the field that's available by using this new technology, GPS tracking, making sure that you have the exact right amount of fertilizer sprayed on the crop. So the farmers are doing a great job. Yields are increasing every year. This year was very unique in that -- and really, across the prairies, we had almost perfect growing conditions, right? Some warm weather, some good, wet moisture at the beginning of the season and then no rain or very little rain here in September, allowing the farmers to get the crop off. So it's going to be a record crop, we believe, and it's going to be a record crop by a pretty significant number, we think so. If you want to take credit for it, Ravi, go ahead. As long as you keep it running, I'm very, very happy to see that continue.

Just as an aside, Cascade, which is the largest shareholder of CN is also a shareholder in John Deere. We had some interaction in John Deere as to how the business is evolving. And it's amazing how much technology and digitization there is in the world of agriculture and agricultural equipment. And that all means better yield, better yield, better yield. And then you have the global warming, which is a favorable win for Northern prairies for Canada in terms of a growing season.

Yes. On the grain side, too, we always talk a lot about carloads, but we've had one heck of a success with our containerized grain program as well, moving over 1 million tons last season and looking to do more even this season. So I mean, grain, that's one of the ways that we are going to serve here as we move into 2021, for sure.

Got it. So certainly, very good news on the volume side with grain. It's also kind of a pretty good space to see this growth because, obviously, the pricing is regulated as well. So you're not going to have kind of a super competitive dynamic there. So can you just remind us again kind of what do you expect in terms of yields in that business for this grain season? And also, again, in the past, there have been some instances where it's been too much growth for you guys to handle, for the entire space to handle. And so I know a lot of new investments have come in, so are both you and the shipper side pretty confident that there is the capacity to handle these volumes?

Yes. Let me start off on the pricing side. Again, we're excited about this grain season on the pricing side as well. It is a regulated commodity. It is a fairly priced commodity, kind of in line with the rest of our business at CN. I'll tell you what, for this year, we're going to see about a 2% price decrease on our VRCPI, that's the index that the government use to calculate what your maximum revenue entitlement would be for grain, and that's really due to the lower cost of fuel. So that's neutral for us. Our Canadian competitor will see a decrease of about 7% on their pricing for Canadian grain. So that brings out a gap between us and the other guy of about 5%, favorable to CN. So we're very happy to see that. Also, as we acquire these new high capacity cars, and our customers continue to bring on these new high capacity cars, that increases the amount of grain we can handle in each car, they're lighter cars and they're shorter cars so we can get more cars per train. So if you look at the same slot, depending on the commodity that we have, we may gain as much as 30% more capacity using the same train slot that we would have used last year. So that gives us the ability to move more grain in a more condensed period of time. On the grain side of things, the battle really is in Q1, right, the market share battle. The more grain that we can drain from our draw area in Q1 creates an opportunity for us to gain share in the back half of the year. So we're very focused on delivering in Q1. And I got to tell you, the significant changes made to the grain supply chain with 50% more capacity unloading in Vancouver, all CN served, significant increase in the number of CN served high capacity, high throughput grain elevators in the prairie is really going to be an opportunity for us, jointly with our customers, to outperform and prove to the world that Canada can deliver this record huge grain crop. Very excited about grain.

Got it. Just moving on to a couple of other end markets that I wanted to touch on. Maybe starting with lumber. This has been a space that maybe hasn't had the greatest outlook in the last 12 to 18 months or so, but now it seems like everything is super tight. I think lumber prices are at a record high. Do you see that as being kind of a temporary thing? And kind of does that kind of help you in the near-term kind of normalize? Or do you also see structural growth opportunities there?

So I don't think we see long-term structural growth from where we are on the forest product side of business. But if you look at what's happened here in the short term, all the mills that were curtailed and not shut down, primarily are BC, are now up and operating. We had about 3,300 center beam cars parked when we were at the trough of COVID. We've got all those center beams out there working, moving lumber for our customers, and we're looking for some short-term leases to add to the fleet to take advantage of this opportunity. Lumber prices have more than doubled since the start of COVID. I guess, there's a lot of folks that were sitting around their house, looking at the deck, looking at the wall, saying it's time to do some renovations and it’s time to do some improvement. And we're very happy to help move that. We are the dominant player when it comes to moving forest products in Canada. Our share is in the range of 80%. So we have a disproportionate benefit when this market recovers and returns. I would say, we're looking out in conversations with our customers what we understand about the market and demand. This high level of demand is going to be sustainable well into 2021. What happens beyond that? Not certain, of course. But my crystal ball looks pretty good into 2021 right now in the forest products side.

Yes, one of the economists from an [ earlier call ] was describing the housing start-ups as a super V. This summer, housing has been at par, housing, renovation and the likes. And I think as long as COVID kind of keep their people at home and near home, there will be definitely an interest in spending money around home, including renovation, white goods, and also housing starts. Some people want to leave their condo and get a little more space and to be able to live a life that's difficult to do with a family when you live in a small space.

Got it. I also wanted to touch on coal and intermodal, maybe starting with coal. I know you guys have a bunch of moving parts there with Ridley and the tech business and such. Can you just give us the latest update on that? I mean you put out an update late last month when we spoke, but can you just kind of help us walk through how that business evolves over the next 12 months or so?

So coal has been a great commodity. All through the pandemic, that's -- we've shown growth in our coal business. Conuma, shipping very, very strong, very stable, looking to do a little more, very successful Conuma. Coalspur, I think we all know that story. They continue to ramp up. I think they're on a run rate kind of in the range of 6 million tonnes, and they want to do it a little more. And we, certainly, want them to do a little more. And the tech business. Tech's a big deal. Tech is a big deal. That's a significant share shift from our competitor onto us for the last mile. We're going to see that tech contract start up in April, and we've made some pretty significance on our investments on our network in order to support that business. But those investments that we've made, particularly in North Shore and Vancouver, create capacity for us to grow in other commodities of our business as well for stuff that's going to the North Shore. So all in, it looks very, very positive, and coal has been a growth accelerator for us. And we expect to see that moving forward, strength in that coal market. U.S. coal is a little different. U.S. coal, we saw a pretty steep decline last year, starting around this time, and we're going to start to lap that in Q4. Q4 U.S. coal, with our new contract we have on pet coke with our friends at BP kicking in, we're going to see some pretty significant growth Q4 in the U.S. coal side of things on a year-over-year basis.