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

Good morning. Thank you, everybody, for joining the 8th Annual Crédit Suisse Industrials Conference. Very happy to have Canadian National here with us today joined by the President and CEO, JJ Ruest; the Chief Financial Officer, Ghislain Houle; and Paul Butcher, who is Investor Relations. So thank you guys so much for participating today. JJ, I believe you had a few opening comments that you want to make and maybe Ghislain as well, and then we can jump into some Q&A.

Excellent. Thank you, Allison. And good morning to everyone, all of the early riser of New York. And if we have any early riser from the West Coast, we would have a special good morning to them. So let's go through maybe just a quick recap of the volume history of this year. Started the first quarter with good decent volume, but we had the illegal blockade in February, which is the dip you see, and then we faced COVID like the rest of the North America with a bottom out in May. So the business came back, but it came back different than what it was before COVID, namely, as you all expect, a large amount of consumer goods as people are staying at home and spending but spending differently and spending more on the hard goods that are coming from especially from overseas as well as lumber for construction. Propane export, very solid. And then the thing that hasn't come back, it may not come back for a while, maybe not in 2021 anyway, is the energy sector, diesel, jet fuel, refined products and crude. However, quarter-to-date, as you would see from the stats that we publish every week, our volume on carload is up 8%, and our revenue ton-mile is up 13%. But it is noted that last year, at this time, we had a work stoppage, which is also a part of why we have such an industry-leading volume growth this year. Next slide. Yes. This is the pipeline -- I think you've seen this slide a number of times, but this is the pipeline of opportunity for CN in terms of growth. CN is definitely a supply chain enabler. CN is a company focused on top line profitable growth. And these are the list of items that we're working on. I mean -- and they're not short term. They're a combination of short term and long term. And as we emphasized in the past many times, it starts on the West Coast, [ anything ] has to do with trade with Asia. So the port of Prince Rupert, the container terminal with DP World is running basically at capacity right now. Just on that point, all of the West Coast ports have been running at capacity now since probably mid-summer. And in our view, the port will be very busy, like near-congestion type busy, all the way between now and the beginning of Chinese New Year in February. So the port business is going to be busy, and we're going to be busy as well. Propane export is finally coming to an age on the CN. AltaGas is doing well and Pembina is going to [ scale up ] their terminal next year. And of course, we have a story on growth on coal export with the new mine on CN. And the story that has been very resilient to all of this COVID here is grain. There is in the making a record crop in Canada. I mean it's officially not yet a record crop, but we're all confident, including the industry players, that by the time that the government add up all the numbers, they will be classified as a record crop. And then from year-to-year, grain's going to be a great story for Canada because of the agroscience and the climate change is very favorable to growing a lot of grain in western prairies. When you go to East Coast, the secular long-term potential of East Coast port on the container side, namely in the case of CN, we're driving hard the Halterm. So you do have a diversion -- a slow secular diversion from West Coast container import to East Coast via the Suez Canal, which is also partly helped by the fact that Canadian ports have their costs in Canadian funds. Therefore, there is also a significant competition for that secular shift between the Canadian ports and the U.S. port. I think for the sake of -- make sure we can cover a lot of question time, I'll pass it on to Ghislain here to talk briefly about our very solid initiative on automating and digitizing the railroad. Ghislain?

Yes. Thanks, JJ. So we are driving technology deep into the organization, first, to deliver improved safety, but also to provide more reliable service and to increase our efficiency and productivity. Allison, as you know, we pioneered PSR. And now through technology and automation, we are taking PSR to the next level. We call it digitized scheduled railroading, or DSR. All major initiatives are progressing even during the pandemic, and let me give you a few examples of the one that excites me the most. Our autonomous track inspection program, the ATIP. We currently have 8 ATIP cars of generation 1, meaning that they're looking at track geometry, rail profile and rail quality, and that's deployed across the network. 300,000-plus miles were inspected year-to-date. That's 20x more than the manual inspections. 100% of our core mainline and 90% of our gross ton-miles are not covered by ATIP. In the U.S., the program is a 4-phase growth. Phase 1, our FRA test program is completed and approval pending for Phase 2, which will bring 50% reduction in weekly visual track inspection requirements while maintaining safety targets. In Canada, we have exemption from Transport Canada to use ATIP on 43 subdivisions. The generation 2 car is in development and will be introduced in 2021. It will add imagery and LiDAR technologies to allow inspection of tie, rail web and surrounding track clearance. Our automated train inspection portals, we currently have 7 generation 1 portals that uses 9 cameras installed, 5 in Canada, 2 in the U.S. Today, more than 50 algorithms are developed, all proprietary to CN, proactively finding defects. Generation 2 portals will be introduced in 2021. We will have 19 cameras, adding undercarriage and diagonal, and 100 algorithms with a goal to replace the certified car inspection. Connection to the back-office system to automatically generate remediation work order will also be added. On the next slide, we are very committed to ESG leadership. We have set out clear goals in this respect. And let me cover a few. To achieve our climate change science-based target of 29% of greenhouse gas intensity improvement by 2030; by 2022, maintain an executive management team in which at least 30% are women; maintain a Board composition in which at least 40% of Board are members of designated groups and continuously drive safety improvements with a vision to be the safest railroad in North America. We are aligned with best practice frameworks, including GRI, SASB, CDP and TCFD. We're the only railroad to be listed on the Dow Jones Sustainability World Index, and I maintain World Index, now for 9 consecutive years. And on CN, on average, we consume 15% less locomotive fuel per gross ton-mile than the average of our class 1 peers. So I think on this, JJ, Allison, we'll open up for your Q&A.

Thank you.

Perfect. Thank you both for your comments. Maybe if we could start with sort of current demand trends. Of course, year-over-year, you've seen sort of an acceleration because of the prior year strike comps, but the absolute RTMs or car loans continue to be pretty solid, I guess, safer for energy. Could you talk about what commodity types have maybe come in better or worse than your initial expectations? And then if you could comment on how we should think about mix for the quarter since there's so many moving pieces.

Yes. So as I said earlier, Allison, thank you for your questions. The commodity which are very strong and related to intermodal, so therefore, domestic intermodal has been very steady all summer long and during the fall. And it's our -- all of our equipment is moving. Obviously, we're in the peak season, getting into Christmas, so everything is very busy on the domestic side. On the port side, the ports are -- they're fluid in the East. They're still very busy on the West, and they'll be busy all the way to the year-end, probably a good part of January as well, meaning that they'll be running close to capacity. Rupert is running at physical capacity basically. And the propane business is a good business. Grain has been steady all along and remained very steady. In November, we created another record for the company. And I think we, basically on the grain, will go from record to record probably to the end of the winter. The part of the business that's weak is refined product and crude. And I think it will stay that way. That's the basis on which we would think [ the thing ] will stay. So the mix is different. Therefore, that's why since late summer, since it became obvious that we were going to have a different mix post-COVID or during COVID, that we're working hard on upscaling the business, which is strong, which is intermodal domestic and overseas. And we're taking position in the marketplace in contract renewal, which are in line with that. We insist to get inflation plus price increase. And in cases where we can't, then we basically walk away. Our intermodal network, the way it is, is already very busy. Our container terminal in the Midwest and Eastern Canada are already busy. So we want to be sure that we have the right business coming in, in these assets that we paid significant capital to build so that we have a good return on investment and can continue to reinvest in our intermodal network.

Okay. Maybe just following up, you mentioned pricing and if I go back to the third quarter call, you guys did emphasize multiple times sort of the notion of actively managing yields. Of course, you want to meet that pricing above inflation and generate the returns that you need. Was there anything with those -- the comments that you made that we should read as perhaps a signal that CN is pushing a little bit harder on the pricing lever this time around?

That's right. So CN is pushing harder on the yield lever. Sometimes it's through price. Sometimes it's through selecting which business we want to do, which business we want to do less of. So it's -- there's a little bit of an exercise right now picking what is it that we want to do more and picking what we want to do less. But in all cases, definitely, it means that we need a price that's -- it's -- that really pays for return on capital and the CapEx that we have. So there is a push on price. But I think I would characterize that more broadly, there's a push on yield, which is price, mix and what runs in the railroad, what commodities or what customer or what piece of the customer business. So in that light, you could do some of that at contract renewal, but also you could do some of that while the contract is still in place.

Do you -- I mean if you think back -- yes, so it was sort of late 2017s or starting in the middle of the year, I mean volumes obviously were very strong just in that broad freight environment. You guys got extraordinary amount of volumes but then faced quite a bit of headwinds from service issues. So if you sort of think back to that time, is the strategy that you just talked about sort of different than it was a few years ago as you're trying to sort of make sure that you're selecting the right freight and focusing more on that and what fits the railroad as to perhaps what happened a couple of years ago?

So I would characterize that as we have a good read of our capacity and -- corridor by corridor, and we want to be sure that as we think some of our corridor are going to be busy, that's important for us to do the right selection. So rather than let the marketplace select us, it's important for us to select the marketplace as to what we are going to be moving in 2021 on our railroad, either commodity-wise or customer-wise or section of business on a given customer. So that's what upscaling and yield management is all about, is you want to be sure that your match of supply and demand is optimized for the enterprise.

I would add, Allison, that in '18, '19, we got behind a little bit on our capital investments in Western Canada, hence why, as you know, we've invested $400 million in both years in '18 and '19 to catch up. We're happy to say that we have caught up. I mean this year, our CapEx will be around 20%. The key here is to stay ahead of the business. And we got behind the business a little bit in those 2 years. So now we're ahead of the business. We invested quite a bit in the last 2 years. And this year, if you notice, even with the pandemic and having our volume significantly down in Q2, we continued to invest in Western Canada. I mean I think, Paul, we're going to -- we're finalizing or completing the third siding in Western Canada this year that we were planning on doing. And then the good news is we're putting significant investments both in Vancouver and in Rupert, and we've now finally convinced the federal government and both the port of Vancouver and the port of Rupert to invest with us. So I think the name of the game here is to stay ahead of the business coming at you. And when you have a lot of business, absolutely, you use the lever, which we did in '18 and '19, of upscaling the business and making sure that the business that comes on your network has the right to come on your network.

Right. Okay. So I mean basically, it sounds like if I think about the slide that you guys had up earlier, there's quite a number of idiosyncratic volume growth opportunities, which you guys have outlined over the last couple of years that should matriculate over the next few. So if we think about those incremental volumes in addition to just like a cyclical recovery, do you -- I mean it sounds like you feel that, that capacity is at a good level. Are there any possible pinch points that you could foresee as a result of those new facilities coming online?

Well, we are -- as Ghislain said, we are investing in capacity. We have this year. We will be next year. And we will be investing in capacity in corridor where we have multiple choices of business to grow. But we don't intend to meet all of these choices. We will be selective in what -- some of these choices which have the better potential, and that's how we manage supply and demand. So we're not trying to -- if you look at the U.S. West Coast, the amount of container coming on the U.S. West Coast is huge in relation to what the Canadian West Coast capacity is all about. So it's really a question as we keep increasing our capacity in the West Coast for grain, for coal, for forest product, for propane and for containers, we also want to be mindful of what is it that comes on our railroad. And it's in that light that we basically are making those choices. So the beauty is you can make choice. If you can make choice, then you can match supply and demand. And again, going back to what I said earlier, is optimize the return for the investment that we make.

Okay. Maybe just, JJ, you touched upon this in your comments earlier and I listened to what you -- your presentation at Rail Trends a couple of weeks ago. I was hoping you could touch a little bit more on the technology initiative that CN is working on. You guys have a lot of different things. I was out there, I guess, almost a couple of years ago, seeing the portal. And I know you guys are very heavy with the use of algorithms and that sort of thing. So maybe if you could walk through the different initiatives in a little bit more detail and then talk about how you expect those to drive incremental productivity gains going forward.

Yes. So we do -- you're right, we do have a -- we're a big believer in what technology can do for the rail industry, for the next generation of scheduled railroading. And -- on 2 fronts. One is basically in our own operation, as Ghislain mentioned a couple, those which are more mature, the track inspection and the train inspection and the mobile device and then others, which are still in early stage, like how we manage the network and how we can automate the different function of things around fuel and around locomotive. But then there's also a segment of our focus of technology has to do with the customers, how do we use technology in a way that's used by other industry to have a more customer-friendly experience when you use the supply chain that involves CN. And these 2 levers are really good long-term levers for us to drive to increase productivity but also to attract business on our network that -- of the -- type of the product that supply chain manager wants to have nowadays. So these are -- it's really that and ESG is really center and key to our long-term strategy.

And I would add on, Allison, that for us, it's clear that technology is the next leg of not only productivity and efficiency but also of safety. I mean if you can fully automate all the inspections that railroads have to do, mainly on track and on cars, and get better preventive maintenance because you get better inspection, therefore lower accidents, lower accident costs, solidifying your social license to operate, it's clear that that's the next leg. The railroad, in our view, is lagging on technology and we have implemented PSR 10, 15 years ago. And now -- to move this to the next level, that's why I call the DSR, is now we need to automate tasks that today are manually performed not only to save on costs but mostly to get better results. That's the key and, therefore, better safety. And cost will be there, will be a good byproduct. But to us, it's clear that the next 4, 5, 6, 10 years technology, it will be the next leg of efficiency and productivity and safety not only for us, I mean I don't know what the other railroads will do, but we know for us, that will be the next leg of efficiency. Absolutely.

And how does -- will any of these benefits flow through in 2021 in terms of margin improvements? And then if you sort of also address -- just kind of going back to the demand side, obviously, things are shaping up pretty well for next year. So get back to the OR. From a resource standpoint, do you feel that you're properly or adequately staffed? And how are you thinking about just operating leverage in general as we go into 2021?

Do you want me to start with the benefit and then you can talk about demand, JJ?

Yes. Go ahead. Yes.

So as you know, when you were at the Analyst Day, we said that these projects would generate anywhere between $200 million and $400 million of benefits. It was going to be back-end loaded at the time because, as you know, you need to build the technology before you can reap the benefits. I think you're going to start seeing it through. I think you're going to start seeing it as we move and some of the projects are more mature as we move forward. We're very pleased, as you could hear, hopefully, in my remarks, that we have clear data points and proof points that we're moving in the right direction. My view is those savings that we've tried to quantify, I think, is we've tried to quantify. But to me, if we get -- not if we, but when we get to the holy grail, it will completely change the way we operate. It will completely -- and we will find areas of opportunities that we have not dreamed about. So to me, I would say absolutely comfortable with the $200 million to $400 million. But as I said, it's going to be more strategic than this, and it's going to change the way we operate in this railroad going forward.

And maybe one project on technology that is matured that maybe people don't know so much or don't remember is our air repeater car. So we're the only railroad who actually have roughly 100 box cars which are equipped with air compressor that we use on our train in the winter months, so mid-December to late March when the temperature goes down and it affects train length and basically the capacity and our ability to generate revenue in the winter months. We now have them deployed. This is going to be the third season we use them. They're really in good shape. They really work well, and they're [ one element ] that create capacity in winter months, which is good, obviously, for stakeholders' engagement with the grain industry, for example, but also for revenue. And then what Ghislain was mentioning, now that we have a network that's going to be in better shape from a productive maintenance point of view, for track inspection and train inspection, hopefully, that means less disruption, less derailment, less of the things that actually disrupt your network and take out some capacity and make it not quite satisfying enough for a customer to do business on a railroad. So all these things add up into really a more consistent sort of a -- something safer and something also, obviously, that is profitable.

Okay. So it sounds like just listening to where you are from a resource standpoint, CapEx, you've sort of gone through the sort of elevated level. So I mean it sounds like it's set up -- for 2021, it's set up to be a pretty good year for OR expansion. Is that the right framework? Or is there any element that you might point out or potential headwinds that we should be aware of when thinking about earnings next year?

Do you want to go with that?

I think, Allison, we continue to try to improve OR. We try to do that all the time. We know OR is a key statistic. It's a key metric for the railroad industry. We also, though, are very focused on earnings growth on free cash flow and on ROIC. So I think that as those benefits start to come in -- and again, we're lifting all the rocks that we're lifting. As you know, the team used the opportunity for the pandemic to cut down on some of the less productive mechanical shops. We cut down on some lower or smaller switching yards as well. We're lifting all the rocks. Going forward, we are going to work very hard on this yield situation, as JJ mentioned. And I think that, frankly, we will continue to work on OR. When you look at our strategy, it has actually, and the data is there, worked for us. I mean when Hunter left in 2010, we said we needed to grow the top line. And from 2010 to 2019, we grew our top line by 80%, so more than most of all the other railroads. And we said we need to preserve that foundation. Well, if you remember, OR was 65.4 in 2010, and we finished last year at 61.7. So not only did we preserve that foundation, we continued to improve it, and we will -- every day Rob and the team are working with us to try to improve and how can we be more efficient, et cetera, et cetera. Our view is the big driver that will move that needle significantly in the next 3, 4, 5 years is really the automation. I think that to us, it's clear, and we've got a clear game path. We're extremely excited to have Dominique Malenfant who worked for GE. He's been in the train business for 30 years. He actually worked on the other side of the fence with us on PTC. And we're happy to report that we're all PTC. We're going to deliver PTC for January 1. Actually, we're all PTC as we speak. So he's coming in. He's got 30 years' experience. And I think that we're extremely excited to have him on board. And I think that the days are looking very good, JJ, in front of us coming forward.

Yes. Yes. So technology, ESG, fuel efficiency and making being the good custodian of the capacity that we have. So there will be demand in 2021. And we want to be sure that the right demand is on our network. And basically, that's how we would prevent any potential congestion if too much business comes from United States, the Canadian port, as an example. And that yield management is going to be part of how we manage the business in 2021. And we continue to invest in capacity. And so it's a combination of all these things.

Right. And just -- I think we're pretty much out of time. I just wanted to ask one last one. Any initial thoughts on CapEx for 2021? Then secondly, do -- any of the automation technology initiatives, will that actually reduce capital intensity over time? And then the third part of the question, I know the buybacks were on pause. How should we be thinking about capital allocation going forward?

Yes. I think first of all, as you know, we've not provided -- or we took away our financial guidance for 2020, obviously, because of the pandemic. We're going to try to aim to reinstate that in January's earning call for 2021. So we will provide -- we should provide some guidance for CapEx. But as I said, we're comfortable in the -- 20% range of revenue is a very comfortable range. This is what we've done historically. And I think to your question on technology, I think the good news is as PTC's CapEx go down, because we are now -- we'll need maintenance CapEx for PTC, then you can see IT automation and rail automation and others and those projects that I've just discussed will nicely fit in that hole. So we're -- it's happening quite good. And then on our capital allocation, listen, our capital allocation strategy has been the same for 10, 15 years. So the first use of cash is towards the business. We want to have a strong balance sheet. We saw the value of it through the pandemic. And then third is shareholder distribution, starting with dividends. We had 7% increase in dividend this year. It was never at risk with the pandemic. So -- and we've increased our dividend 16% since we privatized, very happy with that. And then the second -- the last piece is share buyback. Share buyback is a tool for us to get to a leverage level. And in the past, we've said leverage in terms of adjusted debt to adjusted EBITDA in the range of 1.7 to 1.9, Paul. I think if you round it to 2, that metric was 2.17 at the end of Q3. Hence, why we did not start back -- buying back shares, but we're assessing this on a regular basis. So we like to be boring and predictable, and our capital allocation strategy is an example of that.

Well, JJ, Ghislain and Paul, thank you all so much. This was great. And happy holidays. And we will talk to you guys soon. Thank you.

You too, Allison. Hope you have a good day.

Thank you, Allison.

Thank you. Bye.

Bye-bye.