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

Great, and thanks. Good morning, again, everybody. It's Chris Wetherbee from Citi Transportation Research. Appreciate you joining us for day 2 here. We're kicking off day 2 for transportation with a great lineup. And kicking that off is -- are the folks from Canadian National. So really pleased to be joined this morning by a few members of management. We have JJ Ruest, who's the President and Chief Executive Officer. He's sitting in the middle of the screen, for those who are further back from their screens. And then we have Ghislain Houle, who is the Chief Financial Officer. He's to the right of your screen. Thanks for waving, Ghislain, appreciate that. And we have Paul Butcher, who's the head of the Investor Relations effort. He's sitting on the left-hand side of the screen. So the way that we're going to run this presentation is I'm going to hand it over to the team at CN. They're going to run through some slides and some prepared remarks. We'll leave plenty of time for Q&A after those prepared remarks. [Operator Instructions] We want to make this as interactive as possible because we will have time for Q&A. But in the meantime, gentlemen, thanks so much for joining it. I'm going to turn it over to you for some prepared remarks.

Thank you, Chris. And as you said, I'm here with 2 of my colleague. We're socially distanced, that's why we may look a little small on the screen, but we follow the COVID protocol. And we want to start with some opening comments. And in my case, I'm going to kick it off with our book of business and some comments about short and midterm about the momentum in volume. So volume at CN is very strong. Typically, it's always strong. At the beginning of the year, we're -- I think we're sort of leading the industry from a revenue ton mile. And some areas of real strengths are starting on the slide at the top are grain and fertilizer. The Canadian grain story is a very strong story. U.S. grain story is also a very strong story. We had a big crop last year. Actually, many of our customers, large grain customers are also saying the farmer this spring, the feeling they're getting and the order they're getting on -- in term of the grain seed is such that people intend to plant quite a bit of acreage for the following year. And therefore, that should bode well for the following crop. The farmer is bullish about that, being able to sell this grain, export at a good price. So he wants to plant more and see if he can create another record next time around. We've also invested in the asset. We have lots of brand-new grain cars at CN. We use a hybrid of CN railcars and customers' hopper cars on the grain side. Together, this is quite a large fleet. I think it's 4,200 cars now that came into service recently between CN and our private car grain partners. So that's one of the solid side of the business, not just short term, but also long term. And that's why we're investing significant amount of capital in our grain fleet and do -- and our customers doing the same. The initial sector with COVID, renovation, housing has been strong. So lumber is actually -- it's continued to be very strong. Our fleet is always busy. So now the lumber side for CN, it's not about so much volume growth. Volume is coming because the market is strong. So it's about getting better price or even more price, getting more value for what we offer at the time where lumber is in strong demand. The pulp market is also good. The Asian market for pulp and lumber is also decent. And in coal, I mean what's the long-term story for coal? I mean we probably will have issues in the thermal coal. But right now, Canadian coal and I guess U.S. coal is somewhat in favor with the Chinese because they've got lots of debate with Australia in terms of how these 2 countries are having some trade and political challenge. So Chinese are buying coals from other countries. And also, we have the Teck contract, which will roll in -- sometime in April. And then on the consumer side. So the consumer is buying a lot of goods, buying even more physical goods during COVID than he did pre-COVID. So our port business is on fire, which is I think quarter-to-date were double-digit revenue ton mile growth. So it's not about getting -- are we going to have business in intermodal in 2021 and 2022, it's more about how the sales force is turning this opportunity into better yield and better price. And that's the mandate that they have this year is -- and broadly speaking is -- the mandate of the sales team at CN -- commercial team at CN is business is coming at us. It's coming at us at a pace that is we can accept the infrastructure plan that we have. So be more mindful that -- of what kind of business come in, what kind of business -- how you price it, how you price it in such a way that we get the best value for it and be mindful of the second half when the economy will start to pick up. So there might be even more available. We don't want to just give it up to the first comer. We want it to just be aware there's value for CN such that we can continue the story of reinvestment in our plan, mostly Western Canada, so that this CapEx on the plant expansion for '22, '23, '24 comes in with a good return. So the volume story at CN is good. And by driving price and yield harder, be more focused on that, then we make it easier on ourselves to reinvest CapEx in the business to build the capacity required for '22, '23 and '24 as we come out of COVID. And maybe we can go to the next slide and talk about the other big lever, which is the operating efficiencies.

So maybe, Chris, I can cover the next 2 slides. So as you look at this slide, we are entering 2021 with a fluid and efficient network. I mean January was pretty good. Our weather in Canada was pretty good in January. And when you look, we're quite proud about our 7% improvement in fuel efficiency. And the metrics are there. So workload, up 6%; car velocity, up 8%. And that's in January. But even taking the first 9 days of February, our train length of up -- is up 3%; and train weight, 2% up. Unfortunately, we are in Canada and the weather catches up to you at some point. So we've been -- for the last 9 or 10 days, we were hit by a polar vortex, mostly in Western Canada where the weather and the temperature was as low as minus 30 to minus 35 to minus 40. So just to remind everyone that when we -- when it gets very cold, then we need to reduce the size of our train. And it starts hitting us at minus 25 degrees Celsius. Just to give you an example, at minus 40 degrees Celsius, we don't run our trains at night. We run our trains only during the day. And this is because of the air brake system of a train. When it gets very, very cold, you can't push the air to the back of the train and, therefore, you have to reduce the size, which means that you have to have more train starts to move the same amount of volume. So what the team has been doing, and we've been around for many years, so winter comes every year in Canada, is we run more distributed power trains, which basically has a locomotive in the middle of the train or at the end of the train, and that gives another air source so that you can keep some train length, you still have to reduce but not have to reduce as much. Or the other thing that we're doing, and we've invested some money in building what we call air cars. Air cars is a regular -- a boxcar but with an air compressor in it. And we put the air car in the middle of the train. And again, that pushes and get -- it gives you another air source to the train, and that allows you to keep some train length. Now the good news is we're mid-February. So I think, Paul, I would say that the weather is subsiding as we speak. And therefore, as we get to the end of February, early March, then naturally, the weather will get warmer and it will allow us, hopefully, to put this polar vortex behind us and therefore, it will allow us to get the -- catch the backlog and deliver a very strong margin. Then on the next one, we are driving -- the next slide, [ Lauren ]. So we are driving technology deep into the organization. And going from precision scheduled railroading, PSR, to digitized scheduled railroading, DSR. And Chris, I would say that this is, first and foremost, about safety with a byproduct of reliable service and increasing efficiency and productivity but, first and foremost, is about safety. I'll give a quick example or a quick update on some of the projects. So on the autonomous track inspection program, we have 8 generation-1 ATIP cars that looks today at track geometry, rail profile and rail quality. In -- last year, actually, we inspected 375,000 miles with some key corridors, receiving as much as 17x more inspection than previous methodologies. We cover 100% of our core mainline and 90% of our GTMs. Car 9 and car 10 will be added in the fleet in Q1, and that will protect some important secondary routes that we have on our network. In the U.S., the program is a 4-phase approach, and we're currently in Phase 2, allowing us to reduce by 50% the weekly visual track inspection. And we expect to transition into Phase 3 in the next coming months that will allow us to reduce by 75% the visual inspections. In Canada, we have an exemption from Transport Canada to use the ATIP cars on all of our mainline on our 43 subdivisions. Generation-2 car technology will be operational in 2021, and that will add laser technologies and imagery that will look at tire, rail web and surrounding track clearance. The other one that we're excited about that I will give a quick update is the automated inspection portals. So we have 7 generation-1 portals installed with 9 ultra high-definition cameras, 5 in Canada, 2 in the U.S. We're on track to develop 100 algorithms by the end of 2021 that will be all proprietary to CN. We will be adding 25 additional cameras to our portals to support automation and components that are difficult to inspect for a total of 34 cameras per site. And with these new cameras, we can capture 360-degree view of a train as they travel at full speed of 60 miles an hour through the portal. Once completed, the algorithm will locate defects with 0 human interaction that will eliminate risk of human error. And they will produce automatically generated work orders for car repairs. So Chris, the goal is to eventually replace what we call the certified car inspection, which is a regulated inspection very manually driven today in Canada and to do this all automated. JJ, I'll turn it over to you.

We'll go to the next slide, to the next one. So the first slide that we talked about were about our book of business. They were more short to midterm, the book of business, how we're shaping the book of business and the operating efficiency and what we're doing to make the operation even more efficient. And these last 2 slides, the one that Ghislain just talked about on technology and innovation and the one here on ESG, they're more about our midterm and where we're going forward, what will shape CN in 3, 5, 7 years. And the technology is a big part of that. We want to bring as much technology and automation operation as we can. We also want to bring technology in how we deal with our customers to digitize the supply chain. And we also want to recognize early on the need for our industry to really address climate action plan. Of course, in the railroad, emission has a bit to do in how we burn the diesel, how fixated we are with that, what's next after diesel, biodiesel, what's next after that is electric or hydrogen. But there's an evolution that as an industry we are embarking. But that industry, we will have to embark and CN is very much want to be a leader in that. So we're making sure we do the right thing for things like the Dow Jones Sustainability Index, the CDP A list. We want to be part of -- we want to create a future for CN such that rather than being blindsided by disruption or disruptors like movement toward ESG or climate change or common tax and the like, that we turn this into a positive by starting early enough. And you know, Chris, that we hired our last Chief Information Officer, Dominique, he's actually an engineer. He runs the IT department. But more -- for some at CN, the IT department has become a technology department. And their job is to automate the operation, digitize the relationship with customers and get us with partners, people who build equipment to what will be the next generation of either more automated train and also train which will burn a different fuel with a lower carbon emission. And that's something that we want to create over time, that's something that CN will do as a leader and potentially, depending on level of success, also that becoming a point of differentiation and competitive edge, just like PSR was back in 2010 and the like. So on that, I think we can -- we should probably move on to questions. I'm sure there's a number of good questions out there for us at this point.

Great. Yes. Well, thanks very much for that, for the prepared remarks. Those were really informative. And there's a bunch of stuff I want to touch on, some of which you guys touched on and dig in a little bit more deeply. But let's start with the shorter term because I think that's just important, and I want to kind of get it out of the way. So clearly, weather, and we've been hearing this over the course of the last day plus at the conference here, is a challenge. And obviously, it's not lost on us where your operating network kind of runs through Western Canada, how difficult the operating conditions are currently there. So the sense we've been hearing is it's relatively transitory in the respect that the weather will break at some point, and you guys have obviously operated through challenging winters before. I guess maybe the direct question is, how do you -- number one, do you feel like this is going to be a relatively short-lived issue? Number two, does it have a meaningful impact, you think, on the first quarter? And then I guess the last point, if so, is there a winter in the past 2018, 2014 that maybe you can point to that feels similar?

Yes. So on the demand side, the demand is there -- was there in January, still there. So it's not impacting demand. So there will be some -- as we get on the other side of that, there'll be pent up -- there'll be business for us to go and get. It's a question of how fast we can recover. Definitely, a month like February, or it's not a full month but part of the month, we'll see, it's more expensive to operate because now your train being shorter and your operation being more challenging for the same gross ton mile, you have, let's call it, similar cost, but you don't generate as much revenue. So it makes for a tougher operating ratio month typically. When we come out on the other side, we will have the ability to run our train as long as we can be because there'll be business waiting for us. Last year, when we came out of the blockade -- remember, the month of March was very solid, right? When we came out of the blockade, when the blockade was finally lift, the team did a fantastic job in term of the recovery. So the month of January last year was a good month because when the team was able to get back the railroad and the weather in March was conducive to do good railroading, meaning there was no tier restriction, we were able to operate quite good. So first quarter would have been a whole lot better without this vortex because of the demand, but it will cost us some money, definitely.

I think plus what we're hearing that the weather is to subside by the end of the week. So we'll be able, hopefully, to get back on track. There is a backlog out there that we need to move. But again, I mean we're mid-February. So it will subside. I mean as we get to the end of February and then into March, this will be behind us. And now it's just a matter of how much catch-up we can do. Typically, March is a big month for us. It's when you look at the seasonality standpoint, the biggest 2 month is March and I would say October. So the team is focused. Hopefully, we put this behind us. And hopefully, we can catch up and get a very solid next 2 weeks of February and then get a good March in. And we'll see what happens. But to your point, JJ, the demand is there. The business is there. We just now need to get our train size back to the 12,000-foot intermodal train because it makes a big difference. Like when you look at -- when you're minus 35 on a regular 12,000-foot train, you would have to reduce it by about half. So it is -- coal is -- coal hurts more than snow for railroad.

But having said all that, I think we've got to give kudos to our operating team based on the AAR week -- is it week 6? Our revenue ton mile as published Monday on the website is 9.4%. So we've moved a lot of freight in January, and we're holding on in February, and then we'll come out on the other side of this sometime late this month and at the end of March.

Yes. Got it. Okay. No. That's helpful. And I guess maybe to sort of tie this into what we've seen in the past. In 2018, we had some challenges, and the network maybe was -- I guess maybe stretched a little thinner than it is now entering some of those challenges about bad winter weather. That created I think a bit of a cascading effect. It took some period of time to sort of work through. So what's different today with the network than maybe where we were a few years ago that kind of gives you that confidence that there's recoverability and it could be as quick as maybe just a couple of weeks both to clean up the...

Yes. So obviously, we have more capacity this winter, winter of 2021 than we had in 2018. And the capacity that -- most of the capacity we invested is Edmonton to the West Coast, and some of it Edmonton toward the United States and the Midwest. So that capacity is useful because that's where the growth is. Even the 9.4% revenue ton mile I was mentioning around the AAR week 6 is mostly in our western network. That's where grain, port business, propane export. So we have more capacity. We have qualified crews. We're in good shape for people. But when you run -- when you have delays, eventually, you pay a lot of hours. They're not all productive hours. That's the challenge with February. And as I said on the earning call, I got to be mindful about COVID and whether or not COVID eventually will put too many of our people into rotating quarantine and not -- and what will that have as an impact on the crew supply, say, for the remaining of February and March. So touch wood, that stays under control. But we're better equipped -- putting COVID aside and the impact it may or may not have on our crew supply, we're better equipped than we were in 2018 to move more freight. And you look at our gross ton mile in January, I think they were at company record. So definitely, when the railroad grows well, the railroad can move a lot of freight. And to us, it's really in Western Canada, right? That's where the demand is. And our port business right now is probably close to the physical limit of what port can do on the Canadian West Coast. So...

No. When the weather gets back, I think what we did in January is possible on this other side of this vortex. It takes maybe 10 days for the network to kind of regain its balance of locomotive being in sync back and forth as opposed to be like a backup, everything is east, everything is west, when you restart. But we can move freight. So this -- to that point, the sales team this year, their mandate is somewhat different than the recent past because demand is available and we have some amount of capacity, not an infinite amount of capacity. Their mandate this year is to be more focused and more rewarded on the quality of the book of business and also be recorded at pricing and be less rewarded on bringing volume and revenue. Volume and revenue will come in because we got a good product and the economy is restarting and the economy is in pretty good shape. So we want them to be focusing more about the quality of and the pricing of and put their effort towards that at a time where volume should be available because of the more positive condition on the demand side.

Okay. Okay.

I would say, Chris, as well is rest assured, we would not be able to move all that volume if we wouldn't have invested significantly in Western Canada in '18 and '19. And the other place, as you know, that we've invested is new locomotives. And in the last 3 years, we purchased 260 new locomotives. So these make a difference, and they make a difference in the winter time.

They're more reliable.

They don't -- they're more reliable, and they don't fail on you. So these investments were well made. And we -- you can assume that we will continue to invest in Western Canada going forward. This is the place that we're growing the most, and we do push the sales team to densify more business in Eastern Canada where we have a lot of capacity and also south of Chicago to New Orleans, we have a lot of capacity. So the sales teams, to your point, JJ, they're focused on yield and pricing. And where they're focused on volume is on the eastern network and on the southern network.

Yes. There's an opportunity there. Yes.

Okay. Okay. No. That's super helpful. I appreciate it. We got a question in from the audience that's along the same line, so I want to hit on it. It's a question about the auto business. There's been a lot of discussion about supply chain shortages, chip shortages as they're going into that auto supply chain. Any impacts on your network specifically from that? I know weather -- putting maybe weather aside, if it's possible for a moment and thinking about that dynamic within auto.

Yes. So there is an impact because some of the vehicle that we move, actually, the production rate has been -- has actually been curtailed because of the lack of these chips and some of these parts. So it's basically short-term issues, right? Eventually, there's demand for pickup truck, and I think people will wait. They'll wait up to a point, but I think that's just displacement of demand. And the automotive business at CN right now is weak or weaker. Some contracts at same hand and also some contracts which are us, but to your point, the parts are not available for these factories to run flat out. So that's -- maybe in some ways, it might be good because in the month of February, like right now, where operation is under challenge, if one of your segment is -- demand is displaced to later months because they don't have quite the parts to make it, as long as the consumer waits for it, then it is what it is. I think that's a short-term issue, that's not a fundamental issue. People will buy car, especially SUVs. And eventually, this thing about the supply of these chips will get sorted out. And CN is affected to that like others, but that's -- I think that's accidentally in the revenue.

Yes. Yes.

But it's still a small piece of our auto business.

Yes. I think automotive is what?

4% of our book of business.

4%, yes. Automotive is about 4% of our revenue quarter-to-date, in that range.

Okay. Okay. One other question that's come in that I want to get to because it kind of relates into what we were talking about, but it sort of stretches out to think about 2021 a little bit more broadly. And I do want to broaden out the conversation. So the question is that there's a perception that you guys were somewhat conservative when you provided your 2021 guidance for RTM [ unit ] growth. I think you guys cited weather and potential -- there's always the potential for some degree of disruption on the network over the course of the year. Do you feel like you left appropriate buffer room in that guidance for you for this year to sort of account for things like what we're seeing with weather right now?

Yes. I mean we're always cautious about Q1. One of the reason we're cautious of Q1 is not fully having a good way -- good crystal ball about the impact of COVID on our crude supply West, and whether or not at some critical crude point, we might run out of people because too many people are being caught up in quarantine. And some of the cities where we operate have a fairly significant spike in the COVID case. So we're halfway to the wintertime. Winter -- it's just the way that CN does. We -- good volume demand, good capacity, never quite too sure whether you'll have a mild winter, harsh winter. And the COVID -- impact of COVID on our supply of qualified people coming to work every day is always a bit of an unknown. So when you look at the second half of the year, by then, you would hope, touch wood, vaccine has got enough of an impact that it should not be something we should be concerned in terms of our people coming to work. And on the other side, the impact on the economy, especially the consumer, but also manufacturing and natural resource, even though those last 2 have not been as much impact, would be positive. So second half, there should be less reason for us to be concerned about demand and COVID. And the one thing that's part of the guidance is Canadian dollar. In the Canadian railroad, with something like this, you can get some in the U.S., we have -- unlike most of the railroad, the exchange does impact us. Last year, it was $0.75. We used $0.80 for the guidance, and that's $0.25 not in itself between the year-over-year. So that's -- at constant dollar, we would have had the guidance at double digit.

So you're right on. Yes. That's exactly it.

Okay. Yes. That's helpful. And I think it's an important point because I think to some degree, that got overlooked, the FX headwind, which I think is certainly more material for you than it is your peer in Canada, at least as it flows through the earnings numbers.

That's just the rule of thumb. To remind everybody what the rule of thumb is, is every time the Canadian dollar appreciates by $0.01, then it's $0.05 of EPS on the bottom line on an annualized basis. So it is material. And God knows, I mean maybe the dollar will not stay at 80% -- at $0.80 for the entire year. We've assumed in our guidance that it would remain at $0.80. I mean if you look at today, but I think it's around $0.79. So -- but if the dollar goes -- depreciate, the Canadian dollar depreciates or the U.S. dollar appreciates versus us, then that will help. So -- but it is material, absolutely.