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

Welcome to CN's investor conference call, Full Speed Ahead - Redefining Railroading. I would now like to turn the meeting over to Paul Butcher, Vice President, Investor Relations. Ladies and gentlemen, Mr. Butcher.

Good morning, and thank you for joining us today's conference call regarding CN's vision for the future, our exciting new strategy to redefine railroading for the next generation. With me today are JJ. Ruest, our President and CEO; Ghislain Houle, Executive Vice President and CFO; and Rob Reilly, Executive Vice President and Chief Operating Officer. Earlier this morning, CN issued a press release announcing our compelling, ambitious, but achievable new strategy. You may obtain a copy of this press release and the presentation that we will refer to, on today's call, on our website at www.cn.ca. This call is being webcast live, and a replay will be available on the Investor Relations section of our website. Before we begin, I'd like to draw your attention to the forward-looking statements and additional legal information, which are available at the beginning of the presentation. As a reminder, today's conference call contains certain projections and other forward-looking statements within the meaning of the U.S. and Canadian securities law. These statements are subject to risks and uncertainties that may cause actual results to differ materially from those expressed or implied in these statements and are more fully described in our cautionary statement regarding forward-looking statements in our presentation. At the end of the prepared remarks, we will conduct a Q&A session, and we will ask that you please limit yourself to one question. It is now my pleasure to turn the call over to JJ.

Well, thank you, Paul, and thank you for all of you for joining us on a short notice this morning. It's a very important call. I'm going to Start On page 3, just to introduce our webcast here. I'm here with my team, as Paul said, to discuss the CN strategic and financial value creation plan. Our vision for the future which will deliver both high-quality service to customers while we generate enhanced and sustainable returns for shareholders. I know a lot has been said lately about the wisdom of our bid and the quality of our team. And I'm here to tell you that we fully appreciate that our bid for KCS may not have been in CP's interest, but it has absolutely served CN's interest despite the disappointing outcome. I'm also here to tell you that CN is going to continue to lead the industry towards a growing profitable customer-centric customer service model of railroading just as we have pioneered PSR, when the industry needed to become more efficient. As the STB Chair, Oberman, recently said, it bears repeating that this is 2021, not 1980 or 2008 for that matters, we at CN are focused on the future of railroading, not the past. I am also here to tell you that we have a plan to realize the value of our recent investment in technology and capacity for the benefit of our customers, our shareholders, our 24,000 employees and many other key stakeholders. CN has a rich tradition as an industry leader and of an extensive network that we have built that run through coast to coast to coast, and I'm excited to continue building the premier railroad of the 21st century just as we've done since 1995. Rob, Ghislain and I will lead you through the presentation outlining how we're planning to achieve this goal. We'll go to the next slide. In January 2021, before the KCS opportunity emerged, CN approved a new strategic plan to lead the customer value -- to lead in customer value in operational excellence, in safety, in environmental sustainability and social inclusion to also deliver industry-leading total shareholder return and as well as a major governance reform. The KCS did materialize as a once-in-a-lifetime opportunity, and that was entirely consistent with our long-standing vision to be the USMCA Railways. The KCS bid produce multiple benefit -- net benefit to CN despite being terminated, we reaffirmed -- it reaffirmed CN as a premier North American railroad, we secured USD 1.4 billion from KCS including the $700 million net cash from the breakup fee, and we engaged throughout the process with many, many stakeholders and shareholders and we got a lot of expanded insight as to growth opportunities that CN can now pursue. Our bid was positive for CN shareholders and CM freight customers. Next page. In line with our long-term strategy, CN is positioned to grow over the long term. And I'm not going to go over all the examples on this page, I just want to pick a couple. Customers want congestion-free proven gateway into North America, like Prince Rupert and Halifax. Customers also want to have a good -- great railroad in petroleum and chemical to partner with them as they look at future opportunities in such areas as methanol, propane, hydrogen-based petrochemical and renewable fuel for the future of North America. Customers have also made massive investment in the grain supply chain on our network, and we at CN also have made significant investment in our own grain supply chain, namely 50% of the increase of the grain export capacity on the West Coast is actually being built on CN, physically served by CN. CN also has an industry-leading cargo cool capacity, which is a service for the future to serve the consumer economy. And obviously, we have the fastest-growing ethanol network in North America. And we do have -- and there's a great story to that in terms of truck conversion and ESG benefit. I'm going to turn it over to Ghislain, who can reaffirm our financial outlook.

Yes. Thank you, JJ. On the next page, Page 6, our strategic plan builds on the great foundation we already have, and it starts with reaffirming our 2021 financial outlook. And this is despite weaker volume outlook but offset by rightsizing our cost base. We continue to target double-digit adjusted diluted EPS growth versus 2020 adjusted diluted EPS of $5.31. Our capital investments will complete at approximately $3 billion. We are resuming our share buyback. We expect to complete the remaining $1.1 billion of our $1.5 billion current program by the end of January 2022, and then we target -- we continue to target free cash flow in the range of $3 billion to $3.3 billion. I'll turn it over to you, JJ.

Thank you. So now I want to give you a sense of what we're going to do here in the next -- in 2022. We are targeting $700 million of additional operating income for next year. We will -- first thing we will attack costs. Rob will drive car velocity, train speed and train length. He will give you some more detail later. Our strategic team will review our non-rail business, example: TransX, our vessel and our freight forwarding business to ensure that we have best-in-class operating margin performance in each of these different segments versus their industry peer and/or may divest partially or totally some of these segments. And in the case of the freight forwarding business, we might actually shut it down. We will also -- the management team will also streamline the management and especially the support function to improve our labor productivity by accelerating speed of quality and decision-making. On the revenue side, we are going to be more focused on price than ever, make sure that we price well ahead of rail inflation, reflecting the current strength of pricing and transportation market. But also we'll be looking for volume opportunities in 2022, take into account though that right now, as we sit here towards the end of the summer, the grain crop in Canada will probably be in the range of 33% to 38% volume drop versus last year as opposed to the 5% that we were hoping for back in June. If we go to the next page, that summarizes some of the key financial targets for 2022, our business plan for 2022. As I said, we are looking to increase operating income by $700 million. We're targeting an operating ratio of 57%. We're also going to be putting a CapEx as a percent of revenue at 17%, EPS growth in the range of 20%, return on investment capital range of 15% and about $4 billion of free cash flow. We are shifting our capital spending to 17% of revenue for '22 to '24, unless we have significant market shift in terms of significant growth demand during that period of time. CN is also reviewing its capital structure and financial leverage now that the KCS transaction is not going to go forward with a view to increase total shareholder distribution, including share buyback in the range of $5 billion in 2022, and all of this is a very achievable business plan. We'll go to Rob?

All right. Thanks, JJ. On Page 9, Operational excellence has been and will continue to be a cornerstone in our strategy. All of our key operating metrics have improved over the past couple of years, leading to greater efficiencies and improved customer service. On page 10, from a sustainability standpoint, we will continue to be the leader in the industry. Our fuel efficiency initiatives alone have saved us over $100 million while reducing CO2 emissions. Our disciplined execution from the engineer pulling the throttle to how we utilize our locomotives is how we got here, and we'll continue to find ways to further reduce our carbon footprint with the use of renewable fuels and piloting battery-electric locomotives in the future. Our safety results are not by chance, but through a concerted effort of leadership, training and engineering and technology to minimize and eliminate human error. The CN team is on pace to deliver all-time best in both accidents and injuries. Running a safe, sustainable and efficient operation that partners with our customers are key elements of our strategy. And on page 11, our productivity levels, across the board, in operations have improved to all-time best levels. On Page 12, this plan presented will improve the efficiency of the company as a whole as well. Page 13. The reason we are so well-positioned to implement digital scheduled railroading as part of this compelling new strategy is because we've already made the necessary investments and built the foundation of the next era of CN's growth. Following the reduction in capital spending, enabled by our technology investments, we expect to deliver improved safety, more reliable service and increased efficiency and productivity. Just as CN pioneered PSR, when railroads needed to become more efficient, we are now at the forefront of DSR at a time when railroads need to deliver greater value, choice, service and environmental benefits to their customers. DSR is a modern approach that utilizes state-of-the-art technology and innovation to deliver high-quality services to customers and more sustainable returns to our shareholders over the long term, and it will define our future success. Having said all of that, I'll now turn the call back over to JJ.

Thank you, Rob. We'll go to the -- sorry, the page on ESG. I don't want to cover all the items that CN do on ESG. I think CN has been known as an ESG leader in the rail industry for a long time, not just on emission, but also on quite a number of fronts. But 3 things I'd like to cover that we're very focused beyond our robust disclosure and clear target: One is on the emission side. Already, we are the leader in terms of fuel efficiency, which means that we produce less CO2 emission per ton mile. But we have a target to reduce by 43% of emission intensity by 2030 based on the 2019 level. We also, on the safety side, are very focused on the safety, especially of safety of our own people, our employee. And there's nothing more important in our safety target than to aim for zero serious injuries and zero fatalities at CN. I mean, of all the safety statistics or maybe -- of all the ESG target, it's probably the most important, the one I feel mostly passionate about, and I know Rob feel the same way. On the governance side, CN has updated and modernized our Board's governance, and we've already achieved, at least 50% of the nonmanagement director coming from diverse group, including gender diversity. We'll go to next page. In conclusion, CN truly has the best rail network in North America to drive long-term growth, sustainable growth and profitable growth. We have the right leadership team and management team to execute our strategic plan, both in the short term and the long term. And we have the vision and we have a vision for our industry, which is forward-looking, not backward looking. We're committed to drive the total shareholder return to our operational excellence, and you heard a number of targets today, customer-first culture, railroad -- have the railroad for customers and shareholders, both equally in a balanced way using innovation. Rob covers a couple of those things and really addressing the needs of today, we have to be a relevant contributor to the ESG agenda. The bid for KCS yielded valuable insight into our growth opportunities, and it gave us the opportunity to have positive engagement with our stakeholders, including us listening to our shareholders as to what they want and need and expect from us. And that's partly why we have this business plan here today. Executing on a comprehensive strategic plan targeting $700 million of additional operating income and 57% OR in 2022 is very much part of that. Returning capital, additional capital to shareholders through $1 billion -- resuming the $1 billion buyback between now and the end of the year, but also since we're not going to be doing a large transaction also in the range of $5 billion share buyback in 2022. We are in constant dialogue with all of our shareholders, and we want to be sure that we do what's right for the CN shareholders and what's right for the CN customer. On that note, I think we will prepare -- we will turn it to questions. Paul?

Operator, we'll go to questions.

[Operator Instructions] Your first question is from Cherilyn Radbourne with TD Securities.

With respect to the nonrail businesses, a bit of a shift there. Could you elaborate on what you're grouping in that bucket, if there's anything beyond what's listed on the slide? And just talk about how you will consider the contribution of those businesses to volume on the railroad and determining whether they're candidates for divestiture?

Thank you, Cherilyn. So there's no sacred cow at CN. And when we look at the future, every aspect of the business that we do, every piece of the operation that we do, need to contribute to the ultimate goal that we have. So in the case of the non-rail activities I'm talking about, I'm talking about the Great Lake vessels, the dock, TransX, some of our operation in transload at Rupert port. And when we look at -- and as well as our freight forwarding. So when you look at these things where we've already started the review sometime mid-summer, about do they fit in the long-term strategy. I'd be producing results -- financial results in the range of the publicly listed peer as using as benchmark. And they also -- do they also contribute to feeding the beast or bringing business to the railroad. So when we make those decisions on one end, we'll be looking to improving the cost structure of these business, we'll be looking to increase the price structure -- pricing structure of this business. We're going to be looking whether they stay in CN or they partly divested or fully divested that is done in such a way that the rail business that were contributing to us stays with us. And maybe I think we have some idea, we might actually be able to improve the amount of business we're getting from those, whether we own them totally or partially or not at all. So -- but going back, I think the question often asked is what is the weight of the non-rail business on the operating ratio of CN. I think, Ghislain was about to...

It's about 200 basis points, JJ. TransX alone, and we've said that publicly, is about 100 basis points. So it's about 200 basis points when you put them all together. They're accretive to EPS. But they're dilutive to operating ratio.

Yes, they're accretive to EPS. They produce operating income and then we'll make sure that they either produce more operating income, that they're more accretive to feeding volume to the railroad. But if they can do neither the 2 on a world-class basis, then we might divest partially or totally or we might shut it down. And by the way, on the freight forwarding side, I've taken pretty much in my mind -- pretty much made up that I will slowly over time, shut it down. When I say slowly, I mean, over the next 6 months.

Your next question is from David Vernon with Bernstein.

So JJ., I'm sure you've been on the road a bit talking to shareholders. Can you give us some insight into kind of their level of satisfaction and maybe how the arguments that PCI made either resonated or didn't resonate? And the last part of the question would be around beyond what you're doing with the business, are you also -- is the company also contemplating making any changes at the Board level?

So the -- our shareholders, I would say, if we start -- obviously, the topic this summer was KCS, first and foremost. As you know, twice this summer, were we able to convince the Board of KCS that we had a superior offer, the first time around back in the spring and the second time around when the CP came up with a second offer. And by and large, most of our shareholders, those at least who own CN, were supportive of our bid. And like us, they're disappointed that the regulators is actually, who stopped us. CP didn't stop us. The regulator has actually stopped us. Also, the feedback that we were getting during the summer is that CN should be putting more effort into operating income. And then also re-centering if you ask what kind of operating ratio we should be targeting. So we were obviously getting that feedback during the summer as well. And we were preparing to integrate with KCS sometime in early 2023, with the line that we wanted to enter the transaction to be really fit, fit financially, fit in terms of cost structure. And the plan that we're rolling out today is a result of that, and the plan that we rolled out today is also the result of feedback of our shareholders on these two fronts during the course of the summer. As it relates to the plan -- the Board, I think it's well-known. It was always in our proxy that our Chairman is retiring next April, is at the end of his term. We also have another Board member who is also retiring next April because he's at the age limit. And in time, the Board will make the decision as to who will join the Board of CN replacing those two. The Next question?

Operator, the next question, please.

Your next question is from Walter Spracklin with RBC Capital Markets.

So when I look at OR improvement, obviously, there's 3 components, you got price, cost, and volume. And I think pricing is clear, you're in a good situation there. I want to focus my question on volume. And really, that is -- you highlighted, JJ, that it's going to be a tough year for grain next year, which is a fairly meaningful part of your business. That implies with mid-single-digit growth that you're going to get a fairly nice lift in non-grain businesses. Are you expecting just kind of across the board high -- mid- to high single digits in all lines? Or are you -- could you call out a few that look, you're expecting to see because of line of sight you have with customers or whatever other bases? Or you have line of sight to see some nice growth in any segments in particular?

Okay. So I'll let Ghislain start because our 2022 business plan starts with cost and then price and then volume is last. I can make some color on the volume, but it starts with costs. Ghislain?

Yes. Yes. Maybe -- okay. Thanks, JJ. So thanks, Walter, for the question. So exactly, if I can break down the $700 million of additional operating income, in a couple of buckets. To your point, Walter, $150 million will come from price, $550 million will come from cost, $250 million will come from headcount reductions. We're looking for about 650 headcount reductions in management. And as JJ said in his prepared remarks, it's mostly support functions at the CN that will make up that number. And then there's 400 headcount reductions in unionized, mostly in engineering, mechanical and transportation with the productivity targets that Rob talked about that allows us to run the railroad with 400 less people. And then $250 million coming from lower purchasing services and material, and this is really with less consumptions, including reductions and consolidations of material and contractors. We will eliminate all consultants. Specifically in IT, we will close underutilized buildings and facilities that we have across the network. And finally, we'll be more aggressive with our suppliers when we negotiate contracts. And then finally, $50 million will come from other, including casualty and other. And that we're assuming that a good chunk of this will be with lower accident costs with the improvement of inspections that we're doing both on track with our ATIP car that you know well of, Walter, and our portals. We're doing -- I mean this is now -- this is an example, by the way, of reaping the benefits of some of our technology investments and we are very confident that we'll be able to reduce accident costs next year versus this year. Maybe turn it over to you, J.J., on the volume side.

So on the volume, Walter, as you know, the -- I mean there is volume opportunity at CN exploiting the 3 coasts, exploiting our great natural intermodal network. We also have a very solid franchise in carload, petrochemical forest products inside metals and minerals. The point, though, is next year in our view anyway, there's 2 big negative: one of them is grain, the Canadian grain crop. People have been talking all summer about the fire in British Columbia, which is real. But the real story on the business side is the prairies grain didn't grow. The wheat wasn't very tall, and it was harvested very early, and there was not that much of it. And that's true also for the commodities. So we're looking potentially in the range of 35% to 40% drop in volume for the grain crop on the Canada. So that's as opposed to the 5% growth we were hoping for. And on the crude by rail, and I think if everybody's been listening to what we're talking during the summer on the KCS, CN is not a crude by rail network -- railroad and neither has CN was going to be crude by rail merger combination with KCS. So when you look at that the 2 negatives are going to be offsetting the other many positive. So the focus next year is to make it on our cost, make it on price, make it where there is volume growth in some segments. And when the grain crop resumes late 2022, then the CN growth story, in total RTM, will have the sale, will have to win in our sale again, volume-wise.

Your next question is from Jason Seidl with Cowen.

JJ and team, I appreciate you guys doing this call. You mentioned potential divestitures in there. Are any profits from that baked into your 57% OR. And I guess the companies that you're looking at while they have a higher OR than your base rail business, what's the return profile look like?

So maybe just broadly speaking, the final decision is not made, but obviously, we made some scenarios. And this business are profitable. Make no mistake, they are all profitable. So as in our scenario, as we divest them, they actually bring operating income down to an extent. And when we say that we're going to improve the operating income by $700 million next year, it takes into account the loss of some of these business, which were bringing in operating income. In terms of operating ratio, we're not going to get into what was the weight of each of this segment operating ratio. But all in, in total, all of them together was 210 points.

That's right. If I can add, JJ, if we offload or sell any of these businesses, as you know, Jason, it will be below the line, it will be in other income. So again, it will not be in OR. So no, nothing is included in OR. Because again, if we do offload and when we do offload, you'll see that appear. Any gains, you'll see that appear in the other income line. So therefore, below the OR line.

That's right. It's the same thing as when we sell land at CN, it does not go into the operating income.

That make sense. Now in terms of the question I had in terms of your returns, I mean, yes, I get that they're higher OR businesses, but some of them don't require a lot of capital expenditures. Could you give us a sense on the returns on some of these businesses versus the base rail business?

Yes. I mean, as we said, I mean, they are accretive. They do provide -- TransX, for an example, I mean, we've said and we went back, and TransX, our return on invested capital when we invested in TransX is actually higher than our internal threshold. It is accretive. TransX is feeding the beast. We will look to improve TransX. TransX does some pure trucking. So we will look at that very, very closely, make sure that this fits into the CN strategic model. And we've increased, by the way, the intermodal piece of TransX quite significantly, almost doubled it since we've acquired it. So the purpose here is to have these businesses continue to feed the beast. And the question we're having ourselves is, do we need to own them all of it? Do we need to own part of it? But surely, we want these businesses to continue to feed CM. That was the purpose of acquiring them. That was the purpose of having them. But I think it's always good, Jason, to go back and re-question yourself. The boat is a good example. I remember when we bought the GLT. We were questioning ourselves whether we were going to buy the boats with it or keep the boats with it. And we decided at the time that we would, and this is like 15 years ago. So now we are questioning owning the boats, whether we actually need to own them to have that supply chain with iron ore and our good customer, U.S. Steel. So those are things that we're looking at. And I'd say stay tuned on what will happen on that front. But you can be assured that these businesses will continue. We'll keep the piece that they feed the beast so they feed CN, we'll keep that for sure. But we're questioning ourselves as to whether we need to own all of them, part of them and focus as well on making these businesses better, more efficient and more productive.

But just I want to be sure here, as we talk about this adjacent business, that's not where the improvement plan from next year really come from. It comes from costs: labor costs, operation costs, and it comes from price. So I mean the adjacent business is part of our review. There's no sacred cow. But I think as earlier when Ghislain filled up, how we come up the $700 million, the adjacent business, they're very small factor, a relatively small factor to the overall game plan.

Your next question is from Chris Wetherbee with Citi.

Maybe one clarification and then a question. So I just want to make sure I understand, on the operating income expansion, you talked about $700 million but in the press release, you're talking about 20% year-over-year growth in EBIT and EPS. I just want to make sure that we're talking about 20% because I'm just not sure I'm reconciling that correctly. So is it more than $700 million on a year-over-year basis to get to 20% growth? Or is there something missing there? And then maybe the next question would be about the 57% operating ratio. So great improvement on a year-over-year basis. I think you also mentioned that, that's a good OR for the environment we're in. Do you think that's a stopping point? Or is that just sort of a marker on the way? Because presumably, as the business grows and cost is disciplined and pricing is good, there's incremental operating leverage opportunity beyond 57%. So I just want to make sure I understand your thinking around what you think the operating ratio potential of the business could be longer term beyond 2022?

Yes. So maybe I can start with a question on the operating ratio. So going forward, we at CN believe it's time that the industry look at a balance between what -- how we railroad for shareholders and how we railroad for the customers and the users of the network. Definitely, operating ratio is one of our major focus. We talked about 57%. But also we have EPS target, this is in the range of 27. Free cash flow, return investment on capital, which we believe will increase in the range close to 15%. But it is time really to do the balance between where is the OR. And we spend a whole summer here engaging with regulators and shareholders and customers as well as getting signal -- very clear signal from the STB as well as the White House executive order. And the STB is very clear that they want the rail industry in the United States to be mindful of how far we go in terms of the cost efficiencies at the expense of what it does for customer service and moving customer freight. I mean, some of our peers actually reduced their operating ratio by putting as much, I think, it was 400,000 units. 400,000 units off the railroad -- of intermodal railroad back on the highway. I mean that's a big negative in terms of CO2 emission. That's also a big negative as to the -- the mandate of rail industry in North America should be to take trucks off the road, not putting truck back on the road just to achieve an OR target. So I think when you put all these things together and especially at CN where I think our -- the size of our intermodal segment is the highest of all the industry. I think, Rob, we're about 30%?

Right.

30% of our volume -- of our revenue is intermodal and where others actually for whatever reason, are not as high as that. And this is where the message from the STB come in as well. And I think the message from the executive order is to say, "Hey, I'm not sure that I want you guys to keep growing your spread, your bottom line or your spreadsheet just by getting bigger and bigger by buying one another. You have to find ways to be successful and do that in an environment, well, there will be no more Class 1 merger. So we think -- so we understand at CN any way. And I think the other deal is not necessarily a slam dunk at this point based on the resumed STB and the message from the White House. But also at the same time, we need to be more balanced, and we take 57% is the optimal point, that's the balance point. That's where we're targeting and 55%, if you wish, is kind of what I would call one bridge too far. 55% is going back to, I think, like Mike Mr. Oberman said, you're going back in the past, this is 2021. You got to find a way to look at the future by doing something more than just repeating PSR, PSR, PSR. I'm not putting PSR down, but I'm saying we need to evolve, and that's what CN calls a DSR using technology, getting freight off the highway, making sure that we work on diversity and inclusion, and create a future where there's something in it for investors, there's something in it for customers, and there's something in it also for what like the society expects from us. So we picked 57% in the life of all these different things.

And maybe, Chris, to answer your question on the $700 million of operating income, this is $700 million over and above the financial guidance that we have for 2021. So if you look at our financial guidance and you assume an operating income that would target double-digit EPS growth, then you add on to that $700 million of operating income in 2022. And that's where you get to 57% OR, and you get to 20% EPS growth. We do assume a low single-digit RTM growth due to the fact that the grain crop is down 35% to 40%, as JJ mentioned. I mean, if you do exclude that, then we'd be in the high single-digit RTM growth, so that's what we assume. And we're assuming $150 million of pricing in there and then the costs that I've talked about. So I hope that clarifies a little bit your question and answers your question.

Very clear. And just one just point of clarification. So is it that incremental margins beyond what we're talking about here, are not going to be what we've normally seen without -- through the rest of the group? It's more like sort of a 40% type of level is what we should be thinking about incremental margins for the business going forward?

Yes. I mean, the incremental margins will work with the 57% I've just talked about. When you look at what you can expect next year, in fact, because we do assume that the 57% will be for the entire year. As you know, typically in Q1 and Q4, OR is slightly higher due to winter. I mean, we do have winter in Canada and winter starts sometimes end of October, early November in some parts of the country. So from a seasonality standpoint, the OR is typically slightly higher in those 2 quarters. And then typically, Q3 is the place where the OR is the lowest because you don't have any effect of winter whatsoever. Q2 is slightly higher typically than Q3 because you still have the crop season and the spring and so on and sometimes you may have the washouts out west and so on. So that's in between. So I mean that's the cadence that you can expect that you will see in 2022.

Your next question is from Amit Mehrotra with Deutsche Bank.

JJ, I'm a little bit confused by your last answer, J.J. I was hoping if you can just clarify it because you previously kind of talked down the importance of operating ratio over growth in operating income dollars and EBITDA dollars. And at the same time, today, you're having this pretty ambitious OR target for the company for next year, which is great. But the question is that it doesn't seem like based on your answer to the last question, that your philosophy around how to operate this railroad is changing in the sense that the 57% OR seems like it represents this recalibration of the cost structure that -- and then kind of it's business as usual going forward. Correct me if I'm wrong on that. And then also, when other railroads announce these types of moves, there's obviously some fundamental change to the network that they're also contemplating and pricing costs are really good and you can get credit for that. But is there may be a more root cause issue with respect to the network plan that's caused the incremental margins of CNR to be so much weaker than everybody else's. So I'd like you to address kind of how your philosophy is changing about how to operate a railroad from an OR versus growth perspective? And is there any fundamental change to the network that you're introducing with respect to this announcement?

Yes. So we -- it's a good question. There's a lot in that question, Amit. So I'll see how much of that I can unpack. So definitely, as I said, we've been listening to our customers, shareholders and stakeholders during the course of the summer when we did the KCS transaction. And we've been asked and reminded that we need to work harder on operating margin or operating ratio. So we decided that as much as EPS is one of the things that drives -- one of the key metrics that you see at CN growing EPS and growing operating income that we need to have a more aggressive target on operating ratio. And the 57% is what we believe is a balanced way to look at the future -- railroad in the future for our shareholders, but also having an operating ratio that allow us to also railroad for our customers, and taking the feedback, I think, fairly clear black and white feedback from regulators like the STB. On the network itself, I mean, if we look at CN, one of the things that was in our headwind on the operating margin, one was depreciation. We've had a limited CapEx. When I joined as the CEO of the company, we were short -- we were desperately short of capacity. And also our prior management has also been quite late in getting engaged in spending the capital to do PTC. So we have elevated capital and then -- And then we went down to 20%, down to 19% next year, down to 17% in the next 2 years. So we still have quite a bit of depreciation dollar coming through, which has obviously an impact on a transient basis. I think also CN has -- is the railroad that has the highest amount of intermodal in our network. And as you know, it's no secret that intermodal, even though it's part of the long-term future of the industry, how we benefit in the consumer economy in North America. It does not generate the same OR as carload and bulk. And we have 29% of our revenue coming from intermodal. Some of the railroads have 20%, some other railroads are actually below 20%. So it does have an impact when you try to work out your OR target based on the type of growth available to us and the kind of railroad we want to be. In terms of the operating plan, and I think I should pass it on to Rob, but we are making some significant change, not only just in making sure that the weight of the headquarter and the weight of the function is not excessive on the total labor cost per operating dollar or total labor cost per GTM. But also we're doing things in terms of the operating target. And I think Rob went through a number of them. And maybe, Rob, you want to go through that again, but also talk about some of the new position you're creating in operation to be sure that we're even more focused than the past on some of the day-to-day tactical issues.

Yes. Yes. Thanks, JJ. Yes, I think you covered it quite well in terms of some of our differentiation, whether it's depreciation mix or the adjacencies that we have. But operationally, we're never settled, right? We're always going to try and continue to improve, and that's the way we have been the last several years and we'll continue to be that way. Structurally, from an organizational standpoint, we're going to make some changes, including Derek Taylor, who's a seasoned CN railroader, who will be Head of our Operational Excellence, who will be VP of Operational Excellence that will be dedicated on a day-to-day basis to driving and improving some of our core metrics to even new levels to get to. So we're not sitting still on this, and we're proud of where we've been, but we know we can always get better in operations. So that's where our focus is. And it's really not just singly on the metrics, it's also doing it in line with our key strategy initiatives. It's not sacrificing customer service, as JJ said. It's not sacrificing safety, and it's not sacrificing our sustainability leadership piece of it. So we see improvements across the board with that.

Your next question is from Scott Group with Wolfe Research.

I just wanted to clarify one of the earlier questions and then I've got another question. I'm still confused the $700 million of operating income growth is like 13% off of the '21 base. The press release said 20%. I'm still confused there, if you can help? And then I've got a pair of question.

Yes, Scott. So as I said, $700 million over and above the operating income that we have in our financial outlook for 2021. And then when you do the math and you take out the -- and you assume the share buyback, don't forget, that's $5 billion that we're assuming. And again, that's accretive to EPS. When you do the math, then we get to around 20% of EPS growth and the numbers that we have on the presentation.

Okay. I thought the presentation said operating income and earnings. Okay. That's fine. And then I guess going back to just the last couple of questions about operating ratio and focus, right? I mean I just -- we should probably keep in mind that the STB just approved the merger or the voting trust and everything for the one with the best operating ratio. But that other railroad would say, if you focus on earnings growth, the outcome is just a better operating ratio if you're just growing profitably, and it's just an output of the model if you're running the railroad. Do you think that that's wrong? Are they missing something? I guess maybe that's the same question you just addressed, but I'm still confused by the answer.

I think this is all -- this is JJ. This is all about what is the best optimal point for each network, right? We do have different network. But we definitely, as we mentioned earlier, had different mix of business. So we're at 29%, our Intermodal. And what's the numbers for some of these other railroads, I think, Rob, you had that earlier.

Yes. Most of them are around 20%, some are in middle teens.

Okay. So in other words, we probably have done a much better job in the last decade railroading for freight, which will otherwise be on the highway of freight, which will otherwise be on a U.S. port. And so now our -- the weight of our intermodal business is at a higher level. We would love to move more grain, more coal, more bulk, but there's only so much of that. And the future of the rail industry can't just be, I want to have an OR that is at a specific target. And in fact, truly, I mean, it's a challenge for, in general, for most railroad to grow because the growth is coming from a segment, Intermodal, where the OR is not the same. So I think that's where the -- what the STB is saying, in general terms, can you be a bigger player in the economy? Can you be a bigger player in enabling the economy? Can you be a better player in terms of getting the freight off the highway, which probably means you need to do more intermodal and in some cases, more carload. But we're only talking, by and large, more intermodal. So we have picked a very aggressive plan to move from where we are to where we want to go next year with specific targets on OR, in operating income and EPS growth. And we're going to do that on cost making sure that we don't carry cost in the function in headquarter, which are not conducive to a very profitable railroad. But at the same time, doing that in a way that the operating department is left with enough resource, have enough people to run train, have enough capacity to meet demand such that we can continue to play our role in the Canadian economy and U.S. economy. And just remember, when I took the job back in 2018 kind of on over a weekend, we were coming off a time where the Canadian regulators were about to change how railroading was going to become in Canada. We had a freight, we had a grain service review, we had a rail service review. This is where after that, they applied what they call extended inter-switching. You do not want to be at the point where you have become overly focused on your financial metrics, especially if you're the biggest player -- one of the biggest player, therefore, your impact in the economy is greater than some of the smaller ones. So when you have mishap on capacity and the impact on economy, you just put your whole business model at risk. We're working with sets of duopoly and they exist as long as the market player produce what they should. We pick 50% - 57%. We think that's where the sweet spot is. We think that's where the sweet spot and balance between long-term shareholders. I'm not talking short-term shareholders, but between long-term shareholders and customers, an expectation of regulators from us. And that's where we are. We're convinced that we're in the right spot. Other railroads may have other views. They may have different sweet spot. That's fine. But the one that we pick, the one we think is relevant for us is 55% -- 57%, I'm sorry.

I mean, I guess, I would just say, like every railroads intermodal mix has increased over time and margins have improved. And I would -- I think everybody wants all the railroads to get bigger, right, in the rail industry. We all agree the railroads, they should get bigger. I think we're just all hoping that there should be some incremental margin on top of that if you're growing in the right way. That's what I'd say.

Yes. No. I mean we want to get bigger. We try to do that through acquisition. Now we're going to focus mostly on organic growth, and we want to divert freight from the highway, and we're true to this value. No change on that point and be more profitable for our shareholders.

Your next question is from Benoit Poirier with Desjardins.

Just looking at the plan, assuming you deliver on the 2021 and 2022 objectives and you buy back $1.1 billion of shares this year, $5 billion next year, how should we be thinking about your leverage ratio at the end of 2022 and your ability to keep the investment grade? And also how does it change your philosophy around balance sheet management?

Ghislain?

Yes. Thanks, Benoit. So to your point, it's $1.1 billion or the total program would be $1.5 billion when we're done in 2021, and then $5 billion, our leverage ratio will be still well below the 2.25, which is the threshold that justifies our A investment credit rating. So it will be below. So -- and how do we think about this? Well, listen, I've always said that we like a strong balance sheet at CN for 2 reasons: Number one, if there's a financial crisis, and I lived the financial crisis in 2009. I was a young treasurer at the time. Or if there's a pandemic. You want a strong balance sheet so you can continue to have access to liquidity and capital debt markets out there and so on. And the other reason is if there's a strategic acquisition, then you want to be able to jump on it very quickly. And we showed this loud and clear with the acquisition of KCS, where we actually could put $19 billion of debt on the balance sheet and still remain investment grade credit rating. So this is something now we don't have the acquisition. We know that clearly. We know that other railroads went through the pandemic very, very nicely. And the most of all of our peers are BBB+. We're A investment grade. So I think we're making the balance sheet work for our shareholders for 2022, and we're signaling a $5 billion program. That will still be below our 2.25 as I just mentioned. And we're going to review this on an ongoing basis with our board. We're going to review our capital structure with our Board. We're going to see what we do. But we, for sure, want to make the balance sheet work for our shareholders. And that -- we're not necessarily wedded to a credit rating per se. We'll do the right thing for our shareholders, and we're going to make the balance sheet work for them. And stay tuned for beyond 2022, and we'll review that on a consistent basis with our board.

Your next question is from Tom Wadewitz with UBS.

I wanted to ask you about how you think about culture? So I think one of the concerns when you look at performance for the last several years, and I recognize you've had some things that have gone against you with disruptions to the line and a variety of things. But one of the concerns seems to be execution against the strategy of growth. So how much do you think -- do you think there's a need for culture change? And what gives you confidence you will improve in execution? Maybe another way to ask it is, I think PSR historically culture change was a big component or culture was very important. Is that important in DSR? And do you think there's some need to kind of change the culture versus what -- the path that you've been on?

So culture -- thank you, Tom, for the question. Culture is extremely important in the success of a company. I would say, the culture at CN is strong. You've seen that we have a stronger and stronger culture on safety. Our safety culture is not based on fear. It's based on supporting one another and the people speaking up when you see unsafe condition and not being afraid of bringing up issues as opposed to be penalized because of bringing up issues. We have a strong culture also on ESG. We've always been a leader, and we actually created a job in the VP of Sustainability, Janet Drysdale, doing a fantastic job, not just on the CO2 emission, but also every aspect of ESG. We talked about earlier about having more women on the railroad, making sure that we have inclusion, making sure we bring more diversity in our workforce, making sure that we have specific target, visible target in terms of customer satisfaction. Customer satisfaction at CN is something important. A number of our people actually get rewarded in that in their annual bonus. We measure that with Net Promoter Score, not with trip plan. Trip plan is not a measure of customer satisfaction, et cetera, et cetera. On the cost side, we -- Rob is working hard with his team to make sure that we get the best of what we have. He mentioned a few things on technology. A number of technologies are becoming more mature and are producing good results. You saw the slide where we talked in some cases, about return on investment capital, some of these things like the portal, the ATIP car and the mobile device and what they produce and as they're getting more mature, we're going to get more results out of that. And the job created for Derek Taylor as the VP Railroad Excellence, you could call that VP PSR or VP DSR. But his job is to look really at a day-to-day tactical things of where are the places that needs to be fine-tuned so that some of these events, small events that adds up to big total. I get caught up early enough, fast enough and be dealt with as part of our operating plan. I don't know, Rob, if you want to talk about culture, whether from an operating point of view or just a company culture, but we -- the culture at CN is strong. It may be different than other railroad. But it is -- we have the culture that we want to have. And on the operating side, Rob, do you want to pick it up?

Yes. Yes. I think, JJ, you said it. My experience here in a couple of years at CN is that it is indeed a very strong culture with strong operators out there, and that hasn't changed. These are some of the best in the industry, and I've been doing this a while. And I've seen what other railroads have to offer and I'd take these men and women over anybody. But our culture evolves beyond just switching cars. It is about a safe operation. It is about providing the customer service. It is about embedding technology and continuing the lead in the sustainability piece. So culture is one that's always evolving, and couldn't be more proud of where we're at and where we're going.

Your next question is from Fadi Chamoun with BMO.

JJ, you have owned the kind of nonrail assets for quite some time, even TransX has been quite some time now. Have they been incremental to the company's ROIC? Have they been incremental to the growth prospects of the company? I mean I would think after all these years, you would have a clear kind of idea if these things have been synergistic with the rail business or not? And the second point, just on kind of related to that, with the new financial targets you're talking about, is there a new return on invested capital target that the company has that will kind of guide the capital allocation moving forward?

So all of the nonrail activity at CN are profitable, have been profitable. Most of them usually don't take that much capital. They're not as capital intensive as the rail industry. Some of them, like the freight forwarding actually don't take capital. It's mostly human cost. It's basically -- it's people who do these things as opposed to a large heavy asset, and their role was to bring more business to the railroad to contribute to the growth. So as we do the strategic review, first and foremost, we want to be sure that their cost structure is in line with their peers, right? So is my intermodal business has a similar cost structure than those who are publicly listed, say, for example, J.B. Hunt. My vessel have a cost structure versus other vessels who sail in the Great Lakes. So -- and if that then let's improve those costs to make sure that we are best-in-class and be the better operator in terms of processing this segment. Next thing is, are they helping to bring business to the network. And then eventually, you have to ask yourself, can we do that? Can they bring business to the network, but not necessarily without us owning all of it or owning only half of it. So that's another thing that's under review. But it is a fact that because we have this model, which is different, it has not been always well understood by The Street who prefers to maybe look at railroad as railroad and not for us to step too far out of the bound in terms of rail activities. The more we step out of bound rail activities, the more our result because they're not segmented and may be more difficult to understand. And we need -- realistically, we need to take this into account as well. But are they profitable? Yes. They're not as profitable as -- they as profitable from an ROIC point of view, but not from an OR and some of these other things that we have calculated. So I think most of them will probably play a role in CN or play -- or maybe the ownership structure will be different, and it will definitely still play a role in CN, but that's really what's under review right now. My point on freight forwarding is just on that specific case, we were probably just really reduced activities to either unwind it or put in the hand of somebody else who will maintain the link that we have with some of these shippers from Asia to the Canadian market. I don't know, Ghislain, if you want to add something to that?

Yes. Maybe I can add to your second question, which is, do we have an ROIC target for the business? And we do. I mean, it's in our small presentation. When we deliver 20% EPS growth and $4 billion of additional free cash flow, then the ROIC, we believe, will be around 15% for 2022.

Thank you. I would now like to turn the meeting back over to Mr. Ruest.

Thank you very much. Thank you for joining us this morning on a short notice. Hopefully, you sense from our plan that we're very passionate about it. We're confident we can deliver against that plan. It's a plan that -- even though we talk about 2022, it's a plan that we've actually started to roll some of these elements in the last few weeks. And now that we are public, we're going to roll out, with a lot of energy, things in the remaining weeks of the third quarter and definitely for the fourth quarter. So a lot what we talked about here is going to be taking place in a matter of weeks, not a matter of quarter, and we feel comfortable with the target that we have. I'm confident about the team. I'm very energized about doing it. And because I've been very involved in working out the details of this plan with Rob and Ghislain, I intend to see this plan through all the way to its end. Thank you.

This conference has now ended. Please disconnect your lines at this time, and thank you for your participation.