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

Great. Let's keep the Canadian Rail theme going with Canadian National, our top rail pick in North America. I'm very happy to have with us CFO, Ghislain Houle and Stacy Alderson from IR. Thank you both for being here.

Thanks for having us, Ravi, and it's always nice to come to Laguna. We participate in your conference for many, many years. I've got Stacy with me all dressed in green, so that's the color of going fast.

Before we kick off, please note that for research disclosures, please see Morgan Stanley's research disclosure website or read our research.

With that, Ghislain, do you want to kind of start off with give us a sense of what's going on?

Maybe just opening remarks, and then we'll turn over to your questions, and you've got good questions, Ravi, as usual. So I know everybody is questioning volume. And it's a very volatile environment as we speak. So when you look at our volumes, as you know, in Q2, and I always talk in volumes in terms of RTMs, revenue, ton, miles, they were down 8%. When you look at July in Q3, we were down still 8%, but then it was down 4% in August. And when you look at September to date, it's down 4%. So my view is, I think we've hit bottom. And those volume softness is not specific to CN. I mean you've heard the other rails. I know Jim was here, and I want to congratulate Jim, by the way, on his appointment. Jim is a good friend of mine. I've known him for over 25 years. He was a superintendent in [ Symington ]. Jim, I want to really congratulate you, and I think that him being a few UP bodes very well for CN. He knows our network, and I think we'll work very well together. So I think we've hit bottom. I think definitely, Ravi, Q4 will be better than Q3. I'm convinced of that. I can see it. As you know, we were hoping to get some type of recovery in Q4. I think we're not going to see the regular intermodal fall peak, as we've typically seen. I think this is going to be pushed in 2024. I'm confident that we will see some recovery in 2024. Q1 will be tough comparables. You remember, we had a stellar operating performance in Q1, but I think you can start seeing it at the end of Q1 and then Q2, Q3, Q4. When you look at the areas of weakness, obviously, it's the consumer consumption segments of our business, namely intermodal. You see some weakness as well in force products with interest rates being higher. But the good news is when you look at our center beam orders and center beams of the cars we used to move lumber. They've been up now and rising in the last couple of weeks. So that's good news. When you look at the bulk side of our business, it continues to be strong. I mean, grain is strong, potash is strong. When you look at frac sand as well, coal, a little bit down, but that's more related to customer production issues than anything else. When you look at the coal prices, it's continuing to be favorable for producers. So -- that bodes well for us. Going back to Canadian grain, you probably have heard StatCan came out last week saying that the Canadian grain crop will be or should be or could be about 62 million metric tons. When you talk to experts, people say, anywhere between 61 million and 65 million. That's down versus this year. This year was 75 million because of the dryness mostly in the southern part of the prairies we're kind of fortunate a little bit because our railroad is the railroad of the north. So we don't think we're going to be hit as hard because of where we're situated. So that's related to grain. Let me talk a little bit about the operations side of the business. I'm extremely proud of our operating team. I'm extremely proud as well and happy about the operating model that we're running at CN with a scheduled railroad focus on car velocity. When you look at -- there still -- were disruptions in Q3. There were still some forest fires going on. We had as well the strike of the longshoreman both in Rupert and Vancouver. But still, when you look at our operating metrics, they're all in line with Q2. Whether you look at car velocity or dwell. So the team is doing very, very well. And we have other proof points now and more proof points that this operating model allows us to recover when we have a service disruption. It allows us to recover much quicker than if we would have an operating model focused on train length or train load. So hats off to the team. They've worked very, very hard. And then we actually surveyed our customers through an NPS survey, Net Promoter Score. And the customer service has not been ever as good as since I've been in the business. And we've done that intentionally. And that will lead in into the financial piece. As you know, we've decided to not have any knee-jerk reaction and send people home in terms of conductors. We got ahead of the game in terms of training them to become locomotive engineers. We did not want to slash and cut train starts and then have a negative impact on customer service. So this is intentional to make sure that when there is a recovery and there will be a recovery that we will be ready. So I'm very pleased with that. As well, you've heard from other rails and other transportation companies that with fuel prices going up, right, in Q3, significantly more than at the end of Q2. There will be some noise on fuel surcharge. And in our case, fuel surcharge lag. I think if WTI stays around where it is around USD 90 per barrel. It could be in the $0.10, maybe a little more than $0.10, on a nonfavorable fuel surcharge lag in the quarter. But again, that's noise. That's exactly, that's noise. So when you put all of this together, I think that we are confident that we will deliver on our guidance for this year. And I'm very bullish for the future of this company. I think that -- and you have a question on our CN growth-specific initiatives that we went through in Investor Day. And so I won't still get thunder and will provide more visibility, but they're coming. I mean they're happening as planned. We have clear proof points that this is coming that will allow us to grow more than the economy. So I'm very bullish about the future of this company. I think the team is gelling well I think Tracy made some key people decisions. And people is very important because you can have the best network out there, but if you don't have the team to convert the network into value, then you don't have much. So I'm very pleased with that, and I'm very comfortable that we will deliver on our longer-term guidance that we provided at Investor Day of 10% to 15% EPS growth. It may be pushed a little bit because the recovery started a little later than what we expected. But at the end of the day, people will need to change their dishwashers. People will need to start consuming. Right now, they're pushing. They're relaxing on consuming because they're traveling like people are traveling a lot. But eventually, they need to consume. And like I said, with these CN-specific initiatives, I think it bodes very well for this company going forward. Stacy did I forget anything?

You covered that super well.

That's a great overview. Ghislain. A couple of follow-ups there. The wildfires and the strikes, how much of an impact is that having to your volumes? And can you quantify that in terms of EPS?

Yes, you're right. So as you know, we did quantify it in Q2. So the wildfires, we said $0.07 in Q2, and we said 100 basis points to the OR. It continued in Q3. We haven't quantified it yet. So stay tuned on that one. And on the longshoremen strike as we said, we did recover some business, but not all of it, didn't quantify it yet, so stay tuned for the earnings call in Q3.

Got it. And just to your point if you're very confident in the long-term guidance. You also said you're confident in the guidance for this year, which you took down last quarter. But does that mean that is going to get pushed out to the right? Or will it just be -- will it be a more powerful 2024 because your '23 starting points much lower?

I think it's going to be a little bit of both. I think it's going to be a little bit of both, you're right. I mean and that's a good pickup. We're starting from a lower base but I think it's going to be a little bit of both. I think it's going to be a little stronger. I think -- I don't think though and again, this could be debatable. I don't think the recovery will be a V-shaped recovery. I think it takes time for the interest rates to do what it's supposed to do. The unemployment is still like it's full employment. When you have unemployment at 3%, so people are working. But I think that -- I think we'll have a little bit of both.

Got it. So maybe just moving to the long-term plan here. And at the Investor Day, kind of you have gave us a lot of detail on your new operating plan, just referenced that. So those who weren't at that event or just a refresh on the story. Can you just tell us kind of what are the main kind of building blocks of the new operating plan and kind of how is it going with actually selling that plan was a big focus.

So -- and I can start and Stacy, you can jump in here. So it's really in railroad, there's two operating models out there. There's -- either you have a scheduled railroad. So you move your trains on time. And that's whether the train is big or whether it's small, you move the trains on time. And -- or you wait, you let the cars sit until you've got a big train and then you'll let that train go. When Tracy came, that's one of the things she did was to really come in and clarify what operating plan we're going to use at CN, which is really move the trains on time. So -- and you measure it. So you measure train departing on time. And I must say that now our train departing on time are over 90%. Then you measure train arriving on time. That's over 80% -- that's 80%, around 80%. Then you monitor block integrity because if you don't have the right blocks, then you're just pushing the work to another yard. And that's in the 75%. And then does the train -- does the cars make connection and that's in the 75%, 80% range. And when we started this, we were in the 50%, 60%. Now why is that, to your point. So -- if it's not clear, if I'm the superintendent in Winnipeg and I have a train that's scheduled to depart at 1400 hours. And the train is 9,000 feet. And I know my traffic that's coming in, my inbound traffic. And I know I have another 2,000 feet coming in, but I've got to let that train sit for 2 hours. If it's not clear for me, I'll probably wait 2 hours because I'm going to maximize my yard, and I'm going to maximize my train. I add 2,000 feet and all of a sudden, "Hey, I'm going with an 11,000 feet, same conductor, same locomotive -- great thing. The problem when you do this is you do maximize this yard and the strength, but you suboptimize the network because those locomotives were required further on in the network. Those cars that are entities that will become load were required to make connection to another train. So that's the thing. And the notion when you run with a plan is that you will be able to move more traffic with less cars. Like when you look at it, and it's incredible, like I remember when we got into some of our congestion issues, and you've been following us for a long time at the end of '17, early '18. January of '18, we had 35,000 more cars on the network, and we moved 10% less volume. In Q1 of this year, we were able to move was it 6% more volume with 15,000 less cars. So it's very powerful. And what happens now you say, "Hey, okay, now so therefore, if we own -- the railroad owns the car, then we get the car ownership benefit. If the customers own the car, like, for example, tank cars and the likes frac sand cars, then they do get the benefit because then they can move more volume with less cars or they can return cost to lessors. But what do you think that does when Doug MacDonald goes and the marketing team goes and tries to get a price increase above rail inflation makes it much easier. On top of now, if that scheduled railroading plan allows you to be more reliable, which is why customers come to the railroad in the first place? Like how can you be reliable if you never start your trains on time. But you need to measure and we measure each car, each car. And so I think now it's clear. And the last point I'm going to make is let's say that train is always 9,000 feet. Then there's 2 things you do. You either push. And this is not an or, it's both. You push the marketing team to fill up that train. And Pat -- and you saw those 2 guys, Pat and Derek, who's like -- what do they call them, the nick names they call them Stacy?

Big bird -- and sorry erne bird.

So they work very well to get -- you tweak the plan, you tweak the plan to maximize the business, always with a view of customer service. Customer service is first and foremost. And that's what it is. So scheduled railroading is actually the foundation of great customer service because starting your trains on time provides reliability. And then if you can do it with less cars, then that's the proof of the pudding. So I know for our network, and I've seen both. I've seen running scheduled railway before, and I've seen us getting away from it a little bit. And I can tell you that I'm extremely excited about what we're doing right now, and the team is extremely excited. I can't wait to have those volumes come back because this is going to be terrific.

That's exactly my follow-up point, which is what stood out to me at Investor Day was a very back-to-basics approach. I was really surprised that you guys had a really sophisticated rig that you took 45 minutes to walk us through that basically taught your employees how to walk. I mean that's how back-to-basics you're going to and kind of what you described to me seemed like fairly basic building blocks of PSR, you're running the train on the schedule or respective length. So does this back-to-basic approach means that the execution risk here is relatively low because you're doing stuff that you, again, may have kind of gone away from or like that bad habit may have crept in and so you can kind of make this happen with pretty low risk?

The execution risk of is -- very low because people have asked us, how could you go back and demonstrate benefits so quickly. You remember last year, because we have the muscle memory like I've been around for 25 years, like I'm a finance guy, but I've been in operations for 1.5 years, 2 years. I've been trained by Hunter, Derek Taylor, I remember, was in Vancouver, when Hunter was around fixing up Vancouver. So we have people that have been around and we have the muscle memory. That's why it went so quickly. What we were missing and hats off to Tracy was the clear direction. And if it's not clear because we're diversified, we're geographically diversified, then people are not trying to be bad. They'll do whatever they think is best with their view of the world. So, you need to have the overall view of the network and the network at the end is what we maximize. So Pat Whitehead, he's got the final call on what we do because he's responsible to make the plan. Derek is responsible to run the plan and make sure that we maximize the network. The other thing that we've been doing, and you'd say it's back-to-basics absolutely, is we're working in a more integrated fashion. Believe it or not, in the past, marketing would go out selling, Finance would not have a view of the contracts we're negotiating and then operation would move whatever is in front of them. We're not doing this anymore. So again, we have an operating committee that Tracy has asked me to facilitate where Ed, Doug, Tracy, myself are in. We review all the customer contract renewals. We make sure that there's appropriate pricing and profitability. We look at the OD pair. We make sure that we have the resources and the people to make sure that we will be able to provide good customer service that the customers are entitled to receive. So we have these discussions to make sure that, again, and the key here is that when we look at business in Western Canada, that we just don't grow to grow, but we grow profitably, and we bring on that business to make sure that we bring the top line growth to the bottom line. So that's another key point that we're bringing. And when we look at all of this, I don't look at it with just a finance. I look at it as a business person. MacDonald does the same. So -- and we've known each other for years. So again, the value of the team and the team coming together entrusting each other and wanting to do the right thing is critical, and that's what under Tracy's leadership, that's what we've implemented in the last 1.5 years that she's been around.

Got it. Let's shift gears a little bit and talk more kind of commercial side of things. Obviously, Falcon service, you guys kind of announced on your last conference call. How has the initial market reaction to that been? We kind of did our own surveys and kind of we were -- this may not surprise you, but we were a little bit surprised by how kind of strong the reception was going to be for Falcon service, given that it was a newer offering. So how is the go-to-market been for that?

I would tell you, I'm extremely excited personally, I'll talk personally, I'm extremely excited by this because it allows CN to access Mexico without having to make a huge bet and without having any integration issues. So I think that I'm extremely bullish on this. I think that like anything else, it starts small. But I think that I was happy to hear -- and but not to hear but to see the -- as part of the press release that we're cutting service now -- service the transit time by a day -- and when we look at our transit time right now, as Stacy were talking about this morning. I think the key service from Montreal to Toronto is 5 days, which is truck like. So I think like anything else, it starts small, but I think the opportunity that, that presents is unbelievable, in my view. I think it's all about taking long-haul trucking out of the road to the railroad, which is good for the environment. I think the fact that Jim is -- and I don't want to take anything away from Lance, not at all. Jim knows CN's network extremely well. He worked for us for over 35 years for God's sake. So he knows and knowing him unless with the age, he got a little bit more patient, but it was not all that patient. I'm not surprised. And he's Italian. So -- so this bodes extremely well for that service. So I think stay tuned on that one, but I'm -- I don't know whether you want to add anything, Stacy, but this is going to be good. Now here's what we need to do. And Jim knows this very well, and we know this. We need -- there's 3 railroads, FXE, UP and us, we need to work as a single line railroad that's the key. We cannot set that -- we cannot let that train sit in Chicago, for example, for a week or 2. We cannot, we cannot, we cannot. We need to work and we need to make these interchanges as fluid as if it would been our own network, our own railroad going from Mexico to Canada. If we do that, and we do that on a consistent basis, now stuff will happen. We're now [ door sport ]. There may be some storms on this, on that, people understand that. But if on a consistent basis, we're able to deliver these transit times that are truck-like transit times, with all the benefit that railroad comes from a pricing standpoint and from an environmental standpoint, people will come in. They won't come in -- it won't be a big blob -- they're going to come in a little bit, a couple of low. I'm going to try it. Then oh, I like it. A couple more, a couple of more, a couple of more. And then in a year, 2, 3 years from now, if I'm still sitting in this chair because you know Tracy fired me at Investor Day this year and -- that was hilarious. If I'm still here, we'll look back at this. And if we've done things right, in my view, we'll say, my God, we never thought that this was going to be so good.

Sorry. Just to follow up on that. Again, just factually kind of having multiple rails kind of an interchange is not going to be as quick and smooth as having one rail network from point A to point B, right? So A -- can you just expand on that point a little bit more? Are you guys doing anything tangible? Are you changing the network? Are you changing communications to make sure that those -- you don't drop the ball in the interchange on one line or the other. And second, even if there is a time gap to your nearest competitor that's doing it on their own network, like is there a price adjustment you can make? Is there some way -- does that -- is that even a sensitive point to customers?

Well, you're right. So first of all, what we've put in on the Falcon service, for example, and we've announced some other partnerships with NS, as you know, to offer intermodal service to Atlanta and Kansas City. You need to put in the governance model, okay, to make sure that people follow this up and that, yes, we work as a single line railroad to be successful. And we've done this in Falcon. We're going to do this with NS. And then you need to measure it. You need to measure it because typically what gets measured gets done. And then when people are not doing what they're supposed to do, then constructively, you need to tweak, which would be the same as when you're a single railroad. Because people sometimes you're superintendent there, works for you, but they're not doing what they're supposed to do. And it happens in the single-line railroad or as this happens with 2 companies. I think the important thing is to have the commitment. And I think railroads understand like with us with UP or with us with NS, that this is again to the benefit of both rails. We know that there's not going to be probably another round of consolidation in the foreseeable future, so rails need and rails lost their market share to trucks in the 1950. So now this is an attempt for us to work as an industry to get that market share or some of that market share back. So -- and remember, going to the Falcon service, this is where the EJ&E, the strategic acquisition that some people said we paid too much for is worth gold because we're the only railroad that can go around Chicago on our own track.

I was on that train.

Nobody else and you were on that train, and it's pretty phenomenal. So again, that helps because you don't have to wait for a signal of some another rail when you're sitting there on the locomotive and you have a red and you can't move because you're waiting for the green. So my view, railroads are working better together, and we're a big leader of this to work better with UP and NS. The other place where railroads needs to work better together is on safety. Safety, when there's an accident or a bad derailment happening to one rail, it impacts all of us. And we need to work together, and we've said that at CN publicly, we need to share data. We need to share technology, we need to work together to up our game because if you -- from a regulatory standpoint, safety is number one. If you want to make the regulator happy keep those planes on rail, work together as an industry and then have good customer service, so customers don't have an opportunity to go and complain to the regulator. This is where the industry needs to work together, and we're seeing proof points that -- we're not 100% there yet, but we're getting there.

Got it. Any questions in the audience?

Earlier the benefit to the environment from converting trucks. I feel like that has been talked about a lot over the years, but sometimes it feels like when push comes to shove, it's service and price that ultimately is kind of that deciding factor. So how do you view that as becoming a more important kind of decision-making consideration? Do you think it actually gets to be in the top 2 kind of consideration over time?

I think -- I hope I understood your question correctly. You're saying converting truck to rail has typically been just purely more on price than the environment. And Stacy jump in here. But I think more and more, we see our customers now being cognizant about what they do to the environment more and more. So -- and they know that rails. I mean, our gas emissions are 4x less than truck. So more and more customers -- first of all, we do get a price advantage, but to the truck typically. But you would say currently, I think the trucking pricing is very, like there's a lot of truck capacity as we speak. So it's not as conducive, but people are looking at more and more the environment, and some of them are converting their traffic to us and to the rails related to the environment. The key for me and for them, what they tell us is reliability. So if you're going to do Rupert to Chicago in 100 hours, do it 95%, 96%, 97% of the time. Don't tell us you're going to do it in 80 hours and you hit the pin only 50% because then they can manage their inventories, they can do all sorts of things. Hence, why the scheduled railroading model makes a lot of sense. So that's the key -- that's how they convert. And then if you can help on the environment, you're a good social citizen as a trucking company, working on your own emissions and pushing more traffic to rail, then that's everybody's wins on this. I don't know, Stacy, you want to?

Yes. I would just say that as Scope 2 emissions become more and more important for our customers. Obviously, rail is a solution to the problem. So we're getting more, as you said, more and more requests from customers. We're helping them measure what the savings is. So it's really becoming more of a competitive advantage whereas before, as you said, it was more based on price and service.

Understood. Maybe just to close out here, I want to combine a couple of my questions and go back to something you said earlier, which is you're not going to make knee-jerk reactions to the current volume environment because of how hard it was for you and all your peers to size up again coming out of the pandemic; A, does that mean that rail earnings are going to be more cyclical than in the past because you're not going to flex up and down as much as you used to? And second, how do -- are there any other actions you can take that do not involve labor or some of the kind of fixed cost aspects of the network to actually cut cost in the near term until the volumes come back?

Yes. Going back to labor, I think the key with the labor market right now and trying to attract young folks to work not only for the rails, but for industrial companies, it's been tougher than it was 10 years ago because these young people are not as attracted on financial rewards, that's maybe my generation was. They want their weekends, they want their 2 days off. So I think we need to be aware of this. And like really, it takes about 9 to 12 months to train a conductor. So you want to make sure that and it costs about $75,000 to $80,000. So you let them go and all of a sudden, they've got a young family, they've got a mortgage. They don't come back to you. You need to -- but people will have a tendency to let them go when you think about the quarter. We want to think more midterm. And we know right now, we're carrying a little bit more labor cost than we would have otherwise, but we truly believe that this is the right thing to do from the mid- to long-term standpoint. And I think our employees are appreciating what we do. And so on the other stuff that we do is we were able to park some cars and in some cases, we're able to return cars because we have some cars that are under lease. We have staggered expiry day. So we have a bunch that on any given year expire, we return them. We actually park some locomotives. We're starting to take some out with the grain coming on board in the fourth quarter, but third and fourth quarter, but we did park and we parked the ones that are less fuel-efficient. So there's things that you can do. We're focusing on making sure that from a discretionary standpoint, a spend standpoint that we tighten our belt a little bit. So these are things we do. But we have a mindset. We're not going to run for a couple of pennies on a quarter to do the bad decision for a mid- to long term. Maybe I see the time is at 0, Ravi, maybe just a couple of closing remarks.

Yes.

As I said, I think Q4 will definitely be better than Q3. I think I'm -- we will deliver on our guidance. I'm confident of that. I'm very, very bullish for the future. I think that we've got the team gelling. I'm having fun. I think Stacy is having fun. That's why she's dressing green, the color of a dollar bill. She sees the money right in front of her nose and I think that we have these growth opportunities, and we didn't have chance to go through, but for investors, go back to our Investor Day, and they're all laid out, and we're talking about 800,000 to 900,000 carloads that are going to come at us, maybe not all of it day 1, but these are specific opportunities. They're advancing as planned, some are even maybe a little bit bigger than what we thought about. So -- and that demonstrates to us that this company will be able to grow organically very well in the next years. And with the discipline that the team and Tracy with her leadership brings on board to not oversell our capacity, especially in Western Canada, we will bring that top line growth to the bottom line.

Ghislain, it's always enlightening and always fun to talk to you. So thanks so much for coming here. You'll definitely be back next year.

Thanks for having us. Okay.