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

Good morning. My name is Konark Gupta. I'm the transportation and aerospace analyst at Scotiabank. Thank you for joining us on the second and final day of our 23rd Annual Transportation and Industrials Conference. Yesterday, we learned more about 10 or so great companies. Today, we will hear the story from another 10 solid names. It's my pleasure to kick off the day with none other than CN Rail. And I'm pleased to have EVP and CFO, Ghislain Houle, as well as Patrick Whitehead, who actually officially starts his new role of EVP and Chief Network Operating Officer today. Ghislain and Pat, welcome. Over to you for opening remarks.

Yes, thanks for having us, Konark. Thanks for being here in the room and people listening on webcast and taking interest in CN. First of all, I want to congratulate Pat on his new promotion. It starts today, buddy.

Thank you.

So, as I said yesterday, to your colleague, it's one thing to get it. It's another thing to keep it. So...

In 30 years in this business, that's one thing I've learned. It's one thing to get it. It's another thing to keep it.

So maybe just very quick remarks on volumes because I know that's on top of the head of everybody. And then I'll let Pat talk a little bit about operations. So as heard us before, and we've said that publicly, we believe that the worst is behind us. I mean, I think we hit the trough in terms of volume in Q2, Q3. When you look sequentially, our volumes are improving month by month. I mean, just as an example of over our volumes on a revenue ton-mile basis were up 10% versus September. When you look at November, I think that we're tracking to be above October. And then December, got to be careful a little bit with the Christmas holidays and winter hitting us. So I think I'm very comfortable to say that the worst is behind us. The 2 areas or the 2 segments that are still murky is obviously intermodal international. We're getting signs that it's getting better. I think that will do some type of recovery in 2024. When you look at the bookings for Asia traffic to Rupert and Vancouver, I think that they're now pre longshoreman strike. So I think a lot of questions have been, well, you guys have lost a bit of market share, Rupert and Vancouver going to L.A. Long Beach or Seattle, Tacoma, because of the strike. I think that we're seeing signs that this business will come back to Rupert. The offering is too compelling. When you look at [indiscernible] products, the orders per week of customers in the trough versus where we are today, it's improving, it's much better. It's not where we can be, but it's better. So from an operating standpoint, and I'll let Pat double-click here a little bit. These guys have done an incredible job. I mean, when you look at all the disruptions that we've had either in Q2 or Q3 which we quantified for investors to be about $0.17 of EPS 7 in Q2 and 10 in Q3. And when you look at the way that the Railroad continued to perform from a customer service, I mean it's quite remarkable, and from an operating metrics as well. So I'll let him double-click on this. So when you put all this together, I think we're comfortable that we will deliver on our 2023 guidance of flat to slightly negative EPS growth. And going forward on 2024 and 2026 on our longer-term guidance that we provided at Investor Day, we're comfortable that we will deliver on 10% to 15% EPS growth in CAGR in those 3 years. So on this, I'll turn it over to you, Pat, to make a few comments on operations.

Okay. Ghislain, thank you. And Konark, again, thank you for having us this morning. So I want to spend a few minutes talking about our new organizational structure. And really, I want to think about it from this standpoint, it is really about our structure following our strategy of make the plan, run the plan and sell into the plan. It's not as -- this is going to be 2 very distinct roles of equal importance. This is not simply splitting at Harris in half. As I read a couple of days ago, the concept of Mr. Inside and Mr. Outside. It's not quite that simple. We have very distinct roles. And it's really about what do each of those functions do and what are the things we're going to do differently in this new org structure and get to work that we haven't been able to get to and do as well as possible in the past. So I'll start talking a little bit about what is the network operations team, the team that I lead or the make-the-plan team. And it's not just about making the plan. There's a lot of elements. As you may have read in the press release, we're also taking on the engineering and mechanical functions as well as corporate safety. So there's a lot more to it than just about making the actual operating plan, and I'll talk a bit about that. But as I look at the existing network operations team or make the plan, it is about building a plan and iterating that plan constantly in conjunction and in concert with the field operations team. It's about understanding how is the traffic flowing in all of our corridors and making the optimal plan to best utilize our crew resources, our locomotives and quite frankly, our network. And that is not done in a vacuum. That is very much done in lockstep, but it -- the best way I've always said to test whether you have an effective plan or not is simply to run it. When you run the plan, you will find out whether you have an effective plan or not, and we can make adjustments to that plan. It's also about making sure that we are doing capital work from both the mechanical and the engineering department standpoint more efficiently than we have in the past. Having a longer-term plan for how we spend basic capital to maintain the infrastructure to maintain the plant, also a longer-term look at how do we more efficiently deploy capital, particularly in the engineering space, but also as I look at the mechanical team, how do we invest and plan for the locomotive of the future? And to reach our greenhouse gas emissions reduction goals, we've got to be looking at what is the next technology and working with our partners? So it's very clearly defined what the Make a Plan team does, the network operations team. And I'll talk a little bit about Derek's team and what the field operations team does as well. And I think Derek has said this several times, and I want to reiterate, I think the value, the strength, the bond that we have and is that we have each done the other's job off and on throughout our entire career. I've been in this industry for 30 years, both in field operations, mechanical network operations. And so I've been kind of back and forth in those roles. So I understand what it takes to execute in the field. I understand what Derek's team needs for support in the field and also how we're -- our functions are interrelated. So I look at their team, it's really about how do we continue to run the plan at a high level of efficiency and execute the plan that's laid out there. It's about how do we originate trains on time from terminals, which at the end of the day, is the basis of our operating plan. We count on a disciplined scheduled operating plan launching trains on time from terminals to set the entire network in motion and everything plays off of those on-time departures. That takes a lot of hard work, and it's not just the field, the typical field role in the past. Derek is also taking on responsibility for our intermodal terminals. So it's also about what does that intermodal network look like? How do we execute in the field from an intermodal perspective as well. And as we said several times, railroading is definitely an outdoor sport. And there are plenty of challenges out there as you execute that plan, and field operations is also responsible for always working us back to plan as safely, quickly and efficiently as possible in those disruptions, they keep coming at us. So that the planning work sometimes gets lost in the day-to-day field execution. And really, that's, as you look at our Make the Plan, Run the Plan, Sell the Plan. That's why we have 2 distinct responsibilities that we're responsible for and our teams are responsible for. However, I'll say it this way, while it's 2 different functions, it is very much one team. The value that we have seen and we've been operating this model in essence, since Ed Harris came on board last year, I think we made it a little more prominent with our Investor Day and when we started talking about make the plan, run the plan, sell the plan. But Derek and I have been operating in this capacity really since Ed came on board, and we really -- and Tracy, Robinson and dedicated ourselves to a disciplined scheduled operating plan is our model. So we work very well together on making sure that, that's -- and the plan is our North Star. We're always working back towards that. I will say this about our time and my time with Ed, a Railroad -- truly a Railroad legend, 50 years in the industry. I've known of Ed from a distance for many of those years, but the opportunity over the past year to be mentored by Ed and be exposed to his leadership and the things that he brings to the organization has been tremendous. For me, it's been a great year with Ed, learned a lot, his focus and attention on the car level of railroading, making sure that we are focusing on how each individual car moves to provide that service to the customer. And also, it's the basis of many of the metrics we look at when you think about car velocity, dwell, it's very much car focused. Ed really brought that discipline and that mentality into our organization. So I will put it this way. We're going to do right by Ed and make sure that he actually enjoys his fifth and maybe final retirement. That's the promise -- that we've made to Ed is that we will keep doing the things that he brought to the organization and wish him the best happy and healthy retirement. So I'll say this in closing -- I want to talk about the value that the structure brings in recoverability. And I'll just talk about the number of disruptions that we've seen this year and how we've been able to recover so well from that. So when you look at the wildfires in Alberta and British Columbia flooding out in Nova Scotia, we had the ILWU strike at the West Coast ports to deal with. So that is, in essence, each one of those disruptions and particularly the ILWU strike, we stopped and started the network, a big network like CN to tri-coastal network 3 times in the course of about 2 weeks. Starting -- stopping and starting a network like that or any railroad is -- can be one of the most disruptive things that we do. We did it very efficiently. It was because of the plan. The plan is sacred. The plan is our North Star. As we stopped trains, stored locomotives as a result, we planned for what did the startup look like as soon as we had to start curtailing the operation. We came out of all those disruptions with minimal impact to our -- car velocity was down about 2% -- 1%, excuse me, train speed was down about 2%. Terminal dwell was up just minimally at about 1%. And throughout all of that, actually on-time departures from terminals were up 2% to right at 89%, we strive for that 90% mark. So the value of our plan is that recoverability among many other things. And I'll wrap up with that.

Okay. No, that's great detail. And as you guys were talking, I was just knocking off the questions one by one. Hopefully, I'll have some for you guys...

We prepared.

That's great, and I appreciate that. I want to talk about the volume as well, just a little bit, not too much, I guess, like I think the focus that you want to keep today on Pat and his experience and the path forward. So maybe I can begin with you, Pat, perhaps. You've been at Conrail Norfolk for like 3 decades or so. CN is relatively new, 2 years maybe here. What's your experience being here differently than what Norfolk had? Like they are very different railroads. One is a short haul. One is a long-haul tri-costal. Can you talk about like what have you seen so differently here in the last 2 years?

So I'll go back to actually when I started with Norfolk Southern, I came from Conrail, that is where I started. And so I'm one of the survivors of June 1 of 1999, I call myself. The acquisition of Conrail was -- I tell people that single day, June 1st of 1999 lasted about 9 months of just trying to unravel the complexity of taking a railroad splitting in essence, in half and then operating it separately. So I learned a lot about planning and about, as I hear about potential rail mergers and other, I know what complexity that brings, and I learned a lot from that very early in my career. I would just say this, I spent many years at Norfolk Southern, a great organization, many good friends and colleagues over there, was on board there and leadership roles and transportation net ops and mechanical as Norfolk Southern embraced scheduled railroading and I saw the value that, that brought to Norfolk Southern's organization. I would say what I see here at CN is -- number one, I was quickly introduced to Canadian winter railroading is for real. They kept telling me to be prepared. And I kept saying, look, I didn't railroad in Brazil. I came from a Northeast and Midwestern railroad. It snows there. It's cold there. But when that minus 40 operating conditions hit you, it is quite something. We plan very well for that, and we execute very well during those periods of time. The strength of this network, the tri-coastal network, is quite impressive for me. I think it is we have such opportunity in these ports that we serve. And I would say, lastly, it's the strength of this team. CN, as long as I've been in the industry, I've known CN management leadership team as people who know how to win. And those people still work here. And I think they've proven that they know how to win. They want to win, and they know how to get it done. So been very impressed with the management team, the leadership team.

That's great. And you talked about how this role is not like a split of Ed Harris' role when you work with direct kind of hand in hand for some time. Can you talk about what has Ed Harris done in the last 1.5, 2 years, we know that in terms of -- car velocity is the clear set example of that. We have not seen that consistency in car velocity 200-plus miles per day since 2016, I guess. Where does he leave you after his retirement. What needs to be done? Is it a long list of operation or operational improvements that you need to do? Is it continuity of what he has done, talk about like what's the big change?

Yes. I would say not a big change. It's a continuity of that discipline and that focus that Ed brought. Ed validated the model that many of us already believed in that a scheduled discipline operating plan that operate within the confines of our network. It's not about a long train, heavy load railroad. It's about how do we most efficiently fit our train package into our network and really sweat our assets and provide that first mile, last mile value for the customer. That's the focus that Ed brought and that is what now we take away and we carry forward for Ed and foresee in our customers. It's really not new. It's a continuation of what we started 1.5 years ago or so.

Okay. Network complexity has been increasing. You have regulatory issues in the U.S. Clearly, operating performances have come down over the last few years, I guess, right? That's reflected in the operating ratio. And I know it's an outcome, but it still kind of reflects what the network does. You are doing a lot of things about intermodal with respect to taking trucks off the highways, putting on the rails with the Falcon premium. You have E&P program with Union Pacific. You have a bunch of other kind of [indiscernible] announced recently -- Just recently announced another kind of port access to Gulf Coast. So talk to us about what kind of complexity does it create for your business? And how do you deal with those things? How would you ensure that you really take market share or regain market share back from trucks?

I think the -- I will address the complexity question first. Typical historical railroad interchange is one thing where we interchange at points where we have set up interchange. And it's not necessarily a true partnership. It's not one product. It's railroads, interchanging traffic, where it is best suited for the 2 carriers to interchange. As I look at Falcon Premium, for example, it's a partnership and it's an offering that and extends our reach, right? This is getting to that market where we're 1,500-plus miles of potential haulage versus short haul truck. We're really targeting. And I think that those longer hauls, and I think we will bring tremendous value in more of these partnerships. And we look at it as it is our product, top to top and all of these partnerships, it's not just at the CEO level, it has permeated down into our organization that we jointly own these services with the other carrier. And we have metrics around it. We're following it. It's early days with some of these products, but it is about how do we leverage both of our networks and offer a premium service.

I think I'm very excited about the Falcon as a service. I think the key for the 3 railroads, FXC, UP and CN will be to work as a single-line railroad, which is what railroads have not been able to do in the past. And if that's the case, I think that we will be the role model of how railroads need to work together to get market share because remember, as much as our strength is our network, and you can't replicate that network, our limitation is our network reach. So how do you get to that network knowing that there's not going to be a slew of acquisitions at least from Class 1 standpoint in North America, it will be through partnerships and to pass point to be able to permeate that partnership down to the execution level and governance level, working as a single-line railroad, it's what's the key. When you look at our service levels, right now in our transit time from Monterrey to Toronto, it's 5 days. So 5 days is very compelling versus putting that box into a truck. And the other thing is, of course, we're a more favorably environmental-friendly mode of transportation than trucks. Just one intermodal train takes 300 trucks off the road. So the last piece on this is I'm very pleased that Jim Vena, our ex-COO, now is the CEO of UP. So Jim understands it, loud and clear. As I said, a day ago, I think I said that he had 2 tattoos. It's got a CN on one side and the UP on the other side. You can debate which side it is. It didn't show me. But I think that, that is -- that is -- that to me is very exciting now. The last piece is it's not going to start big because customers that have been dealt and send their business to trucking for the last 10 years are not all of a sudden going to give you all that business tomorrow morning. They're going to test you. So they're going to test you with 10 loads, they're going to test you with 20 loads, then they like the service. They give you more. So you can expect that this will slowly but surely ramp up. And I'm very confident that with the 2 teams together that will make this work. And as I said, we continuously deliver reliably 5-day transit time from Monterrey to Eastern Canada, Toronto. And we have the route advantage going to Eastern Canada, and we have the advantage going through Chicago because we're the only railroad that goes through Chicago on our own line, and we own the dispatching. So when you put all of these pieces together, I'm quite bullish about this initiative. But the proof will be in the pudding, and it's going to be for us to show investors and customers and others that this is working.

Okay. And I focus the attention a little bit on the West Coast operationally as well as from a volume standpoint. You've seen a lot of shuffling between the Canadian West Coast ports, Vancouver Rupert into the U.S. West, north or south recently. It seems like a reaction to the BC port strike we saw in July. Clearly, so the question is, do we get the volumes back to Vancouver and Rupert. And those guys are expanding capacity pretty significantly over the next 3 to 5 years? Is there enough demand to kind of [indiscernible] capacity that they're planning? And are you guys doing any operational changes to facilitate that utilization of capacity?

Maybe I can open up and then Patrick can jump in. Definitely, due to the longshoremen strike that happened in both Vancouver and Rupert, we did lose some market share to L.A. Long Beach and Seattle-Tacoma. As soon as the shipping lines were concerned about a potential strike, what they do is they typically will go to other ports to make sure they can discharge their containers to somewhere else in North America. They will sign -- typically deal with them, typically will not be a couple of weeks, but it will not be a couple of years, it will be a couple of months. We believe that as recovery comes back sometime in 2024. And as L.A. Long Beach, goes back to have some of their issues that they've had historically that at least in Rupert, the offering is so compelling that this business will come back. And as I said in my opening remarks, I think when you look at the -- some of the Asian bookings that are out there, we can see that now it's coming to levels that were before the strike. I'll talk a little bit about the capacity, and then I'll let Pat jump in here. I think definitely, my view is Rupert is a long-term play for CN. I think it's the gig that keeps on giving. I think that it's got like all of the business that goes there is all trained. It has no local traffic, so it makes it very efficient. We're working hard to make it a multi-commodity terminal. I mean, we've just signed a big agreement with AltaGas that's we're very excited about. I think, as you know, they have expanded the terminal to [indiscernible] they're going to stand out to 1.8, and they have land to build another terminal. So the key here is to not get overly excited about growing too fast because Konark, you know, in the last few years, it was not about growth. We probably grew -- we grew over our capacity. We got excited about it. We grew our capacity. And when you do that, then you can bring that top line growth to the bottom line. So we've said a few times at our Investor Day that we will not oversell our capacity. We will sell to our capacity and if demand is higher than supply, then we will get more price. So that's the game plan here. Pat, do you want to jump in on what you see from an operating standard?

Yes. I would say that, as Doug McDonald says, frequently, Prince Rupert is a crown jewel. It is -- it offers a premium service. You look at the transit time coming from Asia and there is an advantage. I think that as volume -- to Ghislain's point, as volume comes back, we are confident that we have the network to continue to handle that. And we do have a long-term strategy on investment in BC to continue to grow that business. And again, it's not just about intermodal, it's multi-commodity and we continue to grow that footprint in Rupert. So I think we're poised for when the volume does recover, and we have a plan for the growth to efficiently grow when the growth comes.

Okay. So moving on the partnership side of things. So you have signed a bunch of partnerships or like in Union Pacific, Norfolk Southern, [indiscernible], et cetera. Some of these U.S. rails, we have had issues in the past, right, in the last couple of years from a service standpoint, clearly, the regulator is kind of going through the reciprocal switching and those kind of things, right? I appreciate like that will have some implications for the industry as a whole later on. But you as partners of these U.S. rails and the service issues they've had, how do you ensure that those service issues do not transfer into our service issues down the road?

So at CN, we are very familiar with reciprocal switching to start off with that. We do understand what the complexity is of. And I think that as I look at the reciprocal switching proposal that's out there for the United States, it isn't about that, it's about poor service. That is what it's -- the basis is how [indiscernible] switching when the service is deemed consistently poor. I will say this that forced interchange creates complexity that elongates cycle times, you add more equipment, you add a complexity level to that relationship that wasn't previously there. I would say that more directly to your question, we run our network on our very disciplined sched of operating plan, and we measure and monitor and also work with our partners around the interchange performance, how do we perform an interchange, and we watch cycle times of our equipment off-line as well. And we do work with our partners to try to get that where we need the equipment back to improve the cycle times of our equipment even when it's off-line.

Okay. Maybe the last one, I guess, we wrap up here, Ghislain, for you. At the Investor Day, kind of we talked about how you guys want to kind of take up some more leverage, create more value for shareholders, clearly. You don't see that as a big risk clearly because your balance sheet has always been pretty conservative, historically speaking. In light of this macro environment right now for the next, call it, 6 to 9 months or 12 months, do you see or do you feel confident in executing on those buyback opportunities and continuing on the path of levering up a little bit?

I think we do. I mean if you follow us, we actualize our buyback program by $500 million. I got our Board to approve this because I think right now, where the stock price of CN is, either CNR, CNI, I think personally, I think it's a steel. I think that if people thought that we were too expensive, that's not the case in my view. And I wanted to be -- we wanted to be at CN a bit opportunistic. And we think that, that investment is a good investment for us. So we went from a budget of $4 billion to $4 billion, $5 billion. I think that over time, we will get to the 2.5x, that's the debt-to-adjusted EBITDA. I think we finished the third quarter to 2.2x. We'll do this over time a little bit. But I think that at the end of the day, our capital allocation, Konark, as you know, you've followed us for many years has not changed. We will first invest in our business with good return to make sure that the company delivers a 15% to 17% ROIC. We like strong balance sheet. We thought at 2x, it was a bit too conservative. So 2.5x is a good space. It's still the strongest balance sheet in the industry. And then it's the shareholder distribution and a mix of dividend, consistency of dividend. If you look at this year, we've increased our dividend 7%, and yet our guidance is flat to slightly negative, and we're not touching the dividend. This is a fixed cost for us. We're very aware of that. And then share buyback is a good flexible tool to get to a targeted leverage. So we're very comfortable. I know we still have a couple of seconds, just to closing remarks. I think I'm very excited about where we are at CN. I think that under Tracy's leadership, you can see the numbers speak for themselves in the last 4, 5 quarters, 6 quarters. I know some people will say, well, that doesn't make a couple of years? Yes, I know that. So stay tuned. But I think that we've delivered, we continue to deliver. I think the team is coming together. I'm ecstatic with this guy here beside me, Pat and Derek, I was with them yesterday. I want to thank Ed. Ed, I've known for over 25 years. He's a great guy. I like to tease him a little bit, as you can see some times. But he's done great, and he has a well deserved retirement. Tracy, I think, is a great CEO. I think that CN is under great hands under her leadership. And I think there's some very good days in front of us going forward at CN.

Great. On that note, thanks for the precious time and all the best to you guys and to you, Pat, as well.

Thank you very much.

Thanks.