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

Good morning, everyone. Welcome to Barclays 41st Annual Industrial Select Conference. I'm Brandon Oglenski, Airline and Transport Analyst and up next here in the second session. We have Canadian National, Ghislain Houle, Chief Financial Officer; and Derek Taylor, Chief Field Operating Officer. So it will be a great conversation here. But as in the first session, we're going to do the audience response questions very quickly. So pick up that BlackBerry looking thing in front of you. If we can queue up question one, please.

Do you currently own the stock? Yes, overweight 2, market weight 3, underweight or no?

If not, you should definitely own it.

All right. [indiscernible] potential owners in the room Ghislain. Question #2, please. What is your general bias towards Canadian National right now, positive, negative or neutral?

It's getting balanced.

Okay. Some positive in here. And then question number three, please. In your opinion, through cycle, EPS growth for Canadian National will be above peers, in line with peers or below peers? All right. Ghislain and Derek, thank you so much for coming down.

Thanks for having us.

I want to focus on the long term here, but I do want to ask the pesky question about the quarter just to get out of the way. Looks like -- and we just had Union Pacific up here on stage previously. Obviously, January was tough from a volume and an operations perspective for a lot of railroads. How do you guys fair in January? And what's really the trajectory on demand?

Right. So first of all, let me make a few comments related to this, Brandon. And first of all, thank you for having us. I mean this is a great conference. We've supported your conference for many, many years because we like to come to Florida in -- if I coming to Montreal, we'd like to come to Miami, unfortunately, the weather has not been that great, but it's getting better. So first of all, I think looking back in 2023 and then I'll talk about January, I'm very, very proud of our relative performance. I mean, when you look at all the adversity that we had, whether it's a deeper freight recession and longer freight recession than we expected, whether it's forest fires, floods, it's the port strike, the West coast port strike. We delivered like the best operating ratio of the industry. So I just want to thank the 25,000 people at CN that delivered this great relative performance. To your point, in January, we had decrease in Western Canada, as you know, a good 10 days of it where the temperature believe it or not was minus 40 to minus 50 degree Celsius. When we get to that level, it doesn't really matter, whether it's Celsius or Fahrenheit, it converges, where literally, we could not move like we could not run our trains. And Derek will talk a little bit about that. So to your point, our volumes were down 7% on a year-over-year basis. But when I look at February, now that this is behind us, it's quite strong. Our volumes are up 2% and this is against tough comps. If you remember, Q1 last year, our EPS was up 38%, and our OR was 61.5%, which is not a winter OR type of thing, when winter OR is more like 64%, 65%. So our volumes are quite strong. And from a workload standpoint, like [ Roast on Mile ], we're running 1.3 billion, 1.4 billion GTMs per day. So that's quite good. Let me talk a little bit about the volumes for the year. We did provide the assumptions that our volumes for the year would be mid-single digit. I wanted to mystify this a little bit. First of all, half of that a mid-single-digit volume growth will come from those CN-specific growth initiatives that we talked about at Investor Day. These are happening. These are coming. These are not necessarily related to the economy. These are CN-specific, customer-specific initiatives that we have great visibility on. The other piece that I want to talk about volumes is this that the West Coast ports like that we had last year had a lingering effect throughout the second half of the year, which accounted for about 1% volume growth, which we don't believe will recur in 2024. So when you look at what we are counting on from the economy, it's quite small. And we are counting on a more supportive economy in 2024, but not to the tune of the 2% industrial production that we talked about at Investor Day. It's more like slightly positive, call it, 0.5% ish, which is what's coming out of consensus as we speak. So when you take this into consideration, when you take pricing, continue to be above rail inflation, I think we will deliver and committed on delivering operating leverage, and we will deliver operating leverage. I think my buddy here, and you can poke him, I think he's a bit conservative on that front. I think that we will deliver the 10%. I'm very confident about our 10% EPS growth in 2024. And I'm very confident with these growth initiatives happening and the compounding effect of it, then we will -- that we'll have in 2025, 2026. I think we're well positioned for a 10% to 15% guidance for [ 2024 to ] 2026. So I'm very comfortable with that. I just want to make one point before I turn it over to him, he wants to make a couple of points on operations, on share buyback. As you know, the share buyback, the Board approved the a buyback program of 32 million shares, [ $4 ] billion budget. I want to remind everyone that when you look at the share buyback on an active financing cost point of view, it's not -- it's essentially not accretive in 2024. It is slightly accretive in the out years because we get the compounding effect of having those shares out of circulation, but in 2024 is essentially not accretive. And that's what we have in our model. So maybe on this, maybe I'll turn it over to him to make a few points on operations.

Thanks, Ghis, and thanks, Brandon, for hosting us here today. I'll focus briefly on how we finished Q4 '23. The operating metrics we were really good. The team delivered on that. That's important to give us really solid momentum coming in here into 2024 and as you may have heard, we're focused on our make the plan, sell the plan or make the plan, run the plan, sell the plan model. But a key foundational color that we talk about from time to time, the plan is sacred. And the reason I bring this up is when you look at some of the challenges we face with minus point in that 10 days in January, it was unpleasant. Now you're not going to see in 24 years, but we do have a plan for winter. We have tier restrictions we put in place, decreased [indiscernible] lines. We have additional inspections we do. So there's a lot of things that happen, but it does inhibit our ability to handle the demand that is out there. But the key with that is there is a plan. We deployed it [ cars ]. We do different things. So we operate in those pretty unforgiving conditions as we can. But when we look at it, the impact of that time that 10 days, as you had 40 to 50 below Celsius, and I tell my American colleagues I don't have to do any conversion at that point, as we said, it's pretty simple, it is cold. But we had impacts the way to Memphis, Tennessee, 70% of our network had an impact. I live 4 years in Memphis we had over 8 inches of snow, so freezing temperature for a week. That doesn't feel well on Memphis, Tennessee routes. But the key is not what has happened. It's really where we're going. You look at that -- the operating [indiscernible] from a car velocity point of view, we're between 150 and 170 miles a day during that challenging 10-day period. By the week of January 22, you're at 205 to 215 in the car velocity. And that's summer like performance really coming out of that really tough falls we had there, right? Then you look at the workload that we had to Ghislain's point, the GTM, we had a couple of 1.4 billion days so far here in February and mostly 1.3 billion. So solid recovery by the team on that. Pat and I respectively put a lot of focus on that. To Ghislain's point, we give a lot of credit to the men and women out there that really get through those tough conditions, but also aid in that recovery. And then I'll just close with this, when you look at it, I think we knew going in that there'd be some challenging Q1 comparison. I think we've been transparent about that in '23, I mean, we really knocked out of the park, really no winter to speak of and really solid operating metrics. But as we recover to Q1 of '24, we're seeing some same momentum.

Okay. But maybe this for the quarter, it's more like a winter operating units with that rate?

It's more like a winter operating rate. Absolutely.

And Derek, you're in a new position, too, as well with operations leadership being split. So can you talk about the new strategic priorities for the organization?

Yes, sure. Listen, my gift to Mr. Whitehead and I. And it's not a true split. Actually, if you look at what Pat and I do, put it together now, it's actually larger than had like I have been for example. But really day-to-day, I'm very focused on the tactical things working with my team, delivering the execution of the operating plan. But that allows Pat would be focused on not just mechanical and engineering but Pat's looking at that 3-year plan, a 5-year plan capital efficiency. So it's really creative space for us both to really be laser focused on 2 key things, with the short-term thing and then the long-term thing. Now with that as a true partnership. We work very well together. We've done each other's jobs. I think people have realized that. He's on my role in his past life, I've done a bit of his role in my past life. So -- it's working very well, but another key piece is the coordination with the marketing Doug McDonalds, right? You have the day-to-day type and then you have the forward-looking type, where you're bringing on the right volume in the right quarters at the right time, for example, right? So I believe it's going very well. And if you look at the numbers that we were delivering on the new concept and Tracy's vision of what it looks like.

What are your nick names again.

Our nick names, [indiscernible] initially. And being in Miami are hoping to graduate the [ rocket and hubs ] or so.

Ghislain coming back to the annual guide for about 10% EPS growth with -- and I appreciate the clarification of volume from that you heard there, do you have positive price at [indiscernible], correct?

Yes, we do. Yes. We're assuming -- we're very disciplined on pricing about rail inflation, Brandon, as you know. And frankly, the fact that we have great customer service is helpful. The fact that we're able to move more volume with less cars, especially for customers that have private equipment is helpful because they get the car ownership benefit. So I mean, I know what we don't provide any numbers related to the specific pricing because none of the way else do. But I can tell you that we continue to price above rail inflation. It's always a negotiation with our customers, but it's much easier discussion when you have good customer service than when you're lagging. So absolutely.

But from a top line perspective, we should be thinking a bit more than mid growth. Is that correct?

From a top line. Absolutely, yes.

Okay. I guess, embedded in this guidance, is there assumed improvement in operating margins or operating ratio?

Yes. And that's where I think he's sandbagging a little bit. I think that we kept the resources in 2023. We did not have a knee-jerk reaction and sending people home. We got ahead of the game and training locomotive engineers. We did not reduce our train starts as much as volume was reduced because we wanted to keep customer service. So now we do have capacity on our trains, specifically on what we call the managements or the merchandise trains. So we do have capacity. So we will add volumes there at very low incremental cost. He will tell you that on intermodal, though, we did reduce train starts, when intermodal went down. And remember that, that was a weak sector intermodal International, so we did reduce train starts. So we will add some starts but these will be direct full train. There will be 12,000 foot trains in Canada going to 10,000-foot trains in the U.S. because that's our network. We have a 12,000-foot network, a siding network in Canada and 10,000 in the U.S. So I'm confident that we will improve and we did commit that as well at Investor Day and talked about it at the earnings call that we will deliver operating leverage in 2024.

Okay. Appreciate that. And just laying on the 50% of that volume outlook that are from CN initiative. Can you give some examples of where you're getting this customer wins?

So it's -- the beauty of it is, it's not one thing. It's a list of different diversified opportunities. So we have opportunities on the BC North, where we invested money. And we've invested on the branch line. We've invested in the siding and now we have propane that is coming out of it and frac sand coming in. We have Derek can talk a little bit about the North [indiscernible] facility in Toronto there.

Yes. No, it's new facilities and what commissioning now, where we'll be getting carloads in end of Q1 here, but it's a very exciting thing. It's a fuel facility bringing fuel to the Greater Toronto area. And for us, whether that's stuff coming out of Eastern Canada or the U.S. say out of Iowa, it's exciting times. And to Ghislain's point, a lot of that volume, this is incremental it's moving current train service, a key proof point when you look at Q4 of '23 compared to Q3 '23 sequentially, volumes were up 10%, but our train [indiscernible] about 6%. So we're already seeing some levers specifically from the manifest side and at this point on the intermodal side, when that [ dose ] back, we build that plan very judiciously to max out those trains when they come back.

Then we have 2 new coal mines that are going to come in operation in Western Canada this year. And when you look at the coal indices, these are 2 metallurgical coal. But when you look at coal indices, whether it's thermal and metallurgical, it's still very profitable to use coal. And then I'll finish on our Falcon service because Jim Vena was just here, our ex-COO. We have CN people implanted a little bit in all the other rails. Very excited about that service in our view. I think this is moving forward. I think there's going to be a bunch of RFPs that Derek going with IMC, but we have a truck-like service right now, imagine going from Monterrey to Toronto in 5 days. So that service is truck-like. It takes a little bit of time because if you've been using trucks for the last 20 years to do a 1,500-mile haul, you're not going to give it all to the rail tomorrow morning. You're going to test. So we get test loads, 20 loads here, 30 loads there. But my view it's coming. It's growing every day. And the last piece I will say on this is I think that this is the role model that we arose will make the partner going forward. I think -- when you look at railroads, we can be -- like the strength of the rail is we cannot be replicated? We own 8,000 bridges. The limitation is you go to where you go and you don't go to, it's do your network reach. So now we don't have access to Mexico. But with UP, we have access to a new market called Mexico without having to pay $30 billion and have integration possibly issues. And UP has -- UP come to Canada. They don't have access to Canada. So if you want to expand your network reach, we know that you will not be able to do it through an acquisition going forward. The STB has spoken. So it's got to be through partnership. But partnership -- that partnership has to be operationalized down to the ground level, day-in and day-out, as if the 3 railroads are a single-line rail. And this is not about taking market share away from our Canadian competitors. This is about taking long-haul trucking, 1,200, 1,500, 1,700 miles and putting it on the rail, and there's enough of that traffic for both railroads. So that's what it's about. That's what we're after. And I'm happy to report that it's moving forward in the right direction.

Derek, how do you deal with those service challenges though on an interline movement like that? Because historically, [indiscernible] have said that whether you could run into some operational challenges, not knowing who to call, who is in charge, where is my shipment...

Yes. First off, it starts with relationships with Ghislain's point, when it was this earlier, relationship matter in this industry. So how we do that is very focused, right? And this isn't just a top-to-top focus. If you ask the frontline supervisor in Chicago on our railway, they're going to know that UP connection is coming to us, what's the time and what train [indiscernible]. So this is permeated down to a very ground level. And the second thing is you don't let [indiscernible] there's going to be challenges from time-to-time, right? But the coordination between the FXC, the UPMC and [indiscernible] that there's an issue, it doesn't faster. So many times in this industry, sometimes do that things faster and faster. In this case, different approach. We take [indiscernible] it's not a matter of blame, it's what can we do to address the issue for the company. So this fall from service, we're very excited about. It is very seamless and continues to grow, and we're excited to what the future holds.

So we know the traffic coming at us. Let's say, we attained the 2P in Chicago. We know it's coming at us the same way as it would be our own train. We make sure that the track is available. We call our crews, that thing doesn't sit there and that train goes as if it's our own railroad. That's the key. And then we get a report every morning. I get a report and the report goes up to Tracy and to Jim and the teams is like one team, and we know this is a win-win. So it's working very well so far there.

I noticed a [ very ] challenge with that. And like I said the different handoffs has been very seamless. And the first in the footing would deliver it on the 5 days from Monterrey to Toronto. I mean, on a very consistent basis we can that. And remember that through Chicago, we're the only rail that goes to Chicago on our own track. So owning the track is key because you want to own the dispatching. When you get someone else's track and they decide to give you a red [indiscernible] plus 2 hours, it is what it is. We own the dispatching, we go through Chicago, and then we go up to Eastern Canada.

And by way, if the audience has any questions, raise your hand, we'll get you a mic. Feel free to keep it interact with if you want. But I guess, along the lines of consistency, that what shippers are really looking for, especially if it's a truck native market?

Reliability. They want reliability because that's how you manage your inventory. So if you're saying I'm going to do 5 days between Monterrey and Toronto, you got to be able to do it 95%, 96% of the time. If you do it only 60 or 70 then you're getting a lot of unknown, a lot of uncertainty. And frankly, when you put it with that length of haul, 1,500-mile haul, when you put it on the rail because of the synergies of the railroad and the scale, you typically have a price discount, like it's typically cheaper now, if you do this reliably, that's when people believe in it, and that's what they do and that's how you get the traffic.

Okay. Ghis, when you did hit on cost inflation has been pretty high for the industry. How are you guys managing inflation? Can you give us an update on your labor contracts?

Yes. I mean labor contracts, as you saw, both railroads are negotiated with the TCRC, see these are the people that are not [indiscernible] with the locomotive engineer. We have filed for a conciliator so that's a regular part of the business. We are sitting at the table with them. We are hopeful that we will get to a negotiated deal. That's what we're looking for. And I'll leave it at that. In terms of cost, yes, I mean, inflation with all the other rails and all the other industries was quite high last year. I think inflation is getting better. I saw yesterday, I think in the Global Mail that in Canada, the inflation now was down to 2.9%, if I'm not mistaken for January, which was lower than what people expected. So we manage inflation. The key, though, is for us is we do price higher than our rail inflation. So that keeps us -- that keeps our head above water. And I think inflation will be a little bit heavier as we move forward.

I think you did identify it as a [ $200 ] million specific?

Yeah specific headwind. We wanted to make sure that this was big enough that was visible. And this relates to depreciation, incentive compensation and pension, and that's modeled 10% EPS growth. And I think that will be offset by some of the operating leverage that we just talked about.

Okay. And then at Investor Day last year, I think your longer-term outlook of 10, 15...

Remember, I got fired on that Investor Day. What in case he didn't say, he's looking for I believe. I am solo now.

Congratulations. Not easy. So can you tell us what's going to be required to get the midpoint of that compound growth?

So I think it's not one thing, it's a lot of things. First of all, if you remember, we said we need a -- we need a supportive economy, we looked at a 150 economic indicators that we track, but to simplify the market and for investors, we said, industrial production has to be at least 2%. So if you look in 2024, it's not going to be 2%. Hence, one reason why we're going to be at the low end of the range. But if you look in the out years, it looks like it's getting there even maybe getting a little bit above. With that, and then we went through all the CN growth initiatives that hopefully convince everyone that we can grow more and more volumes more than the economy. We need to continue to price above rail inflation. We committed to improve our margins on a year-over-year basis. We did not give a number, but we said we need to do this. So when you do this, and then we said we're going to increase our leverage to 2.5x over time through continued dividend growth and possibly share buyback. So when you look at 2023, our leverage was [indiscernible] so we have a good share buyback program in 2024, and we continue and we'll see what happens in 2025, 2026. When you put all of this together and then finally, the right team in the place. So the right players, I think, Ghis you made a couple of people, which was important. Remember, the team is what really delivers at the end of the day. Ed finally, we hired for the fifth time. Hopefully, he remains in retirement. Doug McDonald will now retire. I'm very happy to have [indiscernible], who was the CEO of one of our core products customer coming with us, he is actually on the train, right there in Western Canada as we speak. He's a young guy, I think investors will meet him, when appropriate. But he is going to be sitting with the team. So when you have all of these ingredients, including the right team, I think we deliver 10% to 15%. That's what we'll do, and we're committed to that.

And Derek, you talked about like longer-term operations planning and then how that sits into the market with customer strategy?

Yes, absolutely. I mean from a customer touch point, we've been very focused on, let me call LSCP, right? That's -- do we deliver the customer at the right car on the right day on the right window. Some of the feedback we've gotten to service has been solid, but the ease of doing business, right? So these are all things that Pat and I are aware of to work with Doug on because he deliver a deferable product, let's say, that maybe [indiscernible]. So these are all things to work off. And longer term Ghislain, both Pat and I look at it, what is the need to meet the targets? What is the capital? And to get that capital we are going to meet to your ROE, how is the capital efficiency, right? So when you look at it all in, Pat and I are very close tied together, but building a balance, soon to be [ Remy ] this is very important on how we go forward. And you got a incremental cost in the East and South, right? We can bring volume on, not bring a lot of cost less. We will be very smart with what we do, and that's part of the planing that...

[indiscernible] #4 for the audience. I think there's a question up here, too. Number four, in your opinion, what your Canadian National with excess cash?

The first 2 are M&A. I don't think there's much to do there from a rail [indiscernible] for our 3, share repurchase 4, dividends, 5, debt paydown 6, internal investment but we bought [indiscernible] so I mean, there's short lines if they're contiguous to our rail network, they bring us to market that we don't have access on our own and become available at the right price, we're certainly open for business.

[indiscernible]?

Yes, yes. We are going to [indiscernible] absolutely. I don't have the exact amount, but we are going to be in the market. We typically go either in Canada or the U.S. We tended to be a little bit more in the U.S. than in Canada. We are in -- and I have to report that the last bond that we issued in Canada, we actually had a negative new issue concession, which I have not seen in my 26 of experience. So that's quite positive.

All right. Maybe a question number for the audience. In your opinion, what multiple of 2024 earnings to Canadian National trade?

Can I answer that one?

We'd love your opinion. And then finally, question number 6. What do you see as the most significant share price headwind for Canadian National volume growth, margin performance, capital deployment or execution strategy. When we get the results there. I do want to talk about your capital budget, it is a relatively larger [indiscernible] to some of your U.S. competitors -- what's driving that relative higher spend?

We demonstrate that we can grow. I mean, if anything, we've grown probably too fast in the last few years. So we need to be more disciplined on growth, specifically growth in Western Canada. I think the sweet spot for us on CapEx, when you look at it as a percentage of revenue, within the 18% to 20% range, and that's what we've been and what we do, but one of the things that is important is, as you know, like our growth, when we talk about mid-single-digit volume growths overall, but our growth has typically been more concentrated in Western Canada. So that's where our investments. And some of these investments, like the each pieces of investments we've made, it's passed up. So now sometimes its investments on the bridge, which is the now the new pinchpoint [indiscernible]. We think we now have 1 or 2 double tracks on these opportunities, which is the corridor between Edmonton and Jasper. So the fact that our growth is concentrated in Western Canada, the fact that we're growing our volume, I mean, I can't speak really for the other rails, but for us. When you look at 18% to 20% is the sweet spun. We do it with a view of capital efficiency as well. We know that if you try to do too much like we have parts of our network where the construction period is like a couple of months. If you want to -- if you don't want to build under snow or under freezing. So we want to have close to 100% of our investment in the ground. On capacity in Western Canada, you do it year in, year out because we know this will rebuild capital. We know that if volumes are down it will be time value of money because essentially, eventually, you will need that capacity. And then we need to sell for that capacity and not oversell our network and then if demand is higher than the supply, then you take more price. I mean that's basically what our game plan is there maybe, Brandon, there's only 40 seconds left. I can conclude here with a few points. I think I've been on CN for over 25 years. I've seen the good times. I've seen a little bit of more challenging times. I think that CN is back on the good times. I think that under the [indiscernible] I think, under the leadership of our Board, we have essentially a menu board, I think that we're well positioned. And I think the team is scaling, the team is having -- I think you've seen the results. We were either the best or the second best for the last 8 quarters, several quarters, we had the best operating ratio last year. So hopefully, people believe but for us, what's important is to continue to deliver proof points that we're on the right track and then people will come back to CN. We're in a good basis, and we're very pleased about it.

Thank you both for coming. And just [indiscernible] watchout for him in the rear-view mirror.