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

Good morning, everyone. My name is David Vernon. I'm the transportation and airline analyst at Bernstein. I would like to, first and foremost, welcome you all to day 3 of Bernstein's 40th Annual Strategic Decisions Conference. I would also like to thank you all for showing up in the morning of day 3 and making me look good in front of Canadian National, who's been good enough to join us here for the conference, Tracy Robinson, the CEO; and Ghislain Houle, the CFO; Stacy Alderson, from IR is also here. You guys know the drill by now. I'm not going to tell you what [indiscernible] is or isn't. If you have questions, stick them up in the app, you should be able to get through a QR code. They'll filter up here. I can work them into the conversation. With that, I'm going to kick us off. And first of all, say, welcome, thank you for supporting the conference. And maybe you could give us a little bit of a top-down overview of how you see the state of the economy and the state of your business.

Yes, let me -- maybe I'll start. So firstly, thank you for this. It may only be 9:00, but we're halfway through what a day is in railroading by now. The trains have been running for hours and all night. But it's great to be here in New York. So we're just talking about whether we could swing a weekend out of this. I don't know if we're going to get a chance to do this time, but what a fabulous place. Thank you. And maybe I'll just start with a couple of comments for context as we go forward. We introduced, as you know, a new operating model just over 2 years ago. And scheduled operating and planning, it's not complicated. That's the whole point of it. It's not complicated. We have a network operations team that designs it. They look at all of the volume across the railroad, and they build a plan that moves it all that optimizes the whole. So it's not the long train strategy. It's not optimizing for any individual terminal. It optimizes the whole. And then the field operations team runs that plan. So this is our make the plan, run the plan, sell the plan model. And we've been doing that for just over 2-years now, and it's working very well. We are faster, we are more efficient. Our dwell time over 2-years has gone down now by more than 10%. Our velocity is up by 25%. Our on-time departure and arrival performance. Our on-time departure and arrival performance is up 47% and 53%, I think respectively. And so this is working. And most importantly of all, our customer service levels are very strong. They're consistent. We've seen a dramatic change in that, that's given us pricing power. So we've been able, over that 2-years to drive EPS growth to drive to the bottom line growth in EPS of about 23%. So I'm happy with the way the railroad is running. This is working. This is the right model for us. We're not done yet. We're still tweaking, we're still making it better, but we've got significant traction on the ground every day running this model. And as we turn our attention to growth, once we had that kind of running, we looked forward and did an assessment on how much growth we could see looking out over the next 5, 7, 10 years. And that led us to an Investor Day, I guess, about a year at 1.5 years ago?

Yes, last May.

Where we laid out a growth plan. And the big question was how much growth is there in a rail and rail growth. And we came up with a plan that we laid out in front of you all that's going to drive 10% to 15% EPS growth on average over the next 3 years. But it was driven on 2 things. One was, as railroads do, we will grow with the economy. And a scheduled operating plan is a consistent kind of operation that allows us to really understand our capacity and allows us to respond to what's going on in the economy effectively. Whether it is a positive growth, which we're seeing some of now or whether it's some of the shocks to the system, like the fires and the port strike we had last year, this operating model allows us to recover very, very quickly. So about half of our growth as we look forward this year or as we look forward to the next 3-years is from what we believe will be and hope will be a recovering economy. We're starting to see some green shoots on that now. I'm sure we'll talk about that through the -- through your questions today. The other half are CN-specific initiatives. Now these are efforts that we're making with our customers that leverage our network, leverage our customer service levels that we're providing, where they're growing and we're growing with them. But they're making investments or they and we are making investments together that's going to drive growth in both of our businesses. And that is -- we have a significant -- a long list of initiatives. We've talked about bits and pieces of these. We'll get into the details, I'm sure, over the course of the next hour here. But that's coming on exactly -- actually it's a little bit ahead of plan as we watch those come in. There's a lot of upfront investment. We're starting to see that volume move now. And it will form 50% of our growth as we look forward this year as well as the next 3-years. And so that is -- I'm comfortable with that. We've got the pricing power that's going to support the margins on that as well. And then the final piece that we've been working on of last 2-years, of course, is the team. And it's important, you can have all the plans in the world that you want but you need the right team in order to be able to execute them and in order to be able to respond and anticipate all of what goes on in the world, it's moving very, very quickly. And we started at the top. We now have a team that is a great combination of deep railroad expertise and some very different eyes, different perspectives. And what's really important -- so we have some new folks, right? We've got some old folks right here. They have been around for a very, very long time. Can I say how many very's should I say, very, very -- a long time. And -- but what's really important the way that we're coming together. And this team is moving and Ghis runs our operating committee, where we bring the commercial folks together with the operations folks, with the finance folks and their -- Ghis's plan is to run a process that has us pull all the levers that is going to have us execute the plan that we have and respond to whatever is coming up. So it's a collaborative and very tight process. So I'm happy with where we are. Lots more to come as we look at growth in the future. But I'll maybe leave it there as context.

Sure. So that's a great introduction. Coming back to your commentary around green shoots, I often feel as a sell-side analyst whenever I say green shoots, I'm holding up a sign that says green shoot me, but...

Yes, you may be right.

What are you seeing in the business? What are you hearing from your customers around the economy starting to get a little bit better? Because it does seem like at least in the U.S. side, looking at all those surface rate data, things are still kind of slow.

Yes. It's -- I would say it's still -- we're cautiously optimistic. But one of the good things about our business is we're very diversified. So it's really -- it's a tale of a bunch of different industries. So we saw very strong grain movements over the past number of months. We did expect them earlier in the season. Potash has been very strong. Those are less consumer-centric. Coal is a little bit -- it's off in the U.S. because it's thermal coal and metallurgical coal volumes. We'll have another mine opening up in British Columbia. So we're seeing some strength there. We're seeing some real strength in petroleum and in the refined fuels and petroleum, record kind of exports of propane. For example, we've got new fuel facility starting up in Toronto. But there's -- and automotive continues to be strong. The biggest kind of shift over what we would have been saying when we were here last year was the strength in the international business, the containers coming over. We've reconstructed our portfolio there to fit our Rupert corridor, our Vancouver corridor. And of course, we've got Halifax, it's a little soft right now because of what's going on in the Red Sea, but we've constructed this portfolio to fit our network, and it's really strong right now. So that is underpinned by some consumer demand, some restocking, I think, but we're going to be watching that very closely as we go forward. Ghis watches what 150 or so...

150 economic indicators. Maybe I can add to what Tracy was saying. When I look at the volumes right now are holding quite well, when you look at our volumes in terms of RTMs in Q2, we're up 8%. And we were talking, Tracy, about intermodal international, intermodal international is up 22%. Petroleum & Chemicals, which is sign of, again, the economy and so on is up 17%. And merchandise in and of itself is up 10%. So I think the volumes are holding quite well. I think, to your point, inventories have stabilized. We are not assuming that Intermodal International will come back to pre-COVID levels. But we're assuming in our modeling in this year that it will -- it will get better than last year. When you look at the economic indicators, and I know for shareholders, to your point, Tracy, would follow 150, but we gave one, which is industrial production. Industrial production in Canada started plus 0.3 in January, and now it's plus 0.9. So economists, they do forecast very often and change by small increments, so they can never be wrong. But it's going in the right direction. Same thing as housing has started at 1.3 and now it's 1.4. So all of this is telling us that we're going in the right direction, but we're cautiously optimistic. Like in our modeling, we did not assume that we would go back to pre-COVID levels, whether it's in intermodal international, whether it's in lumber, whether it's in the automotive sectors and so on and so forth. So we're doing pretty good, and it's holding together. I'll finish to say that lumber is stabilizing. That was the other big weakness last year. If you remember, David, in Q2, when we hit the trough. And I would say that lumber, when you look at car orders, and I'm talking about centerbeams because these are like the sail boats with bundles of lumber. In the trough last year, we would have 1,600 or so car orders per week. We finished the year around 1,800 to 1,900. And we've modeled in that range. And I think we've been doing, Tracy, something like in the range of about 2,000. So -- but there's ups and downs. When you look at every week, there's ups and downs on the demand, but overall, that's what we've been seeing. And there's still a shortage of houses in the U.S. And I think, hopefully, people -- 2 things, I think. Number one, people don't believe that we will have a recession, which that was not the case last year; and second, interest rates, although we now -- it's questionable as to whether interest rates will come down and there will be some interest rate cuts, but people don't see interest rates going way back up. I think it's -- people are seeing that it's either going to be there or maybe come down a little bit. So that's good for housing starts. So -- and that's good for lumber. So we're doing pretty good.

Yes, we are. And so if you look at the year, and we've kind of guided to mid-single-digit growth, it's just as -- I think we're about 3% year-to-date, but accelerating 8% year-over-year on the second quarter. And we've got -- talked about all the economic plays, we're watching all of the CN specific initiatives coming in about on plan and that's about half. And then if you look at, as we move out in the year and you look at the compares, you'll recall that we had a pretty significant forest fire season that did impact more customer operations and our operations last year. And we had a pretty significant West Coast port strike last year. So the compares -- the volumes last year went down a little bit. So we're pretty comfortable as we look out for the remainder of the year on where we're expecting volumes to go.

That West Coast port strike actually cost us 1% of volume growth. So we're not assuming this year that this will happen again, obviously. So...

You get to wait another 3 years until the contract is up.

Exactly.

One thing when you think about feeling pretty good about the economy is accelerating, is that a more Canadian thing? Or is that also south of the border? Like is there -- like how do you guys...

It's A little bit of both. Yes, it's a little bit of both. I mean, like I said, -- it's not coming back to the pre-COVID levels. But when we talk to our customers, when we talk to the shipping lines, demand is better than it was last year. Inventories are now back at normal levels, so they will have to be restocked. People are starting to consume. I mean remember, last year, people were worried about a recession and the interest rate. So they needed to know where am I going to cut. They didn't cut on traveling. I mean if you look at traveling and I speak to Michael Rousseau, the CEO of Air Canada is saying -- I mean, we're even short of pilots. So people are not cutting on traveling. People did not cut on restaurants, they cut on consumption. Now it's starting to come back because those fears are mostly behind them. So slowly but surely, but we can see the signs that -- and it's not in one thing. It's across the board, P&C, plastics and chemicals, it's frac sand. I mean, when you look frac sand, Tracy, I think our volumes are up 50% in frac sand with some of the drilling that's happened in Northern BC. That's right, exactly. So the place where really we see weakness is thermal coal. This is coal coming from Southern Illinois going to Convent, Louisiana and then exported to Europe with some of the demand out there that's soft and also the weak natural gas prices. And frankly, I believe that thermal coal eventually will probably go away. But that represents like coal, for CN represent overall metallurgical and thermal coal represents only 3% of our book of business. So that's one of our strength, too, is we're well diversified. The biggest segment we have is intermodal at 25%. Everything else is lower.

And as you think about the interest rate environment, we had the CEO of Prologis, one of the bigger industrial real estate companies, probably the biggest industrial real estate company around supply chain yesterday for a fireside chat, and he was talking about how the construction part of his business is basically shut, right? The new builds on warehousing space has really, really come down as a result of interest rates. Is that have a chance of maybe still having some lingering effects on parts of the construction market or...

So I think we look at as we look forward a number of things. You look at the short term, building permits, housing permits, what's happening in the short term. Surprisingly, I mean that's -- it's not really high, but it hasn't plummeted. But as you look over the longer term, there is a structural shortage we know in housing in this continent. And so there's going to have to be some work done on that. And so we believe that over the longer term, this is going to be a pretty stable market from a lumber perspective. There is a question around where it's going to come from and where is -- how much of it's going to come from Western Canada, Eastern Canada, in the U.S.. But structurally, housing needs investment. We're seeing the same things from an interest rate perspective as there's mortgages that haven't come up yet. There's going to be a shock on those mortgages. But as Ghis says, I think the encouraging piece is there seems to be some comfort that interest rates are no longer going up more, it's how do you manage the current exposures that happens. The thing that we hear about around whether it's in Canada or the U.S. is around just a general housing shortage. So we're going to have to deal with that at some point.

Okay. So you mentioned the guidance for the year being mid-single-digit RTM growth. And I know you guys have been on the road quite a bit and talking to investors. That guidance was initially met with a lot of skepticism. And as you've had those conversations with investors, can you help kind of maybe share with us what you think the market wasn't getting about your outlook? And why that 5% growth in RTMs even in this sort of slowly recovering, but have been a super robust economy...

I think we didn't perhaps get a couple of things initially, although I think that most do now. Often, the railroads will follow the economy. And so often we have -- our volumes are moving often an early indicator of where the economy is going. And we all have a certain view. We're now calling it cautiously optimistic around what the economy is going to do. We're not sure, but it's feeling a little firmer than it was before. But 50% of our growth is not based on the macro economy, what it's doing. 50% of our growth is on very specific initiatives with our customers that we're tracking very well to. So we've got a fuel facility that we've talked about before. It's going to handle kind of thousands of cars is now open and starting to move. We spent a little bit of money up in Northern BC to build an extra line for the frac sand, as Ghis pointed out is up 50%. We've just had an announcement, we've had a couple of FID announcements at Rupert that will come into play in a couple of years, but we've got the canola crush facilities that we've been working on starting to come on in the Prairie's. We're now moving some of that early lithium down from the northern part of Eastern Canada into markets in for exports. So these were all very specific initiatives that are unrelated to how the economy goes. So that's one thing, I think, that we've been able to drive some clarity to. The other one is that is what I just mentioned was that if you -- what we've guided is year-over-year volumes. And we did have an impact last year from both the port strike and from the fires. And that took our volumes down lower than they would have otherwise have been through last year. And so it's a bit of an easier compare. So if you look at those 2 things, along with a cautiously optimistic view on the economic drivers, we're pretty comfortable in where we are on a volume forecast.

Yes. I would say, Tracy, it's exactly right. So investors at the beginning, when we said mid-single digit volume growth, call it, 5%. People thought that we were banking on a positive economy way too much. When you break it down to her point, half of it comes from our CN-specific growth initiative. 1% comes from the fact that we are not assuming that there will be a West Coast port strike. So really, we're looking at the economy to give us about 1%, maybe 1% to 1.5%, and we're assuming industrial production will not go back to 2%, which is what we've talked about as a supportive economy when we did our Investor Day, we're assuming slightly positive, call it, 0.5%. That's what we're assuming. So when you demystify it, then people -- because the other rows, we're calling low single-digit volume growth from the economy, we're about the same. I mean we're even probably maybe a little lower, but we've got the CN-specific. What I like about those is they're diversified. They're across commodities, across geography. So if we're wrong on one of them from a negative standpoint, we're probably wrong on another one from a positive standpoint, and you've got the law of compensating errors. So we're not banking on one initiative. We're banking on a laundry list of initiatives. So we're quite positive about that.

Okay. And then you mentioned the Investor Day about 1.5 years ago, and CN had laid out a multiyear through 2026, 10% to 15% EPS guidance range. We're starting a little bit at the lower end of that range. Can you kind of help quantify for investors how much of the CN-specific growth projects are going to be in this year and what's going to accelerate? Sort of maybe I know it's a big, broad diversified business. But if you could get into a little bit more detail on some of the bigger items like AltaGas and really help us understand kind of how much of this is really bankable growth versus maybe it's going to show up?

So why don't I go to the initiatives and you can sum up the numbers at the end. Does that make sense?

I don't know, I'm not that good with numbers.

You're Better than average, you're better than average.

Slightly better than average. So why don't we just go through some of the initiatives? I think we've spoken about many of these, but I'll give you a kind of a round above them maybe. We'll start with the energy sector, and you mentioned AltaGas. So we're hitting records with the propane export to Japan, but there are other countries in Asia that's looking for as well. And Ghis, this week that AltaGas and Vopak announced a final investment decision on a new facility, a new liquids facility in Rupert. That will be in operation, I think they said by 2026. And so we've got a contract, I think it's one of the largest contracts we've ever signed with AltaGas for propane expansion through Rupert and to export. And that's now going to be supported by additional capacity as we look out beyond 2026. And the energy sector and how it's growing in natural gas, the Montney region, the competitive buffers, it's the frac sand that we've built some capacity for frac sand to get up into Northeast BC right in the key Montney areas that gets that sand very proximate to where the drilling is taking place. A number of partnerships in doing that. If you look at the petroleum, the refined petroleum, our volumes moving refined petroleum and fuels into Toronto right now, into Eastern Canada are up significantly. Ghis will give you the number. But that's in greater demand, plus some of the pipelines in Eastern Canada are being derated. So in advance of that, we've partnered with 2 of the big players in that space. We've contributed some space in our Toronto yard. They are building tanks in big facilities. This will ultimately -- we've just started the shipments -- we've sold out even Phase 2 now. And so this is going to be thousands of railcars and we're starting to see that move now, for example. We put a -- if you think about the ag sector, you know everything that's going on in potash. But we're looking at our partnerships with the biodiesel front with the canola crush facilities. There's a number of that capacity announced. Some of those are starting to come into operation this year. So we've got money in the plan, and we're seeing it come in around some increased canola crush and oil movements coming out of there. If you think about a big part of our growth story was going to be the international. And we have reconstructed our portfolio coming in the West Coast, both Toronto and Prince Rupert. Prince Rupert's 1.6 million TEU capacity now. Soon to be 1.8 million and the 2 million and they've got another facility that they can double that again. And so that volume is lifting per plan. And we've announced -- we haven't announced the Can export facility, the logistics facility was announced. Was it last week now? They got final investment decision, and this is the logistics facility. We're going to haul rail carloads of various commodities, pulses, grains, plastic pellets, wood chips, and they will be transloaded at that facility into the containers. This makes Rupert an even more attractive place. Already, it's the fastest and the most economic way to get from Asia to say Mid-Con in the U.S. That's going to help by giving them loaded returned containers on the way back. And so that's very supportive. If you think about -- it's early on yet, but we are starting to move, as I mentioned, the lithium in -- out of Eastern Canada and South. We've started our short sea service out of Mexico into Mobile that goes up in Chicago. So it serves a port in Mexico that is not rail served. So we're taking truck traffic and putting it up. And of course, we're looking at -- we're advancing -- I'll let Ghis just talk about the interline relationships, the Falcon service with the UP, FXE and also our service with the NS. So these are all initiatives that we're seeing manifest itself. And as we look at the plan as we sit here in -- I guess, is it June today? At the end of May?

No, the 31st.

The end of may, as we look forward, that single -- that mid-single-digit kind of plan, pretty much 50% of it, maybe a little bit more is going to happen this year from the CN-specific initiatives. And as we refresh our view 3-years out, there's reason to be very optimistic on those. Do you want to talk about the interline relationships and then any of the numbers you want as well of the Falcon?

Not really -- I'm kidding. So when we were at Investor Day, as you remember, we said that all of these added together would be 800,000 to 900,000 carloads, obviously, in our plan and in our guidance, we did not assume that everything would happen. But just as an example, AltaGas, we had a target overall of 40,000 to 45,000 carloads of NGLs and AltaGas locked up about half of that already. So the notion is we're banking on this, this year to be half of our volume growth. And as you get to the out years, you get a compounding effect of some of these initiatives because what happens is now you get the full year effect of the 2024 and 2025, you get the new 2025. So you'll get a compounding effect in 2025 and 2026 of some of these CN-specific growth initiatives. And my hope, my belief is as the economy does a little bit better, maybe we'll not reach 2% by 2026, but we'll get away from the 0.5% in 2024, more to 1%, 1.5%. Then hopefully, we get from the low end of our range of EPS guidance of 10% more in the middle and hopefully, to the top end of the range by 2026. So -- and like I said, what I like about this is diversified. So it's not banking on one. It's a laundry list, I have about a dozen initiatives. So some of them will fall off. But -- and then Remi, our new guy, by the way, which I'm ecstatic about him joining the team, and he's an enterprise leader, and I think that Tracy and I and she's smiling. So I would like her to smile when she talk -- when you guys talk about me. He's not sitting on his laurel like they're finding new initiatives like this is a living thing. And then on the Falcon service, I'm quite bullish. And if you listen to a couple of conferences we've done in the past, I think this will change the way railroads need to work together in North America going forward. Because when you look at railroads, there's only 3 ways to grow volumes. You either grow with your customers, you either convince somebody to build a facility on your line and then you've gotten that customer's commitment for the next 30 years or you extend your network reach. And when you look at us, we've got great network reach in Canada with the railroad of the north. We have better access to Canada's natural resources, but we're quite limited in the U.S. We have a straight pipe from Chicago to New Orleans. So how do you do that? How do you extend your network reach? Well, you can do that through acquisitions, and we're hoping to get the STB's approval on the Iowa Northern that's contiguous to our line. It gives us market access and geographic access to more grain in Iowa and so on. These are going to be small. Class II railroads, and we're there. We have a laundry list of railroads that we would be interested in. It's got to be contiguous to our network. But the STB, I think, has spoken that there will not be another round of Class I consolidation anytime soon. I'll be retired way before it happens. So how do you do it? It's going to have to be done by partnerships. And I think that when you look at the partnership we have with UP and we've operationalized with Tracy, started this with Lance Fritz and now with Jim. Jim knows us extremely well, good buddies with him, and so on, and he understands it. When you look at our service from Monterrey to Toronto 5-day service, and this is not about taking market share from other railroads. This is about taking long-haul trucking, 1,200, 1,300, 1,500-mile long-haul trucking, put the mack on the rails. I think I'm pretty bullish, and I think you can expect and investors can expect that there's going to be more of these partnerships that are going to pop up. And I think that not if, but we will be successful and we are successful in the Falcon service I think that will be the model of how railroads need to partner together and operationalize to get market share back from the trucks, which, by the way, David, and I'll finish on this has been the most overly promise and under delivered in the last 20 years.

Let me just make a couple of comments on that. So this isn't easy work, right? Railroads traditionally have optimized to their own network, so this is something that's new and it's heavy lifting. It's not natural for us. So it takes a commitment right at the top. And so Fernando, Jim and I get together frequently, we're getting together actually next week in Montreal, again, and we need to be consistent with it. And the way this works is this, is that we say this often to each other. If we were one single railroad, the 3 of us owned this whole network, how would this go? From a routing perspective, from -- so we have the IT guys together so that we can be -- we can have a positive interface with customers. We have to be easier to do business with. Those are not always easy discussions, but we have them with the team in the room so that we're all aligned that this is the way it's going to go, doesn't always optimize one or the other. So we have to -- there's a lot of give and take in this. But I'm with Ghis in that this is small. We're up -- the Falcon business is up 46% year-over-year, but it's off a very [indiscernible] it's tiny. So it's a lot of work for very small, but this is our effort to step back in as Ghis says to a market that we largely exited a number of years ago and to demonstrate that we can provide the consistent truck-like service that is going to allow this and it's good for climate and emissions. It's good for our business, but we need to demonstrate that we can do it.