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

Great. Next up, we have Canadian National Railway and very happy to welcome back EVP and CFO, Ghislain Houle; and from IR, Stacy Alderson. Thanks so much for being here.

Thanks for having us, Ravi. This is a great conference. I know we've been here for a few years. Stacy and I have been here last year and the year before. I'm not sure whether we're coming because of you or coming because of the location, but we love this place and we love this conference.

I don't care why you come as long as you come, I'm signing up for next year.

And the attendance is good. And I want to thank people, by the way, in the room and people listening on webcast and taking interest in our great company, Canadian National Railway.

Great. Awesome. So you put out a press release last night, so maybe you want to kind of address that and kind of start with opening remarks.

Yes. Maybe give investors a little bit of the context of that press release that we issued last night or late afternoon on guidance and the evolution of where we got to where we are today. As you know, Ravi and most people in the room, there's been a lot of labor uncertainty in Canada for quite a while. And that labor uncertainty was focused on the conductors and locomotive engineers that represented by the Teamsters. For us, it represents about 6,000 employees. The collective agreement expired, and we were hoping to get -- we've been negotiating for about a year. And we were hoping to get an agreement in a deal as early as last May. Obviously, that did not happen. And as you know, the Canadian Industrial Relations Board got involved into the file to look at whether rail service in Canada should be or could be essential service. And it took them a while to get to a decision. And although while they were reviewing it, there could not be any work stoppage. It created a lot of uncertainty for our customers. And mostly, the sector that was the most impacted, I would tell you was intermodal. So -- and we saw loud and clear. We saw loud and clear in our volumes. When you look at June, although on a year-over-year basis, RTMs were up 8%. This was, again, easy comp. We were resourced to do way more volume than this. And we saw a lot of business being diverted from the shipping lines from Rupert and Vancouver to the U.S. West Coast, and also domestic intermodal going to trucking because these customers implemented the contingency plan, they wanted to make sure that they were going to get their products to the market, right? So when we sat back at the end of Q2 and in our earnings call, when we looked at this and we evaluated this, this is when we reduced our guidance as you know, from 10% EPS growth for the year to mid- to high single-digit EPS growth. Now at the time, we were still hoping to get a negotiated deal with our union. We were still at the table. We were still discussing. So the assumption we took, and I think we were quite clear with the market was that we were not assuming a work stoppage, and we were also assuming that the labor uncertainty would be behind us by the end of August. Roll the dice. That did not happen. We had a work stoppage. Although it was short, we had to entirely shut down our network in Canada. And that, of course, it causes issues and got to embargo customers and so on and so forth. And the other thing that happened is we had forest fires in Jasper. And I'm sure some people saw it on TV. It was horrific, about half of the city was burned down. And for us, Jasper is a very strategic location because it's one of the busiest corridor we have on the network. And it's all our traffic going to or from the West Coast have to transit through that location. And I know that location quite well. I've ridden train, believe it or not, I'm a locomotive engineer and conductor, on the essence of going to Jasper. And then when you get to Jasper, you either fork north to go to Rupert or you go south to go to Vancouver. So that's what happened. So we quantified that in our press release, as you saw, both the forest fires and the work stoppage to be about $0.20 negative impact on EPS, Q3 to date. Now the good news is the labor uncertainty for our workforce is behind us. I mean now the CIRB has mandated binding arbitration. I'm happy to report that workers are back, employees are back on the ground, moving cars and running trains and so on. But however, there's still labor uncertainty in Canada, mostly related to the longshoremen where there's still a potential strike that could happen as early -- as late this week or early next week that could impact Rupert and Vancouver. So that still exists. And we see some additional weakness in the macro economy, mostly related to lumber and metals and minerals. So when you consider those items, that's where we are today at our low single-digit EPS growth for the year. And we've also updated our ROIC because ROIC is an important measure. And you and I know that ROIC is very sensitive to earnings. And with that level of earnings, now our ROIC will be 13% to 15% versus the 15% we have previously. Now as I said, our employees are back to work. Our network is back up and humming. We were able to pick that up and balance our asset quite quickly, thanks to our scheduled railroading model that we have. And I'll give you a few statistics and the metrics, the operating metrics are improving every week as we move forward. Our car velocity last week was over 220 miles per day, that's up 3% versus last year and better on a week-by-week basis. When you look at -- train speed was north of 20 miles per hour, that's up 1% or better on a week-by-week basis. And then our dwell, I think, was lower than 7 hours, I think it was 6.7 hours. That's up -- that's better by 3% versus last year and up. So good news on that front. Our network is humming. Our network is fluid, our operations, and we're ready for business. Coming back on demand. As you know, we've laid out a plan on Investor Day on CN-specific growth initiatives that are very specific to CN. They're very geographically diversified. They're not home run here, they're singles and doubles. They're diversified geographically, they're diversified commodity. I'm happy to report that these are panning out the way we expected. And I'll give you an example in a few minutes. And those CN-specific growth initiatives is what will allow us to grow more than the economy. And we quantify that, if you remember at Investor Day, to be 800,000 to 900,000 carloads. Now there are some puts and takes, and there are some things that are falling off. Some things are putting back. But give you a few example we have, and we've talked about it in Toronto, a fuel distribution facility, this is a significant investment by our customers that invested in this facility in Mac Yard, that started to be online in May, and that's giving us great carloads. We have frac sand going to our Northeast BC, where we have tons of projects over there. And we have a customer that actually is now expanding -- is the receiving facility. So that bodes well for -- on that front. We have strong propane export with AltaGas. There's 2 crush facilities on grain that are new, that are come online in -- one in Canada, one in the U.S., And then we have a new metallurgical coal mine that's actually coming on board as we speak. So, bodes well, like I said, is diversified, Remi, our new Commercial Officer, which is onboarding extremely well with our company and the team is pushing the team hard to continue to fill up that pipeline and make sure that we continue to push. And as I said, these are not necessarily related to the economy. These are customer-specific with investments, so volumes are moving on these initiatives. Giving a little bit of an update on Canadian grain. I think the Canadian grain bodes pretty well. The last stats that we have -- the last forecast that we have from Stats Canada was a new crop to be about 72 million metric tons. And that's compared to 69 million metric tons that we had last year. And the grain quality around our draw area, remember, with the railroad of the north, seems to be very good at this point. Coming back to the 3-year outlook, if you remember, we provided this at the Investor Day, we said 10% to 15% CAGR from 2024 to 2026. We've revised that now to high single-digit. And the biggest factor that is causing this is really we're starting from a lower 2024. Now as well, if you remember, we said we need a supportive economy, and we look at a lot of different economic indicators. But for simplicity, for our investors, we own in on one industrial production, and we said that needs to be 2% plus. Well, now when you look at consensus forecast, it's more like 1%. So those are the two factors. But I would tell you the biggest factor is starting on a lower base. Now when you look at all of this and all this noise, you may say and you probably would have the question, what is CN doing? What are you guys doing about this? You have a weaker volume environment. I mean what are you doing about it? Well, we're not sitting on our roles. And we do rightsize our assets and our resources on a regular basis to make sure we're in line with the volumes that are ahead of us. So with weaker volumes, we've parked 100 high-horsepower locomotives. These are the worst of the worst, they're gas guzzlers, so that will create some mechanical maintenance savings as well as fuel efficiency. On the car front, the weakness that we see, as I said, is intermodal and lumber, we are returning about 1,000 center beams. And the center beams, you remember, they're like the sailboat cars and you put lumber bundles on them. We purposely -- we have the biggest center beam fleet in the industry because we're the biggest rail moving lumber in North America. And we've purposefully leased these cars because we know that market is cyclical. And we've intentionally have staggered expiry dates that allows us to return a bunch of cars to the lessors at any given year. So we have these lease expiring. We're returning 1,000 cars to lessors. And then on the intermodal wells, we're pushing offline about 25% of our fleet offline with a per DM relief that will give us car higher expense savings. From a labor front, we've stopped hiring in almost all, if not all, our locations and we're letting attrition work. I would say in the East, we're even going further than that. And we have some -- we have to furlough some employees in the East. In the South, I'm happy that we were able to work creatively with our union to effectively go from a 5-day a week, work week, to a 4-day a week, work week where employees get 1-day time off more but they get it on their nickel and it allows us to get savings without at this point having to furlough. So that's a very creative way of working. So -- and then we're looking at all the other types of expenses. We're looking at discretionary expenses. We're looking at tax. We're looking at everything, making sure that we are aligning our expenses with the volume environment that we have in front of us. So closing in on my opening remarks and our opening remarks, I would tell you that the fundamentals of CN are still very, very healthy. I think that this noise that was out there, hopefully, now there's way more behind us than there is in front of us. Our scheduled railroad operating model is the right model at CN. This is the model that creates value. Now noise behind us. We'll have a good environment in front of us to deliver and railroad the way we need to deliver great customer service, value to our customers and value to our shareholders. And maybe on this, we'll turn it over to your questions.

Great. That was very detailed, very insightful. I think you've answered all my questions. So I have nothing more for you. Clearly you know...

Maybe you'll turn it in French now.

Yes, we'll doing French now. Exactly. I do have a few follow-ups though. One is you mentioned the potential kind of longshoremen disruption potentially end of this week, early next week. Can you expand a little bit more kind of what's the next steps there? Kind of when do we hear more about that? And just to clarify, is that in your guidance now? Or is any disruption related to that?

So we -- so we don't -- right now, we -- what we know -- and Stacy can jump in, what we know, is that a 72-hour strike notice could be served by the end of this week. So we'll see whether that will be the case or not. And then we'll see what happens. My view is in the guidance, we did assume that there could be some work stoppage there. Remember that both ports have not recovered 100% yet.

Correct. This happened last year.

That's right. This happened last year. And now the diversion that happened in Q2 and continuing into Q3, we're starting to recover a bit but not -- we're not 100% yet. So we factored in some impact absolutely in our guidance that this could happen.

Got it. And on the other labor contract, obviously, you're in arbitration right now. Can you remind us again kind of how that process works and kind of when do you expect an outcome there? And kind of maybe puts and takes on what kind of outcome that might be?

Yes. So there is no set time line for the arbitration process. And I'm not an expert in labor relations, so bear with me 2 minutes. I think both parties have to agree on the process. Both parties have to agree on an arbitrator that -- those discussions are happening as we speak. I think that, like I said, there's no time line but the good news is people are working. There cannot be any work stoppage while this is going on. And when you look from a wage pattern, when you look at the pattern that has been set in the latest agreement that have been signed, 4 or 5 last agreement, it was in the 3% range. So we'll see. I'm not going to speculate on what the outcome will be. The only other point I would say is, with the new work West rules, as you know, there has been some unintended consequences in terms of scheduling, in terms of crew availability, in terms of having our crew spend more time away from home, which they don't like. And there's some of these issues on both sides of the fence. And typically, in the past, when there's been an arbitration, these issues are typically not dealt with. It's basically a wage. It's a wage review type of thing. So we'll see what happens on this one but there is a likelihood that some of these work issues will not be addressed through the arbitration process.

Got it. But now that you are in arbitration and you said kind of the network is humming, I think it was your phrase, is that enough for customers to come back? And kind of are they still kind of, hey, this is not fully resolved, you don't have agreement yet. And is that a 2025 normalization?

I think customers are coming back. I think they're coming back slowly. I think -- and again, like I said, the place where we saw diversion is in intermodal. So I think that we're seeing some of it coming back. I think it's going to be -- remember, last year, when we had the port strike, on and off, it took 2 to 3 months to get back to pre-strike level. So we'll see but it's starting to recover. We think that -- and in our guidance, we are assuming that we're recovering somewhat in Q4 but we're being cautious about that.

Got it. I think you mentioned lumber and metals and the other two weak end markets. Lumber, is that mostly Jasper, or is that like a demand issue because of housing?

Some of it is demand. Actually, it's -- when you look at -- you may have seen Canfor has just close down 2 of their biggest sawmills in Western Canada. So some of it is macro, absolutely. Now -- so we've taken that into consideration in our guidance. Now as you saw this morning, inflation is coming to the reasonable levels. Hopefully, like in...

Rate cuts.

That's right, exactly. Exactly rate cuts. I mean we thought we were going to get a lot of rate cuts this year. We haven't gotten yet. We've got a few in Canada. Maybe now in the U.S., it will come. This market is cyclical. I mean I've seen it in 2009 on the housing bubble, we returned 3,000 cars to lessors at that time, and then it came back. So this is cyclical. We're managing our fleet and managing our resources towards what we see today. I'm sure it's going to come back. It's when, and we're being very close to our customers but it's more macro than it is Jasper.

Got it. And I'm not sure whether to ask you this question or not, but I've been reading a few stories about crude-by-rail potentially coming back in some opportunities kind of in the Alberta region kind of -- is that really a thing? I know in the past, you've needed a lot more kind of tangible evidence for that. But obviously, oil price is very low right now but there's been some speculation on that. But...

Stacy can correct me if I'm wrong. And remember, she's the internal auditor. So if my numbers are wrong, guys, she's going to correct me. She's not shy, and she used to be in marketing before. Correct me if I'm wrong, Stacy, but crude at CN has been very stable, and we don't move a lot of light crude. We move a lot of bitumen like the heavy stuff. That's not even a dangerous product. And I think it's been quite stable for the last few years. And I'm not aware of any signs that crude would come back to the industry and to us in a big way. I don't know whether you are...

No, I'm not. But we have made a number of investments in Western Canada down to the U.S. over the years. So we're certainly ready and able to handle that, if that's an opportunity for us.

Got it. So just to kind of leap off your response. Obviously, there were some network disruptions in the second quarter, which you have resolved. And as you said that the network is coming right now. Can you just kind of talk about that a little bit more. Obviously, since Stacy took over, there was a lot of focus on network fluidity and ensuring that the volumes you onboarded kind of had capacity in the network, and that's a huge focus area. So how does this happen? And kind of what's the fixed been?

So here's what happened in Q2, two things happened. Number one, as I said, we were doing extremely well up until the end of May from a volume standpoint. And then we had all these diversions. And so we were resourced to do way more volumes than what we actually did. And in the railroad business, unfortunately, when volumes go down abruptly in front of you, your cost in the short term are pretty much fixed. Because you can't send people home for 2 weeks. You can't park, so your costs are fixed. So that's one thing that happened. The other thing that happened is on the direct -- so we have directional running corridors with our Canadian competitor going to Vancouver. We've entered into that deal 20, 25 years ago because remember that our rail line going to Vancouver follows the Fraser River and on the mountain. So very tough to put sidings. So we actually go on one railroad to the west and one -- the other railroad to the East. What happened is starting at the end of May, and it started even a little bit earlier but our Canadian competitor decided to do a lot of unplanned work maintenance on their track. And that took a lot of capacity. That took like capacity 4 to 8 hours every day out of capacity. And why it impacted us more than them is because we moved 2/3 of the volume going to Vancouver. And these were on plan. So -- and it was every day until the end of June. So that is what happened on the capacity. So -- and we were not aware that, that was going to happen. So it impacted us from a productivity standpoint. And if you listen to the earnings call, I gave some numbers on the productivity, the labor productivity. So Pat Whitehead and the operating team are going to sit with our Canadian competitors operating team this fall to make sure that we agree on a plan on how we're going to maintain these corridor together, plan -- and follow the plan so that this does not happen again. So outside of these on plan, we were very fluid and right when these on plan road blocks finish, we became very fluid. Because we effectively have double [ clad ] going to Vancouver.

It seems like very unusual events just kind of...

That's exactly it.

Okay. Got it. Understood. I wanted to focus on, obviously, CN is a long-term growth story, kind of laid out at the Investor Day. And I think even with your new lower long-term guidance, you're still implying double-digit earnings growth for the remaining 2 years of the 3-year plan. So talk about how macro sensitive that plan is? Is this high line of sight, high visibility, new projects coming on? Or do you need macro to kind of support that as well?

Of course, you always need some macro. You can double-digit EPS growth unless you've got a lot of cost to take out if you have a recession. So you need macro and we called it 2%. So you need a supportive economy. Like this year, for example, if you remember, we were assuming mid-single-digit volume growth and half of it was coming from our CN-specific growth initiatives. So we need some macro. We believe that the CN-specific growth initiative is what allows us to grow more than the economy. Then you need to continue to price above rail inflation. And I'm happy to report, and I know you've got a question on revenue per revenue RTM. And for investors here, this is not trying to get to profitability. This is trying to get to pricing because we don't give out the same-store pricing. I want to reassure you that we are following pricing very closely, and we continue to price above rail inflation. So you need that. And then you need to improve on your operations. You need to improve on your operations and improve on your margin. And when you put all of those ingredients together, then that what gives you that double-digit EPS growth. And you need to have people working. You need to have people working and you -- and when you have all these ingredients, then you get to double-digit EPS growth.

Got it. I can't have a rail fireside conversation without asking an OR question. So obviously, you can -- a lot of puts and takes in the second quarter. It seems like some noise in the third quarter as well. But do you feel like the 4Q OR should be a pretty normal run rate to kind of go into 25%? Or how do you think about...

As my view, assuming we don't have a long-winded strike on the West Coast with the longshoreman, that the volumes continue to bring up, I'm confident that we'll get an OR that will be more normalized, absolutely. I mean, we do have capacity on our train. We have capacity on our manifest train. When we have -- when we add intermodal, typically that we have had train starts, but we have capacity on our trains and it's Remi and the team are working very hard to bring volumes in the South and in the East where we do have lots of capacity from an infrastructure standpoint. And absolutely, when you look at these operating metrics, and the grain will help as well because it's going to bring quite a bit of volume. Because remember, too, last year was one of the only years, I've been around for quite a while. Typically, in Canadian rail, we move grain in Q4 full out. And what happens when you get a big crop is you run out of grain later the next year. Last year, if you remember, because of the world geopolitical issues and the world markets, the grain producers and the grain farmers sat on their grain in Q4. And I've never seen that. So now because the bins are full, I think they will need to push those back grain to the market. And I see grain being quite strong in Q4. And then frac sand continues to be quite solid. Then P&C, as Stacy, I think, was up 11%.

Yes.

So there's pockets of area. And then hopefully, lumber, slowly but surely, comes back and then this labor saying, gets away -- gets resolved on the longshoremen. And then hopefully, we get sooner than later to pre noise level at both ports of Rupert and ports of Vancouver, and we have tons of capacity. Listen, Rupert, we did 700,000 TEUs last year, and it's got a capacity of 1.6 million. So there is capacity there, and we're open for business.

Understood. Any questions from the room? Christine?

You talked a little bit about how you have the capacity on the East, in the South already there, but you guys have also been investing in building capacity on the West. So maybe you can just talk a little bit about kind of where you are in that process and what you expect the growth to be in order to kind of justify that kind of capacity investment?

Yes. So obviously, our growth continues to be a little bit more skewed to the West than to the East. The East, we have capacity because remember, like in Northern Quebec, there was a lot of sawmills and other industries that are not there anymore and the railroad was built for those. So that create -- so we have capacity in the East to move a lot of business. In the West, the growth continues to be skewed there. And the way we look at it is that we invest year in, year out in capacity, and we have a long-term plan, 3 to 5 years even, we have a 10-year plan, believe it or not, where we know where our pinch points are. We invest year in, year out, recession or no recession with a view of capital efficiency, i.e., we want to make sure that we have as close to 100% of our investments in the ground. And we know that if we try to build too much in 1 given year, you've got leakage where people do it on over time and you pay time in half, they don't get the work blocks, you do it under snow. So you build this, you get this done, and then you sell to that capacity. And we're being extremely careful not to oversell our network, all new business coming at us, including new contracts are being reviewed and approved at the operating committee where I facilitate but Stacy is participating, the two operating guys and the commercial guy, and making sure that we've got the capacity from an infrastructure standpoint but also the resource from a conductor locomotive so that we -- and that we price that business to make sure that we bring that top line growth to the bottom line and make sure that we can offer the customer service that the customer is entitled to and great customer service. And if demand is higher than supply, which in some years, that has been the case, then we'll use price as a lever. That's what we're doing, and that's how we think about it. Maybe we're out of time, I'd like maybe to...

Sure. Go ahead.

So I want to reemphasize to investors that the fundamental of CN is very healthy. That our operating model is working that are ecstatic or continue to be bullish on our CN-specific growth initiatives, and these are being rebuild as we speak with Remi and the team. And I'm happy that the noise of the Teamsters and the conductors and locomotive engineers now is behind us, and we're ready for business and we're ready for railroading.

Great. Ghislain, Stacy, thank you so much for being here.

Thank you for having us.

I wish you a very boring for fourth quarter, and we will see you here again next year.

Thank you. Thank you, Ravi.