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

Hello everybody. We're going to go ahead and get started with day 2 of the Wells Industrials and Basics Conference. Thanks, everybody, for joining us. I'm Chris Wetherbee, senior transportation analyst. We're very excited to get started. Wrapping up the rail side of the conference with Canadian National. So thank you very much for joining us. We have Ghislain Houle, who's the EVP and Chief Financial Officer of CN, and we have Stacy Alderson, who's the Assistant Vice President, Investor Relations. Thanks very much for joining us this morning. Appreciate it.

Thanks. I'm happy that you kept the best for the last.

Yes, absolutely. Last but not least, that's for sure. So I think the way we'll do it is I'll kick it over to you for some intro opening comments and then we'll kind of dig into Q&A. I certainly want to make it interactive. So folks in the audience, if you have questions, just raise your hand, we'll get those questions asked. But with that, Ghislain?

Well, thanks for having us, Chris. It's nice to be in Chicago. It's a beautiful day here. Thanks for people in the room and people on webcast, taking interest in our great company. To your point, I'll make a couple of opening comments, and then we can go through your questions. And please keep the hard questions for Stacy, and you can give me the easy ones. So we're quite pleased about Q1 as we started the year. As all of you know, we started the year quite strong. Our EPS was up 8%, OR improved by 20 basis points, and that was supported by volumes that was slightly up 0.5% in terms of revenue ton miles. We did hold our guidance for the year. in the range of 10%, 15% EPS growth. And we do continue to manage our costs very, very tightly to protect that guidance. As we get into Q2, as you know, our Q2 volumes today are about flat -- flattish and managing costs, we have about 550 employees that are furloughed, mostly train crews. We have about 140 locomotives that are stored. We have 7,500 system cars that are also stored and we have about 1,200 intermodal wells that are stored that are leased that we put on a per diem relief to be able to get car -- some car cost savings. So we are managing our costs very, very tightly. When you look at Q2, specifically related to fuel and FX and I think there were some questions related to this. So as you know, last year, fuel was a big headwind. This year, if WTI and OHD remains where it is, we see a small headwind, call it, a couple of pennies in the quarter. FX, however, will be a headwind. If you look at FX, it's currently at $0.73 and our assumptions for the year, if you look at our MD&A, was $0.70. And I want to remind everyone that every penny of Canadian dollar appreciation to the U.S. creates a headwind of $0.05 on EPS on an annualized basis. So now the good news is our railroad is running extremely well. I mean when you look at our car velocity, Stacy, I think it's up 215 to 220 miles -- car miles per day. Our train speed is around 20 miles per hour. Our active cars on the network is about 75,000, which is pretty much like last year, but down 7,000 cars versus April. And I'm talking here about May. So the railroad is running well. We're working hard on June to finish the quarter and we'll see where we end up. Maybe on this, Stacy, do you have anything to add?

No, that was a great summary.

That was a great summary, you should say that again. All right. So on this, we'll turn it over to your questions, Chris.

All right. Well, thank you very much. I appreciate the setup here. So let's stick sort of on the top line and think about the volume environment, I guess you noted kind of flattish year. I guess for the full year, we've talked about low to mid-single digits. I know you guys have talked about the potential for -- there's uncertainty in the market and the economy. I guess as you think about one of the themes we've been covering over the course of the last day is the lull post immediate tariff implementation, but then maybe a potential pickup in activity now that some of the tariffs, particularly on China have come down a bit. We were just in Rupert last week. So we saw some of that and kind of talked a little bit about that. But what's the take on how maybe the rest of the quarter finishes out from a volume standpoint? Is there a pickup coming?

Well, obviously, we'll have easier comps from a volume standpoint in Q3, Q4. I think that we're still looking to be low to mid-single-digit volume growth. And I think, as we've said before, I think 50% of that will come from CN-specific initiatives, and Stacy can walk you through a little bit of those that are not necessarily related to the economy. 1/3 of it will come from the lapping of the labor uncertainty in 2025 versus 2024. And therefore, very small piece, call it, 0.5% will come from the economy. And as you know, what I was saying is, yes, so volume, you should see volume growth much more in Q3 and Q4 with the lapping of the labor uncertainty that really impacted us last year in those 2 quarters.

Okay. And then, Stacy, I don't know if you want to run through any of the commodities specifically that you guys are thinking about? And maybe even if I really zoom in on June, I guess -- and maybe July, do we think things are picking up? I think there was some anticipation that maybe Rupert would begin to see either larger or more frequent vessel calls potentially. And obviously, that's also a possibility of Vancouver, I guess.

Yes. Well, Stacy can jump in here. You were in Rupert last week. Thank you for coming. I hope it was insightful...

It was great.

And so on. So obviously, we're quite excited about Rupert. When you look at Rupert, the volumes quarter-to-date is up 3%. So our intermodal franchise international is down, but mostly due to Vancouver. Vancouver is down 15%. So -- and we do have a new alliance, the Gemini Alliance. And I think you even saw a ship being discharged when you were there. So we're quite pleased about that. I think Rupert will be the gift that keeps on giving. I mean, the fact that the way it's geographically positioned, we can expand capacity and they have even the land to build another terminal. But as also, we're making Rupert more than just an intermodal. We're making Rupert a multi-commodity facility, and that's quite nice for us. I don't know, Stacy, do you want to add a couple of points.

Yes. I mean we hosted about 25 sell-side analysts and buy-side investors and shareholders. We were quite pleased for those folks that were able to tend to lay eyes on the opportunities out there. It's about $3 billion of capital projects that are happening there. And as you said, Ghislain, it's more than intermodal. It's the liquids that are happening, the RIPET facility that exists today as well as the new [indiscernible] facility that they're literally blasting rock to prepare the groundwork there. So it's very exciting. And of course, all the intermodal investment to create that ecosystem and have the exports and the capabilities to transload at the port as well and send the boxes back empty very, very quickly. So it's very impressive. And altogether, we're looking at about a 10% CAGR in terms of volumes at Rupert over the next 3 years. So we're really excited.

And you guys gave us a little bit of that sneak peek in terms of extending the horizon, I think, the year beyond the Investor Day targets, I guess, just as we think about that, as we go through the end of this year, is that kind of how we should start to think about, we'll start introducing some '27 discussion in as we get towards the end of 2025?

Yes. That's what we're going to do. And we're thinking about possibly having an Investor Day. We haven't set the date yet. But coming into our 3-year guidance, I think people will want to know, okay, what do you see in the next 3 to 4 years and so on and so forth. So we're having internal discussions about whether we should have an Investor Day sometime next year. So we'll see.

Well, we're not far from your last one here in town. So [indiscernible] part of town here. So okay. Let's talk a little bit about the -- a couple of other sort of commodities that we just want to touch on real quick, particularly on the Grain side. So how do we think about sort of the shape of Grain for the next couple of quarters? I think the comps get a little bit more challenging here as we move into late 2Q, 3Q.

Right. So when you look at Grain Canada quarter-to-date, we're up 7%. So again, I think the Grain is being a little bit stronger and lasting a little longer than what we expected. But we expect this to drop off as the seeding season will start very, very soon. Grain U.S. is a very good new story. Our grain volumes are up 38%. And this is a new crush facility coming online. We have a new ethanol plant coming online, the Stacy. And so that's a good new story. In terms of what the crop -- like when you look at the crop for 2024, 2025, Stats Canada says it's about 71.5 million metric tons, which is a kind of a 3-year average, 3-year average is between 70 million and 75 million metric tons. I think for the 2025-2026 grain crop, Canadian grain crop, I think it's too early to call. So as our assumptions, what we're assuming is that it would be a 3-year average. So we'll see how it's going to pan out, but that's what we're assuming.

Okay. That's helpful. And let's just kind of talk a bit about the pricing environment. So I think -- pricing I think it's been trending on the stronger side. We've seen, generally speaking, I think price trends across the rail is getting a bit better. Canada has been an outlier to the upside over the course of the last year or so. How do we think about that and maybe move -- sort of weave mix into the discussion as well as we think about maybe 2Q, but broader for 2025?

So overall pricing, again, we've delivered in the past, and we continue to push to a price above rail inflation. And on a same-store basis, I'm happy to report that that's the case. Now you will ask me, well, what's rail inflation? So when you look at our biggest expense, which is labor expense, the last deals that we've signed, they were about 3%. In the U.S., it's a little higher. So we call rail inflation in the range of 3.5%, and we're pricing on a same-store basis above that. Now we're working very hard to reduce our inflation as well. So supply management, procurement reports to me, and we're pushing our suppliers while being fair to try to contain the cost and so on and so forth. But I would tell you, overall, it's about 3.5% rail inflation and we're pricing above that.

So I want to talk about some of the costs, but maybe let's sort of widen it out and think about the network in general. So last year, there was a number of sort of incidents, lots of which were outside of your control that impacted the operations of the railroad. So how do you feel like that rail is operating as we're sitting here in 2Q and kind of as you think about the back half of the year?

Listen, we're an outdoor sport. There's always going to be something, especially from an operating standpoint. Last year, it was a bit unusual with this labor uncertainty, with a long shoreman and even with our union, the TCRC, both railroads had a lockout. So there's been some issues. I'm happy to report that at least now we do, and you and I were talking before the meeting, we have labor certainty now. So -- but things happen. So if you look, we had flooding that occurred in April in the U.S. in the south and our South region, and that's behind us. We had a bridge issue that had an impact on frac sand going to the West Coast that we had to fix. So there's always going to be some issues. But overall, the railroad has never run as well as it's running. I mean when you're talking car velocity in the 220 car miles per day and train speed of 20 miles per hour, that's a good sweet spot that we have. And then what you want to do is just also control the number of cars. This is why I stated the active cars online. You want to control those cars because the more you put on the network, then the more you can congest yourself. So -- and it's all about car velocity and about turning and sweating your assets, which is what we're doing. And the operating team, both Derek and Pat and both of their teams are doing a great job at it.

Okay. And I guess, as we think about the sort of normal cadence, I mean, can we talk a little bit about what think normal seasonality looks like from an OR standpoint, 1Q to 2Q and then maybe talk a little bit -- widen it out a little bit as we think about the operating ratio for 2025.

Yes. So typically, as you know, and you've been following the rails for a long time, especially rail of the north like us, the OR is the highest in Q1. It's the lowest in Q3. And then Q2 and Q4 depends on -- in Q2, it depends on how the snow melts, especially in Western Canada. And in Q4, it depends on how the winter hits. Now what we've seen in the last 4, 5 years is that we've been hit with forest fires in Western Canada that has changed a little bit of that dynamic. So -- but definitely, as your question is, should we expect a better OR in Q2 than in Q1? Obviously, we do. Just from a seasonality standpoint, it's just the way it is.

Okay. And any finer point we want to put on that in terms of what you think normal seasonality might look like? Or maybe how you guys feel like you are performing in 2Q relative to some of those factors that you just mentioned in terms of the snow melt and overall operating conditions?

Well, we purposely, in the earnings call of Q1 -- in the earnings call of Q4 that we did in January, we purposely said that last year, we saw about 200 basis points of OR that was related to one-timers, but that included fuel. Now fuel, as I said, still a headwind this year, but much lower than last year. So just gives you a perspective of the potential improvement in OR that we can have in 2025 versus 2024. We won't have that labor uncertainty this year that we had last year. Now there's still some risk out there and there's a lot of geopolitical risk. And nobody knows exactly what's going to happen with the tariffs. And like now there's a reprieve with China for 90 days. We'll see what happens over the 90 days. Hopefully, there will be a deal. Hopefully, there's going to be some deals made that are going to appease and put down the tariffs, and that's what we're hoping for, but nobody really knows.

So let's talk a little bit about labor. You mentioned that before as an announcement about a week or so ago. I think we now have some certainty around TCRC. So we've got the 3% number there. Maybe just sort of talk about the state of labor on the railroad and what that gives you? How do you feel like sort of the deal provides, whether there's any operational opportunities for you guys? Or is it just more on the cost certainty side?

It's more on the cost certainty side. That's the issue with an arbitrated deal. Typically, an arbitrator will not start changing operating conditions, working conditions that typically won't happen. So -- and nothing significant from a working standpoint, working condition standpoint, was got into that deal. So -- but now at least the people are working. And the cost side, we know 3%, but eventually, we would like to be able to have some of the working conditions of change on both sides, especially on crew availability, as you know, with the work rest rules that are over implemented from the regulator what we already had in the collective agreement really creates issues on both sides, create issues on us on crew availability, but creates issues on the union side as well because people are more away from home than they were before. They make less money because they have to rest more than before, and they're paid by the mile. So there's irritants on both sides and hopefully, at the next round of negotiation, first of all, we'll get a negotiated deal, and we'll be able to resolve some of these issues, some of these working conditions issues. But they have not been significantly resolved on this arbitrated deal.

Okay. So do we think we need to wait? Is it -- I always forget you guys are on the long end or the short end of this deal because I think CP and CN now have different time lines to kind of keep this.

We are on the short end.

You are on the shorter end. Okay. So we have to wait a few years for that progress to happen? Or can something happen in the interim?

Well, we're trying to work with the government to resolve this unintended consequences of the work rest rules. I mean everybody agrees that this was not the intention. So we're not sitting on our laurels, and we're doing some things to try to improve crew availability, as stated. There were some local agreements that we had in Western Canada that we resolved that is helpful. So we're at this on a daily basis. But clearly, the unintended consequences of having that -- those work rest rules be over implemented over what we already have was not supposed to be the case. So now we're trying to help ourselves as much as we can. We're not waiting for the 2 years. We're trying to help ourselves day in and day out, and we're continuing to have discussions with the regulator in Canada to see whether we can resolve this.

I wanted to talk a little bit about like sort of tariffs and how that impacts the business, particularly some of the USMCA stuff. So I want to get back to Rupert in a minute, and I know that's going to be a focus of driving more U.S. bound volume through that port over the course of near term. But in terms of -- I don't think auto from a north to south dynamic is that big business for you. But as you think about particularly Canada U.S. tariffs, is there anything specific that you'd outline is like this is where we're seeing any impact? Or have we started to kind of adjust to the environment that we're in right now?

Right. We're adjusting all the time. Obviously, we're seeing impact on steel and aluminum with 50% tariffs now. For us, this is a small piece of our book of business. When you look at steel, I think it's 0.5% of our overall book of business and aluminum is 1% of our overall book of business. We see as well issues on forest products. I mean, forest products is down. I got it here, it's down like 12%. And again, the potential tariffs going from 15% to 35% creates some issues. From the auto standpoint because you were talking about auto, I think we saw a little bit of pull forward in autos. And when you look at -- in Q1 versus Q2, when you look at autos, I think, Stacy, correct me if I'm wrong, I think auto parts cross-border is 40% and finished vehicle is 28% and autos, if the finish the vehicle and 25% tariff on both sides, by the way, in Canada and the U.S., if it's USMCA compliant, then the tariff don't apply. And on a finished vehicle, if the vehicle is USMCA compliant, then the tariff will apply only on the foreign component. So I don't think -- we haven't seen a big issue so far. I mean when you look at auto -- I've got it here in May, auto was down 5%, but in April, auto was up 2%, auto quarter-to-date is down 1%. So anything you want to add on that?

No. I think the bigger impact on auto for us has been of course, it's very specific to the plants that you serve. It's been that we've had 2 plants that have been down for retooling since last year. So that's more of the bigger impact right now. And I just want to say, very small piece of our business that actually moves southbound from Canada into the U.S.

And I think, if you remember at Investor Day because you attended Investor Day, we had opportunities in electric vehicle and that's been pushed a little bit and postponed. So that's what I would say is the impact on autos.

Okay. And then Falcon Premium, how maybe that been sort of progressing? And how do you feel about that?

Like, it's progressing. I mean, I think it's the -- like there's only 3 ways to grow your volumes. You grow with your customers or you have somebody, you convince somebody to build a plan on your facility, and therefore, you have them committed for the next 30 years or you extend your network reach and Falcon Premium is our way to get access to the Mexican market. And as you know, and I know that you have a question on the chatter related to the M&A and consolidation and so on I think I'll be far...

Read my mind here, yes.

Yes. I think I'll be far retired before that happens, but that's my own personal opinion. So I think that to extend your network reach to grow volume, you will have to do it through a partnership and I think that we have this great partnership with UP and Ferromex. I think that the transit time is still in the 5-day range between Monterrey to Toronto, which is really truck competitive. And we are after long truck -- long-haul trucking, which is where the railroads have lost market share in the 1950s. So we're not after this 500 to 700-mile radius trucking. We're after 1,500, 1,800 and -- but it's slow. It's slow because if you've been used your customer, you've been used to give your business to trucking for the last 25 years. You're not all of a sudden going to give all the business to this partnership. You're going to test it out, you're going to give a couple of loads, you're going to see it out, you're going to -- but I think over time, I think that this will continue to grow. And I think that, hopefully, this will be the role model of how railroads need to work together to get that market share from trucks, long-haul trucking back to the rail, which has been the most overpromised and the most underdelivered in the last 20, 25 years.

I think that's a fair characterization.

Now what it helps too is that CN has been the draft -- the team that has been drafted by all the other rails, it helps to have Jim Vena, the CEO of UP. And he knows us very well. He's a good friend of mine. So it helps -- when people like each other, it helps to do partnerships. If CEOs hate each other, then it's a little bit tough to do a partnership, even if from a logic standpoint, it makes a lot of sense. So we have a good relationship with UP, with Jim, there at the helm. We have good relationship with NS. Claude used to be the Chair. He's now resigned. Good relationship with the CSX with John Orr being the COO there. So we have a little bit of our players a little bit scattered in the other rails, which is helpful.

There's quite a few former CN employees across the rail industry these days. So that's a great segue.

I'm the only one left.

That's a great segue into the M&A discussion. So maybe we can talk a little bit about what your thoughts are on the potential for any more activity in the industry?

Listen, it's a chatter. I mean the test is very, very high, and like imagine, you're taking out a railroad, but you have to prove to the regulator that not only competition has been maintained, but it has been enhanced. And so that's tough and those rules, they were tested a little bit when we tried to do our unsolicited offer to KCS and we saw what that gave, we lost 5-0, which is like kind of the Canadian Habs hockey game. So -- and then the fact that the STB has spoken essentially that they will not allow the use of a voting trust, which makes even more risk. So listen, I mean, at the end of the day, like I said, the like the market share between railroads over time is really a zero-sum game. Like we will brag about getting a contract over our Canadian competitor, they'll brag getting 1 from us, but it's a zero-sum game. The key is the market share to get it from the long-haul trucking. That's what -- and obviously, if you have 2 TransCon railroads, it would give you an opportunity like there's no tomorrow to get that market share back. But like I said, I think I'll be far retired before it happens, but that's my own personal opinion. And you can never say never. You can never say never. From an economic standpoint, the case would be compelling. It's just you have to have a positive regulator that would look at this positively, number one. You have to look at it from a customer standpoint. Already, customers believe that railroads have a lot of pricing power, what would that do. So I mean -- and like I said, those rules have not -- they've been tested a little bit with KCS with us, but they have not fully been tested. So -- but I'm an internal optimist, you can never say never.

I think that's a good way to think about it. Maybe as we start to wrap up here, I'd like to talk just come back to the guidance for 2025 and the earnings growth. You noted FX. So that's a modest headwind as it stands right now to the 10% to 15% range that you reiterated on the last call. So I guess maybe help us understand sort of what are some of the puts and takes that can give us variability on the 10% side, maybe the 15% side, what needs to happen on either side there?

Well, the key will be volume. The key is volumes. I mean, it's tough to grow earnings if you don't have the volume. So the key will be volume. The key will be continuing to operating very, very tight on our costs to protect the guidance. So what we're seeing internally is even if we leave a little bit of money on the table and the upside, we really want to protect the downside of our guidance. We really want to protect, we really want to deliver at least 10%, if not more. So we're managing our costs the metrics that I gave in my opening remarks, we're very, very tight. We're very tight on and very thoughtful about replacing management positions as well. And it's not one thing. It's a little bit of volume, continued price above rail inflation, controlling our costs so that we can deliver our operating leverage. Share buyback, unfortunately, does not -- is not that accretive in the current year, especially at the level of interest rates that we have. But when you put all of these together, then that's how we feel that we're going to be able to deliver our guidance.

You mentioned share repo that was something that you talked about back in 2Q, is that something -- the way to think about it?

Yes, we started back our share buyback. We have authority from our board to do as much as 20 million shares. We're kind of pacing ourselves because we're pacing ourselves. We're still continuing to manage the balance sheet to a 2.5x adjusted debt to adjusted EBITDA. So we're kind of doing our share buyback as earnings are coming in to pace ourselves and so on. And -- but we started the share buyback, absolutely.

Okay. And then I guess maybe the last sort of area I want to touch on was just capital deployment and some of maybe the initiatives that the rails can be working on from a technology standpoint. So we've been doing a little bit more work kind of thinking about the opportunity out there. And so I guess as you think about CapEx, I think $3.4 billion is your target for this year. Maybe we can kind of break that down into how much is for incremental efficiency as we move forward? And is there an opportunity, do you think, to invest in some interesting opportunities on the tech side as we move forward?

Yes, I'll start with the tech side. The tech side, as you know, we've invested quite a bit of money on our automated track inspection cars and on portals. There's no question in my mind that the Holy Grail on the tech side will be to have fully automated inspections. I mean there's no reason why you need to have a pickup truck, a white pickup truck with CN on a track with having somebody looking at rail. The issue is the regulator needs to walk with us because right now, what's happening is we're investing in technology, but it's hard to get the benefit of it because the regulator continues to push the railroads to continue to have the manual process. Like, for example, in the U.S. with PTC, as you know, billions of dollars of investments, we have the technology to have one person crew, but yet it's been mandated that at least two people needs to work -- needs to be in the cab because these are high well-paid blue collar position. So we kind of need to pace ourselves and do these investments as we get certainty from a regulator standpoint that they will allow us to remove the manual process that's behind it. Now at the end of the day, these investments, it's not about economics. It is economics, like it's a good byproduct, it's economics, but really, it's about safety. And when you have a fully automated track inspection, like when I look at our ATIP cars, we have 11 of them? 10 or 11?

That's right. 11.

We're able to inspect the same piece of track 20x more often than we used to on a manual process. Let alone with these lasers going in the rail to see if there's cracks that you would not be able to see it your human eye or if the tie underneath the is rating that you would not be able to see. So definitely, it's the way forward. When I look at like train inspection, we have to do a certified car inspection of a train, let's say, going leaving from Symington. So the train is 12,000 feet. It's sitting there and you have 2 mechanical people looking and getting on their knees and trying to see in the undercarriage of the car. And God knows if you've seen intermodal wells, how low of the ground they are versus going into that portal with 38 high-resolution cameras and algorithms that will be able to tell you whether you have a problem or you have a defect or not, that would never be able to be detected with your eye. But yet, we have these, and we continue to invest in these technologies and these algorithms, but the regulator wants us to continue to do the manual process on the certified car inspection. So it's got to be timed where eventually, as you move forward, then you're allowed to stop so that you can get a return and these investments can make sense.

Do you think there's any progress on that with changes at the FRA? Are you hopeful that maybe there can be some?

We haven't seen any yet with the new administration, anyway, not that I'm aware of. I don't know, Stacy, if you're aware of any significant changes. But we're hopeful that with this administration and being more focused on businesses and productivity, we're hopeful that we will or we can see some changes.

Okay. Yes. I guess -- and so beyond 2025, I guess, as you think about the capital allocation, anything we should be thinking about that you feel like would be required on the rail or any reason to think that, that could change materially?

No, I think it's steady as she goes. I think that, as you know, if you try to do too much, especially from a construction standpoint, then you do it unproductively. When I look at the basic capital and/or the sidings that we're investing, a lot of it in Western Canada, if you try to ramp it up too much, then either engineering doesn't get the work block or they do the work during over time, where they're paid 1.5 half or you finish working under snow. So the way we're looking at CapEx, especially from a construction standpoint is on productivity and capital efficiency. We want to get 100% of our investment in the ground with no or very little inefficiency. And I've been in this business for a long time. And I know there's some years that we've done a little higher, and you try to pin your point, and you try to put your finger on, well, was this productive and in some cases, it was not as productive as it should have been because you try to do too much. On the tech side, these are the most risky investments that you have and what you have to do on the tech side is you have to cut the project in small pieces so that if you're wrong, you're not wrong, $50 million, you're wrong $2 million or $3 million. And so we're -- and as you know, our sweet spot on CapEx, and I know the rails, I like to look at it on a percentage of revenue, our sweet spot is anywhere between 18% and 20%. And I don't see any major changes to that point.

Fantastic. Well, listen, I think we're pretty much out of time. So Ghislain and Stacy, thanks so much for joining us today.