Canadian National Railway Company ($CNR)

All right. Good morning, everyone. Welcome to Day 3 of the 19th Annual Wolfe Global Transportation and Industrials Conference. I'm Scott Group, Transport and Airlines Analyst here at Wolfe. We are going to get going with our first session of the day with Canadian National. We have Janet Drysdale, Chief Commercial Officer; and Jamie Lockwood from Investor Relations. Thank you, guys, so much for being back at the conference. I appreciate it as always. I think Janet's got a couple of quick things she's going to start with, and then we'll jump right into questions.

Sounds good. Thanks, Scott. It's great to be here. As you know, I always appreciate the opportunities to spend time with the investment community. So I'll make just a few kind of brief high-level remarks and then like you said, we can dive right into the Q&A. I think let me start off by saying the railroad is running really, really well. I couldn't be more pleased with the service that Pat and team are providing to our customers. And that matters because the service, number one, helps us to grow volumes. Number two, it helps us with pricing. So let me talk about pricing for a minute. We have been very, very consistent with our pricing strategy. And we have spoken about it on the last 3 analyst calls. I'll speak about it on the next 3 at the risk of sounding like a broken record, but it's pretty straightforward. First and foremost, we're going to price to the value of the service that we're providing our customers. We're going to price ahead of our rail cost inflation, and we're going to sell into our capacity. So let me say a couple more words about that. When we are out meeting customers, when we're out trying to drive new business onto the railroad, what we want to do is make sure that we can service that business really, really well. Because if we do a good job for the customer, the customer is going to win. And when they win, we win. And we service it well, we do it at low incremental cost as well, right? So you're not jamming up your network. So that really matters a lot to us. Let me say a word about revenue per revenue ton mile, while I'm talking about pricing. You'll remember, Scott, many years ago, railroads used to provide same-store pricing. We stopped doing that because it wasn't comparable the way it was measured between the railroads. And so you're kind of left with revenue per carload or cents per RTM as a kind of proxy for pricing. I have to tell you, it's not a great proxy. There's a lot of noise in revenue per RTM, and I think we saw that in the first quarter, when you think about things like FX, the fuel surcharge, and on the Canadian side, we have the carbon tax as well. So it gets hard to measure kind of on a year-over-year basis and really have an understanding of the underlying pricing. When we think about the mix of business, there can be a huge impact to revenue per revenue ton mile based on mix. Just to drive that point home, if you look at the numbers, you'll see intermodal and automotive as examples, where the revenue per revenue ton mile is much higher than the average of the other categories. Now that's not to suggest that intermodal and automotive are the most profitable business units, nor should it suggest that you're getting the most pricing in those segments, but it's just a way to drive home the point that mix has a significant impact on revenue per revenue ton mile. So let's talk for a minute on volumes. We had about 3% RTM growth in Q1. As of this morning, I would say we're pretty close to 3% on a quarter-to-date basis in Q2. So that is running, Scott, a little bit ahead of our expectations. Where we've seen some really good strength is Grain Canada, grain U.S. We've seen strength in our refined petroleum products, and that relates to the Toronto fuel distribution facility that we opened up and are now into Phase 2 of moving unit trains with that facility. Natural gas liquids, which I think we should spend a little bit more time talking about today, have all kind of surprised a little bit to the upside. Some of the other areas that have been more resilient, where we expected maybe more weakness are things like metals and automotive that were impacted by tariffs. These segments have proven more resilient than we expected. Potash is surprising to the upside. Automotive, I think I said automotive already. So we've got -- the more weeks, I guess you could say, under our belt, the more confidence grows. When we think about the second half, I would say it's still a bit murky the macro. And so we remain cautiously optimistic, but the good news for you is that we report volumes on a weekly basis, so you can track it with us as we go. When we look a little further out, so kind of that was half 1, half 2. If we now kind of think about where we're getting to at the end of '26 and what does '27 and '28 look like, I think that's where we're just really excited. I think we have tremendous growth opportunities, multi-project, multi-commodity, and I think the announcement that went out earlier this week on ACE terminal, this is a partnership with Keyera and AltaGas, who have been great partners to CN and will be great partners for many, many more years to come. This is a little bit of an underappreciated, I think, opportunity for CN, where our network is really just built for growth. So if we think about the Montney Shale region, which borders Alberta and BC, this is one of the most significant natural gas deposits in all of North America. Now we don't move natural gas as a railroad. But what's happening in Canada is we're getting more export capacity for natural gas. When that happens, there's more drilling that takes place to produce more gas. This is a deposit that is very rich in liquids. So natural gas liquids, you're talking about propane, butane, ethane, condensate. All of that moves by rail. And so this ACE terminal is going to be an important long-term growth opportunity for us. And this is, of course, all linked to growing export capacity at the Port of Prince Rupert and the new capacity coming online there with REEF to actually get the propane and butane offshore. The ethane is also an important component because this is making it cheaper to produce plastics. And so plastics eventually will be another key export opportunity in Canada as well. So let me wrap up by just saying we're built for growth. We have the capacity available. We have the franchise that is well positioned to where incremental growth is going to come from. And we believe that, that growth is going to be able to come on at a low incremental cost.

Okay. Great. So I'm going to start with some questions. If audience has questions, raise your hand, we'll get you involved. I appreciate your -- you start in your opening comments talking about sort of price -- because I don't know that we typically hear opening comments from rails start that way. So I appreciate that. I guess I agree with you, right, that rev per car, cents per RTM are not perfect, right? We look at it because we don't have a choice. And I guess then I would sort of post to you, why not go back to the same-store price? And you can't say because it's not comparable anymore because no one else is doing it. So why not be the leader and start reporting the same-store pricing?

I think this is an area where there is not a big advantage to kind of be out on your own with the number. I think the guidance that we can give you is that we are pricing ahead of our rail cost inflation, right? And right now, I would say our inflation is driven by 2 major components, it's labor and it's materials. And our inflation is probably running in the 2.5% to 3% range. And so you can assume that we're pricing ahead of that.

And when we say we're pricing ahead of that, right, there's a discussion some rails have pricing dollars and...

Yes, yes. Let me explain what we mean.

Because ultimately, are we -- like it's not obvious, right, that pricing is accretive to margins because margins have sort of been steady, right?

So yes, no, 100%, Scott, it's a good question. So when we measure pricing, we measure it on a same-store basis. So it's a very detailed measure. Is it the same origin, the same destination, the same commodity, the same car type? You kind of have to check off all of those parameters and then did it move volume? So is my price this year higher than my price last year, and I measure it against the volume, which gives me the pricing dollars, okay? So it's a pretty rigorous measure. What we're seeing is that we continue to have this mix headwind. And so we talked about that a little bit in Q1, where mix is essentially offsetting our same-store price dollars at the moment. And the mix impact is really driven by -- kind of headline would be the forest products, right? So we're seeing 40%, 50% kind of tariffs and duties on Canadian lumber into the U.S., and that has hit us hard. Now that will continue to probably about October of this year because that's kind of following the sequencing of when the incremental duties and tariffs were applied last year. Metals has been a headwind. But as I mentioned, it's actually faring better at this point than what we would have expected. So I would put most of the mix issue on the forest products that give you the sense that as we kind of lap the tariffs that were placed last year, we should have the opportunity for the pricing to show through without the mix impact.

And just one more, just on this sort of thing I'll add. If you're pricing 50 basis points above inflation, you're sort of at the whim of mix being a headwind. If you start pricing 1, 2, 3 points above inflation, then you could say, hey, mix the headwind, we don't care. We're still getting net price [indiscernible]. Is there an opportunity to sort of accelerate that price?

So my customers will tell you there's not an infinite pricing capability, right?

Sure. No, I'm not suggesting we go 10 point. I don't know, like is the some opportunity to sort of -- you understand what I'm saying, no?

No, I -- listen, I'm very, very comfortable with the team's approach to pricing, and we do this on a disciplined basis. We're looking at individual origin destination lanes, understanding the relative competitiveness. But there is no point for me to renew a contract at 6% if I don't move the volume. Okay, that's theoretical pricing. What I care most about is dollars that I can put in the bank account that support earnings growth. And so it's not -- there's not unlimited pricing power. I think we're in a market where we've had multiple years of weak volumes. We're seeing that now start to correct itself. So we're seeing the tightening truck rates and capacity. We're seeing all of the rail is getting a little bit more volume growth. So I think we're kind of coming out of the worst of it. And then it's service, like how good of a service are you providing? That's where you need to be able to anchor your price.

And is this trucking phenomenon, certainly in the U.S., is that any signs of it spilling over into Canada so we can...

Yes. There are some early signs. It is stronger, like in the U.S., I would say, and I think you see that from the various companies that you cover. But we are seeing some of that traction take hold in Canada as well.

Okay. And then maybe just -- I'll get to you. One second on questions. If there's a mic, well, we can get around. So you mentioned RTMs tracking up about 3%, again, the guide sort of for the year has been flat, right? You mentioned some macro uncertainty. Do you feel like there's upside potential? Or is this, hey, grain is really, really good right now. Do grain comps start to get harder as the year progresses? Is that sort of part of the...

Yes, I think grain is always the unknown, right? So I think that's an important point. And the single biggest driver of the strength has been grain Canada and grain U.S. Normally, at this time of the year, we actually see a little bit of a slowdown in grain shipments because the farmers around in their field planting. The planting has been delayed. It's been quite wet in Western Canada. And so those volumes are holding steady. And then it's all about trying to predict what the next crop looks like. And as farmers get a better handle on that, they'll make decisions around how much of the current crop they hold back or release. And then that gives us a better sense of what does the, I would say, September to December time period look like in the context of grain. The crop isn't even planted yet. I think that's the key point.

Yesterday, CP suggested that they think from a year-over-year standpoint, grain could look pretty good through December. Do you have that visibility yet or hard to know?

Well, it's hard for me to predict the crop that hasn't been planted. I would say that I think the visibility is pretty good on the crop that's in the bins right now. So we feel good about -- and it's both Canada and U.S., I want to make that point. Like we've had an all-time record crop in Canada, but it was a record corn crop in the U.S. And then the resolution with China on soybeans in the U.S., the resolution between Canada and China on canola, all of that has been constructive for shipments this year.

Okay. And then -- just a couple more on the volume side. So you mentioned we get to October and some of like the lumber, forest product comp should start to ease?

Yes.

We're still in a pretty weak housing market.

We are in a weak housing market.

Are things not continuing to -- are things stabilizing at a low level and so we just have to lap this? Or is there a risk that we just continue to see downward drift on...

Yes, I think that's a little bit of the unknown. I think housing is such an important segment, not just lumber, but for the broader economy. And when housing goes well, you have your lumber, you have your roofing shingles, you have your wallboard, and then somebody builds a new house and they want all new appliances and they want all new furniture. So it actually brings growth in intermodal as well. So when the housing market is doing well, our railroad volumes are doing well. So I would say -- the way I would answer your question is that the #1 issue is the housing starts. The secondary issue is the duties and tariffs. So we will lap that issue, but we don't expect growth to return until the U.S. mortgage rates come down a little bit and we see housing starts move up a little bit.

Okay. You said we should talk more about NGL. So let's talk more about it. So how big is that of a business today? Where do you see over the next 12 months, 2 years, like how much growth should...

Yes. I mean this business is growing at double digits. And this is all related to that Montney Shale region that I was talking about. So the more opportunity that Canada creates to export more natural gas, the more that this is a long-term opportunity. And so there's multiple projects that are being kind of fast-tracked to increase export capacity. I think you've seen kind of the Canadian government be very focused on liberating Canadian energy. And obviously, it's a good time to be doing that. So as that grows, we're going to grow with it. We have more fractionation capacity that's actually coming online in the second half. So what I mean by fractionation, if you're less familiar with that, once you kind of extract the liquids from the production process, it goes through a fractionator, and the fractionator is what separates the products into propane, butane, condensate and ethane. And so more capacity coming online in the second half. And then I think the Keyera, AltaGas, CN announcement is kind of the proof point that this isn't growth for a year or 2. This is a decades-long growth story. And I think that's an important piece. And it doesn't just mean more propane, condensate and butane opportunities. It will help crude oil opportunities. It helps plastics opportunities. So it does have an outsized impact, I think, on overall volumes, and it's something that our franchise is particularly well suited to in that Northern BC area. Frac sand as well. I mean that's the kind of key input to make this happen.

So do you think there should be double-digit growth for multiple...

For that segment, yes.

And is this a -- where does this rank in terms of like, is this a better margin product or something, I don't know.

It's within our Petroleum & Chemicals business unit, which does tend to be at the upper end.

And you mentioned this is a growth opportunity. I've heard over a long, many years, lots of different growth stories. We've talked about -- all the rails, there's Meridian Speedway, there's Lazaro. There's this East Coast Port, there's this triangle strategy and these -- there's one growth pitch that has really, really hit, and that is Rupert. But it's -- the last few years, that has stopped. And Rupert is down a lot from where it was. What wrong with Rupert of late, and when does that start to come back?

So you have to kind of split Rupert in half, okay? Because Rupert used to be just an intermodal story, and it is equally, if not more, a carload growth story today as well as an intermodal story. So on the intermodal side, we did, we had some challenges, labor issues in Canada, both at the port and the rail side, where we lost some of that traffic to the U.S., and we're working hard to get it back. I will say that we have the Gemini service at Prince Rupert. It is going extremely well, exceeding our own expectations, I think. And that creates a proof point for other shipping lines. And so I think all of the structural advantages of Prince Rupert remain fully intact, and it's more about kind of giving the proof point around the stability of kind of labor and the supply chain is the important point going forward, and Gemini is helping us demonstrate how successful the port can be on the intermodal side. The carload side, like I said, we've talked about the NGL exports. We think there's incremental opportunity for metallurgical coal. So it's becoming as much a carload growth story as an intermodal growth story.

What is Rupert growing this year, do you think?

I don't know off hand, but it's outpacing...

Is it growing?

Absolutely, yes.

So you think Rupert, you think is back on a growth...

Rupert is back on a growth trajectory, absolutely.

Okay. Sorry, there's a question. Mic is coming right behind you.

It's more just going back to the pricing side. So you say pricing in excess of inflation. But can you just drill into that a little bit? Like what does that mean? And like, when you talk about inflation, is that like realized inflation or some sort of pro forma thing? And then when you think about this year, I know you do a fuel surcharge pass-through, but a lot of your other inputs would be sort of petroleum-based, I'm thinking like lubes and things like that, that could see really significant inflation. So like how are you factoring that in? And how do you sort of get comfort that the ultimate price will actually be in excess of inflation?

So the fuel is well covered by the fuel surcharge. So it's -- the vast majority of that is the diesel fuel for locomotives. And yes, there's some other products that kind of get used on the railway, but that is well covered with what is a pass-through fuel surcharge. So when we're talking about other inflation, we're talking about labor being a key part of that. In Canada, the labor inflation is about 3%. We have a smaller base in the U.S., that's maybe running closer to 4%. And those are really just based on the negotiated collective agreements. So there are known, and they're typically known kind of multi-years. The balance is materials. And so that's how well you're contracting for other materials that are used on the railway, and that's running a little bit lower. That's more in the 2.5 kind of percent range. So when you put the basket together, -- this is the inflation that we're talking about. It's the specific inflation for CN that we're trying to make sure that we're pricing ahead of. And for sure, that this is dynamic, right? As we kind of go through the economic cycles, when demand is higher, when inflation is higher, we're going to see price move up. We do have regulated grain that we're dealing with. So a certain portion of our business is regulated. This is export grain in Canada. And so that has put a little bit of pressure on our pricing for this year. That regulated grain increase is about 1.7% for the '25-'26 crop year. I wish I could tell you that, that was going to improve as we think about next year, but the pricing has already been released, and it's 0.66% for CN for the '26-'27 crop year. Now that segment, the fuel is embedded in the index. So there isn't a separate fuel surcharge. So fuel can cause a lot of noise in that regulated grain number. And so it's not as responsive. So it tends to be a timing issue of when you kind of get the benefit of fuel, but that timing issue could be like a year later. So that's just something to keep in mind about how we kind of move through the cycle and how we price differently according to the market conditions that are out there.

So what you're -- so August of '26, regulated grain rates only go up less than 1%?

Correct.

And it's on like a year lag, right? So you're going to have -- that piece of your business is going to see a real margin hit relative fuel that's up meaningfully? And then in theory, next August, regulated grain rates, including fuel, go up a lot. And then fuel, hopefully by then, is normal, and regulated grain margins should look really good in the back half of '27?

That's the theory.

Right, in theory.

Now I would just say that it is a bit of a black box in terms of how the government does these calculations and then how they correct for prior year forecasting errors. But yes, the theory that you outlaid is sound.

And is that like enough of the margin hit that mismatch on grain rates versus fuel to impact my model?

I don't think so, Scott. I think you've just got to -- when we talk about the mix headwinds, you got to factor in a little bit on the grain side. I think that's how you should think about it, not showing through maybe as much as we all would hope in the near term, but catching up timing issues.

Okay. So that like, I think leads like a -- like a bigger picture question. I think I asked it to you maybe on one of the earnings calls, but I'll sort of ask it again because I think it's important to sort of understand this, right? For so many years, right, the thought was rails could grow earnings high single digits, maybe even low double digits without much volume growth. There was enough price, there was enough cost margin, there was enough buyback to sort of get us there even without much volume growth. And certainly, it doesn't feel -- that's not what we're -- last couple of years, we're sort of flattish on earnings this year, you're saying volume flat, earnings up slightly more than volume, like can we get back to that better sort of earnings growth algorithm? What has to happen to get there?

Yes. So let me start off and then Jamie can jump in. I think, Scott, we're going to kind of Wikipedia this to your name, Scott Group, earnings algorithm. So it has become a thing.

Instead of the OR question.

Yes, yes. So yes, the earnings algorithm, we believe, is actually fully intact. Now year-to-year, you're going to have some noise. But do we think that the CN railroad has the capacity in a supportive environment, economic environment, good macro, to be able to deliver high single, low double digit? The answer is yes. Jamie, maybe you can give a little bit more color.

Well, and I think if you -- even if you start looking last year, we had 1% volume growth, 7% EPS growth. So I think in 2025, so that as the base going to prove us that earning algorithm theory. This year, we have FX issues and a higher tax rate, some headwinds from other income. But when you pull those aside, Scott, and you look at the base of how the business is performing, how Janet's doing on the commercial side on -- and with volumes, how Pat's doing operationally, I think you see that at the core, and the core engine is running well, and the earning algorithm is actually intact.

Okay. And so looking ahead a year, if we lap these headwinds, maybe there's -- if the volume environment is picking up a little bit, maybe then the pricing environment picks up, like the pieces -- grain could turn into a -- grain pricing could turn into a tailwind back half '20 -- like those are the pieces that could get us back to that.

There's leverage in our business. And when the volume comes back, when you see the volumes come back, you'll see the earnings follow it.

And then just one other -- I know there was a question on fuel -- I did the Canadian grain. Any thoughts of changing the way the surcharge mechanisms work to more frequent resets?

Yes. I mean we're -- we have a 2-month lag. Most of the rail industry has a 2-month lag. On a regulated basis, it's really hard to get shorter than a 1-month lag. You have a minimum 20-day notification period that you have to respect when you're changing tariffs. So I don't think it's a high priority, to be honest, Scott. I think the overall fuel surcharge functions well and as intended as a kind of a pass-through mechanism. So no, I think we're comfortable where we are.

Just sort of a near-term question. You talked about on Q1 call few set headwind from fuel in the quarter and sort of 200 basis points on margin, right? Typically, we see margins improve, I don't know, 2, 3 points, Q1 to Q2. Given that fuel headwind, like do we -- should we still see some degree of margin improvement Q1 to Q2?

I think you'll see it -- Jamie is going to correct me if I'm wrong here, you'll see it on a sequential basis, so that normal seasonal pattern will hold, but fuel is hitting both your top line and your bottom line. And so it kind of comes at 100% OR. And so when we look on a year-over-year basis, I think there may be just more of a headwind.

Do you think it's still fair to see like the normal...

The normal sequential improvement comes through and then you have -- I think just like called it out at -- at Q1 of a 200 basis point hit from fuel. That was -- fuel was at $95 a barrel. So we'll see if it stays north of 100, it was back down yesterday. So there's a little bit of noise, maybe a little bit plus, minus on that 200, Scott.

And then last -- just a few minutes, maybe just a couple of minutes just on the bigger environment with M&A. Maybe just at its core, like what are your greatest concerns about the merger? And what do you say to the argument of, hey, there's already a transcontinental system in Canada. It works. Like why shouldn't we have that here in the U.S.?

I think for us, the biggest concern has been making sure that there is adequate data to make an assessment of the impacts of the merger. And I think we've demonstrated through our various filings that we don't think it's -- we're there yet in terms of the robustness of the data. I think the other piece is really...

Can I jump in for one second, sorry. You're not even making a comment about the merger. You're saying the application is still incomplete in your...

Yes, yes.

And we'll find out next Friday.

Exactly. But this is significant, right? This is the most significant merger, I think that the industry has contemplated. And with the most significant bar in terms of the necessary remedies to demonstrate enhanced competition. And to be clear, the measurement for enhanced competition here is as an existing rail customer. It's not truck to rail conversion. That maybe is kind of community benefit or a social benefit. But if I am an existing rail customer, you have to be able to demonstrate to me that this merger creates enhanced competition. I don't think that bar has been demonstrated to this point, and it is a high bar. So when we think about is this going to happen, is it not going to happen? One, we think having the right data is really important. Two, we are the railroad probably least impacted by the merger just due to the nature of our network. We originate about 85% of the traffic that moves on our network and we originate and terminate about 65%. But if there's a way that we can play a role in the context of remedies or if there's a way we can influence what we think remedies look like to demonstrate enhanced competition, then we're going to be an active participant in that process.

And then maybe just as we wrap up, anything active participant -- any specific things you would like to see from a concession standpoint? And then just hypothetical, if this gets approved, is it inevitable that one merger leads to 2 or 3 or 4 mergers?

Yes. I don't know about inevitable, but I think it's -- we're running all scenarios, and likelihood would suggest so. I think for us, we remain focused on growth. And I think as we've kind of talked about today, we have a network that is really built for growth. We're well positioned to bring volumes on at a low incremental cost and to benefit from our operating leverage. So this is where we're really putting our time and energy. And trying to leverage -- we talked about the NGLs, we talked about Northern BC. We didn't have time to talk about just kind of the build Canada and the amount of infrastructure projects and the acceleration of those infrastructure projects, whether it's critical minerals or other -- just energy products. So we are quite excited about how we kind of move into '27 and '28, and that's what we're focused on, growing.

Do you want to take a minute and just talk about that? Like you just -- what that opportunity is?

Yes. So I mean I think we've taken a new Canadian government, a new approach in terms of trade diversification, desire to really liberate Canada's natural resources, whether it's energy, whether it's critical minerals. And so I think rails are going to play a really important role in that in getting Canadian goods to offshore markets. And I think we're primed to be the railroad to help support that, particularly given our northern reach to where some of these resource bases are located.

Jamie, thanks so much for being here. That was great.

Thank you.