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

Great. Good morning, everyone, and welcome back to Day 2 of the Laguna Conference. We had an exciting day yesterday and hoping for a lot more great content today. So very happy to kick off our day 2 schedule with Canadian National Railroad, and very happy to welcome back to Laguna, CEO, Tracy Robinson. Tracy, thanks for being here.

Thanks, Ravi. Always good to be in Laguna and always happy to come back and talk you about what's going on in the rail space.

Great. That's awesome. I will let you open with some opening remarks. But before that, I have to say that for important disclosures, please see Morgan Stanley's research disclosure website at morganstanley.com/researchdisclosures or please read our recent research. And with that, Tracy, do you want to just open up with the lay of land?

Sure. Listen, I'm really proud of the way the last year has unfolded. But what I maybe I'll do before we get to your questions, Ravi, is I'll spend just a couple of minutes on where I'm focusing my time and where we're all focusing our time as we look forward as well. And that being on some pretty interesting growth opportunities combined with some disciplined operating execution and how that kind of combines to create some interesting shareholder value. So on growth opportunities, first, I got to tell you, I am really happy to be sitting here this year with a network that now extends into Mexico. This agreement that we've reached with the Union Pacific to extend our network to Mexico to connect with the FXE through Memphis is kind of a once-in-a-generation opportunity for us. This is a market, the trade between Canada and Mexico is $45 billion. It grows across all commodities. And this is -- we've got this tremendous origination network. So we're matching that in a really kind of lean, fast route through Memphis down to FXE. We're connecting that with the largest railroad in Mexico and the railroad actually that's growing faster than all of the railroads in North America this year. So we're really excited about that opportunity. We've positioned ourselves really well, and we've done it without straining our balance sheet in any way, which is important to us. And so that's meaningful. And I think you're going to be hearing a lot more from that -- from us on that as we go forward. But back on the base network, we continue to be bullish on energy and on ag. If you look at what's happening in the energy space, we've got a network that sits right on top of the Western Canadian energy complex in the Montney Shale region. and all of the development that's going on in there on NGLs on -- it's interesting because it's multi-commodity, it's multi-market. It's driven by very strong demand for energy across North America and increasingly globally. And it's underpinned by significant investments, long-term investments by our customers and partners in supply chain. So whether you look at on NGLs with AltaGas is investing in facilities in Rupert. If you look at the Keyera Ace terminal, which is a unit train loading facility to load NGLs in Alberta, if you look at the Strathcona crude facility that's ramping up. If you look at those byproducts go into the Dow path to Zero facility that's under construction in Edmonton. If you move over to the bulk, you have can export facility, we were all up there to celebrate its opening in Rupert 2 weeks ago. You've got the BHP potash mine in Jansen that's opening up next year. These are all structural foundational long-term growth opportunities that give us the benefit of that growth, but also none of this growth is really tied to the North American macro. And so this is all very beneficial. And of course, we have a much broader diversified portfolio. Janet is driving growth this year in automotive, in metals, in domestic intermodal. And she's got this boots on the ground program, and she's here with me today. She's got a boots on the ground program that is out there, not just on the big programs and projects, but also in driving and creating opportunities with small customers for smaller opportunities. Those are equally important to us. And so it's a challenging environment out there. It's challenging right now between Canada and the U.S. on the free trade front. But I think that what we're learning is that if we focus on what we can control, we drive those foundational kind of volume growth with key partners, then we will be less attached to the macro. So we're excited about the path forward, 4.5% growth in RTM so far this year. That will moderate a little as we get into a much tougher compare in Q4, but we're feeling pretty good about it. So you match those growth opportunities with really disciplined execution. We launched or relaunched, I guess, scheduled railroading 4.5 years ago at CN, and we've continued to refine it since then through initiatives like fast track and asset utilization and locomotive productivity. And Pat and team are delivering really strong results. So the network is fluid. Velocity is high. The customer service is very strong, and our productivity continues to improve. And that productivity improvement is really broad-based. So it's about the workforce, where this year, 5% better productivity across our workforce. It's 13% if you look at the train crews. Our locomotives are working harder. We are hitting records on fuel efficiency. And this is a drumbeat that we have out there around how we want to continue to drive productivity, getting more for our assets and our workforce every day. And so the question I'm often asked is with all the growth opportunities, are you going to need to start putting more capital in again? And the short answer is no. We did the hard yards of investing in debottlenecking the system, adding 20%, 25% capacity in the West, modernizing our locomotive fleet. So we're continuing to do those things, but the heavy lift is behind us. So now it's around -- we've pre-invested and now it's about filling that capacity and accommodating the growth opportunities. And so we're down to a much more normalized capital spend of between 15% and 17% of revenues as we go forward. And that includes some additional kind of debottlenecking and adding capacity on the network as we go. So that's great. So you bring those -- if you have an environment, if you look at it through the lens of a shareholder value, an environment of unique growth opportunities and really disciplined both operating and capital kind of execution, you create an environment where you have strong operating leverage, some underlying earnings growth and some really good free cash flow generation. And so what we're looking to do now that we've got CapEx stabilized, that excess cash goes back to our shareholders. And we have a very strong balance sheet. We've increased our leverage from 2.5 to 2.7. And we think that we're executing on that. We're very kind of conscious of the macro environment that we're in. We're very careful about the commitments that we make, and we are meeting those commitments. We're delivering on those as we go, and we intend to continue to do that. So I'll leave it there, and we'll get to your questions.

Great. No, that was a super comprehensive update. I think you hit all of my questions, so we can go to the beach now. No, a few follow-ups there, but that was a great start. Just on the growth, you said a couple of times that clearly a long runway of growth, but not necessarily tied to the macro. Are you guys able to unpack like what is an idiosyncratic organic level of growth that just the pipeline can generate and then what the macro can add on top of that?

So if you think about the energy growth that we talked about, so it's multiple commodities, and as I said, multiple markets. And what we're feeling, particularly in Canada, is the push for the diversification in trading. And so there's a lot of focus on finding global markets for this and having -- we have the capacity to do that. Government and focus -- I was at the Investment Summit that Prime Minister Carney ran yesterday, and he made some announcements to -- on tax and a few other things to solidify Canada kind of as a place to invest. And so we're seeing some increasing momentum in investment, not just in the energy space in the production. I mean it's across all sectors, critical minerals, but also in the infrastructure and supply chains in order to get it to marketplace. So I would expect that we're going to see this kind of development not only continue but accelerate. So if you think about it from an energy perspective, NGLs, which for a long period of time was largely a North American market, we've seen over the last 3 years, the NGL exports just through Rupert increase at a CAGR of about 8%, if we look at that just over the next 3 years, that growth rate is going to double. And so we're seeing that kind of growth across the energy portfolio, and that isn't tied to the macro. It is tied to economic policy and some of what's going on, but it's not tied to the macro. And some of the growth, the crude growth that we're seeing does go into the United States. The refined fuels goes out to -- we're in Phase 2 of our Toronto fuel facility. So it's a very kind of diverse network. So some of that will be impacted by the macro and a stronger kind of economic growth. Some of it is just going to be through global demand. The same thing for the ag sector. The Mexico growth opportunity is unique. We know that it is, as I said, a $45 billion in trade. A lot of that moves -- I mean, that's a very natural rail market given the distance that it goes. $3.5 billion truck market, right, that we would -- we're going to lean into. There's others that are leaning into that as well. We think that's very natural. And so there's a number of different phases of that. If you look at -- we'll have the extension of our length of haul down to Memphis. That's an immediate -- it's a benefit right out of the gate. We will have translation for rail volumes that are moving otherwise on rail and then we have the truck market. So that's more structural. Some of that will be tied to the macro. Some of it is more just moving volumes that will always move on to a different mode. So it's a good combination. We still have lumber. We still have automotive. We still have all of our consumer segment, and we like that business a lot. It's about the diversification.

Got it. So CN has always been a long-term growth story. And clearly, that's continuing with everything you've highlighted. But obviously, there's unfortunately been another very noisy chaotic year for the entire industry for sixth year in a row. So maybe we can unpack what some of the shorter-term trends look like. Obviously, earlier in the year, you had kind of very strong grain market, but then you had the whole USMCA deadline kind of be a little bit of a catalyst people are looking at. And then to your point, there's been trade headlines in recent weeks, $6 diesel. Obviously, you don't have as much domestic intermodal exposure. But where does all of this shake out as you look into the back half of '26?

Well, one of the big learnings from all of this is the need to be nimble in the ability to move quickly, right? And so we've looked back over the last 1.5 years since the trade and tariff discussions started, I mean, the first shocks were twofold. One was everyone sat on the sidelines waiting for some certainty in what was going to happen. We've all learned that there's unlikely to be a lot of certainty anywhere, right? So we are seeing most of our customers in our industry come off the sidelines, and they're taking positions, whether it be in inventory or their supply chain or getting into new markets. And so that's been a very positive. And in a lot of ways, it's an opportunity. So where we have the automotive, we have great Michigan franchise in automotive. We also have a Canadian franchise in automotive. But as we sit here now, Janet's driven an increase in our automotive volumes and a lot of that's coming in through Halifax and through Vancouver. So it's imports, but we have the capacity and the ability to be able to respond to that. And so as we look forward, it's going to -- that's what it's going to be, is our ability to be very close with our customers, be sitting with them to be able to find the different markets. Steel is another one that's been under a lot of pressure in Canada. And our steel volumes are roughly what they were, but it's volumes that are now instead of moving across the border, they're moving within Canada and within the United States. We've got new scrap movement that's moving on unit train. So it's about going out there and making your own opportunities. And then there are the underlying -- we had a record grain crop this year, right? And it was a privilege to move it. And we moved, we did a great job. We gained share, and we hope that it returns next year. I think it will be a strong crop next year, whether it will be as strong is a question mark. And we're ready for that. We've got the capacity in place. Our cycle times on those grain cars were significant. If you look at the Western corridor, it outperformed for us this year. So we did put the asset -- we did put the capacity in place, but the volumes were up between grain and energy. And yet -- despite volumes being up, our car velocity was up 6%, our dwell was down 5%. Our locomotive utilization was up 7%. So that it's moving, and we've got the capacity to do more of that. So I think there's going to be a combination of those fundamental structural flows that we'll invest in and having the ability to respond to mitigate the impact, but also respond to the opportunity of the short-term flows. And I'm a believer that we'll get through this what we're in right now and a more stable environment will emerge, then we may be better off for it. There's new opportunities that are emerging because of it.

It's great to hear. I don't know how you see it from your perspective, but I think there is some optimism on a USMCA resolution. Kind of do you feel like that is something that's going to open the floodgates and kind of unlock a bunch of volume? Or how do you see that kind of potentially being a catalyst?

Yes. I think it's industry by industry. And I think it will depend on what the agreement is. We had a near miss recently. And that created some optimism. And I think as I understand it, I think the tone is getting better as we sit here today. So I think it will depend on what the deal is. I think we're all resigning ourselves. It's more of a global phenomenon than just Canada, U.S., Mexico, that trade will look a little bit different and trade incentives, the economic policy will look a little bit different. And so as we look at broadly at the future, we see opportunity in that, both cross-border and the ability to be responsive to what our customers need and what those industries are thinking. But we also see tremendous opportunity in our Northern franchise on the -- sitting on top of the natural resource base of the continent with the kind of port access that we have through Rupert, through Vancouver, through Halifax and St. John and Montreal to play a meaningful role in that development of global markets.

Got it. I know it's not as big a deal for you, but it's sort of a theme of the conference, I have to ask you anyway. $6 diesel, what does that mean for you potentially in terms of volume tailwinds as well as potentially kind of cost headwinds in the very short term?

Well, listen, we've spent -- over the last number of years, we've developed a really strong domestic intermodal franchise, and it's largely on the back of really strong service. You've got to be competitive on price, but really strong service. And the nature of our network on the Canadian side of our business is such long haul that we've got great penetration. Now there's always -- we're focused on continuing to build that business. And certainly, anything that happens in the trucking industry around the fuel costs, around labor availability, it kind of makes -- it kind of confirms rail as a realistic opportunity and alternative. And so we'll make small gains there. But if you think about Mexico and that $3.5 billion truck opportunity, it could be very meaningful for us, and that is going to drive the opportunities for conversion from truck to rail, I think, in that marketplace. And so we're watching it very closely.

Got it. Understood. Obviously, with all of this volume opportunity, there's opportunity for price as well. How are you thinking about that volume versus price dynamic? And what is the opportunity on price, do you think in the medium term?

Well, when we go to market, we play with a lot of levers. So if you think about where our network is, where it can benefit our customers, where we can get them from and to. If you think about -- we think very carefully about our capacity, about the nature of the opportunity around the commodity and where they're trying to get and the sustainability of the opportunity, asset velocity, we think about all that. And then, of course, we price based on that. And so there's different -- we think it differently in different opportunities across our network. And so our objective is always to get maximum value for the capacity that we have. It's our scarcest resource. And so Janet does a great job in pricing. At the end of the day, what we ask her to do is always to come in above our rail cost inflation. And she does a great job of that. But there's a lot of moving pieces within it. What we're looking for is to drive not just growth. Certainly, we want growth, and we want to use our capacity well, but we want to drive profitable growth. And so Pat and Janet worked together very closely on where that capacity is, how we should be using it and price as a mechanism in a manner of how we use it.

Got it. Understood. Maybe let's shift gears a little bit and kind of talk about, again, the topic du jour and the rail industry for the last year...

There's a topic du jour?

There's a few of them. It's a long day. What can I say? But obviously, the merger, you guys were somewhat on the sideline, somewhat critical and then you reached an agreement with the UP that you say kind of helps with a lot of the considerations on the merger. Can you just help unpack that a little bit? Kind of what was the genesis for that? And what does CN gain in the bargain?

So we -- as you know, we have a great origination franchise, probably definitely more than any other railroad. 85% of our business originate on our network. And for the North American business, we pushed this down into North America, and we work with every one of the Class I and a number of the other non-Class 1 partners in order to get that in the marketplaces. And UP is one of them. We work very closely with Jim and his team on all kinds of efforts to jointly build the business. And as we contemplated the merger, I think it's clear we would have been probably and will be the least impacted by the merger given our North-South orientation and our strong origination franchise. But we also made a case quite publicly that we thought that it's a very high bar to meet from -- you have to need to enhance competition. We thought our network could be useful in doing that. And ultimately, in our discussions with Jim, we came to an agreement where we think that, that's the case. And so we will kind of provide a competitive option in Kansas City. If this merger goes forward, we will provide the competitive options for the 2:1s and the 3:2s. And then we'll participate in what some of the gateway provisions will ultimately look like. So the STB has got a broader question to answer, and I'll know they'll do that with all of the full rigor, but we believe that what we said is true, our network is being used to introduce more competition, which is good for the system. It's good for our customers and our customer base and the potential that we can offer them. And we believe that for us, it mitigated much of the harm that the merger kind of would have presented for us. So as we think about it now, we're no longer an opposition in the merger. It's a big question that I think the STB has to answer, but we're no longer in opposition for it.

Got it. Do you have a sense of just how active you're going to be through the process?

Well, we will certainly be active to the extent that we will be putting forward the agreement that we made with Union Pacific and supporting it, and we'll have a voice in the issues around that.

Got it. Just going back to the Mexico agreement, I mean, clearly, kind of very exciting for you guys, and you started out with the opportunity there. Can you just unpack that a little bit more kind of how near term or immediate is the customer reaction to that? Kind of are they saying, hey, we now have this pathway into Mexico we didn't have before. Let's get going. Again, you said that's not necessarily macro dependent, but kind of when do we start to see that show up in the volume numbers?