Canadian Pacific Kansas City Limited (CP) Earnings Call Transcript & Summary

Very pleased to be joined by Canadian Pacific for this next discussion. To my left here, we have the President and CEO, Keith Creel. Keith, thanks very much for joining us today. I think what we'll do is I'll turn it over to Keith just to run through sort of a brief update on the rail, where we stand sort of here in the middle of the first quarter. And then we'll jump into Q&A. Certainly would love to have the audience participate. So just raise your hand, we can get you a mic and get some questions going. But again, Keith, thanks so much for joining us. Appreciate it.

Okay. Thanks, Chris. Thanks for the opportunity to come and sort of talk about our CP story. And I think to put a bit of better context for how the year started, let's go back to 2019. So 2019 was a year of growth for this company. We're the only railway in North America that experienced positive growth. Now would I consider it a knockout year from a growth standpoint? I think you got to understand the comparison and the market that we're in. So we've led the industry the last 2 years as we've effectively created our own self-help counter to maybe some of the cyclical nature of the business, initiatives with our customers to drive that revenue growth. So we're creating our own success in that space. We go into 2020 with some momentum. We had it pretty tough from a comp standpoint, very tough, in fact, a very tragic first quarter last year with a very sad derailment that we had west of Calgary where we lost 3 of our employees. And it happened to be in the density, the most dense part of our network. So obviously, there was a cost impact and a service impact and a revenue impact. So from a compare standpoint, with that out, we should have a stronger first quarter, obviously. So January, with the help of those self-initiatives, we've got Yang Ming that came online, which is a contract we won last year. That's a $150 million annual contract that started. So we're driving growth in international intermodal. Domestic intermodal, we've got a great product with capacity inland at our terminals with the shortest and fastest, most reliable lanes in Canada that's allowed us to continue a third year of growth in that space. We've got crude oil, obviously, growing year-over-year. We exited fourth quarter of last year, 36,000 carloads. And we expect, if you annualize that, we expect that to happen in 2020. So 140,000 to 150,000 is what we're looking at, somewhere in that range. And then we've also got our grain network is starting to really hum. We've got our investment that we announced 2 years ago with the $500 million replacing and retrofitting and modernizing our grain fleet which was going, what I would have said was the worst in the business to probably one of the best. And it's a unique opportunity for us in that it drives an ability to move more grain per train because the cube on the car, so to speak, is much -- probably more -- and the cars are shorter so we can haul more cars per train. So you put all those things together, even with all the choppiness, we're seeing revenue behave the way we expected it to. And in fact, if you think about what corona may or may not do and is doing already to a point, certainly, it's delaying our potash, which is a big chunk of our business. There's some supply chain challenges with the weather. Specific to the West Coast, it has affected our coal business given the mudslides that we had out there and the snowfall in Vancouver and the rain in Vancouver. But in spite of all that, we're looking at, right now, almost 7% carload growth and we're pushing 5% on the RTM side, which is what I pay a lot to -- I'm sorry, 6% carload growth and 5% in RTMs with March to come yet. So we expect to have a strong first quarter. We said, and I think Nadeem led with his chin a little bit that the art of the possible was a 60% OR in the first quarter, and we still see that as the art of the possible. So that sets us up for a good year. There's obviously still a lot of innings in this game, so to speak. We're in the first quarter. There's 10-plus months left, but this company has some momentum. We have an opportunity with -- I talked about Yang Ming. We have an opportunity with our grain product, where we're hauling more per car. We're setting records every month with the grain that we're moving. That's a great product as we expand out that 8,500-foot network that we've talked about so often, as the terminals get built in the countryside and we have the terminals coming online in Vancouver. And we're the supply chain in the middle with a unique car set to be able to optimize that. And those are all -- and I could talk a lot about and detail every lane, but those are some of the things that are allowing us to be different than the rest of the story, so to speak. That gives us confidence and conviction about our -- not only our guidance but our future. Because the things I'm excited about in '20, I've got more on the list that are in play that are going to happen in '21. And then '22, we just bought this railroad. This little railroad we sold, my predecessor sold 25 years ago. We got a route now to the East Coast that I'm super excited about that's going to get us into Saint John. We took it over January 1 with -- the U.S. portion is still under review by the STB. We expect to get a ruling, timing-wise, they committed the 1st of May. We would take it over completely 1st of June assuming it's positive. And we do assume it will be positive. In the meantime, it's been running in trust. But with that said, I wanted to see the network. I went out there 3 weeks ago, I guess. I took a surprise trip. I flew into Saint John. I met with the Irving family. I looked at all of their facilities. And the potential for opportunity to create, when you look at it, it's similar to what we've done across our network. If you look at the way a crow flies, you can just look line of sight and distance, and distance matters. On my best day, if I can get to Montreal, Toronto and Chicago, which are key markets that we serve, in 24, 36 to 48, 72 hours, that's compelling. And I'm doing it because I'm running a shorter distance. That's the art of the possible. That railroad itself, it's not going to move the needle now for us to do that. This year and next year, we're focusing on investment to make sure the railroad is safe, to bring it up to a CP safety standard, to be able to turn those assets safely and efficiently because that's the recipe of our operating model. So once we get beyond that investment, and that's within our own capital envelope, I look at the end of '21 and '22, I see right now, we inherited or bought a $40 million U.S. railroad at a 90% operating ratio. We're not doing our job if that's not a $60 million to $70 million railroad '22 and beyond with CP-like margins. Now there's a lot of work to be done, but I'm telling you, the interest is there and it's not just a wish. I think it's truly possible.

Got it. Okay. That was a great opening comment, so I appreciate that. There's a lot to unpack within that so we'll kind of dig right in. Just to get it out of the way, what's sort of the thought around the coronavirus? How does that sort of manifest through the CP network? Is it primarily international intermodal? You mentioned potash, though, too. So can we think about a little bit of how that might play out over the course of the next month or 2 or so?

Listen, I'm not an expert. My guess is going to be as good as yours. We could compare notes, but I'm not going to tell you it's not going to have some impact. You can't shut the factories that produce the goods that go on the ships that come to the trains that feed North American appetite for goods down and not have some kind of impact. I don't think, though, that at this point, my guess is, based on what I'm seeing and what I know, it will have some impact, but I think it's going to bounce back. And I think it might put some pressure on the supply chain, but I think what we lose, we'll recover most of it in the second quarter and the third quarter. I think that our numbers, though, because again, we're unique, we've got this new contract, we're up double-digit in international intermodal over last year, some of it's going to be muted because of our own growth story. But we're paying attention to it. In that space, we'll see, I think I know 1 or 2 blank sailings now. That could increase. So I expect some impact there. The other place I look at, obviously, you talked about potash. The potash, we went into the fourth quarter and in our numbers, we didn't move near as much potash as we normally would because that contract with China was not signed. And they were in a place, and I think because of a lot of issues that were episodic issues with the swine flu that they experienced, their consumption of potash was not as great as it was. And their own dock inventories moved up. They had an ability to create a whole lot of leverage in the marketplace, so to speak, because they're such a big purchaser of the product. And they didn't settle. And that normally would have happened in the fourth quarter or early first quarter. So what we assume would have happened early first quarter because of the coronavirus, because people are at home and the people that negotiate and sign these deals can't even meet, that's naturally normally going to delay this. But again, I think it gets resolved maybe, I hope next month. But if not, it's going to happen. And I think we'll pick it all back up in second, third and fourth quarter. That's what I would expect. And again, if you look at my compares, a normal shipping product in the fourth quarter against one that was not normal last year, again, helps us feel optimism that we're going to be fine.

Okay. Okay. No, that makes sense. And then let's talk a little bit about, let's start with crude by rail. It's a topic we get a lot of questions about. Obviously, you mentioned the 36,000 carloads, on pace to maybe 140,000, 150,000 over the course of the year. I guess the first thing I wanted to talk about was slow order has been lifted. Has that had any sort of -- is there anything to think about lingering impacts of that when you think about your potential for crude by rail in the first quarter and then maybe for the full year?

I don't know. I mean I think you got to separate the 2 as much as you possibly can. In Canada, if we go back to 2013, we had a horrific accident in Quebec that killed 47 people. And it was a crude train, obviously. So there's, understandably so, hypersensitivity about making sure that crude moves. We know it has to move and it's moved safely. So when you have a series of unfortunate incidents, and we had 2 derailments ourselves and CN had some challenges theirselves, when you look at it in totality, you've got to take a pause and say, wait a minute, do we need to do something differently? And that's what the government did. Their initial response, and I've been candid about this, it was overreaching out of an abundance of caution because they applied it to the entire network, everything, not just crude. And I'm not going to say this is just a crude problem, sure -- or a crude challenge or a crude opportunity. The conversations I had with the minister, with the government as well as with the experts that work in Transport Canada, listen, there's nobody more [indiscernible] conservative than us. I'll let our track record stand for ourselves. We're not a perfect railroad. But in this space, we've created a whole lot of success because of our process, our people and our technology. We've been the best by a long way for 14 years. That's not by accident. So with that said, let's pay attention to the data. And let's see where the data leads us. So listen, I understand we've got to do this for now. But when we have these discussions, let's get the right people to the table and let's make the actions be targeted and specific to mitigate risk and to give us the best answer. And that's why you saw revision come out 2 or 3 days ago that we've been operating on since. And that's a much better place. Obviously, the concern is still there. We have unique investments within our own capital envelope in all those spaces, process, people, technology, that will allow the best to get better. But as I've told the minister and I would tell anyone the truth, there's some inherent risk in what we do. The only way I can tell you we're never going to have a derailment is we never run a train. And there are all kinds of unintended consequences for that as well just like planes and trains and automobiles. But I can tell you that when we make a mistake or if there's a lesson to be learned, this is an organization that believes in getting better every day. And we're going to be objective and we're going to be transparent and we're going to use data and we're going to take action. And that's exactly what we're doing. And that's what's going to fuel what has been good, become better for this railway.

Yes. Got it. So when you think about the future. I feel like I've asked you this question on several conference calls, and you give a fairly similar answer, but I'm going to ask you again anyway. What do you think the capacity is to move crude by rail on the network? So you're talking about 140,000, 150,000 this year.

The reason the answer is the same is because the story is true. We got burned by crude. Not maybe burned, burn is a bad word to use. Our shareholders took a hit because of our optimism in the crude business back in 2014. We believed what we were being told. And I believe that the customers, based on the economics, believe they were going to do that at that time, too. Well, the world changed and the price of oil in the $100 a barrel, it dropped substantially. So the economics disappeared and there were no levers for the railway to protect itself and to protect its investment. So I learned and I said, you know what, when it came back, and we knew eventually it would because we knew what was being built from the production side versus what wasn't being built and delayed on the pipeline side. So that's essentially what's driving crude today. It's -- there's not enough takeaway capacity in the pipeline to handle the product. So as we ramp back up, we constrain demand. I didn't want to be the king of crude. I wanted to have the right amount of crude that would not cause me to go on a spending spree and sink capacity in that's going to be trapped for decades that I'm not going to need when it goes away because it eventually will go away. And those are the discussions we have with the customers. Listen, I want to haul your product. I'm going to move it safely. I'm going to move it efficiently, but I can't let that demand outstrip my capacity and adversely affect my business that I've got that's going to be here now, 12 years from now, 50 years from now. I owe more than that to my customers and I owe more than that to you. So we didn't get into a space. We're handling what we can handle without adding a tremendous amount of capacity. Our capacity in our contracts on our take-or-pays were tied to, what do we have to invest in locomotives to haul the business? They own the railcars, not us. And there's a couple surgical, like in and around Hardisty, we put some additional tracks in. I'm talking about these safety enhancements we're making to the railroad. So all that was baked in. So we're not in a capacity-constrained space. And then what's going to happen and a lot of people don't understand the true power of this. That thesis that it goes away, it will eventually go away when the pipelines are built. Now when that happens, I don't know if it's 3 years, 4 years, 5 years, it will happen. When it happens, what's going to be left is what makes sense to be in the railcar. That's where this whole new narrative about the DRU comes in. And that is a unique value proposition for this company because at this point, although 2 locations have been talked about, there's only 1 where there's a shovel on the ground, and it's exclusively served by this franchise and it's in Hardisty in partnership with Gibson and in partnership with the USD, which are 2 very progressive, forward-thinking companies that know first-mover advantage. So they partner with ConocoPhillips, with CP, with KCS to create a business case that's driving investment to build this DRU at Hardisty. So today, to simplify this, we're hauling 3 starts a day of typical crude oil. So it's heavy Alberta crude, which is 70% bitumen and 30% diluent. The economics that make a pipeline competitive in simple terms is take the diluent out. Eliminate that cost and fill that tank car up now with 30% more pure bitumen. So there's more product leaving per car to the refineries. You create the supply chain in the middle. USD's building through KCS at Port Arthur, they're building the facility to take it out of the railcar. And then the rest of the magic that I love about it as much as the business is the safety aspect. It's not a hazmat product anymore. If you have an unfortunate derailment, if something happens, I don't have the environmental risk. I don't have the public risk. I don't have any of that risk. And it becomes a revenue stream for this company that as long as we burn fossil fuels in this nation, and I don't see that going away anytime soon, although we'll be better at it, it's going to be in a revenue stream. And it's scalable. And that's the next phase of it. Once this thing takes hold and people, I think people being the oil companies, realize they can diversify their own supply chains. They can have the pipeline. They can have the crude by rail pipeline from a DRU, which is a pure bitumen, and they also can have the water. And through those 3 supply chains, they get reliability in their supply that gives them power to make money in their markets, which is going to benefit us. So I think other oil companies eventually will come to the table. And this location, bolt-on more, bolt-on more. Right now, the nameplate capacity when it opens is advertised at 100,000 barrels. And in simple terms, every 50,000 barrels is a train start. So 2 trains a day out of the 3 that we're running out there today. It's not new revenue. It's not incremental. It's going to displace existing. Risk profile is more powerful for us and more exciting for us. Length of haul changes, too. So the revenue per car is not as high because the risk is not as high on a per mile basis, but I'm hauling it, instead of Emerson, the preponderance of it. Ten-year deal that we signed, it comes online next year. Its rough number is $100 million a year in revenue with a potential -- the footprint to double when the business comes and the ability for us to move it without additional capacity in the network when business cuts, other than crews and locomotives. So it's a powerful game changer, I think, for all companies, for this railway. And eventually, there are other players, Cenovus has talked about building one in Edmonton. But in Edmonton, the benefit for Cenovus is they're dual served. CP and CN both have access to their facility. And/or if Exxon or Imperial Oil were able to do something at Edmonton, CP and CN have access. So I'm not disadvantaged at all at Edmonton. It's competitive. CN and CP are there. At Hardisty, we provide a great service. We charge a fair price. It's a solution, a supply chain solution that's going to be baked in for a long time. So again, it's a super exciting development within the crude oil space that makes it -- we're going to talk about it for a long time story instead of it's eventually going to go away.

And so you mentioned the 10-year contract. And obviously, those are interesting terms for those of us who observe the railroad. You don't see that many deals that long. It feels like that's partly generated by the idea that this seems from an economic perspective competitive or closely competitive with pipe. Can you talk a little bit about sort of what the business looks like for your customers that, that competition relative to pipe. Is it close?

Yes. That's what drove it. It is. It's pipeline competitive. Talk to the oil companies for the details, but you condense the difference and you essentially make up with the additional bitumen that's in the car as well as what they can refine from that pure bitumen on the receiving end, it washes out all the difference in transportation cost and it makes that barrel competitive. That's the way I understand it. And the only reason it's a 10-year deal is because everyone is sinking a tremendous amount of capital. If you're going to make an investment of that magnitude on both ends, you need to have some assurance of what your deal is going to look like for 10 years. That's good for all of us. We all can plan to it. It's profitable for all of us. It's value-add for all of us. So in a case like that, I'm not a long-term contract guy, but to get it off the ground and get it started and create that supply chain, it makes good sense.

And last question on this. Do you have capital that you need to deploy to serve this? Or you...

Locomotives and people.

Okay. Got it. Makes sense. Okay. Absolutely, go for it.

In your view, the pipelines will be in service, whether it's a year or 5 years?

It won't be a year, but yes, it's going to happen.

Where would the pipelines have to go from and to? And then a second question is, there's so much light shale oil, would there have to be another U.S. pipe just to carry bitumen?

When you say light shale, are you talking about the stuff down in the Bakken?

What's that?

Are you talking the Bakken stuff or the heavy Canadian stuff, light shale oil?

The heavy Canadian.

Yes. So if you look at the numbers with what's been brought online and what's planned to be brought online, unless that changes, unless somebody backs away from a commitment, there's enough opportunity. You're going to have to have a pipeline going west, which the government is committed to doing at some time. It won't be without its challenges. I think Enbridge is going to come on first going east and then [ a play ]. I don't see crude moving in a train unless it made sense. This DRU is the only thing when all that happens. It's going to make economic sense itself or maybe a surge. If there's a supply chain disruption, a pipeline shuts down. Railroads in the past were a fringe player. We were an insurance clause, so to speak. Those assets cost too much to make long-term investments to be an insurance clause. That's why I'm so excited about this piece. So in the meantime, we're going to continue to move it all. As long as we don't outstrip our capacity on our network. I'm not going to build a church for Easter Sunday for business that goes away in 3 or 5 or 6 years because it's a 40-year decision. I'm going to prepare for that chunk that's going to stay there. And I'm going to help make sure it's reliable and it gets to the end markets and it creates value for our customers so they'll build more of it. And then we'll benefit from that as well.

It's kind of been out of the headlines as of late, but the pipes in Canada, is there something that we should be watching in terms of like [ costs ] or like [ movement ] or...

You know what, unless you saw a headline that somebody's giving up on their project, it's just timing. I don't want to be disrespect and say it's noise. It's just part of the process and it's complicated. But I think at the end of the day, they'll be built.