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

Good morning, everyone. Welcome to the Eighth Annual Laguna Conference. Obviously, in the virtual world this time, but we promise it's going to be just as insightful as the real thing. Just assume that there's crashing of waves outside your window. I'm Ravi Shanker, I'm Morgan Stanley's freight, transportation and airlines analyst. And we are very pleased to kick off the transportation track of this conference with our top rail pick, Canadian Pacific. And we're very pleased to be joined by John Brooks, EVP and CMO; as well as Maeghan Albiston, AVP of IR and Pensions. Before I turn over to the management team, I need to read out that this webcast is for Morgan Stanley's clients and appropriate Morgan Stanley employees only. This webcast is not for members of the press. If you're a member of the press, please disconnect and reach out separately. For important disclosures, please see Morgan Stanley research disclosures website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. Also to the members of the audience who are on the webcast, you can send me your questions for the management team through the Q&A section of your webcast browser. And with that, John and Maeghan, do you want to kick off with any opening remarks?

Yes, absolutely. Thanks, Ravi. And like you, I much rather be in Laguna today, but hopefully next year. So let me start by first of all, I'd be remiss if I didn't, acknowledging CP is the best railroaders in the industry, Ravi. And I'd tell you they've reconfirmed that to me every day, day in, day out, the 12000-strong family that we have at CP through this crisis has done just amazing things. Collectively, the power of coming together and providing safe, reliable service for our customers in North America has been paramount. I've never been prouder as a CP employee. Let me talk a little bit about volume starting off here. So Q3 is actually playing out a fair bit better than we expected. We spoke -- we knew on our Q2 call, and we spoke about it, that we'd have some tough comps as we moved into Q3. We had a really bang-up volume year in 2019, and that's what we saw. July, albeit the tough comps, we exceeded our internal plans on volumes. And we saw a pretty steady increase on our volumes as we moved through August. Now we knew that was going to set up, though, for what we expected to be a pretty strong -- or actually, very strong September. And that has started to play itself out for us. Midway through the month, I guess, today, our RTMs are up about 4.5% year-over-year. A trend -- certainly a nice trend to finally see in the positive, and a trend I expect to continue to see as we move through the year. When I look at specifically as an example, our 7-day average for RTMs, just comparing even like the second week of August versus now, I guess the second week of September, which was last week, RTMs in that instance were up about 9% and are building. So quite optimistic as we move and close out the quarter here in September and move into October. I will note, unfortunately, we did have a derailment yesterday outside of Vancouver in our directional running zone, so we'll have to keep an eye on that. As we all know, that Vancouver territory is critically important, particularly this time of the year. A few more comments. As I look across our book of business, lots of optimism, not only optimism from what I see in terms of recovery, but also maybe more importantly, optimism driven by our own unique opportunities. It's the execution of the commercial strategies that we've been now talking about as we pivoted for -- to growth a couple of years back. And really, those are the areas that, as much of the recovery is nice to see, that's really driving our outperformance. We've led the industry the last couple of years in growth. There's no doubt. My expectation is we follow suit and do that in 2021 and right into -- or 2020 and right into 2021. Our bulk franchise, Ravi, as you know, is a unique strength to CP. It has a high level of resiliency in challenging marketing times. Bottom line is the world needs to eat, it needs nutrients to grow grains and food products and feed products, and the CP franchise is best in class to deliver those. So we're expecting a strong Canadian grain crop, potentially record crop, and we're positioned well. We've embarked upon a couple of years back, our 8,500-foot grain model, and it's really something that the industry across Canada and the U.S. has embraced. But you take that model, along with our investment in our covered hopper fleet, of which I'll tell you, we've got about 3,300 of our new covered hoppers in service as of today. And we expect to be up around 4,000 hoppers by the end of the year. But this is giving us a distinctive advantage in the marketplace. You can see it play out in the last crop year. We can see it already play out so far early in this new crop year. And the exciting piece of that is the industry has just really embraced our model. The terminals in Vancouver, whether it be G3, the terminals on the South Shore, have built their facilities and expanded their facilities to accommodate CP's grain model, let alone all the elevator investment in the country with loop tracks, the new facilities, and then the number of expanded facilities that we have underway. So I'm quite optimistic in Canadian grain. And knocked on wood, but for the first time in a long time, I'm actually quite optimistic about the U.S. grain front. Chinese demand is back. It's been a few years since some of the trade issues that took place. But our movements to P&W for wheat, corn, soybeans look to outperform. And then you overlay that, looking to potash. I'll tell you, so far, in September, our potash RTMs are up about 38%. Canpotex is sold out through December, which gives us, obviously, significant confidence in that area for the balance of the year. But maybe more importantly, I think it's important to point out to the listeners, that Canpotex has done a great job in diversifying their demand markets and particularly during some of their challenges in their Chinese negotiations. So India and Brazil have become much bigger pieces of their book. In fact, Brazil will surpass China in 2020 as Canpotex's #1 end market. So quite bullish on potash, not only in 2020 but as we look to 2021. On the automotive front, it's been an area that we have outperformed our rail peers. We welcome Chrysler and FCA to our Vancouver and Calgary auto compounds in July. The Vancouver auto compound is just another example of CP using our land assets and capacity to create unique solutions that can't be replicated in the marketplace. In addition, we've been talking about this one for years. Glovis business have finally started up here in September with us. Quite exciting. The business levels appear to be much stronger than when we contracted with Glovis a few years back. So September, I think we sit here today, I was looking at the numbers this morning, September automotive RTMs are up about 31% year-over-year on CP. The last business area I'll touch on before we get into some questions, Ravi, is the intermodal front. And I want to then speak specifically to the press release we put out this morning. On the intermodal front, despite, I would say, some early challenges around pandemic and the crisis we're all facing, we are running quite strong now. Our domestic container fleet, in particular, is essentially what I would consider sold out across our property. Volumes are strong in gates and in all our terminals. Our reefer fleet has been sold out going on now our fourth straight month. We had a record by all accounts in domestic intermodal in August. And I think September RTMs are up about 15% -- 14%, 15% as we're halfway through the month now. So quite strong in domestic. In the international side, we've certainly seen volumes ramp up through Vancouver. Our partners are adding vessels to their current lineups. We had the unique situation at the Port of Montreal with the strike. But to be honest with you, it gave us the great opportunity to begin to provide a proof point around our new port at St. John. And so we did 5 vessels through the Port of St. John here over the last month or so. And again, I think it's just becoming a great proof point with our partners there in St. John with DP World. And then you couple that with our over 200-mile route advantage as you depart west out of Saint John into Montreal, Toronto and Chicago, it's a great growth opportunity as I look to the future for our CP franchise. Speaking specifically on the intermodal front, Ravi, with our partner, DP World, I look for upwards of about 1.4 million TEUs of new capacity that's going to fit sort of right into CP's wheelhouse coming on by 2023. When you think about the growth at Centerm on the South Shore, coupled with the growth at the Port of Saint John. So we're quite optimistic on the intermodal front as I look forward. So I do, though, want to now speak and just take a couple more minutes to talk about the press release this morning essentially announcing a new long-term partnership with Maersk. I think it would be best if I took the listeners back to our 2018 Investor Day. And basically, our message that day, if you recall, you that we are going to deliver sustainable, profitable growth at CP, but do it in a surgical, disciplined selling way, and that's what we've done. And that means picking partners that best can leverage the qualities we bring as a railroad, the qualities and advantages we have on our network. It's around picking winners in the marketplace. Those that we believe are going to be successful in the good times and the bad times. And maybe most importantly, how we utilize our unique land capacity to create solutions, Ravi, in the marketplace that, again, just can't be replicated. When you think about our Vancouver auto compound, you think about our -- the things we've built on CP land for Glovis, for IPL, for Suncor, for our transloads in Milton and our new transload, literally, that's opening up -- opened up yesterday in Montreal. All these things are proof points and sort of now a culmination of what we're going to be doing with Maersk in Vancouver. So this opportunity with them sort of checks all the strategic boxes, in my mind. I couldn't be prouder of the team effort to land this opportunity. This partnership will truly be transformational, not only in terms of CP's network, Maersk's network, but also as we begin to think about the consumers across North America, across Canada, frankly the city of Vancouver and the Port of Vancouver. To give you a little more detail. Essentially, CP in partnership with Maersk will be building a new transload and distribution facility using CP land at our Vancouver intermodal facility right at the terminal. So this is going to not only create, best way to call it, sort of long-term stickiness relationships not only with Maersk, but the customers that co-locate with CP at our terminal. The construction of this facility, Ravi, is underway. We expect to have it completed as we move into the second half of 2021. The facility is really going to be designed hand-in-hand with Maersk to really foster their global integrator strategy that they've talked about, offering rail solutions for not only imports, but exports and also domestic intermodal movements. It's quite exciting. It is going to be uniquely environmentally conscious project. It has the opportunity -- I think, unlike other transloads and maybe some of the other inland ports in B.C., this facility is really going to be, I would call it, purpose-built to take trucks off the road. We can -- I can see a solution where, for ultimately, tens of thousands of round-trip truck movements come off the road in B.C. while eliminating, obviously, all the CO2 emissions that come with that. We're excited that we're doing our part in this environmental effort, but not only that but the reduced truck traffic and congestion save road infrastructure in and around. To give you a better sense, it's really going to provide shippers the opportunity to import traffic. Instead of having it trucked into a terminal or into a transload, they're going to be rail-shuttled into our facility. At the same time, it's going to give the capability for exports, whether it be grain or plastic pellets or wood pulp or lumber and panel products, to be railed into the transload facility, reloaded into containers and railed back down to the port to be loaded on vessels. It will also then allow, obviously, those domestic goods, those retail products with our big box customers to be loaded directly into 53-foot containers and shipped, whether it be across Canada or into the United States. So we're -- this partnership is a game changer. We're super excited about it. I think you can tell by my tone. It's just, frankly, another compelling chapter in the CP growth story. So I know that was all a mouthful, Ravi. So maybe let me stop there, and I'd be excited to talk more about it.

No. That was a super comprehensive update, John. Thanks for that. I mean, what pandemic, right? It sounds like you guys haven't missed a beat from where you left off a year ago before all this started off. Maybe if I can throw in a couple of follow-ups to your opening comments, maybe starting with that -- where you enter on the intermodal side. Clearly, a huge growth opportunity has been for yourself and your peers on the Canadian kind of West Coast side. Is this just a pie that is growing significantly? Is this share gain from truck? Is this share gain from the U.S. ports? What is the primary driver of that growth? Do you feel like there's -- you have enough visibility into the volume growth over the next 5 years that you can add all this capacity and more? And kind of is there any risk that there's too much capacity going in relative to demand?

Let me make a couple of comments on it because I think it overlays not only -- it's a good proof point and sound bite relative to what we've seen on the West Coast, Ravi, but also I think what we're going to see in what we're developing in terms of a mousetrap on the East Coast at Port of Saint John. So I think particularly, when you think about CP and our unique story, it's a little bit of all the elements you've talked about. I think we definitely -- well, we have. We've benefited from share rebalance, as we've pivoted to growth, as we've developed in our intermodal -- international intermodal and domestic intermodal products have matured, right? So there's some natural share rebalance that's taken place that we've benefited from. But I really believe the West Coast, and will continue to, has really cemented itself in terms of a distinct advantage of the capabilities to draw traffic out of -- away from California and the West Coast ports of the United States. And I think you've seen, obviously, our competitor at Prince Rupert, ourselves at Vancouver, really capitalize on some of those distinct advantages. And yes, I do believe there's an opportunity for that momentum to sustain itself. Part of that proof point is as I mentioned earlier. We got significant capital investment that went in at Deltaport with GCT, adding capacity to their terminal capabilities. You've Centerm that over the next couple of years, that we'll be adding upwards of 600,000 TEUs to 800,000 TEUs at that facility. And then as I shift to the East Coast, I think the story is as or even more compelling as you begin to think about, again, specifically the opportunity for CP. Our acquisition of the CMQ and the direct route it has given us in partnership with the NBSR into the port of Saint John, it's something that is going to be a -- we haven't begun to feel the effects of that growth opportunity. And I look at it again in 3 buckets. I think, number one, and this is obvious. There hasn't been a competitive alternative in the maritimes for 20-plus years. We believe on that fact alone, and the enthusiasm we're receiving from the intermodal and steamship line industry, that there's going to be a share opportunity for CP in that eastern marketplace. Number two, I think there's a -- and maybe this one is, I'll call it, Ravi, maybe in the early innings. As trade shifts continue to materialize and we understand what manufacturing around the world looks like a little differently over the coming years, whether it's less in China, more in Southeast Asia, more in India, more in South America, maybe nearshoring and how that picks up, I think that is sort of the second bucket of opportunity for us at the Port of Saint John as I look at that opportunity. And then maybe the third bucket, and specifically to your point around our ability to shift share away from the U.S. ports. I think similarly in the Eastern Canada, there is a tremendous opportunity for us at the Port of Saint John to potentially shift share away from New York, New Jersey, up to our terminal. So we're quite excited. There's going to be significant work, turnkey-type work, with DP World to bring that Port of Saint John up to a world-class facility quickly here. So I think it's actually a fairly similar story on both coasts, Ravi.

Got it. That's really helpful. It sounds like the medium- to long-term story here is very firmly intact. Maybe kind of shifting tack a little bit and talking about the short term for a little bit. Clearly, you guys outperformed industry in terms of volume growth in 1Q and 2Q. You lagged a little bit in 3Q, but you were very clear about that in terms of facing a tougher comp. Can you remind us what the puts and takes might be in 4Q in terms of the comp as well as some of the end market dynamics? Anything particularly to keep in mind? I think last year, obviously, crude by rail was in a very different place and your competitor kind of had a strike. So kind of anything in particular we think of in terms of what to expect, RTM-wise or volume-wise, going into 4Q?

Yes. Maybe a couple of comments on that front. So again, I think September is playing out as we expected. We're quite bullish as we look over the final few weeks here. Also as we watch this derailment I mentioned played out. As I look into October, I -- pretty much down the list outside of, let's call it, frac sand, which continues to be challenged; certainly, crude by rail continues to be challenged; maybe a little bit of those refined products have been slower to recover. But really outside of those areas, Ravi, I look for that momentum and the volume momentum to continue as we move into Q4. So I look for the potential for positive RTMs in October. Now as you mentioned, we had -- our competitor had their challenges as we closed out 2020. We also had some pretty significant crude by rail, I think our biggest single month as we closed out 2019. So those comps will be a little tougher as you close out the year. But I also -- as I mentioned, we remain quite bullish on potash as grain is going to be significant in Canada. And the U.S. grain is an area that, frankly, wasn't there last year, but it's going to be this year. So all that into the blender, I think we're still very confident on our guidance and maybe some upside as we close out the year.

Understood. We have a few minutes left. I want to remind the audience to send us any questions via the webcast. I do have a few questions that have come in, so maybe I can kick off with these couple of questions on RTM. Does the 4.5% RTM growth comment apply to September only or 3Q to date? And what have been the main areas of inflection from negative 12% in 2Q to the positive 4.5% in 3Q?