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

Okay. Thank you, everybody, for joining us this morning. Good morning. Thank you for joining the virtual version of the 11th Annual U.S. All Stars Conference with JPMorgan. I'm Brian Ossenbeck, I cover the transports and logistics for the firm. Very happy to have Canadian Pacific with us today. Joining us is the company's CFO, Nadeem Velani. I'll turn it over to him for a little bit of introductory remarks, how the railroads operating right now, and then we'll jump into some Q&A. So if you're on the live stream on the video, feel free to go ahead and drop in questions on the email, and I'll try to filter those and get them to Nadeem as we go through. So Nadeem, thank you for joining us. We appreciate your time, and I'll kick it over to you if you want to make some introductory comments.

Thanks for having us, Brian. It was a pleasure to join you on the fireside chats and be at this virtual one at the one in All Stars. So it's good morning from Calgary here, where the sun hasn't even risen. But not that you can see much of the sun these days given the smoke that's been coming from the south. But fortunately, these are not dark days for CP. So let me start just by saluting our 12,000 strong CP family that continue to deliver impressive results in this uncertain time. This crisis has certainly brought the CP family closer, and I couldn't be prouder of the continued effort, resilience of the CP team of railroaders. The women and men of CP have been shining examples of the importance of CP's role in supporting critical supply chains, the communities we operate in and the Canadian North American economy. From the business point of view, the network continues to operate extremely well. Credit to the best team of railroaders in the industry. Train weights continue to be up 7% and lengths continue to be up 8%. As the volume returns, we are retaining our operational efficiencies. Crew costs are down 12% on the quarter. Crude starts are down 16%. In fact, the first week of September, our crude cost per 1,000 GTM, an all-time weekly best. Q3 has played out as expected. We knew this would be a back-end loaded quarter, and that's what you're seeing play out. We steadily been building momentum that I fully expect to carry into Q4 and increasingly, I'm more confident that we are seeing a V-shaped recovery. As of this morning, our RTMs for the month of September have now turned positive. They're up 6% and for the quarter, we're down 8%, which is slightly better from a volume standpoint than we had anticipated ourselves. We do have a couple of OR headwinds on the quarter to note. We won't have a fuel lag benefit that we saw in Q2. And year-over-year, both FX as well as stock-based comp will be headwinds given the extremely strong stock performance. That being said, I expect us to have one of the best operating ratios for the quarter in the industry again. I'm certainly more optimistic for the full year than I was a few months ago despite the FX and stock comp headwinds as we are more bullish on Q4 volumes. Fully expect fourth quarter year-over-year OR improvement and a 200 to 300 basis point improvement in the OR for the full year. That's a tremendous result given the macroeconomic volatility we've all experience this year. You should expect CP to have the best revenue performance, lowest OR and best train accident ratio in the industry in 2020, what we consider the triple crown. And when you add on to that, the fact that we will likely deliver return on invested capital in excess of 16.5%, it explains why we have been the best-performing rail from a shareholder return perspective for the last 3 years. And the story is far from over. 2021 is setting us up for what I increasingly expect to be a tremendous year as we're getting greater visibility to a strong pipeline of opportunities across the book of business. Going specifically looking at intermodal. We're working with the Port of Saint John and local partners to create a compelling opportunity for an ocean carrier to call St. John. In fact, we moved our inaugural train through the port of -- through the port in early August as Hapag-Lloyd called the Port of Saint John to adjust for the Montreal longshoreman strike. We also see opportunities in domestic intermodal by leveraging our 200-mile routing advantage versus the competition to compete with trucks and then historically underserved rail corridor. On the automotive side, we opened up our auto -- Vancouver Auto Compound 18 months ago and have sold out capacity to Ford and now Fiat Chrysler, which started in July. Glovis, the supply chain arm of Kia and Hyundai, have begun ramping up their volumes on CP. This was yet another market share win we realized in the past few years, but the full shift in share has only begun in September. In fact, in September to date, our auto RTMs are up 47%. Looking at merchandise, we have partnered with Suncor to provide service from Edmonton to their expanding Vancouver export terminal. In our pipeline, we'll be serving IPL's new propylene facility in Alberta in the industrial heartland and we expect to see volume starting in late 2021. On the grain side, 2019/2020 crop year, we move the most grain the company has ever moved in our 139-year history. The 2020/'21 crop is also set up potentially to be a record crop, and we have the capacity service and are leveraging our hopper car investments in strategic partnerships with key customers to drive further growth for CP. As we saw during the course of the pandemic, the world needs to eat and grain has provided our franchise volume support, regardless of the macro environment. We indicated there would be opportunities to backfill the capacity coming online with reduced coal volumes in 2021. And the announcement this week of the Maersk facility to be built on our property in Vancouver is capitalizing on that. And it's probably what I'm most excited about heading into 2021. This will create a one of a kind solution to the capacity constraints customers face in that region. And that is the tip of the iceberg. We still have more than 100 acres of land we can develop. The opportunity matches CP's strategic land with a new customer, looking to control their end-to-end supply chain, reduced third-party truck involvement and removes thousands of trucks round trips from lower mainland Vancouver roads supporting our ESG initiatives. We are investing in sustainability as demonstrated by our recent solar garden announcement at our Calgary headquarters. Our head office will be solar-powered beginning in 2021. We are extremely proud to be named Canada's top 50 Corporate Knights for the first time and had the highest ranking among the transportation and infrastructure companies in Canada. And we're going to continue to grow while building on our track record of being the safest railroad in North America for the last 14 years. Safety is a journey, and it is never over. We are improving safety through a number of initiatives, including our investment in broken rail technology. That will enable us to identify broken rail in dark territory at a fraction of the cost of full centralized traffic control. We continue to reward our shareholders. We announced a 15% dividend increase in July, the fifth consecutive year we've increased the dividend, and we are the fastest-growing dividend rail in the industry. Additionally, our share buyback program that we announced last December is now 60% complete, while we maintain a strong balance sheet. So Brian, I'm sure you can tell I'm extremely proud of our performance. And I'm even more excited about what the opportunities we see ahead of us. So maybe with that, I'll take some questions from you.

Great. Well, thank you, Nadeem. That's was a good update and a lot to cover here in the next half hour or so. One of the things we've been seeing and obviously been delivering in the last couple of years is volume growth has been top of the industry before the pandemic, you're looking at it being 3 years in a row, which is pretty much unheard of. So you haven't -- you didn't drop as much in 2Q, but you didn't bounce as much, at least until recently. So what -- you mentioned potash and autos, you got the recovery going on there, things are building. Is this a V shape for CP or in your specific end markets? Or do you feel more confident in just the overall setup as you look across the broader economy?

Yes. I think there's a number of specific kind of self-help that I'd say that we've had in place, the reason why we've been outperforming the industry on volumes for 3 years now. But I'd also add to that, that there's some, call it, macro benefits that we're also seeing. Certainly, the consumer has back. So our retail volumes are extremely strong. And it sets us up extremely well given our unique customer base. So in Canada, we're serving the biggest retailers in Canada, such as Loblaws. You've got the Home Depots of the world, Canadian Tires, to name a few. So that's driving a lot of the, call it, consumer demand driven -- or consumer demand driven volumes. Autos have come back in a very strong way. I think for the industry as a whole. But I mentioned some of the unique initiatives that we have on that are market share driven or us creating supply chain solutions for our customers, for new customers. And so we see that as a very specific benefit to CP. We talked about the grain crop. Potash is set up extremely well. We -- Canpotex, we're the majority customer for -- shipper for Canpotex, and they're sold out through the end of the year. And things look very strong for 2021. We have some very easy comps in the back half of this year on potash. I think there's a number of very strong areas. We've probably seen the bottom as far as some of the negatives. So frac sand, it's not as bad as it was few months ago. Crude, while down 80%, 90% is showing signs of life. So some of the areas that have been the worst for us are starting to see the bottom and come off of the bottom, which also bodes well. On the international side, international intermodal, we face the Port of Montreal strike, which hampered volumes in the first half of this quarter. That's over. And now there's an opportunity to start seeing volumes pick up. I think the -- overall, we're going to see a very strong fall peak, and it will probably take us right through the holiday season. So I think all of those reasons are why we feel more optimistic, I'd say, as we finish 2020.

Okay. Great. So on the Port of Montreal strike. How did that play out? And what do you think that did for the opportunity at St. John's? Because I think that's maybe the possible silver lining from all this. So was it a material impact in the quarter? Is that volume lost? Or are you able to pick it up in another port and be able to talk about that opportunity as you work towards to develop another access point into the east?

Yes. No. It's -- certainly, there were some volumes that were lost. There were some service that our customers were impacted by just having containers on the ground and dwelling for quite some time. There are some things that were done industry-wide to improve -- to offset that. So specifically, there were some ships diverted to Port of Saint John to other ports in the east. And net-net, we're glad it's over. It did give us a chance to show the capabilities of the Port of Saint John and get good test market for us as far as what that service could look like. Very -- we didn't have a lot of time to get that up and running, us and our partners, DP World, in the Port of Saint John. But that's something that -- it gets us a chance to kind of showcase what's the part of the possible. And so we're pretty excited about what that could look like in the future. And we have reason for optimism that we could see a call in the Port of Saint John in the next year or 2.

Okay. So maybe going over to the other side of the West Coast. Have you seen any benefits into Vancouver? I know you've probably got an opportunity to talk about the Maersk transload facility that you announced earlier this week. But are you seeing more interest as the West Coast got congested last month? Obviously, it's a pretty big surge, but it does highlight some need to diversify. So what can you tell us about, at least the Maersk opportunity, what that can possibly lead to? And then the things are already on the ground and being built with the green terminals, with the terminal expansion in the intermodal side, how is all that progressing as you see the volumes start to pick up again?

Sure. I mean, I think the Canadian ports as a whole in the West Coast have shown the resiliency, have shown the service that can be provided by both the Canadian railroads to service Canada in the Midwest. And we've seen market share shift over the number of years now up north, I think predominantly based on service, but then you factor in -- it is a cheaper option than some of the U.S. West Coast ports. Currency plays a role. I think the strong service as well, the labor -- a bit more labor certainty, I'd say, in that part of -- in the northern part of the ports in Canada relative to the U.S. So I think you put that all together, and we've seen market share shifts over time. And we've seen strong demand over time. And certainly, our partners there have done a fantastic job of last few years of increasing capacity -- of investing in technology that are improving the overall -- the throughput as well. And that's something that we're excited about heading into the next several years. When we look at what we announced as far as Maersk, it was a really exciting announcement. Like I said, it's one of the most things I'm most excited about for 2021. It's -- the fact that it's being built on our property, it's further evidence of the power of our land holdings to provide unique solutions for our customers. It's a strategy we've been talking about for a number of years, and it's a strategy that's paying off. For a customer to invest and pick a partner long term, it shows the confidence that they have in our service and the fact that they also want to diversify their overall supply chain. So to us, Maersk opportunities, it is a one of a kind solution. And the good thing, as I mentioned, it's just the tip of the iceberg. We have another 100 acres there that we can sell. And not only in Vancouver, but across our network. And so in this case, we've got the largest container shipping line in the world. And to me, there's -- I'm excited that we have this new customer, and there's an opportunity to potentially hopefully do more with them.

Okay. Let me shift gears to the OR commentary here. You said that 200, 300 basis point improvement for the full year, 4Q OR improvement, which I think is pretty much consistent with what we said on the last earnings call. Maybe you can -- if you can put some more details around, I guess, the good news, headwinds from stock-based comp. What -- and fuel, which is just what the market is getting you, if you can just put a few more details on what that means for 3Q? And how we should think about the balance between the back half of the year? What were you fitting in that 200 to 300 basis points?

Yes. I mean first of all, I've always felt looking at 1 quarter's OR in our industry isn't the best measure. You're always going to have some level of volatility in the OR just given what we -- the nature of railroads. It's an outdoor sport. You're going to have weather, you're going to have seasonality, there's volumes, you're going to have accruals and fuel surcharge, timing issues and things like that. So we had, I think, a 57% OR in Q2, which was the best in the industry by far. We did get some benefit from fuel surcharge timing that helped the quarter. And so it's going to hurt Q3. And so it's -- we've also seen a very strong run-up in the stock. We've seen the Canadian dollar come on from a bottom of $1.45 below during the heart of the pandemic to improve to $1.30 over the -- recently. So that does have a negative impact to our top line. But from a macro point of view, that's a positive, that shows that there's some resilience in the Canadian economy. It means typically that commodity prices have improved. And so there's positives as far as our volumes of what that -- why the FX Canadian dollar has improved. So overall, our OR, I do think for this year, we're going to have a very strong result. If someone told me years ago that we'd be able to put up that kind of level of high 50s type of OR in the heart of a pandemic when you'd see volumes and revenues down in the 8%, 9% level, I would have thought we were crazy. But it just shows just how far this transformation has gone, just how -- if you look at the industry, what the industry has delivered as well and how you can not get locked in on preconceived notions. So as we continue to take on volumes at a low incremental cost, we've talked about our incremental margins of 75%. And as you continue to invest in the network, invest in capacity, run longer trains through co-investment with customers on the grain side, on the coal side, potash side, it creates opportunities to get operating leverage. And at the same time, it creates opportunities for customers to lower their transportation costs as we turn their assets faster and provide better service for them. They get opportunities to compete in their markets. So I fully expect us to be able to continue to improve the OR. It's not something that we are solely focused on. We're very focused on our overall return metrics measured by return on invested capital. But if you're doing the things right, if you're pricing for the service that you provide, and typically, that should be above inflation as customers get their benefits as well, you get the benefits of pricing, you get benefits of the investments I mentioned and run longer, hit the operating leverage, you should still see 100 basis points kind of improvement year-over-year. That's the challenge we have internally as well.

Okay. I think, yesterday, John was talking about a derailment in Vancouver. So it seemed like it was still early, but was -- is there any other impact from that, that you're seeing on the network? And I think 3Q is always going to be a tough comp, considering due to basically all-time record last year. So is that pretty much the challenge here?

Yes. No, the timing wasn't ideal. It's never a good time, but this is probably the busiest week we've had in, I don't know, 6, 7 months, at least, probably the year so far. It was a derailment on our competitors' line that we both have a coproduction agreement into Vancouver. They had an outage there, was our train. Unfortunately, it did take out some capacity, and it did impact the overall supply chain, and you'll see part of that impact over the next 7 days until both networks can get back in balance. I think we did a very good job of continuing to move trains through that corridor. And the line is back up and running as of 4:01 a.m. this morning. And so hopefully, the worst is behind us from a capacity and supply chain impact. And we'll be able to recover the volumes or -- it will mean that some of the volumes will be pushed into probably the first week of October. But it's not a meaningful impact. I think, no, the grain is still going to move. The potash will be moved and coal and so forth. But it's just a bit of a timing issue.

Okay. Got it. So going back to the incremental margin. You talked about 75% ex fuel in D&A and stock comp, so I guess, more of a pure number. Given train lengths and weights are up 6%, 7%, I'm assuming that, that can be more or less sticky depending on the mix and the customer profile, but is that still coming out of the pandemic and into the V shape? Do you -- is there a reason to believe that, that 75% could actually move up with these longer trains and heavier trains? Or is it still a little too early to tell kind of what's structural and what's more -- maybe more temporary as we go through all this volatility?

Sure. So we did -- I think our operating team did a fantastic job of managing through the pandemic and revisiting what we can do to take out fixed costs and look at what could be more structural. We didn't have the yards to close. We didn't have some of those, I guess, the big fruits to pick. But you can always look at your processes and look at what can be better, what can you do more efficiently, where you need to backfill if necessary as far as where attrition can be helpful to you. So I'm encouraged by what we've been able to achieve and what we've been able to do and how we can continue to take some of the silver linings that came out of this and use it as an opportunity to keep it embedded into our structural costs. So I'm optimistic that we'll continue to be a leader in as far as ORs, and we'll continue to see the improvements in the OR for the next several years. Last quarter, I talked about having that much more confidence and probably for the first time, you've heard me say this, Brian, in my years, that a mid-50s is achievable. And I think part of it is, coming out of this pandemic, what we've seen as far as what we can actually achieve, such a negative volume environment and still deliver the results that, that we've delivered, is what's giving me much more confidence as well as that pipeline of growth initiatives I mentioned. So does it mean the 75% incremental margins has upside? I mean, I don't want to go that far yet. But certainly, we've been able to take out some structural costs.

Got it. So when you think about just the network, in general, from a resource perspective, how has that been a -- CP was pretty active and one of the first to talk about negotiating terms to come back quicker, taking care of the family, considering there's so much volatility and they know what's going to happen and you needed them to come back, you wanted them to stay close. So how has that worked relative to expectations, the recall rates? And I think you were one of the few who are actually kind of spending through the downturn and maybe pulling forward some maintenance to get some better return on that. So where do you feel like resources are now versus how you planned for this to sort of play out?

Sure. So I think, number one, our team does a fantastic job of planning and forecasting. And that plays a critical role, especially when you have volatility in volumes that we've seen. So we don't typically look to use [ our honorism ], build the church for Easter Sunday. So we always do look to constrain things to an extent because you do have volatility and things are not always going to be as maybe as customers believe your optimistic view. So that being said, the way we're organized here at CP with our market strategy and asset management team kind of in the heart of our operations team, marketing sales group and our financial planning team. It's a very collaborative kind of culture. It's a culture that starts at the top from Keith that has set the tone of just how we operate the constructive tension that we have as part of our culture that pushes each other. And the more you communicate, the more visibility you get into what you can achieve. So as far as our volume planning, it's -- that's been done extremely well. We're the only ones to give guidance in the heart of this pandemic, and that's for a reason. Is -- I think we look to push ourselves, and we also look and feel that we have the confidence to have visibility into the business. And I think that, that's a testament to the team. So with that, I think we have we've done a good job of forecasting as far as what we think in this kind of uncertain times, what the market would look like, what we need to do. And with that, as you mentioned, we set up some of the labor agreements. We did some innovative things to keep our -- keep paying the medicals for health care for those in the U.S. and keep them in a situation that they can take care of their families and take care of their own health issues. At the same time, it allowed us to recall employees back faster than your typical 2 to 3 weeks kind of time frame. We did some innovative things on the Canadian side as well. So that's allowed us to recall employees much quicker than the industry and much quicker than historically and allows us to be in a position to move these volumes as they come back in a V-shaped manner. So we're in a very good spot there from a capital point of view. We are a bit of an outlier compared to our peers, and we are spending historically the most capital that this company has ever spent this year. We will invest in the network, and that's an opportunity to take advantage of track time, take advantage of -- even to source things at a cheaper cost because we did feel that volumes would come back. And when they did, we wanted to be able to take them on and provide strong service and take it on at a low incremental cost and make these investments at a time when you could get -- be much more efficient. So I think we only had, I think, 6 days where we were -- we lost time as far as our ability to get track time on the engineering side in the second quarter. And I think typically, previous year, we're at 30 days where we didn't get the full track time. So we've been able to take advantage of that window of opportunity of volumes being down. And so now as volumes have come back, most of our engineering work is complete now when volumes are returning positive. And so I think that, that was done very effectively by our engineering team and by our operating team. And it will serve us well for a number of years. Again, when we look at our capital, we don't look at it on a 1-year basis. We do have a long-term plan. We've been talking about doing some of this exciting work or doing investments in equipment for many years. And case in points on the hopper cars on the grain side. We had committed to this $500 million investment for 5,900 cars, I think, 3 years ago or late '17, early '18. And it's something that we were committed to do once the -- once we had visibility on the returns and regulatory approval on the bifurcation of the rates on hopper cars would be -- would get our return that we could satisfy our investors. And so ultimately, that's been something that we'll be able to do over the next 2 years. And it's not just reacting to all of a sudden, you've got an increased record crop that you need to invest in hopper cars. This is a multiyear plan that we look at our capital investment. So again, something unique in the Canadian industry.