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

All right. Good afternoon, everybody, and thank you for joining the CS Industrials Conference. This is the first transport fireside chat. I'm very pleased today to have Keith Creel, the CEO of Canadian Pacific with us. Had some exciting news about this morning, on top of many other announcements over the last couple of months. So Keith thank you so much for being with us. If you'd like to start with any comments, please do so, and then we can jump right into Q&A.

Yes. Let me do that, Allison. Number one, good afternoon. I appreciate the opportunity to talk about our story at CP. I think it all starts with our people, though, so I'd be remiss not to thank our 12,000-strong CP family that's just done a phenomenal job to create this unique success story at CP, especially in light of the year that we've navigated. So let me start with how the fourth quarter is unfolding. I can tell you that we're ahead of expectations. We're going into the last month, obviously, just starting into December after an unprecedented year with volumes up low single digits. It gets a pretty tough compare, granite. The fourth quarter was one of our strongest quarters last year. Obviously, that was driven by crude and by frac growth, which we're up against. But in spite of that, we're still doing extremely well, exceeding expectations. Our cost control, phenomenal. Train lengths were up 11%, train weights up 8%, which demonstrates we continue to carry out the productivity gains that we've experienced while we navigated through the pandemic. And most importantly, on a cost basis, our crude cost per KGTM, which is what we measure, is down 10% on the quarter. So that speaks loudly of the performance of the operating team and how pleased I am. I can't thank them enough as they continue to execute this railroad day in and day out. So it's been an exceptional story this year during an unprecedented time. I'm super proud of what we've accomplished. And of course, to your point, this morning, being able to announce Hapag-Lloyd that will begin calling regularly the Port of Saint John in 2021. I would have gone back a year ago, and obviously, we knew then that we were purchasing the CMQ. What I did not know then is what it was going to unlock. It was compelling enough as it was strategically to give us reach to an East Coast port, but we stepped into with the spirit of cooperation to leverage that asset to bring customer solutions to our customers, 200 miles closer from tidewater to key strategic servings in Montreal and Toronto. I underestimated in all facts. So to be able to, a year later, say that Hapag-LLoyd is coming with the scale that they represent and with the solution that this is going to represent, it's just a strategic step into validating that value proposition that I've been talking about for the last 6, 7 months. The other piece super excited about was Maersk Albiston. We've announced that as of late -- as of recently. That's another extremely compelling value creator for this company not just for our shareholders or our customers, but also for the environment and the unique solution it creates in Vancouver, given the scale. And the other exciting piece about that is that's actually going to come to us sooner than we anticipated. So we negotiated that contract to take over that business effective April 1, 2021. We're going to see our first Maersk discharge next week. It's entering the Port of Vancouver, which is exciting for us. Obviously, it's not going to be 100%, but it's going to allow us to start on that journey to scale up, and we certainly expect sometime in the first quarter, well before the start of the second quarter to be realizing 100% of that business. And then in lockstep, while we're doing that, we're building that transload facility. We expect that to be done and operational by the end of the third quarter of 2021. So to scale that up, the opportunity that represents is extremely exciting for us in 2021. Then next year, I'll remind people as well, we've got the DRU coming online. That construction has continued through this pandemic. We're going to bring that online in the middle of 2021. Just as a reminder as well, that's a long-term deal that we've signed with COP. They're going to have half the capacity when it opens up, which is about 2 trains a day. It's 50,000 barrels. So if you do the math, it's 2, and we're working hard to sell the second. And I think with the success, that creates, again, a unique story for CP and our revenue streams. It bakes that into our revenue stream on a go-forward basis. So again, good for the customer, good for the environment, given that it's a non-haz mat product. And some of the other unique opportunities that come online in 2021. We've got the IPL facility, which is a greenfield facility built in the Industrial Heartland using our landholdings up in Edmonton. That's going to allow us to continue to drive growth there. And then some of the other exciting things we've talked about on the technology side, driving productivity, driving safety, driving efficiencies. We've got the new grain hopper fleet that's starting to get critical mass. We're going to be over 3,000 cars by the end of this year, on a journey to get up to 6,000 by the end of 2022. That's given us more capacity that's allowing us underlying when you're reading about us setting the grain records every month. You can continue that we're going to expect to set them until we realize the full potential of the build-outs with the grain loading facilities, the new unloading facilities that have came online. You've got G3 that can land those trains now that's new, in 2020. We'll get to realize full benefit in '21. You've also got Viterra, the Cascadia terminal, which we uniquely serve in the South Shore that now can land an 8,500-foot grain train. So there's more to come in that space. I look at fluidity of the railroad. I look at bad orders alone. We're down 40% year-over-year. I've talked about this before. Our grain fleet was the worst grain fleet, lowest capacity, least reliable, high-scales grain fleet in North America. We're changing that narrative to being one of the best as we go forward. So we're going to continue to realize synergies from that. And then the other piece is technology. We've never been one to pound our chest about it. I've always been one. I don't want to be bleeding edge. I want to be leading edge, but I won't action. So the space and the success we've created, taking 2 very important technologies. One is unique to CP, one is not, but it's combining the power of the 2. We just recently realized exemptions from Transport Canada that allow us to take the visual scanning technology where we've got those cameras that can run a train through at 70 miles an hour that the industry has been talking about. And through our approach, we're able to minimize -- reduce bad orders. We've got a waiver now using it to create a safety case that we actually do not have to do a safety inspection that we normally do today on -- or we're doing today -- yesterday on our potash fleets, as well as Conrail technology, we now are able to bypass one of the brake tests because that Conrail technology literally allows you to test the effectiveness of the brakes and to target your repairs on your fleets much better than just a normal human brake test would do. So those 2 together, exemption on our potash fleet, we just started running trains 2 weeks ago. Every one of those trains that goes through Moose Jaw is about 4 hours of dwell that's eliminated because of those 2 combinations of technology applying that. And that amounts up to thousands of hours of train delay that's not uniquely benefited to the potash fleet. It's also benefited and rolls across every other train that runs through that terminal. And it's a very dense terminal for us. So if you think about all those things, there's a lot of moving parts to that. But from productivity, efficiency, safety as well as our unique growth story opportunities, we continue to move the needle and continue to benefit our shareholders and our customers, and we don't see that changing in 2021. The momentum we've created in this quarter will continue to carry into the first quarter moving into a normalization of the economy in the next year.

Well, thank you so much, Keith. There's a lot going on, obviously, and I did hear your presentation at RailTrends. So I would love to dive into the technology piece and all the different things you guys are doing. But if we could just start on the demand side, I don't want to spend a lot of time on Q4, but you said things are turning better than expected. Are there specific areas or commodity types that are coming in a little bit better? Is anything coming in worse? And then I'd love to get into the growth opportunities going forward.

Yes. We've -- I mean, across the board, except for crude, obviously, from a compare standpoint because we were so strong fourth quarter last year and first quarter this year. If not for those 2, we're seeing demand across every business unit. So whether it's automotive, which is up, I don't know, it's compelling, we're up 60% automotive versus last year and this quarter. And again, that's being driven by the creation of the solutions with Globus as well as the contract wins with Ford and Chrysler and that automotive compound that we built in Vancouver. So if you look at that, that will continue to drive very exciting, compelling growth for us in 2021. We don't have a full year benefit of that. That Globus contract just came on in September. Chrysler came on mid-summer. So again, that's going to be pretty compelling for us next year. We look at domestic intermodal. That's been an area of growth. We continue to benefit from demand in that space. Obviously, we've got a superior franchise, given that we have the shortest lengths of hauls in the key domestic markets. We've got more of a book that benefits from e-commerce, given our retail customers, whether it's Canadian Tire, which were their main flagship carrier; Loblaws; Home Depot, with distribution centers on our facility; Dollarama, which we brought to our railroad. I guess now this is the second year that we've had them in our book of business, all those spaces that are benefiting from e-commerce growth plays to our strengths. So again, we'll see additional growth in domestic next year. International speaks for itself with the Maersk win and with the Hapag-Lloyd announcement, which is upside that I'm sure no one had anticipated. That's going to be fueling our growth. We're pretty excited about. And then energy, chemicals and plastics, with what's going on unique again to our industry, outside of the DRU with the expansion with Suncor, the expansion or the own mining of IPL, expansion with shale. All those areas, in all honesty, they all speak to the streets of the franchise. And if I think about -- you try to -- what does that mean? That means pretty firm convictions and no reason in the world this railroad can't realize mid-single to high single-digit RTM growth in 2021, while all the while enjoying margin improvement. So I think that's pretty compelling from an investment standpoint.

It's definitely -- it just answered my -- the question I was going to ask, which is, yes, the possibility of high single-digit RTM growth next year. But maybe just like thinking about all the things you said is I think getting hard to keep track out because there's so many idiosyncratic opportunities. You have the 2 separate Maersk contracts. The Hapag-Lloyd that you announced this morning, the auto compounds and DRUs, and just the list goes on and on and on. So obviously, I mean, it seems like just as long as the economic backdrop cooperates that high single-digit RTM growth is probably pretty feasible next year. But maybe if you could talk about -- I think it's very interesting. You've said for the last couple of quarters, there will be a carrier that calls on Saint John in 2021. Obviously, that has already come to fruition. How are you guys approaching these conversations, whether it's with Hapag-Lloyd or Maersk or even Globus? You're really entrenching yourselves in customer supply chain. Is that the key sort of growth going forward? And if you could sort of address those questions.

Yes. Allison, it's really just been doing what we said we were going to do. If I take you back to our Investor Day back that we had in Calgary a couple of years ago, our franchise strengths or lengths of paws are shorter than our competitor. We serve all the major markets. Before, we were disadvantaged because we did not go east of Montreal. Well, we fixed that with the CMQ acquisition. So if you take that and you take uniquely, you go to these major centers that we serve, we have land in every center. There's not one, whether it's Vancouver, Calgary, Toronto, Montreal, those are the 4 major population centers, and even Saint John in partnership with the NBSR. There's room to grow, and we have land that we -- that's contiguous to our operations to expand on. So we've created supply chain solutions. We've gone to like the Maersk opportunity. It's very unique. It's not replicable. You think about what happens on the West Coast of U.S. There's about 75% of what comes off tidewater gets transloaded. In Canada, that number is about 25% of Vancouver. When you didn't have the facility to be able to do it, all the stuff had to be trucked off the port in a very congested area. The expense is very high. You have to pay for permits. The dray costs are outrageous. So there are some things working against you that made all the sense to become tailwinds if you could create the solution. So that's with our land. We said, listen, we can build a facility inside our footprint. We can give you rail service from the port. We can take the truck out of the equation. You enjoy all those economic benefits. The environment, which more and more we all know, ESG is more topical than it's ever been. It's critically important. This solution is compelling in that sense, which resonates not only with the government, with the world, with our employees, it makes great business sense and economy sense. So to be able to do that and create a partnership that creates a stickiness, something that means something to the customer that allows them to get a competitive advantage so they can grow, and in turn, we grow, is compelling. So anywhere we can replicate that. That's what the Maersk solution is. That's why we built the automotive compound in Vancouver. That's what allowed us to win the Globus contract it. We're not selling rates. We're selling services. The service proposition is that supply chain solution. So we realized a long-time ago, probably after I've been at CP for 2 years. I said, listen, if we're going to win in this marketplace, we've got to matter to the customer. We can have the best-run railway in the world, but we got to create value, and it's got to be defendable, and it's got to be hard to replicate. It's got to be unique, and that's the business we've been about doing for the last 3 years. And these things are coming to fruition. They didn't start yesterday. Obviously, many of these discussions have at least 1-year-plus, 2-year run times. And rest assured, there are other discussions that are ongoing. I'd be disappointed. I can talk about Saint John. The capital investment and the vision and the action is to grow that terminal to an 800,000 TEU capacity terminal. If we don't announce another ship coming to Saint John by the end of 2021, and then growth beyond '22 when all that capacity is going to be there, we're not doing our jobs. But rest assured, sleep well, knowing that those discussions are already -- they've already been initiated and they're being had. And certainly, as we create success, and if you're not Hapag-Lloyd, we've got to compete against Hapag-Lloyd, and they've got something that can allow them to grow, then you want to replicate that. I'd point to the grain story. That's another one that's compelling with the 8,500-foot grain model. G3 came to Canada. They want to build the most productive, highest capacity grain elevator in North American Shore, the first build in Canada in decades. Let's make it world-class, where we were at the table in those discussions. 112-car grain train doesn't excite us. What should it look like? Well, it should look like an 8,500-foot grain train. It should look like an ability in the field to build a terminal that isn't a bunch of ladder tracks, it's a loop track that allows me to pull in with 134 cars, those new cars we're buying, 8,500 feet of cars, lead the power tied to it, you loaded in 12 hours, I put my crew to bed. They're rested. The power stays there. We don't have all the unnecessary debt adding, and we're running it back to tidewater, unload it the same way, and it creates tons of capacity, which is great for the country, reliability and supply chain, and at the same time, drives revenue streams at more compelling margins for the railway that allows us to continue to invest in that model. So those are the things we're about doing. That's what PSR enables. That's the reason it's important that you don't grow for the sake of growth's sake. You can't outstrip your capacity. You got to be in lockstep with and have that discipline to run as an operating company, and it creates marketing solutions that matter to the customers. That's the recipe. You just got to have the discipline to execute.

So when you think about the -- excuse me, there's a lot of incremental volume that's, again, sort of idiosyncratic to CP. Do you feel that you're properly -- not necessarily from a sort of short-term research standpoint, but from a capital standpoint and a capacity standpoint, to be able to handle that volume, which presumably starts to flow in in 2021 and pays dividends beyond that. Is there a point where, and I know you talked about creating capacity, and there's all sorts of efficiency gains that you guys have made even in 2020 with train length and train weight in the grain hoppers, like you mentioned. Do you -- at what point would CapEx need to sort of tick higher to accommodate the growth? Or do you feel that you have sort of plenty of runway from where the network stays today, so you'd be able to handle that growth for the next 2 to 3 years?

Yes. The kind of growth we're talking about, mid-single to high single-digit growth, we've got a lot of capacity. The things we're doing that we haven't realized, like I talked about this technology. How do you put a number on how much additional capacity in that key corridor we're creating just for that one application of the technology to the potash fleet. So we're creating our own capacity as we grow forward. Now if we get to a point where we have a customer that comes to us, and it's a compelling opportunity that says, CP, if you'll partner with us, and we'll use your land, and you spend some money, we'll spend some money and we create a long-term partnership, could that require us to stem more capital? Perhaps, but we tell you about that. In the absence of that, you can expect us with our envelope. We're at 1.6 this year. That's artificially inflated because of the grain hopper investment. That rolls off at the end of 2022. That's $150 million, $175 million a year. So you take that back to free cash flow conversion, that $1.6 million normalized becomes $1.4 million, and that cash is going back to our shareholders. That's pretty compelling, and I don't see any need to change that. I look at our locomotive fleet. We still have locomotives to repurpose. On the sideline, I look at the strategic investments we're making every year. And I said this to my operating team. I have an annual meeting. The operating leader leads it. Obviously, I used to be that guy. So I've stayed tied to it. So the operating team, we do it every November. And we're talking about our growth that we have this year looking at next. So they're thinking about all these things and they're thinking, "Well, that's a lot of growth, Keith," And I say, "Wait a second, guys, you've got to keep this in perspective." You go back to the growth, you layer this on top. We're not getting beyond 2019. And what have we done in the last 2 years? We spent a lot of money investing in capacity in this railway. We've extended sidings. We spent money in Calgary, optimizing that, what was a hump terminal. It's built to grow. So you've got to pay our shareholders back for that investment. So rest assured that capacity is there. I don't see anything over the next 2 to 3 years with what we know with all these initiatives that are going to take us beyond that. And I'm not going to be surprised. That's something that I've learned, and I've watched, and I understand. You can't let your appetite for growth outpace your capacity and ability to be able to handle it. So you've got to measure in lockstep low-cost, profitable, sustainable growth matters. So before I'm going to spend a bunch of money with the customer, there's going to be some stickiness. It's going to make good business sense. And I'm not just going to build the church for Easter Sunday, to coin one of Peta's phrases. How many times do I hear that from him, and it captured the essence of it. You'll go broke if you try to run your business that way. And at CP, we're not going to run our business that way.

So putting all this together, in conjunction with all the productivity improvements in 2020 and even before that. It seems pretty easy to be able to get to a mid-50s OR in 2021. And obviously, I know you want to commit anything like that. And I know you've talked about this before, but it's not like sort of mid-50s OR, is that where things start to tap out? And then it's sort of can't go below that because you need to invest for growth. What's the right way to think about it? Because you guys are pretty close, and you have this massive pipeline of growth opportunities for as far as we can see. So how do investors think about balancing the OR with growth against free cash flow conversion and improving ROIC?

Well, at the end of the day, the OR to me is about balance. It's not about being the lowest. It's a natural outcome to run the business the right way. So I think it'd be hard to ignore the fact that if you look at our thesis, low-cost, sustainable growth. If you grow, and it's profitable, and you're bringing on good business, and you're not impeding your ability to execute a fluid railway, it's a natural outcome. So when you see revenue growth, you should expect margin improvement. Now you get to a point, mid-50s, if you get below that, especially in our space, and I'm talking Canadian. We're in North American railroad, but we're more heavily weighted in Canada than in the U.S. And the regulatory environment in Canada is dramatically different when it comes to customers' ability to initiate rate challenges. It's baseball arbitration, final offer arbitration. So we've always had more conservative and modest. We provide value, we take your rates up, but it's been more conservative compared to our U.S. peers. If we get to a place where we go below that, I think you get to an environment where you introduce a lot of risks where you're encouraging customers to not see the value in which you provide them and see the opportunity in trying to beat your rates down. So I'm just not going to pick that fight. I don't think it's necessary. And I don't think we need to go there unless our competitor were to create a competitive threat with the difference in their ability to make money at a lower cost than us because that's where we were before. We couldn't compete for certain business and make a buck because our costs are so high. We've eliminated that impediment. I think we take a lot of pride we're a little bit better. We run a railway this way, and it's going to be a natural outcome. But again, it's about balance. It's not about being the lowest. But you can expect, you're right, a natural outcome for us is a mid-50s area. And we're in the march to do that, and I think we'll get there before anybody in the industry gets there. Who would have thought in this year that we face the rail industry, given we were sub-60 last year that we're going to realize margin improvement. I could have told you that back in January, you probably could have told me that in January, I said, well, wait a minute. I don't know if it's that good. Well, I tell you, this model works if you run it the right way. With the power of the people we have in this company and this franchise, that's a potential outcome. It's one that we're realizing. It's one -- it's not easy, Allison. It's an outdoor sport. It takes the discipline. It takes the right culture. But if you get the formula right, you can execute it, that's possible, and it's something I'm proud that we're able to produce for our CP family as well as for our shareholders. And it's nothing that we expect to change.

I think this is a perfect segue into -- I mean, first, I guess, maybe back up a little bit. I would love to ask your thoughts on what CSX announced the other day, they're intending to acquire the Pan Am, does connect with the CMQ. So from a CP standpoint, are there commercial sort of collaborations that are possible with CSX sort of taking your reach within the Northeast U.S.? And then more broadly, and this came up at RailTrends quite a bit, but -- and trippers, of course, want more consistency and more tracking and tracing and more proactive outreach. And sort of what it all came down to was, well, can the U.S. class rails grow? And so my question to you, having PSR as part of your DNA and then seeing what you've done at CP, can the U.S. rails grow? And do they just need to adopt the same model that you have at CP as opposed to there just being certain, perhaps dynamics or favorable developments that have benefited the Canadian rails. I guess why would it be different for the U.S. rails outside of a secular decline in coal? I know that's a lot of questions.

Yes. I think I can -- short answer is, yes, they can grow. Dependent upon our ability to pivot to growth and have the discipline in capacity within their organization, not to try to grow for growth's sake. Again, it's got to make sense. And to me, if I'm a U.S. road, I've got to create customer solutions that matter to the customer. That doesn't just swing to the truck every time. Truck rates go down, and we're oversupplied in capacity in trucking. They got to insulate themselves if they're going to invest and grow with the customer and create that mouse trap. So if it's a light-mining company that has the ability and the discipline to be able to do that and not just chase growth, but create solutions that enable growth, that's what this model unlocks. So those that get that right will have an ability to enjoy success more so than those that don't. It's not just about cutting costs. It's about creating low-cost service that allows you to enjoy the synergies that railroads provide over truck, but you got to have truck-like reliability. And you got to have a footprint that helps the customer grow in their market space and save money. And if you do that, and that's what our stories have been. Some will say, in Canada, part of the growth is just because they've shifted international business off West Coast U.S. to Canadian soil. Well, yes, that's driven some of it, but unique to CP. We haven't grown. Our growth has not been driven by international intermodal. It's been driven by domestic intermodal, which speaks to our franchise and the PSR creating that mouse trap. It's growing in automotive. All those areas, grain, potash, it's all about innovating, creating customer solutions. So again, if you can do that, then yes, you can enjoy growth success and still drive margin improvement and drive compelling. Now when it comes to CSX with their purchase of the Pan Am, stand-alone, the Pan Am for us, especially with our purchase of the CMQ because there was a railroad that would have had to interchange to another railroad, sometimes that gets in a way of doing good business deals and creating customer solutions. But I think now with CSX buying that railway, we haven't looked at it yet, but rest assured we will. But if you've got 2 like-minded railroads with similar operating models and similar minds about how to grow and with the desire to grow in that low-cost, sustainable, profitable manner, I've got an -- I've got to say that it's going to unlock some opportunities for our customers that don't present themselves today. So we...

[indiscernible] growth for CP is that the U.S. rails are, most I've seen, very like-minded from a commercial standpoint. You guys have all worked together for years and years. So is this sort of a good framework to think about sort of the next phase of growth for CP is being able to leverage what the U.S. partners are doing and different connectivity and sort of for CP getting a more extensive reach into new markets. Is that the longer-term view? I mean, of course, you're doing some great job in terms of the stickiness and creating solutions for your customers, which is very evident. What's the longer-term thesis?

I think that's just part of the way we run the railways, Allison. I mean we have had and continue to have very productive discussions with our interline partners, whether it's UP, whether it's KCS, whether it's NS, whether it's CSX, literally across the board. Looking at in the absence of a transaction, combining the company, how can we realize some of those synergies? How can we create an operational solution that creates an ability to turn assets better for the customer, that's going to be better for you and better for us. So we've got -- we're not talking about triples, they're singles. I can go railroad by railroad that this PSR discussion has opened up with eyes and a mind to be creating those solutions for their customers that without it never would have been enabled. I'll give you one case in point with UP. Lance and Jim Bennett, the work they've done there. They worked with us to invest in that connection that existed before PSR, going from the BC border to Oregon, to Portland, to create synergies for carload business, to create synergies for potash business and grain business that has been abled by PSR move the needle. Before PSR, that corridor, we had to literally size our Canpotex trains to 130 cars versus the Canadian model, which is 2/3 of the business at 172. Well, imagine the lack of efficiencies and synergies and costs that went up in the air switching trains from 172 to 130. And how much capacity was lost? Well, discussions that PSR enabled, we got to be able to do better. Now we're running 188 car trains. So that means more potash move, more liability, lower cost, incremental fuel expense, saving crew expense, more capacity. I mean, it's compelling. And rest assured, the railways that are implementing PSR, those discussions don't happen in year 1. You don't convert them all. This is going to be a multiyear opportunity for all the railroads that get the power of this model and that protect the principles of the model. You got to make sure you run it as a railway, an operating company, not a marketing company. The natural outcome is you produce a product that the customers will value, but you got to protect those asset turns and the assets and the fluidity of the network. It's not just growth for growth's sake. It's got to make good sense and not impede your ability to run the network fluidly.

All right, Keith, I think we're out of time. If there's one message that you would want to give to shareholders today, what would you say outside of the power of the earnings? But again, the earnings power of the business is substantial, free cash flow is improving, returns on invested capital improving. What are investors missing in the CP story in your estimation?

The -- all I would say is just stay tuned. They've been rewarded. This playbook has many chapters left in it. We said 3 years ago that we're going to pivot to growth. We've done that. We continue to do that. It's not going to change. We've led the industry in the last 3 years. We continue and expect to be leaders in growth, in earnings, as well as revenue as well and margins. It's just the way we run the business. That's not going to change, and there's much more left to come.

Excellent. You guys executed on that so far. So looking forward for more to come on that. And congratulations on the deal announced this morning. Thank you so much, Keith. I appreciate your time this...

Stay healthy. Have a Merry Christmas.

Take care. Bye.

Bye bye.