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

Good afternoon. My name is Gretchen and I will be your conference operator today. At this time, I would like to welcome everyone to Canadian Pacific Fourth Quarter 2022 Conference Call. The slides accompanying today's call are available at investor.cpr.ca. [Operator Instructions] I would now like to introduce Maeghan Albiston, Vice President, Capital Markets, to begin the conference.

Thank you, Gretchen. Good afternoon, everyone, and thank you for joining us today. Before we begin, I want to remind you that this presentation contains forward-looking information, and actual results may differ materially. The risks uncertainties and other factors that could influence actual results are described on Slide 2 in the press release and in the MD&A filed with Canadian and U.S. regulators. This presentation also contains non-GAAP measures, which are outlined on Slide 3. With me here today is Keith Creel, President and CEO; John Brooks, Chief Marketing Officer; and we're welcoming back Nadeem Velani, our Chief Financial Officer and CP's newest conductor. The formal remarks will be followed by Q&A. [Operator Instructions] It's now my pleasure to introduce President and CEO, Mr. Keith Creel.

Thanks, Maeghan. Let me start by thanking our 12,000 strong CP family for their efforts that have allowed us to produce these results in the fourth quarter and certainly over the course of 2022, and I can tell you what I'm most proud of, which is I know is only enabled by their individual and collective efforts is the safety performance that the team produced in 2022, producing our lowest ever FRA accident frequency ratio in the company's history and our 17th consecutive year of being best-in-class, best in the industry as it's related to reportable train derailments in the industry, so to be extremely proud of. And then to Maeghan's point, our bench is only getting better. I'm [indiscernible] that we've got our CFO, Mr. Nadeem Velani, who adds another background into his title, Chief Financial Conductor Officer, CFC, CFO, whatever you want to call it, he's had a very rich experience. He's obviously his business acumen from his time in Harvard has increased, but most importantly, his railroad acumen and ability to apply this business talent has increased with the railroad now that he's obtained the last 5 years, it seems like probably 5 years and there is 25 below. The last 5 months specifically out on the railroad boots on the ground and the ballast, spending time not only getting conductor qualified, but also riding trains, coming the mechanical department time with the track department time in the locomotive department, all the functions that truly make this company run day in and day out by the great professional railroaders that we have the men and women that make CP what it is. So with that said, again, welcome back. Nadeem glad to get you back in the seat. And I also want to commend Chris and Maeghan and Ian for the great work they did when they were going in your absence. So they certainly made you proud. Now moving on to the results. In the fourth quarter, we produced revenues of $2.5 billion and operating ratio of 59.1% and core EPS of $1.14. For the year, total revenues were up 10%. We delivered an operating ratio of 61.4%, core EPS of $3.77, which was flat versus last year. But we knew from the beginning '22 would be a year of 2 halves, and particularly, we had high expectations for the fourth quarter, which we are ready and resource to meet. Unfortunately, there were some factors that impeded our fourth quarter to some degree. But with that said, I'm very pleased with how we began the year. Strong revenue and operating performance in January which carries -- is going to carry great momentum into the first quarter of this year and as we play out in 2023. We're in a great place from a network and resource perspective, in spite of a historically tight labor market in '22. It was a record year of hiring at CP. We added more than 1,600 conductors over the course of last year, and we made some significant progress with our labor agreements with the recent tentative collective agreements, both with the Unifor as well as the BLET both of those agreements are out for ratification specific to the BLET and this has to do with the consolidated territories, which are obviously contingent upon the STB approving our merger application, this agreement with the BLET which are the locomotive engineers and the earlier agreement that we signed with Smart, the conductors for the KCS in Kansas and Missouri, they're both progressively hourly agreements, which will improve our operational flexibility as well as predictability in our employees' quality of life. Again, it's an agreement that gives us flexibility in turn, enables our employees to realize higher pay, scheduled jobs and a better quality of life compared to a traditional labor agreement as in the U.S. rail space. Parts of these agreements, of course, remain subject to the STB's approval of the merger, but we certainly see additional opportunities down the road pending and assuming depending upon an approval to create a framework for the benefit of all employees in a combined CPKC network and also obviously, the reliability benefits in service that this agreement will provide for a combined CPKC. We'll say a couple of words about the transaction. On the CPKC front, both of our teams at both CP and KCS are hard at work preparing to seamlessly integrate these 2 iconic companies. I can tell you there's been a ton of tremendous work that has been accomplished that teams at both railways to ensure the smooth transition. I'm extremely pleased last week also to note the release of the final environmental impact statement. Certainly, that's no small feat and huge quantum avoid by the STB to get that done in the meticulous type of way that they handled not only just the environmental impact statement, but in handling this entire file. So I commend the team for the work they did throughout the process, as I've said, the STB has been very thorough and they're meticulous and we continue to eagerly anticipate their decision on our merger applications, which we expect this quarter. On the environmental front, couple of words. CP continues to also to make strong progress in this space, specifically on sustainability. I'm pleased to see that the company's efforts continue to be recognized for the first time in our history, CP was named to the Dow Jones Sustainability World Index, which is a tremendous achievement for the entire CP family that we can be proud of. We were also named to the Dow Jones Sustainability North American Index for the third consecutive year and finally named to the CDP A list, which is an absolute reflection of our commitment to comprehensive comment disclosure at Canadian Pacific. We continue to demonstrate our leadership and commitment to a more sustainable future, also through our hydrogen locomotive project, which is unique in the industry. In late October, that project had a significant milestone when the locomotive performed its second mainline test and first revenue move and are seen to experience the second hydrogen locomotive, which is the GP38, 4-axle DC locomotives over the next month, which will be making its debut so to speak, as we get it out rolling and operating, so we can work the bugs out of it. So let me close by saying '23, we're poised been ready to roll. It's going to be a very special year for 2-story company. We can't wait to get to work and buying these 2 great companies and creating value for our customers, our employees in the North American economy. We're focused on executing the plan and I'm very pleased with the start that we've had this year to what I expect will be a historic year. So with that said, I'm going to hand it over to John to bring some color on the markets and then Nadeem will wrap up elaborating on the numbers, and then we'll open it up to Q&A.

All right. Thank you, Keith, and good afternoon, everyone. So as Keith mentioned, the fourth quarter wasn't without its challenges as certainly customer supply chains and the winter weather we faced impacted our volumes. We ultimately fell a little short of our RTM growth we expected to deliver for the year. However, I'm pleased, as Keith said, to the start to 2023 and believe we are uniquely set up for the year. I'll take a look at our fourth quarter results now. Total revenues were up 21% on the quarter. Volumes were up 8% on the quarter, while FX and fuel combined to be a 15% tailwind. The pricing environment continues to be strong. Now taking a closer look at the fourth quarter and the 2022 revenue performance, I'll speak to the results on a currency-adjusted basis. Grain volumes were up 27% on the quarter, while revenues were up 42%. Working in concert with our grain supply chain partners, CP set new all-time monthly tonnage record for shipping grain and grain products in October, and we delivered our second largest quarter ever for grain volumes. Our newest 8,500-foot high-efficient elevator, a Richardson greenfield facility in Saskatchewan started receiving grain in December. And in 2023, we expect to be over 50 origin elevators that will be 8,500 foot capable, enabling us to continue to move record amount of grain more efficiently. On the U.S. front, we saw strong demand in Q4 for both our export and domestic markets. I fully expect our grain franchise to continue to be an area of strength as we move through 2023. On the potash front, volumes were down 2% on the quarter, but we ended up 9% on the year. While we saw volumes for export potash impacted by weather challenges, the long-term outlook for potash remains strong and unchanged. I expect to see similar growth in 2023 as we saw last year in potash. And to close out the bulk business, coal volumes were down 25% in the quarter and declined 18% on the year. An outage at Teck Elkview mine in September impacted volumes through much of the fourth quarter and lasted longer than we anticipated. We lost over 100 trains in the fourth quarter due to these challenges. Looking ahead in coal, given the disruptions we faced in 2022, combined with a solid macro demand environment, we have a good setup from a compare standpoint as we move into 2023. So when I look at our bulk franchise, which makes up 40% of our book, it is an extremely well positioned in 2023, whether it's through strong demand fundamentals, favorable compares or both, we have a setup to deliver double-digit growth in this less macro sensitive portion of our book of business. Moving on to merchandise. The Energy, Chemicals & Plastics portfolio saw volumes grow 4%. We saw increased volumes in our DRUbit during the quarter as well as plastics from our new IPL petrochemical facility, single served by CP in the Alberta Heartland. Despite macro uncertainty, I expect ECP volumes to remain resilient as we start off 2023. Forest products were down 4%, while revenues were up 17%. Despite the Q4 decline in volume, this caps a record year for CP and forest products. While housing starts are expected to decline in 2023, CP's demand is softer compared to our record 2022. Our lumber, panel and pulp volumes have stabilized, and we are working with our customers to maximize new market opportunities. Automotive revenues were up 27%, while volumes were up 11% on the quarter. On our Q3 call, I talked about over 7,000 vehicles sitting at CP origins waiting for final components. I'm pleased to see that we are seeing definite improvement in parts supply and more vehicles are moving towards shippable status. We have also begun moving the new Ford business that started up January 1 and I'm pleased with the startup of our new auto compounds at both Edmonton and Bensenville. Looking ahead, demand for finished vehicles remains fairly strong, and we are working with our customers to replenish inventories at dealerships across our network. Those fundamentals, combined with the new business we brought on, has positioned our auto business well for 2023. Now finally, on the intermodal side of the business, quarterly volumes were up 17%, where revenues were up 29%. Despite demand coming off record levels that we've seen in the past few years, our unique market wins have differentiated us in International Intermodal with volumes up more than 40% in the quarter. With favorable compares to the first half of 2023, driven by new business that started out the back half of 2022 and the continued port expansion of the Port of St. John, we are well positioned to continue to outpace the industry in this space. Port of St. John continues to see tremendous growth, eclipsing 150,000 TEUs in 2022, more than a 70% increase year-over-year. Our partners at DP World are in the midst of deploying super new post-Panamax cranes, and this, coupled with the new birth and track at the port will result in a doubling of the capacity by April 1. The Port of St. John remains on plan to grow its total capacity to 800,000 TEUs in 2024. On the domestic side, although demand with our core retail customers have come down from their recent highs, our temperature controlled products continue to be strong. CP is a leader in the temp controlled space across Canada and we look forward to paving the way into new markets across North America with CPKC should the STB approve our merger. We are continuously working hard with a variety of customers on test moves on an interline basis, which are going very well. We recently completed a southbound test shipment from the U.S. Midwest market to Laredo carrying temp controlled products in about 3 days. which is competitive with a single-driver truck. Further, we've also been testing the northbound lanes focused on those service sensitive products to markets across the upper Midwest, U.S. and into Canada. These markets are 100% served by trucks today and present a tremendous conversion opportunity for the combined CPKC to provide truck-competitive single-line service pending the STB merger of our -- approval of our merger. So let me close by saying, as I look out at 2023, with the broader macro environment certainly remaining uncertain, CP strong bulk franchise, our self-help business wins and anticipated opportunities as part of CPKC have us in an advantageous position. My team is focused on staying close to our customers and selling the value of our service. So with that, I'll finish up and pass it over to Nadeem.

Thanks, John, and good afternoon. Great to be back and speaking to the results of the CP team period this quarter. Some of you are aware of being out of the office in the field in the last 5 months. It's been a very energizing time on the railroad. And I'm thrilled to see the passion and pride from our people firsthand. I had a chance to spend a few months in our world-class training center, getting conductor qualified along with a strong pipeline of new railroaders that will enable us to deliver on our growth agenda safely and efficiently. Let me take a moment just to thank 4 specific trainers that help me, Jeff Mclean, Nate Blunt, Mark Mariam and Joe [indiscernible] who shared their collective 140 years of rail experience with me, and I'm very grateful. I too also want to thank Maeghan Albiston and Ian Gray for their support and backfilling for me and doing a wonderful job. So thank you to 2 of you. Now looking at the quarter, the adjusted operating ratio came in at 59.1%. Taking a closer look at a few items on the expense side, I'll speak to the variances on FX-adjusted basis as usual. Comp and benefits expense was up $1 million versus last year. Increased volume and wage inflation were largely offset by lower accruals for incentive and share-based compensation. Fuel expense increased $153 million or 62%, primarily as a result of higher fuel prices, which were up 43% on the quarter versus last year and roughly flat sequentially. Materials expense was up 33% or $17 million as a result of cost inflation, largely in non-locomotive fuel. Equipment rents were up 43% or $13 million as a result of higher car hire payments resulting from stronger volumes in intermodal and automotive. Depreciation expense was $219 million, an increase of $9 million as a result of a higher asset base. Purchased services came in at $310 million, an increase of $54 million or 21% when adjusted for acquisition costs. The main driver of the increase was higher pickup in delivery costs and other third-party services. Moving below the line. The equity pickup from KCS in the fourth quarter was $287 million when adjusted for KCS' acquisition-related costs, purchase accounting and a gain KCS had from an interest rate hedge unwind. Other components of net periodic benefit recovery increased $6 million, reflecting higher discount rates compared to 2021. Net interest expense was up $32 million versus last year as a result of a higher debt balance related to the KCS acquisition in Q4 2021. Income tax expense decreased $49 million, excluding KCS related items and the reversal of a previous provision for an uncertain tax item, the effective tax rate was approximately 17.5% on the quarter. Looking ahead, I expect the CP stand-alone tax rate in 2023 to be approximately 24%. Rounding out the income statement, core adjusted EPS was $1.14 in the quarter. On the year, core EPS was $3.77, flat versus 2021. We continue to generate strong cash flow with cash provided by operating activities of $4.1 billion in 2022. We continue to reinvest in the railroad and finished the year with a capital spend of just under $1.6 billion. I anticipate a similar level of investment for CP stand-alone in 2023. In the fourth quarter, we received dividends from KCS totaling USD 415 million, which were utilized to pay down short-term debt. Over the course of 2022, we received a total of USD 880 million or approximately CAD 1.2 billion in dividends from cash flow in excess of the capital KCS has invested in their railroad. Inclusive of the dividends, we generated CAD 2.7 billion in free cash flow. Over the course of 2022, we repaid more than $1.6 billion in debt. Pro forma leverage ended the year at 3.8x, and we remain committed to returning to our target leverage. Looking at the year ahead, despite uncertainties with the macro environment, inflation and interest rates, I couldn't be more excited. We have a transformational merger with Kansas City Southern and a strong pipeline of opportunities for the team to deliver. With that, let me turn it back to Keith to wrap things up.

Okay. Thank you for your comments to color both John and Nadeem. So operator, let me open up the line for questions.

[Operator Instructions] Your first question comes from Jon Chappell from Evercore ISI.

John, I know that you guys clearly didn't put out any guidance targets for all the obvious reasons. But when you hear you walk through all the different segments, bulk being 40%, double-digit volume growth, the tailwinds on auto, et cetera, et cetera. When you look to '23 on a CP stand-alone basis, understanding the macro headwinds, does it seem to you that you can have volume growth that's not just at or better than GDP, but substantially better, almost like a multiple of that, just given all your idiosyncratic tailwinds that you have on your own network?

Well, Jon, look, I definitely see a path to growth. You know what? We're unique in that 40% of our book is our bulk franchise, and I'm leaning heavy on that. As you said, certainly the macro environment is uncertain, and we're not going to get too far over our SKIs and trying to predict what that's going to look like. But the Canadian grain franchise is set up well. Canpotex gets through their contract negotiations with China and India, we believe there's a path to a double-digit growth opportunity there. And as I said, Teck, we had a tough year between the weather and some of the mine challenges they had. There's, I think, a significant upside in a good market demand environment in the metallurgical coal area. So if you sort of build that out, Jon, and you can make your own predictions on sort of where those more industrial and consumer markets to go, it definitely leads to a path to some growth.

And our next question comes from Tom Wadewitz from UBS.

Wanted to see -- I think you've given us quite a bit of color over time about the opportunities for growth when you get the approval on with KCS. Is anything changing? Or is there anything that's kind of new and developing as we wait for that STB decision? Or is it pretty stable and it's kind of the same pipeline same opportunities that you've been talking about?

Tom, I'll just say this in short. Number one, I can't get ahead of the STB. The STB is the authority here and all explain we need there, the stamp of approval. Now I do think that our facts are very strong and it's a very compelling value creation for all stakeholders and enables growth and all the things that we have said all along remain to be true, but ultimately, they have to decide and when they do. Nothing has at all needed our optimism for the opportunities and all the discussions we've had continued upon that approval, we have an opportunity rich list that we're going to be able to execute that, we're looking forward to get to work on.

Our next question comes from Chris Wetherbee from Citigroup.

I think as well out into 2023 and thinking about sort of the combination of this business, I would guess maybe curious your thoughts on the ability to improve the OR from what was obviously a bit of a transition year or a tale of 2 halves, as you mentioned, Keith, in 2022. So I don't know, team, if you be willing to sort of think about on a CP-specific basis above the line, your thoughts around either EBIT growth or OR improvement from where we finished 2022.

Let me size it up like this, Chris. Let me start by saying the 61.4% is not a CP standard. So that is an absolute fact or the belief. We look forward, there's a lot of moving parts. Obviously, we don't know what the economy is going to do, but we do know our story is unique. And we know we're going to control what we can control, and I do see a path to our improvement. So let me leave it at that.

The next question comes from Walter Spracklin, RBC Capital Markets.

Nadeem, great to have you back. My question, I guess, is on St. John. And you mentioned going to 150 this year, obviously up from a less than 90 run rate and now you're pretty much running at a 300 run rate, so probably double that again in '23. You're pointing to 824. Just curious, when you get to that level, how long do you think it will be that you could fill that 800 capacity in '24? And is L.A. Long Beach in the shorter queues and the less congestion over the West Coast. Does that hurt your ability to get up to 800,000 on a quick basis in '24 or beyond?

Well, Walter, you know what, I don't think so. And the thesis all along, if we think back to when we bought the CMQ. Number one, it was -- there was only one competitor in that marketplace. We identified a route that with our investment, with our partnership with [indiscernible] and the NBSR, we're able to create a service package that ultimately, long term, we believe, is what is the enabler of the growth. We can get to Toronto, Montreal, Chicago on a 200-plus mile faster route. That's not undeniable. And I think that's given us opportunities to talk to these steamship lines, maybe a little differently than we have in the past. And I think the other point is I think about your timeline in '24, '25 and beyond is a CP network that reaches Coast to Coast across Canada. And with the STB, hopefully approving our transaction, being able to link in the Gulf and also potentially Lazaro down in Mexico, gives us a really nice menu to be able to work with our customers on. And as part of that, I see that enabling customers to not only look at the West Coast, but grow that East Coast protocol with us, but then also potentially further diversify themselves by potentially going down and utilizing the ton of capacity that we're going to have available coming in through Mexico.

Next question comes from Ken Hoexter from Bank of America.

Nadeem, welcome back and good luck on the rest of this process as you go through here. It's an exciting time to follow it. Can you talk about the test runs? I think you talked some of the lanes you're testing with KCS on a commercial basis. Is there anything you can kind of talk about in the interim, you mentioned selling was 100% served by trucks. Maybe can you quantify that specific opportunity or the potential then?

Well, Ken, I'll say this at this point. As I said, these are interline test moves that we've put together to, I guess, somewhat replicate or begin to sort of proof of concept with these customers. As I said, there's a moving 100% truck today. So part of the sale is helping the customer understand what that process and what that opportunity could look like. Obviously, in the future, if we're blessed with single-line service between Toronto and Chicago and Laredo and ultimately down into Mexico, we wanted to begin to prove that we can compete head-to-head with trucks and ultimately provide that the liability that those customers are going to require. I can tell you that the second part of the story that's kind of neat around some of these opportunities is in these couple of examples I spoke to, we've done some work with the customers to identify the greenhouse gas emission savings at about 60% to 75% clip versus their current mode on those specific moves. And it's really become a unique and exciting sales tool that maybe far more than ever in the past, some of these customers have stood up to say that. That's beyond the price and the savings and the reliability and the service, this is an important story for our companies. So I hope that helps, Ken.

It sounded something I guess we'll hear about more in the future.

For sure.

Our next question comes from Scott Group from Wolfe Research.

So I understand 61 sort of not the CP standard. So do you think maybe is this a year where we can get back to that 57, 58 OR we had in '21. And then just in terms of like the consolidated results, and I know you can't give specific guidance yet. But last year, you gave us directional commentary, low single-digit kind of earnings growth. Anything you could say it was double-digit earnings, the Street's got high teens earnings growth? Any sort of directional color you can share?

Scott, I appreciate the question. I'd just say if we want to give guidance, we wouldn't have given it. It's difficult in this environment. We're awaiting a decision from the STB. So out of respect for that, I think we should hold off on guidance for a consolidated entity. And in terms of the OR, I think Keith said it perfectly. I mean 61.4% is not something that we write home about. There's opportunities, as John highlighted this year in terms of -- on the volume side, but there's also uncertainty on the macro front. So we think that -- we think and we expect to see improvements. But to give you a quantum, I don't think it's appropriate right now, Scott. We'll update you as the year unfolds. And as we progress on our potential transaction and you can expect an Investor Day from us later this year, and I think there will be time -- plenty of time to give you a more formal kind of guidance when the time is appropriate.

Our next question comes from Jason Seidl from Cowen.

Nadeem, welcome back. I wanted to touch on pricing a bit. I think you guys noted it continued to be strong. I was wondering if you could sort of compare it to where we were at in 3Q? And then does it need to actually get better from here given cost pressures?