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

I think we're okay. Okay. Good morning, everybody. I'm Brian Ossenbeck. I cover transports for JPMorgan. We're going to keep rolling here with the transport track, the industrial conference with CPKC. Excited to have Nadeem Velani, who's EVP and CFO. We have Chris de Bruyn as well from IR. So I'm just going to kick it over to Nadeem to make a few comments to start us off, and then we'll go into questions. [Operator Instructions] But I turn it over to you, Nadeem. Thanks a lot for being here. Appreciate it.

Thanks, Brian. Appreciate being here and being here in person, to tell our CPKC story and give you an update on our transformational journey and give an update on our exciting opportunities ahead. So truly an exciting time to be a part of this integration and this growth story because that's truly what it is. So we've been kind of near term. We finished 2023 with really strong momentum operationally, execution. I think we posted a sub-59 OR. We carried that momentum into January. We saw a little bit of challenge from the weather, I think volumes were down about 20% on an RTM basis at one point in January. But the good news is we've been able to overcome that. And from a volume point of view, it's inflected positive. As we sit here today, I think we're up about 1% on an RTM basis, which is kind of in line and maybe a little bit better than we expected. So we got through kind of a tough January. There were some costs associated with this typical winter weather that we faced up north but nothing that we can't overcome. I think our biggest kind of near-term headwind is more mark-to-market on the stock-based comp. So that will -- as we stand here today, is a bit of a headwind but first-class problems. And we think about kind of where we see the year, we guided to double-digit EPS growth with low single-digit RTM. So nothing changed there. I will say that as we look back today versus where we were a couple of months ago, I think the demand environment seems a bit more favorable today than maybe a few months ago. So that's encouraging. There's still -- we don't have a crystal ball. But overall, I think our outlook is a bit more bullish. When we think about our transformational journey and CPKC. That's gone extremely well. Take a moment just to thank our 20,000 railroaders who are executing for our customers, executing on our service, driving integration, whether that's systems, whether that's culturally coming together as one team. I couldn't be more pleased and more proud of the way the team has delivered. And if you think about all of our key stakeholders, we've been able to do what we said we were going to do as far as our investments back in the community, driving the service, that's not going to impact the communities we operate in, in a negative way, how we're delivering for our customers, providing new competition. And then that's also driving our competitors to provide more products, to inject more competition into the -- for our customers. I think that's a strong positive for our employees coming together across 3 continents as one team. I think the pride is resonating throughout the company, throughout the new CPKC team and then for our shareholders. I mean we're -- we finished the year, I think, around $350 million of revenue synergies. So a little bit ahead of the pace that we expected in year one. We have line of sight to end the year to double that to about USD 700 million of revenue synergies. So I think we're very proud of what we'll be able to deliver for our shareholders as well. So across all of our constituents, I think we feel very positive about this combination. So Brian, happy to take questions.

All right, Nadeem. Thanks for kicking us off there. So just to touch on the near term, you mentioned the potential to finish a little bit up here in the quarter from an RTM basis. What is -- what's sort of driving the upside? It sounds like the network rather bounce back pretty quickly. So I'm assuming that helps. But is there any end markets in particular, are doing a little bit better?

Yes. So I think in overall, a reminder, we had a pretty tough grain crop in Canada, especially on the southern part of the network. So we were a bit more bearish on that front. I think that's come in a bit more positive than we expected or call it, less bad. I think international intermodal has come on a lot more positive. If you look at the volumes coming back into Vancouver and into the West Coast, it's been extremely strong. I think the -- overall, in the U.S. grain side, we've seen strength in that area. So overall, I think some of the upside surprises have been driven by kind of those key segments. I think the synergies are starting to ramp up, and that's been a positive as well. So I think overall, a little bit more volumes than we expected. And operationally, the execution has been tremendous.

So I was actually the shipper conference last week, and you did hear a lot of movement on international intermodal, but you did see a little bit of increasing dwell time in Vancouver. So is that just a sign of things ramping back up? Is there some concern there operationally? I don't think it's risen to the point where we're flagging is a risk, but it certainly seems like that's starting to back up to the point where it's a little bit more noticeable.

Yes. No, that's fair. I'd say that we're working with the inventory to bring it back down, and that's really a result of much more stronger demand than even our customers' forecast. So the volumes that have come into Vancouver are being exceptionally strong. I think 40% stronger than expected. So we're -- it's not a concern. We're going to work through it. And effectively, it's going to just mean volumes and revenues for a longer period as we work to bring that count down, I think by -- through the end of March and into April, that should be back to a normal level. And that's part of the reason why we see such strong volumes today.

Okay. Interesting. So I don't know if you have a sense in terms of what's driving that, but is it a little bit more share shift? Is it either from the I guess, the carrier side or the port side? And it does sound like people are just maybe underestimating how much they're expecting to get in the first place?

Yes, I think the forecasts were lower than expected, and that's -- it's come on very strong. I think we saw the port strike last summer and all of a sudden, there was this view that Canadian ports were going to be significantly impacted. I don't think that, that was actually the case, and so, as far as Vancouver is concerned. And so we've seen healthy growth from our customers. And we've seen kind of the return to volumes into the Canadian West Coast. I think there's been some inventory destocking that's helped overall international intermodal volumes into Canada as well. So I think we're seeing a bit of a turn. And I think the outlook for the year is more positive than we imagined a few months ago.

Okay. So the other sort of near term one I would ask about is the labor negotiations with the unions in Canada. So I think it's a little unique now. You've got both Canadian rails negotiating, right, with the same union. I don't know if there's any precedent for that. But maybe you could just bring us up to speed on sort of the next steps in the process and to the extent just having gone through the U.S. reset of wages, is there something similar in magnitude that could happen here? Or should we be thinking about it maybe a little bit less in terms of magnitude?

Yes. So I'd say that you should look at it less in magnitude, number one. It is unprecedented. This is the first time that the unions have been lined up, the team search for both Canadian rails. We've filed a notice of dispute a month ago, and part of the reasoning was we've been negotiating in good faith since September. Weren't getting much progress. We've provided proposed deals for greater benefits, greater flexibility, greater pay. And so we felt that now is the time was right to seek the assistance of an arbitrator to start that process. So we'll continue through the arbitration or the mediator, I should say, process for the next 60 days. And then barring a deal, typically, there's a 21-day cooling-off period. And if there's no deal before then, both parties have the opportunity to provide 72-hour notice for a strike or lockout. So ultimately, that takes us to the third week of May, as time frame. As far as where things are concerned in terms of what you should assume for incremental increases, I think we've seen a much more greater supply of labor across the opportunities to bring on more labor and it's not as tight a market. We've seen some of the contracts come on, negotiated contracts on the labor side recently in the 3.5% range. So I think that will give you a good indication.

Okay. That's great detail. Thank you. So I think everybody, by my account, has some sort of back half recovery in the outlook. Not to say that it's wrong, but just wanted to see, when we are asking everybody, what's specific to the CPKC, I think it's probably a little more defined just given the synergies and sort of how those are expected to ramp up. I would just love to hear your thoughts in terms of what you see in terms of the back half, it looks better. Obviously, there's a multitude of things, but what's sort of the top couple of ones that you're focused on?

Sure. So as I mentioned, Canadian grain crop, number one. I mean, it's a big part of our business. As new crop comes in. And if it's a more normal crop, I think that's going to provide us a pretty significant step-up of volume sequentially from Q2 to Q3 and into year-over-year comps are going to be very favorable. A reminder, a year ago, we had the West Coast port strike that's going to provide favorable comps. And if you look at what we were impacted by the outage in potash export facility, that's back up and running as of December, so that's going to be favorable. So overall, I think on the bulk side, we see some opportunities on the international intermodal, as we mentioned. And then to your point about the synergies as they continue to ramp up and we continue to see that increase, as I mentioned, doubling from exit run rate in December to -- from $350 million up to $700 million. That's going to provide us a significant step-up in growth. Autos. I think that's an area that we've seen some short-term kind of it's been growing but not as strong as we anticipated. Some of our customers have had some production holds that have impacted volumes. We're going to see that starting to ramp up and see additional growth on the auto side. So I think for -- when we look at our volume outlook, we've been pretty conservative, I would say, in terms of the base business of around flattish. And -- but you see the elements that can take us to that low single-digit growth into for the combined network, including the synergies.

So in terms of additional areas of growth before we get into more of the synergy questions. It's always been interesting to see CP, legacy CP put a lot of good use to land, with some of the terminals and be able to get anchor tenants. Are there any of those that are sort of in the pipeline here? And I think a related topic like KCS, I think had a pretty good land bank as well. So are those starting to also percolate? Or is it a little too early?

Yes. So I think you've seen some announcements, some -- we had a customer, Americold, that's refrigerated warehouses at a -- great partner that we feel that can be a significant growth opportunity across our network. They announced in a broke ground in Kansas City, on legacy KCS and land that's connected to our intermodal terminal. That's going to be a great opportunity to grow with our domestic intermodal, provide a synergy opportunity as well as provide a balanced movement where we can bring protein from the Midwest, protein from Canada down into Mexico, and bring produce and back up north. We have the potential to grow with -- in Americold across our network and other land areas. So to your point, Toronto, we have, I think, greater than 150 acres. We have land in Chicago. We have land in Vancouver, excess of 150 acres. So in the domestic intermodal side, with Americold, we see some great opportunities to grow jointly. If you look at our automotive segment. We talked about the opportunities there. We we're building an auto compound in Wiley in the Dallas-Fort Worth area, which is a huge growth area for us, and that's utilizing legacy KCS land to provide a new solution and new offering into the market. We announced the deal with the MNVR with CSX, where we can look to bring Southeast U.S. traffic and take trucks off the road and auto parts are going to be a big part of that and moving that into that land in Wiley. So certainly utilizing excess land and bringing that as an opportunity to grow traffic is our #1 priority and couldn't take a little bit of investment. It's going to take a little bit of time. but it's going to be a real opportunity to have truck conversion as well.

Okay. So it's already -- it sounds like it's already starting maybe a little bit faster than I thought. So the other one that moves along a little faster was the auto closed loop. So we heard about that Investor Day, and then it does seem like it's ramping up, at least my perspective, a little bit quicker. What sort of helped that get moving faster? And are there any other -- think of that maybe kind of like the grain shuttle. Are there any other commodities or freight types that would necessarily fit that similar sort of model as well?

Sure. So if we think a year ago, the OEMs were struggling as far as getting capacity, getting railcars to move their finished vehicles, move some of their auto parts, it created a bit of a crisis in transportation of -- in that segment. So when we looked at our opportunity to service a lot of those plants, to get involved in a meaningful way. We had kind of underestimated the opportunity and thought maybe a little bit longer. And part of it, our expectation was some of these contracts would be locked up by our U.S. peers. But these, in many cases, the customers came to us to say, "How can we help?" And so we looked at investing in auto racks. We looked at whiteboarding some of these opportunities to really understand how do we find a solution for them. That's a win-win opportunity. And so the closed-loop system came to as a great opportunity, taking parts from Southwestern Ontario finished vehicles back up north as well, and really building that closed loop system. We whiteboarded with our customers, and in some cases, in Mexico, to see how can we improve their operation, John Orr, just running our Mexico operations, went down to the facilities and worked closely with the customers to improve the supply chain, take advantage of these new investments in auto racks. And to create this closed loop, that's truly a win-win. And so really a great outcome driven by a bit of a crisis, but now it's created a unique solution to grow for our customers and for ourselves.

And are there any other commodity types that would sort of make sense in that, along with auto, in grain, I guess you could probably argue the proteins, the cold chain would be one of those.

Absolutely. So Americold is very similar or when we look at the proteins, we just signed on a deal as well on the land side in Toronto. That's going to create a unique opportunity as well to do the very much a similar kind of closed loop. Some of the other opportunities are lumber coming out of Western Canada down into the U.S., down into the Dallas market. And we're moving Southern Pine back up north. So that's, again, utilizing the equipment, getting asset turns, which lowers the overall cost, but also creates that balance in traffic in a premium service. And so it lines up well both for the customer and for us.

And these -- the auto racks, the temp control containers, are those things that CPKC buys and then puts into the price? Or are these things that the customer, the supplier brings in? Like, how does that part of the investment work?

Sure. It varies. In this case, the reefers, we made an investment in 1,000 reefers that's less than $100 million. And we -- in some cases, we have commitments from customers. In some cases, we take on some of that risk knowing that the confidence that we have in selling that service. Same thing as far as the auto racks, I think we've spend less than $75 million, but we have multiyear commitments from the OEMs to take on those volumes and bring that commitment.

So when you think about the synergies in general, obviously, I think there's pretty high expectations for those to ramp up over time, but it seems like they're moving along pretty well already, if you've got line of sight to doubling the $350 million run rate. Are there any ones that have maybe accelerated faster than you thought? Like, what are the drivers to get that to double here in the next, I guess, 12 months?

Yes. So I think auto certainly was one that's accelerated. I'd say that when we look at the intermodal side, we introduced a new service, Mexico and Chicago, 180, 181 flagship service, 4 days, that's difficult for any of our competitors to match. That's -- we announced with Schneider and Knight-Swift, to be the initial 50% or so of that capacity. Since, I think, end of the year, end of 2023, volumes have ramped up about 30% in February from that -- from our December exit run rate. So that's starting to grow extremely fast. I think that that's going to be an opportunity to have the biggest truck to rail conversion. So we're excited about what that means as far as our growth into 2024 -- through 2024. On the ECP side, we've announced a deal with Shell. Those volumes are just now starting to ramp up, but we see on the merchandise side, on the steel side, we announced -- or we highlighted at Investor Day that some of those investments that are taking place in Mexico and what that could mean. So those are kind of the 2 of the key areas that I'd highlight. But automotive is probably the biggest surprise and biggest upside as far as where we relative to our initial expectations. Lastly, I'd just point out that on the pricing side, an area that again, we had underestimated in terms of the impact that could have on pricing some of the legacy KCS contracts that were coming up for renewal. I think that, that's an area, as we provide this best-in-class service and execute that opportunity to drive value for our customers, turning their assets faster, providing them a supply chain solution that can take trucks off the road and lower all their transportation costs. I think the pricing side is going to be a significant upside as well.

Yes. And specific on the pricing, is that more of a multiyear opportunity. I think there's always some consideration just given that KCS was a short-haul regional, maybe didn't get the best economics in some of those cases, but it does sound like maybe this is a little bit incremental to even just that, in terms of maybe the scope and the longevity, but I don't know if I'm thinking about that correct.

No, I think you're right. I mean, when you're a smaller network and you can't get origin destination and you can't provide a strong service offering. You're dependent on other rails and interchanges, that has an impact. It has an impact on prices. Customers don't get the asset turns as quick as they can. So leveraging this unique network to be able to provide a better service for our customers, they're willing to pay more for it because they know the value that it generates for them. Contracts are going to come up over time. They're not -- so I think it's going to be a multiyear opportunity. This isn't something that's just going to be done overnight. As some of these legacy contracts come up, we'll reprice them for the value that they provide. And so yes, it's a multiyear opportunity.

In terms of Mexico, how does that look, I guess, a year after closing the deal. Obviously, you've been looking at this for quite some time through the whole process and due diligence. But is that an area just in general, that has surprised the upside and probably some of those end markets you're talking about embedded within Mexico being a growth driver there. But overall, would you characterize that market as being a little bit better than expected?

Yes. I mean, I think when we started this journey, almost 4 years ago when we started looking at. It was 3 years ago next week that we announced the combination. So it's been a while, and a lot has changed, from when we did that initial due diligence relative to where we are now. And I think it's much more positive as far as what the near-shoring opportunity looks like. If you think about customers and manufacturers that are looking at their supply chains and not wanting to be stuck, lessons learned out of the pandemic. There's this big push for, call it, the China plus 1 or the plus 1 strategy of sourcing and managing their supply chain. But that does take time. It takes investment. And so we're starting to see that opportunity to be larger than we had anticipated 4 years ago. And we're starting to see some of that investment play out. And that's what's given us more confidence as far as looking at our synergies, when we first announced the deal 3 years ago relative to now. At our Investor Day, we highlighted that we see the $1 billion of revenue synergies as being larger and lasting longer. So the size of the pie is bigger. And I think this will be an opportunity that we're not going to be able to just do overnight or in that 3-year time frame that we initially announced. I think this is going to be a 5- to 7-year type of opportunity and the pie is going to be larger.

So truckload conversion plays a big role in this integration and the opportunities. But obviously, the industry has been talking about that collectively for a while. CPKC has had a reputation for really good service in some of the new products. So probably one of the first we would see some of this conversion to happen. So has that started to play out, or given the truck market is pretty soft, it's kind of like wait and see at this point?

Yes. No, I think we've seen the initial opportunities to really present themselves. If you look at the -- on the 180, 181 product offering, that's ramping up, and it's been very well received by customers. You had Mark earlier from Schneider here discussing with you, I think that they've been huge advocates of that opportunity. And so that's an area that truly we're just taking trucks off the road. The Americold opportunity. That's going to be the refrigerated market is 100% truck. That's going to be a truck share conversion. We announced the MNBR deal with CSX, that's going to be looking to take trucks off the road, auto parts going into the -- from the Southeast going into -- from going into the Dallas market. So as we continue to ramp up and it's not been a year yet. So customers see the quality and the consistency and the reliability of the service, they start looking to move their supply chains. And to your point, it's been a weaker trucking market. We've been able to deliver some significant wins in a not a very strong macro environment. So I think as we see that stabilizing, I think we're going to see some conversion and opportunity to grow that truck conversion.

Yes, it does strike me though that where you've had some success and some of it could be pretty significant that you or your partners have had to make investments to really get the ball rolling here, so to speak. So is that, obviously, a service can continue to get better and the cycle will help out as well. But I guess from my perspective it really seems like to -- for rails to have truckload conversion that sticks, you actually have to invest in that. Would you agree with that?

I agree. I mean, I think if you look at what we've been able to do as far as legacy CP, building some of these land deals that I mentioned, we've been utilizing some of our land as an investment and also to create stickiness with the customer. When the customer is in your intermodal facility or adjacent to your yard, drives value for them, but it also creates stickiness where you're not every 3 to 5 years, having to go through a contract negotiation and your competitor coming in and undercutting and so forth. It creates true partnerships. And that's how we differentiated ourselves. You look at what we're doing as far as CPKC, whether that's in the auto sector, looking to build these auto compounds, building stickiness with our customers, both at the origin and at the destination. Looking on the intermodal side as well. Even on the bulk side, we haven't talked about Port Arthur much, but that's another opportunity a terminal that on the legacy KCS side, that one day, we see as an opportunity to grow some of the bulk markets like potash. Again, creating stickiness, investing both in the terminal, both whether that's a customer or us through railcars and eventually locomotives as a resource to drive the volumes.

So in the last couple of minutes here left. I just want to ask a couple of questions on Mexico more broadly. So we've seen quite a few headlines with the Coface, the passenger rail, it's kind of reached the peak and then come back down. So where do we stand right now, I guess, more so on the passenger rail, it looks like there's still the feasibility study coming out in May. I guess the concern I would have at some point, I don't know how this would play out, but if there is an investment that CPKC has to make, because I think the bids were evaluated on sort of the timing, the plan itself and also the level of investment. So is that something we should be worried about or considering? I know it's still early in the passenger rail process.

Yes. So when you think about passenger rail, we're going through the feasibility study for the Mexico City [ Carretero ] line. We're working closely with the Mexican government having very respectful discussions with -- at the most senior level. Keith was in Mexico City meeting with the President in January. We've met with the front runner to take office this year. She's been at our office. We've had some good discussions with her. Where we stand right now, kind of end of May, we'll look to get the feasibility study. I'm not expecting a significant capital investment required by CPKC. If you look at some of the deals that legacy KCS has done, they've done a great job to build a partnership and manage the concession, case in point, a commitment to invest in the [indiscernible] Bypass that gave extension of the exclusivity by additional 7 years. So can you find ways to generate win-win that's not significant capital investment. That's what I anticipate at this point.

So the other big topic in Mexico recently was the task force going down and working on some of the best practices and putting in new systems. So I don't think we've seen anything that would suggest that there's any backsliding, but are there more opportunities there? Because it did seem like maybe there wasn't quite the level of rigor or systems that were in KC or legacy KCSM.

Yes. No, great question. So when we look at that task force led by John Orr, and it was kind of a collective effort of operations and marketing and our demand planning team. They did a terrific job looking at almost whiteboarding and looking at how do we fully implement PSR across the network and across the KCSM, look at the labor opportunities, how can we look at some of the labor deals. Again, how do we look at that whiteboarding and from a customer perspective. And I think some of the outputs that came out of it was also some capital investment that we're doing this year, that's less than $100 million worth of capital, but it's going to drive additional value as far as asset turns and overall efficiencies. We found ways to look at the labor contracts, renegotiated with the union, an opportunity to drive better flexibility as far as our operation, the utilization of the crews there. So that's been a great outcome. If you look at where we are today, I think our February volumes, our car miles per car day, were up 30%, and our overall GTMs and throughput in February for Mexico was the highest GTMs per day that KCSM has done in 10 years and any month in recorded history. And we say 10 years because that's as far as we can get the data back. So no backsliding. In fact, it's been a great outcome and great effort by the team to drive a lot of value, a lot of efficiency and better the operation for our customers.

And then just real quickly on the second bridge at Laredo, how should we think towards the end of this year. But is that a doubling of capacity? Does it help with the fluidity? Obviously, the border is the bottleneck in a lot of instances. So do you see an immediate step up on that? Or is that something that you have to gradually adjust the network?

No, I think it's an immediate step up. It's going to be a dedicated bridge for CPKC traffic as opposed to the current bridge. So you could look at it as more than doubling capacity. And it's going to be a key part of our growth strategy and bringing on additional capacity at a low incremental cost. So we're on pace to have that ready by the end of the year, and we're extremely excited about that investment as well and kudos to the legacy KCS team for that.

Okay. Nadeem. Well, thanks for the update today. We're unfortunately out of time, but really appreciate you making the time to be here with us.

Great to be here. Thanks very much.