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

We got next up is CPKC or Canadian Pacific. I'm pleased to have EVP and CFO, Nadeem Velani with us today. Nadeem, welcome, and I would probably say over to you for any opening remarks, and we do Q&A.

Great. Thanks, Konark, and it's great to be back in Toronto. I do have to say, last time I was in Toronto, I had a little bit of PTSD. I was in town for the weekend for Games 6 and 7. And while they were great games, it was a bit of a tough ending as we can all agree, but it is good to be back in Toronto, nevertheless. Turning to CPKC, excited to kind of end this year very strong. It has been 2.5 years now since we became CPKC and we took control of the Kansas City Southern part of the organization after we acquired it in 2021. And the merger was always about growth and really proud of the team, the way they delivered. We've been able to lead the industry in volumes the last few years. This year, we're up 5% on an RTM basis. We've been able to convert that growth to the bottom line. Last year, we were double-digit EPS growth. This year, we're going to end the year with double-digit EPS growth. We've been the industry leader in safety yet again in the combined entity. We've been able to continue to reduce our train accident frequency ratio, improve on our personal injury rate. We're investing back in the business for future capacity that's going to be needed to take on additional growth, investing in safety and efficiency. While at the same time, we've been able to capitalize on our shareholder return approach of increasing our dividend for the first time since our acquisition this year. Earlier this year, we increased our dividend 20%. We've been repurchasing shares. We just finished our share repurchase program a few weeks back now. We bought back 4% of our outstanding float, so returning cash to shareholders. So I think across the board, when we look at what we can deliver at CPKC, it's outsized growth, bringing it to the bottom line and being efficient and disciplined in our capital return philosophy. And that's -- you can expect more of the same going forward. So with that, Konark, happy to take your questions.

For sure. Thanks, Nadeem. I think that's a good overview, and I think we can unwrap a lot of things there.

Great.

Just maybe we can kick off with the near-term fundamentals, I guess. I mean I think it seems like you guys are pretty confident in the guidance, I think you had for the full year. Like Q3 and the previous quarters have been actually pretty much up to the mark, I guess, right? For Q4, do you think like the traffic numbers are not there yet? I mean they can accelerate further from here because, I mean, they're not up to the mark?

Yes. Certainly, October from an RTM basis started off a little slower. That being said, October was a tremendous month for us across the board operationally. We had a strong month to start the quarter. I think on the grain side, Canadian grain, we had our second biggest volume month ever as a company. And so the new grain crop looks to be exceptionally strong. It could be potentially a record crop, which bodes well for the rest of the year and into 2026. So I think our volumes this month so far to date in November are up about 7%. So for the year, we're still at that 5% level. I'm confident we're going to finish the year strong from a volume perspective as well as our mix is starting to move more positive. Our cents per RTM is inflected positive. So despite the RTMs being slightly lower than maybe we should be, we'll finish strong, and we'll have a sense per RTM to improve the top line. And then from an operating ratio perspective, from a cost perspective, we're -- you can expect us to continue to improve the operating ratio sequentially and year-over-year. So that's what gives me confidence we'll achieve our guidance for the year.

Okay. That's great and comforting. For '26, I know you guys have sort of given us a flavor as to what you potentially could be looking at next year. Like when I'm talking to most of the kind of management and CEOs, I think they're not sounding as confident about the economy. What sort of underlying assumptions do you have for maybe the low double to kind of mid-teen, whatever EPS growth you might potentially get next year? I mean how should we build those blocks to get to those levels? I know you have buybacks, which are getting a little bit accretive now maybe. Besides that, anything else you can tell us?

Yes. I think giving guidance in October, November is always challenging. And I would say that what gives us kind of long-term kind of a view of -- on our long-term guidance that we still feel confident in is what's gotten us through the last couple of years, right? So we've been stuck in this freight recession for 3, 4 years now. It seems to be an unending freight recession. But what we've been able to do and why we've been able to outpace the industry in growth and still grow the top line is kind of the self-help initiatives, what we call -- so taking market share gains off of some of our rail competitors, taking trucks off the road. Obviously, with our transaction, we had significant synergies that have helped us kind of overcome some of the, call it, malaise in the economy. So for '26, I certainly don't expect a robust macro. It would be nice, but it'd be probably wishful thinking at this stage. We're still feeling the effects of tariffs, and we still don't have a trade deal with the U.S. or USMCA hasn't been renegotiated or whatever form that will take. So we're not overly optimistic from a macro at this stage, but I'll go back to some of my earlier comments just on Canadian grain, on bulk, some of those boring commodities that have been able to overcome kind of the macro environment. And we're still moving significant amounts of metallurgical coal for ABR. Potash is going to be strong and continues to support our volumes, and then Canadian grain. When you look at U.S. grain, even the trade deal that's been negotiated between China and the U.S., that -- while the volumes haven't fully moved yet and started to move yet, it's positive for our U.S. grain franchise as well. So when we add it all up and look at what we can do kind of on a self-help and with synergies and with some of our underlying base bulk business, I think it gives us confidence that we'll still be able to grow our volumes, bring it to the bottom line. Pricing is still strong. Our service is valuable in the marketplace, and our customers are willing to pay for that service. And so our overall revenue outlook is still favorable from a self-help point of view.

And I want to like address that self-help and KCS thing. I mean, last 6 quarters straight, I think you guys have done mid-single RTM growth, right? I mean nobody in the industry, I can see that's doing that kind of traffic growth, obviously, right? Is it easy for you to kind of identify how much is coming as a result of the KCS transaction or synergies? Or -- and how much is like self-help pure for CP legacy? Like I mean, it's very difficult to parse out the underlying looking at your traffic numbers because they are so completely out of the books right?

Right. Yes. No, it is difficult sometimes even to -- what's truly a synergy versus you are putting a transload, for example, in place that can help take trucks off the road and a new facility. Take, for example, Americold that we've announced in a few locations. We just opened up a new facility in Kansas City at our intermodal terminal, cold storage facility that's going to start moving volumes. It opened in August, and that's on Chicago into Mexico City, back up into -- Chicago to Mexico and back up into the U.S. that route, our 180, 181 service on the intermodal side. And so you put in a facility like that, is that self-help? Is it synergies? It's -- at some point, you stop calling it synergies because it becomes just growth on the base network after 2.5 years, right? So that being said, these, call it, self-help real estate plays that we've done where we co-locate customers onto our site, it creates a service that doesn't exist today in the marketplace. It creates stickiness with that customer. We both put skin in the game as far as capital. It builds a long-lasting relationship that you can continue to grow, and it's worked well for us. So those have been certainly a big driver of our success. We've got thousands of acres across North America, across our network here in -- just outside Toronto. We've got hundreds of acres that we're looking at potentially within Americold, potentially within the LPG space. Across the network, it's been a great driver of growth. So I think that's what's given us a bit of an advantage versus our peers that we've been able to kind of use that, call it, entrepreneurial approach to a 140-year-old company and bring on additional growth, which maybe is different than our peers.

Okay. And so staying on the synergy side of things, I mean, you guys, when you had the Investor Day, you had laid out some targets for KCS synergies on the revenue side and the cost side. And I think I mean we have been talking about the revenue synergy quite a lot. But I think recently, you guys started to talk about cost synergies and how they're progressing kind of fast now. Can you tell us about like what innings are we in right now on the synergy front based on like, obviously, the targets you had back in those days? And what's the incremental going to be driven by in the next 2 or 3 years that you see?

Sure. Yes. So I think this year, we'll probably end the year at revenue synergies of about $1.1 billion. And next year, I'd see probably 1/4 of that as an opportunity.

I think that's a U.S. number or...

Yes. So we'll see where -- when you think about some of these new services and facilities that we've laid out, we didn't -- we never wanted to have them all come on at the same time, right? You're going to ruin your service if you try to do all your synergies in year 1. We laid out what we thought we could achieve for a 3-year period when we did our STB application, and we laid out kind of a target of about $1.2 billion. We had our Investor Day after we had kind of taken over, and we saw the opportunity to be a bit larger and longer lasting than we had initially thought. So our view at that point was about $1.5 billion of revenue synergies. So here we are kind of end of 2025, we're going to achieve about $1.1 billion. Some of that run rate is going to carry through of recent projects. There's additional contracts that are coming online with customers that we are going to open up that will be part of the 2026 synergies. You've got these new sites and new locations that are coming on. You've got investment in some of our locations in Mexico that will be part of our growth story that are, call it, a synergy as part of the combined network. So when we look at kind of 2026, I would expect in that $200 million, $250 million of additional synergies for 2026. And it doesn't end in 2026. There's an opportunity for some of this stuff to continue. When you look at what happened with some of the trade issues in the past year and the administration change in Mexico, there was a bit of a pause on investment. You can expect some customers that maybe were thinking of doing certain kind of capital investment in certain locations. They needed to kind of wait and see what transpires with some of these trade agreements and trade policies. And so that has led to a delay in some projects that we laid out during our Investor Day, which I think they're not written off, but rather maybe paused. And so that gives me comfort that '27, '28, you're going to see some of these projects come to fruition once the terms of a new USMCA or a new trade agreement comes to place. So from a revenue point of view, I'd say we're probably still mid to -- probably in the sixth inning or so, seventh inning. We probably see some additional opportunities over the next several years. Now the cost side, we talked about $200 million of EBITDA on synergy savings from the combined -- from the deal. I'd say we're probably early mid-innings on that. Some of the benefits on procurement, for example, you can't generate it all at once. Again, you need those contracts to come up on the procurement side to be able to renegotiate and get the combined company to be able to get benefits on -- from your vendors. We had our day in integration, so our system cutover. We had a lot of employees on the IS side and a lot of contract employees that were put in place to support that, that -- now that we're past that system integration, we will see some of those employees kind of naturally roll off as well as other G&A employees that will attrit out over time that we won't need to backfill. So there's still opportunities from a headcount point of view over the coming year or 2 that we'll see as natural synergies.

Okay. I know you touched on that integration on the IT side. I think in May, that's when you guys kind of started that, we saw some disruption on the network side, I guess, and it was kind of well advertised all across media and stuff. But what was sort of your learning from that whole process? I mean, I guess this is probably not the last integration on the IT side. You probably might have more coming along the way. But any learnings from that? And what really caused that issue? I mean, was it totally unexpected on your side?

I knew I shouldn't have said IS integration that you'd ask me about that. No, I'd say that you do a consolidation like this or a merger like this of this scale, you're always -- nothing is going to be perfect. We're certainly not perfect. And we put a lot of time and resources into that integration. And you're dealing with all kinds of different stakeholders, whether it's other railroads, customers across the geography, you're going to have potentially issues, and we did. And so I mean, ultimately, we could talk for an hour about this, but no one will want to talk for an hour about this or hear me for an hour. But I would just say that it comes down to sometimes change management. You can train, you can educate, you can test as much as you want. But at some point, getting in the seat of a customer that may have been doing things a certain way for decades down. This mainly was impacted in Texas and Louisiana and down the southern part of the network. And there's processes that they've been doing for years and utilizing a system that had more flexibility than the newest system we've implemented. So putting in data, if it wasn't completely accurate, there would be ways that the system -- the previous system would accept it, and it would work. When we put in our new system and integrated the combined entities, you ended up having kind of rejection if the data wasn't in a certain way or if there was other kind of ways to pass on information from the customer of a third party wouldn't fit in the fields in a certain manner, it would just not accept it. But it kind of steam rolled into an issue. It became losing visibility into inventory and so forth. And so yes, it was -- it did disrupt the network. The recovery by the team was exceptional. 30 days later, we're back up to normal. And so there were definitely lessons learned on the whole organizational change and change process and how we can do things differently. So next step is Mexico, which is that much more complicated, if you can imagine. And so we paused that to make sure we're -- we upgrade some systems first before we do that full integration. So that will probably be about 3 years' time frame before we tackle that next integration.

Okay. Moving on to the balance sheet, I think. I mean, talking about the CapEx intensity for the network, what's the right level you see like going forward? I think as you said, like obviously, you're later part of the innings on the revenue synergy side of things. So presumably, a lot of the CapEx might have been spent by now. Any more remaining CapEx to support the synergies? And how do you think about just overall for the base business now going forward?

Yes. So this year, we'll have kind of the highest CapEx of the company's history, the combined company's history, about $2.9 billion. And some of that's impacted by currency. The Canadian dollar depreciation certainly has an impact. So we had guided to $2.6 billion to $2.8 billion long term worth as far as our capital investment. I'd say that some of the major projects tied to integrations are now, for the most part, complete. So we'll have less capital required for that. From a capacity point of view, we're in excellent shape. Certainly, if the macro returns, that would be a good problem to have, and we could add additional capacity, but we've got plenty for the foreseeable future. We are investing in locomotives. I think it's the first locomotive we bought since the management change in 2012. So we invested, I think, 100 locomotives this year, Tier 4s that are going to help our efficiency, help our fuel productivity. We have another 70 locomotives that we're going to be acquiring next year, and this is part of our phase-in plan over a multiyear plan to upgrade in our locomotive fleet. So it's going to be a shift in capital spending from the base network to more rolling stock, I'd say, less capital required for systems given what we just discussed. So net-net, I think 2026, we should be closer to $2.8 billion of capital. So you'll see a reduction year-over-year. And on an exchange-adjusted basis, it's very much in line with what we had guided to in that $2.6 billion to $2.8 billion.