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

Let's round out the transportation track at the 14th Annual Laguna Conference by welcoming back on stage CPKC with President and CEO, Keith Creel; and Vice President of Capital Markets, Tax and Treasury, Chris de Bruyn. Gentlemen, thank you so much for coming back to Laguna.

Always a pleasure.

Keith, so much going on from the cycle to M&A, to regulations and kind of obviously, your plate remains pretty full. Wherever you want to start off, again, just give us a sense of where you're spending your time today, kind of what you're focused on and kind of where you think the top priorities are for the company?

Okay. Thanks again for having us. It's always a pleasure to talk about our story. Kind of thinking about the year, the way it's playing out, a lot of things I could not have predicted. Obviously, there's no shortage of challenges, but the things that we could, we kind of put the pain at the beginning of the year. Guiding to mid-single-digit RTM growth, which will allow us to produce a low double-digit earnings CAGR. So in spite of all the challenges, as this thing has played out, I'm very pleased with where we are. We came out of the first half in the momentum, operating strength as well as commercial strength in the second half. RTMs were about 4% year-to-date. Quarter-to-date, we're knocking on 7%. So we continue to gain a little bit of momentum. Operationally, the railroad is running extremely, extremely well. Continued growth in strength in grain, strength in intermodal, moderating headwinds in some of our coal challenges. That 4% I talked about, if not for coal, if it were normalized at 6% RTM growth. So again, as those 2 things start to moderate for us, demand continues to be there. We're clearly in line to deliver on the guidance that we've given for the year. And more importantly, as we continue to build this network out, we're well positioned to continue to lead the industry in growth. We talked about a lot of noise. We've integrated a railroad that I never would have predicted a freight recession over the last 3.5 years. As that begins to moderate, you get to a more normal environment, whatever normal looks like, and you get beyond some of these, I call the trade tribulations and get to more certainty when it comes to tariffs and trade between the 3 countries, the things that are occurring in Canada as a result of those trade tribulations that I think continues to strengthen our network as well as North American economy overall leads to a good place as we go forward.

Got it. It's great setup there. Maybe a couple of follow-ups on that. Do you and your customers know what normal looks like? And maybe do you have to move the goalpost a little bit on what normal looks like? When do you think they can finally maybe effectively get off their hands and kind of say, hey, we need to create economic activity here or we need to build inventory here versus waiting for headline settle?

Well, I think -- I don't know what normal is anymore. I think you can control what you can't control. The customers themselves, what we've seen, certainly when you have volatility and unpredictability, it's going to minimize or at least lessen the full benefit of certainty and the investment to follow certainty. So I think once you get to USMCA, CUSMA, whatever you want to call it, whatever acronym you have, once that gets settled, I think that leads to a better outcome. But in spite of that, you continue to have significant investment in Mexico. You continue to have significant investment in the United States from all the manufacturing and the data centers are being developed, all those mechanisms that are moving. So investments occurring. Trade is flowing. It's going to be accretive once it gets settled. But the biggest impact, especially for us, I think, has already been felt. The things that are being talked about and the potential outcomes, I think, are favorable. And I think some of what we've lost in metals, some of what we've lost in aluminum, some of the headwinds even in automotive. I think once it gets settled, those become tailwinds. And you may not get it all back, there's going to be some rebalancing. More shift is going to happen in the United States perhaps on the manufacturing side. But I still think you have trade in trade flowing between these 3 nations, which we uniquely connect in a very positive way.

Got it. Maybe just to follow up on the point of USMCA. It feels like there is renewed momentum there, some more optimism that we may get a lasting resolution fairly soon. Obviously, you guys are pretty plugged in on that. Kind of do you have any intel there? Kind of what are your views on that? And second, you sort of alluded to it in your comments, but does it feel like there is some pent-up demand there that can be unleashed when that's done?

Well, as far as resolution soon, I'm not certain. I think we're in a better place in Mexico than Canada. But I also think that Prime Minister Carney and President Trump at the end we'll do what's best for the United States and what's best for Canada. And that's a strong trading relationship between the 2 countries. The thing that I am very encouraged about though short term is what Canada is doing to diversify itself to a point. Now they're always going to be connected to the United States. It's the largest single end market. But what this crisis has created in Canada, I perhaps never thought I would see in my -- maybe in my life, much less in my leadership legacy of the company. But to have a country now that is entertaining tax reform. The things that Prime Minister tabled this week that it's going to be tabled in legislation that with its majority government, certainly, the need is there and the political strength is there to get it passed is going to take Canada from being a laggard investment to a leader, a world leader. So it's going to attract additional capital. The capital is going to end up flowing through the build-out to the build that's transported goods through the rail network. So we're going to benefit from that. When it comes to labor reform, that's another area that people don't really understand. If you think about it, the unpredictability, the unreliability, kind of the damage that's been done to Canada's reputation as a reliable trading partner is undeniable. When it comes to the 2 railroads being on strike a couple of years ago, when it comes to the airlines being on strike, when it comes to the ports being on strike, I don't care what markets you get to if you can't get the product to market or get the people move from market to market, it impacts your ability to be able to succeed. So now you've got a government that understands that labor reform is important. And the way it's working, quite frankly, labor relations and the ability to negotiate good agreements for labor, good agreements for company because of the way the process works today, it's broken in large part, at least with some of the most significant major unions, the railroads have, -- the men and women that actually need the product from point A to point B. It's just dysfunctional probably being generous. If these changes occur, the labor reform occurs and you get to a place when all negotiations have been exhausted and as opposed to the pain coming before the solution, which is binding arbitration, the government has an ability to bind the parties to arbitration. You kind of get to where you would have started anyway. That's going to get us to a place where, quite frankly, that I think will allow negotiations long term, not short term, but long term. And that's an art that's kind of been lost in Canada. The art of negotiation. The labor leaders come to the table to list the demand. But if you were to say yes, you'd be bankrupt. You'd have no business. They know that they wouldn't want to admit it, but they know it as well as I know it. So you have to say no to put on this front that you're negotiating. They're not negotiating. You're just creating an impasse that ultimately is the net sum is everybody loses. The employees lose, the country loses, the customers lose. That's not a positive outcome. So this labor reform with investment reform and then the other piece, the final piece is the investment itself. What the government is doing to invest to harden the infrastructure, the port investments, the rail investments to be able to get this resource-rich nation to market, again, the railroad is going to pay a part of that. So in the end, I think what's happened, this crisis has created a country that's woken up and are becoming a stronger Canada. And a stronger Canada is not only good for Canada, it's good for all 3 nations. And it's uniquely good for CPKC because we connect all 3 nations.

Got it. So it sounds like a really strong foundation there. But just to build on that and connect with some of the remarks we made earlier about potentially some manufacturing kind of moving to the U.S. Obviously, still lots of moving parts in so many different ways. But as we head towards more of a multipolar world, I think, obviously, a lot of focus on near shoring kind of in the last several years, not as much of a theme this year at the conference as it has been in the last couple of years. But do you have a sense of where that's settling out and kind of how happy are you with your network and kind of what part it will play in whatever supply chain will look like going forward?

Well, listen, it's still in flux, but the major announcements that have been made public. If I look at my network, it doesn't hurt the network, it helps the network. There are some of the OEMs that might shift production perhaps from Mexico to the United States. They've announced building another facility, but it's production coming out of a facility that I don't serve, served by my competitor in Mexico. The one I serve actually is going to increase production. So net-net, I think it's positive. Nothing that's fundamentally going to hurt our network itself. So again, I get back to where I started, the parts, the engines, the finished vehicles, I think these negotiations might get to countries of origins, those percentages being shifted, but it still leads to products and vehicles being manufactured and produced more so, not less so in Mexico, Canada and the U.S. And again, when you're in the network of the next all 3, however it shakes out, we're going to be a player in it. And the strength of our franchise is undeniable. And the reliability we've created, the piece that's coming online now that hasn't in the past because of the network, it's not just rail shifts. It's also water to rail. It's taking it out the sea and putting it on the rail. So again, we uniquely enable and benefit from that.

Got it. I want to quickly touch on grain here because obviously, it's a huge profit engine for you guys, volume engine for you guys. It feels like it doesn't get as much airtime because obviously, nobody can predict the grain crop. But it feels like this has been a gift that's been giving for you guys for a long time. Obviously, record grain crop this year. There's some concern that it will be a tough comp next year, kind of we'll see what happens. But what are some of the levers you can pull kind of on the grain side that, again, continue to deliver the profitability there and continue to deliver yields there irrespective of what the crop does?

You know what, that's a very insightful point because it's kind of -- the story is in Canadian Pacific, we're a grain railroad. Before we've lived and died by the harvest as we've expanded our network, we diversified the book of business, and we've created an ability to create some resiliency. But along the way, we're also still benefiting from being that one-trick pony. So if I go back to '13, '14, the winter and the crop and the meltdown and regulated grain and the government forcing us to haul grain in Canada, that created innovation. It created an expansion, especially on our network of what was a 6,000-foot feeder network to now we run big long trains, 8,500 feet. Most of our grain elevators is probably the lion's share are all converted now. So the ability to turn those assets, the capacity that was created is huge. The export capacity has been built at the West Coast, the G3 and everything that happened on the North Shore and the additional expansion on the South Shore. That's all realizing its full benefit now. Now you couple into the network now where we can take Canadian product into Mexico. And if you have a drought in Canada, you've got product coming from our U.S. Midwest, the feedstock that's going into Canada. So there are levers that we can pull today because of a diverse book of business that never would have been possible without our merger. So whether it's corn going to Mexico, whether it's soybeans, again, going to China, whether it's grain export out of Canada or grain export out of Canada, wheat into Mexico, it's a very diverse book of business that allows us to continue to pull the levers. And when we have the bumper crops, it's really, really good times. But when the bad times come and you have a drought, it's not -- the lows aren't near as low. So there's a resiliency built in the network because of the merger.

That's great to know. Exactly where my follow-up question was on your merger here. You said at the top of your comments that no one envisioned a 3-year downturn when you did the merger. I think that's absolutely true. But given everything that's happened macro-wise, industry-wise, idiosyncratically, obviously, you guys put the operations together pretty quickly and delivered the cost synergies. But how -- like if you sit here and look back at the merger today, kind of what are the things that you really like and what are the things that may have gone differently than you thought?

Yes. So number one, we're ahead of where we thought we would be in spite of the recession in spite of kind of these puts and takes and challenges. The things that haven't manifested yet that I think not that they won't, they just won't now. Crude oil, that was a big piece for us. That was part of our expanding upon the DRU and the business that we do out of Canada into Mexico from -- in the U.S. That hasn't came. But what has come is transborder trade, trade between the United States and Mexico really, really has surprised us. And this crisis has accelerated. We were doing -- I think when we put the railroad together, maybe $100 million. We're over $600 million, and we're going to $1 billion. And there's more demand, not less demand. So that's even in spite of all the trade situation. So again, that's really kind of exceeded our expectations. We're going to exit this year about $1.5 billion of revenue synergies. But what's most important, what's most exciting is when you get a normalized economy and as you go forward and look forward, as you build this out, this railroad is an infant. We're 3.5 years old, 42 months old, a forever story. You don't build this thing out overnight. So as regulations change and they're changing, as infrastructure is invested and it's being invested, you build out the Americold, you build out SMX, you build out continued MMX, transborder trade between Canada and the U.S., you get to a place where if we're not doing our jobs, if we're not a couple of points better than the industry is because of the network that we've built out and we're creating and we're building out, we don't need to deserve to be in the position. And that's what I tell my sales team. At the end of the day, if the industry is growing at 3 and you're not doing 5%, you need to go work somewhere else. Go grow at 3%, you're not going to grow -- you're not going to be employed because we're going to grow at 5%.

Got it. Just on Mexico itself, the Canada, Mexico land bridge revenue has, like to your point, growing from $100 million to $600 million here. Can you just unpack that opportunity a little bit more? Kind of is it existing customers? Is it new customers? Like what does that pipeline look like?

It's both. It's further deeper penetration in our existing marketplaces. So it's continued growth in intermodal, continued growth in grain, this cold storage piece. We've expanded now the cold storage Americold facility, which kind of was 3 or 4 years into the development, changing the regulations to be able to make the border transparent. It was all based on proteins going south and vegetables coming north. Now we've just literally got the regulations changed. We're going to start taking pepperoni, popcorn, dog food, dry goods, not just cold storage goods, using that same transload facility that's located in our facility in Kansas City. Additional facilities being built in Mexico that haven't been announced yet that are deep into the development phase, something close to Toluca, Mexico City market. going south of Monterrey. So again, all that's still in early stages of being built out and developed.

Got it. I want to switch gears a little bit to -- from talking about the transaction that did happen to the transaction that's been proposed. Obviously, the STB has kind of taken the transaction out of and kind of has moved to the next stage here. Obviously, you've been very vocal for your thoughts on this the entire time. Would love your latest views on where we are right now and kind of what do you think needs to happen here?

I think I've actually been a bit restrained in my true thoughts.

You can -- it's just us here, so you can feel free to be unrestrained. Tell us where you really think.

I know Jim is listening. So number one, I'm going to start with some of his moves. I think he's maybe means a little bit of love. I think what UP and CN did together, good on UP, not so good on CN when it comes to stand-alone. When it comes to the transaction overall, as this thing plays its way out, I feel even more stronger today than I did a month ago or 2 months ago or 3 months ago. I don't care how good the story is. No pun intended. It doesn't trump bad facts. And as the facts get known and understood and they're becoming known and understood and more people are coming out and speaking against, there'll be some fors, but it's the heavy -- it's the preponderance of the bad facts are represented by the against. We're talking about a deal that the industrial logic makes sense. And there are certain benefits when it comes to single-line service. I'm a proponent of single-line service, it makes sense, but it's at what cost. And unfortunately, for the proponents, UP and NS, the regulations require those costs to be measured. Those new regulations say that if the goods don't outweigh the bads, and I'm saying in layman's terms, they should not approve the merger. And if it does get approved, it's going to come with heavy concessions to try to offset the competitive harm that it creates. And I would say and suggest and as these facts get developed, they clearly say that the harms are undeniable. The risks are real, too big to fail, the consolidation, the market power, all that, that gets created if this deal gets approved, and that's just step one. That's not the additional consolidation that would have to occur after. They never can solve for that in this process. So I say and I believe it leads to a no. But if I'm wrong, the concessions are going to be so heavy that, quite frankly, if I were the proponents, I'd be concerned that I'm giving away what I think I'm getting, much like what CN has done. That deal they did with UP relative to Chicago, to me, and I was part of the team that fought for that strategic advantage of decoupling your connectivity in Chicago and creating an interstate around so that when it melts down, you don't melt down too. They just put it in play. They just gave away an asset and an asset to an asset that, quite frankly, UP's network just got stronger, CN's just got weaker. And as a result, because it's in Chicago, when Chicago melts down, we all suffer.

Right. A couple of follow-ups here. You sort of alluded to this, but obviously, they've made some concessions so far with the CN agreement and a few other announcements as well. How far do you think that goes?

Relative to?

Relative to what you would expect in terms of concessions.

Again, I don't think there's enough concessions to offset the harms. And I think when it comes to their merger case, I think it's dilutive to their case because what they've done is said that they haven't exhausted all opportunities to exhaust interline agreements. And that's -- guess what? Even if Jim doesn't like it or UP doesn't like it, that's what the regulations require. I think that's important. Much like some of the comments that have been made that another merger or consolidation ship and worry the STB. Well, guess what, the law says it has to. So you can't just approve one and disapprove the other. You have to take all that into account because we've got no place for an industry that 3 decades ago was 30 railroads. Now we're living in a world there's 6. And if this gets approved, it's a path to 2. And I just don't think the United States -- and again, I'll talk in airline terms because Jim likes to speak to airline terms. If I go to Chicago and there's only 2 airlines, and I'm there in the middle of the winter and I live there and I've been there a lot and I've flown through there a lot. I'm sure you have too. It's kind of scary to think that you've got 2 airlines, you don't have Midway Airport at all. We're all going to go through O'Hare and the nation is going to live and die by how that works. in the middle of the winter. That's a scary, scary reality that it is too big to fail. And I think that this regulatory body understands that, there's your truth, UP's truth, my truth and the truth. And this regulatory body is going to make their decision based on the truth. And I don't think the truth ever is going to enable a yes to that merger.