Canadian National Railway Company (CNI) Earnings Call Transcript & Summary

Thank you very much, François, and good morning, everyone. So our first presenter is a cornerstone of the economy, those who've been a big supporter. They started with us 10 years ago. And I think Ghislain said that he was presenting 10 years ago with us. So he hasn't changed.

I think I did. I'm more gray.

But thank you very much. So they just came out with the third quarter results. So the results were very well received. They took some action given the challenging freight environment. So today with us, Ghislain, Executive Vice President and CFO. We have Stacy Alderson, also EVP, Investor Relations. And François -- also François Bélanger, Senior Director of Sustainability. So this is our first time. So thank you very much for joining us this morning. First question, stronger-than-expected third quarter...

Let me make a few comments. We agreed on that. You're changing your mind, my friend. So first of all, thank you for having us [Foreign Language]. And yes Benoit, we're supporting you, supporting Desjardins. We've been a big partner with you guys for many, many years. So maybe just a few quick comments on the business, and then we can turn over to your questions, and you've got some good questions. So I'm going to try not to steal your thunder. When you look at the volumes and when I talk about volumes, we talk about revenue ton miles because it matters moving a freight 100 miles versus moving freight 50 miles. Our volumes are up year-to-date 1%. And Stacy here will correct me if I'm wrong, and we've got the entire team. When you look at Q4 to date, our volumes are up 6% and November to date, they're up 15%. Obviously, that's with easier comps. If you remember last year, we still had the impact of the longshoreman strike in Western Canada. When you look at sectors that are doing pretty well, intermodal, both intermodal, international, domestic is doing quite well with good customer service. Petroleum and chemicals is doing well with plastics and chemicals doing well. NGL is doing well. Frac sand is doing quite well, and there's some pull forward of frac sand where we'd rather move frac sand in Q4 versus trying to move it in Q1 on the winter. So that's going quite well. And obviously, as you know, we've got a record Canadian grain crop that we're all out to move. Sectors that are difficult, lumber continues to be quite difficult. 45% tariffs on lumber. Canadian lumber is not helping, obviously. Just to give you an idea, in the last couple of weeks, the customer orders for center beams and center beams are like these sailboat cars that we put bundles of lumber. They were in the range of about 1,300. In the good times, we typically have orders of 2,200 to 2,300 and we peaked at 2,500. So just to let you know the order of magnitude of the impact of lumber. And then the lumber prices are below a breakeven point for British Columbia producers. So that's a challenge for us. And we're the biggest lumber mover in North America, as you know, from the rail standpoint. And then iron ore with the permanent closure of the Cleveland-Cliff Minorca mine, that has an impact. However, I'm very pleased with what we've done on costs, and I think you can see that. We've managed and rightsized our costs, rightsize very, very tightly. When I look at OR, people look at operating ratio in railroads in Q3. As you know, we improved it by 170 basis points. We've improved our OR every quarter. We're either the first or the second best railroad in terms of OR. So that's very good. So when you put all of that together with 6 weeks left in the year, I'm quite confident that we will deliver on our guidance. And then as you know, there's been some changes in the team. First of all, I want to thank Derek Taylor, who I known for years about all -- for all of his contribution at CN. And I want to congratulate Pat and Janet on their new roles and looking forward to work with them in their new roles, and they can count on my support and my team's support. I think we have a great team. I'm very fortunate to be part of it and looking forward for, hopefully, an economy eventually that will be more supportive than what it has been since our Investor Day in 2023, as you know. And again, it's -- on the volume side, it's not a CN thing. It's an industry thing. We've been in a freight recession for the few years. But eventually, it will turn. I mean -- and when it will turn, then we will capture that rebound at low incremental cost, and I'm looking forward to that. But on this, did I forget anything, Stacy?

You got everything.

I got everything. Okay. Say it again. All right. So I'll turn it over to your questions.

Yes. Let's start with the first question. Obviously, there was some key announcement around the third quarter. The first one was some action around the $75 million cost reduction initiative. So could you maybe provide more color about where it's coming from? And also in the past, you've said that we need to be careful laying off people because it's tough to hire, it's expensive to train. So could you maybe share whether your view has changed or this was necessary steps to take given where we are in the environment these days?

So I can start, Stacy, feel free to jump in. So the $75 million is really management positions. We were very careful to protect the frontline supervisors. And it's always good, hygiene, to look at management positions and look at span of control. We did this, as you know, in 2021 under J.J. And so it's been 3, 4 years. I think it's always good to do that. And that's what we did. We were very careful on the span of control. I'll give you an example, Sam Forgione, who's our controller, he's been controller, and you know Sam, and I want to thank Sam for his contribution. He's decided to retire after 30 years, and he's been controller for 10 years. So he's going to retire at the end of the year, and we took the opportunity to consolidate both treasury and accounting together. And I've done both roles. I'm very comfortable can we do that. And I think that there will be synergies between cash collection and cash management. So these are the types of things we did. In terms of sending people home on the train crew side, you're right, we were very careful in 2023 because we were worried that if you send them home, then they won't come back. But eventually, as volumes continue to be weak, you need to manage your variable costs. You have no choice. So I think, Stacy, we have about over 700 people on furlough today. We've recalled some of them for the big grain crop that we have. And I'm happy to report that the calling rates has been very successful, like over 90% of the people that we call back actually came back. So you need to manage your costs, like you know, volumes have been weak this year. We don't see a big change in the macroeconomic environment for next year, at least as we speak. When you look at industrial production, it's either slightly negative to flattish. So we're controlling, and I think shareholders want us, and I've done with Stacy, a European road show. And what shareholders were telling us, guys, we know there's a lot of things you don't control, but we want you to demonstrate that you're pushing on everything you do control. And I think so far, we've done a great job at it. Stacy, anything else?

No, I think you covered it. I mean the recall rate is really important to emphasize. We're trying to stay close to the running trades so that when time comes, when things inflect that we'll be able to draw from that employee base.

Okay. And the second key announcement was the CapEx reduction for 2026. We are talking about $550 million cut for next year. So when I look at the free cash flow, it will bring CN among the best-in-class in terms of free cash flow yield. So obviously, this is a tougher environment. There's an opportunity to control costs. So could you talk a little bit about where were you able to find some savings? And also what kind of growth could you sustain? And is the $2.8 billion mark is kind of a sustainable level? Or should we expect the number to go up as volume snaps back?

So I think on the capital side, it's a good news story. If you remember when we were at our Investor Day in 2023, we said at the time we were going to invest -- our sweet spot was 18% to 20% of CapEx related to revenue. And we said we're going to do this year in, year out even if volumes are there or if volumes are not there because we said we're going to do it with a view of capital efficiency. And if volumes don't show up, then there will be time value of money because this will be no regret capital. So that's what we've done. So we did exactly what we've done. And when I look at now the capacity, we're in great shape, okay? So we've got capacity in Western Canada. I'll give you an example, the Edson sub, which is a key subdivision. I actually drove trains on that subdivision. It's west of Edmonton, east of Jasper. All of our trains in Western Canada go through that corridor. And then when you get to Jasper, you take a far right to go to Rupert or far left to go to Vancouver. That subdivision by the end of the year will be more than 60% -- more than 60%, I think 63% to be exact double track. So we're great on capacity. We've used the last 7, 8 years to rejuvenate our locomotive fleet. So we had the oldest locomotive fleet in the industry. The average age, I think, was 24 years. Now we're down to 19 years, right in the middle of the pack. And as you know, we've been out there buying cars. We've rejuvenated our grain. We bought close to 4,500 cars. So we're good on capacity to the point that now that we don't see a big change in the macroeconomic environment, it's time for us to lift the foot off the gas pedal. I've given breadcrumbs to investors in Europe that we're going to do that. We didn't give a number. So on the Q3 call, we did. I don't think it's going to be a 1-year thing. We're going to have to see as the economy turns. When we go back to a supportive economy, and as you know, that means for railroads anywhere between mid- to high single-digit volume growth, we're going to have to look at where is that growth coming from because you've got to look at it on a corridor-by-corridor basis. If it's well diversified, that's one thing. If it's concentrated, then that means that if you're 5% to 7% RTM growth, that means in some corridors, if it's concentrated, you could have volume that are 15% to 20% or 25%. So when that happens, we're going to have to ask ourselves a question, do we put more capacity or do we sell to the capacity we have? That decision will decide when we get there. But I think it's not a onetime thing. And our elevated investment versus U.S. peers, we heard from investors, and we asked their feedback that it was a bit of a pain point. So I think we've got the environment now to lift our foot off the gas pedal, and I think that's the right thing to do.

Okay. And since now, we have François, Director of Sustainability. You've been talking about locomotives, how efficient you've been able to renew the fleet? Could you talk maybe, Francois, a little bit, given sustainability focus, an update on the hybrid diesel locomotive and also the battery electric model being test right now. Where are you and what we should expect going forward? And maybe also how it compares versus hydrogen, which is something also being tested by some of your peers?

Yes. So, so far, we have announced 3 pilots for locomotives, one that is fully battery electric and 2 that are hybrids, one mainline and one kind of smaller model. Two of them scheduled to be received in '26. One is already being tested as we speak. So -- and this is what we need to do. We need to do pilots to test in different conditions in yards, in mainline, especially up north as we can see different type of colder weather, right? So, so far, so good. And we have announced 3 pilots, as I said, all batteries related. It doesn't mean that we think that battery is the solution by itself, but all type of solutions, would it be battery, electric, hybrid or hydrogen fuel cell, they all have batteries. So the learnings we'll have in there will be useful for everything.

Okay. That's great. And now another big announcement was the appointment of Pat Whitehead as the Chief Operating Officer role. So he's a well-established railroader being worked at NSC. Obviously, he was the one that designed the plan. So could you -- and it's a change versus the co-COO model that Tracy has been talking about. So could you maybe mention a little bit about what is -- what makes a good CEO and how the role has evolved over the years?

Yes. I think the double CEO, first of all, we're the only railroad that had it. So we had a lot of questions around it. I think it was a forcing mechanism to make sure that one of the 2 focuses more on the long term and especially focuses on engineering and mechanical that are huge functions for us, like engineering, it's like a $3 billion construction company when you look at it. And the COO, they have a tendency to -- and I told you this before, you and I have talked about this, like they like to extinguish fires, okay? So they'll go in the morning. They look at the railroad. Obviously, if you're a 20,000-mile network, there will be a fire somewhere and they'll go and they'll put it out. We thought that they were not spending enough time in some of the other functions that are critical. And when there's no fire, they'll create one because they like to put it out. So we think that now we have the proof points that have delivered in engineering, and I'll give it over to Stacy. She can talk a little bit about some of these proof points that we've generated either in mechanical and engineering. And so we thought that we're there, and we had to make a decision on one of the 2, and Pat got it. And to your point, Pat has been in transportation. He's been in mechanical and engineering, well-rounded individual, nice to work with too. We've got him out there in front of investors. I'm sure we will continue to do that. But do you want to give a few proof points on engineering?

Yes. We've had meaningful improvements, I would say, in capital efficiency. And one really great example is a new section of double track on the former EJ&E in Chicago between Montgomery and Liberty. We came in on budget and on time. It was completed in October. And we've been able to permanently take out a crew change there and improve fluidity in and around Chicagoland. So that's just one example. I think Pat also talked on the call about reduced contractor engineering contracting services. So I think year-to-date up to the end of Q3, we were down about $120 million. That's offset with in-sourcing some of that work that's design and construction and engineering that cost us about $2 million. So the net savings is a meaningful $100 million so far this year.

And there's also -- and you heard on the call, the cost per tie. The cost to install ties was down $15 per tie. So when you put that on the number of ties, that was a benefit of about $20 million. So the proof points are there. So we're in good shape. We're going to continue to improve on these functions. And we thought that related to this, it was time for us to go back to a more conventional role and have Pat be the CEO.

That's great. And another key announcement was the appointment of Janet Drysdale as EVP and Chief Marketing Officer. So we know -- we all know Janet. She's been there for close to 30 years, very well respected. And it was refreshing also. She's bringing a focus on intensity, urgency, and she was already successful to onboard new businesses. So could you talk maybe, Ghislain, about Janet's go-to-market strategy and how does she approach the marketing function going forward?

To your point, I've known Janet for years. I've been around for 28 years. Janet has been around for a little bit more than that. Janet did different roles. She was Head of Stakeholder Relations. Before that, she was in safety. Before that, she was our VP Finance. So I worked directly with her. I'm very pleased that she got the promotion. I hope that the people that listened to the call could hear the energy and the intensity. I think the go-to-market strategy has not changed. I think it will not change, but it's the intensity. It's running after -- you heard boots on the ground. It's running after every carload possible. I like to say something like we need hunters, not Hunter Ericsson, but hunters versus caretakers. It's always good. You need to take care of your customers, obviously, but you need to knock on doors. You need to get people to convince them to build facilities on your line, then you have them committed for the next 30 years. So you need to do that. I think she's going to bring a fresh pair of eyes on this. She's going to bring the level of intensity and the level of energy that we need. And I can see a change already and very pleased with her. And you can rest assured that she will have all the support from me or from my team in terms of the quickness of decision-making. That's the other thing. We need to be more nimble on how we make decisions, how we provide quotes. Okay? Today -- in today's environment, new customer comes in, it's -- you don't have 2 weeks to give them a quote or to give her quote. You've got a couple of minutes. Otherwise, they pick up the phone, they call somebody else, they call a trucking company and you lose the load. These are the types of things that we need to be focused on. We need to have that level of energy. And I'm very pleased that -- and I hope you heard it on the call. I don't -- Stacy do you have anything else? I mean you know you've been working with Janet...

We're all big fans of Janet internally. She's got a great following. So she's got a lot of internal support.

Okay. That's great. And maybe, François, sustainability is a big world at CN. CN has been also a leader in terms of sustainability. There's a lot to say, but what would you be the most proud of, of the sustainability efforts that CN put in place over the years?

Well, one thing that -- as far as when we look at decarbonizing our company, biofuels plays a big role. And one thing that was really, really good in the past few years, we've been able to increase that level of biofuel up to close to 10% of our overall locomotive fuel last year. And that was a team effort. Like this sustainability is not just a team, it's within the company. So that was working closely with procurement, with mechanical and also outside of CN with our suppliers and with the industry on the testing. So that's something I think that shows that we can achieve and we can also make sustainability part of the whole company and attach it to our core strategy.

Okay. And transcon merger, we need to talk about it...

Before you go, and we were able to increase the level of biofuels at no additional cost, which is key.

Okay. And we have to talk about -- sorry, Ghislain, but we need to talk about the transcon merger.

What's transcon merger? What are you talking about?

You've been at CN since 1997. You were an acquirer at that time. You also were fortunate to -- you ended up receiving USD 700 million of termination fee from KCS Co. You know quite well the M&A outlook. What can you say about the transcon merger? How would you expect this will play out? And what are the potential options for CN?

Yes. Like for sure, first and foremost, people can rest assured and Benoit, you can rest assured that we'll do everything we need to do to protect our franchise and to remain competitive. And all options are on the table, number one. Number two, we've been quite vocal, maybe not as vocal as our Canadian competitor about the merger and about the fact that we don't see what problem it solves because we think that the customer service is pretty good in North America. We feel that the pricing is pretty good as well. So -- and we feel that you're able to -- if it's about taking long-haul trucking back on the rails, you can do that through alliances. And frankly, we've demonstrated that with the alliance we have going to Mexico [ with UP ] themselves, where now our transit time from Monterrey to Toronto is 5 days, which is highly truck competitive. So we don't believe that this is required. We -- so we're not in favor of the merger. I think we can do that through Alliance. But like I said, we will protect our franchise. And we'll see what happens. I'm not going to -- I've got an opinion on whether this should -- this will be approved or not. I think that people today are getting a little bit ahead of their skis. I was happy to hear from the Chair of the STB that they said they were going to look at the merger from a factual standpoint and from a pure regulatory standpoint. I think that it's going to be a tough hurdle because remember, the new rules that have not been tested, not only do you have to demonstrate that competition is maintained, but it's enhanced. It's enhanced and you take a Class 1 out, that's going to be a high bar to -- but it hasn't been interpreted. So we'll see. But I feel that if this thing is being looked at on the current regulatory environment, I think it's going to be very, very -- it's going to be a very high bar to approve. But we haven't seen their merger application yet. I think that this is -- I think they're shooting to file at early December. When that happens, we'll study it very, very carefully. We'll be quite aggressive on concessions and remedies, and we'll see what -- where that takes us. But I think that the -- I don't think it's a good thing for the industry. I don't think the industry needs it outside of financial gains of both companies that are merging together, but the proof will be in the pudding.

Okay. Now let's cover capital deployment. You still target 2.5x in terms of leverage. You were clear on the last call that you target 2.5x given the weak level of macro environment, given the consolidation out there. What would you like despite some of your peers being higher in terms of leverage? So what would you like to see that would make you comfortable to get maybe a little bit higher? So given the big RTM growth that we are seeing in Q4, given your comfort about CapEx for next year. So what would you like to see to be more comfortable? And what would be kind of the desirable level in terms of leverage?

So first of all, as you know, we're trying to be as opportunistic on share buyback as we can. So in Q3, due to the fact that we believe our stock price is low, that we're very, very cheap. We took out 8 million shares out of circulation for over $1 billion. In terms of leverage, this is something that we debate on a regular basis, as you know. We debated internally with management. We debated with our Board. I've been enough -- long enough in the business that I know that a strong balance sheet has value. I mean I was a young treasurer in 2008, going to the liquidity crisis in 2009. I've seen it in COVID as well where overnight like this, markets can freeze and so on. So we all recognize that having a strong balance sheet is important. The key here is how strong does it need to be? So we're questioning this. Stay tuned on this. We are questioning it. And we typically give more visibility on capital allocation, as you know, in January. So we'll give more visibility. But you can rest assured that we will continue to be opportunistic on our share buyback. We are in the market. We think that buying back our shares at this price is a very good investment, and we'll see what we do for next year.

Okay. So that will conclude the time. Thank you very much, François, Stacy and Ghislain, and stay tuned. But the next one will be MDA. We'll start in about 5 minutes at 8:30. Thank you very much.

Thank you.

Thank you, Benoit.