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

First session here. Thank you very much, everyone, for joining us at our Eastern Conference. It's my pleasure to introduce Ghislain Houle from CN Rail, I think, a man that doesn't need any introduction here. We have Nicolas Schmidt from CN, Senior Manager of IR, in the audience as well. I've got a bunch of questions here. It will be a fireside chat. But if anyone has any questions in the audience, please raise your hand and I'll call you out. So Ghislain, thank you for joining us here in Montreal.

Thank you, Kevin. [Foreign Language] Thanks for you guys to be here today. It's a pleasure to be here, Kevin. And thanks to the people on the webcast listening and taking interest in our great company called Canadian National Railway. If you agree, Kevin, I'll make a few -- and even if you don't, I'll make a few introductory remarks, and then we can go through that. So listen, let's start talking about our volumes. I think -- our volumes, we're very pleased with where our volumes are either quarter-to-date or year-to-date. I mean, as you know, our volumes, and we talk volumes in terms of revenue ton-miles because that's a better proxy versus carloads. Our volumes are up 4.5% quarter-to-date, and they're up 4% year-to-date. And this is a lot on the back of Canadian grain. As you know, we have -- and we're benefiting from a bumper crop in Canada this year, which is good because that allows us to move grain well into the third quarter, which is quite unusual. Typically, when you have an average crop, you typically run out of grain by the end of Q2. So this is extremely good. And I must tip my hat on the operating team. They're very, very efficient to move that volume every week for the grain farmers -- for the Canadian grain farmers. If you exclude grain, then our volumes quarter-to-date are up 1% and our volumes year-to-date are up also 1%. There's other sectors that are doing quite well. The energy sector is doing quite well. The metals is doing quite well. Automotive, believe it or not, is doing very, very well. And then there are sectors that we continue to see softness, which we anticipated. Obviously, lumber is one of them. And then international -- intermodal international is another one. And this is really related to the broader market conditions that we are currently facing. Now as you know, we're starting to lap tougher comps as we speak, and we will have that until the end of the year. From an operating standpoint, I'm very happy with the way the network is working. And, as you know, you have a question, I think, that you've noticed that our car velocity is north of 200 car-miles per day. And that always bodes well. That means that your network is fluid, especially when you're able to move more volumes. So we're very pleased with that. From a productivity front, I think it's going quite well. When I look at crew productivity, it's up 13% in the first half of the year. Locomotive utilization is up 7%. And then we're setting a record fuel efficiency in the first half of the year, and that's up 3% on a year-over-year basis. From a cost savings standpoint, I'm going to repeat what Pat Whitehead, our COO, talked a little bit about during our Q2 earnings call, he gave an update on Fast Track initiative. What's Fast Track initiative? It's really taking a blank sheet of paper and reviewing all the processes of every yard that we have, every terminal, auto compounds, which are the facilities that we have for finished vehicles. Looking at our fleet, believe it or not, we have about 5,000 vehicles at CN and making sure that we're as productive as we need to be. And he reported on Q2 that first half of the year, we delivered close to $100 million of savings. So that's very well, and that's very good. On the capital allocation standpoint, we're well on our target to invest our $2.8 billion, which is a significant reduction versus 2025. And with good decent results, I think that bodes very well for us to deliver solid free cash flow and free cash flow conversion. On share buybacks, we've been extremely opportunistic, and we will continue to be opportunistic on our share buyback from now up until the end of the program at the end of January. We still -- we had a ramp-up in our share price. Thank you very much. I'm very happy. I'm a shareholder of the company. I own a few shares, look at the proxy. And -- but we still believe that we're cheap, and we're going to continue to be opportunistic in buying back our shares. Maybe on this, I'll pause, and I'll turn it over to your questions.

Great update, Ghislain. Maybe if I were to maybe round out some of the updates you provided. Diesel has clearly had a huge run-up. You gave us a framework in terms of how to think about fuel surcharge on the Q2 call. Clearly, fuel is at a different price point. Maybe give us an update in terms of how we should think about the fuel surcharge tailwinds or headwinds today versus the Q2 update that you provided in Q2.

If you remember in Q2, I did say that if the price -- if the fuel price stayed the same, then we would have a tailwind on EPS of $0.15 in Q3 and $0.10 in Q4. To your point, now the fuel prices have gone up. It went up WTI almost to USD 105 per barrel. Now I think it's back down to 92. But still -- so fuel prices are going up and my fuel surcharge because of 2-month lag, then it's pretty much locked in for the quarter. So that $0.15 that on EPS is more like $0.10 now. And the $0.10 in Q4 is more like $0.05 to $0.10 on Q4. In terms of OR, again, when fuel prices go up, typically, it's dilutive to OR because you're adding revenue and expenses at 100 OR. So if fuel prices stay the same from now until the end of the year, so the -- it would be a negative impact on OR by about 50 basis points. And Q4, it would be a negative impact by 150 to 200 basis points. Now as you know, it's very volatile and it moves a lot, but that's -- if they stay the same, that would be the number.

Okay. That's very helpful. I'll just throw it out there. It feels like you're tracking very well to your full year guidance. It doesn't feel like there's any real concern in terms of achieving those targets.

Well, we're comfortable. I'm comfortable with our full year guidance. Again, we're getting against tougher comps. And I must say as well, and I think you know this, that the grain crop, we won't benefit from a bumper crop with the new grain crop. And in our catchment area, the grain is a little bit delayed because it's very wet. So the farmers are a bit delayed in harvesting the grain. But despite -- and nevertheless, we're comfortable that we will hit our guidance.

Okay. The Canadian government is introducing a productivity mega deduction to essentially allow companies to write off about 100% of their capital in terms of depreciation. This seems like it's a potential free cash flow lift for capital-intensive industries such as yourselves. Is there a way to frame what that benefit could be for CN from a free cash flow lift perspective?

Yes. So we're very pleased. By the way, we've been advocating for this for a long time. So we're very pleased with the outcome. And I must say, to your point, it's a free cash flow lift. It has no impact on EPS because it's really related to cash taxes. And the current estimate that we have is, would be a benefit in free cash flow for next year of about $150 million. And for 2028, it would be a benefit of north of $200 million.

Okay. Okay. Does that change your capital allocation priorities at all with this incremental free cash, do you lift CapEx? Do you deploy more towards the buyback?

In terms of CapEx, and we've had that question quite often and people were asking, "Is the reduction of CapEx that you've done in 2026 versus 2025, is this a 1-year thing?" And we said, "No, it isn't." Because we're well -- we're very well on capacity. We're good on our railcars, on our locomotives. And therefore, we can see that the level of capital as a percentage of revenue will continue to be in line with the U.S. peers going forward for at least the next couple of years. So it doesn't change. Will we be more aggressive a little bit on our share buyback with that capital -- with that cash? Maybe that's to be determined. As you know, right now, we decided this year to temporarily lift our leverage. We were at 2.5 to 2.7. We've said publicly that we would go back to 2.5x adjusted debt to adjusted EBITDA next year. But this is something we debate on a regular basis. How much leverage should we carry on our balance sheet? We'll continue to do that. But you can assume that our capital allocation will not significantly change even with that cash.

Maybe I'll pause here to see if there's any questions in the audience. Okay, I'll keep on going here. You mentioned in your prepared remarks, the network is running well, about 200 car miles per day or above. How should we think about what that means for incremental margins as volumes continue to move up here? You mentioned you have excess capacity to absorb this. Labor productivity is going well. How does incremental margins play out here as revenue continues to grow?

Well, we always -- first of all, the network and the operations, the first thing is to have great customer service. And, as you know, when Tracy arrived in 2022, we went back to a scheduled operating model. And this is the model that works at CN. It offers reliable service -- more reliable service because now you're getting your trains to go on time instead of waiting to have big trains and not showing up at the customer when the customer is waiting for you. So the other thing that the scheduled operating -- and then I'll talk about your margin in 2 seconds. But the other thing that the scheduled operating model does and people don't realize, but it increases car velocity. And by increasing car velocity, you're sweating your assets and therefore, you're able to move more product with less cars. And that's the notion. And I've seen it. And when we started implementing it, we moved about 6% more volume with about 7% less cars. So then if we own the car, then we get the car ownership savings. A lot of our business are in private equipment, which means the customer owns the car. Well, when that happens, then they get the car ownership savings. But then when we go for pricing and we're able to demonstrate that our service is reliable and that they save money moving the same amount of product, it makes the pricing discussion easier. Now obviously, all of this put together, we are working to improve the margins for sure. And we said every year, year in, year out, we need to improve margins. And you can expect that, that's what we're working on. We're lifting all of the rocks. I talked about crew productivity before. We're very tight on labor in HQ, for example. We're trying to push on automation. So we are pushing on -- and this is what shareholders have told us. They said, "Listen, we are in a very volatile macroeconomic environment. There's a lot of things you don't control. We want you to push on everything you can control." And that's what we're doing at CN and incremental margin is one of them.

You talked about the uncertainty out there in the macro. Clearly, trade between Canada and the U.S. has hit a bit of a speed bump here. What are you seeing on the ground? What are you hearing from your customers?

Yes. The customers -- like a lot of customers, some sectors, first of all, are more impacted than others. And the ones that are impacted, a lot of them, they will try to find alternative markets, okay? And I'll give you an example, metals is one of them. We will have one of the best years in metals. And as you know, metals have 50% tariff going to the U.S. So metal is going -- has significantly reduced going to the U.S., but metals found its way now to stay within Canada. And now we're moving metals from Ontario to Vancouver. I think you were in Symington, by the way and you saw a couple of cars of metal. And this is a long haul. So this is great business for us. So that's -- metals as an example, we've seen increased imports of automotive of autos coming in Halifax and Vancouver, which is why automotive is doing very well this year. Aluminum with 50% tariffs still finds its way to the U.S. because they don't have the capacity to be able to fill their demand and they don't have access to the cheap energy that we have to produce aluminum in Northern Quebec. So the sector -- and then we've started to move unit trains of scrap metal. So water is finding its way basically. The sector that continues to be soft, obviously, is lumber, and -- for a couple of reasons. Number one, it has 45% tariff. But number two, when you look at housing starts in the U.S., it's muted at 1.3 million housing starts. And then mortgage rates, believe it or not, are now close to 7%. So unless this environment changes, I think lumber will continue to be soft for quite a while.

Right. That makes sense. Maybe turning to the MOU you signed with Union Pacific. Maybe first off, like how does that change your revenue pipeline as you extend your network through this MOU?

Well, first of all, this is new. So first of all, I will tell you that I'm very excited with this MOU. I'm very excited with the deal we have with UP. Believe it or not, we've been trying to go to Mexico since 1998. I remember under the leadership of Paul Tellier, like I've been around for a few years. When we bought the IC, at the time, we wanted -- the notion was that CN be the NAFTA railroad connecting Canada, U.S. and Mexico. And at the time, we didn't have the balance sheet to buy both KCS and IC. So we bought the IC and we implemented a marketing agreement with KCS at the time. But if you listened to Laguna last week, Tracy mentioned that between Mexico and Canada, the trade is about $45 billion of goods that are valued between the 2 countries. And 80% of that either goes to -- or comes from Eastern Canada. We have the best network to go to Mexico from Eastern Canada for a couple of reasons. Number one, our route is about 400 miles shorter than the route of our Canadian competitor. And the second thing is we're the only railroad that can go through Chicago on our own track. And therefore, by owning the dispatching going through Chicago, then it allows you to be way more reliable and it allows you to be more fluid. The other thing that this deal will help us is we'll extend our length of haul. As you know, today, we interchange traffic with UP in Chicago. Tomorrow, we'll interchange traffic with UP in Memphis. And we get all of this without having to pay $30 billion to go to Mexico. So I think this is pretty good. I think -- listen, how -- will this change our revenue pipeline? Listen, there's 3 ways to grow your volumes as a railroad. It's very simple. You either grow with your customers. You either convince somebody to build a facility on your line, and therefore, you have them committed for many, many years or you extend your network reach because although the strength of a rail is you can't replicate, like you wouldn't be able to build 20,000 miles of rail in North America today. We own 8,000 bridges. But the weakness of rail is you go to where you go and you don't go to where you don't go. So now we have access to a new market called Mexico. So I think we're going to grow this. I think Janet now has boots on the ground and the team, and we're very optimistic. And as I said, we've got the best route from Eastern Canada going there. So I think stay tuned on that one, but I think this is -- and this is for the long term, I think this will be outstanding.

So should we think of this as complementary to the Falcon partnership you have with UP or you're targeting different commodities maybe outside of intermodal maybe?

You see, Falcon was more intermodal and converting long-haul trucking because believe it or not, you still have trucks that go from Monterrey to Toronto. It's 2,000 miles. We have -- with the Falcon service, we can do that now in 5 days. So there's no reason why that should not come on a train. This deal here is about autos. It's about ag. It's not just intermodal. Like Falcon was really focusing on converting long-haul trucking to rail, which, by the way, as you know, has been the most overpromised and underdelivered. Like I see the people between rails -- market share between rails over time is muted. Like you brag on winning a contract, somebody else will brag. The rails lost their market share in the 1950s to the truck. And we all know that trucks are very competitive in the 500- to 700-mile radius. But when you talk about -- when you look at our length of haul at CN, either domestic or international, it's about 1,800 miles. There's no reason why a box should be on a truck for 2,000 miles. It should be on rail, and this is what we're trying to do. But it takes time because if customers have been used to give that box to a truck for the last 25 years, they're not going to give you all that business tomorrow morning. It's going to take some time. They're going to test you out and so on. So we're at it on Falcon. And now we're going to try to develop all the other commodities through that deal that we have with the UP.

You mentioned one of the benefits is you can basically divert traffic by avoiding the pinch points of Chicago by leveraging your network with the J. What are the guardrails you have in place so that as UP brings volumes up there, that it doesn't congest a key asset on your network?