Canadian National Railway Company (NYSE:CNI) Q3 2023 Earnings Call Transcript

Canadian National Railway Company (NYSE:CNI) Q3 2023 Earnings Call Transcript October 24, 2023

Canadian National Railway Company beats earnings expectations. Reported EPS is $1.69, expectations were $1.38.

Operator: Good afternoon. My name is Julianne, and I will be your operator today. Welcome to CN’s Third Quarter 2023 Financial and Operating Results Conference Call. All participants are now in a listen-only mode. After the speakers’ remarks, there will be a question-and-answer session, during which we ask that you kindly limit yourself to one question. I would now like to turn the call over to Stacy Alderson, Assistant Vice President, Investor Relations. Ladies and gentlemen, Ms. Alderson.

Stacy Alderson: Thank you, operator. [Foreign Language] Good afternoon, everyone, and thank you for joining us for CN’s third quarter 2023 financial results conference call. Before we begin, I’d like to draw your attention to the forward-looking statements and additional legal information available at the beginning of the presentation. As a reminder, today’s conference call contains certain projections and other forward-looking statements within the meaning of the U.S. and Canadian securities laws. These statements are subject to risks and uncertainties that may cause actual results to differ materially from those expressed or implied in these statements. They are more fully described in our cautionary statement regarding forward-looking statements in our presentation.

After the prepared remarks, we will conduct a Q&A session. I do want to remind you to please limit yourself to one question. As usual, the IR team will be available after the call for any follow-up questions. Joining us on the call today are Tracy Robinson, our President and CEO; Doug MacDonald, our Chief Marketing Officer; Ghislain Houle, our Chief Financial Officer; and Ed Harris, our Chief Operating Officer. It is now my pleasure to turn the call over to CN’s President and Chief Executive Officer, Tracy Robinson.

Tracy Robinson: Merci, Stacy, et bienvenue à tous. I want to start today by saying a few words about the evolution of our operation structure. We were very pleased last week to announce the appointment of Derek Taylor to Executive Vice President and Chief Field Operating Officer; and Pat Whitehead to Executive Vice President and Chief Network Operating Officer. You’ve all met both Pat and Derek. They are both accomplished and experienced operating officers, and they will both play prominent roles in CN’s future and our success. Now this – this isn’t splitting as roll into two. We’re making this bigger and we’ll be focusing on work that we haven’t done before. The structure we’re creating will strengthen the competencies that are core to our future of driving profitable growth.

It recognizes the equal importance and the distinct nature of competencies around building the plan and running the plan. Now, Derek and his is field team will focus on continuing to improve the daily execution of our scheduled operating plan across our three operating regions and our intermodal terminal. They will drive on-time performance, along with continued improvement in dwell and in first mile, last mile delivery to our customers. Pat and his network team owned the plan, and their focus will be on two things, continuing to refine the plan to optimize to our volumes and to improve velocity, and to drive a more focused longer-term plan, including resourcing and the development and execution of the capital plan to both maintain our network on a lower cost per unit basis and expand it for growth where necessary in a more cost-effective manner.

Now this structure splits the critical day-to-day focus of running the operation from the very specific work we need to do to ensure that we continue rather to operate well while we grow. And I’m looking forward to working with Pat and Derek as we continue to refine this model. I’m excited about the performance and the innovation that they will deliver in this next chapter. Now, they’re both in the room with us today. They don’t have speaking roles and they’re not mic’d up, but they are here with us. It’s Ed, who of course will carry the operations dialogue on this call, and he’s here and he’s mic’d up and ready to go. You’ll be hearing from him shortly, but before he gets to speak, let me just say how much Ed I have appreciated your willingness to step back in.

I’ve appreciated your partnership in creating our path forward and your leadership in ensuring that we’ve got the right winning conditions in place with our operations team for this transition. You’ve made a real difference and I know that’s exactly what you wanted to do. Now before I hand it over to you though, I have some comments on the business and on the quarter. Our railroad continues to run very well. It is the test of our operating plan that we can maintain our fluidity, our velocity and our customer service levels through different and challenging conditions. We’ve demonstrated that over these past few quarters. Now through the fourth fire season this spring and summer, which was the worst in Canada’s history, the flood conditions in the east and west and the west coast port strikes, our operational performance remains strong and consistent, and we’ve demonstrated the ability to recover quickly.

Our on-train performance and our velocity have remained steady. Now, this is exactly what we’re looking for. In our last month, service has improved. We’ve been consistently over 90% for the last two quarters versus about 80% last year. This is the performance and the resiliency that we’re looking for as the foundation of our growth plan moving forward. Now in volumes, we have a tale of different market segments. You’ll hear from Doug a little more on this. Our bulk business, so think grain, coal, potash, fraction, it’s been strong all year. Our merchandise business is continuing to firm up. For instance, we’ve seen an inflection in chemicals and plastics starting in August. In our consumer-related business, particularly the intermodal business, continues to be murky.

Our domestic intermodal volumes are holding up relatively well thanks to initiatives like the EMP and the Falcon Service. However, the international intermodal has been affected by two things, destocking overall consumer consumption, which has impacted port volumes across the continent for everyone and then the West Coast port strike. Now coming out of the port strike, our Canadian destined volumes have returned. Our U.S. destined volumes moved to U.S. ports during the strike and have not come back fully as yet. Now this is a temporary situation. We’re confident in the value proposition that the Canadian ports offer in both service and cost, and we continue to work to get those volumes back through the Northern gateways. Now I believe we’ve seen the bottom one volumes.

We’ve started a controlled ramp up of the operation to support growth. The growth plan we laid out earlier this year is continuing to progress. It’s a mix of growth tied to economic strength and growth tied to specific customer initiatives. Now the volume growth tied to the economy will come into the economy list. The benefits of our customer-specific initiatives are unfolding pretty much on plan. In both cases, we will see considerable margin leverage as volumes increase. I’m a big believer in the resiliency of the North American economy. This team has managed extremely well to the softer volume and what we can control continues to go very well, faster and better than plan, in fact. And we’re ready as the volumes turn up. We’ve got a lot of confidence in this team, in this network and in this plan.

Now turning to our third quarter results. I’ll keep it to just a few highlights. Our third quarter EPS was 21% lower than last year. And our operating ratio of 62% was higher than last year but remains at or near best in the industry. I am extremely proud that our customer service and operational efficiency have been top tier for six quarters now. The team will take you through the details in the quarter. I’ll turn it over to them now, starting with Ed. Now, Ed I said out a few nice things earlier, but I need now to mention that this is your last quarterly call with CN. Thank you, and let’s make it a good one.

Ed Harris: Thank you, Tracy. Thanks for the kind words. I think before I jump into the quarter, I just want to take a minute to talk about these two guys, Derek and Pat. I’ve really gotten to know them over the past year, and they are among the finest operators I have ever had the pleasure to work with. Investors got to see a bit of their great chemistry and relationship back in May at Investor Day, and how they work together. The entire network benefits from how well these guys operate every day. I can’t tell you how confident I am in the future of the operation and the company with these two working as one, while expanding their responsibilities and pushing the team to be better every day. In fact, this quarter has been a great example of how well they work together because it was a tough operating out there in quarter three.

We started out by dealing with a two-week port strike on the West Coast. We then faced constant disruptions from forest fires and flooding until September. Running to a plan makes all a difference. For instance, we have a two-day outage on our mainline east of Edmonton in the quarter. In the past, that would have taken us up to a week or more to get operations back in sync. This one took two days. The team really took it up a notch in September though, with improvements in car velocity, train speed, through dwell and origin and destination train performance. We told you how we decided not to furloughed train crews earlier in the year, now with grain coming on strong, we’re seeing the benefit of that decision. All in all, we’re set up well for a strong fourth quarter.

I’m very proud of the whole operating team this quarter and especially the leadership provided by Pat and Derek. So how did the quarter shape up? Car velocity averaged 209 miles per day, which was down 1% compared to last year. Some of the other metrics we look at every day like train speed and train length were also down slightly. But when I think about the disruptions this quarter, I don’t think we went a single week in July or August without a major network disruption. Stats that could tell you a lot about the quality of the people operating the network and the resiliency of running to a plan. And as well as the network ran this quarter, our yards were in even better shape. Our origin train departure improved to 89% in quarter three, which is right in the sweet spot that we targeted.

This is one of the keys to delivering for our customers. And as Tracy has already covered our great local performance. Finally on safety, we had six more reportable injuries and two more reportable FRA accidents than the third quarter of last year, which put some pressure on our quarterly metrics. But our year-to-date injury frequency ratio is still 11% better than 2022. And our best-ever quarter three year-to-date performance, and our year-to-date accident ratio is also on track at 16% better than last year. Now Tracy said it, this will be my last call as Chief Operating Officer. I’m going to hand around for the winter to give the team some support through the transition, but I officially hand over the reins to Derek and Pat on November 15.

And like I said before, I have complete confidence in these guys and in this team. Tracy gave me two priorities when I came out of retirement last year, get this place running well again, coach and mentor the next generation of operating talent. As I head off to my fifth retirement, I’ll sleep well at night knowing we knocked it out of the park on both counts. This place is running as well as I’ve ever seen it run and the next generation is ready. And finally, on a personal note, that the team around the table here today has been an honor and pleasure to come back to where I started and finished a career that I started over 50 years ago. It certainly has been my honor to be able to make that happen. Thank you. Now it’s Doug’s turn to talk about top line performance and market outlook.

Doug MacDonald: Thanks, Ed, and all the best on your well-deserved retirement. Also, congratulations to Pat and Derek, I look forward to working even closer with you as we deliver for our customers together. We said it on the Q2 call that our commitment to our customers is to provide industry-leading service, and we continue to deliver on our promise. As for volumes, we believe the worst is behind us. They hit the bottom in July, we saw improvement in August and September. Through the rest of the year, we expect this trend to continue, and I’ll give some more details in a moment. We continue to deliver core pricing ahead of CN inflation. The pricing environment remains robust and our service levels are facilitating pricing conversations with our customers.

We started the quarter in a bit of a hole with the port strike on the West Coast. This impacted International Intermodal more than any other business segment. And as Tracy mentioned, we continue to see a hangover effect from cargo diversions to U.S. gateways. We ended the quarter with UAW strike starting at the Detroit Big 3. Fortunately, this only had a limited impact on our volumes in Q3. Turning to Slide 9 now. Third quarter revenues were nearly CAD 4 billion, down 12% versus last year on lower fuel surcharge rates, lower volumes, but partially offset by solid pricing. RTMs were down 5%, but excluding overseas, were up 1% for the quarter as we see a continuing recovery across the other business lines. For merchandise, metals and minerals finished with the best quarter so far this year, supported by increased drilling programs in Western Canada driving strong SAM shipments.

Demand for forest products remains below pre-COVID levels due to a challenging macro environment. Lower petroleum volumes in the quarter were mostly due to spot crude unit trains that we moved last year. We should lap that tougher comp in the fourth quarter. Plastics & Chemicals sequentially strengthened in the quarter, which is a leading indicator of industrial production. Automotive continued to benefit from strong pent-up demand with limited strike impact. Turning to intermodal, I will remind you that storage revenues were normalized this year following last year’s supply chain issues, which represents an impact of about $100 million in the quarter. In domestic intermodal, we saw the monthly year-over-year numbers turned positive in Q3, in part because of our Falcon service between Canada, Detroit and Mexico.

International Intermodal continues to be weak, but we were impacted and were impacted by the West Coast port strike. We continue to see lighter U.S. discharge at Rupert and Vancouver, and we’re working hard with our customers to get that volume back. Our bulk business has been outperforming since the start of the year. Starting with grain, we saw a strong weekly ramp-up in Canadian grain in September with the crops coming off the field about three weeks earlier than last year. Building on our strong service from the last crop year, grain is now rolling, and we expect strong volumes until at least next spring. We handled record potash volumes in the third quarter to export markets and the U.S. market. The operating team is providing outstanding service to our customers for this incremental volume, but we are being careful not to oversell the network.

Finally, the West Coast strike and subsequent terminal outage had a minor impact on met coal in the quarter, but commodity prices are still supportive of ongoing export volumes. Looking ahead to the balance of the year on Slide 10. We’re seeing lots of momentum across almost all of our markets. With bulk leading the charge, Canadian grain is running full out. U.S. Green will also be strong and similar to 2022, benefiting from record low water levels on the Mississippi and limited barge capacity, but tempered by demand in China. We expect solid potash demand in line with the Q3 run rate, and there could be additional upside with our robust export market. Canadian met coal should be strong for the rest of the year, and we have set an annual export record already with one of our largest customers.

For overseas intermodal, we are seeing clear indicators of positive trends. Destocking appears to be nearing an end but wholesale inventory to sales ratios remain elevated. We are forecasting a gradual improvement throughout 2024. On the domestic side, both retail and wholesale are tracking favorably over last year. As Tracy said, domestic is also held by some growth initiatives. Rounding out with merchandise, we have a strong outlook for drilling with frac sand demand, aided by our network capacity enhancement in Northern BC. We expect automotive to outperform with continued pent-up demand contingent on how long the UAW strike goes on. And we expect a continued positive trend in chemicals, plastics and metals and stable forest products. October is off to a good start and in line with how we have been modeling the quarter.

Before I hand it over to Ghislain, I want to review on some of the unique growth initiatives we laid out at Investor Day. We announced our new long-term agreement with AltaGas yesterday, which will drive an increase in LPG export carloads through Prince Rupert and Ferndale, Washington. CM, along with our customers and supply chain partners, continue to invest and develop the Rupert Gateway, which we highlighted at our May Investor Day. On the Falcon product, we’ve been building up this service since its launch in May. It’s now a solid and consistent product. In line with truck transits, we saw our first loads with STG Logistics a couple of weeks ago and we continue to actively pursue opportunities to build density to and from Mexico as major RFPs come up for bid.

CN’s Eastern Fuel Strategy is progressing with the new distribution terminal in Toronto ready to start receiving cars in December. In line with what we projected at Investor Day, we expect volumes to build over 2024. We continue to work with our customers on building up the electric vehicle supply chain. We now have five announced projects on our network in Eastern Canada. It’s going to take a few years to fully develop this opportunity, but we’re pleased to already see the first shipments of raw lithium moving on CN for export at Quebec City. Our Northern BC strategy is also progressing as we finish the first capacity project in the area this month. This will allow CN to add additional frac sand and propane shipments to the network. To finish, I’m really excited about the next year and I’ll have more to report on these opportunities in January.

Over to you, Ghislain.

Ghislain Houle: Merci beaucoup, Doug. [Foreign Language] But before I do that, I want to thank Ed for everything he has done this past year. I’ve known Ed a long time, and I’d like to wish him and his family a long, healthy retirement. And frankly, now I hope he stays in retirement. And the growth felicitation to Derek and Pat on their appointments. Now, I will top the Slide 12 of the presentation, which will provide more visibility on our third quarter performance. Volumes in terms of RTMs were lowered by 5% on a year-over-year basis, including the impact of the external disruptions that Ed talked about earlier. We delivered operating income of around $1.5 billion, 21% lower than last year. Our operating ratio came in at 62%, up 480 basis points versus the operating ratio for percent lower than last year, but is only slightly higher year-to-date on a year-over-year basis.

EPS for the quarter finished at $1.69, 21% lower than last year. The estimated impact of external disruptions on our network this quarter was unfavorable to EPS by $0.10 and dilutive to the OR by 130 basis points. In terms of expenses, labor was essentially flat versus last year, driven by 6% higher average headcount and general wage increases, offset by the U.S. wage accrual true-up related to new labor agreements in 2022, and lower incentive compensation this year. We have slowed and, in certain cases, stopped the pace of new hires through the quarter. Fuel expense was more than CAD 175 million lower than in the same period last year, mostly due to a 20% decrease in price and a 6% lower workload in terms of GTMs. With rising fuel prices, we had an unfavorable fuel surcharge lag, which had a CAD 0.10 impact on EPS in the quarter, or CAD 0.20 cents of EPS on a year-over-year basis.

We generated close to CAD 2.3 billion of free cash flow to the end of September. We are investing in our rail car fleet and continue to invest steadily in track maintenance as well as capacity expansions with a view to capital efficiency so we can be ready for the rebound. Moving to Slide 13, let me provide some visibility to the full year. Despite uncertainty in sectors related to consumer consumption, most other areas are demonstrating signs of strength. The bulk segment of our business continues to perform very well. We believe the worst is behind us, and you should expect operating leverage to improve as volumes come back. We are still calling for a gradual recovery in consumer related freight demand in 2024. With this in mind, we are reaffirming our full year guidance of flat to slightly negative EPS growth in 2023 versus 2022.

We assume that for the balance of the year, foreign exchange will be in the range of $0.70 to $0.75 and WTI in the range of US$80 to US$90 per barrel. However, full year assumptions continue to be $0.75 for foreign exchange and WTI at US$80 per barrel. We remain committed to shareholder distributions. We are confident in our long-term growth story and have increased the budget of our current share repurchase program, which runs through January 31, 2024, to approximately $4.5 billion, up from the previous budget of approximately $4 billion. Under this program, we have repurchased nearly 20 million shares for just over $3 billion through the end of September. In conclusion, let me reiterate a few points. The team is committed to the scheduled railroad model, which provides reliable service for our customers.

Apart from international intermodal, we are seeing strength in many segments and volumes continue to sequentially improve. With this in mind, we are reaffirming our full year 2023 guidance. We have a strong balance sheet that provides us financial flexibility and we will allocate our capital in a manner that drives long-term value for our shareholders. Let me pass it back to Tracy.

Tracy Robinson: Thanks, Ghis. Operator, I think we’re ready to take some questions.

Operator: [Operator Instructions] Our first question comes from Walter Spracklin from RBC Capital Markets. Please go ahead. Your line is open.

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Q&A Session

James McGarragle: Hi, this is James McGarragle, I’m on for Walter this morning. Thanks for taking my question. We’ve been tracking some TEU trends out of Prince Rupert and some of the weakness that occurred as a result of the port strike in July looks to be extended into August and more recently in September. And I guess my question relates to the extent this might be structural versus temporary? And I know you addressed this in your opening comments, but can you speak more specifically to some of the servicing cost benefits you have versus U.S. alternatives and the confidence you have in that volume coming back? And any update on your conversations with the shipping lines and how quickly do you think we could see that come back? Thank you.

Tracy Robinson: Good afternoon, James. Yes, as we said earlier, we think this is a temporary issue. There are similar structural advantages to Rupert in particular, both, as you noted, economic and service. So we have set Prince Rupert up with a premium container service into the U.S. markets. And that kind of strategy has been working. And as you noted, when the strike occurred, it’s that business that started to move to the U.S. ports, but that structural advantage continues. And we’re two days faster from China in Chicago than the other alternatives, and there are some economic advantages based partly on the currency, the Canadian currency and other that we think they stand even as we look into the future. So we think this business is going to come back or we’re working with our customers on it.

Our call is that it will come back gradually. We’ve lost a little confidence in the West Coast ports. It will come back gradually unless the volume really starts to pick up and then it will come back more quickly. In the meantime, up at Rupert, we’re continuing to lean into an increasing structural advantage. If you think about the import transload is now under construction. The port announced a really as an export Logistics Park that’s been approved in this going forward. So all of that, I think, is very supportive on the container side. And even outside of container some Doug mentioned, our AltaGas deal, we very much appreciate the business and the partnership with AltaGas. But that new agreement is going to drive considerable growth in that quarter.

So we are actually if you think about the growth that we laid out for you at Investor Day on the Rupert corridor, we are ahead of that plan. So we’re feeling pretty good about it and very strong about the structural advantage of Rupert.

James McGarragle: I appreciate it. And just a quick one on BILL C-47 and interswitching, I’ve seen some of the companies post about this one now LinkedIn, but have you seen any customer up-tick on interswitching and any early commentary you can provide on the matter. And I’ll turn it over. Thank you.

Tracy Robinson: Yes. I would say that what we are focused on is driving the highest performance out of our supply chains in the country in the continent. And we are prepared to continue to invest in capacity and that performance. The interswitching provisions and the concept of it, is not at all supportive of supply chains that perform at high-level. It slows, cars down, slow service down, and it is not supportive of continued investment. And so, on that basis, we’ve objected to this. Having said that, we haven’t – we’ve seen a significant impact as of yet, but it’s really good.

Operator: Our next question comes from Brandon Oglenski from Barclays. Please go ahead. Your line is open.

Brandon Oglenski: Hi. Good afternoon and thanks for taking my question. And sorry if this is a little bit near-term focus. But Ghislain, can you just walk us through some of the moving pieces on your implied 4Q guide, because I think it suggests that OR should improve sequentially. And obviously, you had some issues in the third quarter, but can you talk through the moving pieces here on how to get to the full year guide from where you are?

Ghislain Houle: Thanks, Brendan. Well, I think as we said in our opening remarks, I think there’s – we see definitely improvement in volumes on a sequential basis. I mean just when you look at our volume sequentially in October versus September were up 7%. So I think you can expect volumes to improve sequentially and as volumes come in, I think that we are very comfortable that we will deliver some operating leverage. And maybe I’ll pass it on to Tracy do you want to add anything, Tracy?

Tracy Robinson: Sure. I think the other way to think about it, we are seeing the strength in volumes that Ghislain is talking about. Our pricing is coming in exactly the mandate that we gave Doug, and I am really pleased with the margins that this system is providing and this team is providing. I think we’ve had the best margins in the industry for the past five, six quarters. And we’ve got – we know that there’s leverage there, particularly in the Manifest business on the merchandise side as the volume starts to lift again were eager for that to happen, and it looks like it’s starting to happen now.

Ghislain Houle: Thanks for the question Brandon.

Brandon Oglenski: Thank you.

Operator: The next question comes from Cherilyn Radbourne from TD Cowen. Please go ahead. Your line is open.

Cherilyn Radbourne: Thanks you very much. Good afternoon. I wanted to pick up on some of the new interchange relationships that you’ve negotiated with your rail peers. What do you think needs to happen to make these partnerships work better than they have in the past? And do you think that the willingness to cooperate will extend to include trickier situations where perhaps one of the two carriers, have to accept the shorter length of haul.

Tracy Robinson: Yes, Cherilyn. Thanks for that question. It is – I think it is a change that we’re seeing in the industry, right, for various reasons as we have our discussion, I would tell you that we are open for business and very eager to work with our partners and the other carriers to provide and design and provide the services that makes sense for our customers. And the ones that you’ve seen, at least us step into most recently are really targeting getting truck traffic off the road and things like the falcon service, Doug is working as well on our new service with the NS. These are working with FXC in the Cape Falcon and UP. We have a product in place now that’s consistently delivering at very truck-like transits, and that’s pretty remarkable.

I think you’re going to see more of this. And I would say that the nature of the dialogues that we’ve had so far with all of the carriers is that we’ll conduct ourselves in a way as though we were a single carrier, right? And that may mean, in some cases, it’s advantageous to one and in other cases, an advantageous to the other. But that’s a principle that I think needs to underscore these relationships as we go forward. Doug, do you have anything to add to that?

Doug MacDonald: The only thing I’ll add is Cherilyn is that it’s all about service. So the quickest transit times to compete against truck is really what the operating teams between the railways are really focused on. And we don’t really care how long the haul is, right? It’s all about – we need to get it there as fastest truck. All the teams are – have been greatly focused on that. They’ve come up with some great products where we think we are truck competitive in all these corridors and they’re major truck lanes. So I assume that we’re going to take our time. We’re going to start to build this as we build momentum. It’s going to take a while to pull trucks off the road, but we’re pretty happy with the product so far, and we think we’ll be successful.

Cherilyn Radbourne: Thank you.