Canadian National Railway Company (NYSE:CNI) Q4 2022 Earnings Call Transcript

Canadian National Railway Company (NYSE:CNI) Q4 2022 Earnings Call Transcript January 24, 2023

Operator: Good afternoon. My name is Patrick, and I will be your operator today. Welcome to CN’s Fourth Quarter and Full Year 2022 Financial and Operating Results Conference Call. After the speaker’s remarks, there will be a question-and-answer session. . I would now like to turn the call over to Paul Butcher, Vice President, Investor Relations. Ladies and gentlemen, Mr. Butcher.

Paul Butcher: Well, thank you, Patrick. Good afternoon, everyone, and thank you for joining us for CN’s Fourth Quarter and Full Year 2022 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 and 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 1 question. 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; and Doug MacDonald, our Chief Marketing Officer; Ghislain Houle, our Chief Financial Officer; and last but not least, the youngest recruit on the team, 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: Thanks, Paul, and welcome to our earnings call. I’m very pleased, whether you’re with us by phone or webcast. We appreciate you joining us. Now I’m approaching — getting close to the end of my first year with CN. And as I do that, I can’t be prouder of this team and what we’ve accomplished together over the last year, it’s important to me and to all of us that we’ve delivered on what we promised. We drove top line growth and we drove it to the bottom line. We started with a pretty tough first quarter, but we finished the year on guidance with an EPS up 25% and an operating ratio that starts with the 5 first since 2017. We also delivered a return on invested capital of 15.9% and free cash flow of nearly $4.3 billion.

I want to take this opportunity to thank each of our CN employees. I am grateful for your focus and your hard work and delivering to some very big commitments this year. We came together as a team and across the entire organization, we have risen to the challenge. But we’re not done. We’ve got more work to do on many fronts, and we’ll be focusing on this through 2023. Without a doubt, we are in an uncertain economic time. And like many others, we are assuming this year, a mild recession. Now our bulk segment will help us in the first half of the year but we have less visibility in the second half. In this company, like others, we’ve dealt with recessions in the past, and we’ll deal with this one. We have a great network and a diverse book of business provides stability for us in times like this.

So we’re going to remain nimble and close to our customers and will perform well this year regardless of volumes, and we will position ourselves for the upswing when it comes. And while current expectations that North American industrial production will be negative in 2023, we will grow EPS in the low single-digit range. Now the team with me today will walk through our performance 2022 and our outlook for 2023. I am pleased to have Ed Harris joining us on the call today for the first time. Ed was appointed Chief Operating Officer in December. And he brings a little bit of experience, 40 years of experience to our team. Most of that was with the CN running a scheduled operation. He’s pretty passionate about being back and doing just that. Ed will give us an update on our operating performance, and he’ll make some comments on our path forward on continuing to improve our operations and importantly, on his mandate to get the next generation of operating talent ready.

Following a strong top line performance in 2022, Doug and his team are working closely with our customers to monitor volume trends and making sure our portfolio continues to fit our network. We’re going to maintain our approach of selling into our capacity. Doug today will give you an update on our key markets and how we’ll look to outperform that North American industrial production this year in terms of volumes. And Ghislain, as always, will cover the details of our financial performance in the quarter and the year as well as assumptions driving our 2023 financial outlook. Ed, over to you.

Edmond Harris: Thank you, Tracy. Despite what Paul said, Tracy and I do go back a long way, when we both work for our Canadian competitor. And I can’t tell you how happy I am to be back home where I dedicated a big part of my career. Ghislain, Doug, and I also go back a few years from my prior days at CN. Very happy to reconnect with them and also many others at CN. Some of which are the sons and daughters of the people I worked with a few years back. I reached out to Doug early on to better understand some of the challenges that we faced. And we have been working closely — very closely sense to continue to improve our customer service. I love this business, and I feel energized about taking scheduled railroading to the next level.

But more importantly, I’m here to help identify and mentor our talent and develop the next generation of railroaders. I can say that we have one of the best networks in the industry and a darn good team of operating people to maximize the efficiency of this network and enable growth for the North American economy. I came on board in April as a consultant and was very excited about the idea of helping this company refocus on scheduled railroading. You have seen the significant improvements throughout the year. I was convinced that this team had the muscle memory to get us back to where we used to be, and I want to thank all the operating people for their efforts. I have spent a considerable amount of time with the operating team since April.

I’ve been out on the property quite a lot, and let me tell you that the talent is deeper than I initially thought. They are passionate and as a team, they want to drive more efficiencies going forward. While as a consultant, my role was more about suggesting ideas and making recommendations like starting on time and controlling train lengths and getting back to the 3 regions from the 2 that existed. Now as Chief Operating Officer, I can direct and have a more influential role in working with the team to implement some of the changes that will take this company to the next level. I am here to help the company. I want to be fast and quick, but before anything, I want to be safe. We have made great strides when it comes to safety performance. and we are now 748 days without a fatality and 560 days without a serious injury.

Every day, we are beating a record. Railroading needs to remain simple. I think we got away from that over the past few years. Velocity creates capacity, the faster we are, the more we can handle. And the more we stick to the plan, the more reliable we are, which means that I could provide a level of service that Doug can sell to his customers. I’ve heard Tracy say so many times about how we’re working on a more integrated basis. A big part of my philosophy is to work together as a team and work closely with the other functions. Collaboration is key and that’s how we will move forward together. I could talk about railroading for hours, but now let me speak about a few of the operating highlights of the fourth quarter and some of my priorities for 2023.

We continue to make good headway in terms of operating performance, though not without some challenges in the quarter. Car velocity averaged 207 miles per day in the fourth quarter, up 10% from last year, while origin train performance averaged 85% in quarter 4, also up 10% from last year. What I’m most proud of in the fourth quarter is how the operating team responded to the challenges and restore fluidity on the network following a period of extreme winter conditions in Western Canada in late December, with temperatures in some areas, dropping to a minus 50 Celsius for that time frame. Our approach to scheduled railroading and focus of our employees helped us to restore fluidity on the network. I am amazed how the team responded and you can see it in the operating performance.

So far this month alone, car velocity is hovering near 220 car miles per day, similar to the numbers that this company saw last summer. Now winter is far from over, but compared to last year, we are in a much better position to start the year, and it means we should be in a better position to come out of winter into the spring. We are building resiliency based on running a scheduled operating plan with focus on service, asset utilization and velocity. Those terms should be familiar to all of you. Before I pass it on to Doug, let me provide you with some of my priorities for 2023. We’re going to take scheduled railroading to the next level. There’s more yet to be done here with a focus on destination and train performance and individual trip plans.

We continue to drive capital efficiencies and we will deploy capital on the network engineering is already equipped and ready to get started on this year’s program, starting naturally on our . The mechanical team is bolstering in modernizing our fleet of locomotives with camera technology and energy management systems, which will help us be more efficient with fuel and safer. And finally, and perhaps most importantly, we are going to continue to coach and develop the next generations of railroaders. With that, I will pass it on to Doug to discuss top line performance and outlook.

Doug MacDonald: Thank you, Ed, and a huge thanks to you and your team from both me and our customers on the speed of our operating recovery after the extreme winter temperatures on our network in December. The team’s disciplined execution and focus on velocity has delivered the service our customers need, and we are pleased that January is off to such a strong start. I’ll now turn to Slide 9 and provide a review of our solid fourth quarter top line performance. Fourth quarter revenues were $4.5 billion, up 21% over Q4 of last year on 6% higher RTMs. Our bulk segments led the charge this quarter with strong year-over-year volume growth. We continue to achieve rail inflation plus pricing on renewals and the lower Canadian dollar also contributed to our revenue growth in the quarter.

As expected, Canadian grain was very strong this quarter, including an all-time single-month record for tons shipped in October. We also saw growth in U.S. grain given the supply chain shift with the low water levels on the Mississippi River through the fall. For the full year, unit train shipments of U.S. grain to the Gulf beat the previous record from 2006. Coal demand remained strong through the fourth quarter with a strong commodity pricing environment. In fact, we set a record for coal shipment in 2022 with over 30 million tons shipped for the full year. Automotive volumes were strong in the quarter as inventory replenishment continued across the industry. We did, however, see some weakness expand in other segments in the fourth quarter.

A softening in international intermodal as volumes tapered through all gateways due to inventory overstocking. Lower petroleum and chemicals volumes with reductions in refined products as well as lower chemicals and plastics used as inputs into manufacturing due to numerous small outages and a softer market demand. Lumber and panels decreased following additional mill curtailments in British Columbia due to low commodity prices, high stumpage fees in BC and lower housing demand due to rising interest rates. Before I review our market outlook for 2023, let me provide you with updates on some of the initiatives we spoke about earlier this year. Despite some recent softness, the Port of Halifax had a record volume year for intermodal in 2022, handling in excess of 600,000 TEUs and CN and our partners, PSA and Port of Halifax are all working with our customers to grow the terminal in 2023 and look forward to selling out the terminal in years to come.

On the EMP program, which is a shared intermodal equipment pool with the UP and NS, CN has now fully integrated the program into our operations and sales. CN will be adding containers to this pool over the next 2 years as we continue to grow the business for the interline domestic intermodal. CN finished off 2022 averaging over $1 million per week in new business. The Canadian West Coast export propane program continued to gain momentum in 2022. Working with our partners in Prince Rupert, CN moved over 10,000 cars this quarter to terminals in Prince Rupert to support Canada’s growing energy export market, an increase of 17% over Q4 2021. We expect this program to continue to grow as additional drilling and gas processing takes place in advance of the new LNG plant coming online in 2025.

Finally, turning to Slide 10. We are assuming a mild recession as our base case. We have good visibility in H1 as we continue to move significantly higher Canadian grain crop. With the current economic environment, the H2 outlook remains uncertain at this point. On the bulk side, we expect continued strength in 2023. We will be moving last fall’s Canadian grain crop well into 2023, and we are anticipating an average crop for the 2023, 2024 crop year. We expect coal demand to…

Operator: All participants continue to stand by. The lines for the moderators have disconnected. Once again, please continue to stand by. We are back in the call. Please go ahead.

Doug MacDonald: Thank you, everyone. I think we got cut off there, so I’ll just continue with my remarks. So we expect coal demand to remain strong through 2023 with commodity pricing staying favorable. Energy shortages are keeping demand strong, and the backlog in autos and development in Asia will underpin net coal demand. We expect more of a flat to negative performance with most other commodities. The weakness that we began seeing in the fourth quarter is expected to persist through at least the first half of 2023. The international intermodal will have multiple blank sailings as the North American inventories rebalance. Lumber will be slow to recover due to market oversupply and high interest rates dampening demand. Chemical and petroleum production is directly tied to the economy, so we expect demand to be soft in the first half of 2023.

Automobiles are still in a tight supply situation, but this is changing with higher interest rates as well as part shortages. To close, we are working closely with customers to monitor the economic environment as we run a scheduled railroad with a focus on velocity, we are achieving solid performance that will serve our customers well and continue to grow with our customers as the economy recovers. With that, I will pass it on to Ghislain.

Ghislain Houle: Thanks, Doug, and welcome, Ed, it nice that you’re back home. It’s my pleasure to review our excellent fourth quarter and full year financial results. I will talk to Slide 12 of the presentation, which will provide more visibility on our fourth quarter performance. These results highlight the strength and resilience of our franchise as we delivered volume growth of 6% in terms of RTMs and 21% growth in revenues despite some significant weather challenges in December. The top line performance, combined with the strong operating performance, grew solid earnings in the quarter. Let me provide you with more details on the quarter, and I will speak to the adjusted numbers, which exclude advisory costs related to shareholder matters in the fourth quarter of 2021.

Labor expense was up around $40 million in the quarter versus last year, driven by increased wages due to higher average head count of close to 900 transportation employees versus last year. Our fuel expense was up nearly 50% FX adjusted, as fuel prices were over 45% higher in the quarter versus Q4 of 2021 and volumes contributed to the remaining 5%. We delivered operating income of $1.9 billion in Q4, up 21% on an adjusted basis. Our operating ratio came in at 57.9%, which is in line with the adjusted operating ratio for the same period last year. Diluted EPS of $2.10 for the quarter was up 23% versus last year on an adjusted basis. Turning to our full year results on Slide 13. I am very proud of our adjusted EPS growth of 25% versus last year, which is aligned with our guidance, demonstrating the strength and resiliency of our franchise and validates the effectiveness of operating a scheduled railroad with a focus on car velocity and working on an integrated basis.

We generated free cash flow of nearly $4.3 billion for the year, exceeding our guidance. Under our current share repurchase program, which runs from February 1, 2022, through January 31, 2023, we have repurchased over 29 million shares for $4.6 billion at the end of December. Finally, at the end of 2022, our return on invested capital finished at close to 16%, exceeding our 15% guidance. Moving on to Slide 14. Let me provide some visibility to 2023. As we continue to see weakness in certain segments like international intermodal, driven by lower consumer spending, lumber, chemicals and plastics, we also see weakening economic indicators with negative North American industrial production expected in 2023. Therefore, like many others, we are assuming a mild recession in 2023 with some rebound in 2024.

We have good visibility on Canadian grain for the first half of 2023 and currently assume an average crop starting in the second half of the year. As Ed mentioned, we are off to a good start in January from an operating perspective, and Doug and his team remain disciplined on pricing, but we will be facing some headwinds on the Canadian labor front in regards to work/rest rules and paid sick days. Despite a weakening economic environment, we expect to deliver low single-digit EPS growth in 2023 versus 2022. In terms of shareholder distribution, we are pleased to announce that our Board of Directors approved an 8% dividend increase for 2023. This represents the 27th consecutive year of dividend increase since the 1995 IPO and reflects both the confidence in our strong cash flow generation capacity throughout business cycles and the long-term prospects for the company.

The Board also approved a new share buyback program of up to 32 million shares for an amount in the range of $4 billion to be returned to shareholders through a normal course issuer bid from February 1, 2023 to January 31, 2024. In conclusion, let me reiterate a few points. We delivered a strong fourth quarter performance as we continue to push on operating a scheduled railroad. We met our 2022 financial guidance. We are witnessing continuing economic weakness and calling for a mild recession in 2023. Despite this weak economic environment, we are still guiding for EPS growth, demonstrating the resilience of our franchise and the strength of our team. 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 for some closing comments.

Tracy Robinson: Thank you, Ghislain. So today has been a good opportunity to look back at a number of our successes in 2022, and I’m really proud of what we’ve accomplished together. But this team and I are looking ahead to the future to where we want to take our company and it will take a continued focus on performing at an ever higher level across the organization. As Ed said so, it’s not that complicated. We’re going to keep it simple. It starts with the plan. We’re focusing on the next level of operating performance through the scheduled operating plan and further integrating our team across functions. We’re continuing to get closer to our customers, earning their trust through great service and partnering in their growth, and we’re going to leverage the strength of our network to grow with them in a manner that’s good for both of us.

We’re in the longest stretch of our company’s history without a fatality or serious injury, and there’s nothing more important to us than this. But it doesn’t mean that we get complacent. That means we get even more committed to our safety culture and looking out for each other every day. We know now what’s possible. Our efforts on climate and sustainability are advancing. A number of organizations last year recognized our sustainability efforts. We made the CDPA list once again, and we’ve now been listed for the 11th consecutive year on the Dow Jones Sustainability World Index. We appreciate the recognition, but we’re really focused on is to continue to pursue this agenda, which amongst other objectives is going to help us further improve our industry-leading fuel efficiency.

And last but not least, of course, we’re intently focused on developing the next generation of talent at CN. There’s tremendous capability in this company, as you’ve seen. And we have the senior team in place now to bring them and their performance up to the next level. You’re going to hear a lot more details about our vision and our growth plan and our performance at our Investor Day in Chicago in early May, and we’re looking forward to seeing you all there. And now Patrick will open the line to questions, please.

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Q&A Session

Operator: . First question is from Chris Wetherbee from Citi Group.

Christian Wetherbee: Maybe I wanted to start on the guidance and I appreciate the fact that you’re being, I think, cautious about the outlook or may be realistic about the outlook for a recession in 2023. Ghislain or Tracy, maybe you could walk us through some of the underlying dynamics of that outlook. How do you think about RTMs and maybe how do those progress over the course of the year? And then if we can get revenue growth in the year, do you think operating ratio improvement is possible as well to get you to that low single-digit EPS growth.

Tracy Robinson: Chris, that is the question, isn’t it. We’re giving you today our guidance based on what is the best information we have right now. Given the uncertainty in the economy and what may happen this year, I think it’s the right amount of information to provide. We do hope that it will be better than what we expect. And we’ll be ready if that happens. And as we get more clarity, we’ll be in front of you with updates. But I think we’ll keep it pretty much at that level for today.

Christian Wetherbee: Just one quick point. Is it fair to assume that RTMs maybe track roughly industrial production? Is that reasonable?

Tracy Robinson: We think that — I’m going to hand it over to Ghis to comment, but we do believe that we can lift our volumes higher than the industrial production, as Ghislain said in his note.

Ghislain Houle: So you covered it well, Tracy.

Operator: The next question is from Konark Gupta from Scotiabank.

Konark Gupta: Just wanted to follow up on previous question actually. If we look at the EPS guidance for low single digit, we also have a share repurchase here, which could potentially be in the low single-digit range. And then volume, as you said, it’s above IP pricing of inflation. Is there something on the yield or operating ratio that we need to figure out to kind of account for the gap? Is it the mix? Is it the accessorial charges? Something else that you’re missing.

Ghislain Houle: Well, thanks, Konark, listen, as we just said, I think that we’re assuming right now the industrial production in North America will be negative. As Tracy just mentioned, we’re assuming that we’ll do a little bit better than that. We will continue to work on our margins. I mean, we know that we need to improve our margins on a year-over-year basis. However, as you know, it’s tougher to improve margins when you’re in a low volume environment. But we’re very confident over the mid to long term that there’s no question that we will improve our margins. When you look at what we’ve done in 2022, I mean, our incremental margins for the full year was a respectable 50%, and we improved ROR by 130 basis points. So that sets the stage.

And with the scheduled railroading back in full force, I think that it’s all going to depend on volumes and it’s all going to depend on the economic environment. I mean if economic environment does a little bit better, then we’ll ride the way. If it’s deeper than what we think, then — and it’s not mild, but it’s deeper, then we’ll perform. I mean, we’re well positioned to perform in a recession, and we have a strong balance sheet. So I think we’re — and as — and I’ll finish on this, Ed mentioned it, but we’re starting January quite well with the weather collaborating. So our volumes are good. But remember that we are comping versus last year where we were in deep freeze. So — and we can count our chicken too early. We just have about 21 days behind us.