Canadian National Railway Company (NYSE:CNI) Q4 2023 Earnings Call Transcript

Canadian National Railway Company (NYSE:CNI) Q4 2023 Earnings Call Transcript January 23, 2024

Canadian National Railway Company beats earnings expectations. Reported EPS is $2.02, expectations were $1.45. Canadian National Railway Company isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good afternoon. My name is Julianne and I will be your conference operator today. Welcome to CN’s Fourth Quarter and Full Year 2023 Financial and Operating Results Conference Call. All participants are now in 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 Fourth Quarter and Full Year 2023 Financial and Operating 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 US 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 would ask that you please limit yourself to one question, so we can get to hear from as many of you as possible. 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; Pat Whitehead, our Chief Network Operations Officer; Derek Taylor, our Chief Field Operations Officer; Doug MacDonald, our Chief Marketing Officer; and Ghislain Houle, our Chief Financial Officer. It is now my pleasure to turn the call over to CN’s President and Chief Executive Officer, Tracy Robinson.

Tracy Robinson: [Foreign Language] I want to start today by welcoming Derek and Pat to their first call. It’s great to have you guys with us. And I also want to extend a warm welcome to Remi, who’s out in the field today, immersing himself in the operation. You’ll all have a chance to meet him over the next few months or so. Doug remains in charge of our commercial organization and our growth efforts and he is of course here today with us. Doug will be retiring this year and there’ll be a little more to say on this at that time. But I very much appreciate Doug your presence and partnership over the last couple of years. And I know that Doug will do a great job in getting Remi set up with our commercial team. Now this transition later this year will be seamless to both our customers and our employees.

We are railroading here for the long term. And we’re fortunate to have a lot of very strong and experienced talent at CN and we’re going to supplement that now and again with talent with different backgrounds and perspectives. And this is going to make us even stronger, which is important as we continue to refine our path forward and advance our growth mandate. And we’re also taking a long-term approach when it comes to our network. We know that our network has always been core to the CN advantage and to our ability to provide our customers with solutions for their businesses, where it makes sense to add to our network, to position us to do more or better of this, we’ll do so. Now in the fourth quarter, we closed on the CBNS, which will give us more opportunities to densify the eastern part of our network in coming years.

And in December, we signed an agreement to purchase the Iowa Northern. It’s a nice addition to our network in the Midwest. It will give customers in that area better market access, and for us, it will deepen our network reach and boost our Ag business. So I want to welcome those who might be listening in for the first time today to our railroad family. We do expect to fully integrate the Iowa Northern property later this year pending a positive outcome of the STB review process. Now, before I ask the team to get into the details, I’ll just recap where we are and I’ll start with safety. We ended the year with some meaningful improvements in both our accident and injury frequencies, and I am very pleased with both the work that has gone into this and the impact it has had and we’re going to continue those efforts.

This will be a relentless drive to zero. And on the operation, we came into the fourth quarter a little battle-hardened after a couple of difficult quarters last year and where we managed through a freight recession and a number of external shocks. And in Q4, we had the gift of some kinder weather and our operations team took full advantage, posting some really strong on-time and velocity metrics. Now, as we rounded the corner into this year, we kicked off with some extreme winter temperatures across the network. But as we lift out of that, the team is well on their way to getting this place back to that same level of operation. Whatever comes at us, we know that sticking with this model will ensure resiliency, enabling us always to perform at our best.

Our full-year car velocity, for example, and this is including the challenges of the second and third quarters, was 213 miles per day, that’s a 9% improvement over 2022. We’re running a plan. We’re getting more out of our assets and this is driving some very consistent service levels to our customers. A strong, consistent, resilient operation is table stakes in this industry and the necessary foundation to move the economy and for us to deliver our growth agenda. At the end of the day, this is about doing what we say we will do. We have a plan and we’re executing it. We’ve been building up our track record operationally over these last seven quarters and I think I speak for the entire team that it feels really good to have that CN grew back.

Now, turning to our quarter and full-year results, I’ll keep it to just a few highlights. Our fourth quarter adjusted EPS was 4% lower than last year and our operating ratio was 59.3%. For the year, adjusted EPS was 2% lower and our operating ratio was 60.8%. These are the kind of results we can be very proud of in a challenging environment. And we said last quarter that we’ve seen the bottom in volumes and this has played out as we expected. We’ve seen sequential improvement and our Q4 RTMs were up 10%. Now there remain question marks on the economy as we move into 2024. We’re expecting a continued improvement as the year progresses and Ghislain will give you more details on all of our assumptions. But beyond the lift from a strengthening economy, we’re also working our growth initiatives that leverage our network, our strong service, and our customer and supply chain partnerships.

And these are starting to bear fruit and in some cases more quickly than we planned. Doug will give you some color on this and you’ll hear Pat and Derek review the state of our operations and we’re ready for the volumes to start to lift. This gives me the confidence in our EPS guidance of approximately 10% growth over 2023. I’ll now hand it over to the team to fill out the details. Pat, you’re up.

Patrick Whitehead: [Foreign Language] It’s great to be on the call today. I’ll begin with safety. In the fourth quarter, our injury frequency ratio was down 14% and our accident rate was down 29%. These results capped a solid full-year performance, demonstrating our progress toward a commitment-based safety culture. For the full year, injury frequency ratio improved 13% and the accident rate improved 17%. This represents a record-low year for injuries at CN, but we know we can and that we must do better. I’m proud of the positive strides we’re making on our safety metrics, but this is a journey and we won’t be satisfied until all employees go home safely at the end of every shift. We are focused on our vision of a workplace that is free of accidents and injuries.

We are committed to working as a team across all crafts and departments to achieve this vision. Training and development, technology, and behavior-based safety activities are essential to enhancing our safety culture. One of the keys supporting better safety outcomes is running a more predictable operation. Predictability is what underpins our velocity and our resiliency. CN’s scheduled operating model has delivered seven consecutive quarters of operational and service excellence. Now, as we’ve said, the plan is dynamic and needs to adjust to our traffic. So with volumes rising, we have been refining our train package. For example, we added a train start out of Prince Rupert and we adjusted the Vancouver train plan to accommodate an uptick of volume in this corridor.

Departing and arriving trains on time, what we call launch and land, continued to be a key focus of both the network operations and field teams. These are the basics of scheduled railroading. Fourth quarter origin train performance remained solid and in line with prior quarters at around 90%, right where we needed to be to ensure on-time train meets. Q4 destination train performance was 70%, and we know there’s room for improvement here by continuing to reduce our train meet delays and making timely crew swaps at intermediate terminals. I’m pleased with how the network and field teams have managed the complexity to crew scheduling introduced by the new Canadian Work/Rest Rules. We continue to learn and adjust train schedules to adapt to this new requirement.

Now you’re going to hear more from Doug on volumes, but my team is getting ready for the business, making sure we have the right resources in place. We have a number of capital projects that will enable short-term operating efficiency and unlock long-term growth across the core mainline from the West Coast to Chicago. In 2024, we are investing in additional double track along our Vancouver to Chicago corridors, with projects on our Edson Sub and on the former EJ&E around Chicago. We continue to invest in rolling stock. The locomotive modification program is well underway and we are renewing a number of our car fleets. Our training campuses were very busy in 2023. We qualified 900 plus new conductors to cover attrition and meet the requirements of the Work/Rest changes in Canada and we’re now ramping up to align with our growth forecast.

So overall, from a resource perspective, we are poised to meet the forecasted demand and grow with our customers. I’ll now pass it to my good friend Derek to talk about how the team executed in the fourth quarter.

Derek Taylor: Thanks, Pat, and good afternoon, everyone. The team finished the last quarter of 2023 with strong operational momentum and we started the New Year with a very fluid network. While we benefited from unseasonably mild weather and no major disruptions in the fourth quarter, I give full credit to the team for remaining focused and continuing to deliver excellent customer service. Finishing with positive momentum was key because, over the last two weeks, we’ve had more seasonal weather across the network with frigid temperatures, significant snow, and blizzard conditions. As we said before our Make The Plan, Run The Plan approach is not just about driving velocity and reliability, it also builds an operational resiliency allowing us to bounce back quicker after this kind of disruption.

We’re talking days instead of weeks. I’ll now cover-off some of the key operating metrics. Starting with car velocity, what we view as the all-in metric of how well the railway is running, it averaged 215 miles per day in Q4. That is up 4% versus last year in one of our best Q4s ever. Importantly, we maintained this level of velocity right up to the end of the year, even as volumes were ramping up. Through dwell of 6.9 hours was a 4% improvement over last year. This is even more impressive given our traffic mix had less intermodal volume this year, which we know typically does not sit in a terminal for very long. Continued focus on terminal throughput and collaboration between yards and the operation centers enabled this further improvement.

To give you a bit more color on our solid operating performance, network train speed of 19.6 miles per hour for Q4 is flat versus last year, but improved 5% on a full-year basis to 19.8 miles per hour versus 18.9 in 2022. Doug will talk about the customers perspective of our service in a minute, but the metric I keep a close eye on is our local service commitment performance or LSCP. This means getting the customers the right cars on the right day and in the right service window. Our fourth quarter LSCP was nearing all-time highs. I am confident the team will continue to execute and keep it at or above our 90% goal as we go through 2024. Incremental metric improvement is a continuous journey, looking for every gain we can through process and execution.

The team is always looking for any types of operational efficiencies in everything they do. Some of our recent performance, as Ed used to say, has hit the sweet spot for this network. Our focus is to have balance in our metrics, not focus solely on one to the detriment of the other and always being mindful of cost versus benefits. Now, I will turn it over to Doug.

Doug MacDonald: Thanks, Derek. Tracy already touched on the transition later this year with Remi, who is out in the field getting his boots dirty and seeing the operations up close. I got to hand it to Derek and Pat and the whole operating team who continue to deliver top-notch service. The feedback from customers is that we’re continuing to hit the right spot and make adjustments where needed. We continue to deliver core pricing ahead of CN cost inflation. Turning to slide 11 now, fourth quarter revenues were down 2% versus last year on lower intermodal storage fees and a lower applicable fuel surcharge, partially offset by volumes and solid same-store pricing. RTMs, which we view as the best measure of volume were up 2% in the quarter, driven by record potash movements, strong propane, Canadian met coal exports, and refined petroleum products.

We’ve seen sequential volume improvement since we hit the trowel in July, as we said on our last call. P&C volumes were up 12% in the quarter, with the exception of crude oil, all segments were up on a year-over-year basis. We are handling record propane exports and in line with the CN specific growth initiative laid out at Investor Day. We also saw increased gas and diesel shipments out of Alberta and a modest recovery for chemicals and plastics feedstocks. Metals and minerals RTMs were up 3% with positive growth across all segments, including frac sand, scrap steel, and aluminum except for iron ore where cars were up and RTMs were down due to a shift back to more short-haul domestic shipments. To finish off on merchandise, forest products volumes were down 5%, driven by softer market conditions.

For bulk starting with fertilizers, RTMs were up 85%. We handled incremental domestic and record potash exports using our available capacity in the Eastern and Southern regions. Coal was up 1%, with Canadian coal up 5%, due to strong export met coal from Northern BC and US coal down 9% due to an operational issue at one of our customers’ mines. Canadian grain shippers did not use all of the available supply chain capacity in Q4. Weaker global commodity pricing led to a holdback in grain, shifting volumes into H1 2024. Our Q4 US grain exports were tempered by lower demand in China and increased global supply. Automotive RTMs were up 22%, continuing the strong trend that started in early 2023 with dealer inventory restocking. Turning to intermodal, international was down 11%, mainly due to the lingering effect of the port strike, particularly for Prince Rupert traffic.

However imports at both West Coast ports return to pre-ILWU strike levels by December. We are encouraged by the sequential uptick in volumes in the fourth quarter and with our ongoing discussions with steamship line customers. Domestic was down 3%, mainly in our retail segment. Our efforts in the CN-specific initiatives like Falcon and EMP produced volumes, mitigating some of the overall market softness. Moving to the outlook on slide 12. As Tracy said, we will benefit from a more favorable economy, but more importantly, our CN-specific growth initiatives are starting to deliver. We see lumber and panels coming back gradually in 2024. There is optimism in the economy about interest rates coming down, which should help stimulate new construction permits, and there is still a shortage of approximately 6 million homes in the US.

We project more frac sand and LPG shipments due to increased drilling in Northeast BC and this will be supported by the new siding near Fort St. John as mentioned in our Investor Day initiatives. In 2023, crude shipments were at an almost five-year low, but driven — given the forecast for Canadian crude production along with the delay in the start-up of the TransMountain pipeline, we see opportunities to handle incremental crude business in 2024. The CN Fuels facility in our MacMillan yard will begin wet commissioning this month and will start producing carloads and ramping up through Q1. We have now sold out capacity in Phase 2 of this project and construction is underway. For potash exports, we expect to see a year-over-year headwind starting in Q1 related to the business we picked up in 2023, while the Portland terminal was down.

We continue to get strong rateable volumes with our premium service and utilizing our available capacity in Eastern Canada. In Canadian coal, we have met coal production capacity coming online in the back half of the year related to the new Valerie mine and the Quintet restart in Q4. As mentioned earlier, this year’s Canadian harvest is down versus last year, but we are expecting a normal crop for the 2024-’25 crop year and a better Q4 than what we just saw. Recall that this year’s inflation index for regulated grain movements is 12% and will receive our 2024-2025 pricing determination in the spring. US grain will benefit from the acquisition of the IANR pending STB approval, which we anticipate being completed sometime by next fall. We are projecting automotive demand to remain strong and volumes was roughly on par with 2023, even with some outages related to retooling for EV production.

For international intermodal, we continue to work on filling up Prince Rupert and building on recent momentum in Vancouver. We also expect growth in our southern ports in the Gulf, driven by new service offerings into the Midwest. Overall, we see a gradual return to pre-COVID volume levels over the next few quarters. Domestic growth will come from our new interline partnerships specifically targeting truck volumes. We have capacity on the network, in our terminals, and with our fleet to grow volumes as the economy improves. In summary, we’ve rotated through some of the headwinds, which challenged us in 2023. We have good momentum CN’s customer service is excellent and our CN-specific growth projects are delivering. With that, I’ll pass it over to Ghislain and go through the numbers.

Ghislain Houle: [Foreign Language] Turning to slide 14, volumes in terms of RTMs were higher by 2% on a year-over-year basis, while our revenues were down roughly 2%. We delivered operating income of around $1.8 billion, 5% lower than last year, with an operating ratio of 59.3%, a 140 basis points higher than last year. We had two non-recurring items below the line. During the quarter, we implemented a tax reorganization that produced around $700 million of one-time income. As a consequence of this, our overall tax status both in Canada and in the US has not materially changed and our effective tax rate for 2024 will be approximately 25%. So about 50 basis points higher than in 2023. Cash taxes will be around 80% of our overall effective tax, which is in line with prior years.

We also monetize a surplus right of way in Ontario, amounting to approximately $130 million. On a reported basis, EPS was $3.29, up 57% versus last year. However, excluding these one-time items, adjusted EPS was $2.02, down 4% year-over-year. In terms of expenses, labor was 12% higher versus last year, driven by 5% higher average headcount and general wage increases. Fuel expense was more than $100 million lower than in the same period last year, mostly due to a 17% decrease in fuel prices. Turning to our full year results on slide 15, we delivered an adjusted EPS of 2% lower than last year, which is aligned with our revised guidance. Our full year operating ratio of 60.8% was up 90 basis points versus last year on an adjusted basis. Despite significant disruptions in Q2 and Q3 from forest fires, flooding, and the West Coast ports strike that negatively impacted EPS by roughly $0.17.

We generated close to $3.9 billion of free cash flow for the year. Disciplined capital expenditures of $3.1 billion, excluding capital recoverable from customers represents around 18.5% of revenues. We are investing in our rail car fleet and continue to invest steadily in track maintenance as well as capacity expansions, time with our customers’ volumes, and always with a view to capital efficiency. ROIC, which is highly sensitive to the income numerator came in slightly under 15% [Technical Difficulty]. Moving to slide 16, let me provide some visibility to 2024. We believe the economy for the year will be more constructive than in 2023, with slightly positive industrial production growth and interest rate stabilizing. In addition, consensus opinion on the risk of an economic recession appears to have diminished.

However, the environment remains quite volatile with continued monetary policy and geopolitical risk. Weak sectors particularly intermodal, international, and forest products, continue to improve sequentially and should stabilize to pre-pandemic levels. We assume that Canadian grain will come back to a three-year average in the second half of the year. With this in mind, and along with our CN-specific growth initiatives, we expect volumes in terms of RTMs to be in the mid-single-digit range. As volumes come back, we should see the positive impact of our operating leverage, particularly with merchandise business where we currently have capacity on our trains and can bring in — on volumes at low incremental costs. However, we have roughly $200 million in cost headwinds, mostly related to depreciation, incentive compensation, and pension.

We assume foreign exchange for the year of around $0.75 and WTI of US$70 to US$80 per barrel. In this environment, we expect to deliver about 10% EPS growth in 2024 versus 2023. Our CapEx for 2024 will be around $3.5 billion net of customer contributions and we expect ROIC to be 15% to 17% within the targeted range provided at our Investor Day. In terms of shareholder distributions, we’re pleased to announce that our Board of Directors approved a 7% dividend increase for 2024. This represents the 28th consecutive year of dividend increase since the 1995 IPO. The Board also approved a new share buyback program of up to 32 million shares for an amount in the range of $4 billion through a normal course issuer bid from February 1st, 2024, to January 31st, 2025, in line with our previous program’s budget before we opportunistically increased it last October.

In conclusion, let me reiterate a few points. We have delivered seven consecutive quarters of exceptional operating performance. We are providing excellent customer service. We have managed through significant external challenges to deliver strong relative financial performance. Although we remain mindful of ongoing economic and geopolitical volatility, we are calling for some recovery in 2024. In particular, we expect intermodal, international to return to pre-COVID levels and forest products to gradually ramp up over the next 18 months. Our pivot to growth is underway, and assuming a positive economic backdrop we are guiding for EPS growth of around 10% versus 2023, underpinned by mid-single-digit volume growth. We have a strong balance sheet and we plan on using that financial flexibility to take advantage of opportunities.

Let me pass it back to Tracy.

Tracy Robinson: Thanks, Ghislain, and well said. Operator, we’ll now go to questions.

Operator: Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question will come from Chris Wetherbee from Citi. Please go ahead. Your line is open.

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Q&A Session

Christian Wetherbee: Hey, thanks. Good afternoon. Maybe starting on the ’24 guide, if you could maybe unpack some of the moving parts a little bit, so RTM guide mid-single-digits. And then I think, Ghislain, you talked about maybe $200 million of some cost headwinds there. You have about 5% coming below the line. So I just want to make sure I understand sort of the operating leverage of the business, is it mostly offset by the $200 million or maybe we can kind of think about how you should be able to generate incremental margins on that mid-single-digit RTM growth?

Tracy Robinson: Okay, Chris, this is Tracy. Let me take a shot at this. So we’ve got a forecast of 10% EPS and on volume as you’ve noted, the forecast assumes a gentle kind of recovery economically as we go through the year, but it also assumes those customer-specific growth initiatives that you heard Doug talk about. On margin, as volumes come back, we should see the positive impact of our operating leverage. So as volumes went down, we saw it go down. As volumes come back up, we’re going to lift, especially in the merchandise business, where we currently have capacity on our trains. And of course in the pricing environment, you know, as you’ve watched us over the last 18 months, we continue to both deliver and we continue to expect pricing above rail inflation. So that’s all positive news. We do have the headwinds that Ghislain talked about, but that’s going to be offset to the extent that will drive the 10% to the bottom line. Does that make sense?

Christian Wetherbee: It does. So just a way to think about it is there still is the sort of normal operating leverage on the revenue growth mostly offset by that — by those incremental costs that kind of gets you to kind of core growth before the buyback in line with RTM growth. Is that roughly the right way to think about it?

Tracy Robinson: Yeah. You got it, pretty much. Thanks. Next?

Christian Wetherbee: Okay. Thank you.

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

Cherilyn Radbourne: Thanks very much. Good afternoon. Just wanted to dig in a little bit in terms of international intermodal. And you did mention that the Canadian West Coast market share was back to pre-strike levels in December. Just curious, given what we’re seeing in the Red Sea and on the Panama Canal. Just be curious whether you’re seeing inquiries at this point that could be incremental to that market share and how likely those volumes might be to be sticky.

Doug MacDonald: Thanks, Cherilyn. It’s Doug. No, it’s a great question. It’s obviously an ever-changing environment out there. So we spent a lot of time talking with customers about it. We are seeing obviously some capacity come out of the vessel market with them having to go around Africa now. So we see some tightening overall. And with that, we’re starting to hear with different problems at both the Panama and the Suez Canal that the West Coast is looking like a more viable option moving forward. We haven’t seen those volumes come in yet, but we’re expecting them to gradually ramp up if they do come forward, but so far so good. We’ve actually just been able to maintain our pre-COVID levels now for the last, I’ll say almost eight weeks, and we see that continuing on, moving forward on both Prince Rupert and Vancouver.

Cherilyn Radbourne: That’s my one. Thank you.

Doug MacDonald: Thank you.

Operator: Our next question comes from Ken Hoexter from Bank of America. Please go ahead. Your line is open.

Ken Hoexter: Great. Hey, good afternoon. Tracy, you’re just saying, I guess, in the EPS target of 10%, you’re looking at long-term going up to 10% to 15%. Just want to understand the acceleration, you talked about hiring, I guess, pre-hiring employees. Are you saying you’re pre-resourced now because of the work rule changes or are you going to accelerate the hiring? I just want to understand the cost implications versus your growth targets? Thanks.

Tracy Robinson: I’ll start at that one, Ken. So we’ve been hiring through the year to offset attrition, and two, that’s the lever we’re using right now to manage our workforce size is hiring relative to attrition. And as we look forward, you’ll see our hiring ramp up to match the volumes as we see them coming back. We’ve got a great line of sight on a number of the areas. Doug kind of took you through them, and so we’re getting ready for those.

Operator: Our next question will come from Scott Group from Wolfe Research. Please go ahead. Your line is open.

Scott Group: Hey, thanks. Good afternoon. So, when you talk about price above inflation, I’m just wondering, do you see that spread widening or moderating this year? And then just near term, any way to quantify the weather impact we’re seeing in Q1? And then any update you can give us on the labor front just with the conductors in Canada? Thank you.

Tracy Robinson: Sounded like an awful lot of questions, but I’m going to take a quick run over them, if I can remember them, and the guys can come in behind me, but we want one question. The first one was on price. So, I mean, I think it depends, clearly, it’s not as a — is a little tighter pricing environment than we’ve seen in the past, but we have for the guys have given Doug a pretty solid customer service product to sell. And so we are achieving pricing we continue to achieve pricing that’s above inflation. The margin above inflation is going to be different in different commodities in different areas, but we see no reason to believe that, that’s not going to continue. What was the next one?

Doug MacDonald: It’s on the weather.

Patrick Whitehead: The winter weather and I can take that one. So we had a very cold snap of minus 40 to minus 50 Celsius for about a week. We did see some disruption during that period of time as we had difficulty moving throughout that period. But I will say this to speak to the strength, the resiliency of our disciplined scheduled operating plan. Just as we saw as we recovered from the ILWU strike, the wildfires, and the flooding last year in 2023. The way we run the network and we’re always working back to the plan, but that’s our North Star. We were able to get our legs back under us, get the operation moving again, and we’re regaining our momentum, getting our speed and our velocity back. Metrics are improving already.