Canadian Pacific Railway Limited (NYSE:CP) Q4 2023 Earnings Call Transcript

Canadian Pacific Railway Limited (NYSE:CP) Q4 2023 Earnings Call Transcript January 30, 2024

Canadian Pacific Railway Limited beats earnings expectations. Reported EPS is $0.88, expectations were $0.83. Canadian Pacific Railway Limited 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 James, and I will be your conference operator today. At this time, I would like to welcome everyone to CPKC’s Fourth Quarter and Full Year 2023 Conference Call. The slides accompanying today’s call are available at investor.cpkcr.com. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] I would now like to introduce Chris De Bruyn, Vice President, Capital Markets, to begin the conference.

Chris de Bruyn: Thank you, James. Good afternoon, everyone, and thank you for joining us today. Before we begin, I want to remind you this presentation contains forward-looking information. Actual results may differ materially. The risks, uncertainties, and other factors that could influence actual results are described on Slide 2, and in the press release, filed with Canadian and US regulators. This presentation also contains non-GAAP measures outlined on Slide 3. Please note, in addition to our regular quarterly financials, there is supplemental Q4 and full year combined revenue and operating performance data available at investor.cpkcr.com, which some of today’ discussion will focus on. With me here today is Keith Creel, President and Chief Executive Officer; Nadeem Velani, our Executive Vice President and Chief Financial Officer; John Brooks, our Executive Vice President and Chief Marketing Officer and Mark Redd, our Executive Vice President and Chief Operating Officer.

The formal remarks will be followed by Q&A. In the interest of time, we would appreciate if you limit your questions to one. It is now my pleasure to introduce our President and CEO, Mr. Keith Creel.

Keith Creel: Hi. Thanks Chris and thanks, everyone, for joining us today. Give us a chance of the team to share our fourth quarter results as well as our view for this exciting year ahead in 2024 that we have to create value for our shareholders, for our customers and our CPKC family. So with that, we will speak to the results. For the quarter, this team delivered revenues of $3.8 billion, which is up 4% of volume growth of 4%, an operating ratio that represents 220 basis points of improvement versus last year to 58.7%, core EPS of $1.18 also up 4% versus last year. And for the full year, revenues $13.9 billion, up 5%, volume growth of 1%, a very unique industry story, an operating ratio of 62%, core EPS of 3.84% and up 2% versus last year.

So, standalone certainly unique and impressive results, even more so when you think about this is a railroaders in the early stages of an integration working against the challenging macro environment all at the same time. So, here we are 10 months into of fair of story of CPKC and I’m telling I’m extremely proud of the progress this team has made across the organization, meet operationally, sales and marketing, finance, and all areas of the business. This is a team that’s committed to creating value. As we said we were doing exactly what we said we would do. And I can tell you a tremendous amount of work went into preparing for this merger for this combination and even more so has gone into executing it. This leaders, I believe this, we’re not here to sustained performance of here to leave it better.

We’re here to make an impact to improve the product. And that’s exactly what this team has been doing for the last 10 months. We’ve launched new services market solutions across the industry that this transaction has uniquely enabled, be it our 180/181 service, our Mexico Midwest Express, which is the gold standard in the industry in spite of what anybody else might say, trying to imitate it. It’s best-in-class delivering fast reliable, single-line service across a very fluid and always open border. The closed-looped service solution for the automotive industry that provides a differentiated level of service and reliability that the OEMs are embracing and recognize the value that, that creates in the reliable supply chains. Connecting origins destinations of ECP and CE forest products, again, with a unique single line service across three all nations.

We’ve made gains in operating efficiency service, reduced assets, we’ve increased velocity, we’ve reduced dwell, we’ve eliminated handles. We’ve also made strong progress, I’m very pleased to say, on the labor side. On the US side, we’ve expanded our very unique hourly agreements, which I believe gives us a unique competitive advantage not only to serve our customers, but also to attract to retain the best railroad and talent in the industry. And in Mexico, establishing trust and respect with our one union that’s there working towards agreements that not only improves service, but also benefit the employees. So, it’s truly a win-win for Mexico, for employees, as well as our customers that utilize our service. Also through the year, while we’re doing all of that, we’ve continued progress on our Hydrogen Locomotive program.

We’ve now got two low-horsepower hydrogen locomotives that are servicing customers every day in Calgary come rain, come shine, come snow, we’re producing the zero emissions Calgary customers in that market as well as we fabricated our first high-horsepower locomotive, which we completed late last year, which completed its first test movement. We’ll be putting that into service later this year in a closed-loop with the [Indiscernible] cycling coal between the coal mines of British Colombia and the [Indiscernible] in British Colombia in partnership with our largest customer tech coal creating a green corridor. And above all that, while we’re doing that, most importantly, we’ve improved and continue to make vast improvements in our safety performance as a combined company, building upon CP’s long history of industry-leading safety performance.

So, all of that to say, we’ve entered 2024 in a position of strength, industry-leading results, and we’re going to continue to build upon that. Mother Nature has humbled us a bit in the first month. That said, it’s a challenge. It’s not an excuse. We’re well-positioned to recover. We’ve regained our momentum that we started the year with, and we’re in a great position to continue that through this quarter and into the balance of the year. So, let me close by saying 2023 was a very special year. We brought two great companies together, CP and KCS to create a very unique industry-leading most relevant rail network in CPKC. We’ve connected a continent of the way it has never been done before and I would suggest never to be done again — three continents.

Since the combination took effect in April, we’ve seen a steadily build momentum and I can tell you we’re just getting started. 2024 is shaping up to be an even exciting year than 2023. So, that said, let me hand it over to Mark. I want him to expand, speak to some operational points. John is going to bring of color in the markets, and Nadeem will bring us some of the numbers, and then we’ll open up for questions. So, over to you, Mark.

Mark Redd: All right. So, first of all, thank you, Keith. Good afternoon. I’d like to just, first of all, thank the operating team for their continued hard work in delivering safe, reliable service across this great network. If I think about bringing two networks together, certainly this isn’t easy, and there’s been still a long list of opportunities out there, but I’m pleased with the progress we’re collectively making. Also, I’d like to think this team’s effort of the combined CPKC network as we enter 2024 in a place of strength as Keith noted. But while we’ve been dealt with some weather for the first part of the year, we are well positioned to rebound quickly and have done so. As I look at safety, I would remind and I’d like to recognize the entire team for the tremendous safety results that we’ve had.

I’m extremely proud to say again, 2023, we have the lowest effort of train accident frequency on Class 1 railroad building on the CP 17 consecutive years in the industry. This is an impressive milestone highlights the team’s dedication of excellence while ensuring the seek to remain its top priority. It also showcases the strong commitment of safety of both KCS and CP brought together in this merger. As I look at the operating performance year-over-year for the quarter, the FRA personal injuries landed at 1.10, which is a 15% improvement. The FRA train accident frequency was 1.08, which is a 23% improvement. If I look at locomotive productivity improved 13%, our train speed at 6%, our fuel was 2% better and our average terminal well was down 11%, a strong indicator of how well our network is performing.

As I talk about this, I think about the backdrop of all-time record highs of GTMs 5% year-over-year and 11% sequentially. From a safety perspective, I think about 27 subdivisions and around 2,600 miles of dark territories now protected with CPKC’s broken rail detection system, we’re plan on putting eight more additional subdivisions in 2024. So, I’m looking at the acoustic bearing. We’re looking at an additional five across the network, which just will expand on our detection capabilities. So, looking at our capital projects for the year 2023, we in serviced three new sidings and constructed — will construct five more in 2024. This is all part of the $275 million merger commitment that we have. If I look at the Laredo Bridge, we’re 45% complete at this point, we remain on target to be done by end of the year.

We’re also investing in Capital in Mexico to increase capacity fluidity across the North South corridor between Laredo and San Luis Potosi. All of these projects will support growth, further improvement of the network performance and as I look at 2024, we’ll continue to build the momentum that we’ve generated in this past year in 2023. We continue to work strong with John’s team to provide service and generate industry-leading growth that this network can achieve. And with that, I’ll turn it over to John.

John Brooks: All right. Thank you, Mark and good afternoon, everyone. So, having now wrapped up our third quarter as a combined CPKC I’m as excited as ever I can tell you about the opportunities that sit in front of this company. It’s a unique franchise. The year and quarter ended on a strong note, and we are well positioned to continue delivering differentiated growth in 2024. Now looking at our results. On a combined basis, we had record freight revenue of 4% on 4% RTM growth versus pro forma CPKC a year ago, in line with exactly what we spoke about during our third quarter call. Since our RTM was flat year-over-year with fuel and other freight offsetting a continued strong pricing environment. Now, taking a closer look at our fourth quarter revenue performance, I’ll speak to the FX adjusted results on a comparison versus CPKC had the combination occurred in 2022.

Starting with bulk. Grain revenues were down 3% on a 7% decline in RTMs. Canadian grain volumes were down 15% year-over-year, driven by a weaker harvest for the 2023 2024 crop year, particularly in our CPKC drought territory. Additionally, we saw the Canadian farmer be more price-sensitive and hold on to more of their crop, which added to the weakness in this volume on the quarter. While this was a headwind of closing out 2023, ultimately, this grain will still move and it provides some modest upside into 2024. Now that being said, we will still expect to see weakness year-over-year in Canadian grain to persist until we get to the new crop. US grains were up 3% as we benefited from a solid harvest, steady market demand and growth from synergies as we continue to connect new origination and destination pairs across our new network.

Additionally, we continue to see investment in growth in our 8,500-foot model. By the end of 2024, 60% of our franchise in Canada will be 8,500 foot capable including all of the 8,500-foot elevators that Richardson International is developing across our network. We continue to roll out this model and work with customers down in the US and ultimately down into Mexico to roll out this high-efficiency operating model. Moving on to potash. Revenues were up 16% on 20% volume growth. The volume increase was driven by strong supply chain performance and higher volumes of export potash with Canpotex as we work together to find additional outlets for volume given the Portland terminal outage during the first two quarters — two months of the quarter.

In early December, the Portland terminal came back online and were able to quickly return to a full run rate by the end of the year. We are positioned well for strong potash growth in 2024. And to finish out the bulk business, coal revenue was up 32% on a 33% volume growth driven by favorable compares following last year’s outage at Teck’s Elkview Mine. Now, moving on to the merchandise franchise. ECP revenue grew 6% on 3% volume growth. Refined petroleum products and asphalt grew driven by new market share and growth also within plastics to the Midwest. We will continue to benefit from the new business wins that started up in Q3 and Q4 of last year as some of this growth was muted by a facility outage and a slower ramp-up. With solid demand fundamentals, ongoing ramp of these business wins and continued synergy gains, we are setting up for a strong 2024 in ECP.

In Forest Products, revenues were up 2% on a 1% increase in volumes. Despite a softer demand in our base business in this area, we have seen nice synergy wins in this space as customers take advantage of our new single line haul network connecting new markets. The metals, minerals and consumer products portfolio was up 3% on flat volumes. We continue to see strong growth in steel out of our production facilities across our network, supporting industrial and infrastructure growth across North America. This quarter, however, in this area was offset somewhat by weakness in frac sand to the Bakken and also the Permian Basin as we saw in earlier seasonal downturn and some growth in in-basin sand. Automotive revenues continue to be strong, up 22% and 19% volume growth, another record quarter for our automotive franchise.

Our automotive franchise is benefiting from new business, solid continued production from our OEMs and steady equipment supply driven by improved operations and cycle times, particularly in Mexico. We are pleased with the new agreements we have developed that enable closed-loop service solutions, providing this industry service reliability it has never had in the past. Including the use of our new auto compound in the Dallas Metro area and linking customers’ traffic between the US, Canada and Mexico via our single-line haul service. For automotive, 2024 is positioned to be an exciting year as we see a path to a record volume on our franchise. On the intermodal side, revenue was down 11% on flat volumes. Domestic intermodal continues to be challenged by lower retail volumes, ample truck capacity and some general market softness.

Now our MMX180/181 that Keith spoke to, cross-border service continues to perform very well. This is truck-like service with a safe, reliable border crossing between Mexico and the US. You saw growth in this service in the fourth quarter, particularly across our North Long volumes. While the base demand in domestic intermodal is something that myself and my team are watching closely, particularly across Canada, the opportunity for cross-border intermodal will continue to see steady synergy growth from over-the-road conversion and new customer solutions as we move throughout the year. As part of those new solutions, I’ll remind you, we are very excited to break ground in February on the new Americold facility co-located in our intermodal terminal in Kansas City.

This partnership with Americold is another step in creating new rail options for shippers in a market that is dominated by trucks. Moving over to International Intermodal. After a challenging third quarter, this business has picked back up. We ended the quarter with volumes up 2%. Although, we remain cautious on our outlook for 2024 in this space, we are certainly encouraged by the recent trends. We’re also encouraged about the progress we are making in support of Lázaro Cárdenas. In 2023, the terminal saw TEU growth of 30% of while CPKC’s volumes grew by 35% versus 2022. Our customers are enthusiastic as we continue to develop this service and educate them on this supply chain alternatives. When you combined this with our 50% ownership in the Panama Canal railroad, we are excited about the unique solution CPKC can offer ocean carriers and their beneficial cargo owners.

In closing, despite some early weather challenges in January, we are entering the year with strong momentum. While we have a known headwind from Canadian grain and the macro backdrop remains uncertain, we have strong line of sight to remain uniquely positioned to deliver long-term growth. Our synergies in 2024, combined with base self-help initiatives and a disciplined pricing approach will continue to be an exciting story and differentiator for us in this industry. So, with that, I’ll stop, and I’ll pass it over to Nadeem.

Nadeem Velani: Great. Thanks, John and good afternoon. So first, I’d like to thank the CPKC family of railroaders for working tirelessly throughout the year to bring our two companies together. 2023 was truly historic, and I’m extremely proud of the hard work and dedication of the team has displayed. Looking at the quarter, CPKC’s reported operating ratio was 61.8%, and the core adjusted operating ratio led the industry for the second quarter in a row coming in at 58.7%, which was a 220 basis point improvement versus Q4 of 2022. Earnings per share was $1.10 and core adjusted combined earnings per share was $1.18, up 4%, which was also industry bets on the quarter. On a full year basis, CPKC’s reported operating ratio was 65% and the core adjusted combined operating ratio came in at 62%.

Earnings per share was $4.21 and core adjusted combined earnings per share was $3.84, up 2% year-over-year. Now taking a closer look at our income statement, reported operating expenses for Q4 and full year are provided on Slide 14. Combined operating expenses for the Q4 are on Slide 15. Similar to what we shared last quarter, our combined operating expenses illustrates the estimated effects of the acquisition for the fourth quarter is that the acquisition closed on January 1, 2022, and I will only speak to FX adjusted fourth quarter operating results in these prepared remarks. We’ve included full year results in the appendix for records. We’ll star with comp and benefits, its expense was $637 million, up 2% when compared to combined comp and benefits expense a year ago.

This includes $7 million of integration-related expenses. The increase was driven primarily by wage inflation, increased incentive comp and higher volumes. Average headcount was down slightly sequentially in Q4. Looking to 2024, we expect headcount growth to be below volume growth on a year-over-year basis. Partially offsetting the increase with lower current service costs in the DB pension plan resulting from higher discount rates and lower stock-based comp. Looking at 2024, we expect to have a $16 million headwind resulting from lower discount rates, which is more than offset below the line. Fuel expense was down 8% year-over-year. The decline was primarily driven by a 10% decline in combined fuel price, along with a 2% improvement in fuel efficiency that Mark mentioned, partially offset by a 5% increase in GTMs year-over-year.

Materials expense was down 9%. The decline was largely driven by reduced locomotive maintenance material expense. Equipment rents was $76 million, down 1%, improvements in efficiency and an increase in receivables drove the improvement. This is partially offset by an increase from inflation and lower use of CPKC intermodal equipment by other roads. Depreciation and amortization expense was up 6%, resulting from a higher asset base. Purchased services and other was relatively flat year-over-year, a reduction of casualty expense and gains and efficiencies were offset by volume-related increases in inflation. Before moving below the line, I’ll make a couple of comments on inflation. This past year, we were not able to reprice our entire book to offset the impact of inflation on our cost structure, which created a headwind to OR throughout 2023.

As we move into 2024, the impact of inflation on our expenses is moderating. Additionally, the pricing environment remains strong, and we will reprice a portion of our contracts that did not renew during the period of higher cost inflation in 2022 and 2023. Putting these together, we should see some catch-up in a tailwind to OR in 2024 from inflation dynamic. Moving below the line, Other expense was up $12 million in the fourth quarter. Other components of net periodic benefit recovery decreased $34 million, reflecting higher discount rates, compared to 2022. We expect this line to increase by approximately $23 million in 2024, from $327 million in 2023, offsetting the headwind in comp and benefits from the current service cost. Net increase in — net interest expense of $206 million or $200 million on an adjusted basis, the decline was driven by a reduced debt balance.

On the quarter, income tax expense of $275 million and $354 million on a core adjusted combined basis. Looking ahead to 2024 expect CPKC’s core adjusted combined effective tax rate to be approximately 25%. Turning to Slide 17, we continue to generate strong cash flow with cash provided by operating activities of $1.3 billion in Q4. Our first call on capital continues to be the business and growth. And in the quarter, we reinvested just over $700 million in the year, in line with our outlook to invest $2.7 billion of capital on a combined basis. Looking at 2024, we will remain disciplined in our approach to capital allocation and we expect capital spend to be $2.75 billion for the year. This reinvestment in the business builds off of record capital investment as a combined company in 2023 and our network is well-positioned from a capacity perspective to absorb the growth that we have in front of us this year.

We generated $785 million in adjusted combined free cash flow on the quarter is just under $2.2 billion in 2023. Our adjusted combined leverage was 3.4 times to end of the year on our path back to our target leverage of 2.5 times. We expect to reach this target late-2024 or early-2025, at which point we will evaluate shareholder returns with our Board. Looking ahead, despite a known headwind in grain, as John mentioned and is still somewhat uncertain macro, we expect to deliver double-digit core adjusted combined earnings growth from the core business in 2024. We also anticipate generating strong free cash flow, while making record investments in the network to sustain future growth and getting back to our target leverage. Putting all of this together, CPKC offers a truly differentiated investment profile.

And I’m excited to continue delivering on the commitments that we have made to our shareholders. Looking back, we ended 2023 with strong momentum, advanced in industry earnings results as the best yet to come. The network is performing well. Synergies are ramping, and we are well positioned for a strong 2024. It’s an exciting time to be railroading at CPKC. With that, let me turn it back over to Keith.

Keith Creel: Okay. Thanks, gentlemen. Operator, let’s open up the line for questions.

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Q&A Session

Operator: Thank you. [Operator instructions] We’ll take our first question from Walter Spracklin, RBC Capital Markets.

Walter Spracklin: Thanks very much, operator. Good afternoon, everyone. So, on the double-digit earnings growth, I know, Nadeem when you — that’s consistent with what you provided at Investor Day, there in July. And I’m just — I know during — later in the session in — at that day, you kind of gave us an indication into a doubling of your earnings growth by the end of that multiyear period, suggesting kind of a mid-teen of EPS growth in the early year and then perhaps ramping once you’re able to kick in the buyback. Is that still the case that in the early year here in the year one the mid-teen cadence is still holding and then ramping after that or have conditions changed that would cause you to change that overall view?

Nadeem Velani: Well, since we gave our guidance of June Walter, nothing has changed other than I’d point out that we had a grain crop that came in maybe a bit weaker, starting in the grain crop starting in August. So, that’s going to hurt us near-term a little bit probably Q2 of this year. Other than that, the model remains the same. We’re going to support the business with base organic growth. We’re going to have the benefits of synergies, since we’re ahead of schedule on. And then we’re going to see continued margin improvement and then the benefit in the outer years of share buybacks and shareholder returns. So, nothing has changed on that thesis. We’ve guided to double-digit for this year. We’re obviously not going to get a benefit from buybacks in any fashion.

We’re not going to buy back stock until we get our target leverage back. So, that’s going to hurt us compared to the other years of that five-year outlook. But that’s the only changes. I’d say that the macro environment is probably a little bit weaker still in terms of the mobile side that John mentioned. But other than that, we’re right on track, right on our plan of that guidance we gave you.

Walter Spracklin: Okay, I’ll keep it to one. Thanks very much.

Nadeem Velani: Thanks Walter.

Operator: Our next question will come from Tom Wadewitz with UBS.

Tom Wadewitz: Great, thanks. Good afternoon. Wanted to see if you could give a little bit of a perspective on what’s underneath the earnings guidance just in terms of how are you thinking about RTM growth? Do you think of like mid-single digits? What — kind of what ballpark should we be in? And then how do you think about the magnitude of improvement in operating ratio that did would fit into a base case? Thank you.

Keith Creel: No, Tom, that’s a great question. I’ll tell you this. This is what we’re expecting. Most single-digit RTM growth, double-digit EPS in margin improvement. Now, tell me what the back half of the year looks like, tell me what the macro is going to do, we’ve taken, I believe, an appropriate conservative approach in the back half surprises and some of those weaknesses that Nadeem spoke of be it domestic, be it a normalized grain crop, or maybe a little bit better, then there’s some upside there. But we’ve taken a modest approach of responsible, reasonable, conservative approach, and we expect to hit these results. And again, if we get a couple of things that might turn our way then we certainly have an opportunity to exceed them.

Tom Wadewitz: Okay, great. Thank you.

Operator: Our next question will come from Fadi Chamoun with BMO.

Fadi Chamoun: Yes. Good evening. Thank you. At the June Analyst Day, you indicated you had $240 million of kind of actual annualized revenue synergies and you suggested you had a pipeline line of sight to $950 million. I’m just wondering like as we stand today, what does it look like? And how do you feel about the pipeline of 2024 in terms of the revenue synergies?

John Brooks: Hey Fadi it’s John. So, as I said, I feel really good. I think we made great progress in in the first 10 months. I can tell you, we’ve got some contracts and some wins in 2023 that we haven’t realized yet. We’re just starting to ramp up and I think we’re going to see a progression with those. I still think we tail on the 180/181 product as we move through 2024. And hopefully, we see some of the domestic intermodal trends, macro trends, maybe moving our favor a little bit. And honestly, that includes the Lázaro also. It’s been quite an educating process with the steamship lines and beneficial cargo owners around what that port potentially could do. To be honest, I’d hope that’d be a quicker startup, but we are starting to gain some traction there.

So I think we guided to — we mentioned CAD 350 million we saw as a we were very comfortable we’re on that pace. I would tell you right now that we’ve slightly exceeded that we’re ahead of that. And well on the way to those numbers we talked about at Investor Day.

Fadi Chamoun: Thank you.

John Brooks: Thanks Fadi.

Operator: Our next question will come from Chris Wetherbee with Citi.

Chris Wetherbee: Thanks. Good afternoon. Maybe a question on pricing. So, you guys noted that there’s a little bit of catch-up going on in 2024 in terms of some of the contracts. You didn’t get a shot at over the last couple of years, and you have moderating inflation, that’s a little bit different than what we’ve heard from some of the players in the space, particularly some of the US names. So, maybe if you could just put a little bit of color around sort of the pricing environment that you’re seeing and is this sort of upside opportunity in the US versus Canada, if there’s any sort of difference there kind of what the contract renewals are coming in and around?

John Brooks: Yes, Chris. John. A couple of thoughts on that. One is, I’ll tell you, Q3 and Q4 were quite strong. Some of the best rail pricing that I’ve seen. And again, I think part of that was through the year, kind of catching up to some of those inflationary numbers. So, we’re going to get a tailwind on that. There’s been a fair amount of repricing. And as we’ve dug into the bulk of the new company, and some of those contracts have rolled over. There’s been opportunities where we felt that we needed to price — reprice some of that book. I’ll remind you, we took control in April of last year. So, a lot of the contracts leading up to that time, KCS standalone have renewed on their own. So, I can tell you, my team is kind of getting a first look at a number of those contracts that rolled over to start this year.

And the results, I think, most importantly, the results in those areas continue, I would say, on the trajectory of what we saw in Q4. So, again, my expectation would be the first half of this year, remain strong on that front, and we’ll see what the back half comes when we get there.

Chris Wetherbee: Great, thanks very much.

Operator: Our next question will come from Steve Hansen with Raymond James.