Canadian National Railway Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
July 25, 2023

There are 19 speakers on the call.

Operator

Afternoon. My name is Emma, and I will be your conference operator today. Welcome to CN's Second Quarter 2023 Financial and Operating Results Conference Call. All participants are in a listen only mode. After the speakers' remarks, there will be a question and answer session.

Operator

I would now like to turn the call over to Stacey Alderson, Interim Assistant Vice President, Investor Relations. Ladies and gentlemen, Ms. Alderson.

Speaker 1

Thank you, Emma. Good afternoon, everyone. Thank you for joining us for Q2 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.

Speaker 1

S. And Canadian securities laws. These statements are subject to risks and uncertainties that may actually cause results to differ materially from those expressed or implied in these statements. They are more fully described in our cautionary statement regarding forward Q2. Joining us on the call today are Tracy Robinson, our President and CEO Doug McDonald, our Chief Marketing Officer Ghislain Hroude, our Chief Financial Officer and Ed Harris, our Chief Operating Officer.

Speaker 1

It is now my pleasure to turn the call over to CN's President and Chief Executive Officer, Tracy Robinson. It has been a couple of months since we saw many of you in Chicago at our Investor Day, and we're continuing to execute the plan we laid out for you then. Running a scheduled operation that moves our assets quickly and services our customers consistently, and this is the central theme, and we're driving our growth initiatives on that foundation. Over the 3 year period we discussed in Chicago and beyond, our path is very clear. The longer term fundamentals remain strong.

Speaker 1

The growth opportunities are real. We continue to progress that growth agenda built on the foundation of strong service driven by disciplined adherence to our plan. Now the immediate term is a little less certain. This team has dealt with a number of external weather related issues over this past few months as well as a West Coast port strike over the last few weeks. As we sit here today, we're also seeing a little bit more weakness on the economic front than we modeled earlier this year.

Speaker 1

Now all of this is temporary, as you know, and our team is doing a great job of managing through it with an eye on the longer term. The heat and the wildfires in parts of both Eastern and Western Canada over the last few months have impacted our operations and the operations of some of our customers, and that's had a temporary impact on volume. And we've seen more generally a softer volume market economically, particularly in some of our commodity segments. I must say, I have been impressed by our team's response. They are managing through this.

Speaker 1

They're staying true to our plan. They're running the plan. And still through all of it, improving year over year velocity, network train speeds, dwell time and customer service. You'll notice this in our operating stats. They've done a great job, and it's a testament not only to the team, but also to the strength of our plan.

Speaker 1

The plan is working. As we look forward, our focus is on continuing to be nimble, adjusting to the softer volumes in the near term and ensuring that we're prepared for the lift. We continue to refine the operating plan to match the volume model. So we're consolidating train starts, we're laying down locomotives and cars where it makes sense. This keeps our network balanced and our assets moving quickly.

Speaker 1

It maintains our service levels and it mitigates cost. And as we said we would do should we find ourselves in this situation, we're adjusting our hiring plans to match what is now a slower expected return of some of our commodity segments. And we're taking the opportunity to advance some locomotive engineer training to ensure that we're ready for the medium and the longer term. And all of these are the right near term actions that mitigate the impact of lower volumes without jeopardizing our ability to respond when the rebound comes, and it will come and we will be ready. This puts our margins under a little bit of pressure right now, but our margin leverage will return with the volume.

Speaker 1

So let's talk about what this all means. Our 2nd quarter EPS of $1.76 is 9% lower than last year on an adjusted basis, and our 60.6 percent operating ratio is 160 basis points higher. Now this is the impact of both the macroeconomic being softer that we anticipated and those challenges presented by the weather events here in Canada. And on the basis of what we saw in the Q2 and are seen in these few weeks in July, we've taken a hard look at our year end outlook, and we're now assuming that the economic recovery is pushed into 2024. So we expect the year over year change in annual adjusted EPS to be flat to slightly negative.

Speaker 1

The team is going to provide you today with more details about our thinking on this. But before I hand it over to them, I want to say a few words about the situation on the Canadian West Coast ports. We are pleased to see an end to the work stoppage, and we're working hard to get those supply chains back in sync. We expect to move most of the volumes that didn't move during the 1st 2 weeks of July over the coming weeks. This event is another reminder that what happens on one part of the supply chain impacts the full supply chain.

Speaker 1

Major disruptions like the ILW strike, the wildfires and now some flooding in Nova Scotia have impacts across the North American supply chain. And it is critical that we respond as an entire supply chain community to minimize the impact and build ongoing confidence in the North America and the global supply chain performance. This is how we approach our work here at CN. I'm proud of this team's ability demonstrated again in this past quarter to respond in a way that minimizes the impact for our customers, for our employees, supply chain partners and the communities in which we operate. So I'll turn it to the team.

Speaker 1

Ed is going to first give us a little more color, Ed, on the state of our operations and how his team has been working to mitigate the impact of these events. Doug will follow-up with an update on the markets and what our customers are

Speaker 2

2nd quarter has been a tough one and I want to acknowledge and thank the entire operations team for all the great work to keep the network running as well as it has this quarter. Tracy just recently mentioned the floods in Nova Scotia. You've no doubt seen the disruptions in the news clips just outside of Halifax. We're working around the clock and I would like to thank especially thank Millbrook First Nations in Nova Scotia for their intention and taking care in feeding our engineering people through this disruption. It's relationships like these that makes railroads run smoother, safer and we hope we do our part for the community as well too.

Speaker 2

So we're going to try to get this track open as quickly as we can and we really appreciate the help they've given us at the worksite. You heard me say this at Investor Day back in May It's important to repeat now. The plan is sacred. We're not going to change how we operate the network in face of weather and volume challenges. Our scheduled operating model is the right model for our network through all economic cycles.

Speaker 2

Turning quarter. To the quarter, car velocity averaged 2 16 miles per day in quarter 2, up 3% year over year, Meaningful improvement considering the challenges I'll talk about in a minute. Remember that we were also lapping the improvement the team started delivering last year. We're not going to take our eyes off of car velocity moving forward, but I'm very happy with that level of speed. Velocity provides fluidity and creates capacity across the network.

Speaker 2

While this was done moving 9% less gross ton miles, it provides an important foundation for the eventual recovery in demand. We continue to see improvements in our origin train performance. I have to give the team a solid A for achieving above 90% in the quarter. We aim to maintain that level of performance going forward. These operating results were achieved despite some unexpected challenges this quarter.

Speaker 2

We had to contend with record wildfires in Eastern and Western Canada portions of the network, which also had an impact on our customers' ability to operate. Necessity is the mother of invention And we've been actively engaged to protect our infrastructure with sprinkler systems deployed on many of our wooden structures in high risk areas. And our Poseidon firefighting train has been deployed since May. For those who may be unfamiliar, the Poseidon concept Transforms a bulkhead flat car into a self contained rail mounted fire suppression system, which stores water from attached tank cars. In fact, we recently made the decision to enhance our fire response by building 2 additional Poseidon trains to better protect our network and support the communities in which we operate.

Speaker 2

We experienced a nearly 800% increase and heat related delay hours in Western Canada with almost 7.50 hours of delay versus 80 last year. Heat slows mean running trains slower than track speed, which impacts network train speed and car velocity. Even requiring a new heat category called extreme heat conditions. And finally, We had an orderly ramp down in traffic moving in and out of the West Coast ports that were affected by the recent work stoppage. It's the right way to prepare for this sort of thing, but it's not without additional cost.

Speaker 2

These events were impactful, but didn't distract us from executing the plan. In this lower volume environment, we took steps to adjust the plan looking at every train start, every local service, every crew start to make sure we operated as efficiently as we could. By June, our intermodal train starts were down 15 And manifest train starts were down about 5% versus the Q1. We did this while maintaining car velocity and maybe some of our best customer service levels. Having said that, a couple of our operating measures including train length, fuel efficiency locomotive utilization took a short term hit because of the softer volumes.

Speaker 2

Fuel efficiency was also impacted by disruptions in the related stops and starts that we had to endure during the worst of the fire. Even when things were changing quickly out there, we need to keep railroading simple. When we focus on running a scheduled operation, it allows us to recover from issues and outages much quicker. Before I hand it over to Doug, I want to say an important word on safety. I know I speak for Tracy and the whole leadership team when I say that safety is of the utmost importance and needs to be at the core of how we operate this railroad.

Speaker 2

We were deeply saddened on April 28 when we lost one of our own. We have made great strides in recent years, but it's all for nothing if we don't all go home safely at the end of the day. With that, I'll pass it on to Doug to discuss top line performance and market outlook.

Speaker 3

Thanks, Ed. I wanted to take a moment to acknowledge the operations and customer service teams. They have been helping our employees, customers and communities affected by the ongoing wildfires in Canada. Throughout the quarter, the teams remained engaged and our customers are saying that CN is providing the best service in the industry. Before turning to the quarter, I'd like to recap the current situations with the wildfires in the ILW strike.

Speaker 3

Ed gave some good color about the impact The wildfires are affected also affected customers, some of whom are forced to take intermittent shutdowns. This mainly affected forest products customers, but also our coal, sulfur, frac sand and NGL customers. Most of the business impacted in Q2 will not be recoverable, but I can say that CN did not lose any market share with customers. Customers are simply shipping less and matching the demand in the economy. For the ILWU strike, there was a minor impact on Q2 results as we took steps to meter flows into the port terminals before the strike began on July 1.

Speaker 3

The strike lasted 13 days plus a 24 hour Wildcat last week. CN's recovery plan kicked into action on July 14. We are running additional trains out of Vancouver and Rupert to clear the backlog and expect it to take up to 8 weeks to be current if all areas of the supply chain work together. 2nd quarter revenues were $4,100,000,000 down 7% versus last year on 8% lower RTMs. We saw a softer than expected demand environment for consumer related products with significant volume step downs in intermodal, both international and domestic as well as forest products.

Speaker 3

In particular, lumber shipments were down with depressed prices and some producers running at cost. As mentioned, the wildfires in Northern Alberta and BC as well as Quebec also impacted Forest Products volumes. Petroleum and Chemicals volumes declined, reflecting lower spot crude business this year and softer demand for chemical feedstocks. Most bulk business lines continue to be strong with RTMs up 12%. Met coal remained solid in the 2nd quarter, But we did lose some trains due to the wildfires.

Speaker 3

Thermal coal volumes were weaker due to lower export demand, but volumes are picking up in Q3 already. U. S. Grain volumes were down year over year reflecting strong U. S.

Speaker 3

Corn and soybean shipments down to the Gulf last year due to the strong export demand. Canadian grain was the bright spot in the quarter with close to 50% more RTMs versus last year. We continue to deliver for our grain customers and to engage closely to optimize the supply chain. In April, The Canadian Transportation Agency announced a 12% pricing index increase for the upcoming 2023, 2024 crop year for CN. We saw positive growth for both domestic and export products in the Q2 due to the optionality of CN's network going to St.

Speaker 3

John. Core pricing remains strong and we continue to price above rail inflation. But notably, we have had 4 intermodal storage revenues this year and that headwind will continue through the back half of twenty twenty three. Let me take this opportunity to update you on our Falcon service. We started the premium service back in May.

Speaker 3

The product is performing well, meeting the posted transit times and in some cases exceeding them and volumes continue to grow. Turning to the outlook on Slide 10. For the remainder of the year, we see continued uncertainty in the economy. Aside from the impact of the strikes, the broader environment for intermodal continues to be challenging. We see improvement being pushed into 2024.

Speaker 3

Pricing for short haul domestic lanes will be under pressure due to the increasingly available truck capacity. Lumber also remains under pressure, but commodity prices have started to pick up. There is still a shortage of about 7,000,000 homes in the U. S. That need to be built.

Speaker 3

Chemicals and petroleum production may be soft for the remainder of the year due to the extended recovery. For Canadian grain, we are now anticipating the 2023, 2024 crop to be in the mid-sixty million tonne range, low last year's 74,000,000 ton crop and we are closely monitoring the moisture levels across the prairies. This revised view will not affect volumes in 2023. We will be running full outcome harvest, but will be a headwind next spring. Canadian coal demand will be retained steady and product should be strong in Q4.

Speaker 3

Automotive should continue to outperform with new import business via Vancouver. To finish, There is no doubt lots of uncertainty right now. What is certain is that we are working closely with our customers, We are committed to providing industry leading service and we will be ready when the economy improves. We remain on track to deliver on our longer term growth plan that we outlined at Investor Day. With that, I'll pass it on to Ghislain.

Speaker 4

I will start to Slide 12 of the presentation, which will provide more visibility on our 2nd quarter performance. As you have heard from Ed, we had strong operating results in the quarter despite challenging conditions, but our financial results reflect demand environment. Altogether, volumes were significantly impacted with 8% lower RTMs on a year over year basis. Let me provide you with more details on the quarter. My comments will reflect adjusted results, which exclude advisory costs related to shareholder matters in the Q2 of 2022.

Speaker 4

We delivered operating income of around $1,600,000,000 10% lower than adjusted operating income last year. Our operating ratio came in at 60.6 percent, up 160 basis points versus the adjusted operating ratio for the same period last year. EPS for the quarter finished at $1.76 9% lower than last year on an adjusted basis. We have estimated the impact of wildfires was unfavorable to EPS by $0.07 and dilutive to the OR by 100 basis points. In terms of expenses, labor was up over $50,000,000 FX adjusted versus last year, mostly due to an 8% higher headcount.

Speaker 4

Given the current environment, we have slowed or in some cases paused higher. Fuel expense was over 200 and a 9% lower workload in terms of GTMs, partly offset by a 6% worsening in fuel efficiency. Shorter trains along with the impact of operational disruptions that Ed and Doug talked about negatively impacted our fuel efficiency performance. Fuel surcharge lag was favorable this quarter. Moving on to slide 13, let me provide some visibility to our revised guidance for 2023.

Speaker 4

Several unforeseen headwinds now inform our view for the full year. First, the 2nd quarter results came in lower than we expected. 2nd, we now anticipate the demand environment to be both weaker and for longer with the recovery in intermodal pushed into next year and forest products weakness continuing into 2024. We are pleased that the port strike is behind us with volume recovery efforts underway and we expect to recover some business, but not all of it. So far in July, volumes on an RTM basis are down about 11% year over year.

Speaker 4

We are therefore revising our full year outlook and now expect to deliver flat to slightly negative EPS growth in 2023 versus our previous guidance of mid single digit growth. This assumes FX at approximately $0.75 and WTI of $0.75 per barrel. We remain committed to shareholder distributions and under our current share repurchase program, we have repurchased over 11,000,000 shares for around 1,800,000,000 dollars. We still expect to deliver on our budget of about $4,000,000,000 for our current program, which runs through January 31, 2024. In conclusion, let me reiterate a few points.

Speaker 4

The team is committed to the scheduled railroad model through all economic cycles, which provides reliable service for our customers. We expect volume to remain soft with a recovery push to 2024. Given our year to date results and the continued weak economic environment, we are now guiding for flat to slightly negative EPS growth for the year. 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.

Speaker 1

Thanks, Jis. And Emma, let's open the line for questions, please.

Operator

The first question comes from the line of Cherilyn Radbourne with TD Cowen. Your line is open.

Speaker 1

Thanks very much and good afternoon. In terms of your latest view that the recovery will be pushed into Q2024. I was just hoping for a bit of color on what you're expecting for the peak season this year and whether your thinking is that the 2024 recovery will be evident prior to or after the Chinese New Year holiday?

Speaker 3

Hi, Charle Ann, it's Doug. Thanks for the question. Right now, what our customers are telling us is they're expecting a weaker than expected Q3, Q4, which is why we've actually changed our guidance. So we're not really sure what's going to happen in Q1 And beyond. But what we are doing is we're kind of forecasting a normal year beyond that.

Speaker 3

And that's as far as we've gone based on what the customers have told us.

Speaker 1

Thank you. That's all from me.

Operator

Your next question comes from the line of Ravi Shankar with Morgan Stanley. Your line is open.

Speaker 5

Thanks for the opportunity one. Maybe as a follow-up to that question, I think your macro outlook for the rest of the year going in 2024 is a touch more bearish than what you've heard from many of your rail and trucking peers so far. So Again, do you feel like it's something reasonably unique to the end markets you're exposed to, the geographies you're exposed to? Or do you feel like Are you being more conservative? Or do you feel like it's just some realization that hasn't fully sunk in yet for everybody else?

Speaker 3

That's a great question, Ravi. It's Doug again. So listen, we can only forecast based on what our customers are telling us. So really everyone's a little bit bearish right now For the rest of the year, it's a little bit more positive starting in 2024 and that's really all we're forecasting, all we're guiding

Speaker 1

Coming over top of that a little bit, Ravi, I mean, I think that without a doubt, this is something that nobody knows for sure. And so as we approach the way we're going to operate this railroad is we are ready for whatever happens. And I think that we've demonstrated that we can be nimble in turning our service levels down to the plan. And so we're ready. If it comes, we'll be there.

Speaker 1

And if it's not, it waits a little longer, then we have a plan for what we're going to do in that case as well.

Speaker 5

Very good. Thank you.

Operator

Your next question comes from the line of Scott Group with Wolfe Research. Your line is open.

Speaker 6

Hey, thanks. Afternoon, guys. So you said a couple of times adjusting the hiring plan. Any color on exactly what you're doing with headcount going forward in the back half of the year. And then I thought I heard a comment about short haul pricing slowing a little bit.

Speaker 6

Maybe talk more broadly what you're seeing from a pricing renewal standpoint and how pricing is holding up. Thank you.

Speaker 1

I'll start with that one, Scott, and then I'll pass it over to Doug. I think he can talk about pricing. I think he misheard the comment. From a hiring perspective, we said right from the beginning The first lever that we would pull is we would look at the number of people we were hiring. So we've done that.

Speaker 1

As we just outlined, we have stopped in some areas. And in those hard to hire or hard to keep locations, we have slowed down considerably with the view to what we expect volumes to be, Q1, Q2 next year is when those employees would be operational. We are still managing through a level of attrition as we look forward. So if you think about kind of FTEs and people levels, you can expect to see it stabilized through the remainder of the year. And of course, if things change, we've got the plans in place to do that as well.

Speaker 1

So that's how I think about it. Doug, pricing?

Speaker 3

For the pricing that we mentioned, it's really talking about the intermodal product. And obviously, with lots of, I'll say, trucking industry issues right now, Our biggest competition is within the short haul trucking market. So that's where we're seeing some price pressures just in that market. Most of our market in intermodal is long haul, so it's not a big portion, but we just like to highlight the fact that there is some pressure there and that we are starting to see it.

Speaker 6

Okay. But you didn't give like an overall pricing renewal number or anything?

Speaker 2

No, we did not.

Speaker 6

All right. Thank you, guys.

Operator

Your next question comes from the line of Walter Spracklin with RBC Capital Markets. Please go ahead.

Speaker 6

Yes. Thanks very much. Good afternoon, everyone. So, Shazain, when you discussed the impact. I think you bucketed them all together, lower demand, wildfires, import strike being a 10% hit to your original forecast.

Speaker 6

I wanted to see if I could isolate a little bit the non recur or the real non recur being the wildfires and the port strike. If we were to Strip that out if you could quantify that impact and what I'm wondering is if that hit you this year And it was unexpected versus what you were anticipating when you set your guidance. Would we see the potential for a higher growth rate in 2024 given you're lapping a bunch of fairly significant non recurring items Or is there something changed as well in your outlook for 2024? I know as you adjust your grain as well as does that offset Some of that what would have been a higher growth rate in 2014 or 2024.

Speaker 4

Yes. Thanks, Walter. So thanks for the question. So as I said in the remarks, We did quantify the impact of the wildfires in the second quarter to be $0.07 of EPS or 100 basis points of OR. I think in our guidance right now, we're not assuming a Our network as we speak, they're not impacting our customers.

Speaker 4

So we're not assuming, as I said, wildfires going forward. The other thing on the strike, it did impact us month to date, But we believe that we will recover a good chunk of it over the next couple of weeks. So I don't think this will be a significant impact Going forward now, we're assuming that this tentative agreement will be ratified. And then the last big piece that guidance that supports our guidance or new guidance is the fact that as we said before, we were assuming some type of recovery in the second half And now having better visibility, Walter, today, we feel that most of that recovery will be pushed in 20 24. I think when you put all of those pieces together, that's where give us the guidance that we've just talked about today.

Speaker 6

Okay. Appreciate the time, Jayshay.

Speaker 7

Thanks. Thanks, Walter.

Operator

Your next question comes from the line of David Vernon with Bernstein. Your line is open.

Speaker 8

Hey, good afternoon. Doug, maybe first question for you on the set of market opportunities you kind of laid out for us back at Investor Day. It's a pretty bullish set of volumes out there. How should we be thinking about that opportunity set in relation to a weaker 2023? Should we be fixing those numbers kind of in the same range There'll be incremental as the economy recovers or is that scope of opportunity been adjusted for or should we be adjusting that scope of opportunity in line with the economic weakness?

Speaker 3

No. It's a great question. Thanks, David. So with respect to our 2024, 2026 plan, I think that's all still on target. Those are very specific projects that we outlined.

Speaker 3

None of them are really being impacted right now. We have 2 projects that were due to start that we highlighted out to the team with respect to in 2023. One of those is our Northeast BC where we're putting in a new siding to add capacity. That is moving ahead. We have the volumes kind of locked in there.

Speaker 3

Ed's That's moving full steam ahead. So right now everything is on time and on target. So it's actually doing really well.

Speaker 8

Okay. And then just maybe just a quick follow-up. The CapEx numbers that you guys presented at Investor Day were also, I think, maybe a little bit higher than the market had been expecting. Are you at a point now where you need to recalibrate the level of spending given what Seeing either to the upper downside maybe to repair some of the damage that's been done or to delay some capacity investments based on what's happening with volumes?

Speaker 4

Yes. I think that we are looking at CapEx very closely, David. We always do. We are looking at every project. We are making sure that there's An appropriate return.

Speaker 4

We are continuing to do our basic maintenance and when typically when volumes are So we're continuing that program, but as volumes if volumes continue to weaken, absolutely we're looking at discretionary CapEx and making sure to question ourselves whether we need to spend the money or not. But so far, I mean, I think our plan is continuing And we're continuing to add capacity in Western Canada because we believe that we will need it. And yes, volumes are a little lower, so maybe you'll have a little bit The time value of money, but the team right now is being very productive putting the capital, especially the construction capital in with lower volumes.

Speaker 2

David, I can add Ed Harris here. I can add we're taking advantage of some of these disruptions by hardening the railroad. We're spending money smartly. The outage at the washout at Halifax, for instance, we're going with bigger culverts, more culverts, So we don't have to go through this again. And the same thing goes for the areas that we suffered some fires and we saw opportunities for sprinklers and pumps and things like that.

Speaker 2

We just can't go through this type of disruption anymore to be honest about it.

Speaker 7

All

Speaker 4

right. Thank you.

Speaker 1

Thank you.

Operator

Your next question comes from the line of Fadi Chamoun with BMO Capital Markets. Your line is open.

Speaker 9

Good afternoon. Thank you. Apologies if you have this out in the press release, I didn't see it. But what is the RTM growth guidance for this year, maybe more so for the back half of the year, Q3, Q4, if you give us some Sorry about what you're assuming in guidance in terms of RPM growth. But the main question maybe for Doug.

Speaker 9

Prince Rupert has kind of struggled underperformed relative to most of the North American ports even prior to all of this kind of BC strike issues and some of the issues that we saw this year going back into the supply chain issues last year. Do you characterize some of these issues that are hampering Rupert's more kind of transitory? Are you from conversation with your partners at the port and customers seeing the change in behavior and how people view that port and the Purpose of that port into the U. S. I'm just wondering if this is just kind of a transitory issue because of the supply Obviously, the weakness in the demand that we saw this year or if there's more to it than that?

Speaker 3

Hey, Fady, it's Doug. Thanks for that very long question. I'll kind of address in 2 parts. So listen, we're expecting for the RTM forecast to be in above industrial production. That was always what we've said.

Speaker 3

We continue to see that moving forward into Q3 and Q4. We will finish the year above industrial production And we're very confident in that. With respect to Rupert, it's a great question. Listen, before the pork strike, we were starting to see actually Some green shoots if you want for Rupert. We're starting to pick up some business there again.

Speaker 3

So Rupert is one of those cutting edge ports. It's It's really there to serve both the U. S. Market and Canada. And as we see some of the volumes are starting to shift there and then we had a port strike.

Speaker 3

So We're waiting for that to recover. We've actually added 4 trains into the network right now that are moving extra business for it. So we're going to recover and then we're going to see where those markets are, but it continues to be, listen, the jewel in the crown for us. The customers love it. The service has been excellent there for the last year and that's all they can talk about.

Speaker 3

And we're pretty sure we're going to see all that volume recover.

Speaker 6

Thank you.

Operator

Your next question comes from the line of Chris Wetherbee with Citigroup. Please go ahead.

Speaker 10

Hey, thanks. Good afternoon. I wanted to ask Maybe two things around

Speaker 11

how you're looking at kind of the rest of the year and next year, first on the macro side and then maybe a little bit more specifically to the business. But Yes. I guess what are the sort of indicators that you're looking at to get a sense of maybe how long some of this downturn may last? I know you said that you Because it's been so difficult to acquire these employees is important to you. Are there other things that you can pull?

Speaker 11

Or at what point do you think it does make To look at the workforce and let attrition work its course to get it a little bit lower, just kind of curious how you're thinking about that.

Speaker 1

I'll start on that, Chris, and then I'll hand it over to Doug and Jiz to add a little bit of color. Listen, I think Doug did a great job of going through different commodity segments and what we're expecting. I'll do it in short form. We have a very strong ball franchise. It's continuing to operate Very well.

Speaker 1

The demand is strong. We talked about what we're looking at the grain on the grain portfolio on potash and what we're expecting on the pricing on that front. If you the next piece of our portfolio is more the merchandise piece, and that is pretty strong, We're not seeing a big downside. There's a few pieces in there that's softer, but generally fairly strong. The big question mark is on the consumer centric.

Speaker 1

It's the containers and its lumber right now given housing starts. There is no doubt that that's got to pick back up again with The construction has got to take place in North America. It's just a matter of when. Same thing with the container demand. We're not anticipating based on what Doug is hearing to see a big peak before the holiday period, but we are expecting to see some strength start to grow And a return to more normalized level, say, next year.

Speaker 1

So that's it's kind of how we're looking at it. Automotive, we think more on The consumer side is going to continue to be strong from everything that we hear and from our customers as well. And on the cost side, without a doubt, I mean, what we want to do is be really good at managing and responding to the 3rd party impact that we can't control. And I think the team has done a really good job of that, very strong. And then the things that we can't control, we're very methodical about.

Speaker 1

And we are doing that As we laid out for you in Chicago, we're doing that through network operations and the plan so that when we execute, we secure the full benefit of those cost mitigation and we continue to service our customers. As we go along, it is we believe we're taking all the right As we go along, if we come to a different view of the what the economy is going to look like next year and what volumes may look like, then we'll make other decisions. But right now, these are the decisions we're making on the best information that we have.

Speaker 3

Tracy covered that all really well. So the only thing I'll add in from a signpost is I always tend to look Chris at our petroleum and chemicals business And it's actually pretty flat. And that's always a leading indicator as the economy improves. And we just haven't seen it start to go up yet. So that's one of the indicators I would suggest you always watch The economy, especially for the railways.

Speaker 4

And then just to give some examples of cost that we can pull out and we are pulling out actually Yes, for example, we park a lot of center beams, okay. So a lot of those center beams are leased and they have staggered expiry date. We do this intentionally and we're able to return some of these cars to the lessors and obviously reduce our car higher expense. The other place where we, pull costs is we park locomotives. And of course, we park the ones that are the gas and older locomotives and use this as an opportunity to rejuvenate our active fleet that's out there pulling freight.

Speaker 4

So those are Outside of and as we said in our remarks, we are looking at hiring. We still have good attrition at CN, so attrition is helping us and we are pacing ourselves on hiring and slowing it down in some cases. But Want to be clear that we have some hard to hire locations in Western Canada that we're thinking the mid to long term we're continuing to hire in those locations because they're very difficult to get people to come on the network.

Speaker 11

That's great color. Thanks for the time. Appreciate it.

Operator

Your next question comes from the line of Ken Hoexter with Bank of America. Your line is open.

Speaker 10

Hey, great. Good afternoon. Just to clarify that last answer or part of it, Tracy, you kind of target volume to outpace IP. Yet I just want to understand this with the fire strikes, floods, cutting the grain crop, pushing intermodal volumes to next year, pushing demand into next year, You're still targeting outpacing IP. Is IP much larger negative from your point of view or maybe just talk about that perspective.

Speaker 10

And then you mentioned Doug, you mentioned truck competition. You mentioned things about rail is your peer rail is being measured on rail to rail competition on gains. Have you seen that step up in any fashion in this environment? Thanks.

Speaker 1

Hey, Ken. Yes, as you know IP We see ourselves, Doug says, coming in stronger than industrial production in any scenario. So we're pretty firm in that. Doug?

Speaker 3

The only thing I'll add into, Ken, is on the rail competition. We haven't really seen any market share loss with our customers at all, both to rail or to truck. So we are seeing obviously like I said some price pressure on the trucking side for short haul business. But outside of that All of our customers are very happy with our service and we continue to push product. We've seen some temporary gains due to the port shutdown like moving potash to St.

Speaker 3

John instead of it going to Vancouver, but that's about it.

Speaker 10

Doug, I thought you said you did lose the truck given you couldn't move it, So some volume was lost, isn't that what you said given the portion?

Speaker 3

We lost some temporary business. I'll say Like so we lost some temporary coal business and some going to Vancouver during the strike in Q2 in Q3, sorry, that will show up in Q3 business. In Q2, we lost a little bit of lumber as mills were closed due to the fires, things like that, that isn't recoverable.

Operator

Question comes from the line of Benoit Poirier with Desjardins Capital Markets. Please go ahead.

Speaker 12

Wondering if you could provide more details given the lack of accessorial charges boost weather. I assume that you will be facing a tough compare. And very rapidly, just In terms of the average length of all for intermodal, I thought that you were closer to 1600 miles, if not 1800 miles. So I was just curious How much of your intermodal is exposed to short off? Thank you.

Speaker 3

Ben, while the first part of your question got cut off, could you repeat it?

Speaker 12

Yes. Just in terms of yield expectation for the balance of the year, I was wondering what we should expect in terms of yield for the second half given that the accessorial charges won't be a boost anymore. Okay.

Speaker 3

So for the accessorial charges, we have about $100,000,000 plus headwind on that in Q2 and we expect that to Continue through Q3 and Q4, right? So that's part of the yield issue you're questioning. And on the short haul versus long haul, so you're right. You have your number is dead on. We actually have most of our long haul Long haul, so we do move traffic between Montreal and Toronto, Toronto and Moncton.

Speaker 3

So it's a little bit shorter haul than coming off Vancouver going all the way to Toronto, Montreal, Chicago. So that's where we're facing that price pressures in that short haul market.

Speaker 12

Okay. Thanks for the color.

Operator

Your next question comes from the line of Tom Wadewitz with UBS. Your line is open.

Speaker 13

Yes, good afternoon. Wanted to ask you about how we might think about operating ratio and maybe inflation, how that would have an effect. I think, transports have certainly dealt with inflation in the cost base and as the revenue slows down, it's more challenging from a margin perspective finding ways to offset that. I know the Canadian dynamic is a little bit different than what we see from some of the U. S.

Speaker 13

Companies, but how do you think about the kind of profile for inflation as you look 2020 4 with a little softer view and what you might be able to do to kind of stabilize the OR on kind of a year over year basis? Thank you.

Speaker 1

Thanks, Tom. It's Tracy. Listen, we've been pretty clear that we see opportunities in our margins as we go And we see that in a number of places. We're not yet where we need to be from an operating efficiency perspective. We've made significant gains and we've handled some of the external events extremely well.

Speaker 1

There's still more work to do there and we're excited about getting at that. Certainly, we're standing behind our pricing above inflation perspective and Doug is doing a great job Delivering that on the basis of the service that Ed is providing him, that's going to continue. We do have the headwind on some of the storage and other charges that occurred last year when the supply chains got pretty congested. So as we look forward, you're going to see us improve our margins. Right now, we're going to have a little bit of we're going to be a little bit lighter on operating margin while the volumes are down.

Speaker 1

But we are positioned extremely well to get at a very low cost the upside when the volumes return. That's the model. That's how we're going to run it and you'll see us, you'll see that leverage pick up as the volumes come back.

Speaker 13

So you think it's much more driven by volume than by price, just in terms of when we might transition to seeing improvement?

Speaker 1

Yes, absolutely.

Speaker 13

Okay. Thank you.

Operator

Your next question comes from the line of Konark Gupta with Scotiabank. Your line is open.

Speaker 9

Thanks for taking my question. Just wanted to dig into the guidance, if I can.

Speaker 11

So what are some

Speaker 9

of the puts and takes explaining the gap between the top and bottom end? So the EPS guidance range of flat to slightly negative. I'm not sure what the slightly negative mean. Could that be a low or mid single digit decline? Thanks.

Speaker 4

So Thanks, Konark. So what explains the gap between flat to negative is really volume. So in one scenario, we get a little bit more volume than we expected and in the slightly negative, it's slightly negative, then we get less volume in the second half of the year than what we expected. So it's really a volume story.

Operator

Your next question comes from the line of Amit Mehrotra with Deutsche Bank. Your line is open.

Speaker 14

Thanks, operator. Hi, everyone. Good afternoon. I guess I wanted to stress test The 10% to 15% earnings growth framework, I guess, for next year. I mean, you guys are operating pretty well if I look at the cost structure And you're responding at least in terms of what you can control pretty well.

Speaker 14

I'm just trying to understand if we're kind of in this lackluster volume environment. You've got headwinds on grain, you've got headwinds on forced products next year. But you've also got on the other hand a lot of volume opportunity you outlined at Investor Day. So I guess, I mean, what's the likelihood that we're sitting here 12 months from now in a still weak environment and EPS is not growing or staying the same or do you feel like you have enough idiosyncratic volume opportunity where you can kind of move the needle on EPS? How much do you need that's out of your control to get to that

Speaker 1

So I welcome you to the dialogue around our table. If we knew for sure what was going to happen From an economic perspective, we could narrow in on this pretty quickly. So just taking you through what we're modeling next year and as Doug from a volume perspective, You're right. Our railroad is running extremely well, and we're poised to capture the upside and send a lot of that to the bottom line as soon as it comes. So we have a plan in place for next year.

Speaker 1

If it's wrong, then we will adjust. The growth initiatives that we put in front of you in Chicago are there that exist outside of the economic ebbs and flows. And so Doug and Ed are continuing to work on I'll talk to you about a couple that are going to come in and we'll be moving volume prior to the end of the year and that plan remains intact. So that is something that will move us more positively than whatever is going on in the economic environment at that time.

Speaker 14

Can you ring fence

Speaker 4

Just to clarify Amit as well, the 10% to 15% we said was over the 3 year period. So we did not specifically guide by year. Obviously, we're looking at what's happening. We're going to do our business plan with our Board this fall as we And then we typically provide visibility on the year in January. So I want to clarify that the 10% to 15% was over the 3 year period.

Speaker 14

Yes, I just assumed it was linear because that would imply like 15% to 25% in the back half, but I understand what you're saying. Thank you for taking the question. Thanks.

Operator

Your next question comes from the line of Brian Ossenbeck with JPMorgan. Please go ahead.

Speaker 7

Hey, thanks. Good afternoon. A question for Doug. Can you just walk through the assumptions for the Canadian grain harvest. Do you think that's sufficiently derisked at this point given all the weather conditions that we're seeing out there and some of the crop conditions as well.

Speaker 7

And also, U. S. Grain forecast looks like it's actually raised, but similarly same sort of challenges out there from that crop. So can you just give some puts and takes around why those went in opposite directions? Thanks.

Speaker 3

Sure, Brian. So thanks for the question. So With respect to the Canadian grain, obviously, you can't really count it until it's off the fields. But from everything we're seeing, both from our customers' crop forecast, Very accurate, especially in Canada to the government forecast. We're seeing that roughly that 65,000,000 metric ton number, Right.

Speaker 3

So we're pretty confident in that now. At this time of year, unless there's a big change in weather that really has a big impact on the crops, It should come in very close, right? So we're pretty confident on that. The crop on our network, on CN's network has more moisture. So we think we're actually fairly well set up to move things through up until Q2 next year.

Speaker 3

And then we'll only be able to determine that later. With respect to the U. S. Crop, it started off as a very dry crop, almost a drought crop. We've seen significant amounts of rain on our network over the last 4 weeks.

Speaker 3

So that crop forecast on CN through Illinois and Ohio has come up dramatically for us. So we're actually looking at a normal crop in the U. S. Right now. Now things could still change.

Speaker 3

It still has to come off the field as well, but the corn and soybeans are actually have caught up Almost to the average right

Speaker 7

now. Okay. Thanks, Doug.

Operator

Your next question comes from the line of Steve Hansen with Raymond James. Your line is open.

Speaker 15

Yes, good afternoon. Thanks for the time. Just a follow-up

Speaker 16

on the grain crop, if I may. It's obviously been dry and stressed as you indicated, Doug. I suspect we likely get an early harvest this year, which should provide some help on the margin, but I also think we're comping up against a pretty benign winter Through Q4 and probably even more so in Q1 next year. How do we think about that in relative context? Can you actually move as much grain Is last year

Speaker 17

if the winter is more normal?

Speaker 3

So for our network Steve, it's a good question. So we think our network is going to have slightly lower, but not dramatically lower crop overall just because we've had there's been a lot more moisture across the north, right? So we feel pretty comfortable on our numbers. With respect to moving it, we had a fairly normal winter. I know we characterized it as a late winter sometimes, but we had the same number of cold days like below minus 30 as we do in a normal winter.

Speaker 3

We just with the operating plan that Ed put together with the team, they just delivered so much better than our prior years. So So what we're planning, we're planning on moving the exact same type of volumes that we did before for our customers and we think we'll be very successful with Ed and the team. Ed, I don't know if want to add anything?

Speaker 2

No, I can tell you,

Speaker 9

I don't

Speaker 2

see any real problems at all. Today's technology allows us to run repeater cars when it gets extremely cold. We always run distributor power on the loaded grain trains. We'll do just as well this year as we did last year.

Speaker 16

Okay, very good. Thank you.

Operator

Your next question comes from the line of Justin Long with Stephens. Please go ahead.

Speaker 4

Thanks and good afternoon. I wanted to ask about the lag impact from fuel that's getting baked into the guidance for the 2nd half and how that compares to what you saw in the first half. And then just to clarify on the volume guidance, The industrial production number is, as you saw, census came out a couple of days ago and it was negative 0.2. So it's in that range. And on the lag question, I think that we don't expect a lag.

Speaker 4

If fuel prices remain the same, we don't expect a lag in Q3 And neither in Q4. Now on a year over year basis, if you look at Q3, we had a positive lag last Okay, great. Thanks.

Operator

Your next question comes from the line of Brandon Oglenski with Barclays. Please go ahead.

Speaker 6

Hi, thanks for taking my question. I guess just to recap a couple of things here. Doug, does the pricing hurdle or inflation hurdle remain mid single digits because I think you had implied about 5% looking at your longer term outlook, maybe even higher in 2023. Do you think you're getting that outside of some of the markets that you called out? And Ed, it looks like your service metrics this quarter were actually pretty decent despite some of those headwinds.

Speaker 6

So would you expect incremental efficiencies if you can get beyond some of these hurdles?

Speaker 2

Absolutely. When I said it was a tough quarter, I meant it was a tough quarter. The fires, The disruptions we had to deal with, we are very well positioned going into 3rd and remainder of 3rd Q4 headcount, power, equipment. We ought to be able to do even better than we did last year at the same time.

Speaker 3

And Brandon on the pricing, we continue to be strong on that. Obviously, we talked a little bit about the pressures in some of the intermodal, so the short haul. But outside of that, on the rest of the carload business, we're still being Fairly aggressive seeing a great pricing environment based on the service that Ed's providing. So I don't see that changing for the rest of the year.

Speaker 6

Thank you.

Operator

Your next question comes from the line of Jon Chappell with Evercore. Please go ahead.

Speaker 18

Thank you. Good afternoon. Just tying a bunch of things together, Doug, you laid out a pretty detailed bottoms up view of a lot of the growth opportunities that your customers are pursuing. But now in the kind of more maybe uncertain macro backdrop, even you're looking at CapEx budget going forward. Have you seen any type of reluctance to move forward with any of the projects that you laid out from the shipper community as both some of the temporary issues have intensified and the uncertainty has probably been elevated as well?

Speaker 3

John, not to this time, right? We've seen a lot of these projects are longer term big projects that customers are looking at the immediate environment at. They're looking macro. They're looking 2, 3 years out and we're working there with them. So like you take an example like a BHP potash mine as an example like they're well under construction.

Speaker 3

It's only going to come up in 2 or 3 years. We don't see them slowing down. In fact, we're seeing them try to speed up. So There's lots of examples like that where people will try and take advantage of the market and the conditions and they're spending as much money if More because there's more labor availability. So each market is going to be different, each opportunity, but we're working with everyone and we haven't seen anyone slow down to this point.

Speaker 7

Great. Thanks, Doug.

Operator

This concludes the question and answer session. I would like to turn the call back over to Tracy Robinson.

Speaker 1

Thanks, Emma. So an interesting quarter from an external events perspective. I think we've managed it well and we're all looking for a few less interesting quarters coming up, but we'll manage what comes at it. Our plan though is clear and it's not changing. Discipline around building the plan, running the plan, selling the plan is doing exactly what we wanted it to.

Speaker 1

It's working. Is delivering consistent reliable service for our customers and then making effective use of our assets. And as we've talked today as our volumes lift, we're going to see that operating leverage follows suit and we're ready. We've got our eyes on our future. We're advancing our growth projects, preparing for the rebound and doing exactly what we said we'd do back in May.

Speaker 1

That being said, as you've heard today, we're reiterating our 2024 to 2026 financial perspective of 10% to 15% diluted EPS CAGR. That's all for now. Thanks very much for joining us today.

Operator

The conference call has now ended. Thank you for your participation. You may disconnect your lines at this time.

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Earnings Conference Call
Canadian National Railway Q2 2023
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