Canadian National Railway Co Q1 FY2020 Earnings Call

Welcome to CN First Quarter 2020 Financial Results Conference Call. I would now like to turn the meeting over to Paul Butcher, Vice President, Investor Relations. Ladies and gentlemen, Mr. Butcher.

Thank you, Paul. And good afternoon, everyone and welcome to first quarter earnings call. In keeping with our commitment to safety, I hope you and your families are staying safe, practicing social distancing and helping to reduce the spread of Covid-19. We at CN have been diligent in providing a safe environment for all of our employees and I'm happy to report that our railroad is safe and CN never slowed down. As we look back to the quarter, my first message is that despite the unusual challenges we faced, the men and women of CN produced solid financial results. My second message is that the resiliency of CN, which we demonstrated last quarter, positioned us well for recovery. Our investors know we manage the business to deliver long-term performance and we will continue to build for 2021 and beyond. We will balance the need to manage through the short term with a focus on long-term performance. The network is currently in full operation and very fluid. We have the capacity to move goods and enable the eventual recovery of the economy. We also continue to build on our technology initiatives, such as automating track inspection and fully enabling a connected and paperless environment for train crews. Our financial strength will also serve us well both in the near and long term. We have a robust balance sheet and a proven track record of dealing with any type of business disruption. Our capital expenditure will enhance capacity in key areas, particularly around the Port of Vancouver. ESG is a strength for CN. Our carbon footprint continues to decrease and our fuel costs continue to improve. We are beefing up our cyber security while pushing forward on a broad range of key aspects related to gender, human capital, and environmental strategies. In summary, despite a month-long illegal rail blockade, a proven resilience will help us deliver in the near term as we support the recovery and create long-term shareholder value. With that, I will pass it on to Rob, who will talk about the operations.

Thank you, JJ. Our team delivered impressive results in Q1 with car velocity improving by 5%, train velocity improving by 7%, and dwell time reduced by 4%. In March, after the illegal blockades were lifted, car and train velocity improved by 10% year-over-year, while dwell time was reduced by 7%. This means that by increasing car and train velocity while reducing dwell time, we can use fewer locomotives and cars on our network to move the same amount of GTMS. In addition, we had solid performance on safety, where accident and injury rates decreased by 36% and 3%, respectively. Fuel efficiency improved by 6%, setting an all-time Q1 record for CN, while avoiding over 100,000 tons of CO2 emissions. Our disciplined execution led to a $20 million year-over-year savings in fuel efficiency. We remain focused on maintaining our industry leadership and progressing towards our long-term carbon efficiency targets. Despite the challenges, including the illegal blockades, I am very proud of the entire CN team. Our priorities have been to protect our employees, ensure continuity of our railroad operations, and adjust our resources to meet decreasing demand. We have laid up 500 locomotives to reduce fuel, maintenance, and labor costs. Our active online inventory of railcars has decreased by 16%, and we have furloughed over 2,500 employees. We are using this time to strengthen our railroad and to maintain our infrastructure. The FRA has now approved our test program for automated track inspections. This will lead to less on-track inspection time and more consistent evaluations, creating capacity and improving safety. Thank you to all our team members for their role in moving critical supplies to keep the North American supply chain open and fluid. I'll now turn it over to James.

Thank you, Rob. In Q1, we demonstrated our ability to bounce back in times of adversity. This will position us well for recovery. Let's walk through a few specific market segments. In Q1, we set a record for domestic potash with revenue growth of around 20% compared to last winter. We also reached all-time records for Canadian grain and coal in March. Despite challenging conditions, we handled the majority of Canadian grain rail shipments, claiming 51% market share for the quarter and almost 52% in March. In the energy sector, crude by rail grew 45% year-over-year for the quarter, with nearly a third of that volume being heavy, non-dangerous, undiluted crude. We also experienced sequential growth in frac sand from Q4 2019 to Q1 2020 of over 40%. Propane volumes were flat for the quarter due to negative impacts from the rail blockades and other restrictions. However, we grew our market share of Western Canadian propane, reaching almost 80% for the quarter. Looking at the second quarter, we anticipate challenges, knowing that crude, frac sand, and jet fuels are in decline. Western Canada select the Canadian crude benchmark needs to be in the $25 to $30 range before curtailed production can resume. In Q2, we expect to move the majority of our crude volume as heavy, undiluted crude. This is less impacted than dilbit crude in Q2. We will also likely see record volumes in Canadian coal and grain in Q2, similar to Q1. Despite the current environment, our unique geographic franchise will support medium and long-term growth. We are preparing for the commissioning of Pembina's export propane facility at the port of Prince Rupert later this year or early next year.

Thank you, James. We produced strong results in the first quarter and ensured essential products kept moving. On the domestic intermodal front, we continue to develop our offerings to convert business from truck to rail, increasing our market presence in foods and other temperature-sensitive goods. On the international intermodal side, volumes weakened from both supply and demand factors. The automotive industry came to a halt in March due to temporary closures of assembly plants. Our eastern port import business continued but at a reduced pace. Looking ahead, we remain focused on moving essential goods and recognize opportunities in refrigerated segments. We are also working on strategic growth initiatives, including the EMP trans-border volume, which increased by 15% over Q1 2019. Despite challenges, we continue to see growth prospects across our various segments. Our strategies and structural advantages will ensure we are well-positioned for recovery and growth opportunities.

Thanks, Keith. Now I'll summarize the key financial highlights of our first quarter performance. Operating income came in at slightly above $1.2 billion, up $135 million or 13% vs. last year. Our operating ratio came in at 65.7%, 380 basis points lower than last year, despite challenges from the illegal blockades. I'm extremely proud of how the team recovered, and I'm pleased to report our operating ratio for March improved significantly. Net income was slightly above $1 billion, with reported diluted earnings per share of $1.42, up 31% year-over-year. Excluding unusual impacts, our adjusted diluted EPS was up 4% vs. last year. Moving to expenses, our operating expenses were down 5%, totaling $2.3 billion. We have a strong balance sheet and have always taken a strategic approach to our financial management, which has served us well. We are reducing our 2020 capital expenditure program to $2.9 billion due to reduced near-term demand while protecting recovery and growth opportunities starting in 2021. Our liquidity remains strong, and we anticipate generating a minimum of $2.5 billion of free cash flow this year. We continue to focus on adjusting our resources to align with current demand and ensuring we're strategically positioned for recovery.

Thank you, Ghislain. We provided an overview of strong and resilient first-quarter results. Our operations are fluid, and we are managing well through the current pandemic to support our customers and the economy. We remain optimistic about our structural advantages and strategic growth opportunities in 2021. Operator, please direct the questions, and I will ask each analyst to limit to one question for fairness.

If we think about how supply chains might be reconfigured as a result of this pandemic, what are your thoughts on how that might unfold between reshoring to North America versus diversification away from China to other low-cost countries in Asia? How might those shifts impact your business?

I think nearshoring has been occurring partly before the pandemic due to high labor costs in China, which prompted some manufacturing to move to other countries like Vietnam. However, regarding this shift, some of it may be exaggerated, while some is more legitimate. For items like medical supplies, we will certainly manufacture more locally; for containers, the world is certainly changing, and it will not be the same.

We've been monitoring the movement of manufacturing capacities across Asia to lower costs or get closer to supply chains. There will be some nearshoring, but we expect most production to continue in Asia.

Can you talk about your $2.5 billion free cash flow target? What are some of the assumptions underlying this number, especially with the slight drop in CapEx?

Ghislain, would you provide the details?

We're running several scenarios with limited visibility. April volumes are down about 15%, reflecting a worse-case scenario that we've incorporated into our assumptions. Despite this, we believe that $2.5 billion is achievable under these conditions.

Can you help us understand your profitability outlook and the assumptions underpinning the free cash flow guidance?

Our guidance represents a minimum scenario. We've run various scenarios that are better than this, but we want to provide investors with a cautious outlook. There are no hidden factors affecting our assumptions.

How are you managing resources in response to volume declines? Could you comment on headcount and flexibility in your cost structure?

Currently, our headcount is down about 3,800 compared to last year, primarily due to furloughs and fewer employees on the payroll. We continue to right-size our operations in response to changing demand. Rob?

As we manage the decline, we have over 2,500 people furloughed, and we're actively laying up locomotives as well. We have around 14,000 cars in storage and continuing to right-size our operations based on volume changes.

Could you provide more clarity on the pricing environment and yield expectations?

James, can you discuss our pricing strategy?

We maintain price discipline regardless of market conditions. We have to ensure we can offer our customers what they need, positioning ourselves to secure pricing leverage as recovery begins.

Can you share your thoughts on why you withdrew the three-year guidance? Do you anticipate an L-shape recovery?

There are various scenarios for recovery, but the timing of our return to a normal economy is unclear. Our guidance withdrawal reflects our need for better visibility on the economy's recovery timeline.

What is your near-term outlook regarding the impact of supply chain adjustments on your operations?

Keith, could you provide insights on our customer discussions for Q2 and Q3?

While some blanks in our schedule may occur, we are not anticipating as many disruptions as we saw early on. The overall impact on volume will depend on the demand increases in Q2.

Can you elaborate on your long-term fuel efficiency goals?

Our industry-leading fuel efficiency performance is a result of our focus on effective locomotive usage and technology. We are targeting a 29% reduction in emissions by 2030 compared to 2015 levels.

Can you discuss the implications of idle switching yards and whether this is structural or a quick response?

Some of the idling will be structural, particularly regarding locomotive management. Others will depend on future traffic volume recovery. Thank you for your question.

In closing, we appreciate your time today. Our network continues to operate fluidly, and we are prepared to support our customers amid this pandemic. We prioritize employee safety and are strategizing for recovery. Thank you, operator.