Canadian National Railway Co Q3 FY2020 Earnings Call

CN Third Quarter 2020 Financial Results Conference Call will begin momentarily. I would like to remind you that today's remarks contain forward-looking statements within the meaning of applicable securities laws. Such statements are based on assumptions that may not materialize and are subject to risks described in CN third quarter 2020 financial results press release and analyst presentation documents that can be found on CN's website. As such, actual results could differ materially. Reconciliations for any non-GAAP measures are also posted on CN's website at www.cn.ca. Please stand by. Your call will begin shortly.

Okay. Thank you, Patrick. Good afternoon, everyone and thank you for joining us for CN's third quarter 2020 earnings call. I would like to remind you about the comments already made regarding forward-looking statements. With me today is JJ Ruest, our President and Chief Executive Officer; Ghislain Houle, our Executive Vice President and Chief Financial Officer; Rob Reilly, our Executive Vice President and Chief Operating Officer; Keith Reardon, our Senior Vice President, Consumer Products Supply Chain and James Cairns, our Senior Vice President, Rail Centric Supply Chain. I do want to remind you to please limit yourselves to one question so that everyone has the opportunity to participate in the Q&A session. The IR team will be available after the call for any follow-up questions. It is now my pleasure to turn the call over to CN's President and Chief Executive Officer, JJ Ruest.

Well, thank you, Paul, and thank you, everyone, for joining us this evening. We hope you are enjoying a safe fall and ensuring that all of your family is staying in good health. The economy recovery is underway. Looking back at Q2, the team acted very swiftly, thanks to our engaged and adaptable CN railroaders. They are truly some of the essential service heroes of this pandemic. Q3 was a quarter of sequential recovery. The recovery has been underway since the month of July. The operating metrics are improving. We brought many of our employees back to active service, and we added train star. Kudos to the entire team for producing an operating ratio of 59.9%. The recovery has a different mix of business. Some markets recovered quickly in a V-shape, while others have yet to fully recover. All of this evolved into a different mix of revenue ton miles compared to pre-pandemic levels, with a significant decline in crude and a significant increase in Canadian grain. CN rail capacity is valuable, and the team, as always, is proactively making decisions, so the right value quality freight is on our network in the quarters to come, ensuring that we optimize the return of our investment in the business and our return to shareholders. We consistently target same-store price ahead of rail inflation, and we achieved that in the third quarter again. Our focus remains strongly on the long-term strategy, on the positive secular trends that we intend to ride. For example, the growing North American consumer economy, the secular shift to East Coast trade, and the unique cost and service mode of the Rupert gateway, all while being very aware of and preparing for upcoming long-term disruptors like driverless trucks and the battle for control over freight sales by competing channels. On that note, I will pass it on to Rob.

Alright, thank you, JJ. I also want to thank our team of essential railroaders for their efforts, not only this past quarter but since the pandemic started in keeping the critical supply chain open in North America. We really have not missed a beat, and that is a credit to the men and women of CN. As JJ mentioned, we saw a sequential recovery month-over-month during the third quarter, and the team quickly adapted, rightsizing resources to the demand along the way. We have brought back crews, locomotives, and cars to handle the volumes, but our discipline throughout this pandemic and the structural changes we implemented means that we are able to move similar volumes this year versus last year with lower labor costs. Over the past several months, we've idled multiple locomotive shops and switching yards that have remained closed. We completed consolidation of our Canadian dispatch offices from three offices into one location in Edmonton, which allows us to run the network more efficiently. During the quarter, we were able to reduce our yards by 14% while our volumes dropped 7%. Our focus on increasing train length paid off as we increased train length by 6% during the quarter, allowing us to move more freight with fewer crew starts. As volumes returned during the quarter, we've also seen our key metric on car velocity improve by 25% since the end of July as our network remains very fluid going into the winter months. The team's efforts on fuel efficiency continue to pay off as we set new all-time records for fuel efficiency in every month of the third quarter, leading to a new best-ever quarterly record. Our efforts so far this year have saved close to CAD35 million in fuel expenses and avoided over 162,000 tons of CO2 emissions from our fuel efficiency initiatives alone. We are the North American railroad leader in locomotive fuel efficiency and we have every intention of maintaining that leadership. Our efforts underline our firm belief that rail is part of the climate solution and that the best way to reduce our carbon footprint is to continuously improve our fuel efficiency. As planned, we increased our engineering work block production with unit costs for rail and tie installation declining due to disciplined execution from our engineering teams and dispatch centers. This has allowed us to get the work done at lower costs with fewer resources needed. Most importantly, I am pleased to report the team's relentless focus on safety through the pandemic has resulted in improvements in both our personal injury ratio and train accident ratio by 19% and 22% respectively, as running a safe railroad for our employees, our customers, and the communities we operate in remains a core value in everything we do. Despite the volume fluctuations we've seen, we have pushed forward our agenda on the modernization of our railroad operations in everything from robotic process automation of everyday tasks to the use of machine learning and artificial intelligence in how we inspect our tracks and cars. Our autonomous track inspection program is entering phase two in the U.S., and our cars are now covering core routes every week from the Atlantic Ocean to the Pacific Ocean and down to the Gulf of Mexico, making our railroad safer, unlocking capacity, and reducing costs. The railroad is fluid and prepared for the winter season ahead, and the record grain harvest is evidenced by the fact that the CN team has now delivered seven consecutive all-time monthly records for the movement of Canadian grain, and we're on track to deliver a record month here in October. As I turn this over to James, let me reiterate that we remain nimble and responsive to aligning resources to demand while maintaining a very positive momentum on fuel and labor productivity. With that, I'll turn it over to James.

Thank you, Rob. During Q3, we experienced a V-shaped recovery in our ports business, lumber, and automotive, while we saw weakness in crude, frac sand, and refined petroleum products. Demand for Canadian grain, which is not tied to the economy, hit record levels, and, as Rob said, we delivered seven consecutive monthly records. As we manage through this uneven recovery, we will focus hard on key markets, including Canadian grain, Canadian coal, and propane. Let me now discuss in further detail some of the topics on the carload side of the business. As I mentioned, Canadian grain continues to be a bright spot for CN with our best third quarter volume on record, beating the previous best in 2014 by 13%. U.S. grain was also very strong and finished well ahead of last year. Canadian coal was negatively impacted by the temporary closure of CST and Coal Valley mines and the permanent closure of TECK Cardinal River mine. Forest products ramped up sharply in Q3 as our customers brought back idled capacity to take advantage of strong construction activity. Crude, frac sand, and refined petroleum products, which are long-haul heavy tonnage segments, were the weak outliers in Q3, contributing to the shift in our overall business mix for the quarter. The positive momentum we saw in Q3 will help us finish the year strong and position us well for 2021. We are the dominant player in the Canadian forest products market and see an outweighed benefit as this market recovers. We have brought back all the lumber cars that were in storage, and we recently added 500 additional lease cars to meet spot demand at auction prices. Canadian grain and U.S. grain are expected to be growth drivers in Q4 and 2021. The Canadian crop may hit an all-time record, and the U.S. crop is expected to be above average. The step-change in grain supply chain capacity has been years in the making, and we are investing alongside our customers. We have purchased 2,500 new high-capacity grain hoppers and our customers have also invested in a new private fleet of similar high-pay load cars. By the end of Q1 next year, we will have over 4,200 new high-capacity hopper cars cycling on our network. We also expect to take advantage of the 50% increase in grain West Coast export capacity, exclusively and physically served by CN, allowing us to move more grain, faster, using fewer resources. Our three-coast network reach is a long-term structural advantage that cannot be replicated. Propane export volume through Prince Rupert will continue to ramp up, and U.S. coal volumes will grow in Q4, driven by new pet coke volume moving from Chicago to the U.S. Gulf Coast for export. International demand for wood pellets as a green fuel alternative is also strong, and we see this market as a unique opportunity for CN with several new production projects in the works. We maintain a disciplined approach to pricing and upscaling our portfolio of customers and commodities to ensure the right value freight is running on our network. We are focused on managing the mix in the face of a recovery that has not been consistent across segments. With that, I'll turn it over to Keith.

Thanks, James. Our engagement with our customer supply chains enabled CN to fully participate in the strong recovery of the third quarter. Whether international or domestic originated supply chains, grocery business, home improvement retailers, e-commerce, or brick-and-mortar retail restocking, we were there to support all segments of the V-shaped bounce back in those markets. As auto manufacturing accelerated, we successfully enabled our customers to meet the pent-up demand in North American markets. In Q3, our overall business mix was impacted by a surge in container imports on both the West Coast and the East Coast. Our year-over-year volume growth on the West Coast was driven by several of our ocean customers as they moved business from other gateways and supply chains. The work stoppage at the Port of Montreal created opportunities for other East Coast gateways, leading to strong import volumes in Halifax and St. John's. It also benefited our CSX steel wheel interchanges from the ports of New York, New Jersey, and Philadelphia. We experienced a temporary and significant imbalance in traffic in Q3 as the rapid surge in imports was not yet matched with the loaded exports. We also experienced additional temporary imbalances related to the Port of Montreal disruption. In automotive, we faced short-term headwinds as some manufacturers were shut down for retooling new models. Opening in December, our new auto compound in New Richmond, Wisconsin will serve the Minneapolis marketplace. Based on strong feedback from our ocean customer base, we will also be providing intermodal service to that terminal as well. As the North American consumer market evolves, we continue to focus our efforts on yield and its many levers. Technology advancements that we shared with you at our 2019 Investor Day are producing ongoing safety, security, and productivity benefits in chassis, containers, and cranes. Our ongoing efforts to upscale our business and price above rail inflation will continue to improve our intermodal and automotive business margins as the consumer-based economy strengthens in North America. Joint work with our supply chain partners to invest in the long-term future of our ecosystems continues, including with GCT at Deltaport and DP World at Centerm and Prince Rupert to deliver those expansion plans over the next couple of years. Longstanding successful beneficial cargo owner relationships and service will continue to drive volumes through whatever waves the economy presents us with in 2021. I will now pass it on to Ghislain for the financial perspective.

Thanks, Keith, and good evening, everyone. My comments will start on Page 10 of the presentation with highlights of our third quarter performance. Throughout the quarter, as we saw sequential improvements in volumes each month, we remained disciplined and focused on tightly controlling our costs. We continue to adjust our resources for the recovery in certain markets, while being mindful of the mid- to long-term opportunities ahead. Revenues for the quarter were down 11% versus last year at just over CAD3.4 billion. Volumes in terms of RTMs were down 7%, while revenue per RTM was down 3% impacted by significant changes in business mix. Operating income was almost CAD1.4 billion, down 15% versus last year. Our operating ratio was 59.9%, up 200 basis points versus last year. Net income was CAD985 million, down CAD210 million versus financial results in the quarter. Turning to Page 11, let me highlight a few key expense categories. Labor and fringe benefit expenses were 5% lower than last year. This was mostly driven by a 15% lower average headcount in the quarter versus the prior year, partly offset by higher incentive compensation related to period-over-period adjustments to accruals. Purchased services and material expenses were 11% lower than last year, primarily due to lower outsourced services, lower trucking and transload expenses, and lower material costs. Fuel expenses were 33% lower than last year, driven by a 26% decrease in price, 9% lower workload, and an all-time record quarterly fuel efficiency. Now moving to cash on Page 12. Free cash flow was close to CAD2.1 billion through the end of September, almost CAD600 million higher than the same period last year, resulting in a significant year-over-year improvement in free cash flow conversion. Our year-to-date free cash flow performance is solid, and we fully expect to achieve in excess of CAD2.5 billion in free cash flow for the year. At the end of Q3, our leverage in terms of adjusted debt to adjusted EBITDA was 2.17 times, slightly higher than our 2 times target. For financial prudence, the company will continue to pause its share repurchases. We will reassess on an ongoing basis. As you will recall, we withdrew our full-year guidance on our Q1 earnings call. Given that we now have nine months of actuals and that we report weekly volumes, we see limited value in reinstating our guidance at this time. That being said, with the volume recovery we've seen sequentially and the good momentum so far in Q4, we are aiming to provide annual guidance for 2021 on our upcoming January call. We continue to reward our shareholders with consistent dividend growth. To conclude, as we are experiencing a sequential improvement in key markets, we continue to tightly control costs as volumes rebound, and we are seeing good momentum in operations. We support the volume recovery in certain markets and remain confident in our ability to deliver value to our long-term shareholders. And on this note, back to you, JJ.

Thank you, Ghislain. I'm going to wrap this up quickly so we can go through your questions. In the second quarter, kudos to our women and men at CN for demonstrating our resiliency. In the third quarter, we experienced a recovery of a different kind of business, which impacted our new mix of business, and the commercial team is proactively managing for the right book of business to be running on our railroad. Going forward, capacity is valuable again to deliver good long-term value for our shareholders. So, Patrick, we're going to turn back to questions.

The first question is from Ken Hoexter from Bank of America. Please go ahead.

I guess, just to hit on that last point, I guess, Ghislain, you talked about seeing some improving performance. Maybe just step back and think about your pause on the share repurchases or what's magical about the 2 times debt to EBITDA? I just want to understand the confidence you have in the sequential growth you're seeing and the acceleration we should expect into Q4 and into '21?

Yes, thanks, Ken, for the question. Listen, I think we see the recovery loud and clear in certain key markets. I know Keith and James touched upon it. As you know, Ken, we've always used share buyback as a flexible tool to reach a targeted leverage level. Our targeted leverage level has always been internally communicated to the market as 1.7 to 1.9 times. So in my remarks, I rounded it to 2. I think we are comfortable, and since we're already over the 2 times, we're at 2.17 as I alluded at the end of Q3, I think that we're in the right position. We like to have a strong balance sheet. We saw that loud and clear in the second quarter going through this pandemic, as it created many benefits for us. We went out to the market and issued $600 million in 30-year paper at 2.45%, which was the lowest, the second-lowest coupon of any corporate in the U.S. So we see value in having a strong balance sheet. You're right, the targeted 2.25 is the limit that we have that supports our credit rating. Targeting around 2 is good, and we feel good about that. So stay tuned; our decision not to reinstate our share buyback is far from being a lack of confidence in us looking at the recovery. It's just about where we stand now, and we're a little higher and want to stay tuned for what 2021 may bring.

The next question is from Cherilyn Radbourne from TD Securities. Please go ahead.

In terms of the V-shaped volume recovery, which has been most pronounced in intermodal, forest products, and automotive, I'm curious if you have a sense for how much of that might be inventory restocking versus consumers pivoting their spending to goods over services? And to the extent that it's restocking, how much of a backlog is there still left to move?

So, Keith, you want to address that?

Thanks, Cherilyn, for the question. It's a little of both. As we talk to our customers, particularly our overseas customers, they're still seeing an opportunity for restocking, some say into the first quarter. There is that much of a replenishment that's required. I also think that spending is shifting from services to goods, I'm sure it's happening in everybody's household on the call. So we see a little of both there. Thank you. Good question.

Yes, and at the ports, right now, the business is still very high, right. The fall peak is lasting, and there will be a much stronger fall peak this year. Thank you, Cherilyn.

The next question is from Ravi Shanker from Morgan Stanley. Please go ahead.

Ghislain, I get the logic of not introducing full-year guidance when you only have one quarter to go. But can you give us any color on how we think of Q4 in terms of incremental margins or operating ratio? Given the pace of the volume recovery, do you expect a strong fourth quarter, or how should we frame that at this point?

Yes, not even a quarter left to go, but Ghislain?

Yes, I mean, Ravi, we try to get away from quarterly guidance, but I will tell you, as I said in my remarks, we do provide our volumes both on carloads and RTMs on a weekly basis. Looking at the month-to-date in October, I believe we're up 6% or 7%. So, I mean, I think we're doing quite well. James mentioned that grain has been a star commodity. Grain works; people need to eat, pandemic or not. Good news is on the significant investment that CN is making on the grain hopper cars; we will advance some of those cars that were slated to come in Q1 in January, advancing about 800 of those cars in Q4. I think that will help us start well on grain in front of the winter. So I think we should check our volumes every week, but right now, we are quite positive and favorable on what's happening.

Yes, Ghislain loves grain. Just as a reminder, I think this quarter discussing the mix KPI for volume to track would be more the RTM.

The next question is from Benoit Poirier, Desjardins Capital. Please go ahead.

Could you talk a little bit about the fact that you've been short on resources in Q3? Could you quantify the impact on the operating ratio and also about the available resources employees that can be brought back online with the number of cars and locomotives? Thank you.

Yes, that would be good question for Rob. We managed things quite tightly in the third quarter. Do you want to talk about the resource situation, Rob?

Yes, absolutely. Thanks for the question, Benoit. As you said, we saw sequential volume increases month over month during the third quarter, actually entering the quarter on a depressed number. We were down 17% for July, then improved to 9% in August, and we were flat in September. We're up 6% to 7% in October, as Ghislain just spoke to, and managed it quite well. It was a V-shaped recovery. We had over 700 locomotives out of service, nearly 4,000 people furloughed, and thousands of cars. We mobilized that quite quickly and really had the railroad running very fluidly. Throughout that, we were able to stretch ourselves, and as stated, we didn't bring back resources one-to-one; we found that coming out of this V-shaped recovery, we can actually do more with less. We've had permanent cost takeouts, such as shutting down switching yards and locomotive shops. We completed the consolidation of our dispatch centers. Last year, we had three of those in Canada, and now we have one. We've managed to bring train velocity, car velocity, and dwell back up to where they were last year. We're proud of how well the team handled this significant downturn in the second quarter only to spike back in the third quarter. Thanks for the question.

Yes, the return of our employees back to work is a positive for many families out there. Capacity is a little tighter than it was, and the marketing team is tasked with actively managing yields. So, it is one of our teams in the quarters to come. Thank you, Benoit.

The next question is from Chris Wetherbee from Citi. Please go ahead.

Maybe touching a little bit on yields or cents per RTM and getting into the mix breakdown and price in fuel. Can you sort of disaggregate the cents per RTM for us? It seems like mix was a bigger headwind for you. I just want to ensure I understand the main drivers there and then maybe your thoughts around Q4.

Yes, we have given significant attention to that. So, James, maybe you want to provide the broader picture?

Yes, big picture-wise, the mix change we had in Q3 was driven significantly by the decline in energy carloads, crude, jet fuel, and similar products. We reallocated that capacity to move a record amount of grain volumes. We traded off some long-haul 2,500-mile crude business for 1,200-1,500 mile grain hauls. Moving forward, we believe there will be rebalancing; some of that crude business is coming back, certainly not to the 2019 level, but we expect to see some rebalancing on mix. Keith, do you want to mention the ports side?

Certainly. We value our overseas intermodal business, and while we have a balanced approach, the large influx of imports in Q3 happened quickly. The boxes weren't able to move through the supply chain efficiently, influencing our exports. So, that was another factor that may have shown up in the RTMs as an issue.

Yes, we had essentially a tsunami of imports, and a significant lag in exports affected our mix this summer.

The next question is from Fadi Chamoun from BMO. Please go ahead.

I’m trying to square the revenue increase and operating income increase for Q3 versus Q2, as it seems like the incremental under 50%, like high 40%. Meanwhile, it looks like your operating metrics performed well in the quarter, with Rob reporting data on train length, weight, etc. What explains the muted leverage we saw in Q3, and how should we think about this going into Q4?

Ghislain, do you want to discuss that?

Yes, when you look into the details, there was some labor expense that came in that isn't necessarily related to headcount. When we talk about the labor variance, there was about CAD30 million due to two factors. One, a reversal of an accrual of a bonus from last year, and two-thirds was a true-up into our incentive compensation related to some performance share units. So that impact created a variance quarter-to-quarter that isn't directly related to headcount. Additionally, depreciation continues to be a headwind, as we've indicated; it’s approximately CAD130 million headwind annually. Pension also remains a headwind, which we've mentioned has a CAD50 million impact. These factors influence the metrics in our costs.

And maybe one last thing, we've reopened our training center in Winnipeg and Chicago, meaning that we will see some unproductive labor here because we are training people to meet the expected volume growth of 2021, as they remained closed in the second quarter and just reopened mid-summer.

The next question is from Scott Group from Wolfe Research. Please go ahead.

I want to go back to the last question about sequential incremental margins, where depreciation was down and pension shouldn't be a sequential headwind. Should we be thinking about give-or-take 50% incrementals or maybe better or worse going forward? Two specific modeling questions: other revenues were down 25% year-over-year and down sequentially; any thoughts there? And then comp per employee was up 12% year-over-year; any thoughts there?

Ghislain, do you want to address the earlier question?

Yes, based on Scott’s question and the earlier conversation, the labor expenses mentioned earlier explain part of it for certain. I'd add that depreciation continues to influence metrics and impact us too.

Could you address those other revenue questions and comp per employee going forward?

James, would you like to talk about other revenue?

Yes, our vessel revenue was slightly down on a sequential basis as would be expected. When we came into COVID, we had strong activity on the iron range, but we were drawing down inventory at a very fast pace with our vessel fleet. So we had a slight decrease on the vessel side of the revenue. The other revenue decrease, I'm not completely sure.

Yes, we moved less iron ore by vessel in the third quarter than we did the year before.

The next question is from Walter Spracklin from RBC Capital Markets. Please go ahead.

I want to turn to Halifax, especially with the strike at the Port of Montreal. You had the opportunity to see how Halifax handled the diverted volume. How would you characterize how Halifax performed, and what did you learn from that, which could be improved as volumes expand into the East?

Yes, I can take that. We never serve the City of Montreal; the city of Greater Montreal is served directly by vessels coming right into the area. Typically, we are not set up to serve the city exclusively by rail from another port. A 72-hour notice for a strike created challenges; we had to send empty trains to Halifax to pick up imports. We ended up with essentially one-way freight. Exports queued up in the port, but couldn't leave, resulting in a poor mix for us this quarter. In terms of profits and yield, this strike negatively affected us. When dealing with such short notice, our terminals in Valleyfield and nearby locations had to quickly open to accommodate imports. We could handle a lot more freight if given more advance notice. I don't think we conclude much from this exercise, as strikes typically leave very short notice, affecting overall service received.

Walter, I'd like to add that we are not reliant on just one outlet for our business. It wasn't solely a Halifax increase; vessels were also diverted to St. John's and New York, New Jersey, Philadelphia effectively. We have multiple outlets for customers, and you'd want to take all of that volume into account rather than focusing on just one port.

The next question is from Brian Ossenbeck from JPMorgan. Please go ahead.

One more question on mix, can you quantify how much impact that had in the system with the mix shift in some dislocations seen in Q3? I imagine that would be more one-time in nature compared to the top line impact? When looking at your service metrics for intermodal and bulk, which were trending down year-over-year in the quarter, was that affected by the mix shift or what caused that, and how do those look at the start of Q4?

Maybe, Brian, I can start, and then I'll pass it to James. The strike in Montreal is a one-time event; they're back in operations. Additionally, we had a tsunami of freight coming in from the West Coast, creating a lag for exports and causing service constraints. However, our train balance should improve as the capacity for exports back to Asia rebalance more effectively with the imports. The significant reduction in crude, diesel, jet fuel, and frac sand clearly indicates we will take time to restore energy markets. We are shifting toward more domestic intermodal freight, grain, and other segments. Keith, do you want to talk about exports balancing with imports?

They are now balanced. We are receiving many empty foxes heading to the prairies to pick up exports, as well as many transloads across our network.

As far as how the railroad is operating, we are fluid and in good shape heading into winter. We are handling more volume than this time last year, which indicates that we have worked through our operational challenges effectively.

Yes, we have very solid gross ton miles currently in the network. Thank you for that addition, Rob. Thank you, Brian.

The next question is from Konark Gupta from Scotia Capital. Please go ahead.

How do you view margin improvement into 2021 as volumes recover into year-end and next year with new contracts expected? You mentioned opportunities in coal, intermodal, grain, and automotive. What can we expect in terms of margin improvement from these contracts and organic recovery?

Ghislain, do you want to discuss this without providing guidance?

Yes, as 2021 approaches, if you look at consensus, people believe that next year GDP or industrial production will rise by 4% to 5% versus 2020. Not just us as the railroad but economists as well are seeing this growth coming next year. As we recover and as Rob discussed, we are not adding resources one-for-one; we made significant permanent changes during the pandemic. Consequently, you can expect our margins to continue to improve. Furthermore, as we continue to deploy our technology, exciting technological projects will create value. You can expect that these factors will lead to margin improvement over time, and we are quite optimistic about that.

Rob, do you want to add some color on costs going into next year?

We have good momentum, as we’ve found efficient ways to operate through this pandemic. We expect this momentum to continue as we move into Q4 and next year.

Thank you. Do you have any permanent cost-out initiatives pending for next year?

Yes, absolutely. As we develop our plans for next year, we will double down on what we implemented this year and introduce new initiatives into 2021 to realize further cost reductions.

We will have the full-year impact of what we've done this year moving forward into next year, so we're quite optimistic about our plan going forward, Konark.

The next question is from Jon Chappell from Evercore ISI. Please go ahead.

You mentioned this earlier, Keith, but intermodal volumes have been very strong on both an absolute and relative basis. How much of that is Rupert and Vancouver taking share from congestion-related issues in Long Beach and LA? Given the fluidity of your network, what’s your confidence in maintaining that market share as the imbalance in the North American system normalizes somewhat?

Keith?

We pride ourselves on exceptional opportunities created for customer supply chains servicing the U.S. Midwest and Canada. Whether it's a shift away from the West Coast or from one carrier to another, those businesses are aware that the Rupert and Vancouver gateways into the U.S. Midwest on CN work seamlessly. Many articles discuss potential shifts over a longer timeframe, but our focus is on ensuring resilience in our supply chains. We are committed to aligning capacity with what our partners are doing to prevent pinch points that create disruptions.

Yes, Rupert is running at capacity right now. We have realized 1.35 million TEUs this fall, so it’s not just about taking more freight but rather making smart selections of the freight we do handle.

The next question is from David Vernon from Bernstein. Please go ahead.

Looking at the eastern ports, you're effectively doubling capacities sequentially. How long do you think it will take to grow into that capacity expansion, and do you anticipate needing to spend additionally to connect that traffic to what have been lower-density lines?

Well, I think quite…

Yes, to clarify, regarding the East Coast, as our partners increase capacity and we coordinate our marketing to support business growth, our eastern network is underutilized. It was built during periods of higher manufacturing. Some parts of that railroad, particularly in the East, are ideal for handling higher volumes in operations, including double and triple-tracked sections, allowing us to smoothly handle these volumes. We are intensively working with our partners to expand business through the Halifax to Chicago Midwest corridor over the next couple of years. We also have customers ready to bring vessels in today, showcasing our efforts and marketing in the East for increased traffic.

Yes, and I believe we also have development projects moving forward in Mobile, Alabama.

Our partner Maersk has announced that a vessel that normally had its first call in Houston is now listing Mobile as its first call, marking a direct service from Busan, Korea. We hope to see automotive traffic increase through this channel and additional opportunities for exports as well. It’s promising to see this step from Maersk.

We truly value our three-coast network.

The next question is from Jason Seidl from Cowen. Please go ahead.

JJ, you discussed some long-term threats, including autonomous trucks. I appreciate that you brought that up. Can you share your thoughts on how CN and the rest of the rail industry can prepare as that technology develops?

Thank you for the question. Many of us here recognize that competition from the road will intensify at some point. Therefore, we need to focus on our costs and consider how we operate our trains to ensure efficiency. But driverless truck technology is drawing considerable capital investment; we aim to better understand this trend. When will it occur? How can we prepare? We seek to leverage whatever benefits this transition presents, particularly for our intermodal network. We acknowledge this is a serious matter; being prepared for developments in autonomous trucks is key.

The next question is from Allison Landry from Credit Suisse. Please go ahead.

Your competitor mentioned potentially achieving a mid-50s operating ratio in 2021. I know the operating ratio isn't everything, but I'd like to hear your thoughts on finding balance between operating ratio improvement and ROIC longer term?

Yes, I can start. We're balancing multiple factors, including EPS growth, free cash flow growth, total shareholder returns, and operating ratios accordingly. It will be key to analyze crude contracts and all other essential factors; it’s about balance. What do you think, Ghislain?

Certainly, Allison. We have said multiple times, we aren’t enamored with operating ratios. We want to maintain our foundation; we implemented PSR 15 years ago, and we expect to be a CAD25 billion company at a 59% operating ratio versus a CAD15 billion company at a 56% operating ratio. It’s literally about evaluating the math. Looking ahead, we expect to improve operating ratio as we focus on yield. As we extract the benefits of deploying our technology, the operating ratio will improve. While we do not specifically target OR for 2021, we are identifying opportunities and executing accordingly, leading to an improved operating ratio as a natural outcome.

Yes, we certainly have a vision for growth and want to capitalize on that growth. It’s essential to make effective use of our capacity without allowing it to be distributed indiscriminately. Instead, we make strategic pricing decisions to ensure profitable revenue growth. We’ve noted that our compensation system doesn’t include OR as a factor in bonuses, which emphasizes how we balance our priorities.

The next question is from Tom Wadewitz from UBS. Please go ahead.

Can you provide insights on potential RTM growth from 2021? Historically, in past recovery periods following weaknesses, there were about 12% RTM growth rates in 2010 and striking growth in 2017. Is it reasonable to view 2021 as similar growth potential or are there reasons it could be more muted than a 10% figure?

Well, Tom, as I mentioned earlier, we have reopened training centers in Chicago and Winnipeg. This decision indicates that A) we wish to replace employees lost through attrition, and B) we want train start capacity to accommodate higher volumes. We also mentioned that the business mix will change post-COVID in comparison to pre-COVID due to the pandemic's effects on the energy sector. We are focusing on same-store prices over rail inflation. Additionally, several unknowns, such as U.S. elections, Canadian elections, or the second wave of the pandemic, need to be understood. We would like to see 2021 more closely aligned with or even surpassing 2019 figures; this will be our goal for our employees and the economy. We aspire to deliver faster growth than the average; our target is aligning with GDP growth and moving slightly ahead. We can offer more insights during the next earnings call for the first quarter of the upcoming year, as we work toward 2021 guidance.

Going back to the commentary about margin progression and operating leverage as you transition through 2020, if one normalizes for incentive compensation and considers the pacing of asset deployment tied to the volume recovery, must we expect underlying operating leverage improvements from 3Q to 4Q in comparison to what was determined in 2Q to 3Q?

Ghislain?

We aim to avoid quarterly guidance, but during the pandemic's early phase in the second quarter, Rob's team adapted swiftly, and now they’re supporting the recovery efforts. As recovery hangs on certain key markets influencing overall operational mix, we remain careful when adding assets and personnel. That's the best I can share for now. We are pleased with this quarter and the results we achieved.

Yes, let’s highlight that the railroad remains quite busy.

The next question is from Jordan Alliger from Goldman Sachs. Please go ahead.

Could you address your thoughts on employee compensation normalization going forward? I assume a lot will return when obstacles to headwinds are cleared, but any additional insights would be appreciated.

Rob, please outline how operationally we are managing our train weights, train lengths, and current positive trends in our operations.

Yes, absolutely. During Q3, we successfully increased train lengths, which allowed us to carry more freight with approximately 2,500 fewer employees relative to last year. Our labor productivity during this quarter increased by 17% year-over-year, signaling good momentum as we enter Q4. Our focus will continuously center around making our operations as efficient as possible.

We appreciate your engagement. We have time for one more question.

The next question is from Justin Long from Stephens. Please go ahead.

In your comments near the beginning, you mentioned modernizing the network. Has the situation changed how we should view your CapEx framework for revenue in the coming year? Also, with volumes returning, have you reassessed locomotive modernization opportunities?

Rob, could you elaborate on rolling stock and technology investments?

We will continue investing in technology. While we have yet to finalize CapEx plans for next year, I can assure you that we intend to advance our technologies. As previously mentioned, our autonomous track inspection cars are now in phase two, which ensures safer operations. They are integrated into regular revenue service and now in phase two, we can also remove regulated inspections. We established 41 algorithms for our autonomous inspection portals, aiming to reach 55 by year-end. We will expand our portals from seven to 100 by this time next year. The real value lies with the ownership of these proprietary algorithms. Although others may install portals, we own the methodologies necessary to identify defects across the numerous types of cars and the various components they contain. This is a competitive advantage, and we will continue advancing those efforts.

As for CapEx, Justin, we will provide insight into 2021's figures on the January earnings call. Historically, our capital envelope remains around 20% of revenue; we had two years of high CapEx in 2018 and 2019 at about 25%, addressing our catching up. We have caught up and want to stay ahead. We remain comfortable within that range, but as mentioned, we’ll provide updates in January. Please stay tuned.

Thank you. Thank you, Ghislain and Rob. Thanks to all for your questions. We commit to pricing above inflation while managing yields. The commercial team efficiently drives productivity. We have established steady and solid cash flow, and we lead the rail industry in modernization. We maintain momentum leading into Q4, and we are constructively positive about 2021. Conclusively, our vision is about sustainable, profitable growth. On that note, good night to everyone. This marks the end of the call, and we look forward to connecting again in January. Thank you, Patrick.

You're welcome. The conference has now ended. Please disconnect your lines at this time. We thank you for your participation.