Canadian National Railway Co Q1 FY2022 Earnings Call

Good afternoon. My name is Donna, and I will be your operator today. Welcome to CN's First Quarter 2022 Financial and Operating Results Conference Call. I would now like to turn the call over to Paul Butcher, Vice President, Investor Relations. Ladies and gentlemen, Mr. Butcher.

Good afternoon, everybody, and thank you for joining us for CN's First Quarter 2022 Financial and Operating Results Conference Call. Now before I 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.S. and Canadian securities law. These statements are subject to risks and uncertainties that may cause actual results to differ materially from those expressed or implied in these statements and are more fully described in our cautionary statement regarding forward-looking statements in our presentation. After the prepared remarks, we will conduct a Q&A session. I do want to remind you to please limit yourself to one question. The IR team will be available after the call for any follow-up questions. Joining us on the call today are Tracy Robinson, our President and CEO; Rob Reilly, our Chief Operating Officer; Doug MacDonald, our Chief Marketing Officer; and Ghislain Houle, our Chief Financial Officer. It is now my pleasure to turn the call over to CN's President and Chief Executive Officer, Tracy Robinson.

Thank you, Paul, and good afternoon. And now let me start by saying how honored I am to be here with you today. I'm excited to be back in this industry and especially to be sitting in this chair at CN alongside an outstanding group of railroaders. We're working hard and excited about the future. Now I want to take a moment as we start to just acknowledge the difficult challenges being faced by the people of Ukraine these last two months. We all want to find a way to help. CN has donated more than $1 million in support of Ukrainians displaced by the war. And I'm so very proud of my fellow CNers who donated over $100,000 of their own money towards this important cause. Our company will provide a match for these donations, and our thoughts continue to be with the people of Ukraine at this time of unimaginable suffering. I know that you're interested in early thoughts on where we are as a company and where I see us going. My priority over the last two months has been to get out into the field and across the network, getting to know our team and our operations, our strengths and our challenges; you just can't do something like that from the office. I've also started to meet our customers and our stakeholders, some for the first time, and some whom I have known for some time now to get their perspectives on us and how we can work better together in the future. And I spent some time with some of you, and I've appreciated the feedback that you have offered to me as well. So as I sit here, 60 days in, with all of that, I can tell you that I'm more excited about our prospects than when I first arrived. At CN, we have an incredible tri-coastal network, the best on the continent, with the benefit of a diverse customer base across commodities and geographies and a pipeline of growth opportunities across most sectors. We have a healthy balance sheet that provides us with financial flexibility and the ability to be nimble in driving our growth. Now, this is a treasure, especially in these times of rising interest rates and market volatility. We're in the right spot as we continue our sustainability journey. And this team is deeply committed to safety as a core value. And we have a team here of proud railroaders and with the right team, everything is possible. Now we all know what this network is capable of delivering. And we would all acknowledge that we haven't performed fully to our capabilities over the last number of years. We're putting that behind us. And as we go forward, here's what we're doing. First, we're running a scheduled railway with a laser focus on velocity. This will help us deliver more consistently to our customers and to get the most out of our assets. Second, we will curate our book of business to better fit our network and leverage our strengths. Now, this means that we'll be more strategic about how we use our capacity to ensure that we can deliver effectively and that we position ourselves for the future, not yesterday. Third, we're going to work in a much more integrated manner between the way we operate and the way we sell. Between the way we invest and where we grow. And fourth, we'll continue to invest for the long term in both our network and our capabilities to drive efficiency and to position us for growth. And what all this will do is drive our top line growth to the bottom line in the near term and into the future. Now this is not all going to happen overnight. No important effort with undertaking does, but you have my full commitment that as a team, we will bring this company back to being best-in-class. That's our strategic goal and our daily focus. Now, I know that you're going to want more details on our plans. We're working through those now, and I'll be in a position to share a lot more as we advance our work and our plans become more definitive. So stay tuned on that. Now let me say just a few things about the year. We've updated our financial guidance for this year. Harsh weather, mostly in Western Canada, and supply chain disruptions impacted our ability to fully capitalize on the strong demand environment in Q1. The uncertainty from the war in Ukraine and the continuing pandemic disruptions in China and elsewhere, all suggest just a little bit of caution on the year. I expect our EPS growth to be in the range of 15% to 20%. And free cash flow in the range of $3.7 billion to $4 billion. And we expect to have a full-year operating ratio that starts with a 5. I'll note, this will be the first time we've delivered that since 2017. This will be a good year for CN, notwithstanding the global environment. I'm encouraged by our operating momentum since mid-March and through April. We are moving heavier volumes even without the normal grain, and our velocity and consistency is improving. Demand continues to be strong. We're expecting a more normal grain crop this fall, and we continue to monitor the situation in Europe and the shutdowns in China and how that could impact trade flow. Our team is working closely with our customers to ensure that we understand demand and that we can prepare for their needs. We will need to have the right resources, people, and power to respond to what we expect to be a busy year. Recruiting running trades, in particular, is a challenge in certain parts of the network as we look into the latter part of the year. So it's a tough start to the year, but we will deliver to this financial outlook. I am both excited and confident about the future that lies ahead for CN. So I'm going to turn it to the team to discuss the quarter. I have Rob and Ghislain here with me, both of whom you know. I also have Doug here today, our new Chief Marketing Officer. Now many of you have had the privilege of meeting Doug over the years during Investor Days and the like. He brings a wealth of experience in sales and marketing but also in operations where he served as VP of our Eastern Division and in IT, where he was a Senior VP of Information and Technology. He knows our markets and he knows our organization. I'm looking to Doug to work closely with Rob and Ghislain to bring immediate focus to our integrated plan and execution.

All right. Thanks, Tracy. And first, thanks to the dedicated team of CN railroaders who helped get us through a very tough winter season, where we saw Tier 2 operating conditions in place for nearly 85% of the days in January and February. And as a reminder, Tier 2 is when conditions are minus 31 degrees Celsius and colder, which forces us to reduce train size, use more locomotives and crews, and overall, be able to move less freight through the very cold portions of our network. With the weather moderating at the end of February, we were able to regain fluidity on our network in the month of March. We are working closely with our customers that are continuing to face supply chain challenges, particularly in the merchandise sector. We saw all of our core metrics rebound in March and continue to improve in April with our daily GTMs up 24%, our car velocity up 35%, train speed up 18%, and our train length up 9% from the January lows, allowing us to get back to running a more scheduled railroad. As we look forward to the remainder of the year, we are working to have the resources in place to accommodate the growth expected in the second half of the year. And finally, while the extreme weather conditions in Q1 contributed to degradation in our accident ratio, our team of railroaders continued to reduce our injury frequency ratio with an 18% reduction year-over-year, reinforcing that safety is a core value at CN. With that, I'll turn it over to Doug.

Thank you, Rob. Let me start by saying how excited I am with the opportunity of leading the sales and marketing organization, leveraging the best network in the industry and delivering value to our customers. Let me provide you with an update on our top line performance in the quarter. Revenues were up a solid 5% to around $3.7 billion despite volumes on an RTM basis being down 8%. The volume drop did not come from demand, which remains strong, but was mostly driven by extreme winter conditions in January and February, as Rob just said, continued supply chain challenges, and a weaker Canadian grain crop. We did experience significant volume increases in certain markets: U.S. grain shipments to the Gulf Coast for exports, Canadian coal from the new Teck business, as well as two coal mines that reopened in late 2021. Broad-based growth in petroleum products and higher frac sand shipments from our unique reach into Western Canada where drilling activity is strong. As we look out for the balance of the year, we are still expecting volumes to be up in the low single-digit range for 2022 with broad-based growth across most segments. We are assuming a normalized Canadian grain crop starting in the fall. Let me conclude with the following. The current demand environment is strong, and with improved network fluidity, our focus is to improve our service to our customers and drive this growth to the bottom line. Our yield management strategy is broad-based and is backed by a solid pricing environment. I'm working very closely with Rob's operating team so that we are fully aligned to deliver the service required for our customers during the ongoing recovery. With that, I'll pass it on to Ghislain.

I will talk to Page 12 of the presentation and provide more visibility on our first quarter performance. As Doug mentioned, we experienced a solid top line performance despite volume in terms of RTMs being down 8%. Our ability to move the strong demand was impacted in the quarter with very harsh winter conditions and continued supply chain challenges. In addition, geopolitical risks have put significant pressure on fuel prices over the short term. Despite these headwinds, our team of railroaders delivered 7% growth in adjusted earnings per share year-over-year. Let me provide you with more details on the quarter. My comments would reflect adjusted results which exclude advisory costs related to shareholder matters. The condition I just referred to impacted the fluidity of the network leading to cost headwinds such as recrews, deadheads, and more snow clearing to name a few. We continue to benefit from the non-operating headcount reduction that took place last fall as average headcount was down 7% in Q1 versus last year. Our fuel expense was up 44% as we saw fuel prices significantly rising in the quarter, with WTI touching around USD 125 a barrel and on-highway diesel prices spiking up in March, up 27% versus February. We have an efficient fuel surcharge program that deals with fuel price fluctuations like this, but it does create some noise in the short term. In the quarter, we were impacted with unfavorable fuel surcharge lag of $0.07 of EPS versus last year. Our Q1 adjusted operating ratio came in at 66.6%, which was 30 basis points higher than the same period last year and reflecting the headwinds I just highlighted. We delivered adjusted net income of nearly $925 million in Q1 and an adjusted diluted EPS of $1.32, up 7% versus last year. We generated free cash flow of $571 million for the quarter, up $31 million from last year. The increase was mainly from proceeds on the sale of non-core branch lines, which was partly offset by lower net cash from operating activities. During the quarter, we repurchased shares in excess of a simple dollar cost averaging approach as we clearly saw value in repurchasing at the prices that prevailed in early Q1. 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. In conclusion, let me reiterate a few points. The current demand environment remains strong, which should translate into solid volume growth for the balance of the year, including a normalized Canadian grain crop. Network fluidity definitely started to improve in the latter part of March and is continuing in April. We are closely monitoring inflationary pressures with the continued uncertainty in the world. With that, I have full confidence that the team will deliver on our 2022 financial outlook, including a 15% to 20% growth in adjusted diluted EPS versus 2021. We have the best network in the industry, and we know what this network can produce. Let me pass it back to Tracy for some closing comments.

Thanks, Ghislain. And let me close by saying again that I'm excited and energized about building the railroad of the 21st century. This is a great company with significant potential. Our focus is on unleashing the capabilities of this exceptional network and this experienced team of railroaders. We're going to focus on driving long-term sustainable growth to the bottom line as we run a scheduled railroad focusing on delivering for our customers. And we'll invest for the long term in our talent and develop the next generation of railroaders to invest in our networks and our capacity to accommodate our pipeline of profitable growth opportunities. So our goal will deliver long-term value for all of our stakeholders. We are the best in the business. Now we're happy to pause here and take your questions.

Thank you. We will now begin the question-and-answer session. Your first question comes from the line of Jonathan Chappell from Evercore ISI.

Tracy, I know you're only 60 days in, and you've laid out some of your ambitions already. You did step into a pretty big, wide-spread corporate strategic plan just adopted six months before you started. So I'm just wondering, given some of the uncontrollable headwinds that you're seeing in the market today, are there any areas of that September plan that you think need adjusting, whether that's the growth-focused element of it, the resource-based or some of the strategic initiatives?

It's an interesting question. Listen, the most important thing we all do every day is make sure that we provide the service that we've committed to our customers, and we're all focused on that. Now the supply chains in the last two years, two and a half years, there's been a big shock in the supply chains, and we're working very hard to get our rhythm back and our operation back and to serve our customers well. Each one of us in the industry will have different challenges on that. And I'm going to ask Rob to make some specific comments around some of the proceedings that are taking place in the U.S., Rob?

Yes, Konark, we certainly understand the concerns of STB, and we're working with the STB to provide the potential solutions there. And especially with our customers on any service issues that may arise. At CN, we do have a very strong track record in terms of growth, particularly in the intermodal space and also the investment to help support that. So customers are a big part of what we do, and we're going to continue to stay partnered with them and work with the regulator in this case, the STB. I'll be there tomorrow and look forward to the discussion. Thanks for the question.

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

I have a clarification question before I ask mine. You've mentioned a forecast of an average crop on three occasions during this call, but the details of your 2022 assumptions indicate you're expecting an above-average crop for 2022 and 2023. I wanted to clarify that. Now, Tracy, the company has been focusing on the right freight for years. Can you explain what constitutes the wrong freight? Is it simply a mispricing of business? Please share your thoughts on what needs to be addressed regarding freight.

Thank you, Ken. It's great to hear from you again. The key point is to be intentional about what we allow on our network and to understand our capabilities. When we manage traffic, we must be able to deliver effectively. First, we need to comprehend our operating plan's capacity and capability and then sell accordingly, ensuring we can consistently meet our commitments to customers. Once we achieve that understanding, we can truly grasp our capacity and then pursue sales based on that insight. From there, we can look at the excellent growth opportunities ahead of us. Now, I'll ask Doug to address your initial question regarding the grain crop assumption.

Ken, just to clarify. So the industry always talks about a three-year average. That would be the prior three years. What we're doing is we're talking more of a normalized. So we've eliminated the drought year last year. So we just have a more realistic view of a normal Canadian crop. That's all.

Okay. Don, congrats on the new job, and Tracy, welcome and good luck.

Thanks so much.

Your next question comes from the line of Brian Ossenbeck from JPMorgan.

Tracy, if you can just clarify, you mentioned the investment in the past. How are you going to measure that internally from a team? And then just a follow-up on the 12 view on technology application event, probably still a little early, but the railroad has clearly been one of the big proponents of the client technology and towing along the DSR path in the past?

Brian, could you please repeat the first part of your question? I heard the second part about technology, but I didn’t catch the first part.

I'm sorry. You mentioned talking about being best-in-class, returning about what's being best in class. Is that on a warrant perspective, that EPS growth? How would you measure that?

When I left this industry, CN was the leader that everyone else was following, and we all understand what this network and team can achieve. It's not just about the operating ratio or growth; I believe it's both. To grow, we need a streamlined, efficient operation that responds quickly and delivers effectively to our customers, and that's how we'll unlock our real capacity and drive growth. This company knows how to accomplish that, and there is a lot of experience here. I’m eager to be part of that. Regarding technology, I haven't explored it in depth yet, but I can say it’s one of the notable changes I've observed returning to the industry. It's exciting to see the new ideas and capabilities being implemented. I know this company has many initiatives in that area. After 60 days on the job, I haven't delved deeply into it yet, but I'm enthusiastic about the potential it holds. Thank you for your question.

Your next question comes from the line of Cherilyn Radbourne from TD Securities.

Tracy, I've got another one for you. In terms of your objective to curate the book of business, I do appreciate it's still early, but I was hoping you could give us a bit of perspective on how you see intermodal in terms of the scale of that growth opportunity and how attractive do you view that opportunity relative to the return on capital?

Thanks, Cherilyn. Intermodal is an important part of our book. And I think it is now and it will be in the future. The question for us, we've got a really strong pipeline of growth opportunities, and they'll all call upon different parts of our network differently. So it's not a single answer. As we look at this, it's going to be about being intentional about putting the right volume on the right parts of our network so that we can deliver effectively. And when you can do that and you can do that with some velocity, then you tend to like the returns that you get on the capital that you invest. So we're getting into that work now. I can't tell you exactly where it's going to end up. But as I said earlier, I'm excited about the prospects here.

Your next question comes from the line of Chris Wetherbee from Citi.

Tracy, the answer to your first question was at least a little muffled as far as I could understand it earlier in the call, so I apologize. But I was hoping maybe you could kind of give us your perspective on what you think the strategy of the company should be relative to the operating ratio versus balancing that with your profitable growth. I know it's ultimately the goal, I think, for every railroad. But wanted to get a sense, obviously, leading up to you being named as the CEO, there are discussions about taking a PSR path or revisiting a PSR path and potentially different folks who were interested in the job at one point who had different opinions about that relative to maybe where the company had been before. So I really want to make sure I understand the perspective you bring to the table when you think about balancing things like operating ratio relative to top line to the volume growth.

I apologize if the previous comments were unclear; I will speak more slowly this time. The industry has transformed significantly over the past 10 to 15 years. It is now essential to maintain a tight and efficient operation. We will achieve this by focusing on a well-balanced, scheduled operation with an emphasis on speed. This strategy will enable us to consistently deliver to our customers, maximize the use of our assets, and gain better visibility into our available capacity, which will help us determine how to optimize our sales. In my view, a tight, efficient operation is crucial for driving top line growth, and that growth is only valuable if it translates into bottom line improvements. We intend to pursue this by committing to a scheduled approach and prioritizing speed, ensuring that we effectively manage our assets and are deliberate in our business decisions. I hope that clarifies things. Thank you.

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

Tracy, hearty congratulations on the appointment. I'm trying to understand your philosophy around running a business, what a railroad needs to accomplish. And so the question is, three to four years from now, if we can fast forward to that point, if you look back, what would be a successful outcome for you? And I want to leave it open-ended because I want to understand your philosophy, but I would ask if you could to be somewhat specific so we can understand how you are going to gauge a successful outcome over the next three to four years.

Thanks for the question, Amit. So look, with 60 days in. So let me say this for now. Three to four years from now, what we will have done is exactly what we're talking about today, the focus on driving long-term sustainable value. So the way we're going to do that is give velocity and scheduling to the operation, we're going to move our assets quickly. We're going to sell into our network. We're going to drive our top line growth to our bottom line. And then we're going to lift our heads and look at what is a very healthy and interesting pipeline of growth opportunities for us. And as I said, we're doing a little work on this right now. And we'll be happy to share a lot more details on it as our plans crystallize and we get all the specifics in place.

What is the operating ratio? Is it growth or something else? The success of railroads has typically been measured by an impressive operating efficiency ratio. In a business with fixed costs, growth and margins can coexist, which has been the message from C&I for several quarters. I want to understand your perspective: do you see an opportunity for C&I, with its network and potential for velocity, to become the leading operating ratio railroad in the industry in three to four years? Is this an important opportunity for you in achieving a successful outcome?

As I consider how to gauge success moving forward, my focus will be on long-term growth and profitability. The key metrics we will monitor include compliance with our plan, operational speed, growth performance, and profit margins. The operating ratio is significant, and I believe our network and team can excel in this area. An efficient operation and favorable operating ratio enable us to pursue growth opportunities and enhance our profitability. That's my perspective on this matter.

Your next question comes from the line of Walter Spracklin from RBC Capital Markets.

Just a question on the strategic direction of some of the non-core items that have been highlighted previously and just your thoughts on those. I'm referring to trucking operations. Do you view trucking as a growth enabler, or is this a non-core business that you'd look to shed? And are there any other similar types of non-core opportunities that you could see through divestiture going forward?

It's an interesting question. And what I can say now, Walter, is that we're going to continue to evaluate all those pieces of our business. I am aware that there has been some discussion in the past around what we should do with those. There's no change in direction at this point. We're focused on ensuring that we've got the right business on our network for our network and making sure that top line goes to the bottom line in the most effective way. I want to be part of evaluating those options. So I've laid out what our first priorities are. But as we lift our heads in a few months here and start looking at longer-term growth and what choices we're going to make, I want to ensure that we look at all of these pieces through that lens. We have this great advantage network and a strong set of growth opportunities. I can't tell you yet which ones of them will factor in over the long term. But I think we've got some great choices, and I'm pretty excited about getting into this.

Yes, that's right. Walter. We're still assuming that we may reorganize TransX as we publicly said. That's still on the table. And as Tracy said, she's going to review this with us. And I would stay tuned with what we decide to do, but we're reviewing.

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

So Ghislain, I want to kind of stick with you for a second on the guidance. When we take a look at the first quarter RTM performance and look at the fine print, they are expecting up low singles, I think it implies sort of mid to high singles RTM growth in the back half of this year or the next two quarters anyway. How much have you sensitized that against what could happen as a result of the China lockdowns and intermodal and Rupert? And as you think about kind of the puts and takes from this year's guide to adding in sort of the annualization of coal growth and the expansion of Rupert. How good are you feeling about that '23 to '22 OTM build? Not looking for guidance on '23, just kind of some of the puts and takes would be helpful.

I'm going to take that question and then pass it over to Ghis. As we've updated our outlook for the year, we've factored in all of that while projecting an EPS growth range of 15% to 20%. This is based on the normalized crop levels from a grain perspective, which is crucial for us to meet our goals this year. We are closely monitoring the situation in China and other regions, particularly regarding the pandemic, as that poses a risk. However, as we look toward 2023, I believe we will see a return to normalcy. Ghis?

Yes. And I think as you said, I think that currently, as Doug mentioned in his remarks, we see the demand being very, very strong. But as you know, sometimes, this can change quickly. But at this point, we see this demand being quite strong. And actually, what we're doing is we're hiring. And Rob talked about this to make sure that we can deliver on good customer service in the fourth quarter. So we are hiring, and all hands on deck, especially in Western Canada where there are some locations that are harder to hire. So at this point, we see the demand being quite strong, but we are monitoring the global environment very closely because things are volatile and things change. But at this point, we're quite bullish and we're quite comfortable about this 15% to 20% EPS guidance.

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

So the idea of being intentional with the business, when does that start? Is that reflected in the volume guidance for the year? And then maybe, Tracy, your perspective on the balance sheet, you guys have the lowest leverage ratios in the industry. Is that something that is important to maintain? Or do you think that there's potential there.

I'll begin, and then I'll turn it over to Ghis. Regarding volume, I’ll let Doug address that shortly. Our guidance for this year reflects all the assumptions we've discussed with you. Demand remains strong, and we'll monitor how it develops. In terms of capital allocation, I appreciate that we have a robust balance sheet, providing us with flexibility. When considering capital allocation, our priority will always be on long-term value. Building our business will remain our foremost concern, and we aim to keep our strong balance sheet intact. After addressing those priorities, we will contemplate additional shareholder distributions, as we have in the past. Currently, it's an interesting time to recognize the benefits of having a strong balance sheet as we enter a period of heightened inflation. Now, Ghis will go first, and then possibly Doug.

No, I think you've covered it well, Tracy. The use of our balance sheet remains the same, and the primary use of cash is towards the business. We regularly discuss leverage. For this year, we are committed to a share buyback of $5 billion, which we have been executing since February. Ultimately, the key is to use the balance sheet to create long-term shareholder value, and that is our focus. Doug?

Thanks, Ghis. I want to emphasize that our plan includes all of our current business. It's fully integrated and we have faith in it. Additionally, we have a robust pipeline of other opportunities. As we evaluate these, we need to consider how they fit into our network and how we can manage them. This involves being selective about how new opportunities align with our operational environment and Rob's team, as well as determining when we can implement them. Overall, we feel confident that we'll be able to achieve all our targets.

Just if I can clarify one thing about investing in the business. You guys had a long period of spending over 20% of revenue on CapEx. I think this year it was closer to 17%. Any thoughts on where that trends in the future?

Yes. I think we're still on 17%, Scott. I think that when we do reassess our investments on a regular basis. And again, like just rest assured that if there's a good project that's got a great return, we're not going to turn it down just because we want to get to the number. I mean, we'll do the right thing for the long-term shareholder value that this will create. So I think at this point, I would tell you that we're still in the 17% of revenue range.

And your next question comes from the line of Steve Hansen from Raymond James.

Just a question on the service reliability and fluidity improvements that you're starting to see. I think we all understand there's been a number of constraints for specific industries. Forestry and fertilizers both come to mind recently across the broader North American platform. But how long do you think it takes to get back that fluidity and customer service that you had and known historically so well for?

Yes. This is Rob. Thanks for the question, Steve. Appreciate it. In terms of fluidity, the railroad, like I said in my comments, we've really rebounded quite nicely. And actually, we're seeing our metrics back to where they were pre-BC flooding. Doesn't mean there's always room for improvements. We recognized through January and February, just with the weather impacts itself, that had impacts on our customers. And we continue to work with them and particularly out where you're at in British Columbia with some of our forest product customers. And that will be our continued focus going forward. But from a railroad standpoint, we're very fluid right now and really focused on service to our customers. Thanks, Steve.

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

Yes, I wanted to understand better what you have in mind for improving operations. I see you're focusing on increasing speed. However, it seems like changing the schedule or expanding the sidings could potentially help with that, and adjustments to the schedule might allow for quicker progress. Tracy, what are your thoughts on whether there are operational changes that can be implemented in the next six to twelve months to improve the network? Or does this seem more like a two- or three-year effort to achieve meaningful improvements? Any insights you could share on your plans and the expected timeline would be appreciated.

Thanks, Tom. So this team has done a fantastic job over the last six months of working through some pretty significant service disruptions in the Western Corridor last fall and right into a very difficult winter. As we've regained our fluidity, as Rob says, it gives us an opportunity to look at the business that we're moving and whether it's led to a balanced operation, right? So I think we've got some near-term opportunity as we think about building some balance into our operational plan and then selling into that balance. So there'll be some near term. We're going to work on that right now. See what we can get done this summer before what could be a very heavy fall hit. But overall, it's going to be a longer-term effort to find that right sweet spot between the balance, velocity, and volume growth. I don't know, Rob, if you want to add anything to that?

No, I think you hit it. The opportunity is ahead of us, and the railroad has recovered quite nicely from the challenges in January and February. And we look forward to preparing for the second half of this year in terms of the volume growth.

And your next question comes from the line of Justin Long from Stephens.

I wanted to ask about the 2022 guidance. How much of the trend in the EPS guidance was a function of the first quarter and some of the weather events and supply chain issues you faced versus a change in the outlook for the remaining three quarters? And then specifically on the OR, I was wondering if you could unpack the change in the outlook there from 57 to sub-60. How much of that is fuel versus other items?

Yes, Justin, thank you for your question. When we review our guidance, moving from a 20% estimate to a range of 15% to 20%, it is clear that the first quarter's 7% growth has influenced this change. Additionally, we achieved a 66.6% Operating Ratio in Q1, which has also impacted our outlook. However, the positive aspect is that demand remains strong, and the pricing environment looks favorable. As Rob mentioned, our operations are getting back to a normal rhythm, noticeable in late March and throughout April. It’s important to note that we will not separate fuel costs from the Operating Ratio in our initial guidance. Fuel consumption is part of our operations, and we anticipate an Operating Ratio that starts with a 5. We have projected fuel costs for the year to be between $90 and $100 per barrel. While we have an effective fuel surcharge program, it can introduce variability, and it resulted in a $0.07 EPS unfavorable lag in Q1. Overall, after thoroughly analyzing all these factors, we are confident in delivering on our updated guidance. Thank you for the question, Justin.

Your next question comes from the line of Brandon Oglenski from Barclays.

Congrats to Tracy and Doug. Tracy, obviously, Canadian National used to be viewed really best-in-class with a really great culture. But you did mention in your opening remarks about getting operations and marketing and sales efforts maybe a bit more aligned. I don't know if you want to hit that one or Doug. How is this changing? And maybe can you push the culture in a more favorable way to get better outcomes there?

I would like to start by expressing my admiration for this exceptional company, which is one of Canada's leading icons. During my visits across the property and my interactions with our employees, I have been truly impressed by the talent and enthusiasm displayed, along with a strong commitment to succeed. The initial step we need to take is to enhance collaboration between our sales efforts and network operations, something we have already begun. This will open up significant opportunities to improve our immediate results while also allowing us to work together more effectively to identify opportunities and tackle challenges. In a network like ours, an integrated approach is essential, combining finance, operations, and commercial aspects to create a harmonious balance. We must align our operational building with our sales initiatives, as that cooperation is crucial for driving bottom-line growth. I see a lot of positive energy in the company as we embrace this direction, and I am very optimistic about our fantastic network and the opportunities ahead.

Thanks, Tracy. So listen, the teams have always worked well together. So the sales and marketing team has always been hand-in-hand with the operating team. But a lot of it has always been, hey, let's sell, let's operate. Now it's let's sell and operate together. So it's going to be Rob's team and the sales and marketing team at the table saying, here's where we have the assets. Here's where we actually have the fluidity. Here's where we have the actual capacity to handle them. Can you guys sell them to that? Sure. Let's turn to sales and marketing guys, let's do that versus here's where we have some sales opportunities, hey, Rob and guys, can you build the capacity here? So it's going to be a lot more give and take and working together to make sure we get the best value for the railway and drive all that new business to the bottom line.

Your next question comes from the line of Ravi Shanker from Morgan Stanley.

Tracy, welcome, and thank you for all the thoughts today. If I were to continue the line of questioning here. Correct me if I'm wrong, but I think in your prior role, you were a rail customer and may have been a CN customer side as well, so I'm wondering if there's anything that you're bringing to the table on day one. You could have ever thought to yourself those people at CN, if I was ever their CEO, what I do on day one? I think, again, maybe a general railroad versus a super question or a specific question about CN and your experience there. But what is your experience as a shipper kind of bring to the people here?

Ravi, actually, I wasn't a customer of the railways. In some regards in the energy industry, I guess, we kind of competed with the railways. I ran the Canadian Natural Gas Pipelines for TC Energy, and I spent a lot of my time running a big operation, pipelines across Canada and a lot of time building pipelines. But no, I wasn't a customer of the railroads, but always been a fan of the railways, and it's an honor to be here and particularly in this company.

So from my viewpoint regarding the situation with crude by rail, is there anything you've observed from the other perspective that you believe could be quickly implemented here?

Well, listen, I think that I was in the oil side when I was in the energy industry, as I said it was in natural gas. But I'll tell you this. What I've learned over time is that there is absolutely a place and a need for both. There is no better path to be doing big volumes over long periods than pipelines play a great role there. Railroads are very nimble. You can come out of a pipeline in Hardisty and you can get to any market in North America on an existing rail network. And so that kind of flexibility and the ability to be nimble is pretty critical to the energy industry right now. So I think that they complement each other. I think you've seen that happen pretty effectively over the past number of years, and it will be an important part of our collective ability to serve the energy industry going forward.

Got it. I just follow up with a question on the second half volume outlook. I just want to clarify your comments on the kind of China lockdown situation and maybe some of the risk opportunities there. Do you see a potential for like a big international intermodal wave once these lockdowns in China are lifted? Or do you think it's going to be fairly normalized and kind of more of an overall macro view from this point forward?

Thanks, Ravi. It's Doug. The situation with the lockdown has led to another disruption in the supply chain, which we have been managing intermittently. Like other railways, ports, and warehouses, we expect that the next wave from China will create overcapacity along the coast, leading to inland flow issues and bottlenecks at the warehouses. We have experience dealing with these challenges now and are preparing as much as possible, though each segment of the supply chain has its limits. We will all contribute and collaborate with our customers to navigate through it. Thanks for the question.

Your next question comes from the line of Jason Seidl from Cowen.

I wanted to ask a little bit about headcount. Can you talk a little bit about your projections for headcount, excluding attrition? Are you going to grow that? Where is this headcount really targeted? And does CN and really the rail industry as a whole run the risk of hiring into a potential downturn given all the sort of economic, geopolitical, and potential supply chain black swan events that we have ongoing in the crystal ball that we have?

Yes, Jason, this is Rob. From an operating standpoint, of course, I mentioned we're resourcing up for the second half, and that's the demand we see in front of us right now. It is strong, and we're preparing for that accordingly. Obviously, there could be changes in that, and we'll adjust accordingly as those times come. But right now, we're preparing for that more normalized grain crop in Western Canada and the opportunities that are ahead of us. I think from an overall standpoint, you'll see our headcount down year-over-year because of the adjustments we made, and on the op side, we're hiring for volume, and it won't be necessarily on a one-to-one basis, but on the projections that we see in front of us. I hope that helps.

And your next question comes from the line of Benoit Poirier from Desjardins.

With the potential labor issues that LA Long Beach, we've seen a shift in market share from Western ports to Gulf Coast, Eastern ports. So could you provide some color about the market dynamics these days and opportunities you see with Halifax, St. John, and also Rupert?

Thank you, Benoit, it's Doug. I’ll take that. We have observed a shift towards the east, which I believe is something we've all recognized. While business remains strong in Vancouver and Prince Rupert, where we've sold out our capacity, Halifax is showing growth. Our Montreal operations are stable or slightly increasing, which is encouraging as it helps balance our network. We have ample capacity in the East, which positively impacts our bottom line. This balance is beneficial for us. We've also seen growth in Mobile and even in New Orleans. It's an exciting opportunity to discuss how our three coasts can work together across our network. We are optimistic about these shifts and hope to see more developments.

And our last question comes from the line of Jeff Kauffman from Vertical Research.

Tracy, it's great to have you back, and congratulations. So I guess all the really good questions structured at this point. So I'd love to think about the curate decision that you outlined. And I think I understand what you're looking to do with that. But I want to kind of shift beyond the downsizing in the cutting and the restructuring part to the growth part. And think about businesses that maybe CN doesn't do as much as you'd like it to today or businesses where you see larger opportunity with the assets repurchased. And just kind of give us an idea, this is obviously a multi-year process. But what kinds of business would you like to do more of than you do today? And what types of assets or what types of capabilities does the railroad need to handle that, that you're not in a position to do today?

Jeffrey, thank you for that question. This is one of the things that excites me the most. I mean, of course, we're focusing right now on lifting out of some of our winter operations. But as we lift our head and look forward, I am so impressed with the number and the range of opportunities that we have ahead of us. We're doing a lot of work right now thinking about how trade flows may change over the short term and the longer term. We have this great asset of having touching three different coasts and having optionality on all of those coasts. That positions us in a really unique way to think about how we step into some of the growth, whether it's as we've had the questions on today, some of the consumer products or container traffic, whether it's stepping in a different way with our partners in the industry, some of the domestic traffic or whether it's looking at the change in flows of some of the commodities as a result of what's going on in Europe or what I think will be a pretty fundamental change in energy flows over time. So we're going to have some really cool choices, and we've got the best network and the optionality to step into it in the right way. I don't have the answers yet, but it's going to be a lot of fun to take a look at it.

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

Thank you. Thank you all for your time today and for your interest. I'm looking forward to meeting some of you in person over the next few months, then we'll talk other than that on our Q2 call in July. Thank you and stay safe.

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