Canadian National Railway Co Q1 FY2023 Earnings Call

Good afternoon. My name is Lisa and I will be your operator today. Welcome to CN's First Quarter 2023 Financial and Operating Results Conference Call. All participants are now in a listen-only mode. And after the speaker's remarks, there will be a question-and-answer session, during which we ask that you kindly limit yourself to one question. I would now like to turn the call over to Paul Butcher, Vice President, Investor Relations. Ladies and gentlemen, Mr. Butcher.

Well, thank you, Lisa. Good afternoon, everyone, and thank you for joining us for CN's First Quarter 2023 Financial 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 laws. 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; Doug MacDonald, our Chief Marketing Officer; Ghislain Houle, our Chief Financial Officer; and Ed Harris, our Chief Operating Officer. It is now my pleasure to turn the call over to CN's President and Chief Executive Officer, Tracy Robinson.

Welcome to CN's Q1 earnings call. We appreciate you joining us today. Before discussing the Q1 highlights, I want to touch on some recent developments. I'm excited to share that CN, along with UP and GMXT, is launching a new premium intermodal service connecting Mexico, the US, and Canada. This service utilizes steel wheel interchange and combines the strengths of our three networks, providing the most direct route and fastest transit times between Canada and Mexico. It will enhance efficiency for our intermodal customers by allowing for larger payloads and facilitating a shift from truck to rail transport. This initiative exemplifies our collaborative efforts to enhance service offerings for our customers. We will continue to pursue such creative partnerships that help our customers access new and existing markets more efficiently. I’m also pleased to announce that we've reached a tentative agreement in Canada with the TCRC, which covers about 6,000 CN locomotive engineers, conductors, yard conductors, and yard coordinators. This agreement requires ratification by the TCRC membership, so we cannot provide details at this moment, but we appreciate the efforts of union leadership in reaching this agreement. Regarding safety, the secure movement of goods within the communities we serve across North America is a top priority. Our industry and company have made significant progress in enhancing safety operations over the years, and we remain committed to reducing and ultimately eliminating injuries and incidents while protecting our communities. We continue to invest in technology, training, leadership, and culture. While we are not at zero incidents yet, we are making strides. Following the derailment in Ohio earlier this year, all Class One railroads gathered to share our technology and protocols, resulting in the development of new voluntary safety standards for wayside detection. Each company is currently implementing these standards. Regulators should collaborate with us on safety improvements, utilizing a data-driven approach to connect solutions with root causes. Implementing ineffective solutions can hinder safety progress and disrupt supply chain performance. I'm proud to report that at CN, as of yesterday, we have achieved 838 days without a fatality and 650 days without a serious injury, marking the longest periods in CN's history and demonstrating that achieving zero incidents is attainable. Now, I'll provide more information on our safety progress before diving into quarterly results. First, I want to thank all CN employees for their hard work and dedication, which have led to strong performance. Some key highlights include record diluted EPS in Q1, up 38% on an adjusted basis; revenues increased by 16%, with 6% more volume handled efficiently; and an operating ratio of 61.5%, marking a 510 basis point improvement on an adjusted basis—the lowest Q1 ratio at CN since 2016. We're focused on converting top-line growth into bottom-line results, and based on a strong first quarter, we're updating our financial outlook. We now anticipate EPS growth in the mid-single digits for 2023, up from low-single digits previously. It's important to note that our views on the economy remain unchanged. Our current volumes reflect a mild recession, and we’re uncertain about its depth and duration, projecting negative North American industrial production for the year. The industry has faced similar challenges before, and we will emerge from this period. Our focus will remain on our scheduled operating plan. Ed will provide details on our current adjustments to volumes. We will avoid past mistakes by maintaining our workforce and capital investment plans. While margin leverage may be lower due to soft volumes, we anticipate improved leverage when volumes normalize. I’m pleased with the efforts of Ed and the operations team. Although we experienced a milder winter in Q1 compared to last year, it was still a typical winter. Our scheduled operations have proven effective, allowing us to recover quickly from winter challenges. We met our customer commitments. Ed will share further details, but I want to highlight that our origin train performance was 86%, which reflects our commitment to our operating plan. Doug and the marketing team are reporting strong top-line performance. Our commercial team is maintaining close connections with customers, and Doug will provide insights into Q1 growth drivers and our expectations for the remainder of the year. Now, let’s review our solid financial performance in Q1, which is shaping our updated financial outlook. Ed, over to you.

Thank you, Tracy. Let me start off by thanking all the CN employees that helped deliver a solid performance in quarter one. This team is delivering on expectations and I knew from the time I came back to this organization that they had the muscle memory to take CN back into a leadership position. This past winter was milder than the last year with about 45% of the days in the first quarter of this year facing some type of tier restriction in train length versus 65% last year. We still experienced some periods of extreme cold that impacted our ability to operate the railroad as efficiently as expected. What impressed me the most was our ability to recover from these events, demonstrating the resiliency of this network and our ability to serve our customers despite facing these challenges. As I said last quarter, railroading needs to remain simple and we have continued our focus on running a scheduled operating plan, which drives the velocity and creates capacity. This provides a level of service that Doug can sell to his customers. Let me highlight a few key operating metrics for the first quarter. I also want to echo what Tracy mentioned on safety. We are all committed to moving the North American economy and our goal is to make sure all employees get back home safe in a safe manner. I'm very proud of our safety performance with our injury frequency down 17% in this quarter and our accident rate down 41%. Car velocity averaged 211 miles per day in the first quarter, up nearly 30% from the first quarter last year. This is the best first quarter car velocity performance since 2017. Origin train performance averaged 86% in the first quarter, up 62% from the first quarter last year. This performance is on the back of moving 6% more volumes in terms of RTMs in the quarter, including 90% more Canadian grain. To highlight the strength of the operating model, we moved this additional volume in the first quarter with nearly 15,000 fewer cars on the network. We continue to drive our sustainability agenda with fuel efficiency up 1% on a year-over-year basis, as we continue to lead the industry on that front. As we look forward, our goal is to drive continuous improvement on the operating model. We have done a lot of heavy lifting since April of last year when we reverted back to running a scheduled railroad, so we are starting to lap those early changes. We will continue to drive efficiencies, but improvements will be similar, will be smaller and in smaller increments. As we have exited the winter and with volume softening given the uncertain economic environment, we are taking the opportunity to look at reducing train starts and also going after train length, all while adapting to the recent Canadian Work/Rest Rules on top of already working agreements. As the weather warms, so should our performance not only in train operations but also safety. Warmer climates equate to velocity and this creates capacity, which we will quickly convert to efficient capital work blocks that will be built into our scheduled operating plan. As I mentioned in my opening comments, I'm very pleased about how the operating team has been performing over the past year and we still have more to do. Many of you on the call will have the opportunity to interact with the operating folks next week at our Investor Day in Chicago and I'm looking forward to seeing many of you there as well. With that, I'll pass it on to Doug to discuss top line performance and outlook.

Thanks, Ed. I wanted to take this opportunity to thank you and your team for running a fluid and efficient operation as well as demonstrating resiliency against the winter conditions. We were able to deliver on our promise to better serve our customers and help them grow in their markets, a true collaborative effort. I'll now turn to slide nine and provide a review of our solid first quarter top line performance. First quarter record revenues were $4.3 billion, up 16% over Q1 of last year on 6% higher RTMs and led by the bulk segment. Canadian grain was the biggest driver of growth in Q1, nearly doubling our volumes versus last year, including an all-time tonnage record in February. We are delivering for our grain customers, averaging 90% spotting performance over the current crop year and in line with our target. We did pull forward some of the Canadian grain into Q1, which will impact volumes in Q2, but we continue to engage with our customers to refine our demand outlook through the summer and in advance of next harvest. Coal demand remained solid through the first quarter with a favorable commodity pricing environment and strong commitments from our customers. Strong frac sand volumes reflected a favorable market environment supporting an uptick in Western Canadian drilling activity. Automotive continues to be a bright spot for the quarter as inventory replenishment persisted across the industry. We did however see continued weakness in other segments. A softening in international intermodal across all of our gateways reflected the inventory correction that is taking place throughout North America. Domestic volumes held up during most of the quarter but have more recently started to turn negative. Petroleum and chemicals volumes remained under pressure with reductions in refined products as well as lower chemicals and plastics used as inputs into manufacturing, both reflecting general economic weakness. Lumber shipments decreased only slightly despite depressed housing indicators, rising interest rates, low commodity prices, and extended mill curtailments, particularly in British Columbia. Volumes were steady due to the home renovation market doing better than expected. Turning to slide 10. Let me take a few minutes to talk about our top line outlook for the balance of the year. We are still assuming North American industrial production to be negative in 2023, but remain confident that we will outperform this from a volume perspective. While Q1 volumes were strong, we are seeing some softness in certain markets right now and this is reflected in our April volumes so far. On the positive side, our bulk segment remains solid. Canadian grain demand will start to lower as we head into the planting season and we are anticipating an average crop for the 2023-2024 crop year. Canadian metallurgical coal demand is expected to continue at strong pace with solid operational execution for at least Q2. Automotive continues to outperform with strong sales and dealer inventory levels below historical averages. Most other markets remain uncertain given a weakening economy. International intermodal is expected to have multiple blank sailings in Q2 and Q3, while domestic retail volumes are softening due to the mild recession. Pricing is also under strain due to increasingly available truck capacity. Lumber remains uncertain as commodity prices are still at low levels and housing demand is low due to elevated interest rates, despite a significant shortage of homes on the market. Petroleum and chemical production is directly tied to the economy, so we expect demand to be soft for most of the year. One bright spot is our intermodal sector; our recent announcement for new service in Mexico and CN's network in Canada, as well as Detroit, combining the best service in the industry provided by the FXE and UP, will now give CN the shortest routes and fastest service to all of its key markets. Layering this new service with our new EMP product with the UP/NS, CN's customers will have new options to convert truck volumes to rail. To close, we are working closely with our customers to monitor the economic environment. As we run a scheduled railroad with a focus on velocity, we are driving solid customer service that will serve us well and position us to recover volumes when the economy recovers. With that, I'll pass it on to Ghislain.

I will discuss slide 12 of the presentation, which will offer more insight into our first quarter performance. These results once again demonstrate the strength and resilience of our business as we achieved a volume growth of 6% in terms of RTMs and a 16% increase in revenue. The robust top line performance, coupled with strong operating results, led to solid earnings this quarter, even with nearly 15,000 fewer cars on our network. We experienced a beneficial lag in fuel surcharge during the quarter due to declining fuel prices. I will provide additional details on the quarter while focusing on the adjusted figures, excluding advisory costs related to shareholder matters from the first quarter of 2022, and address variances on a constant currency basis. Labor expenses rose by approximately $40 million compared to last year, primarily due to an increased average headcount, particularly in transportation, though this was partially offset by higher capital credits. Expenses for purchased services and materials increased by 8% compared to last year, driven by soaring material costs and a rise in outsourced services expenses. We achieved record Q1 operating income of nearly $1.7 billion, reflecting a 34% increase on an adjusted basis. Our operating ratio stood at 61.5%, which is 510 basis points lower than the adjusted operating ratio for the same time last year. The record Q1 diluted EPS of $1.82 for the quarter grew 38% year-over-year on an adjusted basis. We generated nearly $600 million in free cash flow in the first quarter. Under our ongoing share repurchase program, which runs from February 1, 2023, to January 31, 2024, we have bought back nearly 5 million shares for about $800 million as of the end of March. Moving to slide 13, let me give some insight into 2023. While Q1 showed solid volume growth in the bulk segment, we are still observing weakness in specific consumer-driven segments such as international intermodal, lumber, and chemicals and plastics. We continue to expect a mild recession in 2023, with a forecasted decline in North American industrial production. Currently, in April, volumes on an RTM basis are down around 6%, reflecting economic weakness and some traffic that shifted to Q1. Despite the challenging recessionary climate, we remain dedicated to running our railroad as planned, ensuring reliable service for our customers, and delivering positive results. Given our strong financial performance in Q1, we are revising our full-year outlook and now anticipate mid-single-digit EPS growth in 2023, an improvement from our previous low single-digit forecast. We are committed to shareholder distributions and still expect a budget of approximately $4 billion for our current share repurchase program extending through January 31, 2024. In conclusion, I want to emphasize a few points. We had a strong first quarter as we continue to benefit from operating a scheduled railroad focused on car velocity. While ongoing economic weakness persists, we still predict a mild recession in 2023. In light of this economic backdrop, we are now projecting mid-single-digit EPS growth for the year due to our Q1 outcomes, which showcase the resilience of our business and the effectiveness of our team. We maintain a robust balance sheet that affords us financial flexibility, and we are committed to allocating our capital in a way that creates long-term value for our shareholders. Now, I'll turn it back to Tracy for some closing thoughts.

Thanks, Ghislain. Now before we open up the line for questions, let me just highlight that we are holding our Investor Day in Chicago next week, May 2nd and 3rd, and the presentations on May 3rd will be webcast, and we hope many of you will be able to join us. So let's open the line for Q&A.

Thank you. We will now begin the question-and-answer session. The first question comes from Benoit Poirier with Desjardins.

Yeah, good afternoon, everyone and congratulations on the strong start. Maybe my question is, could you talk a little bit about your transformational partnership with UP and Grupo Mexico and the new Falcon Premium service? And also if you could talk about the other partnerships that you're looking at? Thank you.

Let me start that one off, Benoit, and then I'll hand it over to Doug for a little color on the Falcon service. We believe that the right way to service our customers is to be working with partners where that makes sense. In this case, UP and FXE are a great example of that. We've been able to put together a product that offers considerable transit benefits, helping them and getting trucks off the road. There are other examples out there where we're looking to do the same types of things in different markets, more on that to come as we pull those together. Doug, do you want to make some comments on the new Falcon service?

Yes. So thanks, Benoit. One of the key things we try to do is take the best of what was available on the market. The service with the FXE and the UP have been phenomenal for north and southbound traffic between Chicago and the markets in Mexico. Customers rave about it. Now we've combined that with CN's service from Chicago into the Canadian network as well as into Detroit. We're really looking forward to that. We know from a lot of historical work there are at least two trains each direction moving over the road that we think we can target by providing this service. It will be great, but it will take a while, and we're working with our customers to execute on it.

That's great. Thanks for the color. Have a great day.

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

Good afternoon, and I want to echo the commendations on the quarter. I’d like to follow up with Ed or Tracy regarding the outlook. As you're moving towards mid-single digits, has there been any change? Is this simply a continuation from the first quarter? Are there any adjustments in your outlook considering the improved service performance? Additionally, I’m curious if you would like to discuss the fuel benefit from the first quarter and whether that will have an ongoing impact. I’m trying to grasp what has changed and what the potential upside of this target might be. Thank you.

Thanks, Ken. Listen, nothing has changed on our view of the year. Our guidance has been lifted based on some really strong performance in the first quarter. Ed's going to continue to focus on the next level of benefits from the scheduled operating plan. We have lapped now one year of introducing the scheduled operating plan. The benefits year-over-year won't be as dramatic as they have over the last four quarters. But we're going to be focusing on delivering to our customers, keeping our plan and our execution stable and being ready for when we lift out of this. Ghislain, do you want to comment on the lag?

On the lag, yes, absolutely. As I said in my remarks, Ken, we did have the favorable lag this quarter. To give you an order of magnitude, it's about $0.10 of EPS, and it helped the OR by about 130 basis points.

Great. Thanks for the time and thoughts. Appreciate it.

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

Thanks very much. Good afternoon. Ed, I had one for you. I was hoping you could speak to some of the changes to the winter plan that were particularly impactful year-over-year? And just how comfortable you're feeling about being able to offset the impact of the new Canadian regulations that you mentioned on Work/Rest and paid sick leaves with labor productivity?

Well, let me take the easier one first. The bulk plan for Western Canada during the winter months went extremely well. We scheduled our bulk service between our regularly scheduled merchandise service. Don't forget, we control when we pull the train, when we spot the train, and when we deliver the train. That worked out very well for our metrics and what we needed to address with our shippers. So I think everybody was real pleased with our performance during the winter months, especially on the bulk side. It's a little premature for me to mention the impacts of the new Work/Rest rules. I will tell you this: We are already working on a scheduled operation. We're collaborating with our labor on what we think would be best and what they would think would be best. We were successful in negotiating an agreement with the TCRC, and I see no reason why we won't be successful in negotiating a good Work/Rest plan that fits within the Canadian government guidelines and will be ready to go come May 25.

Thank you.

We'll take our next question from Chris Wetherbee with Citigroup. Please go ahead.

Thanks. Good evening. I wanted to focus on the sort of 2Q through 4Q period. So now that we have the first quarter done and it was obviously a really strong quarter, and the outlook has improved to mid-single-digit EPS growth. I guess you guys are calling for a mild recession. So maybe I just wanted to get a sense of what some of the underlying assumptions might be. How do we think about RTM growth? I know we're off to, I think, down six to which you mentioned here in the second quarter so far. But should we see a low to mid-single-digit decline in RTMs embedded in that sort of back three quarters of the year? And then can EPS be positive year-over-year during this period? Or is it a little bit harder to capture that leverage given that volume is going to be a little bit softer than what we've seen so far?

Yes. Thanks, Chris, for the question. As you can see, we're still assuming a mild recession and assuming industrial production that's negative. If you look at the last consensus, it deteriorated actually from negative 1.3 to negative 1.4. So we see it in volumes. I mean we currently believe that we are in our mild recession. Our volumes, as I said, are down 6% on a month-to-date basis. We're not going to guide on volumes going forward; what we said was we're going to do a little bit better than industrial production. Obviously, the way we've modeled this is Q2 and Q3 will be in the recession, and we're assuming that we're getting more slowly, but surely getting out of it by Q4. And in this, we're also assuming that we have a three-year average Canadian grain crop, and this still needs to be called out as we speak, but that's what we're assuming.

Okay. That's helpful. Thank you.

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

Thanks very much. Good afternoon, everyone. Tracy, when you first took over the role, you mentioned your intention to refine your business portfolio, which involved letting go of some contracts that went to competitors. I sense that process is complete now. Is that accurate? Can you share any metrics or key performance indicators specifically for Falcon? What revenue goals do you have for the Falcon Premium service? Are we likely to see successes in Halifax now that you're launching new train service there? Rupert is performing very well. I’d like to hear your thoughts on transitioning from refining the business portfolio to expanding it.

Thanks, Walter. Now let me first say that I continue to be impressed by the strength of CN's network. As we came on, I think we had oversold a part of the network. That was the curate part. We've done that within a few months. Right now, the portfolio of business that we have fits our operating plan, and there's a great degree of alignment between Ed and Doug and their teams. As Doug is out selling, we're selling into that plant. That is the magic part, right? That allows Ed to run a really efficient operation and provide a very strong service level to Doug to talk to our customers next. So that level of curation is done. We're running a strong plan and delivering for our customers. As we think about the next level of growth, we'll think about it through that lens. I'm going to let Doug give you a little bit more color on the Falcon part of your question.

Yes. Like the easy answer is, you're probably going to have to wait for Investor Day to get some real numbers. But we are looking forward to the new service starting up in May. We know from a transit time perspective that we will be between six and eight days faster than our prior service, which is a dramatic improvement for us. Other questions around being ready, we have reduced service out of some of the ports today with the reduced volumes in international, but we still have all of those crews and all the equipment ready to go as those services ramp up. So we're looking forward to the rebound and we'll be ready to take it.

That's great. Thank you very much.

Your next question comes from the line of Fadi Chamoun with BMO.

Yes, good evening, and congrats on the strong results here. I want to ask a question on the CP UP. I mean, on the CN UP and GMXT deal. How differentiated is this service when you think about it in the context of potentially single-line service by your competitor? What are kind of maybe the targeted markets that you think you'll have stronger opportunities there?

So Fadi, it's a great question. We did a lot of research when we were attempting to buy the KCS. We understand those markets really well. There's approximately two trains a day in each direction that are moving over the road, and we're targeting that business. We believe that with this service, we're going to have the best service actually between Mexico and Canada as well as into Detroit. We'll be in a premium position to pick up some of that off the road. It doesn't matter what my competition does. We have a great product with this, and we think we're going to have the fastest service.

Okay. Thank you.

We'll take our next question from Tom Wadewitz with UBS.

Good afternoon, Ed. I wanted to ask how you believe the railroad can handle weaker volumes in terms of managing headcount. It seems like this situation might be different now compared to the past. Additionally, are there other cost considerations we should keep in mind as you work on improving network efficiency? You've achieved impressive results over the past year, so congratulations on that.

Well, thanks for noticing, Tom. I can tell you we'll be taking out expenses if indeed, the business deteriorates a little bit. We're already looking at combining some train starts and working on what I call organic issues that need to be addressed. You'll hear more of those at Investor Day. I'll just give you a sample: equipment repairs and ensuring that our fleet is up to standard across the board. The comment regarding what we can do in the long run here would be to work with our crews and our crew base to qualify current conductors into engineers; we will strongly work to make that happen over the quieter months and we'll be better prepared for fall and winter this year.

Is it fair, though, to think that maybe headcount is less flexible than it was in the past? Or is that the wrong way to look at it?

I’m not that familiar with Canadian headcount in the past. I just live in today and the future. I think we'll have as much flexibility as we'll need. Certainly, the Work/Rest rules will have something to say about that. A small percentage of our force actually meets the requirement for mandatory rest. We’ll work within those means and those parameters, and we’ll continue to deliver a very good operating model.

And Tom, I'll just add to that; Ed keeps reminding us of the attrition that we have. We're continuing to hire right now, even in a lower volume environment, to offset that attrition and make sure we've got the right folks in place and trained up. We struggle to keep our workforce in various locations. Ed will look at where we need to train them up in different ways and how to use them in the interim. Ultimately, if we get really concerned about workforce and volumes, we have the lever to be able to stop hiring. We don't see that just yet, but we'll continue to take a look at when the right time for that might be.

Okay. Great. Thank you very much.

Our next question comes from Scott Group with Wolfe Research.

Hey, thanks. Afternoon. I've got a question on pricing. We've had some really strong pricing yields over the last few quarters. Any change in same-store pricing in a weaker volume environment? Any color on just trends you're seeing? And then Ghislain, I know you talked about the fuel lag tailwind in Q1. Does that just sort of lap itself and just go away? Or does that actually become a headwind going forward as you think about the rest of the year?

So thanks, Scott, it's Doug. I'll take on the pricing side. Listen, on the carload side, we're still seeing great service and great demand or at least flat demand. I think we still have very good pricing momentum moving forward. We're still re-pricing business. About one-third of our business comes up every year, so I think we're still in really good shape there. There is more pressure on the domestic intermodal strictly because there's more capacity available in the market now, but we have lots of contracts in place with our customer base. We don't see a lot of change right now in that area.

And Scott, maybe on fuel. When you look at fuel lag, it creates a lot of noise in a given quarter. But over the year, if you look at fuel surcharge and our fuel expenses, it's not a headwind and it's not a tailwind. It's about a flat impact over 2023 on a net-net basis.

Very helpful. Okay. That's what I thought. Makes sense. Thank you guys.

We'll take our next question from Konark Gupta with Scotiabank.

Thanks, operator. Good afternoon, everyone. My question is for Ed. Ed, how much additional capacity do you think the scheduled operations and improved car velocity are going to bring to the network? And how are you guys going to market that new capacity?

I can't give you an exact percentage, but I can tell you the faster we are, the more capacity we create. Our ability to reduce our car fleet has paid dividends across the operation of this railroad.

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

Good afternoon. Could you provide more insight into the grain outlook as we move into the second half of the year? I recall there were some initial concerns, and during my last discussion with the team, it seemed the crop might finish a bit early due to a challenging comparison. How should we consider grain volumes from quarter to quarter as we progress through the rest of the year?

Okay. So good question, Dave. We had the same type of question from our Board today. On the Canadian side, we're dipping into the area of how much is left in the country and how much do the farmers want to keep back to sell in the summer. It will all be a function of pricing more than anything else. So we don't know, but all we know is because we had a very low last year, we are still going to have good comps this year on the Canadian side. On the U.S. side, obviously, we're lapping a great H1 in 2022, like we had a record, so we will be a little bit lower, but we still had a great Q1, and we're seeing decent volumes in Q2. There is still quite a bit of crop there to move in the U.S., so we figure that will just be a normal crop for us.

And just as a follow-up, maybe as you think about the moisture and all the stuff that you guys get into the weeds on pun intended, how are you guys thinking about the setup for the second half?

In Canada, moisture content is very good in the prairies right now, probably a little bit too much snow. But recently, over the last storms over the last couple of weeks, but much better than Manitoba was last year, where they were flooded out almost, and they still had a good crop. What the science can do these days with respect to growing crops in wet soil is impressive. We’re expecting still the average crop in Canada, and the U.S. crop is now seeing a recovery with the amount of water that they have had, where the Mississippi dried up, they had a lot of tough areas last year. Right now, they're expecting to have a normal crop as well in the U.S.

All right. Thanks very much for the time. Look forward to seeing you guys next week.

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

Hey, good afternoon. Thanks for taking the question. Just to follow up on Canadian grain. Maybe, Doug, can you give us a sense of where pricing is headed for the 2023 and 2024 Canadian grain crop? I think the CPI is actually due here perhaps in next week or so. Is fuel going to be as big of swing factors as we've seen more recently? And then just maybe, Ghislain, if you can clarify if that $100 million headwind for some of the Work/Rest and time off is still in the guidance or if that's a little bit to be determined as you work through some of these agreements? Thank you.

Thanks, Brian. So I'll start off on the grain crops. I think it's a big black box with the federal government on how this thing gets done. What we're forecasting is roughly a 2% price increase for the next upcoming crop year. We'll see at the same time; you guys will. We think it should be positive, and there might be some upside there.

Yes, we're still assuming a worst-case scenario about $100 million for the Work/Rest and paid sick days. Ed is starting to work hard on the scheduling, which starts with the new Work/Rest rule in May. It hasn't started yet. So we'll see, but we're going to work hard to try to offset some of the new Work/Rest rules going forward. Paid sick days is a cost because people have taken those days. We didn't pay them before; now we pay, so that's a pure cost. But hopefully, there is some room here to offset some of the new Work/Rest rules.

Okay. Thanks very much. Appreciate it.

Your next question comes from Amit Mehrotra with Deutsche Bank.

Thanks. Ghislain, just on the profitability question earlier, do you think first quarter is going to represent kind of the high watermark on operating ratio as it typically does because of the weather? I know weather was less incremental in the first quarter, but can you just talk about kind of the cadence because I know, obviously, you're forecasting a mild recession or we're in a mild recession. So just not sure if that impacts operating ratio versus where you were in the first quarter? And then Tracy, Investor Day is obviously coming up next week. Very much looking forward to that. But I was hoping you'd help us calibrate some of our expectations. I assume it's going to be an event about growth and kind of setting the stage for the next several years of growth. Along with that, should we be expecting kind of multi-year earnings targets, operation? I mean anything to sort of help us calibrate some of our expectations as we head out there next week. Thank you.

So maybe I can start with the OR. Typically, we don't guide on OR for 2023. But to your question, in Q1, typically in the winter, OR is just seasonality higher because of the winter, because fuel expenses are typically higher, etc. It's usually higher. But we don't guide on OR. What we have said to the market, and we're committed to that, is we're going to work to improve our margins. It makes it harder to do in a low volume environment than a higher volume environment. As Tracy mentioned, we're not going to have a knee-jerk reaction and send people home while we have the mild recession. We are going to focus on training locomotive engineers. Tracy, do you want to add to that?

Yes. Thank you and thanks for your question and your interest in Investor Day. We aim to do a few things at Investor Day. You're going to see a much bigger cross-section of our team. We will spend some time with Ed and his team on the scheduled railroad, discussing how we're going to sustain that, where it could go in the future. We will talk with Doug and his team around where we see growth. It will be directional and longer-term in some cases. But we're going to try and put some brackets around how to think about the next three years. We’ll hopefully give you some guidance, and we’re looking forward to having the conversation with you.

Also from an OR and earnings perspective outside of growth?

We will talk to you about earnings. We don't guide on OR, as you know, but I know we’ll be having conversations around leverage and the like. There is a microsite that is going up; it’s either up now or going up tonight or Wednesday. That will give you a little bit of a pre-look at some of what you're going to see there. I won't give you the bottom line, but you can start keeping your eye open for that microsite.

Cool. Alright. Thank you very much. Appreciate it.

Your next question comes from the line of Jon Chappell with Evercore ISI.

Thank you. Good afternoon. Doug gave us the look at April from an RTM perspective. I guess, I'm kind of get that up to Monday anyway. How have your metrics been trending in April? You gave us a great update on 1Q on origin train performance, velocity, etc. Just trying to get a sense for if that momentum is continuing in a weaker demand backdrop? And also how much of 1Q's improvement was actually structural versus just a really relatively easy winter comp?

I don't think winter had a lot to do with our improvement. We got focused on a scheduled environment, and that drives discipline in the network. When you have discipline in the network, you can make things happen. We are literally running 6% more traffic with 15,000 less pieces of equipment. This equates to lower dwell, quicker turns—all through an operating model that works for this railroad. I think we've been very successful in showing that in the first quarter. Quite frankly, I don't see any slowdown at the start of the second quarter. We're off to a great start as well.

Great. Thanks, Ed.

We'll take our next question from Brandon Oglenski with Barclays.

Hey, good afternoon. Thanks for taking the question. Doug, I was wondering if you could talk to the outlook for Intermodal. I think you've made some comments about pricing maybe being a little bit more challenging with the truck market. But also if we look at Vancouver and Prince Rupert imports, they've been down significantly. I mean, are customers telling you this is the new level to expect? Or what's the outlook looking forward into summer and into peak? Thank you.

Yes, no problem, Brandon. So thanks for the question. On the domestic side, it's just a function of domestic truck capacity being weaker; the demand is weaker, so the capacity is there. There's some pressure on that from a pricing standpoint, but most of our customers' business is locked up in contracts. That’s why we don't worry too much about pricing, right? For the international side, this is just a really low point as the inventory gets consumed within North America. The international ocean carriers are looking to ramp up. It’s just a function of when they ramp up, whether it's in Q3 or in Q4. That’s what we're trying to focus on. We expect to get back to normal volumes out of all of our ports probably by the end of the year.

Thank you.

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

Thanks, everyone. So just a couple of follow-ups here. One is kind of on the April softness. Is that just a tough sequential comp? I think there were some grain volumes pulled forward to Q1. But just wanted to check if you're actually seeing a sequential step down in the macro environment and if that makes you incrementally more bearish on the back half than you were three months ago. The second follow-up is just on the new Mexico service. How are you confident that you and your competitor can actually drive truck conversion and not just make it one railroad versus the other going off of that incremental share? Thank you.

Okay. So I guess I'll take both. On the April softness, we're seeing a lot of our carload business is flat and some of it's down a little; petroleum and chemicals are down. That's why we're pretty sure we're in a mild recession. We're seeing the same thing in the domestic trucking side, same thing in some of the consumer product side. The rest of it is hanging in there, and our bulk franchise is still doing really well. Our metallurgical coal shipments are still strong, and we expect that to continue. So overall, some of that softness is directly related to the mild recession we're in, mainly on the consumer product side. Regarding how do we convert the Mexico business over from over the road to intermodal, that's our aim. We need a consistent quick transit time, and that's why we're partnering with the two best railways to do that with the UP and FXE. They have historically been able to convert some of the product over that moves today between Mexico and Chicago, and we've added CN's network where there wasn't that product before. So this is a brand-new product coming into Eastern Canada, somewhat into Detroit and into Western Canada. We can do this at a great cost structure but also have the service that's going to drive it.

Got it. Thank you and see you all next week.

We'll take our next question from Steve Hansen with Raymond James.

Good afternoon, everyone. Thanks for the time. One of the markets that's deteriorated more recently has been the frac sand market, which surprised me to some degree. I wonder if you could speak to the outlook there and what's been driving that sequential move quarter-over-quarter and what you might expect through the back half of the year? Thank you.

That's funny, Steve. I don't recall that frac sand market; we didn't curate it at all. We had a fairly strong Q1. The primary area of our market is in Western Canada, which has seen pretty good drilling all quarter. We're currently in the month of April, where spring breakup happened a month earlier than last year just because it warmed up a little bit faster in Western Canada. With LNG Canada continuing on stream to start pushing product out there, drilling will continue on a very regular basis in that area, and we will continue to move frac sand in there. In fact, we're looking to expand our operations in future years.

Okay. I'm just looking at the trailing three-week data; that's down fairly materially relative to a strong Q1. So just curious about the delta.

No, that's spring breakup there. It's a month earlier than last year.

We'll take our next question from Ari Rosa with Credit Suisse.

Hey, good afternoon, and congrats on a strong quarter here. So Tracy spoke about this a bit in her opening remarks, but I wanted to get a sense of how you're thinking about potential changes to safety regulations impacting operations. Really just wanted to get a sense of what proposals you might be supportive of and which regulatory changes that have been floated you might think are actually counterproductive or would pose risks to some of the operating progress that you've made, whether that's things like limitations on train length or train speeds or some of the other proposals that are out there? Thanks.

Thanks for the question. Let me just start by answering in a general way. We have all been working hard and arms locked to lift the performance of the supply chains since COVID set them on their side. We've focused on improving performance and continuing to invest in capacity. As we think about the regulators, they're a strong partner when it’s based on data and facts. We need to really understand the problem and apply the solutions that will truly impact what we're trying to solve. Many suggestions are favorable solutions tied inappropriately to the issues, and risk not addressing the real issue. The risk of that is that you don’t achieve improvement, and you could have unintended consequences that impair supply chain performance and capacity. We fear that the most and see some of that happening. We are working closely with the other railroads and regulators to ensure this is a fact-based process. There are some good ideas out there, like new tank cars. Some proposals won't improve safety but could impair supply chain performance. We want to be optimistic and work hard with our regulators to land in the right place, ensuring a much safer status as we progress.

Okay. Great. Thanks, Tracy.

Thanks so much. One more question, I think, operator?

Thank you. We'll take our last question from Justin Long with Stephens.

Thanks for fitting me in. I guess first question, I wanted to ask about the new intermodal service and see if there was any color you could provide on the IMC strategy and partnerships that you could utilize to help execute on this collaboration? And then also on CapEx, I was curious if you had any updated thoughts on the outlook for 2023? Thanks.

Okay. Thanks, Justin. For the intermodal, we'll work with everybody. We'll work with our key wholesalers, the UPs, the FXEs, and we expect to have this service offering out to everyone. CN has its own retail product that we can help sell, as well as we have TransX that can also assist with sales. There are lots of options to fill these trains, and we'll collaborate with UP and FXE to execute it.

Yes, Justin, what we plan on doing is recession or no recession, we're going to continue to do our plan, continue with our basic. Actually, our basic maintenance plans mean that even when volumes are softer, we can get better costs for ties and rail. We're going to continue to invest in capacity in Western Canada because that's the gift that keeps on giving. No change on CapEx so far, even with the weaker volumes we see ahead.

Got it. Thanks for the time.

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