Core Natural Resources, Inc. 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, everyone, and thank you for being here for CN's First Quarter 2022 Financial and Operating Results Conference Call. Before I start, I want to highlight the forward-looking statements and additional legal information at the beginning of the presentation. Today's call includes certain projections and forward-looking statements as defined by U.S. and Canadian securities law. These statements carry risks and uncertainties that could cause actual results to differ significantly from what is expressed or implied, and these risks are detailed in our cautionary statement regarding forward-looking statements in the presentation. After our prepared remarks, we will have a Q&A session, and I ask that you please keep your questions to one per person. The Investor Relations team will be available afterward for any additional questions. With that, I am pleased to turn the call over to CN's President and Chief Executive Officer, Tracy Robinson.

Thank you, Paul, and good afternoon. I am honored to be here with you today and excited to return to this industry, especially as I take on my role at CN alongside a fantastic team of railroaders. We are working hard and looking forward to the future. I would like to take a moment to recognize the significant challenges faced by the people of Ukraine in recent months. We all want to do something to help. CN has contributed over $1 million to support Ukrainians impacted by the war, and I am very proud of my fellow CN employees who have donated more than $100,000 of their own money to this important cause. Our company will match these donations, and our thoughts remain with the people of Ukraine during this time of immense suffering. I understand you are interested in my initial thoughts on our company's direction. Over the past two months, my main priority has been to visit the field and network, getting to know our team, operations, strengths, and challenges; you can't fully understand this from the office. I've also begun meeting our customers and stakeholders, some for the first time and some I've known for a while, gathering their insights on how we can collaborate more effectively moving forward. I have appreciated the feedback I’ve received from many of you. Now, 60 days in, I can confidently say that I am more optimistic about our prospects than when I arrived. At CN, we have an impressive tri-coastal network, the best on the continent, supported by a diverse customer base across various commodities and regions, with a pipeline of growth opportunities across most sectors. Our healthy balance sheet gives us financial flexibility and agility to drive our growth, which is invaluable given the current rising interest rates and market volatility. We are on the right path as we continue our sustainability journey, with a team that is deeply committed to safety as a core value. We know what our network can achieve, and while we recognize that our performance hasn’t always matched our capabilities in recent years, we are moving past that. Looking ahead, here’s our plan: First, we will operate as a scheduled railway with a strong focus on velocity to ensure we deliver consistently to our customers and maximize our assets. Second, we will curate our business portfolio to align better with our network, leveraging our strengths in a more strategic manner. This means using our capacity effectively to position ourselves for the future rather than dwelling on the past. Third, we are committed to better integration between our operations and sales, as well as between investment decisions and growth. Lastly, we will continue long-term investments in our network and capabilities to drive efficiency and promote growth. These efforts will contribute to our top-line growth translating into bottom-line results both in the near term and long term. However, this transformation will take time. No significant undertaking happens overnight, but you have my full commitment that we, as a team, will strive to restore this company to best-in-class status. That is our strategic goal and daily focus. I know you are eager for more details about our plans, and we are currently working on them. I'll be able to share more as our plans become more concrete, so please stay tuned. Regarding this year, we have updated our financial guidance. Adverse weather, particularly in Western Canada, and supply chain disruptions affected our ability to fully take advantage of the strong demand environment in Q1. The unpredictability from the war in Ukraine and ongoing disruptions from the pandemic in China and elsewhere suggest we should exercise some caution for the year. I anticipate our EPS growth to fall between 15% to 20% and free cash flow to be between $3.7 billion and $4 billion. We aim for a full-year operating ratio that begins with a 5, which would be a significant achievement, marking the first time we have reached that level since 2017. Despite the challenging global environment, this is shaping up to be a good year for CN. I am encouraged by our operational momentum since mid-March and into April. We are handling heavier volumes even in the absence of the usual grain, and our velocity and consistency are improving. Demand remains strong, and we expect a more typical grain crop this fall. We are also closely monitoring the situation in Europe and the shutdowns in China to understand how they might affect trade flows. Our team is engaged with our customers to ensure we comprehend their demand and can prepare adequately for their needs, as we will require the right resources, personnel, and equipment to handle what we anticipate will be a busy year. Recruiting for running trades, in particular, remains a challenge in certain areas of our network as we head into the latter part of the year. It has been a tough start to the year, but we will meet our financial outlook. I am both excited and confident about CN’s future. I will now turn the call over to the team to discuss the quarter. I have Rob and Ghislain with me, as well as Doug, our new Chief Marketing Officer. Many of you have met Doug during previous investor events. He brings extensive experience in sales, marketing, and operations, having served as VP of our Eastern Division and as Senior VP of Information and Technology. He understands our markets and our organization well. I am looking to Doug to work closely with Rob and Ghislain to provide immediate focus on our integrated plan and execution. Rob, the floor is yours.

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 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 2 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 discuss our first quarter performance as highlighted on page 12 of the presentation. As Doug mentioned, we achieved solid revenue results despite an 8% decline in RTM volume. Our ability to meet strong demand was hindered this quarter by severe winter conditions and ongoing supply chain issues. Additionally, geopolitical factors have significantly affected fuel prices in the short term. Despite these challenges, our team managed to deliver a 7% year-over-year growth in adjusted earnings per share. I will now provide further details on the quarter, focusing on adjusted results that exclude advisory costs related to shareholder matters. The conditions I mentioned earlier affected network fluidity, leading to cost pressures like recrews, deadheads, and increased snow clearing. We continued to benefit from the reduction in non-operating headcount implemented last fall, with average headcount down 7% compared to last year. Our fuel expenses rose by 44% as fuel prices surged during the quarter, with WTI reaching about $125 per barrel and on-highway diesel prices climbing 27% in March compared to February. We have an effective fuel surcharge program to manage such fluctuations, although it does introduce some short-term volatility. This quarter, we experienced an unfavorable fuel surcharge lag impacting our EPS by $0.07 compared to last year. Our adjusted operating ratio for Q1 was 66.6%, which is 30 basis points higher than the same period last year, reflecting the challenges mentioned earlier. We reported an adjusted net income of nearly $925 million in Q1 and an adjusted diluted EPS of $1.32, which is a 7% increase from last year. We generated free cash flow of $571 million for the quarter, a $31 million increase year-over-year, primarily due to proceeds from selling non-core branch lines, partially offset by a decrease in net cash from operating activities. During this quarter, we repurchased shares beyond a simple dollar cost averaging approach because we recognized value in the prices early in Q1. Our strong balance sheet gives us financial flexibility, and we will deploy our capital in ways that promote long-term value for our shareholders. In summary, the current demand landscape remains robust, which is expected to drive solid volume growth for the remainder of the year alongside a normalized Canadian grain crop. Network fluidity has begun to improve toward the end of March and is continuing into April. We are closely monitoring inflationary pressures in light of ongoing global uncertainties. I am confident that our team will meet our 2022 financial outlook, aiming for a 15% to 20% growth in adjusted diluted EPS compared to 2021. We possess the best network in the industry, and we understand the potential it has. I will now hand it back to Tracy for 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 be to 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.

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.

We have an excellent network with significant flexibility on both coasts, strong carload bulk and intermodal franchises, solid customer relationships, impressive growth potential, and a great team. There are many strong aspects to our business. Moving forward, we need to concentrate on refocusing our efforts on the aspects that drive profitability. As we organize the team to work more cohesively, I am confident in the strategy we outlined in September, and I am eager to pursue it. Although it will take some time to get everything in order, I remain optimistic after 60 days. Thank you for your question.

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

Congratulations Doug on a new role here. You mentioned about reviewing the operations and meeting stakeholders, et cetera. I just wanted to understand, given what's going on in the U.S. right now with the STB, I think there is some, obviously, in U.S. we have Class 1 railroads regarding the performance and deliverables basically, and their focus on operating ratio. What's your biggest takeaway from talking to your customers, maybe regulators and shareholders in terms of what needs to be done to get back on track?

Yes. 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. And 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 potential solutions there, and especially with our customers on any service issue 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 working 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 get to mine. I believe you mentioned three times during the call that you're forecasting an average crop. However, the fine print on your 2022 assumptions states that you're expecting an above-average crop for 2022 and 2023. I just wanted to confirm that. Now, Tracy, the company has been discussing the importance of focusing on the right freight for years. I would like to understand what constitutes the wrong freight. Is it simply a matter of mispricing on certain business? Could you elaborate on what changes you see necessary in the freight base?

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 fully understand our capabilities. When we take on traffic, we must be capable of delivering it effectively. This means first comprehending our operational capacity and then aligning our sales accordingly to ensure we can consistently meet our commitments to customers. Only after achieving that will we be able to accurately gauge our capacity, and from there, we can seek opportunities for growth. That’s how I am approaching this as we move forward. Now, I'll ask Doug to provide insights on 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 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 caught the second part about technology, but what was your first piece?

I'm sorry. You mentioned talking about being best-in-class, talking 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 trying to keep up with, and we all know the potential of this network and team. It’s not just about the operating ratio or growth; it’s both. To achieve growth, we need an efficient operation that responds quickly and effectively serves our customers, and that’s where we will unlock our true capacity to grow. This company has the expertise to do it, and I’m eager to be part of that. Regarding technology, I haven't delved deeply into it yet, but I've noticed it's one of the significant changes returning to the industry. It's exciting to see the new ideas and capabilities being introduced. I know this company has many initiatives in that area. Although I’m only 60 days in and haven't explored it thoroughly yet, I’m enthusiastic about the potential it holds. Thank you for the 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 is discussion about taking a PSR path or revisiting a PSR path and potentially different folks who are 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 my previous remarks were unclear, so I'll speak more slowly this time. The dynamics of this industry have shifted significantly in the past 10 to 15 years. It is now essential to maintain tight, efficient operations. We will achieve this by implementing a well-balanced, scheduled approach that emphasizes speed. This strategy will enable us to consistently deliver to our customers, maximize the use of our assets, and clearly identify our available capacity, allowing us to determine how best to utilize it. In my view, both aspects are necessary. An efficient operation is vital for generating top-line growth, which is only valuable if it can be effectively translated into bottom-line profits. We plan to accomplish this by focusing on our scheduled operations and speed. We will effectively manage our assets and approach our business with intention. 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 3 to 4 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 3 to 4 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 give velocity and scheduling 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 about growth or a combination of both? Successful railroads are measured by their impressive operating efficiency ratios. In a fixed-cost business, growth and margins can coexist, which has been the message of C&I for several quarters. I want to understand your perspective on whether, in three to four years, CN has the potential to become the leading operating ratio railroad in the industry. Is this a possibility you recognize and view as crucial for a successful outcome?

As I consider how to gauge our success moving forward, I will focus on long-term growth as the main goal. The specific metrics we'll monitor include adherence to our plan once it's established, operational speed, growth, and profit margins. The operating ratio is indeed significant, and we all understand the potential of our network and team in terms of performance in that area. A highly efficient operation with a strong operating ratio enables growth and allows us to seize opportunities that enhance our bottom line. 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, I guess, the strategic direction of some of the noncore 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 noncore business that you'd look to shed? And are there any other similar types of noncore 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 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.

And your current forecast include those or not predicated on any divestitures?

That's right. I want to take just a quick pause so that I can make a decision with the team on them, but I'm going to ask Ghislain to just comment on that as well.

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'll jump in on that and then pass it to Ghis. As we've revised our outlook for the year, we've considered all these factors, leading us to a projected EPS growth range of 15% to 20%. As Doug mentioned, the normalized crop levels from a grain perspective will be crucial for us to reach our goals this year. We're closely monitoring the situation in China and elsewhere, especially regarding the ongoing pandemic, which poses a risk. However, we anticipate some normalization as we approach 2023. 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 start, and then I'll pass it to Ghis. From a volume perspective, I might pass that to Doug shortly. Our guidance this year incorporates everything we've discussed regarding our assumptions. Demand is strong, and we'll see how it develops. Regarding capital allocation, I appreciate that we have a robust balance sheet, which provides us with flexibility. As we approach capital allocation, our priority is always long-term value; building our business will always come first, and we want to keep that strong balance sheet. After that, we will consider increasing shareholder distributions, as we have in the past. It’s a good time to reflect on the benefits of having a strong balance sheet, especially as we enter a period of higher inflation. Now, Ghis, and then maybe Doug.

No, I think you've covered it well, Tracy. I think that the use of our balance sheet remains the same, and it's the first use of cash is towards the business. We do debate on a quasi-regular basis, the leverage. We do that. I think that for this year, we're committed to do our share buyback of $5 billion. I think that we started executing on that since February. And I think that at the end of the day, to your point, Tracy, I think that the key is to use the balance sheet to create long-term shareholder value. I think that's the key, and that's what we're focused on. Doug?

Thank you, Ghis. I want to emphasize that our plan includes all of our existing business, which is fully integrated and we are confident about it. Additionally, we have a robust pipeline of other opportunities. As we evaluate these, we need to consider how they fit within our network and how to manage them effectively. This involves carefully curating our business portfolio to ensure compatibility with our operational framework and Rob's team's capabilities. We are quite optimistic that we will 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, 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 well known historically?

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 get a sense and congratulations to both of you, Tracy and Doug. I'm trying to develop some intuition on what you have in mind for improving operations. You're emphasizing velocity, but I think about changing the schedule or expanding the sidings. If you change the schedule, that might make things a bit quicker. Tracy, what's your perspective on whether there are operational changes that can be made relatively quickly, within six to twelve months, to drive network improvement? Or are we looking at a longer timeframe, like two to three years, if we're discussing reworking the entire approach?

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 opportunities 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 and 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 revised our guidance from 20% to a range of 15% to 20%, the 7% growth we achieved in the first quarter certainly played a role. Additionally, we recorded a 66.6% operating ratio in Q1, which also contributed to this adjustment. The positive aspect is that we are experiencing strong demand, and the pricing environment seems favorable. As Rob mentioned, we are regaining our rhythm regarding network fluidity, as evidenced in late March and April. It's important to note that we cannot separate fuel from our operating ratio, as it is a factor in our operations and our guidance reflects an operating ratio starting with a 5. We estimate fuel costs for the full year to be between USD 90 and USD 100 per barrel. We have an effective fuel surcharge program, but it does introduce some volatility, resulting in a $0.07 negative impact on EPS for the first quarter. However, after thoroughly analyzing these components, we are confident we can meet the updated guidance. Thank you for your 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’ll take that, and then Doug can follow with his thoughts. This is a remarkable company, one of the most iconic in Canada. As I’ve traveled around the property and met our employees, I am truly struck by the talent and enthusiasm present, as well as the commitment to succeed. Clearly, the first step is to enhance coordination between what we sell and how we operate the network, and we are already making progress in that area. This will provide us with significant opportunities not only to improve our immediate deliveries but also to collaborate more effectively in identifying opportunities and addressing challenges. In a network of this scale, an integrated approach is essential. We must balance finance, operations, and commercial elements, ensuring that our operational building aligns with our sales approach, which can only be done collaboratively. I see a lot of positive energy in this company as we pursue this direction, and I'm very optimistic about the exceptional network and great 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 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, Robin guys, can you guys 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 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 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, considering the current situation with crude by rail, is there anything you've observed from the other side that you believe can be implemented relatively quickly?

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, and 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 lockdown situation has created yet another supply chain disruption. We've been experiencing these issues sporadically, similar to other railways, ports, and warehouses. The upcoming wave from China will lead to overcapacity at the coast and result in bottlenecks at the warehouses. However, we will manage it as we have in the past. We've gained experience in dealing with these disruptions, and we are planning accordingly, though each segment of the supply chain has its limitations. We will collaborate with our customers to navigate through this. 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 this headcount is really targeted? And does CN and really the rail industry as a whole run the risk of sort 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 at LA Long Beach, we have observed a shift in market share from Western ports to the Gulf Coast and Eastern ports. Can you share some insights about the current market dynamics and the opportunities you see with Halifax, St. John, and Rupert?

Thanks, Benoit, it's Doug. I'll address that. We've noticed a shift that has moved more to the east, which has been evident across all our regions. While we still see robust business in Vancouver and Prince Rupert, both of which are sold out for us, we are observing growth in our Halifax operations. Our business in Montreal remains relatively stable or has seen slight increases, which is encouraging as it helps balance our network. We have ample capacity in the East, which positively impacts our bottom line. It's beneficial for us to achieve this balance. Additionally, we're experiencing growth in Mobile and even in New Orleans. This presents a great opportunity to leverage our three coasts and effectively utilize our network. We're quite optimistic about these shifts and look forward to seeing more progress.

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 multiyear 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.