Core Natural Resources, Inc. Q2 FY2023 Earnings Call

Good afternoon. My name is Emma, and I will be your conference operator today. Welcome to CN's Second Quarter 2023 Financial and Operating Results Conference Call. I would now like to turn the call over to Stacy Alderson, Interim Assistant Vice President, Investor Relations. Ladies and gentlemen, Ms. Alderson.

Thank you, Emma. Good afternoon, everyone, and thank you for joining us for CN's Second Quarter 2023 Financial Results Conference Call. Before we 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 actually cause results to differ materially from those expressed or implied in these statements. They 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.

It has been a couple of months since we saw many of you in Chicago at our Investor Day, and we're continuing to execute the plan we laid out for you then. We're running a scheduled operation that moves our assets quickly and services our customers consistently, and this is the central theme. We're driving our growth initiatives on that foundation. Over the three-year period we discussed in Chicago and beyond, our path is clear. The longer-term fundamentals remain strong, and the growth opportunities are real. We continue to progress our growth agenda built on strong service, driven by disciplined adherence to our plan. The immediate term is a little less certain. This team has dealt with a number of external weather-related issues over the past few months as well as a West Coast port strike over the last few weeks. As we sit here today, we're seeing a bit more weakness on the economic front than we modeled earlier this year. All of this is temporary, as you know, and our team is doing a great job of managing through it with an eye on the longer term. The heat and wildfires in parts of both Eastern and Western Canada have impacted our operations and those of some of our customers, leading to a temporary impact on volumes. Generally, we have seen a softer volume market economically, particularly in some of our commodity segments. I must commend our team's response. They are managing through this situation while staying true to our plan. They are executing the plan and, despite everything, improving year-over-year velocity, network train speeds, dwell time, and customer service. You'll see this in our operating stats. Their performance is a testament to both the team and the strength of our plan, which is working. Looking forward, we will continue to be adaptable, adjusting to the softer volumes in the near term while preparing for the lift. We are refining our operating plan to align with the current volume levels, consolidating train starts and laying down locomotives and cars where appropriate. This keeps our network balanced, our assets moving quickly, maintains our service levels, and mitigates costs. As we mentioned, if we find ourselves in this situation, we are adjusting our hiring plans to reflect a slower expected return of some of our commodity segments. We’re also seizing the opportunity to advance locomotive engineer training to ensure we are ready for the medium and long term. All of these actions are the right near-term measures to lessen the impact of lower volumes without compromising our ability to respond when the rebound arrives. It will come, and we will be prepared. While this puts pressure on our margins now, our margin leverage will return with the volume. Now, regarding our second quarter EPS of $1.76, that is 9% lower than last year on an adjusted basis, with a 60.6% operating ratio that is 160 basis points higher. This reflects the impact of softer macroeconomic factors than we anticipated and the challenges presented by recent weather events in Canada. Based on what we've observed in the second quarter and in the first weeks of July, we have revisited our year-end outlook and are now anticipating that the economic recovery will be pushed into 2024. Therefore, we expect the year-over-year change in annual adjusted EPS to be flat to slightly negative. The team will provide more details about this today. Before I hand it over, I want to address the situation with the Canadian West Coast ports. We are glad to see an end to the work stoppage and are working hard to restore those supply chains. We expect to move most of the volumes that were not transported during the first two weeks of July in the coming weeks. This serves as a reminder that disruptions in one area of the supply chain can affect the entire system. Major disruptions like the ILWU strike, the wildfires, and flooding in Nova Scotia can have widespread impacts across the North American supply chain. It is crucial that we respond as a community to minimize these impacts and maintain confidence in North America and global supply chain performance. This is our approach at CN. I'm proud of our team’s ability, demonstrated again in this quarter, to minimize the impact for our customers, employees, supply chain partners, and the communities where we operate. Now I'll turn it over to the team. Ed will begin by giving us more insight into the state of our operations and how his team is addressing the impact of these events. Doug will follow with an update on the markets and what our customers are reporting about volumes as we look ahead. Ghis will wrap it up with the numbers. Ed?

Thank you, Tracy. The second quarter has posed significant challenges. I want to express my gratitude to the entire operations team for their hard work in maintaining network operations this quarter. Tracy mentioned the floods in Nova Scotia, which we’ve seen reported in the news around Halifax. Our team is working tirelessly, and I especially want to thank Millbrook First Nations in Nova Scotia for their support and for providing care to our engineering staff during this disruption. Relationships like these are essential for the smooth and safe operation of railroads, and we hope to contribute positively to the community as well. We aim to reopen the track as quickly as possible, and we truly appreciate the assistance we’ve received at the work site. I mentioned at Investor Day in May that our operational plan is fundamental, and it's crucial to reiterate that we will not alter our network operations due to weather or volume challenges. Our scheduled operating model is the right approach for our network through all economic cycles. Regarding our performance this quarter, car velocity averaged 216 miles per day, a 3% increase from the previous year, which is a significant improvement given the challenges I’ll discuss shortly. It's important to remember we are also building on the progress the team made last year. We will continue to focus on car velocity, and I'm pleased with our current speed. Higher velocity promotes fluidity and increases capacity across the network. We achieved this while moving 9% fewer gross ton miles, establishing a strong foundation for a future demand recovery. We have seen enhancements in our origin train performance, earning the team a solid A for surpassing 90% in the quarter. We strive to maintain that performance level moving forward. These positive operating results came despite facing unexpected challenges in this quarter. We dealt with record wildfires across Eastern and Western Canada, impacting our customers' operations. In response to these challenges, we’ve proactively engaged in protecting our infrastructure by deploying sprinkler systems on many wooden structures in high-risk areas. Moreover, our Poseidon firefighting train has been in operation since May, transforming a bulkhead flat car into a self-contained rail-mounted fire suppression system that draws water from attached tank cars. To enhance our fire response further, we've decided to build two additional Poseidon trains for better network protection and community support. We saw nearly an 800% increase in heat-related delays in Western Canada, with about 750 delay hours compared to 80 last year. Heat affects train speeds and car velocity, necessitating the introduction of a new heat category termed extreme heat conditions. Additionally, we managed an organized reduction in traffic at West Coast ports due to recent work stoppages. While this approach ensures proper preparation, it also incurs additional costs. Despite these impactful events, we remained focused on executing our plan. In this lower volume situation, we reviewed every train start, local service, and crew start to maximize efficiency. By June, intermodal train starts were down 15%, and manifest train starts decreased by about 5% compared to the first quarter. We achieved this while upholding car velocity and maintaining impressive customer service levels. Nonetheless, some operating measures such as train length, fuel efficiency, and locomotive utilization experienced short-term declines due to softer volumes. Fuel efficiency was also affected by the disruptions from the fires. Even with rapid changes occurring, we need to simplify operations, sticking to our scheduled approach that enables quicker recovery from challenges and outages. Before I hand it to Doug, I want to emphasize safety. I believe I speak for Tracy and the entire leadership team when I say that safety is our highest priority and must be central to our operations. We were profoundly saddened by the loss of one of our team members on April 28. Although we have made significant safety improvements in recent years, those efforts mean little if we cannot ensure everyone returns home safely at the end of each day. With that, I will pass it on to Doug for insights on top-line performance and market outlook.

Thanks, Ed. I wanted to take a moment to acknowledge the operations and customer service teams. They have been helping our employees, customers, and communities affected by the ongoing wildfires in Canada. Throughout the quarter, the teams remained engaged and our customers are saying that CN is providing the best service in the industry. Before turning to the quarter, I'd like to recap the current situations with the wildfires and the ILWU strike. Ed gave some good color about the impacts of the fires on our operations. The wildfires have also affected customers, some of whom are forced to take intermittent shutdowns. This mainly affected forest products customers but also our coal, sulfur, frac sand, and NGL customers. Most of the business impacted in Q2 will not be recoverable. But I can say that CN did not lose any market share with customers. Customers are simply shipping less and matching the demand in the economy. For the ILWU strike, there was a minor impact on Q2 results as we took steps to meter flows into the port terminals before the strike began on July 1. The strike lasted 13 days plus a 24-hour wildcat last week. CN's recovery plan kicked into action on July 14. We are running additional trains out of Vancouver and Rupert to clear the backlog and expect it to take up to 8 weeks to be current if all areas of the supply chain work together. Second quarter revenues were $4.1 billion, down 7% versus last year on 8% lower RTMs. We saw a softer-than-expected demand environment for consumer-related products with significant volume step-downs in intermodal, both international and domestic as well as forest products. In particular, lumber shipments were down with depressed prices and some producers running at cost. As mentioned, the wildfires in Northern Alberta and B.C. as well as Quebec also impacted forest products volumes. Petroleum and chemicals volumes declined, reflecting lower spot crude business this year and softer demand for chemical feedstocks. Most bulk business lines continued to be strong with RTMs up 12%. Met coal remained solid in the second quarter, but we did lose some trains due to the wildfires. Thermal coal volumes were weaker due to lower export demand, but volumes are picking up in Q3 already. U.S. grain volumes were down year-over-year, reflecting strong U.S. corn and soybean shipments down to the Gulf last year due to strong export demand. Canadian grain was the bright spot in the quarter with close to 50% more RTMs versus last year. We continue to deliver for our grain customers and to engage closely to optimize the supply chain. In April, the Canadian Transportation Agency announced a 12% pricing index increase for the upcoming 2023, 2024 crop year for CN. We saw positive growth for both domestic and export potash in the second quarter due to the optionality of CN's network going to St. John. Core pricing remains strong, and we continue to price above rail inflation. But notably, we have had poor intermodal storage revenues this year, and that headwind will continue through the back half of 2023. Let me take this opportunity to update you on our Falcon service. We started the premium service back in May. The product is performing well, meeting the posted transit times and in some cases, exceeding them, and volumes continue to grow. Turning to the outlook on Slide 10, for the remainder of the year, we see continued uncertainty in the economy. Aside from the impact of the strikes, the broader environment for intermodal continues to be challenging. We see improvement being pushed into 2024. Pricing for short-haul domestic lanes will be under pressure due to the increasingly available truck capacity. Lumber also remains under pressure, but commodity prices have started to pick up. There is still a shortage of about 7 million homes in the U.S. that need to be built. Chemicals and petroleum production may be soft for the remainder of the year due to the extended recovery. For Canadian grain, we are now anticipating the 2023, 2024 crop to be in the mid-60 million ton range, below last year's 74 million ton crop, and we are closely monitoring the moisture levels across the Prairies. This revised view will not affect volumes in 2023. We will be running full outcome harvest, but it will be a headwind next spring. Canadian coal demand will remain steady and potash should be strong in Q4. Automotive should continue to outperform with new import business via Vancouver. To finish, there is no doubt, lots of uncertainty right now. What is certain is that we are working closely with our customers, we are committed to providing industry-leading service, and we will be ready when the economy improves. We remain on track to deliver on our longer-term growth plan that we outlined at Investor Day. With that, I'll pass it on to Ghislain.

I will discuss Slide 12 of the presentation, which will offer more insight into our second quarter performance. As mentioned by Ed, we achieved strong operating results in the quarter despite challenging conditions, but our financial results reflect the weak demand environment. Overall, volumes were significantly affected, with an 8% decrease in RTMs year-over-year. Let me share more details about the quarter. My comments will reflect adjusted results, excluding advisory costs related to shareholder matters from the second quarter of 2022. We reported operating income of approximately $1.6 billion, which is 10% less than the adjusted operating income from last year. Our operating ratio was 60.6%, an increase of 160 basis points compared to the adjusted operating ratio for the same period last year. EPS for the quarter was $1.76, a 9% decrease from the previous year on an adjusted basis. We estimate that wildfires had a negative impact on EPS of $0.07 and diluted the operating ratio by 100 basis points. Regarding expenses, labor costs rose by over $50 million when adjusted for foreign exchange compared to last year, primarily due to an 8% increase in headcount. Due to the current environment, we have slowed or paused hiring in some areas. Fuel expenses were more than $200 million lower than the same period last year when adjusted for foreign exchange, mainly due to a 30% decrease in fuel price and a 9% reduction in workload concerning GTMs, partially offset by a 6% decline in fuel efficiency. Shorter trains and operational disruptions that Ed and Doug discussed negatively affected our fuel efficiency. This quarter, the fuel surcharge lag was favorable. Now moving on to Slide 13, I will provide insight into our updated guidance for 2023. Several unforeseen challenges are now influencing our perspective for the full year. First, second quarter results were lower than anticipated. Second, we expect the demand environment to remain both weaker and prolonged, with a recovery in intermodal pushed to next year and ongoing weakness in forest products continuing into 2024. We are relieved that the port strike is behind us and that volume recovery efforts are underway, and while we expect to reclaim some business, we will not regain all of it. So far in July, volumes measured in RTMs have declined about 11% year-over-year. As a result, we are revising our full-year outlook and now predict flat to slightly negative EPS growth in 2023, compared to our previous forecast of mid-single-digit growth. This projection assumes foreign exchange of around $0.75 and WTI at $75 per barrel. We remain dedicated to shareholder distributions, and under our existing share repurchase program, we have bought back over 11 million shares for about $1.8 billion. We still aim to meet our budget of approximately $4 billion for our current program, which is set to run until January 31, 2024. In conclusion, I want to emphasize a few points. Our team is committed to the scheduled railroad model throughout all economic cycles, providing reliable service to our customers. We anticipate that volumes will remain soft, with recovery pushed to 2024. Given our year-to-date performance and the ongoing weak economic environment, we are guiding for flat to slightly negative EPS growth this year. We maintain a strong balance sheet that offers us financial flexibility, and we will allocate our capital in a way that creates long-term value for our shareholders. Now, I’ll hand it back to Tracy.

Thanks, Ghis. And Emma, let's open the line for questions, please.

The first question comes from Cherilyn Radbourne with TD Cowen.

In terms of your latest view that the recovery will be pushed into 2024, I was just hoping for a bit of color on what you're expecting for the peak season this year and whether your thinking is that the 2024 recovery will be evident prior to or after the Chinese New Year holiday.

Cheril, it's Doug. Thanks for the question. Right now, what our customers are telling us is they're expecting a weaker-than-expected Q3 and Q4, which is why we've actually changed our guidance. So we're not really sure what's going to happen in Q1 and beyond. But what we are doing is we're kind of forecasting a normal year beyond that. And that's as far as we've gone based on what the customers have told us.

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

Maybe as a follow-up to that question, I think your macro outlook for the rest of the year going into '24 is a touch more bearish than what you've heard from many of your rail and trucking peers so far. So again, do you feel like it's something reasonably unique to the end markets you're exposed to, the geographies you're exposed to? Or do you feel like you're being more conservative? Or do you feel like it's just some realization that hasn't fully sunk in yet for everybody else?

That's a great question, Ravi, it's Doug again. So listen, we can only forecast based on what our customers are telling us. So really, everyone is a little bit bearish right now for the rest of the year. It's a little bit more positive starting in 2024, and that's really all we're forecasting, all we're guiding towards.

And I'll come in over top of that a little bit, Ravi. I mean, I think that without a doubt, this is something that nobody knows for sure. And so as we approach the way we're going to operate this railroad is we are ready for whatever happens. And I think that we've demonstrated that we can be nimble in turning our service levels up or down to the plan. And so we're ready. If it comes, we'll be there. And if it's not, it waits a little longer, then we have a plan for what we're going to do in that case as well.

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

So you said a couple of times adjusting the hiring plan. Any color on exactly what you're doing with headcount going forward in the back half of the year? And then I thought I heard a comment about short-haul pricing slowing a little bit. Maybe just talk more broadly about what you're seeing from a pricing renewal standpoint and how pricing is holding up.

I'll start with that, Scott, and then I'll pass it over to Doug. I believe there was a misunderstanding regarding the comment. From a hiring perspective, we mentioned from the start that the first action we would take is to assess the number of people we are hiring. We have implemented that approach. As previously mentioned, we have halted hiring in some areas. In locations that are challenging to hire for or retain employees, we have significantly reduced our hiring pace, considering our expectations for volumes in Q1 and Q2 of next year when those employees would be operational. We are also managing a certain level of attrition as we look ahead. Therefore, when you think about full-time equivalents and staffing levels, you can anticipate stabilization for the remainder of the year. If conditions change, we have plans in place to address that as well. Now, Doug, would you like to discuss pricing?

Yes. For the pricing that we mentioned, it's really talking about the intermodal product. And obviously, with a lot of trucking industry issues right now, our biggest competition is within the short-haul trucking market. So that's where we're seeing some price pressures just in that market. Most of our market in intermodal is long haul, so it's not a big portion, but we just like to highlight the fact that there is some pressure there and that we are starting to see it.

Okay. But you didn't provide an overall pricing renewal number or anything?

No, we did not.

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

So when you discussed the impact, I think you bucketed them all together, lower demand, wildfires, import strike being a 10% hit to your original forecast. I wanted to see if I could isolate a little bit the nonrecurring or the real nonrecurring being the wildfires and the port strike. If we were to strip that out, if you could quantify that impact. And what I'm wondering is if that hit you this year and it was unexpected versus what you were anticipating when you set your guidance, would we see the potential for a higher growth rate in 2024, given you're lapping a bunch of fairly significant nonrecurring items? Or is there something changed as well in your outlook for 2024? I know as you adjust your grain as well, does that offset some of that, what would have been a higher growth rate in 2024?

Yes. Thanks, Walter. So thanks for the question. So as I said in the remarks, we did quantify the impact of the wildfires in the second quarter to be $0.07 of EPS or 100 basis points of OR. I think in our guidance right now, we're not assuming significant impacts of wildfires going forward. And as you know, some of those wildfires are still occurring as we speak. They're not touching our network as we speak. They're not impacting our customers. So we're not assuming, as I said, no wildfires going forward. The other thing on the strike, it did impact us month to date. But we believe that we will recover a good chunk of it over the next couple of weeks. So I don't think this will be a significant impact going forward. Now we're assuming that this tentative agreement will be ratified. And then the last big piece that guided that supports our guidance or our new guidance is the fact that, as we said before, we were assuming some type of recovery in the second half. And now having better visibility, Walter today, we feel that most of that recovery will be pushed to 2024. I think when you put all of those pieces together, that's where give us the guidance that we've just talked about today.

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

Doug, maybe the first question for you on the set of market opportunities you kind of laid out for us back at Investor Day. There's a pretty bullish set of volumes out there. How should we be thinking about that opportunity set in relation to a weaker 2023? Should we be fixing those numbers kind of in the same range and there'll be incremental as the economy recovers? Or is that scope of opportunity been adjusted for? Or should we be adjusting that scope of opportunity in line with the economic weakness?

No. That's a great question. Thanks, David. So with respect to our 2024-2026 plan, I think that's all still on target. Those are very specific projects that we outlined. None of them are really being impacted right now. We have 2 projects that were due to start that we highlighted to the team with respect to in 2023. One of those is our Northeast BC, where we're putting in a new siding to add capacity. That is moving ahead. We have the volumes kind of locked in there. Ed's team is busy building that siding as we speak. And we still have our Toronto fuels terminal, which should be up and running in Q4 to receive volume, and that's moving full steam ahead. So right now, everything is on time and on target. So it's actually doing really well.

Okay. And then just maybe just a quick follow-up. The CapEx numbers that you guys presented at Investor Day were also, I think, maybe a little bit higher than the market had been expecting. Are you at a point now where you need to recalibrate the level of spending, given what we're seeing either to the upper downside maybe to repair some of the damage that's been done or to delay some capacity investments based on what's happening with volumes?

We are closely monitoring our capital expenditures, as we always do, and evaluating each project to ensure an appropriate return. We continue our basic maintenance, and lower volumes often provide the engineering team with the opportunity to optimize work blocks, allowing us to lower the costs of rail and ties. We are maintaining that initiative. However, if volumes continue to decline, we will reassess our discretionary capital expenditures and evaluate the necessity of our spending. Currently, our plans are still in place, and we are expanding capacity in Western Canada, as we anticipate that it will be required. While volumes are lower, which may affect the time value of money, our team is efficiently investing capital, particularly in construction, despite the reduced volumes.

David, Ed Harris here. I want to mention that we are taking advantage of some disruptions by reinforcing the railroad. We are spending wisely. For example, after the washout at Halifax, we are installing larger culverts and adding more color to prevent this issue from recurring. The same applies to areas affected by fires, where we identified opportunities for sprinklers, pumps, and similar solutions. We cannot afford to experience this level of disruption any longer, to be frank.

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

Apologies if you have this out in the press release, I didn't see it, but what is the RTM growth guidance for this year maybe more so for the back half of the year, Q3, Q4? If you could give us some clarity about what you're assuming in guidance in terms of RTM growth. But the main question maybe for Doug, Prince Rupert has kind of struggled to underperform relative to most of the North American ports even prior to all of this kind of BC strike issues and some of the issues that we saw this year going back into the supply chain issues last year. Do you characterize some of these issues that are hampering Rupert more kind of transitory? Are you from conversation with your partners at the port and customers seeing a change in behavior and how people view that port and the service of that port into the U.S.? I'm just wondering if this is just kind of a trend that's already changed because of the supply chain and obviously the weakness in the demand that we saw this year or if there's more to it than that.

Thank you for your question, Fadi. I'll address it in two parts. First, we expect the RTM forecast to outperform industrial production, as we've consistently stated. We're confident we'll finish the year ahead of industrial production, with a positive outlook for Q3 and Q4. Regarding Rupert, prior to the port strike, we were beginning to see some positive developments there and were starting to regain business. Rupert is strategically located to serve both the U.S. and Canadian markets. Although the port strike impacted some of the volume shifts we were observing, we have added four trains to our network to handle additional business. We're optimistic about recovering from this setback and understanding the market dynamics moving forward. Rupert remains a key asset for us, with customers praising the service provided over the past year, and we believe the volume will rebound.

Your next question comes from the line of Chris Wetherbee with Citigroup.

I wanted to ask maybe 2 things around how you're looking at kind of the rest of the year and into next year, first on the macro side and then maybe a little bit more specifically to the business. But I guess, what are the sort of indicators that you're looking at to get a sense of maybe how long some of this downturn may last? I know you said that you can do what the customers are telling you. You can kind of plan around what the customers are telling you. So I'm guessing that might be the answer, but if there's any sort of guidepost that you think are important to look for over the course of the next quarter or 2, that would be great. And then Ghislain, maybe one for you. When you think about incremental cost levers that you can pull, I know sort of protecting the workforce because it's been so difficult to acquire, these employees is important to you. Are there other things that you can pull? Or at what point do you think it does make sense to look at the workforce and let attrition work its course to get it a little bit lower? Just kind of curious how you're thinking about that.

I'll start on that, Chris, and then I'll hand it over to Doug and Ghis to provide some additional insights. I believe Doug gave a thorough overview of our various commodity segments and our expectations. In summary, we have a robust bulk franchise that is performing well with strong demand. We discussed the grain portfolio, potash, and our outlook on pricing in those areas. The next part of our portfolio focuses on merchandise, which is currently stable and showing strength with no significant downside. There are a few softer segments, but overall, the performance is fairly strong. The main uncertainty lies in the consumer-centric areas, particularly containers and lumber, which are influenced by housing starts. We anticipate that these markets will need to recover in North America; it's just a question of timing. Similarly, for container demand, based on Doug's insights, we do not expect a major peak before the holiday season, but we anticipate a gradual return to more normalized levels next year. Regarding the automotive sector, we expect continued strength on the consumer side based on feedback from our customers.

On the cost side, we aim to effectively manage and respond to the external impacts that are beyond our control, and our team has performed exceptionally well in this regard. For the factors we can control, we are very systematic in our approach. As we explained in Chicago, we are addressing this through network operations and our plan, which ensures that we fully benefit from our cost mitigation strategies while continuing to serve our customers. We are confident we're taking the correct steps. Should our perspective on the economy and volume expectations for next year change, we will adjust our decisions accordingly. However, for now, we are making decisions based on the best available information.

Yes, absolutely.

Yes. Tracy covered that all really well. So the only thing I'll add in from a signpost is I always tend to look, Chris, at our petroleum and chemicals business, and it's actually pretty flat. And that's always a leading indicator as the economy improves. And we just haven't seen it start to go up yet. So that's one of the indicators I would suggest you always watch for the economy, especially for the railways.

We are currently reducing costs by parking some of our center beams, which are leased with staggered expiry dates. By returning several of these cars to the lessors, we can lower our car hire expenses. Additionally, we are parking older locomotives that consume more fuel, which allows us to rejuvenate our active fleet that carries freight. We're also managing our hiring processes carefully, taking advantage of good attrition rates at CN, which helps us pace our hiring and sometimes slow it down. However, we are focused on hiring in challenging locations in Western Canada, as these areas are difficult to staff, and we plan to continue our efforts there in the mid- to long-term.

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

Just to clarify that last answer or part of it, Tracy. You're targeting volumes to outpace IP, but I want to understand this considering the impact of fire strikes, floods, and reduced grain crops, which are pushing intermodal volumes and demand into next year. Are you still aiming to surpass IP, or do you see IP as a significantly larger negative factor from your perspective? Also, Doug, you mentioned truck competition, but didn’t discuss rail. How is your peer rail performing in terms of rail-to-rail competition gains? Have you noticed any changes in that aspect in this current environment?

Yes, Ken. As you know, industrial production is a public figure, and it fluctuates somewhat. Currently, it is still showing a negative trend for the year. Looking at our overall volume expectations based on what we have shared with you, we believe, as Doug mentioned, that we will perform better than industrial production in any scenario. We're quite confident about that. Doug?

The only thing I'll add into, Ken, is on the rail competition. We haven't really seen any market share loss with our customers at all, both to rail or to truck. So we are seeing, obviously, like I said, some price pressure on the trucking side for short-haul business. But outside of that, all of our customers are very happy with our service, and we continue to push product. We've seen some temporary gains due to the port shutdown, like moving potash to St. John instead of it going to Vancouver, but that's about it.

Doug, I thought you said you did lose to truck given you couldn't move it, so some volume was lost in that. Is that what you said given the port strike?

We experienced some temporary business losses, particularly in coal and during the strike in Q3, which will be reflected in our Q3 results. In Q2, we also faced minor losses in lumber due to mill closures caused by fires, which are not recoverable.

Your next question comes from the line of Benoit Poirier with Desjardins Capital Markets.

Could you provide more details regarding the absence of an increase in accessorial charges? I assume you will likely face a challenging comparison. Additionally, concerning the average length of haul for intermodal, I thought it was around 1,600 miles, if not closer to 1,800 miles. I'm curious about how much of your intermodal is related to short haul.

Benoit, the first part of your question got cut off. Could you repeat it?

Yes. Just in terms of yield expectation for the balance of the year. I was wondering what we should expect in terms of yield for the second half, given that the accessorial charges won't be a boost anymore.

Okay. So for the accessorial charges, we have about $100 million-plus headwind on that in Q2, and we expect that to continue through Q3 and Q4, right? So that's part of the yield issue that you're questioning. And on the short haul versus long haul, so you're right. You have your number dead on. We actually have most of our long-haul business in that really big market. But we do move a bunch of short haul, but it's a small percentage of our business, right? It's almost always long haul. So we do move traffic between Montreal and Toronto, Toronto and Moncton. So it's a little bit shorter haul than coming off Vancouver going all the way to Toronto, Montreal, Chicago. So that's where we're facing that price pressure is in that short-haul market.

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

I wanted to ask you about how we might think about operating ratio and maybe inflation, how that would have an effect. I think transports have certainly dealt with inflation in the cost base. And as the revenue slows down, it's more challenging from a margin perspective, finding ways to offset that. I know the Canadian dynamic is a little bit different than what we see from some of the U.S. companies. But how do you think about the kind of profile for inflation as you look into 2024 with a little softer view? And what you might be able to do to kind of stabilize the OR on a year-over-year basis?

Thanks, Tom, it's Tracy. We've been clear that we see opportunities to improve our margins in the long run, and we recognize this in several areas. We're not yet where we need to be in terms of operating efficiency, although we've made significant progress and managed external challenges effectively. There’s still more work ahead, and we’re eager to tackle it. We remain committed to our pricing strategy, which is above inflation, and Doug is doing an excellent job executing that based on the service he provides. This will continue. We are facing some challenges from storage and other charges incurred last year due to supply chain congestion. Moving forward, you will see our margins improve. Currently, while volumes are down, our operating margin may be somewhat lighter. However, we are very well positioned to capitalize on the upside at a low cost when volumes return. This is our strategy, and you will notice that leverage will increase as volumes come back.

So you think it's much more driven by volume than by price, just in terms of when we might transition to seeing improvement?

Yes, absolutely.

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

Just wanted to dig into the guidance, if I can. So what are some of the puts and takes explaining the gap between the top and bottom end? So the EPS guidance range of flat to slightly negative. And I'm not sure what the slightly negative means. Could that be a low or mid-single-digit decline?

So thanks, Konark. So what explains the gap between flat to negative, it's really volume. So in one scenario, we get a little bit more volume than we expected. And in the slightly negative, it's slightly negative, then we get less volume in the second half of the year than what we expected. So it's really a volume story.

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

I guess I wanted to stress test the 10% to 15% earnings growth framework, I guess, for next year. I mean you guys are operating pretty well if I look at the cost structure, and you're responding at least in terms of what you can control pretty well. I'm just trying to understand, if we're kind of in this lackluster volume environment, you got headwinds on grain, you've got headwinds on forest products next year. But you've also got, on the other hand, a lot of volume opportunity that you outlined at Investor Day. So I guess, I mean, what's the likelihood that we're sitting here 12 months from now in a still weak environment and EPS is not growing or staying the same? Or do you feel like you have enough idiosyncratic volume opportunity where you can kind of move the needle on EPS? How much do you need that's out of your control to get to that 10% to 15% next year?

Amit, I welcome you to the discussion. If we had certainty about the economic situation, we could focus on this more easily. Let me share our plans for next year. From a volume perspective, our railroad is performing excellently, and we are ready to capitalize on any opportunities to improve our profits as soon as they arise. We have a strategy set for next year, and if it doesn't work out, we will make adjustments. The growth initiatives we've presented in Chicago are designed to thrive despite economic fluctuations. Doug and Ed are actively working on implementing those initiatives. Doug mentioned a few that will start generating volume before the end of the year, and that strategy is still on track. This will help us achieve better results regardless of the economic conditions at that time.

Just to clarify, Amit, as well, the 10% to 15%, we said was over the 3-year period. So we did not specifically guide by year. Obviously, we're looking at what's happening. We're going to do our business plan with our Board this fall, as we typically do. And then we typically provide visibility on the year in January. So I want to clarify that the 10% to 15% was over the 3-year period.

Yes. I just assumed it was linear because that would imply like 15% to 25% in the back half, but I understand what you're saying.

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

A question for Doug, can you just walk through the assumptions for the Canadian grain harvest? Do you think that's sufficiently derisked at this point given all the weather conditions that we're seeing out there in some of the crop conditions as well? And also the U.S. grain forecast looks like it's actually raised. But similarly, same sort of challenges out there from that crop. So can you just give some puts and takes around why these went in opposite directions?

Sure, Brian. So thanks for the question. So with respect to the Canadian grain, obviously, you can't really count it until it's off to fields. But from everything we're seeing, both from our customers' crop forecast, which are very accurate especially in Canada, to the government forecast, we're seeing that roughly that 65 million metric ton number, right? So we're pretty confident in that. Now at this time of the year, unless there's a big change in weather that really has a big impact on the crops, it should come in very close. So we're pretty confident on that. The crop on our network, on CN's network has more moisture. So we think we're actually fairly well set up to move things through up until Q2 next year. And then we'll only be able to determine that later. With respect to the U.S. crop, it started off as a very dry crop, almost a drought crop. We've seen significant amounts of rain on our network over the last 4 weeks. So that crop forecast on CN through Illinois and Ohio has come up dramatically for us. So we're actually looking at a normal crop in the U.S. right now. Now things could still change. It still has to come off the field as well, but the corn and soybeans are actually have caught up almost to the average right now.

Your next question comes from the line of Steve Hansen with Raymond James.

Just a follow-up on the grain crop, if I may. It's obviously been dry and stressed as you indicated, Doug. I suspect we likely get an early harvest this year, which should provide some help on the margin. But I also think we're comping up against a pretty benign winter through Q4 and probably even more so in Q1 next year. How do we think about that in relative context? Can you actually move as much grain as last year if the winter is more normal?

For our network, we anticipate that the crop yield will be slightly lower, but not significantly, due to the increased moisture in the northern regions. We're confident in our projections. As for logistics, we experienced a typical winter, and while it was described as late at times, the number of cold days below minus 30 aligned with an average winter. Thanks to the operational plan developed by Ed and his team, our performance has improved significantly compared to previous years. We're planning to move the same volume of goods as we did last year for our clients, and we are optimistic about achieving that successfully with our team.

No. I can tell you, I don't see any real problems at all. I mean today's technology allows us to run repeater cars when it gets extremely cold. We always run distributed power on loaded grain trains. We'll do just as well this year as we did last year.

Your next question comes from the line of Justin Long with Stephens.

I wanted to ask about the lag impact from fuel that's getting baked into the guidance for the second half and how that compares to what you saw in the first half. And then just to clarify on the volume guidance, could you share the industrial production number that you're using as a benchmark for this year?

The industrial production number is, as you saw, census came out a couple of days ago and it was negative 0.2, so it's in that range. And on the lag question, I think that we don't expect a lag. If fuel prices remain the same, we don't expect a lag in Q3 and neither in Q4. Now on a year-over-year basis, if you look at Q3, we had a positive lag last year of about $0.10 on a year-over-year basis, that will be negative. It will impact negatively our year-over-year fuel lag in Q3 by about $0.10.

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

I guess just to recap a couple of things here. Doug, does the pricing hurdle or inflation hurdle remain mid-single digits? Because I think you had implied about 5% looking at your longer-term outlook and maybe even higher in 2023. Do you think you're getting that outside of some of the markets that you called out? And Ed, it looks like your service metrics this quarter were actually pretty decent despite some of those headwinds. So would you expect incremental efficiencies if you can get beyond some of these hurdles?

Absolutely. When I said it was a tough quarter, I meant it was a tough quarter. The fires, the disruptions we had to deal with, we are very well positioned going into the third and remainder of the third and fourth quarter. Headcount, power, equipment, we ought to be able to do even better than we did last year at the same time.

And Brandon, on the pricing, we continue to be strong on that. Obviously, we talked a little bit about the pressures in some of the intermodal, so the short haul. But outside of that on the rest of the carload business, we're still being fairly aggressive seeing a great pricing environment based on the service that Ed's providing. So I don't see that changing for the rest of the year.

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

Just tying a bunch of things together. Doug, you laid out a pretty detailed bottoms-up view of a lot of the growth opportunities that your customers are pursuing, but now in the kind of more maybe uncertain macro backdrop, even you're looking at your CapEx budget going forward. Have you seen any type of reluctance to move forward with any of the projects that you laid out from the shipper community as both some of the temporary issues have intensified and the uncertainty has probably been elevated as well?

Jon, not to this time, right? We've seen a lot of these projects are longer-term big projects that customers are looking at. The immediate environment, they're looking macro, they're looking 2, 3 years out, and we're working there with them. So you take an example like a BHP potash mine as an example, like they're well under construction. It's only going to come up in 2 or 3 years. We don't see them slowing down. In fact, we're seeing them try to speed up. So there's lots of examples like that where people will try and take advantage of the market and the conditions, and they're spending as much money, if not more, because there's more labor availability. So each market is going to be different, each opportunity, but we're working with everyone, and we haven't seen anyone slow down to this point.

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

Thanks, Emma. So an interesting quarter from an external events perspective. I think we've managed it well, and we're all looking for a few less interesting quarters coming up, but we'll manage what comes at us. Our plan though is clear and it's not changing. The discipline around building the plan, running the plan, selling the plan is doing exactly what we wanted it to. It's working. It's delivering consistent, reliable service for our customers and then making effective use of our assets. And as we've talked today as our volumes lift, we're going to see that operating leverage follow suit, and we're ready. We've got our eyes on our future. We're advancing our growth projects, preparing for the rebound, and doing exactly what we said we'd do back in May. That being said, as you've heard today, we're reiterating our 2024 to '26 financial perspective of 10% to 15% diluted EPS CAGR. That's all for now. Thanks very much for joining us today.

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