October 12, 2018
CP, PSR – and PHH - A week ago Canadian Pacific held its first Investor Conference in the PHH (post-Hunter Harrison) era, and for several years, to great pomp and circumstance (a la EHH). The timing was great to also absorb the Canadian reaction to the conclusion of the NAFTA 2.0 (“USMCA”) negotiations….While the initial news has been well and quickly reported – pre-announced Q3/18 earnings (above consensus, naturally), financial targets labeled “conservative” (of course; see below), exciting commentary on the Precision Scheduled Railroading “playbook” and its transferability (maybe), as well as on consolidation (for sure, and though I vehemently disagree I note that CP’s investor-star CEO Keith Creel is an actor while I remain merely a critic) – I wanted to check in with some sources (shippers, other carriers, interline connections) and take the time to contemplate what I saw in heard in snowy Calgary.
Message-driven: And I wanted to think through the big phrases we heard often – “rebuilt engine” (PSR-improved rail ops); “playbooks” (holistic looks at combining ops and marketing – and market reach and technology and….to capture or recapture business); “disciplined approach” (to growth – awareness of the value of capacity, not overpromising undeliverable results nor growing for its own sake); and, especially, “constructive tension” (say, to demand excellence or determine a major investment); all of which allows CP to “pivot to growth” (nuff ced). And, if I am to be honest, it’s the baseball playoffs – not that one would have known that in Calgary, where the opening day of the NHL series – eh?! - meant that MLB wasn’t even on TV!).
Post-Hunter: As can be expected, Hunter himself was everywhere, there (in Keith’s commentary, calling EHH the “G.O.A.T.” of railroading; in the copies of “Railroader” stacked up at the meeting; at the very site, named for Harrison). And, make no mistake, CP remains, as Creel said in his night one remarks, an operations-driven company. But there was also PHH signs were everywhere – for example, in his introductory remarks, Jonathan Wahba, VP Intermodal/Automotive, worked at rival Canadian National under the PHH/Claude Mongeau era, moved to trucking, then joined CP last year because, as he said, “CP under Keith Creel was a different CP”. Different from what, or whom, exactly, was unsaid….In fact, under Hunter, CP had no CMO; under Keith, CP’s CMO John Brooks (and team) led (were) the show, along with Nadeem Velani, CFO, of course (this was an Investor Conference after all).
The main takeaway, in my opinion, was the PSR to PHH evolution in three stages as seen in CP’s railroad development, from pre-2012 (ancient regime) to the 2012-16 Operationally-driven (PSR revolution) period, to pivoting (2017 “& Beyond”) to “Sustainable, Profitable Growth”, the classic PHH model (that we think we see at CN and developing quickly at CSX, and as shown on their presentation slide 15). There were plenty of numbers, lots of catch phrases, great discussions, but this “dramatic evolution” was the theme CP wanted to impart (see slide above and attached).
So, lessons for others, or while we’re on the subject, is the PSR-to-PHH playbook transferable? Those of you who attended RailTrends 2017 may recall the exchange between CP’s Brooks on this developing theme and CSX’s former VP-Industrial Products, who vehemently denied that a railway needed to go thorough these distinct phases, from revolution to reconciliation (arguing that they could grow and remain in sync with all of their stakeholders whilst undergoing PSR transformation) - that proved not be the case for CSX in 2017 though they are now moving fast into the early PHH stages. Brooks argued, as Creel did forcefully in Calgary (and Hunter himself did throughout his career) that the revolutionary change required needed a driven leader (with Board support), a painful and radical cultural change, and full, accountable focus and a drive to execute. Can this change be done by an existing management, the financial audience wanted to know?
Looking at Omaha from Calgary: Clearly their focus (both the investors, and at times, CP) was on the Union Pacific’s recent announcement that they, too, were adopting “PSR principles”– and the room’s feeling that “PSR-Lite”, as they saw the measured approach espoused by UNP, was problematic (and the locals did little to dissuade the audience in this regard….I wonder, however, whether UP is going “PSR-Lite” or “PSR 2.0” – an attempt to bring other stakeholders on board during the changes rather than after “under new management “revolution? On the one hand, while the “PSR playbook”, in this case, is more cultural than specific, it hasn’t yet happened that an existing insider, from a strong not to say historic railroad culture, leads the change required in PSR – after all Hunter replaced management at CP and CSX. Could the same folks in an insular, albeit strong and historic culture at UP change themselves? However, one prominent railroad insider suggested that the measured approach UP is taking (“PSR 2.0”) was feasible, and noted that UP was already studying some rather radical steps in looking at their network and operations….It was also much discussed by the investors present that some of the other carriers seem to be at least humming, if not yet singing, from the PSR hymnbook (noting NSC’s recent remarks and interpreting, without substantiating evidence, the retirement of Chairman Matt Rose at BNSF as Berkshire’s PSR push).
Finally, can’t get enough PSR-PHH? Well, neither can we - RailTrends 2018 is a PSR-PHH love-fest, starring many of the major actors in the drama – UP’s CEO Lance Fritz, CSX’s CEO Jim Foote, CN’s CEO JJ Ruest, and the afore-mentioned esteemed Mr. Velani (violating the “No CFO” policy) www.railtrtends.com
The Big Financial Guidelines from the CP Investor Conference (and a blow to the Cult of the OR?) - The CP Financial targets were revealed, of course (the reason many of the attendees braved the foot of snow in what was elsewhere “Indian Summer”). First, CP reported preliminary Q3/18 results that were some 10-15% above consensus (they’ll still hold their Q3/18 webcast on October 18th (where they had better not surprise us after a short time, as they are well aware given recent events elsewhere) - then they targeted:
Growth: Mid-single digit growth in volumes (RTMs) 2018-20 – and that excludes any lasting CBR impact!
Intermodal – both domestic (riding at a 6% CAGR in the last several years, at the NA run rate but not too shabby for Canada) and International, fresh of the ONE victory with some $600mm jump ball business up for bid….
Autos – also some $400mm up for bid, with renewed confidence after Ford became their “anchor tenant” in their new Vancouver Auto “Compound” (the Hyannis-port of auto terminals)
Grain – where they see a current 52% market share in Canada, and growth coming from their $500mm investment in new (larger and yet shorter) hoppers and the new 8500’ throughput terminals, loops, sidings etc; its interesting to recall that only 15 months ago CN touted their chances at market share winning in the Prairie Provinces “jump-ball” opportunities. The new VP of Grains & Fertilizers came from the CN, too – and from 12 years at a Canadian grain shipper (Richardson). Given the realities of Canadian grain (over) regulation – that is some transition! (Though we did see it work at BNSF with Kevin Kaufman) So, stay tuned….Export coal from BC is CP-dominated (after all its form former CP owned mines) but I do wonder how the Teck shippers like being part of the Grain group?
Pricing growth average – in the “best environment in years” – of 3-4%
Operating leverage of 75% (although CP is “no longer a headcount story” – Creel – there are many productivity opportunities such as train length, “demand management” through pricing to remove as much variability as possible, etc)
“at least” 100bps of OR per year, with a sub-60% OR next year….
But hey – not really an OR story anymore – in fact ROIC, now 60% of management comp, will increase to 70% next year! Be still my heart! This Cult of the OR will be defeated by the very PSR-enabled OR warriors who started it (at CN, CSX and CP), though not without casualties and collateral damage in Omaha, Fort Worth, and Norfolk….
Capex in the range of $1.6B (Loonies) a year for the three year period – still representing ~20% of revenues (no “15% or less” plan here), and with lower rolling stock expenditure coming soon, and PTC rolling off sooner, that allows for the (RTM & GTM) growth as they now see it - and a constant theme for CP was “room to grow” – Using banked CP-owned land for terminal or transload expansion in Vancouver (following on the recently opened Deltaport expansion), Chicago, Toronto, Calgary, which will hold down their costs….
The Big Payback, heh! Oh, yeah – 3% annual share buyback rate, approximately, and a path towards a 25-30% dividend payout – a balanced approach….
Good thing they took the phrase “Free Trade” out of the trade deal, eh? Canada’s views on NAFTA 2.0 (USMCA) – relief (it could have been worse) & irritation (still retaining those metals tariffs, etc). Calgary might not be the best place to gauge “Canada’s mood”, even if the timing was fortuitous; Calgary has over 8% unemployment, a quarter of downtown office space is empty and the entire energy-rich province of Alberta is at war with neighboring BC and the federal government in Ottawa over pipelines (and fuming that BC was just awarded the biggest infrastructure project in Canadian history, a $40B LNG export terminal (as Calgarians noted, BC thinks green only when its other folks’ green, ie; Loonies). Nonetheless, it was clear that Canadians were pleased to remove the Damocletian sword over their heads with the NAFTA 2.0 deal; in fact, their auto industry stands to benefit (from the provision for higher-paid – ie; non-Mexican – workers and because they have some 54% upside in production pre-quotas versus Mexico’s 12%). However, they didn’t like:
o The fact that the steel and aluminum tariffs remained in place
o The supposed “legitimizing” of the use of “national security” as a pretext for tariffs
o Sovereignty issues – it was quickly picked up by the opposition and other leaders (Doug Ford!) that the idea that Canada and Mexico would have to essentially get US approval to sign any other trade deal with “non-market economies” (ie; China)
o The manner in which the Canadian PM and their trade negotiator were treated by the US
Canada’s response has been to focus on the positive – and to exclude the US from their own international conference on WTO reform! Overall, for Canadian rails, this is a bigger deal than they have been letting on (Creel: “This eliminates headline risk”) because, as the FT noted, “no deal would have been a disaster for Canada” and as the prime movers of an export economy, the two railroad’s with their nation’s name are Canada….
Anthony B. Hatch