"Ahead by a Century" - Reflections on the Canadian Rails Q4/19and following the Florida Scrambles (and before tomorrow’s tour of the Port of Montreal!)

Canada Flag

Greetings;

 
Canadian rails – ahead by a century?

 

“At its most basic level, “Ahead by a Century” is a song with a broad sweep, as it weaves together past, present and future. It is about time, memory, loss, disappointment and desire. But it is also about Canada’s identity and the politics of hope. It is a song in which the Hip asks us to shed what holds us back, and to imagine a future that sets us free.” Queens (University) Gazette

 
I wanted to wait until the blockades were over but I could wait no longer; the Canadian rails, solidly in their PHR phase, are certainly ahead. OK, by a century? Maybe not, but ahead. I had long planned to borrow this title from the Tragically Hip for the title; I could have used BTO’s “Takin’ Care of Business” or “You Ain’t Seen Nothing Yet” (someday I will). But I have to admit I considered going all rootsy, back to where Hunter grew up in Memphis:

 

Born under a bad sign/Been down since I began to crawl If it wasn't for bad luck, you know I wouldn't have no luck at all.

 
Consider:

  1. The GM Strike.
  2. The Canadian slow-speed rule (which impacted up to 30% of CN’s capacity); since amended.
  3. Their own strike (during RailTrends!).
  4. The Mohawk (etc) blockade of CN/and Via Rail.

Of those, one could argue that #3 was their doing, but certainly not the others (the Ministerial Order followed a CP derailment and decreed in order to not “put safety in danger”- who could argue with that?). The last one, ripped from the headlines, has made CN and its customers (and with the shutdown of the east and 450 layoffs, its employees) collateral damage in a fight over a gas pipeline in BC….reminding one of the teachers strike in Mexico that year ago hurt KSU (but bigger, much bigger). The effects are showing up in Canadian GDP estimates, etc (it was called by one economist an “economic microburst”)– and everyone is looking for someone to step up…. But Canada’s decentralized government and general niceness aren’t a great recipe for hard action. It’s hard for an American to believe that it’s still going on! Three obvious thoughts:

  1. This is not an investable event.
  2. This too shall pass.
  3. There may be some residual good to come out of this – better dispute resolution; more anti-pipeline fervor with possible CBR benefits, better understanding of the railroads’’ crucial role in the economy - and a chance to show CN’s speed at bringing the network back up (as they did, ahead of expectations, after their conductor’s strike late last year).

More bad signs in Alberta? The Alberta Oil Sands are subject to an increasing array of their own bad news. First, the list of investment firms and insurers and other financial institutions refusing in some form to do business in the oil sands continues to grow (HSBC, now Blackstone; or a major fund within Blackstone which ominously said it would not invest in any company that “derives revenues” from the Sands….which obviously includes railroads. Yesterday, a major(~C$20B) Teck Resources project (“Frontier”) was canceled, just days before government ruling on the acceptance of the project was due – the FT quoted that as a “very elegant, very Canadian solution”. Nonetheless, there was criticism from Alberta on Ottawa, of course, but it simply seems that the project's economic viability was in doubt: pipeline den=bates, expense, not just of the project but the need for world oil prices in a range of ~$65-85 – over a decade.

 
So, back to the Hip and earnings….Both Canadian carriers beat earnings estimates in Q4/19; both
predicted growth in 2020, fueled in part by demonstrative projects and wins (DRU in ’21, domestic
intermodal, and auto business in Calgary’s railway; Teck, etc), both are investing (to varying degrees)
offline to feed their respective beasts, both are executing eastern strategies as a hedge against China
imports moving to SEA(and thus through the Suez); both are demonstrating the power of the PHR (Post
Hunter Railway), perhaps most evident in their superior ROIC results (in the case of CP, very superior).
In fact, once again, the biggest spenders on a per capita basis still produced excellent ORs and most
importantly ROICs. Coincidence?

 
“We’re not enamored at CN by the OR” /CEO JJ Ruest

 
CN’s Q4/19 earnings are hard to analyze, given the 9-day conductors’ strike, impacting their OR
(+400bps), volumes, etc. So, given the rapid recovery, their forward-looking statements were more
interesting (before the blockades, of course – again – non-investable). Their slide on market
performance and the outlook is a rare IR slip-up; it’s confusing and wordy – but their call for a mid-single
digit volume (RTM) growth rate, again, more back-end loaded, stands out (as did the fact that Prince
Rupert IM volumes jumped 11% in Q4). Their resiliency meant that the strike cost them less than the 15
cents originally forecast. But the EPS guidance – “mid-single-digit range” after pension and incentive
comp headwinds, again pre-blockade – was met with some disappointment and pushback, but CN views
2020 as a “transitional year” into ’21 when added BC capacity, the Teck contract (and others) win,
reaching stability in BC forest products, reaching stability in trade, etc all come into play (and the OR
dips into the 50s). But CN, as stated, isn’t all about the OR, but, rather, profitable growth and….ROIC –
yes included – which dropped amidst all of this from 15.7% to 15.1% - a very commendable result, given
the circumstances.

  • CN’s two-year capacity build program is completed, (US) PTC is now an operating expense, and
    with the final 41 new locos in Q1 will bring that program to an end as well – so Capex will come
    down to the ongoing (kudos!) rate of ~20% of revenues. There were of course lots of
    questions….
  • The slide presentation made a stirring comeback after the markets slide by providing a terrific
    appendix, recommended reading, with great description of the BC capacity opportunity, and the
    tech projects (ATIP and the portals, etc) update; CN submitted the ATIP track car test program to
    the FRA in December….
  • The safety record in the quarter – yes it was included - was mixed – P/I was down 11% but rain
    accident rates up 13%
  • In a spirit of “self-help”, CN isn’t done with off-line M&A to “feed the beast”, and continuing
    with a line of reasoning revealed at MARS last month, JJ cited short lines as potential targets….

Canadian Pacific takes Quarterly, Annual Honors (Again)

CP’s earnings were up %% YOY (adj) and beat consensus but their OR increased (by only 50bps and to a
still eye-popping 57%). This is came despite a slight volume decline (-3% in RTMs, -1% they were
confident enough to point to a growth year in volumes (units and, as they prefer, in RTMs) and not just
back-end loaded – which will lead to low-double-digit EPS growth. Compare that to what we heard
south of the 49th parallel….And in fact, CP will be lapping both their big derailment and the Midwest
flooding from Q1/19, as well as growing outright, so CP is very (very) confident in a big start to the year.
Nonetheless, they had pushback on their “conservative” outlook – requiring a reminder that they
increased Guidance each of the last 3 years….

  • The call was a nice debutantes’ ball for EVP-Operations Mark Redd and the operating
    performance was better than solid; 5/6 KPIs improved, which included both safety numbers by a
    lot. Only train velocity declined (by 1%), which under PSR/PHR is less important than rail car
    productivity (car miles/day was up 11%). Of course, we know that CP’s derailment in CBR that
    caused the now lifted forced slow-down. Keith Creel made a nice shout out, again, this time to
    the Winnipeg Terminal, a very nice touch.
  • Operating expense was up 4% on the slight volume decline; some of that was stock-based
    compensation, of course. Capex will stay flat in the © $1.6B range, with fewer hopper cars but
    some CMQ catch up capex; Creel gave a great defense, if it needs defending, of the benefits of
    their spend.
    • Creel also stated that “Chicago has never been in better (operating fluidity) condition
      given the benefits of PSR that the other railroads are implementing”. To which it must
      be stated, even if io side with him on this, that the reduced volume helps the fluidity,
      too.
  • The CMQ is expected to be (slightly) accretive right away and they expect to take over the US
    portion after expected STB approval in the spring. This is, of course, re-connecting to a line that
    old CP management sold off. I think the port of St John has great opportunity and CP reports
    lots of short line & regional interest in allying with CP to grow mutual market reach. However, I
    bet I am the only one on this reading list (or in the top 1% of the railway world that has been to
    Searsport. I will eat my hat (or cheer for the Astros) if they can make that pretty, sleepy seaside
    town into a viable rail port. But this investment was called “the art of the possible” so we’ll see,
    but CMQ overall is looking at 2021 into ’22 for real impact.
    • There were a lot of questions on the CMQ deal.
    • Creel stated that they were more focused on rail additions than off rail a la the CN; but
      those opportunities were few, although they have “dry powder” if another comes along,
      possibly some from the Brookfield takeover of the GWR and its portfolio….
    • Creel restated what we noted after MARS in January – railroad consolidation is still seen
      as inevitable by him (and fatal by me, to the extent that matters) but now a decade or
      so away given the capacity freed up by the industry’s (almost) total PSR
      conversion/implementation.
  • The volume story was impacted by the ongoing potash contract drama (revenues down 26%
    YOY). Maybe there is good news on the horizon…. That would be a back-half expectation.
    Interesting tidbits: auto revenues grew 12% in Q4/19 and they expect that rate of growth in
    2020. That’s an interesting contrast to the rest of the industry! Intermodal’s 1% revenue
    decline on a 4% increase in RTMs was a head scratcher….Ag looks promising, especially given
    their fleet renewal and the impact on jump-ball business with CN (which they believe is behind
    on the new hopper cars because of the value of their imbedded, less optimal grain fleet).
  • The big story – their ROIC was 16.9% in 2019, up 700bps, Nuff Ced, eh!

 

Anthony B. Hatch
abh consulting
www.abhatchconsulting.com
abh18@mindspring.com