Opening Night but the Stars are in Canada

Abandoned Forest Industry Nature 34950

Greetings and Happy Opening Night!

“Well, beat the drum and hold the phone
The sun came out today
We're born again, there's new grass on the field
A-roundin' third, and headed for home
It's a brown-eyed handsome man
Anyone can understand the way I feel”
/”Centerfield” by John Fogerty

“Well, that was a phenomenal quarter….a milestone quarter”
/CP CFO Nadeem Velani, giddy about his company’s Q2/20 performance

Take me out to the ballgame – or at least to the TV set: Before we cover the earnings performance of CP
& CN, and understanding that we are in serious and unsettled times, I still have to report that for today,
at least, I am – also – happy with my team’s performance and actually giddy. So on to earnings, even
though, really what’s the point (see “Who Cares?” attached). Well, CP proved me wrong….

Barreling Up - CN & CP joining KSU to make it 3 for 3 to start off the Rail Earnings segment on the eve of
Opening Day; a (too) quick look at CSX, now the cleanup hitter after years as leadoff, suggests they
might have gotten an HBP. Right now it is beginning to look like this lineup is top-heavy, and in fact,
characterized by significant Canadian out-performance. That is really not a new trend but shows in
starker contrast in these trying days. Maybe it’s their “resiliency” (the word of the (earnings) period.
And I know there are more ABs to come – UNP tomorrow, NSC next week, BNSF perhaps on 8/1 (GWR?).
There is a growing sense that, throughout the rail network, we are seeing a bit of a plateauing effect
after the sharp recovery. But though the demand patterns may be similar, the results are not. And it’s
easy to see who the likely MVP of the strange 2020 season will be, and the likely runner-up (the latter
perhaps facing a challenge from the Mexican Leaguer). Why is that?

  • Is it the status pf PSR 2.0 whilst the Americans are still a phase behind?
  • Is it the different country’s response to the pandemic (see The Economist on the USA and C-19:
    07-22&utm_content=article-link-1 )?
  • Is it luck? No, that is not it….
  • Is it spending CAPEX? Well, you all know where I stand on that….CP reported the quarter that
    they did, with an ROIC of 17%+ and obvious benefits from longer/heavier trains, the new grain
    cars and expected benefits from new market developments – and they still get asked about
    reducing CAPEX (and not once but twice)!

Canadian National faced the COVID (19) curveball and ground out solid results – EPS which beat both
Streets (Wall & Bay) but not 2019, down 26%; real OR up 290bps to a still-respectable 60.4% and a
doubling of H1 free cash to $1B (loonies). They did it though PSR-infused operational control – 21%
reduction in crew starts over-matching the 18% drop in RTMs (and 16% in units, where the work is). CN
has a great slide deck, with excellent appendices, but should have more for the two-headed marketing
effort – even if it was a dismal pandemic-infected Q2 for CN (and the industry), with grain & ferts flat
and the rest varying shades of down. They were protected by liquidated damages on the CBR side.
They announced a big purchase of the next-gen grain hoppers (a la CP).

CN still has a great growth pipeline (as it were) and we need to see some of the flow in 2021 or CN, the
PSR originator might be seen as the Tommie Aaron of the Canadian rail brotherhood (or as they might
understand it better, the Dennis Hull). But they have the PSR DNA, the service reputation and capability,
the (tri-coastal) network, the tech chops, and the financial wherewithal to get back on the lead lap
(remember the string of bad luck they faced, and the fact that they have the best investment grade in
the industry). On the technology front, CN hinted (a lot) that there was a new hire/stay tuned – as well
as a new Chief Strategy Officer (I couldn’t find that announcement), and said that they have moved up
to Phase 2 with their track-inspection car pilot program on the US side, with the FRA – and track tests
are up 17X (and, related if not perfectly correlated, their train accident ratio down 22%). They are also
working with Transport Canada on that. And I agree with CEO JJ Ruest that although they have been
developing their Princes Rupert of the East, that near-shoring (of rail products) is not a near term threat
to the #RealPrinceRupert (which should have a record July)….I also agree with him and the team reteaching the lesson – again - to not focus on OR and not equate “yield” and “price” (which they are still
getting at RR-Inflation+).

  • Line segments and off-rail updates:
    • No update on the stalled purchase of the “Massena lines” from CSX, which surprised me
      (and no questions, either)
    • CFO Ghislain Houle stated that the two non-rail acquisitions from 2019, Trans-X and
      H7R, “will deliver higher than our typical ROI threshold we use at CN” and were really
      helping put CN/Intermodal’s reefer thrust
    • But, surprisingly for a company on the hunt for assets to feed it’s rail “beast”, CN
      announced a line sale and took a $486mm non-cash charge – the non-core, non
      the mainline portion of the Wisconsin Central, part of a purchase under Hunter that started
      CN on their journey to continental power. What they are selling, I have been told, is
      decidedly “non-core”(lotsa logs); in addition what CN said in the Q&A about selling to a
      partner to use the short-line value proposition (lower costs, access to government funds
      and the 45-G ITC) to grow. Of course, an early question to management was whether
      they might name the as-yet-unknown proceeds to re-start their paused share buyback

CP leads in OPS railroading (Outstanding Precision Scheduling) - OK, let me think of a better analogy, and
be fairer to CNI, who performed well, but the New Kid was lights out – is CNI Bobby Hull and CP Brett?
Joe D giving way to Mickey Mantle? CP blew away the Streets’ consensus Q2/20 EPS estimates and (on
an adjusted/diluted basis) saw earnings drop only 5% - and improved their OR by 140bps to 57%. All of
that on a 12% decline in volumes (in units; RTMs down 10%). But this was a more balanced effort, with
the top line helping too as CP also posted 3 commodity increases – grain (+5/8%), potash (+6/5%), and
ferts/Sulphur (+18/31%) – and on an RTMs basis (forest products (-5/+2%). They also updated their
limited guidance in calling for EPS growth for FY20 on RTMs down 5% and strength showing by Q4. In
operations, CP showed gains in train length & weight, locomotive productivity, and fuel efficiency.
Headcount was down 10%, better than the unit decline. They resumed their share buyback campaign
but also reiterated their CAPEX numbers (~$1.6B), which makes sense since the pandemic’s opportunity
has led to “capital efficiency improvement of 19%) – and they reported an ROIC of 17.1%! (Yes, despite
that they got the CAPEX question anyway….).

Big hits in future innings - They also talked growth pipeline, including the CMQ effect (but as the only
one on this list or maybe at CP to have actually been to Searsport, I will play Missourian (you know, show me) on that aspect. But St John looks more of a “sure thing” (with its “200-mile route advantage”0 but I
am curious about why CMO John Brooks is “excited about the prospects” of goods shifting to the Suez
and the east (from BC). After all, the eastern US rails have adjusted to the “all water” share shift from
US western ports to eastern ports, but I bet you a beer and peanuts that they would still rather receive
the containers in Chicago (via LA/LB and a western road) – higher overall modal share and longer LoH.
Maybe the proposed eastern Canadian business has similar volume/share/margin/ROIC aspects as BC
business? Meanwhile, they did not mention the Pan Am nor comment on CN selling lines….

Picking it (nits) at the hot corner - All was not perfect in Calgary, of course. Their safety numbers
deteriorated in the quarter – Personal Injury rate by 12% and Train Accident rate by 22%. Also, that
brings up a point, as I had to find the safety numbers in the supplementary materials. I do have a bone to
pick on data released – only 7 (really 6 and ½) slides, no breakdown, for example, on international
(mentioned as close to flat) and domestic intermodal, no train/crew starts….but overall, Nadeem was
right. But I will leave the last word to CEO Keith Creel (perhaps the Mookie Betts of the rail world?):
“….the last three years, as much as we’ve been focused on growth, we have been focused on rebuilding


Anthony B. Hatch
abh consulting
Twitter @ABHatch18