Calm Canada - Rail Earnings as the US Holds its Breath....

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Greetings and Happy (?) Election Day; I trust by now you have voted….Rail issues include trade and stability (for investment and otherwise) but you all know that.


Their Home & Native Land:
   Canadians are nice.  They are our allies.  They are funny – I am sure after all of the awards you have checked out “Schitt’s Creek” but may I also suggest “Letterkenny”?  and, they are, with American help, good railroaders.  So (aside from their US ops) let's look beyond Blue states & Red states to the provinces up North…

Canadian results – near term misses, long term growth:  As I (we) wait for the polls to close and endure the start of my second week of Quarantine I figured it was time to catch up on earnings, starting (for the sake of calmness) with the two Canadian carriers, both of whom slightly disappointed elevated investor expectations on Wall & Bay Streets.  Both results calls were supported by further webinars – Canadian Rail Insight and the annual WESTAC conferences But both have seen a return to real growth led by intermodal and record grain traffic on both, both produced terrific operating rations while coping with the shark’s tooth volume pattern, and both promised further updates in detail in the January calls.  They differed in:

  • Offering Guidance – CP outlined expectations of mid-single-digit EPS this year; CN said that while volumes were up high-single digits now, they preferred to “wait till next year” (January) to gaze in their crystal ball. 
  • They both pursue deals to feed their respective beasts, CP taking up the near term deal announcement leadership role with its Maersk partnership(using its land bank)  and (pricey? Or accretive?)  tunnel deal (and they “remain focused on rail M&A”….even if there might be an airline name involved?). 
  • They both believe in technology, for today and to face the future; if CP seems more of a newcomer (and more reluctant to share) they did win exemption approval from Transport Canada on their own inspection portal, the first to be “put in play”.  CN in their call and subsequently stated that they were, in effect, seriously studying and preparing for the AV truck threat (and opportunity); they are already preparing to be an early EV adopter.
  • Both have been leaders is discussing ESG, inspired by current events, rail structural advantages and, in CP’s case, by their largest shareholder.
  • But step back and note that while they are fierce competitors, like aggressive brothers on a backyard hockey rink, their patterns, like their origins, are pretty similar.  I  worry not about the Canadian rail story; early adopters (originators, even) of PSR, well into PSR 2.0+, funding growth plans and providing investable returns

Gosh Darn Independent, still - Speaking of Operating Ratios, while both were terrific, and both look to improve – CP stating that the mid-50s was “in the art of possible”  - clearly the phrase of the moment in Calgary– I remain a proud GDI outside of the Cult.  And both Canadian railways reminded their investors that efficiency is important, operating leverage is real, technology is being on-boarded - but that lower ORs were “just a natural outcome of our profile” (CP CEO Creel), that of greater importance was “balance; we are not enamored with the OR” (CN CFO Houle).  They state this time and again and yet still have to deal with questions on (sic) “a little more color on the 3Q to 4Q walk”.  So, back to Ghislain: “We would rather be a C$25B company (with) a 59% (OR) than be a C$ 15B at 56% (OR).  I mean just do the math”.  As with the pandemic, you have to fight the despair on the daily…

CN reported a 17% drop in YOU Q3/20 EPS (about 5% or so below expectations) showed an OR increase (200bps) but still reported a 59.9% - and that still includes the dilutive effect of TransX  CN, the PSR “mothership”, showed terrific operating momentum, and has emerging strength in most non-oil related volumes.  These include grain (Canadian & US), Lumber (etc), Canadian coal, propane, and intermodal, both international and domestic.  In fact, intermodal revenues decreased by only 3% in the quarter on flat units, which as much as any subject, represents a “tale of two quarters: within the overall Q3/20.  IM was negatively impacted by the Port of Montreal; strike which also added to the quarter-long network imbalance (CN’s head of IM/Consumer Keith Reardon stated on the call that balance was restored).   With the volume comeback in IM, CN is seeing opportunities in selectivity from a rate/return process.  And CN got some good news from Maersk, as well, a new ship call in Mobile (from Houston).  The steamship expert at WESTAC (from SeaIntelligence) noted that it was impossible to forecast international container shipping for the next 12-18 months due to all of the uncertainties (one of which may be being answered as I write).  But - One clear sign of growing CN confidence is their re-opening of their training centers in Chicago and Winnipeg (also another sign of CN’s willingness to invest in the future; one hopes that the STB and TC and the rest take note).

  • Operating stats were supportive:  Crew starts were down 14% with volume down 6% (in carloads – down 7% in RTMs).  Crew productivity was up 17%.  From the depths of July dwell improved by 24% and car velocity by 25% Full-Q dwell was up 25% and velocity -5%).  Train length was up 6%, weight by 4%, fuel efficiency (invented there) by 3% to 0.85.  Safety improved – in a pandemic/sawtooth quarter – by 19% (injuries) and 22% (FRA accidents).
  • Financial goals were supportive of a long term growth strategy
    • Share buybacks still paused to maintain their industry best investment-grade financial rating
    • Debt/EBITDA (adjusted) at 2.17X slightly above target (stated as “1.7X-1.9X”) – all will be “revisited” in the January call
    • Capex to remain in the ~20% range with current investment opportunities in the grain supply chain (including the next-gen hoppers) – which will be supported (as always) by ROIC
    • No update on their Wisconsin line segment sale process, nor on their petition to the STB to change the restrictive requirements imposed in the CSX/”Massena Line” acquisition deal

CP reported Q3/20 EPS 11% down YOY (about 2-3% below consensus); their OR increased by about the same (210bps) – but still 58.2%.  A more significant number – and KUDOS TO CP FOR REPORTING  - ROIC of 16.2%, down only 40bps and (very) likely industry-leading.  They expect a best-ever Q4 OR as part of the slight increase in Guidance.  CPs slides are still limited but they did give some excellent appendices on their efforts in technology, ESG, and their land bank holdings using Vancouver trans-load as an example.  Their CMQ acquisition is a big potential growth driver, but I do have some (likely) resolvable) issues, from Searsport, Maine to taking share from ports like NYNJ (where only some ~12% of the inbound volume hits a railroad) – but they are strongly hinting that  St. John will get a major steamship call announced soon.

  • As to be expected, operational excellence was in evidence, with improvements in safety (accidents -14%; injuries -26%) and train size (length +9%, weight +7%
  • Revenues were down 6% as units dropped 7% (RTMs -6%).  But I defy any carrier to be more confident in their pipeline than CP….
  • Capex maintained at $1.6B – but the pandemic longer-window opportunities are helping – for example, rail-tie installation is up 30% YOY.
  • CP is more aggressive with its long-term capital goals – running at 2.4-2.5X, which CFO Velani described as “the high-end of their range; which we are comfortable with”….

 

RailTrends 2020 Update – as I suggested in my note on this month’s Main Event (see attached) we will indeed hear from Rail Pulse (the Really Big Deal); we also anticipate adding Mexican participation to complete our NAFTA (2.0) DC/Ottawa participation.  On Rail Pulse, NS, GATX, and Trinity will present jointly to better reflect the coalition nature of this project.  G&W and WATCO already are on another panel. 

The presenters will be:

Mike McClellan – VP of Strategic Planning at NS

Robert DeGroot – VP of Railroad Leasing and Sales at Trinity

Paul Titterton – Sr. VP and COO, GATX

 

  • The Midwest Association of Railroad Shippers annual meetings has always been a major date on my travel calendar; the two days in January really serving as the “start of the new year for freight railroading”.  And they still will, in 2021, albeit virtually, of course.  I write “of course” because January isn’t far away, and we are aware of the state of the world, but as I wrote recently, this first travel cancellation for 2021 served as a symbolic wake-up call and a sad one.  The fact that they are holding it on not one but TWO unofficial national holidays – Inauguration Day and my birthday – is lamentable indeed.  But I will be there…. (Click Here)
  • Consolidation comes to the Oil Sands – the FT sees the Cenovus-Husky deal as the start of trend, as we have seen in the US shale fields
  • The (Toronto/national) Globe &Mail sees the (high) valuations and the post-result selloffs of CP and CN shares as worrisome but notes that rails can operate other levels that can excite investors such as growth….well, yes.

 

Anthony B. Hatch 
abh consulting
http://www.abhatchconsulting.com 
abh18@mindspring.com 
Twitter @ABHatch18