RR Reflections 4 - Northern Soul

Snowstorm 2


Polar vortex – baby it’s cold out there, somewhere (not here, especially). And that will impact railway
ops, of course; CN has already issued a press release noting this. There will be some cost impact, some
shorter trains (air brakes), some lost or displaced business. It’s unusual, though. At least I guess it is –
how many unusual weather events need to occur to change our collective views on what is “usual” or

The last two rails in my “Reflections” series (sounds like a ‘70s album by Al Stewart or some such) are the
two up in Canada – collectively that not always heard the answer to the ill-thought-out refrain “PSR is all
about cost only and not growth or the shipper”. Phooey! Meanwhile, we are waiting on Berkshire
Hathaway/BNSF to complete the group (later this week? Next?).

As always, in hockey, maple sugar, and railways, look to the north….CP produced an OR of 53.9%. Think
about that! Both it and CN, the mothership, beat earnings expectations and had a solid and hopeful
year-end performance - but there were some notable differences:

  • CN’s OR of 61.4% (Q4/20, -380bps)/61.9% FY20 was 750bps/480bps higher than their rivals. It is
    worth pointing out that CN’s breastfeeding nonrail acquisitions add a point or more to the OR,
    and that their intermodal revenues, more than double those of CP, are 27% of the total base
    versus 21%
  • There was also a widening gap in the relative ROIC performance (16.7% to 13.4%). There are no
    caveats to add here, but I assume a convergence over time.
  • Most notably there was significantly more optimism from the management team in Calgary -
    CP’s detailed guidance: “double-digit” EPS growth (adj) on “high single-digit” volume growth
    (RTM) – for CN substitute “high single-digit” and “mid-single-digit”, respectively. This was well
    noted – though JJ Ruest of the Canadian National said “ask us again in April”. I think the former
    (CP) are riding high ad justifiably so while CN is being more prudent in noting the still unresolved
    vax outcomes, etc. It’s a long game to be played and there can be multiple prize winners.
  • So, speaking of prize winners, we will ask JJ again in April (and July and in November when he
    accepts our RailTrends 2021 Innovator of the Year Award! We (Progressive Railroading and
    myself) are thrilled and honored. JJ’s predecessor, Claude Mongeau, now on the NSC board,
    won it; JJ’s predecessor as CN’s CMO, Jim Foote, won it last year as CEO of CSX; his rival CEO,
    CP’s Keith Creel has one as of course does the man currently restructuring heaven’s railway, E.
    Hunter Harrison.
  • It is worth noting the tenor of the analyst/investor questions, often the source of teeth gnashing, in both (really, all) earnings webcasts – about growth plans and especially about
    technology, which entailed some good, detailed answers, albeit with an operations focus (what I
    call “defensive”, using a football reference). I would like to know more about CP’s tech strategy
    (“it’s all part of a pursuit of operational excellence”) and about CN’s by-now acclimated new CIO
    (yes, those are HINTS). CN is again trying out the phrase “Digitally Scheduled Railroad” (DSR) – it
    may be too early yet for that to stick but CN is an industry leader here. CP meanwhile, is doing
    the coolest thing in the industry by developing a hydrogen battery to power a loco on the road
    in the next 12-18 months. And Keith Creel says CP won't be “bleeding edge”!

Speaking of technology, tomorrow is TradePress/Progressive Railroading’s Railroad Technology Summit
with innovation officers from KSU (our pal Brian Hancock) and Trinity (Dan Anderson) among others. I
hope to hear a Rail Pulse update from TRN. The agenda is attached and here is the link: Rail Summit:
Technology Advancement (progressiverailroading.com).

“Strong Finish to (a) Challenging Year” - Canadian National earnings increased 14% YOY (adj) as it grew
its volumes by 10% (RTMs – by 7% in units which I prefer). CN’s own presentation headlines cannot
actually be bettered: Not just the “strong finish” but also (2020 was an) “Unprecedented Year with (the)
Pandemic followed by an Uneven Recovery”. Despite claims of conservatism, signs of optimism were
there if you looked. They reinstated the guidance (above; to be fair, CP maintained theirs throughout
2020), added 7% to the DPS and resumed their share buyback, and slightly increased their Capex

Operationally, despite the shark's tooth pattern of deceleration/re-acceleration, they improved in 4/6
KPIs (only declines were slight and seen in car and train velocity). Their arguably best-in-class fuel
efficiency improved again and now starts with an “8-handle” (0.89 gallons per 1K GTMs). Train length
and weight also improved. Unlike their US peers, CN showed improvements in FY & Q4 accident and
injury rates.

The paired leadership in marketing combine to appear more optimistic than the guidance suggests. That
they have two leaders - James Cairns and “Rail Centric” (read: bulk/IP) and Keith Reardon in Consume
Products (AKA IM/auto) and one slide is….what it is, to quote the bard. Combined, CN’s Janus, CMO,
expect positive results in Ag (both countries), IP (notably propane), lumber, coal, believe it or not,
possibly CBR and IM (both Intl and Domestic), and autos. CN, its forward focus, had two further
mentions of technology, which are still expected to generate $200-400mm in productivity (defensive)

  • “Leading to bring technology into rail operations (again, defense) and the customer
    experience (offense!)”
  • “Remaining mindful of industry long-term disruptors” – yikes! Solid, but not explained
    or asked about.

Some more relevant issues:

  • CN finally got approval for its Milton (Ontario) IM facility, whose two-year buildout should begin
    later this year
  • They see no M&A beast feeding opportunities but will be ready; in the meantime, the Massena
    line purchase from the CSX is still being (re) reviewed by the STB

Canadian Pacific is doing so well they’re giving away Loonies! OK that’s not true – but they did pay out a
$17mm one-time bonus to “front line union workers”, which is outstanding. And they still grew earnings
by 6% and blew away Street (Main, Bay & Wall) expectations. They produced that OR – and predicted
another 100bps (plus) in 2021 and talked “double-nickel” and you know my opinion on that – and that
ROIC. And, by the by, discussed that ROIC, unlike some of their American peers….

  • Operationally they improved their KPIs across the board for the year but were more mixed in
    the quarter – notably a 59% increase in train accident frequency, almost US-like (though not a
    joking matter). For the year that rate showed a 9% improvement….
  • But, to prove the PSR 2.0/Pivot status, marketing was the star, in Q4/20 results and especially
    ‘21G. For the Q4, volume (units) was up 4%, RTMs +2% (up 9% sequentially), and revenues -3%,
    the latter explained by fuel surcharges and mix (also very US-like, though less so). In terms of
    revenues (adj), grain (strong on both sides of the border) was up 8%, potash 10% ferts 14%,
    forest products 14%, auto 31% (hello, Vancouver!), and IM 3%. But for the future, (the only)
    CMO John Brooks sees that for CP, volume has hit an inflection point. And he has new contracts
    turning into units (DRU, autos, Maersk, Hapag-Lloyd – that’s a lot) this year.
  • Intermodal is a puzzle. Units were up 7% but RTMs -1%. Domestic (57% of the ’21 total) set a
    record. New international business coming. But this doesn’t seem to warm the hearts of JB and
    KC and team – Brooks sees “big things” in the bulk franchise, and autos and Creel noted DRUs would be online and moving by H2/21. Creel, while clearly excited and confident, talked about
    the “destruction” in cost and reputation for over-committing the railway, as did (in different
    terms) JJ discuss about his – but this may show that CP has more capacity ready-to-go, on a
    relative basis.
  • Cash! After holding the line on CAPEX during the pandemic (actually increasing it by 1% and taking
    advantage of longer windows and cheaper materials) they are taking it down by ~$100mm (C) or
    6%. Boo! But some of that is pulled forward and reflects fewer hoppers, and a lot of project
    work, some with co-investment, completed. But CFO Nadeem Velani warned (me – he excited
    the rest) that this was a trend.

From the Twitter file (no, I haven’t been banned – yet).

Why’s the railroad industry’s self-financed network so important? Financing the network went from
being a competitive problem due to highway subsidization to a modal advantage for rail as the
politicized NHS can’t maintain itself much less add capacity. For example:
At his confirmation DOT Sec Buttigieg “entered into the politically fraught territory by not ruling out
increasing the gas tax to fund the highways, saying that ‘all options need to be on the table’ - After the
hearing, a spokesman said Mr. Buttigieg opposed increasing the tax”. Lesson learned….



Anthony B. Hatch 
abh consulting
Twitter @ABHatch18