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CN 'Cautiously Optimistic' On Rail Volumes

FreightWaves
·7 min read

Executives with Canadian National Railway (NYSE: CNI) are "cautiously optimistic" that the growth in volumes seen during the third quarter of 2020 will continue in the fourth quarter and into 2021.

"We've got better visibility in front of us than we did in the past. And, but there is still some uncertainty ... I know here in Montreal, we're living a second wave of the pandemic," said CN Chief Financial Officer Ghislain Houle during his company's third-quarter earnings call late Tuesday. He noted that October volumes were up between 6% and 7% year-over-year. "So we have to see and be cautiously optimistic about what's happening, but at this time, so far we're quite pleased with the volumes coming at us in October."

The factors that could influence CN's revenue ton mile in 2021 are a mix of external and internal, executives said. CN has reopened training centers in Chicago and Winnipeg, Manitoba, in anticipation of rising volumes in 2021. It is also seeking to balance the mix of commodities it ships since volumes from the energy sector have fallen amid the COVID-19 pandemic.

But elections in Canada and the U.S., plus uncertainty over how the coronavirus pandemic will play out this winter, are some of the unknowns that CN is hedging against as it heads into 2021.

"We are preparing for growth definitely and then time will tell what kind of economy is available to us," said CN President and CEO JJ Ruest. "But whatever happens, we want to at least ride and outperform the economy. ... We want to be able to move the economy and slightly more, which has always been our target, whether it's in good times or bad times — try to outperform the economy."

Some of the consumer volume growth that is occurring in the second half of 2020 appears to be a mix of restocking and consumers opting to spend money that would have otherwise gone to vacations had the COVID-19 pandemic not occurred. Indeed, the fall peak is "stronger" this year compared with recent years.

"As we talk to our customers, most specifically our overseas customers, they're still seeing an opportunity for restocking, some say into the first quarter. There is that much of a replenishment that's required," said Keith Reardon, senior vice president of the consumer products supply chain for CN. "But I also do think that that trade for buying sprees versus going on vacations is happening. I'm sure it's happening in everybody's household on the call. So we see a little of both there."

Regardless of the pace of volume growth in 2021, CN, like other railroads, intends not to bring back resources "one-for-one."

To trim operational costs during the pandemic-induced volume trough of April and May, the railroads, including CN, had furloughed crews, stored away locomotives and railcars and created longer trains, which resulted in fewer crew starts. As volumes began to rise, CN and other railroads brought back some of those resources but not all.

"We're not adding people one-for-one, and we have done some permanent changes during the pandemic. Therefore, you can expect our margins to continue to improve," Houle said.

He continued, "And as we continue to deploy our technology ... then you can expect that with all of this — and then our focus on yield management — you can expect that all of this will help us continue to improve margins on a going-forward basis."

CN didn't offer a target operating ratio for 2021, but it said that the operating ratio metric wasn't one it focuses on compared with others. Operating ratio (OR), which measures a company's operating expenses as a percentage of its revenue, is a tool that some investors use to gauge the financial health of a company. A lower OR implies improved financial health.

CN's third-quarter OR rose to 59.9%, compared with 57.9% last year.

"As we move forward and as we focus on yield, and as we get more and more benefits from our technology deployment, I think that you can expect the OR to improve. And I would say stay tuned," Houle said. "And I think that our game plan works extremely well. ... We don't have a specific target on OR for 2021. That's not the way we think at CN. We have opportunities and we are focused on executing on these opportunities and the OR will be the result of execution on these opportunities."

Third-quarter financial results

Lower volumes in the third quarter as a result of the coronavirus pandemic put pressure on CN's third-quarter profit.

Net income was C$985 million (US$751 million), or $1.38 in adjusted diluted earnings per share, in the third quarter of 2020 compared with $1.2 billion, or $1.66 in adjusted diluted earnings per share, in the third quarter of 2019. This was a year-over-year decline of nearly 18%. All figures are in Canadian dollars.

View more earnings on CNI

Total revenue was $3.4 billion in the third quarter, compared with $3.8 billion a year ago. Of that, third-quarter freight revenue slipped 10% to $3.2 billion. But operating expenses fell 8% to $2 billion amid lower fuel and labor costs and decreased purchased services and material expenses.

Volumes recovered throughout the third quarter, with some commodities seeing a V-shaped recovery while others have yet to recover, executives said.

CN ($ in Canadian dollars)

2020 Value

2019 Value

Y/Y Gross Change

Y/Y % Change

Freight revenue (in millions)

$3,429.0

$3,618.0

($189.0)

-5.2%

Carloads (includes intermodal) (000s)

1,440

1,531

-91.00

-5.9%

Revenue per carload

$2,256

$2,363

-$107.00

-4.5%

Intermodal shipments (000s)

694

693

1.00

0.1%

Intermodal revenue per carload

$1,429

$1,469

($40.0)

-2.7%

Revenue tonmile (in millions)

$56,296

$60,849

($4,553.0)

-7.5%

Employee counts (quarterly average)

23177

27269

-4,092.00

-15.0%

Train velocity (mph)

17.8

18.7

-0.90

-4.8%

Through dwell time (hours)

9.6

7.7

1.90

24.7%

OR%

59.9%

57.9%

2.00%

3.5%

EPS

$1.38

$1.66

($0.3)

-16.9%

For more on CN's third-quarter results, click here.

To handle the volume rebound, CN brought back crews, locomotives and railcars but maintained some of the structural changes that occurred when volumes fell because of the pandemic.

"Our discipline throughout this pandemic in our structural changes implemented means that we are able to move similar volumes this year versus last year with lower labor costs," said CN Chief Operating Officer Rob Reilly.

He continued, "Over the past several months, we've idled multiple locomotive shops and switching yards that have remained closed. We completed consolidation of our Canadian dispatch offices from three offices into one location in Edmonton, which allows us to run the network more efficiently. During the quarter, we were able to reduce our yards by 14% while our volumes dropped 7%."

The sectors that saw a V-shaped recovery included auto manufacturing and consumer goods such as groceries, home improvement, e-commerce and retail.

CN encountered a surge in container imports on both the West and East coasts, according to Reardon. But each coast had traffic issues. On the East Coast, CN saw "strong import volumes" at the ports of Halifax and St. John because of the September strike at the Port of Montreal. CN also said it benefited from its interchanges with CSX (NASDAQ: CSX), which has access to the ports of New York and New Jersey and Philadelphia.

Meanwhile, import and export activity is becoming more balanced at the West Coast ports, with containerized grain helping to balance import activity, according to Reardon.

A "tsunami of freight" has been coming into the West Coast, and "it took a little while for the export to resume," Ruest said.

Reilly said, "As far as how the railroad is running, we're very fluid and in really good shape going into the winter. We're actually handling more volume than we did this time last year and in really good shape. So we've worked through it."

Click here for more FreightWaves articles by Joanna Marsh.

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Winter weather, COVID-19, trade uncertainties factor into Canadian railways' operational plans

Railways see untapped potential in Atlantic Canada ports

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