Canadian National eyes growth opportunities in intermodal, crude-by-rail

A photograph of a train locomotive hauling railcars.

Recent trade actions in North America could help rail volumes improve, particularly in the second half of the year, Canadian National (NYSE: CNI) executives said Tuesday.

“The trade environment, when you look at how negative it was last year and how things seem to be at least turning [around] … at some point in the months or quarters to come, we will start to see some of the positives of that,” Canadian National (CN) CEO JJ Ruest told investors during CN’s fourth-quarter earnings call on Tuesday. The trade actions are the North American trade agreement that’s poised to be ratified by the U.S., Canada and Mexico and an agreed-to Phase One trade agreement between the U.S. and China. 

“I know at the same time nothing is guaranteed, but our view [is] that we will build our plan and our capacity in house as well as our employee resource efforts, [and] we’re looking at the second half” for more potential business, Ruest said.

Potential growth areas in 2020

Among the segments in which CN could experience volume growth in 2020 is crude-by-rail amid Alberta’s plans to increase crude-by-rail volumes. 

CN expects crude carloads to be “a growth driver” in 2020, with about one-third of its volume coming from heavy diluted crude, which is less dependent on price spreads than diluted bitumen, according to James Cairns, CN senior vice president for the rail-centric supply chain. 

The first and fourth quarters of 2020 look poised to see growth in crude-by-rail volumes, with an anticipated run rate at the end of March near CN’s record run rate of 250,000 barrels/day, Cairns said. 

“This is a seasonal piece of the business where you see the differentials widen out as pipe capacity gets constrained with additional diluent being added to the diluent blend in order to make sure that the product can flow in the pipelines,” Cairns said.

Other potential areas for growth include grain volumes, due in part to a terminal expansion at the Port of Vancouver’s North Shore by Canadian grain producer G3, and frac sand. 

“As we move into the second wave of the energy renaissance in Western Canada, spurred on by new drilling to support LNG exports, frac sand will be the first rail commodity to ramp up and we are well positioned with our unique unit train service that directly connects desirable Wisconsin sand with end markets in Alberta and [British Columbia],” Cairns said

Coal is another area that could see growth in 2020 because of production ramp-ups by Coalspur and CN’s new contract with Teck Resources, a metallurgical coal producer. 

Meanwhile, CN’s intermodal segment could find some volume support throughout 2020, including an “upside” to CN’s West Coast volumes in the first half of 2020 due to contract transitions between ocean shipping liners Yang Ming and Ocean Network Express (ONE).

Inventory levels actually are depleted for some of CN’s customers and they might be seeking to restock this year, according to Keith Reardon, senior vice president of the consumer product supply chain.

“If you look at the ocean liners … although they’ve been blanking some sailings, there’s a lot of boxes that want to get on those [liners]. … So there’s a lot of sentiment that says that the inventories need to be restocked,” Reardon said.

Pending regulations in Canada that would require Canadian truckers to utilize electronic logging devices (ELDs) in 2021 are unlikely to be an impetus that might shift volumes back from the trucking market to rail, Reardon said. But what could swing truck traffic to rail are “the insurance issues that the trucking market is having right now,” he said. 

Other initiatives aimed at shifting truck volumes to rail are CN’s door-to-door retail product and its temperature-controlled business, Reardon said.

Expanding the rail network

CN is planning for its capital expenditures budget to total about 20% of its revenues, which comes out to C$3 billion for 2020.

CN’s combined capital expenditures budget for 2018 and 2019 totaled C$7.4 billion as the railway sought to expand network capacity, particularly in its Western network.

“Growth does not come by itself. We have to go and chase it. … Growth is not just given by the economy. It’s driven also by things that we do, and when we’re successful in attracting that growth, we need to actually put in the asset,” Ruest said. 

He continued, “PSR [precision scheduled railroading] creates some growth for a short period of time, but eventually if railroads are successful in growing their business, eventually they will need to invest.”

The railway also said it would be willing to consider additional merger-and-acquisition opportunities but those opportunities, must “create value that can feed the network,” said Ghislain Houle, CN’s chief financial officer, citing CN’s acquisitions of TransX and the Massena line from CSX (NASDAQ: CSX). 

“We’re going to look. But again, it’s about ‘feeding the beast’ is what we call it here, it’s not about diversification. It’s got to fit with our network. It’s got to either extend our reach or bring more business on the rail. And that’s the notion. And we’re going to continue to look for opportunities to add value for our shareholders,” Houle said.

Ruest added that CN is looking for opportunities for domestic intermodal, such as through partnerships, port platforms or the acquisition of short line railroads, because those would be potential growth areas for CN. This strategy works for CN’s Eastern network, while CN’s Western network is about investing directly into the rail network, he said. 

“We have part of the network which is looking for business, which would be the Eastern network. [From] Halifax to Chicago, we’ve got capacity galore, meaning [that] as the industrial space in North America is in slow decline for the last 25 years, we need to be relevant to … consumers [because] consumers generate freight that is a typical container freight. And that’s why our focus is on the core platform as well as … on the domestic intermodal,” Ruest said.

That philosophy of looking for economy-resilient opportunities is also related to CN’s outlook to how growing freight opportunities benefits the rail industry as a whole, he said. 

“We’re very mindful that for the rail industry to be successful, including at CN, we need to grow the pie, right? So just exchanging pieces of the pie, that’s not a long-term solution,” Ruest said, referring to the exchange of contracts between CN and its competitor, Canadian Pacific (NYSE: CP), such as the one involving Teck Resources. 

“The long-term solution is, yes, we have to have a product that competes and yes, railroads do compete and we don’t shy away from that the fact that we compete and we’re proud of it.” Ruest said. “But at the same time, we need to have a platform for growth beyond just what the economy might bring in or not bring in,” such as the port platform or domestic intermodal opportunities that compete with the trucking market. 

Ruest continued, “That’s why we’re very focused on what can we do [and] that has nothing to do with contract wins or contract losses long term. That’s how we view the success of CN.”

Fourth-quarter 2019 results

“Weak freight demand” and the eight-day labor strike in November contributed to net profits for CN falling nearly 24% in the fourth quarter of 2019, the company said Tuesday.

Net income for the quarter totaled C$873 million, or $1.22 diluted earnings/share, compared with C$1.14 billion, or $1.25 diluted earnings/share, in the fourth quarter of 2018.

Operating income was C$1.2 billion in the fourth quarter of 2019, compared with nearly C$1.5 billion for the same period in 2018.

Source: Canadian National

Fourth-quarter revenue was nearly C$3.6 billion, compared with C$3.8 billion in the prior-year period. Operating expenses in the fourth quarter were relatively flat at nearly C$2.4 billion.

Operating ratio (OR) rose to 66% compared with 61.9% in the fourth quarter of 2018. OR can be a measure of a company’s profitability, with a lower percentage implying increased profitability. Canadian National (CN) defines OR as operating expenses as a percentage of revenues.

Service metrics were mixed in the fourth quarter. Although train velocity increased 3.2% to 19.2 mph from 18.6 mph, terminal dwell — the amount of time a train spends at a terminal — rose 8%, from 7.5 hours to 8.1 hours.

Looking ahead, CN is aiming for an earnings-per-share growth “in the mid-single-digit range” in 2020 compared with adjusted diluted EPS of C$5.80 in 2019.

“We have growth opportunities that we anticipate will translate into low-single-digit volume growth in 2020 in terms of revenue ton-miles (RTMs), despite continued weakness in the broad freight environment,” Ruest said.

Rail ($ in Canadian dollars) 2019 Value 2018 Value Y/Y Gross Change Y/Y % Change
Freight revenue (in millions) $3,408.0 $3,601.0 ($193.0) -5.4%
Carloads (000s) 1,425 1,537 ($112.0) -7.3%
Revenue per carload $2,392 $2,343 $49.00 2.1%
Intermodal shipments 638 668 -30.00 -4.5%
Intermodal revenue per carload $1,453 $1,334 $119.0 8.9%
Revenue per ton mile (in millions) $57,709 $66,535 ($8,826.0) -13.3%
Employee counts (quarterly average) 26524 26047 477.00 1.8%
Train velocity (mph) 19.2 18.6 0.60 3.2%
Dwell time (hours) 8.1 7.5 0.60 8.0%
OR% 66.0% 61.9% 4.10% 6.6%
EPS $1.22 $1.25 ($0.0) -2.4%