Canada’s two Class 1 railways got off to a rough start in 2022. But in first quarter 2022 earnings calls, representatives of both Canadian National and Canadian Pacific expressed optimism that their fortunes would turn around during the rest of the year. That optimism, however, wasn’t enough for the share prices of both CN and CP to take a hit in the days following the Q1 presentations. Canadian National shares on the New York Stock exchange dropped from US$124.34 on April 25, the day before the call, to US$110.93 on May 9. CP stock dropped from C$93.06 a share on April 26 to C$89.94 by May 9. Tracy Robinson, who was named CN’s President and CEO on Feb. 28, vowed to bring the company “back to being best-in-class,” although she added TRACY ROBINSON that CN wouldn’t be able to share details about how the railway will achieve that until “our plans become more definitive.”
For now, the railway has had to update its guidance for 2022. “Harsh weather, mostly in Western Canada and supply chain disruptions impacted our ability to fully capitalize on the strong demand environment in Q1,” Ms. Robinson said. “The uncertainty from the war in Ukraine and the continuing pandemic disruptions in China and elsewhere, all suggest just a little bit of caution on the year.” Nevertheless, she expected growth in such areas as earnings per share (by 15 to 20 per cent), free cash flow from US$3.7 billion to US$4 billion, and “an operating ratio that starts with a 5,” she said. That would the be first time that happened for CN since 2017. (CN’s OR for Q1 of 2022 was 66.9 per cent, up from 62.5 per cent in the same period in 2021.) “This will be a good year for CN, notwithstanding the global environment,” Ms. Robinson said.
However, as Canadian Press reported, it isn’t now expected to be the 20 per cent earnings growth CN had predicted at the start of 2022. Which explains why in her presentation, Ms. Robinson circled back to the “tough start to the year.”
Keith Creel, President and CEO of rival Canadian Pacific, also referenced “the difficult operating environment” of the first months of 2022. “The quarter reflected the impact of last year’s drought on Canadian grain volumes, harsh winter operating conditions and the effects of a work stoppage,” Mr. Creel said in a news release announcing CP’s Q1 results.
TALE OF TWO HALVES
“With a difficult quarter behind us, we are building momentum, which I fully expect will continue to carry through the remainder of 2022,”
Mr. Creel said. In envisioning those brighter days, during the Q1 earnings call, he referred to “a tale of two halves” for 2022. Among the bright spots is CP’s pending acquisition of the Kansas City Southern Railway, which will “create the first single-line rail network linking the U.S., Mexico and Canada,” he noted. (See related story).
Robert Reilly, CN’s Executive Vice President and COO, quantified 2022’s tough start by noting that for 85 per cent of the days in January and February, the railway encountered Tier 2 operating conditions. That meant temperatures -31 Celsius or colder, “which forces us to reduce train size, use more locomotives and crews and overall, be able to move less freight through the very cold portions of our network.” When the weather improved in March, fluidity returned to the network, which continued in April.
For example, car velocity increased 35 per cent and train lengths were up nine per cent over the January lows, “allowing us to get back to running a more scheduled railroad,” Reilly said.
While cold weather disrupted the railways this winter, an even bigger concern going forward is the impact of climate change on those networks, said Dr. Barry Prentice, a professor of supply chain management at the University of Manitoba.
“We saw the big washouts in the Fraser Canyon this fall,” Dr. Prentice said. “It looked horrendous.”
In mid-November, both CN and CP reported they had halted service after numerous washouts that included a rail bridge and derailment, news outlets reported at the time. A trio of “atmospheric rivers” that triggered landslides caused several disruptions over two weeks. However, no mention of those was made during the Q1 earnings calls.
While that phenomenon is no longer news, Dr. Prentice is concerned about more recent news reports from elsewhere that indicate a growing frequency of big storms. “Maybe Vancouver is sufficiently sheltered and Rupert is not far enough north that they won’t be affected,” he said. “But I think that’s one of the aspects of the supply chains that is going to be attracting more attention. We could have our link to the U.S. cut off temporarily if a big storm comes through.” The railways might not even be able to harden their infrastructure to prevent catastrophic washouts in the future. “Maybe they are so exposed because there’s just so many kilometers of rail line out there,” Dr. Prentice said. “A disruption can occur for various many reasons, especially as the climate is twisting around and we’re seeing things that we didn’t see before.”
Dr. Michael Haughton, a professor of supply chain management at Wilfrid Laurier University in Ontario, suspects that the optimism of the railway’s leadership stems from a realization of their importance to Canada’s logistics and supply chain landscape. “And I think with that, they take a can-do attitude,” Dr. Haughton said. “I don’t think it’s a reflection of oblivion to the reality. But it’s more a reflection of a belief that in spite of the dire reality, we’ll find a way. And there’s a basis for believing in that optimism.” For example, he noted that CN’s reductions in costs per loaded mile, for instance, reveals something in the people and technology that reflects a willingness to fight through the tough times. “I really don’t mean to sound like a spokesperson because I’m not,” Dr. Haughton said. While he is the CN Fellow in Supply Chain Management, as an academic he is free to speak his mind.
While the extreme weather degraded CN’s accident ratio, the railway was still able to reduce its injury frequency ratio by 18 per cent compared with the previous year, “reinforcing that safety is a core value at CN,” Mr. Reilly said. CP’s Keith Creel, meanwhile reported a 25 per cent drop in train accident frequency for the quarter, although personal injuries were up 13 per cent, “which is always a reminder to myself, the team and the company that safety, it’s not a destination, it’s a journey.”
CN’s operating income for the quarter decreased eight per cent to C$1.227 billion while its adjusted operating income of C$1.237 billion represented a four per cent hike. But revenues for the quarter were up five per cent to about $3.7 billion despite revenue per freight ton mile dropping eight per cent, noted Doug MacDonald, CN’s Chief Marketing Officer. Most of that latter was because of a 25 per cent drop in RTMs (revenue tonne miles) in the grain and fertilizers category. MacDonald expects that to reverse “assuming a normalized Canadian grain crop starting in the fall.” Nevertheless, CN’s total freight revenue for all categories was up a combined 15 per cent for the quarter; that included for grain and fertilizers, which rose 23 per cent. Mr. MacDonald noted “significant volume increases” in, for example, U.S. grain shipments to the Gulf Coast for exports, Canadian coal, and higher frac sand shipments. “As we look out for the balance of the year, we are still expecting volumes to be up in the low single-digit range for 2022 with broad- based growth across most segments,” he said.
In its Q1 earning results, CP reported a six per cent decrease in revenues to $1.84 billion from $1.96 billion, while its operating ratio increased to 70.9 per cent from 60.2 per cent. Grain was among the hardest hit categories with CP’s grain revenues falling to $260 million from $448 million in the first quarter of 2021.
Coal, automotive, and the energy, chemicals and plastics category also experienced declines while intermodal and the metals, minerals and consumer products categories increased slightly.
Aside from the adverse weather, Mr. Creel also noted during the earnings call that a spike in the Omicron variant of COVID-19 affected about 500 employees, and that the railway also weathered a “work stoppage.” The latter, which began as a lockout and became a strike, lasted only a couple of days before the sides agreed to binding arbitration on March The stoppage did, however, have an impact on the railway’s financials. For example, it contributed about three per cent of the 14 per cent decline in RTMs, noted a presentation by John Brooks, CP’s Executive Vice President and Chief Marketing Officer.
Labour poses another problem for transportation companies like railways, Dr. Prentice said. “The tail end of the baby boomers are in their early to mid 60s,” Dr, Prentice said. “Coming out of the pandemic, I expect a lot of those people, if you try to force them back to the office, they’re going to say, I’ll just take my pension and leave. So that’s a problem for companies, and management.”
Mr. Brooks also noted that the “continued strength” of the CP’s U.S. grain franchise partially offset the Canadian crop challenges. “In Q1, we moved 14,000 carloads of U.S. grain into Canada compared to fewer than 600 in the same period last year,” Mr. Brooks said. He also predicted strong demand for potash, driven partly by disruption of potash production in Belarus and Russia because of the war in Ukraine. And he expected an upside in the coal market as well as strong demand and prices for frac sand related to more drilling activity and higher oil prices. “If you shift to the domestic side of the business, this was our sixth straight record quarter,” Mr. Brooks said. “We are clicking on all cylinders, not only from an operating perspective, but also working with our customers to restock the store shelves across Canada.” He also noted that, “excluding Canadian grain, volumes are up mid-single digits quarter-to- date, and we have over $200 million of annualized new initiatives starting up over the coming months.” It was an example of “the tale of two halves” that Mr. Creel referenced, “and that’s exactly what I expect to play out.”