A tough Q1 for Canadian National, but it touts its capex for the rest of the year

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Not many things went right for Canadian National in the first quarter.

It made less money than it did in the first quarter of 2017, with both net income and operating income down 16%. It had to deal with the U.S. Surface Transportation Board's concerns about service issues for all class 1 railroads. Revenue ton miles, which CN management said on its earnings call was viewed as the most important barometer for performance, was down 4% even as carloadings increased 3%. Operating expenses were up 9% and the operating ratio climbed six points to 67.8%, which is the wrong direction for any transporter.

CN's executive vice president and chief operating officer Mike Cory described the situation the company faced. "We had low resiliency in some high volume areas going into winter," Cory said on the earnings call. "This made maintaining fluidity very challenging," he added, referring to fluidity as a railroad's most important characteristic. The harsh winter was the ultimate culprit.

The end result, Cory said, was a decline in service levels. Two particularly ugly statistics: average train dwell time in hours rose to 21.3 in the first quarter. It was 15.6 hours last year. Average train velocity declined to 21.8 mph from 25.7 mph a year ago. 

Operating metrics in the second quarter will "continue to be under pressure," Cory said, and will probably be flat from that in the third quarter. But by the fourth quarter, much of the new infrastructure that CN has planned will be completed, allowing improvement in those metrics.

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Cory and interim president and CEO JJ Ruest spent a great deal of the call touting the company's capital expenditure plan for the remainder of the year, which involves significant construction of double tracks with emphasis on CN's western regions, adding locomotives, and the hiring of more personnel.

That program is going to increase the company's current capital budget by C$200 million (US$155 million)to $3.4 billion (US $2.65 billion) for the year. The core of the system improvements will be the new track work in western Canada, coming in at C$400 million (US $310 million). It recently touted its plan to buy additional box cars. 

Cory described a current scenario like dominoes falling, with increased demand falling on infrastructure that is already constrained. Trains are moving on to sidings that are 10-15 miles apart, and with increased demand on the system, plus a harsh winter, it leads to delays in delivery. Crews then run into their hours of service rules. "Eventually you run out of operating hours, that means more demand for crews, and the train sits," Cory said.

An analyst on the call asked Ruest about CN's current relations with its customers. At its ports, Ruest said conditions are improving and dwell times have been running at close to normal for the last two to three weeks, "so that situation is resolved." At the company's inland terminals, Ruest said they have improved operations for the onloading of trucks so that it's 45 minutes in, and 45 minutes out, and they are meeting that goal. 

"We learned some lessons and we are humble about this," executive vice president and CFO Ghislain Houle said on the call. "One of the lessons I've learned is that in some key corridors (he cited Edmonton to Winnipeg as an example), you need to build some buffer." The company would therefore target building some excess capacity, and if they're wrong, then the cost is the time value of money. "But if we believe we will grow this business then we will need the inventory at some time," he said.

The other alternative is capacity that is too tight, "and you'd have what we saw in the first quarter of this year," he said. The end result is "unhappy customers" putting pressure on the company through the Canadian government.

Prices were up 2.7% from the prior quarter on what Ruest described as the full book of business. However, core pricing on renewals in the last 90 days is up 4.8%, though that is on a significantly smaller sample than the full book. "Whatever way you cut it, we see slow progressive momentum on pricing," he said.

The quarter's adjusted operating ratio of 67.8, a full six points more than in the first quarter of 2017, included a performance in March that Ruest said "showed definite progress." Ruest questioned whether operating rate is an over-hyped metric. Houle echoed that sentiment by saying they would rather be a company with $20 billion in revenue and an operating rate of 60-62% than a company with $13 billion in revenue and a 57% rate.