As CN (NYSE: CNI) looks ahead to the second half of 2020 and into 2021, the Canadian railway is banking on “stay-at-home consumption” and consumers’ desires to spend disposable income on do-it-yourself projects to boost CN’s intermodal activity and revenue.
“There is pent-up demand right now. We are kind of in a peak season…[with] the discretionary income of the people that are doing all this buying….The contacts that I talked to, they’re seeing it stay strong into at least in the beginning of the fourth quarter. We’ll see how it goes,” said Keith Reardon, CN’s senior vice president for the consumer product supply chain, during CN’s second-quarter earnings call on July 21.
Although exports are “not as strong” as imports for CN amid the coronavirus pandemic, two factors are making CN confident in its intermodal prospects for the remainder of this year and into next year. One is vessel operators’ decisions to add international sailings after previously cancelling them, and another is CN’s discussions with partners in Asia about demand trends, CN executives said.
Furthermore, intermodal opportunities are still ample even if companies seek more nearshoring opportunities, such as moving some manufacturing away from China and to the Americas, as a way to hedge against trade uncertainties, executives said.
If trading patterns change and result in more trans-Atlantic routes because of manufacturing shifting to other countries in southeast and south Asia, CN has capacity on the East Coast and the U.S. Gulf Coast to handle volumes that transport via the Suez Canal, according to Reardon.
“We are very bullish on the strength of the consumer in North America, even more so on the consumer living in the U.S. in a big city because we have a three-coast network and we can access some of the highly populated area. And the consumer disposable income is really key to CN’s future. And the product that’s most-suited to exploit the consumer spending and disposable income is intermodal,” said CN President and CEO JJ Ruest.
Ruest continued, “The business coming by port is definitely one of our mid- to long-term strategies to increase our business in that space, in two ways. One is to try to earn market share. It is a North American market. The border does not exist when it comes to the supply chain.”
CN’s return on investment for its subsidiaries, trucking and intermodal provider TransX and the refrigerated services provider H&R Transport, are also higher than CN’s typical ROI threshold of 12%, according to CN CFO Ghislain Houle.
“The mandate of TransX is to compete with the best of the best, like J.B. Hunt and the OR. They’re not a trucking firm. They are an intermodal firm. And they’re increasing the amount of rail they did since last year,” Ruest said.
Although CN’s intermodal hopes took the forefront in volume expectations for the second half of 2020, other commodities are also expected to show market strength.
Grain shipments should get a boost from CN’s decision to acquire 1,500 high-capacity hopper cars for 2021. The cars will enable CN to ship up to 20% more wheat and 40% more canola using the same resources, CN said.
Wood pellet volumes are also expected to grow amid expansion projects in British Columbia and Alberta.
CN also set “all-time” records for West Coast export propane volume, wood pellets and Canadian coal in the second quarter. The railway also shipped record volumes of Canadian grain and grain products for several consecutive months.
Efficiency and rationalization in the era of the COVID-19 pandemic
CN took a number of measures in the second quarter to reduce costs, many of which are measures that are set to be permanent even after the coronavirus pandemic abates, such as heavier trains and longer train lengths.
The railway also sought to adhere to precision scheduled railroading (PSR) principles and find ways to make the network more efficient, executives said. This resulted in idling four locomotive shops and four switching yards in the second quarter, and storing one out of every three locomotives as well as over 20,000 railcars.
Another PSR-related cost scheme is seeking to rationalize, or sell, “non-core” lines in Wisconsin, Michigan and Ontario, with the hopes that a smaller operator can be more suited to run those lines and be eligible for public funding to maintain the infrastructure.
In the second quarter, train weight and train lengths “reached all-time historic levels,” while crew starts were reduced by 21% amid a 18% reduction in revenue ton miles, according to Rob Reilly, CN’s chief operating officer. Crew productivity also “exceeded all-time record levels,” with train speed up by 5% year-over-year, Reilly explained.
CN also furloughed approximately 4,0000 employees so far in 2020. While some employees have been called back amid increased demand for service for commodities such as automotive and lumber, the return of employees is “ not on a one-to-one basis as volumes come back in,” according to Reilly.
“We’re very methodical about bringing them back, especially as we go into the third quarter. We’re still trying to figure out what the future volume is going to be. So, we’re very, very careful with all of our assets, not just employee resources, but also our locomotives and cars as well,” Reilly said.
Second-quarter financial results
The COVID-19 pandemic hit CN’s second-quarter profits, with lower rail volumes resulting in a 19% decline in quarterly revenue.
“CN’s operation never slowed down for the pandemic. And we will be ready and prepared if there is a second wave,” Ruest said during the second-quarter earnings call. “As we look back, this was among the toughest quarters of my career, with heightened pandemic concern of our employees and a sharp drop in volume of 18% in revenue ton miles. But thanks to our people and our leaders, we performed very well. We take pride in delivering essential services to our national economies.”
CN’s second-quarter net income on an unadjusted basis totaled C$545 million (US$405 million), or C$0.77 per diluted share, compared with C$1.36 billion, or C$1.88 per diluted share, in the second quarter of 2019. Operating income fell 53% to C$785 million.
Second-quarter revenue fell 19% to C$3.2 billion as the COVID-19 pandemic lowered volumes across most commodity groups. CN also experienced lower fuel surcharge rates. But offsetting these losses were increased shipments of Canadian grain, higher Canadian coal exports via Canadian West Coast ports and freight rate increases.
Second-quarter operating expenses rose 6% to C$2.4 billion. Costs of C$486 million, or C$363 million after tax, that were associated with a loss on assets held for sale were partially offset by lower fuel and labor costs. WIthout the one-time cost charge, operating expenses would’ve been down 15% from last year.
For more details on CN’s second-quarter financial results, go here.