CN, after a shakeup and turmoil on the rails, lays out its plan

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It isn't often that a company stands in front of an investors' meeting just a week after its board ousted its CEO, but that's what happened at the JP Morgan Aviation, Transportation and Industrials conference in New York.

The company that found itself in that position Wednesday is Canadian National. Just nine days after the Canadian-based railroad--albeit one with enormous assets in the U.S.--announced that CEO Luc Jobin was leaving the company "immediately," interim President and CEO Jean-Jacques Ruest, a 22-year CN veteran who was Chief Marketing Officer, laid out how the company plans to regain its footing after several months in which its system encountered a growing inability to handle the demand for its services. (Ruest reiterated that there is a search on for a successor).

Merrill Lynch analyst Ken Hoexter said in a report last week after the Jobin dismissal that "while, in our opinion, CN has been the best run North American railroad over much of the past decade-plus, its institutional bounce-back capability seems to have taken a pause as its network was overwhelmed by significant volume gains over the last two years."

Echoing the idea that CN has traditionally been a cut above its major competitors, Keith Schoonmaker at Morningstar last month wrote, in his review of the company's fourth quarter earnings, that the company's "weakened margins still represent all-time bests for nearly every other railroad." But the issue for the company has not been inadequate demand for its capacity. Rather, it has been the inability to handle it. "Quarterly demand surged, even as capacity was hampered by harsh winter weather," Schoonmaker said. "Consequently, the rail shortened, delayed, or detoured trains, driving up cost of labor and leased motive power, which degraded the (operating rate) 380 basis points to 60.4%."

Ruest reviewed the strategic plan of the company to overcome that inability to handle the demand on its capacity. Most of the plan had been revealed by the company previously: adding 130 locomotives to its fleet, bringing on a significant new supply of train conductors, adding sidings on its key Chicago-West Coast route and adding double tracking there as well where necessary. Ruest noted that the company is confident enough in its plan that is not changing its earlier-stated earnings guidance of C$5.25-$5.40 per share. (Hoexter revised his own forecasts downward to C$5.15 per share from C$5.35, and lowered his rating on the CN stock to "underperform." The U.S equivalent of his numbers are a new estimate of $4.12, cut from $4.28.)

Blaming much of the late fourth-quarter problems and early 2018 problems on the weather, Ruest said the winter arrived earlier than usual in November, and things didn't get much better from there. By several benchmarks, CN posted its worst-ever performance in February. "Volume was down and costs were up," he said.

March is starting off better, he said, because dealing with snowstorms is much easier than dealing with the type of bone-chilling cold that gripped so much of North America in late December and early January. The track work will start next month and be completed by the fourth quarter, Ruest said. New locomotives have been ordered, but deliveries will not start until the second half of the year. Until then, the added need for locomotives will be handled by leased equipment.

The difficulties are frustrating to CN, Ruest said, because "for all railroads, not just CN, this should be good times. There's all sorts of business out there for railroads to go and get." For all modes of transports, including truck and barge, Ruest said "there is a lot of business, so capacity is going to get under pressure, so that means capacity right now is more valuable than ever."

The degree of difficulty that the company faced in the fourth quarter was highlighted by one particular statistic quoted by Ruest. He said after the first three quarters of the year, growth in revenue per mile--which he said is the key barometer of a company's performance--stood at 14% year-on-year. By the end of the year, it had slid to 11%. "So for the last two months we were sort of flat, and we've been flat since then," he said. The company entered the winter with essentially no capacity, "and then the weather got bad."

The company's squeeze was exacerbated by good news, in that Canadian port expansions in Prince Rupert--where CN is dominant--and Vancouver were completed.  Ruest said the "huge" amount of business at those ports "was coming in too fast, so we had congestion." He added that preliminary indications are that rail transport capacity there will be sold out for 2018.

CN had trouble handling the business at the expanded ports, Ruest conceded. "Our customers are not happy that we have not been reducing dwell time," he said. "They are accustomed to 2 1/2 days between ship discharge and train departure." Velocity is "not what it is needed to keep the port fluid."

The additional trackage and locomotive capacity will be needed to meet "the demand in front of us," Ruest said, which looked good in several areas including the key CN products like Canadian grains and West Coast port business. Additionally, the energy sector is providing a relatively small but significant boost in the hauling of crude-by-rail and frac sand, the latter of which he said has seen shipments rise in the fourth quarter year-over-year by 100%. "We need to rebuild it a bit more, so we can enter next winter in good shape," Ruest said, adding that he hoped for an "average" winter in 2019.

That led to a discussion of pricing in the face of enormous demand and not enough capacity to meet it all. "As capacity gets tight on all railroads, rivers and trucks, the pricing discussions starts to move from customer service to the value of the capacity," Ruest said. Although market conditions might support increases of 5-7%, Ruest said the CN goal on pricing is to have pricing that is slightly more than inflation, and let the company's profitability compound over time on that spread between base inflation and pricing. That's the company's "core pricing...and it is looking forward."