Uncertainties about consumer behavior and anticipated lower grain volumes are among the headwinds that are giving CN a bearish outlook for the second half of 2023, according to executives’ comments during the Canadian railway’s earnings call to discuss second-quarter 2023 financial results.
“We can only forecast based on what our customers are telling us … [and] everyone’s a little bit bearish right now for the year,” Doug MacDonald, CN chief marketing officer, told investors during Tuesday’s call. “It’s a little bit more positive starting in 2024, and that’s really all we’re forecasting, all we’re guiding towards.”
The headwinds have caused CN to temper its full-year earnings guidance. The Canadian Class I railway now expects flat to slightly negative year-over-year (y/y) growth in adjusted diluted earnings per share in 2023, in contrast to its April outlook of growth in the mid-single digits.
CN had reported late Tuesday second-quarter 2023 adjusted net income of CA$1.17 billion (US$886 million), or $1.76 per adjusted diluted earnings per share, compared with CA$1.33 billion, or $1.93 per adjusted diluted earnings per share, for the second quarter of 2022.
“Right now, what our customers are telling us is [that] they’re expecting a weaker than expected Q3, Q4, which is why we’ve actually changed our guidance. So we’re not really sure what’s going to happen in Q1 and beyond,” MacDonald said. “But what we are doing is we’re kind of forecasting a normal year beyond that. And that’s as far as we’ve gone based on what the customers have told us.”
While CN’s bulk franchise is “strong” amid demand and its merchandise segment is flat but strong, the big question mark is on consumer-facing commodities, according to CN President and CEO Tracy Robinson.
Volumes for petroleum and chemicals are also “pretty flat” and can serve as an indicator for an improving economy, MacDonald said. Meanwhile, CN expects Canadian grain volumes to be in the mid-60 million ton range for the 2023-2024 crop year, down from 74 million tons in 2022-2023.
“It’s the containers, and it’s lumber right now, given housing starts. There is no doubt that that’s got to pick back up again with the construction. It’s got to take place in North America. It’s just a matter of when,” Robinson said on the call. “Same thing with the container demand. We’re not anticipating, based on what Doug’s hearing, to see a big peak before the holiday period, but we are expecting to see some strength start to grow and return to a more normalized level, say next year.”
Because of the currently loose trucking market, CN is seeing the short-haul trucking market as its biggest competitor right now, according to MacDonald. While most of CN’s intermodal market is long haul, the small percentage of short-haul intermodal that CN handles is facing pricing pressures from trucks. These are for lanes such as between Montreal and Toronto, as well as Toronto and Moncton in New Brunswick.
To pare down costs in anticipation of a softer back half, CN has consolidated train starts, and it has slowed down or stopped hiring in certain areas while also managing attrition, according to Robinson.
“We’re adjusting our hiring plans to match what is now a slower expected return of some of our commodity segments. And we’re taking the opportunity to advance some locomotive engineer training to ensure that we’re ready for the medium and the longer term. And all of these are the right near-term actions that mitigate the impact of lower volumes without jeopardizing our ability to respond when the rebound comes, and it will come and we will be ready,” Robinson said in prepared remarks. “This puts our margins under a little bit of pressure right now, but our margin leverage will return with the volumes.”
CN has also taken some rail cars out, such as parking a lot of center beams that are leased and have staggered lease expiration dates, according to CN CFO Ghislain Houle, who said the railway has also parked some older locomotives and locomotives that have been “gas guzzlers.”
Nonetheless, CN wants “to be clear that we have some hard-to-hire locations in western Canada that we’re thinking of in the mid-to-long term, [and so] we’re continuing to hire in those locations because they’re very difficult to get people to come on the network,” Houle said.
Despite the headwinds CN expects to encounter in the last six months of 2023, the railway is still moving forward with the investment plans for 2024-2026 that it laid out on its investor day in May, executives said.
In the immediate future, CN expects to move through the backlog of volumes that occurred as a result of not only the strike by members of the International Longshore and Warehouse Union at Canadian West Coast ports, but also the wildfires in eastern and western Canada and flooding in Nova Scotia. CN is running additional trains out of the ports of Vancouver and Prince Rupert to clear the backlog, and it could take up to eight weeks for the overall supply chain to fully recover, MacDonald said.
CN’s revenues were CA$4.06 billion in the second quarter of 2023, down 7% y/y amid lower volumes of intermodal crude oil, U.S. grain exports and forest products, CN (NYSE: CNI) said in a late Tuesday afternoon news release. The railway said the volume decline was driven in part by lower demand for freight services to move consumer goods, as well as customer outages caused by the Canadian wildfires. Lower ancillary services and a decline in fuel surcharge revenues also contributed.
But revenue declines were partially offset by freight rate increases, a weaker Canadian dollar and higher export volumes of Canadian grain, CN said.
Operating expenses were nearly $2.46 billion, down from nearly $2.58 billion for the second quarter of 2022, amid lower fuel prices. Higher labor and fringe benefits and a weaker Canadian dollar partially offset CN’s expenses in the second quarter.
Operating income was $1.6 billion, down 10% y/y, while operating ratio rose to 60.6% from 59.3%. Investors sometimes use OR to gauge a company’s financial health, with a lower OR implying improved health. CN defines OR as operating expenses as a percentage of revenues.
CN to work with Wabtec to modernize 60 locomotives
In an unrelated announcement Wednesday that came on the heels of the earnings results, CN said it would be working with rail technology provider Wabtec (NYSE: WAB) to modernize 60 locomotives in its fleet.
The modernization process will entail modifying 60 certified pre-owned Dash-9 locomotives to employ AC-powered traction instead of DC-powered traction. The locomotives will also receive technological enhancements, such as an FDL Advantage engine upgrade and the implementation of a suite of digital solutions including Trip Optimizer and LOCOTROL Distributed Power, all of which “are expected to extend the life of the locomotives and provide benefits,” such as targeted fuel efficiency improvements of up to 18% through a combination of engine and digital technology enhancements, a more than 40% increase in reliability, and up to a 55% increase in pulling power, CN and Wabtec said.
The announcement didn’t provide any financial figures for how much the locomotive modernization would cost CN.
“Modernizing these locomotives cost-effectively improves the reliability of our existing fleet and contributes to reducing our rail carbon footprint,” Mark Grubbs, CN vice president of mechanical, said in a news release. “In addition to reducing the environmental impact of our own operations, it helps us to reduce the greenhouse gas emissions of our customers.”
The modernization of the 60 locomotives will bring CN’s roster of modernized locomotives to 110, according to CN. The modernization will also help CN reach its science-based targets to reduce its Scope 1 and 2 emissions by 43% per gross ton mile by 2030 from a 2019 base year, CN said.
“Our modernization solutions allow CN to enhance its existing fleet by upgrading to Wabtec’s state-of-the-art technology to enhance the locomotives’ performance to current standards,” said Alicia Hammersmith, president of Wabtec Freight Services. “Our modernization program supports the circular economy and is a key component of Wabtec’s sustainability approach through processes that reduce waste, extend life, and improve fuel efficiency, thereby driving emissions reductions and helping customers save money.”
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