Major North American railroad operator Canadian National Railway (USA) (NYSE:CNI) reported its second-quarter financial results on July 25. Revenue and profits fell as the railway saw carloads decline across almost all of its segments, though its operating results remained stellar.
Weak cyclical demand played a big role in the challenging environment CN faces, and the company is moving forward with major changes in its executive suite, with a new CEO, CFO, and COO all taking over this month. Let's dig into the operating results, and find out what these management changes could mean for the future. (All dollars are reported in Canadian.)
|Metric||Q2 2016||Q2 2015||Change|
|Earnings per share||$1.10||$1.10||0%|
|Operating ratio||54.5%||56.4%||190 basis points|
Keys to the quarter
CN has proven excellent at managing costs. And as you can see above, the company managed to lower its operating ratio (the ratio of revenue required to cover operating expense) even with revenue and carloads falling.
- Operating expenses fell 12% in the quarter, mainly due to lower volume, lower fuel consumption and fuel prices, pension expense, and the benefit of cost-management initiatives.
- CN also reported improved productivity metrics, including higher gross ton-miles per train mile, higher yard and terminal productivity, and moving more goods faster with each mile of locomotive utilization.
Cyclical declines in volume in almost every segment weighed on both the top- and bottom-line.
- Bulk shipments of grain and coal declined 12% and 30%, respectively. Grain and fertilizer is about 15% of revenues, while coal is only 3% of sales.
- Petroleum and chemicals shipments declined 11%, and is now 11% of revenue.
- Carloads of metals and minerals, which is 10% of sales, fell 23%.
- Intermodal carloads fell 7%. This segment makes up 25% of sales.
- Automotive carloads, which make up 7% of revenue, were flat.
- Forest products carloads were down 2%, and are 16% of revenue.
In other words, it was anywhere from a relatively (forest products) to very (coal) weak demand environment in the quarter with total volumes down 10%, and one that management said was likely the bottom for the year.
Major changes unlikely to change strategic focus
In June, CN announced a major shuffling of the executives leading the company, starting with the retirement of longtime CEO Claude Mongeau, a recent cancer survivor. Mongeau, who had been CEO at CN for more than six years, has been replaced by Luc Jobin, who has served as CFO at CN since 2009. But that was just the start.
On June 27, the company announced that Ghislain Houle, who has been with CN since 1997 and was most recently vice president and controller, would replace Jobin as CFO, and that Mike Cory, a 35-year veteran of the company, would become chief operating officer, replacing the retiring Jim Vena.
So just like that, CN will start the second half of 2016 with a new CEO, COO, and CFO, though none of these three are new to CN. While it's too early to say for sure, there's very little reason to expect a big departure from the company's present strategy. After all, Jobin's hands have been on the purse strings for the past six-plus years already, and both Houle and Cory have spent decades in various functional, operational, and executive roles at CN.
In his opening comments on the earnings call, Jobin directly addressed this, saying that the company's approach, evolved under Mongeau, "still resonates today with our customers," and that the company would "continue with this strategic thrust going moving forward."
Looking down the tracks
While grain shipments have been down recently, the company is gearing up for what looks like a bumper crop -- potentially the biggest in the past decade, while last quarter's intermodal declines were largely the result of downtime at the port of Vancouver due to a major expansion. It hurts in the short term, but the expanded capacity there is great for CN for the long-term. Management said that domestic intermodal revenue was up 4%, and the railway had taken the first container in Mobile from the Panama Canal expansion, and that its east coast port operation in Halifax was up strongly so far this year.
Crude and frac sand volumes were also down again, but the company thinks they've bottomed out. Factor in increased drilling activity in North America over the past month, and it's likely the worst is past. This would not only lift crude and chemical carloads, but also steel products, as the company ships a significant amount of pipe and other steel items used by the energy industry in drilling and pipeline operations.
Lumber shipments to the U.S. were relatively strong, up 17%, and are expected to stay strong on the back of a rebounding U.S. housing market. New home purchases were up 10% in the first half of the year, according to the U.S. Commerce Department, and the bigger macroeconomic picture, including jobs, wages, and low interest rates, supports this trend continuing.
On the downside, automotive volume has likely peaked and coal shipments may never recover, so these two segments are likely to contribute less in quarters ahead. Add it all up, and management expects a balance of improvements outweighing weakness, and held steady on its guidance for the full year of $4.44 per share.
Under Mongeau, the company's stock outperformed the S&P 500 by almost 40%, but leadership changes can have unexpected consequences. Jobin is new to the CEO seat, but ran CN's finances under Mongeau his entire time as CEO. Leadership changes don't get much smoother than that.
And while only time will tell if CN continues to be as solid an investment under Jobin, there's plenty of reason to expect the management approach that's made it a market-beating investment will continue.