Canadian National Railway Company - Q2 2023

Transcript

Operator (participant)

Good afternoon. My name is Emma, and I will be your conference operator today. Welcome to CN's Second Quarter 2023 Financial and Operating Results Conference Call. All participants are in a listen-only mode. After the speaker's remarks, there will be a question-and-answer session, during which we ask that you kindly limit yourself to one question. I would now like to turn the call over to Stacy Alderson, Interim Assistant Vice President, Investor Relations. Ladies and gentlemen, Ms. Alderson.

Stacy Alderson (Assistant VP of Investor Relations)

Thank you, Emma. Good afternoon, everyone, thank you for joining us for CN's 2nd quarter 2023 financial results conference call. Before we begin, I'd like to draw your attention to the forward-looking statements and additional legal information available at the beginning of the presentation. As a reminder, today's conference call contains certain projections and other forward-looking statements within the meaning of the U.S. and Canadian securities laws. These statements are subject to risks and uncertainties that may actually cause results to differ materially from those expressed or implied in these statements.

They are more fully described in our cautionary statement regarding forward-looking statements in our presentation. After the prepared remarks, we will conduct a Q&A session. I do want to remind you to please limit yourself to one question. The IR team will be available after the call for any follow-up questions. Joining us on the call today are Tracy Robinson, our President and CEO, Doug MacDonald, our Chief Marketing Officer, Ghislain Houle, our Chief Financial Officer, and Ed Harris, our Chief Operating Officer. It is now my pleasure to turn the call over to CN's President and Chief Executive Officer, Tracy Robinson.

Tracy Robinson (CEO)

Merci, Stacy, et bienvenue à tous qui participent sur le phone ou par webcast. It has been a couple of months since we saw many of you in Chicago at our Investor Day, and we're continuing to execute the plan we laid out for you then. We're running a scheduled operation that moves our assets quickly and services our customers consistently, and this is the central theme, and we're driving our growth initiatives on that foundation. Over the three-year period we discussed in Chicago and beyond, our path is very clear. The longer-term fundamentals remain strong.

The growth opportunities are real. We continue to progress that growth agenda, built on the foundation of strong service, driven by disciplined adherence to our plan. The immediate term is a little less certain. This team has dealt with a number of external weather-related issues over this past few months, as well as a West Coast port strike over the last few weeks. We sit here today, we're also seeing a little bit more weakness on the economic front than we modeled earlier this year. All of this is temporary, as you know, and our team is doing a great job of managing through it with an eye on the longer term.

The heat and the wildfires in parts of both Eastern and Western Canada over the last few months have impacted our operations and the operations of some of our customers, that's had a temporary impact on volumes. We've seen more generally a softer volume market economically, particularly in some of our commodity segments. I must say, I have been impressed by our team's response. They are managing through this. They're staying true to our plan. They're running the plan, and still through all of it, improving year-over-year velocity, network train speeds, dwell time, and customer service. You'll notice this in our operating stats. They've done a great job, and it's a testament not only to the team, but also to the strength of our plan. The plan's working.

As we look forward, our focus is on continuing to be nimble, adjusting to the softer volumes in the near term and ensuring that we're prepared for the lift. We continue to refine the operating plan to match the volume levels. We're consolidating train starts. We're laying down locomotives and cars where it makes sense. This keeps our network balanced and our assets moving quickly, it maintains our service levels, and it mitigates costs. As we said we would do, should we find ourselves in this situation, we're adjusting our hiring plans to match what is now a slower expected return of some of our commodity segments. We're taking the opportunity to advance some locomotive engineer training to ensure that we're ready for the medium and the longer term.

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. This puts our margins under a little bit of pressure right now, but our margin leverage will return with the volume. Let's talk about what this all means. Our second quarter EPS of $1.76 is 9% lower than last year on an adjusted basis, and our 60.6% operating ratio is 160 basis points higher. This is the impact of both the macroeconomic being softer than we anticipated and those challenges presented by the weather events here in Canada.

On the basis of what we saw in the second quarter and are seeing in these few weeks in July, we've taken a hard look at our year-end outlook, and we're now assuming that the economic recovery is pushed into 2024. We expect the year-over-year change in annual adjusted EPS to be flat to slightly negative. The team is gonna provide you today with more details about our thinking on this. Before I hand it over to them, I just want to say a few words about the situation on the Canadian West Coast ports. We are pleased to see an end to the work stoppage, and we're working hard to get those supply chains back in sync. We expect to move most of the volumes that didn't move during the first two weeks of July over the coming weeks.

This event is another reminder that what happens on one part of the supply chain impacts the full supply chain. Major disruptions like the ILWU strike, the wildfires, and now some flooding in Nova Scotia, have impacts across the North American supply chain. It is critical that we respond as an entire supply chain community to minimize the impact and build ongoing confidence in the North America and the global supply chain performance. This is how we approach our work here at CN. I'm proud of this team's ability, demonstrated again in this past quarter, to respond in a way that minimizes the impact for our customers, for our employees, for our supply chain partners, and the communities in which we operate. I'll turn it to the team.

Ed's going to first give us a little more color, Ed, on the state of our operations and how his team has been working to mitigate the impacts of these events. Doug will follow up with an update on the markets and what our customers are telling us about the volumes as we look forward. Ghislain, as always, on cleanup to bring it all together with the numbers. Ed?

Ed Harris (COO)

Thank you, Tracy. The second quarter has been a tough one, and I want to acknowledge and thank the entire operations team for all the great work to keep the network running as well as it has this quarter. Tracy just recently missed mentioned the floods in Nova Scotia. You've no doubt seen the disruptions and the news clips just outside of Halifax. We're working around the clock, and I would like to thank, especially thank Millbrook First Nation in Nova Scotia for their intention and taking care in feeding our engineering people through this disruption. It's relationships like these that makes railroads run smoother, safer, and we hope we do our part for the community as well, too. We're gonna try to get this track open as quickly as we can, and we really appreciate the help they've given us at the work site.

You heard me say this at Investor Day back in May, and it's important to repeat now: The plan is sacred. We're not going to change how we operate the network in face of weather and volume challenges. Our scheduled operating model is the right model for our network through all economic cycles. Turning to the quarter, car velocity averaged 216 miles per day in quarter two, up 3% year-over-year. A meaningful improvement considering the challenges I'll talk about in a minute. Remember that we were also lapping the improvement the team started delivering last year. We're not going to take our eyes off of car velocity moving forward, but I'm very happy with that level of speed. Velocity provides fluidity and creates capacity across the network.

While this was done moving 9% less gross ton miles, it provides an important foundation for the eventual recovery and demand. We continue to see improvements in our origin train performance. I have to give the team a solid A for achieving above 90% in the quarter. We aim to maintain that level of performance going forward. These operating results were achieved despite some unexpected challenges this quarter. We had to contend with record wildfires in Eastern and Western Canada, portions of the network, which also had an impact on our customers' ability to operate. Necessity is the mother of invention, and we've been actively engaged to protect our infrastructure with sprinkler systems deployed on many of our wooden structures in high-risk areas. Our Poseidon firefighting train has been deployed since May.

For those who may be unfamiliar, the Poseidon concept transforms a bulkhead flat car into a self-contained, rail-mounted fire suppression system, which draws water from attached tank cars. In fact, we recently made the decision to enhance our fire response by building two additional Poseidon trains to better protect our network and support the communities in which we operate. We experienced a nearly 800% increase in heat-related delay hours in Western Canada, with almost 750 hours of delay versus 80 last year. Heat slows mean running trains slower than track speed, which impacts network train speed and car velocity, even requiring a new heat category called extreme heat conditions. Finally, we had an orderly ramp down in traffic moving in and out of the West Coast ports that were affected by the recent work stoppage.

It's the right way to prepare for this sort of thing, but it's not without additional cost. These events were impactful, but didn't distract us from executing the plan. In this lower volume environment, we took steps to adjust the plan, looking at every train start, every local service, every crew start, to make sure we operated as efficiently as we could. By June, our intermodal train starts were down 15%, and manifest train starts were down about 5% versus the first quarter. We did this while maintaining car velocity and maybe some of our best customer service levels. Having said that, a couple of our operating measures, including train length, fuel efficiency, and locomotive utilization, took a short-term hit because of the softer volumes.

Fuel efficiency was also impacted by disruptions in the related stops and starts that we had to endure during the worst of the firing. Even when things were changing quickly out there, we need to keep railroading simple. When we focus on running a scheduled operation, it allows us to recover from issues and outages much quicker. Before I hand it over to Doug, I want to say an important word on safety. I know I speak for Tracy and the whole leadership team when I say that safety is of the utmost importance and needs to be at the core of how we operate this railroad. We were deeply saddened on April 28th when we lost one of our own. We have made great strides in recent years, but it's all for nothing if we don't all go home safely at the end of the day. With that, I'll pass it on to Doug, to discuss top-line performance and market outlook.

Doug MacDonald (CMO)

Thanks, Ed. I wanted to take a moment to acknowledge the operations and customer service teams. They have been helping our employees, customers, and communities affected by the ongoing wildfires in Canada. Throughout the quarter, the teams remained engaged, and our customers are saying that CN is providing the best service in the industry. Before turning to the quarter, I'd like to recap the current situations with the wildfires in the ILWU strike. It gave some good color about the impacts of the fires on our operations. The wildfires also affected customers, some of whom were forced to take intermittent shutdowns. This mainly affected forest products customers, but also our coal, sulfur, frac sand, and NGL customers. Most of the business impacted in Q2 will not be recoverable, but I can say that CN did not lose any market share with customers.

Customers are simply shipping less and matching the demand in the economy. For the ILWU strike, there was a minor impact on Q2 results as we took steps to meter flows into the port terminals before the strike began on July 1st. The strike lasted 13 days, plus a 24-hour wildcat last week. CN's recovery plan kicked into action on July 14th. We are running additional trains out of Vancouver and Rupert to clear the backlog, and expect it to take up to 8 weeks to be current if all areas of the supply chain work together. Second quarter revenues were $4.1 billion, down 7% versus last year on 8% lower RTMs. We saw a softer than expected demand environment for consumer-related products, with significant volume step downs in intermodal, both international and domestic, as well as forest products.

In particular, lumber shipments were down with depressed prices and some producers running at cost. As mentioned, the wildfires in Northern Alberta and BC, as well as Quebec, also impacted forest products volumes. Petroleum and chemicals volumes declined, reflecting lower spot crude business this year and softer demand for chemical feedstocks. Most bulk business lines continued to be strong, with RTMs up 12%. met coal remained solid in the second quarter. We did lose some trains due to the wildfires. thermal coal volumes were weaker due to lower export demand. Volumes are picking up in Q3 already. U.S. grain volumes were down year-over-year, reflecting strong U.S. corn and soybean shipments down to the Gulf last year due to the strong export demand. Canadian grain was the bright spot in the quarter, with close to 50% more RTMs versus last year.

We continued to deliver for our grain customers and to engage closely to optimize the supply chain. In April, the Canadian Transportation Agency announced a 12% pricing index increase for the upcoming 2023/2024 crop year for CN. We saw positive growth for both domestic and export products in the second quarter due to the optionality of CN's network going to Saint John. Core pricing remains strong, and we continue to price above rail inflation. Notably, we have had poor intermodal storage revenues this year, and that headwind will continue through the back half of 2023. Let me take this opportunity to update you on our Falcon service. We started the premium service back in May. The product is performing well, meeting the posted transit times, and in some cases, exceeding them, and volumes continue to grow. Turning to the outlook on slide 10.

For the remainder of the year, we see continued uncertainty in the economy. Aside from the impact of the strikes, the broader environment for intermodal continues to be challenging. We see improvement being pushed into 2024. Pricing for short-haul domestic lanes will be under pressure due to the increasingly available truck capacity. Lumber also remains under pressure, but commodity prices have started to pick up. There is still a shortage of about 7 million homes in the U.S. that need to be built. Chemicals and petroleum production may be soft for the remainder of the year due to the extended recovery. For Canadian grain, we are now anticipating the 2023/2024 crop to be in the mid 60 million ton range, below last year's 74 million ton crop, and we are closely monitoring the moisture levels across the prairies.

This revised view will not affect volumes in 2023. We will be running full outcome harvest, but will be a headwind next spring. Canadian coal demand will retain steady, and potash should be strong in Q4. Automotive should continue to outperform with new import business via Vancouver. To finish, there is no doubt lots of uncertainty right now. What is certain is that we are working closely with our customers. We are committed to providing industry-leading service, and we will be ready when the economy improves. We remain on track to deliver on our longer-term growth plan that we outlined at Investor Day. With that, I'll pass it on to Ghislain.

Ghislain Houle (CFO)

Merci beaucoup, Doug. J'ai le plaisir de parler de nos résultats du deuxième trimestre. I will start to Slide 12 of the presentation, which will provide more visibility on our second quarter performance. As you heard from Ed, we had strong operating results in the quarter despite challenging conditions, but our financial results reflect the demand environment. Altogether, volumes were significantly impacted, with 8% lower RTMs on a year-over-year basis. Let me provide you with more details on the quarter. My comments will reflect adjusted results, which exclude advisory costs related to shareholder matters in the second quarter of 2022. We delivered operating income of around CAD 1.6 billion, 10% lower than adjusted operating income last year.

Our operating ratio came in at 60.6%, up 160 basis points, versus the adjusted operating ratio for the same period last year. EPS for the quarter finished at $1.76, 9% lower than last year on an adjusted basis. We have estimated the impact of wildfires was unfavorable to EPS by $0.07 and dilutive to the OR by 100 basis points. In terms of expenses, labor was up over $50 million, FX adjusted versus last year, mostly due to an 8% higher headcount. Given the current environment, we have slowed or in some cases, paused hiring.

Fuel expense was over CAD 200 million lower from the same period last year, FX adjusted, mostly due to a 30% decrease in price and a 9% lower workload in terms of GTMs, partly offset by a 6% worsening in fuel efficiency. Shorter trains, along with the impact of operational disruptions that Ed and Doug talked about, negatively impacted our fuel efficiency performance. Fuel surcharge lag was favorable this quarter. Moving on to Slide 13, let me provide some visibility to our revised guidance for 2023. Several unforeseen headwinds now inform our view for the full year. First, the second quarter results came in lower than we expected. Second, we now anticipate the demand environment to be both weaker and for longer, with the recovery in intermodal pushed into next year and forest products weakness continuing into 2024.

We are pleased that the port strike is behind us, with volume recovery efforts underway. We expect to recover some business, but not all of it. Far in July, volumes on an RTM basis are down about 11% year-over-year. We are therefore revising our full year outlook and now expect to deliver flat to slightly negative EPS growth in 2023 versus our previous guidance of mid-single digit growth. This assumes FX at approximately $0.75 and WTI of $75 US dollar per barrel. We remain committed to shareholder distributions. Under our current share repurchase program, we have repurchased over 11 million shares for around $1.8 billion. We still expect to deliver on our budget of about $4 billion for our current program, which runs through January 31st, 2024.

In conclusion, let me reiterate a few points: The team is committed to the scheduled railroad model through all economic cycles, which provides reliable service for our customers. We expect volume to remain soft, with a recovery push to 2024. Given our year-to-date results and the continued weak economic environment, we are now guiding for flat to slightly negative EPS growth for the year. We have a strong balance sheet that provides us financial flexibility, and we will allocate our capital in a manner that drives long-term value for our shareholders. Let me pass it back to Tracy.

Tracy Robinson (CEO)

Thanks, Ghislain, Emma, let's open the line for questions, please.

Operator (participant)

Thank you. We will now begin the question and answer session. At this time, in order to ask a question, press star, then the 1 on your telephone keypad. As previously mentioned, we ask that you kindly limit yourselves to 1 question. The first question comes from the line of Cherilyn Radbourne with TD Cowen. Your line is open.

Cherilyn Radbourne (Managing Director and Senior Equity Research Analyst)

Thanks very much, good afternoon. In terms of your latest view that the recovery will be pushed into 2024, I was just hoping for a bit of color on what you're expecting for the peak season this year, and whether your thinking is that the 2024 recovery will be evident prior to or after the Chinese New Year holiday.

Doug MacDonald (CMO)

Hi, Cherilyn, it's Doug. Thanks for the question. Right now, what our customers are telling us is they're expecting a weaker than expected Q3, Q4, which is why we've actually changed our guidance. We're not really sure what's gonna happen in Q1 and beyond, 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.

Cherilyn Radbourne (Managing Director and Senior Equity Research Analyst)

Thank you. That's all for me.

Operator (participant)

Your next question comes from the line of Ravi Shanker with Morgan Stanley. Your line is open.

Ravi Shanker (Managing Director)

Thanks, good afternoon, everyone. Maybe as a follow-up to that question, I think your macro outlook for the rest of the year going in 2024 is a touch more bearish than what you've heard from many of your rail and trucking peers so far. Again, do you feel like it's something reasonably unique to the end markets you're exposed to, the geographies you're exposed to? Or do you feel like, are you being more conservative, or do you feel like it's just some realization that hasn't fully sunk in yet for everybody else?

Doug MacDonald (CMO)

Well, it's a great question, Ravi. It's Doug again. Listen, we can only forecast based on what our customers are telling us. Really, you know, everyone's a little bit bearish right now for the rest of the year. It's a little bit more positive, starting in 2024, and that's really all we're forecasting and all we're guiding towards.

Tracy Robinson (CEO)

I'll come in over top of that a little bit, Ravi. I mean, I think that, without a doubt, this is something that nobody knows for sure. As we approach the way we're going to operate this railroad, is we are ready for whatever happens. I think that we've demonstrated that we can be nimble in turning our, you know, service levels up or down through the plan. We're ready. If it comes, we'll be there. If it's not, if it waits a little longer, then we have a plan for what we're gonna do in that case as well.

Ravi Shanker (Managing Director)

Very good. Thank you.

Operator (participant)

Your next question comes from the line of Scott Group with Wolfe Research. Your line is open.

Scott Group (Managing Director and Senior Analyst)

Hey, thanks. Afternoon, guys. You said a couple of times, adjusting the hiring plan, any color on exactly what you're doing with headcount going forward in the back half of the year? I thought I heard a comment about short-haul pricing slowing a little bit. Maybe just talk more broadly, what you're seeing from a pricing renewal standpoint and how pricing is holding up. Thank you.

Tracy Robinson (CEO)

I'll start with that one, Scott, and then I'll pass it over to Doug. I think he can talk about pricing. I think he misheard the comment. From a hiring perspective, we said right from the beginning, that the first lever that we would pull is we would look at the number of people we were hiring. We've done that. As we just outlined, we have stopped in some areas, and in those hard to hire or hard to keep locations, we have slowed down considerably with the view to what we expect volumes to be, say, Q1, Q2 next year is when those employees would be operational. We are still managing through a level of attrition, as we look forward. If you think about kind of, FTEs and people levels, you can expect to see it stabilize through the remainder of the year. Of course, if things change, you know, we've got the plans in place to do that as well. That's how I think about it. Doug, pricing?

Doug MacDonald (CMO)

Yeah, for the pricing that we mentioned, it's really talking about the Intermodal product. Obviously, with the lots of, I'll say, trucking industry issues right now, our biggest competition is within the short-haul trucking market. That's where we're seeing some price pressures just in that market. Most of our market in Intermodal is long-haul, so it's not a big portion, but we just like to highlight the fact that there is some pressure there and there we are starting to see it.

Scott Group (Managing Director and Senior Analyst)

Okay. You didn't give, like, an overall pricing renewal number or anything?

Doug MacDonald (CMO)

No, we did not.

Scott Group (Managing Director and Senior Analyst)

Okay. All right. Thank you, guys.

Operator (participant)

Your next question comes from the line of Walter Spracklin with RBC Capital Markets. Please go ahead.

Walter Spracklin (Managing Director and Senior Equity Research Analyst)

Yeah, thanks very much. Good afternoon, everyone. Janet, when you discussed the impact, I think you bucketed them all together, lower demand, wildfires, and port strike being a 10% hit to your original forecast. I wanted to see if I could isolate a little bit the real nonrecurring being the wildfires and the port strike. If we were to strip that out, if you could quantify that impact. What I'm wondering is, if that hit you this year and it was unexpected versus what you were anticipating when you set your guidance, would we see the potential for a higher growth rate in 2024, given you're lapping a bunch of fairly significant nonrecurring items? Is there something changed as well in your outlook for 2024? I know as you adjust your grain as well, does that offset some of that, what would have been a higher growth rate in 2014 or 2024?

Ghislain Houle (CFO)

Thanks, Walter Spracklin. Thanks for the question. As I said in the remarks, we did quantify the impact of the wildfires in the second quarter to be, you know, CAD 0.07 of EPS or 100 basis points of OR. I think in our guidance right now, we're not assuming significant impacts of wildfires going forward. As you know, some of those wildfires are still occurring as we speak. They're not touching our network as we speak. They're not impacting our customers, we're not assuming, as I said, wildfires going forward. The other thing on the strike, it did impact us month to date, we believe that we will recover a good chunk of it over the next couple of weeks.

I don't think this will be a significant impact going forward. Now, we're assuming that this tentative agreement will be ratified. The last big piece that, you know, supports our guidance or our new guidance is the fact that, as we said before, we were assuming some type of recovery in the second half. Now, you know, having better visibility, Walter, today, we feel that most of that recovery will be pushed in 2024. I think when you put all of those pieces together, that's where our, you know, give us the guidance that we've just talked about today.

Walter Spracklin (Managing Director and Senior Equity Research Analyst)

Okay. Appreciate the time, Ghislain.

Ghislain Houle (CFO)

Thanks. Thanks, Walter.

Operator (participant)

Your next question comes from the line of David Vernon with Bernstein. Your line is open.

David Vernon (VP and Senior Analyst)

Hey, good afternoon. Doug, maybe first question for you on the set of market opportunities you kind of laid out for us back at Investor Day. You know, it's a pretty bullish set of volumes out there. How should we be thinking about that opportunity set in relation to a weaker 2023? Should we be fixing those numbers kind of in the same range, and they'll be incremental as the economy recovers? Or is that scope of opportunity been adjusted for? Or should we be adjusting that scope of opportunity in line with the economic weakness?

Doug MacDonald (CMO)

It's a great question. Thanks, David. With respect to our 2024, 2026 plan, I think that's all still on target. Those are very specific projects that we outlined. None of them are really being impacted right now. We have 2 projects that we're due to start that we highlighted out to the team with respect to in 2023. One of those is our Northeast BC, where we're putting in a new siding to add capacity. That is moving ahead. We have the volumes kind of locked in there. Ed's team is busy building that siding as we speak, and we still have our Toronto fuels terminal, which should be up and running in Q4 to receive volume, and that's moving full steam ahead. Right now, everything's on time and on target, so it's actually doing really well.

David Vernon (VP and Senior Analyst)

... Okay, then just maybe just a quick follow-up. You know, the CapEx numbers that you guys presented at Investor Day were also, I think, maybe a little bit higher than the market had been expecting. Are you at a point now where you need to recalibrate the level of spending, given what we're seeing, either to the upper downside, maybe to repair some of the damage that's been done, or to delay some capacity investments based on what's happening with volumes?

Ghislain Houle (CFO)

Yeah, I think that we are looking at CapEx very closely, David. We always do. We are looking at every project. We are making sure that there's an appropriate return. We are continuing to do our basic maintenance, and when typically, when volumes are lower, it allows the engineering team to actually get better work blocks, and we can actually put rail and ties at a lower unit cost. We're continuing that program. If volumes continue to weaken, absolutely, we're looking at discretionary CapEx and making sure to question ourselves whether we need to spend the money or not. So far, I mean, I think our plan is continuing, and we're continuing to add capacity in Western Canada because we believe that we will need it.Yes, volumes are a little lower, so maybe you'll have a little bit of time value of money. The team right now is being very productive, putting that capital, especially the construction capital, in with lower volumes.

Ed Harris (COO)

David, I can add, Ed Harris here. I can add, we're taking advantage of some of these disruptions by hardening the railroad. We're spending money smartly. The outage at the washout at Halifax, for instance, we're going with bigger culverts, more culverts, we don't have to go through this again. The same thing goes for the areas that, you know, we suffered some fires in. We saw, you know, opportunities for sprinklers and pumps and things like that. We just can't go through this type of disruption anymore, to be honest about it.

David Vernon (VP and Senior Analyst)

All right. Thank you.

Ed Harris (COO)

Thank you.

Operator (participant)

Your next question comes from the line of Fadi Chamoun with BMO Capital Markets. Your line is open.

Fadi Chamoun (Equity Research Analyst)

Good afternoon. Thank you. Apologies if you have this out in the press release, I didn't see it, but what is the RTM growth guidance for this year? Maybe more so for the, you know, about half year, Q3, Q4, if you give us some clarity about what you're assuming in guidance in terms of RTM growth. The main question may be for Doug. Prince Rupert has kind of struggled, underperformed relative to most of the North American ports, even prior to all of this kind of BC strike issues and some of the issues that we saw this year, and going back into the supply chain issues last year. Do you characterize some of these issues that are hampering Rupert more kind of transitory?

Are you, from conversation with your partners at the port and customers, seeing a change in behavior and how people view that, port and the service of that port into the U.S.? I'm just wondering if this is just kinda a transitory issue because of the supply chain and obviously the weakness in the demand that we saw this year, or if there's more to it than that.

Doug MacDonald (CMO)

Hey, Fadi, it's Doug. Thanks for that very long question. I'll kind of address it in two parts. Listen, we're expecting the RTM forecast to be above industrial production. That was always what we've said. We continue to see that moving forward into Q3 and Q4. We will finish the year above industrial production, and we're very confident in that. With respect to Rupert, it's a great question. Listen, before the port strike, we were starting to see actually some green shoots, if you want, for Rupert. We were starting to pick up some business there again. Rupert's one of those cutting-edge ports. It's in a great location. It's really there to serve both the U.S. market and Canada.

As we see, some of the volumes are starting to shift there, and then we had a port strike. We're waiting for that to recover. We've actually added four trains into the network right now that are moving extra business for it. We're gonna recover, and then we're gonna see where those markets are. It continues to be, listen, the jewel in the crown for us. The customers love it. The service has been excellent there for the last year, and that's all they can talk about, and we're pretty sure we're gonna see all that volume recover.

Fadi Chamoun (Equity Research Analyst)

Thank you.

Operator (participant)

Your next question comes from the line of Chris Wetherbee with Citigroup. Please go ahead.

Chris Wetherbee (Senior Research Analyst)

Hey, thanks. Good afternoon. I wanted to ask maybe two things around how you're looking at kind of the rest of the year and into next year. First, on the macro side, and then maybe a little bit more specifically to the business. You know, I guess, what are the sort of indicators that you're looking at to get a sense of maybe how long some of this downturn may last? I know, I think you said that you can do what the customers are telling you. You can kind of plan around what the customers are telling you. I'm guessing that might be the answer. If there's any sort of guideposts that you think are important to look for over the course of the next quarter or two, that would be great.

you know, just laying maybe one for you, when you think about incremental cost levers that you can pull, I know sort of protecting the workforce because it's been so difficult to acquire these employees is important to you. Are there other things that you can pull, or at what point do you think it does make sense to look at the workforce and let attrition work its course to get it a little bit lower? Just kind of curious how you're thinking about that.

Tracy Robinson (CEO)

I'll start on that, Chris, and then I'll hand it over to Doug and Jess to add a little bit of color. Listen, I think Doug did a great job of going through our different commodity segments and what we're expecting. I'll do it in short form. We have a very strong bulk franchise. You know, it's continuing to operate very well. The demand is strong. We talked about what we're looking at on the grain portfolio, on potash, and what we're expecting on the pricing on that front. The next piece of our portfolio is more the merchandise piece, and that is-

... pretty strong, pretty flat, pretty strong. We're not seeing a big downside. There's a few pieces in there that's softer, but generally, fairly strong. The big question mark is on the consumer-centric. It's the containers, and it's lumber, right now, you know, given housing starts. There is no doubt that that's got to pick back up again with the construction that's got to take place in North America. It's just a matter of when. Same thing with the container demand. You know, we're not anticipating, based on what Doug's sharing, to see a big peak before the holiday period. But we are expecting to see some strength start to grow and a return to more normalized levels, say, next year. That's kind of how we're looking at it.

Automotive, we think more on the consumer side is gonna continue to be strong from everything that we hear and from our customers as well. On the cost side, without a doubt, I mean, what we wanna do is be really good at managing and responding to the third-party impact that we can't control. I think this team's done a really good job of that, very strong. Then the things that we can control, we're very methodical about, and we are doing that through, as we laid out for you in Chicago, we're doing that through network operations and the plan, so that when we execute, we secure the full benefit of those cost mitigations, and we continue to service our customers. As we go along, we believe we're taking all the right actions. As we go along, if we come to a different view of the, what the economy is gonna look like next year and what, you know, volumes may look like, then we'll make other decisions. Right now, these are the decisions we're making on the best information that we have.

Doug MacDonald (CMO)

Yeah. Tracy covered that all really well. The only thing I'll add in from a signpost is I always tend to look, Chris, at our petroleum and chemicals business, and it's actually pretty flat. That's always a leading indicator as the economy improves, and we just haven't seen it start to go up yet. That's one of the indicators I would suggest you always watch for the economy, especially for the railways. Chris?

Ghislain Houle (CFO)

Just to give some examples of costs that we can pull out, and we are pulling out actually is, for example, we park a lot of centerbeams. A lot of those centerbeams are leased, and they have staggered expiry date. We do this intentionally, and we're able to return some of these cars to the lessors and obviously reduce our car hire expense. The other place where we pull costs is we park locomotives, and of course, we park the ones that are the gas guzzlers and older locomotives, and use this as an opportunity to rejuvenate our active fleet that's out there pulling freight. Those are outside of... As we said in our remarks, we are looking at hiring.

We still have, you know, good attrition at CN. Attrition is helping us. We are pacing ourselves on hiring and slowing it down in some cases. Wanna be clear that we have some hard-to-hire locations in Western Canada that, you know, we're thinking the mid to long term, we're continuing to hire in those locations because they're very difficult to get people to come on the network.

Chris Wetherbee (Senior Research Analyst)

Thqat's great, caller. Thanks for the time. Appreciate it.

Ghislain Houle (CFO)

Thanks, Chris.

Operator (participant)

Your next question comes from the line of Ken Hoexter with Bank of America. Your line is open.

Ken Hoexter (Managing Director)

Hey, great. Good afternoon. Just to clarify that last answer or part of it, Tracy. You kind of target volumes to outpace IP, yet I just want to understand this. With the fire strikes, floods, cutting the grain crop, pushing intermodal volumes to next year, pushing demand into next year, you're still targeting outpacing IP as maybe, you know, is IP much larger, negative from your point of view? Or maybe just talk about that perspective. Then you mentioned, Doug, you mentioned truck competition. You didn't mention anything about rail is, you know, your peer rail is being measured on rail-to-rail competition on gains. You know, have you seen that step up in any fashion in this environment? Thanks.

Tracy Robinson (CEO)

Hey, Ken. Yeah, as you know, IP is a public number. It moves around a little bit. It's still showing negative for the year. As we add up, the total volume expectations, based on what we've outlined to you, we see ourselves, as Doug says, coming in stronger than industrial production in any scenario. We're pretty firm in that. Doug?

Doug MacDonald (CMO)

The only thing I'll add in, too, Ken, is on the rail competition. We haven't really seen any market share loss with our customers at all, both to rail or to truck. We are seeing obviously, like I said, some price pressure on the trucking side for short-haul business, outside of that, all of our customers are very happy with our service, and we continue to push product. We've seen some temporary gains due to the port shutdown, like moving potash to Saint John instead of it going to Vancouver, that's about it.

Ken Hoexter (Managing Director)

Doug, I thought you said you did lose to truck, given you couldn't move it, so some volume was lost. Isn't that what you said, given the port?

Doug MacDonald (CMO)

We lost some temporary business. I'll say, like, so we lost some temporary coal business and some going to Vancouver during the strike in Q2, in Q3, sorry, that'll show up in Q3 business. In Q2, we lost a little bit of lumber as mills were closed due to the fires, things like that isn't recoverable.

Ken Hoexter (Managing Director)

All right. Thank you.

Operator (participant)

Your next question comes from the line of Benoit Poirier with Desjardins Capital Markets. Please go ahead.

Benoit Poirier (VP and Industrial Products Analyst)

Wondering if you could provide more details, given the lack of accessorial charges, boost, whether I assume that you will be facing a tough compare. Very rapidly, just in terms of the average length of all four intermodal, I thought that you were closer to 1,600 miles, if not 1,800 miles. I was just curious, how much of your intermodal is exposed to short haul? Thank you.

Doug MacDonald (CMO)

... While the first part of your question got cut off, could you repeat it?

Benoit Poirier (VP and Industrial Products Analyst)

Yes. Just in terms of yield expectation for the balance of the year, I was wondering what we should expect in terms of yield for the second half, given that the accessorial charges won't be a boost anymore.

Doug MacDonald (CMO)

Okay. For the accessorial charges, we have about a $100 million plus headwind on that in Q2, and we expect that to continue through Q3 and Q4, right? That's part of the yield issue that you're questioning.

Amit Mehrotra (Managing Director)

Yep.

Doug MacDonald (CMO)

On the short haul versus long haul, you're right. You have the year number dead on. We actually have most of our long-haul business in that really big market, but we do move a bunch of short haul, but it's a small percentage of our business, right? It's almost always long haul. We do move traffic between Montreal and Toronto and Moncton. It's a little bit shorter haul than coming off Vancouver, going all the way to Toronto, Montreal, Chicago. That's where we're facing that price pressures in that short-haul market.

Benoit Poirier (VP and Industrial Products Analyst)

Okay, thanks for the color.

Operator (participant)

Your next question comes from the line of Tom Wadewitz with UBS. Your line is open.

Tom Wadewitz (Senior Equity Research Analyst)

Yeah, good afternoon. Wanted to ask you about how we might think about operating ratio and maybe inflation, how that would have an effect. I think, you know, transports have certainly dealt with inflation in the cost base, and as the revenue slows down, you know, it's more challenging from a margin perspective, finding ways to offset that. I know the Canadian dynamic's a little bit different than what we see from some of the U.S. companies. How do you think about, you know, the kind of profile for inflation as you look into 2024 with a little softer view and, you know, what you might be able to do to kinda stabilize the OR on, you know, on kind of a year-over-year basis? Thank you.

Tracy Robinson (CEO)

Thanks, Tom. It's Tracy. Listen, we've been pretty clear that we see opportunities in our margins as we go forward over the longer term. You know, we see that in a number of places. We're not yet where we need to be from an operating efficiency perspective. We've made significant gains, and we've handled some of the external events extremely well. There's still more work to do there, and we're excited about getting at that. Certainly, you know, we're standing behind our pricing above inflation perspective. Doug is doing a great job at delivering that on the basis of the service that Ed's providing him. That's gonna continue. We do have the headwind on some of the storage and other charges that occurred last year when the supply chains got pretty congested.

As we look forward, you're gonna see us improve our margins. Right now, we're gonna have a little bit lighter on operating margin, while the volumes are down. We are positioned extremely well to get, at a very low cost, the upside when the volumes return. That's the model. That's how we're gonna run it, and you'll see us, you'll see that leverage pick up as the volumes come back.

Tom Wadewitz (Senior Equity Research Analyst)

You think it's much more driven by volume than by price, just in terms of when we might transition to seeing improvement?

Tracy Robinson (CEO)

Yes, absolutely.

Tom Wadewitz (Senior Equity Research Analyst)

Yeah. Okay, thank you.

Operator (participant)

Your next question comes from the line of Konark Gupta with Scotiabank. Your line is open.

Konark Gupta (Equity Research Analyst)

Thanks for taking my question. Just wanted to dig into the guidance, if I can. What are some of the puts and takes explaining the gap between the top and bottom ends of the EPS guidance range of flat to slightly negative? I'm not sure what the slightly negative mean. Could that be a low or mid-single-digit decline? Thanks.

Doug MacDonald (CMO)

Thanks, Konark. What explains the gap between flat to negative is really volume. When one scenario, you know, we get a little bit more volume than we expected, and in the slightly negative, it's slightly negative, then we get less volume in the second half of the year than what we expected. It's really a volume story.

Operator (participant)

Your next question comes from the line of Amit Mehrotra with Deutsche Bank. Your line is open.

Amit Mehrotra (Managing Director)

Thanks, operator. Hi, everyone. Good afternoon. I guess I wanted to stress test the 10%-15% earnings growth framework, I guess, for next year. I mean, you guys are operating pretty well if I look at the cost structure and you're responding, at least in terms of what you can control pretty well. I'm just trying to understand if we're kind of in this lackluster volume environment, you've got headwinds on grain, you've got headwinds on forest products next year, but you've also got, on the other hand, a lot of volume opportunity that you outlined in Investor Day. I guess, I mean, what's the likelihood that we're sitting here 12 months from now in a still weak environment and, you know, EPS is not growing or staying the same? Do you feel like you have enough idiosyncratic volume opportunity where you can kind of move the needle on EPS? How much do you need that's out of your control to get to that 10%-15% next year?

Tracy Robinson (CEO)

Amit, I welcome you to the dialogue around our table. If we knew for sure what was gonna happen from an economic perspective, we could narrow in on this pretty quickly. Just taking you through what we're modeling next year, and as Doug, from a volume perspective, you're right, our railroad is running extremely well, and we're poised to capture the upside, and send a lot of that to the bottom line as soon as it comes. We have a plan in place for next year. If it's wrong, then we will adjust. The growth initiatives that we put in front of you in Chicago are there that exist outside of the economic ebbs and flows. Doug and Ed are continuing to work on actioning those. Doug talked to you about a couple that are gonna come in, and we'll be moving volume, prior to the end of the year, and that plan remains intact. That is something that will move us, more positively than whatever is going on in the economic environment at that time.

Amit Mehrotra (Managing Director)

Can you.

Ghislain Houle (CFO)

Just to clarify, just to help us?

Amit Mehrotra (Managing Director)

Yeah, sorry, go ahead.

Ghislain Houle (CFO)

Just to clarify, Amit, as well, the 10%-15% we said was over the 3-year period, so we did not specifically guide by year. Obviously, we're looking at what's happening. We're going to, you know, do our business plan with our board this fall, as we typically do, and then we typically provide visibility on the year in January. I want to clarify that the 10%-15% was over the 3-year period.

Amit Mehrotra (Managing Director)

Yeah, I just assumed it was linear, because that would imply like 15%-25% in the back half. I understand what you're saying. Thank you for taking the question.

Ghislain Houle (CFO)

Thanks.

Operator (participant)

Your next question comes from the line of Brian Ossenbeck with JP Morgan. Please go ahead.

Brian Ossenbeck (Managing Director and Senior Equity Research Analyst)

Hey, thanks. Good afternoon. Question for Doug: Can you just walk through the assumptions for the Canadian grain harvest? Do you think that's sufficiently de-risked at this point, given all the weather conditions that we're seeing out there and some of the crop conditions as well? Also, the U.S. grain forecast looks actually raised, but similarly, same sort of challenges out there from that crop. Can you just give some quits and takes around why those went in opposite directions? Thanks.

Doug MacDonald (CMO)

Sure. Sure, Brian. Thanks for the question. With respect to the Canadian grain, obviously, you know, you can't really count it until it's off the fields. From everything we're seeing, both from our customers' crop forecasts, which are very accurate, especially in Canada, to the government forecasts, we're seeing that roughly that 65 million metric ton number, right? We're pretty confident in that. At this time of year, unless there's a big change in weather that really has a big impact on the crops, it should come in very close, right? We're pretty confident on that. The crop on our network, on CN's network, has more moisture, so we think we're actually fairly well set up to move things through up until Q2 next year, and then we'll only be able to determine that later.

With respect to the U.S. crop, it started off as a very dry crop, almost a drought crop. We've seen significant amounts of rain on our network over the last four weeks, that crop forecast on CN through Illinois and Ohio has come up dramatically for us. We're actually looking at a normal crop in the U.S. right now. Now, things could still change. It still has to come off the field as well, but the corn and soybeans are actually have caught up almost to the average right now.

Brian Ossenbeck (Managing Director and Senior Equity Research Analyst)

Okay, thanks, Doug.

Operator (participant)

Your next question comes from the line of Steve Hansen with Raymond James. Your line is open.

Steve Hansen (Managing Director and Equity Analyst of Transportation and Agribusiness)

Yes, good afternoon. Thank you for the time. Just to follow up on the grain crop, if I may. It's obviously been dry and stressed, as you indicated, Doug. I suspect we likely get an early harvest this year, which should provide some help on the margin, but I also think we're comping up against a pretty benign winter through Q4 and probably even more so in Q1 next year. How do we think about that in relative context? Can you actually move as much grain as last year if the winter is more normal?

Doug MacDonald (CMO)

You know, for our network, Steve, it's a good question. We think our network's gonna have slightly lower, but not dramatically lower crop overall, just because there's been a lot more moisture across the north, right? We feel pretty comfortable on our numbers. With respect to moving it, we had a fairly normal winter. I know we characterized it as a light winter sometimes, but we had the same number of cold days, like below -30, as we do in a normal winter. We just, with the operating plan that Ed put together with the team, they just delivered so much better than our prior years. What we're planning, we're planning on moving the same type of volumes that we did before for our customers, and we think we'll be very successful with Ed and the team. Ed, I don't know if you want to add anything?

Ed Harris (COO)

No, I can tell you, I don't see any real problems at all. I mean, today's technology allows us to run repeater cars when it gets extremely cold. We always run distributed power on the loaded grain trains. We'll do just as well this year as we did last year.

Steve Hansen (Managing Director and Equity Analyst of Transportation and Agribusiness)

Okay, very good. Thank you.

Operator (participant)

Your next question comes from the line of Justin Long with Stephens. Please go ahead.

Justin Long (Managing Director and Equity Research of Transportation)

Thanks. Good afternoon. I wanted to ask about the lag impact from fuel that's getting baked into the guidance for the second half and how that compares to what you saw on the first half. Then just to clarify on the volume guidance, could you share the industrial production number that you're using as a benchmark for this year?

Ghislain Houle (CFO)

The industrial, the industrial production number is, as you saw, census came out, you know, a couple of days ago, and it was negative 0.2, so it's in that range. On the lag question, I think that we don't expect a lag, if fuel prices remain the same, we don't expect a lag in Q3, and neither in Q4. Now, on a year-over-year basis, if you look at Q3, we had a positive lag last year of about $0.10 on a year-over-year basis. That will be negative. It will impact negatively, our year-over-year fuel lag in Q3 by about $0.10.

Justin Long (Managing Director and Equity Research of Transportation)

Okay, great. Thanks.

Operator (participant)

Your next question comes from the line of Brandon Oglenski with Barclays. Please go ahead.

Brandon Oglenski (Director and Senior Equity Analyst)

... hi. Thanks for taking my question. I guess, just to recap a couple of things here, Doug, does the pricing hurdle or inflation hurdle remain mid-single digits? Because I think you had implied about 5% looking at your longer-term outlook, maybe even higher in 2023. Do you think you're getting that outside of some of the markets that you called out? Ed, it looks like your service metrics this quarter were actually pretty decent despite some of those headwinds. Would you expect incremental efficiencies if you can get beyond some of these hurdles?

Ed Harris (COO)

Absolutely. You know, when I said it was a tough quarter, I meant it was a tough quarter. The fires, the disruptions we had to deal with, we are very well-positioned going into third and remainder of third and fourth quarter. Headcount, power, equipment, we ought to be able to do even better than we did last year at the same time.

Doug MacDonald (CMO)

Brandon, on the pricing, we continue to be strong on that. Obviously, you know, we talked a little bit about the pressures in some of the intermodal, so the short haul. Outside of that, on the rest of the carload business, we're still being fairly aggressive, seeing a great pricing environment based on the service that Ed's providing. I don't see that changing for the rest of the year.

Brandon Oglenski (Director and Senior Equity Analyst)

Thank you.

Operator (participant)

Your next question comes from the line of Jonathan Chappell with Evercore. Please go ahead.

Jonathan Chappell (Senior Managing Director)

Thank you. Good afternoon. Just tying a bunch of things together, Doug, you know, you laid out a pretty detailed bottoms-up view of a lot of the growth opportunities that your customers are pursuing. Now in the kind of more maybe uncertain macro backdrop, even you're looking at your CapEx budget going forward. Have you seen any type of reluctance to move forward with any of the projects that you've laid out from the shipper community, as both some of the temporary issues have intensified and the uncertainty has probably been elevated as well?

Doug MacDonald (CMO)

John, not to this time, right? We've seen a lot of these projects are longer-term, big projects that customers are looking at the immediate environment at. They're looking macro, they're looking two, three years out, and we're working there with them. Like you take an example, like a BHP potash mine as an example, like, they're well under construction. It's only gonna come up in two or three years. We don't see them slowing down. In fact, we're seeing them try to speed up. There's lots of examples like that, where people will try and take advantage of the market and the conditions, and they're spending as much money, if not more, 'cause there's more labor availability. Each market's gonna be different, each opportunity, but we're working with everyone, and we haven't seen anyone slow down to this point.

Jonathan Chappell (Senior Managing Director)

Great. Thanks, Doug.

Operator (participant)

This concludes the question and answer session. I would like to turn the call back over to Tracy Robinson.

Tracy Robinson (CEO)

Thanks, Emma. An interesting quarter from an external events perspective. I think we've managed it well, and we're all looking for a few less interesting quarters coming up, but we'll manage what comes at us. Our plan, though, is clear, and it's not changing. The discipline around building the plan, running the plan, selling the plan is doing exactly what we wanted it to.

It's working. It's delivering consistent, reliable service for our customers and making effective use of our assets. As we've talked today, as our volumes lift, we're gonna see that operating leverage follow suit, and we're ready. We've got our eyes on our future. We're advancing our growth projects, preparing for the rebound, and doing exactly what we said we'd do back in May. That being said, as you've heard today, we're reiterating our 2024-2026 financial perspective of 10%-15% diluted EPS CAGR. That's all for now. Thanks very much for joining us today.

Operator (participant)

The conference call has now ended. Thank you for your participation. You may disconnect your lines at this time.