Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Canadian National Railway Corporation (NYSE:CNI)

Q4 2010 Earnings Conference Call

January 25, 2011 2 PM ET

Executives

Robert Noorigian – VP, IR

Claude Mongeau – President and CEO

Keith Creel – EVP and COO

J.J. Ruest – EVP and Chief Marketing Officer

Luc Jobin – EVP and CFO

Analysts

David Newman – Cormark Securities

Bill Greene – Morgan Stanley

Cherilyn Radbourne – TD Newcrest

Ken Hoexter – Bank of America/Merrill Lynch

Tom Wadewitz – JP Morgan

Jacob Bout – CIBC World Markets

Scott Group – Wolfe Trahan

Chris Ceraso – Credit Suisse

Jason Seidel – Dahlman Rhodes

Operator

All participants please standby. This is the forward-looking disclosure. CN’s Q4 2010 financial results conference call will begin momentarily. I would like to remind you that today’s remarks contain forward-looking statements within the meaning of applicable securities laws. Such statements are based on assumptions that may not materialize and are subject to risks described in CN’s Q4 2010 financial results press release and analyst presentation documents that can be found on CN’s website. As such actual results may differ materially. Reconciliations for any non-GAAP measures are also posted on CN’s webcast at www.cn.ca. Please standby, your call will begin shortly.

All participants please standby, your conference is ready to begin. Welcome to the CN Q4 2010 Financial Results Conference Call. I would now like to turn the meeting over the Mr. Robert Noorigian, Vice President, Investor Relations. Ladies and gentleman, Mr. Noorigian.

Robert Noorigian

Thank you for joining us for CN’s Q4 and total year 2010 results. I’d like to remind you again about the statements we’ve already read about forward-looking statements. With me today is Claude Mongeau, the President and Chief Executive Officer; Luc Jobin, Executive Vice President and Chief Financial Officer; Keith Creel, Executive Vice President and Chief Operating Officer; J.J. Ruest, Executive Vice President and Chief Marketing Officer.

After our presentation today we’ll take questions from those of you who are listening on the call. Could you please identify yourself when you’re asking the questions? And in order to be fair, and also I realize that we’re doing this in the middle of the day and you have other calls that you’re going to have afterwards, we’re going to limit this to one hour and could you limit your questions to one?

With that brief introduction, I’d like to introduce Mr. Claude Mongeau, CN’s President and Chief Executive Officer. Claude?

Claude Mongeau

Thank you, Bob, and thank you all for taking time to listen to our call. We have the full CN leadership team here today to give you a good update on our results, and they are good results. Our Q4 came in with solid performance across the board, both from an operational service and unfolding of our strategic agenda, and the results are showing that. We’re capping a very good 2010 year and basically I’m very, very pleased with the Q4 performance.

Our revenues were up basically 15% if you adjust for currency on strong double digit volume growth. J.J. will give you the details, but we’ve had growth across all of our commodity group and it’s actually quite encouraging. The level of performance in terms of volumes, during the Q4 are not only good for results, but they bode well for volumes into 2011. Our efficiency, our ability to grow at low incremental cost allowed us to finish the year with an operating ratio of 63.4. That’s almost 2 percentage points less than last year, and so we’re continuing to show that we are able to grow a top line and accommodate it with very good margins and bringing it to the bottom line.

Bottom line is $1.08 in terms of EPS. If I adjust for last year’s non-recurring items, the EPS growth is a full 20% on a year-over-year basis adjusted. Luc will give you some details, but I think it just continues to confirm the thesis and the ability we’ve had during the year to transform top line growth into solid profitability, both earnings and free cash flow. Free cash flow for the year – $1.1 billion, a very strong performance, and all of this, including our prospects into 2011, give us the confidence- our Board this morning, or yesterday actually, agreed to a 20% dividend increase, Clearly an indication of our confidence in the future of this company and a recovering economy.

Similarly, in terms of rewarding our shareholders, we have a solid balance sheet. Luc will give you the details, but we are launching another share buyback program with 16.5 million shares. So all in all, a very solid Q4 and capping off a great year.

Let me just spend a moment before I turn it over to my leadership team for more details, to take a bit of time on the year overall and how the transition has taken place. I’m very pleased with the chemistry of our leadership team, how we’re coming together, and how our basic unfolding agenda is being carried out. We’ve discussed this with you earlier in the year at an analyst meeting – what we’re trying to achieve is clear, the vision is well articulated, and we are delivering on it. And I think the proof points are coming through across a number of areas.

In short, we had the benefit in 2010 and that’s the (inaudible) that was helping in terms of transition, of having an economy that came in stronger than anybody expected last fall. But this story is a lot more than taking full advantage of this economic recovery. It’s about our agenda. Operational and service excellence are coming through. In the year we have the strongest car load growth of any railroad in the industry. And if you look at the metric that Keith will describe in a minute, we have maintained or improved all of our core operating metrics.

We have also launched a bold agenda in terms of customer engagement, innovation, and supply chain collaboration and it’s coming through, not just in intermodal where we’ve had a number of agreements during the year, but also in merchandise and more and more in the bulk sector as well. So the agenda is helping us gain market share, it’s helping us improve service, and it bodes well for the future in terms of delivering solid value for our customers and our shareholders both.

With that I will turn it over to Keith to take you through the operating highlights.

Keith Creel

Thank you, Claude. Let me start by saying I’m extremely proud of the Q4 results that this operating team was able to produce across the board. Certainly it’s a positive reflection of our intention, execution, and focus on doing it day-to-day – all departments, not just transportation, mechanical, engineering; it’s a team sport, team event and team results here.

Let’s take a quick look back at 2009. We showed what this team could do and what this operating model does, managing expenses down against our reduced business demands. But believe me, in 2010 it was quite a bit better ride, much more fun to manage growth while we executed on the supply chain innovation and the service excellence vision that Claude laid out for us over twelve months ago. So throughout the year in 2010 our team, our operating team, enjoyed partnering with J.J. and his team and our customers and our supply chain partners to grow the top line for all the parties involved pursuing these initiatives.

So with that said, let me take a few minutes to review the quarter from an operational perspective and we’ll talk about some of the initiatives that helped us deliver on those results. What you’re looking at, most of you are familiar with the metrics that you see on the slides there. They serve as good indicators of our key service and expense levers of this company.

A quick reminder, mid-year 2010 we changed the way we measure terminal dwell and train speed, which you see on the right side of the charts, to align with the AAR reported measurements, which is why we only have two years of comparative data. As you can also see, all of the 2010 performance is flat, which is quite positive against increased volumes. This is quite significant as far as I’m concerned. We faced 11% GTM growth, 10% car load growth and either maintained our operating metrics or improved on most counts in spite of even weather challenges, specifically in the Q4.

We got back to it being an outdoor sport, winter came a little bit early in the west. We experienced some challenges in November and then that continued in December with blizzards that went across to include eastern Quebec, the Meritons and then quite a bit of snow in the Winnipeg gateway, as well as cold weather which compounded the challenges in the operation.

On the GTM’s per train mile for the quarter, or train load, that’s a direct reflection of our road crew and locomotive productivity. You see a 5% improvement, which basically reflects our continued strategy to deploy a distributive power fleet, our (inaudible) investments and our sidings, and our terminal bypasses strategically in our ongoing focus to match our train service plan, which we provide day-to-day against our forecasted traffic.

Cards per yard switching hour, again, that’s a measurement of our yard crew productivity and our yard fluidity. Our breakeven performance here reflects the great job we did in 2009 taking terminal expense out, but most importantly keeping it out during 2010 as those volumes grew and we stayed focused more on our service side.

You see a good stir on the terminal dwell side, which reflects both service (inaudible) utilization, again, continued focus on matching the service plan to the shifting traffic patterns. In the lower right, flat performance on GTM per available horsepower: this is more of a conscious decision to go a bit long with the locomotive fleet in the Q4 to meet high demand levels, especially grain, which provided some market opportunities there late in the year; and to assist keeping the network fluid in the face of those winter conditions that we were faced with November and December that I mentioned.

And it worked. The strategy worked well for us as you see in the car velocity metrics. We again, reflect positively improvement there in both service and (inaudible) utilization improvements. And finally, on train velocity we were able to maintain it in the face of increased volumes as well as those winter challenges I talked about. So that speaks to the power of the operating model and the fluidity of the network in spite of weather, in spite of increased business.

Let’s talk about distributive power a little bit. We’ve spoken quite a bit about it over the past, specifically DP’s ability to help us in our long train model operating system, maintaining those train lengths in the dead of winter. Typically with winter, as we’ve talked before and discussed before, you often have to reduce train length due to air leakage when you get into some extreme cold temperatures, which we face here in Canada quite a bit. I’m happy to say that in the face of real winter, which I mentioned, we we’re able to not only maintain our train lengths but increase our train lengths greater than ever before.

Everything else being equal, before we used DP power this cold weather effect, train length would drop off a bit in the Q4 and the Q1. This year, as you can see in the results, in fact in large part to the fact, this DP power is helping us. We’re overcoming the air issue, our train load is actually up 2% Q4 versus Q3 comparison. The other real pop with this is what we avoid in congestions in our yards and gumming up the network, so to speak, and driving additional operating costs in the yards. When you have to reduce these trains you hold the cars back, customers’ freight gets delayed and you see adverse impact in the car velocity in your yard expense. So that’s working well for us.

And even now in the face of some real, real serious winter operating challenges, we’ve been able to do some great things with DP power. Last week, just anecdotally I’ll share this with you, we faced some temperatures of about 45 below zero and before that around 30 below zero. In the face of 30 below zero weather, we ran with DP power to pull it on a train, an 11,700 foot train across the NOD. Those 1200 miles in temperatures like that, before if you would have told me we had to do that without DP power I would have said it’s impossible because frankly, it is. But with the way the DP power promulgates the air through the train and keeps the air pumped up, we’re able to do some great things that will help us long-term in our operating strategy maintaining our metrics.

And finally, talking about DP power, right now we ended 2010 with 415 DP equipped locomotives. If we continue that strategy, by the end of this year we’ll be about 450, which is about 42% of our fleet; with a view to go to about 500 locomotives when it’s all said and done based on our current business mix today.

On the fuel efficiency side we made some progress there as well. I’ll just remind you that a 1% improvement in our fuel productivity numbers reflects a cost takeout of about $10 million bottom line. We ended 2010 with about a 3% improvement year-over-year on top of a 4% improvement that we achieved in 2009. Looking forward for 2011, we’re targeting 2% to 3%. If you compound this over three years that’s about $100 million real cost takeout to this operating model.

And all this is made possible not through any silver bullets, but through an integrated approach. We drive trainload DP deployment, we sprinkle some new locomotives in there that are more fuel efficient, our innovative throttle notch limitation which we started the end of 2009 and just gained traction with in 2010; and then recently we’ve initiated some measurement and audit tools that will allow us to make sure we derive compliance with those engine isolation and (inaudible) issues to help us achieve what we’ve got to achieve in 2011.

And finally, speaking on behalf of this operating team, delivering on the new dimensions and successes in there that we’re really excited about; under close leadership, working closely in (inaudible) with J.J’s teams, we’re effectively rewriting the book on what improved service and flexibility means to our customers at CN. It’s a service definition that reflects working collaboratively and much closer with our customers focused on our total supply chain performance basis. The key foundational thing here to remember is mutual accountability and shared measures, and that’s both for the customer, for the supply chain partner, as well as for CN. So we’re all in. CN succeeds – customer succeeds, it’s a we succeed approach.

So to wrap it up, a solid operating quarter closing out a solid 2010 operating performance, which definitely provides us some solid momentum going into 2011. With that said, I’ll hand things over to our Chief Marketing Officer J.J. Ruest.

J.J. Ruest

Well excellent, Keith. Thank you and good afternoon to all of you. All in all 2010 was a very good year. I’m going to guide you through, on page 10, our book of business and as usual we’ll do this on the currency adjusted basis.

Versus 2009 the Q4 revenues were up 15%. 11% came from load volume, that is 10% in carload and 11% in RTM. Our intermodal and bulk business unit both produced the best Q4 RTM volume since 2006. Net of fuel, same store price on same store sales increased by about 3%. Fuel surcharge increased about 1% and you should remember the 2 months lag on our universally applied fuel surcharge program. The mix was positive and exchange reduced revenues by $48 million, or 2.5%, a full $0.04 on the dollar exchange.

Let’s look at the Q4 now in detail, again on the affects adjusted basis, business segment by business segment. Petroleum and chemical was up 13%. Chemical plant operated in the range of 85% in the quarter. Metals and minerals was up 16%. Steel and (inaudible) remain tight and we gained more historical truck volume. Forest products increased 11%. We had strong demand in Asia for lumber and pulp which kept more mills running at very high operating rates. We also signed during the quarter two supply chain level of service agreements with break bulk export terminals in Vancouver. Automotive increased 13% on the strength of a 9% increase in North American production over the Q4 of 2009. Coal was up 25%, our best quarter RTM volume since 2006 mainly driven by offshore markets.

Canadian and US grain were both up 15%. The grain pricing in world markets created a strong export environment and our excellent scheduled grain service added a full five points of Canadian market share, which is the third quarter this year. Fertilizers revenue were up 17%. Intermodal overseas revenue increased by a nice 24%. CN’s Port of Montreal and (inaudible) business have set Q4 RTM records. The volume at Halasack and Vancouver are also on a strong pace.

Domestic intermodal revenues increased 14%. Our door-to-door retail service to the consumer and grocery segment led the way with very high volume right into Christmas. Non-rail revenue increased 11%. The big drivers were our Great Lakes R&R fleet, our coal export doc in Louisiana as well as our (inaudible) services.

Now turning the page toward 2011, we are broadly optimistic on our book of business. Turn to page 11 for the intermodal outlook. Our supply chain agreement with all four Canadian port terminals are creating positive customer response, with both the overseas shipping lines and their big retail customers here at home. In the Q1 we expect strong overseas shipments to precede the Chinese New Year and then to resume in March. We also have good traction in domestic markets. The trucking industry is facing an increasing mid-term issues like higher fuel price and CSA 2010 regulations, which both of these things can only help us. We are and we will be making targeted investment decisions to support our growth intermodal segments during 2011.

On page 12 bulk outlook. The Canadian Wheat Board has increased its guidance for export grain to 17.4 million metric tons, which is up 2 million tons. With our very fluid winter operations we are well positioned to capitalize on that during the Q1. Coal ash demand is strong in both the North America domestic market as well as overseas. This has created a situation where CN can showcase its bulk service again this winter. Coal offshore demand is strong and this will provide Gulf Coast and West Coast growth potential for both our terminal and net coal market, Canada and US.

Finally, merchandise: the operating rates are back over in the 70% range, supported by intermodal production here in North America, energies projects and relatively low inventory in steel service center. The year is also looking good for R&R in the US. For January we will be down near 10% in car loads. Petro and chemicals will see progressive recoveries during the year in line with industrial production in North America. We are also expecting US automotive sales to be around 13 million units with strong production out of the CN-served facilities in our network.

As I conclude I want to thank Keith and his operating team for an excellent winter operation which as Keith mentioned really started in late November. Operations and marketing are working closer than ever and are producing the kind of results that you see. Luc?

Luc Jobin

Alright, thanks J.J. and good afternoon everyone. I’m pleased to report on CN’s financial performance which continued to improve significantly through the Q4 of 2010. As Claude said, the strong finish wraps up an outstanding year, and I’ll comment further on our full-year results in a few minutes.

Let’s first discuss the Q4. Revenues grew 12% versus last year to reach $2.1 billion. That’s a 15% growth on a constant currency basis. As J.J. described this was achieved with the benefit of a solid performance across every product category, with car loads up 10% and RTMs up 11%. Meanwhile, our operating expenses continued to be tightly managed, as the increase from last year was largely attributable to significant increases in fuel costs and higher volume. This cost management focus helped us generate a 19% improvement in operating income.

Our adjusted EPS came in at $1.08 versus $0.90 in 2009, for a full 20% increase. Now it’s worthy of mention that this was achieved in spite of an FX headwind due to the strength of the Canadian dollar and a fuel lag of about $0.03 EPS. Our operating ratio was 63.4% in the Q4 of the year. This is almost two points lower than last year for an overall improvement of 3%, which demonstrates our continued ability to cope with additional volume at lower incremental cost.

Moving on to expenses on the next page, in the Q4 operating expenses totaled $1.3 billion, a 9% increase from 2009 or up 12% on a constant currency basis. The fuel expense increased 29%. This is the result of a significant increase in fuel prices as the WTI went from an average price of $75 up to $84 during the quarter. In addition, we brought on a higher volume of business to the tune of 11%. Fortunately we continued to improve our fuel efficiency by 2% in the same period, offsetting part of this cost pressure.

On the labor and fringe benefit costs, we had an increase of 4% versus last year. This was pretty remarkable performance achieved in the face of an 11% increase in volume while our average manpower headcount only went up by about 3% in the quarter. The rest came down to wage inflation partly offset by lower fringe costs. Going into the Q4 you will recall that we wanted to hire ahead of attrition, deal with increased volumes, and get an early jump on our winter program, and so we advanced our recruitment and training for key trades. In spite of this we still managed to improve our labor productivity by 8% in terms of GTMs per average number of employees and labor and benefit expense for GTMs, certainly a great job from Keith and the operating team.

On the purchased services and material, our expense went up 12% and the increase is mostly attributable to higher use of contract services associated with larger volume on the trucking as far as the intermodal is concerned, and ships on the R&R side of the business. In addition we also had slightly higher repairs and maintenance expense. Our depreciation expense was up 13% mostly from asset additions and the impact of the first phase of our depreciation studies which will have their full effect in 2011.

Now, turning to our 2010 full year results we delivered $4.20 of adjusted EPS, an increase of 30% versus last year which was at $3.24. Considering the sizeable currency headwind which we were facing of some $0.22 of EPS this is a notable 36% growth on a constant currency basis. Revenues were $8.3 billion up 19%, FX adjusted on a car load growth of 18%.

Now, what these numbers don’t indicate, however, is that we delivered innovative supply chain solutions to our customers and improved our service and flexibility throughout the year. We also advanced our partnerships with key stakeholders in the supply chain with groundbreaking collaborative service agreements. Expenses stood at $5.3 billion, up 12% on a constant currency basis as we delivered stellar operating productivity metrics. Our ability to bring onto the network additional volume at low incremental cost is best captured by operating income which stood just over $3 billion, up 33%. It all translated into an impressive operating ratio for the year of 63.6% which is a full three percentage points lower than last year for almost a 5% improvement.

Moving on to the free cash flow for the year, we delivered a very solid $1.1 billion of free cash flow up from $790 million in 2009. We completed our capital expenditure program for 2010 at $1.7 billion as we took advantage of our strong cash generation to accelerate our fleet renewals for locomotives in selected car categories. This was opportunistic on our part as we were able to negotiate attractive prices from our suppliers’ idle capacity and low commodity prices. We also made an additional voluntary contribution of $300 million to our pension plan during the year. Our balance sheet at the end of the year is very strong, with our debt and coverage ratios well within our targets. We also completed our 15 million share buyback program in 2010, with $913 million of cash thereby returned to shareholders.

Now let me turn to our financial outlook for 2011. We continue to see a gradually recovering North American recovery in 2011. Obviously we don’t expect the pace to match 2010 which benefited from sizeable government stimulus and inventory level readjustments. Meanwhile we do expect emerging market economies to continue growing and driving strong demand for North American supplied economies over the course of the year. So this bodes very well for CN as we intend to continue to leverage the recovery.

A number of key assumptions underpin our outlook, such as North American industrial production growing in the order of 4%, US housing starts of about 675,000 units, and US motor vehicle sales of approximately 13 million. In addition we’re assuming a weaker 2010/2011 Canadian grain crop, partly offset by larger stock carryover. Now we see this translating into mid single-digit car load growth in 2011. We also intend to continue with our long-term policy of achieving real price increases throughout the year and in line with the quality and value of our service offering. We do see a few headwinds coming our way, however, which should be kept in mind, namely as it relates to the strength of the Canadian dollar. We assume the Canada/US exchange rate will be around par for 2011 versus an average of $0.97 in 2010. The other area is depreciation cost, which will be rising as a result of detailed studies of our assets and their useful life. These reviews were started in 2010 and will be completed in 2011.

The higher cost impact is expected to represent some 50 basis points of operating ratio if we judge by our past experience. Having said this our guidance for 2011 has us aiming for double-digit growth from our adjusted diluted EPS of $4.20 achieved in 2010. In addition, we are guiding for solid free cash flow generation in the order of $850 million in 2011, and that’s despite cash taxes being more than $225 million higher than in 2010. This cash flow forecast also assumes a 20% increase in dividends approved by the Board of Directors. In addition we have every hope to return to shareholders as much as 30% more cash versus 2010 as we look to complete the 16.5 million share buyback program in 2011. Now, this clearly reflects the strength of our operating performance in 2010 combined with our strong balance sheet and positive outlook for 2011.

Our free cash flow guidance assumes a capital program of approximately $1.7 billion, which is in the same range as what we completed in 2010. The mix in 2011 calls for about $1 billion to be invested in track infrastructure to maintain a safe and fluid railway network, the same as last year. In 2011 our other investments, however, will shift emphasis from equipment renewals specific to locomotive acquisitions to large projects supporting a number of growth and productivity initiatives. This is quite exciting. As we’re working on the development of such things as a major logistics center in Calgary to serve as a platform for revenue growth in this important western distribution hub, a project of well over $100 million in scope.

On the productivity enhancement side we’ll also invest over $100 million in 2011 to advance significantly the connections and integration of the EG&E and pursue the optimization of our footprint in the Chicago area. This will set the stage for productivity improvements as we will consolidate satellite operations, improve efficiency and accommodate future growth.

In closing, let me assure you that we have very strong plans for 2011 as we continue through supply chain management and innovation to evolve this franchise to the next level of operational and service excellence for the benefit of our customers while maintaining our focus on delivering strong value to our shareholders, and that, consistently. On that note, back to you, Claude.

Claude Mongeau

Thank you, Luc, and as you can hear we are clearly delivering on our agenda. And the last page just reminds you what it was all about and I hope that you can find and through your questions in a minute, and through what you’ve just heard from Keith, J.J. and Luc that we are working on basically every one of the key points.

And that gives me a good setup to talk about one area where we’ve made good progress in 2010 and it’s our ability to negotiate labor agreements with our workforce. As you know we were able to reach an agreement, a negotiated one in the fall with our running trades represented by the Teamsters, and I’m pleased to report for those of you who have not picked it up on the newscasts that yesterday we reached an agreement with our employees represented by the Canadian Autoworkers, and these employees are working for us across a range of activities in intermodal facilities, in our mechanical shops, in our clerical workforce and in our owner/operator trucking partners that are helping us day in, day out to deliver the goods, so to speak, to our customers.

So we are pleased. We hope it will ratify. It was done, the agreement was reached in the late hours yesterday at night, and a full 24 hours ahead of the deadline because we were able to solve issues constructively over the weekend. The CAW bargains hard and we had a sense of what we could do, and ended up with win-wins, particularly in the area of working to find ways to accommodate, attract and retain the new generation of employees which will come to us over the next several years now as we face attrition and renew our workforce. It takes solid labor agreements, it takes an engaged workforce, it takes a management team that is connecting together and it takes a solid agenda to do what we said we would do, and to deliver value to our customers and shareholders both. And that’s exactly what we’re doing.

In terms of guidance, I think this guidance is very constructive. And you heard J.J. talk about the strong demand in bulk that we have, the good economy that’s helping us across a range of businesses – intermodal and merchandise; the areas where we’re gaining market share against truck, particularly in the intermodal sector. You’ve heard Keith talk about the solid operating momentum even through a difficult winter, the focus on efficiency but also the focus on service and our ability to continue to drive the business at low incremental cost. And when you put it all together, I think Luc put it well – it’s basically a guidance for double digit EPS growth, a 20% increase in the dividend and up to 30% increase in the cash we use to reward our shareholders through a buyback. And that’s, in my view, solid shareholder returns incurred on a solid game plan overall.

With that I will open up for questions with the rest of the team.

Question-and-Answer Session

Operator

Thank you. We will now take questions from the telephone lines. (Operator Instructions.) The first question is from David Newman of Cormark Securities. Please go ahead.

David Newman – Cormark Securities

Good afternoon, gentlemen.

Claude Mongeau

Good afternoon there, David.

David Newman – Cormark Securities

Solid quarter and thanks for reporting during the day. It makes it easier. Just a quick question on the headcount. You managed the headcount very well in the quarter and I know you’re hiring ahead of attrition, but on a net basis and given the broadening out of the economy here overall, what is going to be your net headcount addition for the year and how can we expect it’s going to roll through the quarters?

Luc Jobin

Yeah, as far as 2011 is concerned, David, we’re looking at attrition probably on the order of 1700 or so employees, and obviously our objective is to replace less than attrition. So that’s kind of where we’re looking and how we’re looking at 2011.

David Newman – Cormark Securities

And what is the timing on that, Luc? I mean how does that come by quarter?

Luc Jobin

Well, we continue to try to hire ahead of attrition, so we’ll be monitoring the extent to which the volume unfolds during the course of the year, but at this point we’re not providing quarterly guidance on that.

David Newman – Cormark Securities

Okay, and just a quick one on the forest products. Obviously the Chinese demand could be very significant here and my understanding that the gap between their own internal demand to supply could be equal to the Canadian harvest. What are you seeing with the Chinese especially as it relates to their Russian export taxes and they’re obviously looking to the Canadians for more lumber? What is the dynamic that’s going on there?

J.J. Ruest

It’s J.J., David. The dynamic is yes, they’ve been looking now for quite a while for large quantities of lumber. Russia, it was their historical supplier for them. That’s not as easily available right now, and what they do is they do a deal where they buy a whole mill’s production. So they come in, they will look for somebody who has an idle mill or a mill that’s not running for the US market, buy the full production for further planning – that’s how these things will start. In order for us also to support that we’re working closely with our overseas customers and container lines to make sure there’s a sufficient amount of import to create the exports return as well as helping to create [stuffing] facilities, namely in Vancouver and/or Prince Rupert.

David Newman – Cormark Securities

How significant is it, J.J? I mean how has the mix changed for you guys over the years? I mean what percentage would be offshore now and how has that changed, and where could this go?

J.J. Ruest

I think broadly we would say obviously we have more (inaudible) in the past which are going directly to the west coast, meaning Vancouver as opposed to long haul to southern US, so there is a bit of a shift right now in the rhythm of cargo growth and RTM growth. The cargo growth is going faster than the RTM. But also we are integrating ourselves into a supply chain, that is we also sell the services in some cases of stopping of the activities. So we have a bit of an added value. Over time we’ll see where that goes. The longer price is up in North America, not so much because of the housing starts; it’s up because of buying, the Chinese are buying the surplus. That bodes well for large lumber customers and make them more financially healthy.

David Newman – Cormark Securities

Exactly. Very good, thanks gentlemen.

J.J. Ruest

Thank you, Dave.

Operator

Thank you. The next question is from Bill Greene of Morgan Stanley. Please go ahead.

Bill Greene – Morgan Stanley

Yeah, hi there, good afternoon. I’m wondering, if we look at kind of the puts and takes here that you outlined for us, when you think about the biggest source of growth for you next year, which one of the key buckets do you think gives you the biggest opportunity for surprises? Is it volume and macro? Or are there sort of levers that you can pull here on maybe productivity or pricing that could surprise?

Claude Mongeau

I think if we look at volume in terms of whether RTM or cargo, I prefer RTM generally. The biggest potential for growth in 2011 as I said in my hope would be the areas of intermodal; intermodal overseas or intermodal domestic.

Bill Greene – Morgan Stanley

Sorry, and just to be clear, that’s the biggest source for growth in EPS, right? That’s the biggest source for surprise?

Keith Creel

Well, we’re focused on running a business, Bill, and what we do in terms of top line growth flows to the bottom line. And so what J.J. was commenting was not so much EPS but he’s commenting on our ability to grow through market share and an economy that will support good volumes in both the overseas and domestic intermodal.

Bill Greene – Morgan Stanley

Okay, fair enough. As a follow-up to that, you know, we used to say that the Canadian dollar at parody was a very significant headwind for Canadian exporters. I’ve encouraged so much commentary about that and maybe that’s because of where I’m based, but I’m just curious how you think about it. Have the manufacturers up there sort of adjusted to this new environment where it’s not as big of a deal, where they’ve fixed cost structures and whatnot? Or is it still a pretty big headwind that if you had a change in that currency it could mean a big upside for you?

Claude Mongeau

I think it’s fair to say that we’ve been living in a world of $0.95 to close to parody for some time now, and adjustments both because of exchange and because of the recession in the supply side of the equation, in our customers’ opportunities, has taken place. So for some of our exporters in Canada, it’s always a little bit more difficult with a higher dollar; but I don’t think it’s driven out of a difference between $0.97 last year and $1.00 this year. I think it’s more how they follow the markets.

To your questions earlier: I think we have a nimble group of producers, for instance, in forest product. They are opening these markets in China. It is big growth because China is big when they enter into a segment, and the opportunity is, just to take that one – if China was to start to have lumber in its building code on a more prevalent basis, it’s huge over time. So people have to adjust. They have to adjust to currency, they have to adjust to market trends and we are trying to help them with our superior transportation service to deliver the goods wherever their products are.

Bill Greene – Morgan Stanley

Alright, that’s great. Thanks for the time.

Operator

Thank you. The next question is from Cherilyn Radbourne of TD Newcrest. Please go ahead.

Cherilyn Radbourne – TD Newcrest

Thanks very much. Good afternoon. When you first introduced this idea of collaborating more deeply with your customers and the focus on a first mile and last mile initiative, one of the metrics you introduced at that time as a measure was your car spotting performance. Can you update us on how you’ve progressed throughout the year from that perspective?

Claude Mongeau

Yes, I’ll let Keith comment a bit further on this but there’s a range of measures. It depends on the specific market, and as Keith said, they are shared measures on the basis of creating a framework of accountability that drives continuous improvements. The measures depend on the segment, and intermodal was focused on [slot utilization]. We’re focused on the dwell time at the terminal. We’re focused on the timeliness of the car supply in and out of terminals. In the merchandise sector, the first measure that is the most important indeed for customers is our car supply ability and our order fulfillment rate, and that’s what we’re measuring. Keith, you want to comment on what we’ve been able to do in merchandise?

Keith Creel

Yeah, I can see on the merchandise side, on the car supply we’ve consistently exceeded 93%, 93% or 94% is a common number as we progressed through the year. And on the spotting performance for the system – mid-80s; and even some parts of the system: eastern Canada – mid-90s. So we’ve had quite a bit of success across the board. The key there is making sure that what we’re measuring actually adds value to the customer. We’re not just measuring for the sake of measuring. So being able to convert that and be in there and spot when it’s as convenient and optimal for the customer as possible without jeopardizing our operating model is the objective here to hit the sweet spot.

Claude Mongeau

And that’s- As you look at an order against a [inaudible] cutoff, but our innovation doesn’t stop there. During the year J.J. and [inaudible] with merchandise, sat down with the team and we looked at how we could be more responsive for, as it relates to meeting orders that are more short lead time orders. And of course you cannot expect to be 90% when you receive an order only a couple days ahead of the required placement, but even there we have been able to increase our fulfillment rates – in some weeks, 65%, 70%. So we have an order fulfillment against cutoff order in the low 90s, high 80s and you have short lead time orders in the 65%, 70% – that’s a good product for a rail-based supply chain and one that we can okay over time to drive into results, growing with our customers.

Cherilyn Radbourne – TD Newcrest

Thanks for that detail. That was my one.

Operator

Thank you. The next question is from Ken Hoexter of Bank of America/Merrill Lynch. Please go ahead.

Ken Hoexter – Bank of America/Merrill Lynch

Great, good afternoon. Claude, let me just follow-up on the grain subject for a second. Maybe it’s a little basic, but if you talk about gaining share on the grain side and your volumes are up 12%, yield’s up only 1%. Is this a game where you can gain share but because of the revenue caps here you’re kind of limited in the profitability as you take that share? Or can you kind of describe how if you can kind of go in and take this share, how you’re able to not meet those limits?

Claude Mongeau

You know what? You know, we would like the grain business that’s regulated in Canada to have a higher revenue because it is not the highest profitability business we have. In fact it’s closer to the bottom of our business segment. But it is a profitable business at the moment and we are following the needs of our customers. The scheduled grain plan that we had introduced at the beginning of the year in my own humble view is nothing short of transformational. I mean we didn’t use the measure spotting performance to the day; we measured it to the week. And today we have a scheduled service and we measure it to the day and to the hour, and we are achieving the levels of performance throughout the year that have been in the 90%, 91% range. Last week was a brutal week in terms of weather in Canada and we were at 70% or just under 70% for our spotting reliability to the date. And this is what our customers are seeing, and so they’re shipping more of their grains through CN points, and we have been able to gain a little bit of market share, and the price is set by regulation.

So that’s the equation we work with and it’s good business to have, and more importantly we are following the market and the demand that comes our way and we believe we have a very, very good product and a construct which adds opportunity for the future. Because once you’ve laid out the scheduled grain plan and you’ve anchored your origins in the countryside, then you can work on the pipeline and how you flow cars to the west coast; and how we work on making sure we have a level pipeline that maximizes throughput on the waterfront in Vancouver and Prince Rupert. And that’s the dialogs we’re having with our customers at the moment and we have a good thing going, operationally and from a marketing standpoint with the grain sector.

Ken Hoexter – Bank of America/Merrill Lynch

Very helpful. I appreciate that, Claude. On the, I guess when you talk about the weather, I’ve been in Saskatchewan when it was 45 below so I guess I can kind of understand what you’re talking about on that side. But when you talk about rolling out more distributive power and keeping your trains at 11,000 feet, is that something we can continue to see more of? Is this kind of a limited example? You talked about going up to 500 locomotives – is that kind of a theoretical limit? Can you keep going beyond that to get it to the whole network? And if you can is there any reason to stop at some point?

Keith Creel

Let me start with the 500. Once you get beyond that you get to a point of diminishing returns, because effectively when you have a three-engine (inaudible) only two of those three have to be DP-equipped. So we don’t have to spend the money to equip 100%. The second issue as far as the weather, it is an outdoor sport. We are and have faced significant weather challenges but when you get to talking about a 12,000 foot train, that’s an intermodal train. You’ve got a very tight train line – that would be the optimal. But even outside of the optimal, when you come to our manifest trays as we deploy the DP power, when it’s 45 below in the past we’d be limited to say a 5,000 foot train. I can run an 8,000 foot train today consistently and reliably with DP power deployed on it. So it creates significant capacity and operational (inaudible) as you deploy these assets.

Claude Mongeau

Thank you, Ken.

Ken Hoexter – Bank of America/Merrill Lynch

Thank you for the time.

Operator

Thank you. The next question is from Tom Wadewitz of JP Morgan. Please go ahead.

Tom Wadewitz – JP Morgan

Yeah, good afternoon. Wanted to ask you a little bit on the expense side. Where do you see, or do you see some cost pressures coming in? I guess it sounded like a little bit on the depreciation side. But are there other areas where you think the pace of cost inflation ramps up in 2011 or you generally think about the pace of cost inflation pretty similar to what we’ve seen?

Luc Jobin

Pretty similar I would say, Tom. I mean I think depreciation is clearly the one that stands out, and I think to some degree you know, we were pleased to see how the year ended in terms of pension, as we don’t expect in 2011 the pension cost to be significantly higher than in 2010. So I’d say generally pretty well in line with general inflation.

Tom Wadewitz – JP Morgan

And then in terms of facility closures you mentioned as you do some work on EG&E and some other areas. Is there anything that ends up being kind of chunky that you can identify that you can put a cost number around or a range around? Or is that kind of a similar benefit to what you’ve seen in the last couple years?

Claude Mongeau

I think it’s a whole range of blocking and tackling and focusing on bringing the pieces together. I mean we have talked to you in the past about our mechanical shop consolidation strategy, which is linked to the [Kierkhart] investment that (inaudible) referred to, and that’s certainly a meaningful element of our ability as we get a facility in Chicago that will be a more, basically a hump yard that has more classifications and capacity. Our ability to bring other satellite yards down to a role of being only an industrial yard and limiting and concentrating all of our activity in fewer yards in the US is helpful, but there’s no big number. It’s an addition of a lot of small numbers that makes this add up to a meaningful amount of productivity going forward.

Tom Wadewitz – JP Morgan

Okay, great. Thank you for the time.

Operator

Thank you. The next question is from Jacob Bout of CIBC World Markets. Please go ahead.

Jacob Bout – CIBC World Markets

Good afternoon. Ridley Terminals just awarded long-term coal contracts to a number of companies including Arch Coal. Does this change things for yourself in far as how you’re looking at growth in coal longer term, or is that really just a displacement issue for Canadian Coal?

J.J. Ruest

I think long-term it has to be good news. The interest on the Canadian west coast terminal allowed this terminal to get the capacity and the money to be able to expand and generate capital investments over the years to come. So one would think that the Ridley Terminal overall capacity over the next few years will go up and therefore that has created a potential for cargo exports. Short-term, there is a bit of nervousness with Canadian Coalminers and we empathize with that, whether or not, how the next two years will turn out. I think long-term that more and more mines, Canadian mines as well as Wyoming and Montana mines are looking at Canada as a place to export, and it has to bode well.

Claude Mongeau

Let me just add to this because I think J.J. is bang on. This is a very constructive story. We have all the capacity in our business, the rail network. We have all the capacity to handle a whole lot of growth on the west coast, whether it’s at Ridley or whether it’s in Vancouver. At the moment the booming business is putting pressure on terminal capacity, but every crisis brings an opportunity, and the opportunity is for them to firm up their business cases, to expand, and to add to their throughput; and as they do this we will be able to accommodate the growth going forward. And it’s very constructive. In the short-term this is where supply chain collaboration comes together. This is not just J.J. and his team dealing with the coal companies and the coal terminals. It’s Keith and his team basically trying to find ways to de-bottleneck, trying to look at opportunities to create capacity. For instance at Ridley recently, Keith had I think two or three of his top people coming in and visiting the facility, and we’ve agreed to change our mix of car steps to go a little bit more towards steel steps as opposed to aluminum steps, and to focus on how we flow the trains into the terminal. When you have a mutual measure and you have an understanding of what we can do together as a supply chain, and you have more business than the current capacity can handle, it’s a quality problem to have and we are geared up to help solve that and grow our business going forward.

Jacob Bout – CIBC World Markets

Maybe just a “part B” here, a different commodity but crude shipment by railcar to the west coast here, obviously top goal in the papers right now. Where are you at with that? How do you see that? What type of opportunity is that for you and have you signed any agreements yet?

J.J. Ruest

We’ve been working on this project for a couple of years and obviously right now there is a much stronger interest in this quarter than there was two years ago when we started this initiative. There’s also a stronger interest into whether or not one day the Canadians and Alcan will export Asia or not. So we’ve had interests from people in China, I’ve been involved in some of those meetings. We’ve had interests from the people at [Calgary Alpatch]. There’s an interest for the US Midwest, interest for the Gulf and interest for the west coast. What we have so far is a number of trial shipments. We’ve done demonstration shipments on a number of product from origin to destination, and we’ve had a number of discussions with a number of players about whether or not this would unfold into large quantities. So time will tell.

Jacob Bout – CIBC World Markets

But at this point there’s no contract per se.

J.J. Ruest

At this point there’s nothing to announce. Until a large contract we’re still very much indeed a commercial discussion.

Jacob Bout – CIBC World Markets

Okay, thank you very much.

Claude Mongeau

Thank you, Jacob.

Operator

Thank you. Your next question is from Scott Group of Wolfe Trahan. Please go ahead.

Scott Group – Wolfe Trahan

Thanks, good afternoon, guys. So quick question first. Casualty and other of $65 million. It’s a good amount lower than we’d seen earlier in the year. Were there any benefits or reserve adjustments in the quarter, and if not can you just give some guidance on this line for 2011 since it tends to be pretty choppy?

Luc Jobin

Yeah, Scott, basically as we do every year in the Q4 there’s a natural review of some of our legal costs with respect to (inaudible) related cleans and so on and so forth. So this year the adjustment as a matter of fact was about 20% less favorable than last year which accounts for the lion’s share of the difference in the number you’re seeing in the Q4. We’re still lining up for about $9 million a quarter but that’s again, as you said, it’s choppy. So from quarter to quarter the number can actually fluctuate. So that’s what we have in mind.

Scott Group – Wolfe Trahan

So you’re saying there was a benefit this quarter but less of a benefit than Q4 last year?

Luc Jobin

That’s correct.

Scott Group – Wolfe Trahan

Do you have those two numbers?

Luc Jobin

The benefit this year was $19 million.

Scott Group – Wolfe Trahan

Great, thanks. And then just a second one if I can. It’s been four quarters in a row of about 3% pricing. With the focus on market share, is this kind of the number you guys are targeting going forward or is there a chance to get back to that 4% pricing range that you guys were at for a few years prior to ‘09?

J.J. Ruest

We’re targeting inflation thrust pricing and then you know, time will tell how inflation will go. I mean all the time we are evaluating our pricing in light of our evolving and improving service as well as our pricing in light of the Canadian transportation marketplace and in light also of how inflation is evolving. So that will set the stage for the next few years to come.

Claude Mongeau

Just to add to this, we certainly don’t have price in mind when we’re talking market share. We sell service. We sell expertise. We sell capabilities and we sell to a market. And we’ve been at this game of taking our pricing up longer than any other railroad. We operate in a market environment and to be able to price consistently above inflation and drive the value to your customer is the game we’re in. But I think your question in terms of relating pricing with market share is not the way we think about it at CN. We sell service.

Scott Group – Wolfe Trahan

Okay, thanks for the time, guys.

Operator

Thank you. The next question is from Chris Ceraso of Credit Suisse. Please go ahead.

Chris Ceraso – Credit Suisse

Thanks, good afternoon. Can you give us a rundown on what idle capacity you have left in terms of locomotives, cars, and people?

Keith Creel

Sure. I mean effectively we still have 100 plus locomotives in storage and we have a few more that are coming on Q1. On the locomotive side, just a rough number I’d say with static what we have now there’s still 25% capacity opportunity there assuming that we don’t improve on productivity, which is not a safe assumption for this railroad. On the car side we’ve got in the neighborhood of about 12,000 cars stored, so still some capacity there as well. So not constrained in our fiscal plan. We continue to improve our operations, our (inaudible) investments day-to-day, our choke points. On an annual basis we’ve got an execution plan that we’re operating to and it’s just going to continue to increase. So capacity wise no issue at all with this railway.

Chris Ceraso – Credit Suisse

Okay. And then as a follow-up, some of the other class 1 rails have begun to talk about mid-term, longer-term operating ratio targets that are more in the CN neighborhood. What’s CN’s longer-term target? Have you thought about that?

Claude Mongeau

Let me put it to you this way – you’re cheating with your third question but I’ll answer it. We’re going to make it tough for them to catch us but if they do it’s all a good thing.

Chris Ceraso – Credit Suisse

Okay, thanks.

Operator

Thank you. The next question is from Jason Seidel of Dahlman Rhodes. Please go ahead.

Jason Seidel – Dahlman Rhodes

Good afternoon, gentlemen, two quick questions from me. One, did I hear you guys correct on employee attritions? There’s about 1700 expected to retire but because you kind of hired in front of that that you expect to replace less than that this year?

J.J. Ruest

I think one for one with an ability to have more product, maybe a little bit less than one for one would be a better way of thinking about this. Because it takes six months to recruit people when you are in a growth mode, and there’s been a lot of growth there, and we continue to invest on that front. So a number of areas. Again, we continue with siding extensions to continue productivity improvements, retrofits for DP power that Keith referred to which is instrumental to the quality of the service we’re providing, and further extending our train modes. So a number of areas like that.

Claude Mongeau

Thank you, Benoit, and we had said we would try to do a one hour. We did the (inaudible) so we’ll just say that our line’s up for our EPS for the Q4. That’s how much flexibility we gave to Bob. And these were good questions. We are glad that we are entering 2011 on a solid note and that we are looking forward. We just need a little bit of warmth here because it is cold in Canada but we are looking forward to have a good Q1 and to have you on the call pretty soon reporting good results. Thank you very much.

Operator

Thank you. The conference has now ended. Please disconnect your lines at this time and we thank you for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Canadian National Railway CEO Discusses Q4 and Year End 2010 Results - Earnings Call Transcript
This Transcript
All Transcripts