Greetings;
I keep trying to get away from the drama and they keep drawing me in! This was meant to be a report on the earnings of CP and KSU – after all of the drama back to the basics – but the aftermath of the yearlong M&A battle and the fallout for the loser in the fight (Canadian National, $700mm richer) continue to reverberate. First was the bombshell – the announcement of the January 2022 expected retirement of CN’s CEO JJ Ruest (see attached, called, of course, “CN’s Bombshell”). Then Elliot Management revealed (allowed to be revealed) that it had a “substantial” (but less TCI’s ~5%+ stake) in CNI and that it had been in talks with CNI for weeks, meaning CNI and JJ knew about this when they dropped their bomb….what to make of this?
- Is this stake part of the share group supporting TCI that got them over the 20% threshold that allowed them to demand a Special Shareholders Meeting (currently, anyway, scheduled for 3/22/22)?
- Or is this separate and in addition? As a rails analyst for whom this is only the fourth activist campaign (two involving TCI and two involving Hunter Harrison), what does it mean for two big activist gunslingers to act together if that is what is happening? Our (rail) experience has been one big gunslinger and support from smaller players or piling in short-term investors….
- Elliott also supports the now open CEO candidacy of Jim Vena, meaning that CN’s search, announced in the smoke of the bombshell, had better be fast (rumor is that they have hired Korn Ferry, so if true they are searching)
- TCI was an existing shareholder of CN (and, remember, of CP) so it has some backing when it says, from an insider’s point of view (and with rail history) “we disagree with the direction management is taking regarding the KCS, etc” – what and how did Elliott get rail religion?
- TCI, meanwhile, applauded the “dismissal” of Ruest as “a good start” (though I am a bit perplexed by their focus on the Board not having rail experience – I thought managements provide that and Boards have general business experience? A glance at CSX’s Board as an example after their excellent quarter showed that only one member had any rail experience – CEO Jim Foote….)
- The announced desire for a “World Class” CEO may preclude internal candidates (who could achieve WC status as we have seen some do, but aren’t current WC card-holders; TCI has put forth that Vena is in that club)
- Is CN’s actions (the bombshell), seen now knowing that they face two gunslingers, a form of “Peace with Honor” withdrawal, covering a “dismissal” with a resignation? Or do they still mean to fight? Is this the existential fight over who decides railroading’s future, or just a fait accompli?
- Maybe we’ll learn more at RailTrends?
CPKC - OK, back to railroading as usual – oh, right, the merger….CPKC overshadowed the near-term results of both carriers (although KSU, holding perhaps its last or penultimate Earnings Call, was where the Very First Question was on Q4/2021 OR, not CN’s, another abh-mea culpa, and unbelievable but true). Both presented mirror image schedules (“CPKC The Path Forward”); CP’s shareholder vote is 12/8, KSU’s TBD (both required), a Voting Trust closure (enter Dave Starling, Trustee) in Q1/22, and full STB approval in H2/22. And, although both managements hinted about an expedited review, I think is optimistic after conversations with STB Commissioners at NARS and NEARS, and CP stated they had no STB updates to report. Not to worry, approval will happen. CP’s CEO Keith Creel addressed my and other’s concerns on concessions saying none were needed in this (and only this) rail merger, though they “were working very progressively with shipper (trade) organizations” and had “very in-depth discussions with a couple of very large railways” that have a lot of touchpoints with the CPKC (hmm, I wonder who?). We’ll see – though we may not ever see as no one knows what goes on, behind closed doors. But I do take his point, this is not like any other merger, it is truly end-to-end and still under the Old Rules.
On a silly note, I am beginning to think Keith Creel has the best turn of phrase since Winston Churchill (see below).
Kansas City Southern had tough headwinds to face some general economy, general rail, and some specific - the supply chain issues, specifically the impact of the chip shortage on the 13 auto plants it serves in Mexico and attendant disruptions, the continued blockade (75 days plus!) of Lazaro by teachers, etc – and produced EPS gain of 3% when ~+5% was expected, and an OR deterioration of 240bps to a still-solid 61.2% (adj). But one thing stood out to me, and after a recent raft of mea culpa, I think I can get away with one Gratus! Another bit of the tailwind facing KCS was called “refined fuel product supply chain disruptions”, described as all were as “transitory” but without visibility to when (how) sic transit tempus? In fact, all near-term Guidance was removed after being restored not too long ago along the lifespan of the pandemic.
Sic transit Imperium….Because I have been worrying, publically and privately about AMLO and refined products imports into Mexico from the US. A) AMLO indeed has not pulled the populist “Yanqui Go Home!” card, and B) wants US economic and USMCA success to aid his historically under-performing economy (and here C) I should say I see no reason to fear Mexican regulatory/COFECE impact on the CPKC combination) but, and most importantly, D) AMLO wants to see, against all odds and economists and oil experts, PEMEX to succeed. I have discussed his desire to build the uneconomic $8B Pemex refinery….that’s a product that would compete with imports, etc. Now, we saw “Energy Reform” volume drop by 18% and congestion in the service increase due to a “government crackdown on permits and inspections” that may have closed, at least temporarily half of the destination terminals! Now, this could be a normal course of business, but if it walks like a populist duck, and quacks like one….and this seemed to surprise many of the analyst questioners. Gratus! On the positive side, the resulting consolidation may help KCS ops and lead to more unit train destination business (which, apparently is being less “inspected” than manifest refined products; as of now trucks (which, BTW, are Mexican) are gaining share in what had been the star commodity for KCSM. It likely will again (quack!), though Keith said “It’s noise in the opportunity chain, but it’s not noise that concerns me at all”.
Other than that KCS showed real operating metric improvement, Q3YOY, and even more so sequentially. COO John Orr discussed some of this at NARS, did so again on the call, and will do even more so at RailTrends. Train velocity, terminal dwell, and fuel efficiency, a big opportunity, all improved (by 6%, 6%, and 2% respectively), while higher headcount and shorter trains were responses to the service recovery plan (once again, “service begets growth” – I will miss independent KCS but not saying or writing “begets” ever again). The OR hit included 130bps in higher service recovery expense, but that was down from 200bps in Q2/21 (another 100bps was caused by those pesky teachers – Lazaro IM volumes were down by 2/3, 50bps from “Mexican outsourcing reform”, 50bps from FX, etc – and 80bps from higher derailment/casualty expense, which isn’t great). Those teachers and the chip shortages hurt IM and auto both (volumes down 13% and 30%; overall volumes were down 3% (US carloads were up 6%). Cross border volumes were flat (remember the 18% “energy reform” hit; X-Border IM volumes were still up 3%Merger costs, taken out of the reported/adjusted, were $0.31. KSU hinted that a “major retailer” was contemplating near-shoring. I believe in this management but I have heard that old song, sung by a variety of singers, before….
Canadian Pacific also showed some stiff headwind impact and also produced results slightly below expectations, with (adj/d) EPS up 7% and an OR….up 120bps to 59.4%. Good for them! They reaffirmed their 2021 Guidance (double-digit EPS growth) despite the mega-hit to the Canadian grain crop (impacting the crop size by ~40%; carloads were down 29% in Q3/21); we are almost 10 months in so that wasn’t a huge leap.
“Making their own luck”, they showed growth. (Was that a dig at CN, and CN’s luck, or at my labeling it so?) Volumes (units) were up 1%, FXA revenues up 7%. IM was up 8% in units and twice that in FXA revenues, led by domestic. Why is that? Not the domestic strength, but compared to international given BC ports relative fluidity (low single-digit ships waiting offshore compared to LALB)? They answered that discussions in this regard are happening. But given the port fluidity, outside of auto chips and cross-border, do they see supply chain issues? They produced some international wins (COSCO/OOCL, more from Maersk due to their new JV, the Vancouver Transload Facility, a PSR “capacity dividend” – that would, I suppose be reclassified as “domestic”. They also reported good success in their new access to Halifax. Pricing, overall, is solid (4%+ - CN who TCI said has a “pricing problem”, reported 5%+), with 25% up for rebid in Q4.
Operations were ho-hum, solid – improvements in train length, weight, productivity, fuel efficiency – but dwell was up 7%, train speed down 4%. Personal injuries were down 65 but train accidents were up, how’s that, 36%. How much was caused by wildfires, perhaps? (For which, to repeat, they were fully exonerated). They still had to face an OR in ’22 question, despite the fact they hope to be a completely different company by the end of next year.
Finally, you know that “Supply Chain Issues” have exploded when they make the late-night talk shows – Stephen Colbert “Cargo Unchained”: Watch The Late Show with Stephen Colbert: Ben & Jerry's And Wine Are Running Low As Global Supply Chain Problems Mount - Full show on CBS
Anthony B. Hatch
abh consulting
http://www.abhatchconsulting.com
abh18@mindspring.com
Twitter @ABHatch18