CN: ‘Strong’ 3Q21, Ruest to Retire (Updated, Cowen, TCI)

Written by Marybeth Luczak, Executive Editor
“CN’s dedicated railroaders produced strong financial and operating results this quarter, despite headwinds from severe wildfires in Western Canada that caused a prolonged disruption to CN’s main line to Vancouver in July,” CN President and CEO JJ Ruest said on Oct. 19.

“CN’s dedicated railroaders produced strong financial and operating results this quarter, despite headwinds from severe wildfires in Western Canada that caused a prolonged disruption to CN’s main line to Vancouver in July,” CN President and CEO JJ Ruest said on Oct. 19.

CN on Oct. 19 followed former merger partner Kansas City Southern (KCS) in reporting financial results for third-quarter 2021, posting C$3.591 billion in revenues—up 5% over the prior-year period; at the same time, CN announced President and CEO JJ Ruest’s planned retirement.

The Class I railroad attributed the boost in revenues to “freight rate increases, higher applicable fuel surcharge rates and an increase in intermodal ancillary services.” CN noted, however, that the gains “were partially offset by the negative translation impact of a stronger Canadian dollar and lower volumes of Canadian grain in terms of RTMs [revenue ton-miles], compared with record volumes in the third quarter of 2020.” The railroad posted a 1% decline in RTMs for third-quarter 2021.

CN also said freight revenue per RTM increased by 6% compared with the year-earlier period, which was “mainly driven by a significant decrease in the average length of haul, freight rate increases and higher applicable fuel surcharge rates; partly offset by the negative translation impact of a stronger Canadian dollar.”

CN Third-Quarter 2021 Results

CN’s third-quarter 2021 financial highlights:
• Operating income of C$1.341 billion, a decrease of 2% from third-quarter 2020; on an adjusted basis (non-GAAP), operating income came in at C$1.471 billion, an increase of 8%.
• Diluted earnings per share (EPS) of C$2.37, growing 72% from the same period last year, and adjusted diluted EPS of C$1.52, rising 10%.
• Operating ratio of 62.7%, up 2.8 points from third-quarter 2020; on an adjusted basis, the operating ratio was 59%, an improvement of 0.9 points.
• Operating expenses increased by 10% to C$2.250 billion vs. 2020, which was “mainly driven by higher fuel costs due to rising fuel prices; C$84 million of transaction-related costs resulting from the terminated CN merger agreement with KCS; and higher incentive compensation compared with significantly lower levels of incentive compensation in 2020 due to below-target results stemming from the impact of COVID-19, partly offset by the positive translation impact of a stronger Canadian dollar.”

CN reported that operating income and operating ratio were impacted by “transaction-related costs for the terminated CN merger agreement with KCS, a workforce reduction provision, and advisory fees related to shareholder matters.” In addition, “for the nine months ended Sept. 30, 2021, after accounting for all direct and incremental expenses as well as income generated from the merger termination fee, CN recorded additional income of C$705 million (C$616 million after-tax), as a result of its strategic decision to bid for KCS.”

As for quarterly operating performance, CN reported that train length (in feet) fell by 3% vs. 2020; through dwell (entire railroad, hours) improved by 20%; car velocity (car-miles per day) improved by 17%; and through network train speed (mph) increased by 11%.

CN reaffirmed its 2021 financial outlook. It said it expects to deliver 10% adjusted diluted EPS growth, vs. 2020 adjusted diluted EPS of C$5.31 (non-GAAP). The Class I railroad noted that it now assumes total RTMs in 2021 “will increase in the low single-digit range versus 2020 (compared to its Sept. 17, 2021 assumption of an increase in the mid single-digit range).” Additionally, it “still targeting free cash flow in the range of C$3.0 billion to C$3.3 billion in 2021 compared to C$3.2 billion in 2020.”

CN President and CEO JJ Ruest

“CN’s dedicated railroaders produced strong financial and operating results this quarter, despite headwinds from severe wildfires in Western Canada that caused a prolonged disruption to CN’s main line to Vancouver in July,” Ruest said. “We are proud of the team’s efforts and dedication, as well as the progress we are making on executing our strategic plan. This includes delivering immediate shareholder value while maintaining our long-term commitment to safety, customer service and sustainable value creation. Our entire organization is highly confident that the investments we have made in safety, technology and capacity over the past three years will support the company in delivering enhanced financial results in the last quarter of this year, as well as in 2022 and beyond. Similarly, we believe that we are well positioned to achieve our targets of C$700 million of additional operating income and a 57% operating ratio for 2022. We are already seeing solid progress toward these goals and are working to continue to deliver results to benefit all CN shareholders.”

The CN Investor Relations site provides more details on third-quarter 2021.

Ruest Retirement

Ruest, Railway Age’s 2019 Railroader of the Year, will retire from CN as President and CEO and a member of the Board of Directors at the end of January 2022, “or such later time as a successor has been appointed to ensure a flawless transition,” the Class I railroad reported on Oct. 19.

“On behalf of the Board, I would like to thank JJ for his dedicated service to CN during 25 years and as CEO since 2018,” CN Board Chair Robert Pace said. “He has provided the company and all of our stakeholders with strong and inspired leadership. JJ deferred discussions on his retirement plans in order to see the company through the potential merger with KCS and closing of the transaction, and the introduction of the strategic plan announced on Sept. 17, 2021, which is beginning to demonstrate results. We are grateful for his leadership and his exemplary commitment of service to the company and wish him the all the best in his upcoming retirement.” 

“I have been honored to lead CN during my time as Chief Executive Officer, and I am confident that the company is well positioned to continue to thrive following my retirement,” Ruest said. “The strength of the company’s management team and Board allow me to announce my planned retirement knowing that the company we have built will continue to prosper.”  

The Board has appointed a committee to conduct the global search for Ruest’s successor and make recommendations. It includes four Board members: Shauneen Bruder, Chair of the Search Committee and of the Governance, Sustainability and Safety Committee, and retired Executive Vice President, Operations for the Royal Bank of Canada; Justin M. Howell, Senior Investment Manager at Cascade Asset Management Co., and Asset Manager for Cascade Investment, L.L.C.; Robert L. Phillips, Chair of the Audit, Finance and Risk Committee, and retired CEO of the British Columbia Railway Company; and Kevin G. Lynch, Chair of the Human Resources and Compensation Committee, and retired Vice Chair of BMO Financial Group, and former Clerk of the Privy Council for the government of Canada.

The Search Committee is working with executive search firm Korn Ferry, and will consider all qualified internal and external candidates, CN said. 

Ruest’s retirement and the CN Board’s search for a successor is most likely, some observers say, a game of cat and mouse: an attempt to head off a planned action by activist investor TCI Fund Management Ltd., which has proposed a slate of four Board candidates and a new CEO, Jim Vena. A shareholder proxy vote on TCI’s proposals is scheduled for March 22, 2022.

TCI, which has developed its own plan called “CN Back on Track,” commented on Ruest’s pending departure, calling it a “dismissal” rather than a “retirement”: “This announcement is a clear admission by the Board that change is needed, and we are here to help usher in that needed change as quickly as possible. We have already identified an excellent CEO candidate in Jim Vena, who is available now, and we encourage the Board to meet with him immediately to secure his leadership. In addition, to solve the governance crisis the Board has created for itself, the Board should meet with the four independent nominees TCI has put forward and expedite their appointment to the Board, effective immediately. We also expect that given the history of failed CEO appointments, the Board would welcome the advice, expertise and participation of TCI’s nominees on the search committee. As the Board has demonstrated with this announcement, change cannot wait.”

Cowen Insight: ‘A New Generation of CN’

Cowen and Company Managing Director and Railway Age Wall Street Contributing Editor Jason Seidl

“As CNI [CN] moves forward with its strategic plan, longtime CEO JJ Ruest announced his retirement amid ongoing pressure by activist TCI,” reported Cowen and Company analysts Jason H. Seidl (Managing Director and Railway Age Wall Street Contributing Editor), Matt Elkott and Elliot Alper. “The third quarter came in above our forecast and consensus expectations, as the company remains committed to hitting its guidance outlook (full-year guidance intact) and improving OR by executing cost initiatives. We increase our PT and reiterate Market Perform.”

Key Cowen Takeaways:

• “Revenues in 3Q grew 5% despite carloadings down 1% (primarily autos, grain) that was affected by the forest fires in July and ongoing supply chain congestion. Adjusted EPS of CAD$1.52 beat our estimate and the Street forecast of CAD$1.43. Adjusted OR of 59.0% improved sequentially and handily exceeded our forecast of 61.6%.

• “Following the company’s strategic plan announced in mid-September where CNI outlined aggressive plans for growth in 2022, 3Q showed impressive results as the company works through headcount reductions. CNI stated they are about 75% through the headcount reductions primarily in Q4, with about 600 at the management level and roughly 190 at the union level; the large majority of the reductions have come in Canada. CNI resumed share repurchases as they announced in September, and expects to complete CAD$1.1 billion worth of share repurchases in 2022.

• “With a target of 57% OR in 2022, CNI will have to continue reducing its cost structure and have strong pricing into the next year; while our previous model assumed 59% OR in 2022, given execution in the third quarter, we improved our assumptions for next year to 57.9%. Management stated they will be able to price about 1.5%-2% above rail cost inflation, and still have about 35%-40% of its book to reprice; YTD, CNI has been up over 5% on same-store pricing.

• “Longtime CEO JJ Ruest announced he will be stepping down as CEO at the end of the year; we commend JJ for his 25 strong years at CNI. The Board has set up a CEO search committee, but has not set a target date. We expect the committee will likely announce a new CEO ahead of JJ’s departure at the end of the year, which may be Jim Vena, the candidate that TCI has recommended for the job. If the committee chooses someone else, strap in for a fight from TCI.

• “We increase our 2021 and 2022 EPS to USD$4.61 from USD$4.50 and USD$5.65 from USD$5.40, respectively. Continued cost-cutting measures and strong pricing should allow CNI to continue down the path to achieve its lofty OR goal in 2022. Hence, we increase our multiple a half turn to 22.5x, and with our new 2022 EPS forecast, we get to our new price target of $127, up from $119. Reiterate Market Perform.”

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