Canadian Pacific Kansas City Limited

Please stand by. We're about to begin. Good afternoon, everyone. My name is Beau, and I will be your conference operator today. At this time, I would like to welcome everyone to CPKC's second quarter 2024 earnings conference call. The slides accompanying today's call are available at investor.cpkcr.com. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press star two. I would now like to introduce Chris DeBruin, Vice President, Capital Markets, to begin the conference. Chris, please go ahead.

Thank you, Beau. Good afternoon, everyone, and thank you for joining us today. Before we begin, I want to remind you this presentation contains forward-looking information. Actual results may differ materially. The risks, uncertainties, and other factors that could influence actual results are described on slide 2 in the press release and in the MD&A file with Canadian and U.S. regulators. This presentation also contains non-GAAP measures outlined on slide 3. Please note, in addition to our regular quarterly financials, there is supplemental Q2 combined revenue and operating performance data available at investor.cpkcr.com, which some of today's discussion will focus on. With me here today is Keith Creel, our President and Chief Executive Officer, Naveen Balani, our Executive Vice President and Chief Financial Officer, and John Brooks, our Executive Vice President and Chief Marketing Officer. The formal remarks will be followed by Q&A. In the interest of time, we'd appreciate it if you limit your questions to one. It is now my pleasure to introduce our President and CEO, Mr. Keith Creel.

Thanks, Chris, and good afternoon. Listen, before we get into the results, on behalf of our CPKC family, I want to extend our heartfelt prayers and condolences to Pat Ottenmeier's family and friends. Our family mourns his tragic passing. We extend our deepest condolences to his fiance, Deanna, his entire family, as well as many friends and former colleagues. Pat's vision and leadership played a monumental role in the great history of Kansas City Southern. He helped reshape the railway industry. We've lost a truly remarkable leader and a cherished friend. All we knew him as a professional and a railroader had nothing but respect and admiration for the material impact he made across so many aspects of our industry, and if you had the honor to have enjoyed a friendship with Pat as I did, words will never capture what a class gentleman and human being he was. Pat's legacy lives on and can be seen in the work we'll do every day at CPKC. I'm also pleased to be hosting this call in Kansas City at our brand-new state-of-the-art U.S. operations headquarters at Nokia Yard. This facility is just one small example of what would have never been possible without Pat's vision and strength as a leader. His contributions as a railroad and as a person will never be forgotten. And moving on to the quarter, I'd like to first start by thanking the 25,000 strong CPKC family for their efforts in the second quarter. As a leader, it's always my honor to represent the results we're going to cover on behalf of this team, which I'm extremely proud of. In the second quarter, the family delivered revenues of $3.8 billion, which is up 8%, strong volume growth, an increase of 6%, operating ratio of 61.8, which is a 280 basis point improvement versus last year, and EPS of $1.5, a 27% increase. Extremely pleased with these results. I can tell these numbers that I just walked through do not happen by accident but through execution. So on the operating front, I applaud Mark and his operating team for their continued strong operating performance across this network. They delivered significant improvement across a number of our key operating metrics. Unfortunately, Mark had an unexpected operating procedure he had done yesterday, so he's not with us today. So I'm going to cover his results and his body of work. Average terminal dwell declined 9% in the quarter, average train speed improved 6%, locomotive productivity up 10%, and fuel efficiency improved 2%. All of these results reflect a network that's fluid, that's running well, and delivering strong service to our customers as we carry that momentum into the second half. And from a safety perspective, train exits were down 4% and personal injuries an astounding 38% improvement. I'm extremely proud the team's continued focus on safety each and every quarter. Commercially, John and his team continue to bring on business that's going to fit our network well, working in close collaboration with our operating and service design team. And the team continues to price the value of the service that this new network uniquely offers. The team's executing on the vision we had when we first proposed putting these networks together, and it's leading us to a differentiated outcome. Well, it's been well publicized. The freight environment continues to be challenging. We're not making excuses. We're leaning into the challenge. We're creating opportunities that are uniquely enabled by this new network. So in closing, let me say I'm extremely pleased with the first half of the year, even more excited about what the second half holds. We're in a position of strength. We're turning momentum into the second half that we're going to build on it. As I said in January, we're positioned to deliver an exciting year of value creation, and that is exactly what this team is delivering. We're uniquely positioned to deliver strong value in 24, and more importantly, for years to come. So with that said, John, I'm going to hand it over to you to provide some color on the markets, and then Nathan will elaborate on the numbers. All right. Thank you, Keith, and good afternoon, everyone. I'm extremely pleased with the strong top-line growth the team delivered this quarter. This franchise is creating the unique opportunities we've talked about since day one. Our operations are strong, and we're pricing to the value of the differentiated service we are providing our customers. Now, looking at our results on a combined basis, we delivered freight revenue growth of 8% on a 6% increase in RTMs. Sense for RTM was up 2% with strong pricing and a slight tailwind from FX, partially offset by Nix. Now, taking a closer look at our second quarter revenue performance, I'll speak to an FX adjusted results on a CPKC combined basis. Starting with bulk, grain revenues were up 17% on 15% RTM growth. U.S. grain volumes grew 17% over prior year. Our franchise is benefiting from strong shipments of corn to the P&W Mexico, and Alberta, along with increased shipments of soybeans and wheat to Mexico, which remains a strong area of synergy growth for CPKC. Canadian grain volumes were up 13% on the quarter, as we saw a stronger-than-expected spring and summer sales program emerge if farmers reduce their on-farm inventory in preparation of the upcoming harvest. Now, looking forward, early indications are that this harvest will be more in line with our five-year average, or if not, stronger. That, coupled with our regulated grain pricing of approximately 6.5%, has us well-positioned in Canadian grain. Now, moving on to potash, revenues are up 24% on 11% volume growth. We moved higher volumes of potash with Campotex to their Portland terminal as we lapped the impact of their shiploader outage back in April of 23rd. Now, looking forward, potash supply chains are performing very well, and export demand is sold out for the second half of the year. We are on pace to set a record all-time tonnage with Campitex this year. Coal revenue was up 3% on a 2% decline in volume. Lower natural grass prices weakened demand for our U.S. coal franchise, and that weakness was partially offset by more export Canadian coal to Vancouver and Thunder Bay. On the merchandise side, energy, chemicals, and plastics revenue grew 10% on a 14% volume growth. The volume growth in the quarter was driven by higher crude as we lapped the impact of some outages last year and growth from synergies across just about all of the ECP portfolio, including LPGs, plastics, renewable diesels, and refined fuels. We are excited about the wins we've captured in this space as we are connecting markets from Alberta to the Gulf Coast and into Mexico with our single line haul service. Looking forward to the ongoing ramp up of these synergies, we are set up for a solid second half of 24 in ECP. In the forest products area, we're down 1% revenues on a 1% decline in volumes. Forced product volumes continue to be challenged by a soft macro environment impacting both our paper and lumber products. However, we are largely offsetting this headwind with synergy growth and extended line haul, shipping more lumber from Canadian producers down to our franchise in Texas and the Gulf markets. Metals, minerals and consumer products revenue was down 3% on a 9% volume decline. Volumes in the quarter were impacted by weakness in frac sand driven by the lower natural gas prices, but also a labor destruction we had at ArcelorMittal steel facility in Mexico. Now looking forward, although we expect the weakness in frac to continue, the labor destruction has ended and we expect Arcelor to ramp up production in the back half of the year. In automotive, we produced another record quarter, with revenues up 28% on 21% volume growth, an exceptional performance by the team. Our auto franchise is benefiting from higher, longer haul volumes out of Mexico as our closed-loop model service solution only continues to ramp up. I'm also pleased to share that our new Dallas auto compound located at our Wiley, Texas intermodal terminal opened in late June. This compound is part of our playbook that unlocks an entirely new supply chain model for the OEMs, giving them new competition, service, and capacity certainty like they've never had before. Our auto business continues to deliver differentiated growth, and we expect a strong performance as we move through the second half of the year. Now, on the intermodal side, revenue was down 7% and a 3% volume decline. Starting with domestic intermodal, volumes were up 3% despite a soft base demand environment. Our MMX or 180-181 cross-border service continues to perform extremely well and what I would consider a very challenging domestic market. Volumes on this service are up 50% since our exit rates at the end of 2023, and we have a strong pipeline of opportunities stacked up for the back half of the year. This includes new wholesale opportunities, new retail opportunities, temp control service operating, and new joint line routes into both the Southeast U.S. and the Ohio Valley markets. And moving on the international side, volumes were down 9%, primarily related to timing of the impact of lingering strike uncertainty and the timing of some share shifts in business. With new business ramping up and a solid outlook for demand, we are well positioned to cross all our ports for the second half of the year. To close, the volumes in the first half came in slightly better than we expected and we're off to a strong start in Q3. While the macro remains challenging in some areas, overall demand has stabilized, and more importantly, we continue to have line of sight, strong differentiated growth from synergies, self-help initiatives, and disciplined pricing. The operations team is delivering reliable, resilient service to our customers, and my team is laser focused on selling into that service and taking advantage of our expansive new network. I'm excited about what we've accomplished so far this year, and even more for the opportunities we have ahead of us. So with that, I'll stop and pass it over to Nadine. Well, thanks, John. That's a great report. So let me start by sharing my enthusiasm for the strong performance for the quarter. Our success is driven by the hard work and dedication of CPKC's railroaders, and I'm proud of what the team is accomplishing. Looking at the quarter, CPKC's reported operating ratio was 64.8%, and the core adjusted combined operating ratio came in at 61.8%. Earnings per share was $0.97, and core adjusted combined earnings per share was $1.05, up 27%. Similar to what we shared in previous quarters, our combined operating expenses in 2023 illustrate the effects of the acquisition for the second quarter as if the acquisition closed on January 1, 2022. I will speak to FX-adjusted combined operating results in these prepared remarks. Now, taking a closer look at our income statement, reported operating expenses provided on slide 11 and combined operating expenses on slide 12, where I'll focus my comments. Moving adjustments, comp and benefits expense was $610 million. The year-over-year decline in comp and benefits was driven by reduced stock-based compensations, as well as efficiency gains from reduced overtime, improved fluidity, and engineering productivity gains. This was partially offset by inflation, volume-driven increases from higher GTMs, and higher current service costs from our DB pension plan due to a lower discount rate at year-end 2023. Looking to the rest of 2024, we continue to expect average headcount to be roughly flat on a year-over-year basis, driving further labor products to be gained as we grow volumes. Fuel expense was $466 million, up 9%. The increase was primarily driven by a $24 million, or 4%, increase in fuel price, along with volume-driven increases from higher GTMs. Increases from price and volume were partially offset by a 2 percent improvement in fuel efficiency, which resulted in a $9 million in savings, another area where we are seeing network efficiency gains translate directly into margin improvement. Excluding adjustments, materials expensed was $95 million. The decline in the quarter was driven primarily by timing of locomotive and freight car maintenance as activity schedules across the network are aligned. Equipment rents were $82 million, down 5% year over year. The decline was driven by reduced car hire payments and receipts, along with efficiency gains from improved cycle times and increased network velocity. Depreciation expense was up 6%, resulting from a higher asset base. Excluding adjustments, purchase services and other expense was $581 million. Cost of inflation and terminal service costs were partially offset by a year-over-year decline in casualty expense. So overall top line growth in the quarter coupled with strong cost control and execution resulted in a 17% increase in core adjusted combined operating income and a 280 basis point improvement in our core adjusted combined operating ratio to 61.8%. Moving below the line on slide 13, Other income was $40 million, driven by higher equity income, along with a gain on some debt repurchases in the quarter. Other components of net periodic benefit recovery was $88 million in Q2. This reflects the lower discount rate compared to 2023, and partially offsetting the headwind to comp and benefits from current service costs. Net interest expense was $200 million, or $195 million, excluding the impact of purchase accounting. The decline was driven by a reduced debt balance. Income tax expense was $292 million or $328 million on a core adjusted combined basis. We still expect the CPKC core adjusted expected tax rate to be approximately 25% for the year. Turning to slide 14, we are generating strong cash flow and cash provided by operating activities of $1,278,000,000 in Q2. Capital investments in safety and growth remain our priority. In this quarter, we reinvested $808 million, in line with our expectation to invest approximately $2.75 billion in 2024. We continue to make strategic investments in capacity across our network, positioning us to continue efficiently absorbing the growth that the merger has enabled. On the quarter, we generated $526 million in adjusted combined free cash flow and continue to repay debt. Our leverage ratio is 3.2 times, and we still expect to reach target leverage in early 2025, at which point we will evaluate shareholder returns with our board. In review of the quarter, the team delivered another strong volume growth ahead of expectations, along with continued discipline on price and cost control. Synergies are continuing to ramp as the network is performing well. We continue to gain momentum on our expense synergies, improvements in velocity, as well as locomotive and car productivity are generating operating savings. We're also gaining procurement savings through consolidating agreements across the company, as well as savings in G&A through combining processes and functions. We're well on track to deliver double-digit core adjusted combined earnings growth, growth driven entirely from the business and without any help from shareholder returns. This network is delivering strong and profitable growth, and I'm excited for the opportunities we have ahead. With that, let me turn it back to you, Keith. That's great, guys. Let's open it up for questions. Thank you, Mr. Creel. Ladies and gentlemen, if you would like to ask a question, simply press star then the number one on your telephone keypad. If you would like to withdraw your question, again, press star two. As previously highlighted, please limit yourself to one question. We go first this afternoon to Chris Weatherby with Wells Fargo.