Canadian National Railway Company

Good afternoon. My name is Mika and I will be your operator today. Welcome to CN Second Quarter's 2021 Financial and Operating Results Conference Call. All participants are now in a listen-only mode. After the speaker's remarks, there will be a question and answer session. I would now like to turn the call over to Paul Butcher, Vice President, Investor Relations. Ladies and gentlemen, Mr. Butcher.

Well, thank you, Nika. Good afternoon, everyone, and thank you for joining us for CN's second quarter 2021 financial results conference call. Now, before we begin, I'd like to draw your attention to the forward-looking statements and additional legal information available at the beginning of the presentation. As a reminder, today's conference call contains certain projections and other forward-looking statements within the meaning of the U.S. and Canadian securities law. These statements are subject to risk and uncertainty that may cause actual results to differ materially from those expressed or implied in these statements and are more fully described in our cautionary statement regarding forward-looking statements in our presentation. After the prepared remarks, we will conduct a Q&A session. I do want to remind you to please limit yourself to one question. The IR team will be available after the call for any follow-up questions. It is now my pleasure to turn the call over to CN's President and Chief Executive Officer, Mr. J.J. Rouet.

Thank you, Paul, and thank you, Nika. So good afternoon, everyone. And today we have two items for this call. First, we want to highlight our quality results. and also we want to give you an update on our KCS combination. Therefore, the call might be a bit longer than usual today. But first, our thought goes out to the community and First Nation of Lytton in BC and the terrible fires impacting British Columbia this summer. We are committed to helping our neighbours in crisis and the several CN employees whose life has been impacted by the natural disaster. Let's go to the Q2 highlight on page 6. I want to start by saying how proud I am of our dedicated shareholders' performance this year, the hard work and exceptional effort that our people continue to deliver on the business. Our results reflect broad-based strength and forward momentum across all of our business and also the enduring power of our vast and diversified CN network. For three quarters in a row, we have delivered year-over-year growth in our EPS. In the last quarter, Our adjusted diluted EPS was $1.49, which is up 16% versus last year, but it's also up 25% at a constant currency. Our operating income is up 76% year-over-year, and adjusted operating income is up 9%. We helped enable the economy with exceptional growth. Volume was up 13%. We diligently worked in our combination with KCS, and we also stayed focused on our yield management and network operation execution. The freight revenue per car load grew 7%, and same-store pricing was up well over 4% in the second quarter. Safety performance, employee engagement index, customer sentiment index have all sequentially improved. We are focused on our customers, on our safety, and on the combination with KCS, all of which will drive long-term value creation for our shareholders. We have confidence in the future. I will now pass it on to Rob, who will review our operation. Rob? All right. Thank you, JJ.

And as you mentioned, our thoughts are with the communities impacted by the wildfires in British Columbia, with nearly 300 active fires still burning, and more specifically with the people of Lytton as they begin the road to recovery from the devastating fires. With those fires, we did lose a critical bridge on our route to Vancouver. Through the great work of our engineering team, we were able to restore service last week after a two-week outage, and we will be a few weeks more before we are fully recovered from the backlog of traffic of the outage. Turning to last quarter's results, very solid performance, delivering on 13% volume growth with car velocity dwell and labor productivity improved year over year. In the quarter, the team delivered another quarterly record on fuel efficiency, improving 2% over last year's industry-leading numbers and also setting an all-time monthly record in June. Year-to-date, the team has saved approximately $20 million from our fuel efficiency initiatives alone and avoided nearly 100,000 tons of CO2 emissions into the atmosphere. Our safety culture is delivering results with an all-time lowest quarter rate Injury frequency ratio, in year to date, our injury and train accident ratios have improved 27 and 30% respectively. Operating a safe railroad for our employees, customers, and communities we operate in is paramount to our success as a company. In the quarter, we also continued to deliver for our customers, as noted in our improvement with customer satisfaction index. And in April, we completed our 14th consecutive record month of Canadian grain movements. We are confident in the business outlook, and to that end, we have 500-plus conductors and engineers in training to support that need, along with having the necessary locomotives ready to pull that freight. With that, I'll turn it over to James.

Thank you, Rob. During Q2, we saw the more balanced demand recovery that we expected, with car load volume up 21%, beating Q2 in almost all commodity segments. Manifest car loan growth was a key driver of our sequential and year-over-year improvement in volume, with a 23% increase in lumber driven by continued record commodity pricing, record propane volumes up over 20%, and better than 150% increase in frax and versus last year. In spite of the impact of three mine closures late last year, we saw volume growth in coal as a result of the startup of our new tech contract and strong U.S. exports. Potash was another bright spot in Q2. On the strength of North American potash market share gains, we increased our average length of haul by over 200 miles and beat last year's Q2 volume by more than 40%. U.S. grain volume was up 21% versus last year, but Canadian grain was a different story. After 14 consecutive months of record performance, grain was an outlier. As we lapped a record Q2 in 2020 and our strong performance in Q1 left us with less than average carryover to move in Q2. We continue to move more grain tonnage with less resources as a result of our aggressive push towards system fleet renewal. We will benefit from continued strong demand for lumber in H2 and escalating demand for frac sand as seasonally adjusted drilling activity continues to improve. Entering Q2, we saw continued volume ramp up through the Watson Island Propane Export Facility at Prince Rupert. This will position us to continue to set new records for export propane volume through the balance of the year. With the worst of COVID possibly behind us and strong export pricing for metallurgical and thermal coal, we may see one or possibly two Canadian coal plants restart in the second half of this year. Our same-store price has been accelerating each quarter since mid last year. We expect this pace to continue through 2021 as customers look to secure valuable capacity. As JJ stated, Q2 same-store price was again well over 4%, with sequential improvement compared to Q1 of this year. We will continue to price ahead of railway cost inflation during the post-COVID economic recovery and maintain a very disciplined approach to yield management. With that, I'll turn it over to Keith.

Thanks, James. The consumer-based economy continued to generate strong volumes for CN. Combined, containers moving through the West Coast ports of Prince Rupert and Vancouver grew 18% versus 2020 and grew 5% over Q2 2019 to set an all-time quarterly record. The CN business through the ports of Halifax, St. John, New York, New Jersey, Philadelphia, New Orleans, and Mobile combined also to set an all-time Q2 record, reflecting our proven track record and industry-leading ability to establish and convert on new products. CN is truly a leader in intermodal execution. Our domestic business continued strong, with volume growth of 11% over Q2 2020 and up 3% over Q2 2019. Working with our strategic wholesale, IMC partners, and through our door-to-door sales channels, grocery, e-commerce, and consumer products purchasing drove the volume. Overall, CN Intermodal volumes were up 14% over Q2 last year, a record Q2 for our intermodal business. Our Automotive 2021 Q2 results show a 98% increase versus Q2 2020 due to the rebound in demand and the reopening of auto manufacturing facilities. CN is well positioned for the microchip supply chain recovery as we serve both Canadian ports and several large, volume, high-demand model assembly plants. We continue to improve train utilization and service metrics. Average intermodal train density increased with 6% more containers per train, a key enabler of profitability. As a result, we are generating additional revenue per train at low incremental costs. Our operational and commercial initiatives such as contract renewal pricing and capacity optimization programs drove double-digit intermodal contribution margin improvement over 2020 and sequential improvement over Q1 2021. With the ongoing strong job creation in both the United States and Canada, we are focused on the optimized use of our capacity and the value creation of our customer-focused services and our unique three-coast network. I will now pass it on to Gisela for the financial perspective.

Thank you, Keith. My comments will start on page 12 of the presentation, which will provide more color on our second quarter performance. During the quarter, we recorded $32 million related to the amortization of the bridge financing fees related to the pending KCS acquisitions. Recall that in Q2 2020, earnings also included a non-cash charge for non-core branch lines held for sale. Excluding these non-recurring items, adjusted net income was around $1.6 billion, up 17%, with adjusted diluted EPS of $1.49, up 16% versus last year. Foreign exchange was a headwind of $0.11 of EPS. In addition, fuel lag negatively impacted the quarter by $0.07 of EPS year-over-year and added around 400 basis points to DOR. If we adjust for these two items, our adjusted EPS would have been up 30%, so a solid underlying performance. Other income was up by around $50 million versus last year due to the mark-to-market gain on inequity investment in autonomous driving technology. Turning to page 13, let me highlight a few of our key expense categories expressed on a constant currency basis. Labor and French benefit expense was up 28% versus last year. This was mostly driven by increased wages due to a 9% higher average headcount and higher incentive compensation. Fuel expense was up 86% driven by a 76% increase in price. and a 14% higher workload, partly offset by another solid fuel efficiency improvement of 2%. Now moving to cash on page 14, we generated free cash flow of close to $1.3 billion through the end of June, $300 million lower than 2020, mainly from lower net cash from operating activities, mostly due to cash tax deferrals last year as part of COVID measures, partly offset by lower capex. We continue to pause share buybacks in light of our proposal to combine with KCS. Moving on to page 15, we are encouraged by the broad economic recovery and continued vaccine rollout, which reinforces our confidence for the balance of the year. Therefore, we are reaffirming our financial outlook and are targeting double-digit adjusted diluted EPS growth for 2021. We still expect to deliver free cash flow in the range of $3 to $3.3 billion, which will drive further improvement in free cash flow conversion. I will now turn the call back to you, JJ.

Thank you, Ghislaine. And if you could join me on page 17, you can see NCCS, safer, faster, cleaner, stronger end-to-end combinations, and we need all of that. I will stop by saying that the deeper we dive into the potential of combinations, the more excited I get about it. The benefits that it will bring to the three USMT economies, the increased rail and natural model competition, the environmental benefits, that makes this combination truly a compelling vision for the future. The combination will create a new seamless single operator service while preserving access to all existing gateways. we will be adding new route choice and enhancing robust price competition with our gateway pricing transparencies. The combination will strengthen the North American supply chain and create the first true North-South North American railroad. New direct connections will be created that allow for more reliable and less expensive supply chains to Canada and Mexico from the American heartland. They are also a very important ESG benefit. Together with KCS, we will shift thousands and thousands of long-haul truckloads off the road and onto the rail intermodal network, and at the same time create new jobs, different kind of jobs, better jobs. The CN and KCS combination represent a pro-competitive solution, a new model for the future, with unparalleled opportunities for a broad group of stakeholders, and they all have responded with strong support. With every step of the process, we are committed to work with the STB to address concerns that they may have and enable a successful combination with KCS. We'll go on page 18. The combined CN and KCS network presents numerous public interest and customer benefits. We will add new single-line routes that will be more reliable and more cost-effective for our customers. Our combined network will enhance the ability to connect with other Class 1 at major gateways. This is a call of growth story with vibrant gateways. By enhancing pricing visibility to all existing gateways, customers will have enhanced rail competition, greater optionality of choices, and new ability to shop for the best price, best service combination. That's the model for a better future. The CN-KCS combination will work in partnership with passenger rail service in both the United States and Canada. We are confident that our plain vanilla voting trust meets the STB insulation from control and public interest requirements as KCS will be fully independent during the voting trust period and continue to grow their business, invest capital, and provide the same high-quality level of service. Together, CN and KCS will be able to recognize great synergies targeting $1 billion of EBITDA synergies primarily from growth. This is a merger based on growth. But there's a lot more, but these are just some of the many benefits that we expect from our combination with KCS, which has already received widespread support that I will talk about more next. Go on page 19. Our customers, the communities, and all of our other stakeholders evidently share the same view as we have. At the end of the comment period, over 1,750 letters of support were filed with the STB, including more than 1,000 which requested the approval of the Voting Trust. Notable support came from more than 30 elected officials, the former STB Commissioner and Vice Chairman William Claver, Jr., and shareholders such as Cascade and CDPQ. Industry experts, including Dr. William Heneke, former director of the Office of Economics and former chief economist of the STB, also recognize the competitive benefit of our combination, including more competitive shipping options. Now, a summary of the PAP to conclusion, the graph on page 20. We are within a few weeks of a decision from the STB, and we made a solid filing on the merit of our submission. Then, the next key milestone is a KCS special shareholders meeting, which will be held on August 19. Subject to approval from KCS shareholders, the STB Voting Trust, and the Mexican regulators, as well as other customary closing conditions, CN will acquire KCS shares and place them into a voting trust. At that time, KCS shareholders will be able to receive that consideration from CN. We are targeting obtaining this approval and closing it to a voting trust in the second half of this year. Our proposed transaction does not require CN shareholders' approval and does not require approval by the Canadian regulators. In the second half of 2022, we expect to obtain common control approval from the STB and other regulatory authorities. Once full STB approval is received, the voting trust will be terminated and CN will acquire voting rights and operating control of KCS. So in conclusion, page 20, our combination is pro-competitive and it will yield significant public benefit. We are committed to increase customer options We're keeping all existing gateway available. We are enhancing rail-to-rail competition with other Class 1. We are committed to divest the only overlapping line between New Orleans and Baton Rouge, creating a true end-to-end transaction. And we will drive conversion from truck traffic to rental motor, providing ESG benefits for the environment and local communities. In the joint CN-KCS filing to the STB of July 6, we demonstrated that our proposed voting trust satisfies the board test. Our voting trust allowed KCS to maintain control during the trust period, and the approval of our voting trust caused no harm and is in the public interest. To conclude, we are looking forward to a policy ruling of the Voting Trust from the STB, and we are fully committed to this highly strategic transaction that will create significant value for all of our stakeholders. So, operator, we will now turn it into the question period. Paul?

Thank you. We will now begin the question and answer session. As previously mentioned, we ask that you kindly limit yourself to one question. The first question comes from the line of Ken Hofstra from Bank of America. The lines are open.

Great. Good afternoon. JJ, I'm actually going to start on kind of operations, not on the M&A. You know, just looking at your train line tick down a bit, you talk about the congestion impacts and getting back to fluidity. Maybe just start with the operations and keep note of the West Coast congestion driving some volumes to other Canadian gateways. Can you talk about the fluidity around the EJME? And similarly, in the answer, you kind of talk about labor and ability to get labor to keep pace with the growth.

Well, thank you, Ken, for the question. We have a question regarding the operation. So, Rob, do you want to talk a bit about EG&E and maybe what's happening in Western Canada?

Yeah, absolutely. Starting with the fires there, Ken, we lost the bridge between Kamloops and Boston Bar on June 30th. and had it restored back July 13th. And that's a segment of railroad that averages about 25 trains a day. So, you know, not moving anything or very little during that time has created a backlog. So, you know, we've opened it up. But I would also say it's a very active situation in British Columbia with the fires. So there are starts and stops out there with some 300 fires out there. But the road to recovery is on, and we're probably – couple weeks as I've made mention in my in my remarks before we're fully recovered and have this thing reset as far as EJ&E we're very fluid there's no issues there and again EJ&E while you bring it up is a true advantage that we have that bypasses the city of Chicago and allows us an advantage that no other railroad has that goes to Chicago so it remains fluid and we're operating quite well down there. Keith did you want to say anything as far as the diversions?

You know, we're working very closely with our supply chain partners in British Columbia, the ports there, to take on any business that has been diverted north. In Q1 and Q2, we've been very, very fluid at our terminals, not only on the West Coast but the East Coast and the Gulf Coast. So we were ready to handle the business coming to us in this very tragic situation. incident that occurred in bc uh we'll get back as rob said a couple weeks and we'll be back uh back fluid thanks for your question ken thank you ken thank you thanks georgia your next question comes from the line of allison vendry from credit swiss your line is not open

Thank you for taking my question. Hello. I just wanted to ask about the incremental margins in the quarter. They seemed a bit muted at under 30%. You know, I understand that the fuel and incentive comp had went back, you know, with poor pricing accelerating to, you know, something north of 4%, you know, one of the second operating leverage to have been a little bit stronger. So, You know, assuming the strength in price persists, how should we think about the incremental margins in the back half? And do you expect operating profits to grow faster than the top line? Thank you.

Yeah. Good question, Allison. Just Lane will take that. He has the detail around the operating margin.

Yeah, the incremental. Thank you, Allison. The incremental margin, you're right. I think in the quarter, on a reported basis, the incremental margins were 30%. And to your point, if you adjust for FX and you adjust for fuel, then the incremental margins were 60%. So quite good. Hopefully, you know, the headwinds on FX and fuel can dissipate a little bit when you look at it today. You know, FX is around 78 cents. It hovered between 82 and 83 during the quarter. Our guidance is supported by an 80-cent FX for the full year. And fuel as well came down. We were talking together here before the call. It used to be last week around $72, $73 WTI. And now it's down to about 65%. So, again, I think that our underlying performance is quite good. And when you look at it, when you adjust for these two uncontrollable factors, you know, our EPS was up 30%. So we're quite pleased with that performance.

Yeah, exactly. We're very pleased with the performance. CN being a railroad that has quite a bit of revenue into currency. If you look at your Bloomberg screen and look at the Canadian dollars in the second quarter, you will notice that it sort of peaked for May and June, and right now it's back to 79, but it was as much as 83 cents. So it has an impact on the short term. Thank you, Alison.

Thank you. Your next question comes from the line of Charlene Radburn. from TV Securities. Your line is now open.

Thanks very much. Good afternoon.

Good afternoon.

As you know, the market reacted with some concern a couple of weeks ago to the Biden executive order, and I was just hoping to get your take on the tone and content of that order.

Yeah. So, Sean, as I've been following this very closely, Sean, you want to talk about DSTB's

and the executive order sure charlotte thanks for the question i guess you know the best um indication to see how uh the chair of the stb uh on the day was issued responded publicly in a press release and uh obviously we share at the end the goals of the order about a fair open and competitive marketplace uh it's a cornerstone of the u.s economy but you know if you look at what the chairman said you know they clearly indicate that the order encourages stb to provide accessible remedies to shippers to focus vigorously on enforcing and accounting for one-time performance standards and avoid unwarranted delays in passenger rail service. That's the focus of the chairman. And, you know, in that same press release, he recognizes that under certain conditions, consolidation can be beneficial. I think this is a good example where our CNCCSC, combination with enhanced competition and obviously the remedies or the possibilities we're setting forth when it comes to open gateways and really going at this, looking at how do we ensure that customers have more choices and not less choices in the combination. We're very comfortable that through the STB overall control application, will clearly demonstrate the benefits of this transaction, and we think that they will do so in a way that recognizes the comments made by Chairman Olbermann on the executive order, but also just making sure that we're putting forward, you know, we're not one of the four railways mentioned in the executive order. We're not in that group, and I think we have an opportunity to show how this end-to-end combination will create more competition, but also really serve customers in a very strong fashion. through all three countries and really connect the continents. So we think that the executive order has some very strong comments that we can build off to show that this combination is a solution to what's being set out in the order itself.

Thank you. It's all from me.

Thank you, Sherilyn.

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

Hi, David.

Hey, how are you? Good afternoon, everyone. So, Governor JJ, you know, you guys are holding guidance into what is a pretty steep headwind on currency, a little bit of a headwind on fuel. There's a little help there from the mark-to-market stuff. Could you just kind of tell us kind of in very simple terms, you know, what's doing better than you thought coming into the year? And then how do you think about sustaining that into the 21 to 22 time frame?

So I will add it and just may without some comment, you will notice on our page where we reaffirmed our guidance that we're using in approximately 80 cents versus the 75 cents that we had originally in our guidance. But today the dollar is running at 78. It's fluctuating quite a bit. It seems to be following the price of crude, which is also very volatile. on the volume uh you know high single digit volume the month of july is affected here by the issue in british columbia the network is a bit of a stop and go as we have to be mindful of what we need to run safely around the communities where we operate where there's some fires and we also a bit of a backup for vancouver on the pricing i think pricing is a strong story And before the fire in BC, I think operating matrix, as Rob described in Q2, they were very solid. And I'm sure sometime in August we'll fall back on our feet on that too. I don't know, Jason, you want to add something?

Yeah, maybe, JJ, just a couple of points. So we are very comfortable with reaffirming our guidance, David, but there's a lot of things and a lot of moving parts going out there. I mean, when you look at the forest fires, for sure, and Rob touched upon them, but we think we're going to be able to recover this in the next few weeks, as you mentioned. There's also now the Delta variant and COVID in the U.S., So I don't think we're out of the woods yet. We'd like to. I hope it is. And then, obviously, the ethics and fuel has moved like a yo-yo. So, you know, I mean, at the end of the day, things are moving in different directions. We're quite confident about the broad economic recovery when you look at different sectors. And consumer consumption, I think, is quite strong. But there's things that are moving out there. So, you know, that's what I would add, JJ, that, you know, we're comfortable with the guidance, but there's lots of moving parts out there.

Yeah. Having said all that, we are reaffirming today our guidance for 2021. Thank you. Thank you, David.

Your next question comes from the line of Scott Group of Wolf Research. Your line is now open.

Hello, Scott.

Yeah, hi. Thank you. So I understand some of the quarterly volatility with operating ratio, but it does seem like we're on track for the fifth straight year of the operating ratio getting worse. And I know you've been more focused on operating income, but Even if we look at second quarter, it's down from four years ago in operating income. So I guess, J.J., my question is, what do you feel like you need to do differently to sort of get this thing going in the right direction again?

So we are not guiding on operating ratio, as you mentioned. We're focused on operating income, focused on growing EPS, and focused on the free cash flow growth. Also focus on, you know, balance scorecard with safety, employee engagement, customer sentiment, which is key in things like merger proceedings, as well as, you know, being good custodians environment by reducing our carbon footprint. The EPS at CN has an impact on exchange this quarter more than another quarter because of the fluctuation. All of us have an impact related to the price of diesel. So I think we're all in the same boat. So I think at CN it's growth, profitable growth with good pricing, running a good railroad, and taking into account that we have – things that last year the bonus at cn was less this year in the second quarter we've actually we finished the bonus you had all these things uh but definitely no we're not aiming we're not running the company for the or we're in the company for eps growth opening income free cash flow as well as balance scorecard has taken into account safety the environment employee engagement and customers' sentiment. So that's really where we're at. And the key thing right now is this long-term, very long-term strategic proposal that we have out there in front of the SED and in front of our shareholders to combine with KCS and really exploit what the future of North America will be in terms of trade at a time where the economy is growing at the time also what tension with china are increasing port business will always be solid for cn but you know that there will be probably a very nice tailwind at least it's our view between uh the three US EMCA countries, and I think creating a network that has good costs, competitive costs for others, but we're not aiming for the lowest cost. We're aiming for this combined balance scorecard I was just talking about earlier, starting with APS, operating income, free cash flow, but also being good custodian of the environment, customer sentiment. We need to railroad for customers in North America. I think that's basically it. the essence I'm getting from the executive order from the president as well as the not-so-subtle message from the STB, and employees' engagement at a time where, you know, the job market is tight and you need to be an attractive employer. So I think it's putting all that in, and this is partly why you see where the relative weight of operating ratio fall in.

And can you just talk to, if the voting trust doesn't go your way in a couple weeks, what the plan is with respect to the merger?

Yeah, Sean can address that. You know, as you know, we filed our final comments on July 6th. We remain confident that... You know, we're going to meet the public interest test. We have met the public interest when it comes to unlawful control of KCS during the voting trust period as well as the financial integrity at the end result. So, you know, we're very confident that we will in the coming weeks get a positive decision from the STB. Same voting trust as was approved in the CP application. So at this stage, we're really focused on getting the voting trust and proceeding with the KCS shoulder vote on July 19th. and getting our Mexican approvals in hopefully October, early November, and closing the voting trust with the KCS shareholders in November or early December.

And I know, Scott, you read all this material, and, you know, we're talking. Huge filing, but our filing is very compelling as it comes to the voting trust and the things that we are proposing for the marketplace. And I think you will equally be impressed by the time that Rob and his team file the operating plan of the proposed combination and how we're going to address the concern of shippers and the STB. So we're confident, but we're confident because we do the homework. Thank you for your question.

Thank you.

Your next question comes from the line of Brian Ozenbeck from J.D. Morgan. Your line is now open.

Hello, Brian. Hey, JJ. Thanks for taking the question. Someone asked about U.S. truckload conversion opportunities, obviously a big part of the industry. growth set going forward, but it's also been a challenge. So can you just walk us through the CN's experience so far in the U.S. with making these conversions happen and making them stick? Where do you think service levels are relative to where you think they need to be going forward? And what sort of investments do you think you need to make on the network to really get that growth and to see it convert and stay with the CN? Thank you.

Thank you. Thank you, Brian. So maybe Keith can start talking about the commercial effort, but I think Rob probably has also provided you a good sense of what we, broadly speaking, that we will put together with KCS in terms of a competitive product to compete with a long-haul truck. So we'll start with Keith commercially.

Sure. And, Brian, if you talk to any of our customers about the service that they get in the States, I think when you – and they talk about the great velocity of the trains and the on-time performance. So I would say that our unique model of working with a lot of Canadian wholesale customers, IMC customers, so non-asset, asset-light customers, as well as our own retail product allows us to dip into a lot of opportunities with customers, a lot of different sales channels. And we've been very, very successful for that. We also are able to have a lot of multiple touch points with the beneficial cargo owner. We start with an import load, and we may touch that load a second time when it moves from a domestic DC onto stores or onto another DC. So we've been very successful, and we will continue to be successful. And the KCS... combination allows us to take that show on the road and be even more successful in the future.

Rob? Yeah, I'd just add, you know, when you look at the combination of the two railroads and the opportunities that are there, it's well documented what we've talked about there. But very simply, you know, we're a railroad that goes to the upper Midwest. We go to places like Detroit and Toronto and southern Ontario. KCS goes to Texas and Mexico. And the opportunity to convert some of that with single-line service is a huge opportunity for us, whether it's coming cross-border or Texas, and go all the way with one railroad I think is a real advantage to shippers. And that's where we see a significant opportunity. We also see opportunities in single-line service from places like Detroit to Kansas City that really only one railroad does now and increasing those options for shippers. So very excited about the truck-to-rail conversion that – may present itself with the merger. Thanks for the question.

Thanks for the question. More option, more competition. Thank you, Brian.

Your next question comes from the line of Benoit Poirier from Bergerdeans. Your line is now open.

yeah good afternoon gentlemen uh just looking at the entire model volume recovery could you talk a bit about the timing related to inventory replenishment efforts and whether it could last longer than expected given the overall low level of inventory and potential changes related to the just-in-time model

yeah so i'll i'll stop recently but keith who's a much closer so definitely and eventually our lower uh retailers and people who we need product coming from other parts of the world are the supply chain are disrupted their things are not working out so they're they try to get the product early they try to replenish their warehouse and it is a significant concern and i think we're it's going to last maybe all the way to the beginning of next year but Keith, you want to add some color in your dialogue with those who went for the product?

Sure. I think we mentioned this about four years ago, that the traditional peak of everything being kind of in the fall has really changed. And that's changed, as you point out, Benoit, with how folks are managing their inventories. When we talk to our customers that are bringing products from overseas into North America, They see this continuing on well into 2022. And I think that I think we will anymore. I think this is going to be kind of. the same way, the same volumes all the time, kind of structured, making sure that the supply chains are filled. I mean, you know, it's unbelievable what our folks and the other railroads, too, have been able to do through this COVID period, keeping products on the shelves and keeping us all full of the things that we need to run our lives. So thanks for your question, Ben.

Thank you.

Thank you.

Your next question comes from the line of Chris Weatherby from Citi. Your line is now open.

Hey, good afternoon, guys. Thanks for taking the question. I wanted to come back to the executive order for a minute and then maybe more broadly. Your position on maybe the potential for negotiation from a regulatory perspective with the STP because of voting trust accomplished, I guess. I think there's been some concern that maybe there would be a willingness to accept something from a regulatory perspective that maybe other players in the industry wouldn't be willing to accept, for instance, something like reciprocal switching in the U.S. I guess I wanted to get maybe sort of just your position on whether there would be some willingness to kind of negotiate some of those regulatory points that we've brought up in the executive order that might come up as the STD goes through the voting trust.

Yeah, maybe I can start. So just maybe a reminder, everything that we filed and all the commitment that we made in terms of how we want to do this combination actually was done formally before the executive order came out. So from that point of view, we shared a broad goal as expressed by the executive order because our CNTCS merger is actually talking about we file on the new rule to enhance competition. We committed to make the end-to-end by divesting the New Orleans to Baton Rouge. We are talking seriously and we've made this commitment in writing that we are in favor of binding arbitration to resolve disputes. that we are you know that the gateway will remain open at the bottleneck you know we will not create bottleneck when we become single line service post combination that we will provide pricing visibility so customers can better shop best price best service combination by providing rule 11 pricing so all these things are really you know in our view uh things which may be we're not we're not saying that one leads to the other but the executive order talk about enhancing competition And he also talked about Amtrak, and we have also talked specifically, and Sean can comment. So a lot of the things that is in the spirit, at least, that was offered, to the existing border. And there were 72 industries. We were just one of them. I mean, we're on track. As regarding reciprocal switching, that's not a CNKCS issue. I mean, that really is in front of the STB. It involves all seven railroads. And it's not because two railroads merged that you actually can... can change the position of reciprocal switching. It has nothing to do with our merger. It has to do with how the STB wants the landscape of competition as related to a specific point in the years to come. And we'll see if they actually provide us a position later this year. Sean, maybe you want to add in?

Yeah, maybe I'll just add in one comment about Amtrak. You know, clearly, again, reference in the executive order, but, you know, in the context of the – application to the STB under the new rules, the current rules, it requires that we address passenger service concerns in the application and ensure that we don't do anything that will negatively impact passenger service. You know, we at CN have a long track history of having VIA run us in Canada, having Abtrak run us in the U.S. We have several commuter services. So we come to this with an open mind of how we can better partner with the passenger service as well as Amtrak in the U.S., and we look forward in the context of the rest of the application. There are good examples where the executive order referred to it, but we knew from the outset that would be an area where we'd have conversations with our passenger service partners going forward.

Maybe, Rob, you could expand also on Amtrak and things. I mean, we're focusing on Amtrak. We're focusing on passenger service. We understand it is one of our, if you wish, social license to run in the U.S., Rob?

Yeah, so we work with Amtrak on a daily basis. You know, Amtrak runs between Chicago and New Orleans, has interstate service in Illinois, and we run a couple trains east out of Chicago. And our latest report card from Amtrak, we were rated as one of the top railroads in terms of service. So, you know, it's a... It's a commitment we have to Amtrak, and we continue to work with them. And as Sean and JJ talked about, we'll certainly work through the Baton Rouge to New Orleans wishes and desires they'll have as well.

Thank you, Chris.

Your next question comes from the line of John Chappell from Evercore ISI. Your line is now open.

Thank you. Good afternoon. Rob, can you maybe speak? Speak a little bit about the speed restrictions that are in place now through October 31st, how that impacts your ability to kind of dig out of the backlog that's accumulated in Vancouver over the last couple weeks, and also any costs that may be associated with that, whether it's fuel efficiency or labor or equipment, as you kind of work through the last 14 days.

Yeah, absolutely. So you're referring for the rest of them that don't know, ministerial order that went into effect at midnight July 11th following the fires in B.C. for all railroads in Canada. So part of that is related to, not to get too far into the weeds, is related to areas that are labeled as extreme fire danger areas. and where the temperature is above 33 degrees Celsius. So when those conditions are met, we have to reduce speed to 25. So it is somewhat contingent on where those conditions are on a daily basis, weekly basis. So if it's for a wide swath of Canada and that applies to all of Canada, it will be impactful. Right now, we're able to work through it. But just as we saw last year with the ministerial order in winter, We're able to work with Transport Canada along with Canadian Pacific to make some modifications of that that actually allows us to operate and do the things that we need to do. So we have been working with Transport Canada and we'll continue to work with them. But right now with some of the conditions out there and the backlog, we're not seeing a huge impact right now. But if we see big spikes in weather along with that extreme fire danger, it will have an impact.

Okay. So to be clear, the maintaining of the high single-digit RTM growth assumes that you're not going to have any much impact whatsoever from these restrictions, kind of return to normalcy starting today?

Yeah. We are working with Transport Canada, and we fully expect to have some modifications on that over time.

All right. Thanks a lot, Rob. Thank you.

Thank you, John. Your next question comes from the line David Zazula from Barclays. Your line is now open.

Hey, Rob, just a question for you. It looks like based on the guide, you're going to need to have two big quarters in terms of volume acceleration coming up. Just wondering what the plan is for locomotives to be able to support that volume increase, whether you're taking them out of storage or externals and how that's going to potentially affect the fuel efficiency gains you made this quarter. Thanks.

Thanks for the question. To answer short answers, we're well prepared for it. We have about 225 in storage as we sit today, so we're able to adjust that as the quarter went on, and we're preparing here for the third and fourth quarter. As we also mentioned last quarter, we're in the process of taking on 75 new locomotives or newer locomotives. Twenty-five of those we've received. The other 50 we'll take in the second half of this year. So we feel like we're well positioned to handle the growth here in the second half. Thanks for the question.

Yeah, and maybe also, I mean, I think our question came up as to whether or not railroads are prepared for the fall peak in the U.S. and the winter coming after that. And as we file to the regulators in the U.S., we have the crews, we have the locomotive, we have the rolling stock. We can go chase to meet the need of economy this fall and next winter. Thank you.

All right, next question comes from the line Tom Wadowitz from UBS. Your line is now open.

Hello, Tom. Yeah, hi, JJ. So I know you have talked about this a bit, but I just want to ask you a little bit more on it. It does seem like the executive order shows a lot of sensitivity from the administration, or I don't know if sensitivity is the right word, but focus maybe, On passenger rail, and there was that specific Amtrak filing against the Voting Trust, is there time to negotiate something, or is there in the future, if that was an issue for STB, do you think there would be an opportunity to come up with something on the passenger side in the future? Because it seems like a potential point of focus where – Your current rating was good, but the last couple of years, the rating with Amtrak wasn't particularly good. So I just wonder if there's a way. I know kind of the time to file something new on voting trust is over, but do you think there's any way to finesse that issue if it ends up being a focus for SPB?

As you said, your words, not mine, our current rating is good, and we are improving, and there's room for further improvement, and we're focusing on that. Passenger service, including Amtrak, not just Amtrak, but including Amtrak, is part of the stakeholders that one needs to recognize and work with in addressing with solutions during the merger proceeding, just like shipper association. communities, labor, and all of these stakeholders. So over time, we will continue to have dialogue with all of the stakeholders, including Passenger Service and Amtrak, but i think already you know we talked about what we could do as it relates specifically to the new orleans to baton rouge corridor if amtrak was to have the funding eventually to run uh create a service in that corridor you want to maybe talk about that sean yeah i think no i wouldn't focus too much on the voting trust comments obviously it was in the context of uh

I think we need to take a step back and understand that Amtrak will have a mandate going forward and it will be up to the host railways, in this case CN, to work with Amtrak both to address their ongoing concerns it might have with the current service. I think Rob addressed it in a very proactive fashion, saying we work with them every day. And again, we will address the impact of the CNKCS combination as it applies to passenger service in the STB application. I'm very confident that when we do so, we'll raise it in a way that we'll be talking to Amtrak and to other to make sure they understand what we're talking about. And I won't go as far as saying they'll be supportive of the overall transaction, but the commitments we'll make will be part of the filing, will ultimately be part of the conditions being imposed. So it's important that we have that dialogue and we understand what exactly Amtrak is looking for and then what is available when it comes to funding both federally or state. to achieve that. So a good example would be Baton Rouge to Louisiana or to New Orleans, particularly where you need to have the required funding to put that in place. So it's great to want to put a service in place, but then you have to make sure that both the customers on the line, the state and local governments are supportive as well as the federal government.

Yeah, and again, as we said earlier, broadly speaking, we do share the goal expressed by executive order, and a lot of the things which are pro-competitive and very positively that the CNTC is proposing were actually proposed in writing as part of our awards in April. And I think in many cases we're very much in line to the spirit of what was being asked in terms of creating competition, creating options, and enabling passenger service when the passenger service has the funding available.

But I guess just to be clear, in terms of coming up with an agreement with them, It's too late to do that to have any influence on the voting trust. You really need to get that decision first, and then you could negotiate with them afterwards if you get the decision.

Yeah, it's important to remember, in the context of the voting trust, these are comments on our petitions. So it's not really an area where you'd enter into a settlement agreement in the context of the overall application what you would do. So in this case, it was open for comments. That was one of the conditions under the current rules. That was normal. People made comments, and we responded to all those comments in our response on July 6th, including the Amtrak response. But, you know, obviously in the context of the overall application, control application, that's where you get into settlement agreements with various parties. So it's not really in the context of the building trust. It's not really an area where that gives rise to that type of agreement as in the overall control application. Right. Okay, Tom.

Thank you for the time. Thank you.

Your next question comes from the line of Jason Seidel from Collin. Your line is now open.

Thank you, Operator. Good afternoon, gentlemen. Quick question. I wanted to go back to the pricing side. You noted that, once again, you were able to get even higher pricing than the previous quarter. You know, KCS noted rising rail cost inflation in the future and the need to probably get even further price increases on their end. Do you think you're getting enough for what you're seeing in the rail cost inflation for the back half of the year? And do you think there's an ability on your end to garner more than you had this quarter?

So there is rail inflation. Eventually, you will see it in the all-inclusive rail index of the AR because there's a bit of a lag in that index. But we all saw it coming. And already, you saw a same-store price for Q1. and the trend of the same-store pricing Q2. I'm not sure. I think we are getting what we need in terms of the rail inflation that we're seeing right now because we're conscious that there will probably be a lag in these index. And as you may know, we have very little business that works with index. Do you want to talk about pricing, James?

Yeah. You know, at the end of the day, the value of our product supports our pricing. Right.

by our customers. So our expectation is we will be able to continue to price well ahead of railway cost inflation moving forward. And I think our performance in the last two quarters is indicative of what we should expect to see moving forward here, pricing ahead of railway cost inflation.

That's good color. I appreciate the time. That was my one Thank you, Jason.

Your next question comes from the line of Connor Gupta from Scotiabank. Your line is now open.

Thanks, operator. Good afternoon, everyone. So just a question on DC wildfire. It kind of goes back to the earlier question, but I want to kind of ask you differently. When you're running slower trains and there is a cost of running those slower trains, Who really bears the cost for that? Is it CN, or do you share that cost with your shippers? And can you somewhat kind of quantify the impact on Q3? What do you see in July, be it in terms of, you know, your operations or EPS? What kind of impact do you expect? Thanks.

You know, pricing is not related to speed of train. I don't know if... Let me take a stab at that.

So, you know, the bridge we just got back was less than a week ago. So it's a bit early to really understand the full impacts of it. So much of it is the big impact will be dependent on the weather. And the weather fluctuates. Right now we haven't seen a lot of 33-plus degree Celsius weather out there that would really trigger that 25. We are running slower, and there is a backlog. So we don't have it all calculated in terms of the impact. It will have impact. But, you know, as soon as we have some more clearing in terms of understanding this. And the other thing I would just say is that it still is very active out there. So speed restriction or not, Still very active in British Columbia with fires, and we've seen times at night where fires spark up in the mountains and come down towards our tracks, and we have to stop for a period of time. So very fluid situation, but as soon as we have some greater clarity on it, certainly share that.

I would add, Conor, that in terms of impact of Q3, we don't offer quarterly guidance. We offer yearly guidance, and we're very confident, again, as I said in my remarks and JJ alluded to, that we are comfortable to reaffirm our yearly guidance of targeting double-digit EPS growth for 2021. Thank you, Conor. Thank you.

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

Good afternoon, everyone. Just a quick one on the grain outlook, if I may. It sounds like the old crop volumes are getting a little more scarce here. We've, of course, got the drought-like conditions weighing on the current yield prospects out there. I think we're also even up against a tough comp with respect to the harvest timing this fall. So just maybe James or someone perhaps a little bit of commentary around the outlook for grains in the back half of the year.

Thanks. James, we had, what, 14 months, record months in a row, but the It's very dry right now.

Yeah, 14 record months in a row, as you know, Stephen. And, you know, for us, that means we're going to finish the crop year end of July at an all-time record for CN, an all-time record for Canadian farmers and their ability to get their product to market. So we're very proud of that. But this new supply chain resiliency that we've created is going to be a real benefit to farmers in Q4. You know, regardless of the size of the crop for next crop year, 2021, 2022, we will have a strong Q4. Farmers always want to move the crop as soon as possible when it comes off. So Q4 is going to be strong for us. I would say it's still early days. Yeah, you know, it's been hot. It's been dry. There's some difficult growing conditions out there. I would say that the conditions are most difficult, the Dakotas and southern prairies. So we're a little bit insulated from that. But all in, it's not going to be, you know, the record bumper crops for sure that we've seen for the last couple of years. But our job is to make sure that we have the people, the assets, the power available. and the resources required to move the grain crop for our Canadian customers, and we're going to be there to help make sure that happens in Q4 of this year as we see a very, very strong demand to move an early crop as quickly as possible to market.

And I think, James, you continue to invest into a long-term in that business through some more hopper cars, and we have some customers also who are building their elevators on the CN network.

Yeah, it's been very successful, this grain supply chain. We've seen over the last year and a half about a 50% increase in export capabilities over the Port of Vancouver. Very robust ability to handle more grain over the Port of Prince Rupert. Lots of investment by our customers in inland elevators and high-throughput elevators, loop tracks. And, of course, on our side, you know, a very significant investment in new hopper cars, new high-capacity hopper cars that allow us to ship more product with fewer resources. Just to put it in context, based on the new hopper cars that we bought, we can ship the equivalent of four extra trains a week of grain products to the coast without adding any additional resources. So it's very good for CN, very good for our customers. And, again, Q4 is going to be solid. Look forward to it.

So we'll compete hard. Thank you, Steve.

Your next question comes from the line of Jeff Kaufman from Vertical Research. Your line is now open.

Thank you very much, and thank you for the explanation of where you stand in terms of the transactions. I just want to ask you, you have two outstanding transactions right now that the rail is pursuing, smaller deals, line sales, things like that. Can you give us an update on where you stand with the regulators on those?

Yeah, Sean is on top of those two.

Yeah, both are pending. One is us directly and one is the purchaser, that case pending at the STB. And, you know, obviously – In the case of Messina Line, we're in conversations with our partner, also the STB, to see how we can get this deal approved ultimately. And the other one has just been filed recently. So those are the cases they're pending. The STB is very busy. They have quite a few cases pending, a lot on their plate. But we are pursuing both of them, and hopefully we'll have some outcomes in the coming weeks.

Okay, that's my one. Thank you very much.

Thank you, Jeff.

Your next question comes from the line, Justin Long from . Your line is now open.

Hello, Justin.

Hi. Good afternoon. I wanted to ask a question about technology. As you think about this proposed merger with KCS, does it change either the magnitude or the pace of your plan technology investments? And if this is something that could accelerate your technology roadmap, Could you speak to some of the incremental opportunities the merger could create?

Yeah, I think Rob is actually using Quite a bit of that already on the CN network. Rob, you want to expand on the power of technology on a bigger network?

Yes, certainly. We do see that as part of the synergies, comparing both of our technologies, but certainly from a CN perspective, getting some of our ATIP cars running across the CN KCS network combined. We've certainly seen big results in terms of the ATIP cars running across the CN network. in terms of making our railroads safer, finding defects before they become urgent defects, and really reducing some of the service interruptions that we have out there. So sharing that kind of technology, you know, KCS has some broad plans as well in terms of portals and that, and just combining what we have in place with our portal technology with theirs, we hope we think can make a difference. a safer, stronger network. So we do see that as an opportunity here.

And for those of you who have never seen a native car, there's a picture of one of them in the preceding slide from Rob's section. It's a box car. It's made. It says safety inspection. And in that example, it's running on an antimodal train. So as the train is moving freight and generating revenue, the box car, the safety car, is also inspecting the network for making sure that we're running safely. Thank you for your question, Justin. Thank you.

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

Boudin. Well, thank you for all of you for joining us today. We wanted to cover both our quality results and giving you an update on our combination with KCS. I know most of you are quite up to date with all the detail of where we're at in terms of our combination, but And, you know, we should know in a couple of weeks, sometime in late July, early August, when the STB has the time to reflect on all the things that we have filed and other people have filed too. But we're very confident that we have a very solid case. We are meeting the test for the voting trust, and we are creating definitely new competition and new public benefit. So we're looking with the answer this summer with optimism and then – We'll talk after the decision. So thank you for joining us today.

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