Congestion issues prompt CN to ramp up capacity spending, lower outlook for year

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CN CEO Jean Jacque Ruest
Canadian National
TORONTO — Canadian National’s congestion-related service problems have prompted executives to downgrade their outlook for the full year and ramp up spending on capacity expansion projects in western Canada.

The railroad’s widely publicized service issues, which began last fall amid an unexpected wave of traffic that swamped CN’s Edmonton, Alberta to Winnipeg, Manitoba, spine, hammered first-quarter earnings as costs spiked amid flat revenue.

CN’s net profit fell 16 percent, to $741 million, on revenue of $3.1 billion. Earnings per share slumped 14 percent, to $1, matching analyst expectations, according to an I/B/E/S survey.

CN’s operating ratio increased 6 points, to 67.8 percent, as costs rose 9 percent. An accounting rules change, which has a disproportionate impact on the Canadian railroads, added 2.5 points to the operating ratio.

The good news for CN is that its key performance metrics are trending in the right direction as spring weather, new crews, and 130-leased locomotives have arrived.

“CN has turned the corner on a difficult quarter and winter,” interim CEO Jean-Jacques Ruest says.

For the quarter, average train speed fell 15 percent and terminal dwell rose 37 percent. But trains began moving faster, and cars spent less time in yards, beginning in March. Container dwell at Vancouver and Prince Rupert, British Columbia, has returned to normal levels and over the past few weeks CN has exceeded targets for spotting empty hopper cars at grain elevators.

The metrics should improve throughout the year and service should be restored to normal levels when track capacity projects are completed early in the fourth quarter, Chief Operating Officer Mike Cory says.

CN will now spend $400 million on additional capacity in western Canada, up from $250 million, as part of a record $3.4 billion capital budget.

A CN representative did not respond to an email requesting details on the additional capacity investments.

CN had previously disclosed plans to add sections of double-track and new or extended sidings in between Edmonton and Winnipeg, as well as on its routes to Vancouver and Prince Rupert. In all, CN has 29 track capacity projects in the works across western Canada, including yard and terminal expansions in Edmonton and Winnipeg.

Executives say they’ve learned from the service failures, increased costs, and damaged customer relationships that came from not adding capacity fast enough last year on the main line across the country.

In the words of former CEO Luc Jobin, who departed unexpectedly last month, CN used to try to time its capacity investments to arrive “at five minutes to midnight.”

No more.

“We can’t build a church for Easter Sunday, but certainly we need to build ourselves a little bit of a buffer,” Chief Financial Officer Ghislain Houle told analysts and investors during the railroad’s quarterly earnings call.

The cost of investing earlier than necessary is far outweighed by the cost of not adding capacity in time, Houle says.

CN will eventually grow into capacity that’s deployed early. But getting caught behind, as CN did last year, makes customers unhappy and increases regulatory pressure from Ottawa, Houle says.

In hindsight, CN should have pulled the trigger on capacity expansion plans a year ago, Ruest says. The increased spending this year will catch CN up — and prepare it to handle growth expected in 2019.

“Our network is going to be quite capable, entering 2019 we’re going to be very fit to compete and we will have very excellent service to offer the marketplace,” Ruest says.

During the past decade, CN’s service levels have enabled the railroad to grow faster than the rest of the big Class I systems and the North American economy.

“We have to have the capacity to respond to it at all times or most times,” Ruest says of the growth.

“We need to build back the resiliency we used to have back in ‘15, ‘16 but lost in ‘17,” Ruest says.

The first-quarter results prompted CN to lower its expectations for the full year by about 3 percent on an earnings per share basis. Volume growth is now expected to be 2 to 4 percent, down from 3 to 5 percent.

CN’s volume fell 4 percent in the first quarter when measured by revenue ton-miles. Carloads, however, were up 3 percent. Only coal, metals and minerals, and intermodal were up for the quarter.

CN announced it will buy 350 new boxcars this year, has leased 150 additional centerbeam flatcars to handle growing lumber traffic, and will buy 250 new centerbeams in the fall. It also will add intermodal cars to its fleet to handle growth in international intermodal.

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