Canadian National Railway Co

TSX:CNR

Earnings Call Transcript 2021-Q1

[Operator]

Welcome to the CN First Quarter 2021 Financial and Operating Results Conference Call. I would now like to turn the meeting over to Paul Butcher, the Vice President, Investor Relations. Ladies and gentlemen, Mr. Butcher.

[Paul Butcher, Vice]

Well, thank you, Christina. Good afternoon, everyone, and thank you for joining us for CN's first quarter 2021 financial results conference call. I would like to remind you about the comments already made regarding forward-looking statements. With me today is J.J. Ruest, our President and Chief Executive Officer; Ghislain Houle, our Executive Vice President and Chief Financial Officer; Rob Reilly, our Executive Vice President and Chief Operating Officer; and Sean Finn, our Executive Vice President, Corporate Services and Chief Legal Officer. [Operator Instructions] 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. JJ Ruest.

[Jean-Jacques Ruest]

Well, thank you, Paul, and good afternoon to everyone. I hope you all had a safe, healthy and constructive start to 2021. Here at CN, we're off to a good, strong running start. The underlying performance of CN has been strong, and this is thanks to our dedicated colleague. Our railroaders delivered despite severe winter operating condition, unprecedented demand in a number of markets like port and grain and ongoing challenge during the pandemic. As you could see from Slide 5, CN is on track to become the premier railway of the 21st century. We are focused on our role as an engine of the North American economy growth and prosperity as well as the supply chain and environmental leader. We pioneer and we're the first to implement Precision Scheduled Railroading across our network and we are a clear industry leader in ESG. Our strong balance sheet is a testament to our operational excellence, and we continue to prudently invest in the business and our strategy as we grow and expand our reach. CN has a long-standing successful track record of strategic and accretive acquisition throughout North America, which has resulted in successful integration of our current rail network. In line with our existing strategy, CN made a superior proposal to acquire KCS. This is the right next step for both CN and KCS towards becoming the premier railway of the 21st century. Turning to Slide 6. We are confident that together with KCS' experience and very talented team, we will be able to continue that success in the combination of CN and KCS to the benefit of both companies. Specifically, this offer will deliver superior value to KCS shareholders. CN's proposal represent a 21% premium to the CP proposal and more than double the amount of cash per share, resulting in not just greater value but also greater certainty of the value for KCS shareholders. The combination will also significantly enhance customers' choice and competition. In particular, it would create a new express route that connect the U.S., Mexico and Canada with end-to-end seamless single owner, single operator service. It would connect [ vibrant port ] from all 3 coasts to more [ intelligent marketing ] cities. It would connect CN and KCS buyers and sellers to more destination. It will also preserve access to all existing interchange option to enhance route choice and ensure robust competition. We are also firmly committed to maintaining open gateway to competitor's network. We believe this combination will enable better solution to our customers; speed of movement of goods from country-to-country, coast-to-coast; enhance competition; create jobs up and down the railroad and prevent millions of tons of greenhouse gas from entering the atmosphere by converting truck traffic to rail supply chain.As an update on where our proposal currently stands, on April 21, we submitted a prefiling notification to the STB of our intent to file an application seeking authority to combine with KCS should the KCS Board of Directors accept our superior proposal. We are proposing to use an identical voting trust structure that CP has proposed, and we are confident that the STB will not subject our proposal to any different standard in approving the voting trust than those that would be applicable to CP. We believe that both voting trusts are equally likely to be approved. If our voting trust is approved and the combination with KCS is consummated, KCS shareholders will receive the value of their consideration being offered when the transaction closes in trust, which we anticipate could be as soon as the second half of 2021. We are fully committed to this transaction and confident in our ability to achieve all necessary regulatory approval to close into a voting trust and then ultimately receive approval to combine with KCS.On Page 7, I would like to provide a brief update on our strong progress as we have made in only 1 week since announcing our proposed combination. We were very pleased to learn on Saturday that the Board of KCS determined that CN's offer is reasonably expected to lead to a company's superior proposal, and we were granted permission to conduct our confirmatory due diligence. We look forward to working towards finalizing a definitive agreement merger to combine our 2 great railroads. And connected with that, the CEO of KCS, over the weekend, reiterated CN's strong enthusiasm, readiness, and most importantly, our deep commitment to begin collaboration with the KCS team towards a successful combination.Secondly, we filed earlier today an application with the STB for the approval of our voting trust and named Dave Starling as a trustee. Finally, a great importance of note, in less than a week of making a proposal to combine with KCS, we have received an overwhelming amount of support from more than 500 freight customers, port ecosystem partners, supplier, government official and other stakeholders. They have voiced their support for a combined CN KCS, which will help them compete in their market and better serve their needs by offering greater choice and greater efficiencies. We have also spoken to our shareholders and many of you as well and appreciate your strong support in this combination.I myself, on behalf of the entire CN team, we are fully committed to this transaction and we are very confident in our ability to achieve all the necessary regulatory approval to close into a voting trust and then ultimately receive approval to combine with KCS. Together, we will create the premier North American railway for the 21st centuries.Moving on Page 8. I am very proud of the CN underlying performance in Q1. This quarter, we realized solid results and we continue to work on our yield of our new business mix. During the quarter, we continued to deliver industry-leading volume growth with RTM up 5%, while revenues were flat versus last year, mainly due to adverse fuel lag and exchange rate. Our yield strategy is working. Our same-store pricing was 4.2% in Q1. Our network is fluid, and we recovered very well from the polar vortex of February.Our efforts are reflected in our ability to capitalize on consumer-driven trends and growth of our intermodal business, which was up 19% for the quarter with significant -- with CN significantly outpacing the rest of the industry as well as our strong financial performance and gain in safety, train length, car velocity, labor productivities, fuel efficiencies and other key measure of operational performance. We are confident in our business and committed to our long-term strategy.With that, I will turn it to Rob. Rob?

[Robert E. Reilly, Executive VP & COO]

All right. Thank you, JJ, and thank you to the talented employees of CN who helped deliver a very solid quarter.As you'll see on Slide 10, our team moved an all-time Q1 record for volume with GTMs up 6% year-over-year despite the impact of the polar vortex that JJ just spoke about in February. While volume was up, crew starts were up only 1%, our active online inventory of railcars was down 3% and train length improved 5%. The railroad continues to run very well and is fluid with car velocity also improved 5%. In addition, our labor productivity improved 9%. All in all, just a solid quarter of winter operation.As detailed on Slide 11, we are the North American rail leader in fuel efficiency. We improved our fuel efficiency 4% versus the same time last year to an all-time Q1 record. These efforts allowed us to save $12 million from our initiatives alone and save the planet over 60,000 tons of CO2 emissions during the quarter. From a safety perspective, our personal injury rate and accident rate were improved an impressive 27% and 36%, respectively, living up to our core values. From a technology standpoint, our FRA-approved autonomous track inspection cars provide safety and cost improvements to our railroad. As we prepare to enter into Phase 3 of our program, we will be able to enhance overall safety while reducing manual inspections by 75%. In Q1 alone, our accident costs decreased over $30 million versus Q1 last year due to this technology and the dense ecosystem of portal and wayside detectors on our network. These cars are now covering 100% of our core mainline and 95% of where our gross ton miles move.As I previously mentioned, we experienced a couple of weeks of February extreme cold temperatures, with temperatures dipping below minus 40 degrees on large parts of our network. During this time, we were able to deploy our air car fleet, which allowed us to use multiple air sources during this challenging time. With this technology, we moved an additional 232,000 feet of traffic in February that would have otherwise been delayed or lost due to the cold. This helped us move 5% more volume during the quarter while holding crew starts flat. Along with that, we were able to continue to deliver for our customers. CN has now set 13 consecutive all-time monthly records for Canadian grain, keeping the streak intact throughout the winter months. We continued deploying technology to make our railroads safer, more efficient and more reliable. And we're starting to see additional benefits from key projects, including track and train inspections.Moving to Slide 12. We are optimistic on the volumes as we look out over the remainder of the year. To that end, our Board approved an additional 75 locomotives over the next 12 to 24 months to support the projected growth and economic improvement. Our business is doing very well as evidenced by our strong performance this quarter. Our capital investments over the last 3 years continue to provide safe and sustainable transportation options for our customers as the global and North American economies remain on a steady path to recovery.As you can see on Slide 13, our strong operational performance, coupled with strong demand, led to record Q1 Canadian grain shipments. We beat last year's revenue record by over 20%, setting a new all-time high-water mark for sustainable grain supply chain volume. In total, as I said, but I'll say it again, we have now set records for grain tonnage now for 13 consecutive months delivering for the Canadian farmers. And as JJ highlighted a moment ago, our intermodal performance has also been very strong, increasing by 19%, which far outpaced industry growth.Turning to Page 14. We are confident in our ability to continue delivering strong results as the economy rebounds. Our network is fluid and we've recovered well from the extreme temps in February. We look forward to realizing the pipeline of growth opportunities in front of us. This includes continuing to grow our position as the clear industry leader in intermodal. We continue to maintain a very disciplined approach to yield management. And the strategy is working, including same-store pricing of 4.2% in Q1. We are also focused on diligently managing our CapEx to drive productivity and best-in-class capacity and resiliency. As we look towards the future, we expect to maintain our leadership in digital scheduled railroading, building on our history as a PSR pioneer. This will continue to be a competitive advantage as we execute on our strategy. And as JJ already mentioned, ESG will continue to be a priority. We've recently undertaken major new ESG initiatives focused on environmental protection, active social responsibility, stakeholder engagement and best-in-class governance. On that point, CN's Board of Directors announced in Q1 that at least 50% of independent directors come from diverse groups, including gender parity, the establishment of the indigenous advisory council and an annual advisory vote on CN's climate change action plan. We expect to continue to grow our ESG leadership and serve as an example in the industry.As I mentioned earlier, our best-in-class employees have done an exceptional job in helping to carry out our strategy. And we know that we have the right talent in place to continue to drive sustainable long-term growth.With that, I will turn the call over to Ghislain to go over our financial results in detail.

[Ghislain Houle, Executive VP & CFO]

Yes. Thank you, Rob. My comments will start on Page 16 of the presentation, which will give a bit more color on some of the highlights of our first quarter performance that JJ discussed earlier.During the quarter, we booked a noncash benefit of $137 million to recover part of the charge we recognized on the noncore branch lines we put up for sale in Q2 last year. Recall that in Q1 of 2020, earnings also included an income tax recovery of $141 million resulting from the CARES Act. Excluding these nonrecurring items, adjusted net income was around $870 million, essentially flat, with adjusted diluted EPS of $1.23, up 1% versus last year. If we adjust for the impact of fuel lag and stronger Canadian dollar, our adjusted EPS would have been up 11%, so quite a solid underlying performance.Now moving onto Slide 17. We generated strong free cash flow of nearly $540 million in Q1, down about $35 million from last year, mainly from lower net cash from operating activities, partly offset by lower CapEx. We have paused buying back shares in light of our proposal to combine with KCS.Moving onto Page 18. We are encouraged about the economic recovery and the vaccine rollout, which is giving us strong confidence for the balance of the year. The underlying performance in Q1 is a testament to the dedication of the CN railroaders who perform day in and day out. We are building off a strong volume performance in Q1 and looking to see the rail-centric part of our business recover. The increase in industrial production will drive growth in our carload segment moving forward such as chemicals, forest products, metals, fuels and plastic. With that said, we are pleased to update our financial outlook and are now targeting double-digit adjusted diluted EPS growth for 2021 versus high single-digit EPS growth previously. This is backed by the assumptions of high single-digit volume growth in terms of revenue ton miles. We still expect to deliver free cash flow in the range of $3 billion to $3.3 billion, which will drive further improvement in free cash flow conversion.I will now turn the call back to JJ to give some closing remarks ahead of the Q&A.

[Jean-Jacques Ruest]

Thank you, Rob, and thank you, Ghislain. So thank you for all of you who are joining us today. It's a proactive approach way, pro-economic growth -- merger that we're proposing, connecting more sellers and buyers. And I would like to take a moment to reiterate some of the highly compelling aspect of our proposal. By combining with KCS, we would compete head-to-head on all 3 coasts at lower cost, safer service, better fuel efficiencies from Mexico to the heartland of America. This will result in a safer, faster, cleaner, stronger railway. In addition, we would bring our leading ESG and operating expertise to KCS' business to the benefit of both companies' stakeholders.As mentioned during our April 20 announcement, based on our conservative and preliminary analysis of publicly available information, the combined company is expected to achieve EBITDA synergies approaching $1 billion, with the vast majority coming from additional revenue opportunity. The strong cash flow generation of the combined company would allow the company to rapidly de-lever following the close of the transaction. We anticipate the transaction will be accretive to CN's adjusted diluted earnings per share in the first full year following termination of the voting trust and CN assuming control of KCS and double-digit accretion and a full realization thereafter.We are confident in the strength of our business and strategies, and we progress towards becoming the premier railway of the 21st century. We look forward to engaging constructively with the KCS Board and all relevant stakeholders to deliver the superior transaction with KCS to deliver greater choice and efficiencies for customers and deliver enhanced opportunities for employee and local communities. Overall, we have a better bid, we are a better partner, better railway and the best solution for KCS and the North American economy.On that note, we will start to take some questions. Operator?

[Operator]

[Operator Instructions] And your first question comes from the line of David Vernon with Bernstein.

[David Scott Vernon, Senior Analyst]

So JJ, I want to kind of ask this question again a little bit. I know we talked about this when you made the bid. But looking at this transaction, why is now the right time to come in with a competing offer here? Like where -- like what's changed in the market that makes this such a better deal than it may have been 2 or 3 or 5 years ago at a lower price point?

[Jean-Jacques Ruest]

So there's many reasons why now, and I covered them -- those earlier last week. But the main reason why now is that the Board of KCS, obviously after a very thorough thinking, have decided that it's time for them to crystallize the value for their shareholders. Therefore, they're willing at this point to entertain doing a merger with a strategic partner, a merger with basically another railroad. That's -- so the timing of that is also very much dependent to whether or not you have a partner with who you could [ dense ]. And then from an economic point of view, we're at the beginning of a post-economic recovery. The GDP forecast for North America looks as good as can be. We had the USMCA, which was renewed, which is also something that has specific value to an [ outside top ] combination. And then depending who you believe, the time of Mexico, this might be the decade of Mexico in terms of new shoring now that there is some challenge between relationship in North America and China, but also the fact that the cost of labor in China has been rising to the point where Mexico might have a better decade. And all that, you put that together the fact that long-term money is affordable, when you put all that together, it says to CN, yes, it's time for you to make a good offer to the KCS Board and for them to consider very seriously.

[David Scott Vernon, Senior Analyst]

That's very clear. Maybe if I can just kind of squeeze one little follow-up in here. As you think about the unique drivers of value, is it more about getting CN's rail connections further West or further South?

[Jean-Jacques Ruest]

So the driver of value here, really definitely for us to be successful, we need to create a superior product, a product that can really compete with the long-haul truck. And on that point, I could ask Rob to comment on that. But right now, the rail network in North America is not really designed to really be as successful as can be for long-haul distance from, say, Mexico City all the way to Detroit and Toronto on the East or Mexico City to Wisconsin and Calgary on the West. In order to do that, you're -- putting 2 railroad together really makes it appealing. Do you want to make some comment, Rob, about the product that we have in mind?

[Robert E. Reilly, Executive VP & COO]

Yes, sure, JJ. David, when you look at it, and as JJ just talked about with the USMCA contract just finalized here last year, it really needs a strong transportation option. We don't get to Mexico. And certainly, the KCS does, and it allows us to really become the true North American railroad, really connecting the continent. But we bring a lot of things to the table when we look at it. When we look at the different industries, the auto industry would get a second line of service between Detroit and Kansas City that would help increase and enhance options. Intermodal service from Mexico to the upper Midwest and Southern Ontario, that's actually being trucked today, it's on I-35. It's really about taking it off the highway, saving fuel and emissions, really increasing choices for shippers. For farmers in the Midwest, Iowa, Illinois, Wisconsin, Indiana and others, see opportunities to better access the Mexican market. Our reach and port access with -- would open the Midwest and KCS shippers to the world, quite frankly, from the Atlantic to the Pacific and the Gulf. For Canadian aluminum producers, the ability to directly reach markets in Southern U.S. and Mexico. For lumber and panel buyers in Texas, CN's Forest Products franchise gets fully unlocked and allows for further optimization and utilization of our fleet of over 10,000 center beams and boxcars. I could keep going on, but there's a lot of things this combination would bring, enhancing choices for shippers and customers and really be in the backbone of USMCA.

[Jean-Jacques Ruest]

Yes, pro-choice, pro-competition and very much focused on growth.

[Operator]

[Operator Instructions] And your next question comes from the line of Scott Group with Wolfe Research.

[Scott H. Group, MD & Senior Analyst]

So I'm going to -- I want to ask about the operating ratio just because it does look like this -- it will be worse among the rails this quarter. And I know you talked about maybe a sub-60 OR earlier in the quarter. Is that now in this higher guidance? And then longer term, CP talked about maybe a low 50s OR pro forma with KCS. How do you think about your OR longer-term on a pro forma basis? And maybe do you see opportunities to leverage some of the success that KCS has had with PSR to get your margins back on track?

[Jean-Jacques Ruest]

So maybe I can start and then Ghislain can add. But when we look long term, we looked at the North American network, focusing on the economic [ trial ] that I was talking about earlier and significant growth coming from intermodal. So in a world of growth, growth from intermodal, the focus at CN will be very much more EPS than trying to get the lowest OR that one could get, for example, if you move a lot of crude, a lot of coal. Ghislain?

[Ghislain Houle, Executive VP & CFO]

Yes. And on that front, JJ, thanks. On EPS, I mean, we're quite proud of our results for this quarter. I mean, when you look -- our earnings are up 1%. All the other rails are down, including our Canadian competitor. They stated that their earnings was up, but if you take out the $50 million onetime land sales, they're actually down 5%. So we're up 1%. And when you look at the underlying fundamentals of the business, as we mentioned, we would be up 11% when we consider the fuel lag and we consider FX. So quite proud of EPS, and this is what we're focused on.

[Scott H. Group, MD & Senior Analyst]

Can you discuss...

[Jean-Jacques Ruest]

Go ahead.

[Scott H. Group, MD & Senior Analyst]

No, no. Sorry to interrupt. Go ahead, JJ.

[Jean-Jacques Ruest]

As I said, we were focused on EPS. The focus is on EPS, that's what we want to optimize.

[Scott H. Group, MD & Senior Analyst]

Okay. And do you mean -- can you clarify where the guidance is on OR, though?

[Ghislain Houle, Executive VP & CFO]

No. I mean, our guidance, as we -- and we're quite proud. I mean, we upped our guidance. I think that we're quite bullish on the economy coming forward on the markets. And we popped our guidance, as you know, to targeting double-digit EPS growth. And that's what our guidance is with -- backed up by a mid -- a high single-digit RTM growth, that's our guidance.

[Operator]

Your next question comes from the line of Cherilyn Radbourne with TD Securities.

[Cherilyn Radbourne, Analyst]

I wanted to ask in relation to the increase in guidance for the year and particularly the increase in your volume outlook, obviously intermodal has been very strong, so maybe that's the upside. But I would love to know if you're starting to see some signs of life on the carload side of the business, which I think would be helpful from a mix standpoint.

[Jean-Jacques Ruest]

So Rob, do you want to talk about what we expect to move between now and the end of the year?

[Robert E. Reilly, Executive VP & COO]

Yes. So Cherilyn, we actually see some positive movement here, particularly in the second half of the year is really where we see the upside as the economy really starts to kick in. We are moving quite a bit of gas moving out to export through the Port of Prince Rupert. Actually, the second gas terminal just opened up. The Forest Products Group has continued to stay strong here. We talked about grain. I think the single -- the carload franchise really starts to move in the second half of the year, quite frankly, is what we see the big side in terms of the upside, Cherilyn.

[Jean-Jacques Ruest]

Yes. It's pretty broad-based, pretty broad-based.

[Operator]

Your next question comes from the line of Tom Wadewitz with UBS.

[Thomas Richard Wadewitz, Managing Director and Senior Analyst]

Yes, JJ, thank you for the question here. I wanted to try to get your sense of the kind of negotiation with KSU and how you addressed maybe some of the concerns that they potentially would have regarding the regulatory process. So I guess, in particular, CP now has visibility with the waiver that they would be able to go to a voting trust. You don't yet have that visibility. And so is that a significant barrier to an agreement with KSU? Are there things that you can do in terms of the negotiation that would address concern that they might have that they reached an agreement with you, but then STB comes back and says, no, we're not going to allow you to do a voting trust?

[Jean-Jacques Ruest]

Thank you for the question, Tom. So we've only put our offer to KCS Tuesday of last week, and only this morning did we file for the voting trust. So -- and we fully intend to address every regulatory issue concern that KCS has. So maybe, Sean, maybe you could give a brief and an update kind of where we're at in the process of doing these different things?

[Sean Finn]

Sure. Thanks, J.J. Sure, Tom, happy to do so. So obviously, we now signed a nondisclosure agreement with KCS and we have access to the data room, but we're going to start a dialogue in the coming days with them. I think you saw today, we filed at the STB a letter setting out our views on the process by which the STB will rule on the voting trust, first of all. Secondly, we also filed a petition with our voting trust, which is identical to the other voting trust before the STB that was put forward by CP. And our application is very simple. We're just asking the STB, as they annunciate their process, to approve the voting trust that they do both at the same time. So the same track, the same standards and ultimately come to the decision at the same time with respect to both CP's voting trust and our voting trust. And we're very confident even working with KCS, who will obviously be interested in both parties, seeing their voting trust getting approved, that be adopted a process that is fair, transparent and evenhanded. And we're confident that the STB will do that. We've asked them to rule by May 31, which puts us in line to be in a position where both voting trusts have been approved of STB prior to the vote by the KCS shareholders sometime in June. So obviously, that dialogue is ongoing. We will be able to show no doubt with the KCS that when it comes to the voting trust, our position is identical to CP's. And hopefully, we're very confident that the STB will rule on both at the same time. We think that's the best approach to have an even level of playing field for everybody. And ultimately, at this stage, as you know, the standards for the voting trust is public interest. It does not go to the competitive issues. But again, our transaction is pro-competitive where you have new choices, additional choices for customers in the U.S. and across the network. And we're very confident that we'll get to a voting trust to be approved at STB in early June, late May.

[Thomas Richard Wadewitz, Managing Director and Senior Analyst]

Do you need an agreement first for them to review it or not -- an agreement with KSU or not necessarily?

[Sean Finn]

No, not. We filed -- we opened our proceeding last week and we filed the voting trust. And it's not required that you have a final agreement signed before they approve the voting trust.

[Operator]

Your next question comes from the line of Allison Landry with Crédit Suisse.

[Allison M. Landry, Director]

Maybe just following up on Tom's question. I mean, there seems to be some disparity between CN's view about what the public interest standard actually means specifically for the voting trust compared with how CP is outlining their view of the public interest tenders. So maybe if you could just sort of walk us through how you understand the STB language? What do you think it means? I mean, basically, CP is trying to -- or is arguing that competition is something that will be considered. I think what CN is saying it's more about financial fitness and the divestiture of the asset. So hoping that you could provide some clarity on your view on what the public interest standard means specifically for the voting trust.

[Jean-Jacques Ruest]

Sean, you want to talk through these technical points?

[Sean Finn]

Sure, I'd be happy to. Well, first of all, again, Allison, our position is that our bid is pro-competitive, will create choices for customers, and therefore, it does enhance competition. I also wanted to comment our view is there are no insoluble regulatory problems. I mean, there is a history of these issues that are raised in the context of an STB application as being mitigated and worked out with, obviously, the customers through the STB process. The standard in respect to the voting trust is very clear. And our trust is exactly the same as CPs. And it's a public interest standard, but it focuses on the risk of financial harm of the applicant carriers. And that goes to if, for some reason, the transaction were not to be approved, that both carriers, in our case KCS and CN, will remain financially viable at the -- post the transaction if you had to unwind the voting trust. And we're very confident both companies are extremely viable and would not have an issue post the voting trust if it were not to be approved. Ensuring that there's no improper control of KCS, and it is clear both in our voting trust that there is no control by CN. The trustee being Dave Starling is an independent trustee with a great experience when it comes to both the railway industry but also KCS specifically, and we welcome his independence as trustee. And therefore, we are very confident that the public standard tests that must be met at this stage will be analyzed by the STB. And again, the issue will be and what we're asking STB to do is apply the same standards and the same criteria and the same time frame for both voting trusts. So we're confident that when the STB receives both applicants' detailed submission on the public interest, that they will come to the view that, in our case, we made the public interest and our voting trust will be approved by the STB.

[Operator]

Your next question comes from the line of Ken Hoexter with Bank of America.

[Kenneth Scott Hoexter, Managing Director and Co]

Looking at the cost side of the [ 66 ] OR again, thoughts on near-term on employees relatively to your -- the flat performance in the quarter. How do you think you ramp as volumes ramp through the year and your thoughts on costs? And I guess, maybe long term, your thoughts on synergies? You mentioned kind of top line versus the cost side as well.

[Jean-Jacques Ruest]

So maybe I can start and then Rob can add in. So the month of February was kind of an expensive month for all the railroad in terms of the polar vortex. We talked about yield, same-store price at 4.2%. So that's a good trend. We like that numbers. And the volume ahead of us is obviously positive and constructive, just like the economy. And when you look at all the series of KPI that Rob was going through during the presentation on the operations side, we've made progress just about on all front, if not all front. So I mean, we are -- with that in light, things look -- it looks positive for the rest of the year. Rob, I don't know if you want to add?

[Robert E. Reilly, Executive VP & COO]

Yes, Ken. If you just look at our operations team, so what it takes to move the freight out there in the first quarter, our operations headcount, even though I said volume was up 6%, our headcount was down 6% in operations, roughly about 800 people less to move that freight. As I mentioned, our labor productivity was up 9%. When we look at it as we came out of the COVID, depth of second quarter last year into the third quarter, we didn't bring all of our resources back on a one-to-one basis. And we've been able to maintain that here through the second half of last year and then certainly in the first quarter this year. As you look at the second quarter this year versus last year, of course, we're going in a different direction. We're seeing growth versus the big downturn. We saw really at the end of April and May is where it started to trough on us. So we weren't doing any hiring last year in the second quarter at all. That all stopped as soon as COVID set in. And we made -- as you'll recall, we had a lot of people furloughed. To the contrary, we're actually hiring. We're actually hiring conductors right now, getting ready for the second half of this year. So we're preparing. We're optimistic about the second half of this year in terms of the volume, and that's really where our focus is, is preparing to move that.

[Ghislain Houle, Executive VP & CFO]

And maybe JJ, I can add. If you're looking, Ken, at the labor cost of Q1 being higher, that's all major variances incentive compensation because to Rob's point, our average number of employees in the quarter were down 3%.

[Operator]

Your next question comes from the line of Brian Ossenbeck with JPMorgan.

[Brian Patrick Ossenbeck, Senior Equity Analyst]

Just a quick one on the end markets. Can you just remind us what impact you think you'll see from the ELD mandate when it becomes effective in Canada mid this year? We have heard some concerns about the availability of devices being certified. Is that really something that you're focused on having impact on some of your end markets that overlap with trucking?

[Jean-Jacques Ruest]

So maybe I can pick this one up. Most trucking firm in Canada will do cross-borders have to have the equipment already because that's what is a legal required in United States. So then you're left with only the fleet that's only running in Canada that has to meet that mandate by mid year. So the impact is I would say I would qualify as slightly positive because already a good portion of the fleet had to be converted because a number of equipment move cross-border, so the impact is a slight positive. But I think it's coming up at a time when the economy is going to be strong. So really the economy is going to be a bigger factor than ELD implementation.

[Operator]

And your next question comes from the line of Jason Seidl with Cowen.

[Jason H. Seidl, MD & Senior Research Analyst]

I want to talk on any of the customer overlap that may exist. And maybe you could walk us through some of your options on how to sort of placate the STB and the customers going forward with the deal.

[Jean-Jacques Ruest]

So the overlap is well known is between Baton Rouge and New Orleans where both CN and KCS have a parallel line. And we know the detail of that and we think we can definitely solve that, as Sean said earlier, to the one problem, but none of them are unsolvable, then we'll resolve them. And I don't know, Rob, you want to add other little color over that?

[Robert E. Reilly, Executive VP & COO]

Yes, I think you hit it. The overlap, just like we said on Tuesday, is really between Baton Rouge and New Orleans where we do have a few customers that their options will go from 2:1. We knew that going in and we said that in, again, that represents less than 1% of the combined railroads network. So we will remedy it. There's a number of things you can do with that including divestiture of the line but we'll cross that bridge when the time comes, but we will handle it. Other places that are out there that have been mentioned. I'll just go through them real quick. Jackson, Mississippi, there's no 2:1; St. Louis, no 2:1; Springfield, Illinois, no 2:1; Council Bluffs, no 2:1; Mobile, Alabama, no 2:1. In fact, the port of Mobile, Alabama has sent in their support for our proposed merger, so they get it. If for some reason there is another issue out there, we'll work with our customers to remedy that as we always have. And as JJ said, it's important to note that in a little over 300 business days, over 500 letters of support, that's significant in terms of what we're seeing out there. Thanks for the question.

[Jean-Jacques Ruest]

Hopefully, this helped clarify. Everything has been said on this in the last week. So thank you for the question, Jason. Next question?

[Operator]

Your next question comes from the line of Justin Long with Stephens.

[Justin Trennon Long, Managing Director]

I wanted to ask about the 75 locomotive orders that you mentioned. I think you got approval for that from the board. Any color you can give on the expected timing of those units and when they should be delivered? And is this an order that's contingent on the merger being approved? Or is this predicated on just the stand alone business and the growth you're expecting?

[Jean-Jacques Ruest]

So I'll pass it on to Rob. But just to clarify, the approval of the Board for the grain fleet expansion and the locomotive fleet expansion took place before we made the offer to KCS. Rob?

[Robert E. Reilly, Executive VP & COO]

Yes, that's exactly right. It had nothing to do with the merger and does not have anything to do with the merger. It's really based on growth and growth prospects we see over the next 12 to 24 months. In terms of timing, we expect to get roughly 25 of those here in the second half of this year. The other 50, the first half of next year. There could be some variability. If volume is bigger than that, we could pull some of those forward, but that's about what we look like in terms of the timing.

[Jean-Jacques Ruest]

Yes. So we're not losing our focus at all on Canadian grain and Canadian farmers. We're making a major capital investment over three years adding renewing 3,500 new low cube, high capacity hopper cars, and the 75 locomotive, we got some flexibility about when we take them. And that's basically our commitment that as we see growth coming, we want to be prepared for it. We want to be able to move the economy and do our part for to enable the recovery post-COVID.

[Operator]

Your next question comes from the line of Chris Wetherbee with Citi.

[Christian F. Wetherbee, MD & Lead Analyst]

I guess maybe a couple of things here. First, just on the on the voting trust, when you think about sort of the similar approaches that you'd like the STB to take to review both of them. I guess I'm trying to make sure I understand that relative to the desire to have your deal reviewed by the new merger rules as opposed to sort of seeking the waiver? Is there a reason why maybe the same rules make sense for the trust as opposed to potentially the deal? And then in terms of what ultimately kind of becomes how the industry ultimately shapes up, how would you expect something to the downstream effects to look if you were to be able to acquire case, do you think this triggers something else in the future? Do you think this is sort of one-and-done and then this is it?

[Jean-Jacques Ruest]

So Chris, it's a question often asked. So we'll refer to our expert here, Sean, to cover that.

[Sean Finn]

On the question of the waiver maybe, which you're asking about, but to be specific, we believe we can close the transaction on new rules or old rules. So for some reason, the STB were to rule, but we've taken the position from the outset that we think that this transaction should be reviewed under new rules. First of all, secondly, it does provide -- and obviously, our 500 or more support letters are recognize the fact that CN has taken the position that we are confident that under the new rules, we can get this transaction approved and closed. And when it comes to evaluating the voting trust, again, we're of the view that clearly in our submission, what we said is that we want the same standards applied in the same time line and the public interest test for the approval of the voting trust. Our submission is that it is the same for both voting trust, leading that to ask the STB to rule both at the same time and hopefully, adopting a process, which will allow us to even a level playfield -- excuse me, which is fair, transparent and even handed. So obviously, our position is that when it comes to the voting trust, our regulatory assessment is identical to CPs when it comes to getting it approved as a vehicle to use to move on to the next level of this transaction.

[Jean-Jacques Ruest]

So I hope this helped. Yes, go ahead.

[Christian F. Wetherbee, MD & Lead Analyst]

Is that downstream effects? What do you think about that?

[Sean Finn]

Well, I think that's something that will be obviously assessed by the Board based on the new rules on the overall transaction, and we'll address those as they come through. But again, our capability of demonstrating it is pro-competitive that has Rob clearly explained that there's no -- there has competition, and there's not -- there are areas where we have to address with mitigation, but we remain confident that on the new rules, we can get this transaction approved and closed.

[Jean-Jacques Ruest]

Next question? Operator?

[Operator]

And your next question comes from the line of Jon Chapell with Evercore ISI.

[Jonathan B. Chappell, Senior Managing Director]

I want to ask about the impact of what's going on in the port of Montreal right now. Obviously, this one was a little bit more expected, and it sounded like there was business already shifting to Halifax. How is your network position for the proactive shift in freight? And if you can just remind us what was the impact both from a volume and a cost perspective on the prior strike? And how do you expect it to be similar or different this time around?

[Jean-Jacques Ruest]

So this is the second time in about 6 months that they have a labor disruption. And the last time it was maybe it caught shippers or importers by surprise. This time because it was the second time, and this was also -- they had a specific deadline. So customers saw it coming, diversion of freight start to take place many weeks ago. That's another important aspect. When the disruption took place last year, it was disruptive to our own operations. So I would say there was some new business, but it was also unplanned costs as a result of. So this time, we're organized differently. I'm sure the importer is also organized differently. There's been a version of freight already to St. John and Halifax, both. And currently, the federal government is actually looking at potentially having some regulation that may bring either their work stoppage to a close or maybe bring the 2 parties closer together. But all in, it's not a big to do in terms of our second quarter results.

[Operator]

Your next question comes from the line of Brandon Oglenski with Barclays.

[Brandon Robert Oglenski, VP & Senior Equity Analyst]

I guess JJ or Rob, there was a lot of public discussion last week about how your potential combination would be somewhat anti-competitive from a rail perspective. And I think it wouldn't be on just the shared line in Louisiana. So can you give us maybe some more extensive response to those comments, especially in relation to underlying agreements, which supposedly could be more challenged going forward?

[Jean-Jacques Ruest]

Well, maybe I'll start. I mean, frankly, our focus from the beginning has been on KCS and creating value for their shareholders and their customers as well as the CN shareholders. We -- the combination that we're proposing is really pro-competitive. It's really about creating new products, new services to compete harder. There's nothing wrong with competition. Competition is good. It brings innovation, raise new services. It helps connect more buyers with more sellers. CN has a bigger network. We can actually connect more destination. All these gateway will remain open. CN is this -- railroad, including CN, we make good money after changing traffic without the railroad. So there's definitely no incentive financially, otherwise, not to continue to grow the interchange business with all the railroad, including the CP at Kansas City. So a merger that's based on growth is a merger that really is looking for a bigger pie of the overall freight in North America, not to -- we're not looking for a bigger pie -- a bigger slide of a small pie. We're looking for a bigger pie and, therefore, enter changing without the railroad as well as competing much harder with truck with obviously what we created now as a premier railroad for the 21st century. We focus on the economy ahead. The economy ahead of us is going to be much more related to consumers and to intermodal, or a lot less reliant on thermal coal. And fruit has been good and bad at time. Crew is too volatile to actually do a merger of this size. And so I mean, there's -- our view is always on the beginning. This is pro-competition. It's to create new product. It's about growth. And it's about creating reason for freight shipper to use a rail network. I don't know, Rob, do you want to add?

[Robert E. Reilly, Executive VP & COO]

Yes. You nailed it. I think you hit on all the key points. I'd just reemphasize, as JJ said, we plan on keeping the gateways open. There's no plans to shut those. So as far as your question on the interline, that's our plan.

[Jean-Jacques Ruest]

Yes. And just to add, when you look at the ports, Mobile, New Orleans, Montreal, Québec City, Halifax, Vancouver, Rupert, Lázaro Cardenas, Veracruz, all these ports with this combination can really connect to even more intel end market. You could connect St. Louis, Memphis, Kansas City to all 3 coast, Transatlantic trade to Kansas City, South American control to Kansas City coming from the West as well. You could potentially give an opportunity again for the Lázaro Cardenas to potentially be an option for those who import product in Houston and/or export product from Houston back to Asia. When you look at the map, you got to look at what it could do to actually enhance the economy and enable something that was put together with a lot of effort USMCA, enable the continent also to do more trade within itself. You have now the content of a finished vehicle North America requires a higher content made from North America. So that means more product, more parts moving within the continent, very long haul. And that's what this combination is all about is to support and enable the economy ahead, not -- no intention of reducing competition or closing gateway.

[Operator]

And your next question comes from the line of [ Amit Recruta ] with Deutsche Bank.

[Unknown Analyst]

So let me ask a question. JJ, I want to ask a previous question slightly a different way, if I could. So bear with me for a second. I mean you and the team have obviously, done a lot of work offered a compelling proposal. I think that's undeniable. But at the end of the day, the outcome is quite binary. And what I was hoping you could help us with is how CNR is impacted by a potential KCS merger, both I guess, with respect to the competitive implications for CNR? And then also, does an outcome like that necessitate the need for your company and the CNR Board to pursue other acquisition opportunities to counterbalance that competitive implication?

[Jean-Jacques Ruest]

So thanks for the question, [ Amit ]. So that's really a question for later. It's something we've been talking about, obviously, for the last many, many years as to the so called end game; our focus really is the opportunity at hand. The board of KCS has decided that they're willing to partner with another railroad, a strategic partner and CN from the very beginning of when we got privatized, the first thing that we did was made an acquisition early on of the Elanor Central, we had a marketing alliance with KCS. And then early days, we've been focused on what was at the time known as NAFTA. NAFTA has now been renewed with somewhat different labor, a lot of the, what NAFTA attraction was still there today. So that's really the focus that we have. I think, if this doesn't happen, then, we'll see at that point at that time, but there's a lot of value. And we believe, as Sean was saying earlier, that we can resolve these different issues as they come. And that's what we're focused on right now.But just look at the CN network the way it is today with 3 coasts, huge amount of potential, just stand alone. Just remember when we started 25 years ago, the company was no way what it was today, we build it up over 17, 18 different acquisitions, big and small, we build it up with organic growth. And that is always be the case. We are very innovative, very nimble. And we're going to keep doing that. Right now, we're focusing on one specific, the KCS. And being the NAFTA railroad, the USMCA railroad. It doesn't mean that we have -- our future is any different long term, we have a bright future no matter what. But we think that this is the time to do this one transaction. First time since I joined CN that actually KCS is actually willing to merge with another railroad. So we'll jump on that.

[Sean Finn]

JJ, if I may just want to be clear that I talked about the voting trust before clearly our application. There's no date yet for the KCS shareholder vote. But our application today, we're looking to have the -- our voting trust approved on the same timeline as CP will interest the same standards in the same criteria, and that would be done prior to the voting trust for KCS. When I said voting trust by the end of May or June and while presumptuous I'm assuming that's when it could take place. But clearly, I wanted to be clear that we want to ensure that the STB rules on both voting trusts prior to the KCS shareholder vote later this year.

[Jean-Jacques Ruest]

Very important point. Thank you, Sean.

[Operator]

Your next question comes from the line of Benoit Poirer with Desjardins Capital Markets.

[Benoit Poirier]

Yes. Obviously, very good color about the voting trust. But now when we look at the data room, could you provide maybe more color about the timing to perform data room analysis? I know it's not your first time, and I would assume it's more virtual these days. And if you could also provide some color about the timing to make a binding proposal and finalize a definitive merger agreement?

[Jean-Jacques Ruest]

Sean, you want to cover that?

[Sean Finn]

Yes. They said, we've started -- we'll be starting tomorrow, hopefully getting access to the data room. Looking at the material that's in there it is a virtual data room to your question, Benoit. That could take us two weeks, two and a half weeks to get our confirmatory due diligence completed, and therefore allow us to then move to finalizing. We've already tabled a draft merger agreement. We have one ready to go. So we'll just update it in line with the due diligence and hopefully, we'll be engaging very proactively and very respectfully in the days to come with the KCS team. And we're looking forward to be in a position to have hopefully, a merger agreement, in the next 30 to 40 days.

[Operator]

I would like to turn the meeting back over to Mr. JJ Ruest.

[Jean-Jacques Ruest]

Well, thank you for joining us today. Obviously, it's an important time in CN history. As we mentioned earlier, we're proud of our first quarter results, economy ahead of us looks good. The operating metrics are solid, fuel efficiency is good. Very important to us also is our safety performance, much improved on the personnel injuries and train accident. So a lot of good things that look good for the quarters to come. On the long term view, obviously, the desire of CN to give reason to the board of KCS to consider a combination with us is very much top of mind. And we're going to be putting a lot of focus and effort onto that in the coming week. So thank you for joining us today and more to come in the weeks and months to come. Thank you.

[Operator]

The conference has now ended. Please disconnect your lines at this time, and thank you for your participation