Canadian National Railway Co

TSX:CNR

Earnings Call Transcript 2021-Q2

[Operator]

Good afternoon. My name is Nika, and I will be your operator today. Welcome to CN's Second Quarter 2021 Financial and Operating Results Conference Call. [Operator Instructions]I would now like to turn the call over to Paul Butcher, Vice President, Investor Relations. Ladies and gentlemen, Mr. Butcher.

[Paul Butcher, Vice]

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 risks and uncertainties 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. JJ Ruest.

[Jean-Jacques Ruest]

Thank you, Paul, and thank you, Nika. So good afternoon, everyone. And today, we have 2 agenda -- 2 items for this call. First, we want to highlight our quarterly 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 neighbors in crisis and the several CN employees whose life has been impacted by the natural disaster. Let's go to the Q2 highlights on Page 6. I want to start by saying how proud I am of our dedicated [indiscernible] 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 3 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 work in our combination with KCS, and we also stayed focused on our yield management and network operation execution. The freight revenue per carload 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 operations. Rob?

[Robert E. Reilly, Executive VP & COO]

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 2-week outage, and we will begin -- 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 injury frequency ratio. And 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.

[James Cairns, Senior Vice]

Thank you, Rob. During Q2, we saw the more balanced demand recovery that we expected, with carload volume up 21%, beating Q2 in almost all commodity segments. Manifest carload 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 frac sand versus last year. In spite of the impact of 3 mine closures late last year, we saw volume growth in coal as a result of the start-up of our new Teck 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 lap the 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. Exiting 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 1 or possibly 2 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.

[Keith Donald Reardon, Senior Vice]

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 3-coast network. I will now pass it on to Ghislain for the financial perspective.

[Ghislain Houle, Executive VP & CFO]

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 acquisition. Recall that in Q2 2020, earnings also included a noncash charge for noncore branch lines held for sale. Excluding these nonrecurring items, adjusted net income was around $1.60 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 the OR. If we adjust for these 2 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 an equity 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 fringe 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 billion to $3.3 billion, which will drive further improvement in free cash flow conversion. I will now turn the call back to you, JJ.

[Jean-Jacques Ruest]

Thank you, Ghislain. And if you could join me on Page 17, the CN-KCS, safer, faster, leaner, stronger end-to-end combination, and we need all of that. I will start by saying that the deeper we dive into the potential of the combination, the more excited I get about it. The benefit that it will bring to the 3 U.S. CMCA economies, the increased rail and intermodal competition [indiscernible] benefit 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 transparency. The combination will strengthen the North American supply chain and create the first true North-South North American railroad. New direct connection will be created that allow for more reliable and less extensive supply chain 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 truckload off the road and on to 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 may have -- that they may have and enable a successful combination with KCS. We'll go on Page 18. The combined CN and KCS network present numerous public interest and customer benefit. We will add new single-line route that will be more reliable and more cost-effective for our customers. Our combined network will enhance the ability to connect with other Class I at major gateway. This is a call of growth story with vibrant gateway. By enhancing pricing visibility to all existing gateways, customers will have enhanced rail competition, greater optionality of choices and new ability to shop 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 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 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 Clyburn, Jr. and shareholders such as Cascade and CDPQ. Industry experts, including Dr. William Huneke, former Director of the Office of Economic and former Chief Economist of the STB also recognized a competitive benefit of our combination, including more competitive shipping options. Now a summary of the path to conclusion, the graph on Page 20. We are waiting 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 the consideration from CN. We are targeting obtaining this approval and closing into 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 right 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 option. We're keeping all existing gateway available. We are enhancing rail-to-rail competition with other Class Is. 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 intermodal providing ESG benefit for the environment and local communities. In the joint CN-KCS filing to the STB of July 6, we demonstrated our proposal -- proposed voting trust satisfies the Board tests, voting trust -- our voting trust allow KCS to maintain control during the trust period and the approval of our voting trust caused no harm and is in no -- it is in the public interest. To conclude, we are looking forward to a positive ruling of the voting trust from the STB, and we are fully committed to this highly strategic transaction that would create significant value for all of our stakeholders. So operator, we will now turn it into the question period. Paul?

[Operator]

[Operator Instructions] The first question comes from the line of Ken Hoexter from Bank of America.

[Kenneth Scott Hoexter, Managing Director and Co]

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

[Jean-Jacques Ruest]

Thank you, Ken, for the question. We love a question regarding the operations. So Rob, you want to talk a bit about EJ&E and maybe what's happening in Western Canada?

[Robert E. Reilly, Executive VP & COO]

Yes, absolutely. Starting with the fires there, Ken, we lost a bridge between Kamloops and Boston Bar on June 30 and had it restored back July 13, and that's a segment of railroad that averages about 25 trains a day. So not moving anything or very little during that time has created a backlog. So 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 a couple of weeks, as I mentioned 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, why 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 divergence?

[Keith Donald Reardon, Senior Vice]

The -- 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 -- in the Gulf Coast. So we were ready to handle the business coming to us in this very tragic incident that occurred in BC. We'll get back, as Rob said. A couple of weeks, and we'll be back fluid. Thanks for your question, Ken.

[Operator]

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

[Allison M. Landry, Director]

I just wanted to ask about the incremental margins in the quarter. They seemed a bit muted at under 30%. I understand the fuel incentive comp headwind but with core pricing accelerating to something north of 4%, you would have expected the operating leverage to have been a little bit stronger. So 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?

[Jean-Jacques Ruest]

Yes. Good question, Allison. Ghislain will take that. He has the detail around the operating margin.

[Ghislain Houle, Executive VP & CFO]

Yes. The incremental -- thank you, Allison. The incremental margin, you're right. I think in the quarter, the -- 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, the headwinds on FX and fuel can dissipate a little bit. When you look at it today, FX is around $0.78. It hovered between $0.80, $0.82 and $0.83 during the quarter. Our guidance is supported by an $0.80 FX for the full year. And fuel as well came down, we were talking together here before the call, was 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 2 uncontrollable factors, our EPS was up 30%. So we're quite pleased with that performance.

[Jean-Jacques Ruest]

Yes, great. Exactly, we're very pleased with the performance. And CN being a railroad that has quite a bit of revenue into 2 currency. If you look at your Bloomberg screen and look at the Canadian dollars in the second quarter, you will notice that it's sort of peak for May and June. And right now, it's back to $0.79, but it was as much as $0.83. So it has an impact on the short term.

[Operator]

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

[Cherilyn Radbourne, Analyst]

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.

[Jean-Jacques Ruest]

Yes. So Sean, has been following this very closely, Sean, you want to talk about the STB and the Executive Order?

[Sean Finn]

Sure, Cherilyn. Thanks for the question. I guess the best indication to see how the Chair of the STB, on the day it was issued, responded publicly in the press release. And obviously, we share at CN the goals of the Executive Order about a fair, open and competitive marketplace. It's a cornerstone of the U.S. economy. But if you look at what the Chairman said, it clearly indicates that the order encouraged STB to provide accessible remedies to shippers, to focus vigorously on enforcing and accounting for onetime performance standards and avoid unwarranted delays in passenger rail service. That's the focus of the Chairman. And in that same press release, he recognizes that under certain conditions, consolidation does have -- it can be beneficial. I think this is a good example where our CN-KCS combination with enhanced competition. And obviously, the remedies that -- or the possibilities are 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, we will clearly demonstrate the benefit of this transaction. And we think that we'll do so in a way that recognizes the comments made by Chairman Oberman, on the Executive Order, but also just making sure that we're putting forward. We're not 1 of the 4 railways mentioned that got the order. We're not in an ad group. And I think we have an opportunity to show how this end-to-end, the combination will create more competition, but also really serve customers in a very strong fashion through all 3 countries and really connect the continent. So we think that the Executive Order is -- 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.

[Operator]

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

[David Scott Vernon, Senior Analyst]

So Ghislain and JJ, 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, what's doing better than you could have thought coming into the year? And then how do you think about sustaining that into the '21 to '22 time frame?

[Jean-Jacques Ruest]

So I will add it and Ghislain would add some comments. You will notice on our page where we reaffirmed our guidance that we're using in approximately $0.80 versus the $0.75 that we had originally in our guidance, but today, the dollar is running at $0.78. It's fluctuating quite a bit. It seems to be following the price of crude, which is also very volatile. On the volume, high single-digit volume. The month of July is affected here by the issue in British Columbia. The network is 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 have a bit of a backlog for Vancouver. On the pricing, I think pricing is a strong story. And before the fire in BC, I think our operating metrics, 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 Ghislain, if you want to add something to this?

[Ghislain Houle, Executive VP & CFO]

Yes, 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 in 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 FX and fuel has moved like a yoyo. So 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 it's quite strong. But there's things that are moving out there. So that's what I would add, JJ, that we're comfortable with the guidance, but there's lots of moving parts out there.

[Jean-Jacques Ruest]

Yes. Having said all that, we are reaffirming today our guidance for 2021.

[Operator]

Your next question comes from the line of Scott Group of Wolfe Research.

[Scott H. Group, MD & Senior Analyst]

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 4 years ago in operating income. So I guess, JJ, 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?

[Jean-Jacques Ruest]

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 focused on balanced scorecard with safety, employee engagement, customer sentiment, which is key in things like merger, proceedings, as well as being good custodian 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 it's -- 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 refurnished a bonus. You had all these things. But definitely, we're not aiming -- we're not running the company for the OR, we're in the company for EPS growth, operating income, free cash flow as well as balanced 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 STB 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 there will be probably a very nice tailwind, at least it's our view between the 3 U.S. CMCA countries, and I think creating a network that has good costs, competitive cost with others, but we're not aiming for the lowest cost, we're aiming for this combined balance core kind of we're just talking about earlier starting with EPS, operating income, free cash flow, but also being a good custodian of the environment, customer sentiment, we need a railroad for customers in North America. I think that's basically 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 the job market is tight, and you need to be an attractive employer. So I think it's -- we're putting all that in, and this is partly where you see what the relative weight -- operating ratio fall in.

[Scott H. Group, MD & Senior Analyst]

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

[Jean-Jacques Ruest]

Yes. Sean can address that.

[Sean Finn]

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

[Jean-Jacques Ruest]

And I know, Scott, you read all this material. We're talking huge filing, but our planning 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 Rob and his team filed the operating plan of the proposed combination and how we're going to address concern of shippers and the STB. So we're confident because we did the homework. Thank you for your question.

[Operator]

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

[Brian Patrick Ossenbeck, Senior Equity Analyst]

So I wanted to ask 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 can you make on the network to really get that growth and to see it convert and stay with the CN?

[Jean-Jacques Ruest]

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

[Keith Donald Reardon, Senior Vice]

Sure. And Brian, if you talk to any of our customers about the service that they get in the states, I think when you survey and they talk about the great velocity of the trains and the on-time performance. So I would say that our unique model of having -- 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 low the 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?

[Robert E. Reilly, Executive VP & COO]

Yes, I'd just add, when you look at the combination of the 2 railroads and the opportunities that are there, we've -- it's well documented what we've talked about there. But very simply, 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.

[Jean-Jacques Ruest]

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

[Operator]

Your next question comes from the line of Benoit Poirier from Desjardins.

[Benoit Poirier]

Yes. Just looking at the intermodal volume, 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?

[Jean-Jacques Ruest]

Yes. So I'll start briefing and -- but Keith, who's much closer. So definitely, inventory are lower, retailers and people who need this product coming from other parts of the world are -- the supply chain are disrupted. The things are not working out. So 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, do you want to add some color in your dialogue with those import product?

[Keith Donald Reardon, Senior Vice]

Sure. I think we mentioned this about 4 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, was the how folks are managing their inventories. When we talked to our customers that are bringing products from overseas into North America, they see this continuing on well into 2022. And I think we won't see this whole peak thing 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, 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, Benoit.

[Operator]

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

[Christian F. Wetherbee, Research Analyst]

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 STB begets the 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 able -- 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 -- judge your sort of your position on whether there would be some willingness to kind of negotiate some of those regulatory points obviously brought up in the Executive Order that might come up as the STB goes through the voting trust.

[Jean-Jacques Ruest]

Yes. Maybe I can start. So the -- 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 expressed as expressed by Executive Order because our CN-KCS merger is actually talking about -- we filed 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 -- the gateway will remain open, that the bottleneck -- we will not create a 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, in our view, things which may be -- we're not saying that one leads to the other, but the Executive Order talk about enhancing competition and they also talk about Amtrak. And we have also -- and I'll talk specifically and Sean can comment. So a lot of the things that, in the spirit at least, that's been -- was offered to the Executive Order -- and there was 72 industries, we were just one of them. I mean, we're on track. As regarding reciprocal switching, that's not a CN-KCS issue. I mean that's really -- is in front of the STB. It involves all 7 railroads. And it's not because 2 railroads merge that you actually can change the position on reciprocal switching. It has nothing to do with our merger. It has to do with how the STB wants the landscape of competition as it relates to a specific point in years to come and we'll see if they actually provide the position later this year. Sean, anything you want to add in?

[Sean Finn]

I'll just add one comment about Amtrak. Well clearly, again, referenced in the Executive Order but 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. We at CN have a long track history of having VA run us in Canada, having Amtrak 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 STB application. They're a good example where -- the Executive Order referred to it, but we knew from the outset that would be an area where we have conversations with our passenger service partners going forward.

[Jean-Jacques Ruest]

Maybe, Rob, you could expand also on Amtrak and things we -- 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?

[Robert E. Reilly, Executive VP & COO]

Yes. So we work with Amtrak on a daily basis. As Amtrak runs between Chicago and New Orleans, as interstate service in Illinois, and we run a couple of trains east out of Chicago. In our latest report card from Amtrak, we were rated as one of the top railroads in terms of service. So 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.

[Operator]

Your next question comes from the line of Jon Chappell from Evercore ISI.

[Jonathan B. Chappell, Senior Managing Director]

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

[Jean-Jacques Ruest]

Yes. Rob?

[Robert E. Reilly, Executive VP & COO]

Yes, absolutely. So you're referring, for the rest of them that don't know, Ministerial Order that went into effect at midnight, July 11, following the fires in BC 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 have -- are labeled as extreme fire danger 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.

[Jonathan B. Chappell, Senior Managing Director]

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?

[Robert E. Reilly, Executive VP & COO]

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

[Operator]

Your next question comes from the line David Zazula from Barclays.

[David Michael Zazula, Research Analyst]

Rob, just a question for you. It looks like based on the guide, you're going to need to have 2 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 kind of storage or external and how that's going to potentially affect the fuel efficiency gains you made this quarter.

[Robert E. Reilly, Executive VP & COO]

Yes. Thanks for the question. And we're -- 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 took -- we're in the process of taking on 75 new locomotives or newer locomotives. 25 of those, we've received, the other 50 will 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.

[Jean-Jacques Ruest]

Yes. And maybe also -- I mean, we -- I think a question came up is whether or not railroads are prepared for the fall peak in the U.S. and the winter coming after that. And as we file through regulators in the U.S., we have the crews, we have the locomotive, we have the rolling stock. We're in good shape to meet the need in the economy this fall and next winter.

[Operator]

Our next question comes from the line Tom Wadewitz from UBS.

[Thomas Richard Wadewitz, Managing Director and Senior Analyst]

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'd 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 STB?

[Jean-Jacques Ruest]

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 need to recognize and work with in addressing with solutions, doing 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 the stakeholders, including passenger service and Amtrak. But I think already, 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 -- create a service in that corridor. Do you want to maybe talk about that, Sean?

[Sean Finn]

I think, no. I wouldn't focus too much on the voting trust comments. Obviously, it was in the context of an opportunity to weigh into the voting trust. I think we 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 they might have with the current service. I think Rob addressed it in a very proactive fashion saying, we look at them every day. And again, we will address the impact of the KCS -- CN-KCS 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 passenger services in the U.S. to make sure they understand what we're talking about. And I won't go as far as saying they will 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 the New Orleans effectively where you need to have the required funding to put that in place. So it's great to put [indiscernible] 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.

[Jean-Jacques Ruest]

Yes. 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 positive that the CN-KCS is proposing were actually proposed in writing as part of our work since 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.

[Thomas Richard Wadewitz, Managing Director and Senior Analyst]

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.

[Sean Finn]

Yes, it's important to remember, in the context of the voting trust, these were comments on our petition. So it's not really an area where you enter into a settlement agreement in the context of the overall application 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 of those comments on our response on July 6, including the Amtrak response. But obviously, in the context of the overall control application, that's where we get into settlement agreements with various parties. So it was not really in the context of the voting trust. It's not really an area where that gives rise to that type of agreement. That's done in the overall control application.

[Operator]

Your next question comes from the line of Jason Seidl from Cowen.

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

A quick question. I wanted to go back to the pricing side. I mean you noted that once again, you're able to get even higher pricing than the previous quarter. KCS noted rising rail cost inflation into 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 is an ability on your end to get even -- to garner more than you had this quarter?

[Jean-Jacques Ruest]

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 same-store price for Q1 and the trend of the same-store price in 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 this index. And as you may know, we have very little business that work with index. Maybe you want to talk about the pricing, James?

[James Cairns, Senior Vice]

Yes. You know at the end of the day, the value of our product supports our pricing going forward. We have been very consistent in our pricing [indiscernible] growing cost inflation for several years in that part. But we are very consistent in the marketplace as we're widely supported 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 2 quarters is indicative of what we should expect to see moving forward here, pricing ahead of railway cost inflation.

[Operator]

Your next question comes from the line of Konark Gupta from Scotiabank.

[Konark Gupta, Analyst]

So just a question on BC 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 you see in July be it in terms of your operations or EPS? What kind of impact do you expect?

[Jean-Jacques Ruest]

We -- pricing is not related to speed of train. I don't know if -- Keith, you want to respond to this?

[Keith Donald Reardon, Senior Vice]

Let me take a stab at that. So 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 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 a very fluid situation. But as soon as we have some greater clarity on it, we'll certainly share that.

[Ghislain Houle, Executive VP & CFO]

I would add, Konark, 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.

[Operator]

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

[Steven P. Hansen, MD & Equity Research Analyst]

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 and we, of course, got the drought-like conditions weighing on the current yield prospects out there. And I think we're also even up against a tough counter 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?

[Jean-Jacques Ruest]

Yes, James, we had, what, 14 months, record months in a row, but it's very dry right now.

[James Cairns, Senior Vice]

Yes, 14 record months in a row, as you know, Steven, and for us, that means we're going to finish the crop year here 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. 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. Yes, it's been hot. It's been dry. There's some difficult growing conditions out there. I would say 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 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 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.

[Jean-Jacques Ruest]

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 building their elevators on the CN network.

[James Cairns, Senior Vice]

Yes, it's been very successful with grain supply chain. We've seen over the last 1.5 years 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 and loop tracks. And of course, on our side, a very significant investment in new hopper cars, new high-capacity hopper cars that allow us to ship more product with fewer resources. Just put it into context, based on the new hopper cars that we bought, we can ship the equivalent of 4 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.

[Jean-Jacques Ruest]

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

[Operator]

Your next question comes from the line of Jeff Kauffman from Vertical Research.

[Jeffrey Asher Kauffman, Principal]

Thank you for the explanation of where you stand in terms of the transactions. I just wanted to ask you, you have 2 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?

[Jean-Jacques Ruest]

Yes, Sean is on top of those 2. Sean?

[Sean Finn]

Yes. Both are pending. One is us directly and one is the purchaser have that case pending at the STB. And obviously, we're -- in the case of machine line, we're in conversations with our partner also in the STB to see how we can get this deal approved ultimately. But -- and the other one has just been filed recently. So those are cases that are 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.

[Operator]

Next question comes from the line of Justin Long from Stephens.

[Justin Trennon Long, Managing Director]

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 planned technology investments? And if this is something that could accelerate your technology road map, could you speak to some of the incremental opportunities the merger could create?

[Jean-Jacques Ruest]

Yes, I think Rob can -- 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?

[Robert E. Reilly, Executive VP & COO]

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 railroad 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. KCS has some broad plans as well in terms of portals in that and just combining what we have in place with our portal technology with theirs, we hope we think can make a safer, stronger network. So we do see that as an opportunity here.

[Jean-Jacques Ruest]

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

[Operator]

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

[Jean-Jacques Ruest]

Well, thank you. Thank you for all of you for joining us today. We wanted to cover both our quarterly results and giving you an update on our combination with KCS. I know most of you are quite up today with all of the detail of where we're at in term of our combination. But -- and 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.

[Operator]

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