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As outlook for commodities weakens, CN looks to container shipping to fill the void
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By ERIC ATKINS
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Monday, July 8, 2019 – Print Edition, Page B1


Jean-Jacques Ruest, the head of Canadian National Railway Co., has been thinking a lot lately about the U.S. consumer. As volumes of coal, oil and other industrial commodities fluctuate or wane, Mr. Ruest is leading an acquisition strategy to ensure Canada's largest railway moves more T-shirts, barbecues and batteries.

CN wants to "ride the back of a very strong U.S. consumer, who's got a job, who's spending," Mr. Ruest said. "He may not be generating freight as if he's a factory but he's generating freight because he's consuming products. That freight moves around in a container."

The Montreal-based company has expanded its reach into container shipping with three non-rail deals since October, not including a failed joint bid by the company and a partner to buy a container terminal at the Port of Halifax.

The deals - two container trucking businesses and a container-ship port project - underscore CN's attempt to safeguard its revenues as the business of hauling commodities, such as coal and oil, is expected to see volume declines within a few years.

Its $250-million plan to expand its container business in southern Ontario, however, has run into local opposition and is the subject of a federal review.

CN's planned rail-to-truck container terminal on 160 hectares in Milton, Ont., west of Toronto, was proposed in 2001, dropped, and then resurfaced in 2015. CN says the yard is needed to serve the growing population of Toronto and the surrounding area and to relieve the nearby intermodal yard in Brampton, which is at capacity.

Many area residents and politicians oppose the project, saying it will create noise, pollution and road congestion while adding few new jobs.

North American demand for coal has slumped in part because of tougher environmental rules, and a switch by power plants to cheaper, cleaner natural gas. Carloads of coal pulled by train fell by a third between 2010 and 2018, even as overall rail volumes were little changed, according to the American Association of Railroads, which includes U.S.

operations of CN and Canadian Pacific Railway Ltd.

The percentage of electricity generated from coal in the United States has decreased to less than 25 per cent from nearly 45 per cent over the past 10 years, and coal railcar volumes have followed a similar trend, said Fadi Chamoun, a stock analyst at Bank of Montreal's capital markets unit.

CN's coal revenues between 2010 and 2018 rose by just $60million to $660-million. Intermodal container sales, meanwhile, almost doubled to $3.4billion, accounting for one-quarter of CN's revenue and making it the biggest division by revenue.

Although Canadian crude-byrail volumes recently set records, Mr. Ruest sees a slowdown coming. "At some point over the next two or three years the rail industry will start to lose some of the business that makes us profitable," he said at a recent investors' conference in New York. "As much as crude by rail should be exciting over the next 24 or 36 months, eventually a pipeline will be built and the crude will go back in the pipeline. So two and a half years from now, when ... coal and crude start to slow down, what will we have to make sure we have some growth out there? That's why we have this effort on inorganic growth."

Walter Spracklin, a stock analyst at Royal Bank of Canada's capital markets division, said CN's additions of non-rail assets will "feed the beast," bringing in new volumes of container traffic to a rail network that has spare capacity in Eastern Canada, a region where heavy manufacturing has been in decline for years.

"We continue to view this strategy favourably and believe that these new deals will increase volumes and that these deals complement CN's rail business as opposed to compete with it," Mr. Spracklin said.

CN's recent deals include the acquisition in October of Winnipeg's TransX Group, a trucking company with 3,000 employees, for an undisclosed amount. CN said the privately held TransX strengthens its refrigerated container business used to ship food.

In May, CN bought the container shipping business of H&R Transport Ltd., an Alberta-based trucking company, and later that month joined with Hutchison Ports to reach a deal with the Quebec Port Authority to build and operate a new deep-water container terminal on the St.

Lawrence River. CN did not disclose how much it will invest in the $775-million project, known as Laurentia, but Desjardins analyst Benoit Poirier estimated the amount at about $190-million over several years.

Mr. Poirier noted Hutchison is an experienced port operator, handling some 11 per cent of the world's containerized trade at 51 global ports. However, he noted the port will likely not be operating until 2024.

Keith Reardon, CN's vice-president in charge of the consumer product supply chain, insists the moves don't mean the company is any less interested in the industrial goods it has hauled for 100 years.

"We want to grow the whole economy, whatever that brings to us. Whether it's the consumer economy that is becoming more prevalent in North America or it's the heavy industrial that's done us very well over the years," Mr. Reardon said.

CN has for years been considered among North America's best-performing railways, capitalizing on a long-haul network that touches three coasts and employing the lean, precision railroading model established by Hunter Harrison during his time there between 1998 and 2009.

Christian Wetherbee, a stock analyst at Citigroup Inc. in New York, said the focus on adding new revenues and customers is one that began in the post-Harrison years, and is in line with Mr.

Ruest's background as CN's head of marketing.

"I feel like this is just a continuation of the strategy [although] obviously M&A is new," he said by phone.

He said there is a risk CN's new deals dilute profit margins and operating ratio, which compares sales with costs. Key to this is ensuring CN's expansion doesn't include a new move into the broader trucking business, as opposed to the intermodal part of that industry.

"You don't want to be in a highly competitive, low barrierto-entry business because that would sort of ruin the value proposition of being a railroad," Mr. Wetherbee said. "They're saying all the right things but those are the things you need to watch."

CN is the only railway to serve the ports of Halifax and Prince Rupert, B.C., and shares access at Vancouver with CP and BNSF Railway of the United States.

Much of CN's container business growth has been fed by shipments from Asia arriving at Prince Rupert, which saw container volumes rise by 12 per cent in 2018. Those shipments reach the West Coast port in 11 days, compared with 14 days to Los Angeles and 13 days to Seattle.

And from Prince Rupert, it takes another four, or four and a half days to reach the key markets of Chicago and Toronto, respectively. Due to the railway's path through remote and congestionfree areas, this is at least one day sooner than from the U.S. West Coast ports.

It's the reason why two-thirds of the Prince Rupert cargo volumes are destined for U.S. markets - and the U.S. consumer that Mr. Ruest is banking on.

But the surge in freight volumes has come at a cost - CN last year spent a record $3.5-billion on locomotives, railcars and track expansion to relieve congestion after complaints from customers about poor service.

Mr. Reardon, CN's vice-president, said the recent deals will add container traffic to CN's eastern network, which is underutilized and not at risk of congestion, nor in need of expensive upgrades.

Associated Graphic

CN's coal revenues between 2010 and 2018 increased by $60-million to $660-million, while intermodal container sales nearly doubled to $3.4-billion.

ANDY CLARK/REUTERS


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