CN CEO: Railway 'Not On the Clock' for Choosing Successor

Canadian railway CN will not give a specific time frame for when it will elect a new CEO, and the board of directors will open the search to candidates beyond one recently recommended by activist investor TCI Fund Management, according to outgoing CN President and CEO JJ Ruest. He announced his retirement late Tuesday.

"The board is looking for the best of the best … and so they're not on the clock," Ruest said late Tuesday afternoon on a call with transportation analysts to discuss CN's CNI third-quarter 2021 earnings. While that doesn't mean that the board will take things slowly, it also means that CN will not set a deadline, he said.

The new CEO should be innovative and take risks in a way that embraces technology, benefits customers, and enables the freight rail industry to compete successfully against trucks and "be more relevant to the supply chain," Ruest said.

In response to TCI's criticism and the recommendations it released early this week, Ruest said the plan was "vague" with "no clear target." But he also said that CN's board would be the party engaging with TCI.

Ruest reiterated comments from past earnings calls about looking beyond the operating ratio (OR) as a strategy to grow the company.

Customers "don't buy a rail service. They buy a combination of transportation modes. And therefore, [that means] having technology that makes it easier for them to track and trace and maintain the inventory that they have. It's a little more sophisticated than how low can you go on the operating ratio," Ruest said.

In response to Ruest's retirement, which will take effect in January or whenever a successor is appointed, TCI founder and portfolio manager Chris Hohn said, "This announcement is a clear admission by the Board that change is needed, and we are here to help usher in that needed change as quickly as possible. We have already identified an excellent CEO candidate in Jim Vena [a former executive of CN and Union Pacific], who is available now, and we encourage the Board to meet with him immediately to secure his leadership."

Hohn continued, "In addition, to solve the governance crisis the Board has created for itself, the Board should meet with the four independent nominees TCI has put forward and expedite their appointment to the Board, effective immediately. We also expect that given the history of failed CEO appointments, the Board would welcome the advice, expertise, and participation of TCI's nominees on the search committee. As the Board has demonstrated with this announcement change cannot wait."

Executives on Tuesday's earnings call noted that volumes at the East Coast and Gulf Coast ports that CN services are up by 20% year-over-year amid the congestion at Southern California ports.

"That's a diversification approach by the customers, not only the steamship lines but the people that are in the boxes [containers]. They're saying, ‘I want another gateway,'" said Keith Reardon, CN senior vice president of the consumer product supply chain. "And that's why the CN network is set up so great for that. We've got three coasts: three different ways they can get in. Thirteen different ports. So, that's why we're so happy that we have this network. That's why we're so bullish on the future."

CN also has been able to open up some capacity at the Port of Prince Rupert in British Columbia, providing access to some retailers that have been chartering smaller bulk carrier vessels that pick up freight at a few ports in Asia before dropping it off at a North American port, Ruest said.

Meanwhile, although grain volumes are lower than a year ago, "strong tailwinds" for coal are offsetting some of the losses from grain, according to James Cairns, senior vice president of the rail-centric supply chain.

"Every single segment across the end [of 2021] is going to be growing in 2022, with the exception of our grain business. … I pivot back to say here we're so lucky to have coal as the backfill for grain as we go into 2022," Cairns said.

CN executives reiterated plans to follow through on a September plan to cut costs and increase operating income by $700 million in 2022.

So far, about 75% of the roughly 1,050 layoffs have taken place, with the lion's share in Canada, according CFO Ghislain Houle.

CN also has parties interested in its Great Lakes vessels, and it is exploring the possibility of reducing its interest in trucking company TransX. CN said it had doubled TransX's intermodal business since CN acquired it in 2019.

Third-quarter 2021 financial results

Adjusted net profit was CA$1.08 billion (US$880 million) in the third quarter, or $1.52 per adjusted diluted share, which is a 9.5% increase from net profit of $985 million, or $1.38 per diluted share, in the third quarter of 2020. One Canadian dollar equals 81 cents in U.S. currency.

Adjusted OR was 59%, compared with 59.9% a year ago. Investors sometimes use OR to gauge the financial health of a company, with a lower number implying improved health.

The adjusted OR accounts for $886 million in merger termination fees garnered by the terminated merger of CN and Kansas City Southern KSU. Advisory fees related to shareholder matters and workforce reduction provision costs also factored into the figure.

Reported third-quarter net profit was nearly $1.69 billion, or $2.37 per diluted share, while reported OR was 62.7%,

Revenues rose 5% to nearly $3.6 billion on freight rate increases, higher applicable fuel surcharge rates, and an increase in intermodal ancillary services, offset by a stronger Canadian dollar and lower Canadian grain volumes, CN said. Freight revenue also rose 5% year-over-year.

Operating expenses increased 10% to nearly $2.3 billion amid higher fuel costs and $84 million on transaction-related costs resulting from the terminated merger agreement with KCS.

"CN's dedicated railroaders produced strong financial and operating results this quarter, despite headwinds from severe wildfires in Western Canada that caused a prolonged disruption to CN's mainline to Vancouver in July," Ruest said in a release. "We are proud of the team's efforts and dedication, as well as the progress we are making on executing our strategic plan."

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