2020 has been a tough year for Canadian railroads. Anthony Okolie talks with David Mau, Portfolio Manager, TD Asset Management, about why there are reasons for optimism for the sector, and how Canadian rail companies can get back on track.
David, there's been a lot of media attention on railways since the COVID-19 pandemic hit, and there's been a lot of talk about airlines, about Tesla, but not rails. What's been going on with railways lately?
- Hi, Tony. Yeah, look, railways aren't something that people tend to think too much about because generally they're not very visible in our everyday lives unless, like you said, we see something on the news about an accident or a labor strike. But other than that, railways tend to not attract too much attention.
However, the rail network in Canada and across North America is one of the most important pieces of infrastructure that we have, and the continuous smooth operation of these railways is critical to the economy. Now, if we think about it, most of the goods that we consume are not made locally. So that means the clothes that we buy, the tech gadgets that we love to use, and even the food that we buy from the grocery store are imported. And that needs to come either from south of the border or overseas.
Now, one example that I like to use sometimes when I talk about this topic is your phone, your smartphone. You, like most people, probably have an iPhone or a Samsung phone. Well, those phones, they're not made here. They're made in Asia, right? IPhones are assembled in China. Samsung phones are made mostly in Vietnam.
So think about what happens to that phone before it gets into your hands. It gets on a boat. It has to sail across the Pacific Ocean. It arrives at a port somewhere on the West Coast, probably in California. And then from there it needs to get on a train and travel across the country to a distribution center or a warehouse nearby before it gets sent by a truck to your local Rogers store or your local Best Buy. And that's where you pick it up, right?
So without that crucial rail link, getting the phone is not going to be impossible, but it might take longer, and it's probably going to cost you more.
- Let's talk about some of those products that are being transported. What are the products being transported by railroads versus, let's say, trucks?
- Well, it really depends on the length of the haul and the volume of the stuff that's being transported, right? So when we're talking about moving large quantities of goods and merchandise over a long distance, shipping by rail is typically a lot more cost efficient than shipping by trucks. So that means as consumers, we're able to have a wider selection and a lower cost when we go shopping.
Now, where trucking has an advantage is trucking is a more direct mode of transportation. It can offer more flexibility. And for shorter hauls, it can potentially shorten the transit time.
Now for us here in Canada, a lot of our natural resources are exported to other parts of the world. So things like Canadian grain and wheat, our other commodities like potash, base metals, and coal, all of these things need to get to a port either on the West Coast or on the East Coast so that they can be sent by ships to overseas destinations.
And the rails are really the only way that these commodities can get to these ports, so a smoothly running rail network is critical to our economy. Without the rail network, our economy would be severely impacted.
- I want to touch on the economy as well because railroads can be seen as a leading indicator for the economy. What are the railroad numbers telling you or saying about the economy?
- So for the first seven months of the year, total car loads across North America fell by about 12% to 13%. That number was a little less in Canada and a little bit more in the US. However, it wasn't a straight decline across the board. As you know, the COVID pandemic didn't really start to impact us here in North America until around March.
So for the first two months of the year, rail volumes were pretty stable. They were kind of normal. And then we saw a very sharp decline in March and April.
Now, the good news is what the rail companies are telling us is that volumes look like they have hit a bottom in late April and early May, and things have picked up since then and are continuing to improve. So I think that's a very good indication that demand in general is picking up, which points to an improving economy.
- And given the cyclical nature of this business, what do you see as the biggest threat to the recovery?
- Yeah. Like you said, rails are a cyclical business, so the biggest threat is if the economy deteriorates or doesn't grow as much as people expect, which means there would be less demand for ground shipping. Now, I would counter that by pointing out too how well the rail companies have adapted over the last few months to the declines that we saw as a result of COVID and how quickly the rail companies have been able to right size their business and cut costs.
Now, another longer-term threat is the potential for autonomous electric trucks. I mentioned before that shipping by rail is typically more cost efficient than shipping by trucks, but if we ever get to the point where electric trucks become viable and these electric trucks don't need a human driver, we could see that cost advantage shrink over time or even completely disappear.
Now, there is one part of the business for rails that I don't think will be disrupted by trucks, and that's the bulk commodity shipping that I mentioned earlier because I just don't see how electric trucks are going to be able to transport 200 carloads of grain or coal more efficiently than one single locomotive.
- And what's been the performance year to date for Canada's two major railway stocks?
- Well, the two Canadian railway stocks, CN Rail and CP Rail, have both performed actually really well year to date. They've actually been a couple of the best performers on the TSX this year for large-cap stocks. They're both up about between 16% and 18%, let's call it, while the TSX today is still down a couple of percent. And over any longer time period, the rails have outperformed the TSX by quite a wide margin. So whether we're talking about five years, 10 years, 15, or even 20 years, rails have done better than the broader market. And, in fact, both CN and CP have outperformed the TSX by more than 1,200% over the last 20 years. So for investors who like to play the long game, they've been rewarded very well for sticking to a buy-and-hold strategy when it comes to the rails.
- And we just have about a minute here, but for investors that might want or have interest in getting some exposure to the sector, what's your outlook for transportation going forward?
- Well, for the rails, we're still pretty positive going forward despite the strong performance year to date. Both CN and CP have a really strong track record of generating positive shareholder value over time, and I think that's going to continue. In fact, both companies raised their dividends this year despite the COVID pandemic. So I think that's a good indicator of just how confident these management teams are in the outlooks for their businesses.
- David, thank you very much for your insights and analysis.
- Thank you, Tony.