Canadian National: The Making Of A Track Star

Canadian National's chief talks about why the railway is the industry's most profitable

As hurricane Katrina was hurtling toward New Orleans, E. Hunter Harrison was overseeing Canadian National Railway Co.'s (CNI ) emergency preparations from his home in suburban Chicago. The company, through its Illinois Central Corp. subsidiary, has hundreds of miles of track and more than a dozen facilities along the Gulf Coast, including a big freight yard just west of New Orleans. Working through the weekend, crews hurried locomotives and other equipment out of the area and then halted all traffic.

CN and Harrison, its 60-year-old chief executive officer, were lucky. The storm took down its intermodal facility near New Orleans, where trailer-size containers are transferred between train cars and trucks. Two weeks later, Hurricane Rita washed out a rail section that had just been repaired. But by Sept. 30 the line was open once again. As a result, industry analysts are sticking with their bullish forecasts, projecting a 31.5% increase in earnings in 2005 and another 16% rise next year.

With 22,500 employees and $5.5 billion in 2004 revenue, CN is dwarfed by the industry's Goliaths. Union Pacific (UNP ) Corp. produced revenues of $12.8 billion last year, while Burlington Northern Santa Fe Corp. (BNI ) hauled in $11.9 billion. But CN tops them and every other major railway in North America in operating margins and total profits, with $1.22 billion in net income last year.

The railroad has also been a rocket for investors. Founded in 1922, CN was privatized by the Canadian government in 1995 in what was at that point the biggest IPO in Canadian history. It then stretched into the U.S. through a series of acquisitions, starting in 1999 with Illinois Central, where Harrison was chief executive. On a split-adjusted basis, the stock began trading at $6.67. Shares closed on Sept. 30 at $70.99.

Timely service is the secret to success. Under Harrison, Illinois Central became a model freight line by running scheduled service, a surprising rarity in an industry known better for low costs than punctuality. Copying passenger railroads and airlines, Harrison guaranteed pickups and deliveries to the hour, even across thousands of miles. He introduced the same plan at CN when he came on board as chief operating officer. Today the Montreal-based railway is No. 1 in efficiency.

Harrison, who was promoted to chief executive in 2003, is a railroad man from way back: He hired on as a laborer with St. Louis-San Francisco Railroad Co. in 1963 when he was still in high school in Memphis. Today, he splits his time between CN's headquarters in Canada and an office outside Chicago. He recently discussed Katrina, and the future, with Senior Correspondent Michael Arndt. An edited transcript follows.

Let me start with the hurricanes. You've just been through two of them in three weeks. How are you faring?

We were very fortunate compared to others. We're on higher ground in New Orleans. We did have some outages because of Katrina, for about a 30- or 40-mile stretch north of the city. And we lost six or eight miles of that again because of Rita. Grain shipments have slowed down because of disruptions to employees, power supplies, and communications lines. There's still not a lot of activity at our intermodal facility in New Orleans, frankly.

But from a financial standpoint, it's a non-event. Most of the revenue loss is more of a timing issue. For example, grain. We're still going to haul the same amount of grain -- it's just going to move later than usual. There's a little more that will fall over into the fourth quarter instead of the third. By the end of the year, it will all be a wash.

Longer term, some economists think the hurricane will be a boon to the economy as reconstruction proceeds.

I don't think there's any doubt about that. We're the largest hauler of forest products in North America. I would imagine there will be a lot of building products moving into the New Orleans area for the reconstruction, so we're making preparations for that. We're looking at putting in new infrastructure for transferring lumber from railcar to truck, somewhere in the New Orleans area.

We're also doing a lot of exploring for potential opportunities to remove debris out of New Orleans. Somebody has to haul the debris. I don't know who will want the stuff. That'll be quite an issue because of environmental concerns, but we're there and positioning ourselves.

What about the economy?

It is not quite as strong as it was 18 months ago. But there's pretty steady growth right now. The only soft spot is the auto sector, and we anticipated that. Our business is going well. We're exceeding our revenue expectations for the year.

Are there any issues that -- pardon the pun -- could derail you?

Energy prices worry me because of the impact on the economy. We have been very successful with our fuel surcharge and hedges. Basically, fuel is a pass-through for us. We adjust our charges every month based on average diesel fuel prices, so our customers pay fuel costs, not us. All of the railroads have surcharges that are similar.

But the longer-term implications of rising energy prices do give me concern. Obviously, somebody has to foot the bill.

Your company is growing, as you noted. Is that because the economy is growing, or are you taking market share from other railroad companies and trucking?

It's a little bit across the board. We have made market share gains over the past five years. Most of that, we think, is the result of our service, which has become more competitive and more consistent. If you're asking for shipment from Toronto to Baton Rouge, for example, we'll quote it at 103 hours, not six to seven days. And we consistently are on time 92% to 93% of the time.

That change of service has given us the ability to capture share that we had previously lost to the highway.

I had thought that over the years trucking was eroding rail's market share. So rail is starting to take that back?

I think there's a turnaround. Particularly at Canadian National, that has been the case over the past five to six years. We move a lot of bulk goods like grain and coal. But we're different from most rails, where most of what they carry is bulk. Eighty percent of our business is nonbulk, such as lumber, consumer goods, steel products, and chemicals, and trucks certainly are competitive for most of that business.

CN has done a number of acquisitions, starting with Illinois Central. Is there much left to acquire?

Not much. There are some regional short-line carriers. But the opportunities are not like they used to be. When I first went to work, there were probably 50 Class I railroads. Today that number is seven.

That said, if there were two carriers that decided they would like to get together, I don't think a combination would run into antitrust issues. We think we're pretty good railroaders, and we're pretty disciplined in our acquisition strategy. If we can acquire rails and extend our reach at the right price, we'll continue to do that.

You have been in the rail business more than 40 years. How did you originally get into it?

I was just an 18-year-old kid looking for a place to work, and the rails paid more money than anybody else. I was fortunate to be at the right place at the right time. A rags-to-riches story? I know the rags; I'm not sure about the riches.

What are the most significant changes you've seen over your career?

Probably the most significant was the deregulation of the rails with the Staggers Act of 1980. Before that, the rails were struggling and it was not a lot of fun in the business. The second was probably the megamergers of the 1990s.

CN is a Canadian company. You are an American. Has that raised any problems for you?

I think a few people would like to see it otherwise. But we like to think of ourselves as a North American company. It has worked very well for us.

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