(CanadianBusiness.com posted the following column by Thomas Watson on its website on May 8.)
OTTAWA — For someone who spent his youth partying with Elvis at Graceland, then later revolutionized the rail industry, Ewing Hunter Harrison has done a remarkable job flying below the public radar. Nevertheless, the new American CEO of Canadian National Railway Co. comes across as one heck of a confident Yank–once you finally get him to sit for an in-depth interview. Leaning back on a couch in his Spartan executive office in downtown Montreal, CN’s former chief operating officer freely admits his significant ego never easily fit in any room already straining to contain the one possessed by his old boss, Paul Tellier. “Our styles are very different,” Harrison explains. “I think a lot of people were waiting for a bomb to go off. To both our credit, that never happened.”
Tellier, of course, doesn’t have a profile problem. Indeed, the market didn’t take long to react on Dec. 13, 2002, when he announced plans to unhitch himself from CN to take on the Bombardier challenge. Investors immediately pushed the jet maker’s stock up 8%. CN shares, on the other hand, finished the trading day down 2%. It was a natural reaction. After all, Tellier is the legendary guy responsible for giving CN its dramatic makeover, transforming a basket-case Crown corporation formed in 1919 into a respected publicly traded company. He is also credited with introducing the highly touted “scheduled railway” strategy, a welcome service that reduces the need of shippers to keep backup stock on hand because CN can now quote delivery times in a matter of hours, not five to 10 days like most other Class 1 rail operations.
Ever since news of Tellier’s departure broke, media outlets have pretty much focused on what he can do for Bombardier. The more interesting story, however, may just be what happens back at CN now that its bulldog from Memphis has been unleashed. After all, it was Harrison who actually made the trains run on time. Tellier had to be sold on the idea.
Harrison started his career as a laborer in 1964, oiling railcars for what is now the Burlington Northern Santa Fe Railway. He likes to get dirty, and is comfortable simply running his trains while someone else plays board games. But emerging from the operational shadows is nothing new for the 58-year-old father of two. In 1993, Harrison was thrust into Chicago’s corporate spotlight after landing the CEO slot at Illinois Central Corp.(IC). He had big shoes to fill. Edward Moyers, the former CEO, had done a remarkable job building IC into a model railway. And people naturally wondered whether Harrison could keep up the momentum. His reputation was also an issue. After all, with his “high reward, high risk” personality, Harrison often makes some folks nervous, which is why he says Burlington Northern made the mistake of letting him jump to IC in 1989. “I’m always semi-controversial,” he admits. “I’ve never been a low-key, known commodity that just kind of rocks along. I have lots of emotion, I’m aggressive, hard-driving, that kind of deal.” IC’s board conducted an exhaustive search before giving him the nod. “We knew Hunter Harrison could run this railroad,” one of its directors said at the time. “The question was whether or not he was the best person for the job.”
Today, it’s hard to imagine the hesitation. Indeed, when CN acquired IC for $3 billion in 1998 to become the only “NAFTA” railroad (one that touches Pacific, Atlantic and Gulf of Mexico waters), it bought the most efficient railway in North America. According to Harrison, Michael Sabia, the current BCE supremo, was responsible for bringing him along for the ride. As CN’s CFO in the late ’90s, Sabia forced Harrison to sell him on the scheduled railway concept. That took hours, red wine and lots of passion. “I sold Michael,” Harrison recalls. “He became a believer, a convert.” Sabia then sold Tellier, who offered Harrison the chief operating officer slot while dining in blackout conditions at Montreal’s exclusive Mount Royal Club during the 1998 ice storm. “I told Tellier I only know one way to railroad,” Harrison says. “And I told him that if he was willing to go along, I’d stay and work my ass off.”
Five years later, CN’s board had no doubts about who should replace the outgoing CEO. Harrison had no idea Tellier was about to jump off the train. But as soon as he heard, he knew he’d get the top job. “It was a huge surprise,” he recalls. “I was at home in Chicago. Paul called and said he was probably going to tell the board he was leaving. We were planning on that, but in 18 months or so.” Harrison hung up, whistled, then screwed up the courage to explain to his retired wife, Jeannie, that CN shareholders would need him for a few more years.
On the coffee table in Hunter Harrison’s office sit the biographies of Jack Welch and Arnold Palmer. The man obviously admires a well-deserved ego. His own is justified. Industry watchers fawn over his track record (pun intended), routinely giving him somewhat flattering titles like “God.” And right or wrong, Harrison clearly thinks he can take CN to the next level. Nevertheless, he is enough of a southern gentleman to respect the old chain of command, which is why he won’t come out and directly say CN may in fact be better off with him in charge. He simply hints that personality conflicts will no longer get in his way. “It’s nice to be at the top,” he says, “where you have free rein to do what you think is the appropriate thing to do, to play the hand the way you think it should be played.”
Confidence aside, CN’s new CEO knows he doesn’t walk on water. After all, constant reality checks come from the home front, where questioning the often glowing nature of his press clippings is a semi-regular family sport, one especially attractive to his younger daughter, Cayce, an idealistic 19-year-old who often sees dear old dad as just another stereotypical member of capitalism’s good ol’ boys club. “My family is proud,” Harrison says. “But they tease me all the time. They know the real me.”
The real Hunter Harrison has seen his odd trip to Graceland as a teen grow into a solid relationship with the King over the years. His powers have also been exaggerated. After all, any deity worth his (or her) salt would have prevented political conflicts from creating North American border issues and would have made it rain more often in Western Canada, where a second bad crop year in a row slashed CN’s grain-based revenue in 2002, forcing a painful 5% workforce reduction.
A God-like CEO could have also picked a nicer day for Harrison’s first state-of-the-union address to the few hundred shareholders who attended CN’s annual meeting in Montreal’s Sheraton Centre on April 15. A storm hit the city in the early hours, and the weather remained unpredictable–gloomy one moment, sunny the next–which was fitting in more ways than one. The shareholder meeting, after all, was held the morning after Liberal Leader Jean Charest officially slew (or temporarily retired, at least) Quebec’s separatist dragon, offering and dashing hope in the province at the same time.
More to the point of this tale, April 15 was the day many French-Canadians and other CN stakeholders got their first real look at the grey and gruff English-speaking foreigner who officially became head conductor of the rail industry’s Quebec-based poster child in January. Harrison, of course, is nothing like his bilingual predecessor. A former bureaucrat and academic, Tellier is a smooth-talker with a degree from Oxford. Decked out in gold (watch, cuff links, two rings and a bracelet), the plain-talking Harrison looks like the quintessential American CEO. He’s too straightforward to be a diplomat. He’s got an honor code that doesn’t bend, which is why he simply can’t tolerate people who throw out common courtesy to play political games. (One of the first things Harrison did at CN was threaten to pound the crap out of a labor leader for being rude to Tellier in a meeting. “Not because he was an executive,” Harrison insists. “Because he’s a man.”)
Most of CN’s annual meeting dealt with housecleaning items, the highlight of which was the election of former TD Bank chairman Charles Baillie to the railroad’s board of directors. But when Harrison finally took centre stage, nobody could help noticing just how much things had changed. “Bo ger, Montreal,” he twanged in his best French. Harrison’s key message on that cold, cloudy day was much better. Indeed, after trying to appease Quebec nationalists by pointing out he was moving out of temporary digs at the Queen Elizabeth hotel into a condo in Old Montreal, he spoke in a language everyone understood. He talked money. Come aboard CN for the long haul, he advised, because–with or without divine powers–the sun will come out tomorrow and return EPS growth to double digits by 2004.
Any way you slice it, 2002 was not a great year for railways, even efficient ones. Weak grain shipments and one-time costs related to 1,146 job cuts, and legal claims south of the border, slashed CN’s annual profit by 23% to $800 million or $3.97 per share. Operating expenses jumped to $4.64 billion, up from $3.97 billion the year before, partly due to costs associated with the integration of Wisconsin Central Transportation Corp., which CN acquired in 2001. CN’s industry-leading operating ratio (the percentage of revenue needed to operate and maintain a railway) weakened to 69.4%, up from 68.5%. And shareholders watched CN’s stock tumble to $65, after starting the year at more than $75.
Investors, however, should note that CN still finished the year as the most efficient Class 1 railroad in North America. The average operating ratio of competitors in 2002 was 81%. CN’s free cash flow also jumped 16% to $513 million, allowing the company to boost its quarterly dividend 3.5¢ to 25¢ per share. And there are relatively solid results for the first quarter of 2003, which prompted comments like “Great quarter, guys,” from analysts sitting in on the company’s Q1 conference call on April 23.
Despite the strong Canadian dollar, harsh weather conditions and continued weakness in bulk commodities traffic, CN’s net income for the three-month period ended March 31 was $252 million or $1.28 per share, up from $230 million ($1.15 per share) in the first quarter of 2002. The results include an after-tax benefit from accounting changes. Excluding the onetime item, profit for the period was down 11%. But that’s still a respectable $204 million ($1.04 per share). Intermodal (containers that fit on trucks and trains) sales jumped 13%. Petroleum and chemicals shipment revenue rose 6%. And sales from moving metals and minerals was up 3%. But those gains were offset by a 13% dip in grain and fertilizers and single-digit declines in automotive, coal and forest products. Overall, sales came in at $1.5 billion, down just 1% from the first quarter of 2002.
Expenses increased 2% to just more than $1.1 billion–mainly due to high fuel prices and added costs associated with bad weather, which conspired to push CN’s operating ratio for the quarter to 75%, up from 73.1% last year. Despite a fuel hedging program, the war in Iraq pushed CN’s fuel bill (which accounts for about 10% of operating costs) up about $15 million, or 13%. The second-coldest Canadian winter in 20 years cost the company about $25 million in higher expenses and lost sales. Snow wasn’t the problem. “We can always dig ourselves out, but it is extremely difficult to railroad with 40-below temperatures,” Harrison told analysts, adding that CN was forced to cut train sizes to prevent damage to the brake systems.
Whatever happens this year, CN expects to bring in free cash flow above the $500-million mark achieved in 2002. (Cash flow in the first quarter was $181 million.) Some of that could eventually go toward a bid for BC Rail if it ever goes on the auction block. CN may also soon get a green light from the Ontario government to acquire Ontario Northland Railway, which would add more than 1,000 kilometres to CN’s network. But company officials remain cautious about profit growth. There are positive signs. Soil moisture, for example, has improved in the West, so grain could become less of a wild card. But high fuel costs and the strong Canadian dollar (every cent of appreciation results in a $50-million decline in annual revenue) could continue to drag down results. At best, CN–which became a publicly traded company in 1995–is looking at a flat Q2 and modest profit growth of 3% to 5% in all areas except grain and coal in the second half of the year.
Harrison, of course, sees the first quarter as a good example of CN’s ability to navigate storms. “It’s like going out on a golf course in 15-mile winds and horrible weather and still shooting a 75,” he says. “That’s a whole lot better than a 68 in perfect conditions.” Analysts agree, which is why there are numerous “buy” recommendations on the stock.
Merrill Lynch recently reiterated its “buy” rating on CN. It has a 12-month target of US$50 on the stock based on a 13.7 multiple of its 2003 earnings-per-share estimate. The historical trading range for Class 1 railways is nine times to 21 times forward EPS. Deutsche Bank–which had CN listed as a “hold” when Tellier was still around–is even more bullish. The firm’s lead rail analyst, John Barnes, has raised his 12-month target price for CN to US$51, which represents an 11% gain from the company’s share price on April 23. That target is based on a P/E multiple of 15 times the firm’s 2003 EPS estimate for CN of US$3.38. Calling the first quarter impressive, Barnes notes CN “has traded as high as 16 times one-year forward estimates.”
In Canada, USB Warburg analysts also reiterated a “buy” rating. They called CN (trading about $66 on the TSX at press time), the “best-run railroad in North America, with good free cash flow and the highest profitability and returns.” Their 12-month target is $80, a potential 20% return from current levels. Gary Yablon at Credit Suisse First Boston and Morgan Stanley’s Jim Valentine, two industry-watching heavyweights, also gave CN rave performance reviews.
Harrison, however, doesn’t think CN investors should focus on quarterly numbers, or even future acquisitions. There has been some speculation that he is looking to cap his career by landing the big one that got away. CN and Burlington Northern (where Harrison worked for 25 years) proposed a US$6.2-billion merger in 1999–and got shot down by US regulators. Harrison insists he’ll buy anything, big or small, if it makes sense. But he is not an angler who wants a trophy fish for the wall. “I love this business,” he says. “But I’m not a foamer [someone who foams at the mouth over locomotives] with railroad pictures all over my den.” Rather, Harrison and his wife are avid golfers. So what really turns him on is improving his game.
When Harrison goes to sleep at night, he says he hopes “for peace on earth” to stabilize fuel prices. He prays for good weather to help grain. But he isn’t betting the farm on oil prices coming down or on a huge increase in traditional bulk sales, which made up only 20% of CN’s business last year. “Coal is dead,” he says, noting it accounts for less than 5% of revenue. “And God, the other God, is going to determine what the rain does.” Even with a better crop, he doesn’t think market share will swing two or three points either way between CN and Canadian Pacific Railway in Canada’s regulated railway duopoly.
CN’s game plan is simple. Harrison wants to generate organic growth by continuing to steal smaller service-sensitive customers, such as autopart makers, from truckers and other rail companies by improving CN’s speed and reliability. That’s CN’s top priority. The company currently delivers on time at least 90% of the time, up from 81% in 1999. While he’s at it, Harrison also plans to grow CN’s intermodal business. “Those two areas,” he says, “are the strengths in a scheduled railroad concept.” A master cost-cutter who has reduced CN’s locomotive fleet by 35% since 1997, Harrison will control his margins by continuing to push his ongoing “war on bureaucracy.” He targets things like CN’s annual $10-million courier bill, which the company hopes to cut in half.
Harrison will also continue to chip away at outdated union rules that he says are passed off as “artificial job security.” In union shops, he says, workers and management shoot each other in the foot every day by not trusting and respecting each other. “Guess what happens,” Harrison says, “when we take a union brother who everyone says is the nicest guy in the world and promote him to train master. The next day he has asshole posted all over him. I just don’t believe in that.” CN’s new boss takes his “one big family” message directly to employees in candid town hall meetings meant to bypass union politics, something he started doing in 1986. “I’ll make you the highest paid railroaders in North America,” he promises workers, “if you become the most productive. That’s what the game is all about.” It often works. Last year, for example, CN negotiated employee agreements with two US unions based on hourly (not mileage-based) wages, which enhances both productivity and flexibility.
Despite what his liberal daughter may think, Harrison–who earned $3.3 million last year, down from $5.9 million in 2001–almost seems too human to be a CEO. He cares about nonmonetary issues. He’d like companies to have more of a social conscience, even in tough times. “I’m no tree-hugger liberal,” he insists. “But I’m telling you now, something is happening to our environment. And I am worried for my children and grandchildren.” Quebec and shareholders are lucky to have him, even if he can’t speak French. Sure, Hunter Harrison is a tough SOB who gets paid well. But CN is in good shape, and shareholder value has increased more than his compensation since he arrived in Montreal. So the only open question for investors may just be how long his wife will wait for him on the golf course. Time is definitely a factor. After all, Harrison is already losing the odd round. And that can be hard for even a demigod to take.