Canadian Pacific Kansas City (CPKC) marked its first anniversary with much fanfare, but a deeper look at their Q1 2024 earnings call transcript reveals a less publicized yet potentially more significant development: a strategic shift in freight mix towards higher-value, longer-haul business.

While the transcript overflows with optimism about synergy realization, it also hints at a deliberate strategy to shed lower-margin, short-haul traffic, particularly in intermodal. This move, seemingly counterintuitive in a volume-obsessed industry, appears to be a calculated play to optimize CPKC's unique network and maximize profitability.

Supporting this hypothesis are several key statements from John Brooks, CPKC's EVP and Chief Marketing Officer. He highlights a shift in intermodal business, stating, "lower margin short haul intermodal business running between Mexico and the border [has] shifted off our network, opening up further capacity for growth in our strategic long haul lanes."

This statement alone is noteworthy, but Brooks further reinforces this strategic shift when discussing the quarter's overall volume performance. While carloads declined 3%, RTMs (revenue ton-miles, a better gauge of profitability) actually increased by 1%. He attributes this to "network unlocking longer lengths of haul," leading to an 8% increase in average length of haul compared to the previous year.

This shift to longer hauls isn't limited to intermodal. Brooks reveals similar trends in other merchandise segments, specifically Energy, Chemicals, and Plastics (ECP). He emphasizes "synergies that we are capturing particularly with new wins in plastics, renewable diesel, and refined fuels as we connect the markets between Alberta, the Gulf Coast and Mexico." These long-haul lanes, connecting production hubs with key consumption centers, are inherently more profitable and less susceptible to truck competition.

The strategic shedding of less profitable business is further evident in Brooks' comment about the strong performance of CPKC's flagship cross-border intermodal service, the Mexico Midwest Express. He mentions that the growth on this service "has helped to offset the shift in the short haul business," implying a deliberate trade-off. Since February, this service has seen weekly volumes grow by over 24%, a testament to CPKC's ability to capture higher-value, longer-haul traffic.

Shifting Freight Mix: Volume vs. Profitability

The table below illustrates CPKC's Q1 2024 performance, highlighting the divergence between carload volume and revenue ton-miles, a key indicator of profitability.

This strategic shift to a higher-value freight mix has the potential to significantly enhance CPKC's profitability. Longer hauls inherently translate to higher revenue per ton-mile, and the focus on premium services, such as the Mexico Midwest Express, further strengthens pricing power. While synergies undoubtedly play a crucial role in CPKC's growth story, this underlying shift in freight mix could prove to be an even more powerful driver of earnings growth and margin expansion in the years to come.

Potential Impact of Shifting Freight Mix

The chart below provides a hypothetical illustration of the potential impact on CPKC's revenue based on persisting trends in average length of haul increase.

Disclaimer: This chart is a hypothetical projection based on the 8% average length of haul increase observed in CPKC's Q1 2024 results and does not account for other factors that may influence revenue.

While the market keenly awaits the unfolding of CPKC's synergy story, this subtle but deliberate shift towards a higher-value freight mix may ultimately prove to be the company's secret weapon – a strategic maneuver that could propel CPKC to a new level of profitability and solidify its position as a true industry leader.

"Fun Fact: CPKC's network spans the incredible distance of over 20,000 miles, connecting major economic hubs across Canada, the United States, and Mexico. This makes it the only single-line railway connecting these three nations."