CP Rail, Kansas City Southern merger clears path for more cargo, but hitches remain

Under the banner of Canadian Pacific Kansas City, the merger of North America's two smallest Class 1 railways became official Friday morning as CEO Keith Creel drove home a platinum spike at a ceremony in Kansas City, Mo.

Combining Canadian Pacific Railway Ltd. with Kansas City Southern Railway Co., the fusion creates the only railway stretching from Canada through to the U.S. and Mexico and marks the continent's first major rail merger in more than two decades after a U.S. regulator approved the $31 billion US deal last month.

It also opens the gate to higher cargo volumes and faster transport, despite several hitches on the network.

"We can control our own destiny for our customers, as opposed to being tied to interchanges or being cut out of markets for the lack of a stronger network," Creel said, in a phone interview from Kansas City.

He pointed to grain, lumber and shipping containers as key areas for growth, including a stronger competitive position against trucking rivals.

"We can operate across the border 24/7 as opposed to the trucks, which are very congested getting to and from Mexico," Creel said.

"But we've got to make sure that we methodically build out this network and don't get ahead of ourselves and jeopardize our ability to be able to provide service to the customers that we're obligated to provide to today."

Stretching from Vancouver to Saint John, N.B., the 142-year-old Canadian Pacific network will now fasten onto KCS at their meeting point in Kansas City. The merged Canadian Pacific Kansas City line snakes down through New Orleans and Houston to Mexico City, reaching ports in the Gulf of Mexico and the Pacific Ocean.

Some hurdles remain, however, including labour shortages, falling freight levels and logistical snags.

Backups on the KCS line north of Mexico City were a periodic problem over the past year, Creel acknowledged, citing labour and railcar capacity.

"That they had some congestion, that they had some challenges with labour, with hiring enough people, with retaining enough people — perhaps so. I think the entire industry has faced that," Creel said.

But he insisted staffing is not a significant issue, with a higher-paying collective agreement to be implemented on several lines before June as an incentive for workers.

"I would suggest that if it was a choke point yesterday, we're going to create a whole lot of capacity," he said.

In the short term, rail traffic is waning amid a wobbly economic outlook for the year. In March, container traffic in Canada dropped nearly 12 per cent year-over-year, according to the National Bank of Canada.

"We see international intermodal as a segment that is particularly at risk of volume declines as retail inventory levels in North America have remained high, which is leading to lower international container imports," said National Bank analyst Cameron Doerksen in a note to investors.

CPKC and its bigger rival Canadian National Railway Co. have both pointed to "continued softness" on container shipments abroad, Doerksen said.

Longer term, the prospects look brighter.

"We believe CPKC will have the most compelling growth of the Class 1 railroads in the coming years," he said.

Canadian Pacific Kansas City broke ground Friday on a new yard office for its U.S. operations centre in Kansas City, Mo., though its headquarters remains in Calgary. CPKC will operate almost 33,000 kilometres of rail and employ nearly 20,000 people.

Despite that vast network, the railway does not own the tracks it runs along between Chicago and Detroit and depends on other railroad operators' lines to move its to cargo across the international border at Windsor, Ont., as well as Buffalo, N.Y. Moreover, the 113-year-old tunnel under the Detroit River cannot accommodate railcars stacked with larger shipping containers.

"I wouldn't call it a roadblock or a nuisance; I'd call it an opportunity," Creel said. CP Rail bought the Detroit River rail tunnel from pension fund manager OMERS for $312 million US in December 2020.

"Five to 10 years out, with the right growth on the network, could we potentially, certainly justify building a double-stack tunnel in Windsor? The answer is yes," Creel said.

But CN Rail, with tracks stretching from Vancouver and Halifax to New Orleans, still offers an appealing alternative to its rival, said railway consultant Greg Gormick.

"The KCS is a pretty rough piece of railway. It goes up and over the Ozarks, it's a razorback railway. If you're looking to get to the Gulf of Mexico, KCS is not the way to go," he said, citing CN's "water-level" route that traces the Mississippi Valley.

Last month's green light from the U.S. Surface Transportation Board cleared the final hurdle in CP Rail's bid to buy KCS.

STB chair Martin Oberman said in March the combined company will speed up freight travel time and encourage tighter competition with the continent's other five railways.

CN Rail had fought a long battle over the acquisition before CP closed the deal in December 2021, placing the KCS shares into a voting trust, which ensured the U.S. railway operated independently during a regulatory review. CN had wooed KCS away from an initial CP offer with a $33.6 billion US proposal in May 2021 before the U.S. regulator rejected CN's bid in August of that year.

CPKC's shares in the railway will remain listed on the Toronto Stock Exchange and New York Stock Exchange under the ticker symbol CP and are expected to begin trading under the new moniker on Tuesday, the company said.

Conditions on the deal include keeping connection points between the CPKC system and other railways open on "commercially reasonable terms" and formally justifying any rate increases over a certain level on interline movements, according to the U.S. regulator.

The agreement also stipulated that four KCS board members would continue on as directors with the amalgamated company: David Garza-Santos, chairman of machinery manufacturers Madisa, based in Monterrey, Mexico; Antonio Garza, a Mexico City-based lawyer and former U.S. ambassador to Mexico; Henry Maier, ex-CEO of FedEx Ground, a subsidiary FedEx Corp.; and Janet Kennedy, former vice-president for Google Cloud's North American region and erstwhile president of Microsoft Canada.

The four appointees will also be nominated for election to the board at CPKC's annual shareholder meeting on June 15, the company said.