Reid Usher
Morningstar DBRS
Canada’s two largest railroad operators—the Canadian National Railway Company (CN; rated “A” with a Stable trend), and Canadian Pacific Railway Company (CP; rated BBB with a Positive trend)—are facing a considerable labour disruption set to begin as of August 22, 2024.
The looming lockout is expected to include nearly 10,000 workers, and could have a significant impact on Canadian businesses and the overall economy. That being said, while the labour disruption will impact near-term shipment volumes, we do not expect the disruption to have a lasting negative impact on the long-term credit risk profiles of Canada’s grain handlers.
Nevertheless, the incident highlights the sector’s vulnerability to rail disruptions and the importance for grain handlers to have adequate railway, infrastructure, and customer diversification to mitigate the associated risks.
Smooth Rail Operations Vital to Canada’s Grain Handlers
Rail disruptions can have a significant impact on grain handlers’ operations. Canada’s grain handlers— including Viterra, Richardson, Parrish & Heimbecker, Cargill, Paterson, and G3—are all highly dependent on Canada’s two large railways: CN and CP.
Once a farmer delivers grain, generally by truck, to a grain handler’s inland elevator, the grain handler moves the grain by rail to its destination, such as the port terminals on the country’s West Coast or the St. Lawrence River in Eastern Canada, for export. As such, any rail disruption has the potential to have a meaningfully negative affect on grain handlers’ flow of operations.
In that context, we note that rail disruptions not only impede the flow of grain from inland elevators to its destination, but they also impede the railways’ ability to return or reposition empty rail cars back to inland elevators.
Negative Effects From Rail Disruptions Can Extend to the Agricultural Economy at Large
Rail disruptions not only affect grain handlers directly, but they also affect associated upstream business, including farmers, as well as downstream business, including food processors. If grain handlers are unable to move grain down the line, inland elevators will ultimately fill up and farmers will have to stop delivering grain, which can add additional challenges around temporary storage if their own permanent farm storage bins are also at capacity.
Irrespective of their ability to safely store grain, if farmers have to stop delivering grain, they don’t get paid, which can affect their ability to purchase crop inputs, such as seeds and fertilizer that are necessary for the next crop. Given the grain handlers’ reliance on farmers to produce grain for them to handle, combined with their role as suppliers of crop inputs to farmers, a healthy farm sector is arguably just as important to grain handlers’ operations as undisrupted rail service.
Similarly, downstream business along the food supply chain, that are reliant on the delivery of grains, could run out of input supplies for them to process. Depending on the duration of a disruption, this could ultimately have a direct impact on the availability and pricing of certain food products at grocers and restaurants.
Disruption Likely to Not Have Material Negative Impact on Grain Handlers
Assuming the potential labour disruption is relatively short in duration, the impact on Canada’s grain handlers should be muted. While shipment volumes will temporarily be negatively affected, considering that grains are not easily perishable, farmers will still need to ultimately deliver grain. As such, we expect any impact on volumes to be more related to the timing of shipments and cash flows, and not result in a meaningful loss of grain volumes and/or earnings.
This is supported by the fact that the railways have been operating well below their maximum grain capacity, and should be able to make up lost shipments at the conclusion of the labour disruption. That said, many of Canada’s grain handlers operate auxiliary processing businesses, such as crushing plants. These operations typically rely on the timely delivery of input commodities by rail. In these instances, a drawn out strike could result in increasingly higher amounts of lost revenues. Nevertheless, we do not expect the disruption to ultimately be material enough to have a lasting negative impact on the long term credit risk profiles of Canada’s grain handlers.
Rail Disruptions Are Nothing New in Canada
Rail disruptions are a recurring challenge in Canada. In recent years Canada’s railways have been negatively affected by fires, floods, blockades as well as previous labour disputes, including the last notable CN rail strike in 2019. This strike was the largest rail strike in a decade and saw more than 3,000 conductors and yard workers stop work for eight days.
It particularly affected those farmers that had access only to inland elevators serviced by CN and those grain handlers primarily reliant on CN for the movement of grain. However, given the potential for simultaneous labour disruption at both CP and CN, the looming lockouts could have a considerably more notable effect.
How Canadian Grain Handlers Can Mitigate Against Rail Disruption Risks
Rail disruptions, because of any reason, can have a meaningful negative effect on grain handler’s operations. This effect highlights the importance of adequate infrastructure, railway, and customer diversification, all of which are key considerations in our credit risk analysis to mitigate the associated risk.
It is outlined in our methodology, Rating Companies in the Canadian Grain Handling Industry (the Methodology), last published in June 2024. Railway diversification (as outlined in the Methodology’s Market Position and Operating Efficiency BRA Factors section)—meaning diversification not only in the railways themselves but also in individual lines and routes between collection, storage, and distribution assets—is a key consideration as greater diversification means a grain handler is less likely to be affected by disruptions related to any individual railway, line, or route.
Infrastructure diversification (as outlined in the Methodology’s Market Position and Operating Efficiency BRA Factors section) is another key consideration because grain handlers whose infrastructure assets, including inland elevators and port terminals, are well diversified across Canada are less likely to be affected by a rail disruption in any particular geographic area as they can turn to grain collected from unaffected inland elevators and/or can divert grain shipments to unaffected port terminals.
However, infrastructure diversification, especially as it relates to port terminals, also requires adequate customer diversification (as outlined in the Methodology’s Market Position and Geographic Diversification BRA Factors section). A grain handler might have port terminals both on the West Coast and in Eastern Canada to service customers in Asian and European markets, respectively. But should its customer mix be disproportionally skewed to one market, the grain handler may be limited in its ability to shift grain that was destined for a West Coast port terminal to a port terminal in Eastern Canada, simply because of a lack of demand.
Reid Usher is the assistant vice-president of Diversified Industries at Morningstar DBRS.
