Canadian National Railway Co (CNI) 2008 Q1 法說會逐字稿

I would like to remind you that today's remarks contain forward-looking statements within the meaning of applicable securities laws. Such statements are based on assumptions that may not materialize and are subject to risks described in CN's first quarter financial results press release and analyst presentation and year-end 2007 management discussion and analysts' documents that can be found on CN's website. As such, actual results could differ materially. Reconciliations for any non-GAAP measures are also posted on CN's website at www.cn.ca.

Welcome to the CN first quarter 2008 financial results conference call. I would now like to turn the meeting over to Mr. Robert Noorigian, Vice President, Investor Relations. Ladies and gentlemen, Mr. Noorigian.

Thank you for joining us today. I'd like to remind you what you already heard, that today -- regarding our forward-looking statements. With me today are Hunter Harrison, the President and Chief Executive Officer of CN, Executive Vice President and Chief Financial Officer, Claude Mongeau, Executive Vice President, Marketing and Sales, Jim Foote. After the presentation, we'll take questions from those of you who are listening on the phone and would you please identify yourself and would you also please try to limit the number of questions that you're asking to two. With that, it's now my pleasure to introduce CN's President and Chief Executive Officer, E. Hunter Harrison.

Thank you, Robert, appreciate it. Thanks to all of you for joining us this afternoon. Thank god, it's springtime. You're going to hear a lot today about our performance first quarter, and Claude and Jim are going to kind of break it down and take it apart and help you understand better. But clearly, I thought last year was a bad winter. This year went far beyond and I guess, as we've been discussing this internally with our management team, the one thing that I think marks this winter to some degree different than others is we had weather everywhere. In the past it's either been in the west or it's been in the east or it's been in the U.S. But this year, we had record snowfalls, I think I'm correct, in Quebec, Ontario, Michigan, Wisconsin and northern Illinois, and extremely, extremely cold weather in Western Canada in the 40 below range and I would remind some of you that 40 below is 40 below, the same -- it's cold. Even to the degree that for about 48-hour period, we felt like the prudent thing to do was to stop -- close the railroad down because we were running trains and making brake applications and couldn't get the brakes to pump or release.

And in face of those things and some of the other headwinds that Claude and Jim will speak to you about, I was very, very pleased with the performance of these 21,000 railroaders. If you looked at our top line, it was up 1% reported despite the weather and economic challenges and Jim and Claude will talk about the impact of foreign exchange. There was a 2.3% deterioration in operating ratio, which is basically an effect of the weather. If you look at this quarter compared to last year I think we talked about C$0.03 or so weather impact and then so much impact on -- as a result of the strike last year and this year it's effectively all negative impact of weather and this is like comparing with -- if there is such a thing as a normal winter like we experienced in 2006, so we were effectively flat but I would remind you flat over 2006, which was a world record year for us. Our diluted EPS was C$0.64. So all in all, all in all, that's behind us, although we are -- we're having some -- a little issue with hopefully the last of the weather in Western Canada as we speak.

But the railroad is back, humming, it's back at metrics that exceed where we were in fourth quarter of '06 when we had our best performance and I think Keith and the operating team have some initiatives in the pipeline that I'm very pleased about, and so I'm looking forward to a bang-up second, third and fourth quarter and with that, let me turn it over to Claude to further analyze some of these numbers.

Thank you, Hunter. Overall, it was a challenging quarter but we performed well overall. Despite the severe weather and the significant weakness in some sectors of our business, we delivered 9% revenue growth FX adjusted. As Jim will describe it to you more fully, with volumes essentially flat, the growth came in from good pricing and fuel surcharge recovery. On the expense front, our costs overall on an FX adjusted basis increased 11%, this was driven by a whopping 56% increase in our fuel expense, increasing our operating ratio by roughly 2 percentage points. If I exclude fuel, expenses increased only 2%, and that's despite the weather impacts which I'll describe a little bit more fully. With this background we delivered C$0.64 EPS which is up 2% over last year. This includes a C$0.02 benefit on the tax front but very solid performance. When you consider all the challenge we faced, this year the FX impact is an increase, foreign exchange, the Canadian dollar went from $0.85 to a $1.00; that has an impact of around C$0.06 on our EPS. The weather would have been something in the order of C$0.08. The lag in the fuel surcharge recovery would be another C$0.02. So when I step back and I look at the results, even adjusting for last year's strike and weather impact, our EPS could have been up on the order of 10% year-over-year and the operating ratio could have been flat as opposed to deteriorating the way it did. So all in all, good results in a challenging environment.

Let's turn to expense. As I said, FX adjusted, overall expenses are up 11%. The main driver is the 56% increase in fuel expense. WTI per barrel was just under C$100 during the quarter, up from C$58 last year. But that's not the whole story. The crack margins were also up significantly. They widened from around C$11 last year to C$17 during the first quarter and as we speak, crack margins are above C$20, closer to C$23 per barrel. Labor expenses were very well behaved. We had the benefit of lower pension expense which helped us to offset the high wages and the slight increase in our headcount. We had lower accident and settlement costs and also better run rates for personal injury at a cost which helped us reduce our casualty and other expenses by a full 9%.

Both our purchased services and equipment ramp were up. They were partly impacted by the tough weather conditions. In the case of purchase services and material, obviously the more snow removal we have to do and some of the other impacts to the equipment had an impact in terms of material, wheel consumption, other such issues. Our ramps were impacted also by slower velocity to our car fleet. I would say combined in those two categories, the impact of weather would be in the range of an increase of about C$15 million in our expenses.

The depreciation is also up 7% on an FX adjusted basis. This is due to our normal CapEx spending but also the impact of our recently completed depreciation study. That study will have an impact on an annual basis of increasing our depreciation expenses by roughly around $20 million. So with winter behind us, we're now focused on fluidity and productivity and delivering the business that's in front of us.

Quickly, if I turn to the free cash flow side, you'll see that we generated $61 million during the quarter. That's a significant increase over last year. But the increase is really driven by a swing in our cash taxes. If you recall, in 2007 we had C$430 million of cash tax payments, so that's a swing of roughly C$340 million on a year-over-year basis. If I exclude this swing, we actually lost ground a little bit on free cash flow mostly because of working capital. We have seen a little bit of an increase in our inventory, but more importantly a slowdown in our collection cycle of a couple days against what was last year very, very strong performance.

During the fourth quarter, we bought 7 -- I'm sorry, during the first quarter, we bought 7.3 million shares for roughly C$370 million. As a result, our debt ratio is starting to inch up a little bit as we had guided and as expected to 42.6% total debt-to-cap.

Let me just wrap up to say a few words about the outlook. As I said, it's been a challenging start to the year. The weather now is behind us. The economic weakness in a number of sectors, particularly forest products and automotive, in particular, are giving us a sense that the economy is a little bit in neutral, perhaps even in a mild recession in the first half, but we are hopeful that the second half will see a gradual recovery and we're also seeing the global economy continuing to grow at a moderate pace.

We are dealing with a significant amount of volatility, both on the Canadian Exchange, but also, more importantly, on fuel prices. As you all have witnessed, the fuel price is hitting record after record and was above C$117, last I checked. So we are calling for the full-year fuel price to be much higher, in the range of C$105 per barrel. We have taken down a little bit our outlook for the economy, from 1.7% GDP growth for the full year, to something closer to 1% for the full year. And with that environment, we will be focused on maintaining our top line growth initiatives, our tight cost control, and we are now targeting for the full year EPS growth in the mid single digit range and free cash flow of around C$650 million. It's tough to call the economy -- it's tough to call some of this volatility, but you can count on one thing. This team is focused on delivering results and overcoming headwinds for the full year. And with that, I'll turn it over to Jim.

Thank you, Claude. As usual, when I go through the revenues, I'll do so on a currency adjusted basis. In the first quarter, in that format, our revenue grew 9%. Our volumes were flat, carloads flat with last year and revenue ton miles increasing at about 2%. These lower than expected volumes reflect the harsh operating conditions we faced in the first quarter, as well as softness in certain markets, especially in forest products. The pricing environment remains strong. On a same store prices basis, on a per unit basis, we increased over 4% versus the first period last year. About half of our revenue growth in the quarter came from the results of our fuel surcharge program, which were up due to the higher crude oil prices.

Going down the various commodity groups, petroleum and chemicals up 15%. The petroleum group was up 19%, where the markets there continue to be very strong. Growth in various segments there are the diluent volumes growing in the oil -- into the oil sand regions, sulfur shipments, very strong as into both the export markets and into the U.S. due to the high price of sulfur and great global demand. Biodiesel shipments in the Gulf Coast region, shipments of heavy fuel oil in Western Canada, partially offsetting those results, lower shipments of plastic pellets and their associated feed stocks. On the chemical side, up 10%, chemical revenues really were very good, driven to a large degree by imports of -- through the methanol through the port of Kitimat and strong chlor-alkali shipments tied to pulp manufacturing. These were somewhat offset by lower industrial chemical, side panel construction and auto production.

Metals and minerals, there a very good quarter as well, up 14%. Metal shipments boosted by strong demand and good commodity prices for flat rolled products, such as steel slabs and plates. Aluminum and zinc volumes and revenues also very good in the quarter. In the minerals side, we benefited there where we in that segment recognized the revenue from big shipments, dimensional loads, which continue to be very strong. But some softness in that area as well, with construction materials, cement, gypsum, roofing materials being down, again, related to the lower construction activity. Iron ore continued the trend that we've seen over the last few quarters, up in the first quarter, up 8%, in fact.

Shifting over to one area where we continue -- have continued to have softness, the forest products. There, lumber and panel producing customers continue to face these difficult markets and are rationalizing their capacity and curtailing production in order to downsize to the level to try to determine where the bottom will be with the U.S. housing market. On a carload basis there, our lumber was down 23% and panels down 35%.

On the other side of the house, paper, down in that segment, basically due the closure of a significant paper mill in eastern Canada which went down in the fall of last year. And wood pulp demand continues to be very strong.

The other area where we had some softness in the quarter, automotive, down 2%. The automotive results came in lower from last year, despite some very strong imported vehicle traffic, primarily through Vancouver, which was offset by some declines in lower production from one of our larger customers due to labor issues.

Let's switch over to the bulk side, which across the board continues to do very, very well for us. In the coal side, up 19%, driven by coal Canada, up 42% in the quarter. Again, strong demand for metallurgical coal to export markets and the development of a new mine capacity in Western Canada helped those results. Coal U.S. on the other hand, down. Illinois Basin coal down this quarter, really a short-term production issue there with one of the mine operators affecting that. Grain and fertilizers, also up very good in the quarter, 19%. U.S. grain business, soybeans moving to export markets, very strong, as well as meal for feed markets propelled those results. Those were somewhat offset by some lower corn volumes moving down to the U.S. for export.

In Canada, on the grain side, lower volumes of wheat for export but that was offset as there was a larger shift in barley and canola moving to those markets and the continued strong performance on the fertilizer side, potash carloads up 21% over last year, driven by continued strong demand for fertilizer into the U.S. Intermodal, up 14%, the first full quarter of operations of Prince Rupert helping that to drive that on the overseas side of the business, as well as larger vessels making calls in Vancouver. Partially offset by some declines on the East Coast in Halifax, where two steam ship companies there have reduced their volumes there, rationalizing their service and good demand on the domestic side, primarily as a result of new customers that we've secured from the highway in Canada.

The other revenue also up strong, reflecting the strength of our non-rail transportation activities there, the new, more intense focus on growing those businesses is staying in line with the growth rates we've talked about in the past.

Moving forward, taking a look at the market outlooks slide, just breaking down kind of the trends, whether things are more negative to positive. You don't see much different in the outlook from what we saw in the first quarter, with continuing issues associated with the housing markets in the U.S. driving the forest products segment down, as well as some issues associated with autos at this point in time. But all in, the rest of the business segments look very strong, especially our bulk franchise, which shows tremendous opportunity for the year.

So, and the last slide here, obviously the solid pricing environment which we've talked about, price increases in the range to 4 to 5%. I see no reason to deviate from that expectation. Our challenge and our focus is on growing the volume and the outlook for the remainder of the year is to continually move towards more positive carload growth in each of the quarters, as we move forward, driven, again, by strength in these segments, these non-housing, non-auto related business groups and we're confident or I'm confident we should be able to achieve top line growth for the remainder of the year, for the full year in the -- on the currency adjusted basis in the range of 9 to 10%. With that I'll turn it over to Hunter.

Thank you, Claude and Jim for those informative presentations. Well, winter is behind us. It's time to move on. I'm very encouraged by the opportunity that we have for growth prospects, especially that Jim mentioned with the exception of those two sectors, the auto and the forest products. As Jim indicated, we see the pricing momentum continue to go forward and some real initiatives on the operating side. We are now -- most of our metrics are at record levels. There's additional opportunities to go forward. We've just -- Keith and the operating team have just completed a revamping of the U.S. ops and have had significant improvement in Michigan, Battle Creek, Fond du Lac, Stevens Point, we have opened the new yard in Memphis early, although we only have about half the tracks in service, but we're getting ready for it to kick in in December, hopefully. We have some new initiatives in Western Canada with BP Power, so it looks -- things look very positive and a lot of opportunities going forward. So I am very encouraged and very bullish on the remainder of the year and Mary, with that, we would be happy to answer questions the group might have.

Thank you. We will now take questions from the telephone lines. [OPERATOR INSTRUCTIONS] There will be a brief pause while participants register. Thank you for your patience. The first question is from Ken Hoexter from Merrill Lynch. Please go ahead.

Hi. Good afternoon. Just looking on the cost side a bit, it looked like casualty jumped up but Claude, I don't think I caught it. You were talking a bit about the impacts that weather had on the line item. Can you maybe review that again?

Actually, Ken, casualty and other is down this quarter, about 9%, if I adjust for exchange and that's really a reflection of better personal injury run rate and also better safety costs. We are getting some benefits in terms of lower accident costs, fewer accidents, less severity and that's been driving the casualty and other down somewhat on a year-over-year basis.

Okay. That's true. That was on year-over-year. If I could do a quick follow-up, sorry, Claude. Same thing on labor and fringe, I see that's down about C$20 million year-over-year. Can you just relate any of that, because did you pay through the work shutdown? Are there any kind of savings you get because you had stopped the operations for a couple days?

No, actually, no, because when you -- you still pay for your employees through these periods. No, what the impact there, again, if you adjust for exchange, our labor and fringe expense is flat on a year-over-year basis and big picture, we've had obviously the cost of higher wages and we have about 2.5% increase in our headcount year-over-year. But that's been offset by other initiatives and including lower depreciation -- lower pension expenses, I'm sorry.

Thanks, Claude. I appreciate it.

Thank you. The following question is from Tom Wadewitz from JPMorgan. Please go ahead.

Yes, good afternoon. Let's see. I wanted to follow up a little bit, Claude, on the comp and benefits just to make sure I understand it, if I could get some thoughts on kind of how to look at the year-over-year going forward. Was there a meaningful reduction in incentive accrual that would have affected the per worker cost, in addition to what you described on I guess the currency impact on the per worker?

No, I think on a year-over-year basis, in the first quarter our incentive compensation accruals were roughly similar on a year-over-year basis. And so really, I think you have to be careful. If you look at the per worker, make sure you use your end of period number of employees, because obviously last year there were at least two periods when we -- the striking employees were not in our accounts. So I think that is really distorting the numbers on an FTE basis, on a year-over-year basis. But big picture, our pension expense is down on a year-over-year about C$18 million, wage and the fact that we have a little bit more employees is offsetting that benefit and that's why you see flat labor expense on an FX adjusted basis.

Okay. And so if you look forward, when maybe FX is a little less of a year-over-year impact, then kind of flattish type numbers is a reasonable way to forecast it. I guess that won't be the case until maybe later in the year though, when FX is less of an impact.

I think Q2 you should expect a very significant FX headwind if the dollar stays at parity. So it's only toward the back end of the year that FX will no longer be an impact. But as far as we're concerned, the -- our pension benefits will continue throughout the year. Our focus on productivity, reducing overtime now that we're out of the winter will kick in and we expect the labor expense to continue to be well-behaved.

Okay. And then the follow-up and I'll pass it along, in terms of your guidance you talk about some expectation of improvement in second half '08. Is that baked into the guidance to get to your numbers you have to have some economic improvement later in '08, or is that -- you're not really expecting it within the guidance?

Actually, we're guiding for the economy for the full year to be about 1% GDP growth and we think the first half is probably contracting a little bit. So that we need a bit of a recovery in the second half, which I think is likely. My sense is that the fiscal stimulus that the U.S. Government has announced, I think the fact that -- I'm hopeful that some of the issues we're seeing in the housing sector will not be too much contagion beyond this sector and we hope that we'll bottom out in the first half and gradual recovery in the second half for full-year economic growth of around 1%.

Okay. Great. Thank you for the time.

Thank you. The next question is from William Greene from Morgan Stanley. Please go ahead.

Yes, hi. Hunter, I'm wondering if you can comment at all, do you think perhaps parts of the network are maybe too lean because I was surprised it took as long as it did to kind of recover from some of this weather. I realize it's quite severe, but do you think maybe you've gone too far in that regard.

I don't think so, Bill. I'm not sure what you mean by recovering. Took long to recover. I mean, we're going through a snowstorm as we speak today. It's virtually behind us, but I thought we bounced back awful quick, when you shut the network down for two days, it takes a little while to recover. No, I think that we have -- if you look across the board, we are up engineering because we are -- we have brought work back in-house that we had contracted out. Most of the savings in the mechanical numbers, there's fewer locomotives in service. There are reductions on the car department side, on the car inspection side, where we did studies, our productivity on the train side is up. So no, I'm very comfortable where we are. In fact, we might not be lean enough.

Okay. Can I ask also on the grain front, how concerned should we be about some of these press reports we see about grain, investigations into the grain rates and this sort of thing?

I don't know. Number one, we just went through a change with the cap as a result of the review of maintenance. We responded to that. You know, there's always going to be some political noise going on out there from time to time. At this point, I'm not that concerned. I mean, if you look at the price of wheat, which is at record levels, to look at doing something further with railroads, just doesn't make any sense to me. But so I'm not concerned beyond where we are today. We were disappointed and we appealed the retroactivity of those increases and we have raised issues of creeping reregulation, but that's just to send a signal that we've got our eye on the ball here.

Okay. Thanks for your help.

Thank you. The next question is from David Newman from National Bank Financial. Please go ahead.

Good afternoon, gentlemen.

Hi, David.

If I look at your balance sheet, you've still got a great balance sheet and the best credit rating in the railroad. And your guidance for the year, does it include an elevated level of a buyback or how are you thinking about the buyback in the second half?

Our buyback will be completed, the one, the current one that we have will be completed at the end of the second quarter. And then we will come back most likely with another buyback program for the balance of the year. And that's something we'll discuss with our Board. At this point in time, we do have the EJ&E acquisition to finance, hopefully before year end and we'll be looking at using our cash flow in line with that, with the guidance that we provided before.

Okay. So for modeling purposes, Claude, we should probably just continue on at sort of the same rate that you're going at right now.

Perhaps a little bit less, given the EJ&E acquisition.

And if I look out, obviously C$117 oil costs, how is it looking out there with rail versus trucks? I mean, I have to think that some of your shippers might be knocking on your door real soon. Are you winning any share out there and are the truckers pricing below variable costs on the back hauls and things like that? How is the competitive market versus the trucks right now?

Clearly, the advantage right now is to the railroads as the prices go up and we are more efficient and as I said earlier, our domestic intermodal is probably the area where it comes on the quickest and there the opportunities are very good for us and expect that we'll capture more and more from the highway as we go forward.

Last one, if I may. Jim, you sort of alluded to obviously the CN WorldWide. Where do you stand on the CN WorldWide? Where do you feel you've got critical mass? Is there parts of the supply chain that you think you need to bolster more? How is that whole initiative going in terms of building the end-to-end?

It's doing very well. We have two components there. One is the CN WorldWide International piece, which is our international freight forwarding business, which is on track with our expectations for the year to grow that little business that we're starting up there, to about C$100 million company. The other North American operations, our trucking, warehousing, bulk trans load capabilities is on track there as well and we've just signed up a new good piece of business out in the oilsands there to manage the logistics and haul in and trans load and deliver large quantities of aggregate for the development of the upgrader development projects, related to the oilsands. So there, everything is on track and we're very happy about the performance of those businesses and especially the 14% revenue growth in the quarter.

How scalable is it, do you think?

It's very easy to adapt and expand its footprint. Consistent with the principles of the way we run the rest of the Company, is the way we run that and we're very confident that we can overlay that business model in many, many different segments of the business.

Excellent. Thanks, gentlemen.

Thank you. The following question is from Ed Wolfe from Wolfe Research. Please go ahead.

Good afternoon, guys. Can we get an update on Prince Rupert, particularly the guidance has been for about C$100 million in revenue and given the tough import world that we're in right now, where you are in terms of that trend and getting a second customer and all those kinds of things.

Sure. The C$100 million in revenue guidance for this year is still right on track. I think Mr. Noorigian has said a couple times publicly that what we expect once it's up and running to be around C$300 million, so that puts us at about a third of the business moving through there and that's about where we are today. I have obviously been more optimistic in the past and thought we would have more of that capacity sold by now. But clearly, the import volumes into North America from Asia are down. But there are two reasons for us to believe that we can overachieve on Bob's guidance of being a third sold out there.

One is we continue to have dialogue with additional customers and there are still a number of major steam ship companies and/or consortiums that are talking to us about making Prince Rupert a new port of call and also we're talking to Costco and their business partners about increasing the size of vessels that may -- they may use to call on Prince Rupert because of some rationalization that's ongoing between the Atlantic and Pacific calls, in order to free up some vessels there, which would also have the capability to bump up our numbers for this year.

So the number of C$100 million that we have out there is already in the bank, so-to-speak, with the volumes we have coming through there today and I'm hopeful that we can increase that and sell that capacity and we're working on trying to figure out -- we're already trying to figure out -- we're confident enough that we are trying to determine ways in which we can increase the capacity through that facility in the future as well.

So Jim, if I understand, you don't need a second customer beyond Costco to get to that C$100 million? If you do, you'll beat your projections, is that fair to say or am I misunderstanding that?

I do not need a second customer to hit the numbers that we have out for this year. A second customer would sell out the facility.

Okay. Get you to 300 kind of level.

Correct.

Also, you mentioned in your presentation there was a paper mill down I think in Eastern Canada and the Illinois Basin coal mine that's down. Can you talk to when those two will be back up?

To be honest with you, on the [Mira Mesa] paper facility out there, that might never come back. They're just giving -- paper industry in eastern Canada is having a -- in the Maritimes is having a very difficult time. It's a very productive and relatively new facility but we're going to need a change in the coated sheet paper market for that to come back. We're not counting on it.

The Illinois Basin mine, a longwall issue there is probably going to take through the summer to work its way out. But a new mine has opened there in late February and has now ramped up, starting in April, which will start to offset that decline. The [glacial] mine there is going to take a little longer for it to get its problems straightened out.

Do you have the number of carloads that the paper mill contributed in '07?

Not off the top of my head, no.

I can get that for you.

That would be helpful. Claude, can you talk a little bit more about the lower pension cost? Is that just interest rates or what's going on and how do we look at that ongoing?

You know, as we guided before, our pension costs this year will be down roughly C$70 million because of a lower interest rate, effectively.

Okay. And when I look at the purchase service and material, is there inflation beyond obviously there's weather issues, why those costs are up, but you should we just look at a world where there's some inflation and these costs are going to be rising.

Well, there is some inflation and the other thing that is coming through with purchased services is the cost of the non-rail activity that Jim talked about. For instance, all the costs of CN WorldWide International goes through purchased services, so you should expect those to continue to increase.

That makes sense. Thanks, guys, for the time. I appreciate it.

The following question is from Walter Spracklin from RBC Capital Markets. Please go ahead.

Thanks very much. Good afternoon. Just on the weather impact, I don't know if you can update us, I believe Hunter you said at the beginning there might be some other issues there, obviously the high snowfall in eastern Canada. Is there any issues with melting, given we had so much more snowfall and is that impacting in the Q2 at all?

No, I mean, we've had some flooding issues in the U.S. in Illinois as a result of some snow and heavy rainfall and storms, tornadoes, but no, there's nothing in the second quarter that I think is going to have any significant impact at all.

Okay. Presumably, some of this volume, if the demand -- all other things equal, we should see some of that push forward to the second, third or fourth quarter I guess, comment on that. Is there any particular segments that you see demand has been pent up, we might see some higher growth in the second, third and fourth quarter as a result?

I think -- then Jim can comment on it. Contrary to other reports, I thought we bounced back pretty quick. We had -- once we got opened up, and this is different places at different times, but we started running record numbers of gross ton miles, exceeding 1 billion for about 12 to 14 days out of 16 or 17, which we had never done before. So most of the business that -- we caught up on. I think if you looked at grain, I mean, grain we've been holding grain back from the West Coast. If you look at potash, we're ahead of schedules. Some of the intermodal, clearly we just missed. So unless Jim knows something that I don't, I don't know that there's any boost that's coming that's a carry-over from first quarter.

Okay. And just last question, Hunter, any update on EJ&E, I guess there's some rhetoric going on out there, difficult negotiation there. Any sense of timing or any update on timing when you think that that might go through?

I'll give you my best guess. We're going to get we think something at the end of April or early in May, from the STB as far as their -- the scope of the environmental assessment. There's not much negotiations going on. I mean, this is a pretty clear issue, I think, at least. The three main issues that we heard the most about were Amtrak, Metro and blocked crossings. Amtrak is behind us. That was a false alarm. We have had told -- guaranteed Amtrak they could keep the same route. We even kept the user fees on that route. We work with Metro on our railroad now. We know the Metro people well. The STAR Line project is not even approved yet. It's not funded yet. That's off into the future.

I think effectively the issue becomes virtually all the opposition is in the communities that have the train tracks increase. If you look at the overall greater Chicago area, my assessment is that the environmental impact will be overall for the greater Chicago area, positive. It will significantly improve service. It will increase capacity for us and other rails. It's a good thing. But it seems that certain people don't want trains coming through their community. And you know, the worst example I guess of increases would be 24 trains a day. And if you look at what we've done with slide rulers and you take 24 days a day, running 40 miles an hour at our average footage, that's two minutes a train or 48 minutes a day or two minutes an hour. Which is not much longer than a traffic light. I'm hard-pressed to understand some of that vocal opposition. But having said that, I think that we would hope and maybe expect once we get the scope of this assessment, I'm hopeful that by first quarter of 2009, we can have some resolution to this issue.

Okay.

I think that's reasonable.

That's great color. I appreciate that. Thanks.

Thank you. The following question is from Cherilyn Radbourne from Scotia Capital. Please go ahead.

Thanks very much and good afternoon. Just wanted to ask a question around the revisions to your guidance. You have left your revenue guidance unchanged, despite what I would see as greater than expected weakness in a couple of categories, forest products and automotive, specifically. So if you could just talk about what is providing the offset to weakness in those two areas. And then you've ticked down the EPS guidance slightly, so am I right to interpret that, that it's a result of the weather issues in Q1 and then a cost issue, largely fuel, for the balance of the year?

Fuel is the big story. Basically, we are increasing our guidance for fuel to C$105 per barrel. Our initial guidance was C$90 per barrel. So right there you have a couple of percentage points of revenue growth that will come as a result of our fuel recovery system. But the expense is there and net, net, we think our EPS should be in the mid single digit range, partly because of this higher fuel environment and partly because of the tough start and the difficulty in the first quarter.

Okay. And second, and last question from me for Jim, you've had a number of initiatives under way to attract more business, particularly in eastern Canada, to offset weakness in forest products. Could you just talk about where you're at with some of those initiatives and I guess how the company feels it's positioned in terms of its utilization of network capacity in eastern Canada, particularly?

Well, the initiatives that we've had underway in eastern Canada really were to try and bring more and more traffic on from an intermodal perspective. And especially on the domestic intermodal side and that has been working well. It's been delayed somewhat, the implementation of it and not really reflected in the results because of the difficult operating conditions in the first quarter. But it's progressing and a big part of the reason why we're more bullish, clearly on the intermodal side of the house for the second half of the year.

So the strength in domestic intermodal that you referred to in Q1 actually doesn't relate to those initiatives in eastern Canada so much?

No, not so much, as specific initiatives there, more in line with -- some of them are, that I talked about, new customers that have come on line where we have taken the traffic off the highway are in eastern Canada. But more and more what we're doing in terms of trying to provide transportation solutions to the people in eastern Canada like the paper people is now when we go into our customers there and have traditionally sold just railcar services, box car kinds of business, we are now also giving them intermodal solutions to kind of round out a complete portfolio of opportunities for them and we are gaining traction there. As an example, in the forest products segment, we have probably picked up 400 or 500 additional containers of business in the first quarter that would be related to those kinds of activities. So it's getting traction and it's working and it's available. We certainly have the capacity there and we're trying to leverage that to find new opportunities.

And just in terms of how the company feels about capacity utilization in the east, it's probably been a little bit weaker than expected. The assets are still right-sized for the opportunities that are there?

Well, we're always doing everything we can to try and leverage the capacity that we have, to find new business opportunities. Obviously, there are a lot of our traditional customers like the paper people in eastern Canada that are having some business issues. And we are finding ways to provide solutions to them and grow that business and we're clearly not in any need to go out and do any kind of crazy things on prices to just try and grow volumes. We want to grow the bottom line here and do it logically and as I said, the forest products initiatives that we've got going are successful.

Okay. Thank you. That's all from me.

Thank you. The next question is from Bill MacKenzie from TD Newcrest. Please go ahead.

Thanks, it's actually Michael Tupholme in for Bill. Just wanted to go back to Claude I think during your prepared remarks you mentioned, you commented on D&A. I wasn't sure I caught that. Could you just clarify your remarks on that?

On what specifically, Michael?

On depreciation and amortization, you suggested you're completing some studies now and that it would have an impact going forward. Could you just clarify that for us?

Our depreciation expense obviously goes up as a result of our capital investment on an ongoing basis. But we've also finalized during the first quarter our depreciation study which we do every three years and the impact of that depreciation study is an increase of our depreciation expense by roughly C$20 million on an annual basis. So you should count on that continuing in future quarters.

Okay. Thanks. And then I guess secondly, maybe for Jim, with regards to Automotive, you mentioned some labor issues during the quarter that impacted volumes there. Can you maybe provide some color as to the breakdown between the labor issues impact and then also I guess maybe general economic weakness and what the contribution from each was?

Well, I think, clearly in the second half of the quarter the supplier, axle supplier issue to one of our customers there created a problem and so to try and off the top of my head here quantify the impact of that versus regular softness offset by imports, I think it's hard to say. Clearly, auto sales are down by -- across the board by all producers and kind of in -- I guess the last number I saw, 5% range. So for us to be down, say, 10% on volumes, maybe you could say that it's half market and half the axle strike. But again, that's just pretty high level calculation there.

Okay. Thanks very much.

Thank you. The next question is from Randy Cousins from BMO Capital Markets. Please go ahead.

Afternoon. Just in reference to the fuel, Claude, I thought you said that fuel was a sort of negative drag in terms of the surcharge of C$0.02. My recollection from the fourth quarter is that you guys said you had a deal on fuel that expired and I wondered if your fuel surcharge, does it actually capture that crack spread? Because I would have thought the fuel drag would be a lot more than C$0.02.

It's in that range, C$0.02 to C$0.03. And our fuel surcharge, it depends. Jim has a few tariffs out there, one is based on WTI, another one is based on highway diesel prices. When a customer is paying the tariff on highway diesel, of course the crack margin is reflective. When they're based on WTI, that's not the case. But overall, you can -- basically on a year-over-year basis, C$0.02 to C$0.03 impact of the lag effect is the right amount.

Well, given the increase, that's outstanding recovery. Second question, just wondered if you could give us some guidance on the tax rate. Obviously I think you said C$0.02 was due to the deferred adjustment, but it looks like the tax rate, at least for the first quarter was well under 30%, even allowing for the deferred adjustment. What should we be modeling on a go forward basis for Q1 -- or excuse me for Q2, 3 and 4, or for the balance of the year?

There's always a little bit of noise, depending on the specific account, but a good run rate to use for our effective tax rate at the moment would be in the range of 31%.

Okay. So it was in addition to the sort of C$0.02, there was a lower number for the first quarter then, did I get that right?

I can't do exactly the calculus, but you would be correct if you did your math right.

One last thing. I want to squeeze it in. The FRA statistics were up in -- FRA action statistics were up in the first quarter. And yet your casualty accrual was down. Was that a function of the fact that -- you know how you do those semiannual tests of what the accrual should be. I just want to get some sense as to whether the reduction in casualty was an experience issue incurred in the first quarter or was it actually just a change in the accrual rates that you use overall to deal with casualty?

Those numbers, the FRA numbers, the criteria -- don't hold me to the dollar, but we report everything over C$9,000 damage per occurrence. And what we have -- and although that TFV number is down, the FRA number is up a little bit, overall flat, but the severity is significantly down. And Claude can help me but we're somewhere around C$14 or C$15 million year-over-year less per train accident.

For train accidents we're down to that degree. And for personal injury, Randy, we are -- we do our run rates on the basis of our best estimate of the frequency and severity of accidents and while our personal injury report is up slightly, those are instances where the severity is not impacting our results.

Okay. Great. Thanks a lot.

Thanks, Randy.

Thank you. The next question is from Mike [Bodenditsel] from Stifel Nicolaus. Please go ahead.

Actually, it's Stifel Nicolaus. Good afternoon, gentlemen. I had a little bit of longer term question. One thing that we tend to hear from investors is because CN is able to run its network so efficiently under normal operating conditions when you don't have weather or strike or those types of issues, what initiatives do you have for further improvement? What are your top three or four things you can do to run your network more efficiently over the longer term, next few years?

Well, a couple things. I mean, you heard me talk earlier about the -- we made a significant investment in putting a mini hub in Memphis, Tennessee, which will greatly improve the terminal efficiency of the U.S. We are making much better use of distributed power and buying more distributed power. In fact, we have been running, until grain started backing up at the ports. I don't know anyone that was running 20,000-ton trains with distributed power as we were. So that's another initiative. The reduction in locomotives has allowed us to bring our labor and material costs down as well as improving the fuel efficiencies of the newer locomotives and then another one hopefully will be the J transaction and the -- as it will free up capacity in the U.S. and cut our costs in the U.S. And I can go on and on, but maybe we'll take this call offline later.

Okay. Thank you.

Thank you. Next question is from Cameron Jeffreys from Credit Suisse. Please go ahead.

Thanks very much. Just wanted to follow up on Randy's question. Can you give us the split on how many -- what percentage of your business is based on the WTI based fuel surcharge and the diesel based?

About 40% of the fuel surcharge recovery comes off highway diesel.

When would you expect -- when would you expect kind of the transition to be completed? Another two to three years away? And how should we kind of think about -- is it a fairly linear pattern from here to there or how should we think about that?

We'll try to convert -- we try to convert as the -- when the contracts renew with our customers, unless they want to convert earlier. We're certainly willing to do that. But it would probably take another, I would think 18 months or so for us to get it up to around 90%, 85%, 90% being highway diesel.

Thanks very much.

There are no further questions registered at this time. I would now like to turn the meeting back over to Mr. Harrison.

Thanks very, very much and thanks to all of you for joining us and we look forward to seeing you, if not before, with our second quarter results. Thank you.

Thank you. The conference has now ended. Please disconnect your lines at this time. Thank you for your participation.