Canadian National Railway Co (CNI) 2011 Q2 法說會逐字稿

Welcome to the CN second-quarter 2011 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 for CN's second-quarter financial results call. I would like to remind you about the comments that have already been made regarding forward-looking statements.

With us today Claude Mongeau, our President and Chief Executive Officer; Luc Jobin, Executive Vice President, Chief Financial Officer; Mr. Keith Creel, Executive Vice President, Chief Operating Officer; and JJ Ruest, Executive Vice President, Chief Marketing Officer. After the presentation today we're going to take questions from those of you who are listening on the call. Could please identify yourself when you're asking the question?

In order to be fair and so we can get through the 30 analysts that are following us at the present time, would you limit yourself to one question? Thank you very much and now it is my pleasure to introduce Claude Mongeau, CN's President and Chief Executive Officer.

Thank you, Bob, and thank you, everybody, for joining on us on this call. We are going to take you through our second-quarter results. These were very good results. I am particularly pleased, given the adversity we face, with the solid growth that we were able to deliver across-the-board.

JJ will give you more detail; but adjusting for currency we had revenue growth of 11% and good growth across all the business units. I am very pleased that our supply chain collaboration is working for us. It is working in every segment, but in particular in the intermodal sector we are seeing very, very solid growth on the backs of our end-to-end supply chain approach.

This bodes well in terms of the balance of the year. Not done here, but -- and we will comment on what we see in terms of the environment; but certainly our ability to lead the industry in terms of cartload growth in the second quarter is a very solid proof point that our strategy is working.

It is working on the top line, but it is also working in terms of operational excellence. I have to say Keith and his operating team did basically a bang-up job. It was an exceptional quarter protecting the integrity of our network and the reliability of the supply chain we served.

We did face, like every other railroad, significant challenges from floods in the southern part of our network, to the western part of the network. Even the east had some exceptional flooding, to fires, to mudslides, all of this coming and kept coming at us throughout the quarter. But we were able to keep very, very solid operational metrics and importantly do so to protect the service and the reliability to our customers.

When you add it all up, this is the one of the key reasons we were able to come in with an operating ratio of 61.3%, which is essentially in line with the performance we achieved last year.

In terms of earnings growth, it's up 12%. Luc will give you some of the details. But 12% despite the headwinds that we face is a very solid performance.

And it was backed up by an equally solid free cash flow performance. At midyear we have delivered CAD823 million of free cash flow, which is certainly indication of the solid results overall that this team has been able to deliver in the second quarter and in the first half in general.

Keith, with that, can you go over the operating results?

Sure, thanks, Claude. Operationally, coming out of a challenging weather-related first quarter, our team's agenda was purely focused on taking advantage of what we expected to be operating conditions much more favorable, which would allow us to restore our service and productivity metrics, to [normal in] our performance standards, clear any traffic backlogs we had at the time, and optimize our network fluidity. But little did we know what Mother Nature has in store for us.

The snow melted, but the weather challenges did not abate. Regardless I am happy to report that this team succeeded, protecting the integrity of our network for our customers by demonstrating the tenacity and the sense of urgency required to ultimately produce these results.

I am especially proud of the relentless commitment and sacrifice that is the contribution of our engineering team who had what I certainly hope was an unusual number of severe weather-related disruptions to deal with throughout the quarter.

To deliver these acceptable operating metrics in spite of this adversity, protecting the integrity of the network, and do it while delivering to most what was an unimpeded service is a testament to the key enabler of success that we have with this franchise, and that is the railroaders that we all work with, all 22,000 of them.

Let's take a moment and look at the key metrics we monitor our success with and report to the market on a quarterly basis. So here you have got the Q2 year-over-year comparisons for the key operating metrics.

Most of you all recognize by now these metrics reflect some of the biggest economic levers we have on the business. If we manage these things properly, I know that we are delivering good service at low cost.

So starting on the upper left and reading across, trainload -- as we measure in GTMs per train mile -- continue to increase in the second quarter versus 2010. This reflects our eco-train strategy; the investments we made over the years in siding extensions and distributed-power; and our ongoing focus on managing the available traffic we have onto our existing service plan. This continues to be one of the most powerful levers we have. It reflects maximum utilization of road crews, locomotives, and fuel.

On the cars per yard switching hour, essentially we had a flat performance, while terminal dwell continued its positive trend. This shows that our terminals continue to process well while dealing with the increased merchandise carload volume of about 5%.

Looking at the bottom row, trailing GTMs per total horsepower, it is off about 6% year-over-year. But this reflects in part our focus on erring on the side of service and revenue generation with both our locomotive and car fleets, and in part the numerous weather-related disruptions we faced this quarter.

Car velocity is off about 2.5% year-over-year quarter-to-quarter, driven mainly by changes in intermodal. Train speed is down some, tied to the weather-related issues we talked about plus a focus on clearing our in-port containers from our ports rapidly. On the lumber side, the switch on the centerbeams, the shorter-haul Vancouver-to-Rupert export flows versus some of the longer hauls that we enjoyed last year.

Train speed, finally, off a similar amount. Impacted by the disruptions that I talked about, the noise in the system. Both of these velocity metrics will recover as the weather and the flooding is behind us and our infrastructure work that we are engaged in now in Alberta, Northern Ontario, and on EJ&E start to kick in, in late Q3/Q4.

So rest assured with the weather behind us we will do what we do best, and that is a relentless pursuit of driving improvements to our operating metrics while we manage our costs in line with the business that JJ's [move] delivers.

Going to slide 7, you're going to ask the question -- what enables CN to produce this level of performance in the face of some of the significant adversities that we continue to deal with? It continues to be our ability to execute our precision railroading operating model, the foundation of our success in the past, and it remains at the core of Claude's leadership and our business strategy as we evolve as a Company.

It has been key to helping us battle Mother Nature in both the first and the second quarters, and it will still be the foundation to the service and operating improvements we expect to convert and make as the balance of the year unfolds.

A couple of those examples in the field productivity front. Continued process and technology improvements, investments in DP and sidings has allowed us to scratch out another 1% gain in fuel productivity year-to-date, on top of the 7% gain we have made over the past few years, despite the disruptions we faced in the second quarter.

Again despite the weather, the work-related workload we placed on our engineering forces year to date, our engineering OpEx still within 1% of last year's performance, which is well within wage and material inflation.

Our plan to execute, measure, and identify improvements and start all over again mindset, which is the foundation of precision railroading, continues to produce additional opportunities where we can fine-tune our reliability, improve service and productivity.

A couple of those that we're converting now. Engine health monitors linked to our electronics investment on our locomotives, which gives us a predictive nature to when a locomotive might fail, before we allow it to fail within our network and affect our fluidity. On the same front, wheel flaw detectors that we are deploying leading-edge technology which we are confident will allow us to identify suspect wheels before they fail in train, as well affecting our network.

Improvements in rail flaw detection and our deployment strategies, and finally leveraging technology again to drive compliance, helping us on the fuel front on our locomotive idling policies.

On the innovation side, myself and my team, as we have talked in the past we continue to invest time working with JJ's team and our supply chain partners to integrate our best practices across the supply chain. I am particularly excited about some of the supply chain's visibility tools we developed in key sectors such as export coal, iron ore, and most recently potash as we're utilizing in the market.

This partnership approach drives end-to-end efficiencies in performance for all the supply chain participants, be it the mines, the terminals, the ports, and our franchise. We strongly believe that when we succeed our customers will succeed. We are convinced these efforts have and will continue to have long-term benefits for the supply chains in which we participate. So now let me turn it over to JJ to hear about how these efforts are paying off, growing our franchise one carload at a time.

Thank you, Keith;, and good afternoon to all of you. I really especially want to thank the engineering forces of CN who put us back in business very quickly every time we have a bit of a service disruption.

All of our business units posted a revenue gain this quarter. The second-quarter revenue was up 8%, or 11% on an FX-adjusted basis. Breaking this down, the volume was up 4.5%; the RTM increased 5%; and the carload increased 4%. The main volume driver last quarter were intermodal, grains, fuel, and iron ore.

Same-store price was a solid 4%, in line with first quarter but also above last year run rate. As a reminder, same-store price apply in approximately three-quarters of our book of business after the removal of the pure revenue.

Fuel surcharge was up [3].5%. Mix was basically flat, and exchange rate reaches revenue by 3%. The Canadian dollar was CAD0.06 above the same time frame last year.

Now looking at the first quarter in detail -- I'm on page 9. All of my comments are going to be on the FX-adjusted basis.

Starting with petroleum and chemicals, which revenue was up 8%, in chemicals we handled increased volume across most segments, mostly chlor-alkali chemicals. On the petroleum side we had greater volume of refined product, but largely offset by the loss of front-end sales to a new pipeline. So therefore combined P&C volume was essentially -- especially flat for the quarter. Metals and minerals revenue was up a strong 21% excluding iron ore; I'm going to talk about iron ore separately. Metals and minerals volume was up 12% in RTM terms and 3% in carload terms. Steel shipments for robust; they were driven by strong market recovery.

We had some market share gains and we also had a recent fleet acquisition. Steel slabs, steel billets, nuggets, and scrap did very well during the quarter. The steel operating rate averaged 74%.

The oil and gas sector is a good sector for CN. We had a strong frac sand and pipe volume to the shale gas drilling area. We will participate in seven pipeline projects and as well as we are attracting new frac sand production capacity in our CN line in Wisconsin.

Despite the permanent closure of two smelters in the last year, which resulted in the loss of metal shipments, we benefited from new long-haul zinc and copper concentrate, and we gained market share. The net result of this industry restructuring has been positive for CN.

Iron ore revenue was up 25%. We had very strong carload growth and RTM growth in iron ore across our customer base.

The forest product revenue was up 10%. Our carloads were up 6% but the RTM were down slightly.

The wood pallet export grew 50% in the quarter on the back of new production capacity, all in British Columbia. We gained in containerboard volume against the truck. We also had very strong Chinese demand for lumber to the West Coast, which in fact were up 40% from Q1.

That was it, and that was useful to offset the persistent weakness in US housing starts. We have strong global demand called for wood pulp, which increased our export volume to Asia.

The slight negative RTM in forest product is a result of the industry restructuring itself for the growing market of Asia, which has less RTM per carload than the lumber and pulp markets in the United States.

Automotive volume was up 6%. We had a 7% increase in carload, reflecting the improved performance of the Big Three. However, we did experience a reduction in RTM for the automotive sector, and that was due to getting less long-haul carload out of Vancouver, which is related to the tsunami in Japan, as well as the nonrenewal of a legacy contract out of the Vancouver Port.

The coal volume overall, Canada and US, was up 8% in revenue. We had good demand for export coal. Our West Coast volume did very well; in fact our West Coast coal volume was up 20% in RTM terms.

All that despite the much lower carloads on the West Coast resulting from the new [tech] interchange contract. We also had some new PRB export via Rupert during the quarter.

Our US terminal coal suffered low volume from US utilities. Basically high inventories of coal, cheap natural gas, and a overall lower burn rate.

The grain and fertilizer revenue was up 16%. We have robust overseas demand for Canadian grain coupled with strong US corn and soybean export.

We also had a Q2 increase in fertilizer which was reflected by the delayed potash application, basically weather-related. Grain prices are high, and the farmers wants to use more fertilizer.

Overseas intermodal was up 16%. We gained volume with our new supply chain service, where the CN focus starts right from the time the overseas box hits the dock to the time it is picked up in the cities served up by CN.

Our volume growth on the West Coast -- by that I mean Vancouver and Rupert combined -- exceeded the North American West Coast port average. Domestic intermodal volume was up a strong 14%. We were basically up in volume in all segments of the domestic retail.

Our nonrail volume was up 2%. We had a nice increase in the CN Great Lakes vessel [lease] activities as well as the CN [PL] trucking, which was offset by a decrease in our freight forwarding activities.

Now, if we turn to what is ahead of us, the outlook, I will go on page 10 for the intermodal. Intermodal is a core growth engine of CN.

We are refining constantly our port services at all three coasts, and we are expanding our network of final destinations to bring products into the hinterland from these three coasts.

Our merchandise business unit sales force is also helping generate export container business from our merchandise customers, which is giving us a better import/export balance. We will take delivery of roughly 1,400 domestic containers, mostly insulated containers, which we will deploy in the fourth quarter in our domestic service. We will continue to drive our strategic focus to expand our repo program of 44 overseas container into domestic freight and domestic service.

The fall peak this year, the fall peak will be later this year as reflected by the weaker Consumer Confidence Index and the recent trend in inventory-to-sales ratio. Nobody wants to gamble on big inventories this fall, it seems.

In the meantime, we still expect the transpacific volume to be higher than last year. And for CN we expect to outperform the West Coast average.

Turning to bulk and the outlook on page 11, the Canadian crop is expected to be more or less in line with the five-year average. It is also expected to be a little late. Therefore, the Q3 results for Canadian crop might be a little flat, waiting for the fourth quarter coming in with a new crop.

Also of note the revenue cap of pricing has been set at 3.5% by the federal government for the coming season. According to USDA latest report the next production of US corn is estimated at roughly 10% above the five years' average; and the soybean production is estimated slightly below last year.

Demand is strong for offshore call for Western Canada. However, mine operation on our lines are currently still affected by heavy rain-related issues, flooding in their areas, and they are still working their way through that.

US terminal coal for CN might be flat in the third quarter. We continue to work on expanding our Rupert PRB business, and we hope to add another shipper to during the third quarter.

Finally, manufacturing -- not last but least. We have a very strong manufacturing franchise. We continue to see strength in offshore demand for lumber and pulp as well as significant expansion of wood pellet production coming online in British Columbia.

Shale gas drilling activities will remain a very strong business for CN. We will also benefit from frac sand production increase capacity in Wisconsin.

The ISM Purchasing Manager Index remain in expansion territory, which is positive. And we have continued some overall positive automotive data. However of note, inventory level is high for pickup truck at dealer lots. So there is some uncertainty out there.

Canadian manufacturers, which are mostly in the east, Canadian manufacturers are facing an ever-rising Canadian dollar. So far in July roughly [CAD0.08] higher than July of last year at the same time.

Iron ore production in Minnesota and Michigan looks very good for the second half of this year. Our new vessel addition, the Great Republic, started its sailing last June.

In closing, this is not a marathon; this is a sprint. And neither the sprint or long-term marathon, so far this quarter you have seen our carloads. We have had about 5% carload growth, so far this quarter. This is less intermodal, both overseas and domestic, also was metals and minerals, good lumber, good fertilizer, good sulfur segment. And the laggard so far has been Canadian coal mine. As I explained earlier if is because they face short-term production problems related to the heavy rain that we had.

On that, I will pass it on to Luc and he will cover the financials.

Great. Thanks, JJ. I think good numbers clearly as Claude and Keith and JJ pointed out. Let me just cover briefly the overview of the financial results.

We are reporting an adjusted diluted EPS of CAD1.26 which is 12% above last year; and on a constant currency basis that translates to 14% improvement. Our reported EPS will reflect the CAD40 million deferred income tax item; and so we will show CAD1.18 on a reported basis. This relates to changes that have been regulated or passed through in terms of state income taxes during the quarter.

Our operating ratio is a stellar 61.3%, which under the adverse conditions that we have been facing in the quarter I think is quite an achievement.

Turning over to our operating expenses, we are showing operating expenses at CAD1.386 billion, which is 8% up versus last year. On a constant currency basis this is an increase of 12%.

The biggest story here is the fuel. In terms of fuel, the WTI increased from $78 in the second quarter of last year to an average of $103 during this quarter, so an increase of some 40%. Fortunately we were able to offset a little bit of that with some productivity improvement of 1%, which probably would have been twice that if the weather had cooperated. In any event, so that is the biggest increase in terms of our expenditures.

Then we have some labor and fringe benefits which was up 7%. The lion's share of that increase relates to stock-based compensation as our stock price increased by some CAD4.00 on a relative basis versus last year. The balance is really just labor and fringe benefits inflation.

Then our purchased services and material increased by some 10%. In this case this was driven by higher volume and more difficult operating conditions, which required a lot more maintenance work and repairs to our track and our rolling stock. So this is one where the temperature and the weather took a bit of a toll.

Last is our casualty and other expense category. In this case we have shown an improvement of some CAD30 million, mostly from the fact that we had lower legal, environmental, and other expenses versus last year.

On a free cash flow basis, turning to page 16, we generated CAD823 million of free cash in the first half of the year. That is CAD135 million lower than last year.

Most of the reason for that decrease is attributable to higher income taxes where we paid some cash taxes of CAD138 million more than last year. As well our capital expenditure program is actually about CAD600 million in the way to a total program of CAD1.7 billion. So in the first half of the year we are running about CAD160 million more in terms of capital expenditures than last year.

This was partly offset by higher proceeds in the first quarter from sale of our Kingston subdivision versus the disposal last year. So very good free cash flow position in the first half and continuing for the second half.

Turning to our financial outlook, I think we have actually delivered a very solid first half. I mean, I think as we stand today we can see some mixed signals in terms of the second half, in terms of global and North American economic indicators. However, I would say that we are cautiously optimistic.

What we know is that we are well positioned from an operational and a service standpoint to handle all the business that is going to come our way. So we will continue to leverage the global and gradual economic recovery, even if it is a bit bumpy. And we continue with our productivity initiatives as well as our supply chain and service excellence drive.

We are continuing to see some solid mid-single-digit carload growth and pricing above inflation. We do have a few headwinds to deal with in the second half. It continues to be a bit of a challenge in terms of the Canadian dollar; it is currently running a little bit above CAD1.05. So clearly this is the headwind that we will have to contend with.

Fuel is actually fairly well behaved these days, and we will see how things go moving forward. But we continue to see it between $100 and $110 on the WTI.

We also have higher Canadian cash taxes and higher depreciation. All of that to say that we continue to be very comfortable with our previous guidance. We see double-digit earnings growth for the year, and we are expecting up to 15% growth over our 2010 adjusted diluted EPS which stood at CAD4.20.

From a free cash flow standpoint, again we continue to see the CAD1.2 billion of free cash flow to be generated in the year, and that is after setting aside a potential additional voluntary pension contribution of some CAD200 million and fulfilling our capital investment program to the tune of CAD1.7 billion.

So all in all I would say that we are well positioned for the second half, and we continue to be focused on strong shareholder value creation. Claude?

Thank you, Luc; and thank you, teams. I think we have indeed a solid first quarter, a solid first half behind us. We are monitoring the direction of the economy, but we are very constructive about the second half and we have good momentum taking us forward.

So I think in terms of financial results we feel good about 2011 and our ability to finish the year on a very positive note.

More broadly in terms of our strategic agenda, I feel very good. I think we are firing on all the cylinders that we have in our game plan. Clearly we are taking our game to the next level in terms of operational excellence and juggling one more ball in terms of service and supply-chain collaboration.

It is paying off in terms of our ability to grow with our customers. Our strategy of delivering sustainable top-line growth ahead of the economy is coming true. You can see it in terms of solid volume, but also in terms of market share versus trucking versus other gateways that we compete with, and solid pricing -- pricing in line with the value of the services that we provide in the marketplace.

So, solid top-line growth, excellent performance in terms of operating efficiency. That is what you need to do to deliver solid earnings and solid cash flow as we have in the past and plan to continue to do for many, many years to come.

And with that we would be happy to take questions from those who are participating on this call.

(Operator Instructions) Cherilyn Radbourne, TD Securities.

Thanks very much. Good afternoon. Since I am going first, I guess I will stay fairly high level.

At this time last year, as I recall, we were talking about containers wooshing back to Asia in anticipation of the peak. And this year you're talking about a later start to the peak, as are your peers.

Your peers that reported last week seem to indicate that they felt customer inventory levels were low and would require replenishment by Christmas. I think I heard you say something different in terms of the inventory-to-sales ratios. Can you just elaborate a little bit more on what you are hearing from customers at this point?

Yes, our view is the customers' inventory are in line with what they need today. We don't see people really try to build up stock in speculation of the fall. I don't think we are saying something different here.

What we are saying is that the peak will be late. The peak will be in line as we get closer to the fall; people will kind of hold their decision to last moment [not to] start with excess inventories.

So as much as we believe there will be an increase year-over-year of overseas container, as much as we believe that we will fare well in that transpacific trade versus others, yet the fall peak will be later and it will not be as much as what us and the shipping line were hoping for, say, five months ago.

Okay. Thanks very much. I will stick to one; so that's it for me.

Bill Greene, Morgan Stanley.

Good afternoon. I am wondering if you can help us think about where real inflation is and where it is going to go. CSX mentioned about 4.5% was a number that they had used as an inflation rate we should think about. How is it for CN?

Just before I let Luc comment, we are not going to try to arbitrate between UP and CSX. We each have our own inflation factors which probably are closer to the 3%, 3.5% than the 4.55 that was referred to. But Luc, where would you put it?

Yes, I would probably put it close to 3.5%. It will run between 3% and 4% depending on what types of commodities that we are out securing and where the commodity prices are running.

We know that labor on average is going to be around 2.5% to 3%, so it is a bit of a moving target. But between 3% and 4% is probably not a bad place.

So when we talk about real inflation and pricing being above that, is there a scenario whereby Canadian pricing could be better than US pricing? Or is it really just the US has a different dynamic from a regulatory standpoint, that won't be the case?

I think we have been trying to consistently price in line with our service and for many years now have guided in the range of 4%. I am pleased that this is exactly what we are delivering. This is clearly ahead of inflation.

At the end of the day, pricing is on the basis of the strength of your service and how you are able to help your customers grow. And it is set in the marketplace. It is not related -- you can have aspirations to be ahead of inflation, but you price in the market. And that is what we have been able to consistently do and do well for many years now.

Okay. Thanks for the time.

Jacob Bout, CIBC.

Good evening. Question for you on the Canadian Wheat Board. Looks like it will be going away likely by August 2012. Maybe talk a little bit about changes that you could see happening to your network asset utilization. I know there has been some speculation about changes for the Churchill one.

I think all these grain companies are good customers of CN, including the Canadian Wheat Board. At this point it's still early to what these things might happen. There's many, many months to go as to how the Wheat Board will look like next year.

We are looking at different scenarios. We will make sure we have a product that is appealing to those customers when those changes are [then involved].

We just to add this, Jacob, we have to move the grain no matter what. The important point from the government's standpoint and the policy that needs to take place is to have a framework that all the players including transportation suppliers can understand. As that framework develops, we will be more able to give you color on the puts and takes and what that could mean. At this point in time it would be speculation on our part.

All right. I will leave it there. Thanks.

Tom Wadewitz, JPMorgan.

Yes, good afternoon. I wanted to touch base on the volume side. I think that clearly, Claude, you had focused your strategies or have focused your strategies on improving service and attracting incremental volumes. It seems like you have had some good success with that.

I think at the same time your competitors had some pretty material weather impacts. So maybe that has played into your hands a bit as well.

Can you make any kind of a guess at how much volume you may have achieved because of some of the competitor issues and the weather issues on their network? Is that something that maybe swings back and perhaps some of the intermodal strength you had would swing back? And if that is later this year or next year?

Well, let me put it to you this way. I think we have all had extremely difficult whether to contend with, and I am pleased with the way Keith and his team reacted to protect service. At the end of the day water tries to find its level, and if we have good service then customers would naturally tend to want to move the business with us.

We think it is more than temporary. Clearly CP had some difficulty with weather over the last couple of quarters, and some business may flow back as they improve their service.

We are here to serve the customer base. It is actually a good thing we were able to accommodate this business, and we hope to keep it as long as we can. But we will keep it by selling service and doing so going forward.

Do you think that impact is material? Or looking out a couple quarters we may not be able to see that material kind of flow back?

I think some business will naturally flow back quicker. Grain would be an example.

But at the end of the day there is a market out there. If we all compete on service and if we all innovate to get better, this is what we need to do as an industry to earn the revenues that we need to sustain our high capital investment. Those carriers that innovate faster and improve service quicker should be rewarded; and that is our game plan and that is the success we have been having for not just a few quarters now, for several quarters. And that is the path we are on.

That's right. We don't take anything for granted and our game plan is not based on the weather.

Right. Well, congratulations on executing well. Thanks for the time.

Walter Spracklin, RBC Capital Markets.

Thanks very much. Good afternoon, everyone. So my first question here is just on the pipeline, Claude. You mentioned the CN pipeline right now allowing you to grow at an incremental basis above that of the competition. And JJ, you mentioned a few specific examples.

I wonder if you could -- not prioritize, but if you could order the ones that you see the most opportunity in. Obviously you have outlined to us in the past a big, big pipeline; but if you could narrow it down to three or four that you really consider to be a significant growth opportunity.

You mentioned coal up through Ridley; that is brand-new, obviously. Intermodal you mentioned the engine of growth. Alberta. Crude oil is another one; you said you can do 1,000 to, what, 200,000 BOE a year.

If you were to order some of those from a magnitude perspective, what gets you most excited?

I think it would be first and foremost on the intermodal service, what is the overseas import or export, as well as the domestic service that we have whether it is Canadian cross-country or northbound movements from the United States.

That really and truly is a very strong product, even stronger now than ever. We are investing in that product. We're making focus on very many aspects -- the capital investment, the terminal inland, the terminal on the coasts. We work with them.

We have beefed up quite a bit our customer service group in intermodal. So that is definitely an area of us of good [min-term] where we have a lot of leg room.

On the bulk side, you are right what's strong. So if potash and coal and grain sells well, we will ride that very hard and get this product to market before this market fades away on you. Because they are a commodity market; they will go up and down. That is what you need to ride. You need to be there when the market is, because if you are there after it is too late.

Merchandise, quite excited about the potential in M&M, in metals and minerals. Whether it is a steel product, that recovery which might be choppy from time to time. Construction material.

The oil sand is a great story. I think the oil sand is a long-term story. It hasn't really fully -- nowhere near fully developed yet. It is back in major investment; that means first and foremost construction material and then we hope one day we can have a first terminal set up somewhere in the Fort McMurray to do pipeline on there. But that is yet to be anywhere near a conclusion.

Nothing commercial on that I guess yet?

Yes, let me -- if I could add one comment in line with JJ's comments on the sales side. Some of the approaches we have taken this year of providing more flexibility to our car fleet, strategically storing them -- the market has recognized that value. They have certainly rewarded that value, and we picked up additional carloads as a result.

So anywhere we have an opportunity to execute that strategy we will continue to squeeze additional revenue carloads out of this marketplace.

So is mid-single digits doable for the foreseeable future? Is that where we are -- with everything that you have got lined up is that what we should get our head around here on the volume growth side?

I think, Walter, it all depends on the economy. We want to grow faster than the economy, and the first quarter has had still some fairly solid rebound from the economy in general. So our goal is to grow a little faster than the economy from a volume side and price a little faster than inflation from the rate standpoint.

If we do both we will deliver it to the bottom line at low incremental cost.

Yes, sounds like a good formula. Thanks very much, guys.

Ken Hoexter, BofA Merrill Lynch.

Hi, this is Steve Sheranski in for Ken Hoexter. On the coal side it looks like your volumes are impacted by you mentioned a new tech interchange contract. But your average revenue per carload was up fairly significantly.

Is that just a reflection of your lower carloads? And if so, is this a good run rate going forward?

We look at what are called the West Coast coal because some of our Canadian coal will also now have some PRB coming to us over the gateway. The volume was up 20% in RTM terms, but it was down in carload terms.

So this is where there is a significant shift here in our Canadian coal business because we did move more coal from a revenue ton mile than we moved -- that's coal in terms of carload. And that is an effect of the short-haul model, the short-haul move that we used to do in large quantities, but not of the Kamloops.

We still do that but at a much lower run rate. The Kamloops volume, you have got to remember it is only 270 miles. So that is a big shift in our mix.

But price on coal is up. The business is robust. But there is a shift in length of haul because of what we move today versus yesterday.

Okay. You mentioned the frac sand opportunity in Wisconsin. Is that natural gas or is that primarily liquid?

The frac sand is all going for shale gas. So what we have in Wisconsin, we are sitting very near the deposit with the right quality sand, and we have more and more of the sand producers who are using CN to ship their sand. Either they come and set up on us, so they have reload on CN, so we are participating on the frac sand business from the origin.

From a destination market, the big destination market that we serve is British Columbia. So we start with the big, growing frac sand producing area in Wisconsin, and that is what I was referring to.

Can you just quantify what production growth you are supporting on your network?

That will be a good strong double-digit. It has been a good strong double-digit now for quite a while. Some of that production there should be yet to come. We are talking to people who are building track and building plant right now.

Okay. That's it. Thank you.

Scott Group, Wolfe Trahan.

Thanks. Good afternoon, guys. First, Luc, just wanted to clarify your comments on casualty and other. Was there something unusual about the number this quarter? Or should we be thinking about somewhere in the CAD60 million range going forward?

Well, I think what happened is we had some higher, much higher level in the last year. Going forward I would still look at a higher number than the CAD60 million. I think it is probably going to be somewhere in the CAD80 million, CAD85 million range.

Historically I have used about CAD90 million as a benchmark. But with the Canadian dollar helping a little bit, that is honing it down a bit. So that is where I think things are heading.

Okay, that's helpful. Then also can you just talk about where we are in the hiring cycle? So headcount is up 5% year-over-year in the quarter.

Should we expect that trend and that growth rate to continue? Or does that moderate going forward as maybe hiring levels level off or attrition starts to kick in?

Well, as we said in the past, effectively we are looking at an attrition curve that is going to be lasting for the next three to four years at the pace it is now. So you could expect similar numbers to that.

There are some double counts; then of course if we hire conductors we have to take conductors out to train to become engineers. So there is some overlap that once we get past the situation bubble you will see that come back down. But on a go-forward basis in the near future I would expect something similar.

I think, Scott, the key is you don't want to be short groups. But it is an easy call when the economy is rebounding. When you have, like we do at the moment, a bit of a pause and the macro environment that is a little bit more uncertain, we want to make sure that we calibrate.

The good news is if we are a little long in terms of headcount we have enough attrition that it takes only a few months to correct our targets and get right back in line.

You have a target for where you are expecting headcount at the end of the year?

We will hire in line with volume growth. We have been -- from where we are at the moment, I would not suspect significant increase on a sequential basis. But we will hire as we see people retire from our workforce.

Okay, great. Thanks for the time, guys.

Turan Quettawala, Scotia Capital.

Yes, good evening. I guess my question was just on the fuel productivity line. Obviously this quarter you had some problems with the flooding and so on and so forth.

Just wondering in the past you have guided to about 1% to 2% improvement on an annualized basis. Is that still the target for the year?

That is certainly still the objective. Some of the noise we experienced in the first quarter impeded our ability to deliver that 2%. But I fully expect to get to that run rate for the balance of the year.

So, should it be on an annualized basis, Keith, or just for the second half?

The second half certainly. I mean do the math if I can deliver 2%; it is going to be somewhere close to 2%, between 1.7%, 1.6%, and 2%.

I'm sorry, that is the full-year number you are talking about, right?

That's correct.

Thank you very much.

David Vernon, Bernstein.

Just one quick clarification on the income tax item. It is that jump of CAD40 million, CAD50 million or so -- is that a nonrecurring item then?

Yes, that is a nonrecurring item.

Okay. Then just one question on the intermodal piece. It looks like there was a little bit of a shift toward some shorter haul domestic. Am I reading that right, or could you maybe comment on that a little bit?

The domestic side we have gained some business. The average gains of business we have may have been shorter than the historical length of haul, which is -- would make sense, because as we compete with truck in some cases we have pretty much all the long-haul business already because of our costs. So where we compete with truck is increasingly on slightly shorter and shorter distance.

So that is more truck competition versus any type of weakness in the international container trade?

For example, when you look at one of the business sets where we have strong success last 12 months is the northbound business from the United States. It may not be the same length of haul, say, as a Vancouver-to-Toronto, for example. That is domestic freight.

Yes, so it is not -- it is less reflective of weakness in international and more reflective of being more competitive over shorter domestic?

Both international and domestic have been very strong in the second quarter. So both of them had double-digit growth in volume.

Very much so. When we move our containers there is less overlap between our domestic and our overseas business. The domestic business we move is domestic, and both segments have been growing.

Okay, thanks.

Gary Chase, Barclays Capital.

Good afternoon, everybody. Wonder if I could ask you to maybe elaborate a bit more on some of the gains that you think are now evident on the intermodal side. You mentioned -- JJ mention some data points on volume growth versus western ports.

Wondering if you think it is helping on the price side; and more importantly if there are efficiency gains that are coming out of this as well. Just was curious if you could give us a key data points just to help us get our head around what the impact might be outside of volume, if any.

Well, let me give you a few. Clearly when you take a mindset of an end-to-end supply chain you start looking at all of the pieces from the time a container lands at the terminal on the dock, to the time that we get it off the ramp in our own terminal in-land and put it on the truck to get the destination. We are measuring every piece of the supply chain. We are doing so on a daily basis with our partners.

And we are seeing significant improvements that are benefiting the customer in terms of end-to-end transit time, whether it is shorter dwell time at the dock, whether it is more tight connections with our trains, whether it is better in-land performance. But we are also seeing at the same time more throughput out of the terminal and better efficiency in our train service.

Our slot utilization with the terminal partners we deal with, for instance on the West Coast, has improved on a year-over-year basis in a range of 3% to 4%. So if you can get slot utilization out of Vancouver, for instance, to improve that is 4% of trains which are now filled with a box, is helping us getting more efficiency.

So we are being more nimble. We have more -- better car supply. We have a train service which is aligned with growth. And we are getting rewarded with higher volume growth and train efficiency. That is the true win-win nature of our supply chain collaboration approach.

Do you think it would be fair to say, Claude, the efficiency side of it rivals what you are getting out of the incremental volume?

I think it is a good balance of both. It's just -- I firmly believe that we are just beginning on this journey, and that the opportunity to line up and execute from an end-to-end standpoint to the benefit of all stakeholders, we are just scratching that opportunity in my view.

Thanks, guys.

David Newman, Cormark Securities.

Good afternoon, gentlemen. Just in terms of pricing once again, not to beat a dead horse, but obviously the customers are taking fuel surcharges at these levels, and as fuel rises there is a bit of an impact here. Some of the volume metrics have softened to a certain degree.

How much can you -- do you use pricing I guess in negotiations? Does this sort of service trump all that in terms of the offering that you have and protects your pricing?

Well, we have got to go, as we said, for inflation plus pricing. We recognize the fact that when the fuel goes up, it is a price increase right to the customer, because that is how a tariff is done. By the way we have no exceptions to this tariff; everybody is paying it. That is why we have a way to basically hedge against that.

And then you have the service offering. In some cases we do. Our customers are shopping. They are trying to get the best deal possible.

Some of our customers are losing money right now. They are in a tough market which are very difficult, so they would like to get better price.

But that is not what we are all about. We are about offering a good product. We are about representing -- we are in the rail industry where our market conditions are -- it is the market that we are in, transportation over rail.

And in some cases we may lose an account if they can get a better price somewhere else. But --

So it sounds like, JJ, you really stick to the pricing plan and you really don't use pricing as a an opportunistic lever at all in any circumstances to win volume share if you can?

No, we don't, because in the long run that would back-spiral on us. In the end what really makes sense, as Claude said, in the marathon as you have to have sustainable pricing. You have to have fuel surcharge coverage across-the-board without discount. If you have that as a backbone and good service and a good operating ratio, the price you put out should be able to be good enough for the marketplace.

There is a point where you have got to withdraw from the table and leave that to others.

Excellent. Thanks, gentlemen.

Fadi Chamoun, BMO Capital Markets.

Yes, good evening. I just have a question. You have been doing -- sort of trying to leverage this good railroading to help your customer win for a while. I was just wondering if you can give us some color whether there are some specific areas you are seeing more success on this strategy than others.

Along the same lines, I wanted to see whether you have had more discussions or more contact with Canpotex with respect to the future of that business after having had some success with them in Q1.

Have you followed up with them? Have you started to look at how you can position CN for that business in the future?

I think, Fadi, where we are getting benefit is really across our whole book of business. I have discussed, for instance, the example of supply chain approach end-to-end in the intermodal sector. Keith mentioned in the bulk sector our new bulk supply chain visibility approach. To use an example, with Ridley in coal, it's transformational. We are collecting and sharing information that allows us to see from mine to ship what is happening for all of the customers that are feeding that facility. We are engaging daily.

We have seen Ridley terminal hit new records in terms of its throughput capability because we are now looking at the end-to-end performance, and we are willing to trade off the way we are bringing the trains if we can address bottlenecks at the terminal, which is the bottleneck to the overall throughput of the supply chain.

It is helping us grow with the PRB coal customers. It is helping us grow with our Canadian met coal customers. We are rolling that concept of potash. We are scheduling our service like we did in grain. And it is helping us gaining market share.

As it relates to Canpotex, we believe that that service offering, the need for Canpotex to have diversity in its supply chain as it becomes a larger and larger export producer, will bring them to the view that they should have CN in their mix of transportation supplier. We are certainly determined to convince them of that opportunity.

And like we do in every other business segment we will sell service, sell the value of our supply chain approach. And we are confident they will come to the view that having CN for a chunk -- a small chunk perhaps initially -- of its business in Vancouver is the right thing to do for Canpotex. And as they grow perhaps they will build on CN's services in Rupert so that we can become a full-fledged partner over time. We will do this based on service and based on the strength of our supply chain collaboration approach.

Okay. Thank you. Maybe I can just throw in one more question to Luc. The cost inflation excluding fuel and FX year-on-year was a little bit higher than volume. I think about 5.5% roughly. Should we think about this moderating as we go into the second half towards where the volume increases at?

Well, actually, if you were to just strip out the variance that was attributable to fuel and to the fuel price I think you would find that our costs were actually up just slightly above 4%.

We had 5% RTM growth. So in the scheme of things I would expect that we had to deal with some higher costs as it relates to dealing with weather in the first half of the year. That will hopefully alleviate as we look to the back end of the year.

And generally I think our costs continue to be well managed and well behaved. So probably more of the same.

Okay, thank you.

Chris Wetherbee, Citigroup.

Great, thanks. Good afternoon. I was just wondering on the coal side, how much volume are you doing of PRB through Rupert right now? How do you think about that opportunity as you move forward to continue to grow that volume?

This is not a huge amount of volume at this point. As I said, we are hoping to add another account this summer. We are looking at what could be done in 2012 and beyond.

I think what is good for Rupert is this terminal is expanding. It has a vision of spending capital, which it's doing this year and then some further capital 2012/2013. The northern BC mine are also expanding, so our program objective is basically to keep the terminal busy. Make sure the terminal has enough business that they never stop investing capital to expand itself.

It will be mostly over the next five to six years, a Canadian terminal for Canadian mine. However, there is room for us to bringing in a permanent basis a couple of million tons of PRB coal, and that is what we are working on.

Okay. That's very helpful. Then one quick follow-up on a separate note. Just the tax rate going forward. What is your best estimate for that? I apologize if I missed that.

No; I mean it continues to be around 29%.

Okay, even though you have done a little bit better than the last couple quarters?

Yes.

Okay. Thanks for the time, guys. Appreciate it.

Jason Seidl, Dahlman Rose.

Thanks, good evening, guys. Quick question, you talked a little bit about the weather impacts in the quarter. Could you quantify it both from a revenue and cost perspective? I don't think I caught that if you said it.

You know what? Railroading is an outdoor sport, and we like to think of CN as one that can prevail and do well for its customers and shareholders whether the weather is good or bad. So I would hesitate to give you an exact number because I would just be focusing on the negative and whining about weather. We are here to please our customers and our shareholders in all weather.

But you haven't seen any carryover thus far into 3Q have you?

Didn't get that, Jason.

Have you seen any carryover from the weather into 3Q at all?

No, I think we are remarkably current on the revenue side because Keith was able to step up and protect the integrity of the supply chains we serve. So we don't see much carryover from Q2 into Q3 in terms of revenues.

We certainly don't see carryover from an operations standpoint, unless we have new events. But it is starting to be in the middle of summer now. Other than some kink in termites we are gearing up for next winter.

Well, let's hope we don't get too many termite infestations. Really quickly, to tack onto the coal question, could you maybe quantify how big the PRB export market could be for Rupert?

As I said earlier, we want to keep step with our partner, the coal terminal in Rupert. They have expansion plans. Some are very well known, very well defined. Some are -- could be come into play two or three years from now.

Our game plan is to make sure that we bring enough business to keep pace. There is a number of mine expansions in BC. We think most of them will come into play, and Rupert is a very logical shorter distance terminal for that.

But there is room for coal from PRB to come either over Vancouver or the Edmonton interchange, and I would say a couple of million tons.

Okay. Fantastic. Guys, thanks for the time as always.

Matt Troy, Susquehanna Financial.

Hey, guys, this is Bascome Majors in for Matt Troy. Earlier I believe you said you were driving outbound intermodal volumes with some of your merchandise marketing teams. I was wondering if you could talk a little bit about what the balance is in your intermodal business there between out and in, and where you think you can take that over time.

I was referring to the overseas container, the 40-foot, where we focus on trying to balance the import and export as much as we can. Because we know for the shipping line we always talk about the import. But the shipping line are losing money and they need some ways to get back to port at the least cost possible [over] some revenue, where that's called an export. It's also called a domestic vehicle.

So what the merchandise sales force does, it talks to a pulp customer, a lumber customer, our steel customers, our grain customers, and try to find it -- maybe try to do a matchmaking between them and what we call the CN-friendly shipping line. Find ways for the CN-friendly shipping line to get some freight for the return back.

Ideally this rate is what we call source-loading, where you get the export not from the Port of Vancouver but you get it in-land where you basically have a way to pay for the return volumes of these containers.

The other way we help the shipping line to balance their return is domestic repo. Take a 40-foot container from Chicago; you move it with domestic freight into Winnipeg or Calgary. That is also helpful.

So we are not 100% balanced. We are balanced going east. For example Halifax, Montreal, fairly balanced. In fact, Montreal -- Halifax is more export than import. But we are working on to generate more export for the West Coast, and we have very great traction with that.

Our merchandise sales force know the Canadian merchandise customers better than anybody else. And we are able to create some positive upside for the shipping line that do business for us.

We call it selling One CN.

All right, guys. Thanks for the time.

Thank you. I would like to turn back the meeting over to Mr. Mongeau.

Thank you, Matthew, and thank you for all of you who have listened to this call. As you heard we are very constructive about our game plan and how our strategic agenda is unfolding.

We think the first half is setting us up well to finish the year on a very positive note. And with that we will look forward to meet you again on the third-quarter call with hopefully just as good results.

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