Canadian National Railway Co (CNI) 2014 Q1 法說會逐字稿

Welcome to the CN first-quarter 2014 financial results conference call. I would now like to turn the meeting over to Janet Drysdale, Vice President Investor Relations. Ladies and gentlemen, Ms. Drysdale.

Thank you, Eric. Good afternoon, everyone and thank you for joining us. I would like to remind you of the comments that have already been made regarding forward-looking statements. With me today is Claude Mongeau, our President and Chief Executive Officer; Luc Jobin, our Executive Vice President and Chief Financial Officer; Jim Vena, our Executive Vice President and Chief Operating Officer; and Jean-Jacques Ruest, our Executive Vice President and Chief Marketing Officer.

In order to be fair to all participants, I would ask you to please limit yourself to one question.

It is now my pleasure to turn the call over to CN's President and Chief Executive Officer, Mr. Claude Mongeau.

Thank you, Janet, and thank you for all of you on the call to join us. We are in sunny Vancouver today for our annual general meeting and we are pleased to have you on the call here to give you an update on our first-quarter results.

There is no question we just went through a very difficult quarter from the standpoint of the weather that we have to face. It is the harshest winter at least I have been involved with and I have been CN for 20 years. And I think Jim will tell you later that it is probably one of harshest he has had too and he has been here with CN for longer than me. So very, very difficult winter conditions that impacted not just railroads but all transportation sectors and it clearly impacted our ability to meet all of the customer demand that we had in front of us.

So at the end of the day, winter is winter. We are learning from it and what I am most proud of is the resiliency and the ability of our team of railroaders to face up to that adversity and perform on a relative basis exceptionally well despite the elements.

So solid performance financially. Luc will give you some of the details in a minute but good top-line growth. It could have been better without the winter. Solid expense performance. Obviously impacted by the additional expenses but we were able to manage the productivity and keep solid earnings growth in the circumstances and it puts us in a good position even though it was a tough quarter to face up to the balance of the year and remain on track.

In fact as I look at April, the recovery is well underway. Our safety, our operating, our service metrics all of those are quickly returning to pre-winter levels and that bodes well for the balance of the year.

We are very focused on continuing to basically deliver on our supply chain collaboration agenda. I will be taking questions later I am sure but we did have a setback. I think it is highly unfortunate that the Canadian government decided in the heat of the moment to react to the 100-year crop for grain that we have and introduced legislation which I think will do little to help move grain and sets us back in terms of the sound transportation policy in Canada. But Parliament is sovereign and I will be happy to answer any questions you have on that matter after the team gives you an update.

With that, I will turn it over to the team. Jim?

Okay, thank you very much, Claude, and listen I am going to be quick, just a few slides today but I wanted to start off with representation. You've all heard the story of the coldest winter and it affected us and just the traveling public everywhere in North America whether it was down in the Chicago or Eastern Canada or through the prairies where we traditionally have a taste of winter every year.

So this slide, it was just a quick representation to say the amount of quarters that we have and what was affected and how we operated through that.

Now operating in these tough conditions no ifs ands or buts added some one-time costs to our day-to-day operations. We had to make sure we had more snow removal. We had a number of contractors come in and Luc will give you a reference of where and what it impacted us to the bottom line on our cost structure.

If you take a look at the bottom of the page, we talk about metrics that are very important to us, train speeds and terminal dwell and they both were off substantially especially during January and February. We saw a recovery in March when the weather started to break and wasn't as intense in all the quarters we had but we had a reduction in train speeds and terminal dwell. And one number that we do not have on there but we saw the similar drop in the close to 5% rate, is our car velocity and car velocity of course, the measure that gives us a good feel of how the network is working.

Now we delivered in the first quarter GTM growth and RTMs growth and Luc will take you through the exact numbers and our trainload was actually up. A lot of that happened because of the results of what happened in March and what we were able to deliver. But we -- there is no way that we would have been able to deliver it with having one of the key four foundation that builds the railroad. So locomotives I think we did a good job of planning and we have a long-term plan of how we bring locomotives in and the purchase of the AC locomotives last year and the additional purchases this year were in the right position moving forward. That helped us.

But it was truly the employees who work for us, the managers, the front-line people, we had people from IP, people from accounting, and people from operations out there operating trains and that is the only way that we were able to operate and be able to deliver growth in GTMs on a very severe winter. And as Claude said, I've been around here a little longer than 20 years and this was a tough one but it is what it is. It is an outdoor sport and there is no use complaining about it. Let's move ahead.

So if you take a look at the second slide under the recovery underway, the investments that we've done both on capital in the last few years and we continue to analyze this as a long-term view not just short-term. I think we are seeing the benefits and we will continue to invest whether it is the investment in the EJ&E and our capability to go around Chicago, the investments at Kirk Yard that give us more hump capacity there. In fact, we saw that operation through Chicago operate not quite as good as fluid as when you would have no winter weather. But really it was not as much of an impact to us as it could have been if we did not have the structural foundation that we have built up in Chicago interchanging with other carriers and also the capability it gives us to move the traffic the interchanges further down the railroad whether it is in Memphis or Salem or other locations that are much more fluid. So excellent there.

We know we are going to continue to work to give more resiliency and recoverability and we will talk about that. The CAD100 million that we spent last year in addition to our regular plan that we put in about this time last year, we did see the benefit of that through the winter. Our recoverability was quicker. It was still was cold, it was colder for a longer period of time -- snow, but when we got to being able to move, we were able to move quicker and in a faster fashion.

So bottom line is there is no change in what we are trying to do. We need to stay excellent at moving the railroad, moving the box cars as fast as possible. But on the other hand and make sure we are balanced and we provide good service to our customers. I think we impacted a number of them in the first quarter and we are going to work hard as the year goes on to regain everybody's confidence and move all the business that JJ is bringing on. So, JJ, over to you.

Thank you, Jim, and good afternoon to all of you who are joining us this afternoon including our very valuable customers and the shareholders.

The next few minutes I'd like to review the last quarter and after that give you a market outlook. The month of January and the month of February were very challenging as Jim described. Most days in the Canadian prairies were below 25 degrees centigrade or minus 13 in Fahrenheit; therefore carloads was down about 1% and revenue was up only 1.5%, FX adjusted during the period.

March got progressively better. We had less days below minus 25 degrees centigrade. Carload grew 5% and revenue was up 7% adjusted.

Overall for the quarter, revenue growth was 9% as reported broken down as follows. Volume and mix was up 2%; same-store price on same-store sales after fuel and exchange was up 3%, and that's including its on all in number including regulated grain and export coal. The fuel impact on revenue was flat and 5% came from the exchange. So therefore when you look at our revenue for the first quarter broadly speaking, do not [end] for a relation between or volume and our customers' demand.

The story in the first quarter was about exceptional winter conditions and the resulting impact on network velocity and network capacity.

So now looking at the quarter in more detail and I will do that as usual on an FX adjusted basis. I will start with petroleum and chemicals which was up 16%. The volume growth came from crude from LPG and most of our base chemical in plastics. We also had a strong market environment in energy as well as in energy-based manufacturing. In that segment, both condensate and sulfur market were soft.

Metals and minerals revenue was up 1% excluding iron ore. Frac sand revenue was up an impressive 23%. Our Wisconsin franchise continued to flourish with the addition of new products and capacity and further scale up of existing facilities. Other revenue from our metals segment were down 7% mostly driven by lower shipment of pipe, steel and aluminum.

Iron ore revenue was down 19%. We had a very difficult winter condition in the upper Midwest which negatively affected our supply chain operation in that area.

Forest products revenue declined 6%. Lumber demand was very strong and was supported by (inaudible) improvement in US housing starts. However, winter affected network capacity in Western Canada and did put a downward pressure on our overall ability to move lumber, pulp and panel carloads.

The Port of Vancouver had a one-month truck strike which also impeded lumber and wood pulp export via that port.

Coal revenue was up 2%. We experienced lower export of pet coke and thermal coal and these were offset by a very strong demand for US domestic utilities.

Grain revenue increased 9%. We had revenue growth which was driven by a big crop in both Canada and the United States. The demand for Canadian export is huge and our supply chain shifted to full gear with the arrival of spring a few weeks ago. Recall that pricing in Canadian regulated grain was reduced by the government by 1.8% for the 2013, 2014 crop year and it is a year-over-year negative on our same-store price.

Fertilizer revenue fell 20% due to network challenge and also to a short-haul sourcing of phosrock by one of our customers who changed his sourcing in the year-over-year.

Automotive revenue and carload dropped 10%. (inaudible) vehicle revenue was negatively impacted by North American industrywide TTX car supply shortage. Intermodal revenue grew 9%, the international business was up 15%, the domestic rose 2%. We had solid growth in the industrial sector, consumer products and as well from a geographic perspective, we had strong transborder shipment to and from Western Canada with the United States.

Our coal supply chain service is gaining market traction in the marketplace and produced double-digit growth. The early Chinese New Year congestion and the Port of Vancouver truck strike which lasted a month has put a toll now for operation especially in Vancouver.

Now looking forward, first I want to reaffirm like I did on the last conference call that our year-over-year linehaul performance will be driven by current strong demand for most of our product by our network capacity to meet that demand and by the still weak Canadian dollar.

Looking at intermodal, the business is looking strong. It is helped by a strong US economy, US consumer confidence, also by still a fairly positive customer sentiment toward a CN product just by the tough winter and as well as some recent marketshare in the marketplace.

Most promising is the business out of the Port of Vancouver, the Port of Montreal as well as the domestic retail. On petroleum and chemical, we will also produce growth. Shale gas is having a positive implication on manufacturing mostly petrochemical. Crude by rail with continuous progression although I am increasingly more interested in the needed price yield improvement of that segment versus strictly only volume growth.

Metals and minerals will be driven by all-in gas production consumable and by the North American automotive manufacturing. We further expect some further gain in frac sands during the course of this year and maybe next year.

Forest products will be driven by good US housing starts and by existing high inventory of pulp, lumber and panel near the production sites. The lost Q1 housing starts especially in the US will not be made up but most of our customers believe that the run rate will be back.

For grain, we have a lot of Canadian grain to export. We will have a lot of it to export all of calendar 2014 as well as in 2015 to be carried over.

For fertilizer, demand for potash export looks solid for the next few months including maybe during part of the summer. Exchange rate will likely be a positive tailwind since the average exchange rate was CAD1.02 for $1 during Q2 of last year.

In closing, the strong market demand remained intact. Housing, energy, automotive, grain, fertilizer, domestic, thermal coal, iron ore, intermodal are all looking solid. Export coal though looked weak same as pet coke and sulfur also looked weaker. We had a disciplined inflation plus approach to pricing and as the overall North American rail network capacity is getting snug, our rail capacity will increase value over time.

Thank you. Luc, we will go to the financial.

All right, thanks, JJ. Starting on page 14, let me walk you through the key financial highlights of our first-quarter performance. These are strong results considering the adversity we face but let me give you more specifics.

As JJ highlighted, revenues were up CAD227 million or 9% to nearly CAD2.7 billion. Operating income was CAD820 million, up CAD40 million or 5% versus last year. Our operating ratio was 69.6%, an increase of 120 basis points versus last year pressured by difficult winter conditions throughout the first quarter and extending over most of our network.

As Jim pointed out, our team worked very hard but we couldn't get to all of our customer demand. And also it resulted in higher operating costs. Other income was CAD94 million versus CAD42 million last year. In the quarter, we sold a portion of a subdivision in the Greater Montreal area to the local transit agency resulting in a pretax gain of CAD80 million. This compares to a similar transaction done last year but last year was in the Greater Toronto area for a gain of CAD40 million.

Net income for the first quarter was CAD623 million, up 12%. Foreign currency translation contributed to a favorable impact on net income of CAD26 million or CAD0.03 of EPS in the quarter. So the reported diluted EPS reached CAD0.75, up 15% versus last year.

Now when excluding significant property disposals which occurred in each of the first quarter for this year and last year, the adjusted diluted EPS stands at CAD0.66, up 8% versus 2013.

Turning to page 15, let me address the operating expenses. Those stood at CAD1.873 billion, up 11% versus last year or 6% on a constant currency basis. At this point, I'll refer to the changes in constant currency.

First, labor and fringe benefit costs were CAD587 million, essentially flat versus last year. This was the result of three main elements. First, an increase in overall wage costs including overtime of CAD37 million or about 2.5 percentage points which partly was offset by higher capital work being performed in the quarter versus last year for about CAD8 million.

A second element is a lower pension expense for CAD24 million of the labor variance. The third element is a lower stock-based compensation expense in the quarter versus last year which also represented CAD8 million of the variance.

Purchased services and material were CAD388 million, an increase of 15% or CAD48 million versus last year. We had higher volume about 5% more revenue tonne miles along with significant increase in winter-related costs. As such, repair and maintenance expenses were up some CAD20 million accounting for 7 percentage points of the increase. As well we had higher utility and material costs for 5 percentage points of the variance.

Crew accommodation and increased intermodal trucking expenses made up the majority of the remaining increase for 2 percentage points.

On the fuel side, the fuel expense stood at CAD468 million, up CAD24 million or 6% versus last year. Higher volume represented an increase of 5 percentage points in the quarter while an increase in price drove the remaining 1 percentage point.

Depreciation was CAD256 million, CAD13 million higher than last year or 6% due to a combination of asset additions and the impact of the depreciation studies. Casualty and other costs were CAD97 million, CAD11 million, or 14% higher than last year. We had higher property taxes and general costs which were offset by lower workers' compensation expense. We also incurred higher accident-related costs for approximately CAD10 million which explains for the most part the variance.

Turning to free cash flow on page 16, we generated CAD477 million of free cash in the first quarter, an increase of CAD343 million versus last year. Cash from operations benefited from higher earnings, lower income tax payments and better working capital.

On the investing side, we had higher proceeds from property disposals partly offset by higher capital expenditures. So our balance sheet remains strong with debt and leverage ratios well within our guidelines.

Finally on page 17, our 2014 financial outlook. We are coming back strong from the extreme weather conditions experienced in the first quarter and which have arguably slowed down many parts of the North American economy as well. Our network is quickly catching up with demand and we are optimistic with our prospects for the balance of the year.

Given this perspective, we are reaffirming our annual guidance and thus we are aiming for double-digit EPS growth in 2014 over the 2013 adjusted diluted EPS of CAD3.06.

Our guidance also continues to call for free cash flow in the range of CAD1.6 billion to CAD1.7 billion. We are increasing however our capital investment program from CAD2.1 billion to approximately CAD2.250 billion. This additional CAD150 million will go towards higher investments in network capacity in our key corridors and additional motive power.

So the CNP remains as committed as always to delivering superior results for its customers and shareholders no matter how challenging the circumstances as we continue to unfold our strategic agenda in 2014 and beyond.

On this note I will turn it back over to you, Claude.

Yes indeed, Luc, our strategic agenda is delivering. I am very pleased with those first-quarter results which are solid in the circumstances. As I said earlier, we are focused on the balance of the year. Luc just reaffirmed our guidance and we are committed to deliver on that guidance and the key is to regain our network fluidity which is exactly what we are doing. I think in the month of April as it stands, it looks like we might actually have a month with 1.3 billion GTMs per day on average which would be by far the highest we have ever done on a consistent basis for a full month.

So that is a good sign that the volume is out there, the fluidity, the speed of the network is recovering and behind that is our focus on first mile/last mile, end-to-end visibility basically regaining our footing in terms of customer service levels. Nothing is more important to our long-term future because we are committed to continue to grow faster than the economy and do so at low incremental costs so that we can please our shareholders for many, many years to come.

In order to do that, as Luc just indicated, we are going to be investing effectively CAD150 million more. I think this is all part of our multiyear plan and we are just taking advantage of his smart monetization. I thank you, Luc again this year for finding a way to create value by selling assets that we don't need for our freight business and to do so at a profit, generating cash flow that we can reinvest in our business.

So I will turn it over to you for question-and-answer but rest assured that we feel good about the balance of the year. We feel we have momentum to deliver solid results again in 2014. Operator?

(Operator Instructions). Scott Group, Wolfe Research.

Hey, thanks. Good afternoon, guys. So, JJ, I heard you mention I think a couple of times that the volume in 1Q wasn't reflective of the demand environment. You know I want to get your perspective first on what you think the demand environment is from a growth perspective; how much do volumes want to grow.

Then just kind of secondly with that how much do you think the network -- how much growth do you think the network can handle? So it's like, I think it's the second year in a row you've had to raise CapEx in the middle of the year. Are we getting to the point where you can't handle some of this growth, or is it kind of just the weather was unusual? I just want to understand that a little bit better.

Thank you, Scott. I will do that, pick up the first one and Jim will pick up the part on capacity.

Most of our segment have a very good demand in the first quarter and it was looking good for the second quarter and in most cases beyond, especially anything that has to do with energy, housing, automotive, frac sand, a number of these different things. Where we have softness is export coal, export sulfur, and export pet coke.

And where we have some capacity, which is not necessarily related to CN but capacity which is more of a North American capacity, is how fast my [center beams] are coming back on my road to move the lumber that I have. Same thing with the box car to ship out back out the panels off-line, the same thing for the automotive finished vehicle, so I can serve my (inaudible).

But the demand looks fairly good and I mean in some sector like grain, it is just huge and it will keep us busy in the spring and the fall -- in the spring and the summer, I'm sorry. And Jim if you want to make some comment on network capacity.

Right. Well network capacity we don't look at it as a short-term view. We need to take a look at it as a long-term view, Scott. So if we take a look at it, we've always got a book that looks at what do we need to do this year, next year depending on where the business is. We want to make sure we are at the right level of capital against our revenues so we still stay within that 18%, 20% range. And Luc can jump in if he wants to add anything to it.

But when we looked at everything that is happening, we thought and with the change in the regulations for locomotives, we thought we needed to take and put some money into delivering some locomotives this year and providing ourselves some options for next year. So that is part of the increase and we wanted to make sure we stayed ahead of the curve there and we weren't waiting until the last minute.

And the other, we have identified some areas that we had that we knew we had to increase the capacity. So we feel with where we are in the business growth that we see moving forward and what we have just seen in April, we want to get some of that done this year instead of waiting until next year and the following year. So that is what it is all about.

I could just add, Scott, maybe we are moving 1.3 billion in April so we don't need this capital to be able to over perform our outlook for the year but we do take it on a multiyear basis. We really like the way the AC locomotives performed for us this winter. It was a very, very tough winter but they performed well for us in the circumstances and we have a chance here to buy more of them before we move to Tier 4. So that is for the locomotives.

And for the rest, it is really we know where they pinch points are. We have the ability to reinvest in the business and we are addressing those pinch points in a very methodical disciplined way to support our growth long-term.

Okay, thanks for the color, guys. Appreciate it.

Benoit Poirier, Desjardins Capital Market.

Hi. Jim, could you comment on the CAD100 million of capital that was invested in the Edmonton, Winnipeg corridor after last year's challenging winter? And maybe perhaps more broadly talk about some of the things that you did to prepare operationally going into this year's winter. Thanks.

Okay, Benoit. Let's go with the CAD100 million first. What we identified was last winter is we had a -- how fast you could recharge the system, how fast you could get the trains and the yards movement. So we spent the money very strategic, put some new sidings in the on the Prairie North Line that allowed us an option to be able to move trains quicker. It is not our primary route; it is not quite as quick as our main line so you don't want to use it but it was important to do that.

We spent money in Winnipeg at Simonton Yard just because of the growth that we've seen in traffic and the flow. We have gone there probably 30%, 40% growth in that yard and traffic moving through there in the last few years so we knew we had to do that. And what we found this winter is it really made a difference. We recovered quicker even with the worst winter Winnipeg West and the prairies than we did the previous winter.

Now what did we do to get prepared? Listen, we run in the northern part. I think there isn't anybody of the Class 1s that operates further north than us. We know winter is going to happen. The question is how bad and how long and the intensity of it. So what we do is we are very methodical about this, is you need people so we are lucky enough and we have taken it head-on to train a number of people to supplement our unionized workforce. That is not our key but just in case we get into a position where we need it. And this winter we had people from across the Company working out in the field.

We had account managers that were getting calls from customers and they were out -- when the train wasn't moving of course -- they were out taking calls and dealing with things. So we did that.

We watched the yards very carefully. We managed it on a day-to-day basis the senior group in operations and watched everything we were doing. It just grows on what we do every day on the rest of the year but you have to be very productive in the yards. Yard productivity again in April is better than it ever has been so we can see that the recovery is there. Our train speed is coming back up where it needs to be. We did that quickly with what we have invested in going through the winter.

So it is a continuous process to see where we can look for opportunities to make the place better, Benoit.

Okay, thanks for the time.

Chris Wetherbee, Citi.

Thanks, good afternoon. Maybe just a pace question on the sort of pace of recovery into the second quarter maybe focus on volume that was left on the table in the first quarter due to weather, what you can sort of make up. And maybe how you think about marketshare opportunity in light of what we've seen as a pretty tough winter so far, any sort of new opportunities that come up as a result of that.

But I guess I just sort of roughly want to get an idea how much volume upside you have over the next quarter or two how quickly can you kind of make up what you lost?

Maybe I can start, Chris. It's JJ. In terms of marketshare opportunity, I don't think there is resulting marketshare versus from the winter. The winter has been challenging for all of us and as far as CN, we have a good book of business. We're happy to have the customers that we have and our focus is to serve those existing accounts.

Regarding the business that we weren't able to serve during the winter, we are going to work hard in some cases, we are going to work hard a few weeks, in some cases it will be months, and in some cases of Canadian grain, it will be up into next year. We don't necessarily have a number specifically but we do have as Jim said, we are doing extremely well the last few weeks with our GTM and the book of business is there. We have demand and it looks good for the next little while here.

And Chris, it's Luc. I mean just to amplify a little bit on what JJ has mentioned, I mean order of magnitude we don't want to focus on a specific number but order of magnitude, we probably left behind about CAD100 million or so of revenues that we just couldn't get to so the quickness in terms of recovery that Jim pointed out is all about going after that volume. We know it is out there and we are getting on top of that very quickly.

So we have every reason to believe that there is a little bit that probably was lost but by and large, we will be able to recover most of it.

But to give you maybe one example, specific example, US domestic thermal coal, the utilities that we serve and one of them is a new customer for CN have ended the winter with very low inventory, much lower than what they would like to be comfortable at this point. So we are going to spend the summer, spring, summer and fall to rebuild it back to the level that we would like to enter next winter.

Walter Spracklin, RBC.

Thanks very much. Good afternoon, everyone. I want to turn to a little bit more of a difficult topic on regulation and Claude, you have been addressing this very well in your -- both in terms of your comments today but also in your public presentations.

One of the questions I have and I posed it the last on the CP call there earlier this morning as well, is less of a focus on the interchange expansion of the 160 kilometer and all that, all of that sunsets of course in a year or so. It is going to take a backseat to the Canada Transportation Act Review.

My question is, is it your sense that cooler heads might prevail now? You mentioned how it was a heat of the moment decision by the politicians that they came out with this regulation on this proposal. This is going to be arguably a year maybe two-year process in which they're looking at the CTA. What might come about in terms of changes to the CTA if interchange takes a backseat? What might we be faced with? Could it be a watering down or more compromise or are you worried that something else might come out of left field on us like the interchange did and catch us by surprise?

Yes, I think we will have -- I mean we are moving grain at the moment in line with what the grain elevator companies are able to unload. I said that would happen a few weeks ago and it is happening as we speak. So we will be able over the summer to show that railroads are not the only issue in the supply chain, that we can only be as good as the collective capacity of grain elevators to load and unload and railroads to move in between.

So I think that will help. As we move more, we are going to have a record year in terms of overall grain throughput and people will have to step back and look at what they have done during the winter when emotion ran high. I believe the Canadian Government effectively gave super priority to the grain business. Now this is summer. We are going to have a chance here to operate hard for everybody but what they have done is give super priority to the grain business.

I think other commodity shippers are going to have to step back and ask themselves was that a good thing? And I am hopeful that some will be wise enough to engage in the debate so that it is not just the railroad talking that customers from all sectors are saying these guys are trying to make trade-offs, these guys are managing priorities, they have their incentives, normal commercial incentives. They are broadly aligned with what we are trying to do in the commercial system is what we trust more than the super priority for grain.

So I think that hopefully will get people to think through and be wise about how they interact with government over the next few months and years as we -- as the dust settles. That is at the level of sectors. But within the regulations that came about, the government also introduced a new regime for service level arbitration for instance, penalties, things of that nature. Well it is the same basic issue. If you allow a certain customers that are more regulatory bent to use the regulatory leverage and jump the queue, get in the line and get a better deal, try to make the railroad become a taxi as opposed to a bus service, I think customers are going to see that the ones that are commercial that they are allowing others to jump the queue and get a better deal by going through Ottawa if that is what happens.

That also should get people who are wise and understand the logic of a commercial system to engage in the debate. So we are going to use this decision which I believe was not a good decision. I think it was taken in the heat of the moment for the wrong reasons and we are going to have a chance to explain to stakeholders our other shippers and the regulators that there is a much better approach and that approach is to encourage supply chain collaboration, to have the sound policy that builds on commercial incentives, and that we will be able to make that case and make it to a point that they not only sunset these provisions in a couple of years but also don't use the CTA review as a big football game around how much do we regulate the railroads.

That is my hope and that is the case we are going to put forward. I think it is important enough for Canada that cooler heads and wiser heads will prevail in due course.

That makes a lot of sense. Okay, thanks very much, Claude. That is my question.

Brandon Oglenski, Barclays.

Good afternoon everyone and Claude thanks for those comments there. Luc, I did want to follow up on the compensation line and looking at revenue growth of 9% and compensation growth of only 3%, how do we think about that relationship going forward? I know you talked about a lot of moving pieces in the comp line.

Yes, I mean again, I think in the first quarter we had the first time that the pension started to be a bit of a tailwind for us as opposed to a headwind. So that is part of the explanation for the change. There was also a fair amount of favorable stock-based compensation swing.

But if you look at the longer-term across the year, we are still looking for labor to be in the sort of 20% of revenue category. So order of magnitude, that is still the number that we have in mind. We are going to be growing our average headcount probably to the tune of 1% to 2% and we are continuing to see wage inflation around 3%.

So those elements will be there throughout the year and we've guided for the pension expense to be favorable to the tune of CAD70 million to CAD80 million this year versus last year.

So that is broad terms that I think is what we are looking at for the labor category.

Thank you.

Bill Greene, Morgan Stanley.

Hi, good afternoon. I wanted to ask JJ about currency. Are we yet seeing any reaction north of the US border from your shippers? Have they been able to ramp up production? Is this going to be a meaningful driver in the second half? Any color you can give us. And if the answer to that is no, maybe sort of what is a normal timeframe for when they would start to react?

I think you can look at -- thank you -- if you look at those really live off the US currency kind of export rather lumber for example, pulp, most of that is sold through Asia so sold in the United States would be in US currency. It does give them the bump. They are more competitive in world markets if you are shipping overseas and they make a little more profit if you ship to the US.

So I think you already see that impact especially in a market where we don't necessarily have a lot of contracts out there like lumber and panel. Pulp tends to kind of quarter by quarter. Currency is also a factor in other markets like in the case of export coal, for met coal for example. The Australian dollar is weaker so it drives the price of the product is in US funds, Canadian dollar is weaker but other currencies around the world also are weaker relative to the US dollar.

But I think when you take all that in, right now we are what $0.90, $0.91 and it is okay. Typically for Canadian manufacturing sector $0.91 is easier than $1 and we have no impact either way and we'll ride both segments. But I think the demand you see already see the impact on some of the Canadian manufacturing sector having some positive benefit.

When you sell to world markets, now you have to look at other world currencies and it gets a little more complicated.

Sure. Okay, thank you.

Cherilyn Radbourne, TD Securities.

Thanks very much. Good afternoon. You guys had a bit of a tough winter last year as well. Nothing to the extent of what you saw this year. But my sense was last year that you weren't as pleased with the way that you handled the winter. I wonder if you could just compare and contrast this winter versus last winter a bit for us and just your ability to regain momentum this year versus last year?

My secret weapon is that I was able to give the keys to Jim this winter. So he did much better than I did in the middle of February. Seriously, the big difference is last year -- like this year on a relative basis, we are doing much better than the other railroads despite being the most exposed in terms of the weather. Last year we had an issue which was winter but also the lack of recovery capability especially towards the [M] in the March period and that was because we were bumping against the line capacity in that Edmonton to Winnipeg corridor.

And so it was a bit more unique to CN and it is something that we should have been smart enough to get ahead of the curve and so that is why we did what we did last year and introduced the CAD100 million program and we are always have and will continue to be ahead of the curve looking at our pinch points. We learn every time we face adversity and make investments ahead of the curve so that we don't bump up against resiliency issues.

It is tough enough to face up to adversity. You want to avoid facing up to recovery lag time when weather gives you a break. So I think those would be the two main -- the two differences between last year and this year, Cherilyn.

Great. Thanks for that color. That is all for me.

Allison Landry, Credit Suisse.

Hi, good afternoon. Thanks for taking my question. You mentioned earlier that shale was actually contributing to some growth in the industrial sector. And I was wondering if you could discuss some of the potential projects that you have in the pipeline in Canada specifically whether it is frac sand, inbound materials, or even LNG exports.

And I think a few weeks ago there was an announcement that a large-scale frac sand train load facility would open in Alberta exclusively served by CN. So just hoping to get some commentary surrounding this topic.

0 Thank you, Allison it's JJ. So maybe I will take that one. I mean cheap gas or cheaper gas really means a whole lot for the North American economy including CN. So what does cheap gas mean? It means people who make petrochemical can make more of them and be profitable. The same thing for fertilizer, which some producer on the CN line same type of people who make plastics, like plastics plant that we serve in Alberta and Louisiana. When you look at LNG, there is a number of projects putting an LNG export terminal on the Canadian West Coast whether it is Kitimat or Rupert because those projects even though they are not approved yet, people are already drilling heavily in Northern BC to get gas because when the project goes forward, you really need to be able to charge this product with a lot of gas day one.

So people are drilling today. They drill, they frac, they cap. They drill, they frac, they cap. So already moving pipe and frac sand to Northern BC to build up a base of readily available natural gas from the well and when the project is announced, they say it takes three or four years to build it, then it is going to be a huge amount of drilling, a huge amount of frac sand. And when we say a huge amount of frac sand, we mean unit train quality and that is where the market is heading to in Western Canada just like I think it is in Texas.

People want to ship 50 car block and eventually leading 200 car block and with lube track really high efficiency high scale operations. So all these things mean a lot of good things for the railroad and a lot of good things for CN whether it is manufacturing or just the resource itself.

Okay, great. Thank you very much.

Steve Hansen, Raymond James.

Yes, good afternoon. My question leads to your emerging crude by rail franchise. I was just hoping you could provide some added color on your suggestion that in addition to volume growth, I think you said you are also starting to see some pricing growth or acceleration and can you provide some color specifically on what is driving those gains, what basins or origin destination are driving those corridors and what specific corridors, that would be helpful.

Okay, Steve, it's JJ again. What we are saying is that it is good to be focused on the profitable volume growth but it comes at a time when some markets are growing at such a pace and everybody gets so excited on them that the profitable market eventually get sacrificed. I just want to be sure everybody understands even though we provided guidance is how much we want to grow that business we will not grow it at the expense of price.

So if we are short of our volume target, it will be because we want to make sure that we focus on first on the profitable before we get on the big volume. And after having said -- and what I have seen the last six months here is that market may have got too excited to the point where some of these deals weren't necessarily the deal we would like to have say two or three years from now. So we took a pass in some cases and want to focus our capacity where it makes the most sense.

Typically for us, it is the business starts somewhere in Alberta or in the West, the prairies and it goes East to our CN refinery or it goes South to either a refinery and/or our barges to get to another refinery. So the flows are from the West to the East and the West to the South.

Jason Seidl, Cowen and Company.

Good afternoon, guys. You talked a little bit about your same-store sales being up 3% and I believe you stated that included regulated grain and the export coal. If you remove those two items, where would we be at?

Even though we do this calculation, we don't provide that level of detail. My philosophy in same-store price is same-store price really means the good, the bad, the ugly and it is what is in between and it is either the whole thing or none of it.

So my message to my troop is we always have areas of weakness and areas of strength and the game plan is to make the average where it needs to be.

But I am assuming the number will be higher then.

That would be correct just because of grain (multiple speakers)

Yes, there we go. (multiple speakers)

He is very consistent and I like his way of thinking. It is like playing a hockey game and the player is asking can we just forget 10 minutes of the game? No, no, the hockey game is three periods. It is the whole thing not just 80% of it.

Guys, unfortunately my hockey team only played about two-thirds this year. That is why they are on the back nine right now.

Just watch The Habs go all the distance here.

All right, guys.

Ken Hoexter, Merrill Lynch.

Great, good afternoon. Claude, when you go through the whole regulatory discussions, is there discussions in terms of what you can do more of in terms of capacity? It sounded like you had mentioned before you are already meeting what the grain elevators can put out. So what are -- are the regulators telling you they expect you to be able to even do more than that? I just want to understand how the discussions have flowed as you have progressed here as the weather broke.

I think the best way to put it to you, Ken, is the following. I think there has been a lot of advocacy throughout the winter. I can understand the grain grower side being concerned about the grain not moving as fast as they would've hoped but you also had grain elevators companies that are private sector companies that are a few and that control a big part of the supply chain that did a lot of grain shifting and basically a lot of self-serving regulatory advocacy.

And all I'm saying to the government is let's follow the facts. Of course in the winter, there was a shortfall. We couldn't meet all the demand and all the capacity of the supply chain but as far as soon as the winter broke, we started to ramp up and at the moment, we are on top of Prince Rupert. They cannot move more. We are on top of Vancouver. This weekend there was 500 hopper cars staged while they were taking a break for Easter weekend and those cars were sitting not being unloaded.

We are full except for one elevator in Thunder Bay and there is only a few vessels coming through the ice that is still blocking the channel going to Thunder Bay. So we are moving just above 5,000 cars and we are absolutely in sync with the grain elevator company. So that is what the supply chain is able to do period, not just the railroads but the railroads and the grain elevator company.

So we are going to go back to the government and we are going to say it is one or two things, you either are allowing the supply chain on a commercial basis the alignment of incentives and use the commercial tried-and-true approach to make sure that people deliver for Canadian farmers, or we regulate. And if we regulate, we should regulate it all, grain elevators, railroads, we should do the coordination, we should tell what people are supposed to do and do it on a regulatory basis.

It is really a choice of half and at the moment the government spoke in the middle of the winter with railroads being blamed. Now the facts are coming out. They are going to have another chance to look at this file and decide. I am hopeful, I am hopeful that cooler heads will prevail and that supply chain collaboration and the sound policy framework that we have worked so hard in Canada to build, we have the best railway system in the world period. We have the lowest rate, the best service. Before we mess with success, we should think it through.

And so it is either supply chain collaboration or it is a regulatory approach. And if it is regulatory, we are going to be arguing that we should regulate the grain elevators and the railroads because that is the only way to bargain for the farmers if that is their goal.

I appreciate the insight. Thanks, Claude.

Thomas Kim, Goldman Sachs.

Thanks. Can you quantify the dollar impact of weather on a few of your cost items, purchased services, fuel and equipment rents?

Yes, I would say, Thomas, that broadly speaking in terms of expenditures, we are probably looking at something in the order of magnitude of about CAD50 million of higher expenditures attributable to the harsh winter so give or take.

Okay, would you be able to break that down into three different buckets or whatever buckets that you have?

No, that is about as good as it gets.

All right, okay. Thank you.

David Tyerman, Canaccord Genuity.

Yes, good afternoon. My question is on your guidance. You have raised your capital budget CAD150 million but not changed your free cash flow guidance. I am wondering what is filling in the gap?

Well we were able to -- it's Luc. We were able to dispose of part of a subdivision in the Montreal, the Greater Montreal area so we realized the proceeds of just shy of CAD100 million. So we have been running pretty good cash, managing the working capital and in addition to which we had this realization.

So all in all, we were able to address the increase in the capital expenditures while at the same time not changing our free cash flow guidance.

And we had a very solid start to the year on free cash flow.

Very, very good strong position.

Perfect, thanks.

David Vernon, Bernstein.

Hey, good afternoon guys. I guess with the CAD50 million weather impact if you were to adjust that out, the stronger start to the year here would that make you more constructive about being able to hit the double digit EPS growth as you look out through the rest of the year or is there something else that is going to be maybe keeping you from getting a little bit more constructive?

No, we are always very constructive. But at the same time disciplined and you have our guidance. We are committed to deliver on it.

Okay. Maybe then just as a quick commercial follow-up. In terms of the expansion of the length of haul that we saw in the manufacturing business, is that something that had a weather impact to it or is that something you'd expect to be sustained through the next couple of quarters given the underlying sort of mix trends in that segment?

I think the first quarter was kind of unusual so before the winter, we had an average length of haul increasing in some of the sectors already. I think we spoke of that in the past quarter but also during the winter, our mix of business was not quite what it was usually. For example in lumber, a lot of our customers truck so they truck to the closest point which was the Port of Vancouver from Northern BC and they kept the railcar to Vancouver -- to go to Chicago gateway for example. So the mix of business for the last quarter has been more about network and customer's choice to use the best possible equipment in the way that serves them the most not necessarily their natural flow.

But you wouldn't expect that 15% uptick in length of haul to sustain?

I think I guess the first quarter was not a good quarter in terms of it was not reflective of demand, it was not reflective of our usual pattern, kind of an oddball. Not sure we can draw a lot of long-lasting conclusions on that.

All right, great. Thanks a lot, guys.

Keith Schoonmaker, Morningstar.

Thanks. We've heard other rails cite Chicago again as a major source of delays this quarter. Jim, I am interested in hearing greater detail on how you are using the J. For example, is most of the traffic moving to and from your Southern lines skirt the city on the J or just hand off from other rails have to move on the belt lines?

If we take a look at the way what the J has done, with the EJ&E being able to have that line around the city, we still have to deliver some traffic into the Belt and over the IHB. We moved everything we can off those two lines and onto our own railroad. We have moved the interchanges. When we worked hard the last couple of years to move the interchanges with all the other Class 1s that we could away from the Belt and the IHB and over to our own locations and we are using the yards that we have in the city.

So what we have been able to do is we control our own destiny. Chicago did slow down for us because we are impacted -- it wasn't as fluid as it normally would be so we were impacted with everything else that was going on. But we did not have a lot of trains sitting waiting. We did not have like we would have before the EJ&E trains sitting at the north end of the city for a few days trying to get through. So the investment was right.

And we just finished -- we've got one more piece of expansion left to do on the line in connection. We will finish that off early next year and we will have the railroad built the way we want and we are finishing off Kirk Yard to make us even more capacity intensive and be able to handle more traffic through Chicago this year and we will have that finished by the end of the summer.

It is huge. Kirk Yard has a home facility right there in Chicago that is huge for us and the ability to bypass Chicago for the vast majority of our traffic, I have got to tell you I was glad we owned the EJ&E this winter.

Thank you.

Steven Paget, FirstEnergy.

Good afternoon and thank you. Just looking at historical CapEx and this year's forecast CapEx as a percent of revenue, run rate seems to be around 20% if I have that correct. Is that a fair run rate to use for the future?

Yes, this is Luc. I'd say, Steven, that we are running -- we have run historically somewhere between 18% to 20% and so right now we are going to be running slightly to the higher end of it and that is a reflection again of our growth agenda. I mean we are seeing our growth is a lot faster than what the economy brings. And we have got pretty good visibility on it so we see the opportunities to improve our performance, improve our network and accommodate all of that growth.

So we are going to be running at a higher end of the range probably for the next couple of years again and I am assuming that we are going to be getting to all of this growth that is out there in front of us.

If I may ask as a follow-up, what physical assets is the increased CapEx buying?

Well, as I mentioned earlier, there is some of the additional requirement that is going to secure an increased number of locomotives so last year, we acquired over 80 locomotives. This year we are going to be acquiring about 60 locomotives. So the motive power is a big component of that but at the same time, we are putting infrastructure investments such as the CAD100 million last year on the Winnipeg Edmonton. We are putting money into some of our key yards to increase our capacity and ability to store and move cars with this -- when you are moving 1.3 billion GTMs per day, that is a lot of traffic on the network and in the yard.

So we want to be in a position where it is not only to help us with resiliency in the winter but basically that we can maintain the performance, the metrics that we have as well as the service as we accommodate the growth. So those are the two main areas that are going to see the capital investment.

Thank you, Luc.

David Newman, Cormark Securities.

Hi, good afternoon.

Good afternoon, David. You just squeaked in on the 5:30 wire.

I did, right under the wire. Right under the wire. As I look at the some of the truckers were talking, they are just going gangbusters this past winter and some of them might have been weather-related whatever. But the trucker spot rates and contractor rates in both TL and LTL were all going up. And as I look at your sort of domestic mixed merchandise and intermodal overall, you are talking about CPI plus type increases.

I mean could we see CPI plus plus here at some point your forward book of business? I think JJ talked about you are busting the seams. Demand is very strong and the only thing to give here is in the pricing you talked about in crude by rail but are you seeing it across the other segments as well or what can we anticipate just on the pricing overall?

I think the word I used was snug not necessarily busting at the seams. But Jim always reminds me to try to get a little more money for our services which we work very hard to provide. Spot rate for truck last winter were very high and those truckers trucking firm were able to keep capacity aside to be sold on spot made very well on that. And then what they sold on regular rate, they probably spent a little more money on fuel and conductors -- drivers I'm sorry -- to make it happen.

I think we want to be middle-of-the-road. We want to do -- we have been very steady at inflation plus pricing. We are sticking to that. We recognize that more and more the North American network capacity is maybe a little snug so what we have is very valuable, what we have valuable is rail capacity. Rail capacity is very difficult to recreate. You don't buy other railroads. If you buy them, the capacity -- they already have business on it and building track we know that from our own program here, it takes time to experiment. It is not easy and it is capital intensive.

So what we have is very valuable. The economy in North America is getting progressively better. The recession was in 2009 how quickly we forget. And I think these assets have a little more value than the past.

One thing that doesn't show in the same-store price is when we work on some lane that may not be as attractive today as they were four years ago, and those lanes sometimes change from one rail carrier to another. It doesn't shrink on price but it does show up in your overall bottom line. And that is also I think part of what is ahead here is to be more selective and mindful not of customers but which lane of the customer fits best with us with or without extended interswitching.

Does it help at all -- will this help at all in terms of any marketshare gains on the TL guys? I know it's one area that you kind of focused on but is it -- does this help accelerate that marketshare gain?

I think as I said earlier, domestic intermodal looks promising for us. I think it's probably promising for all railroads including domestic intermodal interline using for example the wholesale partners and I think that is an area that makes sense because of length of haul, because of trucking costs, because of driver shortage. I think that was there six months ago and it's obviously going to be there even more so 24 months from now. Long-haul truck is expensive and demanding and kind of (inaudible)

And it is right in our sweet spot, David. It is all about filling one CM. It is about putting a product out there that has a lot of value and getting paid for it. You have got to earn it one load at a time and that is our journey.

Excellent. Thanks for taking my call guys, the last call of the day.

Okay, well thank you all and listen, we are very, very pleased with the fact that despite the adversity, we have been able to deliver a solid first quarter. As you can hear, we are committed to deliver a solid 2014 and I would just invite you all to be safe and look forward to having you on our second-quarter call.

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