Canadian National Railway Co (CNI) 2014 Q2 法說會逐字稿

All participants, thank you for standing by. The conference will begin shortly.

CN's second-quarter 2014 financial results conference call will begin momentarily. I would like to remind you that today's remarks contain forward-looking statements within the meaning of applicable securities laws. Such statements are based on assumptions that may not materialize and are subject to risks described in CN's second-quarter 2014 financial results press release and analyst presentation documents that can be found on CN's website.

As such, actual results could differ materially. Reconciliations for any non-GAAP measures are also posted on CN's website at www.cn.ca. Please stand by, your conference will begin shortly.

Welcome to CN's second-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, Patrick. Good afternoon, everyone. Thank you for joining us.

It is a beautiful day here in Montreal. We've certainly got some great results to share with you.

I would first, however, 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; Jim Vena, our Executive Vice President and Chief Operating Officer; JJ Ruest, our Executive Vice President and Chief Marketing Officer; and Luc Jobin, our Executive Vice President and Chief Financial 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 thanks to all of you for joining us this afternoon. We indeed have very good results to announce and we plan to take your questions and delve a little bit deeper about both the quarter but also the outlook for the balance of the year.

If I focus my comments on Q2, we are very pleased that we have had a very swift recovery following what was a tough winter condition. And we did exactly what our customers would expect in terms of getting those supply chains back in sync.

Our core metrics are all in line or better than last year. Jim will give you more details, but service and productivity are doing very good.

We moved all-time record volumes for a second quarter and that helped us rethink those key supply chains. We dealt with the backlog of traffic from the winter and are meeting robust growth opportunity across our customer base. JJ will give you more color and details about that.

But we did during the quarter deliver double-digit volume growth. To be more specific, 14% for revenue ton-miles, which is probably the best indicator of our volume and 11% for carloads.

Specifically, we have a record second quarter for grain. And this is one supply chain that we have been working hard to rethink. And I am pleased to tell you that as I speak today in the middle of July, our Canadian grain supply chain is fully back in sync.

During the second quarter, we moved 70% more grain than last year. We are moving record volumes, spotting every week in the last couple of -- in fact for the last two to three months, now, we've been moving in a range of 5,500 spots or carloads in our Western grain operation. That is an absolute record.

And as we stand today we only have about one week of orders outstanding. All the ship lineups at the waterfront port are at normal level and our overall supply chain is fully back in sync.

For the full year, we should be delivering an all-time record in terms of grain volume, well above an average in the range of 25% more than an average crop is what we will be doing. That should help having carryover stocks that are in the range of 18 million tons, or maybe only 6 million tons more than an average carryout as we close the crop year.

All of this was possible because we are balancing operational and service excellence. That is our agenda. We clearly showed that we are delivering growth.

At very low incremental costs, our operating ratio at 59.6% is an improvement over last year. Luc will give you the core elements of our results, but it is solid financial results in terms of revenue, expenses, free cash flow. And he will also give you a little bit more details about the outlook for the balance of the year, which is very solid for another strong year in total.

We are trying to stay ahead of the game. Looking to next year we have good growth outlook, staying ahead of the capacity curve, investing through the summer. And we are doing that because it matters to us stay in sync with those customers' supply chain and help our customer win in their own market. With that, I will turn it over to Jim.

Okay, Claude. Thank you very much. Why don't we turn to the operating highlights page?

And let me start off by thanking CN's dedicated team of railroaders for their hard work and solid execution which drove a swift recovery from the winter-related challenges that we faced in the first quarter. Overall, the network is fluid and our key operating metrics are in line or better than last year, particularly given the significant increase in workload.

On a year-over-year basis, revenue ton-miles, as Claude mentioned, were up 14% in the second quarter. That is a full 10% increase versus our fourth-quarter 2013, which was our prior quarterly peak.

To come out of Q1 and deliver volumes at 10% above peak speaks to the focus and dedication of the CN team and our commitment to our customers. Let me highlight the year-over-year 4% improvement in train productivity and 5% improvement in locomotive utilization. We are focused on putting the strong volume growth to work for us by running longer and more efficient trains.

Those efforts paid off nicely in terms of employee productivity, which hit an all-time record in the quarter with an almost 12% year-over-year improvement in gross ton-miles per employees. I am very pleased also with our fuel efficiency performance. We reported a 5.5% increase in gross ton miles per US gallon of fuel consumed.

But recall that the comparable would be because we had a negative accounting adjustment last year, the fuel efficiency came in at 3% better for the quarter, which is still an outstanding performance. We will be facing some tough comps, though, going towards the second half of the year and we are working to be -- finish off the year at a 1.5% betterment.

Now in terms of velocity and dwell, we have improved significantly versus Q1, but we are lagging a little bit from last year. Obviously, bringing on 14% to increasing volumes is part of that; traffic mix in the capital programs has also played a role. But we have a number of capital programs that are currently underway which will help us going forward, but we have work to do.

I am very pleased with the operating performance in the second quarter, but there is no ifs, and, or buts that we have got a lot of work to do to try to decrease the velocity and speed, even with the metrics that we were able to deliver in the second quarter. If we can turn over to the next slide on balancing operational and service excellence because this is very important about what we do and what we are trying to achieve as a railroad.

So, the objective is pretty simple -- we need to stay excellent at running the railroad while at the same time continue to improve service that we offer our customers. All that, though, is centered around our employees; they are key and employee engagement is important.

We are continuing to push decision making to the front line and, of course, making sure those employees have the tools and training to make the right decisions. We have just opened two new training facilities, one in Winnipeg and, on July 7, the one in Chicago. We have modernized our curriculum and we have improved our on-the-job training.

On the service side, we continue to make progress with respect to our end-to-end supply chain approach. We are as focused on driving improvement to -- in our customer-centric metrics as we are maintaining our operating discipline. They go hand-in-hand.

We have already made meaningful progress in our intermodal and bulk segments. And I am very pleased that we are slowly starting to rollout our i-Advise initiative to merchandise customers.

i-Advise improves the connectivity between the yardmaster, the customer service rep and the customer and provides our front-line operating folks with the visibility and awareness needed to better meet customer expectations. And it is at the right level; it is at the front line, people doing the day-to-day work that will service our customers.

On the capital front, we are continuing to invest for growth and productivity. In particular, we've got a number of programs targeting greater Winnipeg and the Winnipeg to Chicago corridor in an area that you have heard me speak about that we have specific issues that we have identified that we need to get fixed in the next 18 to 24 months. And we've got a good plan to get ahead of it.

We are also continuing to invest in AC locomotives. This year and next year and the following year, we have got a plan in place and orders in place for this year and next year in what we bring forward.

Of course, safety is the foundation of everything that we do every day. We are going to continue to work all levers, be it technology, process or safety culture to drive improvements. We continue to invest in technology with the announcement last year of extra funds, CAD10 million on technology and processes.

And with the CN campus in Winnipeg and in Chicago, we are going to continue to drive the safety culture and drive improvements in both our metrics. So to wrap it up, Claude, solid operating performance in Q2, but like always, more work to do; never satisfied with where we are.

So over to you, JJ. Just keep that business coming, will you?

Thank you, Jim, and, especially thank you for the 14% revenue ton-mile growth. I will walk you through our second-quarter performance, then we will do the commercial outlook and then conclude with the yield management.

We are pleased to report the second -- pleased to report record revenue for the quarter at CAD3.1 billion and a year-over-year growth of 17%. The breakdown is as follows.

Volume and mix produced 11%; same-store price was just under 3%. Recall that same-store pricing is defined as shipment with the same customer, commodity, car type, origin and destination and reflects about 75% of our traffic.

There was very minimal impact from fuel. And exchange contributed 4%.

Now I will go through the highlight market. And as usual I will do that on the FX adjusted basis.

Petroleum and chemicals continued to be impressive, posting a 12% revenue growth. This was driven by increased crude carload, about 31,000 in the quarter, versus 17,000 last year.

Canadian crude is accounting for roughly 60%. We have continued ramp-up of new loading facilities as well as new customers receiving location.

We had strong butane, propane, gas and diesel, related to tight capacity on the Trans Mountain pipeline and the reversal of the [Cotion] pipeline. Metals and minerals revenue gained 14%. We moved 21,000 carload of frac sand for a 60% carload growth.

We handled our first unit train of sand to Western Canada that will become a new train over time. We had higher volume of semi-finished steel reflecting share gains and improving North American demand for automotive and energy sector.

Short-haul iron ore carload were down 10% as we were bottlenecked by the frozen Great Lakes in April resulting in very slow start of the iron ore selling season. Forest product revenue was up 4% on flat carload. The US housing start increased our lumber and panel shipment to the United States.

This was offset by a lower offshore export of lumber due to a lack of CN's car supply to go to Vancouver. Pulp and paper revenue remains stable. Core revenue was basically flat; we had lower volume of Canadian met coal and petroleum coke for export, which was due to weak market condition overseas.

This was offset by a doubling in shipment of short-haul US utility coal for domestic restocking and from domestic share gains. Grain and fertilizer reported the biggest gain. Revenue grew 31%.

Canadian grain revenue achieved an all-time high for export volume, 50% more than last year. Our US grain revenue were also very strong, up 24%. And we handled strong potash shipments, particularly to the United States.

Automotive revenue increased a good 10%. We have strong demand for finished vehicle which was finally supported late in the quarter by improved TTX car supply.

Intermodal revenue grew a solid 15%. Import and export volume were very strong for CN at the Port of Montreal and Vancouver, as a result of new business and at the Port of Prince Rupert due to change in deployment of vessel capacity.

On domestic, we continued the solid growth in retail which was mitigated by lower revenue for wholesale. Our coal supply chain revenue increased 25%.

On other revenue, which was down 4%, we lost basically one full month of sailing with the iron or vessel fleet due to the heavy ice back in April.

Now turning to the outlook, I am on page 10. The demand is solid. Starting with intermodal, we see a continuation of growth at the Port of Vancouver, Rupert and Montreal.

Currently, with the short-term diversion of US West Coast traffic to the Midwest, our West Coast port capacity is sold out for the month of July and August. In Canadian domestic, we are balancing price and volume growth. But leave no doubt, we have a very strong domestic service offering.

In bulk, we will continue to move last year's record Canadian crop in advance of the new harvest. We also see good things in our US grain volume as well as an potash.

Thermal coal volume will remain strong, driven by ongoing utility restocking and by share gain. Offshore coal export will remain depressed.

In merchandise, demand for crude by rail will remain on the upward trend. Receivers capable of handling unit train volume will generate significant demand pull.

I am also more constructive on the pricing trend for crude by rail new contract and the value of that business to CN. Metals and fracs sand demand look solid. We are adding to our fleet, [sand demand] fleet, 500 units to beat more of the US housing start demand.

We are also improving our intermodal model at Prince George to move more Asian lumber export overseas. Moving to price and capacity yield management, becoming increasingly important in the way we do business. The North American rail capacity is getting snug.

Pricing should be influenced by both the value of our service and the intrinsic value of capacity in of itself. We use same-store price as a better reflection of all pricing action taken. We continue to focus on inflation plus pricing which we define now as 3%, all in including coal, grain, the full book of businesses as it should be.

We find revenue per car and cent per RTM to be weak measure of price and yield as they are generally primarily driven by change in mix. We prefer using better decision tool, revenue-to-cost ratio for customers' private car, contribution per card day for CN provided railcars and round-trip revenue-to-cost ratio model for intermodal.

Our forecast is on upscaling, not just adding volume. In conclusion, there is solid demand pretty much across North America. We are growing faster than the economy at mid to high single-digit carload growth and we are focused on getting value for our service and for our capacity with disciplined inflation plus pricing and with capacity yield management.

Luc?

Yes, thanks, JJ. Starting on page 13 of the presentation, let me walk you through the key financial highlights of our second quarter's performance.

As Claude mentioned, these very strong results demonstrate our quick recovery from the first quarter's weather-related challenges and solid growth momentum into the second quarter. As JJ outlined, revenues were up CAD450 million, or 17% to slightly over CAD3.1 billion.

Operating income was over CAD1.2 billion, up CAD216 million, or 21% versus last year. Our operating ratio was 59.6%, and improvement of 130 basis points over last year as we grew the business at low incremental costs.

Now, this represents a record for a second-quarter operating ratio. And it weighs in as our third-best quarterly operating ratio performance ever.

Other income was CAD2 million versus CAD28 million in 2013. Last year's result included in the quarter a pretax gain of CAD29 million on the exchange of an operating easement.

Net income for the second quarter is CAD847 million, up 18%. Foreign currency translation contributed to a favorable impact on net income of CAD28 million, or CAD0.03 EPS in the quarter.

So, the reported diluted EPS reached CAD1.03, up 23% versus last year. The adjusted diluted EPS also stands at CAD1.03, in this case up 24% versus the prior year.

AS I mentioned, 2013 adjusted results did include the property gain, which I referred to earlier and a deferred income tax adjustment of CAD5 million, relating to a change in provincial corporate income tax rate.

Turning to page 14, operating expenses were CAD1.858 billion, up 14% versus last year, or 10% on a constant currency basis, as we continue to tightly manage costs. At this point, I will refer to the expense changes in constant currency.

Labor and fringe benefit costs were CAD560 million, an increase of 10% versus last year. This was the result of three elements.

First, an increase in overall wage cost of CAD38 million, or about 8 percentage points. This is the product of wage inflation of about 3%, over time, for about 2 percentage points, and a 3% increase in our average headcount versus last year. So, Jim and his team certainly delivered double-digit manpower productivity in the quarter.

This was partly offset by higher capital work being performed in the quarter versus last year for approximately 4 percentage points. And the second element is a higher stock-based compensation expense in this quarter versus last year. Now, this represents CAD40 million of the variance, or 8 percentage points.

The third element is a favorable variance of CAD9 million, or 2 percentage points in pension and benefit expense. This was the result of the pension expense being lower by approximately CAD20 million, which offset an increased benefit cost in the quarter versus last year.

Purchased services and material expenses were CAD390 million, an increase of 11%, or CAD39 million. The key drivers here were the 14% higher volume in the quarter, along with some leftover winter-related costs. As such, repair and maintenance expenses were up CAD11 million, or 3 percentage points, as were material costs in the quarter while the intermodal trucking and transloading expenses were up 2 percentage points as were crew accommodation and utility costs in the quarter.

The fuel expense stood at CAD484 million, up CAD54 million, or 13% versus last year. Higher volume represented an increase of 13 percentage points in the quarter, while an increase in price drove the remaining 5 percentage points.

Fortunately, fuel productivity was approximately CAD20 million favorable on account of a 3% improvement in the quarter while an additional 2 percentage points of the variance relates to a one-time unfavorable inventory adjustment that we incurred last year. Equipment rents at CAD84 million were CAD12 million higher than last year, or 18%. This is mostly attributable to higher agreement leasing costs and more higher expense in the quarter.

Casualty and other costs were CAD83 million, CAD14 million, or 22% higher than last year. The increase year was split about evenly and resulted from higher costs related to environmental matters and higher property taxes.

Turning to free cash flow on page 15, we generated over CAD1.2 billion of free cash in the first half of the year, an increase of CAD482 million versus last year. In comparison to last year's -- in comparison to year-to-date results last year, cash from operations benefited from higher earnings, lower income tax payments and better working capital.

This was partly offset by higher net investment activities for CAD50 million in the quarter. Some of the favorable working capital variance, however, is partly the result of timing, so we may not net off quite as well on that dimension by yearend.

Meanwhile, our balance sheet remains strong, with debt and leverage ratios within our guideline which bodes well for continued support for the business and shareholder distributions going forward.

Finally, on page 16, our outlook for 2014. We are pleased with the swift recovery we achieved from a challenging first quarter. Our entire second quarter's performance was strong from a revenue, service and operating standpoint.

This is a fine demonstration of our ability to grow faster than the economy and do so at low incremental cost. We have good momentum and we continue to be optimistic with our prospects for the balance of the year.

Now, while we clearly have our work cut out, we have the potential in the second half of the year to reach the overall earnings growth performance achieved in the first half. Given this perspective, we are raising our annual guidance, and so we are now aiming for solid double-digit EPS growth in 2014 over the 2013 adjusted diluted EPS of CAD3.06.

We are also raising our guidance for free cash flow to now be in the range of CAD1.8 billion to CAD2 billion. Meanwhile, we are maintaining our capital investment program at CAD2.250 billion.

So, in conclusion, the CN team remains as committed as always to delivering superior results for our customers and shareholders as we continue to unfold our strategic agenda in 2014 and beyond. On that note, back to you, Claude.

Thank you, Luc, and thanks to the team. I think it is fair to say when you look at these results that our business agenda is maintaining a strong momentum.

We are delivering high service levels to meet our customer demand. Our supply chain mindset is a key differentiator and it is helping us outpace the economy and our peers.

We have a disciplined approach to investment. We are looking to support growth, productivity and safety. We are doing it on a consistent way trying to stay ahead of the curve and it is paying dividends.

The goal is to create solid value for both our customers and our shareholders. And I think our Q2 results and the outlook that we have just provided you for the balance of the year is proof to that. With this, Patrick, we will be happy to take questions.

(Operator Instructions). Benoit Poirier, Desjardin Capital Markets.

Hi, could you maybe provide more color on the crude by rail following the announcement made by KCS and Global Partners for the new terminal in Port Arthur? It seems a very nice opportunity for you.

And more specifically, I am wondering how conservative is your guidance of 150,000 carloads for next year and also what we should expect in the second half. Thanks.

Thank you, Benoit, it's JJ. Maybe starting with the guidance. We may do better than the guidance, but I want to put that in the context of the yield of crude.

Crude needs to pay its way in the railroad just like any other commodity, so that is as important as exceeding the guidance on volume. Regarding the announcement of the new terminal on the KCS, this is not the only new terminal that there is being built in the Gulf or Alberta, but it just add up to the size of that pie. It makes a bigger pie for in the present case, Canadian crude, that is where we participate to go down the Gulf.

And we do have connection with KCS over I call it Springfield, some of the people call it Cockrell. And time will tell how the business shape out. It is just more of a bigger pie for everybody to participate.

Okay. Thanks for the time and congratulations for the results.

Brandon Oglenski, Barclays.

Yes, good afternoon, everyone, and congratulations on the good results here. I guess my question is for Claude or JJ.

Obviously, this year, you're seeing a lot of ramp-up in grain markets. You have won some intermodal contracts from your competitor as well as on the auto side, but when we start thinking about 2015 and 2016, how sustainable is this mid single-digit type car load growth?

Isn't that going to start lapping some very difficult comparisons? Do we see maybe a year of pause in 2015 on the growth end or are there some pretty robust pipelines behind this?

Let me take that. I think we are seeing a robust pipeline of growth across all of our lines of business or, I would actually say for the most part, across our lines of business. Definitely energy market will continue to be a strong source of growth into 2015 and beyond.

Grain should have another strong year next year. Because as I said earlier, while we will finish with a carryout of 18 million tons, that is still 6 million tons more than an average. Add to there's a new crop and the need to move it, we should be moving record volumes of grain well into the spring and even summer of next year.

We have good growth in intermodal, good growth in automotive businesses. We have solid growth in merchandise, winning with our customers one carload at a time, so I don't see 2015 as a year of pause.

It is tough to lap strong growth year-over-year, but that is our agenda. And we will give you more contour and color on that outlook when we close in on the year. It is a bit early to call it more precisely at this point.

Appreciate it. Thank you.

Cherilyn Radbourne, TD Securities.

Thanks very much and good afternoon. I would be curious to know given how strong your execution has been since the spring arrived, to what degree you think some of the acrimony between the rail industry and the grain industry has started to dissipate here?

You know, I think you have to put things in context. As I said before, I think some stakeholders and certainly the government reacting to those stakeholders, we lost perspective in the winter with the grain situation.

We were hitting record volume last fall. Even the Minister of Agriculture was saying that we were doing an adequate job at moving this record crop. The winter was very difficult, but when you look at the entire winter, at the end of it, with the strong March performance, we came in with volumes that were only 2% less than an average winter.

Since then, we are hitting absolute records. I said earlier, 70% more Western grain during the second quarter. And we will finish the year in total with 25% more grain than an average year.

I think the facts are speaking to the reality and I am hopeful that ultimately the facts will shape policy. And it is certainly shaping the relationship we have with our customers because as we speak, I think we have, as I said earlier, we don't have a week of outstanding orders. That means we are meeting all of the demand and there should be room to store the grain when it is harvested, especially so it is expected to be harvested late this year, because of a late, late planted crop.

So we will do our work. And hopefully people will see that and shape policy accordingly.

Thank you. That is my one.

Scott Group, Wolfe Research.

Hey, thanks. Afternoon, guys.

So, wanted to ask a little bit about the pricing. JJ, it sounds like maybe that is a lever you're going to start pushing a little bit more aggressively. And just wondering, how quickly do you think that starts to show up in the numbers?

Do you think that you can get another point or two of pricing and still maintain this volume growth well above the rails?

So, there is two things that we are focused on. Focusing on one is pricing, as measured in same-store price. And the other one is yield, which you will not see in same-store price as we do upscaling because upscaling turn out to be new business.

It doesn't get measured in same-store. The two of them are very relevant to driving an operating ratio like we have today. So, we are of the view of pacing ourselves doing this progressively and working with a two lever as opposed to just the one lever.

I think overall, I think capacity in North America -- railroad may have different opinion, or opinion that they say publicly or not so publicly, but capacity is getting a little tight. And capacity, just in itself, has more value today than it had after the recession. And we have been into a recovery now for five years and railroad has been investing billions of dollars, including our self.

But there is some pinch point that from time to time show up after, whether it be weather issues or other issues, which I think are pointing to the value of capacity. And eventually that reflects in your renewal and that reflects also in which business fit best into a given railroad, which I call upscaling.

So over time. But steady Eddie on the way up.

Do you think -- when do you think this starts to show up in the numbers?

Again, over time. We still have this Canadian grain thing to digest up to August 1 and there's some lingering effect in August. And after that, we will -- we are -- after that I think -- you will only see so much in same-store price and the rest, hopefully, you will be able to see more on the bottom line of the Company.

All right. Thanks a lot, guys.

Walter Spracklin, RBC.

Thanks. Good afternoon, everybody. Just a follow-up here.

Clearly with the higher volume that you are getting on your system, and the higher demand, JJ is doing a good job now, as Scott was indicating, of repricing that capacity that you have using the bottom decile group of customers. This question I guess is for Jim.

As JJ is doing that, on that side, what -- how are you looking at the capacity on your side in terms of being able to handle this growth? You mentioned that you still have some work to do on the velocity side.

Is there any risk that we start to see in the back half some cost creep? Or are you still confident that we can get some good operating leverage here? Or is it perhaps a CapEx where you go into Luc and rather than an expense creep you might come back and ask for a little bit more capital?

How do we look at that kind of capacity utilization and the constraints you are having on that end?

I think the way you answered -- you asked the question, you just about hit it all, Walter. So it is a great way to frame it.

First of all, do we have some areas where I would like a little bit more capacity? Yes, but we try to plan capacity out so that we don't get to the point where we are so restrictive that we have an issue in the short term.

You are going to -- you can't spend enough capital for winter. And I have said that a number of times, and you are going to have some issues, whether you like it or not.

But we have some areas that we have identified that we have to work on. We are working on them this year. We spent capital last year between Edmonton and Winnipeg.

And in fact that worked out real good through the winter in that area. We will continue to invest and as I mentioned earlier, between Winnipeg and Chicago because we see growth in that lane, plus the type of traffic.

The second piece is -- and what you want to be able to see is a certain percentage, let's say 4% or 5% go on to the trains that you are running already. Trains have got the room to grow. We bring in AC locomotives, invest on them.

That allows us to put more on the trains especially in that Edmonton to Chicago. So we do all that and then the mix.

And I think the biggest problem I could have is JJ tells me that we've got another 14% next year and I don't see anything that will stop us from being able to handle that kind of business if the market is there for us to bring it in. It is always a challenge. When I talked about the velocity is last year Q3 we basically set a record on most of our numbers.

It is tough to match that with the match of business in what we have. Now, I don't know if we will get right to the numbers. We are going to work real hard to try to get to the numbers, and that is the kind of people we had.

We have people front line working to try to get that last mile, that last car on the train make them a little bit bigger, Walter. So hopefully I answered the question.

Absolutely.

Walter, it's Luc. Just to add a little color on the CapEx side of things. Obviously, again, I think we are trying to invest the money wisely.

We are trying to anticipate the needs. This is not something that would push us above our sort of range. We have always been looking at 18 % to 20% of revenues for CapEx.

So I would expect we are going to stay in that range. We are certainly adding more rolling stock. I mean if you look at just the locomotives, we have actually secured about 500 more locomotives since the back end of the recession.

We have got a pretty aggressive plan to continue to do that. The business is there and as Jim pointed out, on some of these infrastructure requirements, when you work at it over time, so we are on to some of the areas that we feel are creating opportunities for improvement and we are flagging some more for the future.

So it is a matter of pacing ourselves. But the good news is the business is out there and I think we have got a good plan to address it both in terms of operating performance and capital investment.

That's great. Thank you very much.

Chris Wetherbee, Citi.

Thanks. Good afternoon. I was just thinking about the guidance and putting it in context for the second half.

As you are coming out of 2Q and volumes are running very well, the network is clearly running very well. Outside of maybe a slight deceleration in volume as you move into 3Q and 4Q, what is there or is there anything that maybe shows up that could decelerate the pace of growth?

It would seem like you are entering into the back half really with a strong tailwind here. And I am just trying to get a rough sense of putting that solid double-digit EPS growth into context for the back half.

I think the best way to think about it is we finish the first half with roughly a 17%, 18% EPS growth. We have our work cut out to repeat that in the second half, but that is what Luc signed up for, and Jim and JJ will try to beat it.

That's right.

All right. That's helpful. Thanks.

Fadi Chamoun, BMO.

Yes, actually my question was asked, but maybe for JJ, on the intermodal side as we go into the back half of the year, you obviously had a very strong first half with some diversion from the US coast maybe and some sort of above-average growth. How do you think about the back half of the year being more normalized growth rate at this point, or is there anything else going on on that front?

Yes, thank you, Fadi. We are still constructive about the second half for intermodal. Again, more coming from the port, Vancouver, Rupert and Montreal.

Because of things that we gained earlier in the year will carry us through the full calendar year. Your comment about the diversion from the US Midwest, the labor situation on the US West Coast, we didn't get a whole lot of benefit of that other than the latter part of the month of June.

So the impact of that is really going to be in the third quarter. And as I said right now, we have more coming at us than we can handle, so that is not a -- it is a good and bad problem to have.

But all in, there is nothing that says the second half should be hitting a wall or whatnot. Overseas is going to be strong, situation in the US eventually will get its self resolved.

What we are really after is permanent business, not just transient business. And domestic has some pocket of positive and some pocket of negative and we will work with that. But in the end what we are really after is something sustainable but profitable.

Thank you.

If that helps what you were looking for.

Sure, thank you. Maybe you can just give us what was the growth in the domestic intermodal in the quarter?

I don't have that specific number, but the growth was much stronger on the overseas than it was in the domestic, whether it is revenue or units.

Okay. Appreciate it. Thanks.

Bill Greene, Morgan Stanley.

Hi, good evening. JJ or maybe even for Claude, to some extent, I am curious what your view is on the idea of service. So when we look at CN for years your service was kind of second to none for sure in Canada and you guys won a fair amount of shares through that service level.

Now you're making it harder for CP to catch up on OR with this performance here in this quarter. But as that gap narrows and the service levels -- if they are approximately the same, do we have to worry about any traffic that is on CN that is perhaps not naturally on CN so that it would naturally want to go back to CP of service and cost were similar.

Is there a segment of the business, so to speak, at risk over the next few years? Or is that not really the case at all?

I think the business that we have is natural business for CN. We have worked hard over the years to have true end-to-end supply chain approach. And customers are -- that business model is resonating with them.

We keep making headway. We compete against trucks, we compete against ships, we compete against pipeline, we compete against all the railroads in North America, including CP. And our goal is to outpace our peers and outpace the growth rate of the economy.

I think our outlook for growth for the balance of the year and my comment about 2015 support the notion that we see that continuing for the foreseeable future. So you don't win business on an operating ratio. You win business because you have the right franchise, the right mindset and the right business agenda, and we think we have all of that.

In the market where capacity is a little tight, we don't need to go after every piece of business. Should not.

Yes, fair enough. Okay, great. Thanks for the time, appreciate it.

Ken Hoexter, Bank of America Merrill Lynch.

Great, good afternoon and congrats on the nice results. But just digging into maybe JJ a little bit of the outlook. Can you talk about your timing of maybe some new crude by rail activities coming out on the heavy Canadian side?

And then similarly, on the coal side, I think you threw out there that you expected it to remain -- or you are seeing that it continued to get weak, given where global pricing is can you maybe delve into that a little bit as well? Thanks.

So, on the coal side, the export coal is weak is even weaker now than it was early in the year. And I -- we don't necessarily see a whole lot of positive signs, especially on the pet coke and/or the met coal.

On the domestic coal, people are restocking. And we had these one-time share gains early in the year. They stay with us for the full year.

And on crude, these are major project. Actually, we are getting pictures this week of some of these big construction site. And it takes time, so the big ramp-up again, people will work hard to try to do everything they can.

I am talking in Alberta here, in the north there are still areas that are winter from time to time to wrap up this construction site before the coming winter. So, I mean we -- constructive on crude, the market is moving to where unit trains, bigger block of origin, bigger block of destination.

And I think we are staying to our guidance, may exceed that. And we want to be sure that where we move is a decent yield and it pays its way on the railroad.

Jason Seidl, Cowen and Company.

Hey, guys, it's Jason. Real quick, JJ, you talked a little bit about the real strong growth on the frac sand side, but you mentioned that there is going to be a unit train -- that seemed like it was new business going to Western Canada, starting here in the back half of the year.

Can you give us a little color around that? Can that grow beyond one unit train?

So, there is unit train activities today in the United States where people who buy, send and receive large block, meaning unit train quantities. Not the case yet in Canada.

Obviously the market, though, sees all kinds of efficiencies in moving bigger block -- I say unit train would be big block, right? We moved our first big block unit train in the second quarter. And there is a trend where the big buyer of sand would like to receive bigger quantity at a time.

Just light crude, this will eventually move to kind of a different distribution model where people spend a lot of money at the receiving end with lube track or big receiving track, we receive large quantities, which is a sign of volume is going to go up. And if these LNG terminals in Prince Rupert and Kitimat really goes ahead, it really speaks to how much sand we require in Northern BC and in Alberta.

So it is a trend about growing. And is also a sign of how much money -- capital money our customers are investing because they believe the business is there long term.

Is there any difference in the length of haul on that business than the US business?

No, no, we are talking Wisconsin to Alberta and maybe one day Wisconsin to BC. But today it is really Wisconsin to Alberta.

Okay, great. Follow-up question. You also mentioned a little bit about a recovering housing market in the US.

We have seen some mixed data here, down here in the states. And just wondering what you guys are seeing that tells you you have got to order some center beams here.

Yes, what I am seeing is even though the housing starts in June were down and we are struggling with meeting the demand, so in a way it is a silver lining to us the housing starts are not running up too fast, because we would not be able to keep up. So our fleet is -- in the second quarter was basically fully deployed and our customers elected to -- because the supply was tight -- elected to ship more to the US long-haul and do the short-haul to Vancouver by truck.

So we are getting more equipment so that we can participate more to the US housing start. And we'd like also to participate a little more in the Asian export via Vancouver. If you ship a center beam from BC to Vancouver and you load the container as well as do some of that right at the middle or closer to the middle from our Prince George intermodal terminal.

So, I think the relationship between US housing starts and CN [Calliden] lumber is maybe a little tighter than what people thought. Because in June we really had very little reprieve in our order book.

In fact, I would say a number we still have quite a bit of inventory on the ground that we have to clear over the next several months. So we are constructive about lumber movement and at the same story with panels, which is basically the same market.

That's right.

Thank you, Jason.

Well, thank you, guys, as always.

Keith Schoonmaker, Morningstar.

Yes, thanks. JJ, I think you mentioned that heavy crude was about 17% of quarterly crude volume, if I heard that correctly. Could you comment on trends and length of haul within the crude franchise and maybe what you expect in the next year to two?

The heavy crude -- my comment on heavy crude was we are roughly about 60% -- I think in the second quarter -- 60% of our crude was heavy crude.

60%, 6-0?

6-0, yes.

Okay. Yes, and then trends on length of haul, if you don't mind?

Trends on length of haul? I think -- what? Second quarter it's about the same length of haul I think from the first to second quarter.

Crude itself is long-haul business, no question. And it is more and more into unit train or block. But the average length of haul I think is probably stable for our crude business, stable as in the recent past.

Thanks.

Allison Landry, Credit Suisse.

Thanks. Good afternoon. I just wanted to ask a balance sheet question.

Your adjusted debt to EBITDA came down a little bit in the second quarter to about 1.6 from 1.8 in the first quarter. And I was just wondering if you would consider adding some leverage here to potentially increase your share buyback program ahead of the October expiration of the current program?

Yes, as such, we don't have a specific plan to unduly leverage up. We continuously look at the balance sheet. As I mentioned earlier, it is in pretty good shape.

So we will look at -- we will review our policy for stock buybacks and dividends as we get to the back end of the year. Our stock buyback program expires in October, late October. So that will be providing some input -- some update on that probably when we record our third-quarter numbers.

And the dividend we'll reconsider as well in terms of next year's plan and probably report back on that sometime early in the new year. So, good balance sheet. There is clearly some flexibility there.

But you shouldn't expect a major departure in the way in which we are thinking about the balance sheet. So no significant leveraging up overnight kind of thing.

Got it. Thank you so much.

Thank you. It is the same team theme, steady Eddie, but delivering strong cash flow and solid shareholder value.

David Tyerman, Canaccord Genuity.

Yes, good afternoon. A question on the intermodal. In the intermodal you commented that your balancing price and volume growth on the domestic, I was wondering if you could provide a bit more explanation there.

And particularly in light of CP touting this area as an area of major growth. I don't know if it is impacting you or not.

So the domestic intermodal and we are talking the Canadian domestic intermodal is where us and our competing railroad from Calgary offer similar service. And the area where the service overlap the most is Toronto, Calgary, Vancouver back to Calgary back to Toronto.

Ann in that corridor, it is fairly competitive, service wise and pricewise. We are focused on getting a value for our service. And in some cases, all of the effort we put in are deemed to be not worthy of a small price increase.

And in those cases, sometime we might have to take a pass for the bigger picture. So by and large, we are forecasting on the yield and upscaling and in some cases, we may or may not meet the competitive offers out there, if there is some -- when there is some. We want to balance price with volume and it is very important to our midterm game plan here.

Okay. That's helpful. Thank you.

David Vernon, Bernstein.

Hey, guys. Thanks for taking my question. JJ, could you comment a little bit about how the contract was structured for the heavy Canadian crude by rail? Are those US dollar-denominated?

How do you think that the demand should trend as we see the currency separation beginning to develop here as the US dollar is appreciating? Thanks.

When we ship something to the US, we view ourselves as an US railroad. And we price in US funds.

When we ship something into a Canadian city from a Canadian city we see ourselves as a Canadian railroad and price in Canadian funds. So domestic movement, Canadian funds; cross-border movement, US funds.

And the dollar does what it does. Sometimes it is up, sometime it is down.

Do you think, though, that if we started to see the US dollar continue to depreciate that could help create some demand for that heavy crude?

I am not sure how it links back to heavy crude. Crude is really a US dollar-denominated world market anyway to start with. So I wouldn't necessarily make a whole lot of tie-in between exchange rate and how crude moves by rail.

I would agree with that. I think that our opportunities to continue to grow in the energy market is really linked to -- it is a seachange. The shale plays, the new movement of crude by rail, all of these markets are looking for transportation opportunities.

And some of them need infrastructure. And it is more about how the infrastructure is coming into play that we see the growth coming up than movement week to week or month to month of the Canadian exchange rate.

Yes, this should not be confused here with like paper or some of the other commodities which are truly Canadian-based from beginning to end in their costs and different marketplace.

All right, thank you.

Donald Broughton, Avondale Partners.

Good afternoon. Thanks for taking my question. I just want to kind of get inside your head a little bit and think about -- understand how you think about strategically the service issues being had by a couple of your US counterparts in particular.

Has it really changed the way you think about how you operate the railroad, how you hire employees, how you operate the interchange with them, how you invest in your rail? Or is it more a, look, this changes the way we are going to interact with our customers, and what we see is the opportunities for volume, the opportunities for yield?

Is that one or the other predominantly? How do you think about that?

You know, Don, if you get inside my head, you would look out three to four years. And you would see us finding ways to stay ahead of the curve, on service initiatives, stay ahead of the curve on capacity investment, stay ahead of the curve on shaping safety and our ability to be seen as a backbone to the economy.

And if you stick with me and have good access to how we are thinking, you would see that we have a bright future and are looking to ride our agenda. And it is not about what our competitors are doing this week. It is about where we see the market three to four years from now.

And, Don, just to add a comment; it's Luc. I would say that certainly given the infrastructure advantage we have in the Chicago area, this is a pretty lasting advantage that we are going to leverage as much as we can.

That is very difficult for others to get around that. So I think it bodes well from an infrastructure standpoint.

Yes, if you need to go to Chicago, you can ride on us.

Thank you.

David Newman, Cormark Securities.

Good afternoon, gentlemen.

You squeezed in, David.

Nice quarter. So, beside pricing improvement from top grading some of the areas and I would assume that is probably like intermodal, crude by rail, mix merchandise, where as it is obvious where you can do it, is there other areas like where M&A would make more sense?

Are you getting a little tight and a little bit snug? You've got CAD2 billion in free cash flow that you have coming at you, certainly lots of cash. Your balance sheet is in great shape.

You did a great acquisition years ago, obviously. And certainly in Northern Alberta. Some of the short lines that has helped. Is that starting to enter your thinking in terms of maybe there's other areas, rather than deploying CapEx, you might look at some M&A?

Our core strategy is leveraging our franchise on an organic basis. And in addition to solid volume and good pricing, we are -- and that is tied to capacity and there is nothing like being challenged to focus on all the levers.

And there is a new trend. It is about looking at the bottom-line opportunity. How can you get yield by focusing on how you leverage that volume to get the business at lower costs?

So not just price and volume, it is also bottom-line focused through yield initiative. And if you do that consistently and outpace the economy and accommodate the business at low incremental costs, you can, as we did over the last five years, deliver solid results for your shareholders.

We have the balance sheet. If strategic opportunity create themselves, they are also part of this scope of initiatives. But the plan is organic growth and we have got the tools and the ability to act on plan B if an opportunity creates itself.

Very good. May I just squeeze one in? Is it the obvious areas, international, intermodal, crude by rail, mixed merchandise, is that the areas where we have all heard comments about international intermodal being lower margin? Is these sort of the areas that you are looking at to sort of top grade?

I would say that we have opportunity across all of our businesses, more than the ones you just mentioned.

Okay.

And all of our businesses are solid profitability. It is true overseas, it is true of domestic. Obviously, intermodal is a little below the average of the overall book.

But in our case, it is fairly close to the average profitability of our book of business. We look to upscale. We look to create yield and we look for balance and we do that across all the commodities we serve.

Very good. Congratulations, guys. Great results.

Thank you.

Thank you.

Thank you.

Thank you. That is a good question to close in.

Again, we are constructive about the balance of the year, very proud of our second-quarter results. And those results are because we have a very strong team of committed railroaders that are focused day in, day out to serve our customer needs.

And that is what we will do for the balance of the year and in order to deliver solid results and meet with our new guidance. And we look forward to report on that success in our Q3 call. Thank you.

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