Canadian National Railway Co (CNI) 2015 Q2 法說會逐字稿

CN's second-quarter 2015 financial results conference 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 2015 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 call will begin shortly.

Welcome to CN's second-quarter 2015 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, 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 JJ 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.

And with that it's 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. It's a beautiful day in Montreal, and I'm here with the CN leadership team to discuss our very solid second-quarter results.

It was a bit of a tougher environment from a growth standpoint, but I'm pleased to -- I'm really pleased overall still with our top-line performance. As JJ will discuss, we had good growth in our service-sensitive segments, intermodal, automotive. It was much tougher in the bulk sector, particularly coal on an export basis and grain, which is returning to a normal trend.

But overall, we did follow the environment and held our own in what was a bit of a challenging environment. Most importantly, we had a very swift response to that slower growth environment. We're recalibrating our resources to drive efficiency.

As Jim will describe to you, all of our core metrics are in line or better than last year. And that's very important because that's all we can do. When the environment is a little tougher from a volume standpoint it's how fast and how efficient you are at reacting that makes the difference.

How we react, though, is about maintaining balance between operational and service excellence. It's really a combination of both, and I'm pleased to say that we delivered superior service in all of our market segments during the quarter and also delivered a record operating ratio of 56.4%.

Overall, that drove the day in terms of financial results. Luc will give you more of the details, but our diluted EPS at CAD1.15 is up 12% on a year-over-year basis, as adjusted; and we had very strong free cash flow in excess of CAD1 billion free cash flow after only six months during the year. So very good results overall, good balance, good focus, and we're pleased with the momentum that gives us entering the back end of the year.

With that, I'll turn it over to Jim to cover the operational highlights.

Claude, as you said, it's all about balance. Operating a railroad is all about reacting quickly to changes in workload in an efficient way. We responded quickly to the change, keeping costs in line with the business level.

Key drivers for us are train starts, yard expenses, and rolling stock inventory management. In the charts, you will see a small drop in train productivity as measured in trainload; however, this drop was driven by a change in product mix, not by us not responding to the change in business level.

If you look at train productivity in terms of train length, we were up 1.3% year-over-year. With our continued focus on train productivity, we will be able to continue this improvement. In June, train length was up almost 3%, and trainload had improved by 1% both on a year-to-year basis and we continue to see that as we go through the month of July.

With train miles being reduced, we immediately cut back on the active locomotive fleet, pulling the less productive and less reliable units out of active service -- the ones with a little gray hair on them. Currently, we have about 200 locomotives stored, and locomotives we have stored across the whole network to respond to any changes in the market and the business that's there.

Locomotive productivity at 223 trailing GTMs per horsepower hour was the new quarterly record, beating the previous record we set in Q2 of 2014. So a good result.

Yard productivity also improved year-over-year, up 4%. This was challenging to do with workload dropping. You do not want to cut back and hurt throughput. We reacted quickly, undertaking a terminal-by-terminal review, cutting assignments and yard expenses ahead of the curve.

As I've often said there is no better measure of overall railway performance than car velocity. We were up 6% year-over-year in Q2. Again, this is a balancing act, delivering car velocity while protecting service performance.

We cut back on the active fleets, rightsizing it to the business level, and focusing on fleet productivity. Currently we have just over 10,000 of our fleet stored, generating a roughly 4% year-over-year improvement in terms of active cars online. So again, in line with what we had to do with the business levels.

Next, you have to keep cars moving, getting them through yards fast and over the road reliably. In quarter two we cut terminal dwell by 5% and train speed was right where we expected it to be. We had a number of work programs on our mainline to upgrade our main corridor and core route, so we expected it to be flat year-over-year.

This allowed us to deliver car productivity improvements while protecting customer service. We did not want to make the cuts and make sure that we made all the numbers, but forgetting that we have service excellence. In fact our car order fulfillment in the quarter was in the high 90% range of customer demand, and we're meeting every order that's available to us.

If you turn to the next page, please, the other area that we have not talked about too much was on the people front. With slower growth, we adjusted our hiring plans. We've frozen hiring until we see that we chew up some of the people that we have excised; and we've redeployed some running trade employees into other functions, on top of the numbers that we show in the chart that we have laid off at this time.

In certain geographic areas, it was necessary to lay off some employees. We just -- we could not find work for them. But we will be recalling them as our natural attrition rate still runs about 10% with the age curve that we have in our workforce; so we'll see them coming back to work early part of next year, or second quarter of next year, with most of them being back.

Overtime was another area where we took under tight control, and we're squeezing this down to as close to zero as possible.

On the fuel front, our goal was 1.5%. Our target for this year was -- sorry, it was 1.5%, and we had a good head start in Q1. Q2 came in at 1% -- and not the best number possible, but very difficult when you have a drop in volume to be able to even deliver a fuel betterment. But we're still on track to deliver the 1.5% for the year.

So we continue to double down in efficiency. We reduced some train starts while protecting service, keep rolling stock in line, and rightsizing our workforce. This is done by staying close to the marketing team, keeping costs in line, while being ready to deploy resources to respond quickly to business opportunities.

Let me summarize. We responded quickly to the lower workload by decreasing dwell, cutting back on active cars, rightsizing our locomotives, increasing our end-to-end velocity. Key that we didn't concentrate on one piece but end-to-end, and nice to see that again.

I'm not sure how much is left there, but there's got to be something left. And driving productivity gains in train size and cars handled by employee. Overall, Claude, an excellent operating quarter by the team. JJ?

Thank you, Jim, and thank you to the team, to your team for the fluid service we've enjoyed in the second quarter. It's JJ now speaking, and I will walk you through the second-quarter revenue and then provide you with a commercial outlook.

The revenue was flat to last year at CAD3.125 billion. Breakdowns are as follows: the weaker volume accounted for roughly 3.5% to 4% drop in revenue; the carloads were down 49,000 units; coal alone was down 36,000 carloads; grain was down 20,000 carloads; and crude was down a disappointing 8,500 carloads.

Solid same-store pricing came in at 3.9%. As you remember, same-store price is net of exchange. It is also net of fuel surcharge fluctuation.

The weaker CAD0.813 gave us 6.5% of incremental revenue, and a lower applicable fuel surcharge took away 6% of revenue. In short, the deceleration in carload and fuel surcharge revenue was wholly offset by solid pricing and by gain in foreign exchange.

Now I will go through the highlights of the revenue on an as-reported basis to the major business units, starting with forest products. US housing starts drove lumber and panel revenue, and the offshore export of lumber was also constructive.

Wood pulp export was strong, increasing 18%. We have good car supply and we continue to upscale the quality of our business mix using our high-velocity [pool]/low-velocity pool destination program, which results in solid yield improvement across our merchandise railcar fleet.

Automotive revenue growth was fueled by strong industry sales, a favorable long-haul mix of business for CN, and the year-over-year effect of marketshare gain from last year.

Petroleum and chemical: the CN crude shipment were 23,000 carloads in the quarter, a 27% drop in volume from last year. Industrywide, crude-by-rail economies were challenged by narrowing crude spread and by improved pipeline supply/demand balance.

NGL volume grew nicely, reflecting ongoing opportunity to sell stranded Alberta NGL as merchant liquid in tank car into better-paying market than then leaving it in a natural gas. Also good performance in plastic pellets.

Intermodal: the overseas volume increased a solid 10% driven mostly by US import via the CN port, while the import into Canada were weakening with a slowdown in the Canadian economy. Canadian domestic units fell about 3%, also reflecting the sluggish Canadian GDP.

Metals and minerals: following our outstanding first quarter, frac sand revenue fell 5% versus last year. Q2 carloads were about 18,000, driven by a sharp reduction from the shale oil play. We believe the month of May was the low point for our frac sand carloads.

Drilling pipe was down 20% as oil producers moved to destock inventory to readjust it to forward demand. An influx of cheaper import steel dampered the demand for iron ore and semifinished steel. And we continue to see nice growth in aluminum and in nonferrous ore.

Grain and fertilizer: an 11% drop in Canadian grain revenue, which was due to lower export activity versus last year's strong crop inventory carry. US grain revenue were down only 2%, but ours on weaker export as well.

Coal: our Canadian coal mines are really struggling with global oversupply. Revenue was down 65% because of Canadian mine closures. US coal revenue experienced slower demand from domestic utilities; power plants had higher stockpile and natural gas remained cheap.

On export, our US revenue from CN franchise via the Gulf Coast were up. Other revenue did well and they were driven by our Great Lakes vessel fleet.

So now looking at the outlook, in the second half we assume the Canadian dollars and the price of crude will linger and the spread of crude will be volatile. The year-over-year favorable revenue gain from exchange will most likely in good part be offset by lower surcharge revenue.

Delivering a superior fulsome, wholesome service experience, focusing on margin improvement, and producing same-store price will remain part of our core strategy. For crude-by-rail and sand, demand will continue to be weaker than last year and will be volatile.

We are no longer counting on year-over-year growth on energy-related commodities. Crude spread may improve toward the minimum target range to support sequential crude-by-rail volume above the second quarter. Crude spread, for example in Western Canada select versus Brent, had moved from a high of CAD24 earlier this year to a low of CAD10 last spring; and we need about CAD20 spread to create opportunity for rail in the case of those two spread slate.

Reducing rail rate by $1 a barrel does not impact demand for crude-by-rail. And in our view, we should let the marketplace sort itself out without looking at the freight cost itself.

The overall North American outlook for coal is for progressive secular contraction. For CN, year-over-year coal carloads are not expected to inflect positive comparable before Q2 or mid-2016.

The size of the upcoming Canadian crop is heading below the five-year average while the US crop look decent at this point. Regardless, come the harvest time of the new crop in mid-September we will be very busy running at capacity or near capacity on export.

We are introducing new program to the Canadian regulated export trade, and we will have bids for private cars to be integrated into our general fleet. We will have private shuttle train running as intact export shuttle, and we will also introduce weekly car auctions, allowing shippers to bid on block of 25 cars from our general Western Canada pool.

We anticipate sustained demand for Canadian potash and the ramping up of the newly expanded Agrium mine should be positive. We are gearing up for continued growth in US housing starts, and we have the additional railcar capacity to meet expected demand.

We also expect revenue growth from automotive both in carloads of finished vehicles or in containers going to the assembly plants. We are investing in long-term future of our automotive franchise by acquiring more multipart, multi-maxrailcars and by expanding the capacity and productivity of our CN autoport facilities.

Within the context of an evolving North American economy, our intermodal franchise will continue to be an important engine of growth. We see potential in US import growth, supported by a constructive US economy, supported by CN's unique supply chain service and round-trip cost match-back model.

Domestic growth will be more muted, and it will be in line with a weaker Canadian GDP. However, from a market position we now have a third-morning and fourth-morning service into Calgary and Vancouver, which did solidify our strong position within the Canadian domestic marketplace.

Longer-term, the ocean ports that we serve on the three coasts of the continent are in very good shape, and our international franchise will be enhanced by the terminal and rail-on-dock expansion a Rupert, Vancouver, Montreal, and Mobile, Alabama.

In conclusion, as you know we have a very diversified portfolio which carry us through the current rotation of our very diverse commodity market. We have very diverse customer base, and we're also exposed to diverse regional economies -- all these things producing the type of bottom-line results that we just reported today.

We foresee fairly flat [car] growth for the remaining of the year because of challenging comparables from coal, iron ore, and grain. And we reiterate our 3% to 4% same-store price, which is basically continued pricing above inflation; and we continue to focus on upscaling yield. We are running for the long term. Luc?

Thank you, JJ. Starting on page 12 of the presentation, let me walk you through the key financial highlights of our solid second-quarter performance for 2015. As JJ pointed out, revenues were in line with last year at just over CAD3.1 billion. Fuel lag represented a revenue headwind of about CAD8 million, or CAD0.01 of EPS in the quarter.

Operating income was CAD1.362 billion, up over CAD100 million or 8% versus last year. Our operating ratio was 56.4%, a record level for a second quarter. This represents a 320 basis points improvement over last year.

Other income in the quarter was CAD16 million, up CAD14 million versus last year. Now, this is always a bit of a difficult category to forecast for timing, but for the first half of the year on an adjusted basis we are at about CAD20 million, just over CAD4 million above last year.

Net income stood at CAD886 million, up 5%. And the reported diluted EPS reached CAD1.10, up 7% versus last year.

When excluding the deferred income tax impact of CAD42 million or CAD0.05 per share resulting from the enactment of a higher provincial corporate income tax rate in the quarter, the adjusted diluted EPS stands at CAD1.15. That's up 12% versus last year. The impact of foreign currency in the quarter was CAD64 million favorable on net income, or $0.08 CAD0.08 per share.

Turning to page 13, as Jim indicated we made significant progress in terms of efficiency, productivity, and cost management in the quarter. Operating expenses were lower than last year by about CAD100 million or 5%, at CAD1.763 billion. Expressed on a constant currency basis, this is an improvement over last year of 11% or over CAD200 million.

At this point I'll refer to the changes in constant currency. Labor and fringe benefit costs were CAD542 million. Excluding FX, this is an 8% decrease from last year.

Now, this was the product of three elements. First, we limited the overall wage costs increase to 1% versus last year. By the end of the second quarter, we had about 600 employees laid off and our headcount was actually down 3% sequentially versus the end of the first quarter; in turn, it was 0.5% lower than at the end of the second quarter last year. In addition, wage inflation was partly offset by reduced overtime, lower training and compensation costs overall.

The second element was lower stock-based compensation expense, or CAD54 million of the total labor variance.

The third and last element was a higher pension expense for CAD6 million. Now on that note I should point out, however, that taking into account our most recent actuarial valuation which we just filed in June, we now expect the full-year increase in our total pension expense versus last year to be in the CAD70 million range as opposed to CAD100 million initially assumed. Now, that's for the full year.

Purchased services and material expenses were CAD434 million, up 5%. Increased costs in the quarter were driven by a higher level of rolling stock, impacting repairs and maintenance expenditures; we also had higher costs for accidents. Now, these cost pressures were partly offset by more capital work being performed in the quarter.

The fuel expense stood at CAD327 million or 40% lower than last year. Price was favorable by CAD167 million versus last year, and this was also supplemented by lower volume for CAD21 million. In addition, fuel productivity also improved by 1%.

Depreciation stood at CAD285 million, CAD15 million higher than last year, or 6%. And this was mostly a function of asset additions.

Equipment rents at CAD83 million were CAD9 million lower than last year, or 11%. Now this was the outcome of lower equipment leasing costs partly offset by increased net car hire expense. Casualty and other costs were CAD92 million, flat versus last year.

Moving to cash, we generated free cash flow of CAD1.051 billion in the first half of the year. This is approximately CAD220 million lower than in the same period in 2014. This is mostly attributable to higher cash flow from operations for CAD277 million, at CAD2.2 billion, which was partly offset by higher capital expenditures for CAD400 million. Our CapEx program at the midyear point stood at CAD1.1 billion for 2015.

Meanwhile our balance sheet remains strong with debt and leverage ratios within our guidelines.

In closing, let me address our 2015 financial outlook. We continue to be confident in terms of CN's prospects for the year, notwithstanding the fact that we are experiencing weaker conditions than expected in several markets, such as energy-related commodities and coal, along with challenging year-over-year comparables. As we look into the immediate future, while North American economic conditions are somewhat mixed, consumer confidence remains solid and should support continued progress in housing, automotive, and intermodal sectors.

These and other key assumptions underpinning our outlook should translate into carload volume in 2015 generally comparable with 2014, with pricing in line with our inflation-plus policy. Therefore, we are reaffirming our 2015 financial outlook calling for double-digit EPS growth over the 2014 adjusted diluted EPS of CAD3.76. We're also maintaining our capital investment program for the year at approximately CAD2.7 billion.

Furthermore, we continue to pursue our shareholder return agenda with a substantial stock buyback program underway, with a CAD1.7 billion target. So far in 2015, we've bought back 10.7 million shares for CAD833 million.

Our 2015 dividends have also been increased by 25%, while we intend to gradually move towards a 35% dividend payout ratio over time. And on this note I'll turn it back over to you, Claude.

Okay. Well, thank you, Luc, and thank you to the rest of the team. Just to summarize, we reacted quickly to realign our resources during the quarter and delivered a very solid Q2 performance.

We clearly see some global economic uncertainty in the current environment, but we're leveraging a great franchise in a very well-diversified portfolio. As Luc just said, we're reaffirming our EPS guidance for the full year, and we continue to keep our eye on building for the future.

We have a solid pipeline of growth and efficiency initiatives, and we are staying squarely focused on our strategic agenda. With that, Patrick, we'll turn to the Q&A.

(Operator Instructions) Chris Wetherbee, Citi.

Hey, great. Thanks and good afternoon, guys. Obviously a very, very strong performance on the operating ratio. Wanted to get a sense as you think about the rest of the year, and typically from a seasonal perspective 3Q is a little bit better than 2Q on the OR.

When you think about the puts and takes and flattish type volumes going forward or potentially even down, how should we think about that typical seasonality playing out into 3Q and 4Q? Just want to get a rough sense of maybe what might be changing, particularly around some of the expense items. That would be helpful.

Well, as Luc said, Chris, our Q2 operating ratio is a record all time, not just for CN but for the industry. We also had a very good start in terms of our capital program, which brought forward capital credit that normally peak in Q3.

So I think we should be delivering a very, very strong Q3. I'm not sure the sequential or the relation between Q2 and Q3 will hold to history, but we're in the current environment -- and I would like to add, obviously, the low fuel price is helping just the math here in terms of the OR -- but we feel the operating ratio should continue its very, very strong performance between now and the back end of the year.

It's definite to our efficiency focus and the fact that we're reacting swiftly to realign resources.

So it feels like you're appropriately resourced for the volume environment as you're heading into the third quarter here?

We think we are staying in balance, and we'll adjust as we go. But we are caught up right now and should continue to drive very, very strong efficiency as we have in Q2. Thank you for your question.

Great. Thank you very much for the time.

Cherilyn Radbourne, TD Securities.

Thanks very much and good afternoon. We know that the rate on regulated Canadian grain is going to start impacting same-store pricing as you report it next quarter. I was just wondering; excluding that impact do you think the capacity across the transportation space remains strong enough to stay towards the top end of your 3% to 4% pricing objective?

Yes, you're right; we got in the Canadian grain cap. It's effective August 1. But we don't necessarily apply it right at August 1, but it's something that is digested over a period of 12 months from August 1 through July 31.

So we know that, and we know that when we said our pricing will be in the range of 3% to 4%, including what the Canadian government is doing on the grain cap.

Thank you. That's my one.

Tom Wadewitz, UBS.

Yes, great. Thank you. Good afternoon. Wanted to see if you could give us a sense of how you think volumes may play out. I guess you -- I know that's a pretty tough question. I suppose it's a bit of a guess in certain markets.

But you said full-year volume's kind of flat, but you were up a lot in first quarter and down 3% in second. Do you think that you'd see less worse third quarter and then maybe flat year-over-year in fourth quarter? Or do you have a sense of how we might think about that?

And even into 2016, whether you'd have conviction that you would return to growth, or just how we might look at the contour of volumes over a couple quarters. Thank you.

Yes, JJ may add to this, but I think we should see a gradual improvement in Q3 going to the Q4 peak season. We're -- to finish generally comparable on a year-over-year basis, you have to have flattish growth overall for the next six months.

But it's conceivable we would be a little down again in Q3 and then start to turn the corner in Q4. JJ, do you have a little more color on that?

Yes, that's right. So flattish to potentially slightly down in the third quarter; and when you look at the evolution of the carload and the revenue ton miles, the RTM, eventually the RTM will start to come back up a little faster than the carload because of the bulk business. We're not moving a whole lot of bulk right now, and eventually we'll be moving grain and eventually a little more potash during the fall peak.

So fourth quarter volume-wise, whether you call it RTM or carloads should be slightly better than the third quarter. But all of that together is -- we have some bulk segment who are still limping along, as I said: iron ore, coal, grain till the next crop. And the crude-by-rail is sort of -- we're not too sure exactly where that goes from quarter to quarter.

On that energy side, it's margins. If the spreads were to widen significantly, maybe we'll be surprised on the upside. But we're taking the view that right now it takes a while to adjust to the current circumstances, and we're just not sure we're going to have growth in this energy complex that we can count on for the full year.

Any early thought on 2016?

Well, I think we'll cover that when we have a better visibility, Tom. Thank you.

It's early.

Makes sense. I appreciate it. Thanks for the time.

Walter Spracklin, RBC.

Yes, thanks very much. Good afternoon, everyone. Just looking back at your guidance and how it's evolved over the last couple quarters, you were starting the year expecting 3% to 4% carload growth with a little bit more optimism obviously on the energy markets, and pointing to an EPS growth that would approach or target a double-digit.

You then went down to 3%, but went to a solid double-digit or squarely in double-digit. Now you're down to flat but reaffirming.

With incremental margins being fairly strong in your business and with volumes coming down, you're obviously generating a better margin and still keeping your EPS growth. Is this really just a foreign-exchange type of offset and some good cost controls that Jim mentioned? Or is there something else at play here that's allowing you to maintain your EPS guidance while seeing some volume degradation through the year?

All right. That was a comprehensive question, Walter, and thanks for the summary on our guidance, but I think you did it well. I would just say that of course exchange is helping, but exchange has not changed much really over that period. So we're adjusting to the lower volume environment by reacting swiftly and make it up on the cost side would be the bulk of the situation. But, Luc, you may have a slightly different color.

Well, I think I would just add -- I mean again, the volume may not be everything that we had expected, but it's still very solid. And the pricing that JJ was alluding to 3.9% same-store, very solid pricing, so we've been able to make the most out of arguably a difficult environment.

Okay. Thank you very much.

Ken Hoexter, Merrill Lynch.

Great. Good afternoon and congrats on a great OR. Tremendous performance. Just seems like you are bouncing off the bottom on a lot of the energy and other commodities I think JJ was throwing out there.

So I guess the question would be for Jim on that: how do you think about the cost returning in this environment if we do bounce? Claude, you kept talking about parking and adjusting quickly; how about going in the other direction? Do you think you get that snap-back here on some of these volumes, or is it more measured?

Let me just say, bring it on. Jim, over to you.

I was going to say, let them bring at on because we'll use it and we'll see what we can do with it. I think we've shown that we can handle an upside.

Bottom line is, Ken, we're always adjusting. It's a continuous -- every day you adjust to see where the business is going to be. I'm not -- that'd be a real good problem to have if it returns and returns quick.

Appreciate the insight. Thank you.

Turan Quettawala, Scotiabank.

Good afternoon. I guess my question is also on the pricing side. JJ, with softer volumes, obviously some of the capacity snugness is probably a little bit less than we had last year. I'm just wondering: how comfortable are you with that 4% price increase number? And what gets you there on a same-store?

Thank you, Turan. It was 3% to 4%, and we're sticking to the 3% to 4%. But we did 3.9% in the second quarter.

Most of our market I would say are in balance. We have enough equipment and service and crews and capacities and locomotives to do a great job.

In some segment it's fairly recent that we've been able to caught up. Namely in automotive, it's only in June that we were able to get caught up. Now we are caught up.

And we never really tried to do the heavy price increase on one hand and a couple of quarters later to cut the price to get some extra carloads. So we are into a long term and we like compounding effect of inflation-plus pricing.

You look at our chart for the last 10 years that Janet has, it shows the effort and the mindset of compounding effect. So we try to stay away from the commodity-type approach of commoditizing rail freight as you would be tempted sometimes to do, and export coal or crude by rail, because of the downside of that midterm, right?

So we're -- what we have, 3% to 4% above inflation, steady Eddie. That's the game plan for 2015 and 2016.

Great. Thank you. Sorry, go ahead.

Steady Eddie, JJ. Next question. Thank you, Turan.

Bill Greene, Morgan Stanley.

Hi, good afternoon. Claude, I wanted to get your take on the OR again. But what I want to focus on is you mentioned, of course, how you are setting the records here, I think both for you and for the industry.

If the business came back, holding things like pension or fuel concept, is this the new bogey? Is this a new normal?

Or do a lot of these costs come back such that we see with growth comes higher OR? Which in a total dollar sense could be fine, but we need to keep that in mind as we think about longer-term projections.

Well, I would say first and foremost, you've got to calibrate your model to the fuel surcharge. The reality --

Right, holding that constant, obviously, that will have a big impact.

So we're not taking credit for fuel surcharge coming down or fuel price coming down in terms of our OR. But we delivered exceptionally strong because of all of the initiatives that help us drive value. The quality top line with pricing, the focus on the mix that we are able to hold on to, and the reacting swiftly with resourcing: all of that is how you stay in the lead in terms of efficiency, and we're determined to stay in the lead in terms of efficiency going forward.

As to predict where it's going to go and the bogey, there are so many moving parts, Bill, that I hesitate to even venture a guess. We'll be delivering as good an OR as the environment allows us to, and we intend to stay leader.

All right. I appreciate the time. Thank you.

Fadi Chamoun, BMO Capital Markets.

Yes, hi. I just want to say also congratulations on this performance in the context of this backdrop on the volume side. But a question for JJ: if you look at your crude business, can you identify what's economical to keep getting pushed at these low oil prices and what's not?

I mean that I'm trying to figure out if you want to put a number in 2016, and being worst-case scenario for crude, what would that number be, in your mind?

You mean in term of the carloads or the price (multiple speakers) --

Yes.

-- carload? I would not do this at this point because we've -- this year was supposed to be a year where energy were supposed to grow in carload; and in fact we actually have negative growth on those commodities. So the world has changed on us, and at this point it's hard to really get into the next six months. I wouldn't go to 2016.

But crude production in the Bakken that moves by rail seems to be down. Crude production from Western Canada is going up in total, about 200,000 barrel a day for 2016 and 2017. The question is how much of that is going to be available to rail versus crude too versus pipeline?

So the spread right now are -- they are going all over the map. For example, right now consumption of crude in Alberta is down because you have refineries in turnaround. So this is not something secular; those refineries will come back, right? Husky will come back in line; eventually Shell will do its turnaround and come back.

And when they re down, the crude that's locally normally consumed needs to go in the pipeline, so that creates temporary widening of the spread. And eventually refineries come back in and the crude is consumed locally, and that impacts supply/demand of those pipelines.

So many aspect entering. The forest fire in May was a reverse. We had CNR, Cenovus, and MEG, who are producers of crude, who went down for a period of time till the forest fire were close to the refinery. And the spread was very collapsed, right? Because there was excess amount of capacity at that time.

So it's hard to read. So it is what it is. We only have locomotive and crews; our customers have all the equipment. So when there is opportunity, we are willing to chase it as long as the price makes sense.

And the price may or may not make sense; and then after that, we want to focus on the more fundamental stuff. In the case of frac sand, which seems to have hit the lows in the month of May and now which seems to be running at a running rate, and most of the frac sand is related to natural gas or natural gas liquids.

And maybe LNG is up in Western Canada, and that gives us a continuing boost in terms of moving sand long-haul towards Western Canada.

Many moving pieces, parts around the supply/demand imbalance for the pipeline network.

Okay, thank you.

Jason Seidl, Cowen and Company.

Thank you very much, gentlemen. Thank you for the time, and good afternoon. Wanted to focus a little bit on the intermodal growth that you had. Obviously, still looking pretty strong in the quarter.

Just trying to get a sense going forward on that growth rate. Are we going to start to see it slow a little bit? Did you guys feel that you have any residual impact from the issues that some of the West Coast ports have had? Wonder if you could elaborate on that for me.

The second-quarter international growth was as strong as the first quarter, meaning that the business that came to us from, we'll call it, came to us from the US West Coast port stuck in the first quarter; it also stuck in the second quarter. We actually had a bigger volume out of Vancouver -- slightly bigger volume in the second quarter than the first quarter in Vancouver.

So that tells me that our US business is intact. In fact, it was the biggest reason for our growth on the international side, the import to the US Midwest.

So what we had is we're getting into a time where the comparables start to change. We haven't added up a new customer, so we're living off the US economy and the demand for that on the import side.

And on the Canadian side, the Canadian GDP is a little weak right now, and that's showing up on the import to the Canadian side. So we're not going to be more following for the next little while what's happening to the US GDP, strong, stronger; Canadian GDP, a little weaker.

And then our own self-help of initiative that has to do with Mobile and New Orleans and expansion in Rupert and Vancouver and Montreal over time.

You know, longer term, Jason, Rupert announced an expansion of their terminal. During the second quarter, we were at 775,000 TEUs as a run rate, and so this is remarkable.

This terminal not so long ago was built for 500,000 TEUs. We're running 275,000 TEUs more than that, and the capacity is being built as we speak.

Vancouver for us was slightly above a 1 million TEU run rate. And there again we're expecting our partners to be looking at their capacity and most likely make investments to grow the capacity. We're having good growth with the slightly lower Canadian dollar.

In Halifax, there's new service coming there. We're opening new opportunities in Mobile and New Orleans. This is not a one-trick pony: it's following the opportunities in the market as we go, and trying to outpace the economy year after year.

That's right. There's still room in Rupert to fit another call as we speak today. And in the case of Halifax, they will have some new call coming in late this fall on the exports which will be a welcome use for our eastern network.

Thank you, guys.

Benoit Poirier, Desjardins Capital Markets.

Yes, thank you very much and congratulations for the good quarter. Just looking at your safety metrics in Q2, it's pretty much unchanged versus last year; but just for 2015, I'm just wondering how should we be thinking related to the impact on annual incentive bonus plan? And any color on the impact of a recent derailment?

Let me -- we're having a strong focus on safety. It's essential in the current environment, and that's -- a lot of our capital expenditure is focused on upgrading and strengthening our infrastructure.

We're pleased with the fact that we are turning the corner and are getting better safety statistic. When you look at all of the accidents, all of the incidents that we faced -- that includes smaller incidents that are leading indicators -- we are actually down on a year-over-year basis, Jim, year-to-date, 17% or so.

Correct.

Our FRA accident, that's all the accidents that are more than CAD10,000, are flat essentially on a year-over-year basis, year-to-date. And we're focused on making sure that we run the safest possible railroad.

It's all about keeping our social license, making sure we can move the commodities that we handle without impacting the communities that we go through. It's a big focus for us.

Okay. Thank you very much, Claude.

Brandon Oglenski, Barclays.

Good afternoon, everyone, and congrats again on the OR. I think you might have even stole some thunder from your former colleagues here.

Luc, I wanted to talk to you about the labor compensation and benefits line, because obviously that came down a lot sequentially. You did have, I think, a lot of stock comp this quarter which, if it's my understanding, that won't repeat because that's an accrual adjustment one time in the quarter.

But you also mentioned pension. And could we go over the FX, too, in the back half of the year: just how do we look at the labor line?

And maybe even further for Jim, is there further efficiencies we can get out of the current volume environment where headcount could even sequentially come lower in the back half of the year?

Yes, I think -- and Jim can comment to little bit more on that. But essentially what's going to be happening is we should be looking at flat to negative or to a lower headcount during the balance of the year, and we could even end up closing the year probably a couple percentage points lower than last year. So we'll continue to see some definite progress on that line, and that's part and parcel of driving the lower labor costs.

At the same time, we have enjoyed the benefit of lower stock-based compensation. So I think that's an issue which we will have to see how the stocks going to perform in the back half of the year. Certainly last year we gained a lot of -- the stock price went up significantly in the second half, so we may still have a little bit of benefit there. We'll have to see.

On pension, we started out the year without the benefit of the actual valuation. We thought that our total pension expense would go up by about CAD100 million. So this is very good news: we'll be in the CAD70 million range.

And that gives us, if you look at the back half of this year, a CAD30 million reprieve in terms of the cost increase that we had foreseen. So I think those are the key elements to the variance.

Again I think lower hiring implies lower training cost. I mean, we're looking at everything. We're looking, and it's not just on the T&E and the engineering and mechanical, but it's through the entire Company that we're focusing on all of the labor cost and all components of it.

Well, if I could real quick, Brandon, good question. Bottom line is this. My boss is sitting right next to me. There's no way I'm going to give you how much more I think.

Is there is more left in velocity, better utilization of cars? Absolutely. But I'm not giving you a number moving forward.

But same as we're doing up to now, we want to optimize it, and I think there's something left. So no way I'm saying (multiple speakers).

He's not saying it, but we both know there's a lot of potential. And I would say tongue-in-cheek we will gladly take an increased stock price and deal with it between now and year-end.

Smart man, Jim. Thanks, guys.

Steve Hansen, Raymond James.

Good afternoon, guys. Just a question related to the cadence of the expense reduction through the quarter. I'm presuming that April was a little more difficult and you probably got some catch-up in May and June as the expense management really started to flow through. I guess I'm just trying to understand how much of that was completely executed by the end of the quarter and/or how much is in the quarter, versus how much rolls as well through or carries through into Q3 as well.

I think you touched on the labor count issue a little bit already. But just around some of the other categories that might also have some expense reductions built into Q3 that you've already executed on.

Yes, I think -- it's Luc. I can certainly say that we'll continue to look for opportunities to reduce the purchased services and materials. Again we're looking at in some cases redeploying our own personnel in replacement of outside contractors.

The equipment rents: we're continuing to look at what we need to get out there and what can be effectively reduced. Same thing on the C&O.

So I mean we're really going through systematically every category. Is there the same quantum that we've seen in Q2? Perhaps not. But I mean, again, we'll have to see where and how the business settles down.

So we're continuing to push the envelope and we'll have to see how it unfolds. But I think there is still some to be had in the second half.

Thank you.

Thank you. I will go to the next question.

Scott Group, Wolfe Research.

Hey, thanks. Afternoon, guys. Just wanted to follow-up on the pricing. JJ, you had mentioned a couple times on the call so far that you're not cutting freight rates to try and get more volume.

Is this something that other rails are doing that you are seeing out there? Or are you getting pressure from the customers to start doing this? Because I haven't heard you make that kind of comment in the past.

And maybe just more broadly on pricing, I think you were the first one on second-quarter calls last year to talk about how rail pricing should really get better in 2014 -- sorry, should really get better in 2015. Do you feel comfortable giving us an early view on pricing in 2016?

Well, actually year my comments at the time were before -- when energy was in around $100 for crude, the whole network was still snug, North America, and the effect of all the capital investment at all the railroads was still not fully felt. Now we've got more capital that's been deployed, and there's been some cutback especially on heavy RTM commodities like coal, grain, and energy commodities.

The market is still balanced, but in my view the pricing environment as it reflects on the second-quarter results -- I mean, we do have (inaudible) these dollars, they are 3.9%. The way we calculate things and the way we want to do things on the steady Eddie is very solid, in our view.

And we have sent our salespeople to do that. By the way, our salespeople -- one-third of their sales bonus is related to pricing, so it's not just about top-line revenue. It's one-third top-line revenue, one-third pricing, and one-third other initiative; and that's the balance that we like to have going forward.

Regarding crude-by-rail pricing, there is always some pressure on pricing from customers. And the crude-by-rail is an example where the spread is all over the map. The crude producers are under financial distress; of course they want something better.

Then these are big volume that sometime they are more like the mirage, because they're big but you never quite get there. As you get closer to them, you find that there was really no lake; it is just another pile of sand.

So in that context I would suggest that what pricing for us is important is the midterm impact. Chasing something for three months or one month or 20-train is taking the context that we want pricing that we would be happy with in 2016 and 2017. So from that point of view, discipline number one.

You have to be -- I mean in crude, it only takes one accident and it costs a lot of money. I remind everybody, our two incidents during the first half cost us $65 million in terms of accident cost. That's a lot of money; it takes a long time to cover for that.

So we think that the market has to settle. The price is not right, we're not going to move the business. If the price is right, given it's a dangerous commodity, we're going to do it and we're going to do it well and add value to our customers. That's our philosophy and we're sticking to it.

Yes, crude-by-rail carload will be driven by the spread, not by the [recovery].

Think you, Scott.

Okay, thank you.

Brian Ossenbeck, JPMorgan.

Hi, good afternoon. Thanks for taking my call. Obviously you're involved in a tremendous amount of activity in the Canadian economy. Is there any concern you have with the pace of economic growth?

Last week the Central Bank cut rates, basically acknowledging that the economy was technically in recession the first half of the year. A large part of that, obviously, was oil prices.

So just wanted to get your high-level thoughts on the economy as you enter the back half of the year. Seems like you're seeing some stress on domestic intermodal customers a bit. But also what is the sense you get from the shippers and the customers that you speak to on a regular basis? Thanks.

You know, our -- we're a bellwether of the heavy side of the economy, and we have very good visibility on that part. And I would echo what you said. The general economy in Canada has been more sluggish than what we've seen in the US.

The US economy -- consumers' balance sheet have been repaired. There is a propensity to focus on discretionary impact with lower fuel prices. And we've seen better growth in what is driven by consumer demand in the US than we have in Canada.

I think what Canada is facing is people probably understated the impact of the energy complex cutback on capital expenditures. You add it all up, it's not just what happens in Western Canada; it's the component that has to feed those big investments.

It's the labor that's flying from one part of the country to get to Western Canada. It's discretionary dollars. So Canada has seen a bit more of an impact.

But I am of the view that we may see a slight betterment in the second half because everything could turn and get a little bit better. So we're not -- we think Canada will do better in the back end of the year, and (technical difficulty) finish the year a little bit lower growth than people were expecting, but we don't see Canada in a recession. We see Canada in a technical slowdown that happened to take place for the first six months of the year.

Okay, thank you.

Thank you, Brian.

Thank you.

Allison Landry, Credit Suisse.

Thanks. Good afternoon. Following up on the earlier question on the labor line, I know that you mentioned that wage inflation was in the 1% range. So is that something that we should be thinking about in terms of modeling purposes for the third and fourth quarter?

And then could you clarify if there was a separate tailwind on this line item for other incentive comp accruals related to achieving 2015 targets?

Yes, it's Luc. The wage inflation actually is running around 3%. So what effectively we've done is through a combination of headcount reduction, lowering of training expenditures, lowering of compensation overall -- including some portion of incentive compensation -- we've been able to offset part of that wage inflation and effectively come out with a 1% wage cost increase. So that is what I've said.

And over time as a big part of that we've been really, really focused on making sure we reduce overtime and also get more of the work done by our inside forces as opposed to using contractors to do the work. It really is a long list of execution items that allow you to deliver efficiency gains as volume declines.

Okay. Thank you, Allison. Janet, I think that there is one more question, and then we'll close this call.

David Vernon, Bernstein.

Thanks for taking the question, guys. Just with respect to the lower oil price environment, are you guys seeing any negative headwind created on the domestic highway conversions that you guys had been experiencing the last couple years? And could you give us an update on what's happening with the JB Hunt contract that was announced -- or discussed anyway -- at the intermodal site tour a few months ago? Thanks.

The cheaper energy makes the trucking a little more competitive versus rail. The spread of the cost between the two is obviously narrowing. Then you get back down to the basic of how many drivers there is, being the number one bottleneck of growth for the trucking side.

And on the Canadian side, the reason why our domestic intermodal is down like 2.5% or 3% volume-wise is more about the economy itself than it is about conversion back and forth with truck. But long-term, when you have a steady economy or a little more growing economy on the Canadian side anyway, I think the future of intermodal long-haul is extremely viable.

Regarding JB Hunt, they are an example of somebody who does extremely well in good time and bad time using intermodal as a way to compete in the marketplace against the long-haul truckers. This was something missing in our stable of product, to have a good strong partner, a couple of partners who are able to get product from Canada to US just about from anywhere to anywhere: anywhere in Canada to anywhere in the US.

And we're happy that they're going to be partnered with us for the long term. I think over time, steady Eddie, that will produce some benefit for both of us: us and JB Hunt.

Thank you, David, and thank you for all those good questions and thank you for being disciplined. Let me put it to you this way. We delivered very, very solid second-quarter results. We're pleased.

It's a team of railroaders, 24,000 strong that delivers this kind of performance, driving on all factors, and we feel we have good momentum. We feel that we're seeing some green shoots. We're seeing some opportunity to focus on growth.

It's sluggish, but it's out there, and you had a little color there. Now they're going to -- a little expense management, a lot of execution, and a focus on long-term sticking with our game plan is what we need to do to continue to drive value for our shareholders. And that's what we intend to do and report to you next we talk in October.

Have a safe day. Thank you very much.

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