Canadian National Railway Co (CNI) 2015 Q3 法說會逐字稿

CN's third-quarter 2015 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 third-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. Reconciliation 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 the CN third-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, Mary. Good afternoon, everyone. 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 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 yourselves to one question. It is now my pleasure to turn the call over to CN's Executive Vice President and Chief Financial Officer, Mr. Luc Jobin.

Thank you, Janet and thank you everyone for joining us today for CN's third-quarter earnings results. Let me start off this call by providing you with a few highlights of our outstanding results before I turn it over to Jim and JJ for more details on our operating and commercial performance.

Throughout the third quarter, we have been managing certainly a tough volume environment, challenging in the sense of weaker volumes, but the vigor of our performance reflects our ability to leverage the strength of our franchise and its diversity. It also demonstrates how this team has been recalibrating resources to drive efficiency.

It's equally important to point out that we have achieved this while continuing to balance operational and service excellence in a manner that is consistent with our end-to-end supply chain focus. This translates into an all-time record operating ratio of 53.8%. That performance also carried through into strong financial results. Our diluted EPS is up 21% and our year-to-date free cash flow is over CAD1.7 billion.

Let me now hand it over to Jim who will provide a few key operational highlights for the quarter. Jim?

Thank you very much there, Luc. So if we turn to the Q3 operating highlights, I think this slide really speaks for itself. As JJ will describe in more detail, our workload was down. Even with that headwind, we delivered substantial improvement in all key indicators. We demonstrated the resiliency and effectiveness of our operating model even in a weaker volume environment.

We set new records for car velocity, terminal dwell, locomotive utilization and yard productivity. We also set a new record for train productivity, a significant accomplishment in the face of a 6% decline in revenue ton miles. All of this was accomplished while continuing to focus on delivering superior end-to-end service to our customers, which allows our customers to compete in their markets and support long-term sustainable growth. Our approach of balancing operational service excellence appears to be working.

If you could turn to the next page, I would like to just spend a minute and maybe talk a little bit about how we achieved these results. It really comes down to a culture of execution. The operating team headed up by strong operating background leaders is equipped with the information they need to identify opportunities and to continually find new ways to drive incremental efficiency. By pushing the decision-making down to the front line, we are empowering the right people to make the right decisions and to do so quickly. We have the entire team focused on managing their assets and their costs. At the same time, we have a network team that is working to ensure the entire system is optimized. It is a top-down, bottom-up view, as well as driven from the top down to make sure at all levels in the Company we're trying to optimize the operation.

As always, safety remains our foundational priority and we ended the third quarter with strong overall improvement. To continue our progress, we are rolling out the next phase of our looking out for each other program, which involves awareness training for thousands of our employees. The goal is simple. We all go home safe at the end of the day after our work day at CN. In my opinion, a culture of safety and team focused on driving efficiency while meeting the service needs of our customers is truly a winning combination.

Of course, we are also investing smartly in a pinpoint manner in the future. Earlier this week, we cut in a new double track piece on the Steelton Hill and you guys have heard me talk about how important this is on the Chicago to Winnipeg. We removed one of the pinch points that we had in that area. I am very pleased that this is now in place. Perfect timing in November, Luc. It will help us through this winter hopefully. This along with other pinpointed investments we have made in our network from Edmonton and Winnipeg in sidings and at the border for fluidity for our intermodal business just keeps us being able to move the product that JJ is selling in an efficient manner.

In the next couple of quarters, I think we are positioned well. We have excess locomotives, somewhere around 200. Every day, it moves up and down depending on where the workload is. We have good crew availability. We have reacted quickly and we have shown that if we need to react and in fact, year-over-year, we are 1100 fewer employees. We have still about 800 people laid off and will return some of them through the winter and as the attrition works out, we will be calling them back to work.

It would be a much easier story if the economy was giving us more upside, but, at the end of the day, I think we have shown that we can react properly as an operating team and I am very comfortable and very happy with the results that the team was able to deliver this quarter. JJ, over to you.

Thank you, Jim, and great job on that 53.8% operating ratio. Looking over at the revenue, revenue was up 3% from last year. The breakdown is as follows. Volume and mix resulted in a 4% drop in our revenue. The carloads were down 82,000 units, but in fairness a full 62,000 of these carloads were attributed to iron ore shortfall. Same-store price came in at plus 3.3% all in. That is also inclusive of the August reduction of the regulated grain of minus 5.6% and some legacy formula pricing from past mergers. The Canadian dollar at $0.765 added 10% to our revenue and finally, the lower applicable fuel surcharge reduced revenue by 5%.

Now I will go through some of the highlights of our revenue on the as-reported basis, that is in Canadian dollars and inclusive of the fuel, starting with forest products. Lumber and panel revenue rose 16% driven by strong growth in US housing, partly offset by weak Asian exports. Offshore wood pulp export benefited from a pulp mill reopening in northern BC and our paper volumes were down 14% reflecting a steady secular decline in consumption.

Intermodal, overseas revenue increased 5% driven mostly by US import and export, while our Canadian imports were flat. Overall domestic intermodal volumes were in line with last year. Our Canadian transcontinental volume was up 7% on customers' acceptance of our superior service while our US transborder volume was down as a result of stronger highway competition. Truck capacity is currently more readily available and truck costs are down. That is to say diesel fuel is cheaper and the Canadian drivers are paid in Canadian funds for their cross-border work. However, the prospect for highway to rail conversion remains positive over the mid-term.

Automotive, our investment to expand our railcar fleet capacity and the strong vehicle purchased at the dealers produced 13% growth for the segment. Petroleum and chemical, CN crude oil shipments were sequentially flat with last quarter at 23,300 carloads, but down 32% compared to last year. The combined two Canadian railroad third-quarter AR carloads for crude declined by roughly 25% or 16,000 carloads versus last year. It is the crude spread that drives the overall industry rail volume, not the rail rate. Currently, crude by rail volume nomination and crude by rail pricing are increasingly transactional and short term in nature. In the third quarter, we did concede some volume to support pricing.

LPG and refined product continue to perform well; plastics also produced solid results. Fertilizer revenue grew 18% driven by potash global demand. Grain, in line with the volume dip of last spring, we saw a 10% drop in Canadian grain revenue due to low grain stock, but our Canadian grain business is now running flat out and grain stock are available again. US grain business was slightly down reflecting the permanent closure of a major corn processing plant in Memphis earlier this year.

Metals, minerals and iron ore. Frac sand revenue declined 11% in the context of reduced oil drilling activities. Carloads were flat sequentially with last quarter at about 19,000, but down 22% versus last year. Cheap steel import negatively impacted semi-finished steel volumes, scrap iron and iron ore. We are hoping for some US dumping duties to be in place by next spring. A CN-served iron ore mine closed during August. Please take note for future quarters the annualized impact of the mine closure is 260,000 carloads, less than $50 million annualized and that the average length of haul of 21 miles. This will distort CN corporate results on carloads, as well as business mix until August 2016 when we lap the event.

Coal, Canadian coal carloads were down 38% in the quarter and our future quarter comparables should start to partially stabilize going forward. Our US coal volume was down reflecting a secular demand decline from power generation plant and our export by the US Gulf terminal were flat compared to last year.

Now looking ahead, on the whole, we remain constructive, particularly when it comes to consumer-driven demand despite weakness in energy and specific commodity markets. The US economy will be a driver of growth in intermodal, in vehicle manufacturing, in vehicle sales and in lumber and panel. To exploit these opportunities, we added 7% to our automotive railcar fleet and we are also adding 35% to our Toronto auto compound capacity.

Regarding lumber, our centerbeam fleet is about 7 times bigger than our direct Canadian competitor and we also added cars to this fleet this year. Port business should also remain vibrant. Grain and fertilizer should be doing okay and the same for petrochemical and refined product. Crude, the crude volume will remain under pressure from pipeline capacity, but we do have the incremental rail capacity and the cost base to be a player and will be a player in the rail transactional game. Our short-term headwind will remain crude, steel, coal, frac sand and iron ore. The one thing to watch in the case of CN for volume is our RTM, focus on our RTM performance.

The team is also engaged in pre-selling port capacity expansion, namely at the Mobile, Alabama rail on-dock expansion and as you may have seen yesterday, the GCT expansion at Delta Port in Vancouver. The recently announced Trans-Pacific Partnership trade agreement referred to as the TPP only adds to the value of the pre-selling port expansion campaign.

In conclusion, we have a very diversified end-market portfolio, which carried us well here during the third quarter and we have the industry's best operating cost. We continue to expect pricing above inflation in the range of 3%. That is because of the negative impact of the revenue grain cap, as well as some long lag fuel component from past merger legacy index that will be transient headwind [with us] over the next 12 months. We work hand in glove with Jim's operating team on yield management, on cost control and on further developing our end-to-end supply chain competitive edge. So, Luc.

All right. Thanks, JJ. Starting on page 12 of the presentation then, let me address the key financial highlights of our strong third-quarter performance. As JJ pointed out, revenues were up 3% versus last year to just over CAD3.2 billion. Fuel lag represented a revenue tailwind of CAD37 million in the quarter or CAD0.02 of EPS higher than last year.

While we are on the subject of fuel lag, you should keep in mind that in the fourth quarter of this year, this will turn into a revenue headwind versus last year, somewhere in the range of probably CAD40 million assuming that WTI remains in the current level of approximately $45 a barrel.

Operating income was CAD1.487 billion, up CAD200 million, or 16% versus last year. Our operating ratio in the quarter was 53.8%, an all-time record and this represents a 500 basis point improvement over last year, of which the fuel rate impact represented approximately 200 basis points. Net income stood at CAD1 billion, up 18% and diluted EPS reached CAD1.26, up 21% versus last year. The impact of foreign currency exchange in the quarter was CAD107 million favorable on net income.

Turning to page 13, as Jim indicated, we continued to make significant progress in the quarter in terms of safety, productivity and cost management. Operating expenses were lower than last year by about CAD100 million or 5% at CAD1.735 billion. Expressed on a constant currency basis, however, expenses were actually 14% lower than last year. At this point, I will refer to the changes in constant currency.

Labor and fringe benefit costs were CAD588 million. Excluding FX, this is a 6% decrease from last year. This was the product of three elements. First, overall wage cost decreased by 0.5% versus last year as wage inflation and lower capital credits were more than offset by a headcount reduction along with lower overtime. We had 1100 less employees at the end of the quarter versus last year and that is a 4.5% decrease in headcount. In all, we have about 800 employees laid off at the end of September versus 600 at the end of the second quarter.

The second element was lower stock-based compensation expense were CAD42 million of the total labor variance. The third and last element was a higher pension expense for CAD12 million.

Purchased services and material expenses were CAD401 million, 3% lower than last year, as we incurred lower third-party costs in the quarter, which were partly offset by increased cost for materials, along with higher repairs and maintenance. Fuel expense stood at CAD293 million or 45% lower than last year. Fuel cost was CAD156 million favorable versus last year. Lower volume accounted for a CAD19 million betterment while productivity and a minor inventory adjustment contributed CAD15 million. Depreciation stood at CAD287 million, CAD10 million higher than last year or 4%. This was in large part a function of asset additions partly offset by the impact of depreciation studies.

Equipment rents at CAD93 million were CAD4 million lower than last year or 5%. Last but not least, casualty and other costs were CAD73 million. That is CAD25 million less or lower than last year or 5%. As for the most part, we incurred lower accident-related cost in the quarter.

Moving on to cash, we generated free cash flow of over CAD1.7 billion for the first nine months of the year. This is approximately CAD300 million lower than last year. We had higher cash flow from operations for CAD600 million partly offset by CAD700 million of higher capital expenditures and lower proceeds from asset disposals. Meanwhile, our balance sheet remains strong with debt and leverage ratios well within our guidelines.

As for 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 some markets. As we look to the future, North American economic conditions are favorable, consumer confidence remains solid and should support continued progress in housing, automotive and intermodal sectors. This should translate into carload volume for the full year to be approximately 2% lower than last year with pricing in line with our inflation plus policy as JJ pointed out.

Therefore, we are reaffirming our 2015 financial outlook, calling for double-digit EPS growth over the 2014 adjusted diluted EPS of CAD3.76. We are also maintaining our capital investment program for the year at approximately CAD2.7 billion.

Furthermore, we continue to pursue our shareholder return agenda having just completed in the 12 months ended October 23 the repurchase of over 24 million shares for CAD1.85 billion. Our Board of Directors just approved a new normal course issuer bid program allowing the repurchase of up to 33 million shares over the next 12 months and for which we are setting aside a budget of approximately CAD2 billion. Our 2015 dividend has increased by 25% this year and we intend to gradually move towards the 35% payout ratio. We look forward to reviewing our dividend along with our fourth-quarter results in late January.

On this note, let me close by saying, on behalf of this management team, along with Claude who is listening to us out there, Claude, that we are very proud of our third-quarter results and looking ahead, we intend to continue leveraging our great franchise and managing our business to deliver value for our customers and shareholders. We remain committed to our agenda of operational and service excellence and we are on track to achieve our full-year guidance.

We'd be happy to take any questions now. Over to you, Mary.

(Operator Instructions). Ken Hoexter, Merrill Lynch.

Claude, all of the best as you recover there. Luc, maybe you could just start with your thought that -- your last comment there targeting down 2% volume. That indicates quite a negative fourth quarter and maybe just some early thoughts now as you flow into 2016 at this time in terms of the volume outlook. I guess within that, it sounded like you were ceding some volume to support pricing. Does that mean we are seeing the other rails getting aggressive within that or is that just part of your volume outlook?

Let me make a few comments and then I will ask JJ to supplement. Keep in mind what JJ pointed out, which is your carloads in the fourth quarter will be negative. A large impact will be the result of the iron ore closure. So again, don't pay too much attention to the carloads; you should be focusing more on the RTMs. Contrary to this quarter where the RTMs and the carloads were in sync, you will see a different picture as you look to the fourth quarter. So I would encourage you to focus on the RTMs; they will be a much better indicator of the volumes that we are taking on.

As it relates to crude, that has always been a very competitive category. It was right from the beginning from the get-go and we expect that it will continue to be competitive. Having said that, certainly some of the business is volatile, is spot business. And also what we are seeing is a shift perhaps away from manifest to more unit trains, which in and of itself will translate into lower prices as a result of that. So maybe, JJ, if you want to supplement?

Ken, at least for the fourth quarter and maybe for part of next year, you want to look at our RTM. If you look at week 42, our RTM are minus 1.8% and the carloads are minus 8.1% and that is related directly to the big iron ore mine closure, which is a lot of carload, but it is in the range of CAD10 million to CAD12 million per quarter.

Regarding volume and how that links to price, the railroad market is very competitive, will always be very competitive. We don't expect anything less and our forecast or view of what carload will be next year, we don't see foresee necessarily a shift in market share and we will make sure we work hard on this so there is no significant shift in market share.

Great. Appreciate the insight. Thanks, Luc. Thanks, JJ.

Cherilyn Radbourne, TD Securities.

Good afternoon and congratulations on the quarter. Wanted to ask a question on the cost side because when we get a quarter like this where there is a big move in foreign exchange year-over-year, and you get a bit of a shock absorber from stock-based comp, it can be difficult from outside to see how the operations really contributed. So I just wonder if you could give us some insight as to how much credit you can take here and how much your internal productivity initiatives contributed.

Cherilyn, listen, why don't I start and then the other guys can jump in if they want. I was hoping that with those numbers we presented for the highlights, nobody was going to ask me any questions. It is a nice clean quarter. Let's go. But I appreciate the question.

So fundamentally, the challenge always is when you have a lot of puts and takes, it is how is the railroad running itself and that is what is key. And we gave a few of the highlights. I could bore everybody by putting out a whole bunch more information, but bottom line is we were -- the challenge was we had a drop in the amount of GTMs, so we are working against a 4.8% GTM drop, which is a nice figure that we use instead of the RTMs on workload just because of the mix, how far you are hauling and everything else.

But what we were able to do as an operating team and really the discussion with JJ and Luc and all of us together, but this is what we have been able to do, just to throw a couple other things. Train starts dropped 13% with a 4.8% drop. The train miles, we were able to go 4% less. Our train length, which we don't always tell everybody about, was actually up 4%. So more cars on less trains with less miles helped us being able to do it.

We were absolutely diligent looking at locomotive velocity up 4%, GTMs per train hour were just about 10%. So all the metrics, but you don't just stop there. It is how well they are bad orders, the number of bad orders and the amount of work and overtime we had there, we were able to drop it and the fact it dropped double digit, great work by Jim Danielwicz and his whole team on the mechanical side.

Our old dates, we look at velocity and if you only look at velocity, what you get is the overall number, but we also were driving the actual cars that are sitting around the yards a little longer, which we label as old dates and we were able to drop that number down double digit in the quarter.

On top of that, our service metrics -- so how are we doing on servicing the customers because we want to look at it end to end, our destination origination were up double digit in performance. So we ran the trains faster, we ran the trains longer. We put more tons on the train and in the yards, we put the cars through quicker than I have ever seen.

So when you put that all together, Janet would give me heck if I gave you the actual number, but I will tell you this much is we were able to drop the cost even though we had an inflation because of the wage increase, we actually were able to drop our cost on a yard and on the road on running trains close to double digit. So that is the kind of quarter you want to deliver at the base of the operation. Hopefully I answered your question.

Great. That is my one. Thank you.

Chris Wetherbee, Citi.

Just wanted to touch a little bit on pricing if I could. I think you gave some color around the grain impact on pricing and maybe some legacy impact on pricing, but just wanted to get a sense of how you are thinking about sort of the pricing environment sequentially as we move through 2015. And maybe if I can convince you to talk a little bit about it in 2016, but just wanted to get your sense for what is going on in the market right now competitively in that core pricing.

So starting with the bigger impact, why the core pricing is now at 3.3% and heading toward more the 3% is we have about 9% of our business, which is index-related and I would call the Canadian [regulatory] grain cap is basically an index. And in this index, we have a fuel component, which is basically a long lag fuel tail. That is why the Canadian grain cap is down to minus 5.6%. August 1, it was plus 4%, 4.5% before that, because of the drop in fuel last year and you have similar things in some of our life of mine contract that came in as a result of us buying properties back in the days where you have a long lag fuel component that is finally kicking in in the next 12 months. So we have this transient digesting this index.

And then you look at the regular book of business. The regular book of business is still in the range of 3% to 4%, maybe not quite as robust as last year or a year and a half when the rail capacity in North America was snug. I don't believe the rail capacity in North America is snug. Maybe some pockets, but typically not. Then you have these one-timers that come in as an index. So that is why I said, in terms of the same store price, we are heading toward probably more a 3% range, all-inclusive of these lag and the things that we need to digest like grain cap here for a period of 12 months.

Okay, so it sounds like -- any way you can say sort of equal parts from the index or caps versus sort of the relative pricing environment or is that just a little too granular?

These index, like the grain is negative and some of these other legacy index contracts also negative. So you need pricing power to be able to offset that and bring them up to a 3 something percent. Obviously, the marketplace is still positive in terms of price take in carload definitely, in merchandise definitely, in bulk as well. I mean we are getting a price increase in moving coal, for example and in intermodal, we are getting a price increase. Not as much as in carload, but there is still some price increase across the board. It is a question of how much.

I think you also look at what is happening in the trucking industry. The price take in the trucking industry in North America has also slowed down a bit and that is reflecting in some of our market and merchandise and/or domestic intermodal as well.

All right, great. Thanks so much for the time. Appreciate it.

Walter Spracklin, RBC.

Thanks very much. Good afternoon, everyone. So if I could turn perhaps, Luc, to the CapEx program and I guess the one key pushback I get from investors on the rail group in general is the capital intensity and arguably now that you are seeing volumes come down a little bit and your CapEx program is right at the high end of your kind of guided range, understanding that US dollar plays a part in your program and knowing that is higher for next year, obviously, is there any insight as to whether CapEx can now trend down back toward the lower end now that we are seeing some volume respite or do we still see a fairly relatively high CapEx spend going forward?

Yes, Walter, I think we should probably continue to think about the CapEx at the higher end. We typically look to 18% to 20% of revenues, albeit the revenue, there is now a bit more noise given the fuel surcharge component that is out of it. Clearly a little bit of FX pressure, but I think that is a reasonable range for us to consider and we continue to look at that in somewhat of an opportunistic fashion. There is a little bit less traffic on the network, so Jim can use the opportunity to concentrate on making the right investment in terms of the infrastructure, hardening our track conditions and so -- and some of the commodity prices are lower. So we always want to be a little bit opportunistic when we see these changes.

So as such, I wouldn't necessarily look for a significant reduction. As far as we are concerned, as long as we continue to see a productive way to deploy the capital, that is a good place to be. So I wouldn't expect a major discontinuity there and certainly we will guide -- when we get into 2016, we will guide accordingly, but I would not expect a major departure here.

And just to clarify, is the ratio between growth and replacement capital fairly consistent with prior years or are you bumping -- I know you kind of mentioned -- but are you bumping the envelope a little bit more on the growth side?

We are actually probably -- we are going to look for opportunities. The approach we have and certainly, we tell the whole team, is if we see good growth opportunities, we don't feel constrained. So if they have the right profile and we think they are compelling to add value for the franchise, we are happy to push the envelope a little bit here. We will see -- we will share with you guys a little bit more in detail what the mix will be for next year, but the same principles continue to apply.

Okay, thank you very much.

Scott Group, Wolfe Research.

So Luc, maybe if you can give us a little bit more color on the guidance for the year. So you are so far ahead of that double-digit run rate, so can you maybe put some context around fourth quarter? Do you think that double-digit earnings growth is a good bogey or target for the fourth quarter? Just any color you can give us on fourth quarter in particular.

We don't guide on a quarterly basis, so that always is something that we stay away from. Our annual guidance, as you indicated, calls for double digit. Do we feel good about that guidance at the current time? Absolutely. I think with the third quarter, and so far, when you look at the year that we have been clocking in, we feel very comfortable about achieving that. You have got to keep in mind that the fourth quarter last year, we had some very good weather, certainly through December and we also had revenue growth back then of about 17%.

So all things considered, you need to look at the fourth quarter in terms of some tough comparables. But, as I said, we feel very constructive about our fourth quarter given the backdrop of the economy. And I think JJ has given you quite a bit of color in terms of where we are seeing the RTMs evolve. So I would say we are confident that we will meet our guideline and clearly, we have got good momentum going into the fourth quarter. That is the color on that.

Okay. And then if I can just ask one more, so help us put some context around a 53.8% OR this quarter, 56.4% last quarter. Without changes in fuel and currency, is this a new normal and if we see volume growth next year, can we kind of start to think about margin improvement beyond that or is this just something that doesn't feel sustainable and there is some unusual things in here? Again, I understand the fuel and the currency helps, but maybe just outside of changes there.

Right, and one of the big factors, as we all know, this year has been the fuel. But assuming that the fuel would stay at the current level, certainly we see the scope for a sub 60% OR and I think those are the conditions and the profile that this organization can deliver. Of course, you will have the seasonal changes. First and fourth quarter typically are a little bit more affected by the weather, but we are clearly looking at a sub 60% OR environment and FX really is not a significant element there. It is mostly the fuel that can play havoc.

So if fuel prices make a significant run-up then, of course, that will become a bit of a headwind. But we are -- by and large, we are clocking in record performance, even if you did exclude the fuel component. So we feel pretty good about our ability to manage both the top line and the bottom line and continuing to grow the franchise and deliver that balance that JJ and Jim have referred to in terms of operational excellence at the same time as continuing to build value in the service we provide to our customers. All in all, I, historically, would call for a very low 60% OR. I think clearly the conditions now are for sub 60%.

Okay. Thank you, guys.

Brandon Oglenski, Barclays.

Congrats on a pretty decent quarter here. I guess Claude has left the team in good hands and best wishes to him as well. But I want to follow up Scott's question here. Does this OR outcome, and I do think you do have a little bit more US revenue than you do US expense. I have got to believe that is helping a little bit here. But maybe, JJ, this question is for you, but does this help you in markets like intermodal where you can be much more competitive versus a US carrier just given where exchange rates have gone? And on top of that, the West Coast port issues that we have seen that maybe you don't deal with in Vancouver? Can you expand on that a little bit?

So your first question, to clarify, 55% of our revenue are in US dollars, so that is the ratio of our revenue which are US-denominated. In terms of what we exploit, we exploit anything that the economy offers to us. And I call this surfing the wave and one of the waves which is offered to us right now to surf is the weaker Canadian dollar. So yes, of course, we are driving the US dollar as a competitive edge for as long as it might last -- nothing lasts forever -- to bring product to the US with a higher Canadian component. So if you are selling lumber to a US housing start from BC where most of the labor cost and wood cost is in Canadian funds, we really want to drive that very hard and that is why we have expanded our centerbeam fleet to be able to capitalize on both the weak dollar and the strong US housing starts.

On the port business, the same thing. The fact that we price to the US and Canadian ports in US funds and part of our costs are in Canadian funds allow us to be even more competitive and/or a higher yield. Either we get a higher yield or we can get maybe more carloads. Also remember the Canadian port would typically do their contract with the shipping line in Canadian funds. So as their shipping lines are redoing their costing model as to which trains they are going to put -- which container to drop in which port, they also resize -- they put the impact of the currency in their own model, all currency around the world and that is also a positive. We do exploit the Canadian dollar for what it is since we no longer have crude at $95 applies here. We ride what could be driven and what can't be driven, we wait for the next cycle.

Thank you.

Tom Wadewitz, UBS Securities.

Good afternoon and Claude, wish you a quick recovery and also congratulations on a strong operating ratio. It is obviously a very impressive number to put up. I wanted to ask you, Jim, on the productivity, the railroads running very well, what happens in 2016? What do you push on and how much room is there to go if the volume environment remains somewhat muted? Is it train length and taking on more train starts? Where do you go given that the railroad is already running at a very strong level?

Listen, thank you very much, great questions. First of all, we have been investing back in the plant in places that make us more efficient, whether it is a double track out in the prairies between Edmonton and Winnipeg, it is being able to use the humps more efficiently in Winnipeg and in Chicago. It is the J and the investments that we have had on the J around Chicago to get us quicker. So that gives us a framework and we will continue. The double track up to Steelton Hill makes a difference. Tracks at the border, tracks at Pokegama. We have added capacity to make sure that we can grow with the business.

I would like the problem to be next year is that we are up, the economy gives us more business and we have to react in a positive manner in there. I think we have got the team to do that. Very impressive. Is it going to always be easy to be able to improve your yard productivity by 10%? No, but I will take two or three and we are always working to find that opportunity. I don't think the story is finished. We will move ahead and we will react with whatever kind of business that we have coming online.

So even if you don't get much help on volume next year, you think there is more to go in yard productivity and train length and so forth?

Yes, our railroad is built with 10,000 to 12,000 foot sidings, double track and our train length is running around 8000. So I have got room left to grow.

Jim, there is always room left to grow.

Especially with a new locomotive.

Okay, thanks for the time.

Jason Seidel, Cowen and Company.

Just wanted to go back to the comments on casualty and other I mean dropping 16%. It sounds like you are going to get some benefit going forward from those good results when you look at the actuarials. Just wanted to know if you could frame up some comments going forward for that line item.

There really wasn't much in terms of actual results reflected in the third quarter, Jason. So essentially, the major component was lower accident-related costs. By and large, what I would say is again this can be a little bit bumpy in terms of quarter to quarter, but I continue to kind of guide towards roughly CAD90 million a quarter on average appears to be probably a reasonable number to anchor on. So that is what I would, at this point, suggest you keep in mind.

Okay. And I guess the second one here on the consumption in terms of fuel, you had, obviously, a nice savings. Is that something that we should look at going forward in terms of gallons consumed? Obviously, it will move around depending upon your volume type, but you had a pretty good number in the quarter there.

Yes, the number on the quarter, as I mentioned, was a component of two things. About half of the improvement was attributable to a one-time inventory adjustment and the other half was actually a very good productivity, fuel productivity in and of itself. Going forward, I think longer term we continue to look at somewhere around 1.5% type improvement. That is challenging given the mix, but our friends in operations, and Jim certainly at the helm, are keen to take on the challenge and we continue to shine in that particular area.

Yes, you do. Listen, guys, thanks for the time and my best wishes to Claude.

Benoit Poirier, Desjardins Capital Markets.

I was wondering if you could provide, Jim, maybe more comments on the intermodal growth, especially for 2016. I am just wondering, given the expansion plan we have seen in Vancouver, Halifax and Rupert, whether the ports are still expanding at the same pace given that there is some slowdown in the intermodal growth.

So Rupert and also at Delta Port are running pretty close to capacity as terminal operators, so our success will partly depend on how much capacity they can offer in terms of rail loading, but there is still some juice at Delta Port for 2016, a little bit of juice at Rupert for 2016. The fourth quarter, the third and fourth quarter, our business has been growing at Halifax as a result of the two new vessel calls that the Port of Halifax has been attracting. We also have good hope for US Midwest to be a play, a growth area for the Port of Montreal and the Port of Halifax going back to the comment about the Canadian dollar this week. So the Canadian port -- Canadian railroad should capitalize on that short term.

On the domestic side, it will be more in line with what the Canadian economy can offer and what kind of service we can offer versus the customers' next best choice. So intermodal next year will grow, maybe more so on the international side than the domestic side and 2017, this is when we see the capacity coming up at Rupert, coming up at Delta Port. We should have more traction by then at Mobile and 2017 should be a fairly promising year for CN in intermodal.

Just quickly, was there any market-share gain impacting your current intermodal volume?

If you are talking the third quarter?

Yes, Q4, the latest volumes we've see is still robust, so I was wondering if there was any market-share gain.

No, in the third and fourth quarter, nothing to write to your mother, nothing substantial.

Thanks for the time.

Alex Vecchio, Morgan Stanley.

I wanted to just clarify the commentary on the 3% pricing going forward. Is that something you expect to continue into 2016? And then within that context, where are your expectations for broader rail inflation next year? And what I am ultimately trying to get at is it sounds like you are still getting inflation plus pricing, but how do we think about that spread above inflation in terms of is that narrowing next year or expanding or staying the same? Just any commentary or thoughts on that would be helpful.

Alex, I am not in charge of guidance at CN. I leave that to Janet and Luc and they do a good job at that. For the fourth quarter, we feel that, by the time you add the minus 5.6 on the grain cap and some -- for example, the [B call] haulage, which is the haulage we put in place when we merged, is also generating minus 10%. You add that plus inflation plus pricing, this is where you get, we think, weighted average 3% and we still have some of these legacy indexed, including the grain cap, that will be transient headwind at least for the first six months of next year, maybe the first nine months. Without telling you what next year will be, you can have a sense of how many months we have where we need to kind of work through these long lag fuel (inaudible). And after that, my crystal ball is never better more than 12 months at a time. I was not able to call crude when it collapsed, so I am not sure I'm going to call 2017.

Alex, this is Luc. Just in terms of general rail inflation, of course, the labor component is running at 3% and fortunately, what we are seeing is more reasonable prices in terms of supplies and that probably is running a little bit below 2%. Depends on the commodity, of course, but, by and large, we are still -- our inflation plus policy pricing is still intact.

Great. Thanks very much.

Matt Troy, Nomura.

Just wanted to ask a near-term question on intermodal. We hear so much about a retail overhang here in the States. We hear about recessionary conditions in Canada. Just curious what you are hearing from your customers about the potential for any peak at all or a mini peak in the next couple months given that there are moving parts and pieces? You had port diversions last year, which will obscure some of the comps. But I just wanted to get a sense from your end-market read, perhaps, JJ, should we expect to see this typical seasonal ramp or do inventory levels limit or gate what we might see in terms of a pickup?

Thank you, Matt. This is JJ. Yes, we are already well into October, which means we should already be well into this peak; otherwise, the product will not be on the shelf when customers want to buy it. So there is not much of a peak frankly so far. So there is not much of a peak, we are not getting the sense from the customer there is a peak coming. If it was coming, it would already be on the vessel in the ocean and dropping it on us three weeks from now.

Just broadly, one thing that we are not too sure about the fourth quarter is what will the last two weeks of the quarter look like and that's maybe more of a general issue that also includes the manufacturing. If the economy is to be a little weak, why would a producer of steel, lumber or somebody will buy these commodities? Same thing for a retailer. Do they want to finish their year with high inventory or are they going to take a pause the last two or three weeks of the year to kind of deplete what they have on hand and we start placing orders for January 1. Last year, the summer was a very strong month for us. I hope this year is the same, but that would also mean that people will keep replenishing inventory at the same pace that they are doing right now. We will see what they do.

Okay, great. In that same vein, the JB Hunt partnership, I know you went into great detail at the analyst meeting, but it has been a couple of months. Just curious in terms of the pacing and roadmap there, have you learned anything new, anything else you can share with us with respect to the JB Hunt partnership and some of the opportunities you might be able to exploit or capitalize upon over the next let's call it three to six quarters? Thanks for the time.

So on JB Hunt. We are extremely proud of the partnership we are building with them over time. As I said earlier, right now, the cross-border business is challenged by over the road competition. The weaker fuel and the Canadian dollars were the drivers. We are growing our business with some specific partners, but in total it is slightly down. This will take a little time before we can digest the resetting of the capacity of the trucking industry, which is obviously today more readily available as well as the resetting of the trucking firm we do business from Canada to the US. It will happen. We are in this for the long run.

Thank you.

Allison Landry, Credit Suisse.

Thanks for taking my question. So I wanted to ask another one on intermodal. So we have, obviously, seen the pace of growth decelerate in the last couple of quarters for the reasons that you just highlighted. But as we think longer term whether it is the initiatives related to the port expansions and the partnership with JB Hunt, what is the best way to think about a sustainable growth rate for the business in the mid to longer term? Do you think high single digits is something that you guys can sustain over the next two to three years?

We have always said intermodal is probably going to be potentially one of our fastest growth businesses. So right now it stands at 23% of our third-quarter results. You would think over time it sort of [climb lace] -- it could get up from 23% to bigger numbers as coal, for example, at CN goes from 5% to maybe 3.5% at some point. So it will outpace the growth of other business segments of CN and it should also outpace the growth of the economy. We would like to think that the partnership that we do with the port and the investment we do inland to create new terminals, new catchment area, that will also allow us to also outpace market share versus those that we compete. We are very positive construction about intermodal and we put a lot of effort in creating a mouse trap that's as good as any.

Okay. As a follow-up question, thinking about the operating ratio sequentially in the fourth quarter, given that second and third quarter saw above average improvement relative to historical seasonality, I realize that there are puts and takes with fuel and you mentioned weather. But, at this point, would you expect the normal sequential OR deterioration to be a little bit worse than normal?

I think we will have to see. Again, I don't have a good crystal ball in terms of predicting weather and every time we get out there, we certainly aim for the best OR we can and we deal with the circumstances that are there. So no specific guidance there. You should expect a little bit of seasonal erosion and we will see where we end up.

The fourth quarter is not an easy one to call. Right now, the railroad is running real clean and expenses are where they should be on the expense side. But come November, December in Canada, you never know where you are. So the best bet is just to look at history and say what is the change that normally happens fourth quarter.

Okay, great. Thank you.

Tom Kim, Goldman Sachs.

Thanks very much for the time here. Excellent results. Obviously, tremendous performance and improved productivity and I guess as you think about the headcount going to year-end, would you be able to provide a little bit of guidance in terms of what you are expecting to end the year at and to what extent can you give us some initial guide for 2016 on headcount? Thanks.

Yes, I think, as we have pointed out, we were sequentially down in the third quarter versus the second. If you look compared to last year, we were about 4.5% down. I would expect that, in the fourth quarter, we will probably be about 4.5% to 5% down versus the prior year. Jim pointed out we will be recalling a few people to help us through the winter, so that will be a little bit of a factor, but still great productivity and it is still a bit early. I think we are looking to 2016 and we will be providing a little bit more clearer guidance.

So right now, what I can tell you is we are going to maintain as much productivity as circumstances require. The good news is, and Jim mentioned it, we have got people that we can recall quickly. We have got the locomotives and we certainly have the equipment and JJ commented on that. So we are prepared to respond very quickly to market conditions and we are hopeful that 2016, we will see some upside. We will go from there.

Thanks very much.

David Tyerman, Canaccord Genuity.

I just wanted to get some more thoughts on grain, energy and coal. Grain sounds like it is running well right now, but the harvest wasn't so large in Canada. So how long can we go at this rate? On energy, where are we heading right now? Have we bottomed out do you think or could the various energy areas go down further? The same thing on coal. Could we continue to see further declines? It sounds like it is possible from your earlier comment?

So on grain, on the CN network, where more North our crop is harvested a little later, so that showed up in our third-quarter results. We had to wait a little longer to finally get the new crop. In the fourth quarter, there is enough grain out there in our catchment, particularly for the fourth quarter and the first quarter. So sometime next year, I guess spring and summer, the fact the Canadian crop right now is designated to be below the five-year average basically will have an impact into 2016 post wintertime.

On coal, there might be some more further erosion. Our CN coal business is especially down out of the West Coast and we are down to I think only 1% and a bit of our revenue is Canadian export coal. It can't go very much lower, but it could. And on energy, I think it is the wildcard. So on energy, we will do -- we are going to be Johnny on the spot and move whatever business is offered to us and compete hard for it and if we need to do dynamic pricing, we will be very dynamic.

Okay, very good. Thank you. That is helpful.

David Vernon, Bernstein.

A question for you, Luc, on the balance sheet. As you guys are looking to increase the payout ratio up to 35%, should we be expecting the rate of share repurchase to maybe moderate over time or do you think you can offset that through earnings growth and added leverage?

I mean I think we have a pretty steady policy in terms of returning, return to shareholders. So we are trying to balance the dividends with the buyback. We have been growing the stock buyback and really only were out of the market in the dark days of the recession in 2008 and a portion in 2009. So we will look to continue to grow progressively the stock buyback. There is a little bit of releveraging that happens as a result.

On the dividends, again, I mean there is a very good track record, 17% growth since the IPO. So that is 20 years in the making and we continue to drive towards the 35% payout, which implies that we are going to be increasing dividends slightly faster than earnings in the next little while. So I think it is all good. I think we take a very measured and balanced approach to all of these things and I think our shareholders ought to look forward to certainly good continuity in that sense.

So the level of leverage you have on the balance sheet right now, adjusted debt to cap or debt to EBITDA, you feel like is kind of at the upper level or you think you can push that forward a little bit more?

It could be pushed higher; there is no question. But, again, we looked for potential opportunities to continue to grow the franchise. So that flexibility can be tremendously helpful when strategic opportunities come about. So we are mindful of driving towards a little bit more leverage on the balance sheet, but we also want to be in a position to exploit opportunities as they come along. So it is a combination of both.

Excellent. Thanks very much for the time, guys.

This will conclude today's question-and-answer session. I would now like to turn the meeting back over to Luc Jobin.

Thank you very much for all of you that joined in. As I said, we are very pleased with our third-quarter performance. This is true CN performance. Whether the markets are up or down, we go at it hard and we are always focused on our customers first and foremost and creating good, sustainable, long-term value for them as they try to grow in their markets, as well as we keep an eye on the bottom line and are mindful of the confidence that our shareholders are placing on us.

We do look forward to sharing with you our fourth-quarter results at the same time as we will be providing guidance and also sharing with you a dividend, where and how our dividend will evolve in 2016. So we look forward to talking with you folks again sometime in late January. In the meantime, everybody be safe out there. Thank you very much.