Canadian National Railway Co (CNI) 2015 Q4 法說會逐字稿

All participants, thank you for standing by. CN's fourth-quarter and full-year 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 fourth-quarter and full-year 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. Once again, please stand by. Your call will begin shortly.

All participants, thank you for standing by. Your conference is now ready to begin. Welcome to the CN fourth-quarter and full-year 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, Eric. Good afternoon everyone and thank you for joining us. I would like to remind you of the comments already made regarding forward-looking statements and in order to be fair to all participants, I would like to ask you to please limit yourselves to one question.

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. I'm also very pleased that our captain has rejoined the team and will be leading today's call with his very attractive new voice. And so more officially, it is my pleasure to turn the call over to CN's President and Chief Executive Officer, Mr. Claude Mongeau.

Thank you, Janet. I'm not sure about the attractive voice, but it sure feels good to be back on the job. I thank you all for joining us today. I have to say the CN team did such an outstanding job closing out on the year that I could not resist coming back to be on this call today with you. I have a new voice. It is a bit squeaky, but I am full of energy and I'm looking forward to lead CN to new heights in the future.

Let's talk about the results quickly. We had very strong Q4 results. We had declining volume trends, our RTMs were down 5% and our carloads were down 8%, but we continue with our swift response and we're balancing operational and service excellence in a way that is quite, quite remarkable given the challenges that we face. Jim will give you more details about that.

We ended up delivering a diluted EPS of CAD1.18, which is up 15% for the quarter. Given the volume environment, I'm proud of the team and what they were able to achieve and this capped a very solid 2015 performance. We stayed on top of our key markets, chasing carloads in tough markets and keeping with the momentum of the markets that were going better with a keen eye on keeping price where it should be given our service. JJ will give you more on that.

Our efficiency, if you look at it for the full year, allowed us to deliver an operating ratio, which is at a record level, 58.2%. It's 3.7 percentage points lower than last year. Now I would not want to take credit for the bring back of lower fuel prices that gave us a full 2 points on a year-over-year basis. If you look at it another way, the guidance that we had given you in 2013 at our Investor Day in Toronto that we would reach a low 60% operating ratio given what we knew about fuel then. We delivered on that performance in overall financial results. Luc will take you through those. But we finished the year with CAD4.44. That's up 18% on a year-over-year basis and very solid free cash flow at almost CAD2.4 billion.

Now in terms of guidance, we are facing an uncertain environment, but we will share with you constructive guidance and we have confidence in the future and this is why our Board supported management's recommendation to give our shareholders a bit of a gift for our 20th year anniversary of the IPO. We are announcing a 20% increase in our dividend that reflects our confidence and the strength of our balance sheet, so we are pleased with those results. I will let the team go over them and will be back with the question and answer at the end. Jim, over to you.

Well, Claude, thank you very much and listen, thank you very much, nice to have you back on a full-time basis, so away we go. If we can start on the operating highlights page. So the scorecard in front of you clearly displays the results of how we manage the railroad using a long-term view when necessary and executing at all levels. We take a holistic view of capacity, asset utilization, railroad optimization and safety and allow decisions to be made at the correct level within the operating group. JJ will provide more details, but, in the quarter, we faced a high single digit carload drop and a mid-single digit drop in workload.

But even with those challenges, our trains were more efficient. Train velocity increased by 5%. Train productivity, or put another way, the number of cars on a train, increased by 3% and even more important, our gross ton miles per crew hour work increased by 3%. Therefore, each train handled more [break], moved faster and our employees were more efficient in getting them from origin to destination. So a great job by the team on moving the trains.

Looking at the cars, our cars spent less time in our terminals by 15% and the number of cars switched per hour paid increased by 9%. So on the cars, we also showed significant improvement in our productivity and our handlings. We do have 250 stored locomotives, but even with them stored, we were able to use the locomotives that we had and improve our utilization of our fleet by 2% and improved our fuel efficiency for the year at 2%. So great results on the use of the locomotives and the fuel efficiency that we work hard every day to improve.

Our engineering and mechanical departments both delivered results in line with the overall results on a productivity and cost efficiency basis, which helped us deliver a car velocity improvement of over 16% in the quarter and in the year of 13%. So if I could summarize that page, very satisfying results in the face of some headwinds that made some of the results difficult to deliver.

If we can just quickly turn to the next page, which is operational and service excellence, our agenda in 2016 does not change. Safety continues to be the foundation of everything we do and we want to build on the strong results we had in 2015. We will continue to align our resources and react quickly to changing factors and deliver productivity gains across all the operating departments.

So overall, good quarter, good year in 2015 and we will continue to operate with an end-to-end view and deliver on both operating and service excellence so that JJ can go out there and deliver us every piece of business that's possible with this model we have. So JJ, over to you.

Thank you, Jim and, Jim, your team has reason to be proud. 57.2% operating ratio the last quarter, that's quite an industry achievement. So now turning to the business, overall, the fourth-quarter revenue went down 1% from last year broken down as follows. We had lower volume and the lower volume reduced our revenue by 6%. 70% of the CN-reduced carload was a drop in short-haul iron ore. Coal, crude by rail, frac sand for drilling and US grain were also very weak.

Overseas intermodal, Canadian grain, manufactured product from natural gas feedstock, automotive and potash were among the positive business. Same-store price was up 3%. If you remove the Canadian grain price reduction, our same-store price would have been about 3.5%. Our gross margin upscaling program also continued to trend upward. The pricing story is resilient.

As crude collapsed, the fuel surcharge application reduced our revenue by 6%, but crude also brought down the Canadian dollars to a $0.75 average for the last quarter. Therefore, exchange increased our revenue up by 9%. We do have similar dynamics at play entering 2016.

So now let's turn to some of the fourth-quarter highlights and at the same time, I'll cover some outlook for the first part of 2016. The improving US housing starts and the end of the Canada US Softwood Lumber Trade Agreement this past October drove our Canadian lumber and panel export and it also helped our US container import. With such a weak Canadian dollar, the Canadian lumber producers are in a very strong position right now.

Record US and Canadian automotive sales produced solid results for our finished vehicle business unit and for the container import into assembly plants. The automotive industry feels constructive about the prospect of vehicle sales for the first half of 2016.

The crude market caused a 33% drop in crude by rail carloads and a drop of 43% in frac sand for drilling and steel is suffering the cutback of the energy sector capital program. These same segments will be major headwinds for this year.

CN intermodal continued to do well. We had a 5% increase in volume. We had very good growth out of Port Halifax on the East Coast and good growth out of Port of Prince Rupert on the West Coast. Our grain operation is excellent and we have the fluidity to meet demand on our network.

North American natural gas is a very competitive feedstock in the world and our carloads for petrochemical, plastics, nitrogen fertilizer and natural gas liquids have generally trended upward and that trend continues. Coal was in retreat, and in 2016 that will continue. Coal was only 4.5% of our fourth-quarter total revenue, the lowest of any railroad.

Looking ahead, you will remember last year the first-quarter volume was still strong, so we expect negative volume against our first-quarter 2015 comparable and that will be mainly in crude by rail, in sand for fracking, and in coal as those were still very strong last year at the same time.

We continue to produce pricing above inflation, which, at this point, we would define as 3%, inclusive of the impact of the negative Canadian grain cap. We are in position to support those shippers for whom the weak Canadian dollar has become a cost advantage like the manufacturers, like the service industries that are selling into the US market, for example the first [product] industry and the Canadian port terminal industry.

In conclusion, CN's strengths are deep. We rely on our portfolio's diversity, in our profit margin management, our leading operating ratio, which Jim can produce and his team. Our excess capacity in Chicago and all of these things are very supportive doing more trade for the long term.

I will now turn it to Luc who will peel the financial results for you.

All right. I will try to do that. Thanks JJ. Starting on page 12 of the presentation, I'll summarize first the key financial highlights of our solid fourth-quarter performance and then comment on our full-year 2015, as well as our guidance for 2016.

As JJ pointed out, revenues were down 1% in the quarter versus last year at just under CAD3.2 billion. Fuel lag represented a revenue tailwind of CAD14 million in the quarter, but was CAD0.02 of EPS lower than last year. While I'm on the subject of fuel lag, you should keep in mind that while we do expect a positive fuel lag in the first quarter this year, it is more likely to be in the CAD10 million to CAD20 million range, so much smaller than last year's lag of CAD60 million favorable in the first quarter.

Operating income was CAD1.354 billion, up CAD100 million or 7% versus last year. Our operating ratio in the quarter was 57.2% and that represents a 350 basis points improvement over last year. Net income stood at CAD941 million, up 11%. And the diluted EPS reached CAD1.18 and that's up 15% versus last year. The impact of foreign currency in the quarter was CAD87 million favorable on net income or CAD0.11 of EPS.

Turning to page 13, as Jim pointed out, we continue to make significant progress in the quarter in terms of safety, productivity and cost management. Operating expenses were lower than last year by about CAD135 million or 7% favorable at CAD1.8 billion. Expressed on a constant currency basis, expenses were actually 15% lower than last year.

At this point, I'll refer to the changes in constant currency. Labor and fringe benefit costs were CAD608 million. Excluding FX, this is a 5% decrease from last year. Now this was a product of three elements. First, overall wage costs decreased by 4% versus last year as wage inflation and lower capital credits were more than offset by lower overtime and a reduction of 7% or 1700 employees versus last year in our average headcount. At the end of the year, we had about 1,150 employees laid off and we finished 2015 with 9% fewer employees or 2,300 less than last year.

The second element was a lower stock-based compensation for CAD8 million. The third and last element of the labor variance was due to higher pension and fringe benefit expense for CAD15 million. Fortunately, in 2016, our pension expense situation will improve and our defined benefit plans are expected to be in a credit position of approximately CAD120 million. This is primarily due to lower current service and interest costs as we improve the accuracy of these estimates and the benefit of coming from an increase in the year-end discount rate that moved from 3.87% to 3.99%.

Purchase services and material expenses were CAD437 million, 8% lower than last year as we incurred lower third-party costs in the quarter, which were partly offset by increased costs for materials. Fuel expense stood at CAD304 million, or 42% lower than last year. Fuel price was 38% lower versus last year while volume reduction accounted for a CAD19 million betterment and fuel productivity came in 2% better. Casualty and other costs were CAD70 million. This is roughly CAD40 million lower than last year and for the most part this is the result of lower accident-related costs versus 2015.

Now full-year results, we wrapped up 2015 with over CAD12.6 billion of revenues, a 4% increase. This sets a Company record in terms of revenues. Our operating income grew by CAD642 million or 14% to reach CAD5.3 billion. The operating ratio stood at 58.2% versus 61.9% in 2014 and as Claude indicated, that's a 370 basis points improvement and a new all-time record, which is quite an achievement when you consider what we paid in 2014. I think this really demonstrates how effective the team has been in recalibrating resources to drive efficiency.

It's equally important to point out that we achieved this while continuing to balance operational and service excellence in a manner that's consistent with our end-to-end supply chain focus. Net income was up CAD371 million or 12% at just over CAD3.5 billion. This translated into a 14% increase in reported diluted EPS of CAD4.39. Excluding the impact of a major asset sale in 2014 and income tax adjustments in respective years, the adjusted diluted EPS for 2015 stood at CAD4.44. That's an 18% increase over 2014.

Moving on to free cash flow. For the full-year 2015, our free cash flow generated stood at just under CAD2.4 billion. That's approximately CAD150 million higher than in the prior year. This was mostly driven by higher cash from operating activities, partly offset by higher capital expenditures and lower proceeds from property sales. Meanwhile, our balance sheet remains strong with debt and leverage ratios well within our guidelines.

So finally, let me turn to our 2016 financial outlook. We are positive in terms of CN's prospects for the year. Notwithstanding the fact that we are experiencing high volatility and a weaker condition in a number of commodity sectors. As we look to the future, North American economic conditions are still favorable. Consumer confidence remains solid and should support continued progress in housing, automotive and intermodal sectors.

One of our core strengths that supports our ability to perform in good and bad times is leveraging the diversity of our franchise. We have a very low exposure to coal while our network allows us to serve key US consumer growth segments. This along with a stronger US currency provides us with a natural hedge that helps to mitigate the weak commodity environment. Now this should translate into carload volume for the full year to be slightly down versus 2015 with pricing in line with our inflation plus policy. Therefore, we expect to deliver mid-single digit EPS growth over the 2015 adjusted diluted EPS of CAD4.44.

We're also expecting our capital investment program for the year to be approximately CAD2.9 billion, which entails continuing to harden our infrastructure and therefore, we will allocate CAD1.7 billion for network investments in 2016. Doing this in 2016 will allow us to take full advantage of market conditions by providing easier access for working on the tracks, availability of external contractors and low commodity costs. The envelope also includes CAD600 million for equipment, including our commitment to secure 90 new locomotives. We also had a CAD400 million investment on PTC as we continue to advance our implementation program. Now keep in mind that a good part of the increase versus 2015 is actually attributable to the weaker Canadian dollar versus the US currency.

Furthermore, we continue to pursue more importantly our shareholder return agenda. In 2015, we returned to shareholders 80% of net income through dividends and share repurchases. Our current share buyback program is approximately CAD2 billion for 2016 and we're pleased to announce, as Claude mentioned, that our Board of Directors has approved a 20% dividend increase for 2016, reflecting our strong performance in 2015 and our confidence in future prospects as we gradually move towards the 35% dividend payout ratio.

In closing, we remain committed to our agenda of operational and service excellence and so CN continues to manage its business to deliver value for our customers and shareholders today and for the long term. On that note, back to you, Claude.

Well, thank you, Luc and thank you, guys. Well, as I said, there is an uncertain environment out there, but we have a constructive view about our ability to manage in a weaker volume environment. We're going to leverage our franchise, our diversified portfolio and our ability to gain efficiencies in good and bad times. We are truly committed to our agenda. It's working for us and we are focused to deliver long-term shareholder value. As I say to my team, it's a marathon and we are good runners. With that, Eric, I would like to turn it back over to questions and answers.

(Operator Instructions). Ken Hoexter, Merrill Lynch.

Great, good morning. Claude, welcome back. Great to hear you again. I guess if I could just start out, given your outlook for mid-single digit growth, can you maybe talk a bit about what you expect on the employee side a little bit? It accelerated to down 7%. Are there still more costs you look to pull out on the employee side? I guess on a resource side, it's amazing what we see on costs, so just wondering your thoughts there.

Jim, I will let you answer this question, but we manage resources and we manage them in line with volume and we don't know where the volume will be, but we are, as we did in 2015, committed to keep our efficiency levels up. But Jim --.

So Ken, we work on the framework of looking at the operation and be able to react quickly. So there are some things that are, as you've seen in 2015, we reacted in the right way and it took into account where the business level was and where the efficiency and what kind of assets we need to operate. We see that we're going to be able to react positively or negatively. Hopefully we get surprised positively, but if it's different than what we expect, then we have some things going for us. We'll do what we have to do with locomotives.

And on the people side, we have an attrition rate that's a natural attrition rate that's running close to 8%, so it gives us a hedge there that we will be able to deal with on whether we hire or we don't hire or we let the attrition handle itself as we drop the number of people we need. So I think it's the same story as we've done in 2015 and the previous years in 2016, Ken.

Thank you very much for the time. I appreciate it.

Thank you, Ken. And thank you for your kind words. I'm really pleased to be back.

Fadi Chamoun, BMO Capital Markets.

Yes, good evening. And yes, great to have you back, Claude, on the call. So a question on the opportunities in the market. So you keep sort of reducing the cost curve year after year and obviously now we have a little bit of a tailwind from the Canadian dollar. I was wondering whether these factors can help you go after markets or opportunities that would not have been the case before. I know you touched base on a couple of markets where you think you can get some help from the Canadian dollar, but is there other things that are not necessarily just a factor of the Canadian dollar, but also a factor of your cost curve and your service improvement that you can potentially begin to exploit that you haven't yet gone after. Maybe you can answer that, JJ.

Yes, JJ has his eyes on the future.

Yes, I mean the tailwind of the Canadian dollar has also come in with a headwind. The reason why the Canadian dollar is down is we suffer on the energy side of the commodities, so they came in at the (inaudible). We are always ready to exploit what the economy offers. The economy is not offering strong energy right now. It's offering a weak Canadian dollar. What do we do with that? The economy is still offering very cheap natural gas, so what do we do with that? There was an announcement earlier this month of AltaGas who are starting to do more serious work about putting a propane terminal and export terminal in Rupert, which can only take place because the gas in North America is cheaper here than other places in the world. And there's also a benefit from that on the petrochemical industry, plastics and the like.

So we're looking for the strength where there is strength and we want to be sure that we can help capitalize on partners for the people who want to export, for people whose cost is [affected] positively by the weak Canadian dollar, as I mentioned the port and the reason I mentioned the ports because the Canadian industry, the Canadian economy is no longer as much manufacturing as it was 20 years ago and we do a lot of services today and many of these services are export services. You can think of ports as export services, you can think of waterfront logistics warehouse. We do container, come in on one side 40 foot, comes out the other side going into different cities, repack, pick and pack. There's also another export product. Maybe we can also exploit our CNTL fleet, which is Canadian base, Canadian driver cost, Canadian overhead into how we exploit our cross-border business and the like. So I think it's important to see what we have right now and how we exploit that, not just focus on the fact Canadian sector is weak.

Walter Spracklin, RBC.

Yes, thanks very much and Claude, I'd like to echo everybody's comments. It's great to have you back here. I guess my question is for JJ. I'm getting a lot of uncertainty and concern, a lot of investors -- on the part of a lot of investors with regards to the outlook on the economy and the demand level in general. I know you mentioned that first quarter is going to be another tough quarter on a comp basis, but you've got a real dichotomy in your volumes where you've got -- it seems the consumer is doing well, but anything industrial or bulk-related is still struggling.

When you look out beyond Q1 and you point to your slightly negative volume guidance, are you building in a rebound in the economy? Do you think the consumer -- are you building the expectation that the consumer holds in that bulk recovers? Is there anything that is in that slightly negative that would be anything different from the kind of trend that we're going on right now or would you say we're kind of conservative and still focusing on more of the same in terms of the rest of the year beyond Q1?

So maybe we can start with Q1. Q1 2015, you'll remember, our volume was still very strong because I guess the economy had not yet fully recognized where energy was going to go. So we're still moving a lot of carloads of frac sand, crude, coal and iron ore. In our first-quarter results, you'll see that these four commodities are now really the reality has set in. We had an iron ore mine shut down. We have some coal mines that have shut down. Crude by rail is moving at less volume. It's partly back in the pipeline industry and frac sand, obviously, you don't realize [much] more crude as you did actually at the same time.

But the other segment, the manufacturing side, is doing okay. This side has to get the benefit of cheap gas is doing good. The US consumer is doing good. The Canadian consumer is we're not sure, we're not really counting on that and automotive sales, auto manufacturing are good. But these are, at this point, at least for the first quarter, they are not really quite big enough to offset the big carload change in short-haul iron ore and the longer haul chain of carload of crude by rail and frac sand. But we're not counting on a rebound in commodities. I'm not too sure anybody really is counting on a rebound in commodities. That's a little bigger than what North America can deal with at this point.

Yes, that would be a brave assumption if you were counting on it. Does that do the trick for you, Walter? Thank you.

Yes, thank you very much.

Brandon Oglenski, Barclays.

Well, good evening, everyone and Claude, same from us here at Barclays. Great to have you back. And it's an exciting time in the industry to be back too dealing with some pretty negative economic outlooks. But, Luc, I wondered if you could comment on the CAD6 billion shelf that you guys filed back in December or January. Is it common for you guys to file one that big? And I'm just wondering are there big debt maturities that you guys are looking to refinance right now? I know you talked about a CAD2 billion share repurchase. Is this an opportunity where maybe that could be upsized throughout the year? I saw you took the dividend up a lot and frankly is there any strategic alternatives that you're also thinking about here just given some of the noise that's coming out of Calgary recently?

Yes, Brandon, okay, just to pick up on your question, the CAD6 billion, you have to look -- first of all, it's a shelf that's in place for just a little bit over two years. So our financing requirement just on the basis of maturities over those two years, plus the financing necessary to fulfill our stock buyback program and the like is significant. So this year, we'll be looking to raise probably about CAD2 billion worth and I would probably look at a number not too dissimilar in 2017.

On top of that, obviously, keep in mind that a lot of our debt is financed in US dollars and with the FX, obviously, this puts a little bit more pressure. So it's really with that in mind that we've put the shelf, we've put the pin at CAD6 billion, just in terms of giving us a little bit more flexibility. Obviously, should some opportunities come along, we have always said that we wanted and we have a great balance sheet and that we would be prepared to use it. But there's nothing imminent and I think it's just in times where perhaps there is a little bit more uncertainty in the marketplace, we'll be looking to make sure that we've got sufficient liquidity and that we can deal with our maturities and continue to support the business. Thank you.

Cherilyn Radbourne, TD Securities.

Thanks very much and welcome back, Claude. I wanted to ask how you're thinking about mix in 2016. I would think that with the difficult comparables in crude by rail and frac sand in Q1 at least, the mix would be a headwind, but how are you thinking about mix for the full year as you start to cycle easier comps?

JJ did stuff in the current environment to figure out volumes, so mix is even more difficult, but JJ is on top of his game. What do you see out there?

So for what we could see and not all of it is always really clear, it is likely that RTM will be weaker than our carloads at this point in time. So if you are doing a model, RTM will probably be weaker than the carloads. At least a year.

Okay, thank you. That's my one.

Jason Seidl, Cowen and Company.

Thank you very much and Claude, welcome back from everyone here at Cowen. You mentioned that if you adjust for FX and fuel, you guys have met your low 60s OR guidance that you gave a while back. Looking forward, if you just normalize fuel and normalize FX, talk about the improvements that you would expect for CN beyond I guess some of this economic turmoil that we're seeing now.

I will let Luc answer that one, but we certainly hope that the fuel price over time will be a headwind. That would be good for the business. We're not managing for a ratio; we're managing for profit dollars. But, Luc, do you want to take that one?

Sure. I think, Jason, leaving aside for a second the fuel side, which is obviously very volatile, I mean what we're really focusing is on rightsizing the resources, managing tightly to continue to deliver great results, but not at the expense of growing our top line and pursuing these opportunities that JJ pointed out. So I wouldn't necessarily look for something that has a 5 handle on it. I think we've always said that we were intent on managing the business well and for the long term and I think we've achieved ex-fuel the target that we thought was reasonable.

Having said that, we're always looking for opportunities for productivity improvement. Jim is always there on the prowl and I think everybody in the organization is conscious of that need. So I would still say that we intend to stay the course and we intend to be both opportunistic in the short term, but with an eye on the longer term. So we don't want to just -- we're not going to get medals in the short term trying to achieve a lower OR at the expense of our ability to continue to grow the business and create value for both our customers and obviously our shareholders. So it's an industry-leading ratio and I think from that standpoint, we continue to focus on excellence.

I would add to what Luc just said that we clearly intend to continue to be the industry leader in terms of efficiency and even though 2 percentage points of our OR is due to fuel this year, 170 basis points was due to efficiency and other initiatives and that was in a pretty difficult environment. So we're managing to maximize every lever and we will continue to do that and lead the industry going forward.

You definitely had some impressive operating statistics. Gentlemen, thank you for your time, as always.

Chris Wetherbee, Citi.

Thanks, good afternoon and again, welcome back, Claude. Good to have you on the call. Wanted to touch a little bit on pricing, if I could. Maybe as you think about 2016 and the outlook, putting aside the grain cap for a minute, just wanted to get a sense of how you're thinking about pricing and maybe what the competitive dynamic might be looking like specifically in Canada in 2016.

If I could say something before JJ gives you a more focused answer on your question, it's quite remarkable. You have CN that is leading the industry achieving new records in terms of efficiency. You have CP, which, over the last four years, has done a remarkable turnaround and is in every core respect in terms of operating metric is getting very close to our level of efficiency. There's something to be proud here. We have the two Canadian layer railroads really leading the way in terms of performance. I hope that going forward we will protect that profitability and use it to generate a capacity to invest in our networks and to grow the business and grow it against [drops], grow it through innovation and not chase volume for the purpose of chasing volume. It's precious that we are able to achieve this efficiency level and it's incumbent on us to manage for the long term. JJ?

Well said, Claude. Yes, so Chris, as I said in my notes, we're targeting, including the impact of the Canadian grain cap, roughly 3%. We would definitely at this point see 3% as above inflation, inflation as we see it for 2016. And you remember the Canadian grain cap, as well as some of this index that some railroad contracts are likely to stay weak because the crude and the diesel right now is still very weak. So we even think that the Canadian grain cap might be slightly negative for the 2015/2016 season. So 3% including this index would be -- it would produce well for the railroad for CN. That would be above inflation.

Great, thanks for the time, guys.

Steve Hansen, Raymond James.

Yes, good afternoon, guys. I think one of the clear distinctions between you and your closest competitor of late has been the direction of the CapEx budgets. I think you suggested CAD2.9 billion, which is up roughly 7%, I believe. And I know you broke it out by some of the three major buckets, but I was just wondering if you could perhaps elaborate a little bit more on the need to spend that kind of capital in this macro environment and what you're going to get out of that specifically.

I will let Luc give you some more color, but we manage for the very long term. We are a very profitable company. We had an opportunity to do the work at the right time. There is no better time to harden our infrastructure than now. We can do it cheaper, we can do it faster and more productively and we can gain long-term advantage that way. That's our mindset. Much of the increase is because of exchange. We're assuming a dollar that will be in the $0.70 to $0.75 with the US currency and the rest is long-term investments that we believe will pay dividends for many, many years to come. Every company has a different agenda, but we see the strength in our long-term view. Luc, do you want to add some more color?

Yes, maybe just a couple of additional comments. I think if you look at our track record, we consistently look to CapEx in the range of I'd say I'd call it around 20% of revenues. Of course, there is a little bit of noise in there as of late with the fuel surcharge disappearing from the revenue line. But, nevertheless, I think what we see is we look -- as Claude pointed out, we look to the longer term and so we pace ourselves and we will dial up and dial down on certain types of activities when we feel that the need arises. So as an example, we're actually going to look to do a little bit more on our basic capital on the track, on the bridges and so on and so forth because it's a great moment to do so and arguably, as we look to the short term, our needs for capacity investments are not as prevalent.

So we tend to try to be opportunistic. The conditions are ripe, as I mentioned and Claude reaffirmed, for us to take the long view and so we're not -- with the great balance sheet we have, we can be smart. We can actually do these things while people that are under pressure are going to look to reduce their capital budget in order to maintain their free cash flow. So we can still generate good solid free cash flow and we continue to invest behind the network and we talked about safety, we talked about the velocity of the network and the productivity of the network and these are -- the reason why we clock in these performances are industry-leading year in/year out is that we're continuously mindful of reinvesting in the plant in a thoughtful way to deliver both the productivity and the service excellence.

So I think that may strike some people as a little bit counterintuitive because the normal tendency would be to go and cut CapEx. We take a different look at things and we see this as an opportunity to continue on our journey to make this a great franchise for the long term.

If I could ask Jim -- when you're looking at your pinch points and you're looking at investing and getting to permits and getting motion to solve issues, which we were in the growing environment last year, you get that momentum and that focus and it's paying huge dividends. Maybe, Jim, you want to talk about some of those initiatives that we are leveraging as we speak and will continue into the next year.

Absolutely, Claude. You guys have done a great job of explaining why and where the capital envelope is, but it takes a while for us to be able to get permitting, to get the authority to be able to deal with the pinch points and in every railroad, and in ours specifically, there's some points where if you spend the right capital at the right time, it increases capacity through a whole corridor, not just in one place and that's exactly what we've been doing. And I'll tell you, we spent a lot of money to do

uble track up to Steelton Hill and for a few miles of railroad, you start to wonder what the heck you're doing. I'm sure Luc asked me a few times like, man, that's a lot of money for that three miles of railroad. But we've noticed the advantages already and this winter through December and January, we've had events happen above and beyond what we normally would foresee and the reaction and the recovery is so much quicker.

So that's why it's smart to spend the money in the right places at the right time and have a view of what it does over the long term. And what that specific expansion on the Steelton Hill did, it opened up capacity all the way from Winnipeg to Chicago for us, not just in that one little pinch point.

And we're building a competitive advantage.

Yes, so we think it's going to differentiate us in the long term and we feel it's the right time to do so. Thank you for your question, Steve. It's a very good one.

Allison Landry, Credit Suisse.

Good afternoon and Claude, great to have you back. I wanted to ask a question on grain. Given that the last year's harvest, the Canadian crop came in better than your initial expectations while also considering the impact of domestic (inaudible) commodity prices and elevated inventories, how do you see grain shipments playing out over the course of 2016? In other words, at what point do you think the grain has to move such that you would start to see positive year-over-year comps?

So thank you. It's JJ. The crop, the final result for the crop side, the one that came out in December, we're actually showing that the crop was bigger than what we thought it was going to be in August or in October. But, right now, as we speak, the volume of grain that we move in Canada is slightly below last year. That is because probably the attractiveness of the export price is not quite what is at the liking of the owner of the grain, whether the farmers or the grain company who buys from the farmers and sells overseas. So that's basically revenue that eventually will come through. It might partly come through in the second quarter or maybe before the next crop.

Remember, last year, the carryover was very small and we had very weak revenue on Canadian grain for August and September at CN because the inventory in Canada were very, very low. So some of this increased crop that we saw last year, meaning a little bigger than what we thought in the first place, might just turn out to be that we will finish this year, this crop year, with a higher carryover and those revenues will come in maybe late in the year or to 2017. But one thing is for sure, when grain is harvested, eventually it will be sold and in Canada, the population is such that it will be sold overseas. So it will get to the port; it is a question of time.

Thank you, Allison. I look forward to seeing you on the West Coast again for our trip this year.

Sounds good. Thanks.

Matt Troy, Nomura.

Yes, thank you. I wanted a question about intermodal. Quite a divergence, your growth 5% versus your competitor, down in the low teens. I just wanted to get a sense of what's driving that growth. I know you provided some detail earlier. Is it primarily highway to rail conversion or is there some marketshare gain in there? And then as an extension, if I think about the margin profile of intermodal historically being dilutive from a mix perspective, it was your largest growing category and it's the largest portion of your traffic base. Have you reached a critical mass now where the margin in that business is better than average? I just would like to understand, one, where the growth is coming from ahead of peers and, two, is the margin profile of this business, should we think of it differently going forward? Thanks and Claude, welcome back.

Thank you for that and it's a very good question. You're making a full impact with that one question. Let me say the following. For many years now, we've had intermodal's profitability very much in the average of our book of business. We have to have a new approach that allows us to be profitable in that business and a lot of the growth -- JJ will give you some color -- but it's the building blocks of all the initiatives that we have put together over the last five years to add to innovation, the supply chain collaboration, the extension of reach, the chasing of opportunities one container at a time and we are in many markets with a great, great franchise. And that's what's allowing us to grow. But, JJ, where do you see the growth into 2016?

Well, Matthew, it will probably be more on the overseas side than the domestic side, partly because the Canadian economy will only offer so much opportunity in 2016, but the overseas market is a bigger pie and (inaudible) with our initiative in Mobile, Alabama, we hope that when that opens up sometime in May and the Panama Canal open up sometime in May/June that Mobile will start to produce some fruit for CN.

Also because the US Midwest is a market that over the last many years, as Claude has mentioned, we have opened a number of terminals either on our own line like Joliet, Illinois or with partners like Indianapolis and as we are opening more destinations, we have more to offer shipping lines. So the opportunity for the next little while, let's call it 2016, is maybe more on the overseas side and with the destinations more in the US, US Midwest and earlier this -- late in 2015, we had a new call to the Port of Halifax and it produced some growth for us in the fourth quarter. I think it will produce some growth for us also in 2016.

Some of those containers are finding their way in Canada, but some are also US Midwest and also late last year in the fall, we had Maersk who joined the Port of Prince Rupert. Obviously they have strategies of their own to use that port to their advantage because of the type of service they can get there that no other port can offer the way BP [would] and CN provide -- create that service together. We also have some other lines who start to do some business in Rupert by getting slots on other companies' vessels, CMA and Evergreen. So the choice of options and players coming into ports where we play should do well for us.

We do have some challenges in Vancouver with some terminal capacity. That will be because of construction taking place right now. So we'll see how that plays out especially over the next three, four months. Hopefully after that, we will have clear sailing and have all the capacity we need. But roughly it's about those different things and all of those are tied in, as Claude mentioned, to supply chain. Offering just a good price because you have a good operating cost is not what attracts the traffic because anybody can offer a good price. It has to be a good price with a better service than what others can offer.

And as the environment improves and as the consumer sector gets better over time, maybe back end of the year into 2017.

Yes, on margin, we do have a very strong upscaling program. We focus on round-trip economics. We focus on balance. We focus on having the right fuel surcharge for the business and these are levers that particularly -- they don't show up in same-store price; they show up in our internal report that we call round-trip RCRs and the likes -- train length, train density, using the right car on the right port. A lot of small levers that generate big bottom-line dollars.

Yes, what I was saying is we hope that domestic will pick up eventually after, [obviously], into the back end of the year or 2017. Thank you for the question.

Benoit Poirier, Desjardins Capital Markets.

Yes, good evening, gentlemen and great to have you back, Claude. On the intermodal side, your carloads are up 1.5% quarter to date. So could you maybe give some color on what we should expect this year in terms of volume growth given the soft economy, but also given the port expansion you just talked about and maybe also discuss whether the weaker Canadian dollar favors Canadian ports over US ports? Thank you very much.

So we don't provide guidance for a business unit one at a time. The Canadian dollar, as I mentioned earlier, when you look at ports, they are a service provider of the US Midwest and if everybody plays their cards properly, they should have a cost advantage versus the competing ports. The opportunity is more on overseas than on domestic and the first three weeks of the year, we would like to see more growth in the first three weeks of the year. But it's only three weeks.

Remember, last year, the fourth-quarter results showed that really we finished the year very current. Jim's team really cleaned out any backlog we had in any segment. We were current, so we've entered 2016 with no backlog in hand and I think our customers on the retail side also are -- not necessarily replenished their warehouse right away. They are also looking at 2016 and wondering when is the time to stock up and put product in their warehouse. So first three weeks is only three weeks out of 52. We'll see how the rest of the year pans out.

Okay, thank you very much for the time.

Brian Ossenbeck, JPMorgan.

Great, thanks for taking my question and welcome back, Claude. I just had a quick one on EPS, especially related to FX. Clearly foreign exchange, Canadian dollar/US dollar, has been a big driver of volumes, a big driver of mix and so Luc, when you talk about mid-single digits growth for next year EPS off the adjusted base, I was just wondering is that attainable without a bit of a tailwind from FX or maybe you can just tell us how much of that growth you're expecting from the currency markets as you see them right now. Thank you.

Yes, Luc, do you want to handle that one?

Yes, sure. Listen, Brian, the guidance that we provided, of course, and we've laid out the assumptions so you can look at those, for FX, we're assuming a Canadian dollar to the US in the range of $0.70 to $0.75. So that's the range that we have assumed in our guidance and of course, we'll have to see how that goes. As a further, perhaps just to help you out a little bit, I mean I'll remind you that for every penny of FX change, that has an impact of roughly CAD0.04 on the EPS. So it's with that in mind -- of course, there's still a fair bit of volatility in there. I think currently the Canadian dollar is closer to $0.71 and you've got forecasts all over the place, but we have provided you with the range that we have for the full year, that $0.70 to $0.75.

Okay, great. The sensitivity is helpful too. Thank you very much.

Bascome Majors, Susquehanna.

Yes, good afternoon. Towards the end of the year, not just you guys, but a number of rails saw volumes close the quarter fairly weakly and clearly, there was some destocking there driving that. I'm just curious what you're hearing from your customers and maybe you can separate it by retail and oriented and industrial. Where are they looking at their inventory levels today? Do you think the destocking continues well into the first quarter or do you think we've done a lot of what we needed to do and things could stabilize short term?

It's clear that, as you would expect when things are uncertain, people are trying to find the right level. In the last couple of months, the quarter, but in particular November, December, are weaker. We are generally constructive. We may be wrong, but we think that things will stabilize and that the beginning of the year will continue to be difficult, but that things will stabilize in the second quarter and the back end of the year. But, JJ, do you want to give a sense of what the customer feedback is in terms of that dynamic?

Yes, Claude, in an environment where, let's say if we were to talk about commodities, an environment where price tomorrow might be a little better than the price today, the buyer of the product might not want to carry inventory if he thinks he can get say potash next month at CAD10 cheaper than this month. So that creates an impact on people, how much they want to gamble with inventory because once they've bought the product, they own it at that cost. But eventually many commodities? pricing are lower, fairly low already, we're going to hit the bottom depending on each segment, but the buyer, whether he's in China or he's in North America, doesn't believe he can buy iron ore or potash at a cheaper price, which will eventually be the signal. But as things start to reach bottom or eventually go back up, whether it's late this year or early next year, then they will tempted to buy a little more than what they need for the same reason as to why they may be tempted to deplete inventory right now because they think they can buy it a little cheaper six weeks from now than currently.

So in people who play with big inventories, there's how much they need and whether or not now the price, the time to buy and stock up or the time to buy less and destock and I think we're not sure exactly right now where we're at, but we're close to the bottom potentially.

Very good question. Thank you.

David Vernon, Bernstein.

Thanks for taking the question. I think you talked a little bit about this on the intermodal side, but I was just wondering if there was some more granularity you could talk about in terms of helping to dimension some of the volume opportunity. You mentioned some pre-selling up in the West Coast ports, as well as what you're hearing about or thinking about the Gulf. Have you had any kind of more in-depth conversations that would help us put numbers on either the amount that you've presold on the West Coast or what you think could be coming in through the Gulf?

So I don't have specifics to offer to how much we presold, but I can just remind everybody of the capacity that's going to be available for CN. So definitely the Mobile railyard will be ready sometime in the month of May, so we start from zero, so everything from there is an upside where a new player, the new kid on the block, if you wish, in that part of the world.

In the case of BP oil, they have refined the construction schedule and they believe they can have an extra 50,000 TEU available, extra capacity available for sale sometime in the spring and they believe also based on the construction sales book schedule, they will have another 50,000 TEU over and above the spring 50,000 TEU that will come out available for us to go and sell jointly sometime in October of this year.

And then in Vancouver, Jim is working extremely hard with our rail service operation on the South Shore because some of the capacity on the South Shore of Vancouver today is not fully utilized and obviously lots of capacity in Halifax and Montreal. So the investment, long-term investment made by our partners, whether the Port of Mobile or the guys on the Canadian West Coast, is basically the reason why we also invest because we're in this for the long run. It takes time to deploy these assets. The best time to build an ice cream shop is in the wintertime because when you try to open up in July, typically it's chaos. We're building right now for the next cycle. That was the way the Chinese look at the market.

I told you that JJ has his eyes on the future. He's looking at ice cream on his sideline.

Well, thanks for the time and Claude, all the best for a speedy recovery.

Thank you and I'm trying to continue. It's difficult at first with the voice, but the brain is working very well and the voice will get better over time.

Turan Quettawala, Scotiabank.

Yes, good evening, everyone. And Claude, congratulations and great to have you back on the call.

It looks, Turan, like you were able to squeak in at the end.

The caboose in here, right? I guess just one question on the domestic intermodal business here. JJ, is it possible to break down how much of the 5% growth came in in domestic versus maybe the overseas? I'm assuming it's probably all overseas. And then also you talked a bit about the Canadian economy here being weak. I'm wondering if you can give any color whether you're seeing signs of broad weakness across the board or is it still pretty much isolated in certain provinces.

The domestic intermodal was definitely much weaker than the overseas. I won't give you specific numbers and the cross-border is a bit of a challenge. The competition with the truck and the cross-border is fairly stiff. There's more drivers than there was and the fuel price, the diesel price is not what it was years ago. And in terms of the East/West, I mean Calgary, Edmonton, Saskatchewan, they are not quite the booming economy today that they were 18 months ago, especially as it relates to how much capital investment there is there and eventually that will find its way into even down to the consumer. So Canadian domestic intermodal business is a little weak right now and it may be a little weak for a while until we find a new level.

Thank you, JJ and I believe that closes the question-and-answer period for us. We try to stick to that one-hour timeframe. Let me just close by saying two things. We're very proud of how we finished the year. It was not an easy year, but we were able to meet our guidance and deliver nevertheless. We're entering 2016. It's still an uncertain environment, but we feel confident that we have the right agenda, the right focus and the right team to deliver.

On a personal note, I have to say five months is a long time, but it allows you to step back. I was so impressed by how the team reacted, the leadership team, first and foremost. They stayed connected and they delivered as a team. The broader team of CN, I must have received a couple thousand emails of very personal supporting me, encouraging me. Many of you on this call, analysts and shareholders, reached out to me. I was looking forward to get back. I am very pleased. I could not resist coming on this call. I will work on my voice. I have the energy. I feel good about our franchise and we are marathon runners. We're investing for the future. I hope to be part of it for many years to come if you will allow me. Thank you and be safe. We will see you or talk to you on the second-quarter call.

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