Canadian National Railway Co (CNI) 2016 Q1 法說會逐字稿

CN's first-quarter 2016 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 first-quarter 2016 financial results press release and analyst presentation documents that can be found on CN's website. As such, actual results could differ materially.

Reconciliations for any non-GAAP measures are also posted on CN's website at www.CN.ca. Please stand by, your call will begin shortly.

Welcome to the CN first-quarter 2016 financial results conference call. I would now like to turn the meeting over to Sam Forgione, Vice President, Investor Relations. Ladies and gentlemen, Mr. Forgione.

Thank you, Patrick. Good afternoon, everyone, and thank you for joining us today. I would like to remind you all of the comments already made regarding forward-looking statements.

With me today is Claude Mongeau, our President and Chief Executive Officer; Jim Vena, our Executive Vice President and Chief Operating Officer; J.J. Ruest, our Executive Vice President and Chief Marketing Officer; and Luc Jobin, our Executive Vice President and Chief Financial Officer. In order to be fair to all participants, I would ask that you please limit yourselves to one question. It is now my pleasure to turn the call over to CN's President and Chief Executive Officer, Mr. Claude Mongeau.

Thank you very much, Sam, and thank you all for joining us on this call. I think it's fair to say that there is a lot to be proud. We are coming again with very strong results in what is a more difficult volume environment. J.J. will take you through the contour but we're leveraging our diversity, the diversity of our franchise, we're chasing every carload. We're holding our own, but the overall volume is down 7% or 9%, depending how you measure it. But in that context, we are responding very swiftly on the resource side and in terms of efficiency.

Jim will give you the details, but across the board we are setting new levels of performance in terms of efficiency and network throughput. When you put it all together, we are doing this with a view to maintain that balance between service and cost efficiency. Our service has never been better. We need that to help our customers succeed in the marketplace.

We're also maintaining our focus on safety. We've had very strong safety results during the first quarter and we want this to continue going forward.

In terms of the very important operating ratio, we established a record for the first quarter with 58.9%. This is a clearly industry-leading performance if you take the same geography as the industry in terms of how to book real estate gains. So very good performance; we're very pleased in that regard.

And so you put it all together, Luc will take you through this, but our EPS is up around 16% to CAD1 and our free cash flow is very solid. That's CAD584 million. All around, very good results, solid performance by the team. I will let Jim, J.J. and Luc take you through the details. Jim, over to you.

Well, Claude, thank you very much. I think a lot of hard work, lot of things have helped us, but overall, a good performance by the railroad running on a day-to-day basis. I think it is fair to say the team continued to build off the results of previous quarters.

We delivered very strong results in safety, expenditures, service and in operating excellence. The results are shown in the slide, and we put a little note at the bottom that talked about a milder winter, so you can discount them a little bit. There's no ifs, ands or buts the winter helped us.

Nevertheless, the trains were more productive by 8%. Their speed was improved by 10%. And locomotive work load improved by 5%. In our yards, they were more efficient by 9% and the time a railcar spent in a yard dropped by 15%. The result all-in was better locomotive utilization, better car utilization, less cars online, more gross tons per employee, more cars switched per hour worked. And precipitated a clear indicator of network performance with a car velocity improvement of 15%. So overall, satisfying results with everything that was given to us with the volume, the winter and productivity that the whole team worked on.

If you could flip over to the next page, I just want to reiterate, and really nothing -- not a big change, not a change, I guess, at all, of what we're trying to deliver on. Our agenda of operating and service excellence is built on a foundation of safety first. We want to deliver safe, fast, dependable service, executed by the whole team and at all levels of the Company while continuing to drive efficiency across the board.

Before I pass it on to J.J., for us, it's all about making sure we're balanced, we react quick, we're nimble in the changing conditions. And I think the whole railroad showed how we can be nimble at times when things change with us and we react as quick as possible. So J.J., over to you for a little more detail on where we are.

Thank you, Jim. And Jim, you're very humble; it's a very solid quarter. We're a team, 58.9% operating ration, so kudos to the operating team of CN. Overall, the first-quarter revenue went down 4% from last year and is broken down as follows: Volume and mix reduced our revenue by 7%. The carloads and RTM were down 7% and 9%, respectively. February was our best month, but March was soft. Crude by rail, coal and frac sand continued significant decline. On the positive side, we benefited from the divide in demand coming from US consumer spending, from the manufacturers that use natural gas based feed stock, from vehicles purchased by consumers and from the new housing construction.

Same-store [price] was up 2.5%. All in, if you remove the Canadian and [regular] grain and other legacy index agreements that have had a long fuel lag component, price was up 3%. The fuel surcharge application lowered our revenue by 5% but exchange increased our revenue back by 6%.

Now, let's turn to some of the highlights of the last quarter. Revenue derived from housing starts remained a bright spot and area of growth from last year for CN, accounting for close to 15% of our overall book of business. This would include lumber to the US, OSB panel, plywood, containerized household goods, whether domestic or overseas and other construction material. With a weaker Canadian dollar, the Canadian forest product producers are in a strong position and so is CN.

We had strong vehicles purchased by consumers. It does not matter where the vehicle is manufactured, whether it's Europe, Asia or the NAFTA region. The CN network of auto port facilities in every major city where we have a rail network gives us a very high market share of what the consumer buys from the dealers. Our automotive business unit was up 18% with an impressive 20% carload growth.

With the collapse in energy markets, Brent crude purchased by the coastal refineries was very cheap and affordable and there is also ample pipeline capacity to go around. Those two things are making crude by rail economies broadly unattractive. Our crude by rail volume dropped by half to 14,000 car loads. But the more relevant aspect of the crude story is the prevalent incremental rail capacity pricing that brought crude by rail to become the least profitable of the unit train business.

The downturn in oil and gas capital program also impacted our steel, cement, aggregate and frac sand business. Frac sand was down 45% in volume to 13,000 carloads in Q1. Our frac sand business is now largely related to natural gas drilling as opposed to shale oil drilling.

Domestic intermodal revenue grew 4% driven by volume in our Canadian door-to-door retail service. If you exclude the impact of the NS triple crown restructuring and the related loss volume, our overall domestic volume was up 7%.

International intermodal started out very strong in the quarter. But in March, we hit a decline on the West Coast business, as in the Canadian and other US West Coast ports, mostly exports falling off, but also a pullback on imports. On the East Coast, Halifax was very solid and grew more than 50% in volume in the quarter. All in for the quarter, international volume was up 1% and revenue was down 1%.

Our grain operation was in excellent shape last winter. Canadian grain revenue was overall flat to last year, with better carload volume but lower regulated pricing. US grain was impacted by the strong US dollar. Therefore, our overall US grain volume was down 13%.

Lower natural gas prices have supported a 7% carload growth from manufacturers of petrochemical, plastics, nitrogen, fertilizer and other natural gas liquids, the list of which I've just listed is based on natural gas feed stock. The retreat of coal continued. Our coal revenue ton-mile was cut by about half versus last year. Coal is now only 3.1% of our total book of business, the lowest exporter of coal of any railroad.

Now, looking ahead, we expect coal, crude and frac sand to continue their volume decline until a bottom is found, hopefully later this year in the case of crude and sand and late in 2017 in the case of coal. Canadian grain will also be weak until the next harvest comes up this coming September.

The economic environment continues to be uncertain, but we will exploit the positive forecast in the manufacturing sector and the related rail demand derived from housing starts and consumer spending. We also are very well positioned to exploit the huge potential of the mid-2017 expansion from our West Coast port terminal partners. In regard to Port of Mobile, the rail operation will be ready soon and both Maersk and Cosco have announced new Panama Canal all-water service that will stop in Mobile to start in June.

The pricing environment remains constructive for the rail industry, although a bit weaker and we expect to broadly produce pricing above inflation, I would say in the 2.5% range all-in. We still have legacy index pricing that had a long fuel lag component that required the remainder of this year to be digested. We anticipate the Canadian grain cap to be about plus 1% this August and the market is also dealing with the capacity pricing experiment of one of our competitors.

We are actively supporting our shippers and logistics partners for whom the weak Canadian dollars and/or the cheap energy is a competitive cost advantage to exploit. Example of that would be the Canadian port, the forest product mill, the aluminum smelters, the automotive assembly plant, the petrochemical complex and the refineries.

In conclusion, we at CN continue to invest and innovate for the future. Our strength lies in our portfolio diversity and our best in class profit margin operating ratio and in our solid Chicago solution right in the heart of the continent. Luc will give you the financial color of our first-quarter results.

Okay, thanks very much, J.J. Starting on Page 12, then, let me provide you with the highlights of our very solid first-quarter performance. Revenues were down 4% at just under CAD3 billion. Fuel lag was a revenue tailwind of CAD16 million in the quarter. However, when compared with last year's lag, it represents a headwind of CAD41 million, or CAD0.04 of EPS.

In spite of facing a challenging revenue environment, however, operating income was up 14% versus last year at just over CAD1.2 billion. Our operating ratio, as Claude mentioned, was 58.9%, a record level for a first quarter. This represents a 680-basis points improvement over last year.

Net income stood at CAD792 million, up 13%. And the diluted earnings per share reached CAD1, up 16% versus last year. The impact of foreign currency was CAD57 million favorable on net income, or CAD0.07 of EPS in the quarter.

Turning to expenses, we once again made excellent progress in the quarter in terms of safety, productivity and cost management while maintaining superior service. Intense focus on right-sizing resources given the lower volume drove operating expenses down 14% versus last year, at just under CAD1.75 billion. Expressed on a constant-currency basis, this is a 19% improvement. At this point, I'll refer the variances in constant currency.

Labor and fringe benefit costs were CAD590 million, a 16% decrease from last year. This was the result of two elements. First, overall wage costs decreased by 9%, as wage inflation was more than offset by lower overtime and a reduction of nearly 10% in average headcount for the quarter versus last year. Sequentially, the average headcount was also down 4%. The second element contributing to reduced labor costs was a lower pension expense for CAD51 million.

Purchased services and material expenses were CAD408 million, 14% lower than last year, as lower volume, cost management initiatives and favorable weather helped reduce material costs, repairs and maintenance, and crew accommodation as well as utilities. The fuel expense stood at CAD235 million, or 40% lower than last year. Price was CAD109 million favorable. In addition, lower volume accounted for CAD23 million of the improvement and fuel productivity advanced by 2%.

Depreciation stood at CAD307 million, 1% lower than last year. This was a function of asset additions, offset by the impact of depreciation studies and other minor adjustments. Casualty and other costs were CAD112 million, which was CAD55 million lower than last year and for the most part, attributable to lower accident-related costs.

Moving on to cash, we generated free cash flow of CAD584 million in our first quarter. This is CAD63 million higher than in 2015 and mostly the result of higher cash generated from operating activities. Capital expenditures were essentially flat with last year at CAD469 million.

Finally, our 2016 financial outlook. We remain constructive in terms of CN's prospects for the year, notwithstanding the fact that we continue to experience high volatility and weaker conditions in a number of commodity sectors. The pace of North American industrial production is also slowing down considerably.

Fortunately, however, prospects are still favorable on the consumer side of the economy and this should continue to support moderate growth in housing, automotive and intermodal sectors. We now estimate that this will translate into a decline of our annual carload volume in the 4% to 5% range versus 2015 while pricing will stay ahead of inflation.

The strengthening of the Canadian dollars to the US exchange rate and the evolution of oil prices, however, are clearly different from our original expectations. These factors, when combined with more [modest-strength] demand will make things more challenging for us in 2016. Accordingly, we are revising our original guidance, and so CN now aims to deliver 2016 earnings per share in line with last year's adjusted diluted EPS of CAD4.44.

On the capital front, we remain committed to reinvesting in our business to support the safety, service and efficiency of our network. Therefore, we maintain our capital investment program for the year, which after adjusting for our revised currency assumptions, now stands at approximately CAD2.75 billion. Furthermore, we continue to focus on sustainable value creation and rewarding our shareholders with consistent dividend and share buy-back returns. CN's annual dividend was increased by 20% earlier this year, while we are gradually moving towards a 35% dividend payout ratio. In addition, our current share buy-back program is approximately CAD2 billion.

So despite a more challenging environment in 2016, we are focused and committed to managing the business in a manner that protects earnings, while not compromising our long-term competitiveness. And on this note, back over to you, Claude.

Thank you, Luc and team. Let me wrap up. There's a lot to be proud of. I said at the outset that our results were very solid during the quarter. We are leading the industry, if you look at it in terms of a run rate basis.

Luc communicated our revised guidance. The challenges are in front of us. The volumes are weaker and also the assumptions that are the framework against which we provide you a consistent and transparent set of assumptions. Those are currency and fuel prices and the general rate of economic growth. This is just a world out there that we have to face too, and things are turning from a tailwind or shock absorber to somewhat of a headwind as we look forward to the balance of the year.

So we got our work cut out, but we are responding swiftly. We are focused on doing what we can to protect profitability and to continue at the same time building for the long-term future. That's why we are holding the line on our investments for safety, for service, for efficiency and we are constructive. The prospects are out there. It's just a question of running the Marathon with a view to build competitiveness over the long-term. With that, I will be happy to take questions with the rest of the team. Patrick?

(Operator Instructions)

Cherilyn Radbourne, TD Securities.

Thanks very much and congratulations on your performance.

Thank you, Cherilyn.

In terms of your volume outlook, maybe you can give us a bit more color and a bit of a ranking in terms of some of the more important deltas. It sounds like it's crude, frac sand, coal, but also perhaps international intermodal.

It's J.J., Cherilyn. It is crude, frac sand and coal, definitely. For second quarter, it would also be Canadian coal. You also remember last year we had a [narrow node] mine that shut down in the summer, so we still have some of that.

And currently as we speak, it is also the OSM, international business on the Canadian West Coast. That's a phenomenon that started in March. February was strong. And we believe that this is only a phase. It should come back sometime in the middle of the second quarter based on customers' indication to us, but also based on maybe what the US economy in terms of [indeventury] and whatnot. OSM is a phase where oil frac sand and crude is something more steady.

Great, thank you. That's my one.

Thank you, Cherilyn.

Ravi Shanker, Morgan Stanley.

Thank you. Good afternoon, everyone. J.J., if I can follow up on something you said, did I hear you right when you said that you thought coal would bottom in late 2017? Because that would probably be a little later than some people expect. Can you talk about where you're seeing that market, please?

Well, as I said, our coal revenues first quarter were close, about -- I think it was 3.1% of the total book of business. So already our exposure is quite a bit less than most. So you got to start from that starting point. We know of what the next three quarters look like. And our sense is that in terms of export and in terms of US consumption in the US, at least the utility we serve, we might see some further erosion in carload in 2017.

So I think the consensus by most railroads is there will be some further weakness in 2016. And after that, it's a question of your crystal ball and where you're at. Again, remember, we start from here, about 3% book of business at this point.

Great, thank you.

Thank you, Ravi.

Jason Seidl, Cowen.

Afternoon, everyone. I guess my one is going to be around the pricing side. You say expectations remain above inflation. But what's the feel for it going forward? Is it weakened somewhat? Or are you still confident that pricing's going to hang in there, maybe even moderately improve if trucking capacity tightens?

J.J. could add to this, but it's a tough world out there for our customers and it's a shrinking pie in terms of volume. In that context, we have to do everything to help our customer win in the marketplace. But we provide good service and so it's incumbent on us in the industry to protect pricing.

But right now, it's a shrinking pie and it's tempting to do incremental capacity pricing or things like that. We intend to protect our book of business and we think the value of our services should allow us to continue to price ahead of inflation. That's what we've done at 2.5%. We're not different than other railroads who provide you same-store pricing information. And we hope to keep it at that level for the balance of the year. J.J., do you have any other color?

Yes, one of them is this issue with trucking capacity, which is right now is more ample than, say, 18 months ago. That's a cyclical thing; eventually trucking capacity will tighten up again. We don't necessarily believe it will happen in 2016. Then we have the phenomena of digesting the index pricing which has a fuel component, Canadian grain cap. That's another thing to take into account. That also eventually will pass, that's cyclical.

Typically the average contract we get, we do get the 2%, 3%, 2.5%, 3% price increase. We have this little phenomena of capacity pricing, which, if the capacity is coming from the highway, maybe it could work out. But if it comes from one railroad to another, it has a bit of a dilution effect.

I think we have very good customers, long-term business and know that we intend to keep their business. That's what we've done here in the last 12 months. And we think that this year is about 2.5% and in future years, inflation plus taking into account what we just said here, trucking capacity, which is cyclical, and some of these indexes are also cyclical.

And J.J., how do you view your cost inflation going forward? Are you around that 2% mark?

Luc, you want to talk about rail inflation?

Yes, if you look at rail inflation, it's probably running just a little bit around 2% and probably -- some of the commodities are running below 2%. But on the other hand, in terms of wage inflation, that's running probably closer to 3%. So that's the world we're in. So J.J.'s description of inflation-plus is in the right band.

And take into account an operating ratio of 58%. The 2%, the 2.5%, it's just a 3%, we're working on different scale dollar. I think on material, there is some good pricing material. Maybe, Jim, you want to say how effective our capital program is right now?

Sure. Two things, one is you always have wage inflation. We know what our contracts is. We know what we have to work against. That's why it's so important to us and we continue to drive to make sure that the trains are more efficient, the yards are more efficient. We get more out of each person that comes to work by being more efficient.

That leads me into the capital program. The capital program, CAD2.75 billion with the adjustment of the exchange. And when we said it, we wanted to make sure that we had the number. One of the comments we had was we think that we have better use of the dollars and the time when the volume is up a little bit. And that's exactly what we've realized.

We've been able to be out there in the first three and a half months. The productivity that we get and the amount of infrastructure that we've been able to put in and renew is substantially better for the same amount of money. And that's what we want to continue to do in this time, J.J.

Very good. Thank you so much, Jason.

Thank you, as always, guys.

Thank you.

Fadi Chamoun, BMO.

Yes, good afternoon and good quarter, guys. But looks like you may have a little bit of headwinds in the coming quarters. I have a question on incremental pricing, J.J. You mentioned that on the crude by rail side, have you seen this anywhere else in terms of the business that you have? And what is the risk that you think this could roll into some other categories of business that you got? And maybe a quick one for Luc, the CAD51 million pension income in the first quarter, how should we think about the run rate for the next three quarters on that?

All right, Fadi.

There's a few questions in there.

We will allow for you that one and a half questions.

Sneaking in there, Fadi. (laughter)

J.J., quickly on the --

I did brought it up on the crude by rail. It is an area where we -- what we call incremental capacity pricing. The pricing on crude by rail unit train is, if you are on the volume side of those services, it's a fantastic deal. I think it's potentially because sometime when things are predicted to be huge volume-wise, you actually have so much expectation. And when the market is not growing as much as you hope, you may tend to over-react and cut the price and see if you can make it up in volume and see if you can make the product move.

Railroad is a demand-derived industry. We don't create demand, we feed demand. And I think the crude by rail is an example of that. It doesn't matter how low you go, if the product can move in a pipeline, it will. All you're doing by going very low is just the making business pretty unattractive. Right now, crude by rail volume is weak, will get weaker. And the pricing is not the greatest.

There is some of that happening in other segments, not to the same extent. There's really no loss of volume with it, because when a car is lost, another one is -- we made it up with another one. So you're trading a car for a car and that's a not-going-anywhere type exercise. Luc?

Fadi, in terms of the pension expense, as we disclosed to you guys in the last call, we expect to have a tailwind of about CAD150 million for 2016 versus 2015. So that's the number that you should really be using. Obviously it is not spread out evenly throughout the year, so you have to look back to last year and what's going on. We'll be providing some input, or some update, on that as we will file our actual evaluations at the end of June. Stay tuned, we'll update the number. But CAD150 million as a tailwind is the right number to use for the full year.

Thank you. Thank you, Fadi.

Ken Hoexter, Merrill Lynch.

Great, good afternoon. Wanted to follow up a little bit on that. Luc, the average cost per employee was down about 2% year over year. Are there any special things in that?

Maybe you can walk us forward in your outlook now on flat earnings. Is that solely on the volume side? Or is that on this, on whatever you have in the cost per employee as well? Can you walk us through how we should think about the cost per employee going forward? Thanks.

As I mentioned, you've got to separate what's going on on the pension side from what's going on on the headcount. Wage inflation, as I mentioned earlier, is running at about 3%. We are managing very closely the headcount. We were down about 9.5% in the first quarter versus last year, so that's about 2,400 fewer employees in our service. And the entire team is focused on improving productivity and getting more out of the workforce.

These are the key drivers. So it's back down to productivity, wage inflation. We certainly are also working very hard to reduce overtime. So that's another lever that we're pulling. That's really what you should be factoring in, is continuing to push as we have last year.

Obviously when we get into the second half of the year, we'll be comping again a lot of the improvements we made last year. But we feel pretty good about our ability to continue to push and get great operational improvements while at the same time balancing the service dimension. So that's my best guidance for you.

Thank you, Ken.

Thank you.

You're welcome.

Walter Spracklin, RBC.

Thanks very much, good afternoon, everyone. Just wanted to focus here on your new volume expectation for the remainder of the year. As you indicated you're reflecting the continued weakness in some of your bulk commodities. When you forecast that out for the rest of the year that's implied in your guidance, are you effectively taking a view -- maybe you could give us some more color on the relative optimism on that new view based on your revised guidance.

In other words, are you just looking for a continuation of the current run rate level? Or are you building in any back-half recovery that's already in your numbers? If you could give us a little sense of what level of conservatism or optimism you're building into your forecast, perhaps by each of those merchandise bulk and intermodal segments, that would be very helpful.

Yes, I would say J.J. always tries to put the church in the middle of the village. So J.J., you want to give more color?

Yes, Walter, it's J.J. If we look at the next three quarters, we view the second quarter as maybe the toughest of the three in terms of volume, partly because what I just talked about. Grain will have to wait for the next crop on the Canadian side and also because overseas intermodal is a little slow right now and it will need to ramp up sometime in the next couple of weeks before the -- when this [pain] starts.

What I was saying on positive side, as I've said, anything that has to do with US housing starts, I mentioned a list of commodities that are actually a benefit from that on the CN side. You have manufacturing of vehicles on the container import, but also on the finished vehicle side. Right now, even North American sand plant, their inventory on the ground is basically, for the whole industry North America is a target, meaning none of us have backlog, so we're moving what's producing. But every time they produce a vehicle that tends to drive our intermodal container business.

And then we have the consumers, US consumers, Canadian consumers. So intermodal, so [product automotive] for the manufacturing side or serving the dealers. Some of our customers love the fact energy is very cheap because natural gas is a feed stock and I mentioned some of those commodities. So it's probably a longer list of items as opposed to, say, we're going to be moving a lot of coal with one given account or we're going to be moving a lot of crude with two refineries, which was may be the stories of 20 months ago.

Okay, thanks very much, J.J., thanks Claude.

All right, thank you, Walter.

Brandon Oglenski, Barclays.

Good afternoon, everyone, and thanks for taking my question. I think, Luc, in your prepared remarks, you did talk about the strength of the consumer in North America. But J.J., I just wanted to follow up with you. Intermodal, not just for you guys, but the industry, is down, I don't know, let's call it 5% to 8% here to start off April. What's going on on your retail customer side? Should we read this as more negative for the economy, or is this a destocking issue? How do we think about it?

I think, Brandon, it's a good point, meaning that maybe CN is a little more transparent than others. The stats for the industry show the last four weeks of intermodal in North America and in Canada are weak and the West Coast are weak. So it's an industry phenomenon.

I think partly is because the way we had, all of us typically have fairly good start to the year, including February, Chinese New Year was a different time this year. And we never quite get our legs from under us after Chinese New Year, which will happen at some point later in the spring, I got to believe. Retailers' behavior, maybe people, the way they played up their supply chain.

I think broadly there is initial is to how strong February was and then February was [scaling] forward. And now we're into a stage where people are re-looking at their stock and deciding how much they really need.

So it's not -- I wouldn't call it a CN story. I think it's when you look at the year of stats, especially the last four weeks US, West Coast, East Coast, there is a bit of a slowdown that I think we all experienced that should come back sometime during the spring.

Okay, thank you.

Thank you, Brandon.

Chris Wetherbee, Citi.

Thanks, good afternoon. Was wondering if you could talk a little bit about the impact of the Canadian dollar from a customer perspective. If you're seeing anything at this point yet in terms of impact on your customers, particularly with some of the export business into the US. Or when maybe you think you would see that. How much does the currency need to affect the terms to see those [lows] change?

We see obviously markets then to balance out, so over time exports from Canada, we expect that to be positive with the dollar where it is, but it takes a while to kick in. J.J. likes to think of the services. If we add lower-cost services at ports or trans-loading activities, we have opportunities to move more goods through a supply chain that goes through Canada. So we have to take advantage of the opportunities everywhere they are.

And they are adding up in total. But at the end of the day, it doesn't move. There's always a lag. And it's only been a little bit less than a year that the dollar is quite a bit lower. J.J., do you have anything to add?

That's right, there is always a lag because it takes a little time for people to turn around and secure more of the sales of a US account versus an overseas account or domestic account. But the Canadian port, the Canadian West Coast have a little limited capacity today. But by 2017 when they lower capacity, if the dollar is still CAD0.80, they should be able to exploit that to get business to US Midwest.

Canadian saw mills, Canadian pulp mills, Canadian aluminum smelters, these are plants which most of their costs are in local currency and therefore they do have a cost advantage now. If you look at some other assembly plants or petrochemical plants, there is a higher proportion of their costs which is in US funds despite the fact their plants are in Canada. But still at the margin, they do have an advantage now versus when the dollar was at par. These are just some of the examples of how some of these things play in some of these different sectors.

Okay. I'm thinking there's a little bit from the reversal for us, so maybe if we see a reversal in the currency, it might not see as of that potential benefit come to fruition. But I guess it takes some time to see.

Yes, the short-term our shock absorber are impacted in terms of conversion that Luc explained. In terms of the movements of goods these things don't adjust as quickly and the dollar is still much lower than it was only year, 15 months ago. At CAD0.80, the terms of trade are good and favor Canadian exports.

That's right.

Very helpful, thank you.

All right, thank you, Chris.

Justin Long, Stephens.

Thank you and congrats on the quarter. Intermodal seems to be a focal point for the business going forward. I wanted to ask about intermodal margins and where they stack up relative to your other businesses today. Looking ahead, how do you anticipate intermodal margins will be impacted as you start to factor in the port expansions and the opportunity for growth in the US domestic intermodal market?

We've been having a model in intermodal for years now that is a balanced end-to-end approach. Our intermodal margins are, they are not at the top of the list in terms of profitability, but they are really very much in the middle of the pack. So the growth opportunities in that business are very favorable to long-term profitability and we want to keep it that way.

Jim and his team are focusing on end-to-end service. We are working with our partners at the ports, not just to provide good service, but also to provide efficiency gains, loading up the trains, lining up the cars, so that we are as efficient as possible. If we keep going that, that's what we need to maintain a secular long-term growth opportunity in intermodal. That's our strategy. It has been working and we see it continuing for the foreseeable future.

Okay, great, I appreciate the time.

Allison Landry, Credit Suisse.

Thanks, good afternoon. With volumes down a bit more than you originally thought and currency and fuel moving the other direction, do you think that you can still drive year-over-year margin improvement for the balance of the year? And I know that you talked about driving some incremental efficiency gains. Wondering how to think about all the puts and takes with respect to the OR.

Yes, as I said, the famous OR is a very closely-watched metric. I think I'll let Luc comment more, Allison, but I think it's fair to say that we have a pretty good start to the year with a very significant improvement and a record operating ratio. At today's level of fuel prices and with all of the initiatives we have to offset the lower volume, we see a good opportunity for margin improvement in 2016, that's for sure.

Long-term, our goal is to stay in the leadership position that we've been holding for a long time on that key metric. We don't only focus on it because we tend to want to focus on all the pieces, including cash flow and return on capital. But at the rate we're going, we want to stay in a leadership position. Luc, do you have a view that would add color?

No. I think you've provided pretty well, Claude. It's all about -- it's an end result. We don't start with an OR and work our way back. All of us keep pushing the envelope, Jim and his team, everyone around the table, to find the most efficient way we can do things. While at the same time, I, in terms of protecting the service and longer term, growing the business.

So we have a great start. You should expect us to continue to have industry-leading operating performance and that ultimately translates into operating ratio. That's just the way we look at the business and it's not the driving force. So stay tuned, but the numbers should be good for the year.

Thank you.

Thank you, Allison.

Brian Ossenbeck, JPMorgan.

Hi, good afternoon, thanks for taking my call. I had a question on -- Claude, you mentioned the overall volume pies could be shrinking, reference to customers that are under some pressure and we've heard some comments about the environment being more competitive. So are there any -- I was wondering if there's any contracts, probably thinking more on the international intermodal side? Or anything else that's really coming up for bid throughout the rest of this year?

We offer such a good service, the rail industry in general, that it's very important to protect the profitability with good pricing. That's our thinking. At the same time, you have to react to competitive pressure and that's what we're doing to keep the business that we have earned over time.

On the international front, our large intermodal accounts have been renewed, J.J., and we don't have any large contracts until next year. So we are focused on delivering the business that we have at this point and we feel confident about the future. We have a very good service, a good end-to-end supply chain approach. Our network reaches deep into the US from the three coasts, so we think we are a great partner in that field. It's a competitive market out there and we'll just have to earn the business the old fashioned way.

Brian, we have contracts every year [from our use]. That's just normal course of business. It's not a risk, it's just how things do. Most of our major contracts [for the units] have turned out. And as to what might happen next year, it is all speculation. I believe that is what we hear from our own customers.

Okay, thank you for your time.

Thank you.

Tom Wadewitz, UBS.

Yes, good afternoon. Wanted to see, J.J., you referred a couple times to the capacity coming on. Just wanted to see if you could run through the different capacity events in 2017 and frame the size of the Mobile, Alabama this year so we have a sense of the size of those and also your best sense of the timing.

Okay, so they can run roughly the three major ones. One is Prince Rupert, [Dubai] port. The capacity we'll add in the range of 500,000 TU. That will come up roughly in July 2017. And we believe about 95% of these 500,000 TU capacity is available for rail in and out.

GCT Global Container in Vancouver also has capacity expansions on the rail side about a similar amount, let's call it 500,000 to maybe 600,000 TU. Being rail loading, it's all for rail and I would say historically in Vancouver, the market share roughly is two-thirds, one-third, 70%/30% between us and the other railroads, us being the dominant player. So that will give you a sense of how much capacity is available for us to go in and market and mostly market in the US.

And in Mobile, Alabama, the terminal is expanding at the vessel discharge. The rail operation that they are building right now will come in operation last, early June, sometime in the next 30 days here. And the capacity that we're targeting there is eventually to be able to reach as much as 20%, 25% of what is discharged by the ship. So today all ship discharge will be 100% trucked in, trucked out.

Cosco and Maersk are the first two companies who are basically sellers two weeks ago to offer the service and offer some pricing to do Panama Canal, Mobile and north. Then we'll and see how successful they are in helping us and helping the terminal operator to enter. In the case of Mobile, you start brand-new, so give it a little time before we get our legs from under us.

If you get 25% of Mobile, what does that translate to roughly?

So the Mobile capacity today is, I think what they discharge, is in the range of 200,000, 250,000 TU. Their aspiration is to have a bigger terminal and to enact more discharge all in, whether it's rail or truck. There is only one terminal.

We would like to get to a point where a quarter of the terminal, as the terminal is growing, is moving out of the terminal by rail. That might take a little time because we need to prove the service, just like we did back then in Rupert and also in the new terminal in Vancouver.

And what was the GCT timing in Vancouver? I didn't catch that.

July 2017.

July 2017.

So Rupert July 2017. Mobile is month of June of this year.

Thank you, Tom.

Thank you.

Turan Quettawala, Scotia Bank.

Good afternoon. I also had a question on intermodal. Prince Rupert obviously been a great growth driver for you guys over the last few years, but certainly in the last quarter it's been a little bit weak. J.J., maybe you can give us some color as to what's going on there. Is it more of a temporary issue, you think? Or is some of that market share going back to the US?

So it was strong early in the year, in the case of Rupert, and then it slowed down. At the same time, and again, if you look at the statistics, US West Coast or some of the Port Tracker Magazine or some of the articles in the Wall Street Journal, I think we all have seen a slowdown on the imports in the West Coast, especially in March.

A little more so at Rupert because Rupert is a rail, it's a long haul, it doesn't have the local market. Rupert has also suffered up to a point, like other ports, about the challenge of export related to US dollar. Because a good deal of the exports from Rupert actually were coming from US Midwest.

We're working through that with our major customers in Rupert. The historical one, like Cosco and [Engine], or the newer one, like Maersk. Everybody is intending here to make full use of the capacity that we collectively have at Rupert. So the goal is to get it back to what it was.

I think it will probably mean also you would think that US West Coast will also get a little stronger from where it is today. We may have a bit of an industry phenomenon, I don't think it's a Rupert phenomenon.

Yes, and I would say, Turan, you're right, that on a year-over-year basis, it's down. On a run-rate basis, Rupert is still above 700,000 TU on an annual basis. So the port is functioning well. It's a question of end demand picking up so that we can regain momentum.

That's right.

Great, thank you very much. That's my one.

Thank you.

Thank you, Turan.

Scott Group, Wolfe Research.

Thanks, afternoon, guys.

Hi, Scott.

Wanted to go back to the pricing discussion for a second because as I think about it, in like the past 10 years or so, I'm not sure I really remember you guys ever guiding to pricing of 2.5%. I feel like we've always been in this 3% to 4% range. So I want to understand, is this something that is a temporary issue because of RCAF and grain and once we get through that we'll be back in 3% to 4%?

Or do you guys see that the environment has changed? And you mentioned the competitive environment a few times on the call. Do you think we're just in, for the foreseeable future, in a little slower pricing environment? Can you clarify some of your competitive pricing comments, if that's truck, if it's the other rail in Canada or -- and then what segments you're seeing it in.

Scott, let me repeat what I said earlier. I think rail as an industry, we have a very good service. At the end of the day, we move with the demand that is out there. And so we could service and with a derived-demand framework, I think it's incumbent on all of us to keep pricing that allows us to reinvest in the future and to be disciplined in how we go about things. And we think that's the goal for everybody.

Right now, the shrinking pot maybe makes it a bit more tempting to try to do incremental capacity pricing, but we all want to defend our business. In the end, you're trading four quarters for a dollar. So we think it's hopefully temporary.

We provide you very detailed information about our pricing performance. On a same-store basis, it's come down a little bit. Some of it, as J.J. has said, is because of fuel and regulated grain. Some of it is because of adding to response to a competitive pressure. And we hope that as fuel goes back up and as the industry focuses on disciplined pricing, that we should go back up more towards the range that we've used to be delivering. But we will react to the market and just have to see how it goes. Thank you for your question.

Thank you, guys.

Thank you, Scott.

Bascome Majors, Susquehanna.

Thanks for taking my question here. I believe you mentioned that the capital budget cut was entirely FX-driven. Can you go back and confirm that's what you said? Is there an opportunity to shift out some of the growth capital expenditure? Would it make sense to do that if the demand environment continues to be as pressured as it is in the near term here?

Bascome, this is Luc. To respond to your question, essentially the lion's share of the decrease is a function of the revised exchange rate. There's a little bit of productivity in there as well, which as Jim pointed out, we've been doing extremely well on the productivity front. So there's a little bit of that as well.

With respect to the outlook for the year, we are pretty well focused on fulfilling this plan. It doesn't have a whole lot of investments which are, what I would call, chasing growth. We are focusing on hardening the infrastructure. We do have some commitments around rolling stock, which obviously are not things that we can change lightly. PTC is a major category where we have stepped up the investment and we're committed to fulfilling the regulated mandatory implementation.

So in the scheme of things, I wouldn't look for significant reduction in CapEx. We take a long view on CapEx. We think it's actually a good time to be hardening our infrastructure and we can see the benefits are coming through loud and clear. Velocity is fantastic. We can maintain great service. The safety numbers are all showing the right signs.

So all of these things. And Jim is getting some very good working blocks for the engineering team to get on the track and work in addition to reasonable commodity prices. So it all makes sense and frankly this is typical of us taking a little bit of a longer view on things and not just trying to chase the next quarter. It's something that the whole team looks at very closely. So we don't take free cash flow and CapEx lightly, but we're pretty committed to this envelope.

The best way to say it, it's a long-term marathon and we're building for the future. So we're holding the line on our CapEx until further notice. Thank you for the question.

Thank you.

Thank you.

Benoit Poirier, Desjardins Capital Markets.

Good afternoon, gentlemen. My question is on the petrochemical. There's a lot of talk, excitement about the opportunities in the Gulf Coast. I was wondering if you could provide more color about the size, the timing of the opportunity with the implication for CN.

So the excitement on the petrochemical and Gulf Coast is typically related to a new plastic plant being built, either the one that there is today running flat out or the one to be built. It takes a few years to build these big plants. You need to build first a cracker and then the plastic plant so this is not like tomorrow.

But the trend looks good because of the costs. The cost of making plastics in the Gulf right now, Louisiana or Texas, some of them are close to CN lines. Some of them are obviously not close to CN lines. The cost is such that you can export to the world. You can make product and sell it here but also you can compete with other countries.

So typically it may not mean a lot of rail business because a product that's produced in the Gulf, most of it will want to go overseas. And that's why, partly, we benefit in Mobile, Alabama with this new Panama Canal service because one of the things that the shipping lines are targeting is when they go to the Panama Canal, first stop is Houston. And the reason they like Houston more today than in the past is because they're going to get a lot of polyethylene plastic export in containers. And then they go to Mobile and then after that they go to some other cities.

So the plastics story might be as much as an overseas international business as an export. So you truck to the port or maybe partly rail short haul. You load at the plant. You send it to storage and transit. You get it out of there. You send it to a place where you're going to bag it. The container gets lifted, goes to the port then goes overseas.

Okay, thank you very much for the time.

All right, thank you very much, Benoit. And thank you, all, for joining us on this call. As we discussed, we had a good start to the year. We remain constructive about our prospects for the full year, even though there are some challenges out there.

We are managing the business for the very long-term but we are also nimble and responding swiftly to make sure we protect profitability to benefit our shareholders, at the same time as we continue to deliver solid service so that we can help our customers in what is a difficult period. That's what you can do and that's what we plan to do. And we hope to see you at the end of the second quarter. Be safe and see you then. Thank you.

Thank you, all.

Thank you.

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