Canadian National Railway Co (CNI) 2016 Q3 法說會逐字稿

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

Welcome to CN's third quarter 2016 financial results conference call. I would now like to turn meeting over to Mr. Paul Butcher, Vice President Investor Relations. Ladies and gentlemen, Mr. Butcher.

Thank you, Patrick. Good afternoon everyone, and thank you for joining us on our third quarter 2016 earnings call. I would like to remind you of the comments already made regarding forward-looking statements. With me today is Luc Jobin, our President and Chief Executive Office; Mike Cory, our Executive Vice President and Chief Operating Officer; JJ Ruest, our Executive Vice President and Chief Marketing Officer; and Ghislain Houle, our Executive Vice President and Chief Financial Officer.

In order to be fair to all participants, I would ask you to please limit yourself to one question. I will be available after the call for any follow-up questions. It is now my pleasure to turn the call over to CN's President and Chief Executive Officer, Mr. Luc Jobin.

All right. Thank you very much, Paul, and let me in turn welcome all of you to CN's third quarter call. As Paul indicated, the whole team is here today, and we are very pleased to report another outstanding quarter. One that has seen us continuing to advance our performance in terms of safety, in terms of service, and in terms of productivity. These results demonstrate how nimble we are at adapting to today's reality.

Seizing opportunities to deliver bottom-line results whilst positioning ourselves to meet tomorrow's prospects. Our revenues were down 6% while RTMs declined by 3% in the quarter. These results were reached while we were still experiencing the lingering effects of corrections in major commodity sectors combined with a sluggish economic growth and a delayed harvest of the Canadian grain crop. JJ will give you more color on this in a minute.

In terms of operating performance, we clocked in a record-breaking operating ratio of 53.3%. It is difficult to achieve this level of results and to do so without compromising our long-term goals. So kudos to the entire team. Our steadfast focus on safety combined with balancing operation and service excellence came through again in this quarter. Michael will give you details on how we fared across all our key metrics.

We continue to deliver superior service by leveraging our collaborative supply chain approach. This quarter we earned an adjusted diluted EPS of CAD1.25, only 1% lower than in the third quarter of last year. We also generated free cash flow of over CAD1.7 billion year to date, which is in line with last year's results.

Ghislain will expand on our financial results. I will now turn it over to the team for their comments starting with you, Mike.

Thank you very much, Luc, and I'd like to thank the entire CN team for achieving outstanding results in the quarter. Our operating team of employees and leaders are top of class and they strive each day to improve our service offering. So with that let me turn over to the results.

As you can see we had a solid quarter against some very tough comparables. Those comparables continue to get tougher when you look ahead and especially considering the exceptionally mild winter we had last year. Our mandate continues to be a strong focus on executing the operating plan. We take a strong position on maximizing use of our assets in line with ensuring our service offering is what our customers need. I'd like to touch on three key core areas that remain our team's focus moving into Q4. And these are safety, service, and productivity.

Safety is fundamental to our success at CN and our safety performance this year remains strong but we are never comfortable to sit on that front. Year to date we've seen major improvements in both main track and non-main track accidents. Our FRA accident ratio has improved from 2.06 year to date in 2015 to 1.32 year-to-date in 2016. As you can appreciate, this improvement in our FRA accident ratio has resulted in a corresponding reduction in the costs associated with train derailments.

However, our FRA injuries have been flat year-over-year and that leads us to engage deeper in order to realize the improvement that we must have. Our balanced approach to investment from infrastructure and technology to people and assets creates the platform our team uses to leverage innovation from the ground up. Everyday we work to balance the core operating leverage you see on the slide. This drives our operational and service excellence mandate.

One metric I'd like to highlight is our train productivity. We were able to increase the GTMs per train mile by 6% while improving both our car velocity and our train speed. This illustrates our ability to run heavier, longer trains faster than the year before. This ensures we drive out cost, but not at the expense of speed or service to our customers.

Let me share a few examples of this with you. With the bumper grain crop coming off the field we are able now to run 12,000 foot 28,000 ton grain trains from country origins to port. This decreases overall labor cost while increasing fuel efficiency and reliability in moving the grain. We have also increased the number of long trains operating in the northern Ontario segment which is a 1,200 mile segment between Winnipeg and Toronto. We have done this by utilizing strategically placed long siding investments, adding distributive power to increase train size and adjusting train schedules for customers needs and precision meets.

We've also increased the size of our potash trains by 25% in Saskatchewan and Nova Scotia. That's over the same segment. So with these improvements in train size, we're still able to protect premium service for our customers. Our investment in infrastructure over the key Winnipeg to Chicago corridor, including the double track over the Steelton Hill in Wisconsin, has allowed for double-digit productivity increases over the last two years. Car velocity, locomotive productivity, train speed and trainload have all sequentially improved.

This foundational view on productivity and service has prepared us well for the future growth of the Company. In our line of sight is the bumper grain crop in both Canada and the US. We are handling and ready to handle more of the crop that has been produced. In order to deliver the efficient reliable services supply chain requires, we have recalled employees back to work, we've repaired grain cars and deployed them close to our customers so they are ready for use after harvest. We have available locomotives in position as needed, and we've made and continue to make strategic investments in infrastructure across our network.

Over the last few weeks, we achieved a record weekly performance for grain car spotting on more than one occasion. Coupled with this, we continue to work in tandem with our partners in the supply chain to maintain fluidity through the fall peak period. Now winter has already started in the prairies, and this has contributed not only to a delayed harvest, but to some severe storms on the West Coast which has produced excessive rain.

As I stated earlier, we know our operating comparables will get tougher going forward for both Q4 of this year, Q1 of next year as a more normal winter is forecast on our network. But the operating team is fully focused on executing the plan. And as I mentioned in the last quarterly results call, it's not about doing one thing well, it's about working all of the levers in a balanced way. I know we're gaining market share by following these core principles.

So before closing, I want to speak about the importance of leadership and development. Our operating leaders are committed to developing our people and growing our bench strength. We have been out and will continue to be out across the property developing our future leaders on the principles we believe in as we know they bring us success. Ensuring we teach these lessons is something we hold each other accountable for and it shows as our future leaders become leaders of the day.

So in closing, it's about teamwork. Innovation and empowerment allows the greatest resources that we have here at CN, our people, make the difference they do and as a result, I am convinced we will create many innovative initiatives that will allow us to continue to excel on our operational and service excellence agenda well into the future. With that, over to you, JJ.

Thank you, Mike, and great job from the operation team on that 53.3%. The third quarter revenue went down 6.5% or CAD208 million from last year, mostly due to four commodities and from the application of cheaper fuel surcharge. Carload was down 3.4% and revenue ton mile was down 4.4%. US coal, crude by rail, frac sand for drilling and sulfur from energy represented roughly CAD150 million of the revenue decline. The fuel surcharge application lowered our revenue by another CAD74 million.

On the positive side, we had volume benefit from US harvesting start, from some US economy growth, from some organic market share gain, US grain volume and it feels like volume have come up the second quarter bottom in most segments. The all in same store price on same store sales was up 2.2%. Same store price on same-store sales was up 2.8% when excluding the regular grain and excluding index breaks legacy contract. The Canadian dollar impact was neutral this quarter.

I will now go to the results and outlook on some selected segments. Housing stock drove our lumber and panel revenue by up almost 10% versus last year. Our lumber shipment to the US increased 11% while export carload to Asia were flat. The softwood lumber agreement expired October 12 and our carholders for lumber have remained solid during the last four weeks.

Moving to customers' purchase of motor vehicle, our automotive revenue was up about 3% in Q3 following a slow start for the quarter. We now handle a bit more than 60% of all motor vehicle purchased by Canadian consumers. Our supply chain services continue to earn us volume. We are expecting some further carload growth in automotive despite the overall flattish demand for the vehicle in North America. On crude by rail business, it dropped 50% just this last year and our frac sand for drilling was down 30%. But both have sequentially stabilized from last quarter and we could experience some improvement.

Intermodal revenue was down 4%, domestic volume was weak, mostly in wholesale for load, especially in cross-border trade. And the national volume was challenging as well. Rupert had resumed its transit sequential growth in July, but Hanjin filed for bankruptcy in the end of August and stopped its weekly service. Since then other shipping lines are positioning to take a bigger role in the Rupert Gateway.

In Vancouver, we recently picked up a shipping line contract which will come into effect the first of 2017. On the East Coast, Halifax position in the interland market is stronger, the volume growth was about 30% in Q3. We've handled the first small rail volume at the Port of Mobile and in the coming months we have planned to add another intermodal ramp in the US Midwest.

Our grain operation is running very smoothly and my operation partners have described that earlier. US grain revenue was up 20% in the third quarter, driven by corn and soybean export. Canadian grain revenue was down 5% due to the quite small inventory left from last year and a later harvest than usual of this year's crop. The long-awaited Canadian crop is now available since the end of September, and we are now running at record weekly carload for Canadian grain. The near future looks bright for our grain business. Given the bumper crop on both sides of the border, we anticipate upside in grain to through the third quarter of 2017.

Staying with [bulk] commodities potash reduced an incremental 10% and sulfur from oil and gas declined 40%. The fourth quarter outlook for potash carloading is positive, including export by New Brunswick on the East Coast. Overall, coal revenue was down 32% in the quarter, mostly from decline in domestic terminal call. Our US coal revenue was down 40%.

Canadian met coking coal, which is a coal for making steel, was up 13%, but the market is at a cyclical crossroad. One of the idle Canadian met coal at CN will restart this quarter. [Met coal] export from the oil sand from Fort McMurray resume in the third quarter, producing some positive for the upcoming fourth quarter. The Minnesota iron ore mine in UTAC has reopened in mid-August and the Cliff and Par mine also producing iron ore closed permanently in October. Last quarter our combined iron ore rail, dock and vessel business produced flat revenue versus last year, which is a better moment for the coming quarters.

In closing, the sequential quarterly revenue trend has hit bottom last summer and is starting to inflect mildly upward. The fuel surcharge application will remain somewhat of a revenue headwind as the on-highway diesel index will likely be below the CAD2.54 per gallon that we had last year at the same time. The pricing environment remains influenced by the excess capacity in all transportation mode, but we expect to continue to produce pricing above rail inflation. On that point it will be useful to remember that the [AR all-inclusive] less fuel index was below 2% in both 2015 in 2016.

Finally, it is useful to reflect also on CN some key business strength of our model. We have a very diversified book of business. We are connecting North America through the world market by our three coasts, easily pivoting around Chicago with the easy (inaudible) ring railroad advantage, and we are providing services conceived with the customers in mind, and we do have the industry lowest operating ratio and we have had that for quite a number of years. Ghis, I am going to pass it on to you to do the CFO review.

Thank you, JJ. Let me review the financial highlights of our solid third-quarter performance. Revenues were down 6% at slightly over CAD3 billion. Fuel lag on a year-over-year basis represented a revenue headwind of CAD36 million or CAD0.03 of EPS, all driven by a favorable lag experience in the third quarter of 2015.

Operating income was down 5% versus last year at just over CAD1.4 billion. Our operating ratio came in at 53.3%, an all-time record for CN representing an improvement of 50 basis points over last year. Net income stood at CAD972 million or 3% lower than last year. With diluted earnings per share of CAD1.25 versus CAD1.26 in 2015 down by 1%. The impact of foreign currency on net income and earnings per share were negligible in the quarter.

In the third quarter we recalibrated our effective tax rate from 28% guidance, or let me be a little bit more precise, 27.5% to 26.5% full year 2016, driven by more earnings in Canada versus the US which caused the third quarter effective tax rate to be around 24.5% due to the six-month catch up.

Turning to expenses, we definitely made progress in the quarter in terms of safety, productivity, and cost management while continuing to provide superior service. Operating expenses were down 7% versus last year at just over CAD1.6 billion, driven by lower headcount in light of the weak volume environment. As the average exchange rate in Q3 2016 was essentially the same as last year, both actual and constant currency variances are the same.

Labor and fringe benefit expenses were CAD495 million, 16% lower than last year. This was mostly the result of lower wages and pension expense. Wage costs decreased by 6% as wage inflation was more than offset by a reduction of about 8% and average headcount for the quarter versus 2015. Pension expense was CAD49 million favorable and we still expect a pension tailwind of approximately CAD180 million this year, mostly driven by the adoption of the spot rate approach to estimate current service costs and interest costs.

Purchase services and material expense were CAD379 million, 5% lower than last year. Lower volumes and our continued cost management initiatives helped reduce our trucking and transload expenses by CAD10 million and material, repairs and maintenance by another CAD10 million. Also, our solid safety performance contributed to lower accident costs by CAD7 million of the overall favorable variance. These elements were partly offset by lower capital credits for CAD8 million and increased outsourced services by also CAD8 million.

Fuel expense came in at CAD269 million or 11% lower than last year. Price was favorable by CAD13 million and lower volumes accounted for an additional CAD10 million reduction. Fuel productivity came in at 1% but when you exclude an inventory adjustment in 2015, it was up 2.9%. Depreciation stood at CAD312 million or 9% higher than last year. This was mostly a function of net asset addition.

Casualty and other costs were CAD68 million, which was CAD5 million lower than last year, mainly attributable to a favorable settlement of a claim with CP for CAD25 million essentially, offset by an increase in provision for bad debt related to the Hanjin bankruptcy for CAD20 million. Turning to cash, we generated free cash flow of CAD1.743 billion through the end of September which is essentially flat versus 2015. Capital expenditures was slightly above CAD2 billion, or CAD35 million lower than the same period of last year.

Finally, our 2016 financial outlook. Given our solid performance in the third quarter, we are raising our earnings outlook for 2016, now expecting adjusted diluted EPS to be up approximately 1% versus last year's adjusted diluted EPS of CAD4.44. The economic environment continues to be uncertain and volatile and we believe that energy market related volumes, namely crude and frac sand, hit the trough in the second quarter. Although sequentially positive in the third quarter, we still expect them to remain below last year. On a positive note, we continue to see relative strength in lumber and panels and automotive while grain in both Canada and the US looks to be strong. We still expect carloads to be lower than last year in the mid single-digit range while pricing will stay ahead of inflation.

We assume that the Canadian to US dollar exchange rate will continue to be in the range of CAD0.75 to CAD0.80 while fuel prices using WTI will now be between $40 and $50 per barrel. These factors still make it a challenging environment for us, including tougher cost management comparables for the fourth quarter on a year-over-year basis and more normalized winter operating conditions versus unseasonably warm weather last year. With respect to capital investments, we continue to reinvest in our business to support the safety, superior service, and efficiency of our network.

We are keeping our capital investment program at CAD2.75 billion for the year, and we have been deploying this capital very productively, generating mid-teen unit cost savings. Furthermore, we continue to deliver sustainable value for our shareholders and reward them with consistent dividend and share buyback returns. CN's annual dividend was increased by 20% earlier this year and we are moving towards a 35% dividend payout ratio. In addition, we our completing our current 2 billion share buyback program on October 29, and I am pleased to announce that our Board of Directors have just approved a new normal course issuer bid program for the repurchase of up to 33 million shares and approximately 2 billion to be completed over the next 12 months.

Over the past five years, CN has repurchased 135 million shares, returning approximately CAD8 billion to its shareholders. So despite a continued challenging environment in 2016, we remain focused and committed to managing the business by protecting earnings while strongly positioning ourselves for the future and long-term competitiveness. On this note, back to you Luc.

Thanks, Ghis. So to recap, as we look ahead, you heard JJ describe how our volume environment is shaping up. Still sluggish, but improving sequentially in a number of markets. Mike I think illustrated very well how the operating team continues to drive our agenda of operational and service excellence, leveraging innovation and staying true to our objective of providing quality service to our customers. Ghislain shared with you our updated annual outlook and the new share buyback program. On that note, we will be happy to take your calls.

Thank you.

(Operator Instructions)

Scott Group with Wolfe Research. Please go ahead.

Hey, thanks. Afternoon guys.

I think I heard you say a couple times talk about inflation plus pricing. I wanted ask you, though, if we see an uptick in inflation next year, are you still confident that you can see an uptick in your own pricing and see inflation plus pricing next year too?

Maybe I'll take up that one. It's JJ speaking.

I think they might be aligned, depending how inflation evolves. I'm not sure inflation will really pick up that fast, but when inflation picks up there might be some lag in time between the base of inflation and the pricing following behind. But if you take it more than just one quarter at a time, inflation plus pricing is still the model, I think, that in the rail industry is the model.

I think, just back to JJ's point, at this juncture we're not seeing inflation running away so we'll have to see how things evolve and then over time we still feel that we have the ability to adapt. And historically inflation has not necessarily been a bad thing in terms of ability to price. So we're optimistic that we can sustain our position of inflation-plus. Thanks, Scott.

Okay. Thank you guys.

Thank you.

Thank you. Walter Spracklin with RBC. Please go ahead.

Yes. Thanks very much. Good afternoon everyone.

Looking at your operating ratio, obviously very successful operating ratio again this quarter and congratulations on that. As we look out to next year, looking at anything that might not be sustainable? Or we should look at particularly those headwinds that you're aware of and know about today? What would you point us to, and understand you're not given guidance on OR, but if we are looking out to 2017 as we are, are there any known headwinds that you'd really flag when we look at our OR assumptions for next year?

Yes, thanks, Walter. It's Luc.

I would probably say that the rising price of oil will play a role, as you know. Just the pure mechanics of it, plus the add to that the lag that comes with it, so that's an area that's going to put a little bit of pressure, I believe. Also, I think Ghislain may want to talk a little bit about how we see pension. But this year it's been a significant tailwind, and I think next year, Ghis, you're looking more at a little bit of a headwind, right?

Yes. Walter, as I mentioned in my remarks, this year pension has been a tailwind of about CAD180 million. If you assume that discount rates at the end of December remain to where they are today, and interest rates are around 3.25%, then we could be looking at a headwind on pension next year of around give or take CAD50 million.

CAD50 million.

Again, this is determined on the interest rates at the end of December; but if they remain that way, then that's what we're looking at.

And, Walter, it's Mike here.

We're predicting a more normal winter than we had last year and the spread of it is unsure yet. I don't know if it's going to start in the prairies of Alberta or the prairies of Manitoba or Saskatchewan, but we know there's going to be more snow, more cold, and that will start up in December and carry right through for a normal winter. So that will have an effect also.

Casualty and other, there, Mike? Was this a particularly good year on casualty and other? Should we model that as well?

I think we have all -- Walter, this is Ghislain.

We have always guided around CAD90 million per quarter. I think that is the right run rate and I would continue to assume that.

Yes. Walter, I mean this is something very difficult to predict, of course. I think what we've done is, we've made a number of very significant improvements in terms of our safety record. I would expect that a lot of that is going to stick. But if you have a very cold winter, then obviously we will be facing a little bit more of a headwind, as Mike described. I think the key point here is, no matter what the conditions are, you can expect us to perform at an industry-leading level. And I'll remind everybody that we don't necessarily manage the business for the operating ratio. We manage the business to do what's right for our customers and we do it safely, efficiently, and that's really the formula that we keep working against.

So it will fall where it falls. You just should rest assured that we'll give it our best shot and usually that's industry-leading.

Okay. That's great. Thank you very much.

Thank you.

Thank you. Tom Wadewitz with UBS. Please go ahead.

Good afternoon.

I don't know if you can clarify on the CAD50 million headwind. Is that a year-over-year number? Is that what you were saying?

Yes. Tom. It's a year-over-year number.

That's year over year. Okay. Okay. Great.

On the intermodal, you talked about a couple markets that seemed to be bottoming. I think the tone of overall volume outlook seems constructive. What are your thoughts on intermodal volume outlook? And then, I don't know if you could offer a thought on pricing competition in intermodal? It seems like that's been a market which has been pretty weak and it seems like it's tough to have visibility to what the freight outlook is in that market. So any thoughts on those two would be helpful. Thank you.

Yes, Tom, it's JJ.

I think looking short-term, the overall volume I think North America and for CN is a little weak. But domestically where we compete very hard with the trucking industry who has lesser capacity and better cost than they did when the drivers were in short supply and fuel was expensive. And on the product coming from overseas, those trades are not as buoyant as they were two years ago. So things are a little on the weak side right now in intermodal, so I think we have to recognize that and look for 2017 to hope to see some better environment on the volume side.

And on the price side, we all compete for the business. As I have said, competition over the highways [is really] tough, especially in the case of CN where we do cross-border, because that's a shorter length of haul. And when the product comes from the coast we compete with many railroads and many ports and this is where operating ratio comes in handy. We use it responsibly where it makes sense and where it doesn't make sense we don't. So it's a competitive environment. That's all it is.

Okay. Great. Thank you.

Thank you.

Thanks, Tom.

Thank you. The next question is from Fadi Chamoun from BMO Capital Markets. Please go ahead.

Yes. Good afternoon. Thank you for taking the question. Just one clarification first and then I have a question on pricing.

So, for your fourth quarter, your guidance implies, if my math is right, about a 5% lower earnings on a year-over-year basis. Although you have a bit of a more tailwind on the volume side. I was wondering if this is just a function of what you have just indicated, which is normal winter and maybe some tough comps on the costs? Are there any other factors going in there?

And secondly, on the pricing side, just big picture question for JJ: so I think over the last 12/14 years you've really have had pricing of 3% or more in every single year even though we have gone through episodes where the transportation industry had excess supply. And I was wondering whether there's something different about this freight recession we are in. Are we seeing a business mix that is probably more cyclical and therefore we're seeing the pricing being a little bit more vulnerable, this freight [downtime]? Is there something changing in terms of this pricing story? Are we maybe at a more mature stage in this pricing story? If you can add any color on that would be great.

Maybe I can start, Fadi. This is Ghislain.

On the fuel surcharge, just to make sure that you remember last year we had a positive lag in the fourth quarter of about CAD0.02. Obviously, this year, as Luc mentioned, if fuel prices stay to where they are, we assume a slight headwind on the fuel lag in the fourth quarter. So that has to be taken into consideration. And as you mentioned as well, and Mike mentioned it, obviously we are assuming a normal winter operating condition in December, and if you remember last year December was unseasonably warm. And I remember in Montreal on 23 December it was around 20 degrees Celsius. So when you take that into consideration, that's what supports our guidance of what we put forward.

Also just maybe to add a little color, Fadi.

It remains to be seen, given the lack of visibility where generally our customers are going to have -- how they're going to taper down. As we get to the last few weeks of December the inventory levels may see some adjustments or we may see as well a little bit of early shutdowns for maintenance and so on and so forth. So I think we put the guidance out there because we wanted to give you our best view. It does reflect some of these factors that we don't control and obviously we'll have to see how those things eventually pan out. But we feel comfortable with the guidance that we've put out there. It calls for generally more normal conditions and will see where we are.

Yes. It's JJ, Fadi.

Ghislain asked me that question earlier. What's going to happen the last two weeks the quarter? And we don't know. If we understood the last two weeks of the quarter where the customers will overstock, destock, and what kind of weather we will have, it would be easier for us to call the fourth quarter.

Going back to your question on pricing, I think it's important to reflect, and as you said on our last many years and the rail industry in the last many years has always been inflation plus pricing. So if you do the compounding effect of all these years, will we get the inflation plus something? It's quite a powerful model and that's how as an industry we get these operating ratios that we all have. We all improve. It's more than just the fact that fuel is cheaper. It's also the fact that the industry is getting healthier and the industry is getting good compounding same-store price above inflation.

I think another factor is, historically, we may have all made some mistakes five, ten years ago; and as contracts get repriced we reprice them closer them to market. So you get some of these one-time effect; I think all railroad had some of that, some of the railroad more than others; but we all benefited from that up to a point. What's maybe a little more specific at this point where we're at, the economy has been weak now for a bit and many of us, including at CN, we all have invested a lot of capital, so all the railhead have lots of capacity. The railway system is at capacity and trucking industry is at capacity and we all have equipment parked. We park locomotive. The trucking industry is parking rigs, and that has an effect, obviously, on the industry impact. So eventually, on the whole North American transportation industry is sort of digesting a little more of its capacity. I think the pricing power will get us stronger. But inflation plus pricing in the current economic environment after about 10 years of inflation plus pricing is very good.

Yes.

Thank you very much, Fadi.

Thank you.

Thank you. Ravi Shanker with Morgan Stanley. Please go ahead.

Thanks. Good afternoon, everyone. Just to follow up a little bit on the pricing commentary.

Is it safe to assume that you will see stable pricing at the current levels of, say, a high 2% range X regulated grain, unless you see a big spike in inflation? Also, when does the grain pricing show up in the overall pricing?

Okay. We don't provide guidance or outlook on pricing per quarter. We are not providing guidance for next year, either. So that's why we stay with the general term of inflation plus pricing. If anybody can give us exactly what inflation would be next year maybe we could be more precise on how much pricing we hope to get.

Regarding the grain side, the regular grain is somewhat under beyond our control to formulate a federal government run. The formula produced a 4.8% price increase available August 1. We at CN did not take at August 1; we will take it at the beginning of the fourth quarter. That is why I've used -- I took out the regular grain because it was a bit of a headwind for us in the third quarter. It will become a tailwind in the fourth quarter. As you know, we do have some legacy contract life of [mind] where the pricing includes the fuel. That's why those are obviously still negative in that point of view. (multiple speakers)

Sorry go ahead.

Go ahead.

Will all the grain reprice right away? Or will that take time to work through the volumes?

The grain price we took effective October 1. You know the grain cap gives you a formula. You can take the price over the 12 months, 10 months, 9 months. It is up to each company to decide how we do that. In our case we decided to wait for the crop to come in before we took the price increase.

So, Ravi, we'll effectively work through the balance of the season as JJ is pointing out.

Thank you.

Great. Thank you.

Thank you. Cherilyn Radbourne with TD Securities. Please go ahead.

Thanks very much and good afternoon. So a question for Mike.

You provided some good detail on productivity in your bulk network, but I was actually pleasantly surprised by the year-over-year improvement in your yard productivity, particularly given some puts and takes on the merchandise volumes. Maybe you can just elaborate there a little bit more?

Sure. Cherilyn, we -- you know I spoke about significant siding investments, but we've also over the last few years taken a close look at our yards and to accommodate the size of those trains we've done things like lengthen tracks and yards so that we eliminated the amount of handlings we had on the cars. We have done that in our hump yards with pullbacks. We have reconfigured tracks in our yards in order to gain both speed and safety. So we never take our eyes off the yards. We do the same type of investment approach as we do on the mainline because, again, it's about safety, productivity, and service.

Great. Thank you. That is all for me.

Thank you, Cherilyn.

Thanks, Cherilyn.

Thank you. Jason Seidl with Cowen and Company. Please go ahead.

Hey, guys. How is everyone?

Very good, thanks, Jason.

So my one here is going to be on the productivity. Now, I think you mentioned, obviously it's going to get a little bit tougher with the winter weather, especially on a year-over-year basis, but how should we start thinking about 2017 and productivity? There's nothing really preventing you from continuing to post gains on this front, is there?

No, because, Jason, you know it's our approach. I'm just going to keep repeating the same things. You know we start with making every effort that we can to have a safe and reliable network. That's job number one. And then really, our key driver after that when it comes to productivity is the train length size. And we are in position over the majority of our network to run at the size that we run in more. So there is some incremental opportunity with volumes that start to come back, depending on mix, of course. And then, third, we still will target specific investments where that ROI feeds back into that productivity cycle.

So with that longer train we also are able to get productivities in fuel and locomotive use. But it's going to be the same story, same approach as we go forward, so we expect good results. No different than they are today and that's where we are going.

And, Jason, just to add to Mike's comments, I think again we have to see what the level of volume will be, and obviously we've worked very hard to bring a significant level of improvement in terms of our service. It is important to our customers, and needless to say, it's a balancing act here. So the improvements we are making on productivity are not coming at the expense of service, and there are times where we're also willing to invest in service for some of our great customers because that's how we build long-term relationships. And those things matter.

So obviously, the guys never cease to amaze all of us in terms of their innovation and the way they look at the business and the way we interact with the supply chain also gives us a big edge. Otherwise, we wouldn't be able to identify and pursue a lot of these initiatives. So it gets tougher because I think the level of performance is just impeccable. It's stellar. So it always gets tougher. But we have never shied away from looking at our business and continuing to improve. So maybe the quantum. You know you can't bank on the same quantum of improvement, but clearly the game plan of the team is clear, as Mike laid it out. I mean, everybody, that's our agenda. It should be no surprise.

So I guess the game plan is for you guys to keep making your year-over-year comps difficult for yourselves.

Absolutely.

Appreciate the time, guys.

Thank you. Turan Quettawala from Scotia Bank. Please go ahead.

Oh, hi there. This is [Malan Sarcon] for Turan. Just want to talk a little bit about the coal market and the coal mines in Northern BC. Now that coal prices have risen dramatically, if that sticks, how long do you think it would take for some of the mines to really start ramping back up and what kind of opportunity could this be for you? And I know you mentioned there's one that's coming online in Q4, but are there any others? Or what's the opportunity there? Thanks.

It's Mike here.

We actually have already started to move some of the coal from the first mine that had available stockpile. The second mine, and JJ will talk to it here in a second, is actually starting up and we're in preparation of making that happen. So, go ahead JJ.

Yes. So these were the mines -- we are talking met coal, right? Were not talking (inaudible) coal.

Yes. Yes.

Yes. On the met coal side, we had some mining that we used to be under the ownership of Walter and that went bankrupt and they came back from bankruptcy with a new owner and one mine is restarting and they will restart this quarter. I would take as a positive sign, right, rather than having a decline in revenue we have a revival with some volume. Take that for what it is. The real issue, though, is that the met coal market in the world is not improving because the Chinese are buying more coal. It's because the Chinese are producing less coal because the government has decided that they will produce less coal.

So the price is up right now. It's not because the demand is strong; it is because they have cut back supply. So hoping that this will stay in place, the price stay high, and the Chinese decide to stay with their model of cutting back, forcing their own local mines to restrict production, then we should see more coal mines coming out from BC. Obviously, starting a mine takes quite a while, but if you restart a mine that was in operation it takes less time.

And we have the capacities to move whatever comes our way. So (multiple speakers) the story.

Okay. Great.

That's positive to be negative.

Okay and thank you. And this is moving through Ridley? Is that correct?

That's correct. Yes.

Ridley and Rupert.

Thank you.

Thank you very much.

Thank you. Brandon Oglenski with Barclays. Please go ahead.

Yes. Good afternoon everyone and thanks for getting my question in.

Luc, you have had about a quarter now with your new executive leadership team. So just wondering, you got some pretty big shoes to fill after the prior two CEOs. First with CN Precision Railroading and then Claude Mongeau, really focusing on supply chain enablement and a lot of top-line expansion, a lot of energy expansion in Canada. What's going to be your legacy at CN with this management team? You guys already have the industry best leading OR, buying back CAD2 billion of stock. What's your vision going forward, and what do you do from here?

Yes. Thanks, Brandon. That's an easy one to cross out, right?

Well, first and foremost let me say a few words about the first 100 days and the leadership team. You know, I'm really into -- I think the team is gelling together very well. We enjoy working with each other. We challenge each other, and I think that's a very good environment to work in.

I've been out on the property, certainly with Mike, meeting all of our employees, getting them energized, talking about the way forward and I'll come back to that in terms of the vision. JJ and I have been meeting with customers, so a lot of good engagement there. And what I am hearing from the customers is they like our product, they appreciate the efforts that we're doing in terms of pushing forward in supply chain. So that bodes well, and I think we continue to impress them in terms of our ability to move their precious cargo to market. Paul and I and Ghislain as well, we've been out meeting with investors and they are also telling us that they like the way CN has been performing. Our strategy continues to resonate with customers. So from that standpoint I would not expect any major change. Sean and I have also been out there meeting with the regulators, engaging with them, and I think that's also has been a very positive series of meetings.

So all in all, the first 100 days confirm what I knew already, but it's good to see. The property is in good shape. We've got a great strategy, which continues to resonate with our customers. It's all about going out there and with our supply chain mindset continuing to innovate, continuing to operate in a way that balances the productivity in the service improvements. And so, to a large extent I would say the journey continues, And this is a strategy which many of us, certainly JJ, Ghislain, and I have been part of working through with Claude, and so we are continuing on that same momentum.

We don't make up the economy, so to a certain extent we've seen a significant correction in some of the commodities where we had a lot of growth in the last couple of years. But we're a pretty resilient bunch. You can see our numbers. We're continuing to grind it out there, and we've got a very innovative commercial team as well as operating team. So I feel very good.

I think in terms of looking at the future, if there is anything, I think what we want to do is, we want to leverage a little bit more and deploy a little bit more technology to continue to make advancements in terms of safety, productivity, and service. So that's one area that we will be focusing a little bit more on in the next few years. But otherwise, I would say this is not a revolution. This is going to be an evolution. And you've got a tremendous franchise. JJ pointed to the diversification in terms of geography and customers and commodities. And you've got a very energized team of railroaders all the way from the front lines all the way up to the headquarters and the leadership team around this table. So I feel pretty good. And I think if I can continue the momentum that was built by my predecessors, that's pretty good. I would take that gladly.

And I think I'm not at the point where I feel there is a breakthrough strategy that's just waiting around the corner. This is a continued progress in a competitive environment with a great franchise and probably the best management team in the whole business, bar none. So I feel pretty good.

(multiple speakers) Luc, thank you. (multiple speakers)

Just watch us.

Thank you. Chris Wetherbee with First City. Please go ahead.

Great thanks. Thanks for the time this afternoon.

I wanted drill down a little bit on the volume outlook. When you think about the fourth quarter I think some of the sequential improvements in some of these end markets, JJ, that you highlighted, do you think we can get to positive carloads for the fourth quarter? And then, looking at comps and all the puts and takes as we start to think out 2017, any early outlook towards what you like, what market you like, what you don't, how that might play out in terms of carload growth? That would be helpful. Thank you.

It is JJ, Chris.

I think I will leave 2017 for the next conference call. Some of the fourth quarter, so far this quarter when you look at the CN carloads we're positive. The reason for that, we have a lot of noise in our short haul business of [R & oil]. We have a minor shut down when it reopened. Maybe much more relevant is our revenue tonne miles, which is right now slightly positive. I am hoping -- I would hope that we can have some slightly positive revenue turn out by the end of the quarter.

As we said earlier, the last 20 days of December, we have challenge in the weather, which would impact [rain] or if we have customers who decide that they want to end the year with very low inventory or in manufacturing or in retail, then obviously I think the game will be played in the last 20 days of the quarter. And that's -- you know we are hoping for something slightly positive, but definitely sequentially the things just get better and better slowly but surely. I don't know if that can help. When we get into 2017 you ask me that question again the next quarter.

Fair enough. Thanks very much. Appreciate it.

Thanks, Chris.

Thank you. Bascome Majors with Susquehanna. Please go ahead.

Thanks.

You talked a little bit earlier about having the best management team in the industry. You know that's historically led competitors to hire some of your key people away. And you recently have gone through a pretty significant reshuffling at the senior management level. Can you let us know how you make sure the competition doesn't poach your top talent, be it existing or recently departed, and use them to compete against you either in Canada or the US?

Yes, Bascome, this is Luc.

Listen, I think first and foremost it's about getting our team to be really engaged in what we do. In this industry everybody has pretty decent compensation. What is actually more important is how people are involved in leading the Company and making a difference. And so I would tell you that the level of engagement that we have at CN is very high. And with this leadership team, even higher than ever before. And that's not a criticism on the past. That's more how excited I am about the future. So that's in terms of retaining our folks.

We also have, needless to say, compensation plans which focus on long-term compensation and that long-term compensation comes with a caveat in terms of people leaving the organization. So that never-ending guarantee because somebody can actually buy you out, so the first job is to get everybody engaged and making a difference in terms of the team. Then, also, as Ghislain pointed out, we did come to an agreement with CP with respect to some outstanding litigation. As part of that, we have agreed with them and they have agreed to extend for another two years a non-hire agreement that we had which was due to end at the end of December 2016. So now this will extend to 2018.

So those things are mechanisms to prevent poaching or to minimize the risk of poaching. But I would say job number one is get everybody engaged, get everybody contributing, energized, and that's really what makes the difference. Beyond that, these are the mechanisms that are out there to help us cope with aggressive behaviors to get to our great talent. Thank you for the question.

Thank you.

Thank you. Allison Landry with Credit Suisse. Please go ahead.

Hi. This is Danny Schuster on for Allison. Thank you for getting my question in.

So you had another very strong quarter in automotive from a volume perspective, and I think last quarter you actually cautioned that auto sales might be looking a little bit peakish. But just wondering whether the new business you started in September and October should be enough to drive absolute volume growth over the next few quarters here? And also in that context, it looks like your automotive RPU declined sequentially by a couple percent. Was that due to the new customer starts? Or is there something else driving that and should we expect to see that going forward?

Hi, it is JJ.

Yes, I think it's probably a fairly wide consensus wherein there was a following in the automotive industry that automotive sales in North America would be down the US. Sort of reached plateau and may start to -- I mean I wouldn't say decline, but they may not be the growth that we had the year over year the last two years. That is number one. That's the environment that we all have. So in the case of CN, we focus on the cities where we do have a rail network and how much of the market share do we have of the vehicle purchased by consumers in those cities. And along those lines we've been able -- are able to slowly grow our parts space and what's purchased in those cities, even though the market might be slightly flat or slightly down. And that's the reason why we have revenue growth and we expect to have some continued revenue growth here for a period of time.

We got in the revenue per car load or I think you were talking these are the mixed length of haul and the mix of business we have now, which is a mix of business we had three months ago and six months ago and I've never been really big on revenue [per car]. You have exchange, you have [fuel], you have length of haul. These numbers are hard to come to any conclusion on.

A lot of noise on those numbers.

Thank you for the question.

Thank you.

Thank you. Benoit Poirier with Desjardins Capital Markets. Please go ahead.

Yes. Thank you very much and good afternoon, guys.

Just in terms of financial position, obviously you came in with, again, strong numbers with the debt EBITDA of 1.7. Obviously 2016 has been a big year in terms of locomotive purchases. There are still some upside in terms of raising the dividend, but I was just wondering, looking ahead, whether you still see some opportunities for some tuck-ins or you could become a little bit heavier in terms of a share buyback going forward? Thanks.

Yes, hi, Benoit. This is Ghislain.

As I said in my remarks, our Board has just approved a share buyback. We are pleased about that. The 33 million shares or CAD2 billion. You know, in terms of dividends, this will be decided in January, as we usually do. So we are in our planning process as we speak. So we will look at it. So stay tuned.

In terms of CapEx, as you alluded to on the locomotives, yes, we had about all received our 90 new locomotives this year. Again, we will look at capital hard, and as we've said in the second quarter call, obviously it gives us an opportunity to reduce our CapEx. We are talking about CAD300 million related to these locomotives. But one area that I want to make sure that you understand is, we will not compromise on our basic investment. We have not compromised this year and we will not compromise, because we believe in the long-term value of our franchise. And when you decide to reduce basic, actually you don't avoid CapEx, you just defer CapEx. So we have been deploying CapEx this year and our rail and ties that have been installed this year we've actually produced somewhere between 15% and 20% savings in unit costs. So it's been very good deployment. And this is an area where we will not compromise.

And, Benoit, this is Luc.

Just to supplement a little bit of what Ghislain is saying. We continue to look at and we want to be opportunistic in terms of bolt-ons, so if we see some tuck-ins out there that make sense, historically, I think the pricing environment was way too rich. And so we're pretty disciplined in terms of deploying capital. So we haven't necessarily made any significant acquisition.

So we will be looking things over a little bit tougher for a lot of the smaller railways, and I think that there could be some opportunities out there that could come to fruition. These would not be of a multi-billion dollar scale. But we're clearly keeping an eye out there, and on top of that, I think just to add to the comments from Ghislain, if we see some good piece of business, some good customers, and there are opportunities to invest, coinvestment with them in terms of growing the franchise, we are a longer-term player. So we are not shy about putting the money forward, and if that is to potentially take us to raise our capital budget, well, so be it; we're here to grow the business. It's just that we are disciplined and the opportunities for investment have been a little bit scarce. If you look outside of our own network at this juncture.

Okay. Perfect. Very good color. Thank you very much.

Thank you.

Thank you, Benoit.

Thank you. Brian Ossenbeck with JPMorgan. Please go ahead.

Hey, good afternoon. Thanks for getting me on the call here. Just had a quick one for JJ.

You mentioned that crude and frac sand hit their trough in the second quarter this year, so what are you seeing to conclude that? And it's probably not a big bounce, but the [mia to BCS] spread has actually fallen through at all of third quarter. I was also curious, the comments that you made in the slide deck about being opportunistic in the approach to continue volumes in this business. If you could elaborate on both those, I would appreciate it. Thanks.

So, in the case of frac sand, we have seen some improvement in the total volume coming to us. I think it may be the case for many railroads, too. The drilling activities is slightly better. First we had to find the bottom. I think the bottom has been found sometime in the summer, depending on which commodity. Surely we did see that bottom in the case of frac sand. If you look at, I think, one other company was talking to their precision drilling [sco] was saying that they have seen some more work coming at them in western Canada regarding drilling activities. Not necessarily a whole lot more work sequentially, but sequentially positive as opposed to, let's say, sequentially negative. So little bit more optimistic on frac sand because it was very negative for quite a while. We might still be below that in the fourth quarter. But something better than sequentially basis.

On the crude, we had a decent third quarter, with crude carload everything was relative from where we came from. And I don't know whether the spread here mattered or not because the movement of crude right now is limited to a handful of buyers and sellers. And they are still moving crude as we speak. So crude is right now seems to be a [finally] run rate.

Unfortunately, as in meaning that we don't sign a long-term contract when it comes to crude; we go by month by month, quarter by quarter, as long as it makes sense for all parties involved we do it. If it doesn't make sense for one of the parties, either the railroad, the buyer, the seller, the crew, then we just slow down. I don't know if that helps, but these are -- you go from negative to slightly positive with better future than what we had in the past.

Thanks for your question, Brian.

Thank you. Ken Hoexter with Merrill Lynch. Please go ahead.

Great. Good afternoon.

I know it's getting a little late here, but I am surprised not too much on the grain crop. Earlier you mentioned just talking about the grain in the winter. Crops running above five-year averages. Can you maybe give a little thoughts, JJ, on your thoughts for the uptick here, the scale of that uptick? And then you mentioned earlier that storage was virtually empty, yet the bumper crop, so you already brought back employees. With respect to employees, any thoughts on margin pressure as you move forward with the growth of that crop?

Regarding storage, when we were getting geared up in August/September to move grain, there was not much grain left from last year. So that is what I meant. We had to wait for the new crop to come in. It did come in, but it came in later than we thought. It's coming in large quantities, so will that be an upside for the fourth quarter and the first quarter of next year, potentially. It will be more about us, because it will depend how hard we can run the railroad and that will partly in the hand of Mike and also the weather. What we can more likely see is, we think there will be more grain left by the time we get to spring, and that's where the big crop [dollars are]. The season extends longer and that's where the benefit will come in. The benefit will mostly come in, in 2017. Not so much in the next quarter.

I don't know Mike if you want to --

Yes. No. Ken, I'm not quite sure what you were asking about with people and the market.

You mentioned that you were bringing employees back on from furlough already, right, to help move the crop. Did I catch that comment right?

Absolutely you did. Yes. And we did that in line with, as the crop; even though it was delayed we were very close with the [great] shippers to make sure we brought them back at the appropriate time. So they're all out there working right now and we're moving, as JJ said, record amounts. So.

So timing with the crop growth, not ahead of time where you have to retrain or anything. So it should be kind of concurrent with the volume growth?

Absolutely.

And, JJ, I'm sorry, did you give a scale or your thought on what kind of percentage growth you should see move versus going back to filling up storage?

I am not sure I understand the question.

The size of the crop -- what kind of grain growth should we expect? Or is built into your numbers in terms of your volume estimates?

I mean the crop is not all in yet. We are assuming a crop maybe in the range of 75 million tonnes, which would be a million tonne or two below the record. Basically what you're asking is basically giving us to 2017 and how much we're going to do grain next year. At this point all I would say is, we will do more next year than we did this year.

All right. Thank you.

Thanks for your question, Ken. All right.

So maybe in closing, I'll make a couple remarks. First of all, I have to say that I'm very proud of what the team has accomplished this year. We've demonstrated our ability to deliver solid results in what is unquestionably a challenging environment. Our industry-leading team of railroaders delivered once again through solid execution and at the same time we continued our focus on leveraging our superior service to our customers, which, as JJ pointed out helps us gain traction in the marketplace. We also continue to reinvest in our infrastructure and you have heard the comments from both Ghislain and Mike on that topic. It clearly is there to support safety, service, and productivity improvements.

So as the economy evolves and commodity sectors gradually recover I think we're very well-positioned to compete and deliver continued shareholder value. So on that note, we certainly look forward to talking to you again in January to review our results for the fourth quarter and for the full year 2016. At that time, we will also provide you with our annual 2017 annual outlook or guidance if you want to call it that. So on that note, thank you very much, everybody, for joining the call. And be safe.

So it's Luc thanking everybody for your participation. Patrick?

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