Canadian National Railway Co (CNI) 2017 Q2 法說會逐字稿

CN Second Quarter 2017 Financial Results Conference Call will begin momentarily. I would like to remind you that today's conference call remarks contain forward-looking statements within the meaning of applicable securities laws. Such statements are based on assumptions that may not materialize and are subject to risks described in CN's second quarter 2017 financial results press release and analyst presentation documents that can be found on CN's website. As such, actual results could differ materially. Reconciliations for any non-GAAP measures are also posted on CN's website at www.cn.ca. Please stand by. Your call will begin shortly.

Welcome to CN's Second Quarter 2017 Financial Results Conference Call. I would now like to turn the 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 today for CN's Second Quarter 2017 Earnings Call. I would like to remind you about the comments already made regarding forward-looking statements.

With me today is Luc Jobin, our President and Chief Executive Officer; Mike Cory, our Executive Vice President and Chief Operating Officer; J.J. Ruest, our Executive Vice President and Chief Marketing Officer; and Ghislain Houle, our Executive Vice President and Chief Financial Officer. (Operator Instructions) 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. Thanks very much, Paul, and welcome, everyone, to our second quarter earnings call. Well, today, the CN team is pleased to report another very strong quarter. Our performance was driven by a sizable increase in revenues, building on volume momentum which started in the fourth quarter of 2016.

Our growth in the second quarter was also broad-based and achieved across most business sectors, translating into an 18% rise in RTMs.

Meanwhile, we maintain our inflation-plus pricing discipline. J.J. will give you more color on our record quarterly revenue performance and a sense of what's in store for the second half of the year.

From an operating standpoint, Mike and his team worked very hard to accommodate this level of growth while staying true to our commitment to balance service and efficiency. The result is evident in our operating ratio of 55.1%, up only 60 basis points versus last year, and our record operating income in the quarter.

Looking at the bottom line. The strength of our quarterly financial results speak for themselves: diluted EPS of $1.36, up 24%; adjusted diluted EPS of $1.34, up 21%; and solid free cash flow generation of $811 million in the quarter. Ghislain will expand on key financial highlights for the second quarter on the call and later today and address as well our outlook for the year.

Let me now turn the call over to Mike, who will give you a sense for how the operating team has brought onboard the substantial volume increase we've experienced thus far this year, while maintaining our industry-leading performance. Mike?

Thank you very much, Luc. And first, let me just say, happy anniversary to the team here in the room for a very successful first year together.

Overall, I'm extremely proud of the operating team's performance in this quarter. It's really a testament to their execution of our operational and service excellence agenda. Our volume growth in this quarter has been the largest in my 36 years at CN, and who would have ever forecasted 175% frac sand increase in 1 quarter. But that's not the entire story. This increase is broad-based across business segments and operating regions.

As a result of the volume increase, on top of attrition, we are hiring for all the operating groups, with new skill set demands at the evolution of PTC, technology and automation bring our attention to proper onboarding and integration is greater than I have ever experienced.

I'm really proud of what this team has accomplished so far and it's a testament to the culture of excellence that we've created that we're able to manage this type of growth and change environment and produce very solid results. So let's take a look at those results.

The volumes of 2016 provided an opportunity to reduce people and assets. Most roads, if not all, saw the benefit of added capacity to more experienced workforces, line and terminal space and less unproductive assets in the mix. Train speed, terminal dwell, fuel and locomotive productivity all improved as a result. So for context, I'm using a similar volume period against the same infrastructure backdrop.

Actually, my comparison of 2015 isn't exactly that, as workload or GTMs were 6% less in 2015 than they are in 2017. 2014 is actually a truer comparison workload or GTM wise, but we did make infrastructure improvements in '14 -- excuse me, in '15, so I'm going to use 2015 as an example.

The biggest driver of locomotive utilization and car velocity is train speed. With the year-over-year growth, our train speed has declined and affected both of these metrics. However, in comparison to 2015, again, even though volumes were still 6% lower than this year, we improved our velocity while matching both train speed and locomotive utilization. We did this through an aggressive approach to increasing train size, something that we will continue to focus on.

On the productivity front, both our yard and train productivity improved over both 2016 and 2015. Our plan to tackle train speed reduction is in place. It includes both innovative approaches as well as improvements that will be made through capacity and safety investments. Our focus on efficiency and reliability will never wane, with a longer-term plan to fundamentally change operations through technology, automation and optimization. The introduction of new operational and service systems will provide the opportunity for our customers to grow their markets efficiently.

On the safety front, we continue to build a greater understanding of risk awareness within our team. We're capitalizing on our strong relationship with our operating unions to ensure everyone genuinely looks out for each other. Our FRA accident ratio did increase from 1.57 to 1.61 on a year-over-year comparable. While both those numbers are a continuous improvement over the last 5-year run rate, our accident costs this quarter, while in line with previous year's run rates, were higher than in 2016.

For injuries, we're slightly up over our ratio for last year. Comparing to the last 5-year run rate, though, we continue to improve on the absolute number. However, productivity improvements that reduce human work hours have affected the ratio.

To all of us, this slip is just not acceptable. And regardless of volume increase and mix of employee experience, we know that our most valuable asset is our people, and we will correct this.

Overall, we're working very hard to improve our safety record, and I have a number of initiatives headed up by a newly developed and integrated team.

So overall, I'm very pleased with the team's performance in the quarter. With the volume growth, we definitely had challenging conditions to deliver these results. It's clear the team came through once again, and I'm grateful for the opportunity to lead them.

With that, over to you, J.J.

Thank you, Mike, and great job on moving all those crates. Today, I will keep my comments to 3 high-level topics. I will start with a high-level description of how we achieved success in the last quarter, followed by last quarter major variance, and I will close with recent progress on our commercial agenda.

So let's start with how we achieved success in the last quarter. First, we outperformed the economy. Our revenue was up $487 million or 17% above last year. Year-to-date, our revenue was up almost $750 million or 13% above last year, more precisely, $729 million.

We also outperformed the rail industry. CN's AAR carloads were up 14.5% versus the industry average of 6.7% in Q2. Year-to-date, our carloads were up 11.8% above last year versus the industry average of 4.6%.

Also very important to us is to achieve broad-based diversified source of growth. And to that point, all of our business unit produced good growth this quarter. On top of that, 3 segment have had all-time record -- company record, namely, international containers, automotive finished vehicle and frac sand for oil and gas drilling.

Finally, we generated same-store price above rail inflation at 2.3% for the quarter and 2.5% for year-to-date.

I will now highlight selected segments that produced the most variants.

Frac sand, as Mike mentioned, was up 175%. Total Canadian grain carloads were up 23%. Container volume from Vancouver South Shore Vanterm and Centerm terminal were up a combined 135%. Potash carloads were up almost 20%. Automotive carloads were up 9%. It is worth noting, CN handle about 75% of all the finished vehicle sold in Canada. Coal carloads were down 3%, but revenue was up a solid 33% because of business mix.

The Port of Montreal and Halifax volume, when combined, were up 10%. Our volume for natural gas liquid, plastic pellets and condensates were down.

The Canadian dollar and our fuel surcharge program versus last year were both positive tailwind to our reported revenues, respectively, $85 million for FX, $62 million for the fuel.

Now I will highlight recent progress of our commercial agenda. The new customers that we onboarded earlier this year are delivering solid growth. The Port of Prince Rupert created an all-time high rail volume in June, a good omen for the upcoming 3 years. Sand product of Blair, Wisconsin opened a new frac sand mine on CN, and we expect another of our sand customers, Wisconsin propane company of Hixton, Wisconsin, to further increase production on CN as well.

Crude volume bounced back from last year's Fort McMurray fire, but the last Eastern Canada refinery that was using crude-by-rail will stop doing so sometime in late August.

Whirlpool announced they will build a regional distribution center in our Calgary Logistics Park, which further progress our co-location strategy with distribution centers in intermodal. But our strategy also applies to grain, where we have a number of grain country elevators, either as newbuild or expansion of existing elevators, to be done by Viterra, Cargill, GrainsConnect, G3, P&H, ILTA. And the same co-location strategy also apply to export transload. We have Ray-Mont Logistics, who are building a major grain transfer facility in Rupert for the summer.

CMA, the ocean shipping line, will start a new service on the East Coast at the Port of Saint John, New Brunswick, further building our 3 coast strategic advantage. And the case for the Port of St. John, our strategic focus is on ocean container, on coal supply chain business and on bulk export of potash.

The new Duluth, Minnesota container terminal is now in operation, and we are also finalizing plan to have a container terminal service in Regina by the 2018 grain crop. This is further advancing our overall strategy of increasing our geographic reach by adding new and more destination.

And last but not least, our technology business team, which is now fully staffed, is in full project development mode to digitize CN next generation of supply chain services and build a foundation of our future competitive edge.

In conclusion, to wrap this up, we had a good, diversified quarter, with a number of good business unit coming through with good result. The economic outlook for Q3 look constructive and we're on track to the full year volume guidance.

Ghislain, do you want to pick it up from here?

Thanks, J.J. Starting on Page 11 of the presentation, I will summarize the key financial highlights of our solid second quarter performance. As J.J. previously pointed out, revenues for the quarter were up 17% versus last year at slightly over $3.3 billion.

Fuel lag on a year-over-year basis represented a revenue tailwind of $20 million or $0.02 of EPS, mostly driven by an unfavorable lag in the second quarter of 2016 of the same amount.

Operating income was slightly under $1.5 billion, up $202 million or 16% versus last year. Our operating ratio came in at 55.1% or 60 basis point higher than last year. Fuel prices had no impact on the increase this quarter.

Net income stood at $1,031,000,000, or 20% higher than last year, with reported diluted earnings per share of $1.36.

Adjusted EPS was up 21% to $1.34 from a year earlier EPS of $1.11, excluding the impact on deferred income tax expense from the enactments of changes in provincial income tax rates in both years.

The impact of foreign currency was $28 million favorable on net income, or $0.04 of EPS in the quarter.

Turning to expenses on Page 12. As Mike previously pointed out, we continue to make progress in the quarter in terms of efficiency gains, including disciplined cost management initiatives, despite a significant increase in volumes. Our operating expenses were up 18% versus last year at just over $1.8 billion, mostly driven by stronger volumes and higher incident costs. Expressed on a constant currency basis, this represents a 16% increase.

At this point, I will refer to the variances in constant currency.

Labor and fringe benefit expenses were $527 million or 10% higher than last year, as increased wages and incentive compensation expenses were partially offset by higher capital credits. On a full year basis, we still expect pension expense to be roughly flat versus last year.

Purchase services and material expenses were $432 million or 12% higher than last year. This was mostly the result of higher outsource services and repair and maintenance costs, mostly driven by higher volumes.

Fuel expense stood at $329 million or 30% higher than last year. Higher volumes accounted for a $37 million increase and price was an unfavorable variance of $27 million versus 2016. Fuel productivity was about 1% improvement in the quarter versus last year.

Depreciation stood at $326 million or 8% higher than last year, mostly as a result of net asset additions.

Equipment rents were up 8% versus last year driven by increased car hire, partly offset by lower lease expense. Casualty and other costs were $117 million, which was $42 million higher than last year, mostly driven by higher incident cost of $21 million and an increase in environmental provision of $7 million.

For the balance of the year, we can expect about $90 million to $100 million per quarter for casualty and others.

Moving to cash on Page 13. We generated free cash flow of $1,659,000,000 through the end of June. This is $490 million higher than in 2016 and mostly the result of higher cash generated from operating activities, lower capital expenditures and lower cash taxes.

Finally, our 2017 financial outlook on Page 14. We achieved solid volumes in the first half of the year, reflecting strong performance across most segments. We continue to see favorable economic conditions in North America, including a stronger than expected Canadian economy. In addition, consumer confidence remains positive, while a strong energy sector is driving shipments of frac sand and steel pipes.

Crude volumes are strong, but this remains a spot business. However, we expect volume growth in the second half of the year to be more challenged, as comparables with 2016 will be more difficult, particularly in the fourth quarter. We believe this environment should continue to translate into volume growth of approximately 10% in terms of RTMs for the full year versus 2016, with overall pricing remaining above inflation.

We have experienced -- we had recently experienced the strengthening of the Canadian dollar versus the U.S. dollar. And assuming the current spot rate of around $0.80, this will create a headwind on earnings going forward.

As a reference, $0.01 appreciation in the Canadian dollar versus the U.S. dollar results in an annual headwind on net income of approximately $30 million or $0.04 of EPS.

Despite the dollar headwind, we are reaffirming our guidance and continue to expect to deliver adjusted earnings per share in the range of $4.95 to $5.10 versus 2016 adjusted diluted EPS of $4.59. In fact, should foreign exchange remain at $0.80, we could finish at the upper range -- at the upper end of our range.

On the capital front, we remain committed to reinvesting in our business to support safety, service and growth. In this regard, we continue to target a capital envelope of $2.6 billion for the year and about 20% of revenues going forward.

Furthermore, we continue to reward our shareholders with consistent dividend returns, and we are on track with our current share buyback program of approximately $2 billion, having repurchased just over 14 million shares for $1.3 billion since last October.

In closing, we remain committed to our agenda and continue to manage the business to deliver sustainable value today and for the long term.

On this note, back to you, Luc.

All right. Thank you, Ghislain. So in closing, let me add a few words. Looking ahead, we hold a positive view of the economic environment, and we expect to have volume growth in the second half, although we will be facing some tougher comps versus last year.

Our strategy of leveraging CN's superior supply chain approach to grow faster than the underlying markets continues to bear fruits, and J.J. highlighted a number of opportunities for us on the way forward. Mike and our operating team are energized, and all hands are on deck to balance operational and service excellence. Our focus remains on delivering value for our customers and, ultimately, for our shareholders.

In spite of a stronger Canadian dollar, as Ghislain confirmed, that we're also on track to deliver against our yearly outlook, both in terms of earnings and reinvesting in our franchise.

So on that note, we're happy to now take your questions. And we'll turn the call back over to you, Patrick.

(Operator Instructions) The first question is from Ravi Shanker from Morgan Stanley.

A couple of questions, if I can squeeze it in. One is on pricing. Clearly, there's an industry-wide issue, but -- and you guys saw a sequential price deceleration, like everybody else, but can you just elaborate a little bit more on the drivers of this? And as inflation increase in the second half, what could be your sources of price gains?

Ravi, it's J.J. So at 2.3%, I believe that we are in the range of our industry. We're also in the range of the first quarter. On the grain side, we do seasonal pricing, so we don't take the grain cap and spread over 12 months. We apply for that price increase when the demand is strongest and take it away when the demand is least. But at 2.3%, I think, we are meeting our objective of same-store price above rail inflation. Rail inflation is below that at this point. And I think...

And as it increases in -- sorry, go ahead.

And I think, to work forward, that's the range that we're in as an industry.

The next question is from Fadi Chamoun from BMO Capital Markets.

So J.J., just a question on the crude-by-rail, which seems like it could be a significant opportunity for you guys going into 2018, and maybe even at the end of this year. Can you give us your thought on this? Have you had any discussion with a producer, what this opportunity might look like and sort of potential timing of that ramp-up?

Yes, I think, Fadi, I like one of your headline from one of your report where you say crude-by-rail opportunity interesting, but not yet exciting. Meaning, there's not yet huge capacity shortage of the pipeline capacity. So production is ramping up. Depending on who you talk to, it may be later this year or early this year, but production exceed pipeline capacity, at which time, there would be a window for crude-by-rail to move product from Alberta to wherever the consumer within North America. But at this point, it's not part really of a base case that we expect a lot of crude-by-rail pick up in 2017 anyway. But if there is, we do have the network and the locomotive power to do that, so we are in position to be able to do that. And if ever the Canadian grain crop is a little less than the average, that crude-by-rail would be a nice way to fill up the second and third quarter of 2018. At this point, it's a whole car that's -- we have to wait for the pipeline industry to be tight.

The next question is from Walter Spracklin from RBC.

So I guess, my -- I want to focus here on grain and the outlook here. I know most of your levers are pretty low on the Prairies right now. So my question is, how do you look at the -- your forecast versus a fairly significant comp from last year? How should we be modeling an average crop or the risk that it goes below average? And do you expect that to be aggravated by any share loss relative to a fairly strong share gain you had last year? So could you talk whether you think you're going to lose a little bit of share next year temporarily, if anything? And what the impact downside could be if we don't get any rain in the Prairies here in the near-term?

So if we take the usual half end of the year, it's J.J., in the third quarter, what really matter is how early is the crop? Is it coming -- is it harvested in early September, so we can move in September? Or was it coming in quite late where it's too late for the third quarter? When you get to the fourth quarter, every year, Mike's team railroad very hard because we know the crop is super big, well, less than average, everybody wants to sell grain in the fourth quarter, so we run flat out. Typically, the same thing in winter time. So the size of the crop is really a second and third quarter 2018 question, and that's really, I think, it's too early to tell. We will know by the time we have the third quarter result in late -- mid-October, we will know how big is that crop and then we'll know the story for 2018. In terms of share, I would advise that people not to bet against us. We're pretty competitive when it comes to the marketplace.

We -- let's just say, Walter, that we don't plan on losing share, so -- and the rest for us is all upside and when we're focused on growing the business, so we'll see how things unfold.

The next question is from Tom Wadewitz from UBS.

Just wanted to see if you had -- I guess, we've heard from CSX and they've talked about some people from another organization that knows about precision railroading, that some operational talent has come over to them. It's not really clear what level or whether that's from -- directly from you or former CN people. But I just wanted to see if you could comment on whether there are concerns about any kind of operational managers leaving and whether that's something you see at this point?

Tom, it's Mike here. Look, we've lost a few frontline supervisors. So really, the effect is small. And just so everybody's clear, my job, my team's job is to continue to teach, coach, develop people so that we can look down the bench and always have the right amount and the right type of people in line. And right now, I look down the bench and I'm extremely comfortable. So it's a compliment for others to come and emulate our approach and we'll continue to develop people and go forward, but no issue on our part.

Is there a way to kind of frame the magnitude of it? Like -- and it doesn't sound like something you're concerned about, but is there a way to say, out of how many people out of that level of -- is it 2 out of 30 people at that level or any way to kind of gauge it?

I guess I'd use the word not -- the words "not significant."

The next question is from Cherilyn Radbourne from TD Securities.

I wanted to give J.J. a bit of a break by asking Mike a question. Obviously, continued strong performance in accommodating the volume growth that you've had. And I think most of us in the call would have some familiarity with how mix can impact metrics like revenue per carload or revenue per RTM, but I just wondered if you could speak in a bit more detail about how you look at those 6 key operating metrics and assess them internally in light of volume growth and mix to assess how well you've done?

Okay, Cherilyn. Really, it's been a little bit difficult of a year in terms of trying to compare it to a previous, especially 2016. With the volume growth itself, the key components here that we -- where we look at, train speed, car velocity, locomotive productivity, locomotive utilization, those things are going to have an impact from that much of a volume growth. We've identified clearly areas that we've got to get closer in and diagnose the issue in terms of the train speed. We've identified some pinch points. But really, we'll do the same thing we always do, that's use an integrated team approach, use all the resources we have and really look at the existing plan and infrastructure and go from there. You can -- in terms of just pure productivity, our focus is on trainload, on how we handle cars and cost to put them through yards, whether it be an intermodal yard, or whether it be a switching yard. Those things never change, and that's something that's always right, front and center of us, if that helps answer any questions you have.

The next question is from Scott Group from Wolfe Research.

So I don't know if this is for Luc or Ghislain. I just want to ask more broadly kind of the way the model is working. So it's the second quarter in a row where revenue growth outpaced operating income growth. And is there, in your mind, something unusual in the past 2 quarters just given either something on the cost side or just the magnitude of the revenue growth? Or is this how you -- maybe we should think about the model going forward and maybe more as we kind of look to the back half of the year when revenue and volume growth decelerate into tougher comps, should we still think about operating income growth growing slower than revenue growth? Or do you think we should go back to maybe the normal way of thinking about rails where you see some operating leverage and operating income growth exceeds revenue growth? I know, a long question, but hopefully, you...

Scott, thanks for the questions. It's Luc. Listen, we don't think that there's any significant change. It's really a question of mix and how much business is coming onboard. In addition to that, there are occasionally one-time items that can cloud a little bit the analysis. So we still think that the historical model does work. From time to time, what will happen is you're bringing onboard a significant amount of volume. So in that sense, your incremental margin is now going to be even and progressive. So I think that's a little bit of what we've seen. But if you take a step back and look at the first half of the year, our incremental margin is probably sitting around 50% or something like that. And when we look at the back half of the year, Mike is in a good position to continue to improve on the operating metrics, and we feel pretty good that we can see potentially a little bit more operational leverage kicking in. So -- and the nature of -- the mix and the nature of what we're bringing on, a lot of it has been long haul business, unit train, and in many cases, customer cars. So that also will tend to create some noise in terms of if you're looking at the revenue yield versus the operating profit yield. But we feel comfortable that there is no fundamental change in the model and the way we look at the balance of the year and the way forward.

And Scott, this is Ghislain. I would also say that, as in my remarks, that we had a little bit of a spike up on a year-over-year basis on incident costs by about $21 million. So again, that is reflected in the numbers. But to emphasize Luc's point, I think the model is working.

The next question is from Turan Quettawala from Scotiabank.

Go ahead, Turan.

Sorry, I was on mute. So I guess, my question was on the fuel lag here. I was just wondering if you could talk about whether that started to benefit you at all at the end of the quarter and maybe if there's something that could benefit you in Q3? And is it going to be enough potentially at current prices to offset some of the FX impact?

Turan, this is Ghislain. So as I mentioned in my remarks, fuel lag helped us by $20 million or $0.02 in the second quarter. And that in the third quarter, very, very small. I would say, we're looking possibly at a positive lag at this year of about $10 million. So -- and there was nothing last year. So on a year-over-year basis, you could be talking about $0.01 in the third quarter.

The next question is from Ken Hoexter from Merrill Lynch.

Can you just maybe, J.J., talk a little bit more about intermodal. I think, you mentioned a new Regina container program for grain. Are you focusing converting bulk traffic over and away from the highway? And maybe talk a little bit about the benefits of the tightening U.S. truck market, if you're seeing that on growth opportunity yet.

Okay. So the initiative in Regina has to do with balancing the extension we have at Prince Rupert and at Deltaport to offer the shipping line a revenue that makes sense for them. We need to offer them not only just a good destination but also some revenue on the way back. And in Southern Saskatchewan, there's just big growth on the specialty crop. Most of them are sold overseas; a lot of them are sold in containers. So 2 products we're going to be offering in order to do that. One is this summer. Ray-Mont Logistics will have its transport facility completed by the month of August in Rupert. They will be able to receive full unit train of specialty crop from anywhere in the Prairies of the U.S., to loading container at the port itself. And then, by the summer of 2018, we will be able also to receive loader container or specialty crop to be loaded in Regina, which is much closer to where the products are being grown. Regarding the question on trucking, I guess it's almost like a capacity and price question. We're not really seeing yet the tightening of the marketplace within the highway, at least on what we do, which is mostly repeat contract business, not spot business. That's actually driving price yet on domestic intermodal. So at this point, that's, I guess, it's something to come, but not there at this point. If that helps, I can...

Yes, it does.

The next question is from Steve Hansen from Raymond James.

My question is on coal specifically. We've seen a pretty significant mix shift of late that, I think, you described in your remarks. I'm just curious about your outlook here, the met side in particular and some of the traffic that's coming out of the northeast part of British Columbia, and what we should expect into the balance of the year and next year.

Thank you, Steve. So the Canadian coal that we moved to the West Coast is mostly met coal, some thermal coal but also met coal. We also do quite a bit of petroleum coke from Northern Alberta, which is also in our coal result; pet coke is mixed in our coal result. So those business, whether it's pet coke from Fort McMurray, or Canadian coal from Canadian coal mine in B.C. and Alberta, I would describe them as steady. So now, we're at a cruising phase, and the sequential volume will probably stay at this. When it comes to U.S. coal, it's one of our question mark for the fourth quarter. So why we're not sure yet how much growth we will get in the fourth quarter in total is related to U.S. coal, is related to U.S. grain and how that will pan out because the U.S. crop doesn't look fantastic. And the crop in South America looks great. They have a lot of product, and we don't know if we were going to be competing to move corn and soy beans to the Gulf by unit train, or will a lot of that will end up moving by barges on the Mississippi since the Mississippi barge rate are quite low.

The next question is from Brandon Oglenski from Barclays.

I guess, I want to revisit Scott's question maybe in a different way. When we were at the Analyst Day last month, you guys focused a lot on the intermodal opportunity. So I guess, just thinking into next year, if you're going to see mix more from intermodal outgrowing rest of the business, could this be a potential source of margin headwind as we would think about, especially with the Canadian dollar strengthening? And could be 2018 maybe a continuation of the themes we've seen in '17?

Thanks for the question, Brandon. It's Luc. Listen, again, we don't really see that as taking shape. We've always said that the margin on the intermodal business is on the average for the book of business. So in that sense, we don't see a significant shift. And again, we've got the structure to actually take on the volume, so we don't foresee a significant change.

The next question is from David Vernon from Bernstein.

Luc, I wanted to kind of hit a little bit on the same topic. It does look to me like the incrementals, if you strip out the favorable benefit of the pension and even a little bit of the currency, you're running closer to 20%, and yet, your volume growth is running at the high end that we've seen over the last 10 years. What is it that's taking away the normal volume-driven leverage we would expect to see? I mean, if you're getting price above inflation, this kind of volume-driven leverage, I would've just sort of expected a better operating income result.

Yes, David, let me take a step back and kind of walk you through this a little bit because this is a question that's come up a couple of times, and I think we want to make sure people get a clear sense of what's going on. A lot of the growth that we've had is actually been very much long-haul business around coal, around...

Potash, frac sand.

Potash and frac sand, and so on and so forth. So it's very good growth but it's long haul. It's also, as I mentioned earlier, customer equipment. So when you look at the revenue, what you're going to get is you're going to get a lower revenue yield. So that's not a factor of weak pricing. That is a factor of the revenue we charge for the book and haul business, and a lot of it is unit train as well. So that is -- we have to disassociate that from the cost structure because the cost structure for moving that business is, in fact, lower. You don't have to pay for the car supply, and we do have a very good margin on that business. So in effect, if you look at what's happening in terms of the operating ratio and leave aside some of the noise which Ghislain referred to, which may happen from one quarter to the next, in some cases, you've got FX, you've got fuel, then you've got some of the casualty costs that can distort a little bit your quarterly numbers. But on the whole, as I mentioned earlier, when you look at the first half of the year and our incremental OR is 50%. So we were not seeing a shift away from profitability. What happens is the mix and the nature of the business we're picking up is leading to very strong GTMs and RTMs and -- but the revenue profile is different. So I think that is something that certainly was present in the first half of the year. Probably, we're not going to see as much of that in the second half, but there will be some. So you kind of have to work your way through the nature and the mix of business, and you have to look at other metrics, not just your revenue yield, to assess the quality of what we're bringing onboard in terms of growth as well as our efficiency numbers. So when Mike looked at some of the operational productivity numbers, again, they're solid when you compare against similar work levels and volume levels back to 2015. So when you look at all of the other measures, you should gain some comfort that there isn't something going on here where we're bringing on what I would describe as low-quality growth. That's not the case. And I mean, again, the team is very much focused and very -- we want to bring in good business onboard, but we also -- as I said, it can be lumpy. So in this quarter, we picked up a lot of business, and so did we in the first quarter. And the team -- the first mission for the team is bring it on, make sure that the levels of service are good and then we kind of look at grinding it out. So we're constantly looking for opportunities where we can not only lower the cost of servicing the business, but as a matter of fact, how can we enhance the service levels? So you will see that taking place. And that is why I think, longer term, we don't feel that we turn -- we have to turn business away. We have confidence that we can do it. We don't -- and J.J. showed you what the pricing levels are. So we're very thoughtful in pricing the business and attracting good business and then working it through to maintain the profitability levels that have made us the leading Class 1 in the space. So all that to say, we feel pretty good about where we are and we'll continue to crank out these numbers on the way forward. And probably, you'll see a little bit less of this pattern, but it will -- there will still be some, certainly, in the second half of the year.

And maybe just as a quick follow-up to that. As you think about grinding up, is that a question of rewriting the contracts, or is it a question of maybe just getting it more ingrained in the operation and catching up a little bit on the productivity side?

Yes, it's not rewriting the contract, trust me. It's the innovation. It's pushing the envelope. I mean, this is what Mike and his team excel at doing day in and day out. So it really is looking at where and how can we improve, as I said, on the 2 key dimensions that we always focus on, efficiency and service. And we -- the team's mission and the team's mandate is not to achieve one at the expense of the other. So that's what you have to look at, and keep your eyes on the team. That's what they do best.

The next question is from Chris Wetherbee from Citigroup.

I wanted to talk a little bit about the volume cadence in the back half of the year. So I think you've had a couple of comments about some of the things that could be variables, particularly to the fourth quarter. But when you look at the RTM guide and your progress so far, I guess I'm just curious, what is the risk to the fourth quarter in terms of actually seeing negative RTMs and maybe what are some of those major variables. I'm guessing grain, and I think you mentioned U.S. coal could also be part of it, but I just wanted to get a sense maybe with some more detail about what some of those moving parts could be in 4Q?

Chris, it's J.J. When we get to the fourth quarter, one of the thing we're unsure of at this point, one is U.S. coal, U.S. grain, the crop, but also whether they move on the long-haul railroad or short-haul railroad. Sulfur is also a question mark for us, either liquid or going to the U.S. or dry going to the coast. So it's really typically on the bulk side. And potash, Uralkali and Canpotex have both settled their contract with the Chinese, which means now that all contracts will be settled for all other countries. But we don't know whether or not we will have the same record potash moved that we did last year in the fourth quarter, which was very strong. And by the way, that's an example of where Mike has rewritten how we do business. When we move these potash trains from Saskatchewan to St. John, we now move them in 205 cars. Nobody moves train of 205 cars in North America. So obviously, your cost per unit is down. That's how we can compete on a lower cent per RTM and make money despite of that. So the fourth quarter question mark is more about the bulk side and whether or not we will have below last year or surprise ourselves and be as good or maybe better than last year. We feel more confident about the rest of the economy.

But as it stands, you got positive RTMs into your model for the fourth quarter?

Yes, some. And then, the place in the model where we have negative RTM is bulk-related and the uncertainty of other commodity, which I talked about.

And clearly, Chris, I mean, it is tapering down. There's no question about that. But we don't -- as J.J. pointed out, we don't see negative RTM growth, but there is a tightening up that will take place in the fourth quarter. So far, the third quarter is looking good.

Yes, first 3 weeks is pretty good.

So we'll have to walk it home.

The next question is from Konark Gupta from Macquarie Capital Markets.

Just a question on metals and minerals. I guess, frac sand, iron ore and steel have driven the segment so far this year. So where do you see trends in those commodities in the second half in 2018? Is there any stickiness basically in the existing frac sand business if growth and drilling activity slows down more materially?

Yes, it's J.J. So yes, there is stickiness in the frac sand business. We foresee frac sand sequentially stay at the rate where it is right now. They'll eventually [relap], but we have very strong second quarter in frac sand, and if it sequentially maintain that rate, it's very positive. When you look at the CN M&M, metals and minerals category, where you have frac sand into that, you have steel, you have mineral, you also have iron ore, but the one that really is driving this category year-to-date is the frac sand, and we believe the frac sand will hold.

The next question is from Benoit Poirier from Desjardins Capital Markets.

J.J., a lot of color about the currency impact on translation and also on the EPS, but when you talk to customers, I was wondering if you could point out the strength of the Canadian dollar, whether you see some potential impact on some commodities and whether it makes the Canadian ports losing some of their competitive advantage? So talking about grain, coal, forest product, whether it could impact some volume in the longer term?

Yes, thank you very much. So it's still early on. It's what, a couple of cents, maybe up to $0.05, I don't know if the Canadian dollar will go up from this point or stay where it is. No, I don't think -- we don't have customers at this point where those $0.04, $0.05 is going to have a material impact on their sales to the United States or sales abroad. Now frankly, at $0.70, $0.72, Canadian dollar is quite weak, too. So one would not think the Canadian economy has to rely on such a weak dollar. I think, at this point, I mean, this is not a huge change, a couple of cents, from the point of view of our customers and their production costs.

The next question is from Brian Ossenbeck from JPMorgan.

So Ghislain, going back to the Investor Day, you said the cost of train control would increase and it wouldn't be a small number. So Mike mentioned hiring some people for technology and PTC. Where does the OpEx and G&A stand related to that system right now? And where do you expect that to settle out when everything's online, call it, 2018 first half, subdivision is done in 2020, when everything is wrapped up?

Yes. Thanks, Brian. When you look at PTC this year, I think what we're looking at is possibly about $120 million. 1/3 of that would be depreciation. And in terms of the future years, I think we're not going to provide guidance for the future years. I think we're very focused and the team is very focused on delivering. And we're in the thick of it and we're advancing, so it's good. And we'll see. And frankly, we need to deliver PTC first before we know, once we're there, how much it's going to cost us to support it. But we know this year that it will be $120 million. 1/3 of it is depreciation.

The next question is from Justin Long from Stephens.

I know it may be a little bit early for this question, but I was wondering if you had any thoughts or expectations on this year's peak season, just given some of your port capacity expansion projects. I thought you might have an early read. So I'm curious what you're expecting and what's baked into your guidance for the back half of the year?

Justin, it's J.J. I think for us, for this year, especially this year, the fact that Rupert's capacity should be available to all of us by late August in Deltaport, sometime in the fall, might be more relevant than the fall peak itself, because now we have the ability to access a lot of capacity. And the question will be whether or not CN, (inaudible) and GCT collectively would have been able to sell some of that as early as August, September, October, November. So we are planning for significant growth in, obviously, intermodal related to fall peak, but more about the capacity available to us now that premarketing that we did about the service that we collectively offer, including the service that we have on the south shore of Vancouver, which already has huge -- been a huge help to us in the last 6 months.

Okay. Great. But maybe to just follow up, as you strip out the capacity additions that you have planned, does it feel like the underlying demand environment as it relates to peak will improve this year relative to last year?

I wouldn't say so. No, I don't think the peak this year will be of a different trend or bigger than last year. But the Canadian economy right now is doing fairly good. So I mean, the consumption by the Canadian consumers and the U.S. Midwest and U.S. mid-American consumers seems to be solid and good. And obviously, we've benefited from that as well.

The next question is from Allison Landry from Crédit Suisse.

Thinking about the guidance for the 10% RTM growth, it's basically implying a full year number, which is, I guess, slightly above the peak that you saw in 2014. So are you at the point where you're basically really needing to think about ramping up resources? And is it fair to say that you're potentially approaching capacity levels? Mix, I know, is a factor, but any way you can help us think through this would be helpful.

Yes, Allison, this is Ghislain. From a resource standpoint, we do and we are hiring. I mean, if you look at the end of Q4 2016 versus the end of Q1 '17, we added about 300 people. And our labor productivity in terms of million GTMs per employee was up 14%. When you look at the end of Q2 versus the end of Q1, we've added another 540 people, and again, our employee productivity was up 14%. So we are adding people. We said we were going to do that, and we have to do that a little bit in advance because there is a lead time to train these folks, whether it's our crews or whether it's engineering or mechanical folks. So we're trying to be ahead of the game. But obviously, as you can see from these statistics, we are not adding one for one. So we are absorbing. And then, I'll ask Mike to settle in on capacity. Mike and I and J.J. are connected very close at the hip. We're looking at volumes coming. We're always working together to see potential pinch points, where they are, and we want to be ahead of the game. We want to be investing before it happens, but we don't want to do that too early either. So we are currently investing to support our intermodal business. We are investing to support our growth in frac sand. From a capacity standpoint, we will continue to look at this and do that next year. So I think that it's a lot of volume coming at us, so we're pleased about the work that we've done. We're pleased about the fact that we've been able to absorb, and we'll continue to absorb some of that volume, and we're pleased about the fact that we're trying to stay ahead of the game in terms of our investment.

I can't add a whole lot since Ghislain said most, but I'll refer to what Luc was talking about. Allison, we really -- we clearly diagnose whatever the issue may be that's creating what we might see to be a pinch point. And before we spend, we look internally, whether it's infrastructure we already have, whether it's some innovative way to approach it, but that's been our template for a long time, and that will continue. But to Ghislain's point, we know the areas that we've seen extreme growth. We know the areas that we've seen train speed drop to a degree. We definitely come together as a group and we've identified a lot of things we're going to do, and we'll see where that takes us and we'll do what we have to do in order to service the customer the way they expect and need and the way we need to keep the cost down.

And Allison, just to put icing on the cake here, you're getting all 3 for 1. I would say -- it's Luc. I would say that what we constantly do is we triage and we prioritize where we see the most leverage and the most opportunities for deploying capital. So that is always what we've talked about is within the scope of our capital envelope. And what we do is we prioritize depending on where and how we see the opportunities. So you shouldn't expect a significant shift in the profile of our CapEx over time. It should be in line with what we've described at the Investor Day.

The next question is from David Tyerman from Cormark Securities.

Yes. So just following up on the comments on hiring. So should we expect hiring to continue at 300 to 500 people additional, or does it slow down quite a bit as the volume growth slows down?

Listen, I think I'm not going to give you, David, a specific number of what we're going to do, is continue to -- we will hire. We're looking at what's ahead of us, but we'll not hire one for one. So that's the key, and we're going to continue to absorb some of that volume with the service and the operations that we have. So...

All right. Well, thank you for the questions. Obviously, we're very pleased and we're very proud of our second quarter results. I think they continue to support what we have been doing for several years in terms of advancing our strategy and gaining traction in the marketplace. And we continue to see future growth ahead of what the base markets can bring to us. We've got a lot of good initiatives going on. Our offering in the marketplace is resonating with customers. So we feel good about our ability to attract, retain and work through -- efficiently work through the business that we're bringing onboard. So a good quarter, a very good quarter, actually, when you look at these numbers. And I think the year is shaping very well. And again, we're restating our guidance and we're staying, in spite of some of the changes in currencies and other little headwinds, we're staying the course. So we're looking forward to bringing you up to date when we have our third quarter call. And in the meantime, thank you for joining in and we'll see you later.

Thank you.

Thank you. Have a great summer.

Thank you, Patrick.

You're welcome. The conference has now ended. Please disconnect your lines at this time, and thank you for your participation.