Canadian Pacific Kansas City Ltd (CP) 2006 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Canadian Pacific Railway second-quarter results conference call.

At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue up for questions. (OPERATOR INSTRUCTIONS). I would like to remind everyone that this conference call is being recorded on Tuesday, July 25, at 11 AM Eastern time.

I will now turn the conference over to Mr. Paul Bell, Vice President-Investor Relations of Canadian Pacific Railway. Please go ahead, sir.

Thank you, Melissa. Good morning, ladies and gentlemen. Thanks for joining us on our 2006 second-quarter teleconference.

The presenters today will be Fred Green, our President and Chief Executive Officer; Marcella Szel, our Senior Vice President of Marketing and Sales; and Brian Grassby, our acting Chief Financial Officer and Controller.

Before we get started, let me remind you that this presentation contains forward-looking information. Actual results may differ materially. We make reference to assumptions used in our guidance, and we provide sensitivities to these assumptions in the appendices, which can be found on the last section of the presentation material. The risks, uncertainties and other factors that could influence actual results are described on Slide 2 in the press release and in the MD&A filed with the Canadian and United States Securities regulators. Please read carefully as these assumptions could change throughout the year.

I remind you that all dollars quoted in the presentation are Canadian unless otherwise stated. This presentation also contains non-GAAP measures, so please read Slide 3. The slides are available on our Web site, so please follow along.

Here, then, is Mr. Fred Green.

Thanks, Paul, and good morning, everyone.

Let's begin by turning to Slide 5. This was a tough quarter for bulk volumes with over $70 million less revenue versus last year due to short-term market softness in coal and potash. The team responded appropriately with a focus on cost-containment and the continued pursuit of sustainable yield. Our scheduled railroad also delivered some stellar service improvements.

Costs were in line with my expectations, particularly equipment rents. We sold our Latta subdivision as planned, and the change in tax rates helped EPS in the quarter.

Our operating ratio improved 40 basis points to 75.1 in Q2, bringing our year-to-date operating ratio to 77.2, an improvement of 160 basis points from the first half of 2005. We delivered 15% EPS growth, despite serious bulk revenue headwinds, and although I am satisfied with the results, given the bulk situation, there is much more opportunity for improvement.

Looking at operations, if you will turn to Slide 6, you can see that we posted some impressive year-over-year improvements in operating performance, driven by our focus on execution excellence. In the top left-hand chart, you can see that our train speeds improved 14% in Q2 versus 2005. We continue to leverage our infrastructure and coproduction capacity initiatives, delivering greater fluidity to our operations.

The top right-hand chart depicts a 26% Q2 improvement in terminal dwell. In the bottom two charts, you can see the impact of this success. We've improved our car velocity by 8% and we've reduced our average cars online by 7%, which has driven down our equipment rents.

Our scheduled railroad has also improved service consistency. Our intermodal trains were 97% on time in Q2, and our merchandise trains are now running at 93%. The railway has never run better, and we are on track to hit our operations expense reduction targets of $35 million by year-end.

Moving to Slide 7, during the quarter, we implemented the second phase of our scheduled railroad, moving from executing the integrated operating plan to operating in balance. The balanced IOP is basically a plan to run the same number of trains in each direction each day the week. To give you a sense of what running in balance means, we saw 1000 less taxis and 700 less deadheads in June alone, the first full month of operation. We are now pushing opportunities to increase average train weights by taking pairs of trains, and this will progress as the third quarter unfolds.

Phase III, the bulk IOP, will also begin later this quarter, which will introduce even more discipline to the system. Finally, in Q4, we will begin applying a smoothing strategy to our local pick-up and delivery services.

Our yard dwell performance continues to improve. We're rolling out our fluidity initiatives to ten locations this year, and I expect we will beat our tough second-half (indiscernible) shaving another 5 to 10% off yard dwell.

Finally, I should mention that, during quarter two, we took advantage of lower volumes and chose to pull forward some expenses. We advanced vacations of train crews and we accelerated our engineering programs. We are poised for a busy second half, and we have the ability to move record volumes.

With that, I will turn it over to Brian for some details on the financials.

Thanks, Fred.

Please turn to Slide 9 on the income statement. Marcella will review freight revenue in detail in a moment.

Other revenues were up 9 million. The key piece was the sale in the Latta subdivision. This is largely timing and year-end other revenues are still expected to be in the 140 million range.

Total freight and other revenues were up a combined 25 million or 2%. Excluding the impact of the strengthening Canadian dollar, which cost us 39 million, total revenues would have been up 6%.

Operating expenses were up 2%, and operating income was up 11 million or a 4% improvement.

Below the operating income line, other charges are up 2 million, as expected. Interest expense is down due to our U.S. dollar debt position and the stronger Canadian dollar.

Our income tax rate declined t o 29% from 34% in Q2, 2005. This was due to the new federal and provincial tax legislation, which took effect in the quarter, as well as other tax-planning initiatives. The tax rate for the full year will be in the 30 to 32% range, down from the 32 to 34% that we originally indicated.

Rounding out GAAP earnings are 41 million foreign exchange gains on long-term debt and a 176 million gain from the income tax changes. So our reported diluted earnings per share came at 2.36 or a 207% increase versus 2005.

Turn to Slide 10, and I will reconcile our EPS growth, which excludes the foreign exchange gain on long-term debt and the 176 million tax gain. Starting on the left, wage and benefit inflation is running in the 3 to 4% range, in line with expectations. Once you add the 10 million of increased pension expense, the total EPS impact is $0.09. Depreciation dropped the EPS by $0.04. The net volume and mix change hurt us by a further $0.04. The early quarter exposure of our stock-based compensation, prior to implementing our total return swap, combined with 2005 property and sales tax credits, impacted EPS by $0.06.

More than offsetting this was the income tax change and other revenues contributing $0.11. Our strong yield program, offset slightly by our net fuel exposure, added a positive $0.18. Our initiatives, namely the headcount reductions, the scheduled railroad and coproduction, saved 23 million or $0.10 EPS. Finally, the negative impacts of foreign exchange and some other small items rounds off $1 of EPS.

Overall, our team performed well, both operationally and on the yield front, overcoming volume and inflationary pressures and delivering 15% EPS growth.

Now, let me give you more detail on our operating expenses, on Slide 11. Compensation and benefits was marginally down on the quarter. I will give you more details in a moment. Fuel was up 15 million or 10%, a combination of higher WTI prices and refining margins, a reduced hedge position and lower volumes. Materials were up 9 million or 19%. This can be attributed to inflationary pressures and increased wheel changes. The scheduled road improvements show up on the equipment and rents line with expenses down 10 million or 19%. Also with coal and potash volumes down, we subleased excess railcars and tied up locomotives.

Depreciation expense came in as expected and will be about 7% higher than 2005 on a full-year basis. And, improvements from [coal] production was offset higher casualty cost and inflation purchase services. So overall, once you strip out the impact of fuel price, operating expenses declined 2%.

Go to Slide 12 and I will give you more detail on compensation and benefits. Wage and benefit inflation came in as expected and cost us 10 million. The 10 million increase in pension expense, quarter-over-quarter, reflects the current annual service costs of 70 to 80 million, which is up from 40 million in 2005. Stock-based compensation cost us 8 million. As the total return swap was only implemented mid-quarter, we were exposed to the early-quarter changes in the stock price. Going forward, the total return swap will limit the impact of share price volatility at a minimal cost.

Our scheduled railroad efficiencies and lower volumes reduced crew costs by almost 5 million. Our program to reduce management and administrative positions saved approximately 10 million. This is in line with our stated run-rate. Foreign exchange benefited the quarter by 8 million and some other small expenses round things off. All in all, we're pleased with our progress on cost control. Our initiatives are taking hold, and we are ready for the rebound in coal and potash.

I will now turn it over to Marcella, who will take you through the revenue story.

Thanks, Brian. Let's go to Slide 14 and freight revenues. Total revenues were up 2%. Breaking this apart, strong pricing, including fuel, pushed revenues up by 8%. Soft markets in some commodities reduced revenues by 2%, and foreign exchange negatively impacted our results by almost 4%. All-in, we had some tough headwinds from coal and potash, but the marketing team drove positive results in other segments of the business and remains focused on our quality revenue game plan. That is targeted growth in key markets and price improvement.

Turn to Slide 15 and the commodity results by line of business. We had an impressive quarter for grain, up 19%. This growth is directly attributed to our improved service resulting in more equipment supplies, plus strong Canadian export grain shipments. U.S. grain volume was up slightly as we moved more export corn and soybeans. Coal revenues were down 28% or $55 million. As you know, Elk Valley coal lower their forecast a number of time since November, resulting in reduced export and eastbound volumes. On the U.S. side, the Latta sale, which was completed in May, reduced short-haul carloads by almost 4,500 units for June. A full-year Latta run-rate is approximately 54,000 units, of which 40,000 are coal. Sulfur and fertilizer revenue was down primarily because of the deferral of export potash volumes. On the upside, we had a good quarter on price for our other fertilizer shipments and some healthy growth in domestic sulfur markets.

Revenues were down 12% in forest products. Soft markets for lumber and panel as well as shutdowns in the paper and pulp sectors, are the issues. We have told you before that this sector is extremely sensitive to the rising Canadian dollar, and we are seeing the impact.

Industrial products revenue was up 18% or 23 million, driven to a large extent by the Alberto oil sands activity. We saw strong inbound volumes of steel, pipe and aggregates and increased petrochemical volumes. This segment is a good example of our targeted growth efforts.

Autos were a good news story with revenue up 12%. We saw steady growth in our Toyota and Honda business and some uptick on the domestic side due to strength in the marketplace and increased demand in Alberta.

Intermodal revenue was strong for both domestic and international. Volume growth in the core segments was good with domestic retail up 10%, and we saw solid yield results continuing.

On the overall yield front, our pricing programs continue to deliver results. Contract controls were typically in the 4 to 6% range, and fuel recovery also improved. Revenue per revenue ton-mile was up 8% on the quarter or 12% FX-adjusted. Despite the marginal drop in our coal rates, we are on track to achieve our same-store price targets for the year. Overall, no slow-up in yield.

On Slide 16, I will give you some insight into the market and full-year revenue outlooks. On the grain side, the Canadian crop is looking very good. Moisture conditions are excellent, and our program is set up to move a lot of grain. We are modeling the crop to come in around normal production levels, and coupled with a large carryover from the '05-'06 crop and strengthening export projections by Ag Canada, we are anticipating a strong second half. U.S. grain is less certain. Some of the crop needs moisture and we're keeping a close eye on this area.

For coal, our outlook is firming up. Year-to-date volumes have been extremely soft, but we believe the worst is behind us. For those of you who track car loadings, you'll note that already the first two weeks in July, we've improved 800 to 1000 carloads per week above our Q2 average. Driven by improved exports, we now expect Canadian coal volumes to be slightly stronger than the second half last year. We continued to model within [EVC's] guidance of 22 to 25 million metric tons sales.

Now, looking at coal on a full-year basis, remembering the decrease carloads from the Latta subdivision sale, we are forecasting our year-end volumes to be off 10 to 15%. We like the medium to long-term fundamentals of the MetCoal business. Both Elk Valley and the export coal terminal continued to spend capital. Elk Valley has spent 170 million to increase mine capacity and (indiscernible) plans to spend over 40 million to expand their facilities. We are encouraged by Elk Valley's new CEO, Boyd Payne is an established marketer coming over from BHP Billiton, where he was responsible for their coal marketing and sales activities.

On potash, we are encouraged by the fact that the Russians have finally settled their price negotiations with China. We are optimistic that the Canadian producers will settle very quickly. Once this happens, we expect to move all the potash they can throw at us. We are now modeling full-year exports to be about 85 to 90% of last year's levels. Significantly, total potash fertilizer and shipment (indiscernible) sulfur revenues for the second half should be up double-digit versus 2005. As I mentioned previously, both our potash customers and the port terminal operators have invested over 400 million to grow their capabilities, which demonstrates the solid fundamentals of this business.

In merchandise, we expect mixed results. Forest products, with plant closures hurting the paper side and soft market in lumber, are generally weak. Lumber and panel may see some recovery in the fall.

On the industrial products side, we expect solid second-half revenue growth in steel, chemicals and mine products. Volume growth will be muted by the decision to exit low-yield business.

In automotive, year-to-date growth rates will moderate a bit due to the impact of some of the 2006 plant shutdowns announced by the Big Three, but we are modeling to finish the year higher than 2005. And looking beyond this year, our recently announced arrangement with Toyota to serve the Woodstock, Ontario plant is very positive news, worth an estimated 20 to 30 million in annual new revenues, which will start in 2008. If Toyota does what they have done to many of their new plants -- that is, double up their new production -- there could be significant additional upside.

Finally, we believe both international and domestic intermodal will remain solid. We are well-positioned to handle growth, and we intend to lever volume growth through the West Coast of both U.S. and eastern Canada. There is ample capacity at the Port of Vancouver for future growth, as two key partner facilities have just completed their expansions, increasing handling capacity by over 30%.

So, to wrap up, we have more certainty in coal. The Canadian grain crop looks strong and on August 1, we're raising our rates by 6 to 6.5% on regulated grain. Potash looks as it will break very soon. Our service is excellent, and price yield remains positive and sustainable. Overall, we continue to model full-year freight revenues up 5 to 8%.

Back to you, Fred.

Thanks, Marcella.

On Slide 18, you'll recognize our shareholder frame. We've revised two key assumptions. WTI is now forecast to average US$76 in the second half. This brings the annual average fuel cost to $70 per barrel, up from our original $58 estimate. On currency, the Canadian dollar is now expected to average $0.89; this is up $0.04 from the start of the year. These changes negatively impact 2006 by $0.14 per share, versus our original assumptions. Despite these impacts, we still expect revenue growth of 5 to 8% with our forecast now at the lower end, given the past coal softness and potash delays, and our 2006 EPS forecast of 3.60 to 3.85 remains unchanged.

Now, please turn to Slide 19 and we will wrap up. This quarter, we endured some serious blows and the team still delivered solid EPS growth. (indiscernible) the long-term the market prospects remain very positive and we have the infrastructure in place to take advantage of anticipated growth opportunities.

Ladies and gentlemen, our scheduled railway is enhancing fluidity, driving expenses down, and supporting yield growth. You can expect this trend to continue.

Operator, I will now turn it back to you and we can answer questions until five minutes to the hour. Please state your name and limit your questions to two. Then we will go to media.

One moment, please. Ladies and gentlemen, we will now conduct the question-and-answer session. We will take questions from analysts first, followed by the media. (OPERATOR INSTRUCTIONS). Tom Wadewitz, JPMorgan.

Yes, good morning. Fred, I wondered if you could give a sense. You kept the range despite some of the revenue pressures in the first half. I think, if I heard you quickly, you said the revenue might be a little bit at the lower end in your guidance range, but you didn't really comment on where EPS might be within the guidance range. Can you offer any thoughts on that, just in terms of where you might see EPS within that guidance range -- low, high, you know, end of the range?

Tom, we're not going to guide within the range. I appreciate the question but we're just not going to go there.

Okay, did I hear you correctly, though, on the revenue side, you expected a little bit towards the low end of the range?

That is correct.

Okay. How much confidence do you have on the coal and potash volumes coming back? It sounds like you have pretty good visibility to that. In terms of the operating leverage you would see on that, would we be fair to think that you would see pretty good expansion of the margins and pretty good operating leverage as those volumes pick up?

Tom, let me break it into two pieces. The first would be, with regard to our view on the two key marketplaces, it is increasingly apparent that the coal activity, as Marcella stated, has picked up in the last two weeks, and through our dialogue with our major coal, MetCoal client, it's our understanding that the activity level in the second half of the year will be consistent with what Marcella said -- slightly above what we experienced last year. So that is really firming up for us and we are mobilizing our assets to take care of that opportunity for ourselves.

On the potash side of things, as Marcella said, the Russians -- and that includes Belarus as well as Russia -- have now settled. We saw rumors yesterday -- I don't know if it's firmed up yet -- that Israel, which is a very small player but a potash producer, has settled and it is our expectation now that the global price has largely been established, that the Canadian team will be doing their best to very, very quickly settle up. So we are poised. We're not going to spend any money until we've got confirmation, but we are poised to move an awful lot of potash over the coming days, weeks and quarters.

Now, sorry, Tom, I forgot the second part of the question.

I was just saying, I mean, how much confidence do you have that as that comes in that you would really see some strong operating leverage and that that increased volume on coal and potash would translate into stronger margin improvement than you saw in the second quarter?

Well, again, I think the proper way for me to respond to that is again to be consistent with what we've said in the past. We wouldn't comment on the profitability of any segment of our business versus others, but there are those who believe that the potash and the coal and other bulk commodities, because of the nature of solid 120, 130-car trains moving in a very fast cycle to and from the coast, could be pretty attractive to us. So I will let you reach your own conclusions about the profitability and the value, but we are excited to have the business back.

Okay, thank you.

Robert Fay, Canaccord Adams.

Just two things -- Marcella, I just wanted to confirm with you that you are expecting grain rates on regulated Canadian crop to go up by how much?

By 6 to 6.5%, Bob, is the increases that we're putting in place effective August 1.

Okay. A second question -- could you comment a little bit about the intermodal side, and I guess whether or not you are seeing any smoothing out of the peak cycle that occurs in the fourth quarter?

We are in fact looking to smooth out the peak cycles into the fourth quarter. We are always -- we're going to have a peek into the fourth quarter but with our balanced IOP, with our management of our intermodal terminus, we are working to smooth that out. We are going to be in fact forcing some of that smoothing to occur and we're working with our customers on an ongoing basis, going into the peak, that they're going to be comfortable with the way we move the container.

Okay. The last question, if you could give us a little bit more -- if Brian could give us a little bit more color on the equipment rent and the run-rate for the rest of the year of the different cost levels. Is there any unusuals in the quarter in any of the cost items?

No, it's a fairly clean quarter. I think, with the IOP initiative driving it, it was a very strong quarter on it. We expect (indiscernible) the balance of year with the volumes going up. We expect to be in the 45 to 50 range for the balance of the year.

Okay, thank you.

Ken Hoexter, Merrill Lynch.

Good morning. I just wanted to kind of go over a couple of things. One, let me just wrap up on the potash. Fred, how quickly when the contract is signed, does that turn into volumes moving?

Ken, I would think in hours. We are poised, ready to go. We want this business.

Okay, great. I just wanted to understand the timing there.

Then on the comp and benefits, you noted that you kind of pulled forward some expenses as some trains were or volumes were a little bit light. Can you quantify the comp and benefits? Because they actually looks like you did fairly well on the comp and benefits expense line, so if you're pulling forward even some more fixed expenses from the back half of the year, I just want to understand that potential ramp there.

Ken, this is Brian. No, I mean we pulled -- what we did was we advanced certain vacations and that was impacted of roughly 50 to 75 crews so that they would take their vacations earlier versus later in the fall, as well as the engineering programs not impacting expenses, but really impacting capital to a degree and we advanced those, again, to make sure that we are ready for the return of coal and potash. But we're not talking about material expenses.

Just for order of magnitude, you will recall that, over the quarter, because we had hired and trained people, anticipating the volumes but it appears as though we will now see -- we had up to, at one time, 425 people laid off, so there was -- at the end of the quarter, we probably had that number down to 200-ish, plus or minus 25. So of those, almost half of that, 100-plus people, had been advanced. We brought them back to -- sorry, we put them on vacation is a better way to say it, so that they could get their vacation days out of the way prior to the big peak of activity that we anticipated, and it looks like it's going to happen starting pretty soon.

Great, thanks.

Randy Cousins, BMO Capital Markets.

Two questions -- I wonder if you guys could comment on the inventory position at the docks for both coal and potash. Is it going to take some time to -- do the customers have to clear some dock inventory before the trains really get to move?

Well, let me just speak first on the coal side. I don't know if you read Jim [Popowich's] comments on their quarterly call, but he observed they had about 3.5 million tons of inventory, which is spread across the various ports, both in Canada and other countries, at their mine sites and even in railcars. So we work with them to manage their inventory levels. It's not just a simple case of depleting an inventory; it's a case to quality and the type of coal they sell. So they inventory at the port might not necessarily represent the next ship. You still might be railing to the port in order to move the particular quality of coal out.

But are we going to see a sort of surge in carloads as the inventory's cleared first?

We -- (multiple speakers).

After the inventory's cleared first? In other words, like inventory has to be cleared out of the ports and then we're going to get a carload lift?

No, they inventory is not cleared first. There are different qualities of coal that are stored and stockpiled at the port. So it depends on which boat is nominated to come to pick up which quality of coal. So the railings will be continuous to ensure that the right quality of coal is at the port for the vessels that will arrive as nominated. So it's not a case of clearing one out and filling it up, but rather an ongoing management of the port stockpile.

Okay. The second question, just with reference to the waterfall chart on Slide 2, which is comp and benefits, pension expense is $10 million; interest rates have been backing up. That should be good for I presume funding and for the deficit position. How do you guys see that sort of pension line on a go-forward basis?

Randy, right now, the long rates are up about 50 basis points, and just to go back to the sensitivity, about 100 basis points change impacts our deficit by roughly 650 million, so good news is that the long rates are going up. The rates that -- the pension expense is locked in this year but yes, if the rates continue to go up or stay where they are, we expect a favorable impact on pension expense next year.

Avi Dalfen, Blackmont Capital.

Thank you. In the earnings description, you talked about the positive impact of the gain on sale from the Latta line, but you did not quantify the impact. How much did that help the quarter?

Well, the net impact quarter-over-quarter was 9 million. The Latta, the actual gain on Latta, which was a gain on land as well as trackage rights was about 17 million, but that was -- we also had some land sales in 2005, so the net impact year-over-year is 9 million.

Okay, so I'm sorry, this gain on land sales of 17 million, is that an after-tax number?

That would be a before-tax number.

Okay. The difference again between the two numbers here would be the revenue that you had in the prior year from the volumes?

Exactly.

Bill MacKenzie, TD Newcrest.

Good morning. Just, you know, if we do see coal continue to improve and the potash comes back and grain stays strong, I am just wondering if you could talk about -- I mean, it seems like you've done everything you can to start bringing people back early and getting them to take their vacations early, but do you foresee any risks or do you have any concerns on your ability to manage sort of a big surge in volume that conceivably could happen?

Bill, it's Fred. You know, we're just plain excited about the opportunity to do this. You recall a year ago we went out -- or over a year ago -- and convinced our Board to spend the money to create capacity. We also went out and hired the 600 people and trained them and unfortunately had to lay a bunch of an off for a period of time. So I'm not saying there won't be a selective day or a little opportunity here or there where we wish we could do it a little bit better, but in my opinion, we have not even begun to use the capacity we created. We had, at one point in time, almost 100 locomotives parked. Some of those have been brought back of late. We had 400 people laid off. So we've got the assets in place; we've got a team of people that are very focused on moving this. When you get a surge, as may happen, that little bit of catch-up, it's inevitable that we will have to smooth the surge a little bit, working with our clients and we are fully prepared to do that, as are our clients who recognize why this situation exists. But between now and the end of the year, we're going to move a lot of coal, a lot of grain and a lot of potash, in our view, in addition to what we have already committed to for our other customers.

Okay, great. Thanks. Then just one other housekeeping clarification -- Brian, on the free cash flow guidance for the year, does that include or exclude the proceeds from the Latta subdivision sale?

That includes the proceeds from the sale of Latta.

Okay, great. That's it. Thanks.

Ted Larkin, Orion Securities.

Just before I ask the question, just a comment to Paul Bell -- I think he's got three weeks to go from today and then he's a free man. I just want to thank him very much for his help of the years. He's been outstanding to work with, and I wish him all the very best.

Fred, I just want to ask, if you can give us some insight into future traffic to and from China, based on your personal insights who you've been meeting with, and also your marketing team, can you give us some idea of what you are seeing over the next 18 months or so?

Well, Ted, I think every indicator that we've been able to pull on, whether it's the movement of metallurgical coal to China or whether it's the outbound products, particularly on the retail side, it appears that our retailers are similar to what other retailers are experiencing. They see increased activity. We think they're running about 50-ish% of their inbound product that's on the shelves is now of Chinese origin, and they think it could creep up to 60-65 maybe over the next couple of years. So we see increased activity off the West Coast on an inbound basis. We see feedback that we're picking up in other businesses with regard to China -- is that as the standard of living rises, the aspiration for higher output per acre on the agricultural community demands more potash, so that looks like -- they are the single biggest consumer of potash, by the way, at over 5 million tons. Keep in mind, we only exported -- Canada only export 8 million tons last year, just to put that in perspective for you.

So I think every indicator we've seen and heard would be very favorable with regards to the amount of activity between China and Canada or Canada and our U.S. Midwest properties. So we're still planning to be able to participate in substantial growth around China.

Okay, that's very helpful. My second question just relates to the aforementioned capacity expansion on Western corridor, just west of (indiscernible). Can you just give us an idea what rate of capacity you're currently operating at right now, and how you see that playing out going forward over the next, let's say, 18 months?

Well, Ted, I think I am going to talk about the rest of the year, because we really haven't talked too much about our expectations for next year but you can extrapolate as you wish. At this point in time, I would suggest to you that we are -- we haven't even begun, other than for the benefit of some fluidity of the railway, we haven't even begun to use the 12 to 13% capacity expansion that we created with our investment last year, so we are at 0 or less. In other words, I think we're moving less today. You saw our tonnage. We're down 6% on GTMs, much of that in the West corridor. So we've got all kinds of capacity expansion in the West corridor, just to catch-up to where we were, which we will do this fall and then I would anticipate, probably by the mid of fourth quarter this year, assuming everything comes to be the way it appears to be unfolding on the potash side, that we might be using, I'm going to guess 15 to 20% of the capacity that we created last year. That bodes very well for our ability to continue to grow next year as coal grows again and as potash really hits a full-year stride, plus what looks like a great grain crop is going to move right through the winter months. So it's a little hard to speculate, other than to say that, assuming all those things unfold, we could be using maybe 50% of the capacity we have created and still have room to grow after that.

Okay, that's great. So near-term need to go even beyond that at this point?

No. I think the exciting part is, when you look at what [Neil] and Brock have done from a validity perspective, you look at the train speeds, you look at the yard throughputs, you look at the car miles a day, the locomotive miles a day, GTMs hauled per horsepower hour, every one of those metrics is going in such a favorable way that we're creating capacity without the capital investments. I think we've got the ability to do more in that regard. So I'm optimistic we can defer any substantial capital investment out well beyond the immediate horizon.

Okay, Fred, thank you very much.

David Newman, National Bank Financial.

Good morning. Just a couple of quick ones, one on the MetCoal. We're looking at sort of the freight revenue per (indiscernible) being down around 5.3% this quarter. Is that kind of what we should expect for the remainder of the year? As we head into next year, I think it's the first year where the collar actually moves down. Any order of magnitude on what we should be modeling out for the next coal year?

David, on this year, I think it's order of magnitude about the same. There's always little puts and takes because remember that there's an eastbound portion of the business that has dropped off as well, and the timing of that is a little different than the timing of the export activity. So I think you are in the order of magnitude, plus or minus a couple of points as far as the rest of the year is concerned. That's the rest of the coal year, through the end of March next year.

The only comment I would like to make at this time is to be consistent and to repeat what I said in the past -- is that our expectations is that the incremental volumes, plus the addition of a new fuel surcharge as of April 1 next year, will put us back in the zone of the absolute revenue that we expect to have this year. So the consequence -- you can appreciate that because you have to move more volume, there's obviously a price per unit reduction in there, but I think what were not going to do is -- at this time anyway -- be any more specific than that. We do have a confidential contract and it would be very awkward for us to comment other than to give you that same consistent order of magnitude impact that we've given in the past.

Okay. What sort of volumes are you sort expecting next year? I mean, I think the range is around 22 to 25 million tons this year. Do you think it will be 25, 26, or is there some number that you are sort of internally modeling up?

Well, again, I think you can assume that we are expecting increased volumes for sure. We have a range of possibilities in that regard. Obviously, it's going to be entirely based on what Elk Valley is able to, A, produce and B, sell. As Marcella mentioned with the transition of Jim, who will retire in August, Jim [Pompowich], the current CEO, who has got an operating background, Boyd Payne comes to the party as their new CEO, who has got a very strong marketing and sales background. So we are optimistic but it is speculation on our part. We are simply optimistic, based on the intent of hiring an individual with Boyd's capabilities and the belief that the market will remain strong. We've seen prices settle in the 115, $116 a ton range, which is again still very high in the marketplace, so it's hard to speculate. It's going to be a function of what our major customer can do but we like the way the stars are lining up with regard to their production capabilities and the leadership that they're bringing in, who has got a sales orientation.

Very good. And last one, if I might? Just on the grains, I mean looking at sort of the puts and takes as we head out into the latter part of this year into next year, I mean obviously the U.S. Western Plains is under draught-like conditions. You've got Australia, which has had their own fair share of problems. Obviously, you've done more of a Canadian network. Do you think, in looking at it, obviously grain prices have risen dramatically, canola prices, corn prices. Do you think, even if there's any sort of yield compression whatsoever, that the higher prices will induce the farmers to just move more grain as well as buy more crop inputs like fertilizers, etc.?

We are certainly encouraged that the farmers, in fact, would move more grain. What we're looking for this year was a higher quality, particularly off the Canadian side -- is that they're going to take this opportunity to take some of the stock they've got, the inventory, which was of poor quality last year, and move it. So, we've got two things happening here, David. One is the existing crop, which is looking excellent and the price is looking excellent for the producer, as well as the opportunity for them to use the higher-quality crop to mix the lower-quality crop. So we've got two things we think that is going to come at us. And as one of our customers told me when I was chatting with them last week is expect a wall of grain to hit you this fall.

Excellent. Thanks so much.

Walter Spracklin, RBC Capital Markets.

Thanks very much. Good morning. A question alluding to the wall of grain you're talking about here. If we do see potash coming back where you're going to be shipping 85% of last year's total shipments in somewhat of a more truncated period of time, you've mentioned in previous quarters how the lower volumes that you've been moving have certainly allowed you to increase your productivity measures, your velocities and so on, because of the lower volumes in potash. If we do have potash coming back at 85% and big grain coming down as well, how is that going to be impacting with each other, particularly on these productivity measures?

Walter, we're not at all apprehensive about this. We think there may even be opportunities to continue and maybe even pick up the pace here, and that may sound a little odd but this railway is just humming. The team is just focused; they are delivering great speeds, great yard throughputs and all of the metrics I mentioned before on the activity levels. So I think to put it in perspective for you, Campotex, which is the major exporting potash company, it is the potash exporting company -- of course own all their own fleet. So they've got their capacity sitting on the sidelines ready to do, and the minute they pull it out and get going, that takes care of that demand.

Our cycle times, just for perspective for you, our cycle times on grain at Thunder Bay and Vancouver have improved by 14%, so we are able to move a lot more grain with fewer cars obviously, or the same number of cars can move a lot more grain may be a better way to say it.

Operationally, I don't anticipate that you will see any substantive impact in train speeds. Obviously if you've got a little bit more on the bulk commodities running through the mountains, it will be a little heavier weighting so that could have a modest impact on what you look at as a weighted average train speed, but the railway is pretty to go, the capacity is in place and I just don't see a big impact out there.

Okay, that's great color. Just second and last question here is I know you don't like commenting on your '07 guidance but just on I guess on a general sense, we're seeing a lot of weakness in the U.S. rails here today, concerns I guess UPS has just come down below expectations; the CFO is talking about lots of -- he sees a lot of evidence of a weakening U.S. economy. Just your color on sensitivities and what your view is on CP's positioning in the event of a North American downturn in the economy, excluding some of the other short-term benefits we are seeing from some of the improved service -- or the improved demand that we are seeing on a short-term basis.

Well, Walter, with regard to the marketplace, again I think we've been very consistent in kind of speculating and then now identifying that the paper business was the whole forest products segment of the paper business was the weakest of the bunch and in fact, that exactly what has unfolded with a bunch of paper mill shutdowns and some machines shutdowns within other mills.

We've seen a little bit of hot and cold on the lumber side in that it has been a little bit soft in the last month or so. On the other hand, there's lots of speculation that the fall could pick up because interest rates still are, by historic standards, very low and housing starts may or may not continue to boom.

It's important to understand the franchise. Our franchise is heavily weighted to the global economy. We do import/export containers, we do a lot of export bulk materials. So nearly 45, 50% of our franchise is actually driven by the global economy, not by the U.S. economy. So although some people may be seeing it, we are not seeing it other than the areas I mentioned and of course the Big Three auto. The domestic economy in North America appears to be strong from what we've been able to see. We are situated with so much of our business coming into Alberta, and Alberta as everybody knows is just going wild with regard to construction materials, steel, fabrication components and everything to support both the oil sands and the oil patch, as well as residential and all of the retail consumers based on the wealth that's being created here from the automobiles through to retail store materials.

So in summary, Walter, we don't see the slowdown in the -- when we look at what we are experiencing, other than in the paper and maybe the forest products side and the domestic auto side. Neither of those is very significant to our franchise; they are kind of like 5, 6, 7%. Being heavily weighted to the global economy, we really like the franchise and where we are positioned.

Okay, again, that's great color. Thanks very much, guys.

Cameron Jeffreys, Credit Suisse.

Thanks very much. Maybe a different way to ask Tom's question from earlier in the call -- would it be fair to say that your OR was maybe impacted by somewhere in the range of a full point perhaps on the potash side? I mean, would I be in the right ballpark in kind of suggesting that kind of impact in terms of the weakness of the potash and the coal?

Cameron, there has been a lot of speculation. You know I'm not going to comment just as I didn't for Tom -- (multiple speakers) -- to the specific profitability, but I think it's fair to observe that other parties have made the comment, over the course of time, that because of the nature of the bulk commodities moving in such very, very efficient trains, I'm going to put it in perspective for you, Cameron, that the potash trains that we were not moving were 17,000 ton trains. These are our most efficient trains that we have in our whole railway. The coal trains that were not moving were our 15,000-ton trains, so for perspective, the merchandise trains tend to be in the 5 to 6000-ton range. So when you think about productivity and you think about efficiencies, it's fair to assume that the "most efficient" trains that we have in the railway are the heavy, heavy bulk trains -- exactly the most heavy of our bulk trains are the two trains types that did not move. So, I will let you reach your own conclusions about value and profitability, other than to say these are very, very efficient trains.

Okay, great. I thought I would try anyways. The second question would be on just maybe a little bit more color on the bulk IOP that you're kind of putting into place, maybe a bit more detail or some specifics on some of the characteristics, initiatives, examples and so on.

Well, I think the key thing is the success that we have had through our merchandise and our intermodal business has been basically trying to get ourselves perfectly in balance. We have done that very, very well although we think they're still more opportunity on the intermodal side and on the merchandise side. As I said, on that component, the next step, now that we're pretty well in balance and you start to see the benefits and we've started to feel the early parts of the benefits, the next part of that of course is to take out some train sets and elevate the train weights by moving the same amount of product on fewer trains.

Now, with regard to the bulk model, there will always be incremental opportunities. It depends on -- a simple example would be, in the grain world, the more of the 286 heavy-loading grain cars we can get over time to replace the 268 light-loadings, that's opportunity for us to move more product now and more efficiently.