Canadian Pacific Kansas City Ltd (CP) 2007 Q1 法說會逐字稿

Good morning ladies and gentlemen. Today we're located here in New York City and have attendees here with us in this room as well as on the phone. Thanks to everyone for joining us for our 2007 First Quarter Conference Call.

The presenters today will be Fred Green, our President and Chief Executive Officer, Brock Winter, our Senior VP of Operations, Marcella Szel, our Senior Vice President of Marketing and Sales, and Mike Lambert, our Chief Financial Officer. Also in attendance today is Brian Grassby our Controller.

Before we get started, let me remind you that this presentation contains forward-looking information. Actual results may vary materially. We make reference to assumptions used in our guidance and we provide sensitivities to these assumptions in the appendices, which can be found in the last section of the presentation material.

The risks, uncertainties, and other factors that could influence actual results are described on Slide 1 in the press release and in the MD&A filed with Canadian and U.S. securities regulators. Please read carefully as these assumptions could change throughout the year.

All dollars quoted in the presentation are Canadian unless otherwise stated.

The presentation also contains non-GAAP measures. Please read Slide 2. The slides are available on our website so please follow along.

Here then is our President and CEO, Mr. Fred Green.

Thank you Janet and good morning everyone. Q1 2007 has been a challenging quarter and this railway met that challenge. In spite of some very difficult operating conditions we managed to post some good results versus 2006.

We grew EPS by 8%. We kept pace with last year's record setting operating ratio and we moved more GTMs and we improved personal safety performance. This was accomplished with 2% fewer employees, improving our GTMs per employee by 3.6%.

Our focus on network fluidity and execution excellence have transformed CP into a more resilient railway, better able to manage through and recover from uncontrollable events. While we had planned a better start to the year, we remain confident that we will deliver our 2007 targeted results to our shareholders.

I'm going to turn it over to the team right now. They're going to walk you through our operations, our markets, and our financial results. What you'll hear from Brock, Marcella, and Mike is the confidence that we have in our business plan.

I'll back come up and wrap up before going to Q&A. And, Brock, over to you.

Thanks Fred and good morning. Before I turn to my first slide I would like to provide some color on the operating challenges we faced in the first quarter. Despite reports on global warming that this has been the warmest winter on record, it has been one of the toughest winters we've experienced on our western corridor through British Columbia.

As you would expect, this has caused slides, washouts, avalanches and at a much higher rate shutting down rail lines, customer facilities, ports' facilities and the highway system in this critical corridor numerous times.

For operations, this course was about the effective implementation of our winter contingency plan and recovering quickly. We demonstrated a new level of operating resilience this quarter and remain committed to returning to our key principles of train balance, velocity, and daily smoothing of volumes.

Let's talk about our operations performance in Q1 in the face of those challenges. We can say with confidence, despite the very challenging weather events, we delivered solid operating performance and will continue to do so for the remainder of 2007.

Let me tell you why I believe that. Please turn to Slide 6.

We've had a tough winter but we will return to 2006 performance levels and better for the remainder of the year. We were slower on train speed and had increased [inaudible] dwell as a result of the winter challenges and some impact from the CN strike.

Car miles per day were volatile as a result of the many line outages. This drove our cars online up impacting our equipment rent.

As illustrated in the bottom right hand chart, we're trending favorably on this critical velocity metric. We're now consistently tracking better than last year. I expect these fluidity metrics to improve for the balance of the year.

Turning to Slide 7. This is a timeline for Q1 and Q2 showing our daily production against the outages we faced. 2006 is in the background for comparison. The key message of this slide is how quickly we recovered in each case.

You can see our production as illustrated in the blue line. As a consequence of an outage production dropped, but then we rapidly recovered and continued to surpass 2006 performance. All in, we finished the quarter handling 1% more gross ton miles and in the last two weeks we're now moving 0.75 million gross ton miles per day and this is indicative of our improving trend.

We've faced some difficulties but my team is showing it's resilient, and combined with the investments we've made in capacity this is allowing us to recover more quickly.

We can say with confidence that despite very challenging weather events we delivered solid operating performance and will continue to do so in 2007.

What does this mean going forward? We said we would deliver C$55 million in operating savings in the last two years and we did that. We said that we would reduce a further C$35 to C$35 million in 2007 and we remain committed to deliver this. We'll do this with the execution of our integrated operating plan and our focus on velocity, a balanced railroad, efficient maintenance, and improved safety performance. We'll continue to extract cost and steadily improve service.

I look forward to reviewing our progress with you next quarter. And I'll now turn it over to Marcella.

Thanks very much Brock. Good morning.

I want to begin by saying that despite the challenges that Brock outlined we grew our freight revenues top line by 2%. Not surprisingly, the first quarter weather impacts have resulted in delayed revenue particularly on traffic moving to and from the port of Vancouver. I expect to recoup this revenue over the coming months.

So let's turn to Slide 9. I'll start by covering the quarter by commodity group, then provide an outlook for the balance of the year.

Starting at the top with grain. Our performance on western exports was hurt by weather but revenues were up C$8 million or 4%. This was driven by strong cross border demand, a successful winter rail program to eastern Canada, and excellent yield results.

Coal volume, and thus revenues, were down C$29 million or 18%, mainly due to the weather and the sale of the [Ladder] subdivision.

Offsetting coal, sulphur and fertilizer revenues were up C$29 million or 31%. This reflects normalization of potash, export potash volumes, and robust demand to feed increasing corn acreage in North America.

On the merchandise side, forest products remain soft. A weak U.S. housing market and low lumber and panel prices curtailed production and shipments.

In the industrial products portfolio, revenues were up C$4 million or 2%, supported by double digit growth in the chemical and energy markets.

In automotive we bucked the industry trend and had quarter on quarter growth.

On the intermodal side we generated solid topline growth with revenues up C$19 million or 7%.

International volumes were strong. And on the domestic side we saw growth on cross border traffic.

Overall, despite the challenges, we grew the freight revenues by 2%. This broke down as follows -- price was up 4%, FX up 1%, fuel was flat, and volume and mix had a negative impact of 3%.

Moving onto Slide 10. On the yield front our program continued to deliver good results. As I just said, price was up 4% and all non-coal was up 5%. Average revenue per car was up over 5%. Contract renewals, again, averaged over 5%, which is very consistent with 2006.

So once again, a good quarter on yield tracking as expected.

Turning now to Slide 11, I'll update the outlook for the balance of the year starting with the bulks. For grain we still have two quarters of the current crop to move. Nearby demand remains very strong and supply is in the bins.

For the fall, we continue model normal production carryover, an average crop, and continued strength in the export markets.

On the coal front, our assumption of an incremental 2 million metric tons was confirmed by the updated sales forecast issued by Elk Valley in March and reconfirmed this morning.

I would like to remind you of the coal price changes we discussed in November. On an annualized basis, price will decline 7% to 9%. And the sale of the Ladder subdivision will continue to negatively impact unit comparisons through to June.

Sulphur and fertilizer markets continue to look very strong. World stock to use ratios are low and China and Brazil remain hungry for new trends. And corn demand should push the domestic spring peak well into May. We're modeling double-digit growth for the year with very strong year-over-year first half shipments.

On to merchandise where our revenue guidance remains unchanged. For forest products, our smallest segment, we're modeling continued weakness for the remainder of the year. In industrial products we expect growth n the GDP range. This is driven by the upcoming construction season and a healthy Alberta market, both originating and terminating.

On the automotive side we expect above average growth. This is because of the continued gains by the transplant and strong new car sales in Alberta.

Our success in this business was recognized when Toyota recently awarded us with their top honor -- the President's Award for Best Rail Carrier Performance in 2006.

In intermodal we expect historical growth rates to continue. This will be driven by global trade and improving truck competitiveness in domestic markets.

Now, going back to the delayed traffic that I referred to. It's tough to pinpoint but we think the impact was around C$35 to C$45 million in Q1. I expect that this traffic will move through the balance of the year and you've already seen our car loadings increase this month.

And, looking at our whole portfolio, our demand is fundamentally strong. Our customers' confidence is reflected in their plant expansions. Recent announcements include IPSCO expanding their steel plant at Regina, Potash Corporation of Saskatchewan further expanding their potash production, Dominion Energy plans to construct the largest biofuels refinery on CP lines, and the government of Canada recently doubling their pledge to almost C$1 billion for improvements to the Pacific gateway.

And it's not just these announcements, but over the past year customers across several business segments have announced plans to spend over C$0.5 billion in capacity expansions. The market confidence is very reassuring.

So, in summary, I'm confident that we can and we will move the deferred volumes and achieve our full-year revenue growth target of 4% to 6%.

Thank you. And Mike over to you.

Thank you Marcella and good morning. Before I turn to Slide 13, let me just say that good cost control and a strong yield program were key components to this quarter's results. So, as usual, let's walk through the income statement on Slide 13.

As Marcella reported, freight revenues were up 2%. Other revenues were down C$18 million, which is largely the impact of a land sale last year. So, total freight and other revenues were up C$5 million or about 0.5%.

With good cost control, operating expenses were up only C$3 million.

Operating income was C$229 million, up 1% , and the operating ratio was 79.5%, which is somewhat better than last year. I'm satisfied with the numbers given the challenges we faced in the quarter.

Below the operating income line, other charges were down C$2 million and interest expense was flat as expected.

So, our adjusted income, which is before foreign exchange gains or losses on long-term debt, was C$123 million or a 6% improvement versus Q1 last year.

And our reported net income came in at C$129 million.

On Slide 14, I'll reconcile our Q1 EPS growth. Before I start I'd like to remind you that our Q1 '06 adjusted EPS was restated for a change in stock option expense accounting. This restatement lowered our Q1 '06 EPS from C$0.74 to C$0.72.

So starting on the left. Wage and benefit inflation and pension expense impacted EPS by C$0.03. Favorable returns from our pension plan helped keep this number down. Fuel price, net of surcharges, cost us C$0.04. I'll explain this in a moment.

We estimate that the winter and other adverse operating conditions cost us C$0.10 on the quarter. Half of this is an additional expense while half is revenue versus last year. Other volumes and mix cost us C$0.03.

Our strong price program added C$0.18, more than offsetting the operational difficulties. Our initiatives continue to be accretive adding C$0.05 EPS.

We benefited from the final stages of our headcount reduction initiative. And while IOP execution was not where we expected, we still saw a benefit of C$5 million versus '06.

At quarter end we had approximately 350 fewer employees on the property than we did a year earlier due to our headcount reduction initiative and productivity improvements.

All other items added C$0.03 to EPS, including the benefit from our share buyback program and an improved tax rate.

Overall, we're satisfied with our performance delivering C$0.78 in adjusted EPS or 8% growth in the quarter.

To Slide 15 and operating expenses. Starting at the top. Compensation and benefits was down C$20 million or 6% on the quarter. Wage and benefits inflation expense of C$10 million was more than offset by lower pension expense, C$6 million headcount reductions, and a C$15 million benefit in stock-based compensation.

Fuel was up C$13 million or 8%. Despite favorable year-over-year crude prices North American refiners continue to experience unscheduled shutdowns, and with extensive spring maintenance programs planned there are upward pressures on the price of diesel.

We said last November that refining margins would cost us C$30 to C$40 million versus 2006 and it looks like we may exceed the top end of this range.

Materials expense was up C$5 million or 8%. This is largely an inflation-based increase and higher instances of wheel change outs.

Equipment rents was up C$11 million or 24%. We did plan for higher expenses on the year due to lease rate inflation and lower offline receipts. But the impact of winter on fluidity and the timing of inter-railway settlement, which can be lumpy, moved the number even higher this quarter.

Depreciation expense came in as expected. And finally, purchase services and other was down C$10 million or 7% and is mostly attributed to a land donation in Q1 '06.

When we look at approximately the C$10 to C$13 million in weather related costs, versus a better than normal Q1 '06, you can split it evenly into labor, fuel, material, and equipment rent.

Foreign exchange moved expenses up on the quarter by C$7 million.

So all in, operating expenses were up C$3 million or less than 1%.

As we look at 2007 on Slide 16, we're projecting a 4% to 6% increase in revenue. We have a lot of ground to make up but we are confident we can hit this number.

Operating expenses are expected to rise 3% to 5%,. The anticipated GTM workload increase of 5% to7% will be partially offset by our initiatives, which will deliver C$50 to C$60 million expense savings.

We're modeling WTI at C$58 per barrel and an average foreign exchange of C$1.15 per U.S. dollar or C$0.87 per Canadian dollar.

Our capital project spend remains between C$885 and C$895 million. And in March we announced a 20% increase in our quarterly dividend to C$0.225.

And, for the second time this year, we are increasing our free cash flow projection. As our cash pension-funding requirement has been reduced from C$150 million to approximately C$100 million, our free cash flow is now expected to be in excess of C$300 million.

We also announced in March a share buyback program where we intended to buy back up to 5.5 million shares or approximately 3.5% of our outstanding shares. We have now initiated the process to amend the current share buyback program to repurchase up to 10% of our share float. This would equate to repurchasing up to 15.5 million shares.

We can increase the share repurchase plan because of our increasing generation of free cash flow and our strong balance sheet.

So to close, Q1 was a challenge. April has been a good month. The railway is running well and the demand is there. We are confident that our diverse commodity mix and strong yield program will bring in good results and we will continue to control costs.

With that, and despite a tough first quarter, there is no change to our 2007 EPS guidance of C$4.30 to C$4.45 or a 9% to 13% increase versus 2006.

Now, back to

Well thanks Mike. Just before I get back to my key message I think I should provide a quick update on labor. We have a ongoing dialog with our associates in the teamsters group, Maintenance of Way Group. We've been discussing for an extended period of time. I'm pleased to say that we're still at the table trying to find a solution. I think that's a tribute to the leadership of the Union as well as our team. I'm optimistic something good will come of that but until we have good news obviously there's nothing to report.

We are in the final days of the cooling off period and that puts us subject to a 72 hour notice should there be some form of proposed work stoppage.

I can assure you and I hope it doesn't happen. I'm optimistic we'll find a solution but should it occur this Company is very well prepared to do what has to be done. We have over 1300 managers well trained, focused on how to work safely and keep our railway going.

So we will do all we can to try and find a good solution. If that doesn't happen we will run the railway as we have to and we will deliver a good quality product, a very good quality product, until such time as that issue can be resolved.

I'm going to return now to my key message and I think CP demonstrated its resilience this quarter. It was a very tough quarter but under Brock's leadership the team did a great job operationally. I think they managed their costs well; they enabled the railway to recover quickly.

Market demand is looking very, very solid and we fully expect that our focus on execution will allow us to handle traffic with increasing efficiency.

The operational and carload metrics are headed in the right direction and I expect the improvement to continue.

We expect to deliver EPS growth of 9% to 13%.

As Mike outlined, our cash flow expectations have again improved. And the decision to substantially increase our share repurchase plan demonstrates both our confidence in the longer term and our commitment to create shareholder value.

Just for perspective, you saw Brock's GTM chart and his recovery and the huge numbers in April. Using our normal metric of a seven-day average, I can tell you that Brock and his team have established workload records virtually every day in April.

With that, I'll turn it over to Janet and we'll open it up for questions.

We'll now conduct our question and answer session. Rachel, we'll start with the attendees in the room and then move to conference call audience. And for those of you asking questions I'd ask you to identify yourself, your organization, and limit your questions to two.

For those on the phone, please feel free to queue up at any time by pressing star 1 and we will move to your question.

Yes, good morning it's Tom Wadewitz from J.P. Morgan. I've got two questions for you. First one, the pricing outlook I guess X the coal looks pretty robust still. Your primary competitor last night indicated they're actually ratcheting up their target for price increases. They had been saying 3 to 4 and how they're saying 4 to 5. And I'm wondering if that's something-- you don't know where they're going to do that, if that's competitive business or elsewhere, but is that something that leads you to consider perhaps looking for more on the pricing side? And then I have a follow-up just on leverage and share repurchase.

Well, I think, Tom, anyone who's running a business in any industry looks at the competitive forces at work. The market is very, very robust. The demand that we have seen, basically pent-up demand that exists in so many of our commodities, is an indicator of the value people place on our services. So it is our responsibility as a leadership team to continually recalibrate.

I think what we want to do is be wise enough to pursue what the market will bear as long as we are ensuring that our clients can remain competitive in their markets.

So we find that balance on a daily and a weekly basis. We're optimistic that there continues to be a very robust and strong pricing environment.

I would hesitate at this point in time to simply start changing our assumptions. We're going to deliver our numbers with the assumptions we've delivered-- we've provided to you. If there's more upside there and the market can take it, and I think it's Marcella's team's responsibility to pursue that within reason. Do you want to comment Marcella?

Tom, just to remind you that our price targets for the year are 4% to 6% on renewals. So we've already started at a different baseline and my expectation is that we'll deliver. We've got our Q1 results and the contracts that we've turned over in April already are tracking toward the 4% to 6% on renewals.

Okay, great, yes that's helpful to reconsider where you're coming from with the more aggressive point.

On the share repurchase, it's a pretty significant move towards a more aggressive pace on share repurchase. What ultimately are you comfortable with if you look out the next couple of years in terms of balance sheet or cash flow metrics by debt to cap or perhaps debt to EBITDA type metrics? Where do you think you could ultimately get to and what that would imply for future share repurchase.

Yes, I think that's a good question. So it's Mike Lambert speaking. Yes, obviously we can do the-- we have confidence in doing this increased share buyback because of our increase in free cash flow, also the strength of our balance sheet. If you were to look back just a couple of years, our metrics in terms of coverage and I think ability to service debt is more coverage ratio as opposed to balance sheet debt to equity. I think debt to equity just in terms it allows your balance sheet to work harder in terms of producing return on equity.

But our increasing free cash flow, the strength of our balance sheet, allows us to go out and buy back more shares.

I'm going to help you do the math. Free cash flow, C$300 million, our announced share buyback program of C$15.5 million, if you take today's share prices is well over C$1 billion and obviously there's a gap between the two.

The third thing around that is that some of our brethrens, if you look inside the other class one rails, have announced that they're either-- they've gone to the market or they've announced they're going to the market. It allows us a window to look into the market in terms of the market dynamics, pricing, as well as demand.

And so we're considering our alternatives in terms of how much leverage that we can take and when and if we're actually going to issue debt.

The great opportunity right now is there are others playing in the market and we're assessing our alternatives carefully.

So we shouldn't necessarily think of this as the end point. Obviously it's a fairly aggressive step, but it's possible you reconsider when you see where the balance sheet is and the covered ratios down the line you could take another step.

We could. We don't want to get ahead of ourselves. We're feeling very confident about the upcoming year. We're feeling very good about the position we're in right now in terms of free cash flow and the strength of our balance sheet.

Okay, thank you.

Scott Flower, Banc of America Securities. A couple of questions. And again, maybe I address this to Marcella. Again, going back to Brandex in Canada. They had talked about looking at divisions with the U.S. railroads and looking at how those should play out dynamically, that the U.S. roads perhaps have been on some of the joint line moves a bit more aggressive.

How do you see that playing out? Do you see that there's room for you in your divisions to have more of a play in what's happening in the U.S.? And do you have uptake on that? How do you view the whole division issue?

I'm going to jump in Marcella and just say Scott we're not going to negotiate divisions with our classroom counterparts on a call. I heard the comments other parties made and if the opportunity exists and the competitive dynamics are such that there's an opportunity for us to expand our divisions, then obviously that would be the subject of ongoing normal dialog. But we sure aren't going to make those kinds of statements here.

The other question I guess I had was on equipment rentals. And I know Mike gave us some color on the different moving parts and pieces. But when we think about the lumpiness of the settlements as well as some of the offline receipts and then also lease rates, how should I think of catch up into Q2?

In other words, my sense would be that some of the offline receipts were due to fluidity issues. Maybe there are some other things there. Some of the settlements may come back in the future quarters, the lease rates may be ongoing. Help me understand what moving parts are just timing versus what are ongoing either costs that drop out as we look toward 2Q and beyond.

Yes, it's a good question and there is lumpiness here. In terms of modeling looking out, we did-- in November we anticipated that the rates would be higher this year. On top of that you add inflation. For modeling purposes, approximately C$50 to C$55 million per quarter and we should end up about just ahead of C$200 million on the year, which I think is up just over 10%.

Does that answer your question?

Yes.

Is there any other questions here? Okay, Rachel we're going to turn things over to our conference call audience.

James David with Scotia Capital.

Hi, good morning. Just going back a bit on the balance sheet issue. Think it's great, the implied move to borrow-- to buy back shares. Do you have-- Mike, do you set sort of a target for your coverage ratios or is it something you prefer to think about for a while?

Well, we are thinking about it and it's something I think about a lot. One of the things that I don't know if I mentioned earlier but our coverage ratio's just versus two years ago, if you look back on 2006, in total, have improved by 1.5 times. And our-- if you look at our outlook this year it's going to improve again in '07.

So we're feeling very good in terms of our capacity but it's something we think about all the time.

Okay. And I know that in the case of [CN], they sort of reached a run rate on free cash flow for dividends and until yesterday it was sort of a set number. Do you expect that over time that you will simply see-- I mean it's sort of a question but would you see your buyback activity kind of proportional to the growth of your free cash flow or do you expect at some point we'll sort of hit an absolute number and then maybe use some of the discretionary cash flow to invest in your operating ratio, for example?

In terms of our priorities, and we tried to make this clear previously, our priorities are to first reinvest in the business and to the extent that we can invest in growth that would be our second priority.

We'll always filter these investments with a return in capital employed requirement. And they're pretty onerous. They're 20% return on capital employed. So those are our first priorities.

Then to the extent that we have free cash flow, we'd consider returning it back to the shareholder which is another objective of ours.

And just finally, Marcella or Fred, I noticed in the traffic stats we are seeing the recovery as you point out. It tends to be biased towards your intermodal versus your non-intermodal business. Is there any specific reason for that or is it just the [inaudible] of the drag on your intermodal?

Right now it's just a drag on pulling the intermodal out. We've got the bulks particularly. There's a pent up demand for the bulks and you should start to see those increasing. The potash, you've seen the numbers on the potash, the RTMs are up about 44%.

So you should see that continued through the first-- through the next quarter for sure.

And finally just quickly. You point out-- you say it's the recovery on the deferred revenues in Q1 to take place over months. Is that a-- can that take place in second quarter or would you rather see that sort of spread over the further?

It will likely be spread a little bit further than that because we're obviously going to keep up with the plan, which is an aggressive plan, and move the deferred volumes. So I would expect to see it move past the second quarter to the third.

Okay, thanks.

Edward Wolfe from Bear Stearns.

Hi good morning. Michael, just a little more clarification on the share repurchase. First of all, is there some timing around how we should look at how you're going to purchase the 15.5 million shares?

Yes, that's a good question Ed. There are limitations, especially in terms of Canadian regulations. 2% a month is our maximum with our blackout periods. We're going to be as aggressive as we can be but 2% per month is our limitation.

So if you're -- for modeling purposes evenly throughout the next 12 months would be reasonable.

Okay. And then when you talk about coverage, are you talking about interest coverage debt to EBITDA, and what kind of levels do you no longer get comfortable in?

In terms of the coverage ratios, we talk about all of them. Debt to EBITDA is a good indication right now. I'd tell you that, again, versus two years ago, we're about 1.5 times better than we were two years ago. And so, we're feeling pretty good about that. And at the end of this year, we could find ourselves almost two times better than two years ago.

But on an absolute basis, if you ended '06 at a little bit less than 2.5, would you go up to four or fives times at some point?

No, I wouldn't want to say that here. I think what I'd like to declare is that we're pretty comfortable with where our ratios are now and it gives us capacity.

Okay. Just switching gears then on the Teamsters negotiation. How many--first of all, is that just maintenance workers? And roughly what percentage of labor is--could be impacted by that contract?

Yes, it's Brock. And it's--there's about 3,000 total employees in our maintenance of way forces. About half are maintenance employees expense and the other half are--they're completing capital work programs.

Just for clarity, they're not all active at this point in time though. There's only probably about 2,300.

About 2,300 now.

2,300 on the property because we haven't worked--ramped up our work programs. So obviously, in a situation like that we would bring the capital programs to a complete halt and we would focus all of our energies with our 1,300 replacement qualified workers doing the work that the 1,600 or 1,700 are doing today.

Thanks, Fred. Could you also talk about after the Teamsters, which other labor comes up next?

The--well, actually, Brock, why don't you go ahead.

Sure. We have--we're right now at--in negotiations with our running trades employees in Canada. Our conductors and locomotive engineers are represented by the Teamsters. And we're having--we're at the table in active discussions with those folks right now. And towards the end of this year, our contract with our CAW folks, who do all of our mechanical repairs, expires at the end of the year. So we'll be--we have a contract up till the end of this year. We'll commence the negotiations with them in the fourth quarter.

And the two that you're negotiating now, when are they eligible to walk off?

As Fred said, the maintenance of way are obligated to give us 72 hours notice. We're not in any period right now with the running trades employees. We're in active negotiations. And there would be an 81-day notice period should they apply for conciliation.

Okay. Thank you very much for the time.

Your next question comes from Cameron Jeffreys from Credit Suisse. Please go ahead.

Thanks very much. Marcella, just a question for you on the yields in coal being quite strong in the quarter. Can you give us some help on how we should think about that as we move through the remaining three quarters of the year? I mean, you're up--you're going to be down seven annualized, I mean, but you're up 10 in the first quarter here. So--.

--The coal changes are largely due to some mix changes in average length of haul. As we return to more normalized Vancouver export traffic, which we expect to do through the balance of the year, that may come down a bit. So it really depends on the mix, on where the coal is going to. Right now, it's going on longer hauls, so that should change marginally.

And just to confirm, the 35 to 45 number you gave us was a revenue impact, correct? Just on the--yes--.

--Yes, it was the revenue.

Right, right. Okay. And secondly, just wanted to get some commentary maybe from you, again, Marcella on the coal corridor in the Elk Valley. I mean, with Fording, there's a ton of stuff sitting there--pardon the pun of stuff sitting there--at the mine site. And I think Fording is saying it could take several quarters even for that to get back into balance where they normally like to see things. Do you have any comments on that? Would you agree with that type of assessment?

I agree wholeheartedly with that assessment. There's a lot of coal on the ground at the mine site, very little coal at the port itself. Our job over the next--over the balance of the year is to move the coal off the piles at the mines, move them to the terminals, and also to move the production--keep up with their production. So it's looking like a very healthy coal year for us.

Cameron, maybe just for clarity though, we move 20 million tons of coal a year or thereabouts. And there's less than 1 million tons of stockpile at the mines. So let's put this in perspective that while it may take the rest of the year to fulfill the full volumes that we said we would move on the year, that's because we're really going to be going hard all year just on normal volumes. And of course, the [eat up]--a million tons of--.

--The excess, sure--.

--Stockpile is--it's not a monster task. We just have to consistently chew away at it, so we can get the inventory shifted from the inland side to the port, which gives them more flexibility for their ship loading.

Right. Great. That's helpful. Thank you. And just finally, if I may, on--I had to jump off quickly. I'm not sure if you answered this already. But just on the debt-to-cap ratio, is there an optimal level kind of where you would still be comfortable? I mean, in the mid-40s? I mean, maybe stretching to 50? Is that something you would be--you would consider as comfortable or would that be maybe stretching things a bit too far?

Yes, Cameron. It's Mike, again. What I did say is the debt-to-cap is really--doesn't give an indication of debt capacity. It's the coverage ratios.

Okay.

So debt-to-cap is just--from our perspective it just indicates how hard the balance sheet can work to improve return on equity.

Okay.

So we--we're focused on coverage ratios in terms of capacity.

Okay. Thanks very much.

Your next question comes from Randy Cousins from BMO Capital Markets. Please go ahead.

Two questions on yields. I guess, Marcella, I wonder if you could comment on the prospects for improvement in yield in the grain side because you've got both regulated and unregulated grain products. Have we seen the new grain rate come through the system yet in terms of regulated? And what are the prospects? It certainly sounds like the U.S. guys are very bullish, are very positive on grain rates or ag rates in the U.S.

Randy, the--when the [ICPI] formulas come out, it's tentatively a preliminary set at 3.4%. If you recall, last year it was at 6 to 6.5%. So that's the number that we're looking at this year. That will be our export regulated grain. We, of course, have our commercial grain where we're targeting around a 4 to 6% increase on our commercial grain. The U.S. market continues to look strong for us, as you've heard from other rails. And we will certainly follow the same trend on the yields in the U.S.

Okay. And then, the second question, with reference to potash the yield was down in the first quarter. And my recollection, of course, is that [Campotex] supplies all the cars, so that has a positive effect on yield. But I guess the issue is with--my recollection of your Campotex contract is there was some sort of price linkage component to it - and one of you correct me whether that's true or not - but also deal with the fact that potash prices are kind of like at all-time record highs and is that going to have an impact on yields in your sulfur and fertilizer business.

Well, first of all, Randy, I will confirm to you that the yields are in the potash and fertilizer business, in fact, this whole segment, sulfur and fertilizer. The bulk of the goods in this segment moves in customer shipper supplied cars. So you're right on the Campotex side, as well as on the other portfolio. In our potash, the contract that we have, I, obviously, can't disclose any terms of it to you. But I can say that there is some improvement as price improved on the potash commodity price.

Randy, I'll jump in. It's Fred, again. The--because we just need to be consistent with past messaging. Marcella's phrase is absolutely correct, but I want to quantify that in the sense of saying it's really very modest. Because of the relationship we have with the Elk Valley contract, people get a sense of the big swings. With our relationship with Campotex, while there is some correlation between price and our freight rate, it is much, much more modest. So nobody should be swinging high or swinging low on that.

But this would be a point of positive variance relative to where your guidance is, would it not?

No--.

--Our guidance reflects our assessment of where we thought the markets would go and I don't think the markets have gone anyplace we didn't think they would go, Randy. So I wouldn't change any modeling in that regard.

Okay. Thank you.

Your next question comes from Robert Fay from Canaccord Adams. Please go ahead.

Thank you. Marcella, I just wanted to get a little bit more flavor for the customer expansions you talked about. And also, for the state of where things are at the Vancouver port and how that will play out over the next year or two.

Sure. I'm happy to [indiscernible]. On the [ESCO] side they're looking at some of their flat rolled steel, some of the--and increasing their dimensional piping. So they will have--by the time they complete all the expansions--they announced some earlier expansions--they will have increased their capacity by I think about three-quarters. So that's good news for us. The new biofuel facility, which you may have seen announced, in the [Innisdale] area just north of Calgary, is on our line. And they are planning that to be the largest Canadian--I'm not sure that they said North American.

The largest North American--.

--North American facility--biofuel facility will be located there. So that one's up and coming. Potash Corporation announced some plans to expand their mine capacity. Some of that capacity, about 250,000 tons, is expected to come on this year in 2007 and the balance over '08 and some into '09.

On the port side, the recent announcement with the--was with the federal budget. And as you probably know, Bob, the government has not yet specifically designated exactly where all the funds will go, but it is to the group of infrastructures that make the port, the Pacific Gateway, more effective. They're well on in their process in looking at what those particular projects might be and how they value them and the relationships that they have with the province. But clearly, both the provincial and the federal government are absolutely committed to ensuring that the Gateway expands as commodities, particularly on the intermodal side, continue to grow into Canada.

Marcella, we might want to add in for Bob's benefit, if you were thinking, Bob, about the status of the port kind of in a current window, there is virtually--correct me if I'm wrong, Marcella--virtually no backlog of containers. We have cleaned up that backlog over the last couple of weeks and month and we're almost current, plus or minus a day or so I think.

That's exactly right, Fred.

Okay. On the intermodal ports on the--in Vancouver, what's the sort of timeframe we're looking at now for the expansions that were under discussion?

Well, they've got--last year, they were about 2.2 TUs--2.2 million TUs that they handled. The expansion they've already started with the [Birth 3]. That construction has already begun. That should be online I think in 2009 is the expectation. Terminal two, they have begun. They've been looking for contractors and terminal two partners, so that is out there in the public. And they will be proceeding with that.

That obviously will take longer--about three or four more years beyond that to come online. So they expect to grow both the existing capacity at [the interim] center in Delta port with a lot of process improvements. And the terminal operators have been acquiring assets, such as cranes, for instance, to increase their capacity. So that will increase. Allocations have been increasing at the terminals. And then, with that we'll start following with new infrastructure.

So there's a good partnership between all parties working with the governments, the port operators, the railways, our shipping line partners to plan those capacity increases as the volumes grow.

Very good. One other thing, I guess, Fred, can you give us some sense on what you're seeing from the point of view of governments here in North America to help the rail business out with the capacity issues that are out there right now? Do you get any sense on any initiatives that you could see coming down the pike?

Well, I think we have to break it, Bob, into Canada/U.S. And in the U.S. in the last week or so the investment tax credit has been sponsored and is--has a long list of parties--interested parties, be they shippers or infrastructure parties, who are supportive of that bill. How--where it goes and how long it takes to get through, if I recall correctly, they were talking about 20 to 25% investment tax credit on anything related to rail infrastructure whether it's a truck facility that uses rail or a port or the rail itself.

So there is clearly a very strong appetite and a lot of sponsorship for that type of vehicle in the United States. In our dialogue in Canada at the federal level there is a natural aversion, candidly, towards tax credits for reasons that are historic. But we've really--as you've seen with Marcella's comments of the Pacific Gateway funding going from 600 million up to 1 billion in the last quarter, there is clearly an understanding about the role that infrastructure can play, either as the governor on the economy or perhaps as the engine of the economy.

So I'm optimistic, although I can't tell you there is anything that's progressed far enough to declare a victory on, that the federal government will continue to pay a lot of attention not just to the importance of how to stimulate the economy through infrastructure and enable it, but also because of the relative importance of having a partner to the south who may have incentives and may cause business that could otherwise come through Canada to be drawn to the states and that would have economic impact. So we'll see whether it's for offensive, defensive, or just sound business reasons what the federal--Canadian federal government position will be. But we'll continue to keep them informed and hope that they see good judgment on a go forward basis.

Great. Thank you.

Your next question comes from David Newman from National Bank Financial. Please go ahead.

Good morning.

Good morning, David.

I understand the cash flow and the balance sheet [argument] in the buyback, but does it also reflect let's say private equity interest in the infrastructure space at all?

Well, there's clearly people circling all over the place in every industry. So you can't say yes, you can't say no to that, David. What you can say from our perspective is really simple. The Board of Directors has a very clear mandate for me. I understand it very clearly--and that is to do a heck of a job with a franchise that we think is extraordinary in an industry that's on top of its game. So our team is absolutely focused on delivering the EPS we said we would and delivering even more beyond that. We have no discussions ongoing. And we're entirely focused on running a great business. So I think that's probably the simplest and best, the most focused answer I can provide to you.

Okay. And then, if you look at the 4 to 6% revenue growth assumption, how much of that would be strictly volume?

The 4 to 6 that I mentioned is actually the price target that we have.

Okay.

We have--I've also got the overall revenue growth. It's the same - 4 to 6%. So that may be a little bit of the mix up. But our revenue--our volume growth target is 3 to 5%.

Okay, very good.

Which is built-in to the 4 to 6% total revenue growth with 4 to 6 also on contract renewals.

David, we know that sounds complex. At the end of the day, there's a great big pricing adjustment for coal, if you recall from the--.

--Right, yes.

That's what makes it look odd.

Yes. We had that 1 to 2% headwind that I talked about, or Judy talked about, I apologize, in November. And that 1 to 2% is the coal price change headwind and a bit of the grain headwind on the revenue cap formula.

Right. And just on the grain, if the Canadian Wheat Board--this is kind of a political one--but the Canadian Wheat Board becomes elective. Is there--do you believe this government would move forward with deregulating also the transport--rail transport pricing at all?

Marcella doesn't have an opinion on that.

I'm sitting here shrugging my shoulders saying, I don't have an opinion.

The net outcome with consolidation on the [grains] though and now that barley has become--looks like it's becoming elective, is there any rail impact at all for you guys?

No. David, I don't expect any rail impact from any of these changes. Just to give you a bit of a sense of it, barley is about 4% of our grain business. Nothing--we won't see any of the changes which would cause problems to the grain transportation and handling system. We support anything that will improve that grain handling and transportation system. And there have been a lot of strides taken that we've taken ourselves and collectively the industry has taken over the years. And I expect that to continue, particularly with the consolidation in the grain elevator companies themselves, who are looking for more and more efficiencies, which includes the whole handling and transportation system.

Excellent. Thanks so much.

Thank you.

Your next question comes from Ken Hoexter from Merrill Lynch. Please go ahead.

Great. Good afternoon. It's Ken Hoexter from Merrill. If I could just follow up, Marcella, on the coal questions you've gotten. I just want to understand the volumes that you're going to get from this increase--increased shipments. But you said that it would be down 7% year-over-year. But is that just for the Fording Elk Valley? And then, I want to understand what the current 10% growth is from. I understand you said the increased length of haul. So what kind of volume numbers, car loading numbers, should we be looking for for the rest of the year?

The volume numbers that we explained in November is that we expect to move 2 million metric tons more than we moved last year in terms of volume. The 7 to 9% decline is pure price related to contract changes. You'll recall that coal years are April 1--begin April 1 and at the end of March. So all the price changes occur in that period of time. So the 7 to 9% decline was an annualized price change that we expect to see through 2007. The volume--the 10% that you see on the yield side on the [fly] sheet is really about mix. It really isn't impacting the total volume. It's about the mix in terms of the change of the average length of haul.

Okay.

That should normalize as the months go forward.

Okay. Very helpful. Thank you. And sorry I couldn't be up there today. Obviously, part of being downtown--it's so far away from midtown meetings. But I wanted to follow-up on your EPS outlook of 9 to 13%. With a buyback that is three times the size of what you had when you set this kind of same target, I'm just wondering why there's no--I guess, upside. Are you seeing a rougher environment than you anticipated in the back half of the year? I just want to understand your outlook in reiterating your target yet while seeing a sizeable stock buyback within that.

Yes, Ken, it's Mike Lambert. Our buyback, as I mentioned earlier, contemplates that we'll do it evenly over the next 12 months. When you take into account a whole bunch of factors in terms of the timing and also in terms of our funding, the impact on EPS actually is not very big in the current year. The impact in out years is significant. So next year, you can adjust your models by about 7.5%. So the accretion next year would be about 7.5%. Accretion this year, not significant.

Mike, you're saying 7.5%?

I'm sorry. Yes, 7.5% next year. So a 10% buyback. You take financing costs on that, it's about a 7.5% accretion next year.

Great, that's very helpful. And then, Fred, I guess, is there a way to kind of take a look at--obviously, with Brock, you're kind of signifying that we're doing great on fixing costs and taking costs out of the system. Is there a way to look at first quarter impact if not for weather and other kind of items and say, yes, we're really on track for pulling these costs out? Or are you looking at this and saying, you know what, this was a bit of a disappointment and we need to fix [them].

Let me give you a bit of a qualified answer. And then, I'm going to ask Mike maybe to hit the quantified side. Ken, I am absolutely delighted. I just have to say that Brock and his team have come through hell. If you looked at that chart and you saw the avalanches and you dealt with all of the issues this team has dealt with, they have done nothing short of an extraordinary job to deliver 8% EPS growth in the first quarter when other parties haven't been able to do those kinds of things.

So I'm delighted with where we are in that regard. Of course, my excitement level rises because I want us to immediately recover and surpass. Of course, Brock and his team have to put up with me encouraging them to do that regularly. But I want you to understand this. This team is doing a fantastic job. But we've hit some hard, hard strides. It will take--well, it's largely back, but it will take a little bit more time till it's fine-tuned. And then, we're going to not only do what we did last year, but far better. So the team is on it. The team's in great shape. But, Mike, maybe you can put a little quantification there.

Yes, let me put some numbers on it. I'm actually delighted, too, from a numerical perspective. Here we had probably one of the most challenging quarters we've had in a long time, and yet our operating ratio improved slightly. Had we not had these tough operating conditions, our operating ratio would be up 200 basis points. And I'm being optimistic there, because it's very difficult to say if things hadn't happened what your revenues would have been and what your expenses were.

But in very round numbers, we think our operating ratio would have improved by 200 basis points versus last year. In terms of EPS, we talked a little bit during our commentary about a dime--we're saying $0.10 to $0.15 we think we could've had, had these conditions not persisted throughout the quarter - $0.10 to $0.15. And as Marcella indicated in her commentary, we'll get a lot of that back because the revenues didn't all go away. And that's one of the reasons that we're not adjusting our outlook. We're feeling pretty good about the year. The demand is robust and we got through a very challenging quarter with positive numbers.

Great. Appreciate the time. Thanks.

Your next question comes from Walter Spracklin from RBC Capital Markets. Please go ahead.

Thanks very much. Good morning.

Good morning, Walter.

On the share buyback and the potential for increased debt, your--Mike, have you gotten any sense of what the rating agencies have come back with? I noticed that DBRS has just changed their trend on you to negative. And I'm wondering if--how you're framing this going into this sort of refinancing and what your expectations are [inaudible].

The message we got in terms of DBRS, we should point out that they just rated us higher. And so, in terms of their announcement today, it's just getting us back to where we were a little while ago. So I want to make sure that that's clear to everybody. As much as that may sound negative, it's not, it's just getting us back to where we were. In terms of the rating in the industry in general, and I'm talking about our rating with the rating agencies, we're a mid-investment grade. Two years ago we were mid-investment grade. And I think I mentioned that our coverage ratios have improved by about 1.5 times.

If we did nothing to improve the--to make the balance sheet work harder, we'd be about two times better than two years ago. And so, one of the things that we are doing is dialoguing with the rating agencies and making sure that they're comfortable with where we get to.

Okay. So you're confident there won't be any changes or downward revisions in your rating?

I'm never comfortable about what the rating agencies are going to do. They are independent. But we're dialoguing with them and we take care to make sure to dialogue with them carefully.

Great. Just my second question to Fred. Just on the union negotiations, I was wondering if you might be able to give us some color as to--and obviously this is a confidential type of negotiation--but what the major points or what is the contentious issue here in terms of this particular union. And going into the union negotiations for the back half of the year, are you looking for essentially contract negotiations that are in line with previous rate--wage inflation, or [inaudible]?

Well, let me deal with number two first and just say that we're very early in our dialogue with our associates in the running trades. So I don't really want to say anything today that might play with the negotiations that are just--really just getting going. So I'd prefer not to talk about where that may go. We do have a great working relationship. We hope that there will be a fruitful dialogue and a good settlement that's good for both parties.

With regard to the maintenance of way, I think it's been quite well publicized that the contentious issue--and there's hundreds of issues that are involved in behind the scenes--but the contentious issue is that a party would like to have a rate increase or a salary increase larger than that which has been established at about 3%. And we're a pretty reasonable group of people, but at the same time, we have to find ourselves respectful of the things we've done with other groups. And we have to command some form of improvement in our collective agreement in the sense of improved work rules and something that could create efficiency, if we're going to fund something other than what it is that we've already negotiated as the pattern.

So therein lies the crux of the issue. We are open minded to solutions, but those solutions have to involve productivity or else we're going to find ourselves going down a real silly path and it just gets out of control. So we're well equipped to deal with what we have--to do with what we have to--or sorry, to deal with what we have to should we not be able to get to a solution. But we're really, really optimistic we'll find some work rule changes or ways to fund if that's what people want. And we're going to keep going down that path hopefully with a good outcome.

That's great color. Thanks, guys.

Your next question comes from Bill MacKenzie from T.D. Newcrest. Please go ahead.

Thank you. Just a couple of questions on the cash flows. My concern is the CapEx guidance. Can you just remind me what the breakdown would be between sort of the cash component of that and the [inaudible] or other accrual expenditures?

Bill, it's Mike. I don't know the breakdown offhand. I'm going to look over to Brian here to see if he can help me.

I think from a year-over-year--I mean the 885, 895 is all cash - no capital leases in that component. The increases over last year is really on the basic maintenance as well as in that metro area [game plan] funding.

Which is our secret code word for Toyota.

Okay. And then, in terms of our restructuring payments for the year, it's sort of [inaudible].

Yes.

Okay. And then, just one last question on the grain. Marcella, I think you mentioned that the revenue cap [indiscernible] is going to amount to 3.4%. Does that include any exchanges to sort of [inaudible] I guess debated a little bit in Ottawa? Or is that something that will potentially become--?

--I think, Bill, Marcella--I'm not sure if she caught the whole question. But my interpretation would be that the answer is no. If 3.4% is the price increase, should there be a change by legislation involving the CTA with regard to any kind of maintenance as we forewarned in November that something could be happening, and we have modeled for something that could happen. That would be an additional change.

The 3.4% we've included in our modeling on the overall price changes, Bill. And then, the additional headwind is something different.

Okay. So we haven't heard anything yet on--I guess what I'm getting at is I think you had incorporated some headwind into the guidance.

Yes.

Like incurred [indiscernible] from the government on that particular headwind so that it would leave you with a little bit of wiggle room in terms of what you might [inaudible] guidance for the full year.

Well, Bill, to be candid, we modeled it in to hit in a midyear period because that tends to be how the grain business works on the grain year, as opposed to the fiscal or the calendar year. So I think our model is quite accurate at this point in time, subject obviously [to what they say].

All right. Thank you.

Thank you.

Your next question comes from Sal Vitale from Calyon Securities. Please go ahead.

Good morning. Just a few questions here. One is on the cost guidance. I understand that's 3 to 5% operating cost for the year. Can you give some color on what the non-fuel operating expense growth you are contemplating in your guidance is? So that's operating expense ex-fuel.

If you scrub out fuel, it would be about the 2 to 4% range.

2 to 4%. Okay. And the variability in that, would you say that that's more volume based, contingent on what happens to volumes? Or is that more on other types of cost inflation?

Inflation--both components would be volume, which Marcella talked about before, as well as inflation, offset by the productivity improvements that were talked about.

Okay. Thank you.

Your next question comes from Robert Delaney from Bloomberg News. Please go ahead.

Yes. Hi. Good morning. I just wanted to clarify the bit about the labor talks. I heard you saying that you're in active negotiations with the maintenance of way workers, representing about 3,000 of them in total. I guess my understanding was that they have the option as of I think this evening or maybe tomorrow to strike. And I just wanted to know if this is a change in the situation that you are now in active negotiations with this group, or am I confusing it with another group. Thank you.

Robert, you have your facts correct, but the conclusions--I hesitate to reach the same conclusion. The group has been in dialogue with us frankly for the last four or five days I guess after many, many prior dialogues. There is nothing unusual about that and we're delighted that we're still able to stay at the table. They have in the Canadian regulatory scheme as it applies to labor--there is, as Brock referred to earlier, an 81-day period, including a 21-day cooling off period. We are at the end of that cooling off period. And therefore, nothing has changed. They have exactly the same rights and abilities that they've always had. And we are hopeful, obviously, that we'll stay at the table. But because we've reached the end of a period that was prescheduled and clear to everybody, they now have the ability, should they wish, to issue a 72-hour strike notice.

Thank you.

You're welcome.

Mr. Green, there are no further questions at this time. Please continue.

Well, okay. Thank you very much everybody on the line and everybody here today. We appreciate it. Thanks for joining us for the call and we'll see you on our next call.

Ladies and gentlemen, this concludes the conference call for today. Thank you for participating and please disconnect your lines.