Canadian Pacific Kansas City Ltd (CP) 2008 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to Canadian Pacific's first 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. (OPERATOR INSTRUCTIONS) This conference call is being recorded today, Tuesday, April 22nd, at 11 a.m. Eastern Time.

I will now turn the conference over to Ms. Janet Weiss, Assistant Vice President, Investor Relations of Canadian Pacific. Please go ahead.

Thank you, Patrick. Good morning ladies and gentlemen, thanks for joining us for the 2008 first quarter teleconference. The presenters today will be Fred Green, our President and Chief Executive Officer, Kathryn McQuade, Chief Operating Officer, Marcella Szel, our Senior VP of Marketing and Sales, and Mike Lambert, our Chief Financial Officer. Also joining us on the call today are Brock Winter, Senior VP of Operations, and Brian Grassby, VP 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 sensitivity 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 in 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.

This presentation also contains non-GAAP measures, please read slide two. The slides are available on our website, so please follow along. Following the presentation, we will conduct a question and answer session. Please feel to queue up for questions now or at any time by pressing the star followed by the one on your touch-tone phone.

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

Good morning. I am providing brief opening comments and then come back to wrap up. It is obviously a challenging market place to predict, so I have asked our team to assure that our assumptions are clear, and that some sensitivities are provided. We experienced some serious Q1 challenges, but have come through it with improving service levels, and a renewed intensity on efficiency.

Looking at the balance of the year, we fully expect to realize gains in operational fluidity, and to additional bulk volumes into global markets. However, we are now forecasting substantially higher fuel prices, particularly in the crack margins, and a more significant economic slowdown. We are expecting forest and auto traffic to be particularly hard hit. Making productivity gains on our manifest trains more difficult to achieve. Given these facts, we have reduced our guidance to reflect the expected headwinds, and we have expanded our guidance range to reflect the market uncertainties. The new range takes us into the mid-single digit EPS growth for 2008.

With that, I will turn it over to Kathryn to outline operational performance.

Thank you Fred. Yes, it was a tough quarter in terms of weather. Northern Ontario and the prairies experienced extreme cold for extended periods. Montreal, Toronto, and much of the East dug out from record snowfalls. Despite these very difficult conditions, we moved increased first quarter GTM. This speaks to the fluidity we maintained in the western corridor, as a result of the many actions, as shared in the Q4 call. In the quarter we moved 4% more GTMs, and we did it with an operating expense per GTM excluding fuel and foreign exchange impacts, up just over 1%.

Let me assure you that we are focused on improving productivity. Now looking more specifically at our results, let's start with Safety on Slide 6. Our safety results were mixed, on a positive note, our personal injury frequency improved by 24%. This is clear evidence of our safety culture and the personal commitment we have made to safety. Out total number of train incidents declined by 6%. However our FRA train incident frequency deteriorated by 18%. With the harsh operating conditions, and the remote locations, the cost of these incidents were higher, negatively impacting our first quarter casualty costs. Mike will speak to this later.

Please turn to Slide 7. While we made some significant fluidity improvements in our western corridor, it was not enough to overcome the impact of several train incidents, and tough operating conditions on the other four sets of our network. Let's look at the numbers. Train speed improved by only 1%. Terminal dwell was worse by 1%. Active cars on line and Car miles per day both improved by 3%, despite higher volumes. These service metrics are not where we want to be, but the winter conditions held us back from reaching our full potential. We see that our initiatives are working, and I am confident you will see continued improvement in our fluidity.

Turning to Slide 8, you can see the challenges we faced. In particular, it was the intense and prolonged cold in the prairie, the timing and remote locations of the train incidents in our key transcontinental corridor, and the record snowfalls in the East, that combined to increase our train operating and casualty expenses. I don't want to dwell on the winter and our train incidents, but we spent $22 million more this year. These costs included such items as extra snow clearing, excessive overtime, unproductive train staging, idling locomotives, and increased contractor and rerailing costs. The extensive extreme cold hurt our locomotive reliability, requiring us to lease short term power, and incur higher maintenance costs. These locomotive issues are now behind us.

We are now focusing on execution of our integrated operating plan, and we will improve our operating performance and efficiencies, despite the softening merchandise business. It is a challenge to eliminate train starts, given that we are seeing only small reductions over many hundreds of origin destination pairs. But we are very focused on cost control and we are proactively making changes in our IOP, as well as shutting surplus locomotives and cars as our fluidity metrics improve. We are still committed to our IOP savings of 25 to 30 million.

Finally, I would like to give you a DM&E update on Slide 9. This past quarter we met a key milestone with the submission of Safety Integration Plan to the STB and FRA on February 5th. We are working through the various steps in the STB filing processes, and to-date have encountered no surprises. The STB should render a final decision on September 30th, and if approval is granted, an effective date for control would be October 30th, 2008. We continue to work with members of the DM&E team. The plan for a smooth transition, and from a day-to-day business perspective, the DM&E management team is meeting their targets.

I look forward to reviewing our progress with you next quarter. I will now turn you over to Marcella.

Thanks, Kathryn. Excluding FX, we delivered over 9% revenue growth with fuel recovery accounting for more than half. A reasonable outcome for Q1 given a weakening U.S. economy, and weather impacts on our product. I will now review the quarter by market area, and then turn to the balance of the year. As in the past, I will refer to numbers excluding the impact of foreign exchange.

Turning to Slide 11 to review freight revenues, grain was up 14%, reflecting strong demand and commodity pricing fundamentals. U.S. grain performed very well due to exceptional production levels in North Dakota. Turning to Coal we were up 9%, we moved 15% more export tonnage in the quarter for Elk Valley. Revenues reflect the negative year-over-year export coal pricing adjustments, and this is the last quarter I will need to provide the reminder, as our prices increased April 1st.

Rounding out our healthy bulk franchise, Sulphur and fertilizers was up 14%. Potash is a driver in this portfolio, where excellent demand fundamentals continue, based on the global need for nutrients. In Forest products, new lows continue in the lumber and panel sector with U.S. housing starts the lowest in 17 years. The overall sector is off 19% in carloads, and 8% on revenue. In contrast, Industrial products was up 21%. The foundation was price gains, including fuel, and continued strength in the Alberta energy economy.

On the Automotive side revenues were off 4% on weaker U.S. demand, a slow return to full production in the new year, and the American Axle strike impacting General Motors. Intermodal was up 7%, domestic Intermodal was limited by retail softness and some weather impacts, particularly in eastern Canada, but it has rebounded in April.

Turning to slide 12, I will sum up the quarter. Despite this year's challenging conditions, we delivered some solid revenue improvement over 2007. Before FX impacts, freight revenues were up over 9%. If you follow the waterfall for the breakdown, price and fuel excluding the coal price change was the key driver at just under 9%.

The coal price takes us down a little over 1%. Volume and mix was about 2%. And a tough FX compare reduced revenues by 6.5%. This lead to an all-in reported revenue growth of 3%. Disciplined pricing continues, and contract renewals achieved on average a 5.5 increase in Q1, on-track with my expectations and our 2007 experience.

Turning now to the balance of the year on Slide 13. I will first share our view of the economy. It is clear that the U.S. economic weakness will be deeper and longer than originally projected. We are now modeling GDP to be a little above 1%, with U.S. housing sales at less than 1 million, and U.S. vehicle sales of about 15 million. And WTI originally at $80, is now modeled to average $98. For the commodity outlook, I will start with bulk. It is largely unaffected by North American GDP, as global fundamentals for grain and resourced products remain compelling.

Demand remains strong in grain, as farmers strive to take advantage of high commodity prices. We are still modeling a normal crop for the second half. Respecting the Canadian Transportation Agency's February 19th decision on the maintenance adjustment in the revenue entitlement formula, we will vigorously challenge it. In our view, it is not supportable, and we filed an appeal.

Turning to export coal, we are now modeling about 1.5 million metric tons over the 2007 actual volume. This includes about 0.5 million tons carried forward from 2007. Commencing April 1st, the new coal year, there was an upward price adjustment. Pricing will improve over the balance of the year, but will be flat on average with 2007. Potash demand remains very strong. We are modeling solid export growth. Record potash price settlements reinforced the great prospects of this product. Overall, we anticipate healthy demand to remain substantial subject to key dependency on supply chain practices.

In Merchandise, it seems that every week has produced an announced slowdown or shutdown in the Forest products sector. Automotive will also underperform to original targets. I do expect positive results in Industrial products, primarily chemicals and energy linked to Alberta, as well as continued pricing gains across the portfolio.

In Intermodal we expect to see both the Port of Vancouver and Montreal to deliver growth. I anticipate this import/export business will help offset any weakness in domestic Intermodal, given lower economic projections, however, with overseas containers also weighted to retail activity, and a slower ramp-up following the Chinese New Year, I am watching the import/export for signs of softness.

As I noted for pricing, contract renewals remained solid. Respecting the fuel outlook, I do have some concerns. As I have stated in the past, we have coverage across the full portfolio, and our recovery in Q1 was close to 90% on incremental expense. We are also actively and aggressively migrating to run highway diesel within our program. However, with crack margins increasing 45% over original assumptions, recoveries will be pinched, as a significant portion of our business remains tied to WTI. In addition, some legacy contracts limit the responsiveness of the fuel program at current price levels.

So in summary, in a challenging quarter, we have delivered solid growth over 2007, through good pricing, and the performance of bulk and intermodal. Looking forward, I am modeling bulk remaining healthy, merchandise impacted by the deeper U.S. downturn, and intermodal slightly weaker. Higher fuel prices and our continued focus on pricing will partially offset the impact of reduced volume. I now expect a revenue breakout as follows, 1 to 2% from volume and mix, 5 to 7% on price including fuel, offset by 2 to 3% on FX. S o still within my original freight revenue guidance of 4 to 6%.

Now Mike, over to you for the financials.

Thanks, Marcella, and good morning, everyone. As usual I will take you through the quarter, and then give you some color on our expectations for the remainder of 2008. The trend of a high Canadian dollar and high fuel prices continued into Q1, with the dollar up $0.15 year-over-year, and the price of crude increasing a staggering 59%. As you can imagine, these two items created a tough hill to climb in Q1.

To put these headwinds into perspective, fuel price and FX combined to impact our Q1 operating ratio by over 200 basis points. Before I get into the details of the quarter, I would like to point out that despite these challenges, I am pleased that we still drove efficiency gains with GTMs per active employee up almost 3%.

Now turning to the numbers, I will start with our income statement on Slide 15. Starting at the top right corner with total revenue I will focus my comments on FX adjusted variances. Total revenues were up 9%. Operating expenses, which were impacted heavily by fuel prices and harsh weather conditions, were up 13%. This translates in to a decrease in operating income of 6%.

Looking to the left, you will note our reported operating income was 198 million with an operating ratio of 82.7%. Below the operating income line, DM&E equity income net of tax added 11 million, while interest expenses rose to 60 million, as a result of the increased debt taken on to finance the purchase of the DM&E.

Finally, our income taxes fell by 45%, due primarily to a reduction in provincial tax rates. Our adjusted income is up by 1%. When FX is added back, our adjusted income falls to 116 million, or a decrease of 5%. Before leaving the income statement, I should note that we further reduced the valuation of our investment in asset backed commercial paper by 21 million. This represents another 15% markdown, essentially doubling the amount we took in Q3 of '07.

Now on Slide 16, I will reconcile our Q1 EPS. Starting on the left, this quarter we estimate the weather combined with the higher than normal casualty costs, added an incremental $0.10, or 22 million in operating expenses over last year. All other operating expenses were up by $0.42, driven by fuel price increases, while foreign exchange cost $0.05. On the positive side, Freight revenue increases added $0.47, mostly from price, including fuel. The DM&E contributed $0.03 to EPS. This is an all-in number and includes the gains from the equity pickup, and the increased interest costs after tax. We are still on-target to hit the $0.15 to $0.17 range. Next, the provincial tax benefits added $0.07 to our EPS, and finally, All Other cost us $0.03. Overall, we ended the quarter at $0.75 which is 4% below our 2007 results.

Turning to Slide 17, and a more detailed look at our operating expenses. I will start at the top and work my way down. Again for this breakout, I will talk to the FX adjusted numbers, which are in the far right column. Compensation and benefits was up 2%, due to higher volumes and labor inflation, which were tempered by reduced pension expenses. Fuel expense was up substantially, coming in 47% higher than last year. This was driven by a US$35 per barrel increase in the price of crude, weather related impacts on fuel consumption, and a 4% increase on workload as measured by GTM.

Material costs were up 13%, due in most part to the issues Kathryn talked about incremental locomotives, and their lower than expected reliability. Equipment rents improved 5%, driven by lower lease rates and fewer active cars online. Improved fluidity in the western corridor aided in the improvement. Depreciation and amortization came in on-target, while purchased services and other was up 13%, due to tough weather, higher casualty costs, volume increases, and inflation. So all-in, operating expenses were up 13%, with the majority of the increase attributable to fuel, weather, and increased workload.

Now let's turn to Slide 18, and look at some of the major headwinds that are leading to our decision to lower 2008 guidance. In October last year at our Investor Conference, we provided a guidance range of $4.70 to $4.85. since that time the environment has changed. In February we reduced our guidance by $0.05, due to the Canadian Transportation Agency's announcement to reduce our regulated grain revenue entitlement by $2.59 per ton.

Throughout Q1, brutal weather added incremental one-time costs to our operation. Thirdly, fuel prices have gone well beyond our expectations, with crude hovering at record levels, and crack margins increasing by an estimated US$7 per barrel over 2007. We are not only seeing our fuel expenses climb, but we are also seeing a growing gap between the expenses and our fuel recovery program. So to help you model, we are estimating our all-in fuel costs will be approximately US$3.35 per gallon in 2008, with a fuel recovery in the mid-80% range for the year.

Finally, the slowdown in the economy will impact both Forest products and Automotive revenues, and will create challenges in reducing the train starts needed to manage expenses. With that, we are lowering our 2008 total year EPS guidance to a range of $4.40 to $4.60. This is a wider range than we have traditionally given, to compensate for the increased uncertainty.

Let's now turn to Slide 19, and I will tie everything together. We are estimating that total revenues will grow between 4 and 6%, with increased fuel revenue partially offsetting the reduced traffic volume anticipated. We are expecting Other revenue to fall by close to 15% on the year, with Q2 looking very similar to this quarter, due to lower land sales than a year ago. Operating expenses are expected to rise by 6 to 8%, with fuel price driving the largest portion of this increase. Free cash flow is expected to be approximately 200 million, which is lower than our original estimate of $250 million.

On the capital front, our plan for 2008 is under review, due to the recently-announced U.S. tax stimulus package, as well as the consideration of other targeted infrastructure investments. We are averaging WTI to average US$98 per barrel for the year, and continue to assume the U.S. dollar at par. Finally, with the adjustment in corporate tax rates in Canada, and the Q1 provincial tax benefit, we are now modeling a 2% improvement in our full year tax rate, now modeled at 27% to 29%.

With that, I will now turn it back to Fred.

Thanks, Mike. As you have heard, the circumstances are very different than the market conditions we saw at our Investor Conference in October. On the positive side, our bulk business continues to thrive. Our price plan is intact, and our operational performance is improving, with the return of more normal operating conditions. The core DM&E franchise is exceeding our expectations, and the FTB approval process is on-plan. But we have had a tough start to the year, and believe it is prudent to update our guidance with the new realities that we are faced with.

Our business model has worked in the past, and will work well in the future. I expect that our exposure to growing global markets, and our focus on operational efficiency will deliver positive earnings growth in 2008. To-date in April, our performance is showing promising gains in operational fluidity, with a 6% improvement in car miles per day, and 7% improvement in yard develop versus March.

In summary, you can expect this team to stick with our game plan, focus on efficiency, and ensure that we are positioned to grow, as we work through this short term set of circumstances. The model is solid, the team is focused, and the long term fundamentals of the rail industry and CP remain very sound.

Now I will turn it over to Patrick, and we will take some questions.

Thank you. Ladies and gentlemen, (OPERATOR INSTRUCTIONS) Please limit your questions to two. We will take questions from analysts until five minutes until the hour, then we will go to the media. One moment please for the first question. Your first question is from Fadi Chamoun, UBS Securities. Please proceed.

Good morning. Just wanted to understand a little bit about the change in the guidance. It looks like your expenses you are guiding higher by about 100 million, which is mostly related to fuel if my calculations are right. But on the other hand, it look like you are covering half or 2/3 of it in the pricing can you help me understand the moving part on the top line side?

I am going to ask Mike to give you some details. In principle I think you have captured it correctly. Marcella reported back at the Investor Conference in the fall, at that time we only had 35% of our business on highway diesel fuel surcharge, because we are in our fourth of fifth iteration of what these fuel charges have evolved to. We have migrated to the point today where we are at about 39%, and Marcella said we expected to have about 50% by the end of 2008.

The bad news from our perspective is that the crack margins have expanded dramatically, I think Mike said $7 per barrel on crack margin. And that is only recoverable from about half our customers, actually a little less than half of our customers willing to half by the end of the year. So your assessment is correct that in principle we are paying for fuel. And because of some of the earlier iterations of fuel surcharges, we are not as able as we would like to be to collect that from our clients in the short term. The good news is that it is a vehicle which corrects itself with time, and it is not a fundamental flaw, but rather unfortunately, a contractual set of arrangements that we have to work our way through.

I will add some numbers around that. And just to help you model, we use about 7 million equivalent barrels of fuel each year. And as Marcella said, our coverage on WTI is in the mid-80s, so 85% probably going forward. It was 90% in the first quarter. And on crack, less coverage. At the Analyst Day I think Marcella mentioned we are moving to be in excess of 50% coverage by the end of the year. But now call it 40%.

I will give you some round numbers to help you model. For every $2 increase in WTI, it is going to cost us about a penny. For every dollar increase in crack, it costs us about $0.02. So those are good walking around numbers to keep in mind. You assessment in terms of total expenses, our increases in expenses are principally fuel.

Those sensitivities you just gave, those are net of fuel surcharges basically?

Impact on the bottom line.

Impact on bottom line after fuel surcharges.

In terms of round numbers, for every $10 change in cost for fuel, whether it's WTI or crack, it increases our total expenses almost 2%. And because of the recovery on revenues, it increases our revenues by about 1.5%. All those numbers jive into very, very round numbers.

Okay. That is great. Thank you.

Your next question comes from Ed Wolfe of Wolfe Research. Please proceed.

Hello?

Hello, Ed.

Hi, Fred. A couple thoughts. First of all, Fording last night with their guidance of 23 to 25 million tons, and price around $200. How does that compare to what you have modeled and what you are thinking, and does your latest earnings take that into account.

It is Marcella speaking. In terms of the modeling, the modeling for the tons that we will move, is in the range that they have for their sales forecast. Their sales forecast is 23 to 25 million tons, and as I said, our forecast for moving tons is 1.5 million over what we moved last year. So we are right within their guidance.

In terms of the price for their coal, I am sure you understand they what they have got is some carryover tons for price from last year into this year, because of the calendar year and the coal year. Plus in that price they have their PCI and some thermal coal as well for the $200 average that they gave. We do have the price built into the price increase, which took effect on April 1st of this year.

I missed that. What was the April 1st increase?

On April 1st, we increased our price on the coal contract. The coal contract turns over with the coal year, April 1st of each year. And because of the increased price of coal, our price went up as well.

So coal pricing year-over-year now is better than flat?

Ed, we have to break it into two pieces. On the three quarters from April 1st to the end of the year, the prices are higher. On the first quarter, the prices were substantially lower. And the total of all of them on average year-over-year is flat.

And that flat, does that include fuel surcharge, or does not include fuel charges?

That includes fuel surcharge, Ed.

The guidance of $4.40 to $4.60, Michael, does that include the $0.07 tax gain in first quarter?

Yes, it does, in round numbers. The reduction of $0.25 is half due to fuel, and the other half to our reduced volumes in Forest products and Automotive, and then of course, the first quarter weather impact offset by the tax rate coming down.

Our next question comes from Bill MacKenzie, TD Newcrest. Please proceed.

Thank you. I had a question regarding Fording, they have been fairly vocal in their most recent results. That they feel that rail shipments have been below their expectations. When I look at your coal carloadings this quarter, I think Marcella indicated that the export volumes were up around 15%, if I got that number right. I appreciate that last year was maybe an easy comp in that region, because of the severe weather issues there.

It does look to me that within the coal franchise things are showing an improvement. Your Coal velocities have been improving. I was wondering if you could help reconcile some of their public vocal comments, versus your own views on your performance there? Whether this is kind of contract posturing, or whether there are any kind of unrealistic expectations, in terms of how quickly the supply chain can ramp up? I know you don't like talking publically about your customers, but they have been fairly vocal on this, and I am just curious to see if you have a response?

This is Fred. I think the sum position, you captured it correctly. People say things that suit their purposes, and we understand that. The facts don't always support things that are said. We have moved substantially more coal. The capability of the supply chain, if all the members of the supply chain behave, and act in the best interests of the collective group is considerable.

The behaviors of other parties was not supportive of the most efficient use of the supply chains throughout December, January, February. We took some actions to bring to the attention of those parties that their behaviors would need to change, that behaviors have changed, and you are seeing tremendous cycle times. We are spinning cars in about 85 hours on the railway these days to and from the port, and we have been doing that consistently for the last month.

We did put on some more power to power up some trains, but we only did it after we had the commitment from the other parties that they would change some of their behaviors. I hope that continues. And collectively we have a great supply chain moving a lot of coal right now. I hope that continues, and I hope that the production capabilities of Elk Valley, and the handling capabilities of the unloading facilities are consistent with the upside opportunity. That would be good for all of us.

Thanks, that is helpful. And maybe just a follow-on to that. Fording has longer term targets of 28 million tons out of those mines. Do you think the supply chain working efficiently is capable of shipping those levels of volumes, if we ever get to those levels a few years down the road?

Interesting enough, in discussions that I personally sat at four years ago, we talked 28 to 30 million tons. Unfortunately the production has not materialized.

Because of that, it is a little hard to judge whether all of the resources that we rallied and put in place at the time to meet those expectations, of course never were produced, would be available on a moment's notice. Let me make a simple statement, that if we have a client and he is prepared to enter into terms and conditions that are suitable to our shareholders, the capacity and the capability of this enterprise will never be a bottleneck in the movement of product to market.

Thanks. And just one last housekeeping question. Marcella on Slide 12, you showed us that price increases at 8.7% to a revenue growth. Can you give us a breakdown between how much fuel surcharge added versus pure yield?

Yes I can, the breakdown is just a little over half on the fuel side, the balance on price.

Thanks.

Your next question comes from David Newman, National Bank Financial. Please proceed.

Good morning. Just a few, looking at the truck obviously you have fuel surcharges as well. I would assume that are primarily based on their diesel costs, no?

I can't verify that but intuitively, I would say you are probably correct.

Are you seeing any volume coming your way? Obviously, the trucks are getting squeezed dramatically, and I am hearing that on the back hauls they are pricing below variable costs. Are there any customers knocking on your door, any volumes coming your way?

I think what we have got is probably an inability, or lack of transparency on what is going on. The logic here is that the market is changing so much in certain sectors, based on the economy that we can't tell. The demand is overall not that different.

As Marcella said down in certain sectors. From a share perspective we might well be picking up some share, because of the fundamentals of rail transportation compared to truck are clearly in our favor. I just don't want to say yes or no. We can't decipher with the declining economy and the volumes, how much is attributed to what. Overall though one would think, that certainly over the course of time, you are pointing out a very appropriate factor that is going do help us as mode, relative to truck.

Very good. As you look at the western corridor, you are obviously moving a lot of coal, potash, and grain. Do you have a priority based on GTMs that would give to one of the commodities? And how much capacity are you now utilizing, in other words, how much can you crank the western corridor up?

With regard to the client base that we have, they are all very valuable customers and we don't prioritize them. What I would reiterate to you is a comment I made earlier about Fording. And that is, that if opportunities exist for us to move more product, it is incumbent on us, and we are prepared, as long as the terms and conditions of the contract are appropriate, to continue to create capacity.

So the work that the teams have Brock and Kathryn and their teams have done in the last while to introduce some powered up model, over powered, higher powered trains, has enabled us increase our speed, and to put more capacity in without putting more physical plant in place. We continue to look at the array of options that will ensure that corridor is very fluid. I can tell you that the work they did has resulted in a double-digit improvement in train speeds in that corridor Q1 over Q1. Granted against a pretty easy compare there.

On balance, the message I would like to leave with you is the same one we leave with the clients. If terms and conditions are suitable to our shareholders, We are delighted to move more business, and we are not going to be the bottleneck in their supply chain.

Our next question comes from Walter Spracklin, RBC Capital Markets. Please proceed.

Thanks very much.

Good morning.

Just back to the guidance. If I were to break down, and we are looking at Slide 18, when we look at your total change in guidance, I guess we are down from the 4.70 to 4.45, down to 4.40 to 4.60. $0.05 attributable to the CTA. Looking at the tax, you have lowered your tax by 200 basis points. By my math, it is about a $0.13 benefit from the 200 basis tax on the taxable income that you were projecting before. When we add the $0.13 in and subtract $0.05, can you break up the quarter with weather and fuel, as to the other two components, and the rest will be the economic declines?

You are saying the quarter, or the forecast.

For the forecast.

What I gave out earlier is a good breakout. So you are absolutely right. Pretty close in terms of our tax impact. You would add a little bit in terms of interest rate benefit as well, we are in a lower rate interest environment.

All-in the balance in terms of the decreases, half of it comes from fuel. The other half I break into two. The first half is essentially the first quarter weather, and the second half is lowering volumes, in terms of our outlook around Automotive and Forest products. And in very round numbers those are the puts and takes.

Right. Just going back on the Fording, when they reported their results, it was interesting that they came in with Q1 sales of up 22%. They are guiding 23 to 25, and they did about 23 last year. So up 22% in the quarter seems to me they are on-track to hit their 23 to 25. But there are saying there are not enough railcars. There is a disconnect there. Are they saying, it is probably a better question for Fording, but can more coal move based on that? Or is it just, are we really seeing some rhetoric in posturing, in the run-up to negotiations?

I think the term rhetoric in posturing is probably pretty good, Walter, but I wouldn't want to imply that. I think what we have got is a situation where there is a busy supply chain, and there are many partners in the supply chain, and the behaviors of those supply chains is what is going to calibrate the capability to move more coal. As we have watched over the last five or six weeks, as people changed their behaviors, we ended up moving a lot more coal as a supply chain. If people continue to behave in a responsible way, as they are these days, we will collectively move a lot of coal. If people choose to be self serving and optimize their own sub-piece of the supply chain, unfortunately as we experienced earlier, we will end up with less coal moving.

So the opportunity exists to move an awful lot of coal. I won't attempt to put words in their mouth. If they have a point of view, they are entitled to express it of course. I know our supply chain is running very, very well these days, and I hope it continues to, and I hope that all of the parties see the merits and value of behaving the way we are all behaving today.

The next question comes from Ken Hoexter, Merrill Lynch.

Hi, two questions. First on the Intermodal side, I think Marcella was talking about solid volumes at Vancouver and Montreal. Can you delve into that a little bit? Are we seeing any less shipments moving East, are they coming back to the West coast? Are you continuing to see what is moving, stay split between west and east? Can you talk a bit about the trends that you are seeing?

The trends that we are seeing are similar to what we said in October. The Port of Montreal is normal, and we typically and expect it to grow to about a GDP growth. Over this last quarter, it didn't grow as much as we would have expected, because of two things, number one, the severe weather in the east affected it's operations, it had more snow than it had ever seen in history. And then there were some vessel delays as well. In Q1 it didn't grow at the same pace that it would normally grow, but I fully expect it to return to the full GDP growth expectations that we would have for the Port of Montreal.

In terms of Port of Vancouver, they also performed very well in the first quarter, in terms of their overall throughput for containers, and we participated in that growth. So we would expect to continue to project that they would be growing at more than double GDP, given the change in the GDP figures, and so far our signs are subject to the slowdown that we have seen coming and the Chinese New Year, we would expect them to return to the full productions they would have expected.

And my follow-up question is for Mike on the DM&E, it sounded like you were saying that the $0.15 to $0.17 target still stands. I guess from earlier comments, I thought you had also said the core DM&E, letting alone the decision of whether to build comes later, but the core DM&E structure had been performing maybe slightly ahead of target. Can you talk a bit about that?

When you say DM&E structure, you are talking about our ownership?

I am talking about the current network, as opposed to anything to do with the builds. I thought the current network operations EBITDA was ahead of target.

Regional railroads. So we haven't adjusted since our last call. Our last call said we were happy with the projections. They came in slightly ahead of our initial projections around them in '07. And then their '08 plan is up double-digit sales, and double-digit EBITDA. And everything we see so far, and we can't manage it, we can only listen and learn. Everything we see so far says they are on-track. The transition plans are in place, as you heard Kathryn say. We are feeling pretty good about the acquisition.

Your next question comes from Tom Wadewitz, JPMorgan.

Good morning. Marcella, I wanted to ask you a question on pricing. I wanted to see if you could refresh us on what percent of the book do you actually touch in 2008? And what type of pricing do you expect to get on that? And has the pricing trend changed at all?

Tom, the book is just over 50% of our book will turn over in 2008, and that is pretty standard for us. The price expectations that I mentioned back in October was a range of 3 to 5%. In fact, over the first quarter, we achieved 5.5% so slightly over my expectations on the quarter. And I am sorry, you had a third part to the question, I have forgotten it already.

On the trend in pricing, it sounds like you are running a little bit above what your range had been.

Based on Q1, we are running slightly above our range, Tom.

Okay, great. And then in terms to have margin performance in first quarter, I guess maybe for Mike or Fred, you had a lot of pressure in margin, fuel was obviously an impact and weather. What do you think about margin going forward? Do you think that fuel continues to drive margin down? Or is the fuel headwind moderate enough that you can look to see some margin improvement later in the year?

You are talking about operating ratio?

Operating ratio, yes.

if you take the major headwinds out, so just the known ones, foreign exchange, if you take out the fuel impact in the first quarter, and the harsh weather we had, it is worth about 400 basis points just on the quarter. Our operating ratio would have improved versus last year, had we not had these three major headwinds.

In terms of our view going forward, our objective is to improve our operating ratio exclusive of foreign exchange and fuel, that they are not controlling the buy outs. Our objective is to improve our operating ratio going forward, and that is in our plans.

It is Fred. I will just add a bit more color. One of the things that I am pleased about, it was obviously a tough quarter, and nobody likes to adjust guidance, but one thing I am pleased about, if you look at the operating metrics on the productivity and efficiency side, I want to stress for you that it is despite very difficult conditions, every one of them, or the vast majority of them improved only modestly. We look at Q1 as kind of a big missed opportunity forced by outside circumstances. But the trends that you are seeing, and the focus on efficiency and productivity will continue through the balance of the year.

Right off the bat, Fadi got it on the nose, when he talked about the fact that we have just got this period of time with fuel prices going up faster than our ability to collect from our clients, because of some contractual fuel surcharge terms. And what we have to do is not let that affect our behavior over the coming quarters, and the rest of the year. We need to stay focused on efficiency, focused on preparing to grow with some of these clients that are able and want to grow. And if we do that, we will be very well positioned for '09.

Next question is from Cherilyn Radbourne, Scotia Capital.

Thank you, good morning. Apart from the equity income line on the DM&E, is there any color that you can give us on how that business performed during the quarter with respect to volumes, yield, the operating ratio, and so on?

It's not, we haven't made it public but I will say this. They are essentially performing consistent with their plan. We actually like their book to business as well. They are right in the middle of the bread basket of the U.S. And if there's any area you want to be in now, it is agri products, and that is clearly a third of their business.

And aren't as affected by the economic uncertainty, as the industry as a whole. We are feeling pretty good in terms of their book to business. In terms of their management, we like their management. We also like their projections.

Okay. And I wonder if I could just clarify something that is [inaudible] to the financial statements. It sounds like there were a couple of one-time items that went against the equity income in the quarter, just related to finalization of the purchase price equation. Am I reading that correctly?

In terms of one-time, there were some purchase price adjustments. We wouldn't call those one-time. What is typical with acquisitions is you, in the year following the acquisition, you will usually true-up some estimates you made during the acquisition. And what you are seeing come through are some of those true-ups. Nothing significant has come through yet.

So 11 million then is about the right run rate for that equity income line?

When we say run rate, that would be typical of the first quarter. They do have some seasonalities, so you will see the year actually increase as we go.

Okay. And then just with respect to the EPS waterfall, wondering if you could as you did in Q4, isolate the impact for us of the incremental fuel expense that wasn't captured by the surcharge?

You are saying for the quarter?

The EPS impact of the gap, or whatever you want to call it in fuel recovery.

Somewhere between $0.05 and $0.07. Very round numbers.

Thanks very much.

Your next question comes from Cameron Jeffreys, Credit Suisse. Please proceed.

Thanks very much, good morning. Just a follow-on question on the fuel surcharge and the recovery. Can you give us any more color on that legacy contract, that doesn't allow you to fully reflect the current fuel prices? Is there a ceiling involved in there? Can you give us any kind of clarity? What area of your business is that in? And secondly, what kind of oil price, or where would oil prices have to drop to, for you to, or what is the ceiling on that if there is one, which is what I assume is involved in that contract? When does it expire?

There are a handful of legacy contracts that have fuel coverage in them. A combination of indexed or a customized program that we developed obviously some years ago, as Fred mentioned, our fuel program has gone through several iterations, and back a number of years ago, we all thought differently about fuel. It is covered, but it is covered under a different type of program.

How we understand exactly what the limitation is in some of those. Or give an example of how you're not getting, how you are not fully captures where the price is right now. There must be a cap in there somewhere, I would think?

I can tell you that each of them is tied to some form of WTI, as opposed to crack or margin spread. I can tell you that much.

In terms of the actual structure of the deal, it is very difficult for me to disclose that to you under confidential contracts. I can tell you that we have cancelled legacy contracts, covered less than 10% of the revenue, again we do cover fuel related to WTI. Just not the crack or refining portions.

And you get all of the WIT, even if it goes to $200 a barrel you will get that included in that contract? Because it sounds like you are not getting everything that WTI is going up, you are not getting even if it is all just tied to that, not the crack, irrespective of that for a minute.

There is a customized formula for each one of them. And remember also, that there is a segment of our business that got 8% of our business, which was tied to the volume and related index factor on regulated grain as well.

The bigger impact is of course, the crack margin. Our coverage is less than 50%, and we are going to 50%. In terms of our other, the biggest impact is our projected crack margins.

Your next question comes from Randy Cousins, BMO Capital Markets. Please proceed. Mr. Cousins, your line is open.

Good morning. I would like to have a little more on the guidance side. Obviously you are very negative on Forest products and Automotive. What I am trying to understand is how these can have such a material impact on your book of business. Because they are frankly the two smallest product segments you have got, and you compete with some other railroads that have got much larger Forest products business, and has less transplant than you may have. Are you basically assuming your Forest products are going to zero? I am at a loss to explain how these two particular business units can have such a material impact on the profitability outlook?

Randy, I think that your assessment is correct. We are delighted that they are not monster sectors for us, but they are still significant sectors. One is 300, and the other one is $350 million if I recall correctly. When something moves dramatically, and I will give you an order of magnitude, and say that the Auto relative to last year, I am going to guess off about 15%, something like that.

Close to that.

So 15% on a $350 million business Randy, is still a pretty big top line revenue to move.

For instance in the Forest products side, and this is just anecdotal. As of yesterday, I think the numbers were our lumber and panel shipments were down 59%. 5-9. 59% in the month of April.

Are there extraordinary circumstances, is it a blip in the market, I don't know, but at the end of the day we are not talking about 2 and 3% movement here. We are talking about some pretty dramatic movement. And what we have tried to do is recognize that we don't want to surprise people. And the best thing we can do is translate this 1.5 million, housing starts down to 1million. Obviously it has a huge impact on certain commodities.

That would be the fundamental factor that has caused us to be very wary about the Forest products segment. When we are experiencing those kinds of order of magnitude changes in the first three weeks of a month, we better be smart enough to recognize that there is a pattern emerging here. I hope it is more favorable than that. But we have to protect against it.

At the end of the day you guys might be being overtly conservative, relative to some of the other railroads. I think you have the best carloading data of all of the Class 1s in the first quarter. And I am just wondering if you guys are being ultra cautious in providing your revenue guidance. Your Intermodal business has hung in extraordinarily well versus the U.S. roads.

I think you are right. We have a very, not right on the conservatism, but right on the fact that our business portfolio is actually pretty good given the circumstances.

Our problem is as we sat before you guys in October, and again when we did our Q4 call in January, we weren't feeling the orders of magnitude of the merchandise slowdown, or of the Intermodal softening. And something has changed, we have started to feel that based on the numbers I have just provided to you, Marcella has commented that on the West Coast, that the demand is there, but the Chinese New Year, and the volumes off the coast are clearly somewhat softer on the Intermodal side, and the merchandise side is as we have described it.

So we are living and breathing it for the last six weeks. That is very different than what we lived and breathed in October, and again in January when we spoke with you. We owe it to you to be as transparent as we can about these emerging trends. I hope they are not as bad as they feel right now. We have got to predict that they could be and we have to prepare ourself in case.

Ladies and gentlemen, at this time we will be taking questions from the media. (OPERATOR INSTRUCTIONS)

First question comes from Brent Jang of Globe and Mail. Please proceed

Yes, I had a question for Fred. Even with your reduced earnings guidance, it is still higher than last year. So another potential record year or something overall near record. Same story at [CN]. I was wondering as a big picture question, whether you think the railway industry's renaissance is still alive and well?

I really think the fundamentals of the industry are incredibly sound. If you are able to put a little box around the fuel surcharge issue, that we are wrestling with over the couple coming quarters, a year to a year and a half on the outside, the underlying demand for our product, the efficiencies that we are driving into the industry, and into our company all bode incredibly well for a successful longer term, medium and longer term growth. We really do see it as a bit of a blip, that we are working our way through. An unfortunate set of circumstances that have come out of the blue, with regard to the extreme and rapid rise in fuel prices. But if you look at the underlying efficiency, the underlying productivity, and the good demand, particularly on the bulk side, and inevitably over time on the merchandise side, I really do like this industry, and where it is positioned for the medium and long term absolutely.

Thank you.

Thank you.

Your next question comes from Hugo Miller, Bloomberg News.

Hello. Just given the gloomy long term prognosis for the U.S. Auto industry, and by extension the Auto manufacturing in Ontario, is this you said it is not one of the biggest, but it is still an important 300 or $400 million business. Is this something that it would make sense to kind of slowly get out of? Or is that too radical a reaction to what is going on? Just given that the long term prognosis is not great?

I would suggest that we do need to be wary about which industries are in decline and in growth mode, but I think when you look at it over the long term, people are going to need transportation, and the likelihood of all of that transportation arriving from foreign shores is highly unlikely in my view. People will have to reconfigure, they will have to do things differently than they did.

When you are aligned with global players like the Toyotas, who are really just opening plants, I am pretty comfortable that the sector called the Auto industry, it may slightly different, it might be slightly bigger or smaller, but it is going to be around for a long time. And the only way to cost effectively and efficiently move the numbers of automobiles around the country, whether they come from offshore or whether they are produced in North America, is by rail. And as a consequence, I think this is a valuable part of our franchise, and will remain so for a long time to come.

Am I able to ask a follow-up here?

Go ahead.

Can your give any sense of how your business breaks down to the Big 3 versus foreign auto makers? Obviously the health of foreign auto makers is clearly better at the moment than the Big 3. Anything you can tell us on that?

We have long standing and significant activity with all of the parties in the Auto business. As the world as unfolded over the last four, five, six years, the percentage of our business that we do with the transplants, the Hondas, Toyotas in particular, has grown to be over 50% of our total volumes these days. So we are aligned with parties that have done well in recent years. But yet we retain our relationship with the underlying North American companies as well, because I think over time they will reposition themselves for success.

Okay. Thanks very much.

My pleasure.

Our next question comes from Scott [Cival], National Post. Please proceed.

I am sorry. I am not sure that I caught when you said you would be renegotiating these contracts with the handful of players that don't allow you to recover your fuel costs.

It happens over time, Scott. Some of them are literally within a year. Others go out a year or two beyond that. For the most part, the big volumes in the area that Mike pointed out on the crack margin, that will be 50% by the end of this year, and probably 75% by the end of next year. And it will probably never get to be more than 85 or 90% because of the grain business, which is indexing. Largely by the end of '09, we are caught up on the margin issue, which is the one that has the big, big impact.

Is it fair to assume going forward you have changed the way that you are negotiating those contracts?

Absolutely Scott. We are on the fifth iteration of fuel surcharges and indexes. As we learn more, the world we live in today from a risk management perspective, clearly has a greater awareness of the risk attached to the volatility of input prices like this. And things that made a lot of sense four years ago or three years ago, clearly don't make as much sense today. There is a rigorous set of steps that have to be passed through from a risk management perspective, to try and avoid these situations.

And as I said earlier, the good news is that they are temporary. They expire. And we move on. The bad news is we have to struggle through them for a little bit longer.

Your next question is a follow-up question from Hugo Miller, Bloomberg News.

Just to confirm some of the dates in connection with the DM&E acquisition. I think Kathryn said that September 30th is when the STB gives it's final assessment. Is that final assessment essentially just a yay or nay to the final approval of the acquisition? And then you said if that is a confirmation, then October 30th is when you would formally take over DM&E?

You are correct on the dates. And what the STB will do, will rule as to whether we can take control of the DM&E. And they have the opportunity at that point to place conditions on that ruling. So again, we don't know exactly what the STB's position will be until September. But to this point, I think as I mentioned, there have been no surprises in terms of who has made comments. And we are in the process currently at responding back to those comments. So it is very much a regulated process, and we are moving through it as expected. And then the ruling would be September 30th. And 30 days thereafter assuming that they grant us control, would be when we can take control of the property.

Okay. And in any conditions without speculating too much, are things such as the acquisition can go ahead, with perhaps one part removed, or with certain additional capacity that you are looking to add being pared, or being cut back, or what kind of conditions do we have they have the power to authorize?

Hugo, I think the best way to address that would be to say that the purpose of the STB review, is to determine if there is a competitive diminishment of competition. And if there is no diminishment of competition, there would likely be few, if any conditions at all. And all of the submissions have been made by other parties have largely either been addressed, or certainly don't emphasize anything in a significant way, with regard to reduced competition.

As a consequence, I don't want to put words in the mouth of STB. We will have to let that unfold. But there don't appear to be any substantial reasons or conditions. And arguably even as recently as this week, the U.S. Department of Transportation has weighed in with a very positive statement, saying they don't see this in any way, as competitive or less competition, and being supportive of it. At the end of the day, Hugo, we will have to let them do their jobs, but all of the early evidence is that we are well-positioned.

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

Thank you Patrick, and thanks to everybody who took the time to join us. We look forward to talking to you again at our next call. Bye now.

Ladies and gentlemen, this concludes our conference call for today. Thank you for participating. You may now disconnect your lines.