Canadian Pacific Kansas City Ltd (CP) 2014 Q2 法說會逐字稿

Good morning. My name is Jay and I will be your conference operator today. At this time I would like to welcome everyone to Canadian Pacific's second-quarter 2014 conference call.

The slides accompanying today's call are available at www.CPR.ca. (Operator Instructions)

I would now like to introduce Nadeem Velani, AVP Investor Relations, to begin the conference.

Thank you, Jay. Good morning and thanks for joining us. I am proud to have with me here today Hunter Harrison, our CEO; Keith Creel, President and Chief Operating Officer; and Bart Demosky, our EVP and Chief Financial Officer.

Before we begin, I want to remind you this presentation contains forward-looking information. Actual results may differ materially. The risks, uncertainties, and other factors that could influence actual results are described on slide 2, in the press release, and in the MD&A filed with Canadian and US regulators. This presentation also contains non-GAAP measures outlined on slide 3.

The formal remarks will be followed by Q&A. We would appreciate if you limited your questions to two strategic items; and if you have any modeling questions, please follow up with Investor Relations after the call.

It is now my pleasure to introduce our CEO, Mr. Hunter Harrison.

Thanks, Nadeem; and thanks to everyone for joining us this morning. I'm going to try to be brief here, but I guess I could more characterize the quarter as record after record after record. Although there are a lot of moving parts this quarter, and let me just highlight a couple that you should keep in mind as we go through the presentations from Bart and Keith.

First of all, we had -- operating ratio was pretty outstanding. I trust you've seen the press release. But I would also add on that side is that we had a pretty significant headwind of about 2 points in stock-based comp, which is probably a [first to last] problem to have, and I'm am not sure what the impact is going further.

I would also highlight to you that -- this is a little bit of a complex issue, but we have changed our policies and internal philosophy as it goes to grain rates and staying under the revenue cap. So given that we saw we were going to exceed the cap, we had to back up with rates.

And our rates are down -- or the quality of revenue for grain is down about 8% or 9% this quarter. After -- when the new crop year in August, you will see 1 more month of that in July. And then we'll back to a, quote, normal run rate for grain.

There has been some conversation about the so-called now Southern Corridor, which we had some challenges with in the second quarter, and we will probably have some challenges going forward. But I know that Keith and his team are working very diligently to get those issues resolved.

They involve the continuing issue with Chicago and interchange. Is it much better than it was? Absolutely.

Is it where it should be? No.

Is it going to be a continuing challenge to the industry until we work through some things? Yes.

And now we have experienced some further delay in the Minneapolis/St. Paul corridor where we operate over another carrier. And once again, Keith and his team have been negotiating and working to come up with a longer-term fix there. But that is all on the positive side.

We continue to see good demand out in the market going forward. And I think we have -- we're ahead of our schedule on the buyback program, which Bart will talk to you in more detail. But overall, I mean, record quarter, record metrics, record -- if you peel it back -- fundamental operating performance.

So I'm very pleased, to say the least. And with that, let me turn it over to Keith to talk about some of the operating results and market trends going forward. Keith?

Thank you, Hunter. I am pleased to highlight a few points in what was overall a very strong operating quarter, in spite of what I will term the winter drag that carried over into April and, to your point, Hunter, some of the headwinds we faced with volume-driven foreign road challenges operating both Chicago and in St. Paul.

In spite of these challenges, second-quarter performance was strong with continued improvement in train length, train weight, fuel efficiency, which of course are all important levers driving improved service, reducing costs, asset utilization. As noted on these charts, we experienced notable improvements in each area.

I will note that the fuel efficiency performance is an all-time record for CP and is approaching an industry-best performance. On the safety front, the most encouraging important area of operational improvement, in my view, was our train accident performance.

That said, to be clear, one accident or injury is too many, in my mind. Our team is going to remain focused and committed to driving further improvements in all facets of safety. However, these results do provide powerful proof points that our focus to evolve our safety culture is working, coupled with enhanced -- with our strategic investments to strengthen our physical plant.

As you can see, our FRA train accident ratio improved 47% over the second quarter of 2013. This performance,, coupled with a strong first-quarter performance, has produced an industry-best year-to-date FRA train accident frequency ratio of 1.0 accidents per million train miles. So in summary, these operational and safety improvements are translating into revenue opportunities.

So over to the revenue side, solid demand strength summarizes the quarter. Title revenue was 12% higher in the second quarter of 2014 versus 2013, with significant growth across the Company's business units.

Leading the revenue growth was grain. A strong performance across the network contributed to strong increase in this revenue. Gains in Canada and the US accounted for 46% of CP's freight revenue gain in the quarter. This performance was fueled by record Canadian grain crop, which obviously drove meaningful increases in our export markets, as well as a significant increase in our US grain destined to the Pacific Northwest drove improvements on the US side.

Intermodal was the second highlight of the quarter. Our market-best premium domestic service offering across Canada that we rolled out early fall last year continued to attract new domestic customers.

On the international side, our existing customers are rewarding our service offering with increased traffic, which has partially offset some of the foregone traffic that was related to a large contract we chose not to renew at the end of 2013. Excluding this foregone contract, international revenue increased 17% second-quarter 2014 year-over-year.

Energy-related traffic was the third source of superior revenue growth, driven by crude oil, frac sand gains, that are a result of the creation and ramp-ups of newly constructed facilities on our network. Continued expansion of oil and gas production has resulted in increased revenues from other industrial product customers as well.

So looking at the balance of 2014, we see strong fundamentals on the demand side; we expect to see further gains in price and volume. With that said, given that we're providing more visibility on the revenues this quarter, I will not speak to each line of business. I would rather save time to address your specific marketing questions in the Q&A.

Now over to Bart to translate this operating and marketing performance to the bottom line.

Okay. Thank you, Keith, and good morning, everyone. This certainly has been a record Q2 for CP, and I'm going to cover some numbers that I think any CFO would be proud to list off.

Starting with record revenues of almost CAD1.7 billion; operating income up just under CAD560 million, which is 40%; and net income up 47%; combining or resulting in diluted EPS of CAD2.11. And last but not least, a record operating ratio of 65.1%; that's a 680 basis point reduction for the Company and the lowest in our Company's history.

Hunter covered this, but a little bit more flavor. When you account for the reduction in the Canadian grain rates that Hunter spoke to and the CAD30 million of headwind we saw in the quarter on stock-based comp, our underlying run rate is now in the low 60%s, which bodes very well for us for the rest of the year and obviously for go-forward.

On the operating expense side there are a couple of items I just want to highlight. On the comp and benefits area, efficiencies generated from headcount reductions and lower pension expense, which combined totaled about CAD35 million, more than offset the impact of a rising share price over the quarter.

Fuel was up, but primarily as a reflection of higher workload, which is a positive thing. We did have some fuel price impact as well, but that was partially offset by the 5% improvement that Keith's team made on the fuel efficiency front. So in the last couple of years we have gone from back of the pack when it comes to that metric to near best-in-class, and those benefits flow straight to the bottom line.

We did see an uptick in materials expense this quarter, which is a reflection of the higher input costs and insourcing of work previously done by third parties. I would say that that insourcing work that hit us in the quarter, this will be the last quarter where we see that; and that represented about half of the uptick in materials expense.

Equipment rents continue to be favorable, with the savings from our fleet reductions far outweighing the impact of higher volumes and inflation. And lastly, on the purchased services area we continue to see dramatic improvements driven by lower casualty costs in the insourcing initiatives, which have allowed us to reduce IT and third-party maintenance costs.

Now as we look forward, the comps are going to get a bit harder here in the back half of the year. So the team is going to have to continue to dig deep and stay focused. That said, with RTMs up 7% and costs only up 2%, we are clearly growing our revenues at a low incremental cost, which bodes very well as we move forward.

I just want to touch on free cash. It's not an area that we provide guidance on, but we made great progress, so I thought it was worth highlighting this quarter.

Year-to-date we've generated

CAD534 million of free cash. And to give you a little bit of context on that number, in the first half of the year CP has generated as much cash as we did on a full-year basis in 2013. Again, that points to a very, very strong trend as we move forward.

Consistent with the rapid improvement in the operations and the financials, our credit metrics have also improved dramatically. I am very pleased to note that in the last 3 months CP has received ratings upgrades while retaining positive outlooks from all three of our rating agencies.

Pricing of our debt in the capital markets reflects even higher credit quality and ratings. Our financial position and strength to support the business and operating plans have never been better.

Lastly, on the buyback, our CAD1 billion buyback program is well underway. Since announcing the program in March, we have repurchased now over 3.3 million shares at an average price of CAD172.90, versus a weighted average market price of over CAD181. So clearly the program is creating value for shareholders, and we continue to see repurchasing our shares as a strong value proposition for shareholders.

So with that, thank you very much and I will turn the call back over to Hunter.

Hunter, real quick, I think it's important I provide some clarity and color on the revenue growth at 12%. Price, 3.5% of that; volume mix, 5%; foreign exchange, 4%. So that's it, Hunter.

All right. Thanks, Keith and Bart. So, Jay, we will -- we're ready to field questions from this group.

(Operator Instructions) Fadi Chamoun, BMO.

Good morning, gentlemen. I would like to dig a little deeper into the issues in the Midwest. If you can talk specifically about what exactly there, are these things that are within your control that you can solve with capacity? Or is this a thing that you have to work on with the other rails?

Also, what kind of time frame you think some of these solutions can be found?

Fadi, let me make a couple remarks and then Keith can fill in the blanks. But it's kind of all of the above.

It's -- obviously we have a working arrangement in Minneapolis-St. Paul where we operate adjacent to and over BN Santa Fe. That is no secret.

I think they have had some capacity issues and some challenges that I will let them comments on. But as a result of that, it is that impact on that corridor, and slows the velocity down, which has had some negative impacts on us.

Now, having said that, Keith, I know has been with those folks; they've been sitting down, going through agreements that date back years from various mergers. They have been looking at various operating solutions, and this is something that we can deal with.

It's going to be a shorter-term challenge. But I think that while we're doing this, Keith is doing more of a permanent fix where we will not be dependent upon another carrier. And we hope that some of those things will come together.

So, Keith, you might want to fill in.

Got you. I think the key again, Fadi, to Hunter's point is mitigating the impact short-term while we work on long-term solutions. As Hunter said, we effectively co-operate with the Burlington Northern Santa Fe. Now the BNSF and their leadership team, they're very engaged; they're good railroaders; they're focused.

They have got plans to expand capacity. It just takes a little bit of time to do it. And specific actions that they're taking, as well as CP has specific actions that we're taking.

In fact, just as of last week or week before last, something that we started last summer which is going to prove very helpful for us: We powered up a switch and started to use a line that we had that takes our Westbounds off of this shared territory with the Burlington Northern Santa Fe and allows us to control our destiny a little bit more.

So that's going to help. The BNSF's investments in its own capacity are going to help. And to Hunter's point, there are some other things that I'm looking at specifically strategically that will further reduce our dependence upon that piece of railroad and let us control our own destiny in St. Paul.

So short-term, mitigate; long-term, we will solve.

Now, Chicago? Chicago is Chicago, Fadi. I don't see a big change short of a transaction down the line. I think it's always going to be very fragile.

I think with increased traffic growth for all the roads, you get another winter like we had this past winter, then maybe you see a similar result. I do think that, on the positive side, that all of the roads are working closer than they ever have, trying to identify opportunities to create capacity in a very challenging environment. I.e., take traffic out of the corridor that doesn't necessarily need to be in the corridor.

So long-term fix, I am not going to suggest that I've got a silver bullet to do that. But I am encouraged that we're doing some things to mitigate the impact.

Okay. That's helpful. Maybe one quick question on the crude business as well. We have seen a couple of terminals that have come up, and one is a big one in the [Hardesty] area.

Do you see visibility right now on how we think this is going to ramp up going into the second half and into 2015? Is this more of a 2015 ramp-up for you guys? Or are you starting to see that volume move right now?

The volume has started to move, Fadi. Obviously it's got to ramp up. I would expect to have the potential to be at -- order of magnitude -- a train a day by fourth quarter.

So that's very encouraging. We expect the run rate to finish this year around 140,000 carloads, which is up from last year.

You will see the mix change. Right now, probably 54% of our origin comes out of US on crude. You will see that shift to more than 50% coming out of Canada by the end of 2014, as we go into 2015.

Okay. How does that impact the RPU? Is this, from an RPU point of view, this is --?

It's a positive story. We're working hard to improve the quality of revenue on the existing Bakken crude. But as we bring on more of this heavy Canadian crude, it will help drive that in a positive direction.

Okay, thank you.

Bill Greene, Morgan Stanley.

Hi, good morning. Keith, can I ask you to comment a little bit further on some of the revenue trends? Because we've got a lot of moving parts, as you identified in your opening remarks. And I think it would be helpful to understand how to think about what the underlying maybe organic growth rate of the business is.

Perhaps June is a good month; but then again we have flooding. So maybe if you have a normalized sense, can you share what your best guess is on where the underlying organic growth rate is of the revenues?

Well, I mean, effectively just reinforce what we've said already. We're looking at double-digit revenue growth. What we have seen this quarter, there are some puts and takes in it; but overall that demand level and that performance is something we expect to see the second half, driven by pretty strong demand and growth across all markets.

Again, grain is going to be a key driver. We see that this year; we see that next year.

This international business, although like I said, if you take out the business that we've lost, we're seeing pretty significant recognition of our service offering there. And of course, domestic is going to continue to be a winner for us. That's something truck can't compete with and other roads can't compete with, and we are leveraging this franchise to continue to drive profitable growth on that side.

So, across the board I don't see demand weaknesses. I see opportunity to continue to drive and produce that double-digit revenue growth.

Okay. Very helpful. Thank you.

Bart, maybe I can ask you a question, just on the cash flows. The second quarter cash flow, really good; right? If we look at the conversion of net income to free cash flow, basically 100%, even if we exclude those asset sales.

So as I think about what you're talking about here with the normalized OR being in the low 60%s, and we've got a very good outlook for the production of the free cash flow growth from here, you've already done a run rate now in the second quarter on buybacks of CAD1.8 billion. I don't see any logic here for thinking that slows from that pace.

But there's a lot of puts and takes in cash flow, I know. So, can you talk a little bit about comfort level either at the Board level or at the management level for continuing this pace or accelerating it?

Yes, Bill. Great question. Having the kind of cash flow generation and cash flow growth that we have is certainly a quality problem.

Our focus for use of that cash to date, as you've highlighted, has been our repurchase strategy. And the key there is we're trying to improve shareholder returns.

The opportunity so far has been very strong. Our share price, as you can imagine, is below what we would view to be the intrinsic value of the Company. So we continue to see repurchasing shares as a strong value proposition for the shareholder.

We have not yet outlined plans, as you know, beyond our current Normal Course Issuer Bid. We'll be having those discussions with the Board shortly. And without stealing all of our thunder, we're going to probably provide some more clarity at our Investor Day at the October 1.

Maybe I could just ask one comment, then, on the Board. Are they getting increasingly comfortable with the pace? Because I know last year there was a little bit of reluctance to go as far as perhaps management was willing.

Yes, Bill, this is Hunter. I think that it's clear that the Board grows more confidence with the operating performance of the Company all the time, which certainly starts to reflect in the cash flow. They're certainly, as they should be, concerned about taking care of the needs of the Company from a capital standpoint; and we presented that to them.

And we see potentially some things that we're exploring that might be some other opportunities. But if you put all of that in the blender, I think -- and you look out forward, and you continue to see and buy into this operating performance, I think you will see a more aggressive buyback program all the time as we go forward.

All right. Very helpful. Thank you for the time, guys.

Turan Quettawala, Scotiabank.

Yes, good morning. I had a real mundane kind of question here. But on domestic intermodal yields, I'm just trying to understand that. Those have been down here for the last few years. Maybe, Keith, you can talk a little bit about why that's the case.

Is it mainly a mix issue? Because obviously truck pricing has been rising, so one would expect those to go up as well.

All right, a little clarity on that. You've got to understand it's about balancing the network on the domestic side. So when I say balanced network, more specifically it's trying to match that headhaul with backhaul business.

The backhaul business obviously is not as profitable as the headhaul business, but it allows us to manage our fleets and to turn those assets and keep them balanced and overall drive the profitability of the business unit.

I see; got it. Okay. So should we expect that to continue? How much more of this backhaul -- like a lot of the growth I guess is coming from the backhaul side, then.

Yes, well, no, that's not necessarily correct. For instance, headhaul on 101 is up 27%, so that's not the case.

You will see some of that. I don't think that you will see the deterioration continue because we'll start to price the book of business in the service with some of the customers that we have now, just demand for the product. Probably might lose a seat on the train because they're not going to be able to pay the same freight that a more quality customer would.

So you will see that reverse. Some of that also is driven by our increase in our Toronto-to-Montreal roadway service that we've got. That's not the most profitable business; we still make a buck on it, but it's not nearly as profitable, nor do we enjoy the same margins as we would domestic headhaul, so to speak, from Toronto to Calgary.

Okay, thank you. That's helpful.

Thomas Kim, Goldman Sachs.

Thanks very much. Keith, can I just break down the commentary on the double-digit revenue growth? Specifically I am curious about the loadings.

In the second quarter, obviously we've seen a nice little ramp here. I'm wondering if you can quantify how much loadings you think you may have lost due to congestion. And then, when do you anticipate getting back to the mid-single-digit volume growth going forward?

You know what? If I had to put a number on that I would say maybe 1%, less than 1%. I mean there are some puts and takes in it. There was a little bit of pickup in the second quarter from maybe some coal that we didn't move during the first quarter because of winter. But that is muted obviously by some of these challenges we have had at St. Paul and Chicago.

So again, I would point back to this overall performance. What you're seeing now is similar to what you're going to see the balance of the year.

Okay, great. Then just with regard to any incremental costs associated with making sure that you're delivering what you're delivering so far. In the first quarter, you called out about CAD75 million due to weather. In this quarter we didn't necessarily see any comment specifically as to how much additional incremental cost incurred due to the increased resourcing required to get the network back.

Do you have a number in terms of what additional cost that might have been incurred due to these network constraints?

I would say again I'm not going to make excuses for costs. To me it's not material. It's not like the first quarter. So I would say nothing.

Okay. All right. Thank you very much.

Allison Landry, Credit Suisse.

Hi, thank you for taking my questions. Hunter, over the past few months you have talked about becoming the most efficient rail in either 2Q or 3Q. And Bart, your comments that the core OR run rate in the second quarter was in the low 60%s, if you exclude the stock-based comp and the grains. So based on this, is it fair to infer that it's possible that we could -- or you guys could potentially see a sub-60% OR in the third quarter?

Is it possible? If everything hit, and we don't have any issues or problems, and everything hits, and the stock doesn't go up, are we going to see a day that we break through that barrier? Yes.

That's not some -- like we're trying to break through the 4-minute mile. I think you see looking forward in the longer-range outlook we clearly have low 60%s that is in our sights that we can see.

Now -- so that's good. We've looked at -- and that converts to some degree to the cash flow that Bart has talked about and to more of the buybacks.

The thing that it doesn't -- the missing component there is the conversion potentially of the low cost and the service that Keith has talked about into potential growth. So that's the story.

Could we hit a number that starts with a 5 one day? Yes, sure we can hit it on a quarter basis. I hadn't seen yet -- I don't have in my sights that we can do a 5 throughout the year, based with seasonality and so forth. But you're going to see, probably, hopefully, if there's no unforeseen issues in the third and fourth quarter, you're going to see some pretty good numbers there.

Now, somebody is going to ask me: Before I get there am I going to change my guidance? No. The guidance has been 65%-ish going back to the original plan 2 years ago, which was supposed to be a 4-year plan, which people said you couldn't do that -- all the experts, some of you in the room -- that that wasn't doable.

Well, it is doable. We're going to -- we will produce stronger numbers than that, clearly.

And I think this is a case that we're going to be moving from. It's not as -- how low can you go necessarily on the cost side? But it's the top-line opportunity to convert, which will then start to provide a lot of opportunities for the Company that we have not had before.

So, yes, we're going to see some numbers like that. But we're not going to be obsessed with that and miss the opportunity for growth on the other side.

Got it. Thank you for that comprehensive answer. Just one follow-up question.

Can you maybe talk a little bit about pulling the tender offer back in June? It seems like the rates that you offered were attractive. So I was just trying to understand.

Was there something related to the profile or the style of the debt holders that maybe inhibited them from rotating out of the bonds? Obviously, there are high coupon rates. Could you maybe talk a little bit about that decision?

Yes. We changed our mind.

Sometimes you do that. You get smarter the further you go along.

And I think we may be second-guessed ourself, and there were some other issues, and we decided to withdraw it. Now, I will let Bart give you more specifics, but I don't -- there is nothing material or nothing to be concerned there that was any significant issue. Bart, you want to?

Yes, thanks, Hunter, and thanks, Allison. The only thing I'd add to Hunter's comments, Allison, is that we do obviously constantly look at opportunities to bring our costs down. We did identify an opportunity here; but the take-up wasn't as strong.

There is some impact of mix of investors. We have got investors in our bonds that match those holdings to duration, and so pricing is very important. And we're not going to overpay on anything if we're going to buy debt back or do other things.

So nothing out of the ordinary here other than the price wasn't right. So we're moving on to other opportunities.

Okay. That makes sense. I think just to your point of duration, we had heard even in some other industries longer-duration investors like life insurance companies and that sort of thing, so that was just where my questions come from. But thank you so much for taking my questions.

Benoit Poirier, Desjardins Capital.

Good morning. My first question is on the crude by rail. Just wondering, Hunter, if you could provide more detail with respect to the new terminal that has been announced by Global Partners in Port Arthur. Just wondering, what's your selling proposition? Any advantage you're going to be selling through KCS or over CN? And probably any color on the time frame and the magnitude of this opportunity.

Well, Benoit, I can say this, we connect with KCS, and CN doesn't. Clearly there is an opportunity.

Now, there's other people that go to Kansas City; but clearly there is an opportunity for us. I'm not sure if Keith is up to speed more than I am, but there has been no discussions that I'm aware of that anyone else has closed the door and has preempted us as far as an arrangement there.

I know this is a longer-term project to get that terminal up and running. So I think given our position of the sourcing, and given our opportunity and direct connection over Kansas City with KCS, that we'll be right in there in the fight.

Keith, is there anything else that I missed?

No, Hunter, I would just emphasize your point. This is all about the strength of this franchise. The origin source with the heavy crude, the connection with KCS and Kansas City, we're going to be players regardless who the competitor is.

With respect to the size, would there be any bottleneck on your track right now, looking at this corridor?

No.

Okay. Maybe second question for Bart. I was wondering if you could provide any update on the asset monetization, whether it's still a 2015/2016 story.

Yes, Benoit, more to come on that when we get together at Investor Day. But we're working through the real estate portion of the book to see what assets can be freed up.

We would see this as something that's going to happen more over the 2- to 3-year time frame; it's something that's nearer term. But so far, it's looking quite good in terms of the opportunities that are there.

Okay. Thanks for the time.

Chris Wetherbee, Citi.

Great, thanks. Good morning, guys. Bart, maybe just if I could circle back to some of the thoughts around capital structure, and you think about the debt profile you have. And it sounds to me like buybacks provide a pretty interesting and compelling financial return opportunity for you currently.

But as you think out over the next year or 2 and maybe the -- could you give us, I guess maybe frame up the opportunity as you see it to potentially maybe do something on the debt side to refi or ultimately lower some of that coupon debt as you move out over the next couple of years? Just curious what maybe that opportunity looks like right now.

Yes, Chris, we would agree with you completely that the opportunity to repurchase shares at a good value is there. Hunter touched on the point that the Board is getting a lot more comfortable as the operational performance continues to just get better and better, and that the cash flows are going to be there, and that the balance sheet is going to remain strong.

So we're now shifting our thinking towards: Can we model in over the long-term more buybacks, if we can get them obviously for the right price? And is there a sustainable level of leverage that makes sense too?

So if you look at where we're at today and what the business performance improvement is going to drive going forward, we're going to produce a lot of cash. Our debt-to-EBITDA ratio is going to continue to come down. And you know what that means in terms of leverage levels reducing; and ultimately that's not optimal for shareholders over the long term.

So I think what it all points to is a very positive situation where, if we can continue to buy shares at the right price, it's going to be material. We don't have details on it today though, Chris. That's something we are just working through right now and we'll talk more about come October. Okay?

Yes, that is definitely fair. I appreciate the color. Just a quick follow-up on that.

When you think about the longer-term leverage, your comfort with longer-term leverage levels I guess, can you just give us a rough sense? I think in the past you have suggested in the neighborhood of maybe 2 times. I just want to get a rough sense of maybe how you think about that going forward. Has that thinking changed at all?

That would be in the zone. I think we highlighted in one of our slides last quarter that we target something less than 2.5 times.

We do have a target credit rating that aligns with that metric. But you want to keep some flexibility on the balance sheet, too, and have some shock absorber ability. So probably something in that 2, 2-plus, but below 2.5 makes good sense.

Okay. That's very helpful. Thanks for the time; I appreciate it.

Walter Spracklin, RBC.

Thanks very much. Thanks for taking my question. I guess my first question will be on, Hunter, your commentary with regards to shifting a little bit of your focus from operating ratio to growth. I would like to just get some clarity in terms of where you see the key growth coming from.

Either through -- is it through rail share gains? Is it through truck share gains, or through new market organic growth opportunities, either organically or through markets that we haven't seen or we were seeing fast and revenue growth in?

If you could bottle -- if you could segment into those areas where you see future revenue growth, how would you categorize it into those buckets?

Well, if I went across the board, I think for an example that over -- if you want to look at some 5-year averages or what, we're going to see some yield improvement with Canadian grain. I think there will be some shifting away from maybe commodities, from wheat to corn or what it might be. So I think there'd be some pickup there, which is part of the strength of the franchise.

I think you see, if you look at potash and you look at the huge investment from K+S on top of our strong franchise to begin with, you will see some incremental growth there.

Clearly, I think you -- everybody is focused on the crude story. So there is going to be some certainly upside opportunity on crude. And how much and over the long run, hard to predict, given what happens with pipelines and other competition.

This is almost and to some degree in order of how this will occur. I think clearly, Keith has pointed out this morning that there has been tremendous improvement in domestic intermodal. I think that's more -- that's mostly off the highway.

I think we will be focusing on other markets domestically. You know the old conventional wisdom of -- that you couldn't haul something on the railroad; it had to be at least 700- or 800-mile length of haul to be able to make a buck is not true anymore. As railroads have gotten their costs down as well as us, you move that into the low 60% range, you can almost look at the linear impact of what we can do as far as competition from that standpoint.

And then there will be, I think, some return of some lost business internationally, mainly as a result of service. And then I think the little bit of the longer-range, it's a little bit harder to make a conversion, but the [size] to me as much as everything is this whole book of merchandise business that people tend not to focus on both internally and external that I'm trying to be a champion of. It's all the other stuff.

So I think, yes, it's some organic. Yes, it's some market share gains, both from the competition, rail competition, but to a small degree. But mostly from the highway.

And it's a pretty simple formula. When you provide the best service, if we do that, and you're the lowest cost carrier out there, you've got a hell of an opportunity. And all you need there is a strong economy.

Okay. In your comments there, you touched on hard to predict. I guess where I would ask you is -- you certainly attack your costs with a high degree of confidence in your ability to reduce those costs given the control you have over those.

How do you compare the revenue growth opportunities as you go into that next stage of value creation for shareholders? How do you consider the revenue opportunities when compared to what you did on the cost side in that confidence level?

Well, I think it's almost a flipping the coin. I think that we have seen this franchise is becoming stronger from the basic infrastructure. Safer from the road bed up, from the ballasts up, from rails and ties. And at the same time we're doing that, I think one of the things that people happen to miss in rail is Keith and his team are working very hard in strategically placing longer sidings in, and mainline fueling facilities, and things that add raw velocity and speed.

So if you're able to then convert that service, that raw speed, to the customer -- and Walter, I would hasten to point out as we go forward in this plan -- I'm not talking about this year. But if we look out in the 4-, 5-, 6-year horizon, I don't think you're going to see interest rates stay where they are. I do think you will see interest rates will rise.

I do think you will see carriers that are providing quality service, when people look at the carrying costs of their inventory, get rewarded. So I think at a point we'll become -- hopefully, our goal is to become as much a revenue champion as we are a cost champion.

If I could tuck in one last one, that's a fairly ambitious -- certainly ambitious and interesting opportunity. You have obviously had some changes now in your executive team on the sales side. I think, Keith, you are shouldering the load here right now.

Is that something that you expect to do just for the interim? Or is this something, given the significance of the revenue opportunity that you're going to be chasing, is that something you're going to look at sourcing some expertise from either outside or inside the Company?

I'd say, Walter, that, number one, I'm having a great time. I'm learning. I've got hands-on teaching and developing a very confident, competent, confident marketing team in each of the business unit leaders.

I've got strong shoulders. I'm not overwhelmed at all.

So I don't see any short-term change. Long term, if we were to identify the appropriate candidate, be it internal or external -- of course we're in the business of developing people -- we will hire someone. And we'll do that.

But right now, it's nothing that I am seized with or concerned with. I think it's working extremely well. We'll continue to do more of the same.

Okay. Thank you very much.

Scott Group, Wolfe Research.

Hey, thanks. Morning, guys. When I look at the revenue numbers in the quarter, there is definitely some good help from mix and currency. Don't see a ton of pricing yet.

And wondering, Hunter or Keith, when do you think that the pricing can really start to take off, now that the service is getting better?

Well, let me take a shot at that. Number one, I've said and we've said going into this, that that's the hardest conversion, number one. Okay?

Number two, we have got legacy contracts that -- for an example, if you just change policy overnight they're not going to change the quality of revenue. I think the quality of revenue is going to be a little bit of a lag of people seeing our performance.

So, I don't expect and I don't think customers are going to come out and make a big conversion and change to us, and/or give us a price increase until we deserve it and earn it and it creates value for them.

So, I think this same time frame, I think that -- I would call 2015 kind of the year of transition, where we're getting our costs close to the end of the line of wringing cost out where it's smart. Could we go lower? Yes, but maybe not smarter.

And then through 2015 and then as we move into 2016, I think we will see some -- certainly in certain commodities, and it's relative to the competition, but we will see the ability to increase the quality of our revenue on the individual components. Because if you look at it from a overall look of business and you look at the regulated grain and some of the things that you can't impact.

But to Keith's point earlier, I think the domestic intermodal will improve. I think the crude will improve. So I think you start seeing this ramp up, probably really ramp up back half of 2016.

So is it fair, Hunter, to think about you guys have some visibility on some things outside of price that should sustain this double-digit into next year, and price maybe picks up in 2016 to keep the double-digit going?

Yes, I mean that's kind of what we've said all the time in the plan. The key to all this, I would say, that you can wrap a lot of this up, strategically where we are is velocity. Trying to make a definition between velocity and speed.

If we can prove improve the physical plant and have a safer physical plant, we can move faster on it; we can lower our cost as a result. We can have greater asset turns and provide better service to the customer. That all works and comes back to provide this -- the bottom line.

We have -- I mean underlying this, to some degree, we are right now, I think it's safe to say -- well, I will say it anyway. We are very, very close -- very, very close to making an announcement, hopefully, on a breakthrough with a collective bargaining agreement in the US, which will be looked at very favorably, I think. There will be a Phase 1 and a Phase 2 there.

And that, on a longer-term basis, once again looking at 4 or 5 years, is part of the strategy of the Company overall, is -- if we can improve the speed, and if we can pay our employees and make them the top-paid employees with the highest quality of revenue, but overall lower our labor costs, this all fits together.

Yes. No, that makes sense. And just one last follow-up, Hunter. As we are growing -- starting to grow the volume more, when should we -- or should we be thinking about starting to increase headcount or CapEx again? Or do you feel like you can do this without having to add those -- any resources back?

Well, there is some dependency here. Number one, in certain areas clearly we can grow capacity if you look at our train sizes, and what our capacity is, theoretical capacity. You can have some rather significant growth without adding.

There are a few other areas that might have to be added to. For an example, what happens to some of the collective bargaining agreements has a significant impact there.

So, I would say that either way where we're positioned right now, you're not going to see in the shorter term, the next 2, 3, 4 years, significant changes in the headcount, up or down.

Got you. All right. Thanks a lot for the time, guys.

Cherilyn Radbourne, TD Securities.

Thanks very much and good morning. I am just going to ask you one, and it relates to dividend policy. Clearly, with the EPS growth that you've had, the payout ratio is now well below a 30% to 35% that your peers generally target. And likewise, the dividend yield on the share price is low relative to peers.

So appreciate that you have been very active on share buybacks. But just curious whether dividend policy is a conversation that you are having with your Board at this point.

It is, and I think I can characterize it this way. To some degree everything in what you said is exactly true.

I think you have to take into consideration the mix of ownership of the Company. Right now -- and I hope this improves significantly -- but the ownership in Canada is down 20%, 19%, 20% range. So in the US, it's like 77% or 78%; and then others.

Well, clearly from the US perspective, where most of the shareholders are, it is not as tax efficient as it is in Canada, for an example.

Having said that, is it time for a little increase in the dividend in spite of the fact that the raw numbers indicate that the share buybacks are the best returns to shareholders overall? There are a few champions for dividends on the Board.

So yes, they are being represented. Yes, that's being discussed. And, yes, I think you will see a little bit of a change in policy there. That is a prediction.

Okay. Thank you. That's all for me.

Ken Hoexter, Bank of America.

Great. Good morning. Hunter, you've mentioned velocity a lot. Any thoughts on the mandate to slow down trains, particularly with respect to crude? Could that move more crude maybe back off the rail and force the building of some of the pipes to -- if that mandate continues?

Well, again, let me answer it this way. Number one, I have said this: I don't know, and I don't know of every incident, but I keep up pretty close. I don't know of any incidents with crude that's been caused by speed.

We keep slowing down this North American network over the years. We don't get better with speed, we get worse.

Now you can't keep growing the country, for an example, growing the economy, growing the population, and continue to move stuff on rail, cutting the speed back but don't want to add any infrastructure. That doesn't work. That's a timetable to disaster.

So hopefully we can convince people, regulators, legislators that there is a safe, efficient, effective way to move crude -- and other commodities, not just focusing on crude -- that this industry has done for years and years. So I hope there is recognition for that.

I have always said from day one, I'm not talking down and saying we shouldn't have pipeline. Look, there's perfectly appropriate places for pipelines. We're not out lobbying against pipelines. I think there is enough for all of us to do effectively.

So they got it wrong with speed, okay? If they're going to restrict the speed of trains, then something is going to have to happen.

We're criticized as an industry in certain markets because we haven't put infrastructure in to handle the growth. But then when you try to put infrastructure in, then the not-in-my-backyard lobby kicks in and says: We don't want you here.

Well, somebody is going to have to figure out another way to move commerce. And I think this is all going to come to a head and there's going to be a cleansing, if you will, over the next 2 or 3 years, and rail is going to come out of that doing very, very well.

Thanks for that. Let me follow up with I guess the same thing on speed. Just given the Canadian grain market, a couple questions here.

Your outlook in storage versus where the market pricing, if we stay low, what has to move? And just thinking about the carry into 2015. So do you have good visibility into that, 2015?

And while you're talking about that, maybe throw in your thoughts on the regulatory view both up in Canada on the service comments and then the STB's mandate on the service updates.

Well, I guess, Ken, my reading recently is that the recent flooding that we have experienced in Central Canada, in the prairies, is not as significant an impact on this year's crop as I thought it might be. I think people are talking 6% to 8% range.

But at the same time, there is a carry from 2014. Now, there has been great debates -- and this is one of the problems -- about how much is the real carryover and how much is it phantom orders that are not really there?

Having said all that, I think there is going to be plenty of demand for grain going forward for us into 2015, which will be good for us. I think it's obvious and clear in my statements, I don't think the revenue cap in Canada makes a lot of sense in the market.

I don't know why you'd choose one commodity, of all the commodities effectively in North America, and say: Here is the only one we're going to regulate; it happens to be Western grain. Well, what about Eastern grain? This makes no sense.

We come to customers. Customers say: We want to pay a premium to get a better service; can we buy a premium service? We can't charge it. We can't serve the markets in the appropriate way.

Anyone that thinks that some of this legislation, this emergency order so-called, that said we and our friends in Montreal had to haul so much grain or they were going to fine us every day, could have had an impact on moving grain -- they're nuts. They don't know anything about the infrastructure or the movement of grain, okay? So I am not a very big advocate of that.

Washington, STB has certain oversight responsibilities. But somebody who gets involved in this has got to get involved in what's the solutions, not compiling all the complaints or issues.

So I think the markets are better left to the marketers than the regulators and legislators.

Thanks.

If you think I don't feel strongly about that, then ask me another question.

(laughter) Thanks for the thoughts.

Daniel Chew, Raymond James.

Hey, good morning, everyone. Just a quick question here on the domestic intermodal business. First, product uptake has been really strong on the new service, and I believe you mentioned that you've sold out quite quickly.

Just wondering here, how much more capacity do you guys intend to open up in the network to accommodate this incremental business, and what the total opportunity might be for domestic intermodal in the next 2 to 3 years? Thank you.

Well, I would say that as long as there is profitable demand there, we will match the capacity to the demand. So we still can grow on the trains we've got now running across the network. I would say there is probably 10%, 15% more opportunity on that before I have got to worry about adding another train start.

Long term, I'd still see strong, say probably double-digit growth over the domestic intermodal side as we go forward over the next couple of years. There's still a lot of opportunity.

There are still some customers, to Hunter's point, that are profitable, reputable customers that, once we continue to prove and do what we say we're going to do, we're going to get an opportunity to be rewarded with their freight. So I think more to come, and it's all positive on the domestic intermodal side.

This franchise is strong. We have grown a lot and optimized Toronto-to-Calgary. There is still more to do. Calgary-to-Vancouver, there is still more to do. Vancouver, back the other way as well, even down to the States on the international side. So I feel very bullish overall about intermodal growth.

Great, thank you.

Brandon Oglenski, Barclays.

Yes. Good morning, everyone, and thanks for taking our question. Hunter, at the risk of asking another question on regulation, I think it was pretty clear with the first answer. But I did want to come back to a comment you made earlier regarding capital and speaking to the Board. You did say you were looking at some other opportunities as well.

Should we be thinking, with the markets that you're looking at, increased CapEx going forward to achieve some of these growth ambitions? Or are there certain places in the network that you think could be operating better, especially with all the service issues that we've seen in the last half-year?

Well, we're always going to be looking for other opportunities or things we have missed that might be taking place. The point I'm trying to make there is this. We're not going to get locked into a buy strategy and overlook opportunities to improve the Company's infrastructure that has a longer-range impact, whether it's through the safe roadbed or whether it's through increasing velocity or whatever it might be.

So there are some -- for an example, there are questions that come up about the relationship in maintaining railroads between capital and maintenance. There's cases to be made that, if you spend the right amount of capital with the right timing, it dramatically, dramatically cuts operating expense from out-years.

Not unlike you buying a car. You're going to buy a new car and expect it to work a long time, with just some simple little preventive maintenance? Or are you going to buy some clock that you buy a whole lot cheaper, but you've got to pay a lot of operating expense to keep it running?

So there are some real questions about, on a timing issue, on a catch-up of capital, and what it would do in the relationship to operating expense.

So I just want to make the point that the Board's view is this: The first call for capital is the Company needs internally to run the railroad in an efficient, safe manner. That's number one.

We kind of looked at that three ways. We looked at obviously replacement capital, which is too high in the rail industry; that's basically 50% -- round numbers if you want to get into it.

We looked at productivity capital, and we looked at potentially expansion capital. Now if we don't see those things internally that can give us the appropriate returns relative to the other opportunities of buying back or rewarding customers through dividends, then we will not do that.

But do I see some big bubble out there that you should be looking for? No. I just want to be sure that everybody understands that these are a lot of moving parts in these decisions; but we are flexible. The Board has been very flexible with us.

And that really -- we could not have done some of the things we've done without their confidence that they have shown us.

Well, appreciate it. Thank you.

Jason Seidl, Cowen and Company. (technical difficulty) My apology for the quality of that line. David Tyerman, Canaccord Genuity.

Yes, good morning; or I guess it's afternoon now in the East. I just wanted to ask about the comment you just made, Hunter, about the CapEx. Did you suggest that you thought the long-run ratio should be something like 15% of sales?

If so, you're not at that level right now; when would you expect to see heading toward that level?

We're not -- I think that those kind of numbers have been guidance in the past to use. We're not trying to shoot for a number that spends that much of revenue.

I'm just trying to make the point that we have a first-class issue here that we have a lot of cash that the Company is throwing off, and we have opportunities to sit back and look at all the opportunities that managements have to decide where we might deploy that capital. So we are very flexible there, and we are going to do the appropriate things.

I am not clear where you think the long-run level would be, because that makes a fair difference on the amount of free cash you're going to generate.

Well, I think that we have -- our guidance before has been that we've been in the CAD1.2 billion to CAD1.3 billion range.

Right.

I said over this next 4 or 5 years that that -- could we see that go to CAD3 billion or CAD4 billion? Yes.

Should something come along that we're not aware of today, a new technology or what, are we in position to take advantage of that? We certainly will. But if you're trying to look at a run rate with everything we know today, I think CAD1.2 billion to CAD1.4 billion is where we're going to fall.

Okay. That's very helpful. Thank you. Just the other question I had was on the pension.

There's been quite a good headwind this year from the OR. I was wondering -- and this is probably for Bart -- if you think this is sustainable, whether you can continue to generate income from this, or whether we should be thinking of something different in the longer-term.

Yes, it has been a healthy tailwind for us for this year. We have got income being booked in the CAD50 million range.

The thing about pensions, we're continuing to see strong returns out of the pension plans. But there's factors outside of our control, like interest rates. They have come down a bit this year; they will remain volatile over time.

But the trend for our pension is very, very positive in terms of its funding levels. And, subject to a little bit of cooperation on the interest rate side, we should continue to see either modest income or flat to maybe a little bit of expense. But it does change over time.

Okay. Very helpful. Thank you.

Jason Seidl, Cowen and Company.

Thank you. Hopefully this is a little bit clearer this time. One quick question regarding intermodal. We saw some pretty good growth in the quarter; the outlook seems pretty positive.

How much pull forward do you think you saw potentially from the worries on the West Coast ports down in the US?

I think was net neutral. I don't really think it's material at all. We've seen a little bit of uptick in business, but it's nothing that to me is going to move the needle.

We have to be careful. We have to watch that. If it were to get worse, then obviously it could result in revenue opportunity, but at the same time operational challenges.

There is only so much capacity in the Port of Metro Vancouver. If it were to get a groundswell of business, be it us or our competitor, I think it would cause some challenges for us.

But to your question specifically, I don't think there is a lot of pull forward.

Okay. Thank you much for the time.

Keith Schoonmaker, Morningstar.

Thanks. Keith, in your earlier comments you emphasized progress on a couple of material operational aspects, both safety and fuel efficiency. Certainly these can have powerful financial impacts as well.

Could you add some detail into how these were accomplished?

Well, on the safety side specifically, to Hunter's point, we have invested. Last year we experienced some pretty unfortunate derailments on parts of the territory where, quite frankly, the infrastructure was not to our standards.

We invested quite a bit of money. The Board supported an advancement of capital of about CAD100 million on our North line, where a lot of this grain, potash, and crude comes from, which has proved positive for us.

The other point, when you get to some of the fuel-efficiency improvements, it's about running fewer, longer, heavier trains. So as you use DP power, as we reduce train starts, as we optimize the network and run longer trains, you're going to get some fuel savings as a result of that.

And then also reducing locomotive counts. Fewer locomotives out there running, fewer train meets. It's just across the board.

So there is no silver bullet. It's a bunch of singles and doubles.

But again, there is more to come. There's things that we have not implemented yet, things in my previous life that we may have done with the throttle requirements or throttle regulations, with technologies that we haven't even equipped these locomotives with yet.

So it's something that we've -- pretty proud of the progress we've made, but as we continue to invest in the physical plant, make longer sidings, run longer trains, fewer of them, and implement some of these strategies, you will see some continual improvement in this area.

Quick follow-up on that, Keith. You mentioned more effective use of DP was part of the improvement. What portion of the lanes or what portion of the miles do you plan on running or would benefit from DP? And what sort of progress has been made on that so far?

Well, all of our mainline locomotives are equipped with DP, so it's really an issue of the strategy. If you've got an opportunity to take train starts out, then we're going to use DP to run longer, heavier trains.

But I'm not going to just DP a train to DP a train; there's operating costs associated with that, that if you get too enamored with the thought of DP you're probably going to miss something.

So right now, I would say probably half and half. But again, it all depends on the opportunity as this business grows. I will take a look at what the opportunity is with the mix, and if it says that we need to go to 75%, we will; if it says I need to go to 40%, I will.

Thank you.

Steven Paget, FirstEnergy.

Thank you and good morning. Some of your strongest price increases versus second-quarter 2013 are in the old industrial and consumer products segment. Could you please comment on what is driving those increases?

I would say it's the focus on improving the quality of the book of business, dropping off some of this business that, quite frankly, we were hauling for practice; as well as going to more tariff pricing, trying to get our book of business to tariff prices as opposed to the alternative.

So again, no silver bullets here. It's just the focus on the quality of revenue, and this operating team providing service and the marketing team converting it.

Thank you, Keith. Second question. A CP Board member once noted that CP was 70% of the size of CN in terms of track and RTM, but only had 40% of the enterprise value. The railroad has now moved to having 58% of CN's EV; but that quote from a couple years ago tells me you still have a lot of running room. Would you agree?

Absolutely.

Excellent. Thank you. Those are my questions.

Jeff Kauffman, Buckingham Research.

Hey, everybody. Well, congratulations on overcoming the challenges this quarter. Hunter, you kind of answered what I was going to ask on CTA, so let me come at Keith.

Keith, your train length is 6,800 feet right now. How much more do you think that can grow without throwing a lot of resources into the network?

Well, I guess you've got to define what a lot is. I mean just based on what our plans are this year, we're adding an additional 11 sidings. With that we're going to see some improvement.

Down the line, I've got a multiyear plan to match up against this revenue growth opportunity that will see us add more sidings, that will see us -- and also take some sidings out, that will allow some additional improvement. So, I see somewhere in the range of 10% to 15%, 20% opportunity on train length improvement as we go forward over the next several years.

So you are thinking we could see 7,500-, 7,600-foot trains over 5 years?

Over 5 years? Yes.

Okay, guys. Thanks.

Mr. Harrison, there are no further questions.

Hunter, no other questions. Over to you.

Okay. Well, thanks for joining us. Extremely positive dialog here, and I hope you have direction of where this organization is headed. And we certainly look forward to seeing you October 1 and 2 at the Analyst Meeting, and we will have hopefully a good productive couple days together. Thanks.

This concludes today's conference call. You may now disconnect.