Canadian Pacific Kansas City Ltd (CP) 2023 Q2 法說會逐字稿

Good afternoon. My name is Leo, and I will be your conference operator today. At this time, I would like to welcome everyone to CPKC's Second Quarter 2023 Conference Call. The slides accompanying today's call are available at investor.cpkcr.com. (Operator Instructions) I would now like to introduce Chris De Bruyn, Assistant Vice President, Investor Relations and Treasurer, to begin the conference.

Thank you, Leo. Good afternoon, everyone, and thank you for joining us today. 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 U.S. regulators. This presentation also contains non-GAAP measures outlined on Slide 3. Please note, in addition to our regular quarterly financials, there is supplemental Q2 combined revenue and operating performance data available at investor.cpkcr.com, which some of today's discussion will focus on.

With me here today is Keith Creel, our President and Chief Executive Officer; Nadeem Velani, our Executive Vice President and Chief Financial Officer; John Brooks, our Executive Vice President and Chief Marketing Officer; and Mark Redd, our Executive Vice President and Chief Operating Officer. All our remarks will be followed by Q&A. In the interest of time, we would appreciate if you limit your questions to one. It is now my pleasure to introduce our President and CEO, Mr. Keith Creel.

Thanks, Chris, and good afternoon. Let me start by thanking our CPKC family of railroaders across all of North America have been hard working, bringing these 2 companies together, serving our customers and issuing each other. As you can imagine, the quantum of work has been monumental. The effort against that quantum of ethics is has been inspiring.

So let's take a look at the results in the quarter. In the second quarter, we produced revenues of $3.2 billion and operating ratio of 64.6% and core EPS of $0.83. We saw volumes down 5% in the quarter, headcount up 6% versus last year. So no doubt a challenging quarter as we dealt with a softer demand environment, but John is going to speak more about that in a few moments. Despite the challenges in the quarter, as we stated in our press release, we continue to expect to deliver on the guidance that we laid out at our Investor Day.

Let me spend a few moments talking about some of the early wins. So looking where we stand today, we're just over 105 days old forever into this combination, but I'm extremely proud of the work team has done to get us to this point than what we've accomplished so far. First and foremost, a seamless transition operationally and combining the 2 networks, which is no small feat. I think in historical terms, it's refreshing to see the results versus most merger histories.

Understandably, based on those histories, there's been no shortage of skeptics that pointed to an industry with a history of merger-related services challenges. -- as I said we would, we've taken a realistic and measured prudent approach, a more humble approach to bring these 2 networks together and it's paid dividends. As we bring the networks together, we'll continue to identify areas of opportunity to make the service better and to improve operationally. In the second quarter, we are proud to announce several key customer wins, Schneider, (inaudible), Americold. These are deals that, as we said before, in some instances, for 18 to 24 months in the making. They utilize the advantages of this unique network, including our land holdings as well as the only single-line service spanning, U.S., Canada and Mexico.

And again, on March 11, we launched our flagship 180/181 Mexico Midwest Express service. which, again, is the only single line, fastest transit time consistently across our 3 nations or I guess, from Chicago into SLP, we've executed well beyond our advertised transit times of less than $100 each week. We've also not been resting on our laurels from a strategic point of view. We continue to expand the service offering and our reach with the MBR transaction that we announced connecting CSX in Alabama, creating a new gateway between Mexico, Texas and the Southeast United States.

And on the sustainability front, again, we announced a very strategic partnership with CSX to expand on our hydrogen locomotive program. And finally, we also announced part of our extended partnership with tech and the contract that we just renewed, plans to utilize the hydrogen locomotive in our Western corridor. So listen, a lot of tremendous work leading to this combination. I applaud the great railroaders that's made this possible. prior to and since day 1 to come out to this result. And listen, this is not to say that everything has been perfect. -- certainly been challenges, this softer macro environment, the strike at the port. That said, on the strike, I'm encouraged that the longshoremen are back to work, we've got a contract that's out the ratification. We should get a result from that, if not today, tomorrow, and I'm anticipating a best outcome for everyone involved for the ratification of that agreement.

Heading into the combination of these companies, the last thing also that we were going to allow us to be short on resources. We certainly can't grow without the resources in place to accommodate it. You'll see that reflected in our costs this quarter. But at the end of the day, that is the absolute right thing to do. This is a long game. It's not about the first quarter of a combined company. It's about ensuring that we're prepared to grow with the growth that we see coming and position this company for long-term success.

So in closing, we're in the early stages of this combination despite some short-term headwinds, the unique growth outlook that we laid out last month is unchanged. TPKC is poised to be the most relevant rail network in North America. We're uniting a continent, we're enabling commerce amongst the United States, Mexico and Canada. With that said, I'm going to turn it over to Mr. Mark Redd to speak to the operations before John brings some color to the markets and they do elaborate some of the numbers.

All right. Thank you, Keith. I'd like to start by thinking the CPKC operating professionals to continue to work tirelessly to deliver best-in-class performance or delivering on our service commitments to our customers. As John will discuss the long-term opportunities in the pipeline. My team has been working closely with the marketing and asset management teams to evaluate and onboard new business that fits within our network.

Turning to our safety performance in the quarter. I'm pleased to report that during the first quarter as a combined company, CPKC, we continue to build upon its industry-leading lowest train accident frequency, which declined at 48% to a 0.79 comparable to Q2 at 1.51. From a personal injury perspective, our Q2 FRA reportable personal injury rate increased to 25% to 1.25. It's just a continuing reminder that safety is ongoing journey. We still have a lot of work to do in that space. Safety and leadership development is critical to CPKC success. We will continue to will continue to be a key area of focus. In the first 90 days, we have rolled out our Homesafe program across our CPKC U.S. property, and we are now in the process of introducing in at Mexico.

Home Safe is an initiative designed to build on the safety culture by tapping into the human side of safety, but also promoting both safety engagement and feedback. We launched Comsat back in 2016 back on CP properties have derived record improvements in the reduction of personal injuries across our system. This program, along with our safety walkabouts, where we directly engage with our employees across the property is a centric of building strong, consistent safety culture across the entire network. Safety has been to remain our top priority. I'm also pleased with the nearly 100 KCSR operating leaders who have already gone through our 2-day leadership program. We fully expect to have U.S.-based leaders through this program by year-end.

Turning to the metrics a feature metrics on a comparison versus CPKC, if we combine during the 2022 year, average trains be is 1% versus last year. Average train weight is down 2%. Our average train length is flat versus last year. Our productivity for locomotives improved 4% versus the Q2 2022. Bringing 2 companies together in the size of CPKC is no feat. We have spent a lot of time planning preparing in advance. I'm pleased to say that our network is running smoothly. As part of that, as Keith spoke to, heading into the merger, we ensure we are prepared for a resource perspective of hiring and training. This puts us in a strong position to generate operating leverage as the volume environment improves.

We're also continuing to identify and implement opportunities to improve operating practices. We talked about Investor Day, I spoke about 130 locomotives that we reduced from the network, 1,000 cars that we reduced from the network by aligning operating models and improving efficiencies. These efforts will continue to happen.

We'll stay focused on the recovery of the strike of the part of Vancouver, which will take some time to achieve and in close and I'm confident the changes we have made in the first 3 months are continue to make, but generate benefits in the back half of the year. With that, I'll turn it over to John.

All right. Thank you, Mark, and good afternoon, everyone. So as Keith said, we're just over 100 days in CPKC. I'll tell you, I'm extremely proud of the work my team has done to begin to capture and deliver the growth that this new French franchise will undoubtedly unlock -- and while we are certainly not immune to the broader economic headwinds and supply chain challenges, our unique business and self-help initiatives continue to serve us well compared to the industry and put us in a strong position as volume environment recovers. Now looking at our second quarter results.

On a reported basis versus CP stand-alone in 2022, total revenues were up 44% in the quarter, while volumes were up 24%. On a combined basis, CPK saw total revenue grow 2%, while volumes declined 5% versus pro forma CPKC a year ago. FX was a 4% tailwind in fuel was a 3% headwind on the quarter. The pricing environment continues to be in line with expectations with inflation plus renewals across our book of business.

Now we'll take a closer look at our second quarter revenue performance. I'll speak to the FX adjusted results on a comparison versus CPKC had the combination occurred in 2022. Grain volumes were down 5% on the quarter where revenues were down 2%. Canadian grain volumes were strong on a year-over-year basis, driven by an improved harvest for the 2022 '23 crop year. However, that volume was offset by stronger -- or softer demand for U.S. grain, driven by the challenging year-over-year comps we faced by moving a lot of corn out of the U.S. into Western Canada due to the drought.

As we move into this year's harvest, I expect our grain franchise to return to growth. On the potash front, volumes and revenue were down 18% in the quarter. The decline in volumes in the quarter were driven by a major mechanical failure at Canpotex Portland bulk terminal that happened in April. We are not planning for the Portland terminal to come back online before the end of the year. In the meantime, we are working hard with Canpotex to divert volumes to Neptune, Thunderbeck in a variety of other terminals across North America.

Looking ahead, despite the Portland outage and of course, the most recent impact of the strike in Vancouver, I'm excited as ever about the long-term opportunity for export potash as Canpotex has effectively and continues to expand their market share across the globe. And to close out our bulk business, coal volumes were up 1% in the quarter where revenues were down 3%. The with favorable compares in the back half of the year following last year's outage of tech's Elkview mine, I expect to see strong growth in coal in the back half of 2023.

Now moving on to merchandise. The energy chemicals plastics portfolio saw an 8% decline in revenue and volume. We saw our crude and plastic businesses impacted by core spreads in the market and maintenance outages, respectively, while also our LPGs were lower to a warm spring across our network. On the contrary, our refined fuels have remained steady across our entire network, driven by business growth, leveraging our broader network service offering.

And we are pleased to announce today a new material expansion of our deep partnership with Shell through the execution of a new multiyear contract that will unlock significant volume growth of new share across all lanes of the CPKC network. Looking ahead, as Shell ramps up in August, we expect to see upside in ECP as we begin to move through the back half of the year.

Forest Products revenues declined 4% on a 5% decline in volumes. Although we are seeing the impacts of a softer economy on residential construction and related building products, we are very encouraged about the development of long-haul lumber shipments from Canada down onto the legacy KCS markets. This is a prime example of where our new network is connecting markets and creating opportunities that didn't previously exist for our customers.

The Metals, Minerals and Consumer Products portfolio grew 7% on a 5% increase in volumes. The growth in this area was driven by higher volumes of frac sand and steel, which drove a record quarter for this area. We are particularly encouraged by growth in Mexico as we recently added new steel products unit trains from Lazaro Cardnet into the interior of Mexico. We are also working closely with both Ternium and FDI on their new industrial development opportunities that will further accelerate growth in this business over the coming months.

Automotive revenues were up 24%, while volumes were up 11%, again, an all-time record for this area. Demand for finished vehicles remains strong as the industry continues to play catch up on North American inventory shortages that were a result of part shortages and of course, supply chain challenges. PCKC is working with our key automotive partners to develop unique transportation solutions that leverages unmatched benefits of this expanded franchise and also our development of new auto compounds.

On the intermodal side, quarterly revenue was down 10% on a 4% volume decline. Domestic Intermodal is challenged by soft market demand, high inventories across North America and certainly a more competitive over-the-road rates. However, we are extremely encouraged by the early success as Keith spoke to of our new 181 cross-border train. We have seen a steady increase in volumes as our partners begin to take advantage of our fast truck-like service on this unique North-South service offering.

International Intermodal helped insulate our intermodal business with a record Q2 volumes. Our self-help wins with CMA and continued growth at the Port of St. John helped to offset softer macro demand in the international space. And finally, we are very pleased, as Mark and Keith spoke to, to see the strike at the Port of Vancouver finally get resolved. We are working closely with operations and our customers to rebalance the network and move the backlog of traffic that could not move during this outage. At this point, we are estimating the strike had a negative impact of about $80 million in revenue, much of which we will work hard to claw back over the remainder of Q3 and into Q4.

So let me close by saying we are just over 100 days into this journey as CPKC. I can tell you my team is out on the street. We're excited. We're energized, we're incentivized to get out and capture this unmatched growth opportunity. As we laid out a few weeks ago at Investor Day, we have a very strong pipeline of opportunity in front of us, and we are laser-focused on locking in the right business for this network and delivering on our commitments to all stakeholders. So with that, I'll pass it now over to Nadeem.

Great. Thanks, John, and good afternoon. I also would like to thank the entire CPKC team for their work and dedication to bringing these 2 companies together. Although it was a challenging quarter financially, I'm very proud of the progress that we have made and extremely excited about the path ahead for the combined CPKC family. Looking at the quarter, CPKC's reported operating ratio was 70.3% and the core adjusted combined operating ratio came in at 64.6%. The Earnings per share was $1.42 and core adjusted combined earnings per share was $0.83.

Taking a closer look at a few items on the expense side. I'll speak both to the reported operating expense on Slide 14 and the combined operating expense on Slide 15. Our combined operating expense illustrates the estimated effects of the acquisition for the second quarter as if the acquisition closed on January 1, 2022. Reported comp and benefits expense was $659 million or $690 million on a combined basis, up 26% on an FX-adjusted basis. This quarter's comp and benefits expense acquisition-related costs of $63 million, which have been excluded on a core adjusted basis.

The year-over-year results on an adjusted and combined basis include increased share-based and incentive compensation, driven primarily by higher stock price. Wage inflation and higher T&E headcount also drove the year-over-year increase. As I mentioned at Investor Day, we have resourced appropriately for expected volume growth starting in the back half of 2023. Given some of the shorter-term volume headwinds, we are carrying surplus headcount and incurring additional expense in the quarter. However, as the growth comes on in the second half and into 2024, we will be prepared to handle it with strong incremental margins.

(inaudible) and benefit increases were partially offset by lower current service costs in the DB pension plan resulting from higher discount rates. On the fuel side, fuel expense on a reported basis increased $27 million year-over-year. As the transaction occurred in 2022, fuel expense would have declined $144 million on an FX-adjusted basis. The decline was driven by lower fuel prices on the quarter as well as lower year-over-year volume on a combined basis.

Materials expense was up $35 million versus Q2 2022 CP results. On a combined basis, materials expense increased $13 million on an FX-adjusted basis, driven mostly by increased safety and maintenance activity across the network.

Equipment rents were up $51 million versus Q2 2022 CP results or $22 million on an FX adjusted basis have the businesses being combined in 2022. Equipment rents increased due to increased use of pooled equipment fleets and efficiencies driven by supply chain challenges, along with lower locomotive receipts. Depreciation expense was up $199 million on a reported basis or up FX adjusted $21 million of the businesses being combined in 2022, resulting from a higher asset base.

Purchased services and other was $586 million on a reported basis. Combined PSO came in at $615 million, up 23% on an FX adjusted basis. The quarter's purchase services expense includes acquisition-related costs totaling $53 million. The year-over-year increase was driven primarily by increased casualty expense of $45 million, which accounted for more than half of the variance, excluding FX.

Assuming a more normalized quarter from a casualty perspective and excluding acquisition-related costs, I expect (inaudible) to land in the $530 million level per quarter in the back half of the year. Moving below the line. The equity pickup from KCS for the first 13 days of the second quarter was $26 million. Other components of net periodic benefit recovery decreased $18 million, reflecting higher discount rates compared to 2022 and other expense increased $14 million.

Net interest expense was $204 million. You will note also a $7.2 billion loss on remeasurement of KCS resulting from the transition from equity accounting to consolidation of bond control this quarter. The loss relates to tax attributes of the equity investments, which are realized separately as a $7.8 billion deferred tax recovery. These 2 items net together for a favorable impact to reported earnings of $657 million.

Reported income tax recovery was $7.7 billion, which includes the outside basis tax recovery that I mentioned a moment ago, continue to expect the CPKC quarter adjusted effective tax rate to be approximately 25.5% for the rest of 2023. Rounding out the income statement, our core adjusted combined EPS was $0.83. We continue to generate strong cash flow with cash provided by operating activities of $892 million in Q2. Our first call on capital remains the business. And in the quarter, we reinvested just over $600 million. We continue to expect to invest approximately $2.7 billion in capital in 2023. We generated $431 million in adjusted combined free cash flow on the quarter.

In the quarter, we repaid USD 439 million in term debt, and our adjusted combined leverage is down to 3.6x on our path back to our target leverage of 2.5x adjusted combined net debt to adjusted combined EBITDA. Following the close of the transaction, we increased our credit facility from $1.3 billion to $2.2 billion, while also increasing our commercial paper program to $1.5 billion.

So as I sit here today, we are in a strong position from a resource perspective and have pre spent and invested to some degree when it comes to hiring and training. John's team continues to bring on synergies. And as the changes mark in the operating team are making take hold. I think we're set up well for the back half of the year to deliver on our guidance and carry us into 2024.

While we have some ground to make up from a prolonged strike at the Port of Vancouver, the future is certainly bright, and I look forward to sharing our success with going forward.

With that, Keith, I'll turn it back over to you.

Thanks, John, Mark and Nadeem, why don't we spend the rest of our time taking questions. Operator, if we could open up the line.

(Operator Instructions) Your first question comes from Ken Hoexter of Bank of America.

Great. Maybe a little - Nadeem, you ran through a lot of numbers there and obviously a lot on the combined accounting here. Maybe just talk about the cost side, right? It looks like costs got maybe a little bloated here. And I want to understand you kind of gave the purchase services and kind of run rate there. Maybe just your thoughts on how we should think about that in the back half in terms of what costs are coming out, especially as you look at things like casualty expense, you note was a little elevated. Are there things going on in the blended network now you look and you can see ways to continue to take expenses out and what we can see near term in that blended?

Sure. Thanks, Ken. So casualty, we faced a couple of onetime items, I would characterize a tune of about $45 million. One was a litigation settlement and one was a very expensive derailment that added to it. So part of the reason why I say a more normalized number of about $530 million is these aren't things that are going to occur on a quarter basis. So we feel very confident that purchase services and other will come down to a more normalized $530 million. Certainly, we're in the early stages of cost takeout from a synergy point of view. We're in this for the long game. So as we mentioned, we've hired -- we -- certainly, the macro environment, the volume backdrop wasn't as strong as we expected and kind of is by surprise.

That being said, we weren't going to take a short-term view and big headcount now just to kind of mitigate it, knowing what we have in the back half of the year, certainly on the bulk side and some of the market share gains that John mentioned. And then as we sort of 2024, what we have in front of us and then the natural macro recovery as we expect. So we see a strong path to volume recovery in the back half and Q4, the high single digits. So -- we're long people right now short term, but it's the right choice to make to maintain that level of people.

It takes a long time to hire and train to also attract and retain employees. And so they've elevated our costs. There's no doubt with the volumes that we had, labor being up 5%. That delta is at its peak. It will normalize as we get through the back half of the year, I expect labor to almost be flat to slightly down year-over-year and volumes to inflect positive high single digits. So you'll see a much better expense and productivity performance in the back half of the year.

Yes. If I could add a little bit of color to that, Ken. You used the word bloated. I wouldn't say bloated. I'd say that we had the one-timers that Nadeem, spoke to. But above that, carrying the headcount, that was an intentional decision. It's a timing issue. Obviously, if we didn't own softness would have been here, perhaps we would have hired a little bit later and trained a little bit later. But nevertheless, we have very unique growth opportunities that are counter to the macro environment that give us great confidence that it doesn't make a lot of sense to let a lot of employees off or risk losing them and not having them 4 weeks from now, 5 weeks now when you've got potash moving, very strong demand. You've got the harvest that came in, and we've got some of these self-help initiatives that we've got -- that we talked about coming online. I don't -- John hasn't gotten to a lot of detail, but there's some pretty exciting business share shift wins that we're going to start benefiting from in August that's going to help cover some of those intentional costs that we carried.

The other point I would say on the operational front, Margin is we said this in the beginning, we're going to make sure we get the U.S. network and the Canadian network stabilized. We've done that. Now we're turning our attention to Mexico. If you look at Mexico and the numbers, you see the same numbers I see, there's a lot of opportunity for some improvements in Mexico and the way we serve our customer, the way we control our cost, the way we manage the business. So in preparation for that, effectively, actually next week, we've got John, a team of about 50, 55 officers that are going to go to 2 locations in Mexico, implant them sales there from a holistic business approach standpoint from the commercial side, from the customer transactional side, the operational side.

So we're going to spend a lot of time with our brothers and sisters and family members in Mexico getting that operation to a point that at the end, I fully intend and expect to see our velocity improve, our train speed improve, some of those costs that are tied to excessive car dwell indoor, not getting it to where it needs to be is going to be able to complement the productivity we're already starting to see on the locomotive side that Mark and the team are producing. So more to come on that. But certainly, again, bloats not the right, I would say, word, I would say, intentional and expect more improvement over this next quarter as we start to realize the benefit of those initiatives.

Your next question comes from Tom Wadewitz of UBS.

Yes. If we're -- maybe, John, I could ask you a question just in terms of kind of demand framework. We're generally hearing from, I think, transports and the other railroads about caution on market conditions, maybe intermodal improvement being pushed into next year, maybe forest product system areas of weakness in chemicals. How do we kind of think about the, I guess, impact of that underlying weakness or your optimism on that relative to some of the things you're talking about that obviously are maybe idiosyncratic good news or maybe on the bulk side. So just kind of trying to figure out how to think about the combination of those 2 in volume looking like 3Q and beyond that.

So Yes. There's no doubt. I think we're in the same boat as what you've heard from the other rails in terms of the intermodal business. I'll tell you, we saw sort of our valley or trough point the last half of April, beginning of May. But on a week-over-week basis, we've started to actually see a little bit of improvement. Frankly, if you look at legacy CP, legacy KCS, the combined companies over these last 8 to 10 weeks, again, not a very hockey stick-looking improvement, but at least as the numbers are starting to improve a little bit. I do believe a certain amount of that is self-help, Tom. I've got the team, I'll tell you right now. We are on a 3-week blitz over 3,000 cold calls. We got boots on the ground. We're blitzing all our major territories. We're not sitting idle. I do see the intermodal challenges persisting, but we're going to make self-help. We've got the fastest intermodal service in our north-south super highway. We're going to continue to put more footage on that train.

Mark has been giving me a hard time that the trains are too small. And the mandate is the team to go out there and add business to that. I see upside opportunity, Tom, as you think about the automotive business. There's a lot of vehicles that remain on the ground down in Mexico. And we are working closely with those OEMs to create new solutions that I think initially, we felt were long-term plays. But I think there's some opportunities there given the situation where we're going to see some benefit in the near term with some of those opportunities. Our frac sand business continues to be strong. Our steel business, as I spoke to, is quite strong in and out of Mexico.

And we're no dissimilar - we're not dissimilar to the other rails as you think about the forest products in the lumber business. It's hard for me to see a major rebound in that space in the near term. But I can tell you we're doing a lot on the self-help initiative front in that space to prepare. So we're out working with these customers to create these long-haul cycles with our center beams, opening up new markets. We're deep into kind of, in my mind, creating a whole new mousetrap in the Texas and Dallas market around transloading -- again, stuff that probably you won't see a lot of needle moving in that space in the near term, given the headwinds. But as this housing construction area bounces back, it's an area we're going to be ready, and I think we're set up for success when that comes back.

And finally, maybe the other thing I'll point to is we went out and we bought 1,000 refers not that long ago. We announced the Americold development. And I can tell you that progress in terms of getting a spade in the ground and getting that building built in Kansas City is well underway, but that's not the start of that journey. That journey has started now, and we're already starting to see a building of our refer product on that 180/181 train payer. And again, beyond just the dry opportunity as we look to the coming months, I think you're going to -- we're going to see a nice buildup of that opportunity of refers down to Laredo and ultimately down into Mexico to service that market.

So again, that's, I think, an opportunity as you think about this unique franchise that we're the only one doing it out there in the marketplace. And if the intermodal domestic market remains soft, there's another area where I think we can potentially outpace it to some degree as we build this refer product. lots there, but I hope that helped.

Your next question comes from Walter Spracklin of RBC Capital Markets.

So I wanted to focus in on bulk, John, you highlighted a few things that have happened in your key franchise within bulk that have created a lot of volatility here in particular, the outage at Texmine and the other Canpotex terminal. We've also seen a pretty significant crop this year that now the conditions look a little less favorable for next year. So I'm trying to put it all together here to see what the layout for next year looks like given some of those significant outages. Is it possible that we see kind of high single-digit, low double-digit increases in your coal and potash business just based on simply lapping those outages? And on the flip side, as you see the crop that's developing from where we are now? Is this a risk of kind of high single-digit downside risk on the crop side for -- as we go into 2024. Big items here in your bulk franchise, lots going on. Just wanted to make sure we're modeling it correctly.

Yes, Walter, it has been noisy and it's 6 months ago, if you would have said all that would transpire in our bulk franchise, I wouldn't have believed yet at all. It's been frustrating. But nonetheless, look, as I said, I remain very bullish on the outlook for potash. We've actually got a very big plan for Q4. We've worked our tails off to diversify some of the ports. We're crossing our fingers that maybe Portland can get opened a little early. And I think our belief and frankly, Canpotex is the belief around their position and our CPKC as being their #1 transportation provider looks strong for 2024. So I would expect, I think, double-digit as you look to 2024, given what we've seen is definitely a reasonable expectation as you think about potash. On the coal side, we're going to see strong compares to close out the year. That Elkview mine issue that took place Q4 right at the end of Q3-Q4 last year will give us really good comps.

And as you look to 2024, I don't know if you see as big as a jump as it relates in that space. But you know what, we're optimistic that tax outlook or at least our discussions with (inaudible) so far looking to next year, look to be positive in terms of growth, probably not as extensive as you described relative to potash.

And on the grain front, look, if this crop comes in closer to 65 million metric tons, what let me think is kind of the middle point of what our customers are seeing. You got to remember, we've got a much bigger carry in this year, call it maybe close to 10 million metric tons. So I really don't see any impact as you think about the gut slot in Q4 in that time period. We're going to run hard. We're going to run hard, right, probably into the spring. And then we'll see. And it's not, we'll see because I don't think there'll be grain out there yet to move.

But as we saw this year, this sort of the weather issues and the dryness that did persist certainly put the farmer on the sideline more than we expected to happen. I'm pleased with our year-over-year compares as you look at Canadian grain in Q2. But I actually I'll tell you, I thought it would be much bigger. And certainly, I think the Canadian farmer and U.S. farmer, to some extent, got spooked and fat on the sideline a little longer to see what would transpire in that space. So look, we're for grain haul and railroad and now with the combination of the KCS network to create more markets as those develop, I certainly expect 2024 to continue to be a growth area for us in grain.

And maybe I'll just throw one more comment out there because you got me going on grain, Walter. If we see some dryness in some crop further deterioration in our Southern territory, Southern Alberta, Southwest Saskatchewan, it actually begins to present that opportunity for that corn hall into that area to feed those cattle markets. And I can tell you, just over the last 3 weeks, -- we've seen a pretty significant uptake on those markets connecting and some train volume beginning to build for that market. Again, that's an area that we didn't have in the calculus a few weeks ago, but certainly could provide a little further upside to the U.S. part of our franchise if that further develops.

And John, if I could add just one key point is from the operational side, it's allowed us to open up the engineering work lines a bit more West of Calgary. So when we do get it into Q3, Q4, we won't have maintenance gains in a way so we can cycle the crane fold certainly potash to the West Coast.

Your next question comes from Chris Wetherbee of Citi. I was wondering maybe we could kind of run through some of the assumptions around the mid-single-digit EPS growth for the year, particularly in the back half, maybe get a sense of the -- the pace of RTM recovery in the back half? And then maybe some thoughts around the operating ratio even if possible.

Well, if you think about the -- Chris, the RTM piece, as we sit here today, end of July, we're -- we remain slightly positive on a full year RTM basis. We got ourselves dug into quite a hole here in July with the strike. But I think you're going to see -- and my expectation is we're going to claw our way back as we move through the quarter. And certainly, I expect improvement versus where we sit today. And then there's upside as you think about Q4. So I think, ultimately, we see volume growth.

And so Chris, just in terms of -- when we think about sequential OR and earnings, given we see a stronger Q4 as we get some of the share wins and the synergies start getting up to their full run rate the first year of the synergies. Q4 we see a much larger performance than Q3, for example. But sequentially, certainly, we see an improvement in the OR sequentially from Q2. I think Q4 is going to be the breakout order, and I think it sets us up well for 2024. But we have confidence in that mid-single-digit EPS guide that was -- we wouldn't have kept it there and reiterated it. I think we just have some catch-up to do from the strike. But the volume is there are both franchise and from the synergy perspective.

Your next question comes from Brandon Oglenski of Barclays.

Nadeem, I guess maybe following up with that, and maybe John can chime in too on like the self-help contracts that you guys are talking about. But does that set you up for potentially a stronger 2024, just given some of the headwinds that you've had early in '23 when you look at that '24 through '28 outlook?

Yes, absolutely. I mean I think some of what John has described today, and I know we couldn't get into much detail from a confidentiality perspective and a customer perspective. But we've had some wins since Investor Day that we weren't factoring in to be quite frank. So I feel very good about 2024. I feel very good about Q4 to be at to be honest. And like I said, we're long people. We kind of have a peak on from -- if you think about the volume versus workforce, we have a peak of a delta in a nonproductive way. That only start evening itself out in Q3 and into Q4, and it sets us up well to the operating leverage we talked about both into the back half of this year, but 2024 looks very strong.

And so if we see that path to recovery this investment in hiring and training, I think it's going to pay the dividends as well as the work we're doing on the capital front on the network as well as the work we're doing on the capital front on acquiring railcars and then we'll start seeing some benefits of the synergies on the expense side from that operating leverage and the work that's taking place to improve operations for their sales on the network. So I'm pretty excited, although we've seen obviously a very tough reporting quarter for us in all the rails. I think we have a pretty optimistic view on this year and into 2024.

And Brandon, I might just add that -- I mean you're right, the macro environment and some of these broader challenges have been very frustrating. But -- the fact that we're planting the seeds right now, I think you're right when you say you begin to see some of the benefit of some of these projects. I just think about our efforts right now to get BCOs all set up for Lazaro Cardon as you look to 2024. I think about our announcement on the auto compound down in Dallas that will be up second quarter-ish in 2024.

If you think about the Toronto fuels terminal in Milton aging court that Coby spoke to at Investor Day that all come up in 2024. The Dallas transload that support the lumber and that market down there coming up in 2024. All those things, I think, support what Nadine spoke to. And if we get a little bit of tailwind on the macro background, then I think, again, we're off to the races.

I can't help it add a little bit more color than that. So as an operating CEO, I've been dreaming about and having visions of a closed loop automotive network since my days of servicing automotive manufacturing facilities back in the late '90s. Going through the pain and suffering of not having enough empty car supply to keep your production lines going and being the guy or the gal to get the that because of that when you control the destination, believe scars that you don't ever forget and it created opportunities. So we said from the very beginning of the vision, what are the visions of this network, this extended reach network when you connect the bookends, the manufacturing in Mexico, manufacturing in Ontario and automotive compounds in between and create this closed-loop network is powerful.

I can tell you that we have made some significant progress there to the point that we're close to ordering cars to serve is closed network and those that we partner with in this space that have taken this step of faith with us are going to have our own guaranteed car supply by turning those assets, and it's going to allow them to get more vehicles from their manufacturing facilities to the dealerships that need to sell them and create our own (inaudible) supply to feed the opposite end of the loop. So that's not a dream anymore. That's coming to fruition. That's going to be showcasing itself in a very powerful way in 2024, and that is ahead of my expectations. So we're super, super excited about that development.

Your next question comes from Scott Group of Wolfe Research.

Thanks. So just a couple of things. The high single-digit growth in Q4, maybe just some color on which overall segments you think will do best. And then, Nadeem, I just want to clarify, are you saying that labor costs come down sequentially from here or actually come down year-over-year, that would be a pretty big sequential drop. And then all the other rails have talked about some big fuel headwinds in the back half of the year. Are you any different? Or should we assume same kind of headwinds there?

Scott. So as Keith spoke to, I think our auto sector, a frac sand sector, steel sector, we'll see fully I'm going to push markets to see that materialize in our grain business, our coal. We've got easy compares there in strong demand. So I see a lot of upside in coal. We have a decent potash Q4 last year. If we hit the expectations of our partners, you'll see good growth in potash. So I call out those areas. And then the Shell contract win is significant. And that's going to start up in August for us, and I think that will only help not only insulate potentially show some good growth in our ECP business also.

Scott, just on headcount. Should be flat sequentially in terms of our workforce and so forth, and we'll see what stock-based comp does just in terms of what the stock price does. That's been a headwind for us. So my point is the productivity volumes will increase headcount will stay relatively flat. So -- and then year-over-year, I think in Q4, we see a benefit on headcount year-over-year. So that will be our meaningful efficiency for us. On the fuel side, I wouldn't say we see a meaningful headwind on that front for us.

Your next question comes from Fadi Chamoun of BMO Capital Markets.

Yes. Just one quick clarification first. So Nadeem guidance is basically $3.95. You've earned $1.73 year-to-date. So we're talking about a 28% kind of sequential improvement in the second half versus the first half. I just want to make sure we're on the same page on that. But my question is maybe Mark or Keith, the speed is 18 miles per hour now. CP did 22, 23 consistently in the past. The same thing if we look at locomotive productivity in train length and all these metrics. But what does this record look like 3, 4 years down the road? Is this a step-up that we're going to see consistently and what's going to drive it? Is this the revenue mix? Have you take on that business that you highlighted in June? Or is it investment in the infrastructure that you need to do? I'm just trying to understand kind of what does this network look like once you're done doing some of these key kind of programs that you highlighted in June?

Certainly, for all the synergy that we're talking about bringing on Say, we're going to need those investments. But the way I kind of look at it right now, the CP standard is something we're working to. That's what this merger is all about. So as we integrate the operations, what we've seen, which we expected is on the former KCS network, train speed has improved. (inaudible) has improved. We put this operating plan in place and it's working.

On the Mexican network, at this point, that's -- that's what's diluting the overall improvement opportunity, and that's exactly why Phase 2, we're focused on Mexico. So will we get to '23, I haven't done the math yet, will it prove in a material way you should expect so. And you'll see from that driving of our synergies. You'll see car hire savings because we're going to need fewer cars to move the same amount of business. Those assets are going to turn. They're going to see revenue improvements. There's not enough car supply to feed all the demand we have for automotive. As we speed the network up in Mexico, we're going to create our own car supply. We're going to get more loads. It's going to drive more revenue. So you get it on both sides, on the bottom line and on the top line, and you'll start to see some material impact to our results. But again, is it going to be 23%. It's not going to be 15%, maybe it's not 23%, but it's certainly going to be somewhere between 17%, 18%. I'll do the math later, I have it at this point. I just don't want to have a very firm expectation that it will improve in a material way.

In fact, we're guiding to $3.95 core adjusted combined diluted EPS.

Your next question comes from Konark Gupta of Scotiabank.

Just wanted to ask you, John, any color on the Shell contract contribution analyzed? And wondering if it is a result of merger synergies and as well, do you expect any more conversion of opportunity pipeline heading into '24?

Thanks for the question. I know it's probably coming from somebody, and I can't provide any further details. I will say this. Shell's a great partner of ours, and they have been in a number of years. And one of those customers that identified that early on that this combination was going to be meaningful to them. And it's just, again, been a culmination of a lot of work between our teams to create the right package and opportunity, and you're exactly right, leveraging the entire CPKC network. So again, you'll see the results come through our ECP areas. We begin to ramp that business up once we get into August here.

Your next question comes from Brian Ossenbeck of JPMorgan.

Just want to ask a couple of clarifications. Nadeem, can you just walk through what the FX exposure looks like right now? I see there's a line item on, I think, Slide 15 in terms of the bulk -- so can you just maybe talk about hedging or how we should be thinking about modeling that? And then just on the Mexico, if you can elaborate to the extent you can in terms of what's actually the challenges there? How long do you think it will take? And generally, what you're trying to work through to get that network a little bit more fluid.

Brian, I'm just going to have Ashley and Chris follow-up with you on the FX piece. It's just pretty late in the call here. So we'll give these details. And I think we have some posted as well on upside, but assets.

I think the main focus on Mexico was getting our inventory reduced so that we can get the terminals more fluid. We're also taking a concerted focus on renewing our existing contract at this moment until we can see benefits in the operation overall, there's no sense to distract ourselves trying to create any kind of potential conflict integrating a more modernized agreement. That's not to say that we're not still interested and it's not very compelling. That's going to be more Phase II as opposed to a Phase 1. Our employees need to want our deal. It's much better for the employee. They'll make a lot more money. They'll have a better quality of life. But right now, the first-order business is making sure that we optimize our network and fluidity with the existing contract we have, which we're seized and focused on and then step 2 will be to discuss modernization when the time is correct.

And your next question comes from John Chappell of Evercore ISI.

Just talking about the yield side a little bit, Nadeem you already pointed out that you're not going to have the same fuel surcharge headwinds that most of the others will. You're repricing the portfolio, both the core business and then the combined business, is there a lot of kind of step-up opportunity in the second half of the year from a yield perspective to kind of help you get to that guide to the back half?

I think, John, there's certainly the discipline that you've seen from, I guess, legacy CP and how we approach the contracts and our pricing. The step function is how we sort of overlay that disciplined approach to the KCS network in some of those contracts -- is that quantum leaps? No, but I think that's a lot of singles and doubles. We're still seeing renewals in the, I would say, low high single-digit type range, which I'm quite positive about. I don't foresee that changing as we move through the remainder of the year. And there are some legacy contracts and opportunities out there that we're working with a variety of customers on around repricing for the value of our capacity and service. And some of those could create a larger step function in some areas. But I don't -- I'm not going to call that a major driver in terms of as you think about Q4 and actually, that probably creates a bigger benefit for us as we look into the 2024 renewals.

Your next question comes from Benoit Poirier of Desjardin Capital Markets.

Yes. Looking at intermodal, obviously, it's an important part of your growth story going forward. I was wondering if the current softening environment brings more opportunity than an increased number of discussion with customers? And what would be your average length of all on the intermodal side for the combined entity? I would be curious to know whether the lower fuel expense and lower spot rates bring more competition from the [truck] right now.

Yes, Benoit, maybe a couple of comments on that. I do believe, and I've said this before, these types of depressed markets, typically, the transportation buyer becomes more aggressive in terms of looking for options to lower their prices. That is a buying opportunity for my marketing and sales people. As I said also, we're not sitting by and waiting for the phone to ring. We're outbound in the pavement looking to fill that train up. We need to continue that train length to that 180/181 pair and frankly, get the business going back on our legacy franchise across Canada.

Train length, I think about -- if you think about our legacy network in the 1400 to 1,700 mile sort of wheelhouse between Toronto and in Calgary. I look at that very similar as you think about specifically Chicago down to Laredo and down to the San Luis Potosi area or Monterrey area. It's a very similar length. And I do believe, historically, we're more insulated across Canada. And I think so in this quarter, to some extent, against that shorter haul movement that might be more conducive to flip quickly back to truck. So I think that makes us a little more sticky. And again, our focus on today is adding density in that corridor.

Okay. So that said, it's been a long call. We can't get to everyone. I apologize for that, but I would encourage you to have any further points to address touch space with our they'll make themselves available for any follow-up. And we look forward to sharing our third quarter results. In the meantime, we're going to continue to focus on integrating well, growing uniquely as we build out this network very methodically and obviously stepped function improvement when it comes to operational performance, most specifically in Mexico. With that said, have a safety. We appreciate your time this afternoon, and we'll talk soon.

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