CSX Corp (CSX) 2014 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the CSX Corporation fourth quarter 2014 earnings call. As a reminder, today's call is being recorded. During this call, all participants will be in a listen-only mode.

For opening remarks and introduction, I would with like to turn the call over to Mr. David Baggs, Vice President of Capital Markets and Investor Relations for CSX Corporation.

Thank you, Wendy, and good morning, everyone. And again, welcome to CSX Corporation's fourth quarter 2014 earnings presentation. The presentation material that we'll review this morning, along with our expanded financial quarterly report and our safety and service measurements, are available on our website, at CSX.com, under the Investor section. In addition, following the presentation this morning, a webcast and pod cast replay will be available on the same website.

This morning, our presentation will be led by Michael Ward, the Company's Chairman, President and Chief Executive Officer, and Fredrik Eliasson, our Chief Financial Officer. In addition, Clarence Gooden, our Chief Sales and Marketing Officer, and Oscar Munoz, our Chief Operating Officer, will be available during the question-and-answer session.

Let me remind everyone that the presentation and other statements made by the Company contain forward-looking statements. You are encouraged to review the Company's disclosure on the accompanying presentation on slide 2. The disclosure identifies forward-looking statements, as well as the uncertainties and risks that could cause actual performance to differ materially from the results anticipated by these statements.

In addition, at the end of the presentation, we will conduct a question-and-answer session with the research analysts. With about 30 analysts now covering CSX, I would ask, as a courtesy for everyone, to please limit your inquiries to one primary and one follow-up question.

And with that, let me turn the presentation over to CSX Corporation's Chairman, President and Chief Executive Officer, Michael Ward. Michael?

Well, thank you, David, and good morning, everyone. Yesterday, CSX reported fourth quarter earnings per share of $0.49, up 17% from $0.42 in the same period last year. This represents a new fourth quarter record for the Company. Revenue grew 5% in the quarter, to $3.2 billion, also a fourth quarter record, with broad based growth across nearly all of our markets, reflecting continued economic momentum.

Furthermore, the timely addition of operating resources enhancements through the fall peak have supported strong volume growth. As a result, operating income increased 11%, to a new fourth quarter record of $901 million, and the operating ratio improved 140 basis points, to 71.8%. This quarter's performance is further evidence of CSX's ability to capitalize on economic growth that is helping to drive strength across the Company's diverse markets.

Turning to the next slide, I'll discuss our full-year performance. The past four years have been transformative for CSX, and we have emerged a stronger company for our customers and shareholders. That strength drove new full-year records in 2014 for revenue, at $12.7 billion, operating income, at $3.6 billion, and earnings per share of $1.92, and the operating ratio remained essentially stable at 71.5%.

That's an extraordinary testament to the work of the CSX employees, because it follows a period during which we lost nearly $900 million of coal revenue, as the country transitioned through changes in the energy sector. At the same time, the diversity of CSX's business mix generated revenue more than offsetting those coal losses. That growth, combined with inflation plus pricing, efficiency gains, and cash deployment for share buybacks, generated modest earnings growth for the shareholders during this transition period.

These financial results are continued evidence that the Company's employees, core strategy, and diverse business mix can create sustainable value for shareholders, even in an evolving and challenging business environment. With strategic infrastructure investments, locomotives, and operating employees coming online, we expect service levels to gradually improve throughout 2015 to superior levels.

With that, I'll turn the presentation over to Fredrik, who will take us through the top and bottom line results in more detail. Fredrik?

Well, thank you, Michael, and good morning, everyone. Let me begin by providing a summary of our fourth quarter results. As Michael mentioned, revenue increased 5% versus the prior year on 6% higher volume, driven by broad based strength across merchandise, intermodal and coal.

Expenses increased 3% versus last year, driven primarily by higher volume, and included a $39 million G&A workforce reduction charge. Operating income was $901 million, up 11% or $88 million versus the prior year.

Looking below the line, interest expense and other income were slightly favorable versus the prior year period. And income taxes were $284 million in the quarter, reflecting higher pre-tax earnings for an effective tax rate of approximately 37%. Overall, net earnings were $491 million and EPS was $0.49 per share, up 15% and 17%, respectively, versus the prior year period.

Now let me turn to the market outlook for the first quarter. Looking forward, we expect a positive demand environment in the first quarter, with stable to favorable conditions for 96% of our markets and unfavorable conditions for the remaining 4%.

Looking at some of the key markets, chemicals is favorable, as we continued to capture opportunities in the domestic oil and gas industry. Housing starts are expected to rise considerably in 2015, which should drive a favorable outlook across our construction markets, forest products, minerals, and waste and equipment. Automotive is favorable, driven by growth in North American light vehicle production and the recovery of volume lost to trucking last year.

Strong intermodal growth will continue, as our strategic network investment support highway to rail conversions. We expect domestic coal volume growth will be strong in the first quarter, attributable to cycling weaker first quarter 2014 volume and a new iron ore facility.

Export coal volume is expected to be significantly lower in the first quarter, through reflected continued soft global market conditions. For the full year, our best estimate at this time is around 30 million tons. Overall, we anticipate high demand levels for our service will continue in the first quarter.

Turning to the next slide, let me talk about our expectations for expenses in the first quarter. Beginning with labor and fringe, despite G&A workforce reductions, we expect first quarter average headcount to increase sequentially by 1%, as we continue to ramp up operating employees to accommodate higher volumes. This represents a 4% increase versus the prior year.

We expect 2015 labor inflation to be around $35 million per quarter in the first half and then moderate to around $25 million per quarter in the second half. This represents an increase from the $20 million per quarter levels seen in 2014, driven by union wage inflation and payroll taxes.

The union component is consistent with what you should expect to see across the industry as a result of national bargaining and reflects both the carryover of the July 1, 2014 wage increase, as well as a January 1, 2015 increase. In addition, you will recall that we amended a locomotive maintenance agreement in June of 2014, which resulted in a $15 million shift between labor and the MS&O expense lines in both the third and the fourth quarters. This trend will continue in 2015 and we will be cycling the expense shift during the first half of the year.

Looking at MS&O expense, we expect the first quarter to be driven by inflation and volume growth in line with the trends seen during 2014. Fuel expense in the first quarter will be driven by lower cost per gallon, reflecting the current price environment, higher volume, and continued fuel efficiency through technology and process initiatives.

We expect depreciation to increase around $10 million versus the prior year in each quarter in 2015. This reflects the ongoing investment in our business partially offset by an asset life study conducted in the fourth quarter. Finally, equipment and other rents in the first quarter is expected to increase year-over-year, driven by higher freight car rates and incremental volume.

Now let me talk about our capital investment plan for 2015. In 2015, CSX plans to invest $2.5 billion in our business. This represents a moderate increase from the 2014 level, and core investment is expected to be about 17% of revenue.

In the chart on the left, you can see that about half the capital investment will be used to maintain core infrastructure to help ensure a safe and fluid network. Our equipment investment in locomotives and freight cars ensure CSX has an appropriate level of rolling stock to support commercial demand and improve on-time performance levels.

In addition, we will continue to focus on strategic investments that support long-term profitable growth and productivity initiatives. In 2015, we are prioritizing infrastructure projects that will increase line of road capacity on the northern tier to improve fluidity and system velocity.

Finally, looking at our investment in Positive Train Control, we have invested $1.2 billion through the end of 2014 and plan to invest an additional $300 million in 2015. As the implementation of PTC extends over a longer period of time, we anticipate spending at least $400 million beyond 2015. As a result, our current estimate for the total cost of PTC is at least $1.9 billion.

Now let me wrap up on the next slide. Overall, CSX delivered solid financial performance in 2014, with robust volume growth offsetting the impact of last year's weather, network performance, and a weak coal pricing environment.

We continued to see broad based strength across our diverse business portfolio, and the strength is translating into more visible and more meaningful earnings improvement. CSX achieved double digit earnings growth in both the third and the fourth quarters, and incremental operating margins expanded throughout the year.

For the full year 2015, CSX still expects to achieve double digit EPS growth. Even as we cycle strong 2014 volume growth, we expect merchandise and intermodal to again grow at a faster pace than the broader economy. We continue to target pricing above inflation, as capacity remains tight across all modes of transportation, and we expect to deliver productivity savings approaching $200 million in 2015.

Domestic coal volumes should remain relatively stable in 2015, while the export coal market remains challenged. That said, we will be keeping a close watch on natural gas prices and heating and cooling degree days as we move through the year.

Finally, we expect margin expansions to resume in 2015, which reflect improving service levels, a strong pricing environment, and continued economic expansion. Over the longer term, we continue to target an operating ratio in the mid 60's. With that, let me turn the presentation back to Michael for his closing remarks.

Well, thank you, Fredrik. The strong 2014 demand reinforced the importance of freight rail industry and CSX in supporting the global supply chain and American competitiveness. The economic and environmental benefits of freight rail network increasingly serve a country with a growing population and a critical need for transportation infrastructure.

To continue delivering these benefits and creating value for its shareholders, CSX has transformed itself by forging new capabilities aligned with opportunities in energy, manufacturing, agriculture, and global commerce. We're generating record results by leveraging the most diverse business mix in the Company's history with new opportunities across nearly all of the markets we serve.

We remain focused on executing our core strategy of delivering service excellence for our customers, which drives our ability to grow merchandise and intermodal businesses faster than the economy, price above inflation, and continue to drive improvements in asset utilization. The Company is poised for a bright future of strong financial returns and expansion, and we thank you for your ownership of and interest in CSX. Now we'll be glad to take your questions.

Thank you.

(Operator Instructions)

The first question is from Tom Wadewitz with UBS.

Good morning, Tom.

Good morning Michael, Fredrik, David. Wanted to see if you could talk a bit about utility coal, and I guess your visibility to stockpiles. Also how much risk you see if natural gas prices stay at current levels or go below, in terms of switching from coal to gas and how that might affect.

Good morning, Tom. This is Clarence.

Hello, Clarence.

We see the stockpiles, both in the North and South, are pretty much where we expected them to be. They're at normal levels in both the North and the South. We think the comps in the first quarter will be very favorable for us when you look at what the weather was last year versus what the weather is this year.

If these gas prices stay where they are now, which are around $3.00 or sub $3.00, there could be some downside risk out in quarters two and three, from what we have planned. But from right now, it looks to us like the rest of the year should be around flat going forward.

Okay. Great. And then the follow-up question, that we've had such a dramatic move in oil prices, I think it's hard to get your arms around what the impact could be across your book. And obviously, there could be some risk accrued by rail or frac sand and pipe and so forth.

But given what you see right now, if you look to second half of the year, would you expect that to come through and drive weakness in those areas, or how would you look at maybe not just first quarter but out a little bit more, in terms of effective lower oil prices on your book of business?

Right now, as we look out through 2015, we don't see any significant impact at all in our crude oil by rail into the Eastern markets. And certainly in our frac sand markets where we go in -- where we're moving into the Utica and the Marcellus area -- where the natural gas and the natural gas liquids, we don't think it will impact the frac sand that we're moving into those areas at all.

Okay. Great. Thanks for the time.

Thank you. The next question is from Allison Landry with Credit Suisse.

Good morning, Allison.

Good morning. Thanks for taking my question. Following up on Tom's question, how are you thinking about the broader economic tailwinds that result from lower oil prices? And if we think about a scenario where, let's just say for argument's sake, that crude and anything shell related evaporates, how do we think about where you could see upside in intermodal or some of your other lines of business?

Allison, we feel very positive about it. There's been some studies that come out that essentially only 10 states have employment that's directly impacted by the oil boom. It's less than 2% of the US population.

For us, the crude by rail is less than 2% of our business. For the average US tax, US person, it's like getting a tax break of almost $2,000 a year, so it puts a lot of dollars into the economy. From any indication that we see, it's a positive experience for the American taxpayer, for the American economy. So I think lower crude oil prices is a very positive for our economy and very positive for CSX.

Okay. Great. And then as my follow-up question, the $200 million of productivity gains, that's quite a bit higher than what you've generated in the last few years, which has averaged, I think, $130 million to $140 million. Is this inclusive of the incremental or unusual weather expense that you saw last year, or is that on top of the $200 million?

Allison, this is Oscar Munoz. I think a portion of that number is weather, although not as significant as you might think, probably 15% of that number, roughly.

So just to clarify on the $200 million, so what we have is the operations normal target of about $130 million to $150 million, plus we have about $50 million that is linked to the G&A workforce reduction program that we outlined, the severance charge in our fourth quarter.

Okay. And then the rest would be weather.

Part of the operations productivity savings is to cycle what we cycled last year, as Oscar outlined.

Okay. Great. Thank you so much.

Thank you. The next question is from Rob Salmon with Deutsche Bank.

Good morning, Rob.

Hello. Good morning, guys. As a follow-up to Allison's question, could you give us a sense in terms of what sort of network, how quickly you're expecting the network to return to normal, and what sort of key velocity and dwell metrics we should be looking for as we're thinking about that $200 million?

Thanks, Rob. So the productivity initiatives are broad across a lot of different aspects, volume absorption, specific initiatives, certainly weather, winter sort of overlap. But I think, if you think of the incremental resources that are coming online, it's going to just reestablish the discipline that we've had over the past three or four years around the internal operations of both scheduled and the unscheduled networks.

And specifically, while velocity will be a bit of a lagging indicator, as will dwell, the public measures you see, I think dwell in particular will be a key metric to watch. Internally, we have intermediate and home terminal dwell that we're monitoring. But I think the dwell, I think, will be an area that you can focus on and that, when it stops dwelling there, it increases cost in a big way, and that will be the first focus and benefit from the incremental resources.

That's helpful. And did you guys quantify the savings expectations for the employee -- the management workforce reduction program, and was any realized in the fourth quarter?

So the estimate is about $50 million for the overall program, which labor is the largest part of that, but there's also some other MS&O savings. And to the question around anything was realized on the fourth quarter, no, none was realized really in the fourth quarter.

Perfect. Thanks so much for the time, guys.

Thank you. The next question is from Thomas Kim with Goldman Sachs.

Good morning, Thomas.

Good morning. I just wanted to ask about the fuel surcharges. And if we go back through history, the last time oil prices collapsed the way that they did, your recovery was quite effective in capturing the fuel cost savings. And as we look forward to this year, with obviously the precipitous drop, do you think that your fuel surcharges are well placed to ensure that you're able to fully neutralize the impact of lower surcharges with the drop in fuel?

This is Fredrik. Yes, we do think we have a fuel surcharge mechanism that is effective. It's not a profit driver, but it makes us neutral to fuel price volatility. There are periods, such as when the prices decline, that we get the lag benefit which we saw here in the fourth quarter. And likewise, when fuel rises, our fuel surcharge mechanism lags a little bit, so we have a little bit of a detriment there. But overall, the fuel surcharge is working well. And we think that we are neutral to any sort of price volatility, with the exception of the lag effect.

That's great. That's very helpful. And I guess just in terms of this decrease, obviously certainly beneficial for customers, how do you think that this helps you in terms of your ability to push through higher GRIs during the course of the year, where you're seeing general pricing?

Well, Thomas, this is Clarence. I think that it's a positive for us. It's less cost, obviously, overall in the package to the customer. So as we push for our price increases, it makes it more powerful as we go to the customer and the overall package.

Great. Thanks very much.

Thank you. The next question is from Bill Greene with Morgan Stanley.

Good morning, Bill.

Hello. Good morning. Clarence, can I ask you to follow-up a little bit on that pricing comment? So I would guess that we're going to start lapping some of the big export coal price declines. So that's going to make our comps, I would think, a bit easier in FY15.

And of course, the overall market is a lot stronger, particularly on the truck side, so I think that would be helpful to your pricing dynamic. So is there any flaw in the logic to think that pricing for CSX in FY15 should be stronger than it was in FY14?

No, I think you're absolutely correct. I think you'll see much stronger pricing in FY15 than you did in FY14, absolutely.

Okay. And then maybe for Fredrik or for Oscar. As we think about the cost structure insofar as volumes disappoint us this year -- so they're unexpectedly weak -- how much of your cost structure is variable? How much can you sort of tweak that $200 million higher, if you had to, and how much is more fixed such that as you dedicate these resources, locomotives, employees, to move the current volume, we run the risk that we create a higher cost structure in the second half, let's say?

Well, and I think if you go back to 2008, 2009 time frame, you can see what we did there, which was pretty remarkable, in terms of variablizing the cost structure. And in the scenario that we don't think that you're going to be, you're correctly predicting or forecasting -- but if volume would be softer than we are currently anticipating, we do have the opportunity to take cost out more than what we have in the current plan. And we've proven that in the past that our cost structure is more variable than perhaps some people might think.

But I think it's important to note that volume is not weak.

And we're answering a hypothetical question, Bill. Specifically, when you think of crews and locomotives, probably the most expensive aspect of that, I've got roughly 1,000 people in the pipeline, and I've got roughly 1,000 people potential attrition. So that, I think, offsets itself.

And then on the locomotive side, we've got lease returns that we can work through. So I think citing back to the old days of 2008, 2009, when we did the math and proved the variability that has come into this industry. So we monitor that very closely.

Yes. No, things look strong, obviously. It's more just folks worried, is the oil price indicative of some weakening that's bound to come? So just trying to think through what your flexibility is. Thanks for the time.

Thank you. The next question is from Ken Hoexter with Merrill Lynch.

Good morning, Ken.

Good morning. Just a quick question on export coal. Clarence, can you talk about what is left on contract within the export side and what is still variable? Just looking at the market rates, it seems like stuff, that the export coal side just shouldn't be moving at these prices. So maybe just some thoughts on the export side.

Well, we have about 40% of the export contracts are currently -- export coal movements -- are currently under contract. The rest of it is up for negotiation. Does that answer your question?

Yes. Is that kind of typical, at the 40%? Are we seeing increasing amounts coming on, too?

I would say that it's fairly typical this early in the cycle. Most of those metallurgical contracts, as you're aware, tend to go more on quarterly basis, but still tend to follow the traditional line of thinking, which pretty much settles in March/April.

Okay. And then just a follow-up on the service metrics issue. You hit on the dwell and velocity. Oscar, can you talk about the on-time performance? Just seems like it continues to remain at that 50% level. What needs to happen to get that back? Is that decreasing congestion? Is it just fixing something, getting more locomotives and crew? Can you walk us through that a little bit?

Yes. We really are down to that point, Ken, that locomotives are the biggest last sort of aspect of this. And we got 200 over the course of 2014. I'll get roughly 100 here in the first quarter, another 150 or so in the second quarter. And our service measures and a lot of things will be almost pretty significantly correlated to the arrival of those locomotives. Crews have been trickling in over the course of the year, so we're in pretty decent shape there. It is a power issue up against this great volume that we're getting.

It's important, though, we are, in essence, open for business. Our fluidity has gotten a little bit better across the network. Our cost structure is improving. The span around our misses is a little bit narrower. We've got crews and locomotives coming online, and the infrastructure that we've been building has improved fluidity. So we're feeling good about where we are starting the year.

Wonderful. Appreciate the time.

Thank you. The next question is from Brandon Oglenski with Barclays.

Good morning, Brandon.

Hello. Good morning. This is Keith Mori on for Brandon. Could you give us an idea of the costs associated with improving service levels this quarter tied to the recovery, and when should we think these costs start to go away? Oscar, you mentioned that service levels are starting to improve, the cost structure is starting to improve. Should we start to think that's a first half event?

Yes. So this is Fredrik. I think if you go back to the third quarter, we were somewhere around $15 million to $20 million of what we call service related costs, where the network wasn't performing at the level we wanted, the fluidity wasn't there. So extra overtime and equipment rents and so forth.

Here in the fourth quarter, probably pretty similar to that. And as Oscar outlined, as we get the additional locomotives, we should see the fluidity improve and therefore see reduction in overtime, improvement in our equipment rents, et cetera. And that's going to come gradually.

I think it's unrealistic to think that it's going to be meaningful here in the first quarter, because while the weather has cooperated so far, we're not through it yet. And generally that slows things down. But as you get to the second quarter, we get the brunt of the equipment specific to the locomotives that we are expecting. I think at that point and late in the second quarter, I think you should start seeing some significant improvements.

Okay. And then I guess the follow-up, what inspired the recent workforce reduction program? When you look across the operations, are there any other strategic initiatives that you can point to or talk about that have similar type cost impacts?

Well, I think in terms of the G&A workforce reduction, it simply was an opportunity for us to streamline some functions, stop doing some of the things that we have been doing, and just process changes allowed us to be a little bit more aggressive there. We've had a program in place for six, seven years now to try to offset inflation, and we've been able to do that. But this was just a way to be a little bit more aggressive on that side.

We, through the pipeline of productivity initiatives that we have as a Company, not just for 2015 and 2016 and 2017, where we try to get that $130 million, $150 million a year, we continue to work very hard. That's a big part of the value equation for CSX and has been over the last decade, and it's going to continue to be over the next decade.

All right. Thank you for the time.

Thank you. The next question is from Chris Wetherbee with Citi Research.

Good morning, Chris.

Good morning, guys. Thanks. When you think about the double digit earnings growth for FY15 and you look at the various buckets of the opportunities that are presented, where do you think the potential risk could come from? Clarence, you talked about the domestic coal side up in the first quarter and I guess implied down in Q2, Q3 and Q4, based on flat for the full year.

Does it come from there, if natural gas prices stay at these levels or dip down? I guess I just want to get a rough sensitivity of the variability of the model. I know you talked about costs, too. So just some color there would be great.

Sure. With any plan that you put together, there are challenges and there are opportunities. And I would say that the challenges that we're seeing is on the coal side and on the crude side. Right now, we feel that on the domestic side that while we think flat is the right place to be, there's probably more downside than upside to that.

Export, we outlined that we expect export volumes to drop close to 25% for the year. And crude, while we're not hearing from our customers that there are any change in the shipping patterns, clearly we're monitoring that closely, as well.

But if you look at our opportunity side, I think you've heard about our productivity initiatives, close to $200 million. We expect to grow our non-coal business faster than the economy as a whole. And the pricing environment continues to get stronger and stronger, frankly.

So when you add all that up, we feel that double digit is the right place to be. Nothing is ever a slam dunk, because it wouldn't be meaningful guidance if it was, but it is something that we think we can achieve.

Okay. That's helpful. And then just a follow-up, just thinking about the pricing dynamic that you just mentioned, certainly seems like it's firming up into FY15. When you think about intermodal and the relationship to truck, with declining fuel surcharges, it would still seem that there's the ability to price that business up at a reasonable pace, given what's going on in the truck market, but just wanted to get some rough sense. Do you feel a cap, to some extent, if we see diesel prices continuing to fall from where they are currently?

Chris, this is Clarence. I think there's a very positive trend in the intermodal pricing. We see that the truck issues still remain there, even with the 34-hour rule that's been turned back. There's capacity issues. There's driver issues. Even with Class 8 truck orders being up, there's still the issues of being able to get the drivers to move the business. So we think that there's a lot of pricing opportunities in intermodal itself.

Okay. Perfect. Thanks for the time, guys. I appreciate it.

Thank you. The next question is from Ben Hartford with Baird.

Good morning, Ben.

Good morning, guys. Just turning the attention to the longer term margin outlook and the reiteration there, a lot of focus on FY15. But if we can put FY15 aside, what is contemplated in terms of what's required to get to the mid-60s OR target long term, if you could speak in kind of broad strokes as it relates to coal and crude and then base pricing and productivity gains and service normalizing and those types of items? How are you thinking about the calculus to get to that mid-60s target?

This is Fredrick. Clearly, we expect to start moving towards the mid-60s here in FY15, after having absorbed that close to $900 million of coal loss over the last couple years. Going to make some meaningful improvements towards there.

Now as we think about the three components, it's ultimately price, volume and productivity. The last decade, it was more probably price and productivity. And as we think about the next decade, I think it's going to be more evenly split between the three, as we continue to see good volume opportunities for us, we continue to have a strong healthy pipeline of productivity initiatives, not just for 2015, but in the years beyond that, as well. And then pricing environment, after having been a little bit slower over the last couple years, I think, is becoming more vibrant, as well.

So the three of those components together, with continued good cash deployment of the free cash flow, is the way we get there. It's continuously the blocking and tackling that we've done over the last couple of decades that got us from the high 80s down to the low 70s. We're going to continue to push that going forward.

A couple specific questions. Does it require a strengthening of the pricing environment from current levels, one? And two, from a coal standpoint, does it require any improvement in the coal markets relative to whatever the baseline is for FY15? I guess those are the two key concerns in terms of the sensitivities that we have.

Yes, I think we're going to try to stay away from too much of the detail around specific pieces, because generally, as I said before, whenever you put a plan together, I think it will be obsolete as soon as you put the plan together.

But in terms of pricing specifically, inflation plus pricing is critical to everything that we do. We are not necessarily banking on coal on the domestic side coming back significantly from where it is today. It would be nice to see, but that's not necessarily anything we're banking on.

Export coal, we're in a down cycle at the moment. And two years from now, who knows what it's going to be. But we think there's enough other factors within our business to drive that earnings growth without just focusing too much on the coal business itself.

Okay. That's helpful. And then real quick, if I could get just a clarification on the tax side. What are you assuming for a tax rate for 2015?

Generally, we see a tax rate right around 37.5%. It was a little bit lower this quarter because of some tax credits that we got. But generally, about 37.5%.

Okay. Thank you.

Thank you. Our next question is from Cherilyn Radbourne with TD Securities.

Good morning, Cherilyn.

Thanks very much and good morning. It was certainly nice to see your pricing improve sequentially. And I just wonder, given the nature of the contracts you have in place, how long should we expect it to take before the tightness in transportation capacity which really emerged in Q2 FY14 is more fully reflected in your same-store pricing?

Well, our pricing is -- thank you for noticing, by the way, that it improved sequentially -- it's like sometimes watching paint dry to watch those numbers go up. I think you're going to see it improve sequentially each quarter going forward. We have momentum in it. We are constantly watching what happens in that pricing.

About 20% of our contracts will renew in the first quarter. We expect to get very strong pricing in the first quarter. As the year progresses, I think you'll see it improve sequentially in each of those quarters, particularly in our non-coal business.

Okay. That's helpful. And just a quick follow-up. Your quarterly materials mentioned that resource constraints impacted your ag shipments in Q4. Just curious whether there were other areas where you missed out on the full volume opportunity because of resources?

Mainly in our ag business and in our aggregates, our stone business, we were constrained in both those areas in the fourth quarter. That has improved significantly here in the first quarter. Our aggregate business in the first quarter, except in some of our Northern areas, where its been weather impacted, has significantly improved, as well as in our ag business.

Great. Thank you. That's it for me.

Thank you. The next question is from David Vernon with Bernstein.

Good morning, David.

Good morning and thanks for taking the question. Fredrik, given what we know right now about fuel prices, and obviously given the outlook for flat domestic and down export coal, would you expect full year revenue in FY15 to be up or down relative to FY14?

I would expect it to be up. But clearly, that depends on ultimately what you think about the fuel itself. But we do expect, as I said, our overall merchandise and intermodal business to grow faster than the economy as a whole, and the domestic to be flat and the export coming down. But I still think we have an opportunity to grow the revenue.

The key part here is that fuel surcharge is really a pass through for us. So even if the overall revenue number comes down because of fuel surcharge, that really doesn't impact the bottom line except for the lag, as I said earlier.

Okay. And then maybe just as a quick follow-up, how does the service metrics and stuff like that play into the pricing environment? Obviously, Clarence, you've made the point here that you're expecting pricing to accelerate next year. Is that in line with the service recovery or are you expecting to be able to take that rate up independent of trucks maybe getting a little more modally competitive and the service level still being weak?

I think the answer is yes to both questions. I think just the overall capacity issues in all of the modes of transportation, whether it's barge, truck, or rail, has given us a positive pricing environment.

And certainly, as our services improve -- and I'd like to point out that we had a point of inflation last summer. Our service has been continually improving since last summer. In fact this fall, in our fall peak, we had an excellent fall peak with UPS, for example, being one of our prime premium service partners. Our service has been continually improving, and that makes it much easier for our sales force to go out and get the rates up.

All right. Thank you.

Thank you. The next question is from John Larkin with Stifel Nicolaus.

Good morning, John.

Good morning, gentlemen. Thanks for taking the question. Just with the service levels having remained stable, but maybe not where you'd like to see them or your customers would like to see them, what was the decision thinking behind keeping your CapEx just a little bit greater than last year? There was one railroad in the West that dramatically increased their CapEx. Why didn't you decide to do that to try and accelerate the service recovery?

Well, I think we took it up slightly. And that's really a reflection of the fact that we do need to get the power, and that's where the biggest area is for opportunity to make an impact on the service recovery. So maybe we could have gotten more locomotives, but the reality is that we can't get more locomotives right now. But even with the locomotives we're getting and our internal repair opportunity, because we do have a fair amount of locomotives internally that we're bringing back in revenue service that perhaps other railroads might not have that opportunity, and that's a cheaper form of capacity than buying new ones.

Got it. Thanks. And then as a follow on to the service-related issues, some of the service problems are caused by issues beyond your control, i.e. all the connecting traffic over Chicago. Can you talk a little bit about how Chicago is operating now and how the railroads have worked together to try and increase the fluidity over that critical hub?

John, it's Oscar. You know, a lot. We've had, knock on wood, a good almost 11-plus weeks where Chicago has been on what we call a normal alert level. And so that's the good news. The communication and coordination that you referred to, we've always known it's been critical. It's been ramped up, both at the most senior levels of the industry, but also at the local level with that Chicago terminal coordinating office and the efforts around that. And so everybody is working closely around that.

We've had a couple fits and starts. Chicago was incredibly cold last week. We mustered through that. We all take our turns in the barrel, struggling through various interchange points. But by and large, the industry, the entire industry is working very closely and very well so far with that.

Now the next few weeks will test us again. And of course, when volume returns here in the spring peak, Week 9 or so, we're focusing on that. But so far, so good, John.

Appreciate it. Thank you.

Thank you. The next question is from Bascome Majors with Susquehanna Financial.

Good morning.

Good morning. You've talked before about the intermodal margins in your portfolio rising to a level fairly in line with the rest of your business, with the exception of coal and chemicals. Can you just give us a little update of where intermodal margins are tracking directionally versus your other businesses today and whether or not the big drop in diesel prices is going to impact the profitability of intermodal going forward?

This is Fredrik. Yes, so if you look at the margins when you exclude chemicals and coal, it's pretty much in line with the rest of our merchandise business. Because of the fuel surcharge that we have in place in the intermodal business that essentially mirrors the trucking industry, when you see price volatility, when prices comes down as they have done here on the fuel side, what happens is not so much that this is a volume play for the industry. It's really the fact that our margins in our intermodal business gets a little squeezed, because we are more fuel efficient, so more of the dollars from fuel surcharge in intermodal goes to the bottom line. Net-net for CSX, that's not the case, but just on the intermodal business itself.

So there is some margin squeeze when fuel comes down, but it's not significant. And the statement that it's in line with the rest of our business is still a true statement.

Okay. Thank you for that color. And just one question on export coal. I know the pricing comps get much easier year-over-year as we go forward. What do you expect sequentially in 1Q, as we think about that business?

What do we expect sequentially in--

-- in export coal pricing.

As far as the pricing goes, we think it's going to be flat.

All right. Thanks for the time, guys.

Thank you. The next question is from Jeff Kauffman with Buckingham Research.

Good morning, Jeff.

Good morning, everybody. Thank you for taking my question. Mike, I have a question about a comment you made on your CNBC interview yesterday, where you had mentioned that the suppliers that you were working with out of Bakken to ship the crude by rail to the East Coast, you had thought that at $35.00 oil that they could be competitive.

You obviously understand a little more about this than we do. Could you help us understand -- because you mentioned the frac sand volumes were just fine, the crude by rail is moving fine -- what gives you confidence that you would continue to see these types of volumes at $35.00 crude?

Well, one, it's not at $35.00, but we think they could continue, with the existing facilities, to be competitive. As you know, once you've made that investment, you could get back in there and refrac those and get additional without additional huge capital outlays.

So we think in the short and intermediate term, which certainly includes all of FY15. We think that the shipments we've been seeing, roughly 3.5 trains per day, continues and maybe even grows a little bit. Longer term, if the prices stay at those levels, there's questions whether the capital will go back in for new facilities, Jeff.

Okay. No, I just wanted some clarity on that. Mike, thanks so much and congratulations.

Thank you.

Thank you. The next question is from Scott Group with Wolfe Research.

Good morning, Scott.

Hello. Good morning, guys. Wanted to just clarify a couple things on coal. How much is the iron ore, the new iron ore business, and is that inclusive in your commentary on flat domestic? And then when you think about those moving parts of iron ore, less export coal, fixed variable on the domestic side, how should we think about yields in 2015 in coal, positive or negative?

Well, the iron ore is a large move. It's both a prior and a subsequent move, meaning that the raw material comes in, is processed, and then it goes out as a finished product of iron ore. And the yields, you should consider going forward to be very positive.

But that is included in your domestic coal.

But it is included in the domestic coal, yes.

Okay. That's helpful. And then just one for you, Fredrik. The past few quarters, you've given us some rough parameters or guidelines for how you think about earnings in the current quarter. And this is the first quarter is a tougher one, just because of the comps and weather last year.

Any color or comments you want to give us on first quarter earnings? I'm guessing, given the comps, it's going to be a good amount better than just double digit earnings growth, but any additional color you have would be helpful.

Yes, I think that's what we tried to lay out the key assumptions by expense item in the presentation itself, so you know how we're thinking about it. I gave you some of the components there. Clearly, you're right that the first quarter, I think, will be a strong quarter and supportive of our double digit earnings growth for the year.

Okay. Thank you, guys.

Thank you. The next question is from Jason Seidl with Cowen and Company.

Good morning, Jason.

Hello. Good morning, everyone. How are you guys today?

Great.

Just want to focus a little bit on some of the non-coal export side. Obviously, we've seen Russia in and out of the wheat market. And then this morning, I think Shell received some favorable product classification rulings for condensate export. Could you talk about things that could provide upside to the numbers on the export side for you guys?

You talking about export in terms of condensate or export in terms of coal?

Export in terms of anything.

Non-coal.

Non-coal.

Non-coal.

Most of the condensate that's going to, that I'm aware of that's being exported out of this country is mostly being exported over the Gulf. So for example, Mexico and the United States a couple of days ago have a major exchange of condensates and heavy petroleum products that are being exported in exchange mainly through the Texas refinery, so that's where you'll see most of it. The East Coast has some condensates that will be exported through Yorktown, but they're very small numbers that impact us. So we're not seeing a lot of that activity that you're describing in the condensates.

Okay. And anything on the export ag side?

The soybean market is pretty heavy, mainly out of Norfolk and out of Mobile, and we are seeing quite a bit of activity in those areas.

Okay. And as a follow-up, guys, getting back to pricing, we saw it in our survey that we do to the shipping community that we published yesterday. When you're talking about an acceleration throughout the year, I'm assuming this is obviously going to be ex-coal, but where are you going to get the most bang for your buck? Is this primarily in your truck competitive business?

On the pricing side?

Yes.

I think we're getting it across all segments of our marketplace. If you look, barges are tight right now, so we're able to get pricing in those areas in our bulk commodities. We're able to get pricing, particularly in the truck side of the business is coming up. So pricing right now is very much in favor of the carriers.

Okay. Gentlemen, thank you for your time, as always.

Thank you. Our next question is from Matt Troy with Nomura.

Good morning, Matt.

Good morning, guys. Question, a lot of people out are there talking about the decline in fuel prices lowering the absolute per mile cost per trucking. Obviously, intermodal rates are going to go down, as well, as the surcharges decline there. But just curious, academically or in practice, are you hearing from any of your customers about a desire to switch from intermodal back to trucking?

Some folks are speculating that. I would think not. A, you just can't switch a whole bunch of business into an industry that doesn't have capacity. But given that prices have come in, I figured I'd ask the question. Are you seeing it? Do you see it as a risk to intermodal in FY15?

We absolutely do not. The big issue that has been in trucking remains the big issue in trucking, and that is driver availability. Most people that I'm aware of don't want their sons to grow up to be truck drivers. And so truck drivers become an issue. People don't want to be away from home five, six, seven days.

There's issues in passing the drug test to get a commercial CDL. There are barriers to entry now in becoming a truck driver and getting new Class 8 trucks purchased and the cost of getting into the business is much higher. So it's more than just having the capacity itself. It's all the issues that surround it.

So we see intermodal, in fact, growing. Our intermodal business grew faster last year than the GDP of the country did. If you look at the AAR data, intermodal in general grew faster than the economy did last year. So I think what you're reading in the periodicals is people writing that don't have anything to write about.

Right. That is, agree, is more of an academic observation. Lower fuel surcharges don't create drivers.

I guess my second follow-up question would be natural gas. If you look at the futures curve, it's implying pretty much $3.00-ish for the rest of the year, or well into the year. Just wondering, I know the Appalachian coal and from a switching perspective has been out of the money for some time. Should we just think about the vulnerability in your domestic coal business being Illinois basin at current levels at $3.00?

And have you triangulated in your guidance a nat gas price assumption in your earlier comments about 1Q flat for the year? Just wondering what might be at risk, because last time we saw gas down here, stockpiles were north of 200 million tons. We're at a 6-year low at 130 million tons, so that variable obviously won't hurt. Just trying to triangulate what might be vulnerable if we stay at $3.00? Thanks.

Well, about 47%, 48% of our coal business today comes out of Northern App or the Illinois Basin. So we try to look around $3.00, $3.50 at natural gas as a number that if you get much under that, we start to hurt a little bit in our burn. So those are the numbers that we triangulate against.

Okay. And in Illinois Basin, you're not hearing anything about switching from those customers yet?

Well, I'm not sure exactly what you're asking. But what we're seeing is a lot of our customers are moving to the Illinois Basin in coal, which is good for us because it gives us a longer length of haul, gives us higher RPU, and it's a good thing for us.

I was just more talking about the switching sensitivities of the various sourcing basins. But I got it. Okay. Thank you.

Thank you. Our next question is from Cleo Zagrean with Macquarie Capital.

Good morning, Cleo.

Good morning and thank you. And Happy New Year. My first question is also with regards to the domestic coal business.

Can you help us think just more specifically around the sensitivity of EPS for FY15 to plus or minus 5%, or whichever way you think is good for a band, in domestic coal volume around that base case of flat for this year? What would plus or minus 5% domestic coal do to EPS for FY15, given the profitability in the new profit set up, the new mix, and also given the fixed variable structure that we've seen affect earnings so far? Thank you.

This is Fredrik. I think that in terms of fixed variable, that is less of an issue. I think in terms of sensitivities, Cleo, there are sensitivities if coal comes down and it is not flat, that's going to be sensitivities to our EPS guidance. But at the same time, as we said, there are opportunities to offset that. So there's a lot of different pieces that goes into our guidance. So I think it's a little bit dangerous to get down to isolate specific pieces.

When we add all the things up, as I said earlier, and we think about the business as a whole and some of the vibrancy we're seeing in certain markets and some of the productivity opportunities, the pricing, we feel that we can absorb some of those sensitivities on the coal side. But we'll have to wait and see, and we're going to have to get a couple quarters under the belt until we get full visibility into what is doable and what's not doable for the year.

Thank you. And my second question is with regards to operating ratio excluding fuel. You've highlighted, deservedly, that fuel is a pass through. So I would appreciate any help you can give us to think about the performance of the business, ex this noise in the revenue and expense line.

Are you looking at a path for OR ex-fuel, any kind of progression that you have in mind that you can share with us so we can track performance on that basis? Thank you.

Well, the positive lag in the quarter itself here for the fourth quarter was about $23 million and I think [$16] million year-over-year, so that was a favorable coming from fuel. We also saw a little bit of favorability, because wholesale prices, I think, came down faster than the retail prices. And it's the retail price that our fuel surcharge is tied to. So what we paid at the pump probably declined faster than the fuel surcharge revenue itself. So that's another benefit that we saw here this quarter.

But overall, frankly, if you look at our margin expansion and our operating ratio, this is not a profit element. If fuel prices come down, it's actually generally slightly positive to our path towards the 65% operating ratio longer term. But as I said, overall, not a profit element. There is some lag effects, and here we saw an additional lag perhaps here in the fourth quarter or the fact that wholesale prices went down faster than retail prices and net--

So I'm sorry, so in a lower fuel price scenario, should we expect that you are finding it easier to reach that mid-60's target sooner?

Yes, it's immaterial in the scheme of things. But if you just think about the fact you're adding, for example, $100 million to the revenue line and you're adding $100 million to the expense line, this is not a profit driver. The operating ratio of that is 100%, because you're not getting a margin on that. So as fuel price comes down and your fuel expense goes down, of course, following them out, you actually get a little benefit from it.

Thank you very much.

Thank you. The next question is from Keith Schoonmaker with Morningstar.

Good morning, Keith.

Good morning. I'd like to ask about the 2% decline in chemicals revenue per unit. Is this simply a mix issue, where growth in crude where the shipper provides a tank car is having a mix effect on this, or is there something else at work?

Absolutely. You are correct.

Thus there's no read through to lower margins on this business that I could derive just from that?

Right. That's correct.

And then a follow-up question on modal shift. I think the commentary in the quarterly report indicated automotive growth was constrained by customer transportation modal changes. Could you elaborate on that, please?

In the early part of last year, in the heavy freezes that were occurring, some of the auto makers pulled business off of the rail and went to the haulaway carriers. The haulaway carriers would not take the business without contracts duration of around six months, for obvious reasons, and that's what you're seeing there.

Thank you.

Thank you. The next question is from Justin Long with Stephens.

Good morning, Justin.

Good morning and thanks. First question I had was on the service. With the locomotives coming on the next couple of quarters and the service improvements being correlated to this additional power, as you mentioned, Oscar, is the expectation that you can get back to normal service levels that we saw in 2013 by the end of the second quarter, absent any major weather event?

Yes, I think normal service levels -- those were record service levels back then. I think we will gradually steam up to that area as the locomotives arrive, and that it will be gradual over the course of the year. Not quite ready to commit to those higher levels that quickly. Again, we have a spring peak that goes from week 9 through week 23, that's the end of June. So I think there will be some lagging effect. But again, I think you're going to see the efficiency, the productivity, and of course, the growth that we've seen altogether start to come together certainly by the second half of the year.

Okay. Great. And second question I had was on pricing. I just want to get a better sense of how the pricing environment has improved. And I was wondering if you could provide anymore color on how recent renewals have been trending. Generally speaking, are you seeing something closer to the mid-single digits on renewals versus the 2.5% to 3% overall core pricing that you posted recently?

Justin, my friend David Baggs tells me numbers are not my friend, so I can't give you a specific number. But I would tell you that I am very pleased with the pricing that we're getting. It has been very positive, and you will be very pleased when we report our numbers for the first quarter this year.

Fair enough. I appreciate the time. I know it's been a long call. Thanks.

Thank you. Our next question is from Donald Broughton with Avondale Partners.

Good morning, Donald.

Good morning, Clarence. It turns out mommas aren't supposed to let their babies grow up to be truck drivers. I always thought it was cowboys, but I'm glad to learn that this morning. (Laughter)

That said, a year ago, on highway diesel -- and obviously, that's not the price you all pay -- but averaged $3.96 a gallon. Looks like we're on course for it to average $3.10 a gallon or less in the first quarter this year. I know you're getting base yield, and you're doing a great job there. But just the fuel surcharge overall, can you kind of give us some parameters?

Is the absence of the fuel surcharge and a drop from what is essentially $4.00 a gallon to $3.00 a gallon, or almost, is it 1% yield headwind, 2% yield headwind, 5% yield headwind? What does it represent for your overall book of business?

I don't think we have the math here in front of us to do that. You do have this total fuel surcharge revenue that we report to the SDB that I also think is actually in our quarterly flash. So you can look at the total revenue from fuel and then you can model that out, I think, to get a sense, depending on different highway diesel prices, what the impact would be.

All right. So I'll just back into it that way then. Thank you, gentlemen.

Thank you.

Thank you. Our final question today is from John Mims with FBR Capital Markets.

Good morning, John.

Good morning. Thanks for slipping me in here. So a question on the chemical book. If you exclude crude oil and oil and gas comments for a minute and just look at more traditional volumes, can you provide some color or just outlook on demand and pricing and contracting for your activities down in the Gulf and your non-oil related volumes?

Yes. The other lines of chemical business is growing about 2% to 3%. That's pretty much in line with what the chemical industry has been growing. Actually, it's a little high on the plastics end, growing at about 2% to 3%, over what it's been for the last six or seven years.

Pricing has been very good in the chemical side of the business, particularly in the renewals that have occurred in the fourth quarter and are, in fact, incurring in the first quarter. So we're very pleased with what we're getting in the pricing in those areas. Does that answer your question?

Yes, it does. It's helpful. And what's the split between your traditional chemicals versus your oil and gas right now within that segment?

Oil and gas is a major part growing of that portfolio, but it's the plastics part of the business is still the largest by far.

Is there percentages you can give? I know you've put out numbers as far as what gas is for the total book, but just within chemicals?

I don't have it off the top of my head.

Okay. All right. I can just back into something. All right. Thanks a lot. Other questions have been answered.

Thank you.

Thank you, everyone, for your attention and we appreciate it. We'll see you next quarter.

Thank you. This concludes today's teleconference. Thank you for your participation in today's call. You may disconnect your lines.