聯合太平洋集團 (UNP) 2015 Q3 法說會逐字稿

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  • Operator

  • Greetings and welcome to the Union Pacific third-quarter earnings call.

  • (Operator Instructions)

  • As a reminder, this conference is being recorded.

  • And the slides for today's presentation are available on Union Pacific's website.

  • It is now my pleasure to introduce your host, Mr. Lance Fritz, Chairman, President and CEO for Union Pacific.

  • Thank you, Mr. Fritz, you may now begin.

  • - Chairman, President & CEO

  • Thank you.

  • And good morning, everybody.

  • Welcome to Union Pacific's third-quarter earnings conference call.

  • With me here today in Omaha are Eric Butler, Executive Vice President of Marketing and Sales; Cameron Scott, Executive Vice President of Operations; and Rob Knight, our Chief Financial Officer.

  • This morning, Union Pacific is reporting net income of $1.3 billion for the third quarter of 2015.

  • This equates to $1.50 per share, which is down 2% compared to the third quarter of 2014.

  • Total volumes decreased about 6% in the quarter, more than offsetting another quarter of solid core pricing gains.

  • Carload volume declined in five of our six commodity groups, with Coal down the most at 15%.

  • Automotive was the one commodity group with a year-over-year increase in the quarter, with carloads up 5% versus 2014.

  • On the cost side, we've made significant progress aligning our resources to current demand.

  • And I'm pleased report a quarterly record operating ratio of 60.3%.

  • Going forward, we will be intently focused on generating further productivity improvements.

  • In addition, developing new business remains an important part of our strategy.

  • Whether we grow existing markets, develop new business with existing customers, or find new market opportunities, our commercial team is constantly filling the business development pipeline.

  • I'm encouraged with the progress we've made as the men and women of Union Pacific work tirelessly and safely to serve our customers and deliver value to our shareholders.

  • With that, I'll turn it over to Eric.

  • - EVP of Marketing & Sales

  • Thanks, Lance.

  • Good morning.

  • In the third quarter, our volume was down 6.5%.

  • With gains in automotive, more than offset by declines in the other business groups.

  • We generated core pricing gains of 3.5%, but it was not enough to offset decreased fuel surcharge and mix headwinds, as average revenue per car declined 4% in the quarter.

  • Overall, the declines in volume and lower average revenue per car drove a 10% reduction in freight revenue.

  • Let's take a closer look at each of the six business groups.

  • Ag Products revenue was down 4% on a 3% volume reduction, and a 1% decrease in average revenue per car.

  • Grain volume was down 11% in the third quarter.

  • The strong US dollar and high worldwide inventories reduced grain exports by 32%.

  • Slightly stronger domestic grain shipments partially offset the export decline.

  • Grain products volume increased 1% for the quarter.

  • July and August saw the largest domestic soybean meal crush on record, resulting in a 17% increase in the soybean meal shipments.

  • Partially offsetting this was a 4% decline in ethanol shipments, driven by strong 2014 comps of higher production and shipments.

  • Food and refrigerated product volumes were flat for the quarter.

  • As strength in import sugar and barley were offset by declines in frozen meat and potato shipments.

  • Automotive revenue was flat in the third quarter, as the 5% increase in volume was offset by a 5% reduction in average revenue per car.

  • Finished vehicle shipments were up 5% this quarter, driven by continued strength in consumer demand.

  • The seasonally adjusted annual rate for North American automotive sales was 17.8 million vehicles in the third quarter, up 6% from last year.

  • In auto parts, volume grew 5%, driven primarily by increased vehicle production.

  • Chemicals revenue was down 6% for the quarter on a 3% reduction in both volume and average revenue per car.

  • We continued to see strength in plastic shipments, which were up 7% in the third quarter, due to stable resin pricing and strong export volume.

  • However, our volume gains were more than offset by declines in shipments of both fertilizer and crude oil.

  • Lower grain commodity prices and market uncertainty resulted in farmers delaying fertilizer purchases.

  • This resulted in a 10% decline in our fertilizer volume.

  • Crude oil volume, which was down 40% in the quarter, continues to be impacted by low crude oil prices and unfavorable price spreads.

  • Coal revenue declined 18% in the third quarter on a 15% volume decline and a 4% decrease in average revenue per car.

  • Southern Powder River Basin tonnage was down 12% in the quarter.

  • Low natural gas prices continued to put downward pressure on coal demand, as Coal's share of electricity generation declined from 38% in the third quarter of last year to 35% this year.

  • Coal inventories, which are currently 20 days above the five-year average, contributed to the sluggish demand.

  • Colorado Utah tonnage was down 32%, driven again by soft domestic demand and reduced export shipments.

  • Industrial products revenue was down 16% on a 12% decline in volume, and a 4% to increase in average revenue per car during the quarter.

  • A reduction in shale drilling resulted in a 31% decline in minerals volume, primarily driven by a 36% decrease in frac sand carloadings.

  • Metals volume was down 26%, as lower crude oil prices suppressed drilling-related shipments and the strong US dollar drove increased imports.

  • Demand for construction products resulted in a 1% volume increase in the third quarter, driven by continued demand in road and construction projects in our Texas Rock Region.

  • Intermodal revenue was down 11% in the third quarter, on a 4% lower volume and a 7% decrease in average revenue per unit.

  • Domestic Intermodal volume was up 1% in the third quarter.

  • Even though retail sales were down slightly year over year, we still achieved a best-ever third quarter of domestic Intermodal volume.

  • Internationally, the Intermodal volume was down 9% for the quarter.

  • As compared to a strong third quarter at 2014, when cargo owners advanced peak season shipments in anticipation of port labor strikes.

  • With relatively high retail inventories, some international Intermodal customers have reduced orders, and not all East Coast diversions have migrated back to the West Coast.

  • I'll update you on peak season in just a minute.

  • To wrap up, let's take a look at our outlook for the rest of the year.

  • In Ag Products, although we've had another strong crop year, low commodity prices and abundant global supply create uncertainty in our volume outlook for grain.

  • In food and refrigerated, we expect continued strength in beer, but we're facing headwinds in other markets from increased truck availability year over year.

  • We expect automotive sales to remain strong for the rest of the year, driving growth in finished vehicles and parts shipments.

  • We continue to expect coal demand to remain below year-ago levels, due to low natural gas prices; higher-than-average coal inventories; and headwinds in the export coal market.

  • As always, a key factor in demand will be weather conditions.

  • Most chemical markets should remain steady for the remainder of the year, with strength expected in LPG.

  • We continue to expect that weak oil prices, reduced production, and unfavorable spreads will remain a significant headwind for crude-by-rail shipments.

  • At Industrial Products, lower crude oil prices will also continue to challenge our minerals and metals volume through the rest of 2015.

  • While the housing market is slowly strengthening, the strong dollar and relatively weak China lumber import market are driving more imports of Canadian lumber to the US.

  • We continue to expect demand for construction products to remain strong, particularly in the southern part of our franchise.

  • Finally, in Intermodal, we continue to see highway conversions.

  • And we expect this will be the seventh consecutive year of record domestic Intermodal volumes.

  • We expect that relatively soft retail sales will cause headwinds in our international Intermodal volumes.

  • Overall, we will continue to focus on solid core pricing gains, strengthening our customer value proposition and developing new business across our diverse franchise.

  • With that, I will turn it over to Cameron.

  • - EVP of Operations

  • Thank you, Eric.

  • Good morning.

  • Starting with our safety performance.

  • Our year-to-date reportable personal injury rate improved 12% versus 2014, to a record low of 0.92.

  • While we continue to make significant improvement, we won't be satisfied until we reach our goal of zero incidents.

  • Getting every one of our employees home safely at the end of each day.

  • With respect to rail equipment incidents or derailments, our reportable rate increased 17% to 3.56, driven by an increase in yard and industry reportables.

  • While our reportable rate has taken a step back this year, we are confident that our strategy aimed at eliminating human factor incidents and hardening our infrastructure will put us back on a path of long-term improvement.

  • In public safety, our grade crossing incident rate increased slightly versus 2014 to 2.25.

  • We continue to focus on driving improvement by reinforcing public awareness through channels, including public safety campaigns and community partnerships.

  • Moving on to network performance.

  • Our operating metrics showed a step function improvement in the third quarter, with network velocity reaching levels not achieved since 2013.

  • While weather conditions in the quarter were more favorable from an operating standpoint, year-over-year volume swings and business mix shifts continued to create a dynamic operating environment.

  • However, the men and women of Union Pacific proved up to the challenge, diligently leveraging the strengths of our franchise to serve our customers proudly.

  • In regard to service, one of the key metrics we use to track our performance is our service delivery index.

  • The measure, which gauges how well we are meeting overall customer commitments, improved 8% versus the third quarter of last year.

  • We also generated improvement in our local service product to customers, with a 95.3% industry spot in poll, which measures the delivery or pulling of a car to or from a customer.

  • But we know there is still more work to do, and we are working hard every day to further improve service and reduce costs.

  • Adjusting resources to current demand continued to be a key focus area for us in the third quarter.

  • While we noted back in July that we had our locomotive fleet close to being rightsized, we've made meaningful progress adjusting our TE&Y workforce over the past couple of months.

  • By the end of September, we had around 2,700 TE&Y employees either furloughed or on alternative work status, compared with 1,200 at the end of the second quarter.

  • In addition to adjusting to lower volumes, our improvement in network performance has translated into fewer recrews, lessening the resource demands of our network.

  • Overall, our total TE&Y workforce was down 10% in September versus June.

  • Around half of this decrease was driven by fewer employees in the training pipeline.

  • Our active locomotive fleet is down 140 units from the end of the second quarter.

  • As we currently sit, we still have some work left to do.

  • But our resources at the end of the third quarter were more closely in line with current demand.

  • While resource alignment has been a key focus throughout the year, we have not lost sight of other initiatives which also drive productivity.

  • We ran record train lengths in nearly all major categories, remaining agile and adapting our transportation plan to current demand.

  • We were also able to generate efficiency gains within terminals, as productivity initiatives led to record terminal productivity, even with the 4% decline in the number of cars switched.

  • Growth capacity investments, alongside process improvements, have enhanced our ability to generate productivity and have increased the fluid capabilities of our network.

  • In addition, our progress in adjusting resources demand has helped enable gains in asset utilization, including locomotive productivity.

  • While the mix headwind from running lower coal volumes largely drove the 1% decline versus the third quarter of 2014, this fleet productivity metric has improved 6% sequentially from second-quarter levels.

  • To wrap up, as we move forward, we expect our safety strategy will yield record results on our way to an incident-free environment.

  • And while we gained significant traction throughout the quarter, we continue making operational improvements by leveraging the strengths of our diverse franchise to deliver a service product our customers have come to expect.

  • With our resources now closer in line with demand, we'll continue our focus on other productivity initiatives to further reduce costs.

  • We also believe running a safe, reliable and efficient railroad creates a value for our customers and increases returns for our shareholders.

  • With that, I'll turn it over to Rob.

  • - CFO

  • Thanks.

  • Good morning.

  • Let's start with a recap of our third-quarter results.

  • Operating revenue was just under $5.6 billion in the quarter, down 10% versus last year.

  • The decline in volume and lower fuel surcharge revenue, along with negative business mix, more than offset another quarter of solid core pricing.

  • Operating expenses totaled just under $3.4 billion, decreasing 13% when compared to last year.

  • Drivers of this expense decline were significantly lower fuel expense, along with volume-related reductions and productivity improvements.

  • The net result was a 5% decrease in operating income to $2.2 billion.

  • Below the line, other income totaled $30 million, up from $20 million in 2014.

  • Interest expense of $157 million was up 9% compared to the previous year, driven by increased debt issuance during the last 12 months.

  • Income tax expense decreased about 7% to $781 million, driven primarily by reduced pretax earnings.

  • Net income decreased 5% versus last year, while the outstanding share balance declined 3% as a result of our continued share repurchase activity.

  • These results combine to produce quarterly earnings of $1.50 per share, down 2% versus last year.

  • Now turning to our top line.

  • Freight revenue of $5.2 billion was down 10% versus last year.

  • Volume declined about 6%, and fuel surcharge revenue was down $407 million when compared to 2014.

  • All in, we estimate the net impact of lower fuel price was a $0.05 headwind to earnings in the third quarter versus last year.

  • And this includes the net impact from both the fuel surcharges and lower diesel fuel costs.

  • And as we expected on our last earnings call, business mix was a negative contributor to freight revenue for the third quarter.

  • The primary drivers of this mix shift were significant declines in frac sand, steel shipments and bolt grains, partially offset by a decline in international Intermodal volumes.

  • Looking ahead, business mix will continue to be a headwind to freight revenue for the remainder of the year.

  • A 3.5% core price increase was a positive contributor to freight revenue in the quarter.

  • Slide 21 provides more detail on our core pricing trends.

  • While down slightly from the first-half levels, core pricing continued at levels that are above inflation and reflects the value proposition that we offer in the marketplace.

  • Of the 3.5% this quarter, about 0.5% can be attributed to the benefit of the legacy business that we renewed earlier this year.

  • And this includes both the 2015 and 2016 legacy contract renewals.

  • Moving on to the expense side.

  • Slide 22 provides a summary of our compensation and benefits expense, which decreased 2% versus 2014.

  • The decrease was primarily driven by lower volumes and improved labor efficiencies, as we continued to realign our workforce.

  • Labor inflation was about 4% for the third quarter, driven by agreement wage inflation as well as higher pension and other benefit expense.

  • For the fourth quarter, we expect labor inflation to also be about 4%.

  • Looking at our total workforce levels, our employee count was flat when compared to 2014.

  • And excluding our capital-related employees however, our workforce level declined about 3%.

  • And as Cam just mentioned, we made significant TE&Y reductions in the third quarter.

  • And we are most closely in line with current demand.

  • For the fourth quarter, we now expect our total force levels to be down 1% or so when compared with the fourth quarter of 2014.

  • Turning to the next slide, Fuel Expense totaled $484 million, down 45% when compared to 2014.

  • Lower diesel fuel prices, along with an 8% decline in gross ton miles, drove the decrease in fuel expense for the quarter.

  • Compared to the third quarter of last year, our fuel consumption rate increased 1%, driven by negative mix, while our average fuel price declined 40% to $1.81 per gallon.

  • Moving on to our other expense categories.

  • Purchased Services and Materials expense decreased 9% to $589 million.

  • The reduction was primarily driven by lower volume-related expense and reduced repair costs associated with our locomotive and car fleets.

  • Depreciation expense was $507 million, up 5% compared to 2014.

  • We still expect depreciation to increase about 6% for the full year.

  • Slide 25 summarizes the remaining two expense categories.

  • Equipment and Other Rents expense totaled $302 million, which is down 3% when compared to 2014.

  • Lower locomotive lease and volume-related expenses were the primary drivers.

  • Other expenses came in at $205 million, down 15% versus last year.

  • Decreased freight, equipment, and property damage costs, along with a reduction in general expenses, were the primary drivers.

  • We now expect Other expense to be close to flat on a full-year basis, excluding any large unusual items.

  • Turning now to our operating ratio performance.

  • The third-quarter operating ratio came in at a record 60.3%, an improvement of 2 points when compared to the third quarter of 2014.

  • The operating ratio did benefit about 1.5 point from the net impact of lower fuel prices in the quarter.

  • Early in the year, we challenged the organization to safely and efficiently rightsize our resources and reduce costs.

  • And I'm pleased with the results that we've been able to achieve.

  • Ongoing productivity initiatives, along with pricing above inflation, have been key drivers to improving our overall margins.

  • Turning now to our cash flow.

  • Year-to-date Cash From Operations increased to just over $5.6 billion.

  • And we invested around $3.3 billion in cash capital investments through the first three quarters.

  • Taking a look the balance sheet.

  • We continue our efforts to rebalance our capital structure, while maintaining a strong investment-grade credit rating.

  • Our adjusted debt balance grew about $1.6 billion through the first three quarters of this year, taking our adjusted debt to cap ratio to 44.5%, up from 41.3% at year end 2014.

  • Our adjusted debt to EBITDA has increased from 1.4 times at year end to 1.6 times at September 30, 2015, on a trailing 12-month basis.

  • This is consistent with our target ratio of 1.5-plus.

  • Longer-term, we define that to mean less than two times.

  • Our profitability and cash generation enable us to continue to fund both our capital program and cash returns to shareholders.

  • Year to date, we've repurchased more than 28 million shares.

  • Almost half of these shares were repurchased in the third quarter.

  • Year-to-date spending totaled $2.9 billion.

  • The third quarter alone was up 45% versus last year to over $1.2 billion.

  • This demonstrates our opportunistic approach in the marketplace and should not be considered a new quarterly run rate.

  • Adding our dividend payments and our share repurchases, we returned $4.3 billion to our shareholders through the first three quarters of 2015.

  • This represents roughly a 22% increase over 2014.

  • While we've made good progress in the third quarter, we do expect to see some difficult year-over-year comparisons as we close out 2015.

  • In the current demand environment, continued lower volumes versus last year and an even more challenging business mix will both negatively impact fourth-quarter results.

  • And when we compare it to last year, fuel prices will also continue to have a negative impact on earnings for the fourth quarter.

  • Keep in mind, we did report a $0.05 positive fuel benefit in the fourth quarter of last year, making the fuel comparison more challenging year over year.

  • On the plus side, we will continue to focus on achieving solid core pricing gains, and building on the progress we have made with our cost reduction and productivity initiatives.

  • When you add it all up, we will fall short of last year's fourth-quarter and full-year earnings-per-share records.

  • As for next year, we are still early in the planning process.

  • It looks like we may have opportunities in many of our business segments.

  • But it also appears that our energy-related volumes will continue to be challenged.

  • Given the uncertain environment, we're taking a hard look at our capital spending for next year.

  • We have not finalized our plans, so it's too early to tell how it will relate to our longer-term guidance of 16% to 17% of revenue.

  • But from an absolute dollar perspective, we do currently expect that it will be somewhat less than this year's $4.2 billion.

  • And the plan does include the acquisition of around 200 locomotives as part of the long-term purchase commitment.

  • Overall, we will remain intently focused on running a safe, cost-efficient, and productive operation.

  • And we remain committed to providing our customers with excellent service and our shareholders with strong financial returns.

  • With that, I'll turn it back over to Lance.

  • - Chairman, President & CEO

  • Thanks, Rob.

  • As you've heard from the team, we've made great progress in meeting this year's challenges.

  • Our operating metrics have improved to more efficient levels, and our resources are now more closely in line with demand.

  • We'll continue our unrelenting focus on operating safely and providing a quality service product for our customers.

  • We will also continue to grow existing business into established new markets.

  • Even so, as Rob said, there are some question marks as we finish 2015 and head toward next year.

  • One uncertainty, of course, is the extension of the positive train control deadline.

  • We continue to believe that Congress will do the right thing for our country and our customers and will vote to extend the deadline.

  • Beyond that, energy prices, the consumer economy, grain markets, the strength of the US dollar, all will be key to future demand.

  • Over the long term, we are well-positioned to safely provide our customers with excellent service, while delivering strong value to our shareholders.

  • So with that, let's open up the line for your questions.

  • Operator

  • (Operator Instructions)

  • David Vernon, Bernstein Research.

  • - Analyst

  • Good morning.

  • Thanks for taking the question.

  • Rob or Eric, could you help us frame the -- how challenging coal could be next year from a volume outlook?

  • If we were to assume normal demand patterns, gas prices staying where they are, are we looking at similar declines as we saw this year or something smaller than that?

  • - EVP of Marketing & Sales

  • As we said, David, coal demand really depends on a couple of major factors.

  • One, the competitiveness against natural gas.

  • And so what, the outlook for natural gas pricing is, and certainly the weather, and certainly export markets will have an impact on the coal markets.

  • At this point, if you look at natural gas futures, there is no discernible improvement in that natural gas pricing.

  • So you would assume natural gas will remain very competitive versus coal.

  • I don't think you would project any improvement of coal market share against natural gas pricing, and the weather is always an open factor.

  • - Analyst

  • But deterioration, would you expect -- are the things that you know about your retirements on your fleet or new builds anywhere in the network that would give you some cause for saying that there is going to be a material deterioration?

  • Assuming the competitiveness remains unchanged?

  • - EVP of Marketing & Sales

  • Again, the key driver is competitiveness of coal.

  • I think you should also look at the current inventories.

  • The inventories, as we mentioned, are about 20 days above historical five-year average levels.

  • They're actually about 30 days above last year third-quarter levels.

  • So you could assume that there would be some desire of utilities to manage those inventories down to a more normal level.

  • - Analyst

  • Okay, great.

  • Maybe one quick follow-up thing on the pricing.

  • Obviously, we heard a little bit from one of your interchange partners down in the Central South making some concessions on rates to maybe incentivize some coal burn.

  • How do you guys think about that?

  • Are you guys changing your thinking about that given the changing competitiveness right now with coal and natural gas?

  • - EVP of Marketing & Sales

  • We don't, as you know, we don't talk about specific customer issues or specific commercial issues with customers.

  • Our strategy has not changed.

  • We think we have a strong value proposition and we're going to price to the value proposition to generate a return for our Company, our strategy has not changed.

  • - Analyst

  • Thank you.

  • Operator

  • Ken Hoexter, Merrill Lynch.

  • - Analyst

  • Great, good morning.

  • Lance and team, great job on the operating ratio.

  • But now that you are at this 60% level, can you maybe talk a little bit about what projects you still have that can improve?

  • Obviously, we saw a tremendous improvement in the velocity during the quarter.

  • Is that something that you still seek and return to even a couple years-ago levels and there's more to get that into the 50%s?

  • And maybe talk about what projects you have underway that can keep improving that into the next few years.

  • - Chairman, President & CEO

  • Sure, Ken.

  • Before I turn it over to Cameron for a little more technicolor.

  • Like we've answered historically, there are almost limitless opportunity for us to continue to improve the business.

  • What you saw in the quarter and what we've reported for an average quarterly fluidity reflected in velocity has been accelerating through the quarter.

  • So as we're stepping into the fourth quarter, we feel pretty bullish about the ability to continue to make gains.

  • The other thing to think about from a service perspective is, while the fluidity of the network at this moment in time looks like it has at any previous period, from the standpoint of very good, they're still opportunities in specific service products that we can continue to make strides on.

  • Cameron, I will give it to you to talk a little bit more specifically about projects for productivity.

  • - EVP of Operations

  • We continue to see opportunities in a number of different areas.

  • Including variable cost control, train length growth, terminal productivity, C-rate or fuel efficiency, and engineering and mechanical efficiency initiatives to help squeeze out as much productivity as possible.

  • We are gaining traction in all of these areas, as Rob mentioned.

  • - Analyst

  • Great.

  • I appreciate that insight.

  • If I could have a quick follow-up.

  • On the pure pricing, you mentioned that it decelerated to 3.5% from 4%.

  • Is that due to more truck competition?

  • Eric, I don't know if you mentioned it, I don't know if they're pricing contracts down, or what is driving that?

  • But maybe you can delve into that a little bit.

  • - CFO

  • This is Rob.

  • Let me jump on that, couple points.

  • One, you know how we calculate price at Union Pacific, and I'm very proud of it.

  • And that is, we only count what actually moves.

  • So we calculate the yield per price, so the point being, volume has an impact clearly on our reported price.

  • The other thing I would say is, our attitude and our focus has not changed at all in terms of our commitment and understanding to drive price.

  • It's a key contributor to what we've been able to achieve up to this point, and it will be a key contributor as we move forward continuing to get that solid core pricing.

  • I would not read too much, frankly, into the change from the second quarter to the third quarter.

  • Because there is volume issues, there's the legacy that we've called out, and there some round -- we always round the numbers in terms of what we report here.

  • So there's not as big of a gap, if you will, from the second to third as you might otherwise think.

  • Again, our commitment and our focus on pricing is unchanged.

  • - Analyst

  • Appreciate the time and insight.

  • Thanks, guys.

  • Operator

  • Jason Seidl, Cowen and Company.

  • - Analyst

  • Good morning, everyone.

  • You guys talked a little bit about some of the East Coast business not flowing back to, not all of it at least, flowing back to the West Coast ports.

  • Do you think it's now permanently based in the East now?

  • Do think people have changed their supply chains?

  • - EVP of Marketing & Sales

  • This is Eric, Jason.

  • No, we do not.

  • Frankly, as we said last quarter and I think the previous quarter, we do think that ultimately the cheapest, best, fastest supply chain will win and that still is West Coast ports.

  • There's still probably a couple of 3 percentage points of share that migrated over to the East Coast ports during the port strike that has not migrated back.

  • We think some of that is some short-term risk management, some hedging for the market and retail inventories.

  • But we fully expect that the shortest, quickest, most economic supply chain wins in the end, and that is the West Coast.

  • - Analyst

  • Okay, that's great color.

  • And, Rob, a quick question on pricing.

  • I think you mentioned that about 0.5 point was due to the legacy mix pullforwards that you had.

  • So as we start looking out to 2016, should we start basing our assumptions on about 3% core pricing?

  • - CFO

  • Nice try.

  • - Analyst

  • You can't blame a guy.

  • - CFO

  • No, I get it.

  • Clearly, we are saying that you can assume that the legacy is not going to continue.

  • But in terms of what happens underneath or beyond legacy, we have not given a precise number of guidance other than our commitment to core pricing gains above inflation.

  • We're not changing our attitude or our focus there.

  • What the number actually ends up being, stay tuned.

  • - Analyst

  • Sounds good.

  • Guys, I appreciate the time as always.

  • Operator

  • Tom Wadewitz, UBS.

  • - Analyst

  • Good morning.

  • You've been -- obviously been asked a couple of questions on price.

  • As I understand it, you're saying you're not changing your approach, but the market can change.

  • So I'm wondering whether you perceive that what we heard about from KSU and presumably another competitor taking a rate down on coal.

  • Do you think that the market is changing in terms of more broadly than that?

  • Or would you say, there are targeted actions that you really shouldn't read into broadly.

  • Because I think you're clear on what you're doing, but the market matters as well.

  • I'm just wondering what you think on whether the market is really going to change or not.

  • - Chairman, President & CEO

  • Tom, this is Lance.

  • Historically, we have always focused on providing an excellent product and then charging for the value that that product represents to our customer base.

  • We've faced markets that are very difficult, different headwinds, and we've faced very robust markets, and that philosophy doesn't change.

  • We are in a very competitive business.

  • We compete aggressively for the business that we enjoy.

  • And at the same time, we expect to receive a price that represents the value that we provide, and it has to be reinvestable.

  • All of that is real, and all that continues to be real as we look into the future.

  • - Analyst

  • Is it fair?

  • If we look at you versus the market or a competitor, however you want to characterize that.

  • Over the last several years, it's probably you have been a little bit willing to give up some volume.

  • I think there were some contracts that moved away from you in coal in, I think 2013 and 2014.

  • So you'd say, well that's an example of being firm on price and being willing to give up a little volume.

  • Is it fair to say that's been your behavior, and that willingness to give up a little volume to keep prices.

  • Is that the way we should view you're saying we are continuing with the same thing?

  • - Chairman, President & CEO

  • Tom, I would not change my answer to you at all.

  • We expect to be paid for the value that we represent, and we expect to be able to reinvest in our business.

  • - Analyst

  • Okay.

  • Thanks for the time.

  • Operator

  • Rob Salmon, Deutsche Bank.

  • - Analyst

  • Thanks.

  • To piggyback off of Ken's earlier question on the productivity front, it was very impressive that you guys were able to pretty much extend train length across the network in an environment where volumes were down about 6%.

  • Can you give us a sense of what citing constraints you guys have across the network, and the opportunity to expand that further?

  • - EVP of Operations

  • Most of the train size, as you saw there, equates to about 6,000 feet, and almost 90% of our network is 7,200 feet capable.

  • So we really don't have any citing constraints, and it's up to us to maximize train length and meet customer commitments.

  • We have a lot of opportunity in that category going forward.

  • - Chairman, President & CEO

  • I would add, it's very dependent on the lanes around the network.

  • We still do have targeted capital investment that is oriented towards citing length, extensions, and being able to increase maximum train length on a particular route.

  • Over and above what you see as average train lengths here.

  • So there are always -- or right now there are opportunities for us to continue to invest targeted capital to make that happen.

  • But we are a far way away from being at our average train length threatening our current citing length.

  • - Analyst

  • Thanks.

  • I really appreciate that color.

  • With regard to PTC, Lance, you had briefly alluded to it in the prepared comments.

  • Can you give us a sense of what the impact across the network would be if Congress does not extend it?

  • And any lessons that you learned from the massive uptick in volume we saw in 2014 that you could deploy?

  • Because to me, in reading the announcement -- the press release you guys had put out on the topic, it would be -- it would impact a substantial amount of the network.

  • - Chairman, President & CEO

  • Rob, what we have announced, what we've said that we would do if there is not an extension, and again, I'm very optimistic that Congress will be prudent and will pass an extension before we have to take any action.

  • But what we have said is, around Thanksgiving, in order to remove TIH from our railroad, we would have to start imposing an embargo.

  • That would be impactful.

  • That means we'd have to stop allowing interchange product onto us of those commodities, as well as start working with customers to try to figure out a way for them to ship it in alternative lines.

  • Also, we said as we approach the end of the year, we would start working with our Amtrak as well as the commuter agencies that we host to stop passenger traffic.

  • Both of them would be very bad for the US economy and for commuters.

  • The TIH includes commodities like chlorine that is used to clean drinking water.

  • It includes products that go into fertilizer and other manufacturing processes.

  • So that would all have an impact on the US economy.

  • And then you can imagine in a place like Chicago.

  • If the commuter lines were to stop running January 1, what commutes would be like for the 300,000 people a day that rely on those commuter lines.

  • - Analyst

  • Thank you so much for the time.

  • Operator

  • Tom Kim, Goldman Sachs.

  • - Analyst

  • Good morning, guys.

  • Nice quarter.

  • With regard to the cost side, obviously, we're seeing them come down year on year, but also importantly sequentially.

  • I'm trying to get a sense of the pace of declines we should be anticipating for the fourth quarter.

  • Do you think the run rate we've seen in Q3, is it a reasonable Q on Q?

  • - CFO

  • Tom, I would not take the run rate, because we're satisfied that we've made great progress.

  • But that was a pretty steep -- a successful decline from the second quarter, which we're very proud of.

  • And all I would say to you is we're going to control the things that we can control.

  • And as Cam has mentioned, we've got continuing opportunities.

  • While we've made great progress right sizing and realigning the organization, we're not done yet.

  • We're going to continue to take initiatives to squeeze that out and be as effective as we possibly can.

  • So the run rate probably will be different, but the success of our continuing to be realigned and look for every opportunity we can to further that productivity initiative will continue.

  • - Analyst

  • Okay.

  • That is helpful, thank you.

  • And then what is (technical difficulty), and that's that truckers are increasingly competitive with the rails.

  • And there's a comment suggesting with pricing down for the TLs, that there are potentially competing less share.

  • Obviously, that's more of a threat on Intermodal.

  • But I'm just wondering, with regard to the rest of your book of business, how much could you size up would be potentially at risk of diversion to trucking?

  • My sense is that it would be relatively limited, but I just would love to hear your thoughts on that.

  • - EVP of Marketing & Sales

  • I think if you look at what's going on currently in the trucking environment, the lower fuel cost is allowing trucks to be more competitive vis-a-vis rail, just by virtue of that fact.

  • Long term, trucks still have the same systemic long-term issues that they've always had in terms of driver shortages, some of the productivity headwinds that they have with some of the CSA regulations, the road congestion, et cetera.

  • So we are still very confident of our ability to drive truck conversions, which we demonstrated even in the third quarter in our Intermodal business.

  • Certainly, trucks are a great competitor and there is some competitive impact that we always are cognizant of.

  • But we're still positive about the position that we are in as a rail and driving conversions from truck to rail.

  • - Chairman, President & CEO

  • And case in point, you grew domestic Intermodal in the third quarter by 1%.

  • - Analyst

  • Outside of Intermodal, is it much of a threat or something we should be thinking about?

  • - EVP of Marketing & Sales

  • Trucks are always a competitor.

  • We feel very good about our value proposition and our ability to compete.

  • - Analyst

  • Thanks very much.

  • Operator

  • Scott Group, Wolfe Research.

  • - Analyst

  • Thanks, good morning, guys.

  • Rob, wanted to just follow-up your comment about headcount in the fourth quarter being down about 1%.

  • That implies a slight sequential increase from the third-quarter average, even though you ended the third quarter a lot lower than the average.

  • I guess I'm not sure I follow the down 1%, are you adding headcount back in the fourth quarter?

  • - CFO

  • No.

  • Scott, just to take you back.

  • Remember, we had previously guided that we thought would finish the year flat-ish with 2014, I think it was roughly 48,000 number.

  • What we're saying now, given the confidence we have and the progress we've made to date is, we expect to end the year with the number being down 1% or so.

  • I think compared to where we are now, it's flat-ish.

  • But of course, volume and other initiatives will dictate exactly where that number lands.

  • But that's the math.

  • - Chairman, President & CEO

  • Our job going forward, Scott, is Cameron continuing to stay focused on getting the house in order from an operating craft headcount.

  • We're also in the process of getting our house in order on a non-agreement perspective.

  • We talked about that in an announcement late in the third quarter.

  • We've got an opportunity in capital headcount, particularly in light of Rob's discussion that capital is likely to be down next year.

  • As we exit this year, we have got an opportunity to make adjustments there.

  • - Analyst

  • Okay.

  • And, Rob, you said a couple times I think 4% labor inflation.

  • What does next year look like?

  • - CFO

  • We have not finished our planning for next year, Scott, on a number of initiatives.

  • But I think it's safe to say that the labor inflation will be lower than it was this year.

  • Remember, this year we had the double wag, we had other issues that pushed the labor inflation full year up closer to the -- we had 5%, 6% in the first half of the year.

  • So I think I'm confident to say it's going to be lower than that, exactly where that number lands at this point time, again, stay tuned.

  • - Analyst

  • Great.

  • Lance, just a quick thing.

  • On the CapEx, is your comment that it's going to come down but we may not be able to get it down all the way to 16% of revenue, or a lot is on the table, we could get it even lower than 16%.

  • We just don't know.

  • - CFO

  • What I'm saying there is, the absolute number we would expect to come down, but it may not be in that 16% to 17% guidance range yet.

  • Because remember this year, because of the fall off in revenue -- driven largely by the fall off of fuel surcharge revenue.

  • And as you know and others know, we don't set our capital plan based on revenue.

  • It's just a guiding marker that we provide to you.

  • So it's possible that it won't quite make it all the way down to that 16% to 17%, depending on how the revenue number looks as we work through our planning process.

  • And that's what I'm suggesting.

  • - Analyst

  • Great.

  • Thank you guys.

  • Operator

  • Allison Landers, Chase Group.

  • - Analyst

  • Good morning.

  • I know there's been a lot of questions on price.

  • But thinking about core price above inflation, I was wondering if you could give us a sense of what overall rail inflation is currently running at?

  • - CFO

  • Allison, this is Rob.

  • This year, overall inflation, again, largely driven by that discussion I just had with the labor line.

  • It's probably in the 3%-ish -- maybe slightly higher than 3%, full year this year.

  • Again, Allison, as you know, we don't set -- again that's another marker similar to my discussion on capital.

  • We don't set our pricing based on any one particular period's inflation expectation.

  • That's just a marker that we expect to continue to achieve above, that can be lumpy from one quarter to the next or one period to the next.

  • But to answer your question, inflation overall was 3% plus-ish this year.

  • - Analyst

  • Okay, that's helpful.

  • Then thinking about Intermodal, how much of the decline in the segment stems from your main competitor taking some share back as its network recovers?

  • Do expect to further bleed in the fourth quarter, given that [BN] has opened up its northern region and added some new expedited Intermodal service from Chicago to the PNW?

  • - EVP of Marketing & Sales

  • Allison, as we mentioned, the decline in our Intermodal space was really in the international Intermodal space.

  • There's really a number of different dynamics that are going on in that.

  • One is, not the complete re-immigration, if you will, from East Coast to West Coast, so that is progressing

  • One is, as you know, in the [liner] steamship business, there's number of different dynamics going on there with the different alliances.

  • And different entities deciding what lanes they're going to put their ships in.

  • And certainly, the suggested softness in China and other parts of the Asian rim are all having an impact on that.

  • So those are really the drivers.

  • In terms our domestic Intermodal franchise, as we mentioned, we grew -- this will be the 7th consecutive year of record volumes.

  • We feel great about our franchise, the position of our franchise, and strength of our franchise.

  • - Analyst

  • Okay.

  • So just to be clear on your answer, BN has not taken any of the share back that you may have gained last year, or that's just not a significant factor?

  • - EVP of Marketing & Sales

  • So as we talked at earlier earnings releases, we did have, I think Rob said, a 1% to 2% share benefit last year from business with the difficulties at our competitors.

  • We fully expected that to migrate back, and those were in a couple of areas.

  • Those were in Intermodal, those were in grain, those were in Coal, and we have and are seeing those migrate back and that was aligned with our expectations.

  • - Analyst

  • Okay, great.

  • Thank you very much.

  • Operator

  • Justin Long, Stephens.

  • - Analyst

  • Thanks, and good morning.

  • Maybe to just follow-up on Intermodal again, I know right now, you're facing headwinds from tough international comps, there's uncertainty in the retail space.

  • So I was just wondering bigger picture, when do you feel this business can get back to more of a GDP or a GDP plus growth environment versus the declines we've seen year to date?

  • - Chairman, President & CEO

  • Eric, let me take a stab at that.

  • Longer term, we feel very strong, very bullish on the Intermodal product in general.

  • That, in the long run, is going to be driven in large part by US consumers, and consuming both international product as well as domestic product.

  • It's also predicated on our ability to have a service product that can penetrate against a truck.

  • And all of those secular dynamics are set up positively for the long run.

  • In terms of dislocations that are happening in the short term, it's hard to time things out.

  • It's very dependent on what happens in the US economy, what the jobs picture looks like, what the earnings picture for consumers look like.

  • What the US dollar is doing.

  • Absent all that, we're focused on controlling what we can control.

  • Which is an excellent service product, we have got the best franchise from a domestic and international Intermodal perspective in the US, and that will serve us well over the long run.

  • - Analyst

  • Okay, great.

  • And maybe to follow-up on that.

  • Looking at your Intermodal business today, I know it varies by lane.

  • But what is the average discount for Intermodal versus truck in your network today?

  • And longer term, where do think that percentage could go without causing a significant slowdown in Intermodal volume growth?

  • - EVP of Marketing & Sales

  • We have said historically, 15%, 20% is a rough rule of thumb.

  • It would be part of our core strategy, of course, to minimize that as we increase our value proposition.

  • - Analyst

  • Okay, great.

  • I will leave it at that.

  • Thanks for the time.

  • Operator

  • Alex Vecchio, Morgan Stanley.

  • - Analyst

  • Good morning, and thanks for taking my questions.

  • So you guys have obviously made a lot of progress on aligning the resources in light of the softer volumes.

  • And I know the volume outlook is uncertain in a lot of areas right now, and it's tough to actually point to what might drive an acceleration.

  • But should volumes actually start beginning to surprise to the upside in 2016 for whatever reason, how do we think about your ability to leverage the resources you have right now?

  • And do you feel like there's a lot of operating leverage in the business in where your resources are currently?

  • Or would you anticipate you'd have to add back pretty aggressively?

  • I know it depends on what the volumes actually translate, but how do we think about the operating leverage in the model if volumes actually do surprise to the upside?

  • - Chairman, President & CEO

  • Alex, we would welcome nothing more than a surprise on the upside in terms of volume next year.

  • We are well positioned to be able to absorb that into the existing network.

  • Cameron has got adequate locomotives and crews ready all around the network to be able to handle an uptick.

  • The fluidity of the network would be able to absorb it rapidly.

  • He and the operating team have done a great job in terms of getting the terminal and yard productivity up.

  • And we would be able to bring in cars readily into that environment and handle it fluidly.

  • And between Eric and Cameron and the rest of the team, they've done a stupendous job on stabilizing our train plan, and making sure that it's robust enough to be able to handle some incremental growth.

  • That would have significant leverage for us, and we would welcome it.

  • - Analyst

  • Okay, that makes sense.

  • And then my second question here on -- you suggested that there were some headwinds in the fourth quarter, and that earnings per share would probably be down on a year-over-year basis.

  • Can you help us think directionally relative to the 2% decline that you saw in the third quarter?

  • Can we expect another similar low single-digit decline in the fourth quarter, or probably a bit of a worse year-over-year move there given some of the puts and takes?

  • - CFO

  • Alex, this is Rob.

  • What I'm calling out there, we'll see how the world actually plays out in terms of volume.

  • But as we look at this point, without giving precise earnings guidance, it does look like we're going to have a bigger headwind in the fourth quarter on mix year over year.

  • And the reason for that is last year's mix actually was quite favorable.

  • And if you look at the business, we were running sand fairly strong, coal was relatively strong, ag was a pretty positive mix player.

  • And those are things that we just don't see repeating in the fourth quarter.

  • In addition, as I called out, we see a headwind year over year in fuel.

  • Because last year's fourth-quarter we got the benefit of about $0.05 of the timing of fuel in the fourth quarter of last year, which we don't see that repeating again this year.

  • So I am calling out that year over year, it does looks to us like the fourth quarter does have some bigger challenges then frankly the third-quarter did.

  • - Analyst

  • Okay, that makes sense.

  • Thanks very much for the time.

  • Operator

  • Chris Wetherbee, Citigroup.

  • - Analyst

  • Thanks, good morning.

  • I wanted to talk a little bit about the coal network, and the outlook for next year.

  • Obviously, still some challenges, particularly market share relative to natural gas.

  • When you think about the network, one of your Eastern competitors has started to make some changes in terms of the network that's a little bit more structural in nature.

  • I'm curious from your perspective how you think about that as you look out to 2016 and maybe beyond.

  • Given the coal outlook, are there things that need to be done there, or things that you could do to potentially improve that value proposition there?

  • - Chairman, President & CEO

  • Chris, before I hand over to Cameron for a little more technicolor, the thing to note about our coal network is it's largely run on a shared network.

  • We have made fundamental adjustments in resources that reflect coal being down, you see that in our adjustments to the TE&Y craft, to locomotives, it's also embedded in some of the cars that we have stored.

  • We're constantly looking at our assets as they are currently deployed to make sure they fit the demand profile a for commodity like coal.

  • Cameron?

  • - EVP of Operations

  • You're exactly right, Lance.

  • And our coal network is truly built out.

  • So for us, it's really more of how we manage the fungible assets around locomotives and crews.

  • And we'll continue to do that.

  • Having said that, we'll continue to study the assets around our coal network and react appropriately.

  • - Analyst

  • Okay.

  • That is helpful color, I appreciate it.

  • And then, Rob, coming back to you on the buyback just for a second.

  • Obviously, you'd talked about it not being a run rate in the third quarter, and that makes complete sense to me.

  • If you could you help us maybe think about how you might be opportunistic going forward?

  • I guess I just want to get a, maybe a rough sense of maybe how you view that proposition as you think about this quarter and next in terms of the buyback and the run rate we should be expecting.

  • - CFO

  • Chris, you probably could write my answer here and what I'm going to say.

  • Without giving precise guidance, because in terms of what we're going to buy back because we don't do that.

  • We certainly value and understand the value of a continued buyback program, and we have walked our talk there.

  • And as we've always said, we will be opportunistic in the marketplace based on factors like the price of the stock.

  • So all those are factors in terms of how it will look as we play out into the next several quarters.

  • We're going to continue to take the same mindset, if you will, in terms of how we approach the opportunity and approach how many shares we actually do buyback.

  • - Analyst

  • Okay, that makes sense.

  • Thanks very much, guys, appreciate it.

  • Operator

  • Bascome Majors, Susquehanna.

  • - Analyst

  • Good morning, guys.

  • I want to ask another one on coal here.

  • How much of the mid teens volume decline that you're tracking toward for this year would you attribute to the year-over-year decline in natural gas prices?

  • - EVP of Marketing & Sales

  • Bascome, this is Eric.

  • It varies.

  • I would say the vast majority of the decline is in some way or the other attributable to natural gas prices.

  • As you know, there are different ISO regions that we operate in, and the impact of natural gas is different in those regions.

  • But I would say the vast majority is attributable at the end of the day to the competitiveness of coal with natural gas with one other factor.

  • And that is being our export coal market just the worldwide export coal prices, that's also a factor.

  • - Analyst

  • Understood, I appreciate that.

  • And just to follow-up, I know there's a lot of significant moving parts.

  • But say natural gas prices are flat next year, so you don't have that magnitude of a year-over-year headwind on that front.

  • And winter is normal.

  • Roughly speaking, what kind of 2016 coal volume outcome are looking at here?

  • Is a situation where you could be down double digits again?

  • Or is mid single digits more of what you guys are planning for?

  • - EVP of Marketing & Sales

  • Bascome, as I mentioned earlier, one of the other factors that is a factor is the current level of coal inventories that at the end of the third quarter, they're 30 days higher than where they were last year.

  • And 20 days higher than average a five-year average.

  • I would say it's a fair expectation to assume utilities would work those down.

  • Not only maybe even to the averages, or below the averages if they are trying to be in an inventory management mode.

  • - Analyst

  • Understood.

  • I appreciate the time this morning.

  • Thank you.

  • Operator

  • Brandon Oglenski, Barclays.

  • - Analyst

  • Good morning, everyone, and congrats on a good quarter here.

  • I know cutting budgets can be pretty difficult.

  • Lance, by my calculation, it's been about 12 minutes since you got a question on pricing, so I'm going to come back to it because I honestly think that's probably the biggest concern for your shareholders right now.

  • But I just want to ask a more general question about the industry right now, because it's two parts here.

  • If you look across the industrial landscape, we're definitely seeing deflationary pressure for a lot of your companies.

  • Energy CapEx is likely be down again next year, an obviously commodity prices are a lot lower.

  • So there's just less value to extract from that supply chain when you think about it holistically.

  • But then secondly, the industry obviously has an issue with PTC.

  • Where [laid ran] into a wall, that was probably poorly written.

  • But nonetheless, in this environment where your customers are facing a lot of challenges and we do have revelatory issues.

  • How do we balance the reinvestment, the service, and the price equation such that we try to keep all the constituents happy?

  • - Chairman, President & CEO

  • That's an excellent question, Brandon.

  • One that we're constantly working on.

  • Our primary focus, first and foremost, is a robust, reliable, excellent service product.

  • And in that context, it's making that service product better than the alternatives.

  • That puts us in a position to be able to secure a price premium.

  • And that represents the value of that service product.

  • So long as we're in that position, then we can handle the rest of the pressure points appropriately.

  • When it comes to regulation, our best defense in a regulatory environment is happy customers, and customers that are getting an excellent service product.

  • That won't stop the conflict around the pricing discussions that we have.

  • It won't stop regulators from wanting to find ways to regulate us.

  • But it will stop some of the pressure, and that's our biggest defense.

  • It's the one we focus on most.

  • - Analyst

  • I appreciate that.

  • Is there a risk here though that if we face further declines, which it feels like we are in the fourth quarter, that this whole process just takes a little bit slower pace in terms of railroad margin improvement, return improvement?

  • Just understanding that we have a lot of other pressures across the industrial landscape.

  • - Chairman, President & CEO

  • We are keenly focused on making sure we generate a really attractive return on our invested capital.

  • Embedded in that is trying to make sure we continue to improve our margins.

  • I think we've outlined today that there are ample opportunities to continue to make that happen.

  • One of them is price, but it's only one of the mechanisms.

  • And that's what we are focused on.

  • - Analyst

  • I appreciate it.

  • Operator

  • Cherilyn Radbourne, TD Securities.

  • - Analyst

  • Thanks very much, and good morning.

  • So you've cited high retail inventory levels of volume impediment for the last couple of quarters.

  • I'm just curious how far along you think we are in drawing down those inventories and putting the inventory correction behind us?

  • - EVP of Marketing & Sales

  • We've actually only mentioned it this quarter, and a little bit last quarter.

  • It really depends on the consumer.

  • Consumer confidence does appear to be strong.

  • There does appear to be a trend where consumers are paying down debt and spending on non-product things like data, internet, healthcare services, et cetera.

  • I do think if you talk to a lot of the BCO's and the retailers, they do have an expectation that with consumer confidence remaining strong, there should be a pickup during the holiday season of sales.

  • But time will determine whether or not that happens.

  • - Analyst

  • That is helpful.

  • And just a very quick one on cost.

  • You called out $50 million of inefficiencies last quarter, which was down from $100 million in the first quarter.

  • Wondering what fell in the third quarter, if anything?

  • - CFO

  • Cherilyn, this is Rob.

  • Yes, we make good progress on that.

  • And remember that marker that I was sharing with you in the first and second quarter was against the previous year.

  • And we feel very good about, as Cam walked through, we feel very good about the third-quarter progress we made in better aligning our resources.

  • Having said that, we're not done.

  • Last year was not the end of the game.

  • So we still see opportunities for us to continue to squeeze out productivity initiatives on multiple fronts, and we're going to continue to do that.

  • But in answer to your direct question of compared to what I showed you last quarter on the year over year.

  • We made very good progress in taking out those inefficiencies that we showed you in the second quarter.

  • - Analyst

  • Okay, thank you.

  • That's my two.

  • Operator

  • John Barnes, RBC Capital Markets.

  • - Analyst

  • Thank you.

  • Looking at a couple of the carload outlooks on the positive side that you provided, I think the one think that's starting to get a little bit of attention is the auto side.

  • And I know, right now, auto continues to be very strong, but with a SAR that's at the historical upper end of the range.

  • Any concern there that if you see a bit of a correction and maybe a more normalized level of production, and especially given the case you mentioned.

  • You've got retooling going at a couple Mexican facilities for GM and Chrysler.

  • Is there any concern that you start to see maybe some of that growth in the auto sector slack off as we go into the new year?

  • - EVP of Marketing & Sales

  • John, I think it's a great question.

  • Certainly, as you mentioned, the SAR's rate is at barn-burner rate.

  • The amount of debt associated with auto loans is at a, I think a historic high rate.

  • I think the auto manufacturers would still be pretty bullish because of the features that they think they're providing to the consumer and the average age of automobiles out there.

  • But the sales rate is at a high number, and so that by definition, would indicate a little caution and concern.

  • We don't have too much concern about model changeovers.

  • There is always model changeovers.

  • We see that year in, year out.

  • We have the benefit of a very broad, diverse autos franchise, and somewhere, there's always that happening.

  • So we don't see that as too big an issue, but certainly the sales rate, the amount of debt associated with sales, you could say is something to watch out for.

  • - Chairman, President & CEO

  • John, regardless of what SAR is, what we really are pleased with is the UP automotive franchise.

  • It's outstanding, it gives us great access to Mexico with products produced in Mexico.

  • It gives us great access to the ports of products produced overseas and imported.

  • And we have an excellent distribution system for finished vehicles in the Western United States.

  • We're in a very good place when it comes to the automotive franchise.

  • - Analyst

  • No doubt, and I'm glad to see taking advantage of that now.

  • With a couple of the other pressure points out there and auto having been one of the bright spots.

  • I always get a little nervous about any time you see a trend line maybe begin to return to normalization.

  • That's the reason for the question.

  • One follow-up on the buyback.

  • Rob, you talked about opportunistic.

  • I'm just curious, have you done buybacks over time?

  • Have you ever gone back and done a look at the success of your buyback program as maybe a program done a little bit more ratable per quarter, or a little bit more consistent in terms of the absolute dollar spend or the absolute shares bought back?

  • Versus maybe timing it a little bit and being more opportunistic?

  • Have you ever looked at that?

  • Does that guide you at all in terms of how you approach your buyback effort?

  • - CFO

  • This probably won't shock you, but we look at it every day, and feel very comfortable that what we have done to date works for us.

  • And we're not changing our approach or how we look at it, but I understand the point of your question.

  • But rest assured, we look at what's the right way to deal with this, and we're confident that we're doing the right thing.

  • - Analyst

  • Very good.

  • Thanks for your time today.

  • Operator

  • Matt Troy, Nomura.

  • - Analyst

  • Thank you.

  • It's the housekeeping question.

  • I noticed in your commentary about expenses, specifically on comp and benefits.

  • You did not reference incentive comp accruals.

  • The other railroads it's been a tailwind to the tune of $0.02 to $0.06 and per quarter.

  • I'm just trying to think about forward modeling in fourth quarter.

  • Was there a positive impact that you just didn't call out, or is there potentially a larger true up that we would expect to see in the fourth quarter as we round the quarter into year end?

  • - CFO

  • Matt, this is Rob.

  • I don't see any -- I'm not calling out that there would be any change in terms of the direction we've been.

  • We have not changed our approach.

  • So I don't anticipate there being any big swing in that.

  • - Analyst

  • Okay, thank you for that.

  • And just the second question would be, on coal longer term, obviously, the Eastern rails have had to, are and will have to continue to live under the threat of environmental regulations.

  • Which basically call into question the viability of some their sourcing basins as well as their customers.

  • Some of the pushback we get from investors on Union Pacific is, hey, those guys are going to have to live through it through the next five years.

  • It's a long time ahead of us, but just want to get a sense.

  • Have you, at a high level, looked at whether it's plants being decommissioned, shutting down, or new gas-fired turbines coming online within your system.

  • What potentially just could be vulnerable of your existing business as we look out over, let's call it, a three-to-five-year basis in terms of just sourcing switches or just the viability of certain customers?

  • Thanks.

  • - EVP of Marketing & Sales

  • Matt, this is Eric.

  • We look at that in depth continuously as part of our strategic and tactical analysis of our markets.

  • I would say that at a high level, coal continues to represent on going forward probably a necessary minimum third of electrical generation in the US.

  • Short of some new technology, I'll call it Star Trek technology, just for shorthand purposes.

  • Coal of necessity is going to be a part of the electrical generation of this country for the foreseeable future.

  • And so I think you could perhaps see coal get to a minimum of, call it, a 30% market share.

  • But short of some really new generational technology, I think it will right now for the foreseeable future that's probably the minimum that it will be.

  • - Chairman, President & CEO

  • Matt, this is Lance.

  • So I want to provide a little editorial comment as well.

  • I think the United States is blessed with the coal reserves that we are, and our ability to generate electricity with coal relatively cleanly.

  • And it's never been as clean as it is today.

  • It would be a mistake from the US economy perspective, our competitiveness globally, to continue to regulate that out artificially.

  • I think we have to work on continuous improvement with the emissions from coal-fueled generation, but it would be a mistake to artificially retard that too much.

  • - Analyst

  • Understood.

  • Thanks for the detail, everyone.

  • Operator

  • Cleo Zagrean, Macquarie.

  • - Analyst

  • Good morning, and thank you for your time.

  • My first question, also on price.

  • Against very strong yield ex-fuel this quarter, the relative weakness in Automotive and Intermodal.

  • Could you please comment on the drivers there?

  • Whether it's manly mix or competitive dynamics, and how you expect them to play out into next year?

  • And specifically, do you expect domestic Intermodal to grow more strongly than international with potentially positive impact on price?

  • Thank you.

  • - EVP of Marketing & Sales

  • Cleo, the numbers that you see in Autos and Intermodal from an arc yield standpoint is really hindered by the fuel [first] surcharge reduction.

  • That's more than 100% of that impact.

  • - Chairman, President & CEO

  • And her second question was Mexico versus international on Intermodal?

  • - Analyst

  • No, just the (technical difficulty).

  • I simply added back an estimated 4%, 5% fuel impact to each of the price per ton mile numbers that we see there.

  • And I appreciate that fuel impact would be different across [fade] categories, but so maybe then you could comment -- is it are we missing something by seeing Auto and Intermodal as weakest in terms of yield per mile year on year?

  • And then my second question was, whether domestic should grow faster.

  • Domestic overall, then international next year, and that gets some help through pricing overall from a mix perspective.

  • Thank you.

  • - CFO

  • Cleo, this is Rob.

  • Let me take that first question.

  • I would caution you not to just use a straight line numbers on there.

  • Because I think the piece to answer your question, what are you missing, I think what you're missing in that analysis is mix.

  • Mix has an impact within each of the commodity groups in terms of what ends up being reported as average revenue per car.

  • On top of each of their individual impacts from the fuel surcharge.

  • So I would just caution you that there are differences within each commodity group.

  • - EVP of Marketing & Sales

  • And as you know, we're not going to give guidance in terms of pricing in the future.

  • We do think that the domestic Intermodal market should continue to have strong pricing opportunities in two thousand -- as we go into the future.

  • - Analyst

  • Okay.

  • But faster or slower than international with all the noise we had this year?

  • - EVP of Marketing & Sales

  • There's a lot of input, a lot of ins and outs that happen.

  • There are a lot of dynamics, as you know, going on in the international Intermodal market.

  • That are dynamically driven by other countries and steamship liner carriers.

  • We feel good about our value proposition.

  • We feel very good about our domestic Intermodal franchise, and our ability to get price in that.

  • - Analyst

  • Appreciate that.

  • And the second question relates to CapEx.

  • Can you please remind us of the share that you considered discretionary versus maintenance or required additions?

  • Given the shifts in the geography of demand, and highlight for us those discretionary areas in which at appears prudent to step back at this time.

  • Thank you very much.

  • - Chairman, President & CEO

  • Cleo, we have historically said and I don't think it's changed much, to maintain what we've currently got is about a $2 billion plus/minus number.

  • And after that, it's things like technology, PTC, capacity additions, commercial facilities, new equipment, et cetera.

  • - Analyst

  • Would you be willing to share as if you're speaking to an engineer, what areas would you like to -- you think you see may be prudent for -- as the best candidates for [retraunching] next year?

  • - Chairman, President & CEO

  • As we're making our capital plans next year, we're constantly evaluating both capital productivity in terms of dollar per unit that we put in the ground or buy, and where exactly we're putting it.

  • So I won't make any commentary on exactly what those plans look like.

  • - Analyst

  • Okay, thank you.

  • Operator

  • Ben Hartford, Robert W Baird.

  • - Analyst

  • Thanks, good morning.

  • Rob, a quick question.

  • Just wanted to get your perspective on the risks to continue the return on assets improvement for the rail line.

  • You've done a great job doubling it over the past seven years.

  • We've talked a lot about pricing on this call.

  • But if you think about just the three simple factors to drive that higher going forward pricing volume growth and service improvement.

  • In your mind, what is the biggest risk or point of concern, from your perspective, as it relates to inhibiting continued ROA improvement for the rail lines of those three fundamental inputs?

  • - CFO

  • You're exactly right, Ben.

  • That the levers as you've heard us talk and as you fully understand, the levers that drove us from were we once were to where we are today are productivity, which is driven by the service.

  • That service also enables us to get the right price in the marketplace, and volume is always our friend in that calculus.

  • We're going to control those that we can best control.

  • So I would say, frankly, the biggest risk I see at this point is that which we have less control on and that is the economy.

  • And what that then gives us in terms of volume to play with.

  • But as I've said many times, and you've heard us say, we're not going to use the lack thereof of volume to slow us down on our initiatives to continue to make progress on that which we can control.

  • But that's what we're going to continue to do, as we have over the last decade.

  • - Analyst

  • Okay.

  • That's helpful, thanks.

  • Operator

  • Jeff Kauffman, Buckingham Research.

  • - Analyst

  • Boy, you guys are popular.

  • Congratulations.

  • Question for Eric, broader picture.

  • As we look at the four areas that are the biggest areas of the volume decline right now.

  • So I'll throw coal in there, metals, crude and frac, when are you hopeful that you'll start to see positive year-to-year comparisons?

  • And then I have a follow on related to that.

  • - EVP of Marketing & Sales

  • I think as we've been saying throughout the call, there is uncertainty about the going-forward outlook in all of those.

  • And I'm not sure our prediction -- ability to predict is any better than anyone else.

  • Certainly, the strong dollar is impacting our metals steel business, our domestic metal steel business.

  • Oil prices will be a direct factor in terms of the amount of drilling, the amount of crude-by-rail, and the natural gas will be a direct driver in terms of the amount of coal.

  • So at those points, an ability to predict those items, I'm not sure I have any better ability than anybody else in the marketplace to do that.

  • - Analyst

  • I was curious your view.

  • Let me just follow up on that.

  • The question was asked earlier, you are attacking the variable costs and you're getting a lot more momentum with that.

  • I think you mentioned we're not going to do much with the fixed costs in the coal network.

  • But as you look at the railroad and how these business units have changed over the last 12 months.

  • Where do think there are opportunities to attack the fixed cost infrastructure beyond taking down employees and taking down locomotives and assets dedicated to it?

  • - Chairman, President & CEO

  • Jeff, this is Lance.

  • I don't think we said we're not going after fixed cost.

  • We focused the commentary on some of the variable costs.

  • But where we have opportunity to, for instance, reduce our CapEx, or for instance reduce the physical footprint of shops that maintain locomotives or other areas like that, we're going to take advantage of those as well.

  • I think what we were trying to impart is that our coal network is not isolated and independent from our overall network.

  • And so it would be very hard to tease out individual physical assets, hard assets, that are completely dedicated to coal and isolated on their own.

  • - Analyst

  • So hence the shared network comment.

  • Lance, thank you.

  • Operator

  • Don Broughton, Avondale Partners.

  • - Analyst

  • Good morning, everyone.

  • Real quick, I'm just trying to do some back of the envelope math here.

  • And I look at what's been a 40% decline in fuel, and that's translated into essentially what is a 7.9% headwind in pricing.

  • If I look at your reduction in yield, realized and the core pricing of 3.5% that you stated.

  • Would that imply that you would, even if fuel were to go flat from current levels, that at least in the early part of the next year, you would have to -- I was looking at a 16% decline in fuel.

  • You'd have to achieve essentially a 3.2% or higher core pricing in order for pricing realized to be flat?

  • - Chairman, President & CEO

  • Rob?

  • - CFO

  • Don, you may have stumped me in terms of the actual numbers that you just worked through, because I frankly was not following you.

  • - Analyst

  • Relatively speaking.

  • - CFO

  • But I would say that mix is clearly a factor in that.

  • So be careful in your analysis to factor that in.

  • And again, all I would say about the pricing is we're going to continue to focus on driving value to our customers, continue to drive productivity, and continue to drive price where we can in the marketplace.

  • We know that the underlying value of our service product to our customers is a key component of that, and it all hangs together there.

  • So we're going to continue to focus on driving as much as we can on it.

  • So even with the best service available, are you going to be able to go to customers whose volumes are down in the high single-digit, low double-digit range, and ask for and receive better than 3% pricing?

  • - Chairman, President & CEO

  • Don, this is Lance.

  • There is never a conversation that our commercial team enters into with a customer on price, that is easy.

  • It doesn't matter if their volume is up or their volume is down.

  • Clearly, Eric and his team and in the environment that we're in right now have secured what in the third quarter a 3.5% core price.

  • And in the previous quarters, as much as 4% core price.

  • None of that came easy or was a lay up, and I expect them to continue that good hard work into next year, securing an appropriate price for the value that we represent to our customers.

  • - Analyst

  • Fair enough.

  • Good luck.

  • Operator

  • This concludes the question-and-answer session.

  • I will turn the floor back over to Mr. Lance Fritz for closing comments.

  • - Chairman, President & CEO

  • Thank you very much, Rob, and thank you all for your questions and interest in Union Pacific this morning.

  • We look forward to talking with you again in January.

  • Operator

  • Ladies and gentlemen, thank you for your participation.

  • This does conclude today's teleconference.

  • You may disconnect your lines, and have a wonderful day.