CN Third Quarter 2020 financial results conference call will begin momentarily. I would like to remind you that today's remarks contain forward-looking statements within the meaning of applicable securities laws. Such statements are based on assumptions that may not materialize and are subject to risks described in CN Third Quarter 2020 financial results press release, and analyst presentation documents that can be found on CN's website.
As such, actual results could differ materially. Reconciliations for any non-GAAP measures are also posted on CN's website at www.cn.ca. Please standby your call will begin shortly. [break].
Okay, thank you, Patrick. Good afternoon, everyone, and thank you for joining us for CN's Third Quarter 2020 earnings call. I would like to remind you about the comments already made regarding forward-looking statements.
With me today is JJ Ruest, our President and Chief Executive Officer, Ghislain Houle, our Executive Vice President and Chief Financial Officer, Rob Reilly, our Executive Vice President and Chief Operating Officer, Keith Reardon, our Senior Vice-President, Consumer Products Supply Chain, and James Cairns, our Senior Vice-President, Rail Centric Supply Chain. I do want to remind you to please limit yourself to one question so that everyone has the opportunity to participate in the Q&A session.
The IR team will be available after the call for any follow-up questions. It is now my pleasure to turn the call over to CN's President and Chief Executive Officer, JJ Ruest.
Well, thank you, Paul, and thank you everyone for joining us this evening. We hope you're enjoying a safe fall and making sure that all of your family is staying in good health. The economy recovery is underway. Looking back at Q2, the team acted very swiftly, thanks to our very engaged and adaptable CN railroaders. They are truly some of the essential services hero of this pandemic. Q3 was a quarter of sequential recovery. The recovery is underway since the month of July. The operating metrics are improving.
We brought many of our employees back to active service, we added train start. Kudos to the entire team for producing an operating ratio of 59.9. The recovery has a different mix of business. Some market recovered fast in V-shape, some market have yet to recover. All of this evolved into a different mix of revenue ton mile as compared to the pre-pandemic, with a significant decline in the crude and significant increase in Canadian grain.
CN capacity is precious, and the team, as always, is proactively making decisions so the right value quality freight is on our network in the quarters to come and to ensure that we optimize the return of our investment in the business and our return to shareholders. We consistently target same store price ahead of rail inflation, and we achieved that in the third quarter again. Our focus remains very much on the long-term strategy on the positive secular trend that we intend to ride.
For example, the growing North American consumer economy, the secular shift to East Coast trade, the unique cost of the freight sales by competing channel. On that note, I will pass it on to Rob. Rob?
All right. Thank you, JJ. I also want to thank our team of essential railroaders for their efforts, not only this past quarter, but since the pandemic started in keeping the critical supply chain open in North America. We really have not missed a beat. That is a credit to the men and women of CN. As JJ mentioned, we saw a sequential recovery month-over-month during the third quarter.
The team quickly adapted in right-sizing resources to the demand along the way. We have brought back crews, locomotives, and cars to handle the volumes that are disciplined throughout this pandemic. Our structural changes implemented means that we're able to move similar volumes this year versus last year with lower labor costs. Over the past several months, we've idled multiple locomotive shops and switching yards that have remained closed.
We completed consolidation of our Canadian dispatch offices from three offices into one location in Edmonton, which allows us to run the network more efficiently. During the quarter, we were able to reduce our crew starts by 14%, while our volumes dropped 7%. Our focus on increasing train length paid off as we increased train length 6% during the quarter, allowing us to move more freight with fewer crew starts.
As volumes return during the quarter, we've also seen our key metric on car velocity improve since the end of July by 25%, as our network remains very fluid going into the winter months. The team's efforts on fuel efficiency continue to pay off as we set new all-time records for fuel efficiency in every month in the third quarter, leading to a new best ever quarterly record. Our efforts so far this year have saved close to CAD 35 million in fuel expense and avoided over 162,000 tons of CO2 emissions from our fuel efficiency initiatives alone.
We are the North American railroad leader in locomotive fuel efficiency, and we have every intention of maintaining that leadership. Our efforts underpin our firm belief that rail is part of the climate solution and recognizes that the best way to reduce our carbon footprint is to continuously improve our fuel efficiency. As planned, we increased our engineering work block production with unit costs for rail and tie installation declining due to disciplined execution of our engineering teams and dispatch centers.
This has allowed us to get the work done at lower costs with fewer resources needed. Most importantly, I'm pleased to report the team's relentless focus on safety through the pandemic has resulted in both our personal injury ratio and train accident ratio improving by 19% and 22% respectively, as running a safe railroad for our employees, our customers, and the communities we operate in remains as a core value in everything we do.
Despite the volume fluctuations we have seen, we have pushed forward our agenda on the modernization of our railroad operations on everything from robotic process automation of everyday tasks to the use of machine learning and artificial intelligence in how we inspect our tracks and cars.
Our autonomous track inspection program is entering into phase II in the U.S. Our cars are now covering our core routes every week from the Atlantic Ocean to the Pacific Ocean and down to the Gulf of Mexico, making our railroads safer, unlocking capacity, and reducing costs. The railroad is fluid and prepared for the winter season ahead. The record grain harvest is evidenced by the fact that the CN team has now delivered seven consecutive all-time monthly records for the movement of Canadian grain.
We're on track to deliver an eighth straight record month here in October. As I turn this over to James, let me reiterate that we remain nimble and responsive to aligning resources to demand and maintaining a very positive momentum on fuel and labor productivity. With that, I'll turn it over to James.
Thank you, Rob. During Q3, we experienced a V-shaped recovery in our ports business, lumber, and automotive, while we saw weakness in crude, frac sand, and refined petroleum products. Demand for Canadian grain, which is not tied to the economy, hit record levels, and as Rob said, we delivered, setting seven consecutive monthly records. As we manage through this uneven recovery, we will drive hard on key markets, including Canadian grain, Canadian coal, and propane.
Let me now discuss in further detail some of the topics on the carload side of the business. As I mentioned, Canadian grain continues to be a bright spot for CN, with our best third quarter volume on record, beating the previous best in 2014 by 13%. U.S. grain was also very strong and finished well ahead of last year. Canadian coal was negatively impacted by the temporary closure of CST and Coal Valley mines and the permanent closure of Teck Cardinal River Mine.
Forest Products ramped up sharply in Q3 as our customers brought back idle capacity to take advantage of strong construction activity. Crude, frac sand, and refined petroleum products, which are long-haul, heavy tonnage segments, were the weak outliers in Q3, contributing to the shift in our overall business mix for the quarter. The positive momentum we saw in Q3 will help us finish the year out strong and position us well for 2021.
We are the dominant player in the Canadian forest products market and see an out weighted benefit as this market recovers. We have brought back all the lumber cars that were in storage, and we recently added 500 additional lease cars to meet spot demand at auction prices. Canadian grain and U.S. grain are expected to be growth drivers in Q4 and 2021. The Canadian crop may hit an all-time record, and the U.S. crop is expected to be above average.
The step function change in grain supply chain capacity has been years in the making, and we are investing alongside our customers. We have purchased 2,500 new high-capacity grain hoppers, and our customers have also invested in new private fleet of similar high payload cars. By the end of Q1 next year, we will have over 4,200 new high-capacity hopper cars cycling on our network.
We also expect to take advantage of the 50% increase in grain West Coast export capacity, all exclusively and physically served by CN, allowing us to move more grain faster using fewer resources. Our three-coast network reach is a long-term structural advantage that cannot be replicated. Propane export volume through Prince Rupert will continue to ramp up, and U.S. coal volumes will grow in Q4, driven by new petcoke volume moving from Chicago to the U.S. Gulf Coast for export.
International demand for wood pellets as a green fuel alternative is also strong, and we see this market as a unique opportunity for CN, with several new production projects in the works. We maintain a disciplined approach to pricing and upscaling our portfolio of customers and commodities to ensure the right value freight is running on our network. We are focused on managing mix in the face of a recovery that has not been consistent across segments. With that, I'll turn it over to Keith.
Thanks, James. Our engagement with our customers' supply chains enabled CN to fully participate in the strong recovery of the third quarter. Whether international or domestic-originated supply chains or the grocery business, the home improvement retailers, e-commerce, or bricks and mortar retail restocking, we were there to support all segments of the V-shaped bounce back in those markets.
As auto manufacturing accelerated, we successfully enabled our customers to meet the pent-up demand in North American markets. In Q3, our overall business mix was impacted by a surge in container imports on both the West Coast and the East Coast. Our year-over-year volume growth on the West Coast was driven from several of our ocean customers as they moved business from other gateways and supply chains.
The work stoppage at the Port of Montreal created opportunities for other East Coast gateways, leading to strong import volumes in Halifax and Saint John. It also benefited our CSX steel wheel interchanges from the ports of New York, New Jersey, and Philadelphia. We did experience a temporary and significant imbalance in traffic in Q3 as the rapid surge in imports was not yet matched with the loaded exports. We also experienced additional temporary imbalances related to the Port of Montreal disruption.
In automotive, we were faced with short-term headwinds as some manufacturers were shut down with retool for new models. Opening in December, our new auto compound in New Richmond, Wisconsin will serve the Minneapolis marketplace. Based upon strong feedback from our ocean customer base, we will also be providing intermodal service to that terminal as well. As the North American consumer market evolves, we continue to focus our efforts on yield and its many levers.
Technology advancements that we shared with you at our 2019 Investor Day are producing ongoing safety, security, and productivity benefits in chassis, containers, and cranes. Our ongoing efforts to continuously upscale our business and price above rail inflation will continue to improve our intermodal and automotive business margins as the consumer-based economy strengthens in North America.
Joint work with our supply chain partners to invest in the long-term future of our ecosystems continues, including with GCT at Deltaport and DP World at Centerm and Prince Rupert, to deliver those expansion plans over the next couple of years. Long-standing, successful, beneficial cargo owner relationships and service will continue to drive volumes through whatever waves that the economy presents us with in 2021. I will now pass it on to Ghislain for the financial perspective.
Thanks, Keith, and good evening, everyone. My comments will start on page 10 of the presentation with highlights of our third quarter performance. Throughout the quarter, as we saw sequential improvements in volumes each month, we remained disciplined and focused on tightly controlling our costs. We continue to adjust our resources for the recovery in certain markets while being mindful of the mid to long-term opportunities that are in front of us. Revenues for the quarter were down 11% versus last year at just over CAD 3.4 billion.
Volumes in terms of RTMs were down 7%, while revenue per RTM was down 3%, impacted by significant changes in business mix. Operating income was almost CAD 1.4 billion, down 15% versus last year. Our operating ratio was 59.9%, up 200 basis points versus last year. Net income was CAD 985 million, down CAD 210 million. Change had no material impact on our financial results in the quarter. Turning to page 11, let me highlight a few of our key expense categories. Labor and fringe benefit expense was 5% lower than last year.
This was mostly driven by 15% lower average headcount in the quarter versus the prior year, partly offset by higher incentive compensation related to period-over-period adjustments to accruals. Purchase services and material expense was 11% lower than last year. This was mostly the result of lower outsource services, lower trucking and transload expenses, and lower material costs. Fuel expense was 33% lower than last year, driven by a 26% decrease in price, 9% lower workload, and an all-time record quarterly fuel efficiency.
Moving to cash on page 12. Free cash flow was close to CAD 2.1 billion through the end of September, almost CAD 600 million higher than the same period last year, resulting in a significant year-over-year improvement in free cash flow conversion. We fully expect to achieve in excess of the CAD 2.5 billion in free cash flow for the year. At the end of Q3, our leverage in terms of adjusted debt to adjusted EBITDA was 2.17 times, slightly higher than our two times target.
For financial prudence, the company will continue to pause its share repurchases. We will, of course, reassess on an ongoing basis. As you will recall, we withdrew our full-year guidance on our Q1 earnings call. Given that we now have nine months of actuals and that we report weekly volumes, we see limited value in reinstating our guidance at this time. That being said, with the volume recovery that we have seen sequentially and the good momentum so far in Q4, we are aiming to provide annual guidance for 2021 on our upcoming January call.
We continue to reward our shareholders with consistent dividend growth. To conclude, as we are experiencing a sequential improvement in key markets, we continue to tightly control costs as volumes rebound, we are seeing good momentum in operations. We are supporting the volume recovery in certain markets, we remain confident in our ability to deliver value to our long-term shareholders. On this note, back to you, JJ.
Thank you, Ghislain. I'm going to wrap this up quickly. We can go to your question. In the second quarter, kudos to our women and men at CN, who demonstrated our resiliency. In the third quarter, we experienced a recovery of a different kind of business, which impacted our new mix of business, and the commercial team is proactively managing for the right book of business to be running on our railroad. Going forward, capacity is valuable again to deliver good long-term value for our shareholders. Patrick, we're going to turn back to questions.
Thank you. Please press star one at this time if you have a question. The first question is from Ken Hoexter from Bank of America. Please go ahead.
Hey.
Good afternoon, Ken.
Good afternoon. Thanks, JJ. I just want to hit on that last point. Ghislain, you talked about if you're seeing some improving performance, maybe just to step back and think about your why pause on the share repurchases or what's magical about the two times EBITDA. I just want to understand the confidence you have in the sequential growth you're seeing and the acceleration we should expect into 4Q and into 2021.
Ghislain?
Thanks, Ken, for the question. I think we see the recovery loud and clear in certain key markets, and I know Keith and James touched upon it. As you know, Ken, we've always used share buyback as a very flexible tool to get to a targeted leverage level. Our targeted leverage level has always been internally, and we've communicated this to the market, 1.7- 1.9 times. In my remarks, I rounded it to two, I think we're comfortable. Since we're already over the two times, we're at 2.17, as I alluded at the end of Q3.
I think that we think we're in the right position, frankly, we like to have a strong balance sheet. We saw that loud and clear in the second quarter going through this pandemic. It created a lot of benefits for us. As you know, we went out to the market and actually issued a $600 million 30-year paper or bond at 2.45%, which was the second lowest coupon of any corporate in the U.S. We see value in having a strong balance sheet. You're right, the 2.25 is the limit that we have that supports our credit rating.
Targeting around two is good, and we feel good about that. Stay tuned. The fact that we're not reinstating at this point our share buyback is far from being a lack of confidence in us looking at the recovery. It's just because, again, we're where we are, a little higher, and stay tuned for what we're going to do for 2021.
Thank you, Ken.
Thanks, Ghislain. Thanks, JJ.
Thank you. The next question is from Cherilyn Radbourne from TD Securities. Please go ahead.
Hello, Cherilyn.
Thanks very much, and good afternoon. In terms of the V-shaped volume recovery, which as we note, has been most pronounced in intermodal, P&C products and automotive, just curious if you have a sense for how much of that might be inventory restocking versus consumers pivoting their spending to goods over services. To the extent that it's restocking, how much of a backlog is there still left to move?
Keith, you want to address that?
Thanks, Cherilyn, for the question. It's a little of both. As we talk to our customers, most specifically our overseas customers, they're still seeing an opportunity for restocking, some say into the first quarter, that there's that much of a replenishment that's required. I also do think that trade for buying sprees versus going on vacations is happening. I'm sure it's happening in everybody's household on the call. We see a little of both there. Thank you. Good question.
Yeah. At the port right now, the business is still very high, right? The fall peak actually is lasting, and it will be a very stronger fall peak this year. Thank you, Cherilyn.
Thank you.
Thank you. The next question is from Ravi Shanker from Morgan Stanley. Please go ahead.
Thanks. Good morning, everyone. Ghislain, I get the logic of not introducing full-year guidance when you only have one quarter to go. Can you give us any color on kind of how we think of 4Q from here in terms of other incremental margins or OR? Given the pace of the volume recovery, do you expect a really strong fourth quarter, or how do we frame that at this point?
Yeah. Not even a quarter left to go, but Ghislain?
Ravi, we try to get away from quarterly guidance. I'll tell you, as I said in my remarks, we do provide our volumes both on carloads and on RTM on a weekly basis. If you look, I think our carloads now month to date in October, I think they're up 6% or 7%. I think we're doing quite well. James mentioned the fact that the grain has been a star commodity. Grain works. Whether there's pandemic or not, people need to eat.
Good news is on the significant investment that CN is making on the grain hopper cars, we will advance some of those cars that were slated to come in Q1. Actually, in January, we're going to advance about 800 of those cars in Q4, I think that will help get us started well on grain in front of the winter. Listen, I think, check our volumes every week, but I think right now we're quite positive and quite favorable on what's happening.
Yeah. Ghislain loves grain, and just as a reminder, I think this quarter, talking about mix, the KPI for volume to look to track would be more the RTM.
Yeah.
Thank you.
Great. Thanks, Ravi.
Thank you.
Thanks, Ravi.
Thank you. The next question is from Benoit Poirier, Desjardins Capital. Please go ahead.
Hello, Benoit.
Yes. Good afternoon, everyone. Could you talk a little bit about the fact that you've been short on resources in Q3, maybe quantify the impact on the OR and maybe also about the available resources, employees that can be bring back online with the number of cars and locomotives? Thank you.
That'd be a good question for Rob. We managed things quite tightly in the third quarter. You want to talk about the resource, Rob?
Absolutely, thanks for the question, Benoit. As you said, we saw sequential volume increases month-over-month-over-month in the third quarter. Actually entered the quarter on a depressed number. We were down 17% for the month of July. That improved to 9% in August, it was actually flat in September, we're up 6%-7%, as Ghislain just spoke to, in October. Actually managed it quite well. As stated, it was a V-shaped recovery. We had over 700 locomotives out of service, nearly 4,000 people furloughed and thousands of cars.
We mobilized that quite quickly and really have the railroad running very fluid. Throughout that, though, we were able to stretch ourselves as we said, we didn't bring back resources one to one, we found coming out of this V-shaped recovery, we can actually do more with less. We've had permanent cost takeout in terms of switching yards and locomotive shops shut down. We finished the consolidation of our dispatch centers. This time last year, we had three of those in Canada, now we have one.
We've actually done a really nice job. The velocity, train velocity, car velocity, and dwell are actually back up there to where they were at last year at this time. Really a heck of a job with a significant downturn in the second quarter, only to spike back here in the third quarter. Really proud of the team. Very proud of the team.
Yeah, of the return of a lot of our employees back to work, which I think is a good thing for a lot of families out there. The marketing team is asked to actively manage yield. It is one of our themes here in the quarters to come. Thank you, Benoit.
Thank you.
Thank you. The next question is from Chris Wetherbee from Citi. Please go ahead.
Hey, thanks. Good afternoon, guys.
Good afternoon.
Maybe touching a little bit on yields or cents per RTM and maybe kind of getting into the mix breakdown and maybe price and fuel. Can you sort of disaggregate a little bit of the cents per RTM for us? It seems like mix was a little bit of a bigger headwind for you. I just want to make sure I understand sort of what are the main drivers there and then maybe how you see that going forward. I know it's difficult to predict, but maybe sort of thoughts around fourth quarter.
Yeah. We've given a lot of thought to that. James, maybe you want to give the broader picture from the broader portfolio of CN?
Big picture, if you think about it, the mix change we had in Q3 was driven significantly by the decline in energy carloads, P&C crude, P&C carloads, crude, jet fuel, and the like, as you would expect. We reallocated that capacity to move a record amount of grain volume. We traded off some long-haul, 2,500-mile crude business for 1,200, 1,500-mile grain hauls. Moving forward, we think we're going to see a rebalancing, some of that crude business coming back.
Certainly not to that 2019 level, we're going to see a little bit of a rebalancing on mix. Keith, you want to talk a little bit about port side?
Sure. We love our overseas intermodal business and the fact that we have a very balanced approach. However, in the third quarter with the large influx of imports that happened very quickly, the boxes were not able to go through the supply chain and get the exports to go back out to match up one for one or on as much an equal basis as we normally have. That was another thing that hurt us that may have showed up in your RTMs as well.
A tsunami of import and quite a bit of a lag on export. A few train moving with empty platform, that was affecting the mix this summer.
Okay. That's helpful. Thank you.
Thank you, Chris.
Thank you. The next question is from Fadi Chamoun from BMO. Please go ahead.
Hello, Fadi.
Thank you. Hi, guys. Thank you for taking the question. I'm trying to square a little bit the differences. If I look at your quarter-over-quarter, like Q3 versus Q2, revenue increase and operating income increase, it seemed like incremental were under 50%, like high 40%. At the same time, it looks your operating metrics kind of performed really well in the quarter. Rob went through all this data on train lengths and weight and all this kind of stuff.
What explains kind of the muted leverage that we saw here in the third quarter, and how should we think about this going into Q4?
Ghislain, you want to talk about that?
Yeah, I think when you look at it, Fadi, there was some labor expense that came in that are not necessarily related to headcount. When you look at it, when we talked about the labor variance, there was about a CAD 30 million of two things. Number one, a reversal of a bonus accrual of last year of about a third of that. Then two-thirds of it was a true-up into our incentive compensation related to some performance share units.
That is a cost that came in, that's a variance that came in on a quarter-to-quarter basis that is not necessarily related to headcount. Again, depreciation continues to be a headwind. We've said that. We said it was CAD 130 million headwind at the beginning of the year, that hits you every quarter about evenly. The pension is a headwind as well, and we've said that pension was about CAD 50 million. I'll tell you, it's still about CAD 50 million. Those are some of the things that you may not see when you look at the metrics that are in our costs.
Maybe one last thing, Fadi. We've reopened our training center in Winnipeg and Chicago, meaning that we will have unproductive labor here because we are training people to meet the expected volume growth of 2021. They were closed second quarter and only reopened mid-summer. Thank you for your question.
Thanks, Fadi.
Thanks.
Thank you. The next question is from Scott Group from Wolfe Research. Please go ahead.
Hey, thanks. Afternoon, guys.
Hello.
I just want to go back to that last question, because I think he was asking about sequential incremental margins where depreciation was down and pension probably wouldn't be a sequential headwind. Ultimately, though, should we be thinking about give or take 50% incrementals or better or worse going forward? Maybe just two specific modeling questions. Other revenue was down 25% year-over-year, down sequentially. Any thoughts there? Comp per employee was up 12% year-over-year. Any thoughts there?
Ghislain, you want to expand on the earlier question?
Yeah, I think, as I said, the bonus and the accrual that I've just talked about in labor explains part of it for sure. I think that's what it is.
Thank you.
Just those other parts on other revenue and the questions on other revenue and comp per employee going forward?
James, you want to talk about other revenue?
Yeah, I think our vessel revenue was slightly down on a sequential basis, as would be expected. We came into COVID. I'm talking on the iron range here. We had a lot of activity on the iron range, very good results. We were drawing down the inventory at a very fast pace with our vessel fleet. We had a slight decrease on the vessel side of the revenue. The other revenue decrease, I'm not seeing that.
Yeah, we moved less iron ore by vessel.
Yeah.
In the third quarter than we did the year before. Yep. Okay, t hank you.
Thank you. The next question is from Walter Spracklin from RBC Capital Markets. Please go ahead.
Yeah, thank you very much. Good afternoon, everyone. I'd like to turn to Halifax, and certainly with the strike at the Port of Montreal, you had the opportunity to see how Halifax would react to some of the volume that was diverted there. Obviously, that was unexpected. Preparation obviously had to come in fairly quickly. JJ, when you look at and assess how Halifax did and how it stepped up with regards to when the Port of Montreal went down, how would you characterize it?
What was learned from that can be improved as hopefully volumes expand into the East? What capacity pinch points might you be able to address in the future?
Yeah. Maybe I'll take that one. We never served the city of Montreal as such. The Greater Montreal is always served directly with vessel coming in right into the city. We're usually not set up to serve the city 100% by rail from another port. With only a 72-hour strike notice, obviously, what ended up happening is that's one of the reasons why our mix in the third quarter was worsened, because we had to send empty train to Halifax to pick up the import, we have basically sort of a one-way freight.
The export were already in-gated at the port and couldn't get out of the port because of the strike. We were bringing freight to Montreal and as one-way freight and not a whole lot going back. From a profit yield point of view, this strike was not the best from a CN's point of view. The other thing is, when you get a 72-hour notice, and you have all this tsunami of freight coming at you on a short notice to our terminal in Taschereau, we had to open temporarily a terminal in Valleyfield.
We also had to open temporarily a ramp just close to the office here because of the one-time effect, if you wish. From a PSA and CN point of view, obviously, with a little more notice than 72 hours, we can move a lot more freight from the Maritime, and we could also move it very balanced with what typically will be coming out of Montreal. I'm not sure that this whole exercise was the conclusion of anything, because in strike time, we only get very short notice.
No customer really get the kind of service they would like to get when vessel are out of position and train out of position and terminal are not prepared for the labor required to respond overnight to something of that effect.
Yeah, like.
We did the best we could to help the city of Montreal.
Yeah. Walter, I'd like to add a little piece to that in that we're not a one-trick pony here. It wasn't just that we had vessels diverted to Halifax. We had vessels diverted to Saint John, which we handled very well. We also had vessels diverted to New York, New Jersey, and Philadelphia that we handled very well. We have multiple outlets for our customers at each one of our gateways where we can handle the freight. You have to take all of that volume together and look at it versus just one place.
That makes sense. Appreciate the color, Rob.
Thank you.
Thank you.
Thank you. The next question is from Brian Ossenbeck from JPMorgan. Please go ahead.
Hey, good afternoon. One more question on mix, but from the operational side. Can you quantify just how much impact that had in the system with the mix shift and some of the dislocations you saw during the quarter? I imagine that'd be more one time in nature compared to the top line impact. When you look at the service metrics for intermodal and bulk, both those were trending down year-over-year in the quarter.
Was that something that was impacted because of the mix shift or what caused that, and how does those look to start the fourth quarter?
Maybe, Brian, I can start and then I'll pass it on to James. The thing about the strike from Port of Montreal, that's obviously just a one time, right? They're back in operation, and actually one of the shipping line has added one call in Halifax as a result of their dissatisfaction with the fact there was a labor disruption. On the West Coast, there was a tsunami of freight coming in, and then it took a little while for the export to resume.
Our train balance is going to get a little better here at time, meaning that export from North America back to Asia will eventually get back to a level that is conducive to the amount of import. The real thing that is sort of secular that we have to work on is there's not as much crude, there's not as much diesel and jet fuel, there's not as much frac sand. That's a fact. It will take a while before the energy market recovers. We're going to be moving more domestic intermodal freight, more overseas freight, more grain.
Therefore, as I said earlier, when we allocate slot on the network, we want to be mindful of which train gets the green light and that each train that gets a green light is a train that's worth it to be on the network because we've invested capital money to create that capacity. Anything else you want to add, Keith, regarding when will export start to be more balanced with import?
They already are right now.
Oh, they are?
Yep.
Yeah.
We have a lot of boxes that are heading to the prairies to pick up exports, and all of our other transloads across our network. I would also say that, as James said, records again for grain movements. In the second quarter, we talked about record grain movements in containers. We didn't get as close to the record levels of containers with grain in them, but it was very close, up significantly over last year. I think we're there with the balance.
Brian, as far as how the railroad's running, we're very fluid and in really good shape going into the winter. We're actually handling more volume than we did this time last year, and really good shape. We've worked through it. Thanks, Brian.
Yeah. Very solid gross ton mile right now on the network. Thank you for adding that, Rob. Thank you, Brian.
Thank you. The next question is from Konark Gupta from Scotia Capital. Please go ahead.
Good afternoon, and thanks for taking my question. Just my one would be: how do you think about margin improvement into 2021 next year as volumes are recovering here, obviously into the year-end and heading into the next year, and you are onboarding new contracts? Obviously, we heard a lot about the opportunities you have, that you have kind of sealed like coal, intermodal, grain, automotive, and all those things. How should we think about margin improvement coming from those contracts and organic recovery? Thanks.
Ghislain, you want to talk about this without getting into guidance?
Yeah. Listen, I think as 2021 comes, a consensus came out this week actually that people believe that next year, either GDP or industrial production will be up 4% or 5% versus 2020.
Obviously, not only us as a railroad, but economists are seeing a recovery coming next year. As we do recover, and Rob talked about this, where we're not adding people one for one, and we have done some permanent changes during the pandemic. Therefore, you can expect our margins to continue to improve.
As we continue to deploy our technology, remember that we have very exciting technological projects that are and will create value, then you can expect that with all of this, and then our focus on yield management, you can expect that all of this will help us continue to improve margins on a going forward basis. We're quite optimistic about this.
Rob, you want to add maybe some color on costs for just broadly speaking for next year?
Right. We have really good momentum as I talked about. We figured out ways to do it more efficiently through this pandemic, and we expect that to stick. We're seeing that here as we go into Q4 and certainly as we go into next year.
Thank you. Do you have any permanent cost out initiatives that are pending right now, as in they will take place next year?
I didn't hear all that. I'm sorry.
You have some permanent cost out initiatives that you have taken, right, this year. Are there any cost initiatives that are running into next year?
Yeah, absolutely. As we go into the plan for next year, we'll double down on what we did this year and have some new initiatives as we go into 2021 to take out more cost.
We'll have the full year effect of what we've done this year. Next year, we'll have the full year effect of those takeouts. I think we're quite optimistic about our plan going forward, Konark.
Thank you.
Thanks for the question.
Thank you.
Thank you.
Thank you. The next question is from John Chappell from Evercore ISI. Please go ahead.
Thank you. Good afternoon, everyone. You've touched on this a little bit so far, Keith. The intermodal volumes have been incredibly strong, both on an absolute and a relative basis. How much of that is Rupert and Vancouver taking share from some of the congestion-related issues in Long Beach and L.A.? Given the fluidity of your network that you've spoken about, what's your confidence in being able to maintain that market share when the imbalance across the entire North American system somewhat normalizes?
Yeah. Thank you.
Yeah.
Yeah. Thanks, John. We pride ourselves on creating these opportunities for the supply chains to be servicing customers in U.S. Midwest and Canada for long periods of time. If you look at whether it's a shift of business away from the U.S. West Coast, or if it's a change from one carrier to another carrier, I think that they all know that the Rupert and the Vancouver gateways into the U.S. Midwest on CN is something that works, and it works well.
I know that I've read a lot of articles that are out there talking about how much could shift over the next 5-10 years. We're doing all we can to make sure that these supply chains are resilient. We provide the match back for our ocean customers that allows them to have a profitable economic round trip experience.
We are priding ourselves on putting the capacity in line with what our partners are doing as they increase their capacity so that we're working in lockstep, so that we don't have the pinch points that cause those problems where people have to move away from a supply chain that we created.
Mm-hmm. Yeah.
Maybe just to add, Rupert is running at capacity right now, right? It's 1.35 million TEU annualized this fall. It's not about taking more freight, it's about selecting the freight.
Thank you, JJ.
Thank you.
Thank you. The next question is from David Vernon from Bernstein. Please go ahead.
Hey, good evening. Thanks for the time. I wanted to ask you, Keith or maybe JJ, if you look across the eastern ports in the network, you're going to be effectively sort of doubling capacity on a throughput basis. I'm just wondering, how long do you think it will take to grow into that capacity expansion for the ports? Do you anticipate any need to kind of up spending on the line of road to connect all that traffic that is what is today relatively low density lines?
I think, quite clearly.
I think he was asking about the East Coast.
Yeah.
Yeah?
Yeah. The East Coast ports.
Yeah. It was a little muffled. It was harder to hear you.
Sorry.
Yeah, that's okay. As our partners increase their capacities and as we work with them from a marketing standpoint to increase the business that's going through there, our eastern network is underutilized. You've heard JJ say it numerous times before, i t was built for the industrial period where a lot of manufacturing was up and running. That is not up and running now. Some of that railroad is the best we have. It's double, triple tracked in certain places, and we can handle the volumes.
That's why we're pushing so hard with our partnerships in the east to sell the additional capacity out. I think we will. The Halifax to Chicago Midwest corridor is gonna be one that two or three or four years from now, you're gonna see it probably at least doubled from what it is today. As JJ said, we have customers that want to bring vessels there today, and we're continuing our marketing efforts with PSA to fulfill that.
I think, Keith, you also have some development in Mobile, Alabama?
Yeah, I guess our good partner, Maersk, has announced a vessel that normally first call of Houston is now the first call in Mobile. That's a direct service from Busan, Korea. We hope to see automotive traffic on that that would go up into the U.S. Midwest. We also hope to see some other opportunities for exports going that way as well. We're glad to see that our partner, Maersk, has put that first port of call in. Thank you.
Three coast network. Thank you, David.
Thank you. The next question is from Jason Seidl from Cowen. Please go ahead.
Thank you, operator. Good evening, guys. JJ, you talked a little bit about some of the long-term threats, and you mentioned autonomous trucks. I was actually happy that you brought that up. I'd love to hear your thoughts on how yourself and the rest of the rail industry can work to combat that as it does eventually show up in the marketplace.
Thank you for that question. I think a number of us here, when we look long term, we know, we're convinced at some point, the competition from the road, it will get more intense. We need to work on our costs. We need to eventually also work on how many people we have on the cab to be able to operate. Driverless truck, there's a lot of capital money, startup money, going into driverless truck.
It's something that we would like to study from the inside of the tent. More to come on that. It's a question of when is it going to happen? How do we get prepared for it? How do we leverage to our benefit? How do we understand it such that rather than being a victim of driverless truck, that we are one of the potential user of what that might do, namely for our intermodal network? All I'm saying here is, without giving the detail of what we have in mind, we recognize it is real, and we don't want to be caught up on the blind side.
A, we recognize it, and B, we're getting prepared for it. If you look at the Southern U.S., no snow, no ice, nice big highway, long haul. Yep, it will happen at some point in the next five years or depending on your crystal ball. Thank you for bringing that up. It's actually an important point.
All right. Thank you for the time.
Thank you.
Thank you. The next question is from Allison Landry from Credit Suisse. Please go ahead.
Good afternoon. Thanks. Your competitor talked this morning about potentially being able to achieve a mid-50s OR in 2021. I know that the OR is not the end-all be-all, but I was hoping you could speak to how you're thinking about what the right balance is between the OR growth and ROIC longer term.
Yeah, maybe I can start. We at CN, we're into the balancing of the two, right? Balancing EPS growth, balancing free cash flow growth, total shareholder return, and balancing where does the OR come in to be able to do that. When we look at 2021, you also have to understand a little bit about the crude contract and all of these things, or Charlie's confidential contract. I think it's about balance. What do you think, Ghislain?
I think, Allison, and we've said this many times, to JJ's point, it's about balance. We're not enamored with the OR. We want to preserve our foundation. We've implemented PSR 15 years ago. We'd rather be a CAD 25 billion, a 59 OR than be a CAD 15 billion at 56. Just do the math. I think that really, as we move forward and as we focus on yield and as we get more and more benefits from our technology deployment, I think that you can expect the OR to improve. I would say stay tuned. I think that our game plan works extremely well.
That's what I would say. I would say that we don't have a specific target on OR for 2021. That's not the way we think at CN. We have opportunities, and we are focused on executing on these opportunities, and the OR will be the result of execution on these opportunities.
Yeah. We definitely have a vision of growth. We definitely have a vision of a profitable growth. When you talk about profitable growth, this is where you want to make good use of your capacity. You don't give it out to everybody. You make smart use of it. You want to price it properly. At the same time, you want to be able to grow when the business is available. That's something that provides a decent return on investment and the type of EPS growth that we're looking for.
OR in itself, I think, in fact, in our compensation system here at CN, we don't have OR as one of the bonus factors. That in itself, I think, tells you how we balance things out. Thank you for the question, Allison.
Thank you.
Thank you. The next question is from Tom Wadewitz from UBS. Please go ahead.
Hello, Tom.
Yeah. Good afternoon. I just wanted to see if you could offer some thoughts on what the potential growth might be from an RTM perspective in 2021. If we look at prior periods where you came off some weakness, if you look at 2010, I think you had 12% RTM growth, approaching 11 in 2017. Is it reasonable, do you think, to look at 2021 and say maybe you can be similar ballpark to that, or are there reasons why you'd be more muted than a 10 percentage type of number when you look to 2021?
Well, as I said earlier, Tom, we reopened our training center in Chicago, in Winnipeg. That give you a sense that, A, we want to be sure that we replace through the normal attrition, and B, that we are creating train starts capacity to handle more volume. We also talked about the mix of business post-COVID versus pre-COVID, because of the impact of COVID on the energy sector. We're working on that mix aspect. Same store price is always above rail inflation.
There's a lot of things tend to be unknown, the U.S. election, maybe Canadian election. How will this phase of a second wave that seems to maybe will last all winter, how will that shape out? We would like to see definitely to 2021 to be a little closer or better than 2019. That would be one of our aspiration here for the sake of our employee and for the economy. We're preparing for growth, definitely. Time will tell what kind of economy is available to us. Whatever happens, we want to at least ride and outperform the economy.
We always said it's kind of GDP plus. We want to be able to move the economy and slightly more, which has always been our target, whether it's in good time or bad time. Try to outperform the economy. All boat rides the economy, can we rise a little faster than the average? We'll give you more at the next quarter call when we have guidance for 2021. We will most likely have guidance at that time.
Okay. It sounds like you think looking back at 2019 and maybe doing better than that is a reasonable framework.
It would be nice. We'll wait to see a little more what the crystal ball is from all the economists as we get late in the year and prepare our guidance for the third week of January. Thank you, Tom.
Great. Thank you.
Thank you. The next question is from Seldon Clarke from Deutsche Bank. Please go ahead.
Hey, good evening. Thanks for the question. Just going back to some of the earlier commentary on margin progression and operating leverage as you move through 2020. If you just normalize for the incentive comp accrual, and try and think about the cadence of asset deployment, relative to the recovery in volumes. Should underlying operating leverage improve from 3Q to 4Q relative to what you saw from 2Q to 3Q?
Thanks, Seldon. We tried to get away from providing quarterly guidance, Seldon. I think, frankly, Rob's team did a tremendous job to adapt very quickly to the heart of the pandemic in the second quarter. I think, the team did an outstanding job now supporting the recovery, and the recovery came quite fast, and it came into some key markets versus others that created this mix issue that we've talked about. I think that, again, we're being very careful on the assets we're bringing back on the railroad.
We're being very careful on the people we're bringing back on the railroad, not on a one-on-one. Then that's what I can offer as a bit of color. Obviously we're using the current situation to improve on efficiency and improve on productivity and I would say that that's what I can offer. I think that we're quite pleased with this quarter. We're very pleased with this quarter and delivering an OR that starts with a five. I think that, as I said, our volumes are up on a year-over-year basis in October by 6% or 7%.
I think that there's two more months to go, and the team is energized. We've got better visibility in front of us than we did in the past. There's still some uncertainty. I know here in Montreal, we're living a second wave of the pandemic, so we have to see and be cautiously optimistic about what's happening. At this time, so far, we're quite pleased with the volumes coming at us in October. Yeah, l eave no doubt that right now the railroad is busy.
Yeah.
Definitely the railroad is busy. If we're given the opportunity, you know our track record to grow revenue. We do have a track record the last decade, and we work on our OR like everybody else, we want to be the leading pack, and we do same store price above inflation. If we could get a little luck or a little better environment on the economic side, I think we should have a decent year in 2021. Thank you, Seldon.
Appreciate the time. Thanks.
Thank you. The next question is from Jordan Alliger from Goldman Sachs. Please go ahead.
Yeah. Hi, just coming back to a question that I think had come up earlier. Not sure if it was directly answered on the cost per employee and perhaps headcount as we think forward from here. I assume a fair bit of that normalizes with some of these headwinds moving out of the way, but if you could any color on that would be great. Thanks.
Maybe, Rob, you could just talk about the way we run train right now and some of the positive impact on the train length, train weight, and on the regular operation, maybe that could help.
Yeah, absolutely. I said it in my comments, what we saw with train length and how we were able to move more freight with fewer crew starts. Our crew starts were down 14% while volume was down 7%. We continued with that focus into the fourth quarter. We're actually moving more freight with about 2,500 less employees in operations year-over-year. Our labor productivity for this third quarter was actually up 17% year-over-year. Some really good momentum going into the fourth quarter.
We're going to continue to look for every opportunity to make it more efficient. The railroad's running quite well. We're in good shape here going in, as evidenced by seven straight record months of grain movement. We'll be talking here in about 10, 11 days about an eighth straight.
Very good. Thank you, Jordan. We take time for one more.
Certainly. The next question is from Justin Long from Stephens. Please go ahead.
Hello, Justin.
Thanks for fitting me in. In the prepared remarks near the beginning of the call, you talked about pulling forward some of the modernization of the network. I was wondering if that's something that's changed the way we should be thinking about the framework for CapEx as a percent of revenue as we look ahead to next year and beyond. Also on the topic of CapEx, as volumes have returned, have you reconsidered the pace of your locomotive modernization?
Rob, you want to talk about rolling stock and technology?
Yeah, absolutely. I think you'll see us continue to invest in technology. I'll let Jason answer the CapEx piece of it. We haven't finalized that for next year anyway. You'll continue to see us invest in technology. We feel like we're a leader there in a lot of different things. Let's take a few moments to talk about some of the things we're doing out there. As I said, our autonomous track inspection cars are now in phase II. That allows us to have a safer railroad. Those are entrained in regular revenue service.
Now in phase II, we're actually able to remove regulated inspections as well. On our autonomous inspection portals, we have 41 algorithms now. We'll have 55 by the end of the year, w e have seven of those portals. We'll have 100 by this time next year. Why that's important is that those algorithms will be ours. That's really the value is the ownership of the algorithms.
Anybody can put a portal in there, but to use the machine learning and artificial intelligence to teach it to find a defect on the hundreds of different types of cars with the different components on each car, that is the value, and that's what we're seeing out there today. We're actually finding defects on a daily basis, and we're actually finding some significant defects that, if left unchecked, could lead to something much more impactful.
We'll continue to invest. We've got a new Chief Information Technology Officer here on board who is all in terms of advancing us to the next level in terms of operations technology.
Maybe on CapEx, Justin, I think that, again, as JJ mentioned, we will provide more color on 2021 on the January earnings call. I can tell you that we're quite comfortable. If you look at historically, our capital envelope was typically around 20% of revenue. We had two years of elevated CapEx, a little bit of catch up in 2018 and 2019 at 25%. I think that we did caught up, I think that now we're staying ahead of the game, and I think that we're comfortable in that ballpark. Again, we'll provide more color in January, so stay tuned on that one.
Thank you. Thank you, Ghislain and Rob, and thank you all for all your questions. Maybe I have time to close it up here. Just want to be sure everybody, we make our commitment very clear that we are pricing above inflation.
We reminded them commercial team is managing the yield and Rob's team is really driving productivity, which generates steady and solid cash flow. We're the industry leader as it comes to making the rail industry modern. We're the industry leader on ESG, not just on fuel, but on ESG as well. We have good momentum right now on volume entering the fourth quarter, and it looks good for the remaining of the year. We're positive, constructively positive about 2021 and what 2021 might offer to us.
Focus on long-term, CN is about the long-term. CN is about sustainable, profitable growth and all that. Good night to all of you. This is the end of the call and see you back in January. Thank you. Thank you, Patrick.
Thank you.
You're welcome. The conference has now ended. Please disconnect your lines at this time. We thank you for your participation.