Welcome to CN second quarter 2015 financial results conference call. I would now like to turn the meeting over to Janet Drysdale, Vice President, Investor Relations. Ladies and gentlemen, Ms. Drysdale.
Thank you, Patrick. Good afternoon, everyone, and thank you for joining us. I would like to remind you of the comments that have already been made regarding forward-looking statements. With me today is Claude Mongeau, our President and Chief Executive Officer, Luc Jobin, our Executive Vice President and Chief Financial Officer, Jim Vena, our Executive Vice President and Chief Operating Officer, and J.J. Ruest, our Executive Vice President and Chief Marketing Officer. In order to be fair to all participants, I would ask you to please limit yourselves to one question. With that, it's now my pleasure to turn the call over to CN's President and Chief Executive Officer, Mr. Claude Mongeau.
Thank you, Janet, and thanks to all of you for joining us. It's a beautiful day in Montreal, and I'm here with the CN leadership team to discuss our very solid second quarter results. It was a bit of a tougher environment from a growth standpoint, but I'm pleased to, I'm really pleased overall, still, with our top-line performance. As JJ will discuss, we had good growth in our service-sensitive segment, intermodal, automotive. It was much tougher in the bulk sector, particularly coal, on an export basis, and grain, which is returning to a normal trend. But overall, you know, we did the, we did the, you know, follow the environment and held our own in what was a bit of a challenging environment. Most importantly, we had a very swift response to that slower growth environment.
We're recalibrating our resources to drive efficiency. As Jim will describe to you, all of our core metrics are in line or better than last year, and that's very important because that's all we can do when the, when the environment is a little tougher from a volume standpoint. It's how fast and how efficient you are at reacting that makes the, the difference. How we react, though, is about maintaining balance between operational and service excellence. It's really, it's really a combination of both, and I'm pleased to say that we delivered superior service in all of our market segments during the quarter, and also delivered a record operating ratio of 56.4%. Overall, that drove the day in terms of financial results.
You know, Luc will give you more of the details, but our diluted EPS at CAD 1.15 is up 12% on a year-over-year basis as adjusted, and we had very strong free cash flow in excess of CAD 1 billion of free cash flow after only six months during the year. Very good results overall, good balance, good focus, and we're pleased with the momentum that gives us entering the back end of the year. With that, I'll turn it over to Jim to cover the operational highlights.
Claude, as you said, it's all about the balance. Operating a railroad is all about reacting quickly to changes in, workload in an efficient way. We responded quickly to the change, keeping costs in line with the business level. Key drivers for us are train starts, yard expenses, and rolling stock inventory management. In the charts, you will see a small drop in train productivity as measured in train load. However, this drop was driven by a change in product mix, not by us not responding to the change in business level. If you look at train productivity in terms of train length, we were up 1.3% year over year. With our continued focus on train productivity, we will be able to continue this improvement.
In June, train length was up almost 3%, and train load had improved by 1%, both on a year-over-year basis, and we continue to see that as we go through the month of July. With train miles being reduced, we immediately cut back on the active locomotive fleet, pulling the less productive and less reliable units out of active service, the ones with the little gray hair on them. Currently, we have about 200 locomotives stored, and locomotives we have stored across the whole network to respond to any changes in the market and the business that's there. Locomotive productivity at 223 trailing GTMs per horsepower hour was the new quarterly record, beating the previous record we set in Q2 of 2014, so a good result. Yard productivity also improved year-over-year, up 4%.
This was challenging to do with workload dropping. You do not want to cut back and hurt throughput. We reacted quickly, undertaking a terminal-by-terminal review, cutting assignments and yard expenses ahead of the curve. As I've often said, there is no better measure of overall railway performance than car velocity. We were up 6% year-over-year in Q2. Again, this is a balancing act, delivering car velocity while protecting service performance. We cut back on the active fleet, right-sizing it to the business level and focusing on fleet productivity. Currently, we have just over 10,000 of our fleet stored, generating a roughly 4% year-over-year improvement in terms of active cars online. So again, in line with what we have to do to with the business levels. Next, you have to keep cars moving, getting them through yards fast and over the road reliably.
In quarter two, we cut terminal dwell by 5%, and train speed was right where we expected it to be. We had a number of work programs on our main line to upgrade our main corridor and core route, so we expected it to be flat year-over-year. This allowed us to deliver car productivity improvements while protecting customer service. We did not want to make the cuts and make sure that we made all the numbers, forgetting that we had service excellence. And in fact, our car order fulfillment in the quarter was in the high 90% range of customer demand, and we're meeting every order that's available to us. If you turn back to the next page, please. The other area that we have not talked about too much was on the people front.
With slower growth, we adjusted our hiring plans. We've frozen hiring until we see that we chew up some of the people that we have excessed, and we've redeployed some running trades employees into other functions on top of the numbers that we show in the chart that we have laid off at this time. In certain geographic areas, it was necessary to lay off some employees. We just could not find work for them. But we will be recalling them as our attrition rate, natural attrition rate still runs about 10% with the age curve that we have in our workforce. So we'll see them coming back to work early part of next year or second quarter of next year, with most of them being back.
Overtime was another area where we took under tight control, and we are squeezing this down to as close to zero as possible. On the fuel front, our goal was 1.5%. Our target for this year was, sorry, was 1.5%, and we had a good head start in Q1. Q2 came in at 1%, and not the best number possible, but very difficult when you have a drop in volume to be able to even deliver a fuel betterment, but we're still on track to deliver the 1.5% for the year. So we continue to double down on efficiency. We're reducing train starts while protecting service, keep rolling stock in line, and right-sizing our workforce.
This is done by staying close to the marketing team, keeping costs in line, while being ready to deploy resources to respond quickly to business opportunities. Let me summarize. We responded quickly to the lower workload by decreasing dwell, cutting back on active cars, right-sizing our locomotive, increasing our end-to-end velocity. Key that we didn't concentrate on one piece, but end-to-end, and nice to see that again. I'm not sure how much is left, left there, but there's got to be something left. And driving productivity gains in train size and cars dwelled by—cars handled by employee. Overall, posted an excellent operating quarter by the team. JJ?
Well, thank you, Jim, and thank you to the team, to your team for the fluid service we've enjoyed in the second quarter. It's, JJ now speaking, and I will walk you through the second quarter revenue and then provide you with a commercial outlook. The revenue was flat to last year at $3 billion and $125 million, so $3.125 billion. Breakdowns as follows: the weaker volume accounted for roughly 3.5%-4% drop in revenue. The carloads were down 49,000 units. Coal and oil, coal alone was down 36,000 carloads. Grain was down 20,000 carloads, and crude was down a disappointing 8,500 carloads. Solid same-store pricing came in at 3.9%, and as you remember, same-store price is net of exchange. It is also net of fuel surcharge fluctuation.
The weaker 81.3-cent Canadian dollar gave us 6.5% of incremental revenue, and the lower applicable fuel surcharge took away 6% of revenue. In short, the deceleration in carload and fuel surcharge revenue was wholly offset by solid pricing and by gain in foreign exchange. Now I will go through the highlights of the revenue on an as-reported basis to the major business units, starting with forest products. U.S. housing starts drove lumber and panel revenue, and the offshore export of lumber was also constructive. Wood pulp exports were strong, increasing 18%. We have good car supply, and we continue to upscale the quality of our business mix using our high-velocity pool, low-velocity pool destination program, which results in solid yield improvement across our merchandise railcar fleet.
Automotive revenue grew; growth was fueled by strong industry sales, a favorable long-haul mix of business for CN, and the year-over-year effect of market share gain from last year. Petroleum and chemical, the CN crude shipment were 23,000 carload in the quarter, a 27% drop in volume from last year. Industry-wide, crude-by-rail economics were challenged by narrowing crude spread and by improved pipeline supply-demand balance. NGL volume grew nicely, reflecting ongoing opportunity to sell stranded Alberta NGL as merchant liquid in tank car into better paying market than leaving it in the natural gas. Also, good performance in plastic pellets. Automotive, the overseas volume increased a solid 10%, driven mostly by U.S. import via the CN port, while the import into Canada were weakening with a slowdown in the Canadian economy. Canadian domestic unit fell about 3%, also reflecting the sluggish Canadian GDP.
Metals and minerals, following our outstanding first quarter, frac sand revenue fell 5% versus last year. Q2 carloads were about 18,000, driven by a sharp reduction from the shale oil play. We believe the month of May was the low point for our frac sand carloads. Drilling pipe was down 70%, as oil producers moved to destock inventory to readjust it to forward demand. An influx of cheaper import steel dampened the demand for iron ore and semi-finished steel. And we continue to see nice growth in aluminum and in non-ferrous ore. Grain and fertilizer, an 11% drop in Canadian grain revenue, which was due to lower export activity versus last year's strong crop inventory carry. U.S. grain revenue was down only 2%, but that was on weaker export as well. Coal, our Canadian coal mines are really struggling with global oversupply.
Revenue was down 65% because of Canadian mine closure. U.S. coal revenue experienced lower demand from domestic utilities. Power plants had higher stockpile, and natural gas remained cheap. On export, our U.S. revenue from CN franchise via the Gulf Coast were up. Other revenue did well, and they were driven by our Great Lakes vessel fleet. So now looking at the outlook. In the second half, we assume the Canadian dollars and the price of crude will linger, and the spread of crude will be volatile. The year-over-year favorable, favorable revenue gain from exchange will most likely, in good part, be offset by lower surcharge revenue. Delivering a superior, fulsome, wholesome service experience, focusing on margin improvement and producing same-store price will remain part of our core strategy. For crude by rail and sand, demand will continue to be weaker than last year and will be volatile.
We are no longer counting on year-over-year growth on energy-related commodities. Crude spread may improve toward the minimum target range to support sequential crude by rail volume above the second quarter. Crude spread, for example, Western Canada Select versus Brent, versus Brent, had moved from a high of $24 earlier this year to a low of $10 last spring. And we need about $20 spread to create opportunity for rail in the case of those two spreads lately. Reducing rail rate by $1 a barrel does not impact demand for crude by rail, and we, in our view, we should let the marketplace sort itself out without looking at the freight cost itself. The overall North American outlook for coal is for progressive secular contraction.
For CN, year-over-year coal carloads are not expected to inflect positive comparable before Q2 or mid-2016. The size of the upcoming Canadian crop is heading below the five-year average, while the US crop look decent at this point. Regardless, come the harvest time of the new crop in mid-September, we will be very busy running at capacity or near capacity on export. We are introducing new program to the Canadian regulated export trade, and we will have bids for private cars to be integrated into our general fleet. We will have private shuttle train running as intact export shuttle, and we will also introduce weekly car auction, allowing shippers to bid on block of 25 cars from our general Western Canada pool. We anticipate sustained demand for Canadian potash, and the ramping up the newly expanded Agrium mine should be positive.
We are gearing up for continued growth in U.S. housing starts , and we have the additional rail car capacity to meet the expected demand. We also expect revenue growth from automotive, both in carload, the finished vehicle, or in containers going to the assembly plant. We are investing in long-term future of our automotive franchise by acquiring more Multi-Max rail cars and by expanding the capacity and productivity of our CN Autoport facilities. Within the context of an evolving North American economy, our automotive franchise will continue to be an important engine of growth. We see potential in U.S. import growth, supported by a constructive U.S. economy, supported by CN unique supply chain service and round-trip costs match-back model. Domestic growth will be more muted, and it will be in line with the weaker Canadian GDP.
However, from a market position, we now have a third morning and fourth morning service into Calgary and Vancouver, which did solidify our strong position within the Canadian domestic marketplace. Longer term, the ocean port that we serve on the three coasts of the continent are in very good shape, and our international franchise will be enhanced by the terminal and rail on dock expansion at Rupert, Vancouver, Montreal, and Mobile, Alabama. In conclusion, as you know, we have a very diversified portfolio, which carry us through the current rotation of our very diverse commodity market. We have very diverse customer base, and we also exposed to diverse regional economy. All these things producing the type of bottom-line result that we just reported today. We foresee fairly flat cargo growth for the remaining of the year because of challenging comparable from coal, iron ore, and grain.
We reiterate our 3%-4% same-store price, which is basically continued pricing above inflation, and we continue to focus on upscaling yield. We are running for the long term. Luc?
Thank you, JJ. Starting on page 12 of the presentation, let me walk you through the key financial highlights of our solid second quarter performance for 2015. As JJ pointed out, revenues were in line with last year at just over $3.1 billion. Fuel lag represented a revenue headwind of about $8 million or $0.01 of EPS in the quarter. Operating income was $1.362 billion, up over $100 million or 8% versus last year. Our operating ratio was 56.4%, a record level for a second quarter. This represents a 320 basis points improvement over last year. Other income in the quarter was $16 million, up $14 million versus last year.
Now, this is always a bit of a difficult category to forecast for timing, but for the first half of the year, on an adjusted basis, we are at about $20 million, just over $4 million above last year. Net income stood at $886 million, up 5%, and the reported diluted EPS reached $1.10, up 7% versus last year. When excluding the deferred income tax impact of $42 million or $0.05 per share, resulting from the enactment of a higher provincial corporate income tax rate in the quarter, the adjusted diluted EPS stands at $1.15, and that's up 12% versus last year....The impact of foreign currency in the quarter was $64 million favorable on net income, or $0.08 per share.
Turning to page 13, as Jim indicated, we made significant progress in terms of efficiency, productivity, and cost management in the quarter. Operating expenses were lower than last year by about $100 million, or 5% at $1,763 million. Expressed on a constant currency basis, this is an improvement over last year of 11% or over $200 million. At this point, I'll refer to the changes in constant currency. Labor and the fringe benefit costs were $542 million. Excluding FX, this is an 8% decrease from last year. Now, this was the product of three elements. First, we limited the overall wage cost increase to 1% versus last year.
By the end of the second quarter, we had about 600 employees laid off, and our headcount was actually down 3% sequentially versus the end of the first quarter. In turn, it was 0.5% lower than at the end of the second quarter last year. In addition, wage inflation was partly offset by reduced overtime, lower training, and compensation costs overall. The second element was lower stock-based compensation expense, or $54 million of the total labor variance. The third and last element was a higher pension expense for $6 million.
Now, on that note, I should point out, however, that taking into account our most recent actual valuation, which we just filed in June, we now expect a full year increase in our total pension expense versus last year to be in the $70 million range, as opposed to $100 million initially assumed. Now, that's for the full year. Purchased services and material expenses were $434 million, up 5%. Increased costs in the quarter were driven by a higher level of rolling stock, impacting repairs and maintenance expenditures. We also had higher costs for accidents. Now, these cost pressures were partly offset by more capital work being performed in the quarter. The fuel expense stood at $327 million, or 40% lower than last year.
Price was favorable by $167 million versus last year, and this was also supplemented by lower volume for $21 million. In addition, fuel productivity also improved by 1%. Depreciation stood at $285 million, $15 million higher than last year, or 6%, and this was mostly a function of asset additions. Equipment rents at $83 million were $9 million lower than last year, or 11%. Now, this was the outcome of lower equipment leasing costs, partly offset by increased net car hire expense. Casualty and other costs were $92 million, flat versus last year. Moving to cash, we generated free cash flow of $1.051 billion in the first half of the year. This is approximately $220 million lower than in the same period in 2014.
This is mostly attributable to higher cash flow from operations for $277 million at $2.2 billion, which was partly offset by higher capital expenditures for $400 million, and our CapEx program at the mid-year point stood at $1.1 billion for 2015. Meanwhile, our balance sheet remains strong, with debt and leverage ratios within our guidelines. In closing, let me address our 2015 financial outlook. We continue to be confident in terms of CN's prospects for the year. Notwithstanding the fact that we are experiencing weaker conditions than expected in several markets, such as energy-related commodities and coal, along with challenging year-over-year comparables. As we look into the immediate future, while North American economic conditions are somewhat mixed, consumer confidence remains solid and should support continued progress in housing, automotive, and intermodal sectors.
These and other key assumptions underpinning our outlook should translate into carload volume in 2015, generally comparable with 2014, with pricing in line with our Inflation-Plus policy. Therefore, we are reaffirming our 2015 financial outlook, calling for double-digit EPS growth over the 2014 adjusted diluted EPS of $3.76. We're also maintaining our capital investment program for the year at approximately $2.7 billion. Furthermore, we continue to pursue our shareholder return agenda with a substantial stock buyback program underway, with a $1.7 billion target. And so far, in 2015, we've bought back 10.7 million shares for $833 million.
Our 2015 dividends have also been increased by 25%, while we intend to gradually move towards a 35% dividend payout ratio over time. On this note, I'll turn it back over to you, Claude.
Okay. Well, thank you, Luc, and thank you to the rest of the team. Just to summarize, we reacted quickly to realign our resources during the quarter and delivered a very solid Q2 performance. We clearly see some global economic uncertainty in the current environment, but we're leveraging a great franchise and a very well-diversified portfolio. As Luc just said, we're reaffirming our EPS guidance for the full year, and we continue to keep our eye on building for the future. We have a solid pipeline of growth and efficiency initiatives, and we are staying squarely focused on our strategic agenda. With that, Patrick, we'll turn to the Q&A.
Thank you. We'll now take questions from the telephone lines. If you have a question and you're using a speakerphone, please lift your handset before making your selection. If you have a question, please press star one on your telephone keypad. If at any time you wish to cancel your question, please press the pound sign. Please press star one at this time if you have a question. There will be a brief pause while the participants register for questions. Thank you for your patience. The first question is from Chris Wetherbee, from Citi. Please go ahead.
Hey, great, thanks, and good afternoon, guys.
Good afternoon, Chris.
You know, obviously a very, very strong performance on the operating ratio. Wanted to sort of get a sense, as you think about the rest of the year, and typically from a seasonal perspective, 3 Q is a little bit better than 2 Q on the OR. When you think about the puts and takes and sort of flattish type volumes going forward or potentially even down, how should we think about that typical seasonality playing out into 3 Q and 4 Q? Just wanna get a rough sense of maybe what might be changing, particularly around some of the expense items. That would be helpful.
Well, as Luc said, Chris, our Q2 operating ratio is a record all time, not just for CN, but for the industry. We also had a lot, I mean, a very good start in terms of our capital program, which brought forward capital credits that normally peak in Q3. So I think we should be delivering a very, very strong Q3. I'm not sure the sequential or the relation between Q2 and Q3 will hold to the, to history, but we're in the current environment. And I would like to add, obviously, the, you know, low fuel price is helping just the math here in terms of, of the OR, but we, we feel the, the operating ratio should continue to stay, very, very strong performance, between now and the back end of the year.
It's testament to our efficiency focus and the fact that we're reacting swiftly to realign resources.
It feels like you're sort of appropriately resourced for the volume environment as you're heading into the third quarter here?
We think we are staying in balance, and then we'll adjust as we go. But we are caught up right now and should continue to drive very, very strong efficiency as we have in Q2.
Great. Thanks very much for the time.
Thank you. The next question is from Cherilyn Radbourne, from TD Securities. Please go ahead.
Thanks very much, and good afternoon. So we know that the rate on regulated Canadian grain is gonna start impacting same store pricing as you report it next quarter. I was just wondering, excluding that impact, do you think the capacity across the transportation space remains strong enough to stay towards the top end of your 3%-4% pricing objective?
Yeah, the, you're right. Regarding the Canadian grain cap, it's effective August 1, but we don't necessarily apply it right, right in August 1, but it's something that's digested over a period of 12 months, from August 1 to July 31. So we know that, and we know that when we say that our, our pricing will be in the range of 3%-4%, including, you know, what the Canadian government is doing on the grain cap.
Thank you. That's my one.
Thank you, Cherilyn.
Thank you. The next question is from Tom Wadewitz, from UBS. Please go ahead.
Yeah, great. Thank you, good afternoon. I wanted to see if you could give us a sense of how you think, volumes may play out. I guess you... I know that's a pretty tough question. I suppose it's a bit of a guess in certain markets, but you said full year volumes kind of flat, but you were up a lot in first quarter and kind of down 3% in second. Do you think that you'd see kind of, you know, less worse third quarter and then maybe, you know, flat year-over-year in fourth quarter?
Or do you have any sense of how, we might, we might think about that and, you know, even into 2016, whether you'd have conviction that you'd return to growth, or just kind of how we might look at the contour of volumes over a couple of quarters? Thank you.
Yeah. JJ may add to this, but you know, I think we should see a gradual improvement, you know, in Q3, going to the Q4 peak season. You know, we're you know to finish you know generally comparable on a year-over-year basis, you have to have flattish growth overall for the next six months. But it's conceivable we would be a little down again in Q3 and then start to turn the corner in Q4. JJ, do you have you know a little more color on that?
Yeah, that's right. So, flattish to potentially slightly down in the third quarter. And when you look at the evolution of the carload and the revenue ton mile, the RTM, eventually the RTM will start to come back up a little faster than the carload because of the bulk business. You know, we're not moving a whole lot of bulk right now, and eventually we'll be moving grain and eventually a little more potash during the fall peak. So fourth quarter, volume-wise, whether you call it RTM or carload, should be slightly better than the third quarter.
But all that together is, you know, we have some bulk segment who are still very limping along, as I said, iron ore, coal, grain, till the next crop, and the crude by rail is sort of, we're not too sure exactly where that goes from quarter to quarter.
And on that energy side, Tom, it's, I mean, it's margins. If the spreads were to widen significantly, maybe we'll be surprised on the upside. But we're taking the view that, right now, it takes kind of a while to adjust to the current circumstances. And we're just not sure we're gonna have growth in this energy complex that we can count on for the full year.
Any, any early thought on 2016?
Well, I think we'll, we'll cover that when we have a better visibility, Tom. Thank you.
It's early.
Makes sense. I appreciate it. Thanks for the time.
Thank you. The next question is from Walter Spracklin from RBC. Please go ahead.
Thanks very much. Good afternoon, everyone. Just looking back at your guidance and how it's evolved over the last couple quarters, you were starting the year expecting 3%-4% cargo growth, with a little bit more optimism, obviously, on the energy markets and pointing to an EPS growth that would approach or target a double digit. You then went down to 3%, but went to a solid double digit or squarely in double digit. Now, you're down to flat, but reaffirming. You know, with incremental margins being fairly strong in your business and with volumes coming down, you're obviously generating a better margin and still keeping your EPS growth.
Is this really just a foreign exchange type of offset, or is there and some good cost controls and that Jim mentioned, or is there something else at play here that's allowing you to kinda maintain your EPS guidance while seeing some volume degradation through the year?
Right. That was a comprehensive question, Walter, and thanks for the summary on our guidance. I think you did it well. I would just say that, of course, exchange is helping, but exchange has not changed much, really, over that period. And so we're adjusting to the lower volume environment by reacting swiftly and making up on the cost side, would be the bulk of the situation. But Luc, you may have a, you know, slightly different color.
Well, I think I would just add, I mean, again, the volume may not be everything that we had expected, but it's still, you know, still very solid. And the pricing that JJ was alluding to, you know, 3.9 same store, very solid pricing. So we've been able to make the most out of, you know, arguably a difficult environment.
Okay, thank you very much.
Thank you, Walter.
Thank you. The next question is from Ken Hoexter from Merrill Lynch. Please go ahead.
Great. Good, good, afternoon, and congrats on a great OR, tremendous performance. Just seems like you're, you're bouncing off the bottom on a lot of the energy and other commodities, I think, JJ was throwing out there. So I guess the question would be for Jim on that. How do you think about the cost returning, in this environment, just, if we do bounce? Claude, you kept talking about parking and adjusting quickly. How about going in the other direction? Do you think you get that snapback here on some of these volumes, or is it more measured?
Let me just say, bring it on. Jim, over to you.
I was gonna say, let it bring it on, 'cause we'll use it, and we'll see what we can do with it. I think we've shown that we can handle an upside. Bottom line is, Ken, we're always adjusting. It's a continuous every day, you adjust to see where the business is gonna be. And that'd be a real good problem to have, is if it returns, then returns quick.
Appreciate the insight. Thank you.
Thank you, Ken.
Thank you. The next question is from Turan Quettawala from Scotiabank. Please go ahead.
Good afternoon. I guess my question is also on the pricing side. JJ, you know, with softer volumes, obviously some of the capacity snugness is probably a little bit less than we had last year. I'm just wondering, you know, how comfortable are you with that 4% price increase number, and kinda what gets you there-
Yes.
on the same store?
Thank you, sir. It was 3%-4%, and we're sticking to the 3%-4%, but we did 3.9% in the second quarter. Most of our market, you know, I would say are in balance. We have enough equipment and service and crews and capacity and locomotives to do a great job. In some segment, it's fairly recent that we've been able to caught up, namely in automotive. It's only in June that we were able to get caught up. Now, we are caught up. And we never really tried to do, you know, the heavy price increase on one hand, and a couple of quarters later, to cut the price to get some extra cargo. So we're into a long-term, and we like compounding effect of inflation plus pricing.
You look at our chart for the last 10 years that Janet has; it shows the effort and the mindset of compounding effect. So we try to stay away from the commodity-type approach of commoditizing rail, rail freight, as you would be tempted sometimes to do in export coal or, or crude by rail, because of the downside of that midterm, right? So now we're well, we have 3%-4% above inflation, Steady Eddie , that's the game plan for 2015 and 2016.
Great. Thank you. Sorry, go ahead.
Steady Eddie , JJ. Next question. Thank you, Turan.
Thank you. The next question is from Bill Greene, from Morgan Stanley. Please go ahead.
Hi, good afternoon. Claude, I wanted to get your take on the OR again, but what I wanna focus on is, you mentioned, of course, how you're setting sort of the records here, I think both for you and for the industry. If the business came back, holding things like pension or fuel constant, is this sort of the new bogey? Is this sort of a new normal, or do a lot of these costs come back such that we see with growth comes higher OR, which in a total dollar sense, could be fine, but we need to keep that in mind as we think about longer term projections?
Well, I would say first and foremost, you gotta calibrate your model to the fuel surcharge. I mean, like, the reality-
Right. Holding that constant, obviously, that will have a big impact.
So, you know, we're not taking credit for fuel surcharge coming down on or fuel price coming down in terms of our OR, but we delivered exceptionally strong because of all of the initiatives that help us drive value, the quality top line with pricing, the focus on the mix that we are able to hold on to, and the reacting, you know, swiftly with-
... sourcing, all of that is how you stay in the lead in terms of efficiency, and we're determined to stay in the lead in terms of efficiency going forward. As to predict, you know, where it's gonna, you know, go and the bogey, there's so many moving parts, Bill, that I hesitate to even venture a guess. We'll be delivering as good an OR as the environment allows us to, and we intend to stay a leader.
All right, I appreciate the time. Thank you.
Thank you. The next question is from Fadi Chamoun from BMO Capital Markets. Please go ahead.
Yes. Hi. I just wanna say also congratulations on this performance, in the context of this, sort of backdrop on the volume side.
Thank you.
You know, question for JJ. If you look at your sort of crude business, can you sort of identify, you know, what's economical to keep getting pushed at these low oil prices and what's not? And I mean, as I'm sort of trying to figure out if you wanna put a number in 2016 and being sort of a worst case scenario for crude, what would that number be in your mind?
You mean in terms of the carload or the-
Yes.
Carload. I will not do this at this point because we've... You know, this year was supposed to be a year where energy was supposed to grow in carload, and in fact, you know, we actually have negative growth on the, on those, on those commodities. So the world has changed on us. And at this point, it's hard to, to really get into the next six months. I wouldn't go in 2016, but crude production in the back end that moves by rail seems to be down. Crude production from Western Canada is going up in total, about 200,000 barrels a day, for 2016 and 2017. The question is, how much of that is, gonna be, you know, available, to, to, to rail versus crude, versus pipeline?
So the spread right now are, they're going all over the map. For example, right now, consumption of crude in Alberta is down because you have refineries and turnaround. So this is not something circular. You know, this refinery will come back, right? Husky will come back in line. Eventually, Shell will do his turnaround and come back. And when they're down, the crude that's locally normally consumed needs to go in the pipeline, so that creates temporary widening of the spread. And eventually, refinery come back in, and the crude is consumed locally, and that impacts the, you know, supply-demand of those pipelines. So, many aspect, and during the forest fire in May, it was reversed.
We had CNRL, Cenovus, and MEG, who are a producer of crude, who went down for a period of time till the forest fire were closed to refinery, and the spread was great collapse, right? Because there was excess amount of capacity at that time. So it's, it's hard to read. So it's, it is what it is.
Okay.
We only have locomotive and crews, they're customers of all the equipment. So when there is opportunity, we are willing to chase it, as long as the price makes sense, and the price may or may not make sense. And then after that, we wanna focus on sort of the more fundamental stuff. In the case of frac sand, we seem to have hit the lows in the month of May, and now we seems to be running at kind of a running rate, and most of the frac sand is related to natural gas or natural gas requirements.
Yeah, and maybe LNG...
Yes
... picks up in, in Western Canada, and that gives us a continuing boost in terms of, moving sand, long haul towards Western Canada.
Many moving pieces, parts around the supply, demand, and balance for the pipeline network.
Okay, thank you.
Thank you.
Thank you, Fadi.
Thank you. The next question is from Jason Seidl from Cowen and Company. Please go ahead.
Thank you very much, gentlemen. Thank you for the time and good afternoon. Wanted to focus a little bit on the intermodal growth that you had. Obviously, still looking pretty strong in the quarter. Just trying to get a sense, going forward on that growth rate. I mean, are, are we gonna start to see it slow a little bit? Did you guys feel that you had any residual impact from sort of the issues that some of the West Coast ports have had? I wonder if you could elaborate on that for me.
The second quarter, international growth was as strong as the first quarter, meaning that the business that came to us from the so-called U.S. West Coast port stuck in the first quarter. It also stuck in the second quarter. We actually had bigger volume out of Vancouver, slightly bigger volume in the second quarter than the first quarter in Vancouver. So that tells me that our U.S. business is intact. In fact, it was the biggest reason for our growth on the international side, the import to the U.S. Midwest. So what we have is you know, we're getting into a time where the comparables start to change. We haven't added up a new customer, so we're living off the U.S. economy and the demand for that on the import side.
On the Canadian side, the Canadian GDP is a little weak right now, and that's just showing up on the import to the Canadian side. So we're now going to be more following for the next little while, what's happening to U.S. GDP, stronger Canadian GDP, a little weaker, and then our own self-help of initiative that has to do with Mobile and New Orleans and expansion in Rupert and Vancouver and Montreal over time.
You know, longer term, Jason, the—I mean, the Prince Rupert announced an expansion of their terminal. During the second quarter, we were at 775,000 TEUs as a run rate.
Yeah.
So, you know, this is remarkable. This terminal, not so long ago, was built for 500,000 TEUs. We're running 275,000 TEUs more than that, and the capacity is being built as we speak. The—I mean, Vancouver-
... us with, you know, slightly above 1 million TEU, you know, run rate. And there again, we're expecting our partners to be looking at their, you know, capacity and most likely make investments to grow the capacity. We're having good growth with the slightly lower Canadian dollar. You know, in Halifax, there's new service coming there. We're opening new opportunities in Mobile and in New Orleans. This is not a one-trick pony. It's following the opportunities in the market as we go and trying to outpace the economy year after year.
That's right. There's still room in Rupert to fit another call, as we speak today. And this, in the case of Halifax, they will have some new call coming in late this fall on the export, which will be a welcome news for our eastern network. Thank you.
Thank you, guys.
Thank you. The next question is from Benoit Poirier, from Desjardins Capital Markets. Please go ahead.
Yeah, thank you very much, and congratulations for the good quarter. Just looking at your safety metrics in Q2, it's pretty much unchanged versus last year. But, just for 2015, I'm just wondering, related to the impact of, on annual incentive bonus plan? And any color on the impact of the recent derailment?
Well, let me. We're having a strong focus on safety. It's essential in the current environment, and that's, you know, a lot of our capital expenditure is focused on upgrading and strengthening our infrastructure. We're pleased with the fact that we are turning the corner and are getting better safety statistic. When you look at all of the accidents, all of the incidents that we face, that includes smaller incidents that are leading indicators, we are actually down on a year-over-year basis, Jim, you know, year to date, 17% or so?
Correct.
Our FRA accident, that's all the accidents that are more than $10,000, are flat, essentially on a year-over-year basis, year to date. And, and we're focused on making sure that we run the safest, you know, possible railroad. It's all about keeping our social license, making sure we can move the commodities that we handle without impacting the communities that we go through. It's a big focus for us.
Okay, thank you very much, Claude.
Thank you. The next question is from Brandon Oglenski from Barclays. Please go ahead.
Well, good afternoon, everyone, and, congrats again on the OR. I think you might have even stole some thunder from your former colleagues here. Luc, I, I wanted to talk to you about the labor, compensation benefits line, because obviously, that came down a lot sequentially. And you did have, you know, I think, a lot of stock comp this quarter, which, if it's my understanding, that won't repeat because that's an accrual adjustment one time in the quarter. But you also mentioned pension, and can we go over the FX, too, in the back half of the year? Just how do we look at the labor line? And, and maybe even further for, for Jim, is there further efficiencies we can get out of the current volume environment, where headcount could even sequentially come lower in the back half of the year?
Yeah, I think and Jim can comment a little bit more on that. But essentially, what's gonna be happening is we should be looking at, you know, flat to negative or to a lower headcount during the balance of the year, and we could even end up closing the year, probably a couple of percentage points lower than last year. So we'll continue to see some definite progress on that line, and that's part and parcel of driving the lower labor cost. At the same time, you know, we have enjoyed the benefit of lower stock-based compensation, so I think that's an issue which we'll have to see, you know, how the stock's gonna perform in the back half of the year.
Certainly last year, we gained a lot of stock price went up significantly in the second half, so we may still have a little bit of a benefit there. We'll have to see. On pension, you know, we started out the year, and without the benefit of the actual valuation, we thought that our total pension expense would go up by about $100 million. So, you know, this is very good news. We'll be in the $70 million range, and that gives us, if you look at the back half of this year, $30 million reprieve in terms of the cost increase that we had foreseen. So, you know, I think those are the key elements to the variance.
So again, I think, you know, lower, lower, hiring implies lower training costs. I mean, we're looking at everything. We're looking and, you know, it's not just on the T&E and the engineering and mechanical, but it's through the entire company that we're focusing on all of the, you know, all of the labor costs and, and all components of it.
So if I could, real quick, Brandon, good question. Bottom line is this: My boss is sitting right next to me. There's no way I'm gonna give you how much more I think. Is there more left in velocity, better utilization of cars? Absolutely. But I'm not giving you a number moving forward. But, same as we've been doing up to now, we wanna optimize it, and I think there's something left. So no way I'm saying it.
Yeah. He's not saying it, but we both know there's a lot of potential and, and I would say, tongue in cheek, we will gladly take an increased stock price and deal with it between now and year end.
Smart man, Jim. Thanks, guys.
Thank you. The next question is from Steve Hansen from Raymond James. Please go ahead.
Oh, yes, good afternoon, guys. Just a question related to the cadence of the expense reduction through the quarter. I'm presuming that April was a little more difficult, and you probably got some catch up in May and June as the expense management really started to flow through. I guess I'm just trying to understand how much of that was, was completely executed by the end of the quarter and, and or how much is in the quarter versus how much rolls as well through or carries through into Q3 as well? I think you touched on the labor count issue a little bit already, but just around some of the other categories that might also have some expense reductions sort of built into Q3 that you've already executed on.
Yeah, I think, and it's Luc, you know, I can certainly say that we'll continue to apply, you know, look for opportunities to reduce the purchased services and materials. So again, we're looking at, in some cases, redeploying our own personnel and, you know, in replacement of outside contractors. You know, the equipment rents, we're continuing to look at, you know, what we need to get out there and what can be effectively reduced. Same thing on the C&O So I mean, you know, we're really going through systematically every category. Is there the same quantum that we've seen in Q2? Yeah, perhaps not. But I mean, again, we'll have to see where and how the business settles down.
So, you know, we're continuing to push the envelope, and you know, we'll have to see how it unfolds. But I think there's still some to be had in the second half.
Thank you.
Thank you. Thank you. I will go to the next question.
Thank you. The next question is from Scott Group from Wolfe Research. Please go ahead.
Hey, thanks. Afternoon, guys.
Afternoon.
Just wanted to follow up on pricing. JJ, you mentioned a couple of times on the call so far that you're not cutting freight rates to try and get more volume. Is this something that other rails are doing that you're seeing out there? Or are you getting pressure from the customers to start doing this? Because I haven't heard you make that kind of comment in the past. And maybe just more broadly on pricing, I think you were the first one on second quarter calls last year to talk about how rail pricing should really get better in 2014. So do you have an... Sorry, should really get better in 2015. Do you feel comfortable kind of giving us an early view on pricing in 2016?
Well, with last year, my comments which were at the time where before when energy was in around $100 for crude, you know, the whole network was still snug, North America. The effect of all the capital investment on all the rail was still not fully felt. Now we've got more capital has been deployed and there's been some cutback or especially on heavy RTM commodities like coal, export grain and energy commodities. But the market is still balanced. What in my view is a pricing environment that reflects on our second quarter result, I mean, we do have to pursue these dollars.
If they're 3.9%, the way we calculate things and the way we wanna do maintain things on the Steady Eddie s is very solid in our view, and we have sent our salespeople to do that. By the way, our salespeople, one third of their sales bonus is related to pricing. So it's not just about top-line revenue. It's one third top-line revenue, one third pricing, and one third other initiatives, and that's the balance that we'd like to have going forward. Regarding crude by rail pricing, there's always some pressure on pricing from customers, and the crude by rail is an example where the spread is all over the map. The crude producers are under financial distress. Of course, they want something better.
And, and then, you know, these are big volumes that sometimes, you know, they're more like the mirage because they're, they're big, but you never quite get there. As you get closer to them, you find that there was really no lake, it's just another pile of sand. So in that context, I would suggest that, what pricing for us is important is the mid-term impact. You know, chasing something for three months or one month or 20 trains is, taking the context that we want pricing that we would be happy with in 2016 and 2017. So from that point of view, a very disciplined, number one.
You have to be, I mean, in crude, like, it only takes one accident, and it costs a lot of money. I remind everybody, you know, our two incidents during the first half cost us $65 million in terms of accident costs. That's a lot of money. It takes a long time to cover for that. So, you know, we think that the market has to settle. If the price is not right, we, you know, we're not gonna move the business. If the price is right, given it's a dangerous commodity, we're gonna do it, and we're gonna do it well and add value to our customers. That's our philosophy, and we're sticking to it.
Yeah. Crude by rail, carload, will be driven by the spread, not by the record rate.
Thank you, Scott.
Thank you.
Thank you.
Thank you. The next question is from Brian Ossenbeck from J.P. Morgan. Please go ahead.
Hi, good afternoon. Thanks for taking my call. So obviously, you're involved in a tremendous amount of activity in the Canadian economy. Is there any concern you have with the pace of economic growth? You know, last week, the central bank cut rates and basically acknowledging that the economy was, you know, technically in recession in the first half of the year. A large part of that obviously from oil prices. So just wanted to get kind of your high-level thoughts on the economy as you enter the back half of the year. Seems like you're seeing some stress on domestic intermodal customers a bit, but also, what is the sense you get from, you know, the shippers and the customers that you speak to on a regular basis?
... You know, we're a bellwether of the heavy side of the economy, and we have very good visibility on that part. And I would echo what you said, the general economy in Canada has been more sluggish than what we've seen in the U.S. The U.S. economy, I mean, I think, you know, consumers' balance sheet have been repaired. There's a propensity to focus, you know, on discretionary impact with lower fuel prices. And we've seen better growth in what is driven by consumer demand in the U.S. than we have in Canada. I think what Canada is facing is people probably understated the impact of the energy complex cutback on capital expenditure.
You add it all up, it's not just what happens in Western Canada, it's the components that have to feed those big investments. It's the labor that's flying from one part of the country to get to Western Canada. It's discretionary dollars. So Canada has seen a bit more of an impact, but I'm of the view that, you know, we may see a slight betterment in the second half because, you know, everything could turn and get a little bit better. So we're not... You know, we think Canada will do better in the back end of the year, and we finish the year a little bit lower growth than people were expecting. But we don't see Canada in a recession.
We see Canada in a technical slowdown that happened to take place for the first six months of the year. Okay, thank you. Thank you, Brian. Thank you.
Thank you. The next question is from Allison Landry from Credit Suisse. Please go ahead.
Thanks. Good afternoon. Following up on the earlier question on the labor line, I know that you mentioned that wage inflation was sort of in the 1% range. So is that something that we should be thinking about in terms of modeling purposes for the third and fourth quarter? And then could you clarify if there was a separate tailwind on this line item for other incentive comp accruals related to achieving 2015 targets?
Yeah, it's Luc. The wage inflation actually is running around 3%. So what effectively we've done is, through a combination of headcount reduction, lowering of training expenditures, lowering of compensation overall, including some portion of incentive compensation, we've been able to offset part of that wage inflation and effectively come out with a 1% wage cost increase. So that's what I've said.
Overtime is a big part of that. We've been really, really focused on making sure we reduce overtime and also get more of the work done by our inside forces, as opposed to using, contractors to, to do the work. It really is, you know, a long list of execution items that allow you to deliver efficiency gains as volume declines. Okay. Thank you, Allison. Janet, I think that-
Thank you.
There's one more question, and then we'll, we'll close this call.
Thank you. The last question is from David Vernon from Bernstein. Please go ahead.
Thanks for taking the question, guys. Just as with respect to the lower oil price environment, are you guys seeing any negative headwind created on the domestic highway conversions that you guys have been experiencing the last couple of years? And could you give us an update on what's happening with the J.B. Hunt contract that was announced or, or discussed anyway, at the intermodal site tour a few months ago? Thanks.
So the cheaper energy makes the trucking, more, a little more competitive versus rail. The spread of the, the cost between the two is, obviously narrowing. You, then you get back, back down to the basic of, how many drivers there is, being the number one bottleneck of, growth for the, the trucking side. And on the Canadian side, the reason why our domestic intermodal is down, like 2.5% or 3% volume-wise, is more about the economy itself than it is about, conversion back and forth with, with truck. But long term, when you have a steady economy or a little more growing economy on the Canadian side anyway, I think the future of, intermodal long haul is extremely viable.
Regarding J.B. Hunt, they are an example of somebody who does extremely well in good time and bad time, using intermodal as a way to compete in the marketplace against the long-haul truckers. And this was something missing in our stable of product, to have good, strong partners, a couple of partners who are able to get product from Canada to U.S., just about from anywhere to anywhere, anywhere in Canada to anywhere in the U.S., and we're happy that they're gonna be partnered with us for the long term. And I think, you know, over time, steady, that will produce some benefits to both of us, us and J.B. Hunt.
Thank you, David, and thank you for all those good questions, and thank you for being disciplined. Let me put it to you this way: We delivered very, very solid second quarter results. We're pleased. It's a team of railroaders, you know, 24,000 strong, that delivers this kind of performance, you know, driving on all factors. We feel we have good momentum. You know, we feel that we're seeing some green shoots. We're seeing some opportunities to focus on growth. It's sluggish, but it's out there. And, you know, a little carload there, another little expense management, a lot of execution, and a focus on long term.
Sticking with our game plan is what we need to do to continue to drive value for our shareholders, and that's what we intend to do and report to you next we talk in October. Have a safe day. Thank you very much.
Thank you. The conference has now ended. Please disconnect your lines at this time, and thank you for your participation.