All participants, thank you for standing by. The conference will begin shortly. CN's second quarter 2014 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's second quarter 2014 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 stand by. Your conference will begin shortly. Welcome to CN's second quarter 2014 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. Thank you for joining us. It's a beautiful day here in Montreal, and we've certainly got some great results to share with you. I would first, however, 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, Jim Vena, our Executive Vice President and Chief Operating Officer, J.J. Ruest, our Executive Vice President and Chief Marketing Officer, and Luc Jobin, our Executive Vice President and Chief Financial Officer. In order to be fair to all participants, I would ask you to please limit yourselves to one question. 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 this afternoon. We indeed have very good results to announce, and we plan to take your questions and delve a little bit deeper about both the quarter but also the outlook for the balance of the year. If I focus my comments on Q2, we're very pleased that we've had a very swift recovery following what was a tough winter condition, and we did exactly what our customers would expect in terms of getting those supply chains back in sync. Our core metrics are all in line or better than last year. Jim will give you more details, but service and productivity are doing very good. We moved all-time record volumes for our second quarter, and that helped us re-sync those key supply chains.
We dealt with the backlog of traffic from the winter and we're meeting robust growth opportunities across our customer base. J.J. will give you more color and details about that, but we did, during the quarter, deliver double-digit volume growth. To be more specific, 14% for revenue ton-miles, which is probably the best indicator of our volume, and 11% for car loads. Specifically, we had a record second quarter for grain, and this is one supply chain that we've been working hard to re-sync, and I'm pleased to tell you that as I speak today, in the middle of July, our Canadian grain supply chain is fully back in sync. During the second quarter, we moved 70% more grain than last year. We're moving record volumes, spotting every week.
The last couple of, in fact, for the last two to three months now, we've been moving in a range of 5,500 spots or carloads in our western grain operation. That's an absolute record, and as we stand today, we only have about one week of orders outstanding. All the ship lineups at the waterfront ports are at normal level, and our overall supply chain is fully back in sync. For the full year, we should be delivering an all-time record in terms of grain volume, well above an average in the range of 25% more than an average crop is what we will be doing. That should help having carryover stocks that are in the range of 18 million tons or maybe only six million tons more than an average carryout as we close the crop year. All of this is possible because we're balancing operational and service excellence.
That's our agenda. We clearly showed that we are delivering growth at very low incremental costs. Our operating ratio at 59.6% is an improvement over last year. Luc will give you the core elements of our results, but it's solid financial results in terms of revenue, expenses, free cash flow, and he will also give you a little bit more details about the outlook for the balance of the year, which is very solid for another strong year in total. We're trying to stay ahead of the game, looking to next year. We have good growth outlook, staying ahead of the capacity curve, investing through the summer, and we're doing that because it matters to us to stay in sync with those customers' supply chain and help our customer win in their own market. With that, I will turn it over to Jim.
Okay, Claude, thank you very much. Why don't we turn to the operating highlights page, and let me start off by thanking CN's dedicated team of railroaders for their hard work and solid execution, which drove a swift recovery from the winter-related challenges that we faced in the first quarter. Overall, the network is fluid, and our key operating metrics are in line or better than last year, particularly given the significant increase in workload. On a year-over-year basis, revenue ton-miles, as Claude mentioned, were up 14% in the second quarter. That's a full 10% increase versus our fourth quarter 2013, which was our prior quarterly peak. To come out of Q1 and deliver volumes at 10% above peak speaks to the focus and dedication of the CN team and our commitment to our customers.
Let me highlight the year-over-year 4% improvement in train productivity and 5% improvement in locomotive utilization. We are focused on putting the strong volume growth to work for us by running longer and more efficient trains. Those efforts paid off nicely in terms of employee productivity, which hit an all-time record in the quarter with an almost 12% year-over-year improvement in gross ton- miles per employee. I'm very pleased also with our fuel efficiency performance. We reported a 5.5% increase in gross ton- miles per US gallon of fuel consumed, but recall that the comparable would be because we had a negative accounting adjustment last year. The fuel efficiency came in at 3% better for the quarter, which is still an outstanding performance.
We will be facing some tough comps though going towards the second half of the year, and we're working to finish off the year at a 1.5% betterment. Now, in terms of velocity and dwell, we've improved significantly versus Q1, but we're lagging a little bit from last year. Obviously, bringing on 14% increase in volumes is part of that. Traffic mix and the capital programs have also played a role, but we have a number of capital programs that are currently underway, which will help us going forward, but we have work to do. I'm very pleased with the operating performance in the second quarter, but there are no ifs, ands, or buts that we've got a lot of work to do to try to increase the velocity and speed even with the metrics that we were able to deliver in the second quarter.
If we can turn over to the next slide on balancing operational and service excellence, because this is very important about what we do and what we're trying to achieve as a railroad. The objective is pretty simple. We need to stay excellent at running the railroad while at the same time continue to improve service that we offer our customers. All that, though, is centered around our employees. They are key, and employee engagement is important. We're continuing to push decision-making to the front line and, of course, making sure those employees have the tools and training to make the right decisions. We've just opened two new training facilities, one in Winnipeg and on July 7th, the one in Chicago. We've modernized our curriculum, and we've improved our on-the-job training. On the service side, we continue to make progress with respect to our end-to-end supply chain approach.
We're as focused on driving improvement in our customer-centric metrics as we are maintaining our operating discipline. They go hand in hand. We've already made meaningful progress in our intermodal and bulk segments, and I'm very pleased that we're slowly starting to roll out our iAdvise initiative to merchandise customers. iAdvise improves the connectivity between the yard master, the customer service rep, and the customer, and provides our frontline operating folks with the visibility and awareness needed to better meet customer expectations. It's at the right level. It's at the front line people doing the day-to-day work that will serve as our customers. On the capital front, we're continuing to invest for growth and productivity.
In particular, we've got a number of programs targeting greater Winnipeg and the Winnipeg to Chicago corridor in an area that you've heard me speak about that we have specific issues that we've identified that we need to get fixed in the next 18-24 months, and we've got a good plan to get ahead of it. We're also continuing to invest in AC locomotives this year and next year, and the following year. We've got a plan in place and orders in place for this year and next year and what we bring forward. And, of course, safety is the foundation of everything that we do every day. We are going to continue to work all levers via technology, process, or safety culture to drive improvements.
We continue to invest in technology with the announcement last year of extra funds, $10 million on technology and processes, and with the CN campus in Winnipeg and in Chicago, we're going to continue to drive the safety culture and drive improvements in both our metrics. So to wrap it up, Claude, solid operating performance in Q2, but like always, more work to do. Never satisfied with where we are. So over to you, J.J. Just keep that business coming, will you?
Thank you, Jim. And especially thank you for the 14% revenue-ton-mile growth. I will walk you through our second quarter performance, then we'll do the commercial outlook, and then conclude with the yield management. We are pleased to report record revenue for the quarter at $ 3.1 billion and a year-over-year growth of 17%. The breakdown is as follows. Volume and mix produced 11%. Same-store price was just under 3%. Recall that same-store pricing is defined as shipment with the same customer, commodity, car type, origin, and destination, and reflects about 75% of our traffic. There was very minimal impact from fuel, and exchange contributed 4%. Now we'll go to the highlight by market, and as usual, I will do that on the FX-adjusted basis. Petroleum and chemical continued to be impressive, posting a 12% revenue growth.
This was driven by increased crude carload, about 31,000 in the quarter versus 17,000 last year. Canadian heavy crude is accounting for roughly 60%. We have continued ramp-up of new loading facilities as well as new customers receiving location. We have strong butane, propane, gas, and diesel related to tight capacity on the Trans Mountain Pipeline and the reversal of the Cochin Pipeline. Metals and minerals revenue gained 14%. We moved 21,000 carload of frac sand for a 60% carload growth. We handled our first unit train of sand to Western Canada that will become a new trend over time. We had a higher volume of semi-finished steel, reflecting share gain and improving North American demand for automotive and energy sector.
Short-haul iron ore carloads were down 10% as we were bottlenecked by the frozen Great Lakes in April, resulting in a very slow start of the iron ore sailing season. Crop product revenue was up 4% on flat carload. The U.S. housing starts increased our lumber and panel shipments to the United States. This was offset by a lower offshore export of lumber due to a lack of CN's car supply to go to Vancouver. Pulp and paper revenue remained stable. Coal revenue was basically flat. We had lower volume of Canadian met coal and petroleum coke for export, which was due to weak market conditions overseas. This was offset by a doubling in shipments of short-haul U.S. utility coal for domestic restocking and from domestic share gain. Grain and fertilizer reported the biggest gain. Revenue grew 31%.
Canadian grain revenue achieved an all-time high for export volume, 50% more than last year. Our U.S. grain revenue was also very strong, up 24%, and we handled strong product shipment, particularly to the United States. Automotive revenue increased a good 10%. We have strong demand for finished vehicles, which was finally supported late in the quarter by improved TTX car supply. Intermodal revenue grew a solid 15%. Import and export volume were very strong for CN at the Port of Montreal and Vancouver as a result of new business, and at the Port of Prince Rupert due to change in deployment of vessel capacity. On domestic, we continued the solid growth in retail, which was mitigated by lower revenue for wholesale. Our cold supply chain revenue increased 25%.
On other revenue, which was down 4%, we lost basically one full month of sailing with the iron ore vessel fleet due to the heavy ice back in April. Now, turning to the outlook, I'm on page 10. The demand is solid. Starting with intermodal, we see a continuation of growth at the Port of Vancouver, Rupert, and Montreal. Currently, with the short-term diversion of U.S. West Coast traffic to the Midwest, our West Coast port capacity is sold out for the month of July and August. In Canadian domestic, we are balancing price and volume growth, but leave no doubt we have a very strong domestic service offering. In bulk, we will continue to move last year's record Canadian crop in advance of the new harvest. We also see good things in our U.S. grain volume as well as in potash.
Thermal coal volume will remain strong, driven by ongoing utility restocking and by share gain. Offshore coal export will remain depressed. In merchandise, demand for crude by rail will remain on the upward trend. Receivers capable of handling unit train volume will generate significant demand pull. I am also more constructive on the pricing trend for crude by rail new contract and the value of that business to CN. Metals and frac sand demand looks solid. We are adding to our fleet, centerbeam fleet, 500 units to meet more of the U.S. housing start demand. We are also improving our intermodal model at Prince George to move more Asian lumber export overseas. Moving to price and capacity yield management, becoming increasingly important in the way we do business, the North American rail capacity is getting snug.
Pricing should be influenced by both the value of our service and the intrinsic value of capacity in and of itself. We use same-store price as a better reflection of all pricing action taken. We continue to focus on inflation- plus pricing, which we define now as 3%, all in, including coal, grain, the full book of business as it should be. We find revenue per car and cents per RTM to be a weak measure of price and yield as they are generally primarily driven by change in mix. We prefer using better decision tool, revenue-to-cost ratio for customers' private car, contribution per car a day for CN-provided rail cars, and round-trip revenue-to-cost ratio model for intermodal. Our focus is on upscaling, not just adding volume. In conclusion, there is solid demand pretty much across North America.
We are growing faster than the economy at mid- to high-single-digit carload growth, and we are focused on getting value for our service and for our capacity with disciplined inflation-plus pricing and with capacity-yield management. Luc.
Yeah, thanks, J.J. Starting on page 13 of the presentation, let me walk you through the key financial highlights of our second quarter's performance. As Claude mentioned, these very strong results demonstrate our quick recovery from the first quarter's weather-related challenges and solid growth momentum into the second quarter. As J.J. outlined, revenues were up $450 million or 17% to slightly over $3.1 billion. Operating income was over $1.2 billion, up $216 million or 21% versus last year. Our operating ratio was 59.6%, an improvement of 130 basis points over last year as we grew the business at low incremental cost. Now, this represents a record for a second quarter operating ratio, and it weighs in as our third best quarterly operating ratio performance ever. Other income was $2 million versus $28 million in 2013.
Last year's result included in the quarter a pre-tax gain of $ 29 million on the exchange of an operating easement. Net income for the second quarter is $ 847 million, up 18%. Foreign currency translation contributed to a favorable impact on net income of $ 28 million or $ 0.03 of EPS in the quarter. So the reported diluted EPS reached $ 1.03, up 23% versus last year. The adjusted diluted EPS also stands at $ 1.03, in this case, up 24% versus the prior year. As I mentioned, 2013's adjusted results did include the property gain, which I referred to earlier, and a deferred income tax adjustment of $ 5 million relating to a change in provincial corporate income tax rate. Turning to page 14, operating expenses were $ 1,858,000, up 14% versus last year, or 10% on a constant currency basis as we continue to tightly manage cost.
At this point, I'll refer to the expense changes in constant currency. Labor and fringe benefit costs were $560 million, an increase of 10% versus last year. This was the result of three elements. First, an increase in overall wage cost of $38 million, or about 8 percentage points. This is the product of wage inflation of about 3%, overtime for about 2 percentage points, and a 3% increase in our average headcount versus last year. So Jim and his team certainly delivered double-digit manpower productivity in the quarter. This was partly offset by higher capital work being performed in the quarter versus last year for approximately 4 percentage points. The second element is a higher stock-based compensation expense in this quarter versus last year. Now, this represents $40 million of the variance, or 8 percentage points.
The third element is a favorable variance of $9 million or 2 percentage points in pension and benefit expense. This was the result of the pension expense being lower by approximately $20 million, which offset an increased benefit cost in the quarter versus last year. Purchased services and material expenses were $390 million, an increase of 11% or $39 million. The key drivers here were the 14% higher volume in the quarter, along with some leftover winter-related costs. As such, repair and maintenance expenses were up $11 million or 3 percentage points, as were material costs in the quarter, while the intermodal trucking and transloading expenses were up 2 percentage points, as were crew accommodation and utility costs in the quarter. The fuel expense stood at $484 million, up $54 million or 13% versus last year.
Higher volume represented an increase of 13 percentage points in the quarter, while an increase in price drove the remaining 5 percentage points. Fortunately, fuel productivity was approximately $20 million favorable on account of a 3% improvement in the quarter, while an additional 2 percentage points of the variance relates to a one-time unfavorable inventory adjustment that we incurred last year. Equipment rents at $84 million or $12 million higher than last year, or 18%. This is mostly attributable to higher equipment leasing costs and more car hire expense in the quarter. Casualty and other costs were $83 million, $14 million or 22% higher than last year. The increase here was split about evenly and resulted from higher costs related to environmental matters and higher property taxes.
Turning to free cash flow on page 15, we generated over $1.2 billion of free cash in the first half of the year, an increase of $482 million versus last year. In comparison to last year's year-to-date results last year, cash from operations benefited from higher earnings, lower income tax payments, and better working capital. This was partly offset by higher net investment activities for $50 million in the quarter. Some of the favorable working capital variance, however, is partly the result of timing, so we may not net off quite as well on that dimension by year-end. Meanwhile, our balance sheet remains strong with debt and leverage ratios within our guideline, which bodes well for continued support for the business and shareholder distributions going forward. Finally, on page 16, our outlook for 2014. We're pleased with the swift recovery we achieved from a challenging first quarter.
Our entire second quarter's performance was strong from a revenue, service, and operating standpoint. This is a fine demonstration of our ability to grow faster than the economy and do so at low incremental cost. We have good momentum, and we continue to be optimistic with our prospects for the balance of the year. Now, while we clearly have our work cut out, we have the potential in the second half of the year to reach the overall earnings growth performance achieved in the first half. Given this perspective, we're raising our annual guidance, and so we are now aiming for solid double-digit EPS growth in 2014 over the 2013 adjusted diluted EPS of $3.06. We're also raising our guidance for free cash flow to now be in the range of $1.8 billion-$2 billion. Meanwhile, we're maintaining our capital investment program at $2,250 million.
In conclusion, the CN team remains as committed as always to delivering superior results for our customers and shareholders as we continue to unfold our strategic agenda in 2014 and beyond. On that note, back to you, Claude.
Thank you, Luc, and thanks to the team. I think it's fair to say when you look at these results that our business agenda is maintaining its strong momentum. We are delivering high service level to meet our customer demand. Our supply chain mindset is a key differentiator, and it's helping us outpace the economy and our peers. We have a disciplined approach to investment. We're looking to support growth, productivity, and safety. We're doing it on a consistent way, trying to stay ahead of the curve, and it's paying dividends. The goal is to create solid value for both our customers and our shareholders, and I think our Q2 results and the outlook that we've just provided you for the balance of the year is proof to that. With this, Patrick, we will be happy to take questions.
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 headset 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 Benoit Poirier from Desjardins Capital Markets. Please go ahead.
Hi. Could you maybe provide more color on the crude by rail following the announcement made by KCS and Global Partners for the new terminal in Port Arthur? It seems a very nice opportunity for you. And more specifically, I'm wondering how conservative is your guidance of 150,000 carloads for next year and also what we should expect in the second half? Thanks.
Well, thank you, Benoit. J.J., maybe starting with the guidance. We may do better than the guidance, but I want to put that in the context of the yield of crude. Crude needs to pay its weight in the railroad just like any other commodity, so that's as important as exceeding the guidance on volume. Regarding the announcement of the new terminal on the KCS, this is not the only new terminal that there is being built in the Gulf or Alberta, but it just adds up to the size of that pie, right? It makes a bigger pie for, in a present case, Canadian crude. That's where we participate to go down the Gulf, and we do have connection with KCS over, what I call it, Springfield. Some of the people call it the Carvarol.
Time will tell how the business shapes out, but it's just more of a bigger pie for everybody to participate.
Okay. Thanks for the time and congratulations for the results.
Thank you.
Thank you. The next question is from Brandon Oglenski from Barclays. Please go ahead.
Yeah. Well, good afternoon, everyone, and congratulations on the good results here. I guess my question's for Claude or J.J. Obviously, this year you're seeing a lot of ramp-up in grain markets. You've won some intermodal contracts from your competitor as well as on the auto side. But when we start thinking about 2015 and 2016, how sustainable is this mid-single-digit type carload growth? Isn't that going to start lapping some very difficult comparisons? Do we see maybe a year of pause in 2015 on the growth end, or are there some pretty robust pipelines behind this?
Let me take that. I think we are seeing a robust pipeline of growth across all of our lines of business, or I should say for the most part across our lines of business. Definitely, energy markets will continue to be a strong source of growth into 2015 and beyond. Grain should have another strong year next year because, as I said earlier, while we will finish with a carryout of 18 million tons, that is still 6 million tons more than an average. Add to this the new crop and the need to move it. We should be moving record volumes of grain well into the spring and even summer of next year. We have good growth in intermodal, good growth in automotive businesses. We have solid growth in merchandise, winning with our customers, one carload at a time.
I don't see 2015 as a year of pause. It's tough to lap strong growth year-over-year, but that's our agenda. We'll give you more contour and color on that outlook when we close in on the year. It's a bit early to call it more precisely at this point.
Appreciate it. Thank you.
Thank you. The next question's from Cherilyn Radbourne from TD Securities. Please go ahead.
Thanks very much and good afternoon. I'd be curious to know, just given how strong your execution has been since the spring arrived, to what degree you think some of the acrimony between the rail industry and the grain industry has started to dissipate here?
I think you have to put things in context. As I said before, I think some stakeholders and certainly the government reacting to those stakeholders, we lost perspective in the winter with the grain situation. We were hitting record volume last fall. Even the Minister of Agriculture was saying that we were doing an adequate job at moving this record crop. The winter was very difficult, but when you look at the entire winter, at the end of it, with a strong March performance, we came in with volumes that were only 2% less than an average winter. And since then, I mean, we are hitting absolute records. I said earlier, 70% more western grain during the second quarter, and we will finish the year in total with 25% more grain than an average year.
I think the facts are speaking to the reality, and I'm hopeful that ultimately the facts will shape policy, and it's certainly shaping the relationship we have with our customers because as we speak, I think we have, as I said earlier, we don't have a week of outstanding orders. That means we are meeting all the demand, and there should be room to store the grain when it's harvested, especially so that it's expected to be harvested late this year because of a late-planted crop. So we'll do our work, and hopefully people will see that and shape policy accordingly.
Thank you. That's my one.
Thank you, Cherilyn.
Thank you.
Thank you. The next question is from Scott Group from Wolfe Research. Please go ahead.
Hey, thanks. Afternoon, guys. So wanted to ask a little bit about the pricing. J.J., it sounds like maybe that's a lever you're going to start pushing a little bit more aggressively, and just wondering, how quickly do you think that starts to show up in the numbers? And do you think that you can get another point or two of pricing and still maintain kind of this volume growth well above the rails?
So there are two things that we're focusing on. One is pricing as measured in same-store price, and the other one is yield, which you will not see in same-store price as we do upscaling because upscaling turned out to be new business. It doesn't get measured in same-store. And the two of them are very relevant to driving an operating ratio that we have today. And we're at the view of pacing ourselves, doing this progressively, and working on the two levers as opposed to just the one lever. And I think overall, I think capacity in North America—I mean, railroads may have different opinions or opinions that they say publicly or not so publicly—but capacity is getting a little tight. And capacity just in itself has more value today than it had after the recession.
We've been into a recovery now for five years, and railroad has been investing $ billions, including ourselves. But there is some pinch point that from time to time shows up after whatever, weather issues or other issues, which I think are pointing to the value of capacity, and eventually that reflects in your renewal, and that reflects also in which business fits best into a given railroad, which I call upscaling. Over time, but steadily on the way up.
Thank you.
Do you think, I mean, when do you think this starts to show up in the numbers?
Again, over time. We still have this Canadian grain thing to digest up to August 1st and some lingering effect in August. And after that, we'll, I think you'll only see so much in same-store price, and the rest, hopefully, you'll be able to see more on the bottom line of the company.
Okay. All right. Thanks a lot guys .
Thank you.
Thank you. The next question is from Walter Spracklin from RBC. Please go ahead.
Thanks. Good afternoon, everybody. Just a follow-up here. Clearly, with the higher volume that you're getting on your system and the higher demand, J.J. is doing a good job now, as Scott was indicating, of repricing that capacity that you have using the bottom decile group of customers. This question, I guess, is for Jim. As J.J. is doing that on that side, how are you looking at the capacity on your side in terms of being able to handle this growth? You mentioned that you still have some work to do on the velocity side.
Is there any risk that we start to see in the back half some cost creep, or are you still confident that we can get some good operating leverage here, or is it perhaps a CapEx question where you go into Luc and rather than an expense creep, you might come back and ask for a little bit more capital? How do we look at that kind of capacity utilization and the constraints you're having on that end?
I think the way you asked the question, you just about hit it all. Well, sorry. And so it's a great way to frame it. First of all, do we have some areas where I'd like a little bit more capacity? Yes. But we try to plan capacity out so that we don't get to the point where we're so restricted that we have an issue in the short term. You can't spend enough capital for winter, and I've said that a number of times, and you're going to have some issues whether you like it or not. But we have some areas that we've identified that we have to work on. We're working on them this year. We spent capital last year between Edmonton and Winnipeg, and in fact, it worked out real good through the winter in that area.
We will continue to invest, as I mentioned earlier, between Winnipeg and Chicago because we see growth in that lane, plus the type of traffic. The second piece is, and what you want to be able to see is a certain percentage, let's say 4% or 5%, go onto the trains that you're running already. Trains that have got the room to grow. We bring in AC locomotives, invest on them. It allows us to put more on the trains, especially in that Edmonton to Chicago. So we do all that and then the mix. And I think the biggest problem I could have is, as J.J. tells me, that we got another 14% next year, and I don't see anything that'll stop us from being able to handle that kind of business if the market's there for us to bring it in. It's always a challenge.
When I talked about the velocity is, last year, Q3, we basically set a record on most of our numbers. It's tough to match that with the matching business and what we have. Now, I don't know if we'll get right to the numbers. We're going to work real hard to try to get to the numbers, and that's the kind of people we have. We got people frontline working to try to get that last mile, that last car on the train, make them a little bit bigger, Walter. Hopefully I answered the question.
Well, Walter, Luc, just to add a little color on the CapEx side of things. Obviously, again, I mean, I think we're trying to invest the money wisely. We're trying to anticipate the needs. This is not something that would push us above our sort of range. We've always been looking at 18%-20% of revenues for CapEx. So I would expect we're going to stay in that range. We're certainly adding more rolling stock. I mean, if you look at just the locomotives, we've actually secured about 500 more locomotives since the back end of the recession. The business is there.
As Jim pointed out, on some of these infrastructure requirements, when you work at it over time, so we're on to some of the areas that we feel are creating opportunities for improvement, and we're flagging some more for the future. It's a matter of pacing ourselves, but the good news is the business is out there, and I think we've got a good plan to address it both in terms of operating performance and capital investment.
That's great. Thank you very much.
Thank you, Walter.
Thank you. The next question is from Chris Wetherbee from Citi. Please go ahead.
Thanks. Good afternoon. I was just thinking about sort of the guidance and putting it in context for the second half. As you're coming out of 2Q and volumes are running very well, the network is clearly running very well. Outside of maybe a slight deceleration in volume as you move into 3Q and 4Q, what is there or is there anything that maybe shows up that could decelerate the pace of growth? It would seem like you're entering into the back half really with a strong tailwind here, and I'm just trying to get a rough sense of putting that solid double-digit EPS growth into context for the back half.
I think the best way to think about it is we finish the first half with roughly 17%-18% EPS growth. We have our work cut out to repeat that in the second half, but that's what Luc signed up for. Jim and J.J. will try to beat it.
That's right.
All right. That's helpful. Thanks.
Thank you.
Thank you. The next question is from Fadi Chamoun from BMO. Please go ahead.
Yes, actually, my question was asked, but maybe for J.J., on the intermodal side, as we go into the back half of the year, you obviously had a very strong first half with some divergence from the U.S. coast maybe and some sort of above-average growth. How do you think about the back half of the year being a more normalized growth rate at this point, or is there anything else going on on that front?
Yeah. Thank you, Fadi. We're still constructive about the second half for intermodal. Again, more coming from the port, Vancouver, Rupert, and Montreal because of things that we've gained earlier in the year will carry us through the full calendar year. Your comments about the divergence from the U.S. Midwest, the labor situation on the U.S. West Coast, we didn't get a whole lot of benefit of that other than the latter part of the month of June. So the impact of that is really going to be the third quarter. And as I said, right now, we have more coming at us than we can handle. So that's not a, it's a good and bad problem to have. But all in, there's nothing that says the second half should be hitting a wall or whatnot. Overseas is going to be strong. The situation in the U.S.
Eventually will get itself resolved. What we're really after is permanent business, not just transient business, and domestic has some pockets of positive and some pockets of negative, and we'll work with that because in the end, what we're really after is something sustainable but profitable. It's going to help what you were looking for.
Thank you. Maybe you can just give us what was the growth in the domestic intermodal in the quarter?
I don't have the specific numbers, but the growth was much stronger on the overseas than it was in the domestic, whether it's a revenue or units.
Okay. Appreciate it. Thanks.
Thank you. The next question is from William Greene from Morgan Stanley. Please go ahead.
Hi, good evening. J.J., or maybe even for Claude to some extent, I'm curious what your view is on the idea of service. So when we look at CN for years, your service was kind of second to none for sure in Canada, and you guys won a fair amount of share through that service level. Now, you're making it harder for CP to catch up on OR with this performance here in this quarter. But as that gap narrows and the service levels, if they're approximately the same, do we have to worry about any traffic that's on CN that is perhaps not naturally on CN so that it would naturally want to go back to CP if service and cost were similar? Is there a segment of the business, so to speak, at risk over the next few years, or is that not really the case at all?
I think the business that we have is natural business for CN. We've worked hard over the years to have a true end-to-end supply chain approach. Customers, that business model is resonating with them. We keep making headway. We compete against trucks. We compete against ships. We compete against pipeline. We compete against all the railroads in North America, including CP. Our goal is to outpace our peers and outpace the growth rate of the economy. I think our outlook for growth, for the balance of the year, and my comment about 2015 supports the notion that we see that continuing for the foreseeable future. You don't win business on an operating ratio. You win business because you have the right franchise, the right mindset, and the right business agenda. We think we have all of that.
In the market, where capacity is a little tight, we don't need to go after every piece of business. We shouldn't know.
Yeah, fair enough. Okay, great. Thank you for the time. Appreciate it.
Thank you. The next question is from Ken Hoexter from Bank of America Merrill Lynch. Please go ahead.
Great. Good afternoon and congrats on the nice results. But just digging into maybe, J.J., a little bit of the outlook, can you talk about your timing of maybe some new crude by rail activities coming out on the heavy Canadian side? And then similarly on the coal side, I think you threw out there that you expected it to remain or you're seeing that it continue to get weak given where price, global pricing is. Can you maybe delve into that a little bit as well? Thanks.
So on the coal side, the export coal is weak. It's even weaker now than it was earlier in the year. And we don't necessarily see a whole lot of positive signs, especially on the petcoke and/or the metcoal. On the domestic coal, I mean, people are restocking, and we had these one-time share gains earlier in the year. They stay with us for the full year. And on crude, these are major projects. Actually, we're getting pictures this week of some of these big construction sites, and it takes time. So the big ramp-up again, people will work hard to try to do everything they can. I'm talking in Alberta here in the north, but they still hear the winter from time to time to ramp up this construction site before the coming winter. So I mean, constructive on crude.
The market is moving toward unit train, bigger block of origin, bigger block of destination. I think we're staying to our guidance, may exceed that, and we want to be sure that what we move is a decent yield and it pays its way on the railroad.
Thank you, Ken.
Yeah. Thanks, Claude.
Thank you.
Thank you. The next question is from Jason Seidl from Cowen and Company. Please go ahead. Mr.
Hey, guys. It's Jason.
Hello there.
Real quick, J.J., you talked a little bit about the real strong growth on the frac sand side, but you mentioned that there's going to be unit train that seemed like it was new business going to Western Canada starting here in the back half of the year. Can you give us a little color on that, and can that grow beyond one unit train?
So there is unit train activities today in the United States where people who buy CN receive large block, meaning unit train quantities. Not the case yet in Canada. Obviously, the market sees all kinds of efficiencies in moving bigger block. I say unit train would be big block, right? And we moved our first big block or unit train in the second quarter. And there is a trend where the big buyer of CN would like to receive bigger quantity at a time. And just like crude, this will eventually move to a kind of a different distribution model where people spend a lot of money at the receiving end with loop track or big receiving track to receive large quantities, which is a sign of volume is going to go up.
If these LNG terminals and Prince Rupert and Kitimat really go ahead, it really speaks to how much CN is required in northern B.C. and in Alberta. It's a trend about growing, and it's also a sign of how much money, capital money, our customers are investing because they believe the business is there long-term.
Is there any difference in the length of haul on that business than the U.S. business?
No. So we're talking Wisconsin to Alberta and maybe one day Wisconsin to BC, but today it's really Wisconsin to Alberta.
Okay. Great. A follow-up question. You also mentioned a little bit about a recovering housing market in the U.S. I mean, we've seen some mixed data down here in the States, and just wondering what you guys are seeing that tells you you got to order some centerbeams here?
Yeah. What I'm seeing is even though the housing starts in June were down, and we're struggling with meeting the demand. So in a way, it's a silver lining to us that the housing starts are not running up too fast because we may not be able to keep up. So our fleet in the second quarter was basically fully deployed, and our customers elected to, because the supply was tight, elected to ship more to the U.S. long haul and do the short haul to Vancouver by truck. So we are getting more equipment so that we can participate more to the U.S. housing starts. And we'd like also to participate a little more in the Asian export via Vancouver.
You ship a centerbeam from BC to Vancouver, and you load in a container, as well as do some of that right at the mill or closer to the mill from our Prince George Intermodal Terminal. So I think the relationship between U.S. housing starts and CN's coal and lumber is maybe a little tighter than what people thought because in June, we really had very little reprieve in our order book.
In fact, I would say in lumber, we still have quite a bit of inventory on the ground that we have to clear over the next several months. So we're constructive about lumber movement, and it's the same story with panels, which is basically the same market.
That's right.
Thank you, Jason.
Well, thank you, guys, as always.
Thank you.
Thank you. The next question is from Keith Schoonmaker from Morningstar. Please go ahead.
Yeah. Thanks, J.J. I think you mentioned that heavy crude was about 17% of quarterly crude volume, if I heard that correctly. Could you comment on trends in length of haul within the crude franchise and maybe what you expect in the next year to two?
The heavy crude, my comment on heavy crude was we are roughly about 60%. I think in the second quarter, 60% of our crude was heavy crude.
60.
60.
60, yeah.
Okay. Yeah. And then trends on length of haul, if you don't mind.
Trends on length of haul, I think, what, second quarter is about the same length of haul, I think, from the first to second quarter. I mean, crude itself is long haul business, no question, and it's more and more into unit train or block. But the average length of haul, I think, is probably stable for a crude business, stable as in the recent past.
Thanks.
Thank you.
Thank you.
Thank you. The next question is from Allison Landry from Credit Suisse. Please go ahead.
Thanks. Good afternoon. I just wanted to ask a balance sheet question. Your adjusted debt to EBITDA came down a little bit in the second quarter to about 1.6 from 1.8 in the first quarter. And I was just wondering if you would consider adding some leverage here to potentially increase your share buyback program ahead of the October expiration of the current program.
Yeah. I mean, as such, we don't have a specific plan to kind of unduly leverage up. I mean, we continuously look at the balance sheet. As I mentioned earlier, it is in pretty good shape. So we'll look at, we'll review our policy for stock buybacks and dividends as we get to the back end of the year. Our stock buyback program expires in October, late October. So that will be providing some input, some update on that probably when we report our third quarter numbers. And the dividend we'll reconsider as well in terms of next year's plan and probably report back on that sometime early in the new year. So good balance sheet. There's clearly some flexibility there, but you shouldn't expect a major departure in the way in which we're thinking about the balance sheet. So no significant leveraging up overnight kind of thing.
Got it. Thank you so much.
Thank you, Credit Suisse . It's the same team, a steady hand but delivering strong cash flow and solid shareholder value.
Thank you. The next question is from David Tyerman from Canaccord Genuity. Please go ahead.
Yeah. So good afternoon. Question on the intermodal. In the intermodal, you commented that you're balancing price and volume growth on the domestic. I was wondering if you could provide a bit more explanation there, and particularly in light of CP touting this area as an area of major growth. I don't know if it's impacting you or not?
So the domestic intermodal, I'm talking the Canadian domestic intermodal, is where us and our competing railroads from Calgary offer similar service. And the area where the service overlaps the most is Toronto, Calgary, Vancouver, back to Calgary, back to Toronto. And in that corridor, it's very competitive service-wise and price-wise. We are focused on getting a fair value for our service, and in some cases, all the effort we put in are deemed to be not worthy of a small price increase. And in those cases, sometimes we may have to take a pass for the bigger picture. So by and large, we are focused on the yield and upscaling, and in some cases, we may or may not meet the competitive offers out there if there is some when there is some.
We want to balance price with volume, and it's very important to our midterm game plan here.
Okay. That's helpful. Thank you.
Thank you. The next question is from David Vernon from Bernstein. Please go ahead.
Hey, guys. Thanks for taking my question. J.J., could you comment a little bit about how the contracts are structured for the heavy Canadian crude by rail? Are those U.S. dollar denominated? And how do you think that the demand should trend as we see the currency separation beginning to develop here as U.S. dollar is appreciating? Thanks.
When we ship something to the U.S., we view ourselves as a U.S. railroad, and we price in U.S. funds. When we ship something into a Canadian city from a Canadian city, we see ourselves as a Canadian railroad and price in Canadian funds. So domestic movement, Canadian funds, cross-border movement, U.S. funds, and the dollar does what it does. Sometimes it's up, sometimes it's down.
Do you think that if we started to see the U.S. dollar continue to appreciate, that could help create some demand for that heavy crude?
I'm not sure how it links back to heavy crude. I mean, crude is really a U.S. dollar-denominated world market anyway to start with. So I wouldn't necessarily make a whole lot of tie-in between exchange rate and how crude moved by rail.
I would agree with that. I think our opportunities to continue to grow in the energy market is really linked to, I mean, it's a sea change. The shale plays, the new movement of crude by rail, all of these markets are looking for transportation opportunity, and some of them need infrastructure. And it's more about how the infrastructure is coming into place that we see the growth coming up than movement week to week or month to month of the Canadian exchange rate.
Yeah. It should not be confused, say, with paper or some of the other commodities which are truly Canadian-based from beginning to end in their costs in different marketplaces.
All right. Thank you.
Thank you. The next question is from Donald Broughton from Avondale Partners. Please go ahead.
Good afternoon. Thanks for taking my question. I just want to kind of get inside your head a little bit and think about understand how you think about strategically the service issues being had by a couple of your U.S. counterparts in particular. Does it really change the way you think about how you operate the railroad, how you hire employees, how you operate the interchange with them, how you invest in your rail, or is it more a, "Look, this changes the way we're going to interact with our customers," and what we see as the opportunities for volume, the opportunities for yield? Is it one or the other predominantly? How do you think about that?
No, Don, if you get inside my head, you would look out three to four years, and you would see us finding ways to stay ahead of the curve, stay ahead of the curve on service initiatives, stay ahead of the curve on capacity investment, stay ahead of the curve on shaping safety and our ability to be seen as a backbone to the economy. And if you stick with me and have good access to how we're thinking, you would see that we have a bright future and are looking to ride our agenda. And it's not about what our competitors are doing this week. It's about where we see the market three to four years from now.
Don, just to add a comment, Luc, I mean, I would say that certainly, given the infrastructure advantage we have in the Chicago area, this is a pretty lasting advantage that we're going to leverage as much as we can. That's very difficult for others to get around that. I think it bodes well from an infrastructure standpoint.
Yeah. If you need to go to Chicago, you can ride on us.
Thank you.
Thank you, Don. Quite the slogan.
Thank you. Our last question is from David Newman from Cormark Securities. Please go ahead.
Good afternoon, gentlemen.
Just a week in, David.
Nice quarter. So besides pricing improvement from top grading some of the areas, and I would assume that's probably intermodal, crude by rail, mixed merchandise, where it's obvious where you can do it. Is there other areas where M&A would make more sense? So you're getting a little tight and a little bit snug. You've got $2 billion in free cash flow that you have coming at you, certainly lots of cash. Your balance sheet's in great shape. You did a great acquisition years ago, obviously, and certainly in Northern Alberta. Some of the short lines that's helped. Is that starting to enter your thinking in terms of maybe there's other areas rather than deploying CapEx, you might look at some M&A?
Our core strategy is leveraging our franchise on an organic basis. In addition to solid volume and good pricing, we are in that tied to capacity. There's nothing like being challenged to focus on all the levers. If there is a new trend, it's about looking at the bottom line opportunity. How can you get yield by focusing on how you leverage that volume to get the business at lower cost? It's not just price and volume. It's also bottom line focus through yield initiatives. If you do that consistently and outpace the economy and accommodate the business at low incremental cost, you can, as we did over the last five years, deliver solid results for your shareholders. We have the balance sheet. If strategic opportunities create themselves, they are also part of the scope of initiatives.
The Plan A is organic growth, and we got the tools and the ability to act on Plan B if an opportunity creates itself.
Very good. And just maybe to squeeze one in, I mean, is it the obvious areas of international intermodal, crude by rail, mixed merchandise? Is that the areas where we've all heard comments about international intermodal being lower margin? Is these sort of the areas that you're looking at to sort of top grade?
I would say that we have opportunity across all of our businesses, more than the ones you just mentioned. All of our businesses are solid profitability. It's true of overseas. It's true of domestic. Obviously, intermodal is a little below the average of the overall book, but in our case, it's fairly close to the average profitability of our book of business. We look to upscale. We look to create yield, and we look for balance. We do that across all the commodities we serve.
Very good. Congratulations, guys. Great results.
Thank you.
Thank you.
Thank you. That's a good question to close in. Again, we're constructive about the balance of the year. Very proud of our second quarter result. Those results are because we have a very strong team of committed railroaders that are focused day in, day out to serve our customer needs. That's what we'll do for the balance of the year in order to deliver solid results and meet with our new guidance. We look forward to report on that success in our Q3 call. Thank you.
Thank you. The conference has now ended. Please disconnect your lines at this time, and thank you for your participation.