Good morning. My name is Stephanie, and I'll be your conference operator today. At this time, I'd like to welcome everyone to Canadian Pacific's Second Quarter 2022 Conference Call. The slides accompanying today's call are available at investor.cpr.ca. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there'll be a question-and-answer session. If you'd like to ask a question, simply press star, then the number one on your telephone keypad. If you'd like to withdraw your question, press the pound key. I would like to now introduce Maeghan Albiston, Vice President, Capital Markets, to begin the conference.
Thank you, Stephanie. Good morning, everyone, and thank you for joining us today. Before we begin, I wanna remind you that this presentation contains forward-looking information and actual results may differ materially. The risks, uncertainties, and other factors that could influence actual results are described on slide two in the press release and in the MD&A that are filed with Canadian and US regulators. This presentation also contains non-GAAP measures, which are outlined on slide three. With me here today is Keith Creel, our President and Chief Executive Officer, Nadeem Velani, Chief Financial Officer, and John Brooks, Chief Marketing Officer. The formal remarks will be followed by Q&A, and in the interest of time, we appreciate if you could limit your questions to one. With that, it's now my pleasure to introduce our President and CEO, Mr. Keith Creel.
Thanks, Megan. Good morning, and thank you for everyone joining us today. Let me start off as I always do, thanking our entire CP family. I can tell you after a very challenging first quarter, I'm extremely proud of the resilience and the tenacity this team's demonstrated delivering these results over this second quarter of the year. During the quarter, we produced second quarter revenues of CAD 2.2 billion, an operating ratio of 59.7, core EPS of CAD 0.95. As we expected with a more normal operating environment, the team delivered strong sequential improvement in a number of the metrics that drove the financial performance. We had sequential improvement Q1 to Q2 of 16% on locomotive productivity. Car miles per day improved 15%. Dwell improved 13%.
Also, I'm very excited about the self-help business initiatives that continue to be accomplished by the marketing team with some exciting developments on the customer front, new business announcements and even a port expansion, which John will get into more detail in his comments. On the CPKC front, positive momentum continues toward our transformational merger. Last week, as many of you are aware, the STB announced dates for the public hearings gonna be late September as we continue toward an early 2023 decision date. Customer feedback continues to be overwhelming. We continue to run test shipments on an interline basis and intermodal grain metals and continue to have very progressive and exciting exploratory discussions about new opportunities in export potash. Another key development we're super excited about, the announcement by the KCS.
They successfully negotiated 10-year extension to the exclusivity rights. My hat's off to Pat, Oscar, and the KCS team for this tremendous outcome. Again, the momentum continues as we do our planning to hit the ground running to exceed expectations for all stakeholders. We're in a good spot. We continue to gain ground and look forward to realizing the vision of that transformational merger as we march toward the first part of 2023. Now looking at the back half of the year from a demand standpoint, we continue to build momentum on the CP network. The upcoming grain harvest is looking better every day. The demand environment continues to be strong. We're resourced to deliver crews, locomotives, cars. We still expect to deliver double-digit RTM growth in the back half and ultimately grow RTMs and earnings for the year.
With that said, let me hand it over to John to provide some color on the markets, before he turns it over to Nadeem to elaborate on the numbers.
All right. Thank you, Keith, and good morning, everyone. Let me start by saying and reiterating what Keith said. I'm very pleased with how Q2 played out. You know, looking at the results, revenues were up 7% on the quarter. Fuel and FX combined to be a significant 10% tailwind, offsetting the 2% RTM headwind. Excluding the headwind from Canadian grain in the quarter, RTMs were up high single digits during the quarter. The pricing environment continues to be very strong with inflation plus renewals that actually are continuing to accelerate as we move into the second half of the year. Now, taking a closer look at the second quarter revenue performance, I'll speak to the results in a currency adjusted basis. Grain volumes were down 23% on the quarter, while revenues were down 18%.
As the current crop year comes to a close, we will continue to see the headwinds from the 40% smaller Canadian grain crop until this year's harvest starts to come off the fields. We continue to offset some of that challenging conditions in Canadian grain with another strong performance in our US grain franchise, which posted a third consecutive record quarter. Now looking ahead, there's still a few months yet before the new crop is harvested, but the growing conditions have improved across all of the prairies. Current expectations are for a crop above 70 million metric tons, which is in line or if not a little better than historical averages.
With delayed seeding in Q2 from too much moisture in some areas, we expect harvest to be later than normal, which could push grain volumes into Q4 or actually into 2023. Finally, we received positive news that regulated grain revenues will increase by 12.7% for the 2022/2023 crop year that starts August 1. On the potash front, volumes are up 10% in the quarter, while revenues are up 26%. We continue to see strong global demand for AG nutrients, with the ongoing disruptions in potash supply from Belarus and Russia. We expect Canadian potash to remain a growth driver at CP. Looking ahead, we see the strong likelihood for Canadian producers to continue to accelerate growth capacity and expansions to fill this growing need of potash supply.
The increased demand for Canadian potash is creating great opportunities for the potential to move volume south to new export outlets to reach the growing South American markets. To close out our bulk business, coal revenues were down 4%, while volumes were down 14%. Now, moving on to the merchandise side of our business, the Energy Chemicals Plastics portfolio saw revenues decrease 10%, while volumes were up 3%. Now, excluding crude, core ECP commodities delivered record Q2 results. Now, looking ahead, you can expect ECP volumes to perform well, driven by new business with Independent Energy and IPL, both in the process of ramping up and will continue through the second half of the year. Forest Products volumes were up 1%, while revenues were up 12%.
In MMC, revenues were up 23%, while volumes increased 10%, setting an all-time quarterly record driven by continued strong pricing and demand for frac sand as we see higher drilling activity continue as we also see higher WTI prices. Our sand producers are well positioned on our network to meet this increased demand, and we are working closely with our operating team and customers to increase our train lengths to maximize our capacity and the potentials in these markets. Automotive revenues were up 19%, while volumes were up 4% on the quarter. We saw sequential improvement in Q2, and we expect continued improvement in the back half of the year. The growth we are seeing in automotive is driven by ongoing industry replenishment and self-help initiatives, including our new GM business that started up earlier this year.
Now, finally, on the intermodal side, quarterly volumes were up 14%, while revenues were up 28%. A third consecutive record and an all-time best quarter for RTMs, beating the previous record by 13%. New Hapag-Lloyd call at the Port of Saint John began at the end of May, and we are seeing strong demand for this service. The Port of Saint John, in collaboration with CP and other stakeholders, were successful in securing additional federal and provincial funding to move the port from a 300,000 TEU capacity to 800,000 TEU capacity. When we purchased the CMQ, just taking you back, we talked about growing this business from CAD 40 million to CAD 100 million in 24 months. As we look at it today, we're on pace to do over CAD 200 million in new annual revenues over that railroad.
In Q2, we also announced new market share gains with CMA that started up July 1st. Just recently, we extended our strategic partnership with Yang Ming. We expect to deliver continued strength in the international intermodal space. For domestic intermodal, this was our seventh straight record quarter and our best all-time performance for RTMs, car loads, and revenue. We expect our intermodal franchise to continue to produce strong results in the back half of the year, driven by our service, strong pricing, and self-help initiatives. Let me close by saying, with the new business that we've brought on and a more normal Canadian grain crop just around the corner, I continue to be confident in the double-digit RTM growth in the back half of the year.
The team is focused on executing our playbooks, continuing to sell and price to the value of our service and capacity because that's what we do. We are staying close to our customers and our operating team to ensure we are working closely to navigate any rapid change in demand. Now, finally, I continue to be extremely pleased with the support from our customers and the volume of opportunities as we look to open new markets across North America with our proposed CPKC merger. With that, I'll pass it over to Nadeem.
Great. Thanks, John, and good morning. I'm extremely proud of the dedication the team displayed to produce these quarterly results. I said back in January, we expected to deliver a strong Q2, which we did, and as we stand here today, the balance of the year looks extremely bright. We're building off this momentum and our expectation of double-digit RTMs in the back half to achieve volume and earnings growth on the year. Now, looking at the quarter, the adjusted operating ratio came in at 59.7%, more than 1,000 basis point improvement sequentially. I'm very proud of how the team controlled costs and managed the railroad in spite of rising fuel prices and the continued headwind from grain. Taking a closer look at a few items on the expense side, I will speak to the variances on an FX-adjusted basis.
Comp and benefits expense was down 9% or CAD 35 million versus last year. The primary driver of the decrease was lower stock-based comp in the quarter.
You'll see average headcount on the quarter was up sequentially by about 6%. You'll see another step-up in Q3 as we continue to bring on resources to support back half volume growth. Fuel expense increased CAD 146 million or 65%, primarily as a result of higher fuel prices, which were up 68% on the quarter. Increased fuel prices on the quarter added 220 basis points to the OR. Materials expense was up 15% or CAD 8 million as a result of cost inflation, largely in non-locomotive fuel. Depreciation expense was CAD 211 million, an increase of CAD 9 million excluding FX as a result of a higher asset base. Purchased services was CAD 294 million, an increase of CAD 35 million or 14% when adjusted for acquisition costs.
The main driver of the increase was cost inflation and higher casualty costs in the quarter. Moving below the line, the equity pickup from KCS was CAD 261 million when adjusted for KCS' acquisition related costs and purchase accounting. Other components of net periodic benefit recovery increased CAD 5 million, reflecting higher discount rates compared to 2021. Net interest expense is up CAD 59 million versus last year as a result of a higher debt load related to the KCS acquisition in Q4 2021. Finally, income tax expense decreased CAD 25 million or 11% on an adjusted basis. Excluding KCS related items, the effective tax rate was 24.25%. Rounding out the income statement, core adjusted EPS was CAD 0.95 in the quarter. On the free cash side, KCS has notified us we'll be receiving our dividends shortly, and we continue to repay debt.
While interest rates have been volatile, I'll remind you that 100% of our term debt is fixed rate. As we're focused on paying down debt to return to target leverage, we have no near-term financing requirements. We continue to invest in the railroad and are in a good place from a capacity and resource perspective. We said at the start of the year, 2022 is going to be a tale of two halves, and that's exactly how it's playing out. While there are headwinds from rising fuel prices, inflationary pressures, and a slight delay in the grain harvest, as John mentioned, this team is well-positioned to continue to navigate and execute the plan. We are well-positioned to carry this momentum forward and deliver a strong back half.
As I look ahead to 2023 and our transformational merger with Kansas City Southern, I only get more excited about the opportunities in front of us. We have a unique growth story in front of us with the team to execute it. With that, let me turn things back over to Keith before we answer some questions.
All right. Thank you for those comments. Hey, Dave and John, let's go and open up the line for questions, operator.
Thank you. If you'd like to ask a question, simply press star, then one on your telephone keypad. If you'd like to withdraw your question, press the pound key. As previously highlighted, please limit yourself to one question. Your first question will come from Tom Wadewitz with UBS.
Yeah, good morning. Wanted to ask you a little bit about intermodal. You know, I think we've seen some, I guess evidence of some constraints or some, you know, indication of some issues at Montreal and Toronto and, you know, I guess drayage and terminal, I don't know if terminal issues or warehouse issues. Wanted to see if you could comment on that, whether that's a, you know, you'd expect any effect on your volume in second half. Then also, how would you think about, you know, US consumer weakness and how that might affect the outlook for, you know, for your intermodal volumes in next couple quarters. Thank you.
All right. Thanks, Tom. This is John. Couple thoughts on the congestion piece. Well, certainly, I can tell you at CP, we're moving record volumes of both domestic and international intermodal. I think for the most part, our network has stayed resilient on that front. It's not that we haven't had some hot spots, whether it be at the port, or inland, as you described. For the most part, I'm quite pleased with how the operating team and our commercial team have navigated through that. I can tell you, we're working closely with the ports. We're working closely with our customers to pull the levers we need to pull, to ensure that fluidity.
You know, we've got a unique circumstance at our inland terminals where we have strong levels of capacity, not only greenfield space, but just general, you know, capacity in those intermodal facilities. We'll watch it closely. We'll continue to work. If we need to pull other levers, we will. Right now, I feel pretty good about our positioning. You know, not like and dissimilar that we saw over the last year that intermodal space and particularly international intermodal has been choppy at times as you know as we've navigated through COVID and certainly some of the challenges at the US ports or other ports, that sort of continues. That choppiness is still out there.
Nothing I see tells me that we're not gonna continue to deliver strong record results the back half of the year in the intermodal front. You know, certainly we're watching the news and hear all the reports and, you know, Walmart and others, you know, being precautionary. We're talking to our retailers. Our domestic team is talking to our retailers every day. Actually, I'm still quite optimistic. You know, we see this year continuing to be strong in both of those books, domestic and international. Then we'll see, Tom, what plays out in 2023. You know, frankly, I'm still optimistic that at least the first part of that, we continue to see a tail on this, the strong demand that we're realizing right now.
Yeah. I think the only thing I'd add, Tom, key point, key takeaway. Our terminals, to John's point, we've had a little bit of choppiness at times, but systemically, no issues. We have capacity. We're not holding any freight at West Coast ports or East Coast ports, to pace into our inland terminals. We have the capacity. We're open for business, and we're ready to generate the revenue and for ourselves, our shareholders as well as for our customers.
Great. Thank you.
Thanks, Tom.
Thank you. Your next question comes from Fadi Chamoun with BMO Capital Markets.
Yes, good morning. Thank you for taking the question. My question is on capacity as well. I mean, we've had almost five years now, even more of very strong growth, and I'm thinking about places, especially on the western side of your network in Vancouver, you know, with a strong pipeline for growth over the next two to three years, how are you thinking about capacity? Are you starting to feel the need to kind of look into capacity investments? Do you have the roadway to keep growing at the same pace that you have had in the last few years without making any big capacity investments?
Yeah, the short answer to that, and the absolute answer is yes, we do, Fadi. You know, the last five years, if you look at the overall growth, you know, we have grown better than the industry has. We've done better than others, but it, to me, it's still not an overwhelming amount of growth. All along that period, we've continued to spend money and invest in our infrastructure, extended sidings. We have a very robust planning process. We look at it from a three-year view, a one-year view, a six-month view. So there's a very disciplined process that's truly fundamental, woven into the way a PSR railway works, should work, where you plan ahead, you take a look at lane by lane. We clearly understand where our capacity opportunities are, and we invest ahead.
Just as we invest ahead in locomotives, we invest ahead in people. It's sort of like a just-in-time approach. It's a very disciplined process, but it's one that we've honed and we're very well-versed at executing. It's how we navigate this railway day in and day out. I'm not concerned about oversubscribing this network. We're gonna be a step ahead of that. If we get to a point with capacity and demand that would cause us to have concern, we'll know ahead of time, we'll plan for it, and we'll be ready for it. Much like you know, I'll give you a case in point, that Maersk contract that we signed during the pandemic. You know, that was an eight-nine month planning process, part of that negotiation that we participated in.
Myself and John met with Maersk, and we said, "If we're gonna do this, we've got a responsibility to our existing customers. We do wanna grow, and we're gonna grow with you, but we wanna do what we say we're gonna do. We're gonna deliver for you as well as fulfill our commitments that we've made previously to all customers." There was a very well-thought-out, executed capital investment plan that laid the groundwork to be able to onboard Maersk and grow with Maersk as we have since we implemented that very strategic contract win. That's the approach we're gonna take. We have taken and will continue to take CP as well as the CPKC network, pending the STB's approval of our transaction.
Fadi, the only thing I'd add is during the early part of COVID, when volumes were down significantly, we did take advantage of that, the network being open in order for us to accelerate some of our capital investment and be more productive with what we're investing. That allowed us to do more with less, and I think it's served us well.
Thank you. I appreciate it.
Thank you. Our next question comes from Walter Spracklin with RBC Capital Markets.
Yeah, thanks very much. Good morning, everyone. I wanna go back to your point on intermodal. I know in just some of the news here, 40 container ships sitting outside Savannah. Obviously, a lot of congestion these in the US East and your new option through Saint John and the CMQ looks like it's coming. It couldn't come at a better time. You mentioned you'd gone up to 300,000 TEUs from certainly under 90 and plans to go to 800. My question is: Could you be at 800 sooner? In other words, is the demand there to use more than the 300 you're using. You've committed to right now?
Is the limiting factor the capacity increase that you're looking to bring on? Can that be pulled forward at all, if that's the case? What's the earliest that you see the full 800,000 in capacity being realized in your new route through Saint John?
No. Good question, Walter. Look, the port is the moment we received the funding, started the process. We're filling in some open water fingers that are really the first step of getting that dock space.
Increased, and that is underway. They're working as fast as they can. There are some opportunities to incrementally step that up. We don't jump from three to eight. We'll be able to do some of that work. In 2023, we will be able to take some step functions upward on that, Walter. You're exactly right. I can tell you the Hapag-Lloyd original port of call service, the new service that started in May and even CMA's business that we brought on here in July, all those volumes are materializing at levels higher than I think us and the steamship lines expected. I do believe that is a function of, look, these customers are looking to diversify their books, the challenges on the US East Coast that you described.
Frankly, we've got a 200-plus-mile shorter route into these markets, and it matters. We've been able to, in partnership with the NBSR and the port, put together a really strong value proposition for these folks. All that being said, to answer your question, yeah, I do think there is some incremental steps and opportunities to grow that port, in the meantime, before we actually hit the 800,000 TEU mark.
Great color, John. Appreciate the time.
Yep.
Thank you. Our next question comes from Jon Chappell with Evercore ISI.
Hey, good morning. Nadeem, I wanted to ask you about headcount and comp and benefits. Your headcount on average in 2Q 2022 was roughly the same as 2Q 2021, but your comp and benefits is down pretty meaningfully. Kind of two-part question. One, is there something kinda one-timey in the cost per employee in this past quarter? B, as we think about how you're ramping up your resources over the next six months to meet this demand growth, but ahead of the, you know, big transformational event next year, how should we think about the cadence of headcount growth and cost per employee?
Yeah. Nothing necessarily one-time nature in the quarter. There was some, you know, your quarterly accruals that you have as far as incentive comp and the true-up of stock-based comp that we do each quarter. There was some of that that occurred. Beyond that, if you think about, you know, what we've talked about, which is double digit volume growth in the back half of the year, we've been hiring and training throughout the first half of this year. We're actually absorbing some of those inefficiencies in terms of hiring, training, and the costs associated with that that we're not seeing the volumes and the top line benefit. You're gonna continue to see that through Q3 as we continue to hire and train.
We're gonna have higher labor costs, but not getting that efficiency. That's why, you know, I feel good about the fact that Q4 and into next year, we're gonna have a better overall cost performance and operating ratio, just given the fact that we'll see the benefit of this pre-hiring that we're doing. That's kind of the cadence of what's occurring on comp and benefits.
Okay, just any figures on headcount adds over the next six months to meet the double-digit RTM growth? Again, do we just kinda take this comp, this cost per employee in the second quarter and think about that being similar for the rest of the year? Sorry for the follow-up.
Yeah, no worries. Yeah, you should expect us to continue to ramp up. I think our average headcount was about 12,500 in Q2. You should see that going up another probably 400 people through the end of the year, kinda on an average headcount basis. What was the second part? Sorry.
Just the cost per employee. I mean, it was down pretty meaningfully sequentially. How do we think about that going forward?
Yeah. The cost per employee is a bit of a tricky one, right? Because depending on what the stock price does, affect that. You know, we've seen a strong July, and I think we'll continue to see the stock perform well. You know, as that, you'll see additional costs kinda come up through that as we true up for stock-based comp. You know, you tell me what the stock does, and I'll tell you what the cost per employee will do. That's a tough one.
I'll try my best. Thanks a lot, Nadeem.
All right. Thank you.
Thank you. Your next question comes from Amit Mehrotra with Deutsche Bank.
Excuse me. Thanks, operator. Hi, everyone. Nadeem, can you talk about our expectations for the second half, just given the RTM inflection? Are we kinda solidly in the mid-fifties? If you can just offer some color there. Keith, maybe more big picture, Canadian National is talking about curating some business. That's their words, not mine. They've talked about kinda growing too much in the wrong places and addressing that. Does that create opportunities for CP? If you could talk about that. I know you guys won a decent size CMA contract from them recently. Just wanted to see if what's happening at CN creates incremental volume opportunities for CP and/or pricing opportunities. Thanks.
I feel good about the combined back half that we'll be in that mid-fifties, maybe kinda upper side of mid-fifties, in the back half. You know, I'd point out to a couple things. Just one to the earlier question about stock-based comp. I think we'll see a little bit of that headwind in Q3. I think that John's commentary about the delay in the harvest, so as the grain harvest gets pushed later into Q3, almost into Q4, we won't see the full benefit of operating leverage until kind of that October, November time frame. Gives me, you know, some reason to say I'd rather point to a stronger Q4 than a Q3. If you look at H2 as a whole, kind of upper mid-fifties is probably the right place to think about.
All right. Let me just say this. You know, what I'm seeing in the marketplace and what I hear, you know, see and say, and having a bit of experience in this and understanding this, you know, business for the sake of business, if you can't make money on it, obviously we don't do this for practice. We've got a high cost of capital in this business. You know, it's you gotta pay the light bills, you gotta be able to pay for your seat on the train for lack of a better term. If in your pursuit of revenue, you've made some very unnatural decisions for your network that don't serve your network well, or in fact, in the end, serve the customer well, that's not really a win-win for either party.
As you curate or you take a look at what's unnatural, what doesn't fit, what doesn't work well for you, what doesn't work well for the customer, then yes, that does create opportunities for Canadian Pacific. But I can tell you this, the same disciplined approach that we've taken for the last eight, nine years when it comes to business and making sure that we're able to provide a value proposition for our customers, and in turn they feel the same way about it, is the same approach we're taking. You know, you talk about CMA, you talk about some of this business historically, if you look at the last same time period that swung one way to the other, business that, you know, that's not as sticky, these big contracts.
When we took a look at CMA, as we take a look at our book of business, we're gonna make sure that what we're providing adds value for them, and what they're offering in a rate adds value for us. Again, we're not gonna oversubscribe our network. We're gonna do it smart. Low-cost sustainable growth is what this business model is all about, and that's the approach that we'll take on a go-forward basis. In the end, that is best for the customer, that's best for the rail network as well, because again, you do no good if you oversubscribe your network trying to please one customer and you dissatisfy and disappoint the balance because you don't have the fluidity, you don't have the velocity on the assets, you don't have the service offering that running a true PSR railroad produces.
That's a critical ingredient to success. Again, continue to expect that same disciplined approach in the marketplace from this company as we have and as we will going forward.
Okay. All right. I appreciate the comments. Thank you very much.
Thank you.
Thank you. Your next question comes from Brian Ossenbeck with JP Morgan.
Hey, good morning. Thanks for taking the question. I wanted to ask about Mexico and the US trade complaint that was just filed. Obviously, these issues have been simmering for a while, so just wanted to get your view on this dynamic, you know, headed into the CPKC transaction. I don't know if Pat or Mike are on the call, but any sense in terms of the range of outcomes, you know, how this might impact your refined products business or even longer term, some of the nearshoring or cross-border activity coming into the US?
Well, let me start. Pat and Mike are not with us today, but I can tell you that in my discussions with Pat and the team and obviously we had a lot of insight into this as we analyzed the transaction. Their business has already been impacted by what's going on in the energy work environment, so to speak, in Mexico. Actually, in spite of this dispute, which is part of the USMCA, the refined fuels is increasing. They're actually able to bring more product than they were at the low point in. You know, the way I see this, USMCA provides the structure. There's a dispute mechanism in it. I believe that the parties will work these things out.
I believe that even more so than ever in our country's, our nation's history, the world's history, there's never been a greater need for positive free trade between Mexico, Canada, and the United States. I think this is gonna get navigated. I think at the end of the day that this transformational merger that we're putting together will allow additional free trade to flow between these three nations. I think this is just a moment in time that none of us have to lose a whole lot of sleep about. It doesn't change the thesis at all, and I think it's gonna be full steam ahead, and we'll turn the page and we'll see these three nations grow together and benefit uniquely together.
Thank you, Keith.
Thank you.
Thank you. Your next question comes from Scott Group with Wolfe Research.
Hey, thanks. Good morning, guys. I don't know if it's a little too early to ask this, but as we get closer to the merger approval, any thoughts on how to think about sort of the cost and revenue synergy potential in 2023? Nadeem, you talked about getting closer to the target leverage levels, and I'm just wondering if you see the potential to start resuming buybacks next year. Thank you, guys.
Yes, Scott, John Brooks here. You know, I'll tell you as I worked through the synergy levels and w e think about, you know, initially, I think we've said that you can think of CAD 1 billion as maybe a third, if you think about how it comes on to the network. I can tell you, we continually are calibrating what that looks like specific to, you know, where, how we're gonna invest, where we're gonna have the capacity to haul that freight, how quickly we can generate an intermodal product, you know, that can effectively service three countries in and out of Mexico and certainly that Gulf and Texas market.
I can tell you, as I go through business unit by business unit on a weekly basis with my team, looking at those synergies as we talk to those customers, I continue to feel very confident that the 2023 that's coming out of the chute, there's gonna be significant opportunity to sort of hit that plan as we've described. Again, the traffic mix and what it looks like, and certainly some of those areas that, you know, may require investment like port investment or new transload facilities. You know, that'll take a little time. Some of those likely as construction could start after, you know, we get our final STB control, may take a year.
You know, that's some of those opportunities roll into 2024 just because that investment and that construction needs to take place. All in all, I feel real good about the opportunities that we can turn on, I'm gonna say very quickly to be able to hit that first-year target.
Scott, on the cost side, I can tell you this, the KCS team, they're not waiting as far as improving their operation. You know, they're in evolving chapters of their PSR journey. I can tell you, Jeff Songer leading into this, and now John Orr, leading the operating team, they're working hard every day to run a more efficient network, and you can see it in their numbers, you can see it in their performance. They're investing in their infrastructure standalone, in that lane going down into Mexico to the border.
You know, you think about the gravity of this transaction, we said CAD 275 million of capital investment, that essentially that's dedicated to extended sidings, new sidings, rails, ties, and ballast, CTC, all, you know, hard asset infrastructure that will allow the network to run more efficiently, run safer, more fluidly. That's about 30 sidings, kind of split evenly between the two railways. That said, if you think about the KCS network alone, they're doing an additional 15, 16 sidings standalone before the transaction. At the same time, CP on our side of the railroad, we're doing things in that corridor north of Kansas City that is sort of getting a step ahead, so that as soon as we get these two railroads together, the STB gives us a green light, we'll continue to invest in the infrastructure.
The investments we've already made, the traffic that rides it today, the operating plan that we have ready to engage and execute, you're gonna see cost synergies, that again, this is not driven by cost synergies, but just railroading better, being more efficient with assets, turning cars faster, putting these two networks together and benefiting on the backbone of those capital investments. There's no doubt in my mind that we're gonna overachieve when it comes to the cost synergy standpoint. So again, we're getting ready. We're not sitting here waiting. The objective is when we get the green light, we're gonna hit the ground running. We're gonna be aggressive, we're gonna be responsible. We're not gonna overcommit, oversubscribe. It's gonna be very methodical, but at the same time, it's gonna have a momentum to it, that I think is going to exceed everyone's expectations. I feel very confident about that.
Scott, just on your leverage question. When we look at the outlook for our free cash for this year and the outlook that the KCS team has provided, I think we're in a good spot as far as continuing to delever according to our plan. You know, obviously, let's see what happens in 2023, but as you've heard, there's probably more confidence in synergies than less. I think we'll be in a very good position to get our leverage back down to our targeted level by the end of 2023. I'd just say that, you know, typically we make our capital allocation decisions with the board in that January timeframe.
When I look forward, probably look at that January 2024 as a decision point around what we do with excess cash flow once we delever back to our targeted, you know, 2.5 times. I wouldn't get too ahead of yourselves in terms of 2023, but 2024 is probably the right time to think about capital allocation.
Super helpful. Thanks, guys.
Thanks, Scott.
Thank you. Your next question comes from Ken Hoexter with Bank of America.
Great. Good morning. Hey, just a quick one for Nadeem. Did you talk about gains on the quarter from fuel revenues and costs? Keith, a few big picture thoughts. It seems like a lot I know on PSR is getting tossed out. Maybe your thoughts on one-man crews from the FRA and thoughts on PSR pressure as companies start to return hump yards, bring back employees and locomotives, ongoing pressure from regulators on service levels. Maybe just your thoughts on if companies are missing the PSR commitment or if there's something else going on that it's run its course. Maybe just talk a little bit about that. Thanks.
Yeah. Ken, just on the fuel impact, it was a headwind on the OR by about 220 basis points. But on the, we did get a modest OI tailwind, you know, modest in that around $30 million. That's what I'd point to.
CAD 30 million is the difference in revenue costs?
Yeah, go ahead. I'm sorry.
Yes, correct.
Sorry. Okay. Thanks, Nadeem.
Ken, on the, let me start with the FRA, notice that came out yesterday. I would say this, it's disappointing. You know, I've always been a proponent, personally, until and unless we get the components that we put our trains together with to become more reliable, and until and unless we can make sure that we can get that train over the railroad, without a knuckle breaking, you know, it's gotta be extreme exception, not a normal occurrence. There's just when you put a train together, there's a lot of moving parts, and those moving parts historically have created some challenges. So if a train separates and it's 10,000-foot long, and you don't have a man or a woman to assist the engineer, that can get complicated. So that's something I'm very sensitive to.
That said, we work with our suppliers to improve those components. We should not be put in a disadvantaged place when technology allows safe and efficient operation, components allow safe and efficient operation to be disadvantaged from realizing the benefits of that and staying competitive. That's to me is exactly what that smells of. You know, to put us in a place where all those things being accomplished, we're at a disadvantage, a cost disadvantage. We're not able to do our very dead level best to take trucks off the road, put them on the rail, to allow the customers to enjoy the benefits of those cost synergies as well as the environment, enjoy the benefits of those less greenhouse gas emissions. You know, we're talking about the environment matters. We're talking about zero carbon.
We're talking about reducing greenhouse gas emissions, but yet we're talking and looking at potential actions by the regulator that says we can't do that or we can't optimize that outcome. To me, that's troublesome. I'm sure that, you know, each railroad has their own view. Again, I'm not against the FRA. I've got to work with the FRA. I just hope that as the discussions evolve around this topic, that we really think about the unintended consequences and think about the totality of what's being suggested. That said, when it comes to the regulatory environment around PSR implementation, you know, PSR is not an operating model in name alone. You know, PSR, to me, to truly integrate and implement a PSR railroad, it's a very well thought out process. It is that in and of itself. It's a process.
You've got to have the right number of crews, you gotta have the right number of locomotives, you gotta have the right number of cars. You've gotta have the physical infrastructure. It's not just as simple as implementing and integrating. Different railroads have had various levels of success. I can say that this pandemic and this manpower issue, if you don't have people, trains don't move. You know, some things have occurred in the middle of PSR implementation that quite frankly stack the deck against these other railroads. That being said, once they get their hiring done, once they get their infrastructure to match their aspirations for train sizes, and that's terminals as well as line of road. You know, you don't do a lot of good to run a 10,000-foot train, and it's got nowhere to land.
You know, if you're sitting outside of a terminal, and you can't get in the terminal because the train's too large, there are unintended consequences. If you're doubling trains out of terminals and parking them on main lines, waiting on power because you're holding out one of those big trains because it can't get in the terminal, you have unintended consequences. Again, those are all growing pains. I know they're real pains. I know that obviously it's affected, the railroad's overall ability to serve customers' needs, but I do see it getting better. I see the hiring helping. I see getting to a place that is, as these railroads get their cadence and their rhythm and they get more experience and muscle memory in these processes that it takes to actually effectively run, a PSR railroad.
I think it's the right way to run a business. I think in the end, we'll look back, and we'll say this was a good thing. Hard to say that now, but with my experience, having done this for over 20 years, and I didn't get it all right either. We made some mistakes along our journey at Canadian National and Canadian Pacific and even Illinois Central. We learn from those, we bake those into the way we railroad today, and I think you can produce a better outcome. I think we're proof positive of that. We've managed this cycle with PSR on the down cycle. We've right-sized the railroad.
We've grown like no other railroad has over the last four or five years, and we've created an infrastructure and a rhythm and an ability and a respect with our customers and a trust with our customers that we're helping them win in their marketplaces, as we win for all stakeholders, and we're doing it as a PSR railroad. I think it's a good thing. I think eventually the industry will get there as well. It's just taking a little bit of time to get there. The best thing we can do is continue to improve. Best thing I can do, and we can do at CP is make sure that our story, our unique story, and our unique outcome running a PSR operating model is understood, and that's exactly what we're committed to doing. We do it by what we say, we do it.
Most importantly about what we do and the way we run the railway day in and day out for our customers.
Appreciate the time.
Thanks for the question.
Thanks. Thanks, guys.
Thank you. Your next question comes from Christian Wetherbee with Citi.
Hey. Thanks. Good morning, guys. You know, John, you mentioned, I think in your prepared remarks that contract, the pricing on contract renewals was accelerating in Q2. Want to get a sense of maybe how you think about the pricing environment in the back half. I think there's probably been some sense that maybe we're getting closer towards a plateau of your ability to kind of get accelerating price, but sounds like maybe you're having more luck. Can you give us a little bit of color on that, please?
Yeah, Chris, I know when you flip on the TV, it might be counterintuitive in some sense, with all the noise out there, but then again, you know, inflation hasn't slowed down either. We've got about 20% of our book left to go. And just reviewing that, you know, I've spoke in the past of, you know, that we're even 6%+, and I'm seeing that even accelerate in terms of, you know, my team's expectations on what the market opportunities are. I don't see that changing.
You know, you think about our intermodal franchise and in all the business that we have out there today, the demand. I think our trucking in length of haul is different than what maybe the US roads face day to day. That adds some resiliency in that pricing space in Canada for us. Then just frankly, the other lines of business continue to be strong. As I said, we're gonna get a nice tailwind on the Canadian grain front too, with the VRCPI, the back half of the year too. So, we're not taking our foot off the pedal at all on that front. We'll see what 2023 brings.
As Keith said, and Keith spoke about, you know, the PSR journey, our sales discipline and how we approach the value of our service and our capacity doesn't change in good times or in bad times. Yes, the quantum isn't always 6% plus, you know, but the discipline to keep that, to make sure that we are inflation plus, and we are capturing the value in the marketplace for our servicing capacity has never changed. As you know, a big part of our compensation plan for my sales team drives them on that discipline. That's not gonna change. Regardless of what 2023 brings, we'll continue to be on, I would say, the top end of that pricing bandwidth.
Got it. Thanks very much. Really appreciate it.
Yep.
Thank you. Your next question comes from Brandon Oglenski with Barclays.
Hey, good morning, and thanks for taking my question. John, I just wonder if you could follow up on your commentary on, you know, the delayed harvest. Is that about Canada or the US as well? I guess, you know, you still have a pretty bullish outlook on volumes. What are the favorable offsets that have developed in the interim?
Okay. Brandon, you're kinda quiet there, but I think I got most of it. The grain front. Yeah, again, in Canadian grain, I could tell you we've fully subscribed our train product. I think our customers are chomping at the bit given such a year that we've had in Canada. Really the key point we're watching right now is just simply timing. When will this crop start to come off? Is it mid-September or does it push all the way into October? Regardless, I think we are positioned well, Vancouver, Thunder Bay, US imports, to service that market. The US side is not dissimilar, you know, particularly, Brandon, if you think about our network, we're so heavily dependent on North Dakota.
The growing region, not a whole lot different than Southern Saskatchewan, Southern Alberta. Some of those same challenges persist there. We'll see. I think we're in a little better shape in terms of a normal timing. We should start seeing wheat crop come off here in the coming weeks, you know, soybeans in September. It's really that soybean push to export that really will begin to drive those US grain volumes. Again, we'll be watching tightly that timing. That is typically a second half of the year, September. But we'll see how these next few weeks play out. You know, I think the projections look warm and hot, so that helps get that plant matured and ultimately the opportunity to bring that harvest along on time. You had a second part of the question, Brandon. I can't remember what it is now, or maybe you didn't.
Yeah, John, it was just that, you know, if that's getting pushed back, but you're maintaining your growth estimates, what have been the favorable offsets?
Yeah. You know, as we talked about that intermodal space, continue to drive hard. But I can tell you, as I look to forward demand curve for our system equipment across, say, our merchandise sector, our center beams, our scrap gondolas, our boxcars, our pulp business, we're fully subscribed. That is more about velocity, customer discipline, loading on weekends, how we can spin those assets as fast as possible. And frankly, as some of our connecting partners' velocity improves, we get that equipment back sooner, we get another load. I think you'll see marked improvements in that. You know, we had a little bit of a choppy July in the auto space.
You know, sequentially, we saw nice improvement, but it's sort of like what could have been if July would have performed better. We saw, you know, all our OEMs take some downtime, not unexpected, but maybe a little longer downtime and continue to sort of muddle around with some of these parts issues. But I do believe we continue to see a sequential improvement in our auto business, even as you just think through the quarter as we move into August and September in that space. So, look, the grain is what it is. It's not gonna go away. We'll, if we don't haul it in September, we're gonna haul it in Q4 and in 2023, and we're gonna drive hard in all those other spaces.
I didn't even mention potash, but we're full gas on in that space. Canpotex, as I've spoke about, is very bullish on their second half year volumes. So we're fully subscribed there also.
Appreciate it.
Yep.
Thank you. Your next question will come from Jason Seidl with Cowen.
Thank you, operator. Good morning, gentlemen. Just some quick thoughts here. The Canadian government's proposal to cut fertilizer emissions by 30% in 2030. I'd love to know what you think that could mean for volumes. Do you think it's more of a cut on the domestic side and then a switch to some exports, or is it gonna be a cut overall? Maybe if you can put a little more meat on the bone in some of your comments about running some more test runs with the KCS. I'd love to know to and from and how successful they've been.
Jason, I'll make a few comments on the fertilizer announcement in that. You know, look, it's a little hard to tell right now what the true impact is. You know, this is down to the farm level, which is interesting. There's no doubt Canada has to be a prominent player in terms of providing food and feed for the world, particularly in you know what we've experienced here the last couple years. The great news is whether it's the US farmer or Canadian farmers, these folks have been resilient and figured it out. Farming technology, acres farmable, have only increased. I'm confident the Canadian farmer will figure this out.
It's hard to tell what that means ultimately, if it drives more of that production to export or if it, you know, maybe more in North America and maybe even Mexico. The good news is, CPKC will have the network that, if you do see some trade flows like that I think we can capitalize on it. Maybe the last point on that front is the reality is fertilizer prices have been really high lately anyways. I think the farmer as it is today has made a lot of choices around crop rotation and different things to try to curb their use or maybe be more disciplined in their use to begin with. It's kind of a wait and see, but I think technologies and some of those techniques may, in the end of the day, make it a pretty small event.
Fair enough. The test runs?
Yeah, I'll give you a couple, just a couple of, pretty positive points that are really creating a lot of attention and excitement around the potential of this network, with our customers. Again, this is all on an interline basis, and this is all without the benefit of all that capital investment that we're gonna be putting into the rails, ties, and ballasts and infrastructure over the next two to three years. The transits continue, the trips with the container ship coming into Lázaro deramping, discharging for Chicago markets. We've ran now six, seven trains that have came up from Lázaro all the way to Chicago with seven-day transits. That's West Coast competitive. We've ran, continue to run domestic moves out of Chicago Intermodal that are going to the border at Laredo with 90-hour transit times.
That's against an industry best service offering today, which is 89. We've executed all the investment that we're talking about. Our advertised time in transit is gonna be 80 hours. It's a very compelling market opportunity going south. The other thing, we've run several grain trains that have come out of Manitoba that have gone as far south as Mexico City with super impressive cycle times, hand off to Kansas City, the KCS team, and getting those assets back for that return trip. In each of those spaces, we're demonstrating with our customers what the art of the possible is. We're just sticking our toe in the water, and this is not what we'll be able to do. This is what we can do today on an interline basis.
We get these two networks together, get that infrastructure in, and get those assets turning. It's gonna be extremely impressive and compelling value add. To add a third option. In some cases, a second option or an option at all that some of these customers never have from a competitive standpoint, that's really gonna drive a lot of opportunity for this company.
Jason, I just would add, and you know, you think about our DRU product out of Hardisty down to Port Arthur that we do on an interline basis with KCS today. That product is running on a cycle of 12-13 days round trip. It's impressive. It is a catalyst for other products. Not only that we could look at exporting out of the Gulf, whether it be grain, whether it be coal, whether it be fertilizer, but it sort of sets up this, you know, proof of concept that is a real long-term piece of business that now we're able to take to the marketplace as we have these discussions with customers to sell that. You know, a lot of those equipment types are private equipment.
The faster we can spin those assets, hit that marketplace, has been a compelling opportunity. I'll tell you this, it's also compelling enough to where, you know, our partners in the DRU thinking about the opportunity of this being a combined network and investment that Keith spoke about, what that next second and third generation of that DRU capacity looks like. We're deep into that opportunity.
It sounds like you got some good opportunities there, and I appreciate the color, and I appreciate the time as always, gentlemen.
Thanks, Jason.
Thank you. Your next question comes from Bascome Majors with Susquehanna.
Keith or Nadeem, you don't bargain with the US Rail Coalition, but there's some uncertainty as to how that union wage increase is gonna play out 2024. I was just curious, as an interested observer, do you have any thoughts on the state of US Rail national bargaining as this reaches its final stages? Any indirect impacts that could come out of this to CP that you're looking at? Thanks.
I've got a limited view, but a very strong one in my limited view. I try to stay away from the national bargaining. I've had for the last almost two decades of my railroad career. I think that local bargaining, you come to the best solutions that fit your employment base. You know, on a national level, how do you get four railroads and multiple unions and multiple different sets of expectations to all get aligned to one common vision? I think in and of itself, it's a challenge. I wish them success. I know that both parties want to reach an amicable agreement and through this process, put this thing behind us as an industry.
As far as something coming out of it that will have any kind of adverse impact to Canadian Pacific, I don't see it. We're gonna continue to stand alone. We have a very unique and progressive, I think, industry-best, collective bargaining agreement with our running trades employees. It's unique in that it's hourly. We don't have separation between road and yard. Our employees are very productive, and they make a lot of money, for their productivity. You know, my objective is to make them and make sure they're the highest-paid railroaders in the business, and at the same time, the most productive because the productivity and the reliability is what allows us to execute for our customers and provide a service offering that, again, is unique. I'm glad that we're not part of that.
At the end of the day, getting that resolved for the national group of railroaders that are, as well as the employees that they employ and the members that the union represents is in the industry's best interest. I'm glad that it's getting to a point where we can put this behind us.
Thank you for that perspective. You know, specific to CP, anything on the collective bargaining front that could be impactful or that you guys are watching over the next one to two years? I don't know if related to the KCS merger and integration or just for CP directly. Thanks.
Well, I'd say the only impactful, you know, some excitement, some energy around the space. We just actually negotiated and ratified two contracts. One, the DM&E, which is the property that goes from Savanna, Illinois, down to Kansas City, actually into what will become part of the consolidated territories. That collective agreement, those employees are represented by the BLET. We gave them a pretty significant raise. It was an hourly deal. We've had it for some time. We inherited it when we bought the railroad back, but there was a gap in the wages between what those employees made and what our Soo employees make.
We've said all along, as we invested in infrastructure and we built density, from what was a short line railroad, taking it to a main line railroad, for the lack of a better explanation, that we were gonna close that gap, and that's what we've done. That bodes well for attracting and retaining employees. It shows our employees how much we appreciate them. You know, we did that off cycle. We did it in a way that we felt it was important to get it resolved, and it turned out well. The other piece, east of Montreal and the CMQ, and those employees represented by SMART, took the same approach. You know, that was part of the CMQ property.
Their wages were depressed compared to what market is, so we gave them substantial increase to get them up to market wages so that they're not at a disadvantage working for our company. They understand how much they mean to us, how valued they are as employees, and how critically important they are for us to realize our growth aspirations and to deliver the service we've committed to deliver to our customers. From a labor perspective, this company is in a good spot. Again, it's not perfect. These spaces never are, but our employees know we're committed to them and they're committed to us, and in turn, we can be committed together to our customers.
That's the strategy that's worked well for us, and it's a strategy, again, that we intend to deploy larger scale on CPKC, should the KCS employees on that railway be interested in that approach. I think from a value proposition, when you can make more money and you got a better quality of life, which comes with that collective agreement as well, and scheduled days off and some of those things that have never meant more to employees in these hard jobs that we work on the operating side, I think that's a pretty compelling value proposition.
Thank you, Keith.
Thank you.
Thank you. We have reached our allotted time for Q&A. I would like to now turn the call back to Mr. Keith Creel.
Okay. Well, thank you again for your time this morning. As you can sense from our comments, we're extremely excited about the momentum that we've created, and we continue to march forward, not only standalone for CP and executing our plan in 2022 and setting us up well for 2023, but especially so for this transformational merger that we're on the cusp of getting approved, we hope, pending that the STB aligns with what our views are. This is a very compelling proposition for all stakeholders, public interest customers, employees alike, and for these three nations, commerce together, to grow into the future. With that said, we look forward to executing as we said we would in the third quarter. We look forward to sharing those results, when the time is appropriate later in the year. Stay safe, and we'll see everyone out on the rail. Thank you.
Thank you, ladies and gentlemen. This concludes today's presentation. You may now disconnect.