Off point from there, in our second quarter call, end of July, we were calling for a tailwind from fuel with respect to our operating ratio.
Yep.
Right? We thought we had seen the peak in the May timeframe. Prices were coming down, and we had a pretty favorable forward fuel curve. Well, two months later, that's obviously wrong. What we've seen is prices continue to go up. We've got, based on the curve that came out last week, just really elevated prices for the remainder of the year. That's a significant headwind for us. Like I said, we were thinking we'd be at a tailwind. Now we're a headwind. Really, just to put that in a order of magnitude, that's like 250 basis points on our operating ratio of headwind, again, just from where we were two months ago. We were calling for a sequential, maybe better than seasonal sequential improvement from second to third.
Now we actually think we're going to be a little bit worse than seasonal performance really due to that what's happening with fuel.
Understood. I'll come back to unpack OR in a second, but to Ed's point, are there any non-fuel surcharge, like non-fuel revenue surcharge tailwinds on the revenue side in terms of share gain from truck or something that's a positive offset to that?
I think we are seeing some freight that is coming to us because of the extraordinary costs they're experiencing on the truck side. It's not just on intermodal.
Sure.
We're seeing it across many of our merchandise markets, where the, what I would call the freight is not rail centric or truck centric, but could go either way.
Yep.
Coiled steel, for example, or various paper products, consumer products, even lumber.
Yep.
Which is not an upmarket.
Yep
But we're actually seeing, I think, some share gain there because of what's happening with fuel. It's just pulling freight off the road. Talking about fuel and we talk about $6 diesel, but out here it's $8 diesel. If you noticed on the way in. Which is like science fiction. Anyway, I do keep a very cautious eye, and Jason and I talk about it all the time. What does that mean for the economy.
Yeah, absolutely.
Over time?
Yeah.
I think that certainly is something that we have to keep our eyes open to, and really, we're doing everything we can to put as much sensor in the environment as we can to see what's happening there, because ultimately, over some period of time, that's going to be a drag on the consumer, I think.
Yep. Absolutely.
As Ed said, that's really the key for us is to watch that. The fuel expense and the fuel surcharge we have over time works its way out. Obviously, it has significant impacts quarter to quarter, but it's really that component. Do you get to a place where this really starts to impact demand.
Yep. With that $8 diesel talk, I am going to ask you about electric locomotives in a second. Let us go back to the other two factors you mentioned, which is truck supply and demand. Let us do demand first. You mentioned a few end markets here. Any changes from what you told us on the 2Q call in terms of end market outlooks for any particular, are they positive or negative?
Not really. I would say we still see clear demand growth on the industrial side.
Yep.
You have seen manufacturing expand for what, eight months now.
Yep.
I think that bodes well. We still see a lot of what I would call tailwind for us on the industrial development side and projects rolling over into the design and construction phase, which we think bodes well long term. On the intermodal side, we are clearly seeing some demand growth on the domestic non-premium and on the premium side of the business. On the international side of the business, I think probably some pull ahead occurred earlier this year.
I do not know if this conference has talked about it yet or not, but there is a fairly extraordinary price differential between East Coast and West Coast landing right now. Which I think is probably having some temporary headwind on East Coast port volumes at this point.
Mm-hmm. Got it. Just sticking to the point on intermodal and merchandise volumes. Just on intermodal itself, is this something that you see coming fairly steadily through in a quarter by quarter as truckload goes through whatever issues it's going through, or do you think it's something that's going to, you'll see big step up jumps as you go through 2027?
Well, I wish I knew that part, but here's what I suspect or what I-
Consult your trusty crystal ball.
What I expect is that we're going to continue to gain incremental share in the current environment. I think when we get to bid season for intermodal, which is January through April of next year, that's where we'll probably see our next big opportunity to actually take share from the highway and deliver value for them as new contracts come on board for our beneficial cargo owners.
Got it. On intermodal, obviously there was some share shift with the merger announcement. What innings are we in there, and how do you see that playing out?
Would you ask that again?
What innings are you in for that share shift, and how do you see that playing out?
We are going to lap all that stuff.
Yeah, exactly. Coming up
Coming up in the fourth quarter.
Yep.
I think when you look at the data, what you see is that the local East and the U.S. network has grown the most. I think we'll show well going forward, coming out of here. I think the value of our network and the value of the product that we're putting out there right now is very good for the business and for our chances going forward.
Got it. Understood. On merchandise, are there specific mix factors to call out in terms of certain merchandise end markets versus the other, or is it pretty steady through all of them?
No, there's a whole bunch of puts and takes out there.
Okay. What's the net?
Yeah.
Yeah.
I think what you're going to see over time is on the merchandise side, it's actually a positive mix over the long term. We're actually winning more business in our chemicals book, although frankly, the portion we're winning is the lower-rated side of the chemicals book. There are puts and takes there.
Yep.
Overall, we're going to grow intermodal. We are growing intermodal pretty fast, so it'll be flat to maybe a little bit of negative mix over the long period for the entire book of business. Just to talk about price for a minute, we're executing on price in our merchandise book. Feel really good about that. Our customers are clearly seeing the value in the network that we're delivering for them. On the intermodal side, we're in the early innings of that story, and it'll play out more next year.
Got it. The LTL truckers say that you sort of need ISM over 55 for them to see juice on volumes, 50+ is good but not great. Is there a similar threshold for you guys? Is 50+ good enough for you? Is it 55? Where do you see that step up?
Well, positive beats negative for sure.
Right. Yeah.
More is better, that's the second thing. I would say, honestly, if we're in positive territory, especially with the fuel environment and the regimen the way it is, I feel pretty good about our chances in the marketplace.
Got it. Understood. On intermodal, you spoke of the international dynamics with the port shipping. Remind us again what your mix is like, what kind of potential margin impact there might be with that hit to East Coast volumes versus-
You mean East Coast/West Coast mix?
Not East Coast as much as international to domestic and how that contributes to it.
It's probably 65% or 70% domestic overall. Right? So, international is a minority, and then our West Coast business is a minority of that.
Okay. Got it. Is that something that shows up in 3Q, or do you think it's more of a second half thing?
It'll probably show up a little bit in 3Q. We'll see what happens to those differentials because they're pretty doggone extraordinary right now. Don't know that they're sustainable.
Got it. The conflict in the Middle East is a big factor that's influencing customer thought. What about tariffs? Is that a thing where people are now past that, and we sort of have some kind of, it seems like, stable resolution, the Canada stuff notwithstanding. Or is that still an item of uncertainty that's keeping shippers at bay?
I suspect, I can only go off what I'm seeing in terms of evidence in the marketplace.
Sure.
I look at our industrial development pipeline as a clear piece of evidence there. We had a long pipeline last year that really wasn't moving very much.
Yep.
I think that was really about people wishing to have more clarity before they invest, whether it's tariffs, whether it's the conflict, et cetera. I think frankly, this year, people have reached a point where, and companies have reached a point where they need to invest, they need to expand, and they're going to have to move, so they are. I view tariffs as certainly still perhaps a known unknown, but I think people are mostly past that. The war is different and certainly, the effect on fuel and global shipping routings is something new.
Got it. You briefly mentioned your yield focus here. So give us a sense of what your pricing conversations are like right now. Does the truck market tightness make it super easy for you to basically name your price, or are shippers now super sensitive to shipping cost, so you have to be more reasonable about it? Also, what does $6 diesel mean for that? If your fuel surcharge number is already eye-popping, does that help or hurt with pushing base rates?
Yeah. I think, and this is going to be a really boring answer, but it all goes back to what the value of the product you're offering is.
Okay. Sure.
With a high-quality service product, we're able to go in and demonstrate value to customers, and it's a pretty easy decision for them to come across the aisle, so to speak, and move intermodal. Where you don't have a good service product, that's a damn hard conversation no matter what the price of fuel is, because if they can't trust you, it's very difficult to make those kind of decisions. That's why Jason and I and Brian have spent so much time focused on making sure we have the right resources in the right place, so that we can have those conversations from a position of what I'll call confidence.
Yep.
And a position where our customers believe us.
Okay. Got it. Just on the topic of service, which you referenced a few times. There was a little bit of pressure on service metrics coming out of the winter. That got much better early in the summer. Where do you see that ending the summer and going into the fall, potentially as volumes start to surge with the truck conversion?
Yeah, I think you heard us talk in our second quarter earnings call about some of the issues we had during the second quarter. I think Brian and the ops team have done a fantastic job, really, even by mid to end of July, we were seeing on-time originations were up 20% from where we were in the second quarter. Speed and depth, well, had improved. I think performing really well there, and that's in the face of really pretty high, sustained volumes, 140,000-ish, 145,000 a week. Felt really good about that. I think going forward, the network looks good. I think we're poised to take on additional volume.
We're continuing always to make sure we've got resources in the right place, whether those are people, locomotives, that type of thing, and making sure that we're continuing to build that pipeline to focus on growth to come. I think we're in a really good place from a service and network perspective.
Got it. Just to follow up there, how do you see the current resource utilization? How much excess capacity do you think you have in the network in terms of volumes you can bring on before you start bringing resources back on again?
Yeah, I think, from a T&Ew3 perspective, we've talked before, the folks that are driving train and engine, that is a relatively long period to get people on board. So what we want to do there is keep a pretty consistent pipeline going, right?
Yep.
We're filling attrition. We've got 85 different locations where we hire people. There's some that are more significant. We're making sure those are full. I think it's really watching that and then working closely with Ed's team to see where is that demand going to be, right?
Because it matters. We can't just easily take a person here and move them over to a different location, right? So they need to be in the right places. So we need to know where's the volume coming and what type of volume is it. Is it unit train volume, grain or coal, or is it just manifest cars here and there, right, which is a lot easier to handle. I don't think we're at the point where we've got to spool up disproportionately to the volume increases. But obviously you get to a point where we do need to start adding some additional resources. But again, I think we're in a good place right now from a people and locomotive perspective.
Got it. You guys have delivered a significant amount of productivity savings over the last couple of years, which honestly is a little bit surprising just given how much you took out during the PSR year. Where do we stand there, and what's the opportunity for 2027?
Yeah. Like you said, Ravi, we've harvested about a little over $500 million in the last two years from productivity cost reductions. We're on track this year for another $150 million. I think the thing that's impressive here, it's really all structural what we've done. It's not volume dependent, and in fact, the last couple of years, we haven't grown that much, but yet we've still been able to take these out.
Yep.
Lots of good things in our control there that we're working through, and I think we still have runway there from a, whether it's locomotive modernizations, fuel efficiency, terminal productivity, all things we're continuing to press on. Then you add volume absorption on top of that, and I think it's still a really powerful story. I think we've got a good path moving forward on productivity as well.
Got it. I'll come to merger questions in a second and just how long-term focused you guys are at this point. But just given all of those moving parts, obviously you spoke to headwinds on the OR side for 3Q and 4Q, but what are we thinking, you put all this together, is that long-term sustainable OR level that you guys can target for?
Yeah. I think, when you think about OR, like you said, talked about near-term, our focus is really on safety, service, cost discipline, a nd earning the trust of our customers, right?
Yep.
That is a winning model regardless of what's going on. We think that that will really help to drive us on a long-term basis to an industry competitive operating ratio. I do not know if Ed wants to comment on any kind of commercial things that we could bring in, but when I view it, I think two things that are really in our control. One is service, right? Safely delivering a reliable and consistent service product. That's in our control. There's always going to be hiccups, storms, other disruptions, things like that, but it's how quickly we respond to those and get things back on track, and that's what we've demonstrated here over the last couple of years now. That consistent service product, that will drive growth. It also drives cost efficiency as well.
That's one thing. The second piece is, like we talked about, is on the productivity front, right? It's continuing to push on those things. Not everything in our cost structure we can control. Talked about fuel price, but for the other things, we're doing a good job of controlling what we can control, continuing to push on productivity. I really think those are two significant levers, both in our control, that are going to help us to drive that operating ratio to a perspective of industry competitive. The last thing I'd add in there, the macro probably impacts the timing more than anything else, right?
Sure.
Obviously, if we have a strong recovery, that's going to help improve margins more quickly. If we do not, it's really about execution and maintaining that core strategy.
Got it. So let's switch gears and talk about, obviously, the topic that may have dominated your Q&A so far, which is the merger. So congratulations. The STB obviously accepted the application, moved the merger proceeding from abeyance, and now is in the merits phase. How should investors think of this development, and what can we look forward to from here?
Yeah. I think it's a really good development procedurally as we move into this merits phase. We're pleased to be in that phase of this process right now. I think about it in three big pieces going forward. So you have a comment period and request period, and you also have DOJ and DOT comments. Those are mid-November to early December timeframe.
Sure.
Then you'll have our responses to those, in the February timeframe, and then sometime after March, you'll go into the public hearing. So I look at it in those three big chunks, and that's when I would expect to see big pieces of information coming out from there. So ultimately, the final timing is of course, up to the STB, but I think just having this schedule out provides us a lot of visibility, helps us from a planning perspective, and really gives us a date to drive towards forward on this path.
Got it. We will hear from Jim Vena tomorrow, but so far, how has the procedure gone versus your expectations at the point that we are in right now?
Yeah, I think, sure, we all wanted it to go faster, right?
Sure.
But I think when you think about this, we came out originally and we were talking maybe 18- 21 months or something like this that would take. I think at the end of the day, if this procedural schedule holds, it is not going to be too much longer than that. It is not too far out of that total time period. Again, there has been puts and takes in terms of when things were accepted and when we moved to different phases. All in, I think we are, again, where maybe we thought we would be on a conservative basis, but also right where we should be from getting into the merits of the deal now.
Got it. From your side, you've added several customer protections, expanded Committed Gateway Pricing, reciprocal switching protections, and rate dispute resolution. Can you talk about the process that drove you to offer those concessions? Do you think that meets the threshold for what the STB is looking for?
Well, it's pretty simple. I think we're doing exactly what the STB wants us to, and that's listen to our customers, engage with them, be responsive to the stakeholders that are involved in this. That's really where we came from when we made those additional changes. You think about doubling the amount of freight that's eligible, so to speak, for Committed Gateway Pricing, adding unit train to that piece. Those are clear line of sight responses to what we were hearing from our customer base. You put together those changes with the other parts of this, whether it's the service alternatives or the pricing pieces, and really and truly, I'm biased, but I think it's a very compelling package when we think about offering a lot of value to the market.
Got it. Speaking of agreements you've reached, obviously you've reached an agreement with Canadian National that gives them access to certain 2: 1 and 3: 2 shipper facilities, as well as some Norfolk Southern interests that have been transferred over to them. Should we expect additional agreements like this? Do you think that was a one-off? Do you think that's, again, enough to meet the threshold for the STB?
I know I sound really boring, but I'll go back to what I said a minute ago. I think we're doing exactly what the STB wants us to, and that is we're reaching out to other stakeholders, trying to find solutions that offer value, but at the same time protect the value of this extraordinary opportunity that we have in front of us to deliver for our customers and for America. I think it's strategically important that CN is going to be able to offer that additional access, so to speak, for those 3: 2 and 2: 1. They're going to help us in places like St. Louis and the Terminal Railroad Association of St. Louis and all that kind of stuff, and we'll see what else is out there.
Yep.
I would never foreclose opportunities that may help us solve problems for our customers and for the roads.
Got it.
I would just add on there, I think it's a great development, right, in this process, but it's just one element of what we've presented to the STB in terms of the value that this transaction brings on its own.
Got it.
Yeah.
We briefly touched on earlier the share shift that came immediately after the merger was announced. To your point, you started lapping that pretty soon. When do you think you guys can go back on offense and start taking share back? Does that need the merger to be consummated before that happens? How do you think competitive dynamics might permanently change between the Class I railroad as a result of this transaction?
You're inferring that we were ever off offense.
Well, fair enough. Again, I think some things that happened that may have been slightly outside of your control.
When can you go back there?
Yeah. I think we're always on offense and defense. That's the way of the world. It's a competitive landscape and we're out there fighting every day for new business and to maintain what we have. The power of our network, our intermodal network in particular, it is one of our superpowers, right? We service, I think it's something like 100 million American consumers wake up within 50 mi of one of our intermodal ramps. Some of them wake up within 50 mi of four of them.
Sure.
We have a substantial place in the market in terms of the value that we can offer with that network, and I am very confident as we move forward, merger, no merger, as a standalone company, we are going to be able to deliver that exceptional value because of that network and the way we execute on it.
Got it. That is super helpful. We have a few minutes left. I want to see if there are any questions from the audience. You have one up here.
Thank you. Yes, thanks for giving question. I remember in the past that NSC was relatively strong, especially in automotive, given the location and a lot of cars coming from Western Europe. How is tariffs impacting that trade and how important it is still today in your business? I remember in the past, about 12% of sales also given public information that market margins in automotive are relatively high. What did they do with your business, and have we touched the bottom, and where are we with that?
At the risk of making a bold statement, I would say, I think tariffs have been an event that has occurred and is now in the past. I do not think it has a necessarily ongoing influence on a lot of those markets like the auto markets. We are very lucky, by virtue of geography and the effort of past generations of railroaders, we have a superb automotive network, not only for domestic manufacturing from the Detroit Three, but also from a lot of European manufacturers. We are in a, I think, a very good place. The country is actually in a pretty good place with regard to being able to compete globally, but also be able to deliver values in that network that we have. Tariffs are a thing, but honestly, I think it was maybe a one-time event.
Any other questions? Last question. Mike.
Hi. Just wondering, with the regulatory process potentially extending well into 2027, just wondering how you guys are ensuring that management and employees remain focused on standalone execution and if there's any investments, commercial decisions, or capital allocation actions that become more difficult while the transaction remains pending.
Yeah, sure. I'll start on that. Standalone execution is our mandate, right? I talk about our focus on safety, service, cost discipline, and building trust with our customers. That's key, and we're delivering, we're executing on that strategy. If you look at record second quarter revenue, continued productivity that we're delivering, the list goes on. Second quarter, decent OR, but 5% operating income growth. So, I think we're doing a lot of great things from a standalone perspective. When you think about investments, we continue to invest in our people and in our infrastructure. This year, call it just rough numbers, we're going to spend about $2 billion in CapEx, and that's to continue to support the network from a safety and resilience perspective, a growth perspective, and continuing to invest in technology. So, no change there from our strategy.
Those are things that are going to be important as a standalone company, but also, as part of a combined entity going into that in that merger from a strong perspective.
Any more questions? I did want to ask you about autonomous trucks because that's been a big topic of discussion for us all year at this conference as well. I believe it's come up in every meeting that people have had. How much time are you guys spending thinking about what that means for the industry? Obviously, truck conversion is a big part of the value created by this transaction. How much time are you spending on it? What do you think that means for the transaction for the industry over time?
I'll answer first, you can go into it. I don't know what it means for the transaction itself. But I will tell you, part of my mandate is to look out into the future and try to create a future that outcompetes where we are today.
Yep.
Right? In many ways, I would say that autonomous trucking or trucking writ large has done a pretty good job of moving the ball down the field. Railroads in general, we've got a fair number of headwinds to some of those more innovative pathways that perhaps trucking companies have. I personally think that autonomous trucking probably reaches some sort of scale maybe in the next 18 months.
Okay. Yep.
It's just Ed talking.
We would agree, yeah.
It also means that we have to figure out how we do things differently.
Yep.
And how we deliver additional value to our customers in a way that makes it more compelling than what they can find on the other side of the road, so to speak. That's our job.
Yep.
Technology has to be a part of that. That's just my opinion.
Yeah. I would just add, not necessarily from an autonomous perspective, but just technology advancement. You talk about what we've been able to do here and over a relatively short period of time, we've got 11 Digital Train Inspection Portals that we have across our network. Think about it like a large car wash, but the train's going through there at track speed, 40+ mi an hour, taking 1,000 pictures per car.
That's finding things that the human eye can't detect and definitely not at that speed, right? We're constantly looking at everything that could cause a problem down the line. So allows us to fix it quickly, address it right away. At the end of the day, it's good for us, good for our customers, keeps right on its way to destination. So I think there's things that we're definitely doing in the industry that super proud of that we've been able to do. Even going back to locomotive modernizations.
Yep.
We've just done over 1,000 of those now, and that's been great for our fleet. So really trying to, like Ed said, stay on that front edge of what are the things we can do to advance technology.
I will say, and this is, I'm reflecting on your question now. Look, at the heart of this transaction, this merger, is the idea that we want to become the most user-friendly, most customer-friendly pathway out there. That's very difficult to do when you have multiple railroads with their own strategies on how they're going to become more customer-friendly. You can only touch part of your customers with your own strategy, and they have to live with all these other strategies or maybe not on other parts of their network. So by presenting a combined company that can service the entire array of freight that's out there on a nationwide basis, particularly when I think about the platforms that we've developed, the investments that others have made, we clearly need that kind of innovation to successfully compete. I think that's one of the value propositions behind this merger.
Great. Gentlemen, thank you so much for the thoughts. I hope to have you at Laguna next year, or maybe not. Either way, you'll be fine. So thanks so much for being here.
Thanks.
Thank you.