Greetings, and welcome to the Union Pacific Third Quarter 2016 Conference Call. At this time, all participants are in a listen only mode. A brief question and answer session will follow today's formal presentation. As a reminder, this conference is being recorded and the slides for today's presentation are available on Union Pacific's website. It is now my pleasure to introduce your host, Mr.
Lance Fritz, Chairman, President and CEO for Union Pacific. Thank you, Mr. Fritz. You may begin.
Good morning, everybody, and welcome to Union Pacific's 3rd quarter earnings conference call. With me here today in Omaha are Eric Butler, Chief Marketing Officer Cameron Scott, Chief Operating Officer and Rob Knight, Chief Financial Officer. This morning, Union Pacific is reporting net income of $1,100,000,000 for the Q3 of 2016. This equates to $1.36 per share which compares to $1.50 in the Q3 of 2015. Total volume decreased 6% in the quarter compared to 2015.
Carload volume declined in 5 of our 6 commodity groups with coal and industrial products both down double digits. Agricultural product volumes were up a robust 11 percent this quarter versus 2015 as grain shipments finally started to show some strength. The quarterly operating ratio came in at 62.1%, which is up 1.8 percentage points from the record Q3 last year, but improved 3.1 percentage points from the Q2 of this year. Continued momentum from our productivity initiatives as well as positive core pricing helped partially offset the decline in total carload volumes. While many of the same volume challenges have continued throughout the year, we are keeping a laser focus on our 6 value tracks.
This strategy ensures we provide our customers with an excellent value proposition and service experience while efficiently and safely managing our resources. Our team will give you more of the details starting with Eric.
Thanks, Lance, and good morning. In the 3rd quarter, our volume was down 6% with near record agricultural product shipments more than offset by declines in each of the business groups. We generated core pricing gains of 1.5% in the quarter, reflecting the impacts of competitive markets in a weak economic environment, particularly in our energy related and international intermodal businesses. Despite these challenges, we continue to achieve solid reinvestable returns even in these difficult markets, and we remain committed to achieving positive core pricing gains that reflect our value proposition over the long term. The decline in volume and the 2% lower average revenue per car drove a 7% reduction in freight revenue.
Let's take a closer look at the performance for each of our 6 business groups. Ag Products revenue gained 6% on an 11% volume increase and a 4% decrease in average revenue per car. A robust U. S. Grain supply and lower commodity prices generated export strength and lifted grain volumes 27% in the quarter.
Wheat exports rebounded in the second half of the quarter as adverse weather in South America caused significant losses, elevating demand for the higher protein U. S. Wheat. Grain products carloads advanced 5% in the quarter, primarily due to increased ethanol exports and biodiesel shipments. Food and refrigerated carloads were flat in the quarter, as strong demand for import beer offset softness in refrigerated food shipments and import sugar.
Automotive revenue was down 8% in the quarter, driven by a 2% decrease in volume and a 6% reduction in average revenue per car. Finished vehicle shipments decreased 7% by sales and production levels of passenger vehicles impacting key Union Pacific served plants and contract changes we referenced last quarter that will continue to impact our volumes through the 1st part of 2017. In total, finished vehicle sales in the quarter were at a seasonally average rate of $17,500,000 up 2% from the 2nd quarter, but down 2% from the 2015 Q3. On the parts side, a continued focus on over the road conversions drove a 5% increase in volume. Chemicals revenue was down 1% for the quarter on a 1% decrease in volume and a 1% increase in average revenue per car.
We continue to see headwinds on crude oil shipments, which were down 48% due to lower crude oil prices, regional pricing differences and available pipeline capacity. Chemicals volume excluding crude oil shipments was up 2% in the quarter. Partially offsetting the declines in crude oil was strength in other areas, including industrial chemicals, which was up 3% in the quarter. Coal revenue declined 19% for the quarter on a 14% decrease in volume and 6% decline in average revenue per car. Sequentially, however, overall coal tonnage increased 40% from the Q2 of this year.
Powder River Basin and Colorado, Utah tonnage declined 17% 16%, respectively, in the quarter as increased demands from a warmer than average summer was unable to offset high coal stockpiles. PRB coal inventory levels in September were 90 days, down 13 days from June, but still 27 days above the 5 year average. Industrial Products revenue was down 13% on an 11% decline in volume and a 2% decrease in average revenue per car during the quarter. Minerals volume was down 22% in the quarter, driven by 26% decrease in frac sand carloadings impacted by lower crude oil prices and decreased drilling activity. Construction products volume was down 8% due to weather impacted construction activity in the South.
The strong U. S. Dollar, weak commodity pricing and increased imports pushed metal shipments down 13% year over year. Animoto revenue was down 9% on a 7% decline in volume and a 2% decrease in average revenue per car. Domestic intermodal volume declined 2% in the quarter.
Excluding headwinds from the previously discussed discontinuation of Triple Crown service, domestic was nearly flat. International volumes were down 11% in the quarter as the industry continued to face significant headwinds from weaker global trade activity, softer domestic sales, high retail inventories on the Hanjin bankruptcy. To wrap up, let's take a look at our outlook. In Ag Products, we expect a healthy U. S.
Harvest and strong world demand for U. S. Grain to drive favorable export trends. Grain products will continue to be strong, driven by ethanol exports. In Food and Refrigerated, we expect continued strength in beer imports.
Turning to autos. Light vehicle sales are forecasted to finish 2016 at $17,400,000 down less than 0.5 percent from the 2015 record rate of 17,500,000 dollars Although we expect sales incentives, low gasoline prices and consumer preference will continue to drive demand, we remain cautious with respect to auto sales sustaining at these levels. A continued focus on over the road conversions will support auto parts growth. Our chemicals franchise is expected to remain stable with strength in LPG and industrial chemicals offset by declines in crude oil. Coal volumes will continue to be impacted by natural gas prices, high inventory levels and export demand.
As always, weather conditions will be a key factor of demand. In Industrial Products, lower crude prices and reduced drilling activity are expected to continue to challenge minerals values. We anticipate a softer year end for metals as imports continue to impact domestic shipments and customers manage year end inventories. We expect lumber to be stronger in the 4th quarter as housing starts continue to expand. Finally, in Intermodal, our international volumes continue to be adversely impacted by a strained ocean carrier industry, offset partially by over the road highway conversions.
With the face of a number of uncertainties in the worldwide economy, our diverse franchise remains well positioned for growth as the economy slowly improves. We remain committed to strengthening our customer value proposition and driving new business opportunities. With that, I'll turn it over to Cameron for an update on our operating performance.
Thanks, Eric, and good morning. Starting with our safety performance, our year to date reportable personally injury rate improved 16% versus 2015 to a record low of 0.77. Included in this was a record low number of severe injuries, which have the greatest human and financial impact. Although we continue to make significant improvement, we won't be satisfied until we reach our goal of 0 incidents, getting every one of our employees home safely at the end of each day. With respect to rail equipment incidents or derailments, our year to date reportable rate of 3.13 improved 4% versus last year.
While we made only a slight improvement on the reportable rate, enhanced TEOI training and continued infrastructure investment helped significantly reduce the absolute number of incidents, including those who do not meet the reportable threshold to a record low. In public safety, our grade crossing incident rate increased 13 percent to 2.55. We continue to focus on driving improvement by reinforcing public awareness through various channels, including public safety campaigns and community partnerships. Moving to network performance. While the California wildfires and flooding along various parts of our network created some challenges during the quarter, our network proved resilient as we continue to achieve solid operating performance.
Effective use of our surge locomotive fleet and TE and Y workforce were critical to minimize the impact of these network challenges. As reported to the AAR, velocity improved 2% when compared to the Q3 of 2015. Terminal dwell also improved 2%, but the benefits of a fluid network were somewhat offset by productivity gains such as longer train lengths and other network management initiatives. Moving on to resources. As part of our ongoing business planning process, we continue to adjust resource level to account for volume changes and productivity gains.
As a result, our total TE and Y workforce was down 14% when compared to the same quarter last year, but up 2% sequentially from the 2nd quarter to efficiently handle the 8% volume increase experienced since the end of June. We also continue to evaluate all other aspects of the business with the goal of driving productivity throughout the organization. This includes the rightsizing of our engineering and mechanical workforce, which was down a combined 1900 employees or 9% versus the Q3 of last year. Our active locomotive fleet was down 9% from the Q3 of 2015, but up 2% sequentially to handle the increase in carloads. As you know, we've been planning for the acquisition of 230 new locomotives this year.
We now expect that number to be 200 locomotives this year with the delivery of 30 units delayed into 2017. This would add to the 70 units previously scheduled in 2017 for a total of 100 next year. We're adjusting our 2016 capital program down about $100,000,000 to just under $3,600,000,000 primarily driven by this change in locomotive deliveries. Turning to network productivity. While we remain focused on effectively balancing our resources, we also continue to realize efficiency gains through several productivity initiatives.
Train length is a significant productivity driver and a primary focus area for us. During the quarter, our manifest and grain networks ran at all time record train length levels, while our automotive network set a 3rd quarter record. Recrew rate, a cost incurred when the first crew has insufficient time to complete the trip is an indicative measure of the fluidity and productivity of our network. Our 3rd quarter recoup rate was 2.3%, a near 2 point improvement from 2015 and a 3rd quarter record. As we move forward, we expect our safety strategy will continue yielding positive results on a way in incident free environment.
And where growth opportunities arise, we will leverage that growth to the bottom line through increased utilization of existing assets, while maintaining our intense focus on productivity and efficiency across the network. With that, I'll turn it over to Rob.
Thanks and good morning. Let's start with a recap of our 3rd quarter results. Operating revenue was about $5,200,000,000 in the quarter, down 7% versus last year. Lower volumes and lower fuel surcharges more than offset positive core pricing achieved in the quarter. Operating expenses totaled just over $3,200,000,000 Lower fuel costs, volume related reductions and strong productivity improvements drove the 4% improvement compared to last year.
Operating income totaled almost $2,000,000,000 11% decrease from last year. Below the line, other income totaled $29,000,000 roughly flat versus 2015. Interest expense of $184,000,000 was up 17% compared to the previous year. The increase was driven by additional debt issuance over the last 12 months as well as about $8,000,000 for the fees associated with our recent debt exchange transaction. This increase was partially offset by a lower effective interest rate.
Income tax expense decreased about 14% to $674,000,000 driven primarily by lower pretax earnings. Net income totaled just over $1,100,000,000 down 13% versus 2015, while the outstanding share balance declined 4% as a result of our continued share repurchase activity. These results combined to produce quarterly earnings of $1.36 per share. Turning now to our top line. Freight revenue of 4,800,000,000 dollars was down 7% versus last year, primarily driven by a 6% decline in volumes.
Fuel surcharge revenue totaled $173,000,000 down $141,000,000 when compared to 2015, but up $86,000,000 from the Q2 of this year. All in, we estimate the net impact of lower fuel prices was a $0.05 headwind to earnings in the Q3 versus last year. The business mix impact on freight revenue in the Q3 was about flat, similar to what we experienced in the Q2. Year over year growth in agricultural product shipments and declines in international intermodal volumes were positive contributors to mix, which were offset by declines in industrial products and finished vehicles volumes. Core price was a positive contributor to freight revenue in the quarter at about 1.5%.
Slide 21 provides more detail on our pricing trends. As Eric just mentioned, pricing gains this quarter reflect a competitive marketplace in a soft economic environment. Going forward, we remain committed to our focus on positive return driven core pricing, which reflects the value proposition that we provide our customers. Moving on to the expense side, Slide 22 provides a summary of our compensation and benefits expense, which decreased 6% versus 2015. The decrease was primarily driven by a combination of lower volumes, improved labor efficiencies and fewer people in the training pipeline.
General wage and benefit inflation partially offset these decreases. Labor inflation was about 3% in the 3rd quarter, driven primarily by general wage increases and health and welfare expense, which were partially offset by some favorable pension costs. We still expect full year labor inflation to be about 2% and overall inflation to be about 1.5% for the year. As a result of lower volumes, solid productivity gains and a smaller capital workforce, total workforce levels declined 10% in the quarter year over year or more than 4,700 employees. Looking sequentially, total workforce levels were down about 1% from the Q2 of this year.
For the Q4, we expect our force levels to be similar to the 3rd quarter and also down somewhat from the prior year as comps get a little bit more difficult. Turning to the next slide, fuel expense totaled $392,000,000 down 19% when compared to 2015. Lower diesel fuel prices along with 6% decline in gross ton miles drove the decrease in fuel expense for the quarter. Compared to the Q3 of last year, our fuel consumption rate improved 2% to a record 1.075, while our average fuel price declined 13% to $1.57 per gallon. Moving on to our other expense categories, purchase services and materials expense decreased 4% to $566,000,000 The reduction was primarily driven by lower volume related expense and reduced locomotive and freight car repair and maintenance costs.
Depreciation expense was $512,000,000 up 1% compared to 2015, driven primarily by higher depreciable asset base. For the full year, we still expect depreciation expense to increase slightly compared to last year. Slide 25 summarizes the remaining 2 expense categories. Equipment and other rents expense totaled $282,000,000 which is down 7% when compared to 2015. Lower volumes, which reduced car hire expense and reduced locomotive lease costs were the primary drivers of this decline.
Other expenses came in at $271,000,000 up $66,000,000 versus last year. We did have a couple of one time items impacting the other expense category in the Q3 as well as a few favorable items that we incurred last year. As we discussed back in September, we have written off the $13,000,000 accounts receivables associated with the Hanjin bankruptcy. In addition, we also incurred $17,000,000 of write offs associated with in progress capital projects, which we are no longer pursuing. Higher state and local taxes and increased environmental costs, partially offset by lower personal injury expense, also contributed to the negative variance in this category for the quarter.
For the full year 2016, we now expect the other expense line item to increase close to 10%, including the one time items that I just mentioned. Turning to our operating ratio. The 3rd quarter operating ratio came in at 62.1%, 1.8 points unfavorable when compared to the record Q3 of 2015. Fuel price negatively impacted the operating ratio by 0.4 points in the quarter. Looking at cash flow, cash from operations for the 1st 3 quarters totaled about $5,500,000,000 down about $160,000,000 when compared to the same period last year.
The decrease in cash was driven by lower net income and was partially offset by the timing of tax payments primarily related to the bonus depreciation on our capital spending. For the full year 2016, we now expect the net impact of bonus depreciation to be a tailwind of about $350,000,000 After dividends, our free cash flow totaled about $1,300,000,000 year to date through the end of September. Taking a look now at the balance sheet, our all in debt adjusted debt balance increased to about $18,500,000,000 at quarterend. We finished the 3rd quarter with an adjusted debt to EBITDA ratio of over 1.9 times, up from 1.7 at year end. This brings us close to our target ratio of less than 2 times.
For the 1st 9 months of the year, we bought back over 25,000,000 shares totaling about $2,200,000,000 Since initiating share repurchases in 2,007, we have repurchased about 28 outstanding shares. Between our dividend payments and our share repurchases, we returned nearly $3,600,000,000 to our shareholders through the 1st 3 quarters of this year. So that's a recap of the 3rd quarter results. Looking out to the remainder of the year, volume to be to be down in the low single digits. And we still expect total full year volumes to be down in the 6% to 8% range.
While we do not expect to improve the operating ratio this year, we will continue to leverage our G55 and 0 initiatives to generate positive core pricing and strong productivity to achieve the lowest operating ratio possible. And as Cam just mentioned, we now expect 2016 capital spending to be down about $100,000,000 to just under $3,600,000,000 primarily as a result of the delay in the locomotive deliveries. While we have not yet finalized our capital plans for 2017, we still expect our capital spending to be around 15% of revenue. From a productivity perspective, our G55 and ZERO initiatives have generated significant efficiency savings for the company thus far this year, And we are confident that we will continue to drive further improvements well into the future as we work toward our operating ratio target of 60% plus or minus on a full year basis by 2019. And longer term, we are keeping our eye on the goal of a 55% operating ratio as we gain momentum with our G55 and 0 initiatives.
So with that, I'll turn it back over to Lance.
Thank you, Rob. As the team has articulated here this morning, we continue to experience a difficult but improving market environment in the Q3. While we were pleased to see improving volumes in some of our business lines such as grain and coal, many of our markets still remained at volume levels below a year ago. The macroeconomic environment still has its challenges, an unstable global economy, the relatively strong U. S.
Dollar and continued soft demand for consumer goods. However, certain segments of the economy are showing signs of life. The recent rally in energy prices has crude oil over $50 a barrel and natural gas over $3 per 1,000,000 Btu, which are both encouraging for our coal and shale related businesses. We are also pleased to see strength in the overall grain market. With a record harvest currently underway, we are well positioned with our network and resources to serve an increase in demand from our ag customers.
Closing out 2016 and heading into next year, we're optimistic about the opportunities that lie ahead. In the coming months, we'll continue to do what Union Pacific does best, operate a safe, efficient and productive network while providing an excellent customer experience and delivering solid shareholder returns. With that, let's open up the line for your questions.
Thank you. Our first question is coming from the line of Ken Hoexter with Merrill Lynch. Please proceed with your question.
Great. Good morning. Just can you, Rob, talk a little bit about the projects you're writing off? I just want to understand what kind of costs we have going forward. And it looks like as the business comes back, you're starting to ramp up your locomotives and employees, but you noticed that there are fewer people in the training pipeline.
Should we see some start up costs as you start to bring people back in? Thanks.
Yes, Ken. What I commented in the quarter is, it was around $17,000,000 of projects that were started that we have chosen to not pursue and so we are taking adjustment there. So I think if you look longer term, that's a number that is not going to repeat. I mean, we occasionally will have situations like that, but I think it's safe to assume that that's a number similar to the Hanjin receivable write off that I mentioned that are not going to repeat in that line item. In terms of the costs, we're confident that we are well situated both on locomotives and employees to leverage the volume that we hope does materialize.
So, we've got fewer people in the training line because we've got so many people, if you will, in furlough status at this point. So, we feel very good about our ability to do and we'd love nothing more than to see volume pick up and be able to put resources back to work.
Great. Thanks.
Our next question comes from the line of Cherilyn Radbourne with TD Securities. Please proceed with your question.
With the international shipping lines under continued financial pressures you noted And the prospect of a record grain crop matchbacks is something that I've been hearing more about. Just curious if that's something that you're facilitating and potentially see as a means to increase market share in intermodal or grain or both?
Eric? Yes. As you mentioned, Sharon, there's a significant volatility going on in the international containership business. There have been 3 major mergers, 1 bankruptcy, there are a number of other entities that are in dire or questionable financial shape. One of the things that all of the container ship companies are looking at doing is finding ways to have matchbacks or exports from the U.
S. To Asia. 1 of the large historical exports has been grain, in particular DDGs to China. We are continuing to look at that as an opportunity to grow our business in terms of the westbound business to Asia. We're also real excited longer term or mid term in terms of the opportunity to ship plastics to Asia from the expanding franchise we have in the Gulf.
And we think that that's going to be an excellent opportunity for Matchbox also. So we think both of those things are great opportunities. Of course, China occasionally, as they have right now, has tariffs or other governmental policy things that hinder imports like DDGs. But we think long term that should be an opportunity for us.
Sherri Lynn, this is Lance. What Eric just outlined is indicative of the franchise strength that the Union Pacific brings to the industry. We've got breadth and coverage in a number of markets that allow us visibility into potential matchbacks.
Great. And just by ways of very quick follow-up, when you say medium to long term on the plastics matchbacks, is that sort of 2018 and belong and beyond?
Yes, I mean, we as we've been saying for the last several quarters, we think most of the growth will happen in 2018 and beyond. There might be a tail of a small ramp up toward the end of 2017, but basically 2018 and beyond.
Our next question is from the line of Ravi Shankar with Morgan Stanley. Please proceed with your question.
Thanks. Good morning, everyone. A couple of questions on pricing. You've committed to positive core pricing. Can you also commit to pricing over inflation?
And second, can you just help us understand what the driver of the pricing, I'd say the deterioration in the gains has been. Is it mostly intra rail competition? Is it truck competition? Or is it you guys kind of supporting some of your customers who may be going through a hard time and hoping to get it back a little later on?
Eric? Yes, Ravi. So one of the things that we're really excited about is the great franchise we have and we have a very diverse franchise. And some components of our franchise, obviously, as we mentioned, the energy related and the international related are facing both economic weakness conditions and also some competitive conditions. So we've been talking about the challenges in coal.
Coal, as you know, has been greatly challenged not only by a demand because of weather and other usage demands, but natural gas has been a great strong competitor to coal. The low below $2 natural gas prices is great created a headwind for coal in the past. We're excited or we think that with natural gas being above 3% now and even some of the futures markets showing it in the mid-3s that, that certainly will improve the competitive condition for coal, but that has clearly had an impact. Likewise, the 3 major mergers, the one large bankruptcy in the international intermodal, the volatility that we talked about in previous earnings releases has created economic conditions and competitive conditions in international intermodal. Even despite those challenges in those markets, we still have been able to put our market price at reinvestable returns.
And we think that looking at the broadness of our portfolio, we are pretty positive in the future about our ability to price for the excellent value we provide. And we're going to price above reinvestable returns and we have a broad portfolio of opportunities to drive that message.
Thanks so much for that color. Can you also do you have the confidence that you can stay above inflation pricing?
Robbie, this is Rob. Let me answer that. I mean, clearly, long term, that is still our goal. The one thing with these challenges and opportunities that Eric outlined, one thing is that we haven't finalized yet, but as we look into 2017, at this stage, it looks like Global Insights inflationary numbers are like 2 point 5%, and our number may well be above that from an inflationary standpoint, largely driven by the health and welfare costs on our labor line. So still some work to play out there.
But longer term, absolutely, we're as committed as ever to driving that price.
Great. Thank you.
Our next question is from the line of Tom Wadewitz with UBS. Please proceed with your question.
Yes, good morning. Wanted to ask a little bit more on the pricing side. You commented how the higher natural gas price is helpful for coal. So that's obviously a constructive thing. But I'm wondering if you're optimistic if that will that should help the coal tonnage and obviously have a if you have a normal winter and so forth.
But what about the pricing in coal? If we stay at this gas price or go a little higher, do you think that the you'll be able to go transition to a better competitive environment where you could raise price for coal transport or is that something that some of that pricing pressure would likely persist?
Yes. So Tom, you're asking a couple of different things there. As you know, there are always a variety of market conditions that impact price, transportation, capacity availability and availability on transportation networks for other commodities, as you know, competition, weather, there are a lot of things, natural gas prices that will affect coal wheat. We are positive that the use of coal should be increasing in the midterm. If you just look at, again, the competition against natural gas, if you look at the economic pickup and the use of energy, we are confident that the use of coal should be picking up in the near midterm.
And we saw that in the second to the third quarter in terms of the sequential use of coal. We will continue to price for reinvestable returns based on the value of service that we provide and we're confident in that strategy. We're confident in the value that we're providing and we're going forward.
Hey, Tom, this is Lance. Clearly, an environment where natural gas price is increasing, put it north of $3.50 or so and where weather is favorable and where the stockpiles have been worked down, that's a better pricing and competitive environment than not. So it helps.
Okay. I appreciate that. And then for the follow-up, I don't know if this is kind of Rob or Cameron, but you've shown nice improvement in the train lengths, good momentum there. So that's very favorable. I'm wondering if you look at 2017 and if you do see a volume growth as a couple of things play out, let's say you see a couple of points of volume growth, how does that translate to incremental margins?
Could you see something that's well above the kind of normal 50% incremental margin we're talking about, could you see something 60%, 70% as you expand train length more and see some of the benefit of cost takeout and so forth? Is that a reasonable equation or would you be more cautious about the incrementals in 2017 if the volumes come back? Thank you.
Rob, why don't you take that?
Yes. Tom, this won't surprise you, but we won't give guidance on the actual incremental margins, but everything you said are certainly opportunities. I mean, as you know, our G55 and 0 initiatives, which are some 15 different areas that our view is we're looking at every single cost bucket in the entire company and attacking it aggressively with an eye on safety and efficiency and customer value. So, I would just answer that question by saying the scenario you outlined where there's positive volume and a positive reasonably positive economic environment would give us an outstanding opportunity to continue to drive productivity and staying away from an actual incremental margin calculation, we would expect it to be a positive contributor. And by the way, for us to go from where we are today to our 60 plus or minus by 2019 and with an eye on getting to 55 assumes we're going to have very healthy incremental margins from here to there.
So we're going
to certainly go after it. Tom, as we've opened up the door now to the productivity in your question, I just want to give recognition to the entire UP team who have done a tremendous job in a reduced volume environment of finding ways to grow, for instance, manifest train size 5% year over year. That's a phenomenal effort and that's just one of many in terms of finding productivity on the network. I think the team has done a tremendous job Thank you for the time.
Thank you. Rodney
McMullen:] Thank you for the time.
Thank you.
Our next question is from the line of Jason Seidl with Cowen and Company. Please proceed with your question.
Thank you, operator. Good morning, gentlemen. I'm going to stick on the price horse here for now.
As we look
at that 1.5%, you mentioned tough volume environment, competitive environment. Is this something that you would expect UMP to hover around for a while? Or what could break it out of that 1.5 percent? I'm trying to figure out, is this near term or are we going to see that throughout 'seventeen unless things recover from here?
Jason, we don't give any guidance on price. Clearly, as we've outlined a little bit here this morning, there are certain markers that make the competitive environment better for pricing. Anytime, for instance, capacity and alternative modes tightens up, that's good. Demand for the underlying commodities as it increases, that's good. So you just got to keep your eye on what's happening with, for instance, natural gas prices and stockpiles and weather in the coal world, what's happening on import demand and the financial health of our international intermodal ocean carriers, that helps what happens for industrial production in the United States, that helps What's happening to truck capacity, alternative modes, that helps.
So all of those are a helpful environment for our pricing.
No, I appreciate that. I mean, I just even checking my records, I can't remember the last time you guys were below, we would call your rail cost inflation. Looking at 'seventeen, how does and I know you guys don't provide guidance specifically, But are you pretty confident that you are going to be able to grow your volumes in 2017, forget what percentage, but just grow the volumes?
Eric, do you want to handle that?
We as we said, we don't give volume guidance, but if you look at the markets that we out there and you look at the pickup in different markets that we have, we feel pretty positive that as the economy continues to grow and is slowly strengthening in many of our markets. We feel pretty positive about the run rate opportunity. The one cautionary area that we have talked about before is in automotive sales. We continue to think those are cautionary. If you look at even our Mexico franchise, we had great growth in our Mexico franchise in the quarter.
We still think that there are good opportunities to grow
volume. If I could just add to Eric's comments, Jason, just kind of remind you and everyone else, our thesis from this point over the longer period is a positive volume environment. And you look at the as Eric just pointed out, you look at the unique diverse opportunities of our franchise, while we are giving precise volume guidance for next year, but we do feel there is great opportunity for us to continue to leverage and over the longer period of time for us to have volume on the positive side of the ledger, certainly.
Well, let me ask you quickly another way. So if you saw negative volume next year, that would mean that something would have to decelerate from here with the trends. Is that an accurate statement?
Yes, that's an accurate statement, Jim. Generally speaking, again, we play in multiple markets, but that's a fairly accurate statement.
Okay. Gentlemen, I appreciate the time as always.
Thank you.
Our next question comes from the line of Brandon Oglenski with Barclays. Please proceed with your question.
Hey, good morning, everyone, and thanks for getting me on the call here. So a couple I think a few months into this year, we had been talking about OR improvement even when volumes were down pretty significantly in the Q1. And I know you guys backed off of that in 2Q. But I guess as I listen to the call here, it sounds like pricing might kind of be in line with cost inflation, maybe even a little bit below it next year. And let's say volumes don't come back tremendously, what can you guys do on the operating ratio that maybe we could instill some confidence again that you guys would break into to Weller territory?
Let me start, Brandon. This is Lance. And I'll remind you that we have confidence, extreme confidence in our ability to continually find opportunities to be more efficient, reduce waste and increase the value that we're adding. I'll ask Cameron just to give us a handful of examples of things we're working on when we're going into next year, but our bucket is full of opportunity to be better.
On train size, the only commodity group that is truly optimized or nearly optimized is coal. Every single commodity that we have out there from manifest to automotive to intermodal to grain or rock all has tremendous opportunity for us to continue with the results that you have seen. So we feel confident that that is going to happen in 20 17. The record all time recur rate from a process perspective, we feel like we have well in hand and we should continue to see that into 'seventeen and 'eighteen. And we work on other initiatives like rationalizing our low horsepower fleet.
We've done a great job of moving to single unit local operations versus 2 units. There's a number of initiatives that we have, we're truly, we're just getting started in framing up the opportunity and getting ready to realize it as we step into the new year.
Yes, exactly. And even little things like C rate, that improved 2% year over year here. There's plenty of opportunities. We look forward to become world class, if you will, in consumption rate for diesel. So there's just a host of issues there, Brandon, that we can continue to work on.
And I appreciate all that you guys probably have going on that we can't see from here. But I guess in retrospect, Lance, was it just that volume got a lot worse than we thought in the Q2? Or was it competitive factors? Was it market pricing? What was it that led to the lack of ability to drive OR improvement this year?
Let me let Rob handle it.
Yes. Brandon, I mean, your comment is right that we have always said and we do believe that we can make improvements in the operating ratio in spite of the lack of volume growth. And in fact, if you look ahead over the last decade, we've taken almost 25 points off our operating ratio without the benefit of positive volume over that timeframe. I would say you're exactly right though. Here in the short term this year, I would say that the major driver of not likely improving the operating ratio this year is the pace of which we've been kind of chasing volume down.
I mean, it's we never have perfect visibility as to where that volume is going to trough and that makes it difficult. So we are always chasing it, if you will. And I think that's really the answer to what you've seen this year. So, as we look forward, I think it's still a fair assumption and it's certainly our drive that we expect to make improvements in our operating ratio in spite of what the economy deals us in terms of what happens with volume. Now, having said that, as we look out over the next several years, we do have volume in our thesis on the positive side of the ledger, but we are going to not use that as an excuse not to make continued productivity improvements.
Okay. Thank
you. Our next question is from the line of Scott Group with Wolfe Research. Please proceed with your question.
Hey, guys. Good morning. So wanted to follow-up on pricing. Rob, your point about inflation picking up to 2.5% next year, is that to caution us that pricing could be below inflation or is that you telling us that we have line of sight to inflation getting higher, so we have line of sight to our pricing accelerating to next year? I'm not sure what you're trying to tell us.
Yes, Scott. My point on the inflationary comment is, we do expect inflation to go back up, if you will, to more normal levels versus the below inflation below normal levels that we enjoyed this year. And again, 2.5% global inside our numbers because of health and welfare costs might be higher than that. So my point on that is simply to say, not unusual against historical numbers, but we do expect inflationary pressures to be back to sort of normal conditions, if you will.
But because you have line of sight to inflation picking up, do you have line of sight to your pricing reaccelerating too?
I would say, no. I mean, it's not mechanical. As you know, the way we price and we play in so many different markets that they're not it's not cookie cutter, it's not a one size fits all. And as Eric outlined, there are opportunities for us to achieve stronger price than other areas in the short term. But we will continue to drive service, drive value and price set minimum of reinvestable levels as Eric outlined in spite of what that inflationary number turns out to be.
So I would say they're disconnected, if you will, in terms of the day to day pricing initiatives that we take.
So maybe just bigger picture, it feels like for the long term, you guys have said, hey, we're going to get pricing no matter what. If we get volume, okay. If we don't get volume, we don't care. And truthfully, you haven't had much volume and you've gotten great pricing. Is the philosophy changing where you care more about volume now as part of G55 and so there's it's less clear that you necessarily always get the pricing?
Got it. Our philosophy is not changing. And as a matter of fact, our top line this quarter reflects that it's not changing. We are pursuing business in the marketplace that we can price for the value that we represent and that's reinvestable. And if we can't find that, we walk away from it.
So nothing's changed about that philosophy.
Okay. And if I can just ask one more just thing on grain pricing specifically. So as the grain volumes are finally picking up, are there opportunities to start raising grain tariffs? I was a little surprised by the sequential drop in ag revenue per car this quarter. I don't know if that's mix or a lack of pricing there.
Just anything specifically on grain pricing?
Yes, Scott. I think if you some of grain pricing, as you know, is in public tariffs, which is publicly available. And I think you would see some of that sequential increase in pricing in the publicly available tariffs that mirror kind of the demand that's picking up in grain. I think you'll also see in some of the secondary markets huge increases and kind of the value in the secondary markets for equipment for grain. So some of that is you have public visibility to And I think if you look at those public things, you would see pricing going with the demand increases.
Okay. Thank you, guys.
Our next question comes from the line of Allison Landry with Credit Suisse. Please proceed with your question.
Hi, good morning. This is Danny Shuster on for Allison. Thanks for taking my question here. So just coming back to pricing a little bit, I think investors are looking at the downward trend and wondering whether we could eventually see flat pricing at some point. And I think after today, we're a little bit potentially closer to that.
So what can you tell investors to alleviate the concern that flat pricing is not a possibility?
Just exactly what we've said this morning, which is our pricing philosophy is that we're looking for markets and opportunities where we can price for the value that we represent. And if we can't find that and have it reinvestable, we'll keep searching. As markets improve, as the competitive environment improves, that should translate into an environment where we have more opportunity than not. But our philosophy, our way of conducting business is not going to change.
Okay, great. Thank you. And just switching gears on the fuel side, the discount to spot diesel prices seems to have climbed a little bit this quarter back up to around 66%, another 300 basis points up. So should we expect this trend to continue upwards or in other words expect the discount that you received to spot diesel to diminish as fuel prices go up? Thank you.
Rob? Yes, I guess I would answer that saying it's hard to say. I mean, I can't give guidance as to what that gap may be, but certainly, the way I look at it is overall, as diesel fuel prices increase, we will work hard and have good mechanisms in place to continue to there may be a timing difference, but our surcharges in place. So from a net impact, we work hard to minimize that, but I can't predict exactly what the delta to the spot will be.
Okay, great. Thank you for taking my questions.
Our next question is from the line of Justin Long with Stephens. Please go ahead with your question.
Thanks and good morning. I wanted to ask about the OR. I know you said you're not expecting improvement this year, but do you think we'll see year over year improvement in the OR in the Q4 given what you're expecting for volumes?
Rob, you
want to add? Yes. Just I mean, as you probably are on top of here, comps get a little bit easier, if you will, in the Q4, number 1. And number 2, we're going to continue to drive the productivity initiatives that we've been successful with this year and volumes get easier and if volumes stay kind of flattish as I outlined in my comments, say even flattish with where they are now, we would see the 4th quarter gap over previous year narrowing. So having said all that, again, without giving specific precise guidance on the OR for the quarter, we certainly have an opportunity to do that.
Okay. That's really helpful. And I don't want to beat a dead horse on core price, but we did see the moderation there. And it sounded like in your prepared comments, you said it was mainly due to Energy and International Intermodal. I was wondering if there's any way to frame up how much of a headwind you saw from those two areas of the business, like maybe to say that was all 50 basis points of the sequential deceleration that we saw or something like that?
Justin, this is Rob. We don't break it out that way, but I would just tell you, I mean, again, as you've heard me say many times, we don't have just a simple cookie cutter, one price fits all. So, all of our markets that we enjoy and again, we have more markets because of the diversity of our franchise than many gives us opportunities and it's the pricing opportunities for us are very diverse. But having said that, we don't break out the way you're asking it.
Okay, fair enough. I'll leave it at that. I appreciate the
time. Thank you, Justin.
Our next question is from the line of Chris Wetherbee with Citigroup. Please proceed with your question.
Thanks. Good morning. I do just need to come back to price and I apologize. I know it's been sort of talked about it, not at the end this morning. But just one thought renewals.
You guys report core price maybe a little bit different than some of your peers. And I guess I just wanted to get a rough sense of the relationship between inflation and the renewal dynamic. And I know it's not mechanical, Rob, I think you kind of highlighted that. But just generally speaking, in a higher inflationary environment, would you expect that renewals would accelerate as well? And how much maybe of a lag do you think that there is?
I guess I'm just trying to get a rough sense. Regardless of the magnitude just sort of directionally I'm guessing they work together. Just want to get some color on that would be great.
Yes. Chris, I mean, just a couple of comments I would make. Number 1, as I think you and others know, we have about 25% of our business, if you will, that is affected by Alift. So, over a longer period of time, that mechanism sort of may be lumpy from quarter to quarter, but over a longer period of time, it tends to reflect what's happening with rail inflation, number 1. But I guess I would more broadly say and remind folks the way we calculate price and as you all have heard me say for many years, I'm very proud of the fact that we are very conservative in terms of how we calculate price.
It is not a same store sales kind of number. It is a mathematical calculation of how many dollars we yielded in that particular quarter from our pricing actions and the denominator is our entire book of business. So, it includes contracts that perhaps we didn't touch certainly in the quarter for pricing. So, having said that, there tends to be a little bit of a lead lag, if you will, in terms of the yield dollars that come from our pricing actions. But again, our focus is unchanged from what it's been at this point in time.
We've got a couple of markets out there that are particularly challenging, but our commitment to driving value, driving quality service and driving positive price and positive margins has not changed.
Okay. That's helpful. I appreciate that. And then maybe switching gears, one follow-up on the coal side. Eric, you had mentioned, I think, 27 days inventories are 27 days above average, I believe is what you highlighted there.
What do you think the right number is in terms of the go forward period of where the natural gas curve is, weather has been a factor over the summer. We don't know what it will be like over the winter. But what do you think that right number is? How close are you guys to kind of getting towards normalized inventories, do you think?
Well, if you think about Powder River Basin inventories, the 5 year average is, as I said, was the low 60%, 63%, 65%. And right now, we're still at 90. So that's how you get to the 27 days. I do think that 60 ish number is probably right. If we have normal weather patterns, a normal cold winter, If you look at the natural gas futures curve, I think right now it's like predicting $340,000,000 in the early part of next year.
That will drive the inventories down, that will drive usage of coal. Coal market share in the quarter was 32% compared to like 28% I think in the 2nd quarter. So coal market share has grown. I think it will be in a good place, a good position. You will see coal volumes grow.
You will see the opportunity for coal pricing to grow, you'll see inventories go down and I think we'll be in a better place.
One thing to note, you can get to that day's inventory reduction adjustment a number of ways. If you think about what's happening in the coal world in a different perspective, on a stock level of, call it, 80,000,000 tons of SPRB coal, we're about 3,000,000 tons higher year over year. And that represents, as Eric says, about 25 days of burn. So it really doesn't take much in both how much you have in stock and how much you're burning to affect that days ratio. You can get there a number of ways.
That's really helpful. And real quick, did you say what the coal outlook was for volume within the low mid single digit decline in the 4th quarter?
We didn't, Chris, but it's in the call it in the low teens. It's probably a reasonable assumption, down low teens.
Okay, great. Thanks for the time. Appreciate it.
Our next question is from the line of Brian Ossenbeck with JPMorgan. Please proceed with your question.
Hey, good morning. Thanks for getting me on the call here. Lance, just wanted to get your views on the regulatory backdrop. Obviously, there's been a lot of things coming out of the STB. They had their review of the standalone cost estimates from external consulting come out recently.
We've got some news out of the GAO about the ECP breaks. But just looking into next year, it seems like it will still be fairly busy on the docket. I just wanted to get your thoughts on if there will be any potential impact, changes in regulations in 2017 that you would be particularly focused on?
Brian, thanks for that question. We are focused on the activity at the STB That's largely driven by their reauthorization from Congress about a year ago. In that reauthorization, Congress has essentially encouraged the STB to work through their docket. They had a backlog of a fair number of action items. Our concern is that that's interpreted as a desire to regulate the industry further.
We don't believe that is the desire of Congress. We think Congress's desire was to have the SP work through their workload. So we've got our eyeballs and are working on different activities, things like the reciprocal switching rules or the reduction of exemptions of different commodity groups. We're touching all the right points and making sure our perspective is known and incorporated into the thought process. There's a lot of moving parts there, so it's taking a fair amount of work on my part on our legal team and on our Washington team.
I would say our largest concern would be the kind of overriding overall impact of each individual regulation. If the STB takes those in isolation, we could end up in an impact that is unintended and unconsidered. And so we're also working hard to make sure that the STB takes into account the full perspective of everything they're working on and the knock on impacts of each as a group. Does that make sense?
Yes, it does. It's helpful because I think you see all the activity you think potentially activist, but it just does seem like a docket just needed to move forward a bit. Just one real quick question for Eric on the Hanjin impact. You had mentioned the 13,000,000 dollars write off. I was just curious if there's any operational issues you've been seeing as those containers come onshore and people don't necessarily want to move them.
Anything from the chassis shortage that we've been hearing a little bit about, if that's just a concern? Clearly, there's a lot of other puts and takes in the international intermodal side right now. Thank you.
Yes, Brian. So Union Pacific, I think, has weathered a lot of what I call the operational fallout from the Honduran bankruptcy fairly well. At a high level on the day they went bankrupt, they roughly had about 100 ships on the inflows around the world, 40 owned, about 60 leased. And there are lots of issues in terms of what to do with all of the in traffic flows. There was roughly, I think, dollars 14,000,000,000 worth of goods and in traffic flows, lots of issues about what to do with that.
We had a fairly nominal number of boxes in route on our railroad and we've been able to process all of those through. We probably have a couple dozen left to process through from roughly probably a little over 1,000 on the day of bankruptcy. So we navigated that fairly well. There are issues out there in navigating the rest of that, and it is an issue for the industry and supply chain in terms of what to do with those boxes, both loaded and empty in boxes on chassis, what to do with those. And that's something that the industry is going to be struggling with to resolve.
But for the Union Pacific side, we've navigated that
fairly well.
Our next question comes from the line of John Larkin with Stifel. Please go ahead with your questions.
Yes. Thank you very much for taking my question, gentlemen. I had a question on coal. Keith, you said a couple of times that the stockpiles are still well above kind of targeted levels. Yet sequentially there was a huge step up in coal volume to, in theory, replenish stockpiles drawn down during the hotter than normal summer.
Was that very specific to a few different utilities? Or what really drove that? It seems a little contradictory to make that comment that coal would be up sequentially even though stockpiles are still on average way above normal?
Kurt, can you handle that? Yes. The stockpiles have come down. If you look at over the second to the third quarter, the stockpiles have come down 13 days and they came down because the burn increased. And so our volumes improved roughly 40% and the stockpiles came down because the burn increased even at a higher percent than that.
Okay. So it doesn't sound like the utilities are all that dedicated to drawing those stockpiles down that aggressively if they're been sitting at elevated levels relative to foreign currencies now for a year or longer. What's your outlook on that for the rest of this year and throughout 2017 and the impact it might have on exports, which are so critical in sort of the bulk side of your business?
Yes, John, this is Lance. You're right, the dollar has been strong. We don't make a prediction about what the dollar is going to be going forward, but you got to believe all reasonable expectations are it's going to continue to remain strong. In order to change that, you need real acceleration in the global market, which would enhance the strength of other currencies. And there's just not a lot of catalysts that you see for that.
To your point, a strong dollar does make exports difficult. However, even in today's world, you see, for instance, grain exporting off the Pacific Northwest and the Gulf Coast and into Mexico, despite a strong dollar. So market conditions can still prompt commodity movement in global trade. And the other thing to note is that the U. S.
Is unique in its ability for its manufacturing base to figure out how to be globally competitive over time. I think the shale energy revolution is indicative of that, where a couple of years ago, people would say $70 a barrel shale oil was competitive. In today's world, they say, no, that's maybe more like $50 a barrel. So there's a lot of moving parts there. Clearly, we would prefer an acceleration in the global economy, which would prompt more global trade, which would mean more U.
S. Exports. That all would be really helpful to us.
Got it. Thanks for that explanation.
Our next question comes from the line of David Vernon with Bernstein Research. Please proceed with your question.
Hi, good morning guys and thanks for taking the question. Rob, I know you guys don't want to get too much into predicting price, but maybe could you let us or clarify for us kind of what percentage of the volume right now is under contract that would have a normal inflationary escalator versus those that are going to be subject to more of the competitive or market conditions that are out there?
Yes, David. I mean, we don't necessarily break it out exactly the way you are asking other than I would just remind that overall, about 25% of our book of business is touched by the ALIF index. But to your question of how much do we have sort of under contract or if you will kind of sized from a pricing standpoint, it's the same answer I would have given you last quarter and that's about 70%. I mean every day of every week, we are negotiating with customers and negotiating our deals. So it's not like it's done each quarter on day 1.
So, it's an ongoing continuous process. And roughly speaking, any day of any week, we have about 70% of the next 12 months business under contract or sized up.
And I guess as you think about kind of your outlooks and your sort of near term to 60 and then the longer term to G plus 55, does the recent trend in that same store sales price metric make you as CFO sort of rethink the timing of some of those targets? Or do you think that you see enough opportunity in the cost side here to keep the forward momentum on the margin side?
Yes. We haven't changed our guidance in terms of our 60 plus or minus by 2019 and then our eyeballs on getting to a 55. And I would just say, don't read that we are like changing our longer term view in terms of our commitment to pricing. We're not. I mean, we've got a little bit of bump of the road because of some of the market conditions that Eric outlined.
But as we look longer term, the levers that got us to where we are today that are going to take us to that next rung on the ladder of $60,000,000 and then eventually $55,000,000 are certainly we hope positive volume, but are going to be solid value to our customers, solid core pricing at reinvestable levels plus and solid productivity gains.
Well, I appreciate the color on that. It's been a long call. Thanks for your time and we look forward to hearing more about those G55 initiatives over the coming years.
Thanks, David.
Our next question is from the line of Ben Hartford with Baird. Please go ahead with your question.
Thanks. Rob, quick question for you. You had provided the 15% of revenue target that you had talked about in the past for next year as it relates to CapEx. Can you envision as you march toward this 55% OR target longer term, can you envision a situation in which CapEx does approach D and A on an absolute basis? Is that realistic for a relevant period of time or over a relevant time horizon?
Ben, probably not. I wouldn't use that as a marker, again, because of the timing and these are long lived assets, generally speaking. But to your broader point, I'm very proud of what the team has done to continue to make progress on tightening our capital discipline and I think it's a significant step of getting to that 15% -ish range, if you will, from where we have historically been. I mean, there's a lot of great productivity and a lot of great work that goes into getting to that level. So, we'll get to that rung next and then we'll see where we are at that point.
Okay. That's helpful. Thanks.
Our next question is from the line of Walter Spracklin with RBC. Please proceed with your questions.
Thanks very much. Good morning, everyone. So just on the OR long term, your targets as you mentioned, when we started the year, we heard the entire all the railroads each indicate that they would be able to reduce OR despite a challenging environment. You noted the same. Most have done so and you and your OR unfortunately has not followed that trend.
And I'm just looking on a relative basis, is when you see the improvement across the group, is it can you point to something that is specific to your company that be it a business mix, be it some structural challenges that lead you to have that challenge that the others did not? And I frame it in a relative question. I know you don't like looking at peers, but I know your investors do. So I want to be able to understand, is there something company specific here? Or how do I answer that question when I get that ORE question?
Yes. Walter, this is Lance. So again, I won't compare ourselves to our peers. We are a unique railroad. When we began the year, we were hopeful we were going to make OR improvement.
The top line went away from us, as Rob said, a little more aggressively than we had anticipated. If you think about our ability to improve OR over the long run, we're still confident that we can do it. That's shown in our maintaining the guidance for a plusminus60 in 2019. We did start the year with very low operating ratio. It's still an attractive operating ratio.
We're not pleased that we didn't have the opportunity to improve it this year. And again, we're just laser focused on all the activity necessary to continue to improve our margins for our shareholders.
So coming back to your long term then, I mean, from where you sit today, I mean, that's a 900 basis point improvement. It's a significant improvement. Many several of your peers are there already and many investors are banking on you to achieve that. Given the trends that we're exhibiting, the reversal in those trends, I'm just trying to understand what confidence that we can put in a reasonable timeframe, a long term is a fairly vague definition, a reasonable timeframe for evolution toward a 55 OR?
Rob, why don't you take that? Yes. Walter, I guess I would remind you and everyone that we are confident in sticking with our 60 plus or minus target OR by full year 2019. And as you've heard us talk with eyes on where do we go beyond that to the 55. So while we haven't put a date on the 55, but I would just say that getting to a 60 is a very enviable spot in my opinion.
I mean, we've made great progress on that. So I would not read that this 1 year of perhaps not making OR improvement is a new trend or a new objective or new signal here. It's not. I mean, to get from where we are today to that 60 is going to take all the initiatives we just talked about and it's the same levers that got us a 25 point improvement over the last decade. So, we're going to continue to make that progress and we haven't backed off our 60 OR guidance.
Okay. Thank you very much.
Our next question is from the line of Brian Konigsberg with Vertical Research. Please proceed with your question.
Yes. Hi. Good morning. Thanks for taking my question. A lot of ground has already been covered.
Maybe just on the bonus depreciation and moving some of the purchases on locomotives from 2016 into 2017. So should we just think those 2 are connected and the carryover into 2017 will show up?
I think I would stick with the guidance I gave on bonus depreciation impact this year of about $350,000,000 I don't think that's not going to move much. We haven't finalized what the number is going to look like all in for 2017. But I think I would still just kind of use that assumption of $350,000,000 ish for this year.
But conceptually, a lot of that bonus depreciation is associated with the purchases of locomotives and other things. Is that just the way to think about it generally?
Yes. I mean, it certainly impacts that, but I would say it's still in that $350,000,000 range for this year. And again, we'll see. We'll get some carryover benefit next year, but we, of course, have to start paying back previous year. So we haven't finalized or given guidance as to what the impact all in net will be next year.
But you're right, I mean, the locomotive movement will have some impact on what those numbers are.
Understood. Thanks. And maybe just touch a little bit on balance sheet. So you're approaching look to maybe delever or actively delever or will you naturally do
it through
EBITDA growth? How do you see that playing out?
Yes. I mean, that's we've made great progress on that measure over the last several years. And at this point in time, the biggest opportunity we still have in front of us, which we're laser focused on, is driving EBITDA, driving cash flow and that will give us additional capacity and that's how we're approaching it. So, we think we do have room as we grow our earnings and grow our cash flow.
Yes. I'll leave it there. Thank you.
Our next question is from the line of Scott Schneeberger with Oppenheimer. Please proceed with your question.
Thanks very much for fitting me in. With regard just focusing on the automotive sector, you mentioned some of the contract changes being a headwind into 2017. Could you just kind of compare and contrast what you think the impact will be as it looks like over the road conversions are good? And then obviously there's a lot of near shoring and a lot of development in Mexico and with manufacturing. So just if you compare and contrast within that sector, how you think it you enter next year?
Is it going to be a net up or down in that category? Thanks.
Scott, we love our autos franchise. We think we have the premier autos franchise. We think all of the trends in terms of Mexico production is positive for us in terms of production is positive for us. In terms of our franchise, we think we're in a great spot for over the road auto parts conversions. We've had great success this year, and we think that will continue in the future.
There'll always be contract changes, and it's a competitive marketplace and we saw that this year and that's something that will happen across time. The big driver is, as we've been saying, my view on the automotive side is the cautionary impact in terms of sales. Sales have been at record or near record levels, and there are some indicators out there that should give cautionary lights. It's the amount of debt inherent in auto loans and leases, Actual sales incentives per car were at an all time record level in the quarter, highest since 2,008 was the previous record. So there are some cautionary signs out there.
If auto sales stay strong, we have a great franchise and we're in a great spot. I do think there are some cautionary signs out there.
And just a quick follow on, at Panama Canal, any update there here, what you're hearing from customers just looking for a checkup? Thanks so much.
No, I think the Panama Canal story is what we've been saying for the last several years and certainly, I think the last couple of quarters, we've been mentioning that the amount of traffic hitting the West Coast versus the East Coast did there was traffic that moved to the East Coast because of the strike and BCOs trying to diversify their risk and not be dependent upon the West Coast. We did see that phenomena. We have seen some of that business start come back, but it hasn't all come back from before. The strike that has probably been a larger factor than any canal opening factor. The fact that the BCOs are diversifying their flows in a lot of different ways just to not have that risk.
Having said all of that, we do believe, I do believe that the West Coast ports are the most economical, the best supply chain in terms of transit time to get goods from Asia to the interior of the country and even into the East Coast. And if you look at some of the technologies that some of the West Coast ports are employing to make themselves more efficient with autonomous vehicles and things like that. I think West Coast ports is still going to be positioned to be the best supply chain factor going into the future, though you will see people running to do risk mitigation strategies.
Thank you. I would now like to turn the floor back over to Mr. Lance Fritz for closing comments.
Thank you, Rob, and thank you all for your questions and interest in Union Pacific. We're looking forward to another conversation with you in January.
Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.