Canadian National Railway Company - Q1 2016
April 25, 2016
Transcript
Operator (participant)
CN's first quarter 2016 financial results conference call will begin momentarily. I would like to remind you that today's remarks contain forward-looking statements within the meaning of applicable securities laws. Such statements are based on assumptions that may not materialize and are subject to risks described in CN's first quarter 2016 financial results, press release, and analyst presentation documents that can be found on CN's website. As such, actual results could differ materially. Reconciliations for any Non-GAAP measures are also posted on CN's website at www.cn.ca. Please stand by. Your call will begin shortly. Welcome to the CN first quarter 2016 financial results conference call. I would now like to turn the meeting over to Sam Forgione, Vice President, Investor Relations. Ladies and gentlemen, Mr. Forgione.
Sam Forgione (Head of Investor Relations)
Thank you, Patrick. Good afternoon, everyone, and thank you for joining us today. I'd like to remind you all of the comments already made regarding forward-looking statements. With me today is Claude Mongeau, our President and Chief Executive Officer, Jim Vena, our Executive Vice President and Chief Operating Officer, JJ Ruest, our Executive Vice President and Chief Marketing Officer, and Luc Jobin, our Executive Vice President and Chief Financial Officer. In order to be fair to all participants, I would ask that you please limit yourselves to one question. It's now my pleasure to turn the call over to CN's President and Chief Executive Officer, Mr. Claude Mongeau.
Claude Mongeau (CEO)
Thank you very much, Sam, and thank you all for joining us on this call. I think it's fair to say that there's a lot to be proud. We are coming again with very strong results in what is a more difficult volume environment. JJ will take you through the contour, but we're leveraging our diversity, the diversity of our franchise. We're chasing every carload. We're holding our own, but the overall volume is down, you know, 7% or 9%, depending how you measure it. But in that context, we are responding very swiftly on the resource side and in the terms of efficiency. Jim will give you the details, but across the board, we are setting new levels of performance in terms of efficiency and network, network, you know, throughput.
You know, you put it all together, we are doing this with a view to maintain that balance between service and cost efficiency. Our service has never been better. We need that to help our customers, you know, succeed in the marketplace. We're also maintaining our focus on safety. We've had very strong safety results during the first quarter, and we want this to continue going forward. In terms of the, you know, very important operating ratio, we established a record for the first quarter with 58.9. This is a clearly industry-leading performance if you take the same geography as the industry in terms of out-of-book real estate gains. So very good performance. We're very pleased in that regard, and so you put it all together.
Luc will take you through this, but our EPS is up at around 16% to $1, and our free cash flow is very solid at $584 million. So all around, very good results, solid performance by the team. And I will, you know, let Jim, JJ, and Luc take you through the details. Jim, over to you.
Jim Vena (COO)
Well, Claude, listen, thank you very much. I think a lot of hard work, a lot of things that helped us, but overall, a good performance by the railroad running on a day-to-day basis. I think it is fair to say the team continued to build off the results in previous quarters. We delivered very strong results in safety, expenditures, service, and in operating excellence. The results are shown in the slide, and we put a little note at the bottom that talked about a milder winter, so, you know, you can discount them a little bit. There's no answer, but the winter helped us. But nevertheless, the trains were more productive by 8%. Their speed was improved by 10%, and locomotive workload improved by 5%.
In our yards, the, they were more efficient by 9%, and a time a rail car spent in a yard dropped by 15%. The result all in was better locomotive utilization, better car utilization, less cars online, more gross tons per employee, more cars switched per hour worked, and precipitated a clear indicator of, network performance with a, car velocity improvement of 15%. So overall, satisfying results with everything that was given to us, with the, the volume, the winter, and the productivity that the whole team worked on. If you could flip over the next page?... I just wanna reiterate, and really nothing, not, not a big change, and not a change, I guess, at all, of what our, what we're trying to deliver on.
Our agenda of operating and service excellence is built on a foundation of safety first. We wanna deliver safe, fast, dependable service executed by the whole team and at all levels of the company, while continuing to drive efficiency across the board. Just before I pass it on to JJ, so for us, it's all about making sure we're balanced, we react quick, we're nimble in the changing conditions, and I think, the whole railroad showed how we can be nimble at times when things change with us, and, we react as quick as possible. So JJ, over to you, a little more detail on, where we are.
Well, thank you, Jim, and, Jim, you're very humble. It's a very solid quarter with a clean 58.9 operating ratio, so kudos to the operating team of CN. Overall, the first quarter revenue was down 4% from last year and is broken down as follow. Volume and mix reduced our revenue by 7%. The cars and RTM were down 7% and 9%, respectively. February was our best month, but March was soft. Crude by rail, coal, and frac sand continued their significant decline. On the positive side, we benefited from the derived demand coming from U.S. consumer spending, from the manufacturers that use natural gas-based feedstocks, from vehicle purchased by consumers, and from the new housing construction. Same store price was up, 2.5%.
All in, if you remove the Canadian regulated grain and other legacy index agreement that have a long fuel lag component, price was up 3%. The fuel surcharge application lowered our revenue by 5%, but exchange increased our revenue back by 6%. Now, let's turn to some of the highlights of the last quarter. Revenue derived from housing stock remained a bright spot and areas of growth from last year for CN, accounting for close to 15% of our overall book of business. This would include lumber to the U.S., OSB panel, plywood, containerized household goods, whether domestic, overseas, and other construction material. With a weaker Canadian dollar, the Canadian forest product producers are in a strong position, and so is CN. We had strong vehicle purchase by consumers.
It does not matter whether motor vehicle is manufactured, whether it's Europe, Asia, or the NAFTA region. The CN network of auto port facilities in every major city is where we have a rail network, gives us a very high market share of what the consumer buys from the dealers. Our automotive business unit was up 18%, with an impressive 20% carload growth. With a collapse in the energy market, Brent crude purchased by the coastal refineries was very cheap and affordable, and there is also ample pipeline capacity to go around. Those two things are making crude-by-rail economics broadly unattractive. Our crude-by-rail volume dropped by half to 14,000 carloads, but the more relevant aspect of the crude story is the prevalent incremental rail capacity pricing that brought crude by rail to become the least profitable of the unit train business.
The downturn in oil and gas capital program also impacted our steel, cement, aggregate, and frac sand business. Frac sand was down 45% in volume to 13,000 carloads in Q1. Our frac sand business is now largely related to natural gas drilling, as opposed to shale oil drilling. Domestic intermodal revenue grew 4%, driven by volume in our Canadian door-to-door retail service. If you exclude the impact of the NS Triple Crown restructuring and the related lost volume, our overall domestic volume was up 7%. International intermodal started off very strong in the quarter, but in March, we had a decline on the West Coast business, as in the Canadian and other U.S. West Coast port. Mostly export falling off, but also a pullback on import.
On the East Coast, Halifax was very solid and grew more than 50% in volume in the quarter. All in for the quarter, international volume was up 1%, and revenue was down 1%. Our grain operation was in excellent shape last winter. Canadian grain revenue was overall flat to last year, with better carload volume, but lower regulated pricing. U.S. grain was impacted by the strong U.S. dollar, therefore, our overall U.S. grain volume was down 13%. Lower natural gas price have supported a 7% carload growth for manufacturers of petrochemical, plastics, nitrogen, fertilizer, and other natural gas liquid. The list which I've just listed here is based on natural gas feedstock. The retreat of coal continued. Our coal revenue ton mile was cut by about half versus last year.
Coal is now only 3.1% of our total book of business, the lowest exposure to coal of any railroad. Now, looking ahead, we expect coal, crude, and frac sand to continue their volume decline till a bottom is found, so hopefully later this year in the case of crude and sand, and late in 2017 in the case of coal. Canadian grain will also be weak till the next harvest come up this coming September. The economic environment continues to be uncertain, but we will exploit the positive forecast in the manufacturing sector and the rail demand derived and the related rail demand derived from housing start and consumer spending. We are also very well positioned to exploit the huge potential of the mid-2017 expansion from our West Coast port terminal partners.
In regards to Port of Mobile, the rail operation will be ready soon, and both Maersk and COSCO have announced new Panama Canal all-water service that will stop in Mobile to start in June. The pricing environment remained constructive for the rail industry, although a bit weaker, and we expect to broadly pursue pricing above inflation, I would say, in the 2.5% range, all in. We still have legacy index pricing that have a long fuel lag component that require the remainder of this year to be digested. We anticipate the Canadian grain cap to be about +1% this August, and the market is also dealing with the capacity pricing experiment of one of our competitors. We are actively supporting our shippers and logistics partners for whom the weak Canadian dollars and/or the cheap energy is a competitive cost advantage to exploit.
Example of that would be the Canadian port, the forest product mill, the aluminum smelters, the automotive assembly plant, the petrochemical complex, and the refineries. In conclusion, we at CN continue to invest and innovate for the future. Our strength lies in our portfolio diversity, in our best-in-class profit margin operating ratio, and in our solid Chicago solution, right in the heart of the continent. So Luc, Luc will give you the financial color of our first quarter results.
Luc Jobin (CFO)
Okay, thanks very much, JJ. Starting on page 12, then let me provide you with the highlights of our very solid first quarter performance. Revenues were down 4% at just under $3 billion. Fuel lag was a revenue tailwind of $16 million in the quarter. However, when compared with last year's lag, it represents a headwind of $41 million or 4 cents of EPS. In spite of facing a challenging revenue environment, however, operating income was up 14% versus last year, at just over $1.2 billion. Our operating ratio, as Claude mentioned, was 58.9%, a record level for a first quarter. This represents a 680 basis points improvement over last year.
Net income stood at $792 million, up 13%, and the diluted earnings per share reached $1, up 16% versus last year. The impact of foreign currency was $57 million favorable on net income, or $0.07 of EPS in the quarter. Turning to expenses, we once again made excellent progress in the quarter in terms of safety, productivity, and cost management, while maintaining superior service. Intense focus on right-sizing resources, given the lower volume, drove operating expenses down 14% versus last year, at just under $1.75 billion. Expressed on a constant currency basis, this is a 19% improvement. At this point, I'll refer to the variances in constant currency. Labor and fringe benefit costs were $590 million, a 16% decrease from last year.
This was the result of two elements. First, overall wage costs decreased by 9%, as wage inflation was more than offset by lower overtime and a reduction of nearly 10% in average headcount for the quarter versus last year. Sequentially, the average headcount was also down 4%. The second element contributing to reduced labor costs was a lower pension expense of CAD 51 million. Purchased services and material expenses were CAD 408 million, 14% lower than last year, as lower volume, cost management initiatives, and favorable weather helped reduce material costs, repairs and maintenance, and crew accommodation, as well as utilities. The fuel expense stood at CAD 235 million, or 40% lower than last year. Price was CAD 109 million favorable.
In addition, lower volume accounted for $23 million of the improvement, and fuel productivity advanced by 2%. Depreciation stood at $307 million, 1% lower than last year. This was a function of asset additions, offset by the impact of depreciation studies and other minor adjustments. Casualty and other costs were $112 million, which was $55 million lower than last year, and for the most part, attributable to lower accident-related costs. Moving on to cash. We generated free cash flow of $584 million in our first quarter. This is $63 million higher than in 2016, and mostly the result of higher cash generated from operating activities. Capital expenditures were essentially flat with last year, at $469 million. Finally, our 2016 financial outlook.
We remain constructive in terms of CN's prospects for the year, notwithstanding the fact that we continue to experience high volatility and weaker conditions in a number of commodity sectors. The pace of North American industrial production is also slowing down considerably. Fortunately, however, prospects are still favorable on the consumer side of the economy, and this should continue to support moderate growth in housing, automotive, and intermodal sectors. We now estimate that this will translate into a decline of our annual carload volume in the 4%-5% range versus 2015, while pricing will stay ahead of inflation. The strengthening of the Canadian dollar to the U.S. exchange rate and the evolution of oil prices, however, are clearly different from our original expectations. These factors, when combined with more modest freight demand, will make things more challenging for us in 2016.
... Accordingly, we are revising our original guidance, and so CN now aims to deliver 2016 earnings per share in line with last year's adjusted diluted EPS of $4.44. On the capital front, we remain committed to reinvesting in our business to support the safety, service, and efficiency of our network. Therefore, we maintain our capital investment program for the year, which, after adjusting for our revised currency assumptions, now stands at approximately $2.75 billion. Furthermore, we continue to focus on sustainable value creation and rewarding our shareholders with consistent dividend and share buyback returns. CN's annual dividend was increased by 20% earlier this year, while we are gradually moving towards a 35% dividend payout ratio. In addition, our current share buyback program is approximately $2 billion.
Despite a more challenging environment in 2016, we are focused and committed to managing the business in a manner that protects earnings while not compromising our long-term competitiveness. On this note, over, back over to you, Claude.
Claude Mongeau (CEO)
Thank you, Luc, and team. Let me wrap up. There's a lot to be proud. As I said at the outset, our results were very solid during the quarter. You know, we are leading the industry. If you look at it in terms of a run rate, basis, Luc communicated our revised guide. The challenges are in front of us. The volumes are weaker, and also the assumptions that are the framework against which we provide you a consistent and transparent set of assumptions. Those, currency and fuel prices and the general rate of economic growth, this is just a world out there that we have to face to, and things are turning from a tailwind or shock absorber to a somewhat of a, of a headwind as we look forward to the balance of the year.
So we got our work cut out, but we are responding swiftly. We are focused on doing what we can to protect profitability and to continue, at the same time, building for the long-term future. That's why we are holding the line on, on our investments for safety, for service, for efficiency. And we are constructive. The prospects are out there. It's just a question of running the marathon with a view to build competitiveness over the long term. With that, I will be happy to take questions with the rest of the team. Patrick?
Operator (participant)
Thank you. We'll now take questions from the telephone lines. If you have a question and you're using a speakerphone, please lift your handset before making your selection. If you have a question, please press star one on your telephone keypad. If at any time you wish to cancel your question, please press the pound sign. Please press star one at this time if you have a question. There will be a brief pause while the participants register for questions. Thank you for your patience. The first question is from Cherilyn Radbourne from TD Securities. Please go ahead.
Cherilyn Radbourne (Managing Director and Equity Research Analyst)
Thanks very much, and congratulations on your performance.
Claude Mongeau (CEO)
Thank you. Thank you, Cherilyn.
Cherilyn Radbourne (Managing Director and Equity Research Analyst)
In terms of your volume outlook, maybe you can give us a bit more color and a bit of a ranking in terms of some of the more important deltas. It sounds like it's crude, frac sand, coal, but also perhaps international intermodal.
Jean-Jacques Ruest (CMO)
So, it's JJ, Cherilyn. It is crude, frac sand, and coal, definitely. For the second quarter, it will also be Canadian coal. You also remember last year we had an iron ore mine that shut down in the summer, so we still have some of that. And currently, as we speak, it is also the OSB international business on the Canadian West Coast. That's a phenomenon that started in March. February was strong, and we believe that this is only a phase. This should come back sometime in the middle of the second quarter based on customers' indication to us, but also based on maybe what the US economy in terms of inventory and whatnot. So OSB is just maybe a phase where both frac sand and crude is something more steady.
Cherilyn Radbourne (Managing Director and Equity Research Analyst)
Great. Thank you. That's my one.
Claude Mongeau (CEO)
Thank you, Cherilyn.
Jean-Jacques Ruest (CMO)
Thank you. Thank you.
Operator (participant)
Thank you. The next question is from Ravi Shanker from Morgan Stanley. Please go ahead.
Ravi Shanker (Equity Research Analyst)
Thank you. Good afternoon, everyone. JJ, if I can follow up on something you said. Did I hear you right when you said that you thought coal would bottom in late 2017? Because that would probably be a little later than some people expect. Can you just talk about what you're seeing in that market, please?
Jean-Jacques Ruest (CMO)
So as I said, our coal revenue in the first quarter were close to about 3%, I think it's 3.1% of the total book of business. So already our exposure is quite, quite a bit less than most. So you, you gotta start from that starting point. We know of what the next three quarters look like, and our sense is that, in term of export and in term of, U.S. consumption in the U.S., at least the utility that we serve, we might see some further erosion in cargo in 2017. So I think, the consensus by most railroad is we will, you know, there will be some further weakness from 2016, and after that, it's a question of your crystal ball and where you're at.
But again, remember, we start from about a 3% book of business at this point.
Ravi Shanker (Equity Research Analyst)
Great. Thank you.
Claude Mongeau (CEO)
Thank you, Ravi.
Operator (participant)
... Thank you. The next question is from Jason Seidl from Cowen. Please go ahead.
Jason Seidl (Managing Director)
Hey, afternoon, everyone. I guess my one is gonna be around the pricing side. You say expectations are to remain above inflation, but what's the feel for it going forward? Has it weakened somewhat, or are you still confident that pricing is gonna hang in there, and maybe even not moderately improve if trucking capacity tightens?
Claude Mongeau (CEO)
JJ can add to this, but, you know, it's a tough world out there for our customers, and it's a shrinking pie in terms of volume. In that context, you know, we have to do everything to help our customer win in the marketplace. But we provide good service, and so it's incumbent on us in the industry to protect pricing. But right now, it's a shrinking pie, and, you know, it's tempting to do incremental or capacity pricing or things like that. We intend to protect our book of business, and we think the value of our services should allow us to continue to price ahead of inflation. That's what we've done at 2.5%.
We're not different than other railroads who provide you same store pricing information, and we hope to keep it at that level for the balance of the year. JJ, do you have any other color?
Jean-Jacques Ruest (CMO)
Yeah. One of them is this issue with trucking capacity, which is right now is more tenfold than, say, 18 months ago, but that's a cyclical thing, right? Eventually, trucking capacity will tighten up again. We don't necessarily believe it will happen in 2016. Then we have the phenomenon of digesting these index pricing, which has a fuel component, Canadian grain cap. That's another thing to take into account. That also eventually will pass as cyclical. But typically, the average contract we get, we do get the 2%-3%, 2%-3.5% price increase, and we have this little phenomenon of capacity pricing, which if the capacity is coming from the highway, you know, maybe it could work out, but if it comes from one railroad to another, it has a bit of a dilution effect.
I think we have very good customers, a long-term business, and not only that, we intend to keep that business. That's what we've done here in the last 12 months. We think that, you know, this year is about 2.5, and then in future years, inflation plus. Take into account what we just said here, trucking capacity, which is cyclical and some of these indexes are also cyclical.
Jason Seidl (Managing Director)
JJ, how do you view your cost inflation going forward? Are you around that 2% mark?
Jean-Jacques Ruest (CMO)
Luc, you wanna maybe talk about rail inflation?
Luc Jobin (CFO)
Yeah. Yeah, if you look at rail inflation, it's probably running just a little bit around 2, and probably some of the commodities are running below 2. But on the other hand, you know, in terms of wage inflation, that's running probably closer to three. So that's the world we're in. So JJ's description of inflation plus is in the right band.
Jean-Jacques Ruest (CMO)
Take into account an operating ratio of 58%, and on the two versus the 2.5 versus the three, we're working on different scale dollar. And I think on material, there is some good price in material. Maybe, Jimmy, you want to say something about how effective our capital program is right now?
Jim Vena (COO)
Sure. You know, two things. One is, you always have wage inflation. We know what our contracts is, we know what we have to work against. That's why it's so important to us, and we continue the drive to make sure that the trains are more efficient, the yards are more efficient, we get more out of each person that comes to work by being more efficient. But on the... And that leads me into the capital program. So the capital program, $2.75, with the adjustment of the exchange.
And when we said it, we wanted to make sure that we had, had the number, and one of the comments we had was, we think that we have better use of the dollars in a time when the volume is off a little bit, and that's exactly what we've realized. We've been able to be out there in the first three and a half months, and productivity that we get and the amount, and the amount of infrastructure that we've been able to put in and renew is substantially better for the same amount of money, and that's what we wanna continue to do at this time, JJ.
Claude Mongeau (CEO)
Very good. Thank you, so much, Jason.
Jason Seidl (Managing Director)
Thank you as always, guys.
Luc Jobin (CFO)
Thank you.
Operator (participant)
Thank you. The next question is from Fadi Chamoun from BMO. Please go ahead.
Fadi Chamoun (Equity Research Analyst)
Yes, good afternoon. And a good quarter, guys, but it looks like you may have a little bit of headwinds, I guess, in the coming quarters. I have a question on incremental pricing. JJ, you mentioned that on the crude by rail side, have you seen this anywhere else in terms of the business that you have? And, what is the risk that you think this could sort of roll into some other categories of business that you got? And, maybe just a quick one for Luc. The $51 million pension income in the first quarter, what, how should we think about the run rate for the next three quarters on that?
Claude Mongeau (CEO)
All right.
Jean-Jacques Ruest (CMO)
There's a question in there.
Claude Mongeau (CEO)
We will allow you for that, one and a half question.
Luc Jobin (CFO)
Squeezing in there, Fadi.
Claude Mongeau (CEO)
JJ, quickly on-
Jean-Jacques Ruest (CMO)
Yeah, I did bring it up on the crude by rail. It is an area where we what we call it incremental capacity pricing. Because the pricing on crude by rail in the train is, if you're on the buying side of those services, you know, it's a fantastic deal. And I think it's potentially because sometime when things are predicted to be huge, volume-wise, you attract so much expectation, and when the market is not growing as much as you widely hope, you may be tempted to overreact and cut the price to see if you can make it up in volume and see if you can make the product move. Railroad is a demand-derived industry. We don't create demand, we feed demand. And I think the crude by rail is an example of that.
It doesn't matter how low you go, if the product can move in a pipeline, it will, and all you're doing by going very low is just making the business pretty unattractive. So right now, crude by rail, the volume is weak, will get weaker, and the pricing is not the greatest. There is some of that happening in other segments, not to the same extent. There's really no loss of volume, I would say, because when a car is lost, another one is, we've made it up with another one. So you're trading a car for a car, and that's kind of a not going anywhere type exercise. Luc?
Luc Jobin (CFO)
Yeah, Fadi, in terms of the pension expense, as we disclosed to you guys in the last call, we expect to have a tailwind of about $150 million for 2016 versus 2015. So that's a number that you should really be using, and obviously it is not spread out evenly throughout the year, so you have to look back to last year and what's going on. You know, we'll be providing some input or some update on that as we will file our actual evaluations at the end of June. So, stay tuned. We'll update the number, but 150 as a tailwind is the right number to use for the full year.
Claude Mongeau (CEO)
Thank you. Thank you, Fadi.
Luc Jobin (CFO)
Thank you.
Operator (participant)
Thank you. The next question is from Ken Hoexter from Merrill Lynch. Please go ahead.
Ken Hoexter (Managing Director)
Great, good afternoon. Just wanted to follow up maybe a little bit on that. But Luke, the average cost per employee was down about 2% year-over-year. Are there any special things in that? Or maybe you can walk us forward in your outlook now on flat earnings. Is that solely on the volume side, or is that on this, on whatever you have in the cost per employee as well? You know, can you walk us through how we should think about the cost per employee going forward? Thanks.
Luc Jobin (CFO)
Yeah. Well, you know, as I mentioned, I mean, you've got to separate what's going on on the pension side from what's going on on the headcount. Wage inflation, as I mentioned earlier, is running at about 3%. We are managing very closely the headcount, and so, you know, we were down about 9.5% in the first quarter versus last year, so that's about 2,400 fewer employees in our service. And, I mean, the entire team is focused on, you know, improving productivity and getting more out of the workforce. So, you know, these are the key drivers. And so it's back down to productivity, wage inflation.
We certainly also are working very hard to reduce overtime, so that's another lever that that we're pulling. And that's really what you should be factoring in, is continuing to push as we have last year. Obviously, when we get into the second half of the year, we'll be comping against a lot of the improvements we made last year. But we feel pretty good about our ability to continue to push and get you know great operational improvements, while at the same time you know balancing the service dimension. So that's my best guidance for you.
Claude Mongeau (CEO)
Thank you, Ken.
Ken Hoexter (Managing Director)
Thanks, bye. Thank you.
Luc Jobin (CFO)
You're welcome.
Operator (participant)
Thank you. The next question is from Walter Spracklin from RBC. Please go ahead.
Walter Spracklin (Managing Director and Senior Equity Research Analyst)
Yeah, thanks very much. Good afternoon, good afternoon, everyone. Just wanted to focus here on your new volume expectation for the remainder of the year and current and as you indicated, you're reflecting the continued weakness in some of your bulk commodities. When you forecast that out for the rest of the year, that's implied in your guidance, are you effectively taking a view... Maybe if you could just give us some more color on your, you know, the relative optimism on that new view based on your revised guidance. In other words, are you just looking for a continuation of the current run rate level, or are you building in any back half recovery and that's already in your numbers?
Or, you know, if you could give us a little sense of what kind of level of conservatism or optimism you're building into your forecast, perhaps by each of those merchandise, bulk and intermodal segments, that'd be very helpful.
Claude Mongeau (CEO)
Yeah, I would say JJ always tries to put the church in the middle of the village. JJ, you want to give more color?
Jean-Jacques Ruest (CMO)
Yes, Walter, it's JJ. If we look, just kind of look the next three quarter, we, we kind of view the second quarter as maybe the toughest of the three in terms of volume, partly because what I just talked about, grain. Grain will have to wait till the next crop on the Canadian side, and also because overseas intermodal is a little slow right now, and it, it, it will need to ramp up sometime in the next couple of weeks before the, when the, the spring starts. So while—what are some of the positive side? As I said, anything that has to do with US housing start, and I mentioned a list of commodities that are, you know, actually benefit from that, on the CN side.
You have manufacturing a vehicle on the, on the container import, but also on the finished vehicle side. Right now, I think the North American assembly plant, their inventory on ground is basically, for the whole industry, North America is at target, meaning where none of us have backlogs, so we're moving what's producing. But, you know, every time they produce a vehicle, they tend to derive intermodal container business. And then you have the consumer, U.S. consumer, Canadian consumer. So intermodal, so part of it, part of automotive, you have manufacturing side or serving the dealers. Some of our customers that love the fact energy is very cheap because natural gas is a feedstock, and I mentioned some of those commodities.
So it's probably kind of a longer list of items as opposed to say, we're gonna be moving a lot of coal with one given account, or we're gonna be moving a lot of crude with two refineries, you know, which was maybe the stories of 20 months ago.
Walter Spracklin (Managing Director and Senior Equity Research Analyst)
Okay, thanks very much, JJ. Thanks, Claude.
Claude Mongeau (CEO)
All right. Thank you, Walter.
Operator (participant)
Thank you. The next question is from Brandon Oglenski from Barclays. Please go ahead.
Brandon Oglenski (Director and Senior Equity Analyst)
Yeah, good afternoon, everyone, and thanks for taking my question. So I think, Luc, in your prepared remarks, you did talk about the strength of the consumer in North America. But JJ, I just wanted to follow up with you. I mean, intermodal, not just for you guys, but the industry is down. I don't know, let's call it 5%-8% here to start off April. What's going on on your retail customer side? And, you know, should we read this as more negative for the economy, or is this a destocking issue? How do we think about it?
Jean-Jacques Ruest (CMO)
I think it's, Brandon, it's a good point, meaning that, maybe CN is a little more transparent than others, but in a way, the stats for the industry show the last four weeks of intermodal in North America and in Canada are weak, and the West Coast are weak. So it's kind of a main industry phenomenon. And I think partly it's because the way we had, all of us, typically a fairly good start to the year, including February, because Chinese New Year was a different time this year, and we never quite get our legs from under us after Chinese New Year, which will happen at some point later in the spring, I gotta believe. Retailer's behavior, maybe people, the way they've kind of laid off their supply chain.
But I think broadly, there's an issue here as to how strong February was, and maybe February was a bit stealing forward. And now we're into a stage where, you know, people are relooking at their stock and deciding how much they really need. So it's not. I wouldn't call it a CN story, but I think it's when you look at the year of stats, especially the last four weeks, kind of the U.S. West Coast, East Coast, there is a bit of a slowdown that I think we all experienced, that should come back sometime during the spring.
Brandon Oglenski (Director and Senior Equity Analyst)
Okay, thank you.
Claude Mongeau (CEO)
Thank you, Brandon.
Operator (participant)
Thank you. The next question is from Chris Wetherbee, from Citi. Please go ahead.
Chris Wetherbee (Senior Research Analyst)
Hey, thanks. Good afternoon. I was wondering if you could talk a little bit about the impact of the Canadian dollar from a customer perspective. If you're seeing anything at this point yet in terms of impact on your customers, particularly with some of the export business into the U.S., or when maybe you think you would see that? I mean, how much does the currency tend to affect or start to see those flows change?
Claude Mongeau (CEO)
Well, we see, obviously, markets tend to balance out, you know, so, yes, over time, exports from Canada, we expect that to, to be positive with the dollar where it is, but it takes a while to, kick in. JJ, likes to think of, services, you know, if we have, lower cost services at ports or transloading activities, we have opportunities to move more goods through the supply chain that goes through Canada. So we have to, take advantage of the opportunities everywhere they are, and they are, you know, adding up in, in total. But at the end of the day, it doesn't move. You know, there's always a lag, and it's only been a little bit less than a year, and the dollar is quite a bit lower. JJ, do you have anything to add?
Jean-Jacques Ruest (CMO)
Yeah, that's right. There's always a lag because it takes a little time for people to turn around and secure more of the sales of a U.S. account versus an overseas account or domestic account. But the Canadian ports, the Canadian port, the Canadian West Coast, are a little limited on capacity today, but by 2017, when they have the lower capacity, if the dollar is still 80 cents, they should be able to exploit that to, you know, to get business to the U.S. Midwest. Canadian sawmill, Canadian pulp mill, Canadian aluminum smelters, you know, these are plants which are most of their costs are in currency—local currency, and therefore, they do have a cost advantage now.
If you look at some others, like some of assembly plants or petrochemical plants, there's a higher proportion of their cost, which is in U.S. funds, despite the fact their plant is in Canada, but it's still at the margin, they do have an advantage now versus when the dollar was at par. These are just some of the examples of how some of these things play in some of these different sectors.
Chris Wetherbee (Senior Research Analyst)
Okay. A little bit from the reversal. So maybe it takes... If we see a reversal in the currency, it might not see as much of that potential benefit come to fruition, but I guess it takes some time to see.
Claude Mongeau (CEO)
Yes, the short term, our shock absorber are impacted in terms of conversion, that, Luc explained that to you. In terms of the movements of goods, these things don't adjust as quickly, and the dollar is still much lower than it was only a year, 15 months ago. You know, at 80 cents, the terms of trade are good and to favor Canadian exports.
Jean-Jacques Ruest (CMO)
That's right.
Claude Mongeau (CEO)
All right.
Chris Wetherbee (Senior Research Analyst)
That's very helpful. Thank you.
Claude Mongeau (CEO)
Thank you, Chris.
Jean-Jacques Ruest (CMO)
Thank you.
Operator (participant)
Thank you. The next question is from Justin Long, from Stephens. Please go ahead.
Justin Long (Equity Research Analyst)
Thank you, and congrats on the quarter. So intermodal seems to be a focal point for the business going forward, and I wanted to ask about intermodal margins and where they stack up relative to your other businesses today. And looking ahead, how do you anticipate intermodal margins will be impacted as you start to factor in the port expansions and the opportunity for growth in the U.S. domestic intermodal market?
Claude Mongeau (CEO)
... You know, you know, we've been having a model in intermodal for years now that is, that is a balance, you know, end-to-end approach. And our intermodal margins are, they're not at the top of the list in terms of profitability, but they are very much in the middle of the pack. So, the growth opportunities in that business are very, very favorable to long-term profitability, and we wanna keep it that way. I mean, Jim and his team are focusing on end-to-end service. We are working with our partners at the ports, not just to provide good service, but also to provide efficiency gains. You know, loading up the trains, lining up the cars, so that we are as efficient as possible.
And if we keep doing that, that's what we need to maintain a secular long-term growth opportunity in intermodal. That's our strategy. It has been working, and we see it continuing for the foreseeable future.
Brian Patrick Ossenbeck (Analyst)
Okay, great. I appreciate the time.
Luc Jobin (CFO)
Thank you.
Claude Mongeau (CEO)
Thank you.
Operator (participant)
Thank you. The next question is from Allison Landry from Credit Suisse. Please go ahead.
Allison Landry (Senior Equity Research Analyst)
Thanks. Good afternoon. So with volumes down a bit more than you originally thought, and currency and fuel moving the other direction, do you think that you can still drive year-over-year margin improvement for the balance of the year? You know, and I know that you talked about driving some incremental efficiency gains, but just wondering how to think about all the puts and takes with respect to the OR.
Claude Mongeau (CEO)
Yes, as I said, the famous OR is a very closely watched metric. I think I'll let Luc comment more, Allison, but I think it's fair to say that we have a pretty good start to the year, with a very significant improvement and a record operating ratio. At today's level of fuel prices and with all of the initiatives we have to offset the lower volume, we see a good opportunity for margin improvement in 2016, that's for sure. Long term, our goal is to stay in the leadership position that we've been holding for a long time on that key metric. We don't only focus on it because we tend to want to focus on all the pieces, including cash flow and return on capital.
But at the rate we're going, we want to stay in a leadership position. Luc, you know, do you have a view that could add color?
Luc Jobin (CFO)
No, I think, I mean, I think you've you know provided it pretty well. So, you know, it's all about, you know, it's an end result. It's not—we don't start with an OR and work our way back. And, and all of us keep pushing the envelope, I mean, Jim and his team, everyone around the table to, you know, find what's the most efficient way we can do things, while at the same time, JJ and I, in terms of protecting the service and, and longer term, growing the business. So, we have a great start. You know, you should expect us to continue to have industry-leading, you know, operating performance, and, and that ultimately translates into operating ratio.
But, I mean, that's just, you know, that's just the way we look at the business, and, and it's not the driving force. So, you know, stay tuned, but, the numbers should be good for the year.
Allison Landry (Senior Equity Research Analyst)
Thank you.
Luc Jobin (CFO)
Thanks, Allison.
Claude Mongeau (CEO)
Thank you, Allison.
Operator (participant)
Thank you. The next question is from Brian Ossenbeck, from J.P. Morgan. Please go ahead.
Brian Patrick Ossenbeck (Analyst)
Hi, good afternoon. Thanks for taking my call. So I had a question on, Claude, you mentioned the, the overall volume pie is, you know, clearly shrinking. Reference to customers are under, you know, some pressure, and we've heard some comments about, the environment being more competitive. So are there any-- I was wondering if there's any contracts, probably thinking more on the international intermodal side, or anything else that's really coming up for bid, throughout the rest of this year?
Claude Mongeau (CEO)
You know, we offer such a good service, the rail industry in general, that it's very important to protect the profitability with a good pricing, and that's our thinking. At the same time, you have to react to competitive pressure, and that's what we're doing to keep the business that we have earned over time. On the international front, our large intermodal accounts have been renewed, JJ, and we don't have any large contract until next year. We are focused on delivering the business that we have at this point, and we feel confident about the future. We have a very good service, a good end-to-end supply chain approach, and our network reaches, you know, deep into the U.S. from the three coasts.
So we think we are a great partner in that field, and, but it's a competitive market out there, and we'll just have to earn the business the old-fashioned way.
Luc Jobin (CFO)
Yeah, Brian, it's we have contracts every year to renew, so no one should not. I mean, that's just normal course of business. It's not a risk, it's just how things do. And most, as Claude said, most of our major contracts for this year already been renewed as of today. And as to what might happen next year, it is all speculation. At least that's what we hear from our own customers.
Brian Patrick Ossenbeck (Analyst)
... Okay, thank you so much.
Jean-Jacques Ruest (CMO)
Thanks for your time.
Claude Mongeau (CEO)
Yes, thank you.
Operator (participant)
Thank you. The next question is from Tom Wadewitz from UBS. Please go ahead.
Tom Wadewitz (Managing Director and Senior Equity Research Analyst)
Yeah, good afternoon. Wanted to see, Jim, you for -- or I'm sorry, JJ, you referring a couple of times to the capacity coming on. I just wanted to see if you could run through the different, capacity events in 2017 and, maybe frame the size of the Mobile, Alabama this year, just so we have a sense of kind of the size of those and also your best sense of the timing.
Jean-Jacques Ruest (CMO)
Okay. So if I can run roughly the three major ones. So one is Prince Rupert, DP World. The capacity we'll add is in the range of 500,000 TEU, that will come up roughly in July 2017, and we believe about 95% of this 500,000 TEU capacity is available for rail in and out. GCT Global Container in Vancouver also has capacity expansion on the rail side, about a similar amount. Let's call it 500,000, maybe 600,000 TEU. That rail capacity, this capacity, being rail loading, it's all rail, all for rail. And I'd say historically in Vancouver, the market share roughly is two-thirds, one-third, is, you know, 70/30 between us and the other railroads.
So us being the dominant players, that would give you a sense of how much capacity is available for us to go and market, and mostly market in the U.S. And then Mobile, Alabama, the terminal is expanding at the vessel discharge, but the rail operation that they're building right now will come in operation, I think, last is early June, sometime in the next 30 days here. And the capacity that we're targeting there is eventually to be able to reach as much as 20%-25% of what is discharged by the ship. So today, all ship discharge at Mobile are 100% truck in, truck out.
COSCO and Maersk are the first two company who will, who, basically started up two weeks ago to offer the service and offer some pricing to do, Panama Canal, Mobile and, and North. And then we'll see how successful they are in, in helping us and helping, the terminal operator to, to, to, to enter. So in the case of Mobile, that's, you know, it's, you, you start brand new, so give it a little time before we get our legs from under us.
Tom Wadewitz (Managing Director and Senior Equity Research Analyst)
If you get 25% of Mobile, what does that translate to roughly?
Jean-Jacques Ruest (CMO)
The Mobile capacity today is, I think what they discharge is in the range of 200-250,000 TEU. Their aspiration is to have a bigger terminal and attract more discharge all in, whether it's rail or truck. There's only one terminal. We would like to get to a point where a quarter of the terminal, you know, as the terminal is growing, is moving out of the terminal by rail. You know, that might take a little time because we need to prove the service, just like we did back then in Rupert and, you know, and also in the terminal in Vancouver.
Tom Wadewitz (Managing Director and Senior Equity Research Analyst)
What was the GCT timing in Vancouver? I didn't catch that.
Jean-Jacques Ruest (CMO)
July 2, 2017. So Rupert-
Tom Wadewitz (Managing Director and Senior Equity Research Analyst)
July twenty.
Jean-Jacques Ruest (CMO)
July 17. Mobile is month of June of this year.
Claude Mongeau (CEO)
Thank you, Tom.
Tom Wadewitz (Managing Director and Senior Equity Research Analyst)
Thank you.
Jean-Jacques Ruest (CMO)
Thank you.
Operator (participant)
Thank you. The next question is from Turan Quettawala from Scotiabank. Please go ahead.
Turan Quettawala (Director of Equity Research)
Yes, good afternoon. I also had a question on intermodal here. You know, Prince Rupert obviously has been a great growth driver for you guys over the last few years, but certainly in the last quarter here, it's been a little bit weak. JJ, maybe you can give us some color as to what's going on there. Is it more of a temporary issue, you think, or is some of that market share going back to the U.S.?
Jean-Jacques Ruest (CMO)
It was strong early in the year, in the case of Rupert, and then it slowed down. At the same time, and again, if you look at the statistics on the U.S. West Coast or some of the, you know, Port Tracker, you know, magazine or some of the article in, in the Wall Street Journal, I think we've all have seen a slowdown on the import on the West Coast, especially in March. A little more so at Rupert, because Rupert is a rail, you know, kind of a long haul. It doesn't have the local market. And Rupert has also suffered up to a point, like other ports, about the challenge of export related to U.S. dollar, because a good deal of the export from Rupert actually were coming from the U.S. Midwest.
So we're working through that with our major customers in Rupert. You know, the historical one, like COSCO and Hanjin, or the newer one, like Maersk. And everybody is intending here to make full use of the capacity that we collectively have at Rupert. So the goal is to get it back to what it was. And I think it would probably mean also, you would think that U.S. West Coast will also get a little stronger from where it is today. We may have a bit of an industry phenomenon. That's just a Rupert. I don't think it's a Rupert phenomenon.
Claude Mongeau (CEO)
Yeah, and I would say, Turan, you're right, that on a year-over-year basis, it's down. But, on a run rate basis, Rupert is still above 700,000 TEU on an annual basis, so, the port is, functioning well. It's a question of end demand picking up so that we can, regain momentum.
Jean-Jacques Ruest (CMO)
That's right.
Turan Quettawala (Director of Equity Research)
Great. Thank you very much. That's my one.
Claude Mongeau (CEO)
Thank you, Turan.
Operator (participant)
Thank you. The next question is from Scott Group, from Wolfe Research. Please go ahead.
Scott H. Group (Managing Director and Senior Analyst)
Hey, thanks. Afternoon, guys.
Jean-Jacques Ruest (CMO)
Good afternoon, Scott.
Scott H. Group (Managing Director and Senior Analyst)
So I wanted to just go back to the pricing discussion for a second, just because, you know, as I think about it, in like the past 10 years or so, I'm not sure I really remember you guys ever, you know, guiding to pricing of 2.5%. I feel like we've always been in this 3%-4% range. So I want to understand, is this something that's a temporary issue because of RCAF and grain and-
... once we get through that, kind of we'll be back in 3%-4%. Or do you guys see that the environment has changed? And you've mentioned the competitive environment a few times on the call. So do you think we're just in a little bit of a slower pricing environment for at least the foreseeable future? And maybe can you just clarify some of your competitive pricing comments, if that's truck, if it's the other rail in Canada or and then maybe what segments you're seeing it in?
Claude Mongeau (CEO)
Let me repeat what I said earlier. I think, you know, rail as an industry, we have a very good service. And at the end of the day, we move what the demand that is out there. And so with good service and with the right demand framework, I think it's incumbent on all of us to keep pricing that allows us to reinvest in the future and to be disciplined in how we go about things. And we think that's the goal for everybody. Right now, the shrinking pie maybe makes it a bit more tempting to try to do incremental capacity pricing. But, you know, we all want to defend our business, and in the end, you're trading four quarters for a dollar. So we think it's hopefully temporary. We provide you very detailed information about our pricing performance.
On a same store basis, it's come down a little bit. Some of it, as JJ has said, is because of fuel and regulated grain. Some of it is because of having to respond to a competitive pressure. And we hope that as fuel goes back up and as the industry focus on disciplined pricing, that we should go back up, more towards the range that we've used to, to be delivering. But we will react to the market and just have to see how it goes. Thank you for your question.
Scott H. Group (Managing Director and Senior Analyst)
Okay. Thank you, guys.
Claude Mongeau (CEO)
Thanks, Scott.
Operator (participant)
Thank you. The next question is from Bascom Majors, from Susquehanna. Please go ahead.
Bascome Majors (Senior Equity Research Analyst)
Yeah, thanks for taking my question here. I believe you mentioned that the capital budget cut was entirely FX driven. Can you go back and confirm that's what you said? And, you know, is there an opportunity to shift out some of the growth capital expenditure? Would it make sense to do that if the demand environment continues to be, you know, as pressured as it is in the near term here?
Luc Jobin (CFO)
Yeah, Bascom, this is Luc. Just to respond to your question, essentially, the lion's share of the decrease is a function of the revised exchange rate. There's a little bit of productivity in there as well, which we've been, as you know, Jim pointed out, we've been doing extremely well on the productivity front, and so there's a little bit of that as well. With respect to the outlook for the year, we are pretty well focused on fulfilling this plan. I mean, it doesn't have a whole lot of investments, which are what I would call chasing growth. We are focusing on hardening the infrastructure. We do have some commitments around rolling stock, which, you know, obviously are not things that we can change lightly.
PTC is a major category where we have stepped up the investment, and we're committed to, you know, fulfilling the regulated or mandatory implementation. So in the scheme of things, you know, I wouldn't look for a significant reduction in CapEx. We take the long view on CapEx. We think it's, it's actually a good time to be, you know, to be hardening our infrastructure, and we can see, you know, the benefits are coming through loud and clear. Velocity is fantastic. You know, we can maintain great service. The safety numbers are all, you know, showing the right signs. So all of these things...
And you know, Jim is getting some very good working blocks for the engineering team to get on the track and work, in addition to reasonable commodity prices. So it all makes sense. And frankly, you know, this is typical of us taking a little bit of a longer view on things and not just, you know, trying to chase the next quarter. You know, it's something that the whole team looks at very closely, so we don't take free cash flow and CapEx lightly, but we're pretty committed to this envelope.
Claude Mongeau (CEO)
Yeah, it's the best way to say it, it's a long-term marathon, and we're building for the future. So we're holding the line on our CapEx until further notice. Thank you for the question.
Luc Jobin (CFO)
Thank you.
Bascome Majors (Senior Equity Research Analyst)
Thank you.
Operator (participant)
Thank you. The last question is from Benoit Poirier, from Desjardins Capital Markets. Please go ahead.
Benoit Poirier (Managing Director and Senior Equity Research Analyst)
Yeah, good afternoon, gentlemen. My question is on the petrochemical. There's a lot of talks, excitement about the opportunities in the Gulf Coast. So I was wondering if you could provide more color about the size, the timing of the opportunity with the implication for CN.
Jean-Jacques Ruest (CMO)
So the excitement on the petrochemical in Gulf Coast is typically related to new plastic plants being built, either the ones that they risk to their running flat out or the ones to be built. And it takes a few years to build these big plants. You need to build, first, a cracker and then the plastic plant. So this is not like tomorrow, but the trend looks good because of the costs. The cost of making plastics in the Gulf right now, whether it's Louisiana or Texas-
...Some of them are close to CN line, some of them obviously are not close to CN line. The cost is such that you can export to the world. You can make product and sell it here, but also you can compete with other countries. So typically, it may not mean a lot of rail business, because the product that's produced in the Gulf, most of it will wanna go overseas. And that's why, partly we benefit in Mobile, Alabama, with these new Panama Canal service, because one of the things that the shipping line are targeting is when they go to the Panama Canal, first stop is Houston.
The reason they like Houston more today than in the past is because they're gonna get a lot of polyethylene plastic export in container, and then they go to Mobile, and then after that, they go to some other city. So the plastics story might be as much as an overseas international business as an export. So you truck to the port or maybe partly rail short haul. So you load at the plant, you send it to a storage in transit, you get it out of there, you send it to a place where you're gonna bag it, the container gets lifted, goes to the Port of Houston, and then goes overseas.
Benoit Poirier (Managing Director and Senior Equity Research Analyst)
Okay, thank you very much for the time.
Claude Mongeau (CEO)
All right, thank you very much, Benoit, and thank you all for joining us on this call. We, you know, as we discussed, we had a good start to the year. We remain constructive about our prospects for the full year, even though there are some challenges out there. We are managing the business for the very long term, but we are also nimble and responding swiftly to make sure we protect profitability, to benefit our shareholders. At the same time, as we continue to deliver solid service so that we can help our customers in what is a difficult period. That's what you can do, and that's what we plan to do, and we hope to see you at the end of the second quarter. Be safe, and, you know, see you then. Thank you.
Jean-Jacques Ruest (CMO)
Thank you all. Thank you.
Operator (participant)
Thank you. The conference has now ended. Please disconnect your lines at this time, and thank you for your participation.