Canadian National Railway Company - Q1 2017

Transcript

Operator (participant)

To all participants, thanks for standing by. The conference is ready to begin. Welcome to CN's First Quarter, 2017 Financial Results Conference Call. I'm turning the meeting over to Paul Butcher, Vice President, Investor Relations. Ladies and gentlemen, Mr. Butcher.

Paul Butcher (VP, Investor Relations)

Thank you, John. Good afternoon, everyone, and thank you for joining us for the first quarter 2017 earnings call. We're here today in Regina, Saskatchewan, where we will be holding our annual general meeting tomorrow. I would like to remind you of the comments already made regarding forward-looking statements. With me today is Luc Jobin, our President and Chief Executive Officer; Mike Cory, our Executive Vice President and Chief Operating Officer; J.J. Ruest, our Executive Vice President and Chief Marketing Officer; and Ghislain Houle, our Executive Vice President and Chief Financial Officer. In order to be fair to all participants, I would ask you to please limit yourselves to one question. I will be available after the call for any follow-up questions. It is now my pleasure to turn the call over to CN's President and Chief Executive Officer, Mr. Luc Jobin.

Luc Jobin (President and CEO)

Well, thank you very much, Paul, and welcome everyone to our first quarter results call. As Paul said, we're here in beautiful Regina, and we're going to be holding our annual general meeting tomorrow. As we're looking outside the window, we can see snow and blowing winds, so winter is lingering on through Saskatchewan and Western Canada. In any event, at CN, we deliver quarter on quarter, year on year. So we continue to drive growth and performance improvements, as well as results ahead of the economy and the competition. We do so at low incremental cost. So today, we're reporting the first quarter volume and revenues, which are records, and also translate into a 15% adjusted earnings per share growth.

So I'm very proud of the team and the great performance that we've been able to accomplish as we accommodated some very strong volume in the first quarter. The team was nimble and was able to jump at the opportunities which J.J. and his team brought our way. And so I think that these results are the work of a lot of our 20,000-plus railroaders, which every day make a difference. So let me just kind of give you three areas that the guys will expand on through the call, and then that we can engage a little bit more deeply in when we get to the question and answer session. So J.J., in terms of the top line, we'll talk to you a little bit about how broad-based the progress is and how much we've leveraged our superior supply chain approach.

RTMs were up 14%, so clearly a very strong start to the year, and at the same time, a very positive outlook on the balance of year. We continue to grow in key service-sensitive sectors. In fact, if we look at just one area on the grain side of the business, on the Western Canadian grain, we were able to deliver a 14% increase in the tonnage that we moved. We've also been able to maintain our inflation-plus pricing discipline. Mike will talk to you a little bit about the efficiency and the service levels, which we've been able to achieve while dealing with this strong volume. We faced a real winter this year versus last year, and certainly, our network has demonstrated a lot of resilience.

That's thanks to a lot of the investments that we've done in infrastructure and in resources, and he'll expand a little bit more on that. Our operating ratio at 59.4% is up 50 basis points versus last year, in spite of a heavy fuel headwind, which Ghislain will give you a little more color on. Speaking of Ghislain, he'll walk you through the financial performance in Q1, where again, we showed our ability to deliver the top-line growth all the way to the bottom line. Our adjusted EPS is up 15% versus last year at CAD 1.15. We also achieved some very solid free cash flow in the quarter, and we continue to deploy our capital investment program for the year. In fact, we brought it up a little bit of a tick, about CAD 100 million, and Ghislain will give you more detail on that.

Importantly, on the basis of these results, we are raising our guidance for 2017, both in terms of volume and earnings, and more color on that to come as well. So without any delays, then let me turn it over to Mike to give you the operating report.

Mike Cory (Executive VP and COO)

Thank you very much, Luc. Overall, I'm extremely pleased with the performance in the quarter by the operating team. While I want to keep my comments brief and to the point, I would really be remiss if I didn't start off by just stating how proud and thankful I am for their continued efforts. These people truly make a difference at CN. Our team works diligently to improve on three key focus areas. They are safety, performance reliability, and efficiency. These three key deliverables provide the platform on which we bring the operational and service excellence model to the supply chains we continue to grow the top line with and allow for future growth to be accommodated in a cost-controlled manner. While our safety metrics were in line with winter expectations, they're far from what we believe we will achieve over time.

Our FRA accident ratio is in line with the multi-year target. However, it did increase compared to 2016. While our main track accidents were down and our costs were in line with our record Q1 2016 performance, our capital work, combined with our critical task observations, continue to provide a far more robust network of fluidity in this regard. Our injuries, on an absolute basis, were flat. However, due to productivity gains resulting in less man-hours worked, our ratio increased. Both these areas are of the utmost focus for our operating team. We've made excellent progress over the last 10 months in developing programs that are based on shared beliefs with our union leaders and employees. These programs will allow us the opportunity to fully embrace a culture of peer engagement, ensuring people leave from work in the same condition that they arrived.

In terms of performance, reliability, and efficiency, as I stated in my earlier calls, the comparables for Q1 were very tough. Due to the dramatic drop in volume and weather-related exposure experienced in Q1 2016, I've added a comparison to a time period I believe is more similar in both cases. Q1 2015 represented close to the same weather characteristics in terms of cold and snow. While it was 4% less volume on a GTM basis, it was as close as I could find to compare to the record volume we moved in Q1 2017. On a comparable basis to 2016, all productivity-related metrics have been improved upon, while the speed of cars, trains, and terminal dwell were negatively affected by a combination of volume growth and winter conditions.

However, when comparing ourselves to 2015, which again, I believe, is a more apples-to-apples approach, we've improved upon all the operating metrics. There's no doubt inclement weather affects terminal and road performance. It creates network stoppages, traffic bunching in and out of terminals, increases dwell on equipment, and it reduces velocity of cars and trains. We combat this with our approach to pinpointed investment. In the past, this has included AC-powered locomotives, strategic capacity improvements, and our industry-leading wayside health monitoring detectors. We improve from winter to winter. These improvements allow us to accommodate the growth that J.J. and his team deliver through their hard work and initiatives. And further, the improved reliability of the service offering provides top-line growth opportunities for our supply chains to achieve. We set a record for grain car order delivery and spotting performance in Q1.

Our merchandise car order fulfillment percentage was higher than 2015, even though we experienced delayed equipment returns from our rail partners in some cases and areas. We continue to see the top-line opportunity through improved performance reliability. In closing, our network is extremely fluid, and we believe there are great things to come on all three fronts of safety, performance reliability, and efficiency. Over to you, J.J.

Jean-Jacques Ruest (Executive VP and CMO)

Thank you, Mike, and good afternoon, everybody. So the first quarter revenue was up CAD 242 million, +8% from last year. CN's our carload was up 9.1% versus the industry average of 4.3%, and our revenue ton-mile was up 14%. The team, as Mike mentioned, did outpace the economy and the industry.

The main positive drivers, and there are many this year, are frac sand, international intermodal, retail domestic intermodal, U.S. thermal coal, grain, potash, automotive, natural gas liquids, and quite a few others. Paper, sulfur, and lumber were the only main disappointment. Fuel was positive on the reported revenue as it added CAD 31 million, but the stronger Canadian dollar was a higher negative headwind, taking back CAD 74 million. If we adjust revenue for exchange and fuel, they would have been CAD 280 million above last year, or +9.5%. The all-in same-store price for the quarter was 2.7%. Now, I will provide you with some colors of the drivers of that growth in the last quarter, starting by giving you a point of view of how the operating team contributed with their nimbleness on flexing and pivoting on strong demand. First example is Canadian grain.

Our new Canadian grain plan produced an increase of 14% in grain tonnage from the prior winter. CN outperformed the market, and we moved 55% of the first quarter Canadian grain. Comparatively, last year, we moved 51% of the grain in the first quarter. Mike's team also took over the rail switching operation of the Vancouver South Shore Container Terminal. Our international container revenue at Vanterm Container Terminal increased by 150%, and at the Centerm Container Terminal, it increased by 30%. Pretty spectacular result. Also, the operating team really ramped up the capacity in our branch line in Wisconsin to respond to the surge in drilling activities all over North America. The result, frac sand revenue was up 55%, and volume ran at a record run rate.

Now, on the customer's point of view, from a color from that side, we onboarded in January the new contract with Yang Ming at an international shipping customer's line in Vancouver. We started to move some Canadian Tire new business in March, which is a big box retail of domestic customers. We will onboard this month the Lowe’s and RONA account, which is another big box retail in Canada. For the three combined, this is in excess of CAD 100 million of new business on an annualized basis. Finally, taking a look at organic growth from our organic commodity market, sand market expanded and produced an incremental CAD 35 million. Crude is strong, potash is strong. Two Conuma Coal mine, a steel coking mine, have reopened on the CN Western network, and our automotive business is running at record level.

In conclusion, the end-to-end supply chain service resonates with customers, and it enables us to earn, maintain, and grow shares of their logistics business. The outlook for Q2 is constructive. You will find a detailed summary on page 9. Quarter to date, on an AAR reported basis, week 16, our carloads are up 13%, and the RTM is up 19%. I will now pass it on to our CFO, Ghislain.

Ghislain Houle (Executive VP and CFO)

Thanks, J.J. Starting on page 11 of the presentation, I will summarize the key financial highlights of our solid first quarter performance. As J.J. previously pointed out, revenues for the quarter were up 8% versus last year, at slightly over CAD 3.2 billion. Fuel lag on a year-over-year basis represented a revenue headwind of CAD 25 million, or CAD 0.02 of EPS, driven by an unfavorable lag this year of CAD1 0 million versus a favorable lag of CAD 15 million experienced in the first quarter of 2016. Operating income was slightly over CAD 1.3 billion, up CAD 86 million, or 7% versus last year. Our operating ratio came in at 59.4%, or 50 basis points higher than last year, driven by higher fuel prices, which accounted for an increase of 260 basis points.

For the full year, we expect that higher fuel prices will cause the operating ratio to increase by 50 to 100 basis points, assuming WTI remains in the range of CAD 50-CAD 60 per barrel. Net income stood at CAD 884 million, or 12% higher than last year, with reported diluted earnings per share of CAD 1.16. Adjusted EPS was up 15% to CAD 1.15 from a year-over-year EPS of CAD 1, excluding the impact on deferred income tax expense from the enactment of a lower provincial income tax rate this quarter. The impact of foreign currency was CAD 22 million unfavorable on net income, or CAD 0.03 of EPS in the quarter. Turning to expenses on page 12, as Mike previously pointed out, we continued to make progress in the quarter in terms of efficiency gains, including disciplined cost management initiatives while maintaining superior service.

Our operating expenses were up 9% versus last year, at just over CAD 1.9 billion, mostly driven by higher volumes and fuel prices versus last year. Expressed on a constant currency basis, this represents an 11% increase. At this point, I will refer to the variances in constant currency. Labor and fringe benefit expenses were CAD 580 million, or flat versus last year, as increased wages and health and welfare expenses were offset by higher capital credits and lower pension expense. On a full-year basis, expect pension expense to be roughly flat versus last year. Purchased services and material expenses were CAD 440 million, or 9% higher than last year. This was mostly the result of higher repairs and maintenance costs, trucking and transload, and outsourced services.

Fuel expense stood at CAD 342 million, or 51% higher than last year, as price was CAD 90 million unfavorable and higher volumes accounted for a CAD 26 million increase. These items were partly offset by a 3.2% improvement, or CAD 7 million in fuel productivity. Depreciation stood at CAD 323 million, or 7% higher than last year, mostly as a result of net asset additions. Equipment rents were up 11% versus last year, driven by increased car hire, partly offset by lower lease expense. Moving to cash on page 13, we generated free cash flow of CAD 848 million in the first quarter. This is CAD 264 million higher than in 2016, and mostly the result of higher cash generated from operating activities, lower cash taxes, and lower capital expenditures. Finally, our 2017 financial outlook on page 14. We achieved record volumes in the first quarter, reflecting strong performance in most segments.

We are building on this momentum and will continue to leverage our superior service, which has provided us with the ability to gain market share in key customer service-sensitive markets. We see North American economic conditions improving, with more favorable consumer confidence, as well as a strong pickup in the energy sector, driving shipments of frac sand, steel pipes, and to a lesser extent, crude. So this environment should now translate into volume growth of approximately 10% in terms of RTMs compared to 3%-4% previously for the full year versus 2016, with overall pricing remaining above inflation. Accordingly, we are revising our original guidance and now expect to deliver adjusted EPS in the range of CAD 4.95-CAD 5.10 versus 2016, adjusted diluted EPS of CAD 4.59.

We expect a strong second quarter in light of last year's trough on the energy commodities, while the rest of the year, and particularly the fourth quarter, will face more difficult comps. On the capital front, we remain committed to reinvesting in our business to support safety, service, and growth. In this regard, we are increasing our capital envelope by CAD 100 million to CAD 2.6 billion for the year, mainly driven by the acquisition of 22 new locomotives and other projects to support growth. Furthermore, we continue to reward our shareholders with consistent dividend returns, and we are on track with our current share buyback program of approximately CAD 2 billion, having repurchased nearly nine million shares for an amount close to CAD 800 million since last October.

In closing, we remain committed to our agenda and continue to manage the business to deliver sustainable value for our customers and shareholders today and for the long term. On this note, back to you, Luc.

Luc Jobin (President and CEO)

All right, thanks, Ghislain. Well, as you can see, looking ahead, the CN team continues to see opportunities to build on our supply chain approach. You can certainly count on us to innovate and to improve our product, our efficiency, and driving value for our customers, while at the same time investing in our franchise and providing superior returns to our shareholders. First quarter is a strong start to the year and what should be another great year for CN. On that note, we'll turn the call back to you, John, to entertain some questions.

Operator (participant)

Thank you, sir. So if you have a question, please press star one on your telephone keypad. If you're using a speakerphone, please pick up the handset before pressing star one. You may cancel your question by pressing the pound sign. So please press star one if you have a question. There'll be a brief pause allowing you to register. First question is from Cherilyn Radbourne from TD Securities. Please go ahead.

Cherilyn Radbourne (Managing Director)

Thanks very much. Good afternoon, and congratulations on a very strong start to the year.

Luc Jobin (President and CEO)

Thank you, Cherilyn.

Cherilyn Radbourne (Managing Director)

Unusual to see CN change guidance this early in the year. So I'm just curious if that was a subject of debate internally at all, and what ultimately gave you the confidence to move this early in the year?

Luc Jobin (President and CEO)

Well, I think as we looked at the business, Cherilyn, I mean, it was obvious to us that we were gaining great traction. And sometimes the first quarter is a little touch and go because the weather can play havoc, and the visibility is not always as good as we'd like. What has come together is, I mean, J.J. and his team continue to identify business opportunities for us. A lot of the sectors were actually kind of getting a little bit of a good tailwind from global situation in terms of commodity prices and other factors. And again, without any hesitation, the operating team jumped on it and delivered in spades. So we can see good momentum, and this wasn't really the subject of a lot of debate amongst the team.

I mean, we looked at it, we called it for what it is, and usually, I mean, we've been known to be a tad conservative, but when we see it and we can touch it and we can feel it, we are confident that we can nail it. And so with that in mind, that's why we raised our guidance. And at the same time, we decided to give you a little bit more precision around the guidance, so a little bit of a different approach, giving you a range, a quantitative range, which I think reflects what we think the year potentially could look like. So hopefully, that'll be well received in terms of giving you guys a little more clarity. And I think we're constructive both in terms of looking at the full year, in terms of the volume growth. And again, I mean, J.J.

and his team have been canvassing the business and the opportunities, and we have the resources, and we continue to improve on our performance, but we have the resources, and we have the quality product that actually gives us the confidence to upgrade the guidance.

Cherilyn Radbourne (Managing Director)

Thank you. That's my one.

Luc Jobin (President and CEO)

You're welcome.

Operator (participant)

Thank you. The following question is from Chris Wetherbee from Citi. Please go ahead.

Chris Wetherbee (Managing Director)

Yeah, hi. Good afternoon, guys. I wanted to touch on what you just mentioned there on the capacity side. So understanding sort of the purchase for the locomotives and maybe a little bit of color of what types of opportunities you might be deploying those in, and then just thinking a little bit bigger picture about sort of the opportunity set for growth relative to the need for capital investment. I think we're running around 20% of sales. Just want to get a sense of maybe how we think about that bigger picture when you look at the big volume opportunity ahead of you.

Mike Cory (Executive VP and COO)

Well, Chris, I'll take the locomotive story, oh it's Mike here. We've had such great success with the investment of our DP locomotives over the last few years, and further with the AC tractive effort, we've been able to increase the size of our trains and just create that natural capacity that we need to make the trains bigger, to grow at a controlled cost for the traffic J.J. brings. Now, we're starting, and we started to see it in the first quarter when as volumes ramped up, there's areas we're going to need to look structurally at capacity because we did take a bit of a holiday for the last year or so. But up to that point, last year, the capacity was there from a network perspective. It still is there, and we're still focusing on those areas to grow that business.

Where we need to invest in the structure, we're looking at that, but it'll all be dependent on where the traffic's coming, the traffic mix, and at what stage it's going to come, so.

Ghislain Houle (Executive VP and CFO)

Yeah, Chris, it's Ghislain here that if I can add to Mike's comments on the locomotives. So we did have a one-time opportunity to acquire Tier 3 locomotives that, as you know, they're more reliable, they're more fuel efficient versus the Tier 4. So that was a good opportunity that we jumped on, looking at the volumes coming to us that these locomotives would support this volume going forward. And we do still have some locomotives in storage. They're older locomotives, and therefore, with these new ones, we'll take the opportunity to take the older ones that we have in storage and cascade them into yard service. So I think this is very good. We're very pleased with that. These locomotives are to be delivered starting in September. So again, we will have them for the fall, heavy intermodal and grain season, and then obviously for next winter.

So we're pleased about that. On the capacity front, we always are looking at where some pinch points are. My team works very closely with J.J.'s team and with Mike's team to see how the volume is coming, where is it coming. And as you know, at CN, again, our first call on cash is always towards the business, and we haven't changed, and that's what we're doing. And so we're monitoring this closely. And if we need some CapEx in terms of capacity, we'll be up for it.

Luc Jobin (President and CEO)

Yeah. And Chris, I mean, just to close up on the issue, I mean, as Ghislain said, we look at opportunities to continue to grow and develop our business. So we're not moving away from roughly 20% of revenues in terms of CapEx as a general rule. But having said that, you know what?

When we do see the opportunities for growth or the opportunities to bring more efficiency, more reliability, we have been known and will continue to do investments a little bit ahead. I'd like to be in the position to take on the business, which J.J. and the team bring us out there. And it's always best to be there at 5:00 P.M. to midnight as opposed to 5:00 A.M. after. That's the way that we continue to evolve the credibility of our product. And we work hard to give our customers better and better service all the time. So the last thing we want to do is be in a position to disappoint them.

However, things can be volatile out there, so we have to stay nimble. We don't want to go too far out, nor do we want to be caught falling short of expectation and the full business potential.

Hopefully, that helps you gain more clarity around this issue. Thank you.

Chris Wetherbee (Managing Director)

That's very helpful. Thanks for the time, guys. Appreciate it.

Luc Jobin (President and CEO)

Thank you.

Ghislain Houle (Executive VP and CFO)

Thanks, Chris.

Operator (participant)

Thank you. The following question is from Turan Quettawala for Scotiabank. Please go ahead.

Turan Quettawala (Director)

Yes, good afternoon. Thank you for taking my question. I wanted to chat a little bit about the intermodal business. There's a lot of port capacity, I guess, coming online over the next few months. Could you talk a little bit about how quickly you may be able to translate that additional capacity into volumes? And I think, J.J., you also mentioned about some growth in the domestic business here with new customers. If you could provide that number of new business again, that would be helpful. Thank you.

Jean-Jacques Ruest (Executive VP and CMO)

Thank you, Turan. That's J.J. So the first thing we did, though, early in the year, we started to do the switching ourselves from the South Shore of Vancouver, West Hampton, and Vanterm had available capacity today that we could exploit, and therefore, we're exploiting that in the first quarter and the second quarter. By the time we get to the summer, Deltaport and DP World in Rupert will have the expansion come in. So you're roughly talking, in both cases, 500,000 TEU rail capacity, in both cases, available for us to go and grow. Along that, we are expanding our terminal in the US. We're expanding the terminal in Memphis, the one in Detroit. And we're also expanding Joliet. We'll also do some expansion in Toronto.

So it's like playing baseball where the port throws the ball, and we have the capacity to catch the ball in the hinterland. On the domestic side, we did some gain with two large Canadian retailers, getting a piece of the contract, Canadian Tire. So we're extremely proud of the confidence that they've given us in giving us some of their business. We also earned all of the Loblaws, our own Canadian Loblaws, RONA business, another big box retailer in Canada. So in both cases, again, it's a testament to the work that Mike is doing on the door-to-door service and that model, which includes also, as you know, our CNTL, the trucking service that origin and destination. So I hope that gives you a sense of what you were looking for.

Turan Quettawala (Director)

Mike is not concerned about the pressure of taking on the new business, right, Mike?

Mike Cory (Executive VP and COO)

Not at all. All right.

Turan Quettawala (Director)

That's great. Thank you very much. J.J., could you give us some color around the half a million TEUs? Is that sold, or should we see some of that come through in the second half here?

Jean-Jacques Ruest (Executive VP and CMO)

So as you know, there are all the alliances on the ocean that have been reshuffled. These alliances came together basically in the month of April. We started to see the discharges shipping up in May. I wouldn't say necessarily that at this point, it's not about contracts moving from one railroad to another. It's about how these alliances will fare against one another and the totally new services that they're offering right now. So we will see some growth. I can't quite quantify at this point how big that growth will be, but we see the second half as constructive. That's partly why we have the guidance that we have.

Turan Quettawala (Director)

Thank you very much. That's very helpful.

Ghislain Houle (Executive VP and CFO)

Thank you, Turan.

Operator (participant)

Thank you. The following question is from Brandon Oglenski from Barclays. Please go ahead.

Brandon Oglenski (Director)

Hey, good afternoon, everyone, and thanks for taking my question. Luc or J.J., can you just talk about the competitive landscape? We heard from your peer last week about how they're going to compete pretty aggressively to get back some of their natural share that they feel maybe isn't on their network today. And obviously, there's a lot of growth coming to the ports too, and you guys have a history of really outgrowing markets. I mean, I guess in light of a more service-focused competitor, do you think you can maintain a profile into the future that can consistently beat macroeconomic outcomes?

Jean-Jacques Ruest (Executive VP and CMO)

Yeah, we're very confident about the quality of our product and how the supply chain services that we have does resonate with customers. This question of natural market share, I think now is getting an old story. It's been around for a while. And eventually, the proof has to be in the pudding. And maybe the last pudding was Yang Ming; we decided to come our way. So I think the series of gains should speak for itself. And I guess it's like playing football, right? So eventually, as a quarterback, in my case of the offensive team, we're expected to win game. And if you don't win game, eventually, you've been asked to sit on the bench. And everybody, when you can't win game, you try new different games. It doesn't mean that our track record is going to be necessarily affected by that.

No, we're confident that the story should keep running.

Luc Jobin (President and CEO)

I certainly echo J.J.'s comments, Brandon. I mean, in our book, I mean, everything is very competitive out there. There's no question about it. We never underestimate our competitors. Suffice it to say, though, that we continue to invest in improving our product. So we encourage people to sort of play catch-up to us. But we're playing our own game, and we're deepening our competitive advantage every day. That's what we do. That's what we like to do. And it's proven that our customers are rewarding us accordingly. So one can never guarantee that you always have the upper hand. But when you take the long view and you deliver on the short game, usually things go your way. So we'll leave it at that. But a high level of confidence, we're not cocky here, but we earn our business the old-fashioned way.

We earn it every day by giving our customers the best service we can. Thank you.

Brandon Oglenski (Director)

I appreciate it. Thank you.

Jean-Jacques Ruest (Executive VP and CMO)

Thank you.

Operator (participant)

Thank you. The following question is from Fadi Chamoun from BMO Capital Markets. Please go ahead.

Fadi Chamoun (Equity Research Analyst)

Good evening, guys.

Jean-Jacques Ruest (Executive VP and CMO)

Hi, Fadi.

Fadi Chamoun (Equity Research Analyst)

Great. Thanks. So I wanted to maybe, if you can, J.J., dig a little bit deep into this conversion of volume to revenues. We noticed the freight revenue per RTM declined, I think 3% adjusted for currency. Were there mixed issues going on this quarter? Because you mentioned the price was pretty strong.

Jean-Jacques Ruest (Executive VP and CMO)

Yeah. So some of our areas of growth, and I think you wouldn't know enough of our business to relate to that, is we had a lot of growth on the long-haul grain, Canadian grain. Canadian grain is long-haul from the prairies to the coast. A lot of long-haul business growth on potash. We have been successfully diverting business from the West Coast terminal to Saint John in New Brunswick. That's very long-haul. That's a great job by Mike. We also had a lot of long-haul grain business success in sand, sand going to Western Canada from Wisconsin, crude to the Gulf. And most of the commodity I just mentioned moves in private equipment. So their revenue per car isn't constant because the customer supplied equipment, not us. So a lot of long-haul business, and that's been probably some of our biggest areas of growth.

It explains the divergence between carload and RTM, and of course, also the revenue per car and the yield per RTM.

Fadi Chamoun (Equity Research Analyst)

Thank you.

Luc Jobin (President and CEO)

Thank you, Fadi.

Operator (participant)

Thank you. The following question is from Ken Hoexter from Merrill Lynch. Please go ahead.

Ken Hoexter (Managing Director)

Great. Good afternoon. Just wanted to, I guess, delve into the productivity side you were talking about before. Luc, the employees have started to rise sequentially. You talked about buying more locomotives. Your fuel efficiency may be taking a little bit of a tick down. Does that mean we're past the peak of efficiency gains, or is this just as the volumes start coming on at double-digit pace on RTMs, you've got to restock on the employee side, and that's just kind of reloading on that side to get ramped up?

Luc Jobin (President and CEO)

Yeah. I think good question, Ken. I mean, this is, again, I'll point in the direction of what we've always done. So we're not changing our spots. What we're trying to do is to adjust our resource levels, whether it's the employees, whether it's the locomotive, the capacity, the cars, the car supply, and so on and so forth, on the basis of where we see the business heading. So the challenge that we lay out for the team is we want to grab this business. We want to be able to service it better than anybody out there, but we want to do so with a high level of efficiency. And that's the challenge that we lay out on Mike and his team.

So as we start to look for the balance of the year, and in fact, we're looking into starting to look into 2018, that's what we're trying to do, is ascertain what's the best pace to actually strike that balance. And as I said, I mean, our level of confidence in terms of looking out over the next 12 months or so is as high as it can be. Of course, the second half, once you start to get into the second half, you have a little bit less visibility. But we want to be positioned for continued growth. At the same time, we don't want to go too far out into investments and lack of or less productivity. But that's a balancing act. It's a very delicate balance. Mike, you want to talk a little bit about, give a little more color?

Mike Cory (Executive VP and COO)

Sure. Just can I start with the fuel productivity? We're actually 3% more fuel efficient this quarter. And again, I mean, I got some basic principles that I follow when we talk about efficiencies. We're trying to run the biggest, heaviest train in line with meeting the customer demand. So our focus isn't so much on any particular part of the asset equation other than to try and minimize the use of them. To Luc's point, we're not on any hiring sprees. We're not on any fast, quick spend in order to attract business. We, first of all, try to incorporate it into what we have, and then we methodically take a look at how we do it the cheapest way possible.

Maybe I can add to this, Ken. I mean, when you look at employee productivity in terms of million GTMs per employee, it was up 14% in the quarter. And then when you look at our operating ratio, and I referred to that a little bit in my comments, the OR is up 50 basis points. But if you exclude, and we had given you visibility on this, when fuel prices were going down, it was helping the OR. And we were telling you before that the heads-up, when fuel prices are going to go back up, then there will be a headwind in terms of OR. And in this quarter, it was in the tune of 260 basis points. If you adjust for the increase in fuel prices, then our OR was actually down from last year by 210 basis points. So I think we're very proud of productivity.

I think the numbers are out there in spades that we did deliver in light of a more normal winter versus last year. Yes, employees on a sequential basis are starting to be up a little bit versus the end of the year because the volume is coming up, but it won't be on a one-to-one basis. Trust us, we're not going to keep our eye off the ball in terms of productivity.

Ghislain Houle (Executive VP and CFO)

Yeah. And it's not as smooth a line as we'd like to see. So I think, again, I mean, I think the confidence that we have in the team is to actually say, "You know what? Let's build up the next level of resources. We may need to have more train starts. We may need to have more crews." And that's all right because we need to continuously go and get the business, earn it, and sustain it. But then the challenge on the team is to say, "Okay, well, we're working at that level now, so how do we get better at it? How do we continue to innovate, evolve the product both from a service standpoint as well as an efficiency standpoint?" So with those levels of GTMs and RTMs that we're seeing clearly, it will call for more resources.

But you can certainly count on our commitment to continue to seek out and achieve efficiency gains along the way. They just may not be exactly of the same magnitude as the first quarter. But by and large, again, we're not running the business for a given quarter. We're running the business with a slightly longer-term perspective. Having said that, we're not giving anyone a holiday on efficiency gains.

Luc Jobin (President and CEO)

Just one last point of clarification, Ken. We're hiring whatever craft it is. There's a couple-quarter lag in terms of training and development. And then to Ghislain's point, it's not one-for-one. It's mostly on attrition.

Ken Hoexter (Managing Director)

Very good. Truly appreciate all that insight. Thank you very much.

Luc Jobin (President and CEO)

Thank you, Ken.

Operator (participant)

Thank you. The following question is from Walter Spracklin from RBC. Please go ahead.

Walter Spracklin (Canadian Equity Research Management and Co-Head of Global Industrials Research)

Yeah. Thanks very much. I was wondering if we could turn the question to technology. CapEx spend is, yes, up a little bit. You talked a bit about it, locomotive purchases. But can you talk about, perhaps, Mike? I know you've discussed it a lot. And Luc, I think it's part of your key mandate. What opportunities do you see out there from a technological standpoint? What ones are you investing in today? And how far a lead time can we see a result of those types of investments? Is this something we have to wait years for the development to come along, or is it something that we can see come into your margin, your efficiency sooner rather than later?

Mike Cory (Executive VP and COO)

Well, you know us, Walter. We're very urgent, yet we're patient to do it right. So if we talk about technology, I mean, high level, we're talking as much automation, as much less human interaction as possible, first of all, from a safety perspective and a quality of job perspective. And then you tie in the reliability and the efficiency with that. So we've already embarked down that road in various components of our mechanical, whether it's reliability or, again, trying to understand the life cycle and get the part out before it actually gets us. In terms of engineering, we look at it from both a tactical and a planning mode. You can rest assured that we're obviously into getting as much big data, predictive analytics. These are things that are in the blender right now. How far out?

We've internally looked at horizons that we want to introduce and get the technology bedded out. We're not there yet, but that's a big, big focus for us as we go forward.

Luc Jobin (President and CEO)

Yeah. And to add to what Mike was saying, Walter, there really are, at this point, a couple of components. The first one is meeting the mandate for PTC. So as you look at the CapEx this year, we've got about CAD 400 million of capital that's going to be deployed to get us along the way to our objectives of 2020 with the checkpoint in 2018. So a lot of our capital, which is currently being deployed behind technology, is heading in that direction. And job one there is going to be to actually achieve the PTC mandate with the least amount of disruption to the capacity and the velocity of our US franchise. So that's really job one.

Having said that, there are a number of other initiatives, and Mike referred to some of them, where we are looking to deploy more technology in terms of automation, in terms of leveraging a lot of the potential of our scale and scope in terms of making continued improvements. And that's not just in terms of cost. That's actually in terms of safety, and that's also in terms of how we improve the product for our customers. So the capital will start to build up once we get into 2018. And I would say probably over the next five years, we're going to see a little more capital going that way. There is, as you rightfully point out, there is a lead time.

I mean, before we can actually get some of the data architecture, some of the systems, and we're looking at some of the business processes, we see a lot of opportunity. And what we're going to try to do is to prioritize. Some stuff is a little bit longer to bring on board, so there is lead time. But Mike, Serge Leduc, our head of IT and OT, and the whole team, we've been looking at this. And what we're going to try very much to do is to move quickly on the low-hanging fruit. And certainly in the areas of automation, I think there is a potential to get some wins sooner while at the same time putting down some key infrastructure, getting some additional talent to get us to exploit more fully the potential that we see out there.

But that's, I mean, this is going to be a journey and something that you'll see us starting to build momentum as we get into 2018 and beyond. That's not to say we're not busy at it today, but we're in the process of accelerating formulating those plans, accelerating the delivery of those plans as we speak. So it's very much top of mind. And we're going to be able to give you a little bit more insight when we get into our investor day coming up in June. And obviously, more to come over the next 12 months or so. More clarity, a little more clarity around all of that. So that's kind of where we are, Walter.

Walter Spracklin (Canadian Equity Research Management and Co-Head of Global Industrials Research)

All right. That's great color. Thanks, Mike. Thanks, Luke.

Luc Jobin (President and CEO)

Thank you.

Operator (participant)

Thank you. The following question is from Ravi Shanker from Morgan Stanley. Please go ahead.

Ravi Shanker (Equity Research Analyst)

Thanks, Jeff, everyone. Luc, I think you said in your comments that you're encouraged by a few end markets and to a lesser extent crude. We're hearing about a potential opportunity here for crude by rail in the second half with the ramp in production out of the Alberta oil sands, but without the pipeline capacity to move it. Are you hearing something similar? Does that give you encouragement for the second half of the year? And do you have the capacity to manage those volumes when they come on?

Luc Jobin (President and CEO)

All right. Well, ask J.J. maybe to comment, and then I'll supplement, so.

Jean-Jacques Ruest (Executive VP and CMO)

Yes, Ravi. So I mean, as you know, all the capacity exists today. There's ample loading capacity in Western Canada, ample unloading capacity at the different refineries in North America. And the tank car fleet to move crude in North America is huge. So we do have the capacity to move if there is a market. At this point, as you know, the spread between WTI and Western Canadian Select is quite small because there's some production problem issues in Alberta. So this is all speculation of what might happen because it's not quite there today. There are some of our customers who think that the production in Alberta might be such that it might outstrip the pressure on the pipeline capacity sometime, if not this year, next year. At this point, we're not extremely bullish on it in terms of our planning base.

If there is a demand, we can definitely meet it because most of these assets, our customers' assets, and they're already in place.

Luc Jobin (President and CEO)

Yeah. And just to add a few comments here, Ravi, I mean, this is a good example of some of the commodity sectors where the visibility is just not that great. I mean, it depends very much on where and how the spot moves and what is the capacity and where is this crude looking to go. So there are certain sectors of the business where we have a higher level of confidence, and we can see the contour of the volume. In this case, it's a little bit more of a not quite a spot market, but it's much more volatile. So I hope this helps you get a better handle on it.

Ravi Shanker (Equity Research Analyst)

Yep. Very helpful. Thank you.

Luc Jobin (President and CEO)

Thank you, Ravi.

Operator (participant)

Thank you. The next question is from Steven Hansen from Raymond James. Please go ahead.

Steven Hansen (Managing Director)

Oh, yes. Good afternoon, gentlemen. Just a quick follow-up question on your recent market share gains, where it does strike me that we've seen a large cluster of wins here in, I'll say, a pretty condensed period of time, at least the last three, four quarters. And just trying to get a sense whether it marks. Has there been a deliberate shift in strategy to chase your competitor's business, or is it just a function of the timing of the contracts coming up for renewal? And I guess as a follow-on to that, should we expect more business to be had in the same fashion? In other words, are you chasing more contracts and do you have the ability to handle it?

Jean-Jacques Ruest (Executive VP and CMO)

Okay. Thank you, Steve. So some of it is not really customers' contract-related. If you look at Canadian grain, where we moved 55% of the grain in the first quarter, that was up from 51% the year before. So these are not necessarily contract situations. They're more about the execution of a different grain plan. And same thing on potash. As you know, potash contract for the West Coast, a very long-term contract for both Canadian and Railroad. So the strategy there was to look for other export terminals that could get potash to market, like Brazil or more the Atlantic side. And with the success of the Saint John terminal, nothing related to contract, but you've seen significant diversion of product that would have been usually exported over to the West Coast under the long-term contract, now going to the East Coast under CN.

And then in intermodal, I did mention the three. All these things typically are probably 12, 18 months, 24 months in the making. And the timing of those has to do with when the contract comes up. So we do have a strategy to grow and outperform the economy. So in some cases, it's the product that we do with Mike. In some cases, it's some customers who like the service that we offer that like to come on our side. And some of it has to do with being Johnny on the spot, like when drilling activities or crews start to kick up, that we actually exploit it as opposed to miss it.

Luc Jobin (President and CEO)

Yeah. And Steve, I mean, I think, as J.J. pointed out, I mean, it's not one single thing. It's doing all of these things. And we have been very successful at listening to our customers, understanding their challenges, their needs, and then turning around and putting it as a challenge to the team. So how do we actually innovate? How do we change the product? How do we reconfigure? And that takes time. That takes a certain level of credibility and dialogue in the customer relationship. And certainly, quiet confidence that the team can not only earn the business for one move, but actually sustain a level of performance, which is where the customer is expected. So it takes a while. Once the momentum starts to build and the team starts to really do all of these things well, you've got a it's a nice flywheel.

And again, we don't take it for granted. There are challenges out there. And certainly, a best example was the winter we had. The resilience we demonstrated in winter conditions and still delivering against a grain plan, which was redesigned from the ground up this year, is a testament to, again, pulling all the levers, doing all of these things well. That doesn't mean that we can't and we don't have some challenges at times. And that doesn't mean that the world stands still. But that's what gives us forward momentum. And so we didn't wake up one day and say, "We're going to chase business." This is a concerted effort, an integrated team to build a product, to build better understanding of the customers, and to try to deliver more consistently a product that is difficult to replicate.

So frankly, from the sounds of it, you may think that we've achieved it. We're not satisfied. So we're still pushing the envelope, and we still see opportunities out there. And so I think the walk-away feeling you should have is a sentiment that what we have is a sustainable level of performance. And that's what we're going to continue to work to build upon.

Jean-Jacques Ruest (Executive VP and CMO)

Definitely sustainable.

Steven Hansen (Managing Director)

Very helpful. Thanks.

Jean-Jacques Ruest (Executive VP and CMO)

Thank you, Steve.

Operator (participant)

Thank you. The following question is from Brian Ossenbeck from JPMorgan. Please go ahead.

Brian Ossenbeck (Managing Director)

Hey, good evening. Thanks for taking my question.

Jean-Jacques Ruest (Executive VP and CMO)

Sure.

Brian Ossenbeck (Managing Director)

So just had a quick one on incremental margins. Carloads are up 9%. RTMs up 14%. You mentioned the impact of weather this quarter, and it sounds like mix might have been a bit of a headwind as well. But looking at incremental margins that are in the mid-30s%, I guess, but I'm assuming that's impact from fuel this quarter. So just wondering if there's a better way to think through the operating leverage than what was typically used in the past. Obviously, it sounds like fuel is going to be a headwind on OR throughout the rest of this year as well.

Ghislain Houle (Executive VP and CFO)

Yeah. Brian, it's Ghislain. I must commend you on your math because actually, when you look at incremental OR, and if you do adjust for fuel in the quarter, then our incremental OR was 35% in the quarter. So right there, that demonstrates to us that we were very productive. And again, as I said in my remarks, if you look at OR on a full-year basis, if you do assume that fuel remains about where it is, then we think it will impact OR in the tune of about 50 to 100 basis points.

Brian Ossenbeck (Managing Director)

Okay. Thanks. That was my question.

Luc Jobin (President and CEO)

All right. Thanks, Brian.

Operator (participant)

Thank you. The next question is from Scott Group from Wolfe Research. Please go ahead.

Scott Group (Managing Director)

Hey. Thanks. Afternoon, guys.

Luc Jobin (President and CEO)

Afternoon, Stef.

Scott Group (Managing Director)

J.J., I wanted to go back to the question that someone asked about the yield growth in the quarter. I'm not sure I understood because I know you talked a lot about longer length of haul. I would have thought that that would have helped yields, at least on a revenue per carload basis. So when RTMs are up so much more than carloads like we saw this quarter, typically, I think that helps yields again on a carload basis. Doesn't feel like we saw that this quarter. So maybe just help us kind of bridge the gap of the mixed benefit of RTMs going faster, pricing going up, but yields kind of ex-fuel, ex-currency only up flat, up 1%. Is the new business coming on at much lower pricing? Maybe just help me bridge the gap here?

Jean-Jacques Ruest (Executive VP and CMO)

There's a lot of moving parts. One was exchange, and then one was fuel. Then the length of haul, the new business that we have, quite a bit has been long-haul, crude by rail, private equipment, long-haul, Canadian grain, mostly to export, long-haul, potash, very long-haul, private equipment, frac sand, a lot of it long-haul going to Western Canada from Wisconsin, all private equipment. Then there's also been some short-haul business that we lost. You remember we lost the DP contract that was high revenue, say, high cents per RTM, low revenue per car, huge amount of carloads. Our auto business the first quarter is up as well, up to a point. That's very short distance. You have all these many, many puts and takes. That's the challenge when you add all of these apples and try to make juice out of them.

You really have a mix that probably doesn't save very much in terms of yield. But really, when we focus on yield, we focus on operating ratio. We look at a specific OD pair. We look at the revenue-to-cost ratio of that OD pair, which is the reverse of the operating ratio. If it's a piece of equipment that way I supply the rail cars, like moving steel or moving pulp, I'm looking for a contribution per car a day. And these are really the ones that really drive yield, the true yield, the bottom-line yield, the one that generates an ROI for the company. Because the cents per RTM and the revenue per car is such a wide range of things that go into that that create mix. It's hard to make any conclusion for that.

Luc Jobin (President and CEO)

I think, again, part of the component, Scott, is how the volume is growing in terms of private equipment. So that alone is great business and good OR and good contribution, but it is obviously significantly less than if we were providing the equipment. So it's down to the mechanics of the mix. And the good news and what you should be hopefully comforted with is what J.J. is telling you, which is we do the homework. We actually work it through and look at it through multiple lenses that best reflects where and how we are getting a satisfactory return on the business we're bringing on board.

Jean-Jacques Ruest (Executive VP and CMO)

And that's why it's flowing through to the EPS, the OR, and the free cash flow. All this incremental business was helping the bottom line very much so.

Scott Group (Managing Director)

Okay. Maybe I'll follow up with Paul offline on that point. But have you said if or do you look at it this way as the incremental business coming on at higher or lower kind of revenue per car than average?

Jean-Jacques Ruest (Executive VP and CMO)

Again, it has to go down by commodity by commodity. We're talking the crude, the sand, the lumber, which didn't move very much in the quarter. I mean, you have to go down to something more narrow, a more specific segment of commodities or customers that have enough in common to be comparable as opposed to add iron ore with long-haul potash.

Luc Jobin (President and CEO)

All right. Well.

Scott Group (Managing Director)

Thank you.

Jean-Jacques Ruest (Executive VP and CMO)

Thank you.

Luc Jobin (President and CEO)

Very good, Scott.

Operator (participant)

Thank you. The following question is from Alison Landry from Credit Suisse. Please go ahead.

Allison Landry (Analyst)

Good afternoon. Thanks. So I just wanted to follow up on Scott's question. So I'm looking at the revenue per RTM in essence. Basically, in aggregate, and pretty much for every commodity type, with the exception of forest products, which was flat, you had down year-over-year comps on this metric. So I'm a little bit confused, I guess, about your comments about having a longer length of haul, but this metric being down across the board. And then you sort of mentioned that part of it might be due to whether or not you own the equipment for these moves. Am I understanding that correctly? And if not, what am I missing?

Jean-Jacques Ruest (Executive VP and CMO)

So take a comparable. Take, say, crude by rail, which all moves in private equipment. We move more crude by rail. And in the crude by rail, you will find that if we were publishing the crude by rail cents per RTM, or the crude by rail revenue per car, you would find that that business has moving volume, and the pricing is positive. But when you combine crude by rail with plastics, with chemical, with chlorine, with ammonia, you're really looking at things which are not comparable. And now you're trying to draw a conclusion from that. And that's what I'm just saying is when we look at the yield, we look at the yield on the same account, same OD pair, if it's private equipment, revenue per car, RCRs, if it's rail equipment, contribution per car a day.

That's how we measure yield, as opposed to add things which are not the same. Therefore, all you have is something that has no correlation to the profit yield of the business.

Allison Landry (Analyst)

Understood on the last point. But maybe thinking forward, would you expect the freight revenue per RTMs to continue to be negative?

Jean-Jacques Ruest (Executive VP and CMO)

It will depend on which of our business is growing. Because I think what you're looking at is at the business unit level. At business unit level, you have a lot of different commodities and different car types for different customers that moves in these average. So it will depend on which account is growing, which commodity, and is it private equipment. Like sand is private equipment. It's in metals and minerals. But steel is not moving in private equipment. It's moving in railroad cars. And obviously, right there, you have an apple and a banana in the same business unit.

Allison Landry (Analyst)

Okay. Thank you for the time.

Operator (participant)

Thank you. The following question is from Thomas Wadewitz from UBS. Please go ahead.

Luc Jobin (President and CEO)

Hey, Tom. I guess we lost him, John.

Operator (participant)

Mr. Wadewitz, your line is open, sir. If you're not responsible, move on. The following question is from Bascome Majors from Susquehanna. Please go ahead.

Bascome Majors (Senior Equity Research Analyst)

Yeah. I wanted to follow up on an earlier question about capacity. Sounds like there's not significant pinch points in your network yet. But as you look broadly across the North American rail network, are you seeing certain interchanges with other carriers start to get a little tight, or any really pockets where you think capacity needs to be addressed more broadly to keep the network fluid?

Ghislain Houle (Executive VP and CFO)

Thanks, Mike. Here, Bascome. Overall, no, the answer would be no. But when you take weather and put it into the equation, and you take the upswing in traffic that we experienced, the Western Canadian corridor, not so much for us, but other carriers, there was difficulty. For us, we look at a long view on this, and we've already plotted out, I could say, the next five years, depending on the growth J.J. and the team bring, where we know where our pinch points are, and we get to them beforehand. Now, we don't do that before we innovate, change what we're doing. We do everything we can to prevent the expense of capital. However, our Western Canada corridors are heaviest, and it's really probably not a lot different for some of the other carriers. And that's where there were some capacity issues that were experienced.

But overall, no, we don't have any issues with interchanges and with our own network in terms of pinch points. And Bascome, this is just saying, remember, you hear a lot of our peers complaining about congestion in Chicago, and this is where our EJ&E line, which is fully connected with our network, is helping. So we love Chicago. We like it. And we're very fluid, and we'll be fluid for the next 50, 75 years in Chicago.

Luc Jobin (President and CEO)

Lots of capacity there. Well, that's easy for you to say. You're not going to be around for 75 years, Ghislain.

Ghislain Houle (Executive VP and CFO)

I hope I will.

Luc Jobin (President and CEO)

Building for it. Thanks, Bascome.

Operator (participant)

Thanks, Bascome.

Bascome Majors (Senior Equity Research Analyst)

Thank you, guys.

Jean-Jacques Ruest (Executive VP and CMO)

You too.

Operator (participant)

Thank you. The next question is from Jason Seidl from Cowen. Please go ahead.

Jason Seidl (Managing Director)

Thanks, guys. Only one for me. You talked a little bit about international intermodal. Talk about the domestic side and where you see demand.

Jean-Jacques Ruest (Executive VP and CMO)

So demand, we're more exposed to the Canadian market. We do some cross-border. We've seen some improvement in our carload, in our container movement, if you wish. And it's okay. It could be better. If we were to strip some of the gain that some of Jean mentioned, it would not be as strong. The cross-border business is still very competitive, partly because of exchange rate, partly because of the very strong competition from the highway. So domestic intermodal, all in, whether you're competing with other mode or over the same mode, it's still quite competitive. But we have positive growth, and I think we are doing as good as economies, if not slightly better.

Jason Seidl (Managing Director)

Okay. Thank you. Very updated, gentlemen.

Luc Jobin (President and CEO)

All right. Thanks, J.J.

Operator (participant)

Thank you. This concludes the Q&A. I'll turn the meeting back over to Mr. Luc Jobin. Please go ahead, sir.

Luc Jobin (President and CEO)

All right. Thank you, John. So thank you all for joining our first quarter call. I think, hopefully, you've gotten a lot more clarity and color around the strength of our performance in the first quarter, as well as how we continue to build momentum and continue to improve our product and the prospects that we have on the way forward. So we're pretty excited about the opportunities that we see out there. And I think the team has put out some very constructive guidance and more color around where and how we see us continuing to grow and to perform for our customers, and then ultimately how that comes down to the bottom line for our shareholders.

So we do look forward to catching up with you as we will have our second quarter call in July, as well as for those of you who will be joining us at our investor day on June 12th and 13th. We look forward to also giving you a little bit more insight into what's the secret of the Caramilk at CN. And we can't give you all the secrets, but we'll try to give you a peek preview in terms of how we continuously are trying to reinvent ourselves and continue this great journey. So thanks very much, and be safe. Thank you.

Jean-Jacques Ruest (Executive VP and CMO)

Thanks for joining us.

Luc Jobin (President and CEO)

Thank you.

Operator (participant)

Thank you. The conference has now ended. Disconnect your line at this time. Thank you for your participation.