Canadian National Railway Company - Q1 2018

Transcript

Operator (participant)

Welcome to the CN first quarter 2018 financial results conference call. I will now like to turn the meeting over to Paul Butcher, Vice President, Investor Relations. Ladies and gentlemen, Mr. Butcher.

Paul Butcher (VP of Investor Relations)

Thank you, Patrick. Good afternoon, everyone, and thank you for joining us for CN's first quarter 2018 earnings call. I would like to remind you about the comments already made regarding forward-looking statements. With me today is J.J. Ruest, our Interim President and Chief Executive Officer, Mike Cory, our Executive Vice President and Chief Operating 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 yourself to one question. The IR team will be available after the call for any follow-up questions. It is now my pleasure to turn the call over to CN's Interim President and Chief Executive Officer, J.J. Ruest.

J.J. Ruest (Interim President and CEO)

Thank you, Paul, and good afternoon, everyone, and welcome to our first quarter results. You're joining us here in Toronto, where CN is going to be holding our annual shareholders' meeting tomorrow morning. It's a beautiful week in the north, and the winter is finally over. But before we get started on the earnings call, we would like, on behalf of the CN family, to take a moment to say our thoughts and prayers with all those affected by the tragic event here in Toronto earlier this afternoon. Returning to the earnings call, first off, I'm very honored to be here with my colleague, very experienced railroaders, all of us having decades of building CN from the ground up. This is not our first test. This is not our first mission.

Our service has been challenged since last fall, but I want to salute the huge personal effort of our team of operating railroaders, who dealt with strong demand and with harsh winters. Our Q1 results reflect those challenges. We delivered basically flat revenue, and volume, as expressed in RTMs, was down 4%. The market recovery was good, but not quite enough to cover the volume weakness of January and February. On the cost side, a slower network, the cost of onboarding additional train crews, and low network resiliency resulted in higher operating expense. Adjusted diluted EPS was down 13% for the quarter. Our operating ratio came in at 67.8%, which is 600 basis points higher than last year. But March showed definite progress. Today, we are also updating our guidance. Ghislain will provide those specifics in a few minutes.

Our team of railroaders is definitely not throwing the towel on the year-end results. I will now provide an update on our top line on the commercial side, followed by Mike's overview of our operation, and Ghislain will follow up with the financial performance and our momentum going forward in the next few quarters. The first quarter revenue was in line with the available capacity. Demand was strong, remains strong, and it looks also very broad-based for the remaining of the year. Volume, as expressed in RTM, was down 4%. Same-store price in the first quarter came in at 2.7% from the 2.4% that it was in the prior quarter. Core pricing from recent renewal concluded in the last 90 days averaged about 4.8%.

You will recall that same-store price is a backward-looking measure of price on the full book of business executed in Q1, while core pricing on recent renewal is a forward-looking measure of price trend for the deal concluded in the last 90 days. The strong Canadian dollar was a negative headwind of $80 million in reported revenue, and the fuel surcharge program was a $70 million positive tailwind. We experienced a significant increase in empty export containers volume in this quarter to the West Coast, which is the main driver of our mix, explaining the major gap between our carloads and our RTM. CN's ports are fluid, with normal ground count and inventory, and the dwell time being back at the target range. Our 2018 outlook is to operate at near-port capacity on the West Coast of Canada.

Prince Rupert revenue was up double-digit and continued to grow ahead of schedule. Montreal was up double-digit as well, and Vancouver was up mid-single digit. Frac sand revenue stayed solid. Refined petroleum product was up, mostly from the new Northwest upgraders around Edmonton. Coal revenue grew by 13%. The winter operation limited our ability to move more Canadian export than last year. However, the outlook for coal exports for 2018 is quite positive on both the Gulf Coast and the Canadian West Coast. Canadian grain volume was down 10% from last year as the prolonged extreme cold weather reduced our train length in the prairies and impacted export. In the last seven weeks, we made quite significant progress, and we are now running current weekly car orders as placed on us by the grain companies.

CN spotted 5,700 grain hopper cars per week in March, up 40% from the run rate of February. The export season of grain will extend into the second quarter. In line to our capacity challenge, we've reduced our crude-by-rail business the last two quarters. Crude carload was reduced 25% versus last year in Q1. Since our progressive replenishment of network capacity, meaning the construction work we'll be doing this summer, we will ramp up volume in the second half, and we will have re-entered that market for the second half. Concluding on the commercial review, pricing trend is up at renewal and as well as for new deal, reflecting tighter supply and reflecting the value of our fresh investment capital of this year. On volume, growth will progressively return, and it will be in line with our new siding and double-track investment as these things come online. This will produce the capacity required for us to do the year-end result on RTM. I will turn it to Mike. Mike, if you want to take it away.

Mike Cory (EVP and COO)

Thanks very much, J.J. First, I want to thank all the railroaders of CN for their efforts in the challenging first quarter. From an operations perspective, the results were a combination of two things. We had low resiliency in some high-volume areas going into winter, and this made maintaining fluidity very challenging. Fluidity is the most important thing. This low resiliency, coupled with extremely harsh winter conditions in those same areas, resulted in a decline to service levels and an increase in cost for our operation, as evidenced in our operating metrics. After an extremely difficult February, conditions began to subside, and we started to make progress. Our focus since March has centered on catching up on volume, gaining back the confidence of our customers, and sequentially improving our operating metrics in line with reducing our costs.

Although we have months to go before we regain our rightful standing as the operational and service leaders in the industry, our work since the harshest part of the winter has produced some very good results. We've made positive strides in reducing our port dwell at the West Coast, bringing back inline terminal dwell, and the velocity for our international container business. This has allowed us to reduce the amount of intermodal fleet we require, has provided port operators the fluidity they need in order to keep the dwell in line with the customer demand. On grain, we've delivered consecutive strong weeks of grain car spotting, meeting the demand of the industry. Across each commodity business line, our team is focusing on every opportunity to achieve the same result.

As an example, we more tightly control the private cars getting on the network, working with our customers to reset the size of their private fleets. As a result, our terminal dwell has improved in key locations where mainline resiliency is still at a premium. The relationship between terminal dwell and network train speed is much like a highway ingress/egress point during rush hour. The lineup to get on the highway is longer, and it takes more time to enter, while at the same time, the off-ramp and disbursement to the city streets also takes longer. During non-rush hour periods, movement across and onto and off the highway is much faster. To improve these areas of constraint, we are adding capacity. We're building infrastructure to increase our fluidity and resiliency on both our busy highways and major terminals.

In addition, we are hiring and training employees and purchasing locomotives in line with that demand. This work will deliver service and productivity improvements. Overall, the bulk of our infrastructure investments are directed to our Western Canada corridor, with some investments taking place in our Winnipeg to Chicago gateway and across our intermodal inland terminals. Let me give you some color on how some of our infrastructure additions in 2018 will help us with capacity, overall fluidity, and resiliency. An example of capital we are deploying on our main line is the addition of double-track sections across the Prairies. Currently, that portion of our railway is primarily a series of 12,000 ft sidings that have return grids of around 15-25 minutes. These return grids are between 10-15 miles apart. We do have some double-track sections on this portion of our network, though.

As we add trains to the main line, we slow the overall speed down anytime the flow is disrupted and trains have to stop, or it's a rush hour scenario and the subdivision has a heavy flow of traffic. With a disruption or very heavy levels of traffic, crews in particular, due to the regulated hours of service, can run out of time to complete their trip. In either of these scenarios, trains can be required to stop back 5-6 sidings in order to meet another train or trains. This decreases the overall speed of the subdivision and increases the likelihood that they won't reach their destination where the next crew gets on. On a best-case scenario, with continuous movement, additional volume results in trains traveling slower over the corridor, leading to an unproductive use of the assets.

What transpires in the winter in this landscape example is far more extreme and results in crews running out of operating hours. The demand for crews then increases, and eventually, you run out of crews and trains sit. This also ties up the other existing mainline capacity, which is a place to meet or pass a train, and makes the return grids even longer due to the wait time of the train before it can leave. What a stretch a double-track does is reduce and eliminate return grids so trains can move up behind each other closer. The recovery is much faster when there is a disruption, resulting in the assets being more productive as the time they are stopped is decreased. As well, it allows for more balanced flow of traffic over the subdivision during normal periods and reduces the rush hour effect of the highway.

In the end, the commitment made to the customers fulfilled, and the productivity of the asset drives the reliability the customer needs. Our deployment of these stretches of double-track are in our Edmonton to Winnipeg corridor, where volume growth and the need for resiliency is the highest in our network. From a regional performance perspective, both the southern and eastern regions have bounced back to normal levels, with small pockets of exception. The western region has improved from the depths of winter. High volumes are currently being moved. However, mainline capacity constraints remain present, resulting in lower productivity of our assets. Looking ahead in Q2, operating metrics will continue to be under pressure as compared to Q1 2017. It should be flat in Q3 as we will have additional crews and more reliable locomotives, but still limited additional track infrastructure.

In Q4, new crews will be more experienced, new locomotives will be online, and most track infrastructure will be completed, leading to positive operating metrics year-over-year. I've experienced growth and capacity constraints in the past, and I know that we have the right plan to regain our rightful place as leaders of operational and service excellence. Back to you, Ghislain.

Ghislain Houle (EVP and CFO)

Thanks, Mike. Starting on page 11 of the presentation, I will summarize the key financial highlights of our first quarter performance. As J.J. previously pointed out, revenues for the quarter were flat versus last year at just under $3.2 billion. There was no impact on EPS related to fuel lag on a year-over-year basis in the quarter. Operating income was slightly over $1 billion, down $194 million, or 16% versus last year. Our operating ratio came in at 67.8%, or 600 basis points higher than last year, driven by challenging operating conditions, including harsh winter weather and low network resiliency. Higher fuel prices accounted for 60 basis points of this increase. Also, the new GAAP pension accounting reclass resulted in a 250 basis point increase to the operating ratio in the quarter.

Net income stood at $741 million, or $143 million, lower than last year, with reported diluted earnings per share of $1 versus $1.16 in 2017, down by 14%. Excluding the impact on deferred income tax recovery from the enactment of a lower provincial income tax rate in 2017, our adjusted diluted EPS for the quarter was down 13% versus last year. The impact of foreign currency was unfavorable by $24 million on net income, or $0.03 of EPS in the quarter. Turning to expenses on page 12, our operating expenses were up 9% versus last year at $2,164 million, impacted by higher fuel prices, low network resiliency, and harsh winter conditions. This was mostly expressed on a constant currency basis. Excuse me. This represented a 12% increase. At this point, I will refer to the variances in constant currency.

Labor and fringe benefit expenses were $714 million, 10% higher than last year. This was mostly the result of higher wages driven by increased training costs for new hires, partly offset by lower incentive compensation. Purchase services and material expenses were $481 million, 11% higher than last year. This was mostly the result of a higher level of activity in trucking and transload services and higher material costs. Fuel expense came in at $393 million, or 20% higher than last year. Higher fuel prices accounted for $60 million of the increase, while lower volumes were a $9 million favorable variance versus 2017. We delivered lower fuel productivity by 2.4%, or $7 million in the quarter versus last year, mostly driven by lower network velocity. Depreciation stood at $323 million, 2% higher than last year.

This was mostly a function of net asset additions, partly offset by the favorable impact of some depreciation study. Equipment rents were up 16% versus last year, driven by the slower network, car hire expenses, and the added locomotive leases. Finally, casualty and other costs were $140 million, which was 22% higher than last year, mainly driven by an increase in the provision for legal claims and higher incident costs. Now moving to free cash flow on page 13. Free cash flow was $322 million in the first quarter. This was $526 million lower than 2017 and mostly the result of lower net income, higher cash taxes, and higher working capital, mainly driven by advanced ordering of material to get a head start on infrastructure capacity investments as soon as weather permits. Finally, let me turn to our 2018 financial outlook on page 14.

The demand environment is solid in a number of different sectors, and we are optimistic that the North American economic conditions will be supportive with favorable consumer confidence. We continue in our plan to hire crews, take in delivery of 60 new locomotives starting in June, and began construction on our aggressive infrastructure capacity investment plan, which is now projected to be completed in the fourth quarter of this year. With this in mind, and in light of lower than expected RTMs in the first quarter, we are revising our 2018 financial outlook and now expect to deliver adjusted earnings per share in the range of $5.10-$5.25 versus 2017 adjusted diluted EPS of $4.99. This compares to our previous financial outlook, which was for EPS to be in the range of $5.25-$5.40.

We continue to assume that the Canadian to U.S. dollar exchange rate will be around $0.80. This environment should translate into volume growth in terms of RTMs in the range of 2%-4% for the full year versus 2017, compared to our previous expected volume growth of 3%-5%. Overall pricing is trending up. On the capital front, we are committed to investing in our business to support safety, service, and organic growth. Given the strong volume growth we have experienced in 2017 and to continue to support future growth opportunities with superior service, we are further increasing our capital envelope for 2018 by $200 million to approximately $3.4 billion versus our previous outlook of $3.2 billion. This increase continues to step up our capacity infrastructure investments to accommodate strong demand and restore our network fluidity and resiliency.

This increased capital envelope is supported by monetization of surplus non-core assets. In April, we closed two transactions that generated over $150 million of cash that we will redeploy in the business to more productive use. We will continue to consider other asset sales to redeploy capital and improve asset efficiency. Furthermore, we continue to reward our shareholders with consistent dividend returns, and we are on track with our current share buyback program of approximately $2 billion, having repurchased over nine million shares for an amount of $925 million since last October. In closing, we remain committed to our agenda of operational and service excellence with our supply chain focus, and we continue to manage the business to deliver sustainable value today and for the long term. On this note, back to you, J.J.

J.J. Ruest (Interim President and CEO)

Well, thank you, Ghislain, Mike. Operator, before I turn it back to questions, I'd like to make two important comments. First off, the support of the change is very strong inside CN, and the people are very energized about the plan that we have. People are buying in, and we are one to get this done. Regarding the operation, we will continue to get sequentially better. We are getting better in the second quarter for the month of March, but also the third quarter will be better in the second quarter. And by the time we get to the fourth quarter, our network is going to be quite capable. Entering 2019, we're going to be very fit to compete, and we will have very excellent service to offer in the marketplace. We're investing in our future. CN is coming back and back and better. Operator, Patrick, we'd like to turn it back to questions.

Operator (participant)

Thank you. 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 Brian Ossenbeck from JPMorgan. Please go ahead.

Brian Ossenbeck (Managing Director)

Hey, good afternoon. Thanks for taking my question. If I can just, I guess, start with the CapEx. It's up a bit from the last outlook. Can you tell us if anything from 2019 was pulled forward into 2018? If I'm reading the release and the commentary, right, it seems like it was additional equipment and spending that you were making for this year. So maybe you can give us a sense of what changed since the initial update and also why it seems like it's taking a little bit longer than expected for the construction period this year.

Ghislain Houle (EVP and CFO)

Yeah, Brian, thanks for the question. This is Ghislain. Yeah, we're increasing our capital envelope by $200 million. The $200 million is an increase in capacity investments. So again, some of this will be more infrastructure that Mike is looking for in the west. So previously, if you remember, we were targeting $250 million of infrastructure investments in the west. Now that's going to be up to $400 million. And then the additional $500 million will be part of it will be terminal. Some of it is grading, some of it is track, and some of our intermodal terminals. That accounts for $100 million. And then $400 million is locomotives. That's the same locomotives as we had, plus we're adding some intermodal equipment. So all in all, it'll be $900 million of capacity investments.

Your second question, again, we were targeting, as some of you know, and Brian, you probably we told you that we were targeting to have most of our infrastructure investments done by the end of September. Again, we have more capacity that we want to put in the ground, number one. And number two, we all have houses, and sometimes when we build, we have a target to get it done in a month, and then it takes a little longer. Again, this is outside work. This is out there in the elements and so on. And we feel that essentially most of our capacity investments will be more in the ground in the fourth quarter versus a very, very aggressive schedule of the end of Q2 before.

When you consider all of this, including the fact that the volumes in the first quarter were a little lower than what we expected, I think that's the reason why we reduced our guidance on EPS for the year.

Brian Ossenbeck (Managing Director)

Okay. Thanks for the details. It's helpful.

Ghislain Houle (EVP and CFO)

Thank you, Brian.

Operator (participant)

Thank you. The next question is from Cherilyn Radbourne from TD Securities. Please go ahead.

Cherilyn Radbourne (Managing Director)

Thanks very much and good afternoon.

Ghislain Houle (EVP and CFO)

Good afternoon.

Cherilyn Radbourne (Managing Director)

Wondering if you can sort of elaborate on the tenor of your discussions with customers? I guess what I'm driving at there is just trying to get an idea of how much damage was done since the fall and whether you're starting to get recognition for these sequential improvements you're making.

J.J. Ruest (Interim President and CEO)

Well, thank you, Cherilyn, it's J.J. So yes, there's been a lot of discussion with customers since last fall regarding where we made the most progress in terms of the service recovery. One of the areas was on the grain. As I mentioned in my comment, the last two weeks, including this week, this week would be the third week, we are meeting all of the orders being placed on us. It doesn't mean that there's no backlog. There's still a backlog of grain to be removed in the second quarter. But right now, for the last 20 days, we are 15, 20 days we're on cadence with the supply chain with the grain companies with their program. In terms of the port business, which was another area of concern, all of our four terminals that we serve are in the Canadian and West Coast.

The ground count is quite low, and the dwell time of the containers after ship discharge is running below 3 days and has been below running 3 days of average dwell for the last 2 or 3 weeks. So that situation is resolved. We've also resolved the situation on our inland terminal where we had congestion from time to time regarding the truck drivers coming in and out. Most of our gate time, our terminals, are now really within the service KPI of 45 minutes from gate in to 45 minutes to gate out. Where we still have backlog to deal with, in fairness, it's mostly in Western Canada, and it's mostly on the world of carload. And lumber is one area, for example, where there's still quite a bit of lumber product in Western Canada that's trying to find its way into the U.S. market.

We are going to be getting more centerbeams this year to address that more long term. We're leasing 150 in the lease market, and we actually have sanctioned from the board to add 250 centerbeams that will be constructed sometime this fall. So I think the sentiment of the customers is getting better, definitely. They are seeing the impact and also seeing the goodwill and also seeing definitely the whole capital program that Mike was talking about this year. The section of double-track and deciding that we will install this summer from basically this month to the end of October will have huge impact in what kind of service we can offer to the trade and those who export come late this year and early next year. Still more work to do, but by the time we get to the end of the year, things will look pretty strong and pretty solid.

Cherilyn Radbourne (Managing Director)

Great. Thank you. That's my one.

J.J. Ruest (Interim President and CEO)

Thank you.

Operator (participant)

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

Brandon Oglenski (Director)

Hey, good afternoon, everyone. Thanks for taking my question. So J.J., I just wanted to ask, if we go back to 2014, I think the network was running at similar levels of activity, and the CapEx profile of the business was obviously quite a bit lower. So can you just help? And Mike's comments around what's been happening were very helpful, but can you just compare and contrast to the challenges you're facing today versus maybe where the network was a few years ago?

J.J. Ruest (Interim President and CEO)

Yeah. So Mike, we'll help you with that. But when you look at 2014, which is today, you have to take the total business on the network. The first thing you should look at is the different mix, right? The business in the east is not as strong as it was, and some of that workload has been shifting to the west, plus we've had total growth. But Mike can actually expand on today versus 2014.

Ghislain Houle (EVP and CFO)

Yeah. Brandon, we're seeing probably upwards of 10%+ volume growth versus 2014 in the pinch points of the western corridor. And I'm just trying to think of the first part of your question, how can I explain it best? To J.J.'s point, there's a mix difference, but we did not really spend, after 2015, a lot of capital in that corridor. And so that's why after a winter like this, it's just a matter of catch-up. And we don't have the resiliency when things do fail out there to catch up as fast as we want. So it's a different railroad. Certainly more volume and the mix, the higher amount of intermodal, which demands more track capacity, to be honest with you, priority has really affected us.

J.J. Ruest (Interim President and CEO)

So much more intermodal from Prince Rupert, from Vancouver, much more Canadian coal who wants to go mostly to Prince Rupert. Grain business has been steadily increasing because of the size of the crop every year. So our network has become a little more of a western network, and therefore those ton-miles from the east out of the west, they need sidings, they need sections of double-track. We're also investing just to meet the demand of this year. The whole capital program that we have is also to look for 2019. I think I'm not sure if I said that in my note, but we already did a very detailed granular forecast for 2019, almost like a budget level. We have very high visibility where that business growth will come in.

We believe it will be very strong, and it will be especially strong in the west where we are adding this section of double track and siding. So it's partly to meet the demand of today, but also the demand of 2019, and we're very optimistic about 2019. I hope this helped.

Brandon Oglenski (Director)

It did. Thank you.

J.J. Ruest (Interim President and CEO)

Thank you.

Operator (participant)

Thank you. The next question is from Fadi Shamoun from BMO Capital Markets. Please go ahead.

Fadi Chamoun (Analyst)

Thank you. Good evening. CN spent many years building trust relationships with customers. I'm just wondering, just kind of when you look back at this operational issue that kind of you've been going through, does it change how you think about capacity overall for the rail network to kind of avoid these kind of issues in the future? Do you build more in order to allow for your kind of unexpected volume or volume surges? The other related question is, are you able to build kind of all the capacity you think you need given volume outlook this year, or should we think that there's going to be a little bit of overflow into 2019?

Ghislain Houle (EVP and CFO)

I can start, Fadi, with.

Mike Cory (EVP and COO)

We're all going to get in on this.

Ghislain Houle (EVP and CFO)

We're all going to get in on this as a team. In terms of what we've learned, we've learned some lessons. We're humble about this, and we've learned some lessons in 2017 for sure. One of the lessons I've learned from a financial standpoint is that in some key corridors, for example, where you're talking Edmonton and Winnipeg, all of our commodities and the business go through that corridor, we need to build ourselves a little bit of buffer. Because frankly, and I always look at it as the cost of being wrong, if we've overinvested in that corridor, then at the end of the day, and we're wrong, then it's the time value of money.

Now, we don't like to invest too early, but if we believe, and we truly believe that we will grow this business, then we will need that infrastructure at one point in time. If on the other hand, we manage these key corridors too tight, which typically railroads have a tendency to do, and we've done a little bit in the past, and we underinvest and we're wrong, then you have what we saw in the first quarter of this year where you've got a lot of unhappy customers, you've got a lot of pressure being made to Ottawa and the like. So one of the things that we have learned out of this is that, and then I'll let Mike and J.J. jump in, from a financial standpoint, in some of the key corridors, we need to build a little bit of buffer.

We can't build a church for Easter Sunday, but certainly we need to build ourselves a little bit of a buffer so that we don't get or we don't get into that type of situation going forward. Mike or J.J., you want to add anything?

Mike Cory (EVP and COO)

If I can jump in before J.J., first of all, we've got a responsibility to our customers that are growing their markets through us to be there before it happens. That's number one. And so I can tell you from an operating perspective, the alignment between our team, the marketing and sales team, and the finance team, and J.J. said it earlier, on having the granularity of the volume, that line of sight being really clear is really what's key for us going forward. So we're not out of the woods on that yet. We've got a lot of work to do for not just that portion of the forecast of the volume, but it's the modeling of capacity.

If you look at the type of growth, the mix of growth that we've had and the amount, there's not really. I don't know if you could pick another railway, Fadi, that's like this. So we're going to develop this ourselves, and that's really what we're working on so that we have the capacity, the service delivery in place in line with what the customer needs, and we do it very productively. So that's a big part from my end.

J.J. Ruest (Interim President and CEO)

Yeah. So being a company who's organic growth oriented, we will and we will invest in our business. We need to build back the resiliency that we used to have back in 2015, 2016, but lost in 2017. Because in order to be able to grow organically and provide the level of service that actually attracted this kind of growth in the CN network, we have to have the capacity to respond to it at all time or most time. I mean, one can be off on Easter Sunday because Easter Sunday church is one day out of 365, but we can't be off for three months in a row. So we need to have enough capacity that's actually in line with what we said we would do, which is that we will outpace the economy and we will have organic growth. In order to do that, you have to have a service that's above the industry average.

Fadi Chamoun (Analyst)

Okay. That's great. And the part about are you able to build the capacity you need this year, or is it going to kind of overflow into 2019 as well?

Ghislain Houle (EVP and CFO)

No, I think we've never been as close, tight to the hip between the finance team, the transportation team, and the engineering team. I think we have a very detailed plan of how we're going to build this infrastructure before winter hits. I think we're monitoring the build actually on a weekly basis, and we're comfortable that we'll be able to build what we have in the plan. That will really help us, as J.J. mentioned, in the fourth quarter, but also give us tons of momentum to enter into 2019.

J.J. Ruest (Interim President and CEO)

But make no mistake, Fadi, as we grow, like we suspect, we will be continuing to build capacity next year.

Fadi Chamoun (Analyst)

Great. Thank you.

Ghislain Houle (EVP and CFO)

Thank you, Fadi.

Operator (participant)

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

Jason Seidl (Managing Director)

Thank you, Albert. Thank you for the time as well. I wanted to focus a little bit on sort of just the pricing dynamics and comparing and contrasting that to the current environment that you're in serving.

J.J. Ruest (Interim President and CEO)

Yeah. With the pricing environment, I mean, the pricing environment is always typically a factor of two things. One is the factor of supply and demand. Is the supply of our services tighter than the demand? If it is the case, transportation service capacity right now is more limited in total than it was a year or two back. Then two, the quality of the service. So rebuilding the capital plan that we're putting is not only to be able to offer organic growth, the one that we're chasing at CN, but also to provide a service that allows us to grow and grow at good pricing. But in the meantime, really, where most of the discussion is taking place in terms of the pricing is basically the basics of supply and demand, like in any other market.

The supply of transportation services is tight, and you see that reflected in our pricing performance, either the same-store price or the core pricing going forward. And you see that especially in some segments which are maybe more volatile than others, crude-by-rail, frac sand, and the likes, where you have the biggest spike in volume up and down. And I think it's only fair that those segments where the volume has been quite volatile in the last few years, that this business is repriced or priced in a way that reflects that environment. But we're very bullish going forward. Going back to our customers, including when we discuss price, I mean, our relationship with customers, by and large, is very strong. They understand what we went through. We are humble and honest about the fact that we've all learned.

We're all responsible and accountable around this table here about what we did last year and didn't do. I think in hindsight, we should have probably triggered a lot of this action plan sometime in April or June of last year. It would have given us the time to execute. But having said that, we're very energized and have a sense of urgency to get it done as soon as possible. In some segment, we're really back. In some of the segments, we need more time. On the grain, for example, today, the board has approved that contingent on some condition that we can rebuild our Canadian grain fleet and place orders in 2019 and 2020 to get 1,000 new-generation hopper cars, something that would really help us rebuild our reputation, but also create a good position for CN in the Canadian grain trade.

This is all contingent on Bill C-49 to go to the house the way it was originally written. But all these things really are very tangible action. I mean, when you hire as many people as CN is hiring and you deploy the capital we're hiring, I mean, this speaks loudly with our customers, and they see that it's more than just word that we provide a better service. They actually see the capital, the time, and the effort that we're putting behind it, and also the progress already in the last eight weeks. So the pricing discussion is price trend is up, and we'll probably be up for most of this year, if not all of this year.

Jason Seidl (Managing Director)

Thank you.

Operator (participant)

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

Steve Hansen (Managing Director)

Yeah. Good afternoon, guys. Just a quick one for me on the labor side. I don't know how much you can tell us just yet, but given the turmoil that we've seen at one of your primary competitors of late, I was hoping you'd give us an update on your recent agreement with the TCRC. I believe you signed a tentative agreement back in March, but I don't believe it's been ratified just yet. So any update on that process would be appreciated and whether or not you think it'll ultimately ratify. Thanks.

J.J. Ruest (Interim President and CEO)

Mike will take that one.

Mike Cory (EVP and COO)

Yeah, certainly. Well, we have a tentative labor agreement with our locomotive engineers. It's being voted on right now. We expect to get the results, I believe, around, let's just say, the end of May. And really, we've got a very constructive labor environment that we're working with them, so no issues here.

J.J. Ruest (Interim President and CEO)

Yeah. That should be in good hands.

Steve Hansen (Managing Director)

Okay. That's helpful. Thanks. That's it.

Ghislain Houle (EVP and CFO)

Thank you, Steve.

Operator (participant)

Thank you. The next question is from Chris Wetherbee from Citigroup. Please go ahead.

Chris Wetherbee (Senior Research Analyst)

Hey, hey. Thanks. Good afternoon, guys. I wanted to touch a little bit on the guidance, if I could. Just wanted to get a sense of maybe the cadence of the improvement. So you have a pretty challenging comp in the second quarter, and then maybe it sort of tails off as the year progresses. But just want to get a sense of maybe how quickly you can sort of right the ship from an earnings perspective. It would seem a decent amount of growth is embedded here. Maybe you can help us with some of the puts and takes to better understand it.

Ghislain Houle (EVP and CFO)

Yeah. Listen, thanks, Chris. We don't provide quarterly guidance, as you know, but what we've said, and I'll reiterate a little bit what Mike has mentioned. So as you know, our operating metrics have been challenged, and everybody knew that for the first quarter. But we've seen some sequential improvement. We are going to continue to see some sequential improvement in the second quarter. We still believe on a year-over-year basis that the operating metrics are still going to be challenged. However, I think when you look at as the new locomotives come in and we're hiring new people again coming in as train conductors, in the third quarter should be flattish, give or take, and then the operating metrics should be humming and even be better in the fourth quarter. And that will translate into our costs are going to be again back online.

Because as you see, and this is what happens when the network is a bit of a sham the way we have it today. Look at the first quarter results. Our revenues are about flat, but our expenses are up by 9%, which means that because everything is slower and because we're catching up on hiring crews, then our costs are just out of whack. So as the operating metrics come back online towards the second half of the year, then these costs will come back in line, and you'll see operating ratio and EPS reflect that. And we're very optimistic. But again, we've said it before, and I'll reiterate, we need that track. We need that third lane of the highway. And yes, we are seeing sequential improvement, but it's limited because, again, we need that infrastructure.

That infrastructure will come online mostly at the end of Q3 and mostly in Q4. We need that. We'll show sequential improvement, but I think the second half, including Q4, will be, in our view, quite strong.

J.J. Ruest (Interim President and CEO)

Yeah. So as the sections of double-track come in service, unit costs improve, and obviously, we're going to be in better position to do revenue ton-mile and GTM, and revenue will go up as well. So we'll have the two levers at that time.

Chris Wetherbee (Senior Research Analyst)

Okay. Thank you very much.

J.J. Ruest (Interim President and CEO)

Thank you, Chris.

Operator (participant)

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

Walter Spracklin (Director)

Yeah. Thanks very much. Good afternoon, everyone.

J.J. Ruest (Interim President and CEO)

Good afternoon.

Walter Spracklin (Director)

Just coming back to pricing, J.J., 4.8% on renewals is very significant. And I'm just curious how if you're seeing that in certain lines, and is that lifting the average, or is perhaps the tighter trucking capacity having an impact on intermodal? And if you could speak, I know you've touched on it a bit already, but the customer conversations after a fairly challenging quarter, frankly, I was pretty surprised to see you get that level of pricing. So just curious to hear how that was achieved and how sustainable you see it in the next, call it, 6 to 12 months.

J.J. Ruest (Interim President and CEO)

So the pricing discussion is an across-the-board discussion. Any situation today where somebody would insist, and there's no reason why they would be wrong, would insist that they have a better offer than somebody else from us, we will not bid you at any price on any condition. So we don't have any drainage in our price calculation or price going forward. And if there is, we would rather lose all business than do otherwise. In terms of where the pricing power came in, it comes from different pockets. Some pockets stronger than others. The stronger pocket are those who are really, really trying to ramp up their volume, frac sand, crude by rail, and the likes.

Those where the value of their commodities short-term and mid-term is such that they would rather pay a market price to be able to move more volume as opposed to be very cost-focused on the unit, and then at that point also sacrifice very profitable sales where their market is doing well. And then in the case of intermodal, some of these contracts are long-term. Some of these contracts are fairly short-term. In the world of domestic intermodal, that's more of a short-term world. That's also the world where what's happening in the trucking environment in terms of capacity pricing is quite relevant. And it's also in the case of the world of domestic intermodal, the mandate that we have for our team is very simple.

One is we want to fix the service to make it as strong as it can be and to make it a leading service if it's not back at this point. So number 1 is service. Number 2 is to get pricing, good pricing for the capacity that we have. And number 3, we're not adding capacity before the next few months or the next few quarters before we have fixed the service and get the value pricing that we need to have. And then when we have these things, then we'll talk about whether or not we run more trains for domestic intermodal. So when you put these things into order, and remember again, today we only have so much capacity to offer in Q2 and Q3. So we take that into account in how we roll out these different programs. This is how we add up to the 4.8 core pricing, for example, that we've had in the last 90 days.

Walter Spracklin (Director)

Okay. Appreciate the insights. Thanks very much, J.J.

J.J. Ruest (Interim President and CEO)

Thank you.

Operator (participant)

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

Scott Group (Managing Director and Senior Analyst)

Hey, thanks. Good afternoon, guys.

J.J. Ruest (Interim President and CEO)

Good afternoon.

Scott Group (Managing Director and Senior Analyst)

So can you say the $150 million of asset sales, what's the gain there? And can you say if that's included in the guidance or not? And then just bigger picture maybe for you, J.J. So one quarter only, but your first quarter operating ratio, I think, is going to be second worst in the industry. So as you think about the long term under your watch at CN, how important is it for CN to get back to having the best operating ratio in the industry? Or is that potentially less of a focus for you and more of the focus is on the resiliency of the network and things like that? Or maybe they're not mutually exclusive.

Ghislain Houle (EVP and CFO)

Hi, Scott. This is Ghislain I can take the first part of the question, and then I can let J.J. or Mike take your second part. So on the asset sale, this was a Q2 transaction. So again, we got $150 million of cash. From a gain standpoint, again, these are one-timers. I mean, we're trying to find and always did, and we these opportunities of monetization of surplus assets. But again, this is one-time other income, and that's not part of our guidance. That's not part of our adjusted EPS and our $5.10-$5.25 guidance. It's not part of it.

J.J. Ruest (Interim President and CEO)

Yeah. Regarding the question of OR, as you know, the Canadian railroads have an adjustment this year coming to pension. In the case of CN, it's basically a permanent step change of 2.5 points of OR. So you got to take that into account. The way the accounting is now in OpEx pension is meaning we will have a higher OR than historically. In our case, we're talking 2.5, 250 basis points. I mean, the model we have, if we continue to be able to grow more than the economy and more than the railroads, we need to deploy capital. And also, we need to hire people. So as we hire people, namely train crews, we will always have kind of an ongoing basis as long as we grow very strongly. A number of employees who are so-called non-productive, they're on training, they're on the payroll, and the first six months of their being on the payroll, they don't move GTM, they don't produce revenue, but they are part of a unit cost.

In the case of 2018, as we replenish, because we ended up last year being short, and we intend to finish the year to be fully ready for the next winter. So we're adding more people right now than even the growth because we're catching up. And also, we want to be sure that the winter of 2019 is a solid winter. So we have more unproductive people in the payroll this year than usually. These will be very strong, solid conductors, but this is kind of another one-time adjustment. Regarding the future of CN in terms of organic growth, we believe that the model of OR may not be really, I think we've discussed this a number of times, the way to measure success for our business. Return on investment is a very strong way to do that.

Having an OR that may not be the lowest of the industry, I think would still give us the type of EPS growth that kind of fits our network. So there's a trade-off. We are sort of at a crossroads of two. Whether or not it is wise for us to try to be the lowest operating ratio of the industry. Based on our last year's experience, I would say that it has definitely an impact on how much growth you can offer.

Ghislain Houle (EVP and CFO)

And if I can add, Scott, to J.J.'s point, we've said that publicly many, many times. We're not hammering at CN with the OR. The OR is kind of a result of what we do. I think we'd rather be, and we've said that before, we'd rather be a $20 billion, 62%-63% OR than a $13 billion at 57%. I mean, just do the math. So I mean, this business we're bringing in, it's profitable. We need the investments and the track infrastructure to bring it in at low incremental costs, but we're not in hammer. We want to grow, and we're very pleased about the organic growth and the prospects we have in front of us. We have a good solid pipeline of growth opportunities that J.J. highlighted last year at the Investor Day between $1.5 billion-$2.2 billion. We need the investments to accommodate that growth. Our first call on cash is toward the business. We're pleased about that. We're pleased about the organic growth, and we're not in hammer by having the lowest OR in the industry. We just want to be the most productive, best-serving business that's out there. That's what it's about.

Scott Group (Managing Director and Senior Analyst)

That's very helpful. If I can just ask one more if that's possible. So if I look at the guidance for the year, it looks like by the fourth quarter, you're expecting sort of high single-digit RTM growth. You have built already a budget for 2019. Do you think that's a sustainable sort of growth rate in 2019?

J.J. Ruest (Interim President and CEO)

Well, since this is your second question, I will answer it shortly. The fourth quarter result will be solid, and it's too early for us to provide specific guidance for 2019.

Scott Group (Managing Director and Senior Analyst)

Thank you, guys.

J.J. Ruest (Interim President and CEO)

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. Thank you for taking my question. I guess if I may, I just want to get back to the CapEx question a little bit. I wonder just if you can provide any color on how you think 2019 CapEx will be. Obviously, there's a significant uptick here in 2018, but any color you can provide on 2019 would be helpful. And also, I guess related to that, obviously, you're still continuing with the buyback here. Just any color you can give on leverage expectations here at the end of 2018 would be helpful as well. Thank you.

Ghislain Houle (EVP and CFO)

Yeah. No problem. Thanks, Turan, for the question. So yeah, exactly. I think if you look at CapEx, again, early to provide guidance for CapEx in 2019, but what we've said was to expect that CapEx for the next few years will be north of 20%. I mean, I think whether I would tell you between 20% and 25%. And again, as I said before, our first use of cash is for the business, and we have these growth opportunities that are in front of us, but we need the infrastructure. So we will deploy that capital towards the business and bring that organic growth and bring some good solid EPS growth going forward. In terms of leverage, I think, again, we are not changing from our strategy and from our financial policies.

We do value a strong balance sheet, and we saw the value of this when actually we hit the recession in 2009. So we will continue to have a strong balance sheet in 2019. You can expect that. And again, in terms of share buyback, we see this as a residual. So the first thing is first use of cash is toward the business. Second is to keep a strong balance sheet and agree on what our leverage should be. And then we think first of dividends. And then as the residual, if now we need a share buyback to get to that targeted leverage, then that's what we look for. So you can expect that this will be this is the way we see things. And of course, as we get closer to 2019, then we'll provide more specific guidance around these parameters.

Turan Quettawala (Director of Equity Research)

Okay. Thank you very much.

Ghislain Houle (EVP and CFO)

Thanks, Turan.

J.J. Ruest (Interim President and CEO)

Thank you, Turan.

Operator (participant)

Thank you. The next question is from David Vernon from Bernstein. Please go ahead.

David Vernon (Managing Director and Senior Analyst)

Hey, good afternoon, and thanks for taking the time. So I wanted to try to reconcile the acceleration in core price and the improving metrics you guys are seeing with the guide for the year. Is there a way to break down how much of the cost growth that's embedded in the guide is due to maybe just lower productivity as you're building out the program versus inflation, the cost of securing the resources you need to actually complete the plan? I'm trying to get a sense for how much productivity is underwhelming in the year because of the construction work versus things like higher labor costs.

Ghislain Houle (EVP and CFO)

Let me talk a little bit about it, and then David, and then I can get Mike. So of course, when we do our usual basic CapEx plan, and when you do that, obviously, you need a work block for the entire time that you're going to maintain your mainline. So that is one thing that's baked into our assumptions. When on our capacity investments, the beauty is you don't need a full work block because actually the people are working beside the mainline so the train can go through, and the engineering forces make sure that they get safely out of the way the train goes through. And you need a work block actually when you put the turnout and you connect either the siding or the double track to the mainline, that's what you need the work block for.

But it's not as extensive work block as when you do your basic CapEx. So I think this is, but we understand. I mean, there's a lot of volume in front of us. This is a very extensive capital plan. This is why I said in some of my remarks, and I think Mike alluded to it as well, that we are very joined at the hip with engineering and transportation. Transportation and engineering are looking at this on a daily basis, make sure that the work blocks are there, make sure that we don't delay trains, and make sure that we're going to build this infrastructure at the lowest cost possible. Mike, anything you want to add?

Mike Cory (EVP and COO)

No, I think you hit it.

J.J. Ruest (Interim President and CEO)

Yeah. On the price, maybe I could just help you get some color. So the same store price in Q1 was 2.7%. It was 2.4% the prior quarter, so there's a bit of a momentum going on that front. And the relevance of that 2.7%, it's on the full book of business. It's on the full book of business, whereby when we talk about core pricing, we're not talking about core pricing of 4.8% on the full book of business, only on the business that was renewed in the last 40 days. So obviously, it's on a smaller impact than when we talk about the historical. But whichever way you cut it out, I mean, we see slow progressive momentum on pricing, whichever way you look at it. And when we issue the results, the one that matters the most is same store price.

Same-store price is the one which is tied in on the quarter result of the prior quarter. That pricing environment is favorable to those who have some capacity, and obviously, capacity at CN is tight. And because capacity today has more value, is more valuable than it was two years ago. So I think that's just the basics of any marketplace where supply and demand shift a little more to those who have the capacity that eventually the pricing power gets a little better.

David Vernon (Managing Director and Senior Analyst)

Appreciate that. Maybe just as a quick follow-up, if I can slide one in here, is there any update on the timing for the board to make a decision on the CEO search?

J.J. Ruest (Interim President and CEO)

No. I mean, the search, the whole exercise has started, obviously, and they don't have any specific timing for an announcement of any sort. So no timing.

David Vernon (Managing Director and Senior Analyst)

All right. Thanks very much, guys.

J.J. Ruest (Interim President and CEO)

Thank you.

Operator (participant)

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

Ravi Shanker (Managing Director)

Thanks for offering me one. If I can just follow up on 2019, you said you weren't going to give detailed guidance on '19, which I understand, but also that you have a detailed operating plan. So I'm just trying to get a sense of all this time, money, and effort that's going into the network right now. What are you building at CN? Is it a railroad that can grow at high single-digit RTMs, and then when you put pricing on top of that, can deliver low double-digit EPS growth going forward? Or what's CN going to look like from 2019 onwards?

Mike Cory (EVP and COO)

Ravi, ask Mike, let me just start it off because I'm getting bored. Go ahead. We're talking.

Ghislain Houle (EVP and CFO)

Go ahead.

Mike Cory (EVP and COO)

Just kidding. Look, from an operating perspective, we're building a three-year plan just based on understanding what capacity we have. And then it's a matter of puts and takes, whether we do something or not, but to get ourselves in position, get our line of sight so we know what we need to do as the volumes come. And I'll let J.J. and Ghislain speak about the future, but we're armed and ready. Three years out, we want to take it out even further. That's just understanding your network and our view on growth, the strength of our growth, our organic growth leads us to have to do that to be successful.

J.J. Ruest (Interim President and CEO)

Yeah. And so maybe the network we're building, which is in line with what we view is the potential of the marketplace. And that's why our focus is to build a network, strong network from the Canadian West Coast, from Vancouver and Rupert, all the way to Chicago, and then from Chicago and the Prairies all the way back to Vancouver and to Rupert. So because this is where we see with strong visibility that there's a strong demand for the product that we have, that we have a geographic position where there's a lot of physical activities that would be conducive to have much more capacity. So West Coast to Chicago, Chicago Prairies back to the West Coast. That's where the future is for CN in 2019. And for many years after that too.

Ravi Shanker (Managing Director)

Guys, if I can just quickly follow up on that. I mean, also in response to a previous question, you said that the difference between now and 2014 is that the growth is in the west. Does that mean you have opportunity to take capacity out of the east, which leads to prolonged potential for real estate gains or kind of normalizing the network in the east versus the west?

J.J. Ruest (Interim President and CEO)

The capacity we have in the east, I would say, is more something that we would like to leverage from time to time when there is a business opportunity. But at this point, we're not necessarily planning to take our track away. But the sales that Ghislain was talking about earlier was mostly eastern sales. But these weren't necessarily they weren't rail capacity. They weren't assets that were producing rail EPS. They were assets that were actually valuable assets, but they weren't producing EPS growth. So by selling them and redeploying the capital west is one of the ways that we kind of move our book of assets to the west, namely the $150 million of $150 million that was sold in April. No one can argue all of that has been basically going to be redeployed in Western Canada in the next six months to the sidings and double track section.

Mike Cory (EVP and COO)

And Ravi to Mike, we have a very well-run, healthy franchise in Eastern Canada that is built for growth also. So we're not doing that.

Ravi Shanker (Managing Director)

Great. Thank you.

Mike Cory (EVP and COO)

Thank you.

Ghislain Houle (EVP and CFO)

Thank you.

J.J. Ruest (Interim President and CEO)

Thank you, Ravi.

Operator (participant)

Thank you. The next question is from Benoit Poirier from Desjardins Capital Markets. Please go ahead.

Benoit Poirier (VP and Industrial Products Analyst)

Yeah. Good evening, gentlemen. Could you provide an update on the crude by rail, kind of the discussion you're having these days, how many carloads you handle in Q1, and also kind of additional capacity you're willing to deploy by the end of the year and also in 2019? Thank you.

J.J. Ruest (Interim President and CEO)

Okay. So very quickly, on crude by rail, in the last six months, we've actually curtailed that business. We no longer really do any spot business. We have signed contract business that will start up a little bit of it in the second quarter, but most of it in the third and fourth quarter and in 2019. How much capacity we're willing to take, these, I would call this at this point, confidential. We don't want anyone to share exactly how much more capacity we're willing to deploy. But obviously, that has a link back to our capital program, which is one of the reasons why we feel comfortable that our capital program will have return on investment because there are ways to actually tie some of these investments with very specific takeover volume in some segments. I think at this point, that's all we would say as it relates to crude-by-rail, Benoit.

Benoit Poirier (VP and Industrial Products Analyst)

Okay. That's my one. Thank you very much for the time.

J.J. Ruest (Interim President and CEO)

Thank you.

Operator (participant)

Thank you. The next question is from Ken Hoexter from Bank of America Merrill Lynch. Please go ahead.

Ken Hoexter (Managing Director and Senior Research Analyst)

Great. Good afternoon. J.J., certainly a lot on your shoulders, and good luck as you work through this and through the build-out. Appreciate the thoughts on the operating ratio there. My question, Mike, would be in the STB letters, one of the largest rails talked about the difficulty of hiring engineers, conductors, even to the point of instituting some signing retention bonuses, all of which you need, plus capital employees. Are you seeing, given the scale with which you want to add on and the pace, are you seeing any difficulty in keeping to that pace as you plan those CapEx programs and the hiring that J.J., you talked about getting ahead of the curve?

J.J. Ruest (Interim President and CEO)

Okay. Thanks, Ken. Like any massive hiring program, there's always going to be a little difficult situations. For us, it's in smaller remote areas. We have the luxury, though, with our collective agreements to use other people from other locations up in those places that are hard to find. But it speaks louder to, again, we want to grow in the future. So we're very focused on our retention and looking at it differently than we have in the past. So right now, I'm not concerned with getting the people. Our HR department's done a wonderful job to bring the people on that we need. Again, I go back to making sure that they're also included in this line of sight, and we have far enough advance warning to make those decisions on finding ways to make sure we have the people. People want to work. We'll always have difficulty in the smaller places, but this is a strategy that we're continuing to develop as we go because we believe in our growth. Is that okay?

Ken Hoexter (Managing Director and Senior Research Analyst)

Great. Yeah. Thank you.

J.J. Ruest (Interim President and CEO)

Thank you, Ken.

Operator (participant)

Thank you. The next question is from Tom Wadewitz from UBS. Please go ahead.

J.J. Ruest (Interim President and CEO)

Good afternoon, Tom.

Tom Wadewitz (Senior Equity Research Analyst)

Yeah. Good afternoon, J.J. and team. I think, Ghislain, you had some comments and maybe the broader team just in terms of kind of, I guess, reflections on some of the constraints and maybe lessons learned. So wondered if you could comment on how you look at the volume versus price equation going forward. You had a lot of success in growing volume over time, but then maybe one could argue that you grew a bit too fast. And then you could say, well, maybe there could have been more, I guess, of a focus on raising price versus the volume. Is the experience, and as you think about lessons learned, is there a difference in the way you look at volume versus price going forward? Or would you say, "Hey, we just need to plan a little better on capacity and no change in that volume versus price equation"?

Ghislain Houle (EVP and CFO)

Yeah. I think, thanks, Tom. I can open up, and then J.J., you can obviously jump in. But I think we haven't changed our views about price. I mean, we're trying to go out there and get the best price as we can. And remember, 2017, yes, we were a little bit caught by surprise. I mean, remember, we were coming out of 2016 where volumes were down 5%. So 2017 came in, and if you remember, energy markets hit the trough, namely frac sand and crude in the second half of 2016. And in December, who would have thought that the frac sand at the year-to-date at the end of the third quarter in 2017 would be up 135%? So we were caught a little bit by surprise related to frac sand, which is a highly volatile commodity.

Some of that growth came a little bit, and we've been a bit a victim of our success. If you look at Rupert, it's a very good example. I mean, Rupert expanded its terminal, as you know, by 60%. Even last year at the investor day, we were hoping to get 80% of that expanded capacity by 2020, and we're almost literally there as we speak. Rupert will stay with us for the next 30 years, 40 years. So listen, we were caught a little bit by surprise. In the railroad industry, the problem is if now you lack infrastructure, it's nothing you can fix quickly because you've got to build it, and it takes time to build it. This is why I said that one of the key lessons learned is that we need to be ahead of the game.

We need to be ahead of the investments. And we need, in some of our corridors that are key corridors, build ourselves a little bit of buffer because I will re-say it, is the cost of slightly over-investing in some of the key corridors is lower, mainly time value of money because I will need this infrastructure versus under-investing. So we've learned. But the good news is we have good pipeline, solid growth opportunities in front of us. J.J. and the team are getting as much price as we can. We have not changed our views on price.

And I can remember vividly that years ago, in 2010, people were asking us, "How are you going to grow?" And now one of the lessons learned, I guess, from 2017 as well is we've convinced ourselves that we can organically grow. And that's good news. That should be good news for investors that we have that growth story, but we need to invest to accommodate that growth at low incremental costs, and that's what we're going to do.

J.J. Ruest (Interim President and CEO)

Yeah. It's a fair comment that price has to be part of the discussion, especially as we deploy very fresh and large quantities of new capital. So the commercial team at CN got that message loud and clear too that fresh new capital does require a solid return, and therefore price has to be centered in those discussions. Regardless of the fact that right now, our service is a little challenged. This will get fixed. Has been fixed in some segments. Will be fixed in other segments in the weeks and months to come. But capacity today, especially capacity coming from fresh new dollars of capital investment, has a higher value than it had 12, 18, 24 months. So I think that's the price is important, obviously. Thank you, Tom.

Tom Wadewitz (Senior Equity Research Analyst)

Do you think that reflects any change in mindset going forward or not really?

J.J. Ruest (Interim President and CEO)

It reflects, for example, how we approach crew now versus two years ago. It reflects how the dialogue we have with the frac sand industry, who is much more volume-focused themselves than necessarily. They would rather move more volume than debate back and forth the last fraction on the unit price because it has more value for them to move more product when the market wants to move it as opposed to the debate back and forth, the freight rate of each rail cars. And I think, as my comment mentioned, on domestic intermodal, we will definitely work very hard to reestablish a very strong product offering. But at the same time, we want more money for the existing capacity that we have today. And before we deploy a whole lot more capacity on the domestic side, we want to get a better value for what we have already.

Tom Wadewitz (Senior Equity Research Analyst)

Right. Okay. Thank you. Thanks for the time.

J.J. Ruest (Interim President and CEO)

Thank you.

Ghislain Houle (EVP and CFO)

Thanks, Tom.

Operator (participant)

Thank you. The next question is from Kevin Chiang from CIBC. Please go ahead.

Kevin Chiang (Director)

Hey. Thanks for all the color there, and good afternoon, everybody. Just a quick one from me. A lot of comments around, I guess, your focus on ROI when you look at your longer-term growth. And you did lay out a pretty positive volume growth outlook at your investor day. I'm just wondering, do you think the profile, though, incrementally is different than the volume ROIC profile is different looking forward than what you had in the past? When you look at the last three years, you'll have spent a significant amount of capital, seen a lot of volume growth, but effectively flattish operating income over, let's say, a 2016 to 2018 period. Do you see a step function change in the ROIC profile of the volumes over the next three to five years versus, say, the last three to five years?

J.J. Ruest (Interim President and CEO)

No, we don't. I mean, if you look at the overall ROIC, we're hovering between 15%-16%. And we've said that when we look at when we look, if now you go to specific projects, and we've guided to this at our investor day last year, is that our internal threshold on ROIC, on return on investment on projects, is 12%. So we want to make sure that what we invest has a return of 12%. Now, some of this could be small, could be lower, but if it provides value, we will look into it. But I would say that right now, this is profitable business coming at us. And we have a lot of volume. And when you look last year, our volumes were up 10%.

The problem is that because we were short of crews and because we didn't have the infrastructure, our cost came out of whack. So we need that infrastructure back so that our costs come back in line so that you can see metrics that the market has been used to see, and we can accommodate that growth at low incremental cost because otherwise, that's what happens. If you don't invest the capital, then Mike will have recruits. He will have deadheads. The network will be slower. Therefore, you need more cars on the network. You need more locomotives on the network that probably shouldn't be there in the first place. And then your operating costs are going to go through the roof. So that's what we need to fix. That's what we're going to fix this year. We're going to stay ahead of the game for 2019 and going forward.

Kevin Chiang (Director)

Thank you for the color.

J.J. Ruest (Interim President and CEO)

Thank you. Operator, I think at this point, we would like to close. Before we do the closing, I would like to maybe just make some last few comments. As you saw, we have a very solid capital investment program at $3.4 billion this year. This is all about capacity and service and rebuilding our brand and coming out a bit stronger as opposed to be just the same. Mike has described to you what that capital investment entails. It's track infrastructure. It's locomotives. It's train crews. It's mostly in Western Canada. This is where our future is for the remaining of 2018, 2019, and probably 2020. We have a very strong balance sheet, and we also deploy our capital in a smart way.

One example was these asset sales in the east that we're not contributing to the volume or revenue that we're going to deploy in the section of double track in the west. We're a very strong bench strength of operating guys. I'm extremely strong of our transportation department. We didn't equip them properly in the last six months. We didn't have people locomotive for them to be able to do the job they're able to do. But their talent is the same as it was. This is a CN scheduled railroading model, and people are given the tools. They do produce the result. Obviously, we're very strong in line of sight on the demand. Already, basically, we have a very detailed list of things we'd like to do or could do in 2019. We talked about price on this call. There's more price right now.

The value of what we have, the capacity that we have, is more valuable than in the past. I think most of our customers understand that for us to deploy the extra capital dollars that they want us to deploy, that will come in at a reasonable good price such that we can get a return capital plus a fair profit over and above that. On that, I'd like to close the call, and we'll see you sometime in July. Patrick, this is the end of the call for today.

Operator (participant)

Thank you. The conference has now ended. Please disconnect your lines at this time, and thank you for your participation.