Canadian National Railway Company - Q2 2013
July 22, 2013
Transcript
Operator (participant)
All participants, thank you for standing by. CN's second quarter 2013 financial results conference call will begin momentarily. I would like to remind you that today's remarks contain forward-looking statements within the meaning of applicable securities laws. Such statements are based on assumptions that may not materialize and are subject to risks described in CN's second quarter 2013 financial results, press release, and analyst presentation documents that can be found on CN's website. As such, actual results could differ materially. Reconciliations for any non-GAAP measures are also posted on CN's website at www.cn.ca. Please stand by. Your call will begin shortly. Welcome to CN's second quarter 2013 financial results conference call. I would now like to turn the meeting over to Ms. Janet Drysdale, Vice President, Investor Relations. Ladies and gentlemen, Ms. Drysdale.
Janet Drysdale (Head of Investor Relations)
Thank you, Patrick. Good afternoon, everyone, and thank you for joining us. I'd like to remind you of the comments that have already been made regarding forward-looking statements. With me today is Claude Mongeau, our President and Chief Executive Officer, Luc Jobin, our Executive Vice President and Chief Financial Officer, Jim Vena, our Executive Vice President and Chief Operating Officer, and JJ Ruest, our Executive Vice President and Chief Marketing Officer. In order to be fair to all participants, I would ask you to please limit yourselves to one question. It's now my pleasure to turn the call over to CN's President and Chief Executive Officer, Mr. Claude Mongeau.
Claude Mongeau (CEO)
Thank you, Janet. The team and I are in Montreal. We're pleased to take you through our solid Q2 results. But before I do so, I'd like to take a moment to make a few comments about the tragic Lac-Mégantic accident that occurred right here in Quebec. I would first like to say that our thoughts and prayers are with the families and loved ones of the 47 victims, and our expression of support goes to all the citizens of Lac-Mégantic, who have been severely impacted. Now, CN was not involved in any way with this train movement, but we had our safety, dangerous goods, and environmental leaders on site from day one to lend a hand to MMA and to all the first responders involved. They were there to help, but also to learn firsthand about the accident and the safety implications for CN.
Learning is what we're doing as we speak. Jim and his team are reenacting every aspect of what could have gone wrong on this highly unusual accident and are reviewing our policies accordingly. I think it's fair to assume that it will take a few months for the TSB to complete its investigation, but we are not waiting and have initiated a fact-based and rigorous risk assessment with a view to further improve our solid safety record. Okay, onward to the highlights of our Q2 results on slide 4. Our second quarter results were strong. I think we had solid team execution. You can see it on the solid top-line growth that we delivered. Our revenues overall were up 4% at constant currency. We saw growth in all of our business units, except for coal and automotive, as JJ will further explain a little bit later.
We accommodated that growth at low incremental cost. Basically, all of our key productivity metrics are up. Train load is up, car velocity, locomotive utilization, labor productivity, just to mention those. They're all up. Jim will give you a sense of, you know, what we are focused on in the steady improvement that was not just operating metrics, but also our service performance. We delivered solid free cash flow generation, solid earnings per share. Our adjusted EPS is up 11%, and our free cash flow for the first six months is standing at CAD 437 million. Luc will give you more detail on all of the numbers. So clearly a solid second quarter, solid team execution and steady improvement. With that, I'll let the team give you more color. Jim, over to you.
Jim Vena (COO)
Thank you, Claude. Great second quarter, proving the value of our agenda of operational and service excellence. Looking at our productivity, you can see our volumes are up, and we delivered steady productivity results year-over-year, even with an expanded capital plan. Before digging into the productivity metrics, I'd like to spend a few moments to talk about safety. The events of July sixth in Lac-Mégantic are a horrific reminder that safety is a foundation of everything we do. My thoughts go out to the families, community, and everyone affected by this tragedy. Personally, as an experienced railroader and with all the employees at CN, we work together as a group to improve safety. Our commitment is reflected in our safety metrics, which demonstrate an improvement year-over-year and a 29% improvement in main track incidents.... Having said this, we must not dwell on this improvement.
Rather, we must continue to work hard to ensure we have the safest work environment for ourselves, our customers, and the public. As I mentioned earlier, and Claude mentioned, the metrics are strong across the board. The regions are delivering on speed, throughput, and volume absorption. Specifically, looking on page 6, train productivity improved by 1%, allowing more traffic to be moved on the same number of trains. Yard productivity or cars handled per yard switching hour improved by 10%. Terminal dwell, which indicates how much time a rail car spends in a yard, also improved by 1%. Key metric to see if you're missing those cars that come in and make the tightest connections, the 32-hour cars, which we measure on a daily basis, improved by 26%. The result was an improvement in car throughput with a decrease in yard switching hours.
The focus was strong across our system. Looking at locomotive utilization, and you got to beg my pardon with my math background, I decided to add one more significant digit on here. If you look at locomotive utilization or GTMs per total horsepower, we went from 209.6 to 210.12. Janet, otherwise, was gonna show me as flat. The Western and Eastern regions were substantially better in the quarter. The Southern region held us back slightly, or else the overall result would have been even better. Train velocity is a very important guide to network fluidity, and we again delivered an improvement from 27.26 to 27.31. The key metric is car velocity.
It's the one that I look at every morning when I get up, and car velocity probably is the most important metric in showing a broader picture of how our railroad is performing, has improved. We've been able to deliver a 4% improvement in car velocity. I am proud that the improvements are reflected in all three regions across system cars, private cars, as well as any foreign cars we had on the railroad. Great job by Mike Cory, Jeff Liepelt, John Orr, and Mack Barker in driving this across the whole company. If you turn to page 7, proof is displayed for our capability to balance operational and service excellence.
Switch window compliance or placement in promised window is at 91%, and our grain spotting performance, which is placement on day promised, is up to 86%, which in turn drives better operational balance, asset utilization, as well as improved service. If you truly understand the value of end-to-end railroading and the supply chain, you're able to drive better asset utilization with better dwell, faster trains, and increased car utilization. In turn, you drive better train and yard productivity with a key in operations and cost control view. I'm very proud to work with this group of professional railroaders and dedicated people. The operating team delivered a strong quarter in both service and operations. With that, JJ, I'd like to turn it over to our Chief Marketing Officer to put more color to our quarter.
Jean-Jacques Ruest (CMO)
Thank you, Jim, and thank you for all of you to joining us here on this beautiful July afternoon. I will start with the highlights of our, of our quarter. Our rail freight revenue was up 6% in the quarter, breaking down the following: same store price on same store sales, including coal, was up 3.4%. The volume and mix produced 3.5% of the rail freight revenue growth. The carload grew 2.3%, the revenue ton mile grew 4.7%. The weaker Canadian dollar added almost 1% to our revenue, and the fuel surcharge, especially from WTI, reduced the revenue by almost 1%. Now, a quick rundown by this, of each segment, I will do that, as usual, on the FX-adjusted basis.
Petroleum and chemical, the revenue was up 17% on 2% carload growth. Crude by rail revenue increased 150% in the quarter to reach nearly CAD 100 million. This was driven largely by new loading station on our network. We actually had 10 more loading station than last year at the same time. In terms of carload, our second quarter run rate was about 70,000 annualized. The metals and minerals revenue was up 3% on 2% carload growth. The frac sand volume drove that segment with new plants and rising production on our Wisconsin franchise. Sand revenue was up 50% in the second quarter. The remainder of metals and minerals was flat to soft, except steel for pipeline projects. Forest product revenue was up 3% on flat carload.
On the very positive side, lumber and panel revenue were up 10% and 8%, respectively. Our export to U.S. housing start into Asia were up in both cases, while the shipment to Canadian destination was down. On the negative side, the remainder of forest product was weak, namely, pulp export to Asia was down double digit because of demand. Coal revenue was down 1% on a 2% decrease in revenue ton mile. Revenue for pet coke export and for coking coal export were up in both cases. Thermal coal for domestic and export was down from last year. Now, looking at grain and fertilizer, the carload was down 4%, but the revenue was up 4%. The great story in that segment was potash, which revenue was up 40%, and fertilizer, which revenue was up 12%. However, grain was another tale.
Canadian carload were down 12% on lack of grain for export activities. US grain was also lackluster, with lack of soybean and corn for inventory, and inventory to be able to sell. Automotive revenue was down 4% on negative revenue ton mile of 7%. Carload volume was flat, RTM was down, and we had less overseas import to the Canadian consumers. Intermodal revenue was up 3% on 6% carload growth. Please remember the challenging comparable we had with last year, when one of our competitor experienced a work stoppage. Overall, CN intermodal second quarter revenue were up actually 20% from 2011. The business in overseas was up 5%. The Port of Vancouver posted a strong 19% revenue growth and is constantly growing. Rupert was soft as the port customer lost share.
On the domestic side, revenue increased 2%, with strong grain gains from the industrial sector. Our overall intermodal revenue per unit was impacted by the weaker WTI fuel surcharge and by the year-over-year mix change from the work stoppage comparable. So all in all, a solid quarter in the second quarter. Now, moving to the outlook. Broadly speaking, when you look at the third quarter, the carload will probably be positive but will be muted because of the weak coal, grain, and fertilizer market. Both coal, grain, and fertilizer will be weak in the third quarter. We think the carload, the total carload, will pick up at a better pace in the fourth quarter, all that subject to the new crop in Canada and the U.S. Midwest.
Looking at intermodal specifically, the comparable would be more favorable, and the market demand looks somewhat mixed, so therefore, our business initiative will drive these results. For example, our excellent service, like our Toronto to Calgary by the turn morning, our new product, like our focus on reefer service, new market, like our Joliette terminal, which just opened a few weeks back, new customers like MOL, as well as filling underserved market, like in Saskatoon. On bulk, we remain guarded as it relates to the coking coal market in Asia, especially China, and also remaining guarded when it comes to thermal coal in general. The outlook for manufacturing, we see sustained demand for crude by rail from an increased number of loading stations and increased overall activities on the network.
We also see ongoing growth demand in energy consumables for drilling, for example, frac sand. There will also be ongoing growth for lumber and panel to the U.S. and Asian market. In conclusion, all in, we will be able to outperform the economy and maintain our objective to achieve inflation plus pricing. So, Luc?
Luc Jobin (CFO)
Thanks, JJ. Starting on page 14 of the presentation, let me walk you through the key financial highlights of our second quarter's performance. Revenues were up CAD 123 million, or 5%, at nearly CAD 2.7 billion. This was a record quarter for rail freight revenues, gross ton miles, revenue ton miles, and car loads. All in all, volume was up 2.4% in terms of car loads and 5% in terms of RTMs. Operating income was CAD 1.042 billion, up 6% versus last year, as solid productivity and service levels were coupled with expense management in the quarter to complement revenue growth. Here again, this is also a quarterly record. Our operating ratio was 60.9% in the quarter, which represent an improvement of 40 basis points versus last year.
Other income stood at CAD 28 million in the quarter, compared with CAD 9 million in 2012. We concluded in this quarter an agreement with another Class One railway to swap operating easements, including track and roadway assets on specific rail lines. While this did not involve any monetary considerations, we accounted for the transaction at fair value, resulting in a gain of CAD 29 million, or CAD 18 million after tax. In the second quarter, we had a CAD 5 million increase in deferred income tax expense, resulting from the enactment of a higher provincial corporate income tax rate. This was offset, however, by a CAD 15 million tax recovery from the recognition of U.S. state taxes relating to non-operating losses. Excluding the impact of these items, our effective tax rate is 28%.
So our reported net income for the second quarter is CAD 717 million, up 14%, and the reported diluted EPS stands at CAD 1.69, up 17% versus last year. Excluding the impact in the quarter of the deferred income tax expense and the gain on the exchange of easements, the adjusted diluted EPS stands at CAD 1.66 in 2013, which represent an 11% increase over last year's second quarter. Turning to page 15, operating expenses were CAD 1.624 billion, up 4% versus last year, or 3% on a constant currency basis. At this point, I'll refer to the changes in constant currency. Labor and fringe benefit costs were CAD 498 million, a decrease of CAD nine million, or 2% lower than last year.
This was the result of an increase in overall wage costs of 4.4%, mostly the product of wage inflation and a 1.4% increase in average head count versus last year's. GTMs were up 5%, so we did enjoy 3%, a 3% gain in labor productivity in the quarter. Second element is a higher pension expense, accounting for three percentage points of the variance. Offsetting these cost increases were two factors. The first was a lower stock-based compensation expense in this quarter versus last year, accounting for four percentage points. The other factor relates to more capital work being performed in the second quarter of this year versus last year. Purchased services and material expenses were $341 million, up 11%. This was the result of higher volume and cost incurred in repairs and maintenance.
six percentage points of the variance is the increase, is due to increase in, or higher locomotive and freight car repair costs, as well as higher facility and maintenance expenses. The balance of the increase for 5 percentage point relates to the contracted services with third-party carriers due to volume increases in non-rail transportation, including intermodal trucking and transloading. The fuel expense stood at CAD 402 million, an increase of 5%. Higher volume represented four percentage points of the increase in the quarter, while higher consumption rate accounted for the balance. Although actually, when you exclude those one-time inventory adjustment relating to previous periods, the average, consumption would actually be flat versus last year. Depreciation is CAD 19 million higher than last year or 8%.
This is due to a combination of asset additions, depreciation studies, and other adjustments to the remaining useful life of specific assets. Equipment rent at CAD 68 million were CAD eight million higher than last year or 14%. This is attributable to increased car hire costs and higher rental charges for intermodal and rail, and rail car lease equipment. Casualty and other costs were CAD 65 million, CAD 17 million favorable to last year as we incurred lower environmental, legal and other claims, partly offset by higher general costs. Turning to free cash flow on page 16, we generated CAD 437 million of free cash in the first half of the year. CAD 1,384 million was generated from operating activities.
This was higher than 2012 by CAD 48 million, mostly as a result of CAD 350 million of lower pension contributions and better working capital. This was partly offset by higher tax payments of CAD 427 million. In 2013, CAD 572 million of cash was used in investing activities versus CAD 277 million in 2012. The difference is mostly a function of CAD 260 million lower proceeds from non-core asset sales and higher capital expenditures in 2013. Meanwhile, our balance sheet remains strong, with debt and leverage ratios within our guidelines. We also continue to advance our stock buyback program of CAD 1.4 billion, announced last October, consistent with our strong shareholder returns agenda.
In the second quarter, we bought back 3.6 million shares for a consideration of CAD 365 million. Finally, on page 17, our 2013 financial outlook. We continue to see a gradual, although modest, improvement in the North American economy, combined with opportunities in domestic energy-related commodities. However, as JJ pointed out, we're witnessing some softness, specifically in bulk markets, including grain as well as domestic and export coal. So, with a strong second quarter performance behind us, cautious optimism is warranted as we look ahead to what may be a challenging second half of 2013. Nevertheless, we are maintaining our annual guidance, which aims for high single-digit EPS growth in 2013 over the 2012 adjusted diluted EPS of CAD 5.61.
We also continue to target free cash flow in the CAD 800 million-CAD 900 million range. On that note, I'll turn it back over to you, Claude.
Claude Mongeau (CEO)
Okay, thank you, Luc, and team. As you can see, this team of railroaders has solid momentum. The second quarter saw us achieve a number of performance records. We're pursuing growth opportunities on all fronts, and we are also tightly managing our costs. Clearly, there's a soft patch in terms of demand here, particularly in the third quarter, and we hope the economy will continue to help us in the fourth quarter. But we are gearing up to meet our full-year outlook and deliver solid performance for our shareholders. And with that, Patrick, I will turn it over to you.
Operator (participant)
Thank you. We'll now take questions from the telephone lines. If you are using a speakerphone, please lift the handset before making your selection. If you have a question, please press star one on your telephone keypad. At any time, you may cancel the question with the pound sign. Please press star one at this time, if you have a question. There will be a pause while participants register for questions. Thank you for your patience. The first question is from Ken Hoexter from Merrill Lynch. Please go ahead.
Kenneth Scott Hoexter (Analyst)
Great. Good afternoon. Maybe if we could just talk about your, your outlook. Are you using, just initially, are you using the $1.69 or $1.66? And on that, what are your thoughts on the cost per employee going forward, in terms of the, the volatile labor line, given what you talked about on the incentive comp and, and the like?
Luc Jobin (CFO)
Yeah, we always use the Adjusted Diluted EPS, so CAD 1.66. Secondly, looking forward, in terms of, you know, headcount, we're looking probably somewhere between flat to up slightly, you know, somewhere around 1%. We continue to enjoy, you know, pretty good productivity, obviously, as we try to contain the, you know, the headcount increase, but we're still seeing some favorable GTM growth. So I think that's kind of where we're heading. Otherwise, the, you know, the wage inflation is about 3%.
Kenneth Scott Hoexter (Analyst)
Thank you, Ken.
Luc Jobin (CFO)
Thank you.
Operator (participant)
Thank you. The next question is from Benoit Poiré, from Desjardins Capital Markets. Please go ahead.
Benoit Poirier (Analyst)
Yeah, thanks. Claude, we've seen your comments with respect to CN's robust train securement policy. Could you please share with us your thoughts on the broader safety implication for CN and the rail industry following the runaway train accident on the MMA at Lac-Mégantic?
Claude Mongeau (CEO)
Thank you, Benoit. It's a fair question. As I said earlier, we are analyzing every aspect of what could have gone wrong on the MMA to cause a runaway train situation, and we're also assessing all of our train securement policies. When it's for a train that is attached to locomotive, our policies require our crew members to put on a full application of air brake on the entire train, and that's in addition to adding the independent and the hand brake applied on the lead locomotive. We also require our locomotives to be locked when they're unattended and have a reset safety control device in place to act as backup to prevent uncontrolled movements, even if the locomotive is shut down.
So the bottom line is we feel that our train securement policies are robust, but we are nevertheless reviewing them in light of the accident. But before we conclude our assessment, we first need to understand what actually happened here. We don't know at this point exactly what happened, and suffice it to say that it's much more complicated than just finding out how many hand brakes were set. The TSB will have to answer several questions to understand how many issues combined to breach multiple safety defenses and cause this tragic accident. You know, were the handbrakes properly secured, and was a push-pull test done? What caused the fire on the controlling locomotive? Why was the locomotive shut down without compensating action? Why did the air pressure on the independent brake leak out in minutes as opposed to in hours?
Even then, why did the required Reset Safety Control device not play its role as an ultimate backup safety defense to stop the train when it detected movement? As you can appreciate, Benoit, a lot of things had to go wrong, and it really is premature to conclude or render judgments on safety policies without all the proper facts. This accident is a sobering reminder to industry that safety is of the utmost importance, and I hope that stakeholders as well as regulators will allow careful analysis to shape decisions and properly target actions to further improve safety in the future.
Benoit Poirier (Analyst)
Okay, thanks for the time.
Operator (participant)
Thank you. The next question is from Tom Wadewitz, from J.P. Morgan. Please go ahead.
Thomas Richard Wadewitz (Analyst)
Yeah, good afternoon. I think this is a question for you, JJ. You mentioned that you're up to a run rate of about 70,000 annual loads, I think, in the crude by rail. How do you think that... how do you expect that to trend in the second half of the year? Would you expect a further step up? And I guess, you know, one of the questions that's come up for other railroads is just any kind of impact from spreads. I know you wouldn't be tied as directly to, kind of WTI Brent, but is there any kind of change in the customer, I guess, discussion that you have related to the kind of, you know, broader changes in spreads? Thanks.
Jean-Jacques Ruest (CMO)
Thank you, Tom. Well, starting with our expectation for the next six, 12, 18 months, we still believe there will be an increase in the volume. The percent may not be the same because the base is getting bigger, but there's still a, you know, a likelihood that crude by rail will continue to rise in volume. The question of the spread, we're more tied to the Western Canada Select than we are to the spread with the Brent. I think that's more relevant to our marketplace. Those spreads have been narrowed, but they're not, it is not as narrowed as the spread between WTI and Brent. I think short term, the change in the spread has no impact, because people already made a decision.
They've bought their product. Product that has been bought, they will be delivered. So the question is maybe more a couple of months from now and whether or not, you know, there will be some change in the run rate. I think all in the value of using the two mode is real. It has generated much better pricing for the Western Canadian and Saskatchewan producers. I think, based on those success, those improvement, year to date on spread, you know, people would be likely to maintain the use of the two mode because that has really worked out for them. Time will tell after that, but, you know, what we see today in the change of spread has been a result of using the two mode.
Thomas Richard Wadewitz (Analyst)
Okay, great. Thank you.
Claude Mongeau (CEO)
Thank you, Tom.
Operator (participant)
Thank you. The next question is from Sherilyn Radbourne from TD Securities. Please go ahead.
Cherilyn Radbourne (Analyst)
Thanks very much. Good afternoon. I also wanted to ask you one on crude by rail, because on last quarter's call, you alluded to some discussions that you were having with larger producers and refiners with respect to crude by rail investments. So I just wondered if there was any update you could give us on those dialogues and when we might hit an inflection point and see a shift to more unit train, traffic on your network versus manifest.
Jean-Jacques Ruest (CMO)
Okay. Thank you, Sherilyn. Yes, most of these projects are based in Western Canada, mostly Alberta, mostly around Edmonton. Those investments are proceeding, meaning terminal around Edmonton or north of Edmonton, who will be able to either a new one or, you know, what's most of the more likely is unit train that could load unit train and ship that out. So sometime late this year and next year, you will see a train that will move into movement of block based on the on the terminal, which are built by a large company, you know, well put together, something with a lot of efficiencies, something eventually also will mean that more and more refineries will may probably get the product directly as opposed to via you know, transport terminal.
Cherilyn Radbourne (Analyst)
Okay, thanks. That's my one.
Jean-Jacques Ruest (CMO)
The interim investment is still there today.
Cherilyn Radbourne (Analyst)
Thanks. That's my one.
Jean-Jacques Ruest (CMO)
Thank you, Sherilyn.
Operator (participant)
Thank you. The next question is from Chris Wetherbee, from Citi. Please go ahead.
Christian F. Wetherbee (Analyst)
Thanks. Good afternoon. Maybe just a question, when you think about kind of the guidance for the second half of the year, what's implied by the guidance for the second half of the year? I think, JJ, you mentioned that the volume outlook is a little, is positive, but a little bit softer in the third quarter, and it kind of implies a bit of a pickup on the volume side into the fourth quarter. Maybe you could help us kind of run through some of the dynamics that may change as you go from the third quarter into the fourth quarter with a pickup in that volume. I think it's mostly around the bulk side, but just curious to get a little extra color there.
Jean-Jacques Ruest (CMO)
Yeah. Thank you, Chris. So definitely, when you look at the summer months, summer being all the way to the end of September, the grain will be soft because both in Canada and the U.S., there's basically barely any grain for us to move. We have to wait for the next crop. So that's one of the difference between third and fourth quarter. Another difference is in the summer month. Right now, we're moving, you know, barely any kind of significant amount of fertilizer, whether it's potash or nitrogen, nitrogen-based fertilizer. Again, we hope that in the fall, there'll be a good application season, and what's already in the marketplace, inventories are very high. But if there is a fertilizer application in the fall, that we will see some of that.
And then you have intermodal, which there will be a peak, and nothing to have a nosebleed, but there will be some kind of a pickup in intermodal. Some of our customers are saying maybe, like a 3% increase in the run rate, if you wish, from the quarter to quarter. Some are saying it could start as early as, sometime in August. Some are saying what might be as late as September. Time will tell. But these are some of the difference between third and fourth quarter. Big difference on the bulk side. Bulk is soft, grain is soft, and coal has been, you know, coal is sort of changing a bit of direction here, whether it's coking coal or thermal coal, we've had more success in the past.
Christian F. Wetherbee (Analyst)
Great. Thank you.
Jean-Jacques Ruest (CMO)
Thank you, Chris.
Operator (participant)
Thank you. The next question is from Walter Spracklin, from RBC Capital Markets. Please go ahead.
Walter Noel Spracklin (Analyst)
Thanks very much. Good afternoon, everyone. Just wanted to follow up on the volume expectations, JJ. It seemed to me, going through the quarter, following your weekly car loads, that you had been running still at a very strong rate right up until the very end of the quarter. It seemed to have taken a little bit of a hit toward the end. I would assume that that's sort of the backing behind your caution going into the third quarter. My question, I guess, is around the nature of that decline. It does seem broad-based, but I'm curious as to whether you're seeing any just a significant reduction in demand, or are we seeing some market share shift to truck or over to your competitor?
Just if you could give us a little bit of color around the dynamic around the declines you're seeing.
Jean-Jacques Ruest (CMO)
Yeah, the month of June. Thank you, Walter. The month of June was definitely different than what we had in May and April. The month of June is where we start to see this major slowdown in the grain export. In June, we start to run out of grain export, both Canada and the U.S. There was not a whole lot in the U.S. to start with. We also saw also the decline of the fertilizer, namely potash. Potash was still fairly strong in month of May, namely, to the U.S. and overseas, and then, you know, that eventually, we've hit the wall with our customers. So what I was talking about in terms of the third quarter, some of that we've already started to experience in a significant way in the month of June, so.
Walter Noel Spracklin (Analyst)
No market share shift there, or?
Jean-Jacques Ruest (CMO)
No, there's no market share shift in any of our markets of any significant. There's always some, puts and takes back and forth, but these are not the reason for the change in run rate between, May, April, you know, June, July. It's the fundamental amount of product out there for us to move, especially on the bulk side.
Walter Noel Spracklin (Analyst)
Great. Thank you very much.
Claude Mongeau (CEO)
I would just add to JJ's point. In fact, if it was not for our market share gains, we, you know, there is a soft patch in demand, particularly in the bulk, but we are holding our own and continuing to make gains, and that, frankly, is the strategy for the balance of the year. We need to outperform base markets in order to drive our agenda forward, and that's what we've been doing in the first half and will be doing in the second half.
Jean-Jacques Ruest (CMO)
That's right. Next question?
Walter Noel Spracklin (Analyst)
Thank you.
Operator (participant)
Thank you. The next question is from Keith Schoonmaker from Morningstar. Please go ahead.
Cherilyn Radbourne (Analyst)
Yes, thanks. I'd like to ask a particular question on coal, and maybe you could elaborate a little bit on shifting demand trends. A competitor indicated strength in Illinois Basin. Has this portion of your franchise grown?
Jean-Jacques Ruest (CMO)
...The on the US coal, thank you, Keith. On the US coal, both our domestic and export were weaker. On the domestic side, because our franchise, geographically, is quite limited, we don't serve as many facilities as any other railroad in the US. The exposure we have to the franchise on thermal coal in the US domestically, we'll probably see some pickup in 2014, and but, probably not so much this year. On the export, it's all about the pricing overseas, you know? Anybody's crystal ball, the price of thermal coal in the open market and the price of coking coal in the open market, slightly better price would help us. As you know, the price is weak, our producer are gonna have a bit of a challenge.
So, you know, reading the crystal ball of the world market, these two commodity is what will eventually turn the tide for thermal coal and coking coal in export market.
Claude Mongeau (CEO)
We do find some comfort, Keith, that the producers on our line for export met coal are a low-cost producer. So it's difficult for all producers in a tough market, but they're working hard to maintain their advantage from a cost standpoint, and we hope the business will recover into 2014.
Jean-Jacques Ruest (CMO)
And in the meantime, we keep building the infrastructure, both, you know, the service to Rupert and service to U.S., and to Gulf, such that as market come back, we, we don't have logistical, bottleneck, at the port. So those, those efforts, logistically, and as well as investment in those terminal, is still going on, getting ready for the next, upcycle.
David Michael Zazula (Analyst)
Thank you.
Claude Mongeau (CEO)
Thank you, Keith.
Operator (participant)
Thank you. The next question is from David Tyerman, from Canaccord Genuity. Please go ahead.
David Michael Zazula (Analyst)
Yes, hello. I was interested in your comment, Claude, that you've been making market share gains, in the first half, and you intend to in the second half, too. I was wondering what areas you're seeing, particularly, that you're making gains. And related to that, obviously, your major Canadian competitor is lowering its cost base significantly. I'm wondering if you're seeing any more aggressive, market share things going on from them at this point?
Claude Mongeau (CEO)
Mm-hmm. We focus to outperform base markets. That means we have to gain market share against the other railroads, not just our principal competitor in Canada, but all railroads that we compete with. We also have to make market share gains against other modes of transportation, truck first and foremost, but also pipeline, and to a lesser degree shipping, barge, and other shipping opportunities. That's basically what we're doing. We're innovating, for instance, in our intermodal service, both overseas and domestic, and we're gaining market share against trucks, against other railroads, and a range of initiatives that are helping us outperform base market in that particular segment. Similar story in merchandise. It's about leveraging our franchise in frac sand and energy consumables.
It's about improving our service so that we can help our customers, you know, win in their own market and allow them to give us a higher share of their wallet. We're doing it in bulk. The market share there is more against other sources around the world. Especially in tough times, we have to have the best possible service so that our coal producers don't miss a beat and move as much coal as the market will allow, especially in a down market. And so at the end of the day, for the last three years, we've been outpacing markets because we are gaining market share in all of those segments against all modes, and that's what we plan to continue in the future.
David Michael Zazula (Analyst)
Great. Thank you very much.
Operator (participant)
Thank you. The next question is from Bill Greene from Morgan Stanley. Please go ahead.
Bill Greene (Analyst)
Yeah. Hi there, good evening. Luc, maybe I could ask you to comment a little bit on your cost inflation. What sort of where do you peg it, and what do you target in terms of productivity each year?
Luc Jobin (CFO)
Well, it's a, it's a tough question from the standpoint of it depends, again, on what the business volumes are and what we're, you know, what we're seeing in terms of, you know, train starts and those kinds of things. So I mean, ideally, we'd like to see a continuous push on productivity. The business is not linear, so there are moments where we're adding on more business, and, and it just, it goes, you know, up in, in terms of step function. Clearly, we're seeing a little bit of, of slowdown, and I think we're gonna be mindful of, just, you know, pacing ourselves in terms of, of headcount and, and ensuring that, you know, we're getting the most out of the, you know, the productivity of the existing workforce.
So, typically, we've been more on the, you know, hiring a little bit ahead of schedule, given that we were seeing some, a little bit steeper growth. So now we're kind of recalibrating that a little bit, and, maybe Jim has a few comments he'd like to add on that.
Jim Vena (COO)
Luke, we're always looking to make sure that we get the best Train Productivity, the most amount we can add on the train service we have, and you hit it right on the nail. There's times when you have to, you have to have new service on. When you open up the Frac Sand and the Barron Sub that we opened up last year, you know, it's a brand-new service, and you have to add people on there because you can't add anything from scratch. But on the other hand, I think, with where everything I'm being told from JJ and what the marketing expertise I'm getting, we're looking at, we are gonna tighten up how we hire.
We're not gonna be looking out so far, so far forward and make sure we've got a lot of, lot of ways in the company to be able to help ourselves with the, the use of-- the way we use people. So I think we're gonna tighten up forward our hiring and not be looking out quite as far, just to make sure that we're not, long.
Jean-Jacques Ruest (CMO)
...Thank you.
Luc Jobin (CFO)
Thank you, Bill.
Operator (participant)
Thank you. The next question is from Brandon Oglenski from Barclays. Please go ahead.
Brandon Oglenski (Analyst)
Hey, good afternoon, everyone. Maybe if I can just follow up on that question from Bill. Specifically on D&A you know, that had a big upstep this quarter. And Luke, should we be modeling that new level of run rate of D&A? And then secondly, I do think you called out an item in casualty and other, but how do we look at casualty expense going forward? There's obviously some volatility there.
Luc Jobin (CFO)
Yeah, I mean, depreciation and a, I think, you know, overall, as you look through the year, I'd probably peg it somewhere around, you know, 10% of revenues, I mean, ballpark. And what we did indicate is we're seeing some headwind in terms of the depreciation studies that we're in the course of completing. They're not all done, but, you know, we have more to do there. All in all, I'm expecting probably somewhere in the order of about CAD 75 million increase in depreciation, as we look to complete the year. So we'll see. I mean, you know, that's still a little bit up in the air, 'cause we haven't completed all the depreciation studies.
On the C&O, you know, again, it, it can be a bit bumpy, so, these things don't, are not linear, and they don't go in, you know, every quarter like clockwork. We did have a very good quarter. And again, we're very mindful of expenses. So I, you know, somewhere between CAD 75-80 million a quarter is, is usually something that I would think is, is doable. So, you know, I'd, I'd look around CAD 80 million as a safe number to use. All in all, that's about 3%, again, of, of, revenues year in, year out.
Brandon Oglenski (Analyst)
Thank you.
Luc Jobin (CFO)
Thank you, Brandon.
Operator (participant)
Thank you. The next question is from Steve Hanson, from Raymond James. Please go ahead.
Steven P. Hansen (Analyst)
Oh, yes, thanks. Good afternoon. As it relates to the crude by rail phenomenon, several of Canada's largest heavy producers seem to have suggested here that they're intent on strategically committing a certain portion of their output to crude by rail, and that would seem to suggest a growth commitment, irrespective of the spread environment. I'm just wondering whether or not you guys are seeing, in your discussions, any sort of type term commitments out there, or take or pay type commitments on some of the terminaling side and, or in the rail business itself?
Jean-Jacques Ruest (CMO)
Yes, Steve, definitely, there's when you talk about the heavy crude, the one that you would move before you actually add the diluent, now you're, you're into a different ballgame. The spread is important, but the fact you'd be sending a product which is undiluted is also very, very important for both the seller and the buyer. If the buyer is looking for heavy crude, he's looking for heavy crude, not diluent. And if the seller would rather not put the diluent into it, if he can sell it as is. So there is quite a number of these terminals which are being built in around Edmonton, which are targeting a more heavier type product, if you can capture it before it gets diluted to pipeline spec.
That's one of the attractions of moving it by rail: moving in product which is more heavy and more attractive to those who can refine it. So it is one of the positive stories of rail, and it's one where some of the investments are coming in as we speak in Alberta, both on the fleet side, because you need a different tank cars, and also on the loading side, because you obviously load and unload these products differently than if it was Bakken crude.
Luc Jobin (CFO)
And it requires a little bit of more investment in terms of steaming capability-
Jean-Jacques Ruest (CMO)
Yes.
Luc Jobin (CFO)
So those, those supply chain are being built as we speak, and they require, you know, large refiners or, you know, oil producers to back up those investments.
Jean-Jacques Ruest (CMO)
Yes.
Luc Jobin (CFO)
We're there in the middle to connect those markets to destinations with the flexibility that comes with rail.
Jean-Jacques Ruest (CMO)
Well, you're right, that is the producer would back up those capital investments, either terminal or fleet, with volume commitment or commitment to use them. And, you know, these are obviously part of their ways to hedge the commercial risk, commercial risk of, you know, one mode versus another.
Steven P. Hansen (Analyst)
Okay, helpful. Thank you.
Luc Jobin (CFO)
Great. Thank you.
Operator (participant)
Thank you. The next question is from Scott Group, from Wolfe Research. Please go ahead.
Scott H. Group (Analyst)
Hey, thanks. Good afternoon, guys.
Luc Jobin (CFO)
Good afternoon, Scott.
Scott H. Group (Analyst)
First, real quick, hopefully, this doesn't count as my one, but Luc, can you just clarify what you said on an earlier question on CN? When you talk about a CAD 75 million increase, are you saying full year 13 versus 12, or kind of the second half versus the first half is a CAD 75 million?
Luc Jobin (CFO)
No, full, full year 2013 versus 2012.
Scott H. Group (Analyst)
Okay, perfect.
Luc Jobin (CFO)
Yeah.
Scott H. Group (Analyst)
Okay, great. Thanks. And then just... So my question is on the yield side. We saw three of the segments reported yields down slightly year-over-year, and we haven't seen that in a while. And just kind of wondering if you think that that's kind of intra commodity mix, or if there's any underlying slowdown in pricing? And why aren't, just maybe at a higher level, why aren't yields better if you're getting 3%-4% pricing and RTMs are growing faster than carloads? I would think that'd be positive for mix and yields would be even better.
Jean-Jacques Ruest (CMO)
Scott, are you referring yield as in cent per RTM?
Scott H. Group (Analyst)
Revenue per carload, I guess, is how we, we have it in our model.
Jean-Jacques Ruest (CMO)
Okay. Revenue per carload, again, your revenue per carload, the biggest factor in revenue per carload is length of haul, so you're going back to mix and same thing percent per RTM. I mean, that's, I guess fortunately or unfortunately, I mean, the data, the public data does not really give a good reading when it comes to yield. The real yield come from same store price. Exact same sales year over year, same payer, same origin, same destination, same car. And, and, and after you strip out the fuel surcharge impact, and you strip out the exchange, that's how you get to, that's how you get to yield. And based on those, more precise figures, and that's how we manage yield, you know, the, the price, the same store price, as I said, was up 3.4%.
By the time you get that into a revenue per carload or cent per RTM, now you get a whole, you know, impact of fuel surcharge, the whole impact, especially of mix.
Cherilyn Radbourne (Analyst)
And exchange?
Jean-Jacques Ruest (CMO)
And exchange. And last year, we had, one of my competitor had a work stoppage, or a mix of business, obviously, year-over-year was kind of a little different from a runway point of view. So the same store price was 3.4%. The rest, you know, it's all in the, basket of, mix and, these other things that we talked about.
Claude Mongeau (CEO)
Thank you, Scott. You have squeezed in 1.5, but everybody's been well behaved so far.
Bill Greene (Analyst)
All right, thanks, guys.
Operator (participant)
Thank you. The next question is from David Vernon from Bernstein. Please go ahead.
David Scott Vernon (Analyst)
Thanks, guys. I wanted to see if you could maybe comment a little bit on the length of haul for the crude oil business by rail, and then also how that's impacting the employee productivity, which, congratulations, hit another all-time high in the quarter of 4.25, based on our quick math anyway.
Claude Mongeau (CEO)
Well, you know, clearly, we hit a number of records on productivity metrics, and also in terms of our overall volume and profitability. The crude business is very length, long haul. Our franchise from Western Canada, all the way down to the Gulf, or our franchise from Western Canada, all the way to Eastern Canada, are very long-haul moves. And so, it's business obviously allows us to have efficient train service, and it's volume that's helping our productivity and helping also our volume and revenue.
David Scott Vernon (Analyst)
Do you have a specific number on the length of haul, just to help us kind of model out what the RTM would be looking like?
Claude Mongeau (CEO)
I don't have a specific number, and we know Janet would be happy to give you a sense of things, but it's about the longest haul we have. When you get all the way down to the Gulf Coast, it's more than 2,000 miles, and depending on where you're going in Eastern Canada, it's clearly above 1,400 miles, you know, to get from Alberta, say, to Eastern Canada refinery.
David Scott Vernon (Analyst)
Great. Thank you.
Claude Mongeau (CEO)
Thank you.
Operator (participant)
Thank you. The next question is from Allison Landry from Credit Suisse. Please go ahead.
Allison Landry (Analyst)
Good afternoon, thanks for taking my question. I was wondering if you could give us your thoughts on the Canadian Rail Service legislation that was passed recently, and how you think that might affect the competitive landscape for the rail industry going forward.
Claude Mongeau (CEO)
Well, we've been on this file for the last four or five years, Allison, as you know. Our strategy is to improve service and become a true supply chain enabler. So, we will continue with that strategy. As long as we offer good service, we hope the customers will recognize that and give us more business and be willing to pay a fair price for our services. The changes in the law are in. We'll see how it goes, but as long as we provide good service, hopefully, we don't need to go to the government for arbitration.
Cherilyn Radbourne (Analyst)
Okay. Thank you.
Operator (participant)
Thank you. The next question is from Steven Paget, from FirstEnergy. Please go ahead.
Steven Paget (Analyst)
Good afternoon, and thank you. On intermodal, do you believe you might gain some pricing power in the second half of the year after per unit prices declined in the first half?
Jean-Jacques Ruest (CMO)
On intermodal, again, it's a question of same-store price versus revenue per unit or revenue percent per RTM. So we'll have this issue of mix behind us eventually in terms of the relation with the work stoppage. And in intermodal, our fuel surcharge is based on WTI, and you saw what's happening to WTI. It's a little weak. Yeah. And then it's eventually gonna come back up.
On the same store pricing, I think the intermodal segment is not our biggest segment in terms of price power, but we're working very hard to make sure that we trend in the right direction, step by step, step by step, and that's where the effort is all about. Well, thank you, JJ. That's my one question.
Steven Paget (Analyst)
Thank you.
Operator (participant)
Thank you. The next question is from David Newman from Cormark Securities. Please go ahead.
David Newman (Analyst)
Yes, one for Jim here. It looks like you guys pulled out all the stops, pardon the pun, in Q2 versus Q1 on a tough weather comp. I guess my question is: How much is systematic based on some of the initiatives you've put in in the past with SmartYard versus tactical to recover from Q1? I guess, how sustainable is it, and are these the new levels we can kind of expect going forward?
Jim Vena (COO)
Well, appreciate the question, David. First of all, I didn't even look back at the Q1. You never heard me mention it.
David Newman (Analyst)
It's a tough weather comp, but I'm just kind of looking at Q1 was tough, so obviously you've made a concerted effort in terms of improving the operations in Q2, which I believe customers appreciated. But where are you at, and is this sustainable?
Jim Vena (COO)
Well, we're lapping previous, previous, year's numbers, and in fact, in June, we had a spectacular June in our operating metrics, and we're doing it by being out on the ground. I spent a lot of time out in the field with the whole team, and I know John Orr, you know, he's willing to give up his holidays or vacation to get out there and see what we can do better, but I told him to go because it's important to go. So is it, can we maintain this? I think we can maintain. There's always in operations, things you can't control, and weather can be one of it. So-
... I'm always cautious in saying this is maintainable forever, but I don't see anything else stopping. We were able to take the extra volume that came in this past quarter and be able to keep the metrics running at where I'd like them, and maybe there's a little bit of room left yet even to make them a little bit better. So I'm looking forward to the challenge with the rest of the team.
Operator (participant)
Very good. Thanks, gentlemen.
Claude Mongeau (CEO)
Yeah, David, Jim is very humble. I've been watching him here for the last, you know, couple of months, and I have to say that it's a range of initiatives, blocking and tackling, leveraging on the, you know, fundamental structural initiatives that we have out there to improve service and improve productivity at the same time, and we are hitting new heights. I mean, every one of our metrics is at or near our best performance ever, and I see momentum. I think it's the floor. You'll see continued progress. As long as we can focus with discipline, we can accommodate that business at low incremental cost. We can do it with good operating metrics and continue to operate to improve service. That's the game plan. It's working, and Jim is doing a bang-up job.
Operator (participant)
Congrats, guys.
Jim Vena (COO)
Well, thanks for the pressure, David. You just told me I better get out in the field. I got my bags packed.
Operator (participant)
Thank you. Thank you. The next question is from Turan Quettawala from Scotiabank. Please go ahead.
Turan Quettawala (Analyst)
Yes, hello, good afternoon. I had a quick question on intermodal. JJ, you talked about some weakness here at Rupert, and I know you said it was related to shipping, shipping companies changing market share there. I'm just wondering, are you gaining some of that back, I guess, in Montreal, in Vancouver, sorry, or is that being lost to your competitors just based on the changing in the shipping companies or maybe even leaking to the US? Thank you.
Jean-Jacques Ruest (CMO)
Thank you, Turan. Yeah, we are. I'd have to believe that in large part, we're gaining it back. We're when you look at total market share, without getting into specific numbers, we're the dominant carrier in Canada for overseas, so business from time to time shifts from one shipping line to another. In that case, it probably shifted from the Port of Rupert to the Port of Vancouver. Our Vancouver results are very strong. Some of that might be product that used to be coming over Rupert. One of the lines in Rupert tried to be very aggressive on pricing, and they have lost some business during that, you know, main contract re-season.
They're trying to get some of this business back, but they lost to somebody else, and that somebody else is probably more likely coming out of one of the three terminal in Vancouver. So I would call that market share shifting within the shipping line more so than shifting between, you know, one railroad to another. I mean, the Canadian market is maybe not quite as strong as one would have think, and the US economy is a little better than the Canadian market right now. So we've seen better days in terms of the Transpacific trade, all in the Canada, US. But I think what's happening at Rupert is specific over one shipping line strategy for this year's contract season.
Claude Mongeau (CEO)
We applaud their effort because the shipping lines have to improve pricing over time, and it's quite constructive. I would just add to JJ's comment that with housing starts on the mend here, with good recovery, this should bode well, not just for lumber movement between Canada and the US, but also for container traffic out of the West Coast port. When people, you know, buy a new house, they tend to buy furniture, TV, and a whole lot of appliances. And typically, for every housing start, there's lumber, but there's also a lot of container goods that come from Asia. So we're hopeful that the trend in Vancouver, which is very positive, will continue, and we are hopeful that Rupert will gain momentum here in the next little while.
Maher has ordered and is about to install another crane at their terminal, and Luke was giving me a report today that our siding at the Kaien Siding is gonna be complete between now and year-end. So we will have capacity to accommodate growth at Rupert when the business comes back.
Turan Quettawala (Analyst)
Great, that's very helpful. And I guess really quickly, is there a change in the US to Canada bound volume for your, for your intermodal?
Jean-Jacques Ruest (CMO)
Our business to the U.S. is still growing.
Turan Quettawala (Analyst)
Okay.
Jean-Jacques Ruest (CMO)
It's growing as a result of what, flow adjusting here in economy and housing stuff, but also growing because we're added these smaller terminal, which are just about to start up.
Turan Quettawala (Analyst)
Great. Thank you very much.
Jean-Jacques Ruest (CMO)
Thank you.
Claude Mongeau (CEO)
Thank you.
Operator (participant)
Thank you. This concludes today's question and answer session. I would like to turn the meeting back over to Mr. Mongeau.
Claude Mongeau (CEO)
Well, thank you, Patrick, and, thank you to all of us. You were very disciplined. I think we had two one-and-a-half questions and a number of very good questions. We are pleased, as again, as I said, we are pleased with our results in the second quarter. We do have momentum in place, and we are gearing up to finish the year strong and deliver on our commitment to you and our shareholders in terms of overall financial performance for 2013. To all of you, have a safe day, and wish to talk to you soon on our Q3 results.
Jean-Jacques Ruest (CMO)
Thank you.
Jim Vena (COO)
Thank you.
Turan Quettawala (Analyst)
Thank you.
Operator (participant)
Thank you. The conference has now ended. Please disconnect your lines at this time, and thank you for your participation.