Canadian National Railway Company - Q2 2019
July 23, 2019
Transcript
Operator (participant)
Welcome to the CN second quarter 2019 financial results conference call. I would 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)
Well, thank you, Eric. Good afternoon, everyone, and thank you for joining us for CN's Second Quarter 2019 Earnings Call. I would like to remind you about the comments already made regarding forward-looking statements. With me today is JJ Ruest, our President and Chief Executive Officer, Ghislain Houle, our Executive Vice President and Chief Financial Officer, Keith Reardon, our Senior Vice President, Consumer Product Supply Chain, James Cairns, our Senior Vice President, Rail-Centric Supply Chain, and our recently appointed Executive Vice President and Chief Operating Officer, Rob Reilly. Once again, I do want to remind you to please limit yourself to one question so that everyone has the opportunity to participate in the Q&A session. 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 President and Chief Executive Officer, JJ Ruest.
JJ Ruest (President and CEO)
Well, thank you, Paul, and good afternoon, everyone, and welcome to our Second Quarter Earnings Call. We delivered solid results from top-line revenue growth of 9%, which is actually our best-ever quarter in the company history, and from adjusting our costs to the slower pace of growth we experienced in selective markets during the quarter. We produced adjusted EPS growth of 15%, revenue growth of over CAD 200 million, and the operating ratio was a solid 57.5%. I'm going to do a quick review of the last quarter operation. Our GTM production, our production rate, was up 3% over the last year, but more important, it was up 5% in our key Western Region, a record production for the West. Our operating metrics also continued to improve on a year-over-year basis. For example, car velocity was up a strong 9%, and railcar dwell time was down a solid 11%.
During the quarter, we reduced active rolling stock and park, or return lease, or scrap, the least productive of our rolling stock for a total of roughly 8,700 railcars and 60 locomotives. We currently have about 200 qualified train crews on temporary layoff in our Western Region, waiting for the crude-by-rail volume opportunity to pick up higher. We continue to progressively tighten down our overall management headcount. As a result of these actions, our operating ratio sequentially improved every month during the quarter, and it stood at a solid 57.5 for Q2, which is 70 basis points better than last year. Now, a quick review of the second quarter top line, which, as I said earlier, was our best-ever quarter in the company history, with nearly CAD 4 billion of revenue. Carload and RTM were both up 2%, and the price continued to be solid and above rail inflation.
Intermodal revenue was up 15%, reflecting the addition of the TransX intermodal product into our suite of product. Automotive revenue was up 5%, and we have line of sight on future new business. Coal revenue grew 1%, as our Canadian coal export franchise did offset the current weak U.S. coal market, and we like our position in Canadian coal over the midterm. Canadian grain revenue was up 11%. CN Canadian grain export tonnage is now up 2.1 million tons ahead of last year, and yet the Chinese ban on Canadian canola is pushing some of last year's crop into a higher carryover opportunity into the next year's crop. U.S. revenue of grain was also positive, up 21%, mostly from export. On crude, we moved on average 150,000 barrels a day in April, 180,000 barrels a day in May, and 200,000 barrels a day in June.
We estimate our capacity can support a total of about 300,000 barrels a day, with ability to generate more revenue ton-mile growth than carload growth because of our unique long-haul reach into Louisiana. Lumber production in British Columbia is facing some recent cyclical downturn, so we parked and returned the lease of 16% of our least efficient lumber cars. Frac sand demand did not turn out to be nowhere near what our customers had indicated that their market would require. Looking to the balance of this year and next, we are cautiously optimistic. We have a diverse pipeline of organic growth and line of sight on some market win ahead of us. We are also integrating TransX and the unique product depth that we now have in the less-than-truckload intermodal marketplace. Our first market win using our more sophisticated suite of product is a Canadian retailer, Hudson's Bay.
In regard to 2019, we are reaffirming our guidance with continued focus on cost, focus on our PSR operation, and focus on growth, but staying very mindful of market volatility. With that, I would like to introduce Rob Reilly, our Chief Operating Officer as of July 1st, and I'll have Rob give you some comments.
Rob Reilly (EVP and COO)
Thank you, JJ Thank you. I'm very excited to join the CN team under JJ's leadership and his vision of one team after 30 years of railroading with the Santa Fe and BNSF Railway Companies. In the short time that I've been here, I've had the opportunity to spend the majority of my time out in the field, seeing the operation, meeting the key players, and I've been very impressed with the leaders I've met. Really, there is no better example of the CN team working together as one than what I personally witnessed at the Sarnia Tunnel derailment a couple of weeks ago, with the team working tirelessly around the clock to restore service to our tracks, not only restoring service to our track, but most importantly, completing that complex undertaking injury-free. It was very impressive to see the CN professionals in action out there.
It's clear to me that this is a well-run organization, and it's a privilege to be part of it. However, our work is not done here. So I believe we have opportunities to improve in safety, become more efficient leveraging the technology, as you're able to see at our Investor Day in June, and still continue to grow with our customers, and not only grow, but grow profitably for our shareholders. That is where my focus will be, is in running a safe, efficient railroad for our customers and shareholders. And again, very glad to be part of this team. With that, I'll pass it over to James for the marketing outlook. James.
James Cairns (SVP of Rail Centric Supply Chain)
Thanks, Rob. So looking at the second half of the year, we still see volatility in a few markets, including grain, lumber, U.S. coal, and crude. Fundamentals for crude remain strong for the second half of 2019. August spreads are challenging for rail, but we have a few new contracts starting in August that will ramp up through the balance of 2019. A change in government curtailment policy could impact demand moving forward. U.S. coal could recover in Q3 as water levels on the Mississippi River subside. The API 2 U.S. coal benchmark pricing has shown some improvement recently. We are watching this closely. Canadian coal will continue to ramp up through H2 as Coalspur's new mine increases production. We were very happy to see the announced sale of RTI to AMCI and Riverstone.
With the right level of investment, Ridley can double its coal handling capacity, and this bodes well for CN bulk export opportunities via Prince Rupert. Propane volume will continue to be strong with sequential growth from Q2 to Q3, driven by full ramp-up of the AltaGas facility in Prince Rupert. Next up for propane will be the Pembina project at Watson Island in the Prince Rupert area, which is scheduled to start up in the second half of 2020. We have the capacity to move more grain products than there is current demand. Uncertainty around the ban of canola exports in China will push a larger-than-expected grain carryover into the new crop year. New export facilities on the West Coast, combined with new-built loop track elevators in the country, will help us continue to move record volumes into new crop year.
Refined products revenue is up 20% in Q2, and we expect to see continued growth in this segment through the balance of 2019. We handle a significant majority of refined products originating in Alberta and over 90% of Greater Toronto Area destined refined petroleum products carloads. Full impact of BC mill closures and production curtailments will be a headwind for the forest products volume for the balance of 2019. We're right-sizing our fleet and resources accordingly. Thank you, and I'll now pass it over to Keith Reardon, who will provide a brief overview of the consumer products market outlook. Keith.
Keith Reardon (SVP of Consumer Product Supply Chain)
Thanks, James. Good afternoon, everybody. While the consumer products market is more tied to consumer spending in North America, we have also been faced with some softness in the segment. On the international intermodal front, trade tensions between the U.S. and China created a pull forward of traffic late last year and early this year, which eventually led to a slowdown in volumes in Q2. As we start heading into the traditional peak season, we do expect volumes to recover. It is currently difficult to assess the size of this year's peak. However, we are seeing volumes improving over Q2. We are seeing this at the port of Prince Rupert, for example, where in June the volumes were up 3% and up more than 24% so far in July. Rupert is running at an annualized run rate of 1.25 million TEUs.
I'm also very pleased to announce that we have renewed several of our long-standing customer contracts in this segment, including Hapag-Lloyd and Evergreen. When appropriate, we will also announce the other overseas customers that we have successfully concluded negotiations with. This once again highlights the strong relationships with and commitments from our partner steamship lines that benefit from our strong service offering, our unique market reach, and our key competitive advantages. We are also very excited to have teamed up with Hutchison Ports, a world-class port operator from Hong Kong, and a JV to build a container terminal in Quebec City, which is connected to CN and many destinations across our respective networks. While this is still a few years out, we are committed to continue to grow in the international intermodal segment.
We are also looking forward to working with PSA, the new owner of Halterm in Halifax, and developing that long-term relationship to attract more business to Halifax. Moving over to the domestic intermodal market, we've been working very closely with our operating team to continue to build on the service improvements that we have been seeing. These improvements have enabled us to regain more share of business back from our existing customers, and it has led to new business wins. As JJ mentioned, we continue to work on cross-pollination opportunities between CN and TransX. These efforts are also translating into new business, such as recently signing a deal to handle all of the domestic intermodal business of the Hudson's Bay Company, a major retailer in Canada.
We are also progressing with opportunities in new markets, such as the West Coast transload model, full partnership in the EMP Program, the new intermodal terminal in Regina, opening in September, as well as our continued growth in the CargoCool segment. Let me finish off by talking briefly on our automotive franchise. While motor vehicle sales in North America remain pretty muted, we are seeing new product launches moving via CN-served locations and also seeing continued growth in the SUV segment. Our new Autoport facility in Vancouver is now open, and we expect to see volumes begin to move there in a substantial way in October. We have been recently renewing contracts of several of our automotive customers. In time and when appropriate, we will be able to make those individual announcements.
But for now, I would like to announce that we have reached an extension agreement with GM that will also see us increase our business with them in October in Vancouver at the new auto compound, and in 2021 at our new auto compound in Minneapolis, which will be open in the fall of 2020. Thanks for your time today. Looking forward to answering any of your questions during the Q&A. With that, let me pass it on to Ghislain, who will provide an update on the financials. Ghislain.
Ghislain Houle (EVP and CFO)
Thanks, Keith. Starting on page nine of the presentation, I will summarize the key financial highlights of our record second quarter performance. Let me start by highlighting that this is the first quarter fully integrating TransX into our financials, impacting intermodal revenues, and on the expense side, mostly labor and purchase services. As JJ previously pointed out, revenues for the quarter were up 9% versus last year, just shy of CAD 4 billion. Fuel lag on a year-over-year basis represented a tailwind of CAD 17 million, or CAD 0.02 of EPS, driven by an unfavorable lag this quarter of CAD 11 million versus an unfavorable lag of CAD 28 million for the same period last year. Operating income came in at CAD 1,682 million, up CAD 163 million, or 11% versus last year. Our Q2 operating ratio is 57.5%, or 70 basis points lower than last year.
On a comparable basis, with every railroad that had reported, excluding the benefit of any land sales, this represents the lowest OR in the industry for the quarter. Also, the inclusion of TransX increased our Q2 operating ratio by 110 basis points. Net income is CAD 1,362 billion, or CAD 52 million higher than last year, with reported diluted earnings per share of CAD 1.88 versus CAD 1.77 in 2018, up 6%. Excluding the impact of a deferred income tax recovery from the enactment of a lower provincial income tax rate this quarter and gains on surplus asset sales in 2018, we achieve record adjusted diluted EPS of CAD 1.73, up 15% versus last year. The impact of foreign currency was favorable by CAD 28 million on net income in the quarter, or CAD 0.04 of EPS. Turning to expenses on page 10, our operating expenses were up 8% versus last year at CAD 2,277 million.
Expressed on a constant currency basis, this represented a 6% increase. At this point, I will refer to the variances in constant currency. Labor and fringe benefit expenses were CAD 681 million, 4% higher than last year. This was mostly the result of higher wages driven by increased headcount and a U.S. payroll tax rate in 2018 of roughly CAD 15 million, partly offset by lower incentive compensation expense. Looking at headcount, the year-over-year increase was mainly attributable to the onboarding of approximately 1,400 TransX employees in March. We also adjusted our workforce in the second quarter in light of weaker volumes in certain markets and have recently been recalling those employees, mainly to replace attrition. Purchase services and material were CAD 571 million, 18% versus last year. This was mostly the result of the addition of TransX business and higher material expenses.
Fuel expenses came in at CAD 442 million, or 2% lower than last year. Lower fuel prices accounted for CAD 20 million of the reduction, while higher volumes were CAD 13 million on favorable variance versus 2018. Fuel productivity improved by approximately 2.5% this quarter, as our track infrastructure investments enabled increased network fluidity. Depreciation was CAD 363 million, or 8% higher than last year, mostly a function of net asset additions. Equipment rents were 10% lower than last year, driven by reduced locomotive lease expense, as we have returned approximately 100 leased locomotives over the past year. Finally, casualty and other costs were CAD 116 million, which was 5% higher than last year, mostly due to higher incident costs from the derailment in our Sarnia Tunnel at the end of the quarter, which was shut down from over 10 days.
Now, moving to cash on page 11, free cash flow was CAD 799 million through the end of June. This is CAD 497 million lower than 2018 and mostly the result of higher capital expenditures due to the upfront delivery of new locomotives, partly offset by higher net cash from operating activities. Finally, let me turn to our 2019 financial outlook on page 12. While volumes in Q2 came in below our expectations and while trade and geopolitical issues are creating significant volatility, unemployment levels are still at record lows and consumer spending remains resilient. In the second half of the year, we are counting on CN-specific revenue growth opportunities that continue to ramp up, such as the new Coalspur thermal coal mine and the new propane terminal in Prince Rupert, both which started shipping in Q2.
In addition, as James mentioned earlier, our crude oil shipments have increased significantly in the quarter, and we're optimistic that the Alberta government will enable that momentum to continue for the balance of the year. We are therefore continuing to expect mid-single-digit volume growth in terms of RTMs for the full year versus 2018, implying a step-up in the second half of the year from the 3% RTM growth that we experienced in the first half, along with favorable pricing. In addition, we now expect our full-year effective tax rate to be approximately 25% versus the roughly 26% that we discussed last quarter. The updated estimate reflects a more thorough understanding of the draft regulations related to the U.S. tax reform that were issued last December, as well as the implementation of effective tax strategies to mitigate the unfavorable impact of those regulations for 2019.
We are maintaining our EPS guidance of low double-digit growth versus 2018 adjusted diluted EPS of $5.50, and we'll continue to right-size our resource base as needed. This guidance maintains our assumptions for the Canadian dollar at CAD 0.75 versus the U.S. dollar. However, should foreign currency remain at the current spot rate of approximately CAD 0.76-CAD 0.77 for the second half of the year, this would create a headwind for us. On the capital front, we are advancing on our large capacity track expansion program, which are expected to be substantially completed by the end of the third quarter ahead of our busy fall period. We have received so far around 125 new locomotives out of the 140 expected, and we are taking the opportunity to return expensive, less reliable leased ones.
Furthermore, we continue to reward our shareholders with consistent dividend returns, and we are on track with our current share buyback program of CAD 1.7 billion, having repurchased 6 million shares at a cost of roughly CAD 725 million since the end of January. In closing, we remain committed to our agenda of operational and service excellence, and we continue to manage the business to deliver sustainable value for today and for the long term. On this note, back to you, JJ.
JJ Ruest (President and CEO)
Well, thank you, guys. To wrap this up, where we stand right now, our operating metrics are at PSR Railroading level, and we are in good position to have good results going forward. For example, in the last four weeks, the last 28 days, our RTM are running at 6% growth so far. In the next three years, as you know, as per what we've mentioned at the investor day, we are aiming for low double-digit diluted EPS growth, normalizing our capital intensity, producing a high 50s operating ratio with ROIC in the range of 15%-17%, free cash flow that is growing faster than earnings, and dividend per share that grows in line with earnings. So, Operator Eric, we will now turn it back to you for a question from the people on the call.
Operator (participant)
Thank you, Mr. Ruest. Please press star one at this time if you have a question. The first question is from Ravi Shanker with Morgan Stanley. Please go ahead. Your line is open.
Ravi Shanker (Freight Transportation and Airlines Analyst)
Thanks. Good evening, everyone. For my first, Rob, if I can ask you, kind of now that you've been in the seat for a while and the analyst day will be around the corner, CN obviously has a long and proud history of scheduled railroading in its blood. Your former employer didn't have that, but can you just talk about some of the aspects outside of scheduled operations, maybe some of the best practices or what your former employer did really well that maybe you can bring to CN?
Rob Reilly (EVP and COO)
Yeah, thanks. Thanks, Ravi, and look forward to seeing you again. Certainly not here to compare and contrast rank and look at the BNSF Great Run Company and had great experiences there. What I've seen at CN, I've been very impressed with in terms of how they make their decisions, the speed in which they make their decisions. Great example was in the second quarter before I got here, some of the decisions were made in terms of reacting to the volumes out there, how quickly they laid up locomotives, how quickly they reacted in terms of assets. Very impressive that their finger is on the pulse. Very obvious that this is a seasoned group of scheduled railroaders, and they do a lot of things really, really well, and I've been very impressed in my few weeks here.
Operator (participant)
Thank you. The next question is from Cherilyn Radbourne with TD Securities. Please go ahead. Your line is open.
Cherilyn Radbourne (Managing Director and Equity Research Analyst)
Thanks very much and good afternoon. You knew you were going to get a question on crude by rail, so I'll go ahead and ask it. Can you just give us your thinking as to when the Alberta crude contract could transition to the private sector and how quickly thereafter you would expect to see a ramp-up in volumes?
JJ Ruest (President and CEO)
I think James is being our expert. We'll take that up.
James Cairns (SVP of Rail Centric Supply Chain)
Yeah, thank you, Cherilyn. So it's tough to say when government's involved, but I think they've stated publicly that they fully intend to have the contracts transferred to the private sector by the fall. We're ready to go as soon as those contracts get transferred over. I think the real determining factor, Cherilyn, is going to be the pace and scale of the ramp-up is going to depend on whether the transfer of contracts is timed with a reduction in curtailment or exclusion of curtailment for crude by rail barrels. We're very hopeful that's going to happen and could see some very positive news here this summer.
JJ Ruest (President and CEO)
Hopeful and ready. Got the resource. Thank you, Sheryl.
Operator (participant)
Thank you. The next question is from Benoit Poirier with Desjardins Capital. Please go ahead. Your line is open.
Benoit Poirier (VP and Industrial Products Analyst)
Yep. Thank you very much. Keith, could you provide maybe more color on the Yang Ming contract loss and also how that will impact your service at Deltaport given that your competitor's market share is expected to go from 20%-70%? Thank you.
Keith Reardon (SVP of Consumer Product Supply Chain)
Sure. Sure. So it's kind of two questions, but I'll take them. Thank you, Benoit. So the first about the Yang Ming contract, we were sitting at the negotiation table and got to the point where we said no. And that's pretty much the end of that story. With regard to the transfer of the contract over at Vancouver to Deltaport, it's a very complicated thing because you have multiple alliances, multiple carriers, slot charter agreements, and that type of thing. I can tell you within the last four years, there's been anywhere between 12 and 13. I'll look at my notes, but 12 and 13 times that the market share of who's handling the business there has gone up and down for us and back and forth. It's been a long time, though, since we've had a significant, significant share in, I think, 2015.
I think the share right now is right around 50/50. So we know that there will be a lot of changes. I think there's four or five different scenarios about what could play out over the next six months with different alliances talking to us and talking to the terminal operator about moving some vessels around, strings, that type of thing. So I don't think we can call who's going to have what type of market share and what that's going to do with regard to how much footage gets dropped on a weekly basis. So we're going to wait and see how it all plays out there.
Benoit Poirier (VP and Industrial Products Analyst)
Okay. That's great color. Thank you very much for the time.
JJ Ruest (President and CEO)
Thank you.
Operator (participant)
Thank you. The next question is from Chris Wetherbee with Citi. Please go ahead. Your line is open.
Chris Wetherbee (Senior Research Analyst)
Hey, thanks. Good afternoon.
JJ Ruest (President and CEO)
Good afternoon.
Chris Wetherbee (Senior Research Analyst)
Yeah, maybe James and Keith, maybe you could give us a little bit of a rundown of the specific drivers that you sort of have the most confidence in in terms of building the RTM growth as we move into the second half of the year. Sounds like crude by rail is likely to be one, and I think coal and maybe a couple of others are sort of the key drivers there. But can you sort of break them out a little bit and go into a bit of detail there?
James Cairns (SVP of Rail Centric Supply Chain)
Well, I think, Chris, you hit on the first two. It's going to be crude, and it's going to be coal. It's going to be grain, and it's going to be propane and intermodal, key drivers of our RTM growth going into the second half of the year.
JJ Ruest (President and CEO)
Thank you.
Operator (participant)
Thank you. The next question is from Allison Landry with Credit Suisse. Please go ahead. Your line is open.
Allison Landry (Senior Equity Research Analyst)
Thanks. Good afternoon. Just wanted to follow up on the international intermodal. It sounds like you've had some good success there, and I think you said that you had won some new contracts. So just wondering if you could give us a sense of the potential magnitude and timing of these new contracts and if we should expect any of that volume to flow through in the second half of the year. Thank you.
Keith Reardon (SVP of Consumer Product Supply Chain)
So most of those contracts are renewals, Allison. We are working on some of the other, I'll call them open contracts that are a renewal for our competitor as well. We're always looking at that. They're looking at ours. But the renewals that we had, Evergreen and Hapag, I can announce we have renewed some other contracts. It's just it's not at the appropriate time to do that, to give that announcement out per our customers, but we have renewed some, yes.
Allison Landry (Senior Equity Research Analyst)
Okay. Thank you, guys.
JJ Ruest (President and CEO)
Thank you.
Operator (participant)
Thank you. The next question is from Jason Seidel with Cowen and Company. Please go ahead. Your line is open.
Jason Seidl (Managing Director in Industrials as Airfreight and Surface Transportation Research Analyst)
Thank you, Operator. Hey, JJ's team. I wanted to touch on pricing a bit. Your outlook is to continue to have pricing above rail inflation, but how would you categorize sort of the pricing environment now and into the back half of the year compared to how it came into the year?
James Cairns (SVP of Rail Centric Supply Chain)
Yeah. Thank you, Jason. I would characterize it as stable. We continue to have success pricing ahead of a railway cost inflation. That's been our model for many years now, and we see no reason to deviate from that, and we're having success in the marketplace.
Jason Seidl (Managing Director in Industrials as Airfreight and Surface Transportation Research Analyst)
If I could follow up on in the back half of next year, obviously, the truckers are going to get some curtailments by the governments with the devices being put in their cars. Do you see that as an opportunity to maybe push up pricing on the domestic intermodal a little bit more?
JJ Ruest (President and CEO)
So maybe you want to pick that up, Keith?
Keith Reardon (SVP of Consumer Product Supply Chain)
Sure. So we saw that happen in the States. The ELDs come in line June of 2021, right? So we've already seen a significant amount of large trucking firms and large intermodal firms in Canada have already begun using those devices because a lot of them do some trans-border work as well. So I don't think you're going to see the big bang that you saw in the States, but there will be some of the smaller firms and maybe some of the mid-sized firms that they will be impacted a little bit more. We see good pricing power now. I don't know that that's going to increase at the ELDs.
Jason Seidl (Managing Director in Industrials as Airfreight and Surface Transportation Research Analyst)
Some more of a muted response than we saw in the States, then?.
Keith Reardon (SVP of Consumer Product Supply Chain)
It's not going to be the big bang. I don't think so.
JJ Ruest (President and CEO)
Just because of the cross-border, a lot of companies are already equipped. Yeah.
Keith Reardon (SVP of Consumer Product Supply Chain)
Yeah. Yeah.
Jason Seidl (Managing Director in Industrials as Airfreight and Surface Transportation Research Analyst)
Makes a lot of sense. Appreciate the time as always, gentlemen.
JJ Ruest (President and CEO)
Thank you.
Operator (participant)
Thank you. The next question is from Steve Hansen with Raymond James. Please go ahead. Your line is open.
Steve Hansen (Managing Director and Equity Analyst)
Yeah. Good afternoon, guys. Just a quick one here on the coal side. The Coalspur facility ramp-up is encouraging, but I think it has been a little bit slower than expected. Can you maybe just give us a sense for the cadence through the back half of this year and into next year and any specific issues that you see as accelerating or slowing that down? Thanks.
James Cairns (SVP of Rail Centric Supply Chain)
Yeah. I won't speak to any kind of specific challenges that Coalspur has had. Anytime you start up a new facility, a mine like that, you're going to have bumps and starts, and kind of we've seen that. Talking with our good customer, Coalspur, we see a continued ramp-up going through the balance of this year, Q3 and then into Q4. All signs are very positive for continuing growth in the carload volume that we see out of that facility.
JJ Ruest (President and CEO)
We also see the fact that the RTI coal terminal in Rupert is now finally being sold. It's in the hands of good private investors who have intent to invest and also create opportunity mid-term to see some growth in Rupert because of the new ownership.
Steve Hansen (Managing Director and Equity Analyst)
That's great. Thanks, guys.
JJ Ruest (President and CEO)
Thank you.
Operator (participant)
Thank you. The next question is from David Vernon with Bernstein. Please go ahead. Your line is open.
David Vernon (Senior Analyst)
Hey, guys. Just a quick question on the intermodal RPU. Is there a way you can separate out kind of what the growth was from TransX versus what the core growth was in the business?
Keith Reardon (SVP of Consumer Product Supply Chain)
Specifically, do you want me to bring just TransX and then our intermodal business and what the growth was?
David Vernon (Senior Analyst)
In terms of the RPU growth of 14% or whatever it is year-over-year. I'm just trying to get a sense for what it was for rail versus TransX.
Keith Reardon (SVP of Consumer Product Supply Chain)
Well, I believe I'm going to give you a roundabout number. How about this? The numbers for TransX are about CAD 100 million.
JJ Ruest (President and CEO)
In total revenue.
Keith Reardon (SVP of Consumer Product Supply Chain)
In total revenue. Should be able to back into the rest of it from there.
JJ Ruest (President and CEO)
Okay.
Operator (participant)
Yeah. Okay. Thank you. The next question is from Walter Spracklin with RBC Capital Markets.
Walter Spracklin (Head of Canadian Research Management and Co-Head of Global Industrials Research)
Thanks very much. Good afternoon, everyone. So when I look at your operating performance on a sequential quarterly basis, barring last year, it's very typical you're getting summer railroading in Canada tends to be a lot easier. So your operating ratio historically has been a lot better in the third quarter versus Q2. Just wondering if there's anything—I was just saying if you're flagging anything in the operating side that might pop up or anything that would indicate that historical trend, albeit barring last year, that historical trend wouldn't continue into the summer period here for CN this year.
Ghislain Houle (EVP and CFO)
Yeah, Walter, thanks for the question. Listen, I think it's steady as she goes. Obviously, we're not going to give any guidance on the OR on a quarterly basis, but as you can see, we're continuously improving our OR on a year-over-year basis as the capacity is there and as we have the right infrastructure. So that's exactly our game plan. And I think over the next couple of years, as we provide guidance at our Analyst Day that you've attended, I think that we're comfortable that we'll get into the high 50 OR, which is what we've said to the market. And on a quarterly basis, you can make your own assumptions. We're not going to go there on a quarterly basis. Just be careful when you look at it on a quarterly basis. There's sometimes timing.
So, OR, you need to look at it, and we look at it over the next few years. We're right on our game plan, and we're very pleased this quarter because we actually delivered what we said we were going to deliver. So we're very pleased about this. When you adjust for asset sales, as I said in my remarks, then we have the lowest OR in the industry. So we're pretty pleased about that.
Walter Spracklin (Head of Canadian Research Management and Co-Head of Global Industrials Research)
Okay. Thank you very much.
JJ Ruest (President and CEO)
Thank you.
Operator (participant)
Thank you. The next question is from Brandon Oglensky with Barclays. Please go ahead. Your line is open.
David Zazula (Senior eVTOL Equity Research Analyst and Transportation Associate)
This is David Zazula on for Brandon. Just had a quick question. What we saw at the Investor Day was the infusion of some outside talent that you'd brought in. We'd heard from Rob already. We noted you had hired a new Chief Digital Officer and was wondering if you could talk about some of the experiences and things he will bring to the table as they apply to the digital initiatives and technology initiatives you had highlighted at the investor day. Thanks.
JJ Ruest (President and CEO)
Yeah. Yeah. So it's JJ. Maybe I can pick this one up. So David comes from a big Canadian industrial company, which also has a lot of remote locations. Been in business with companies and been in business for a long time, heavily unionized. So he comes from a background that's similar to what we experience here in the rail industry at CN. And also, his role is to help us out, apply technology, advance technology to our operation, but also to help us automate regular administration processes. We still have in the rail industry at CN a lot of jobs which are repetitive, combining data, going to spreadsheets, and we can automate those through RPA. But also, we're looking, as we saw in the Investor Day, to automate track inspection, train inspection.
Him and Michael Foster and Mike Farkouh, who basically are mandated to bring a new level of skill and efficiencies into schedule railroading that takes into account what's now readily available to any large industrial company like CN. So it's time for us to really, as an industry at CN, to really push forward on that. And David was the last piece of the talent that we were looking to add to our team. In fact, he already bought his house, but he's going to be with CN sometime in mid-August. So it's all coming up together nicely. The rail industry can automate just like any other industry.
David Zazula (Senior eVTOL Equity Research Analyst and Transportation Associate)
Thank you.
JJ Ruest (President and CEO)
Thank you.
Operator (participant)
Thank you. The next question is from Seldon Clarke with Deutsche Bank. Please go ahead. Your line is open.
Seldon Clarke (Research Analyst)
Hey, thanks. Can you just talk about some of the maintenance projects that you're undertaking in the third quarter and whether we should expect the same type of network disruption that we saw in 2018?
JJ Ruest (President and CEO)
Yeah. Maybe Rob, it's a combination of maintenance, but also a capital program.
Rob Reilly (EVP and COO)
Yeah. Yeah. So we're in the middle of work block season right now, obviously putting rail and tie-in during the summer months. We do have our expansion plan well underway. We've got a couple of those projects completed in the first half of this year. And the rest that are planned to be completed in the third and fourth quarter are all on track and should be completed as well.
Ghislain Houle (EVP and CFO)
Just to add on, I mean, we did learn from our deployment of our basic CapEx maintenance and also our capacity from last year. Obviously, this is a big program this year, similar to last year. The team did a good post-mortem starting the season. The way that we're deploying our capital is actually better so that you should not expect to have some of the impact that you had last year on the third quarter. We did learn. Stay tuned. But as Rob said, we're on track, and this capacity will help us when we get to the busy fall season, which is coming up.
JJ Ruest (President and CEO)
Thank you.
Seldon Clarke (Research Analyst)
Thank you. Thanks.
Operator (participant)
Thank you. The next question is from Konark Gupta with Scotiabank. Please go ahead. Your line is open.
Konark Gupta (Analyst in Transportation and Aerospace)
Thanks, and good afternoon. Just wanted to follow up on the volume outlook for the second half. So you pointed out a few commodities and segments which are obviously clearly ramping up. And then you also have easier comps and fracs sand autos, I guess, in the second half. So just wanted to understand the 6%-6.5% RTM growth we have seen so far in July and with the contracts that you have mentioned that you've just won or renewed. What do you think the second half volume outlook should be in that upper sort of mid-single-digit range? Is that sustainable, or do you think there's this further acceleration you can expect?
JJ Ruest (President and CEO)
Well, I think we just to make a point before passing on to Keith and James, all we're talking about is 2019. We're not to 2020 at this point. And the contract winner we're talking about, case of General Motors, that's starting in October. James or Keith, you want to add to what you said earlier?
Keith Reardon (SVP of Consumer Product Supply Chain)
So as JJ just pointed out, the contract win that we have with General Motors in Vancouver is in October. And we feel confident with the numbers that all line up to the mid-single digits. Yeah.
James Cairns (SVP of Rail Centric Supply Chain)
I can talk a little bit more about kind of what we see that sequential ramp-up in H2 compared to H1. So if you think about what we did on the coal side of things, we got the full ramp-up with Coalspur that we talked about. Then we have the full ramp-up of our propane export facility with our good friends at AltaGas. On the grain side, we're looking very positive on grain. Could be a crop in the range of the average for the last three years, but big carryover from this crop season and new crop season and potential to have a 10- or maybe two-week earlier start-up compared to last year's late start for the crop. I mean, these are easy times to execute when you can kind of get the grain crop started a couple of weeks early there.
And I think the last one I talked about was coal, propane, intermodal. You did.
Keith Reardon (SVP of Consumer Product Supply Chain)
Yeah. Maybe we should talk a little bit about the follow-up on the press release on the new stuffing facility in Prince Rupert, where we'll be moving some resins that way. It'll be about 400 containers a month that we'll be stuffing there with our Charlie Raymond and his team. That not only adds to the revenues for James, but it's very helpful to our steamship line folks that are looking for a revenue ride back to Asia. So it's a really, really great thing that the team has been working on, and it'll come to fruition here very shortly.
JJ Ruest (President and CEO)
Yeah. If there is some further market shift or contract shift, if you wish, we will only talk about those things when our customers are comfortable that we can talk about them. Thank you.
Konark Gupta (Analyst in Transportation and Aerospace)
Thanks.
Operator (participant)
Thank you. The next question is from Jordan Alliger from Goldman Sachs. Please go ahead.
Jordan Alliger (U.S. Transportation Analyst)
Yeah. Hi, afternoon, everyone. Just a quick follow-up. I just want to make sure I heard right. You had talked, I think, about the frac sand markets. I think you said that perhaps customers were suggesting something, and then maybe it wasn't coming in quite as expected. I know that was an opportunity set for you guys you talked about, and I just wanted to get a little color around that to make sure I heard that correct.
JJ Ruest (President and CEO)
Yeah. So it's JJ talking. So these words are my comment. It's basically we were geared up in the second quarter to do much more frac sand than what we did and much more than basically to be in line with our customers' own prediction. And the combination of, I guess they were too optimistic, but also that marketplace is maybe a little tough or tougher than what they thought. Plus, they're also competing with local sand in different areas. So we had the resource ready. And you may remember the winter of 2018. There was a lot of public comment made that CN wasn't ready for frac sand, where we got geared up with people, track, locomotive, and whatnot. But in the second quarter, here was the reverse. What the industry was talking would have happened and not what happened. So that's what it was.
Jordan Alliger (U.S. Transportation Analyst)
Would you say, I mean, do you anticipate sort of shorter term or just not clear yet?
JJ Ruest (President and CEO)
This is all related to how much shipping activities that there is right now related to, I think, the frac sand industry in North America is maybe not quite getting the volume across the board that we're hoping for and CN is experiencing the same thing.
Jordan Alliger (U.S. Transportation Analyst)
Thank you.
JJ Ruest (President and CEO)
In terms of how much sand will be required in the future, again, it will be back to the basics that James kind of was talking about. What's the price of natural gas? What's the price of crude? And how much drilling activities will there be?
Jordan Alliger (U.S. Transportation Analyst)
Thank you.
JJ Ruest (President and CEO)
Thank you.
Operator (participant)
Thank you. The next question is from Ken Hoexter with Bank of America Merrill Lynch. Please go ahead. Your line is open.
Ken Hoexter (Managing Director and Senior Equity Analyst)
Good afternoon, JJ and team. JJ, may we just revisit some of your opening comments? You talked about balanced growth and parked capacity, and it sounded like you're bringing some employees back from furlough. It looks like employees were up 5% normalized for the TransX. Maybe you could just talk about the kind of what's going on on the employee side and how you balance it out with this, I guess, mid-single digit growth you're looking for in the second half. Thanks.
JJ Ruest (President and CEO)
Yeah. So maybe I'll start and maybe just lay it out some colors. But on the headcount side, on the people side, we're doing three things. One is we've had in 2020 last year quite a few. Remember, we used to talk paycheck and employee. And really, paycheck is really what matters the most. And we are trying to reduce the number of contractors or consultants we have at CN because those paychecks are more expensive than the people who work full-time. So on one end, we are insourcing work because that work is done more cost-effectively with full-time employees. And also, we retain the skill. That's mostly in the world of IT, in the world of PTC, for example. And on the other one, on the operating side, we want to right-size the size of our labor to the workload.
And we were prepared for more workload this summer than what we had. Crude by rail, for example, is even, it's a growth story. We've been there quite what it was. So we had some layoffs the second quarter, 500, and the 500 is now down to 200 because of attrition and where we're at. And the third leg is on the management side. When I say management, I mean headquarters, but all non-unionized jobs at CN. And to give you a reference point, in October 15, 2018, we had 6,900 management jobs at CN. And now in July, we're roughly at 6,000, 6,030 to be precise. And we want to finish the end of the year at 5,700. So we're streamlining our management structure. We are sizing our crews based on volume and attrition.
And then also by the same time, we are insourcing some work from the consultants, mostly in IT, because these consultants are too expensive. And also, we end up training people for their next consulting job as opposed to the next project at CN. I don't know if Chris, Ghislain, you want to add?
Ghislain Houle (EVP and CFO)
You covered it very well. I think what, Ken, you need to be mindful of again is attrition is a good lever for us because there's quite a few people that go, that retire. And therefore, when we're a little bit up on the headcount side, it only takes a couple of months, and the attrition eats into it. So that's really a good lever that we have and that we use. But otherwise, JJ, you covered it very well.
JJ Ruest (President and CEO)
So Ken, rest assured, we're very focused on headcount.
But remember the discussion that we learned back in the days with Hunter? It's more about the paycheck than the headcount. So sometimes you have to increase your headcount to reduce the cost of these outsource services that we buy from outside.
Ken Hoexter (Managing Director and Senior Equity Analyst)
Helpful wrap-up. Thanks, JJ. And just want to appreciate it.
JJ Ruest (President and CEO)
Thank you.
Operator (participant)
Thank you. The next question is from Scott Group with Wolfe Research. Please go ahead.
Scott Group (Senior Analyst)
Hey, thanks. Good afternoon, guys. So the 10,000 carloads of crude in June, what's the run rate you're assuming for third quarter? And then separately, Ghislain, if I look comp for employees down 2% year-over-year in the quarter, how much of that's the incentive comp? How much is just a mix of tranches? I'm just trying to understand if we should think that that continues to fall year-over-year in the back half of the year.
JJ Ruest (President and CEO)
James, you want to add some more colors on the crude by rail?
James Cairns (SVP of Rail Centric Supply Chain)
Yeah. Specifically on crude, we're going to see a slight ramp-up from our June volumes as we go into the third quarter and then into the fourth quarter.
JJ Ruest (President and CEO)
And this is all based on our own gut feel of the spread and what the Government of Alberta may or may not do, and how early they will do it.
Ghislain Houle (EVP and CFO)
Yeah. I'm not sure I got your question, Scott, on the second piece. I know there's one on incentive comp. So yes, incentive comp helped us absolutely on the labor side this quarter. And this just demonstrates that some of our incentive model is working. And I mean, on the people side, I think we've answered it, and we're going to try to right-size our resources. What we're proud about this quarter is obviously our volumes are lower or softer than what we expected, but we were very quick to react. And this is partly why we have the quarter we have.
So again, we've talked about in our opening remarks that the markets are changing very quickly, very volatile. So our pulse is very close to the demand, and we can react very quickly to what's happening out there in terms of the cost side. So we're very pleased about that. And I think, stay tuned. Our business plan is working, and we're delivering what we said we were going to deliver.
Scott Group (Senior Analyst)
Maybe I didn't ask right. If I can just ask it more directly. The comp per employee for the TransX people, is that lower than the overall average? Meaning, as we add that into the model, does that bring comp per employee lower?
Ghislain Houle (EVP and CFO)
TransX is part of CN. I wouldn't start commenting on their comp model versus our comp model. I think comp is comp, and the numbers are there. I'm going to let you make your own assumption.
JJ Ruest (President and CEO)
Yeah. So maybe they may not have as many senior positions, and they're all based in Canada, so all their salary is on Canadian funds. Maybe that could help because on the rail operation, we have quite a few people who are based in the United States.
Scott Group (Senior Analyst)
All right. Thank you, guys.
Ghislain Houle (EVP and CFO)
Thank you.
JJ Ruest (President and CEO)
Thank you.
Operator (participant)
Thank you. The next question is from Brian Ossenbeck with JPMorgan. Please go ahead.
Brian Ossenbeck (Managing Director and Senior Analyst in Transportation)
All right. Thank you for taking the question.
JJ Ruest (President and CEO)
Thank you.
Brian Ossenbeck (Managing Director and Senior Analyst in Transportation)
I just wanted to go back to the resource allocation. It sounds like you've obviously made some adjustments to where it seems a little softer. If you could just give us a sense which areas you're watching closely that could be a little bit weaker into the back half of the year? Also give us a little bit of context as to how the digital twin that you're rolling out, I believe at year-end, imagine you have a decent working model for that. Is that starting to show some benefits in terms of adjusting more in real time, or is that something you don't expect to get a lot of mileage out this year versus next when it's fully ramped out?
JJ Ruest (President and CEO)
Yeah. So if I may start on the digital twin or the tool that we want to have in terms of first to model our capital plan and resource plan, we're not using it yet in today in terms of a day-to-day tool. That's not where we're at. We're still building that tool, and we want to use that tool at this point for the first use to be modeling the network and making the capacity decision more kind of a month-by-month. It's kind of a midterm tool. And ultimately, eventually, we'll go from midterm to more short-term to more and more short-term. So that's work in progress, but huge payback in what we might be able to extract as incremental capacity by using the network much smarter. I think I forgot what was your first question within the two questions.
Brian Ossenbeck (Managing Director and Senior Analyst in Transportation)
Yeah. Just asking if you could give us a sense of what you're looking at in the second half. It might be a little softer. You kind of hit the highlights in terms of whole crude grouping.
James Cairns (SVP of Rail Centric Supply Chain)
We keep an eye on all of our markets. We try and keep tight control over that, make sure that we're right-sizing our resources continually. Some of the markets that we're watching very closely, forest products, for example, U.S. coal and, of course, crude, need to make sure that we're able to react either way. Crude could have to react up, could have to react down. It's going to be very interesting to see what happens in the fourth quarter here.
JJ Ruest (President and CEO)
Yeah. Coal product is tough, and the Mississippi River is still high, and the API 2 in Europe is always we need to stay very close to that.
Brian Ossenbeck (Managing Director and Senior Analyst in Transportation)
Okay. Great. Thank you very much.
JJ Ruest (President and CEO)
Thank you.
Operator (participant)
Thank you. The next question is from Justin Long with Stephens. Please go ahead.
Justin Long (Managing Director of Equity Research for Transportation)
Thanks. Good afternoon. I was wondering if you could help us understand the quarterly cadence of RTM growth. It's baked into the guidance for third quarter and fourth quarter, just given some of the moving pieces with new contracts, the comps, etc. Then Ghislain, on the tax rate, even after the adjustment, it was lower than the 26% you guided to last quarter. Curious if that assumption in the guidance has changed as well.
Ghislain Houle (EVP and CFO)
Yeah. I can start with the tax adjustment. So last quarter, as you know, we discussed, and I did provide some visibility that our effective tax rate for the full year would be 26%. I've just said in my prepared remarks that now we see 25% of effective tax rate for the full year. And that's mainly due to tax strategies that we are employing to reduce some of the unfavorable impact that the U.S. tax reform has on CN. So this is good news. And I can comment, and then if my colleagues in marketing want to jump in on the RTM, I mean, if you look, we're still guiding for and it's not a guidance. It's an assumption. So our assumption is still mid-single digit volume growth in terms of RTMs. So I mean, that is mid.
So you can decide what mid is, but in the first half of the year, we delivered 3%. So you can just do the math, and you can see that. And that's what I said in my remarks as well, that we need an uptick in RTM growth in the second half. But at the end of the day, volumes are volumes. What we are focused on is to protect earnings. That's what we're focused on. At the end of the day, if volumes come at four instead of five or six or whatever it is and whatever your midpoint is, we want to protect earnings. And what's important for us is to deliver our guidance on earnings, which is low double-digit EPS growth. I think that's what our investors want to see, and that's what this team is committed to deliver.
JJ Ruest (President and CEO)
That's right. It's about modulating the resource to the volume. Slower growth means slower increase in resource. And as a network is also becoming more efficient, we need to bring that to the bottom line. So rolling stock, headcount, either permanent headcount like in management, as I said earlier, that we are progressively bringing down. And I guess the operation side is to go from week-to-week, month-to-month, to decide how many people we need to have and make sure we have enough people, but at the same time, not more than what we need. So it's almost basically now a weekly exercise in terms of how much rolling stock we have out there and how many people we have on the furlough board on layoff. It's very dynamic. We keep it tight. Thank you.
Justin Long (Managing Director of Equity Research for Transportation)
Okay. Great. Thanks for the time.
JJ Ruest (President and CEO)
Thank you.
Operator (participant)
Thank you. The next question is from Tom Wadewitz with UBS. Please go ahead. Your line is open.
Tom Wadewitz (Senior Equity Research Analyst)
Yes. Thank you for the time. There were some comments, I think, about peak season, some optimism, and I think your comments on intermodal in general in the second half showing some expecting some growth. How much visibility do you have at this point? What kind of underpins the view you have at this point on peak season?
JJ Ruest (President and CEO)
Keith?
Keith Reardon (SVP of Consumer Product Supply Chain)
Yeah. So a couple of different things. We have the ability to talk to our domestic customers who have the inventories in the warehouses and what they see is going to be their needs. But we also have our discussions with the lines and what they're doing with their vessel calls and the size of their ships and where they're calling if they're moving some stuff around. And we can see out I mean, we know what's on the vessel three, four weeks out anyway. So that's the guidance or that's the visibility that we have, and we make the best decisions we can with it.
JJ Ruest (President and CEO)
Yeah. We have more and more better system and also cooperation with some of the terminal operators who have the visibility of what's coming for CN, right, for CN Rail to go into land as the vessel are loaded. So we kind of see three weeks out. I mean, what's loaded today will get to us three weeks from now. So we have at least that better visibility on what's loaded on the ship, which are at this time to CN, CN port, and CN cities. So that's helpful.
Tom Wadewitz (Senior Equity Research Analyst)
And-
JJ Ruest (President and CEO)
Thank you
Tom Wadewitz (Senior Equity Research Analyst)
What about you?
JJ Ruest (President and CEO)
Yeah. Go ahead.
Tom Wadewitz (Senior Equity Research Analyst)
Yeah. You commented a bit on the inventories. Is that something that's, is there much visibility in terms of you think inventories have actually come down or coming down, or is that kind of a broader macro data that you're looking at?
Keith Reardon (SVP of Consumer Product Supply Chain)
Well, that's also what I said earlier is that we can't say how big the peak is going to be, but we do feel that there will be volume growth over Q2. There will be a peak season. We just don't know how big of a peak it will be, right? So can't regulate what the answer is. But we do make a lot of phone calls and a lot of visits to our domestic side to triangulate the information to see if we can figure that out. And it's probably not an exact science, but we do our part, and we do a lot of work to try and figure that out.
Tom Wadewitz (Senior Equity Research Analyst)
Okay. Thank you.
JJ Ruest (President and CEO)
Thank you, Tom.
Operator (participant)
Thank you. There are no further questions registered at this time, so I would like to turn the meeting over to Mr. Ruest.
JJ Ruest (President and CEO)
Okay. Thank you, John.
Operator (participant)
Oh, I'm sorry. I'm sorry. We have one that just had Mr. Scott Group pop up from Wolfe Research. Please go ahead.
JJ Ruest (President and CEO)
Okay.
Scott Group (Senior Analyst)
Oh, hey, guys. Thanks for the follow-up. Just big picture, the guidance you've got, you're assuming accelerating volume growth, but decelerating earnings growth to get to low double-digit earnings growth. Maybe help walk us through that, and do you think that there's potentially upside on the low double-digit for earnings growth based on the first half?
Ghislain Houle (EVP and CFO)
Yeah. Listen, the guidance is there. I mean, there's a lot of stuff, as you know, there's a lot of different moving parts to the equation. And I mean, there's pricing, there's volume, there's various commodities, etc., etc. And then there's the comparables as well, what we did versus last year in Q3, Q4. So all in all, our best foot forward right now, and what I can tell you is we are maintaining our mid- to single-digit volume growth in terms of RTM, but we need an uptick to get there as an assumption because we did 3% in the first half.
With our math, and you can do your math, obviously, but with our math, and we are confident at this point that this will result in low double-digit EPS growth for the year, and we're proud of that, and we're confident that we will deliver on that. Okay.
Scott Group (Senior Analyst)
Okay.
Ghislain Houle (EVP and CFO)
Thank you.
Scott Group (Senior Analyst)
Thank you.
Ghislain Houle (EVP and CFO)
Thank you.
JJ Ruest (President and CEO)
Thank you, Operator.
Operator (participant)
Thank you. There are no more questions registered at this time, so I would like to turn the meeting over to Mr. Ruest.
JJ Ruest (President and CEO)
Okay. Thank you, everyone, for joining us today. We're very proud of our result, but the race goes on, and we're already working on the third quarter. So thank you for all joining us today, and this is the end of our call. Thank you.
Operator (participant)
Thank you. The conference has now ended. Please disconnect your lines at this time. Thank you for your participation.