Canadian National Railway Company - Q4 2013

Transcript

Operator (participant)

Welcome to the CN Q4 and full year 2013 financial results conference call. I would now like to turn the meeting over to Janet Drysdale, Vice President, Investor Relations. Ladies and gentlemen, Ms. Drysdale.

Janet Drysdale (VP of Investor Relations)

Thank you, Michael. Good afternoon, everyone, and thank you for joining us. I'd like to remind you of the comments already 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 Vice

Benoit Poirier (Analyst)

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, and thank you for all of those who are on the call today. We're here in Montreal. The temperature in the east is good, and things are warming up slightly out west. So we feel good about that because weather has been a bit of a challenge lately. We'll be discussing that through the call. But December was tough.

Benoit Poirier (Analyst)

We had the difficult weather, but Q4 overall came up with very good results. The team will share the details, but, you know, solid revenue growth during the quarter. You know, the ability to bring that business at low incremental cost again, and that allowed us to deliver $0.76 for the Q4, which is an increase of 7% from last year.

Now, when we met with you in December, we, we had hoped that maybe we could finish at the higher end of that tight, range that we had given you. December, you know, brought us basically in line with the middle of that range, so we feel, you know, reasonably pleased with the, with that performance.

Allows us to turn in a full year EPS of, on an adjusted basis of $3.06, which is effectively 9% year-over-year growth. We're in line with our guidance for, for high single digits or close to a double-digit EPS performance. And again, if we're building on our supply chain, agenda, it's working. We've been able, for the full year, to outpace, the economy and grow, faster than base market conditions.

I think we finished the year with record volumes and record revenues. The volumes were up faster than our peers in the industry, and that's consistent with our game plan. We were also able to maintain our industry-leading operating ratio. Despite significant headwinds on pension and depreciation issue, we turned in an operating ratio for the full year of 63.4%, for again for the full year, which is only half a point of an increase over the prior year.

Maybe the number that I'm most pleased with, given the challenges we faced lately with the focus on railroad safety performance, is our safety performance for the full year in 2013. We actually delivered 9% year-over-year improvement in our accident ratio.

We had 33 main track accidents last year in the full year. That's about as good as we've ever done. In fact, it matches effectively the record performance we had achieved in 2012. It's not just 2013. This is effectively a decade-long trend of improvement in our safety performance.

Obviously, every accident is one too many, and we've had a few accidents to deal with during the Q4, but that does not detract us from the focus on a continuous investment in detection technology, tightening of our processes, and an investment to have a quality plant infrastructure to continue to prevent accidents from happening in the first place and to respond effectively in the rare cases when we do have issues to deal with.

So solid performance overall, and, you know, good finish to the year in the Q4. We do have issues to deal with, with weather. The December was, you know, quite challenging, and it's continuing into January, and I'm sure Jim will give you some insights into that as he gives you right now an overview of our key operating metrics and what we're doing on the railroad. Jim?

Jim Vena (EVP and COO)

Okay. Thank you very much, Claude. Overall, very impressed with our Q4 operating performance as we kept improving our metrics across the board. The story of the Q4 can be divided into two parts. October and November, when we finished those two months, our velocity was up by 6%, our train load was up 3% better, and the volume higher than ever before. So very strong October, November. December, I'll have to admit, was difficult.

Benoit Poirier (Analyst)

But we ended, even with all of that, when you put all the numbers in, we ended up with a 1% betterment in train productivity, 8% better in yard productivity, which continues a very strong year in how we're processing cars going through our terminals, and a 2% betterment in car velocity, which most of you have heard me say is the single biggest metric that I like to look at that tells me how fast we're moving the cars. So even with a very difficult December, I think we finished the year and delivered.

We had put ourselves in a little bit of a hole during the Q1 last year, and were able to deliver most of the metrics that betterment through the year, and we had a strong Q3 and continued with a strong Q4 that was tempered some because of the weather. Now, I've been railroading for a number of years, and I know some people have asked me how many years, and some people have said that I was a rookie, and other people have said I've been around forever.

But I'll have to admit, this year, December and January, they have been tough. But I'm very proud of the team and everybody that works at CN, from the unionized employees out on the ground that are dealing with very cold weather in a number of locations, not just the traditional Canadian prairies.

We've had cold, and we've had snow as far south as our territory runs into the United States. Now, we continue to deal with the weather. January has been difficult, and we continue to have to set priorities. We have added a number of assets, whether it was the new locomotives that we brought online on

purpose during the end of the Q3, the AC locomotives, whether it was the DP locomotives that we put in place, whether it was processes in the yard. But even with all that, we are setting priorities, and we know that we are not able to move all the business that that JJ was lining up for us to move in the Q1.

Even given all that, though, we can, to this day, our movement, the number of GTMs we're moving per day is higher than it ever has been, and hopefully, we will continue to do that as we move forward. On safety, and Claude already mentioned how important it is to us, and it was nice to see our safety record continue to improve, and we delivered best ever numbers in some categories.

But more importantly, we will continue to invest on technology. We announced a $10 million additional investment in this last quarter, and we will continue to invest smartly for technology and gains, and especially on processes, to continue to drive our safety record better in how we're handling all of our products.

Now, volume continues to grow, and JJ and the whole marketing team are doing a great job of continuing, and we will continue to invest strategically for productivity and capacity. We completed the previously announced $100 million additional investment between Winnipeg and Edmonton, for example, and we will be investing more this year on this corridor, and specifically looking at some other

corridors where we, that we have it in the plan, that we need to take a look with the increase in volume that we expect this year and moving forward, that we need to make sure that we've got the capacity and the resiliency to operate. Listen, no if, ands, or buts, we have our work cut out for us. And just like last year, we will need to work hard to recover the expenses. I am very confident that we got the team, and we will deliver this year the same as we did last year. JJ?

JJ Ruest (EVP and CMO)

Well, thank you, Jim, and thank you to all of our running trade and our engineering forces out there working very hard the last eight weeks. Good afternoon to all of you joining us today on the call. The next few minutes, I'd like to review the last quarter, of course, and then I'll give you a commercial outlook for the going forward. The month of December, as Jim was mentioning, has been extremely cold condition, and it did impact the overall supply chain in Canada, Canada in many of our sector.

Benoit Poirier (Analyst)

Having said that, we did post solid revenue growth of 8%, which is 5% adjusted revenue growth on an exchange basis. Now, looking at it on, from a freight revenue point of view, we delivered 6% growth on the FX adjusted basis.

4% came from the volume and mix, 2% came from price. Fuel surcharge impact was negligible in the quarter. On the pricing side, to be more specific, same-store price came close to 3%, slightly down from the Q3. As a reminder, same-store price is calculated after deduction of fuel surcharge revenue, and it is applied on about 75% of our freight revenue on the same book of business, which is the same-store book of business.

Regarding the mix of the quarter, we had an increased length of haul of 18% in petroleum chemicals. We also had an increase of length of haul of 8% in metals and minerals, but we had a 9% decrease in the average length of haul for coal. The carloads for the quarter were up 3%.

The revenue ton for the quarter were up 5%, and in both cases, it mostly came from the October, November operation. Now, looking at last quarter in more detail, we'll do that on a FX adjusted basis, as we do usually. Metals and minerals revenue grew 7%, mostly from energy consumable, namely increased frac sand production on our Wisconsin network

. The ferrous and non-ferrous metal were weaker. Cross-border revenue grew 6%, mostly related to U.S. housing start, while Canadian housing start and forest product export were flat to weaker in the quarter. Petroleum and chemical revenue was up 17%. All commodities made positive contribution to these results, except for sulfur.

There was a number of new crude by rail loading facility coming online during the quarter, and of note, the 2013 crude carloads were almost 75,000 for the full year, and the Q4 run rate was almost 25,000 carloads. Automotive revenue overall was flat, but we did see growth in our presence with the cities where we have Autoport facilities, and our Canadian bound revenue was up a strong 14%

. But that was offset by a non-recurring Q4 2012 military movement. Intermodal revenue was up 10% from a diverse source of growth, namely in retail, in industrial sector, in our cold supply chain, and the Port of Vancouver.

Our recent terminal investment, which are aimed at making the CN intermodal map bigger and more dense, also produced growth, namely in Joliette, Detroit, and Saskatoon. The coal revenue was down 12% on a FX-adjusted basis for the quarter on account of weaker exports for pet coke and terminal coal, while the met coal export was actually a bright spot for CN. Canadian and U.S. grain export demand was very strong, and revenue growth was limited to 3% due to the very cold Canadian December and resulting network challenge.

Fertilizer revenue was down 7%, and as was the case in grain, December operation was a limiting factor. Now, if we want to look at looking ahead at the outlook on page 10. On a year-over-year basis, line-haul revenue performance will be driven by strong demand, network fluidity, as well as a weaker Canadian dollars.

On the more promising side, intermodal business is looking strong. It is helped by a better U.S. consumer confidence, by positive customer sentiment toward the CN product, and by our recent gain in the marketplace. Most promising are the Port of Vancouver, the Port of Montreal, and the domestic retail product. Petroleum and chemical demand will also produce strong growth.

Shale gas is having positive implication on chemical and plastic manufacturing, and crude by rail will continue its progression. Metals and minerals will be driven by oil and gas production consumable, as a, for example, frac sand. Acceleration of capital spending by industrial corporation should also foster a more positive backdrop for the metals segment. Forest products will be driven by U.S. housing start, which is led by lumber and panel.

Exchange rate will be a positive tailwind, since the average exchange rate was 0.99 CAD per $1 during the Q1 of last year. Now, with the uncertain side, the met coal market, which we are working diligently to offset with our domestic terminal coal initiative and with Canadian West Coast export. Also of issue is the strong demand that we experienced for grain and fertilizer in the Q1, and the potential challenge, and the operational challenge that it represent in the middle of the winter.

Having said that, we should have a lot of grain to move all of calendar 2014. So in closing, as we discussed at our recent Investor Day in December, we have an integrated sales model and a culture of so- service innovation to get it done in the marketplace. We have a disciplined inflation-plus pricing approach in the marketplace, and we have a clear vision and commercial strategy to continue our drive for growth. Thank you, and on that, I'll pass it on to Luc.

Luc Jobin (EVP and CFO)

All right, thanks, JJ. So starting on page 12 of the presentation, let me kind of walk you through the key financial highlights of our Q4 and the 2013 full year performance. First, let's take a look at our solid Q4 results. Revenues, as JJ indicated, were up $211 million, or 8%, to $2,745 million. Operating income was $967 million, up $45 million, or 5% versus last year. Our operating ratio was 64.8% in the Q4. That's 120 basis points higher than last year, as both Claude and Jim indicated, pressured by difficult winter conditions in December.

Benoit Poirier (Analyst)

Other income was a $2 million expense versus a $5 million expense last year, as we continue to see lower property and land sales to offset ongoing real estate and other costs. On a full year basis in 2014, I would expect other income to turn slightly positive and be in the $10 million range. But as usual, this will likely be lumpy through the year. Net income for the Q4 is $635 million, up 4%, and the diluted EPS reached $0.76, up 7% versus last year. FX was favorable for $19 million on net income, or $0.02 on the EPS in the quarter. Our effective tax rate was 27.3% in the quarter, higher than last year at 26.6%.

Turning to page 13, our operating expenses were $1.778 billion, up 10% versus last year, or 7% on a constant currency basis. At this point, I'll refer to the changes in constant currency. First, labor and fringe benefit costs were $594 million, an increase of $120 million over last year. This was the result of principally three elements.

First, we had an increase in overall wage cost of 7%. This was partly the product of wage inflation at 3% and a 1% increase in our average headcount versus last year. The balance of the wage cost increase relates to a higher overtime for about $9 million and less capital work being performed in the Q4 this year versus last year.

This was partly the result of volume increases, but for the most part, due to the harsh weather we had in the month of December. Second element is a higher stock-based compensation expense in this quarter versus last year, which represents 9 percentage points of the variance, as we did have higher increase in

the stock price through this quarter versus the same period in the previous year.... Keep in mind that our stock-based compensation in 2014, specifically in the Q1, will not have the benefit recognized in the Q1 of last year, resulting from the settlement of employment matters relating to former executives for $20 million.

The last element of the labor variance is higher pension expense for $49 million, and that, as such, is the pension expense increased by about $30 million in the Q4 this year versus last. The balance of the pension variance relates to 2012, when we recognized the gain resulting from the forfeiture of pension benefits for a former senior executive. We did, however, finish 2013 with some good news in terms of key assumptions for our 2014 pension costs. The discount rate increased to 4.73%, and the return on our plan assets reached 11.2% in 2013.

As such, we now expect our pension expense for 2014 to be in the $10 million-$20 million range, a constructive improvement over the $90 million incurred in 2013. By the way, this represents about $15 million better than we had originally expected. Turning to purchased services and material expenses, those were $364 million, up 4%.

This was due to higher volume, resulting in increased intermodal trucking expenses for two percentage points. Also, higher volume, along with winter-related costs, including utilities, materials, namely wheels and others, repairs and maintenance expenses accounted for about six percentage points of the variance. Now, this was partly offset by lower project-related contract and contracted services for about four percentage points.

So the extreme cold weather brought us higher labor and higher purchased services and material costs in December, which at this point, I would probably estimate to be approximately $15 million. Unfortunately, this little twist of Mother Nature is also extending itself well into January, and consequently, we are having a similar monthly cost pressure to contend with starting in 2014. The fuel expense stood at $422 million, essentially flat to last year.

Higher volume represented an increase of 5 percentage points in the quarter. Improved productivity constituted an offset of 1 percentage point, and price was also favorable by 2 percentage points. The balance of the variance, the variance is attributable to the favorable impact resulting from fuel inventory adjustments for 2.5 percentage points.

One item I'd like perhaps to just remind everyone, is that revenue ton miles is the best indicator of workload across a number of our expense categories, and especially for fuel. If any of you are still anchoring your estimates on car loads or other factors, you may be actually understating expenses as a result. Depreciation is $254 million, $13 million higher than last year, or 5%. This was mostly due to asset additions and the impact of Canadian and U.S. depreciation studies for track and road properties. In 2014, we will be carrying out a depreciation study for rolling stock.

So between asset additions, the full year impact of studies done in 2013, and the potential impact of 2014's depreciation study, I would expect our full year depreciation expense to be about $75 million higher than in 2013. Equipment rents were $71 million, $4 million higher than last year or 6%. This is mostly attributable to increased freight car and intermodal equipment leasing costs.

Casualty and other costs were $73 million, $38 million favorable to last year, as we incurred lower legal and other claims-related costs, lower FELA and occupational disease costs as a result of an actuarial review, in addition to lower general costs versus 2012. I would expect this category of expenditures to be in the $80 million per quarter range, on average, in 2014.

Now, let's turn to our full year results, which are summarized on page 14. So we wrapped up 2013 with nearly $10.6 billion in revenue, a 7% increase. This sets a company record in terms of both volumes and revenues.

Our operating earnings grew 5% to reach $3.873 million, and our operating ratio stood at 63.4%, only 50 basis points higher than in 2012, which for us was a record year. And this is quite an achievement when you consider that we faced, in 2013, a strong pension headwind of one full percentage point of OR, along with other accounting and related matters.

Net income was down $68 million, or 3%, at $2.6 billion, mainly as a result of lower gains on disposal of rail assets for $242 million, which was partly offset by an increase in operating earnings of $188 million in 2013. So this translated into a 1% increase in reported diluted EPS of $3.09. Excluding the impact of major asset sales and income tax adjustments in both years, the adjusted diluted EPS for 2013 stood at $3.06, a 9% increase over 2012's $2.81, in line with our guidance calling for high single digit growth.

Moving to free cash flow on page 15. For the full year, 2013, free cash flow generated stood at $1.6 billion, just a little bit above $1.6 billion, $1.623 billion, actually, $38 million lower than in 2012. We generated over $3.5 billion of cash from operating activities. Notable elements here were income tax payments of $890 million, working capital changes, including pension contribution of $239 million.

On the pension front, for the combination of higher discount rates and return on plan assets that I mentioned earlier, should translate into a going concern surplus of $1.7 billion and a solvency deficit of $1.7 billion.

We estimate the required solvency contribution in 2014 will be $335 million, which will actually not require cash outlay from the company, as the funds will be drawn down from the $470 million balance in our ad-advanced voluntary contributions already made in prior years.

So we estimate our cash contribution in 2014, mainly for current service costs, will be approximately $130 million. In 2013, $1.852 billion of cash was actually used in investing activities. Our capital expenditures in 2013 were $1.973 billion in terms of cash CapEx.

When you actually take into account $44 million of assets acquired through capital leases, we get a total of $2.017 billion in line with our guidance. We had proceeds from non-core asset sales of $52 million and other investing contribution of $69 million to complete the picture in investing activities. Deducting the change in restricted cash of $73 million leaves you with $1.623 billion, which is our free cash flow generated as per our new definition of free cash.

For those of you trying to reconcile our old definition, to our old definition of free cash, simply deduct the dividends of $724 million and the change in FX on cash of about $19 million, and you get to $918 million of free cash generated in the year, slightly ahead of our guidance in 2013. Meanwhile, our balance sheet remains strong, with debt and leverage ratios within our guidelines.

Finally, on page 16, let's take a look at our 2014 financial outlook. We continue to see a very good progression in the North American economy, combined with opportunities in grain, lumber, intermodal, and domestic energy-related commodities. We expect otherwise a modest progression in other resource export markets.

We assume as well, North American industrial production will increase by approximately 3% in 2014. Housing starts will continue their strong progression, and we estimate they will be in the range of 1.1 million units in 2014. These and other key assumptions underpinning our outlook should translate into mid-single-digit cargo growth in 2014.

On the pricing front, as JJ mentioned, we maintain our inflation plus pricing policy. So having said this, we are reaffirming our annual guidance as communicated to all of you last December. So we are aiming for double-digit EPS growth in 2014 over the 2013 adjusted diluted EPS of $3.06. Our guidance also calls for free cash flow in the range of $1.6 billion-$1.7 billion.

Our free cash flow guidance assumes that we will invest in capital programs to the tune of about $2.1 billion. Consistent with our strong shareholder return agenda, our board has approved today a 16% increase in our dividends. In addition, we continue with our agenda of rewarding shareholders through our stock buyback program.

In 2013, we've brought, we bought back 27.6 million shares at an average price of $50.65 for $1.4 billion total. In 2014, we continue with the program approved by our board last October to buy up to 30 million shares, and we have set aside about $1.4 billion towards achieving this objective.

So in conclusion, the CN team remains committed to delivering superior results and creating value for shareholders as we continue to unfold our strategic agenda in 2014. So on that note, I'll turn it back over to you, Claude.

Claude Mongeau (CEO)

Thank you, Luc. As you can tell, the team is lining up a number of impressive achievement and milestone. There's a lot to be proud of in terms of our 2013 results. To deliver basically record revenues and record operating income and to continue our remarkable journey is the goal, and basically, 2013 came in in line with that objective.

Benoit Poirier (Analyst)

Our board is very confident, and so is management. And indeed, the dividend increase of 16% reflects that confidence. I will note to you that it's a remarkable track record. For 18 years, we've been increasing the dividend, and the dividend has increased 16% on a compound annual growth rate for that extended period.

Our focus now is turning to 2014, and we do have a challenge with weather. We discussed it. Jim gave you the core element that we're dealing with, with the extreme cold weather. It is rather unusual to have snow in New Orleans and to have Winnipeg.

I think Winnipeg was at the coldest month of December since 1879. So we are dealing with very difficult weather conditions, which have impact on our railroad operation, and so we're dealing with it from an operation standpoint, and we're focused on maintaining productivity. But we have line of sight on the impact this has on our customers.

We are managing priority the best we can so that we can avoid creating undue hardship, and we'll be breaking loose as soon as weather gives us a break to rethink and get the network back in a mode where we can meet demand and deal with the rollover that we have from December into January.

Even though the Q1 will be challenging, we have two months to go, and we feel confident we will be able to deliver, you know, good performance in the Q1 and stay on track for our full year guidance as Luc just explained to you. Our agenda of safety is first and foremost. We are taking it to the next level.

Our three-prong approach to prevent accidents, to shape the agenda and help regulators in the industry come forward with solutions for those DOT-111 tank cars, to strengthen our capability together with industry and other carriers in terms of mutual aid and the capacity to respond when there is an unfortunate accident, and to engage with communities, to have an approach where we are transparent

with information, share best practice, and reassure the general public is our approach to meet the challenge and take our safety agenda to the next level. So we're pleased to take it over to you with question, and we do so with the commitment to deliver a very solid 2014 again this year. Operator, we'll go to questions.

Operator (participant)

Thank you, sir. Ladies and gentlemen, we will now take questions from the telephone lines. If you have a question and you are using a speakerphone, please lift your handset before dialing your selection. If you have a question, you can register by dialing star one on your telephone keypad, and you can cancel your question, if you wish, by dialing the pound sign. Please press star one at this time if you have a question. And the first question is from Walter Spracklin at RBC Capital Markets. Please go ahead. Your line is now open.

Walter Noel Spracklin (Analyst)

Yeah, thanks very much. Good afternoon, everyone.

Claude Mongeau (CEO)

Hello, sir.

Walter Noel Spracklin (Analyst)

I guess, my first question here is on the Canadian dollar, and perhaps you can update us on the revenue and expense impact, if it's changed at all, with a one penny move on that exchange rate. But really, I guess where I'd like to focus my question is on flow of goods, and if in your past experience as the Canadian dollar appreciated, certainly the export picture for Canada into the U.S. was not as strong as it was when we had a cheaper Canadian dollar.

Benoit Poirier (Analyst)

Just curious if that's something you anticipate on the flip side now, is there anything that wouldn't suggest that this would reverse? Are you seeing any indication from your customers that perhaps the flow of goods is starting to pick up as the Canadian dollar depreciates relative to the U.S.?

Luc Jobin (EVP and CFO)

Thanks for the question, Walter. It's Luc. I'll take the first part, and then I'll ask JJ to comment a little bit more on, in terms of the flow of goods. Just from a financial standpoint, every penny translates into somewhere between one to two cents of EPS. So, that's really the impact, netting out the revenues and expenses.

Walter Noel Spracklin (Analyst)

Do you have the revenue and expense specifically, or, or?

Luc Jobin (EVP and CFO)

No, we-

Walter Noel Spracklin (Analyst)

Okay.

Luc Jobin (EVP and CFO)

We don't provide that.

Walter Noel Spracklin (Analyst)

Okay.

JJ Ruest (EVP and CMO)

But on the Walter, on the, on the, the revenue side, obviously, Canadian manufacturing companies, especially those who have a heavy amount of their production on the Canadian side, do benefit from, you know, they export to the U.S., do benefit from a weaker Canadian dollar. That is, if they are in production today, and they're not running flat out as it is.

Benoit Poirier (Analyst)

So I think on a, you know, kind of a midterm basis, it's, it's positive. If you have a plant, you can run it harder. You can, you know, seek more sales in the U.S. and have those profitable sales. In the long term, you know, you only want to be dependent on weaker dollar so much. Eventually, you want to be able to invest capital and, and, and rely on something else in this exchange. So it's positive, but,

Walter Noel Spracklin (Analyst)

Any indication so far of any ramp-up in that flow of goods at all, or is it still too early to tell?

JJ Ruest (EVP and CMO)

I think it's too early to tell, right? We've only, you know, like a few weeks. I think that this, the forest product sector, for example, whether it's housing or, you know, related, construction material, pulp, paper, the like, historically have benefited from a weaker Canadian dollars.

Claude Mongeau (CEO)

Thank you, Walter.

Walter Noel Spracklin (Analyst)

Okay. Thank you.

JJ Ruest (EVP and CMO)

Thank you.

Operator (participant)

Thank you. The next question is from William Greene at Morgan Stanley. Please go ahead. Your line is now open.

William Greene (Analyst)

Yeah. Hi there, good afternoon. You know, Claude or JJ, can I ask you to talk a little bit about sort of if you feel like the underlying trends in the economy are actually improving? I know there's a lot of weather pieces here, so it's hard to piece it together all.

Benoit Poirier (Analyst)

You have a more positive outlook this year, so to some extent, embedded in that may be a view that things are getting better. But it also felt like Q4 had a bit of an inflection in demand in some segments of transport. So I'd like any color, if you can provide it, on what you're thinking on 2014, how it may evolve.

Claude Mongeau (CEO)

...Well, let me, Bill, I think we have seen good demand in Q4. We're certainly seeing good demand as we speak. Our challenge is to meet that demand in very cold weather when effectively our velocity being reduced, it's taking away our capability to meet all the demand. But the broad markets in the U.S. are constructive.

Benoit Poirier (Analyst)

The Canadian markets in general are also, I think, constructive. Obviously, some commodity sectors like grain, we have a huge crop, and things are looking good, you know, well, for the balance of the year and probably well into 2015.

The other, the only area where it's a little bit more touch and go, and I'll ask JJ to give color and comment, is the global impact of concerns for commodity markets with Asia seeming to slow down a little bit at the moment. JJ, any other color on that?

JJ Ruest (EVP and CMO)

Yeah, Bill, since December 2nd or December 8th, I think, Jim, we - from that, from that point on, you can't really look at car loads from railroad, at least from the CN point of view, as an indication of demand. Because now you get the noise of what's happening in some of the challenged network, and same thing on the January result.

Benoit Poirier (Analyst)

Because right now, we're not in a position to meet the demand. But where the demand, you know, this is where it gets tricky with what's in our book of business, which is demand, and how much is just a pent up from the past week.

But U.S. housing start, U.S. consumer confidence, which would be reflected in the global containers that are for automotive, looks good, energy, chemical, plastics, and you know, as Claude said, grain looks great. Late during the third and Q4 last year, we weren't too sure if fertilizer was look great. Fertilizer right now looks very great for first, both export and domestically.

What's maybe a little weaker is, you know, what used to—we used to ride, you know, in some of the year past, which is a trade with Asia, and namely, shipping goods to Asia, natural resource, Canadian natural resource. That's obviously weaker.

So really, our focus right now is more about the internal demand, what's happening in North—here in North America, what we're consuming, and also at what cost can we consume it. In the case of Canada, with a weaker Canadian dollars, in the case of United States, with an industry who can now benefit from real affordable energy, whether it's energy as in gas, energy as in electricity, or energy as in oil. So I think when we're past this sort of Arctic vortex, we should start to see eventually again, the relation between cargo and the economy.

William Greene (Analyst)

That's great. Thank you for the time.

JJ Ruest (EVP and CMO)

Thank you.

Claude Mongeau (CEO)

Thank you, Bill.

Operator (participant)

Thank you. The next question is from Turan Quettawala at Scotiabank. Please go ahead. Your line is now open.

Turan Quettawala (Analyst)

Yes, good afternoon. I guess I just had a quick question on crude by rail. Obviously, there's been a lot of increased regulatory scrutiny here on that, and it seems like there's probably pretty likely that there's gonna be some tank car regulation at least coming in. I guess my question is just: do you think that any of these changes, at least from what you know right now, can disrupt the volume trajectory at all on that front?

Claude Mongeau (CEO)

I don't think so personally. My view is, at the end of the day, what we know now is that the DOT-111 is a car that is more prone to failure, and it can have—it's a low probability of having an accident, but the high severity of the consequences is calling into question the design of those cars, which have been known for years to be more prone to failure.

Benoit Poirier (Analyst)

But now, obviously, the focus and the industry have spoken, you know, and personally, and CN is on the record, thinking that the DOT-111 cars have to be dealt with over time, but phased out, and we need to move to a new tank car design.

As far as our own franchise, we move a lot of our business in coil insulated cars, or we move a lot of our business in cars of the new standard, the CPC-1232, and those cars are materially safer. The conditional probability of a CPC-1232 versus a DOT-111 is 50% less risk of failing.

And if you look at a coil insulated car, that does, it's not exactly a thermal jacket, but it acts like one, and the risk of a conditional release is probably something like 70%-75% less than a DOT-111. So we are dealing with safer cars. A lot of what we move is also, you know, crude oil from Western Canada, that is heavy oil, that has a higher flashpoint.

And the light oil, over time, will migrate towards safer cars, and the railroads will improve their safety record, and the regulator will make sure that we all are held to a higher standard. And I think if we succeed at that, we should be able to continue to serve those markets and help energy move to market efficiently. That's our agenda, and I don't think, you know, we have issues to deal with and a lot of people to reassure, but what I think the hard facts are supportive of a continued ability to do our job, delivering energy to market.

Turan Quettawala (Analyst)

Great. Thank you for that color, Claude.

Claude Mongeau (CEO)

Thank you.

Operator (participant)

Thank you. The next question is from Thomas Wadewitz at J.P. Morgan. Please go ahead. Your line is now open.

Thomas Richard Wadewitz (Analyst)

Yeah, good afternoon. I suppose when it's this cold out, you could probably would ask for as much capacity as you could find in certain respects. But what's your view, Jim, or Claude, on capacity in the network, given that you've had pretty tough weather conditions for, for two months now?

Benoit Poirier (Analyst)

Do you feel like you need to, you know, kind of ramp it up and spend more money, or the, the network's more fragile in certain areas than you would expect? And, you know, kind of how do you match that up with the, the significant added volume you have coming on and maybe risk to, you know, handling that in a way that the customer likes?

Jim Vena (EVP and COO)

I think, great question. I think we, to start off with, we always have a long-term view of where the volume's gonna be and what our, what our planning period could be. So you know, we don't wanna react. If we have to react, like we did last winter, when we added $100 million, we'll do that, and we have the capability to do that or move it from somewhere else.

Benoit Poirier (Analyst)

Now, as far as what we've learned with the winter is, I think that everything that we've done, and we did last year, has helped us. But we need to make sure that we've got the right capacity everywhere, and we'll take a look at it as we go through this winter.

What I know for sure is, is the money that we spent last year between Winnipeg and Edmonton has helped us. We've seen a significant improvement of moving the trains through from Saskatoon west, and we've got money allocated this year to invest some more between Winnipeg and west towards Saskatoon, so we're gonna do that.

We have we know we have an issue coming between Edmonton and Chicago, and we're gonna continue to build on that to make sure, especially with the way the traffic flow is, JJ keeps on going and selling more business in that quarter, which is good, but we need to make sure that we're ready for it. So I don't see anything specific that we missed, but I'll tell you, if we do miss it, we'll be quick to react, and we'll make sure we put the money in that we need quickly so that we can remedy any situation.

Claude Mongeau (CEO)

Tom, maybe I could just add, because, you know, to you, but also to our customers, the hard reality here is it's not an issue of capacity, it's an issue of an extended period of extremely cold weather and the impact this has on train technology.

Benoit Poirier (Analyst)

The reality is we have more locomotives, we have more network capacity. But if you have a few days, which is normally the case, a few days or a few periods of a few days with -30 degrees, you cannot run the train, you cannot get the air to qualify, and you lose capacity. Your velocity can come down 15%. You have to shorten trains, so you need more assets, and you obviously build up a backlog.

If that happens for a short period, and then you have a few days to recover, it's more bumpy in winter, like every winter. What we're seeing this year is just extended period with no reprieve. I said earlier, December, you have to go back to 1879 to have a month of December in Winnipeg that was colder. In Saskatoon, there were 18 days where the temperature was less than -30 degrees.

We've had a new record temperature south towards Chicago, and what that does is, over an extended part of your network for extended periods of time, you have this velocity and train length impact, reducing your ability to move cars in the whole pipeline. This is not a network capacity.

If we had more locomotives or more sidings, we would not be able to push meaningfully more traffic than we are able to at the moment. It's the way we're set up with the technology of air to basically feed the braking system of train. Thank you.

Thomas Richard Wadewitz (Analyst)

Okay, great. Yeah, thanks, Claude. Thanks, Jim.

Claude Mongeau (CEO)

Thank you.

Operator (participant)

Thank you. The next question is from Scott Group at Wolfe Research. Please go ahead. Your line is now open.

Scott H. Group (Managing Director and Senior Analyst)

Hey, thanks. Good afternoon, everyone. So been a lot of talk about weather, and wondering if there's any way to put a number on trying to quantify what the impact was, one in the Q4, and then is there any kind of early view as to what it could look like in the Q1?

Benoit Poirier (Analyst)

And I guess the crux of the question really is, so you've got pension helping more than you thought, the dollar helping more than you thought, and demand getting better. Do you think that weather in Q1 kind of fully eats away at those positive things, or does it create some potential upside to the full year outlook that you guys have?

Claude Mongeau (CEO)

I'll let Luc comment, but I think you framed it right, Scott. We have a bit of a challenge, and we have upside area, and that's why we're reaffirming guidance for the full year. Dirk?

Jim Vena (EVP and COO)

Yeah, Scott, I mean, just to answer your question, as I mentioned, in my comments, you know, when we looked at the Q4, specifically December, I mean, on... You know, again, these numbers are not always exactly precise, but, you know, in the range of about $15 million more expenditures were clearly incurred as a result of the very, very extreme cold.

Benoit Poirier (Analyst)

I would expect that we're gonna see something similar for January. So that's on the cost side. Obviously, as well, I mean, you know, you're not getting all of the volume through on the top line that you'd like, so that's gonna, you know, that's something that we'll have to assess.

It's still a bit early because, you know, through the next two months, you know, the team will be working very hard to try to recover some of that, and, and so we'll see. You know, on the pension front, yeah, I mean, we're getting a little bit of a better position than we expected.

I did mention that we do have some headwinds, as an example, you know, the settlement we had in terms of some of the labor costs last year. So, I mean, net-net, on labor costs, you're not gonna see a big upside in the Q1. You're likely to see a little bit of that through the, you know, third, second, third, and fourth. We do still have some depreciation headwind that we have to contend with, but by and large, I mean, I think, you know, the way we ended the year, leaving aside for a second the winter impact-

JJ Ruest (EVP and CMO)

... sets up, you know, sets us up reasonably well for fulfilling our guidance, and that's why we, you know, reaffirmed it. We'll see how we end up faring through the Q1. But I think we all feel pretty pretty positive about the year. All the signals are looking good. A little bit of extreme cold, you know, which we're dealing with. And I think that's where we are at this point, so.

Claude Mongeau (CEO)

Thank you, Scott. Thank you.

Scott H. Group (Managing Director and Senior Analyst)

All right, thanks, guys.

Operator (participant)

Thank you. The next question is from David Newman at Cormark Securities. Please go ahead. Your line is now open.

David Newman (Analyst)

Hi, good afternoon, gentlemen. Just to reconfirm, Luc, you said it's $15 million, 15?

Luc Jobin (EVP and CFO)

Right.

David Newman (Analyst)

Okay, very good. My question is more on the pricing side. You know, obviously, weather is a bit of a hindrance right now. But as you look out, I mean, obviously, the demand environment's getting a bit better. You know, the trucks are facing a lot more regulations, et cetera, so it's getting a bit tougher for those guys.

Benoit Poirier (Analyst)

I mean, can you see a day when we get back to sort of better than CPI kind of price increases at some point here as this evolves? And obviously, you guys are doing great on the service front. I mean, can you see that kind of picking up beyond those levels at some point?

JJ Ruest (EVP and CMO)

I think for this year, again, for this year, for 2014 calendar year, inflation-plus pricing, I mean, at 3%, is our goal. You know, taking stock on everything you said, not all commodities obviously will carry the same weight. There is some segment where we can get more, and there is some segment where we will get less.

Benoit Poirier (Analyst)

One of the segments that's been the most challenging for us this year is regulated grain, you know, which is basically, you know, what the Canadian government decide, and that will be a headwind for us, first, second, and Q3. But on the flip side, on the other extreme, we are taking bigger increase and more emphasis on the price for dangerous goods like TIH and LPGs, for good reason.

I think what's important also is to put the perspective of the price increase we get versus the inflation. In the end, we're looking for a net, right? We're looking for a price increase, which is better than inflation. One of the things that maybe this year look better is inflation in North America is not that strong. I mean, that's maybe one of the positive side of how this, this week, this year might unfold on inflation plus, minus inflation type scenario.

David Newman (Analyst)

Do you, do you have any longer-term contracts that you could shorten up? I know CP is talking about doing that. Anything on that front at all?

JJ Ruest (EVP and CMO)

We don't have that many long-term contracts. We're mindful, I think, as all railroads to how far out we want to extend ourselves in terms of commitment. It's tough to read the future, for many reasons. Sometimes keeping your options open is the best thing.

David Newman (Analyst)

Yeah.

JJ Ruest (EVP and CMO)

We, any contract we sign, though, we live up all the way to the end. I think that's just good business. If I'd be on the other side of the contract, I'd want my customer to do the same. But we are mindful that when we sign these contract, which are multi-year, we're mindful of some of these indices that sometimes give you pretty close to nothing. So we tend to shy away from some of the index that sometimes get you in a bit of a challenge.

David Newman (Analyst)

Okay. And just let me squeeze one more in. Domestic intermodal overall, are you seeing any wins there, JJ, that you can illuminate on?

JJ Ruest (EVP and CMO)

Say that again?

David Newman (Analyst)

On the domestic intermodal side, are you seeing any recent wins that you could sort of highlight that you're seeing on the retail side?

JJ Ruest (EVP and CMO)

No, not specifically. This year, our bigger win are more on the overseas market.

David Newman (Analyst)

Right.

JJ Ruest (EVP and CMO)

On the domestic side, it's more, you know, kind of one at a time. Not so much one customer at a time, but one piece of business at a time. As you know, our domestic franchise is both Canada, U.S. We do, you know, a significant enough amount of business on the U.S. side of our domestic business that you need to keep that into account of the marketplace. We're more than just, you know, Western Canada to Ontario.

David Newman (Analyst)

Excellent. Thanks, guys. Let's hope for some global warming here.

Claude Mongeau (CEO)

Yeah, that's right. That's right.

JJ Ruest (EVP and CMO)

It will come. It's a question of time.

Claude Mongeau (CEO)

All right, next question.

David Newman (Analyst)

Thank you.

JJ Ruest (EVP and CMO)

Thank you.

Claude Mongeau (CEO)

Thank you.

Operator (participant)

Thank you. The next question is from Jason Seidel at Cowen and Company. Please go ahead. Your line is now open.

Jason Seidl (Managing Director and Senior Analyst)

Hey, hey, gentlemen. Real quick, going back to the crew zero. Claude, you know, when you look at the DOT-111s and the current fleet and some of the proposals out there, how long do you think the industry needs to sort of get it up to snuff, if you will? And do you foresee maybe any issues where there's a shortage of cars that might impact volumes over your network?

Claude Mongeau (CEO)

I think the industry, just like the railroads, have an incentive to reassure the public. And I think all of the strong players in that space are very safety conscious. So I'm of the view that many of our customers today are looking at ways that they can evolve as quickly as possible away from the DOT-111. Now, that's, you know, the responsible industry player, that's the railroads who are doing that.

Benoit Poirier (Analyst)

I think the regulators can help by framing that and making it, you know, making it a standard. So you can hear noise of associations that say, "We don't agree," but that doesn't mean the world doesn't agree that this is something that needs to be done.

Having said this, you know, we have moved for years using DOT-111 cars, and we do so extremely safely. The railroad industry moved 99.998% of dangerous goods to destination without incident. And so we have to make sure that we keep things in context and give normal time frames for the phasing out to occur. Is that 5 years? Is that you know 7 years? The you know that will be flushed out over time, but but I don't I think the the world is recognizing that this needs to happen for highly flammable products.

Jason Seidl (Managing Director and Senior Analyst)

Okay, great. I guess my next question is for Luc. In terms of the CapEx, for 2014, and even going forward, can you pull out the PTC impact for me?

Luc Jobin (EVP and CFO)

Yeah. On PTC, you know, obviously, we're ramping up. You know, our view is we've probably got about $300 million or so to fulfill the full program from this point on. You know, we're probably gonna invest about $50 million or so during the course of 2014.

Jason Seidl (Managing Director and Senior Analyst)

Okay, fantastic. Gentlemen, I appreciate the time.

Claude Mongeau (CEO)

Thank you.

Luc Jobin (EVP and CFO)

Thank you.

Operator (participant)

Thank you. The next question is from Benoit Poirier at Desjardins Securities. Please go ahead. Your line is now open.

Claude Mongeau (CEO)

Hello, Benoit.

Benoit Poirier (Analyst)

Yeah, on a tough start, given the tough weather, -1.2%. But on the other side, the RTM is still up 4% during the quarter. And if we look at the spread, there was also a positive spread back in 2012, of almost 4%. So how should we be looking in terms of RTM and car load spread going into 2014?

Claude Mongeau (CEO)

At the moment, I think the first few weeks of 2014 have a bit of noise in them, you know, Benoit, but there's no question, and you pointed out, we are growing as we speak. In fact, we have, you know, in railroad terms, we have good growth even through this very tough period. We are a backbone to the economy, and we have an agenda to help our customers win in the market. When we tell you we're facing challenges, we measure that against the commitment and the demand we see from our customers.

Benoit Poirier (Analyst)

So we're proud of being in a growth mode despite difficult weather, but we are mindful that we're not meeting the demand of our customers and impacting them in terms of their ability to reach market, and at times adding cost or a lot of sweat and anxiety because of our difficult service performance. So the two elements are not in contradiction, and we're doing our best to come out of this

. We have February and March, where we'll be running strong, if the weather permits, and you know, recover the backlog, restore our normal service level, and grow from there, and meet our overall guidance for the full year. I think that's the best way to give you a straight answer on this question.

Okay, thanks for the time.

Claude Mongeau (CEO)

Thank you. Thank you very much.

Operator (participant)

Thank you. And the last question for today will be from Thomas Kim at Goldman Sachs. Please go ahead. Your line is now open.

Thomas Kim (Analyst)

Thanks. Luc, can I just ask you a quick question in regard to your guidance for the effective tax rate as well as the effective interest rate for the year?

Luc Jobin (EVP and CFO)

Yeah, the effective tax rate is gonna be around 28%-29%. I mean, that's... You know, I'd, I'd probably err on the side of the higher number there. In terms of interest rates, we don't particularly provide guidance on that, so.

Claude Mongeau (CEO)

But it doesn't really change at the margin-

Luc Jobin (EVP and CFO)

No.

Claude Mongeau (CEO)

of our business.

Luc Jobin (EVP and CFO)

Shouldn't be a big change.

Claude Mongeau (CEO)

You can decide what the interest rate is, but much of our book of debt is fixed.

Thomas Kim (Analyst)

Okay, great. Thanks a lot, guys.

Luc Jobin (EVP and CFO)

No problem.

Claude Mongeau (CEO)

Okay, well, thank you. That was a good wrap-up question. We will leave it there and thank everybody who joined us on the call. You know, we are committed to deliver a solid 2014 year. We have good momentum. Our agenda is on track, and we will be looking forward to report on the Q1 results in a couple of months with hopefully some good news on how we were able to recover from tough weather. Thank you very much.

Luc Jobin (EVP and CFO)

Thank you.

Claude Mongeau (CEO)

Thank you.

Operator (participant)

Thank you. Ladies and gentlemen, your conference has now ended. All callers are asked to hang up their lines at this time, and thank you for joining today's call.