Canadian National Railway Company - Q4 2014

Transcript

Operator (participant)

Begin. Welcome to CN's fourth quarter 2014 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)

Great. Thank you, Mark, and good afternoon, everyone. Thanks to all of you for joining us today. I would like to remind you of the comments that have already been made regarding forward-looking statements. With me today is Claude Mongeau, our President and Chief Executive Officer. Luc Jobin, our Executive Vice President and Chief Financial Officer. Jim Vena, our Executive Vice President and Chief Operating Officer. And J.J. Ruest, our Executive Vice President and Chief Marketing Officer. In order to be fair to all participants, I would ask you to please limit your questions to one. It is 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 thanks to all of you for joining us on this call. I think it's fair to say we had a great quarter to finish another banner year. During the fourth quarter, we delivered $1.33 diluted EPS. That's up a full 36% over last year. Now, we did have some help from a number of factors that are outside of our control. Luc will help you unpack them, but clearly, FX effect was a tailwind. The lower WTI is helping also with a positive lag, and our stock-based compensation was helpful in the quarter. But you know, even without that, the results that we delivered were absolutely solid overall. Jim clearly took advantage with his team of the great weather during December.

They drove volume at extremely, you know, good operating metrics and low incremental cost. I'm pleased to report a 60.7 operating ratio to finish the year. JJ will explain this in more detail, but we clearly outpaced the economy. We continue to do so. Solid growth across the board, particularly proud of our grain performance in the fourth quarter and throughout the whole year. As you know, it was a difficult year with a 100-year crop and a very, you know, brutal winter last year. But we finished the year with a record movement of grain, more so than we've ever moved in our history by a large margin, close to 13%-14% record in our grain movement.

At the end of the year, we only had 1,500 outstanding orders on our wait list, and we are totally in sync with the other participants in the grain supply chain. So solid performance overall, a banner year, and a lot of momentum coming into 2015. And that confidence in our prospect is what gave you know, confidence to our board to accept our recommendation to increase the dividend by 25%, and Luc will explain to you, also increase our policy for distribution on a go-forward basis. So that's the highlight. I will turn it over to the team and wrap up at the end. Jim?

Jim Vena (COO)

Okay. Thank you very much, Claude. Our agenda has not changed. In order to grow faster than the economy, allow our customers to win in their markets, we need to continue to build on a foundation of operational excellence and deliver excellent service. Both goals are only achieved if you operate a safe railroad. We are still in the cycle of hiring for attrition and growth, and we continue to leverage our two new state-of-the-art training facilities that deliver the latest curriculum and embed our culture on safety, operational, and service excellence. Productivity improvements are key, and we found improvements by driving decision-making down to the front line and to the correct level. We continue to roll out innovative and updated customer initiatives, which provide our customers with better notice, better visibility, and using iAdvise, for example, notification of our service and recovery, if required.

Nothing changes moving forward. We will continue to manage our business on an end-to-end approach with an end-to-end supply chain view from one end to the other. In 2014, we invested $2.3 billion of capital on safety, growth, capacity, productivity, and infrastructure. We brought on 60 new locomotives and expect 90 more in 2015. We invested in rail equipment and invested in our plant to allow for both capacity on our mainline corridors and within our yards. Given all that, now, why don't we turn to the metrics to see how we did against our agenda?

If you take a look on the next page, on the operating highlights in the fourth quarter, as a base, we start with the car loads being up 11% year-over-year, our RTMs up 9%, and GTMs, which I also look at for the amount of workload we have, was up 12%. So if we take a look at the metrics, let's start with the one metric that was down in the quarter, and that is terminal dwell, and it came in where I expected it. With the change in business, with the flow of business that we have and the change in flows from one end to the other, we didn't expect to be able to maintain the same terminal dwell. But on, excuse me.

But on the rest of the metrics, train productivity, which is how many cars you can add. So if the business goes up, you need to add cars onto the same trains to be more productive. We were able to improve it by 3%. On yard productivity, the number of cars that our employees were able to switch efficiently with the amount of hours, again, improved 7%. The train speed or train velocity, even with the increase in business and in a good reflection of the capacity that we put into the system, was able to maintain flat. And, our car velocity, which is, and I've said it just about every call, is my favorite number because it gives me the best view, was up 1%, even with the increase in-- the double-digit increase in car loads....

We added 60 locomotives, and the locomotives have been able to deliver a fuel efficiency gain the whole fleet of 2.5% for the year, when in the first quarter, really, we had our work cut out to be able to deliver by the end of the year. But very good, very comfortable that the team embedded through the whole system, because it takes the locomotive engineer driving it to the systems that we have in place at a higher level to be able to understand what we're doing with it. We're very comfortable and very happy with that number after the what we started off with. And locomotive utilization, so you bring in 60 locomotives, if we use them properly, again, 6% better on the amount of GTMs per total horsepower. So JJ, I think, keep the business coming.

We got a good model and all yours.

J.J. Ruest (CMO)

Okay, thank you, Jim. For the next few minutes, I will go to the fourth quarter revenue, as I do usually, and then I'll conclude with our business outlook. Looking at the quarter, the total revenue was $3.2 billion, a 17% increase over last year. As Jim mentioned, we led the industry in carload growth at near 11%. The breakdown of the $460 million increase in revenue is as follows: volume, price, and negative mix together produce about 12.5% or $240 million. The strong U.S. dollar did add near 6% or $150 million, and the impact from fuel on our revenue was negative this time by roughly $30 million or -1%.

On the same-store price measure, with price was up 4% sequentially from the prior quarter and our best quarter for the year. For the full year of 2014, we did 3.2% on same-store price. So all in, solid top-line growth and, good pricing. Now, if we go through on some of the variants, I will only cover the big variants, the big variants in order of absolute dollar ranking, and I will do as usual on the FX-adjusted basis. The first revenue driver was grain. Our grain business was up 14%. Breakdown is roughly our U.S. grain was up 19%, our Canadian regulated grain was up 9%, and our Canadian commercial grain business was up 15%.

The official production tally of major crop harvest in Western Canada for 2014 is now 61 million metric ton, basically back to the 5-year average trend line. Second revenue driver for CN in the fourth quarter was our crude business, which was up over 40%. We moved a total of 34,000 carload in a quarter and approximately 128,000 carload of crude for the year. Last year, in every quarter, we moved more crude carload than the other Canadian railroad. In the fourth quarter, our mix of heavy versus light crude was about 60% in favor of heavy, and our mix of Canadian versus U.S. crude was about 75% in favor of Canada, making CN less reliant on the Bakken shale oil as we enter 2015.

The next one was sand business, which also produced solid results. It was up 80%. We moved 29,000 carloads in the quarter of sand to finish the year at 89,000 carloads, which generated a full revenue of roughly $350 million for the year. Four new plants continued to ramp up production on our line and started to ship unit trains on a consistent basis, namely Hi-Crush, Northern Frac, Superior Silica Sands, and Source Energy Services. About two-thirds of our sand is going to shale gas or liquid-rich shale plays, and about one-third goes to shale oil. On intermodal, the business grew 7%, driven by gains in international business, equally split between the Port of Vancouver, Port of Montreal, and the Port of Prince Rupert. We ended the quarter very strong, with a very strong momentum on the West Coast.

Our U.S. coal revenue were also a bright spot, up 35% on good demand from local utilities, but also on new services like coke and coal blending solution that we now provide from our dock on the Great Lakes. The iron ore supply chain, which includes our vessel and dock revenue, was up 20% as we completed our customers' restocking goal. Steel product was up 35%, mainly from, mainly from semi-finished steel. The automotive supply chain, which includes our Autoport operation, was up 10%, leveraging our strong franchise of Autoport terminal and our business relationship with all the producers. Lumber and panel produced 9%, driven by U.S. housing, which was partly offset by lower market share of the export to Asia, something that we are working on.

The main negative drag of the quarter on total revenue was Canadian port coal exports, which were down $26 million, mainly from mine closure. So now turning to the next page, turning to the outlook. Broadly speaking, we see core pricing to remain resilient, benefiting from the industry's snug capacity and producing real rate of increase above inflation. On the question of fuel surcharge program, we are entering 2015 with only 20% of our revenue with in an index based on WTI, and we will be progressively converting to an on-highway diesel index in the next 18 months-24 months. Volume outlook remained positive among most sectors, except Canadian coal, which will be down about $100 million in revenue in 2014, but we are positive about our U.S. coal sector.

The rail versus truck competitive landscape will continue to be dominated by the fact that there is a driver shortage, and that's becoming the more relevant issues, more so than the drop in the fuel surcharge. Now, let's get into some of the specific of your recent interests, namely energy. In 2015, we aim for an increase of approximately 75,000 carload that is combined carload of frac sand and crude from a combined base of 217,000 carload in 2014, and for frac sand, we foresee a sequential pickup in volume from the fourth quarter into the first quarter, then a slowdown during the spring breakup in Western Canada, which is a new business phenomenon this year, and then after that, a return to growth.

For crude volume, the pickup of the pace will probably take place mostly in the spring after the completion of major heavy crude shipping infrastructure in Alberta. In Intermodal, the international segment should stay strong as the congestion at the U.S. West Coast port is remaining in place, and which gives us an opportunity to make use of our fluid capacity. Furthermore, we feel constructive about the prospect of the Rupert terminal capacity, which should give CN a West Coast opportunity, as well as a weaker Canadian dollar is good for Canadian ports selling at the U.S. Midwest. On the domestic side, the pace of growth would be less than the international segment, and we look at a progressive pickup during the year. You should also make note, the productivity level of our domestic business is equivalent to our international segment.

We are positive on the automotive business, and we aim to outpace the growth of U.S. automotive sales. On potash this year, this year could be solid. The Russian potash production is in trouble with the loss of a 2.3 million metric ton mine. The world potash market seems to have found its bottom, and Canpotex signed a base supply contract with the Chinese for the next 3 years. For lumber and panel, we see a bigger rail car fleet to exploit the market. We have steady U.S. housing starts, and the devalued Canadian dollar support Canadian exporters. When you look at the lumber price curve over the last 18 months, if you look at it in U.S. funds, and then you look at it in Canadian funds, you will start to see the new difference from a Canadian exporter perspective.

For grain, we expect Q1 to be positive versus last year's polar vortex, but from the mid-spring and up the next harvest in September, the comparable will become much more challenging. With a drop in oil price, we also expect the Canadian revenue cap to turn negative at the next regulated cap update of August first of this summer. In closing, our diversified book of business will benefit from the U.S. economy. We are focused to grow faster than the economy, targeting cargo growth in a range of 3%-4%, and we are aiming for inflation plus pricing in the range of 3%-4%, and at the same time, as we continue our focus on yield and selective upscaling. Thank you. I'll pass it on to Luc.

Luc Jobin (CFO)

All right. Thanks very much, JJ. Starting on page 12 of the presentation, then let me walk you through the key financial highlights of our fourth quarter and full year performance in 2014. Starting with the fourth quarter, revenues were up $462 million, or 17%, to reach $3.2 billion. Operating income was $1.26 billion, up $293 million or 30% versus last year. As Claude pointed out, our operating ratio in the quarter was 60.7%, and this represents a 410 basis points improvement over last year. As we move strong business volumes for our customers, and in contrast to 2013, we did so at low incremental cost, as we benefited from more favorable weather conditions, specifically in December.

Other income was $13 million, a $2 million versus a $2 million expense last year, as property sales helped offset some of the real estate and other costs. Net income for the fourth quarter is $844 million, up 33%, and the diluted EPS reached $1.03, up 36% versus last year. Foreign currency was favorable for $45 million on net income in the quarter. Turning to page 13, operating expenses were up 10% at just over $1.9 billion. Expressed on a constant currency basis, this is up 5% or $91 million versus last year. At this point, I'll refer to the changes in constant currencies. Labor and fringe benefit costs were $592 million, a 3% improvement over last year. This was the result of three elements.

First, an increase in overall wage cost of 9%, partly the product of wage inflation of 3% and a 7% increase in average headcount versus last year. Now, that gave us a 5% labor productivity, since, as Jim pointed out, we had a 12% GTM growth in the quarter. The second element is a lower stock-based compensation expense in this quarter versus last year, which represents seven percentage points of the variance or $40 million. The third and last element is lower pension expense for $25 million or 4% of the labor variance.

We finished 2014 with some solid returns on our pension assets, but unfortunately, this was overshadowed by disappointing news in terms of the discount rate at December 31, which actually decreased to 3.87%, and as a result, we now expect a headwind in our total pension expense for 2015 to be in the range of $100 million versus last year. Purchased services and material expenses were $442 million, up 18%. This is mostly the product of higher volume, resulting in increased costs, including materials, repairs and maintenance, and externally supplied services. The fuel expense stood at $448 million, or 1% lower than last year.

Higher volume represented an increase of approximately $55 million in the quarter, while price was favorable by $47 million, and improved productivity also constituted a positive offset for $13 million or 3 percentage points. Casualty and other costs were $101 million, $25 million unfavorable to last year. Our U.S. personal injury claims were $11 million lower than last year, but this was offset by higher loss and damage claims, as well as other costs. I would expect this category of expenditures to remain in the $90 million or so per quarter range on average in 2015. Before I move on to full year results, let me make a few comments on the significant change that's taken place in terms of fuel prices.

JJ spoke to our 2015 prospects for energy-related shipments, so I want to deal here with the impact of fuel prices, the impact of fuel prices on fuel surcharge, as well as the fuel expense. It's not an easy subject. There's a lot of moving parts here, so let's see if I can be helpful. The first set of issues relates to the timing and the direction of the fuel lag. The fuel lag represented a revenue tailwind of $38 million in Q4. So we will only have a portion of the full lag benefit show up in the first quarter of 2015 revenues. This will give rise to a timing issue in matching the revenue versus the expense impact.

In addition, we're forecasting an average WTI price of approximately $50 for 2015. Implied in this is a lower price for the first half of the year, but we do expect prices to rise modestly in the second half of 2015 to, hopefully, a $55-$60 per barrel range. This would, in turn, give rise to a fuel lag revenue headwind through the latter part of 2015, and more significantly, of course, in the fourth quarter when compared to 2014. Next is the fact that WTI prices have come down more rapidly than on-highway diesel prices in relative terms. Since roughly 20% of our revenues are WTI indexed, the associated fuel surcharge revenues have been falling faster than our fuel expense. Then, consider additional complexity.

CN has five different fuel surcharge formulas with different methods of application, such as revenue, a percentage of revenue rate and dollars on a per mile basis, different strike prices, foreign exchange complications, and the lag issue, which I've mentioned earlier. So well, you can appreciate the difficulty in forecasting the year-on-year impact in 2015. However, as I said, in the spirit of trying to be helpful and on the basis of our assumptions for fuel prices, both absolute, relative, and timing-wise, as well as FX, we see the potential for a 2015 negative impact to operating earnings, which by and large, could be somewhere in the range of a pension-like magnitude. All right, so let's turn now to the full year results. We wrapped up 2013 with over $12.1 billion in revenues, a 15% increase.

Our operating income grew 19% to reach $4.6 billion. The operating ratio for the full year stood at 61.9%. That's 150 basis points better than 2013, and a new all-time record, beating our 2006 mark by 70 basis points, which is quite an achievement since, as you know, Jim mentioned, when you consider the fact that we faced in 2014, a very harsh winter through the entire first quarter of the year, this is quite an accomplishment. Net income was up $555 million, or 21%, to just under $3.2 billion. FX was favorable for the full year by about $120 million of net income, or 15 cents of EPS in 2014.

This translated into a 25% increase in reported diluted EPS at $3.85. Once you exclude the impact of major asset sales and income tax adjustments in respective years, the adjusted diluted EPS for 2014 stood at $3.76, a 23% increase over 2013. Moving on to free cash flow. For the full year 2014, we generated $2.2 billion of free cash, approximately $600 million more than in the prior year. This was mostly driven by higher net income, lower cash taxes, and higher proceeds from property sales, partly offset by higher capital expenditures. Meanwhile, our balance sheet remains strong, with debt and leverage ratios well within our guidelines. Finally, our 2015 financial outlook. We continue to be optimistic about CN's future prospects.

We see opportunities in the North American economy and continued, albeit more modest, global growth in export markets. We assume that the North American industrial production will increase in the 3%-4% range in 2015. These and other key assumptions underpinning our outlook should translate into cargo growth in the range of 3%-4% for 2015. And as JJ pointed out, on the pricing front, we maintain our inflation plus policy. So therefore, our annual outlook aims for double-digit EPS growth in 2015 over the 2014 adjusted diluted EPS of $3.76. We're also assuming a capital investment program of approximately $2.6 billion.

This represents a $300 million increase over 2014's program as we continue to invest in our franchise to support our safety, growth, and productivity agenda. Also, in this 20th year since CN's privatization, our commitment to a strong shareholder return agenda continues. Building on a strong balance sheet, a robust performance in 2014, and with confidence in our future prospects for generating earnings and free cash flow, our board has approved today a 25% increase in dividends. This is also consistent with our new objective of gradually moving towards a 35% dividend payout ratio. In addition, we continue with our agenda of rewarding shareholders through our stock buyback program. In 2014, we've bought back 22.4 million shares for $1.5 billion.

In 2015, we are carrying on with the program approved by our board last October to buy back up to 28 million shares, and we've set aside $1.7 billion to achieve this objective. So the CN team remains well committed to delivering superior results and creating value for shareholders as we continue to unfold our strategic agenda in 2015. On that note, back to you, Claude.

Claude Mongeau (CEO)

Thank you, Luc and team. So clearly strong, fourth quarter results to close in on a banner year, and we're maintaining that momentum on a go-forward basis. Our agenda of supply chain enabling and operational and service excellence is resonating with our customers, and it's helping us deliver strong results for our shareholders. I'm looking at the beginning of the year, it looks like we are having a much easier winter. Winter is not over, but a month of it is almost passed, and so far in January, we are maintaining very solid metrics and very fluid service. In fact, the last five days in a row, we had more than 1.3 billion GTMs every day in our rail network. The growth on a go-forward basis, there's uncertainty out there.

You read the news flow, you know, oil prices, what's happening in Europe, you know, some of the uncertainties, job layoffs, particularly in Canada lately. It's not like there's not uncertainty out there that we have to face up to. But we believe the environment is conducive to continued growth, particularly as we see the impact of lower oil prices on consumer income and the North American economy, the U.S. economy in general, that we are leveraged to. The Canadian dollar, as JJ mentioned, should help us, and our Canadian customers who are exporting into the U.S. So the message here is we have a diverse set of opportunity. Our energy markets are continuing to grow, even though perhaps at a slightly lesser pace than the last two quarters. But clearly, overall, good scope for growth if the economy holds.

The key to holding on that, pattern of growth, both the top line and the bottom line, is to innovate and stay ahead of the curve. We're innovating, doubling down on service, and we're staying up, ahead of the curve in terms of how we resource our operation and how we invest back into our business. This is what we need to do to continue to help our customers win in their marketplace and deliver solid shareholder value for many, many years to come. With that, I will turn it over to the questions. Mark?

Operator (participant)

Thank you. We will now take questions from the telephone lines. If you have a question and are using a speakerphone, please lift your handset before making your selection. Please press star one at this time for any questions. You can cancel your question at any time by pressing the pound sign. Our first question is from Brandon Oglenski from Barclays. Please go ahead.

Brandon Oglenski (Director and Senior Equity Analyst)

Well, good afternoon, everyone, and congrats on the quarter.

Claude Mongeau (CEO)

Thank you, Brandon.

Brandon Oglenski (Director and Senior Equity Analyst)

You know, Claude, I guess I'm gonna address the question that a lot of your investors are asking right now, which, you know, pertains to that disclosure that JJ talked about with frac sand and crude oil representing, you know, 200,000+ carloads. But is there a way to quantify the, you know, the derivative impacts of energy markets in Canada? And, you know, what gives you the confidence of that 75,000 carloads of growth this year, and what are you seeing for projects beyond 2015 and into 2016 and 2017? Is it still, you know, the, the key growth market that you've been talking about the last two years?

Claude Mongeau (CEO)

Let me give you the big picture, and then JJ can fill in with his perspective. There's a lot of investments that are being made by our customers in the energy market, whether it's new frac sand plants or whether it's new infrastructure to allow to move crude and other petroleum products. We believe those investments are made for the long term, and we believe our customers are producing with a run rate that is there for the long term. So there will be uncertainty. The price is obviously a key factor. This is why we have reduced our expectation in terms of this market, but the investments are being put in place, and the markets will need those services, and we think they will need them not only in 2015, but also for the long term.

The general economy, you know, and obviously the capital expenditure, the deferral of some big projects, that will reduce consumption of other types of products that we move, aggregates, pipes, et cetera. But that's part of the broader industrial, you know, base of commodities that we move, and they are part and parcel of that 3%-4% industrial production and carload growth that we are guiding to. JJ, you wanna add to this?

J.J. Ruest (CMO)

Yeah. And basically, we're gonna be harvesting the momentum of a major infrastructure from 2014, which are carrying into 2015.

... you know, major infrastructure in crude production, major infrastructure in crude by rail infrastructure as well. So last week, the CAPP, Canadian Association of Petroleum Producer, came out with their new forecast of crude production in Canada, and they, they see a, an increase of 150,000 barrels per day in 2015 versus 2014, meaning that there is this carry forward major capital investment from the, the past year, the past two, three years, that's still gonna be carrying in 2015. Same thing in sand. On our track, you know, there's, there's been major capital investment made on production side. I've mentioned those, in my notes.

We also have major capital investment on the receiving side, on loop track, of course, to be able to receive the frac sand in Western Canada, which will come into place, you know, sometime in the spring or during the summer. These dollars are about to produce a return, and they will be put in operation, and that's what will help us see a growth in carload in both frac sand and crude in 2015.

Brandon Oglenski (Director and Senior Equity Analyst)

Great. Appreciate the detail. Thank you.

Operator (participant)

Thank you. Our next question is from Cheryl Radburn from TD, TD Securities. Please go ahead.

Cherilyn Radbourne (Managing Director and Senior Equity Research Analyst)

Thanks very much. Good afternoon. Wanted to ask you about the U.S. West Coast port congestion, and how much you think that benefited Canadian port volumes in 2014. But, more importantly, to what extent you think it's been bad enough for long enough that it will help to support demand for further expansion at Prince Rupert?

J.J. Ruest (CMO)

Well, Cheryl, definitely last summer, in our second quarter results, we did see an increase in our volume to the U.S. Midwest from Canadian port. There was this big rush, you know, coming at the end of June that came in. That lasted with us in July and August. And then we saw that again, ramping up November and December, and we're still in it right now. The Canadian port on the West Coast are very busy, and CN is benefiting of that because of our access to a number of destinations in the U.S. Midwest. So it is, it is, it is positive. And then in the case of Rupert, Rupert, as we speak, is fluid. It's busy, but it's fluid. It could actually take more business.

We're hoping for a non-slowdown during the Chinese New Year. And after that, I mean, ourselves and Maher, the terminal operator and owner, are very committed to, you know, make Rupert as good as it can be in the current environment, where capacity is tight and the supply chain in the U.S. West Coast has had some challenge. So it's an opportunity for us. And then, you add the Canadian dollar, so now we can compete in the U.S. Midwest even more so today at $0.85 than when we were at par.

Cherilyn Radbourne (Managing Director and Senior Equity Research Analyst)

Great. Thank you. That's my one.

Claude Mongeau (CEO)

Thank you, Cheryl.

Operator (participant)

Thank you. Our next question is from Chris Wetherby from Citi. Please go ahead.

Christian F. Wetherbee (Senior Research Analyst)

Great. Thanks. Good afternoon. This is a question on capacity, thinking about sort of the outlook for growth and really the tremendous growth you've been able to manage fairly effectively from a service standpoint over the course of 2014, and even 2013. Just kind of curious how you think about capacity. Are you getting close to the point where maybe the incremental costs get higher? Do you feel like you really can manage, particularly as you, you're forecasting a bit of a step down here into that 3%-4% range? Just maybe broadly speaking, some color on capacity would be helpful. Thank you.

Claude Mongeau (CEO)

Chris, let me give again the big picture, and then Jim will give you his perspective there. You know, I'm very pleased. We had a brutal winter last year. It's, we call it the winter of a lifetime, and obviously it impacted us. But in actual fact, despite being the most exposed railroad, we ended up performing, I would argue, the best in terms of maintaining our train velocity and maintaining our yard fluidity. We recovered extremely fast right after the winter. We recovered, you know, in April, you know, very, very quickly and have been able to maintain very solid metrics throughout the year. What that tells me, because we saw our GTMs go very strong in the second quarter, and we are seeing them right now continuing at very strong levels.

What that tells me is we have much latent capacity, and we're continuing to invest ahead of the curve to maintain the latent capacity that's required. So I think we've proved to ourselves that when the weather is collaborating, you know, within normal band of cold temperatures, we have all the capacity we need to grow with the business and stay ahead of the curve. But Jim, why don't you take it from your perspective?

Jim Vena (COO)

Listen, Claude, the only thing I can add is this: capacity, Chris, comes from people, from locomotives, and how you handle the equipment through the yards, how efficient you are. And then on the road, you always have some pinch points that you're working against. You plan for long term, not short term. You react, and we try to react just before we get there, so we have a chance. And I think we've shown the last couple of years, if we react fast enough on the capacity on those pinch points, it opens up more capacity in the other places because you're more fluid. So at the end of the day, same, same structure.

I'm, I'm not worried about the investments that we're making and the capacity that we have for what JJ is planning to bring on this year and next year. So I'm real comfortable. And then, if you take a look at Chicago, I think it, it's a good example of what we've done over the long term. Chicago now is fluid. We're working through January and December. We've, we've used Kirk Yard as a benefit to help out if we have to in other places. So Chicago was a great investment, gives us a competitive advantage, my feeling is, over the, over the long term, and we're very fluid operating through there, Chris.

Christian F. Wetherbee (Senior Research Analyst)

That's great color. Thanks for the time, guys. Appreciate it.

Claude Mongeau (CEO)

Thank you.

Operator (participant)

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

Walter Spracklin (Managing Director and Senior Equity Research Analyst)

Thanks very much. Good afternoon, everyone.I just want to come back to pricing, and just before I ask my question, JJ, did you mention that it was 4% in the quarter sequentially, or year-over-year on pricing? Just to clarify.

J.J. Ruest (CMO)

Same-store price in the fourth quarter was 4%, which was sequentially up from prior quarter, and for the year, we were at 3.2%.

Walter Noel Spracklin (Analyst)

Just year-over-year in the fourth quarter, do you have that number?

J.J. Ruest (CMO)

Yeah, the fourth quarter was 4%, which is-

Walter Noel Spracklin (Analyst)

Year-over-year.

J.J. Ruest (CMO)

Four.

Walter Noel Spracklin (Analyst)

Okay. And so when I look at pricing for 2015, I know you said 3%-4%, which is quite a wide range, but I, you know, you're 20% above your pre-recession peak, so clearly, your product is very scarce. We know regulated grain is, you're gonna be up above 4% this year, and from what we're hearing, crude carloads are starting to price upwards. So when I build all that in, are we not pointing more toward the high end of that 3%-4%, or perhaps through 4%, if we factor in all those moving parts?

J.J. Ruest (CMO)

It's 3%-4%. It's a marathon. We're gonna be doing this for a long time, and you know, we don't want to be, you know, being passed maybe by someone else for a quarter is one thing, but we're in this for the long run. Just coming back, comment on your, the grain, the Canadian cap, it will most likely be negative come August, and it could be, you know, a few% negative. So, I mean, that will be a headwind for whatever that is for the second half. But we're setting a pace, and we want to keep with that pace.

Claude Mongeau (CEO)

Yeah, I think, Walter, you'd be better to go start from the 3.2% for the full year and inch up. That would give you a better base to work on. And we, we manage our book of business with a view for the long term. That's our strategy. It's worked for us for the last 10 years-15 years, and we're sticking to it.

Walter Noel Spracklin (Analyst)

That doesn't include foreign exchange, though, right? The 4%, that's a-

Claude Mongeau (CEO)

That's the beauty with the... what JJ tells you. It's pure price, same store, the same way every quarter.

Walter Noel Spracklin (Analyst)

Right.

Claude Mongeau (CEO)

It does not include anything but pure price.

J.J. Ruest (CMO)

Take out-

Walter Noel Spracklin (Analyst)

Okay.

J.J. Ruest (CMO)

-fuel, we take out exchange, and we look at the 70%-75% of the b-book of business, which is same store.

Walter Noel Spracklin (Analyst)

Perfect. Okay. Thank you very much.

Claude Mongeau (CEO)

Thank you.

Operator (participant)

Our next question is from Tom Wadowitz, from UBS. Please go ahead.

Thomas Wadewitz (Managing Director and Senior Equity Research Analyst)

Yes, good afternoon. Wanted to ask you a question about currency and how you think the weaker Canadian dollar might, you know, benefit what parts of the book? So I guess if you think of it, normally, I think, well, Eastern Canada is more manufacturing and maybe more chance to benefit, but could you break down, you know, maybe what % of your book is origination and what % of that origination is in the East, the U.S., and the West? You know, just put it in those three buckets, and is it fair to think that a certain region would really be the primary area you benefit from a weaker Canadian dollar?

Claude Mongeau (CEO)

Tom, welcome back, Tom, and you, you've kept your strategy of using that one question very effectively. The-

Thomas Wadewitz (Managing Director and Senior Equity Research Analyst)

Thank you.

Claude Mongeau (CEO)

Yeah. Let me, let me answer that question broadly. Now we originate 85% of our traffic locally on CN. You know, we have 50% of our business, which is either in the U.S. or transborder into the U.S. and out of the U.S. to Canada. I mean, it's a range of commodity. JJ mentioned lumber, for instance, forest products, all the manufacturing base. We see not so much our origination, we see the U.S. economy with more discretionary income because of lower fuel prices and already good momentum because of employment trends. We see the U.S. economy being a bright light. We see the Canadian economy benefiting from that. And so we're, you know, constructive about intermodal and cargo in general.

It's not geographically based, it's not one commodity, it's the whole book of business in that end market that we see, benefiting into next year. As we discussed, we see very strong growth potential, albeit at a smaller, at a slower pace in energy markets as well. The only market where we face a meaningful headwind, and JJ gave you the contour of that, is really our, our coal and more generally, bulk franchise with Canadian and, US grain returning to more normal crops into 2015.

Thomas Wadewitz (Managing Director and Senior Equity Research Analyst)

That's all very helpful, but I guess I'm just... Is there a frame for currency that you'd say, you know, maybe it's not the geographic, maybe it's not the East, but are there particular businesses where there'd be more benefit, just so we can kind of think about that currency impact a bit? It's just been a while since the Canadian dollar's been as weak as it is right now.

J.J. Ruest (CMO)

Well, definitely, you look at what's produced in Canada and more where most of the cost is Canada. So forest product, if you're making a forest product, a lumber, you chop the tree here, you trim it, you ship it out, most of your costs are in Canadian funds. So lumber from BC, lumber from Quebec, paper from the east. Pulp will typically not go in the US, it will go offshore. Ontario will benefit, because that's typically where the manufacturing base is. So it's a little more an eastern story, less of an Alberta story right now, because Alberta does not really produce manufacturing product. It produces energies.

You know, for those of you who hopefully are gonna be buying a house or expanding your house in the U.S. and filling up the furniture, these will come from Asia, and that's where Rupert, Vancouver, you know, they come in, you know, basically competing for product from Asia, going to the U.S. Midwest.

Claude Mongeau (CEO)

Thank you, Tom.

Thomas Wadewitz (Managing Director and Senior Equity Research Analyst)

Thanks for the time.

Claude Mongeau (CEO)

Thank you.

Operator (participant)

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

Fadi Chamoun (Managing Director and Senior Equity Research Analyst)

... Yes, hi. I want to circle back on the energy question a little bit. So, I mean, it seems like there is probably strong case that if crude prices stay at these sort of depressed level for a while, we could see some of that conventional heavy crude production in Canada sort of being cut. So wouldn't this free up some pipeline capacity and potentially create a more competitive environment for this crude by rail business? And, or are you thinking that the barriers to switching are too high for that to happen? I'm just curious if you have any thoughts on that.

Claude Mongeau (CEO)

I would say that the pipelines that exist today are not meeting the demand, and the demand that we are serving often goes to places where there are no pipelines at all. I think you have to trust these, you know, large integrated companies, which are increasingly the large bulk of our customer base, to know what they're doing when they're building a supply chain. They're investing, in some cases, close to $1 billion to create a supply chain that gives them resiliency, redundancy, and a competitive product to get to market. Now, it's a tough market out there, and, you know, it's a little more difficult to predict, but we believe our energy markets are gonna be growing, and they're gonna be growing for the next several years.

There's no certainty out there, but that's our constructive view of the future.

Fadi Chamoun (Managing Director and Senior Equity Research Analyst)

Okay. Is there a percentage of what you're doing right now tied up with take or pay in the crude by rail?

J.J. Ruest (CMO)

What we really do is, you know, we don't invest much capital, if any, but we have a capital-

Fadi Chamoun (Managing Director and Senior Equity Research Analyst)

Yeah.

J.J. Ruest (CMO)

Rolling stock that we can use for anything else, same thing as a mainline network. So we're competing with existing infrastructure. If the pipeline exists today, obviously it's an option. If the pipeline doesn't exist today and rail is a better option, rail is a better option. And whether you're looking at doing new major capital investment in crude by rail or new capital investment in pipeline, in today's market, you're probably gonna be thinking about it twice. 'Cause the cash flow from crude is not what it is today versus, you know, what it was 18 months ago. So anybody who's looking for, you know, building new major infrastructure, whether it's a new pipeline or a new $50 million crude terminal, you know, you got to get the backing for that.

Those decisions today are not as obvious as they were 8, 6 months ago. But what is there today, almost completed, that's coming on stream, that's real, that's money on the ground. People will want to use that as much as they can.

Fadi Chamoun (Managing Director and Senior Equity Research Analyst)

Okay, thank you. Congratulations on the good results as well.

Claude Mongeau (CEO)

Thank you, Serge.

Operator (participant)

Thank you. Our next question is from Ken Hoexter from Merrill Lynch. Please go ahead.

Kenneth Scott Hoexter (Research Analyst)

Hey, Claude, good afternoon. Echo that, congrats on some impressive performance. Claude, maybe some thoughts on your major contract wins over the last year, year and a half, from your peer, when they were maybe struggling in their terms. You know, your thoughts on ability to keep some of that versus do you think about losing some of that back as they improve their performance? And how does that contrast with, I guess, the pricing thought when I look at metals and grain yields, both very robust, were there any numbers shifted in that, or is that a mix, or is that just the market itself getting prices?

Claude Mongeau (CEO)

I think, you have to be very careful at looking at the, you know, revenue per cars or, you know, you got exchange, you got fuel surcharge, you got mix, you got all sorts of, other elements. You know, when JJ says to you 3.3, 3.2% same store price across our book of business last year, it's, it's a, it, you know, it could be a little bit up from that, it can be a little down, but it's, it's a good indication of the pricing that we're getting across our entire book of business. And it, it doesn't, you know, vary from simple to double. It's variations around that mean is how we go to the marketplace.

On your market overview, we—I mean, we have an agenda that we are basically unfolding for the last five years. It's about helping our customers win in the marketplace. It's about, you know, serving them to help them, you know, save costs, and it's about providing to them innovation. Innovation in the form of supply chain redundancy, end-to-end visibility, and that's our agenda. It's working, it's resonating. We are winning market share against all modes, whether it's pipelines, trucks, you know, even shipping in some, you know, few instances. Obviously, a little bit about against other railroads, all railroads, not just our principal competitor. We are trying to innovate, we're trying to outpace the economy, and we think that's gonna continue to be the case for the next few years.

You know, you win some contracts, you lose, you know, some contracts, but if your agenda is working quarter after quarter and sustainable growth comes with it, then I think we have enough of a track record to anchor, you know, our positive prospect and confidence that we will continue to be able to outpace next year and into into the future.

J.J. Ruest (CMO)

And just on that, revenue per carload is not a measure of yield. Revenue per carload is a measure of revenue per carload. That's all it is. You know, you have exchange, you got mix, you got fuel surcharge, you got everything that basically is equal noise. But really the measure of yield is, I mean, to cost ratio, contribution per car day around to OR.

Luc Jobin (CFO)

... Wonderful. Appreciate the time. Thanks.

Claude Mongeau (CEO)

Thank you, Jim.

Operator (participant)

Thank you. Our next question is from Benoît Poirier from Desjardins Capital Markets. Please go ahead.

Benoît Poirier (Managing Director and Senior Equity Research Analyst)

Yeah, thank you very much, and congratulations for the very good quarter. Just to come back on free cash flow, so $2.2 billion in 2014, so obviously a very strong performance. I was wondering if you could provide more color for the expectation for 2015, but also discuss about the further cash deployment opportunities in the long term, aside the CapEx increase and dividend increase. Thanks.

Luc Jobin (CFO)

Yeah, Benoit, this is Luc. Let me comment on that. So, as it relates to 2015, you know, we are not as such providing specific guidance on free cash flow. But what we are, you know, what we've put out there is certainly, first and foremost, an indication that we were increasing our investments in capital expenditures up to $2.6 billion. You know, I think we feel pretty good about the outlook generally, as you can see from the guidance we provided. So, you know, we think that we'll continue to generate some strong free cash, and we're maintaining the discipline in terms of reinvesting in the business. That's job one.

Our balance sheet, indeed, is pretty good, very strong balance sheet, and we're using that opportunity to return more and more to the shareholders. This year, that was, you know, $1.5 billion in stock buyback and $800 million plus of dividends. So the dividend increased, and we're currently working on a $1.7 billion stock buyback. You know, it all bodes pretty well for our shareholders. So we're maintaining the discipline, and, you know, we're not, we're not the types to, you know, to take a drastic view. But progressively, as we generate, you know, good cash, and as we see good prospects for continued sustainable growth, in the future, we do feel that it's important to continue to reward our shareholders.

So the 35% target payout ratio is one critical example of that. So over the next few years, we'll make our way there. And you know, I mean, we the program that we have currently calls for potentially up to 28 million shares to be bought back. Should there be a significant discontinuity in the marketplace that provides an opportunity? Sure. I mean, you know, we'd look at some of these things. But by and large, we're pretty disciplined, and you know, we like to look at this as a longer-term proposition. So we feel good about being able to support the business and at the same time, provide you know, superior return to shareholders.

Benoît Poirier (Managing Director and Senior Equity Research Analyst)

Okay, very good color, Luc. Thanks for the time.

Luc Jobin (CFO)

You're welcome, Benoit.

Claude Mongeau (CEO)

Thank you, Benoit.

Operator (participant)

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

David Scott Vernon (Senior Analyst)

Hi, thanks for taking the question, guys. Could you talk a little bit about the $2.6 billion, the extra spending that we're getting in this coming year? How much of that is going for kind of additional power to either rebuild or stay ahead of volume growth, and how much of that is going actually to expansion of the physical plant and the network itself?

Luc Jobin (CFO)

Yeah. The way we've got it lined up currently is about $1.3 billion going into what I guess we refer to as track infrastructure, maintenance of our network to keep it, you know, safe, productive and fluid. So that's about $1.3 billion. As far as equipment is concerned, we've got about a $500 million allocation, and that entails, among other things, securing 90 brand-new spanking locomotives for Jim and the team to, you know, to have the proper level of assets to deliver to our customers and keep things moving. And the balance is really a split between opportunities we see for investing in growth and productivity across our business.

In some cases, it's in the form of you know, improvements in yards, you know, different types of things, as well as also, you know, we've been undergoing certain special projects. The Steelton Hill is one example, where we see the opportunity to deal with pinch points, invest a little bit more, and give us that additional capacity that Jim was referring to. And it is working beautifully, because if you look at the investments we've made over the last couple of years, we've really stepped it up. But we can see, you know, the kind of numbers, the productivity numbers we're pulling together, in decent weather are just, you know, I mean, are record-breaking all the time.

We're accommodating a lot of that, you know, incremental business at low cost. So, you know, we feel pretty good about the CapEx program, and I guess that's where we are.

Claude Mongeau (CEO)

I would add, you know, basically, you know, we're basically done in Chicago proper. We may have one more connection, I think, Jim, to do, but, you know, after several years of investment, we've built our infrastructure for our Chicago advantage. The focus in terms of capacity, resiliency, productivity, where the lion's share of our business is, is Chicago North, and, you know, Western Canada to Chicago, that corridor between Edmonton and Chicago. We're also, you know, looking at our branch line network. We are seeing a lot of growth in frac sand, a lot of growth in energy-related product, a lot of growth on a go-forward basis from the resource sector, and we want to make sure that we have a branch line network that supports that growth. So, you know, first call on cash.

Capital investment back in our business, and the rest, you know, consistent marathon runner type, distribution of our excess cash to our shareholders is the name of the day.

David Scott Vernon (Senior Analyst)

All right. Appreciate the time, guys. Thanks.

Claude Mongeau (CEO)

Thank you.

Operator (participant)

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

Scott H. Group (Managing Director and Senior Analyst)

Hey, thanks. Good afternoon. So wanted to ask about intermodal, and curious if you think the changes in the dollar could incent some shippers to start increasingly using Canadian ports, instead of U.S. ports. Wondering if you think that has an impact? And then on the domestic outlook, what's changing to go from flat volumes to growth this year? Is there... Are you seeing anything changing in the competitive environment with CP, or is that more just a view of the market share gains from truck are going to accelerate?

Claude Mongeau (CEO)

Scott, thank you, Scott. I'll start with the first one. Our rate to United States from the Canadian port, when you come from the ocean container, are in U.S. dollars. So the impact with the Canadian dollar in that case is more about, you know, what we can do in terms of some of the new business that we don't have, that we can maybe attract at today's exchange. And the same thing for the terminal operator of the port, which costs is also in Canadian dollars. So it's more about, you know, the things that in the past may not have been possible, that today would be possible.

On my comment regarding, I think you were referring to my comment domestic, regarding domestic intermodal, as I think, as you see, and as I said, our domestic intermodal has been a little more flat, and now we're gonna start to lap some of these flat comparables from last year. Over time, sometime in the spring or the summer or the fall, we think we will start to pick up, you know, a better pace than what we had, say, in the third fourth quarter. Some of the areas where we're innovating and adding, you know, solutions to the marketplace, for instance, is northbound domestic movement. You know, using our inbound containers from the shipping line, we have opportunity to use those same containers in our domestic repositioning program for export. That counts. It's kind of a double win.

You know, it helps our shipping line, customers reduce their costs, but it helps us grow domestic northbound, traffic. Our partnership with wholesale players in the US are exciting. Once you get momentum with these, large players, and they like what you do from a service standpoint, we have a lot of cross-border opportunity, and we have a lot of, overall truck market, continued innovation, stay with our customers across our entire, book of business and domestic. So we, we see, we see reason... Like, economy-like, growth in that segment, on a go-forward basis.

Scott H. Group (Managing Director and Senior Analyst)

Okay. Thank you, guys.

Claude Mongeau (CEO)

Thank you.

Operator (participant)

Thank you. The next question from Turan Quettawala from Scotiabank. Please go ahead.

Turan Quettawala (Director of Equity Research)

Yes, good afternoon. I guess my question is on the expense side. Luc, you did mention that there was about a $200 million headwind year from pension as well as from fuel surcharges, I guess. My question is, can you talk a little bit about maybe some tailwinds that you might have in the year here? I know the weather's been a little bit more normal here, I guess, this year. I think that was, if I remember correctly, about a $50 million expense item in Q1 of last year. So if you could just talk a little bit about some tailwinds around the expense side, that'll be helpful.

Luc Jobin (CFO)

Yeah, Turan, I think, you know, there are gonna be a couple of things. The issue is there are gonna be, you know, the timing of some of these things. Like, for example, I mean, you know, I talked about the headwind overall, you know, potentially for the fuel issue as being CAD 100 million. But when you look at the first quarter as an example, I mean, this is gonna be lumpy. So it's gonna come in as actually a tailwind in the first quarter, and soon to turn as the year unfolds. So that's one. Clearly, yeah, I mean, I do expect our costs through the first quarter to be significantly better than last year.

And again, I think we'll be able to show that in terms of the cost structure, in terms of the business that we can accommodate and the overall cost.

Claude Mongeau (CEO)

Productivity, fuel efficiency.

Luc Jobin (CFO)

Fuel efficiency-

Claude Mongeau (CEO)

You know, mm-hmm.

Luc Jobin (CFO)

Clearly continues to be a, you know, a good solid point. I mean, we are looking at somewhere between 1% and 1.5% of fuel productivity. We will look to continue with overall absorption of the traffic as much as we can, in terms of the, you know, in terms of the yards and in terms of the overall business. So, you know, I think it's, there's no single major area, but I think in many places we're, you know, we're leaving no stones unturned, and we're looking at, you know, what can we do better and how can we give ourselves a little bit more margin.

I think it's an ongoing challenge, and I think it's actually more a fundamental way we look at the whole business as opposed to, you know, one particular windfall.

Turan Quettawala (Director of Equity Research)

Great. Great, thank you. I guess I was just referring more to the one time from last year. So apart from that weather impact, I guess that was the big, big one for the most part?

Claude Mongeau (CEO)

That would be, and the rest, it all falls in. There's no question that, you know, with lower fuel prices, the ability to have reported better margins is working with us. So we're not, you know. It's about operational and service excellence, and we can chew gum and walk at the same time. You keep track, we'll deliver solid results on both sides.

Turan Quettawala (Director of Equity Research)

Great. Thank you very much, and solid results in 2014 as well?

Operator (participant)

...Thank you. Our last question today will be from Bill Greene from Morgan Stanley. Please go ahead.

Bill Greene (Managing Director)

Hi, good afternoon. Thanks for taking the question. Claude, last year, we had some surprises, in Canada, out of the government, and, I'm curious if you can talk a little bit about how some of the changes in reciprocal switching have affected the business. But as important, do you see anything on the horizon for 15 that we need to keep an eye on, whether it's the transportation review or whatnot? Just things that we need to keep in mind from a government perspective, 'cause what happened last year was a bit of a surprise.

Claude Mongeau (CEO)

Yeah. You know, like a winter of a lifetime and a hundred-year crop in the same year is a recipe for a little bit of emotion. And coming from the grain sector, unfortunately, last year, the government felt like they had to act to protect the interests of Canadian farmers. But when you step back at the end of the year, we moved a record amount of grain in Canada. We moved, as I said earlier, 13% more than at any other time in the history of Canada. We finished the year with effectively an average carry-out. So a hundred-year crop, a brutal winter, and we finished the year with a normal carry-out. I mean, it doesn't happen without solid service and solid throughput. You gotta give credit to Jim and his team.

They delivered a bang-up job last year, despite, you know, some of the noise and the advocacy. You know, in this quarter, I'm sorry, in this new crop year, crop to date from August to now, we are up 16% on last year's record. We had a strong start, you know, throughout. We're moving good through the month of December, and even last week, we did almost 5,000 car spots in Western Canada for the benefit of grain farmers. We, we have moved more grain than ever. We've done that with the solid service. We are in sync with the supply chain capacity. I think policymakers are looking backward, and they're realizing now that we did a great job and that the market, the commercial framework, works.

It's our challenge now to take that evidence and convince them to reflect with facts as opposed to emotion, and that's our opportunity. We think the review panel is led by a very wise man that will look at the facts, will have the right balance and perspective, and I'm hopeful he will give good advice to the government when he submits his report. In my view, there is nothing like a commercial system, and there's nothing like supply chain collaboration to deliver solid results for the benefit of Canadian farmers. It's a tried and true approach, and it works.

Bill Greene (Managing Director)

Okay, thanks for the time.

Claude Mongeau (CEO)

Thank you, Bill, and thank you to all for joining us. We are again benefiting from good trends. We're committed to deliver a solid year. The first quarter should be a good one because, you know, things are lining up good on a year-over-year basis. But we are not running this business for quarters. We are running this business as a marathon for the long term, and we are investing for the future with strong confidence in our ability to continue to deliver value to our customers and our shareholders for many years to come. Thank you, and have a safe day.

Operator (participant)

Thank you. The conference call has now ended. Please disconnect your lines at this time, and we thank all for participating.