Canadian National Railway Company - Q4 2015

Transcript

Operator (participant)

Welcome to the CN fourth quarter and full year 2015 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, Eric. Good afternoon, everyone, and thank you for joining us. I would like to remind you of the comments already made regarding forward-looking statements, and in order to be fair to all participants, I would like to ask you to please limit yourselves to one question. With me today is Luc Jobin, our Executive Vice President and Chief Financial Officer, Jim Vena, our Executive Vice President and Chief Operating Officer, and JJ Ruest, our Executive Vice President and Chief Marketing Officer. I'm also very pleased that our captain has rejoined the team and will be leading today's call with his very attractive new voice. So more officially, it is my pleasure to turn the call over to CN's President and Chief Executive Officer, Mr. Claude Mongeau.

Claude Mongeau (CEO)

Thank you, Janet. I'm not sure about the attractive voice, but it sure feels good to be back on the job. I thank you all for joining us today. I have to say, the CN team did such an outstanding job closing out on the year that I could not resist coming back to be on this call today with you. I have a new voice. It is a bit squeaky, but I'm full of energy, and I'm looking forward to lead CN to new heights in the future. Let's talk about the results, quickly. We had very strong Q4 results. We had declining volume trends. Our RTMs were down 5% and our carloads were down 8%. But we continue with our swift response, and we're balancing operational and service excellence in a way that is quite, quite remarkable, given the challenges that we face.

Jim will give you more details about that. We ended up delivering a diluted EPS of $1.18, which is up 15% for the quarter. Given the volume environment, I'm proud of the team and what they were able to achieve. This capped a very solid 2015 performance. We stayed on top of our key markets, chasing carloads in tough markets and keeping with the momentum of the markets that were going better, with a keen eye on keeping price where it should be, given our service. JJ will give you more on that. Our efficiency, if you look at it for the full year, allowed us to deliver an operating ratio, which is at a record level, 58.2%. It's 3.7 percentage points lower than last year.

Now, I would not want to take credit for the benefit of lower fuel prices. That gave us a full 2 points on a year-over-year basis. If you look at it another way, the guidance that we had given you in 2013 at our Investor Day in Toronto, that we would reach a low 60 operating ratio, given what we knew about fuel then, I—we delivered on that performance. In overall financial results, Luc will take you through those, but we finished the year with $4.44. That's up 18% on a year-over-year basis, and very solid free cash flow at almost $2.4 billion. Now, in terms of guidance, we are facing an uncertain environment, but we're—we will share with you constructive guidance, and we have confidence in the future.

This is why our board supported management's recommendation to give our shareholder a bit of a gift for our 20th year of anniversary of the IPO. We are announced today a 20% increase in our dividend. That reflects our confidence and the strength of our balance sheet. We are pleased with those results. I will let the team go over them, and we'll be back with the question and answer at the end. Jim, over to you.

Jim Vena (COO)

Well, Claude, thank you very much, and listen, thank you very much. Nice to have you back on a full-time basis. So, away we go. Let's say, if we can start on the operating highlights, page. So the scorecard, in front of you clearly displays the results of how we manage the railroad using a long-term view when necessary and executing at all levels. We take a holistic view of capacity, asset utilization, railroad optimization, and safety, and allow decisions to be made at the correct level within the operating group. JJ, will provide more details, but in the quarter, we faced a high single-digit carload drop and a mid-single digit drop in workload. But even with those challenges, our trains were more efficient.

Train velocity increased by 5%, train productivity, or put another way, the number of cars on a train, increased by 3%, and even more important, our gross ton miles per crew hour worked increased by 3%. Therefore, each train handled more freight, moved faster, and our employees were more efficient in getting them from origin to destination. So great job by the team on moving the trains. Looking at the cars, 15%, and the number of cars switched per hour paid increased by 9%. So on the cars, we also showed a significant improvement in our productivity and our handles.

We do have 250 stored locomotives, but even with them stored, we're able to use the locomotives that we had and improve our utilization of our fleet by 2% and improved our fuel efficiency for the year at 2%. So great results on the use of the locomotives and the fuel efficiency that we work hard every day to improve. Our engineering and mechanical departments both delivered results in line with the overall, overall results on a productivity and cost efficiency basis, which helped us deliver a car velocity improvement of over 16% in the quarter and in the year of 13%. So if I could summarize that page, very satisfying results in the face of some headwinds that made some of the results difficult to deliver.

If we can just quickly turn to the next page, which is operational and service excellence. Our agenda in 2016 does not change. Safety continues to be the foundation of everything we do, and we want to build on the strong results we had in 2015. We will continue to align our resources and react quickly to changing factors and deliver productivity gains across all the operating departments. So overall, good quarter, good year in 2015, and we will continue to operate with an end-to-end view and deliver on both operating and service excellence so that JJ can go out there and deliver us every piece of business that's possible with this model we have. So, JJ, over to you.

Jean-Jacques Ruest (CMO)

Thank you, Jim. And, Jim, your team had a reason to be proud. 57.2 operating ratio in the last quarter. That's quite an industry achievement. So now turning to the business. Overall, the fourth quarter revenue went down 1% from last year, broken down as follow. We had lower volume, and the lower volume reduced our revenue by 6%. 70% of the CN reduced carload was a drop in short-haul iron ore. Coal, crude by rail, frac sand for drilling, and US grain were also very weak. Overseas intermodal, Canadian grain, manufactured product from natural gas feedstock, automotive, and potash were among the positive business. Same-store price was up 3%. If you remove the Canadian grain cap price reduction, our same-store price would have been about 3.5%.

Our gross margin upscaling program also continued to trend upward. The pricing story is resilient. As crude collapsed, the fuel surcharge application reduced our revenue by 6%, but crude also brought down the Canadian dollar to a 0.75 average for the last quarter. Therefore, exchange increased our revenue by 9%. We do have similar dynamic at play actually in 2016. So now let's turn to some of the fourth quarter highlights, and at the same time, I'll cover some outlook for the first part of 2016. The improving U.S. housing starts and the end of the Canada-U.S. softwood lumber trade agreement this past October drove our Canadian lumber and panel exports, and it also helped our U.S. container imports. With such a weak Canadian dollar, the Canadian lumber producers are in very strong position right now.

Record U.S. and Canadian automotive sales produce solid results for our finished vehicle business unit and for the container import into assembly plants. The automotive industry feels constructive about the prospect of vehicle sales for the first half of 2016. The crude market caused a 32% drop in crude by rail carloads and a drop of 43% in frac sand for drilling, and steel is suffering the cutback of the energy sector capital program. These same segments will be major headwind for this year. Intermodal continued to do well. We had a 5% increase in volume. We had very good growth at Port of Halifax on the East Coast and good growth at the Port of Prince Rupert on the West Coast. Our grain operation is excellent, and we have the fluidity to meet demand on our network.

North American natural gas is a very competitive feedstock in the world, and our carloads for petrochemical, plastics, nitrogen, fertilizer, and natural gas liquid have generally trended upward, and that trend should continue. Coal was in retreat, and in 2016, that will continue. Coal was only 4.5% of our fourth quarter total revenue, the lowest of any railroad. Looking ahead, you would remember last year, the first quarter volume was still strong, so we expect negative volume again against our first quarter 2015 comparable. And that will be mainly in crude by rail, in sand for fracking, and in coal, as those were still very strong last year at the same time.

We continue to produce pricing above inflation, which at this point we would define as 3%, inclusive of the impact of the negative Canadian grain cap. We are in position to support those shippers for whom the weak Canadian dollar has become a cost advantage, like the manufacturers, like the service industries that are selling into the U.S. market. For example, the forest product industry and the Canadian port terminal industry. In conclusion, CN strengths are deep. They lie in our portfolio diversity, in our profit margin management, our leading operating ratio, which Jim can produce and his team, our excess capacity in Chicago, and all of these things are very supportive of doing more trade for the long term. I will now turn it to Luc, who will detail the financial results for you.

Luc Jobin (CFO)

All right, I'll try to do that. Thanks, JJ. Starting on page 12 of the presentation, I'll summarize first the key financial highlights of our solid fourth quarter performance and then comment on our full year 2005 for 2016. As JJ pointed out, revenues were down 1% in the quarter versus last year, at just under $3.2 billion. Fuel lag represented a revenue tailwind of $14 million in the quarter, but was $0.02 of EPS lower than last year. While I'm on the subject of fuel lag, you should keep in mind that while we do expect a positive fuel lag in the first quarter this year, it is more likely to be in the $10 million-$20 million range, so much smaller than last year's lag of $60 million favorable in the first quarter. Operating income was $1.354 billion, up $100 million or 7% versus last year.

Our operating ratio in the quarter was 57.2%, and that represents a 350 basis points improvement over last year. Net income stood at $941 million, up 11%, and the diluted EPS reached $1.18, and that's up 15% versus last year. The impact of foreign currency in the quarter was $87 million favorable on net income or $0.11 of EPS. Turning to page 13, as Jim pointed out, we continued to make significant progress in the quarter in terms of safety, productivity, and cost management. Operating expenses were lower than last year by about $135 million or 7% favorable at $1.8 billion. Expressed on a constant currency basis, expenses were actually 15% lower than last year.

At this point, I'll refer to the changes in constant currency. Labor and fringe benefit costs were $608 million. Excluding FX, this is a 5% decrease from last year. Now, this was a product of three elements. First, overall wage costs decreased by 4% versus last year, as wage inflation and lower capital credits were more than offset by lower overtime and a reduction of 7% or 1,700 employees versus last year in our average head count. At the end of the year, we had about 11,150 employees laid off, and we finished 2015 with 9% fewer employees or 2,300 less than last year. Second element was a lower stock-based compensation for $8 million.

The third and last element of the labor variance was due to higher pension and fringe benefit expense for $15 million. Fortunately, in 2016, our pension expense situation will improve, and our defined benefit plans are expected to be in a credit position of approximately $120 million. This is primarily due to lower current service and interest costs as we improve the accuracy of these estimates and the benefit of coming from an increase in the year-end discount rate that moved from 3.87% to 3.99%. Purchase services and material expenses were $437 million, 8% lower than last year. As we incurred lower third-party costs in the quarter, which were partly offset by increased costs for materials.

The fuel expense stood at CAD 304 million, or 42% lower than last year. Fuel price was 38% lower versus last year, while volume reduction accounted for 19, a CAD 19 million-dollar betterment, and fuel productivity came in 2% better. Casualty and other costs were CAD 70 million. This is roughly CAD 40 million lower than last year, and for the most part, this is the result of lower accident-related costs versus 2015. Now, full year results. We wrapped up 2015 with over CAD 12.6 billion of revenues, a 4% increase. This set a company record in terms of revenues. Our operating income grew by CAD 642 million or 14% to reach CAD 5.3 billion.

The operating ratio stood at 58.2% versus 61.9 in 2014, and as Claude indicated, that's a 370 basis points improvement and a new all-time record, which is quite an achievement when you consider what we faced in 2014. I think this really demonstrate how effective the team has been in recalibrating resources to drive efficiency. It's equally important to point out that we achieved this while continuing to balance operational and service excellence in a manner that's consistent with our end-to-end supply chain focus. Net income was up $371 million or 12% at just over $3.5 billion. This translated into a 14% increase in the reported diluted EPS at $4.39.

Excluding the impact of a major asset sale in 2014 and income tax adjustments in respective years, the adjusted diluted EPS for 2015 stood at $4.44. That's an 18% increase over 2014. Moving on to free cash flow. For the full year 2015, our free cash flow generated stood at just under $2.4 billion. That's approximately $150 million higher than in the prior year. This was mostly driven by higher cash from operating activities, partly offset by higher capital expenditures and lower proceeds from property sales. Meanwhile, our balance sheet remains strong, with debt and leverage ratios well within our guidelines. Finally, let me turn to our 2016 financial outlook.

We're positive in terms of CN's prospects for the year, notwithstanding the fact that we are experiencing high volatility and weaker condition in a number of commodity sectors. As we look to the future, North American economic conditions are still favorable. Consumer confidence remains solid and should support continued progress in housing, automotive, and intermodal sectors. One of our core strengths that supports our ability to perform in good and bad times is leveraging the diversity of our franchise. We have a very low exposure to coal, while our network allows us to serve key U.S. consumer growth segments. This, along with a stronger U.S. currency, provides us with a natural hedge that helps to mitigate the weak commodity environment. Now, this should translate into carload volume for the full year to be slightly down versus 2015, with pricing in line with our inflation plus policy.

Therefore, we expect to deliver mid-single-digit EPS growth over the 2015 adjusted diluted EPS of $4.44. We're also expecting our capital investment program for the year to be approximately $2.9 billion, which entails continuing to harden our infrastructure, and therefore, we will allocate $1.7 billion for network investments in 2016. Doing this in 2016 will allow us to take full advantage of market conditions that provide easier access for working on the tracks, availability of external contractors, and low commodity costs. The envelope also includes $600 million for equipment, including our commitment to secure 90 new locomotives. We also have $400 million dollar investment on PTC as we continue to advance our implementation program.

Now, keep in mind that a good part of these of the increase versus 2015 is actually attributable to the weaker Canadian dollar versus the U.S. currency. Furthermore, we continue to pursue, more importantly, our shareholder return agenda. In 2015, we returned to shareholders 80% of net income through dividends and share repurchases. Our current share buyback program is approximately CAD 2 billion for 2016, and we're pleased to announce, as Claude mentioned, that our board of directors has approved a 20% dividend increase for 2016, reflecting our strong performance in 2015 and our confidence in future prospects, as we gradually move towards a 35% dividend payout ratio.

In closing, we remain committed to our agenda of operational and service excellence, and so CN continues to manage its business to deliver value for our customers and shareholders today and for the long term. On that note, back to you, Claude.

Claude Mongeau (CEO)

Well, thank you, Luc, and thank you, guys. Well, as I said, it's an uncertain environment out there, but we have a constructive view about our ability to manage in a weaker volume environment. We're gonna leverage our franchise, our diversified portfolio, and our ability to gain efficiencies in good and bad times. We are truly committed to our agenda. It's working for us, and we are focused to deliver long-term shareholder value. As I say to my team, it's a marathon, and we are good runners. With that, Eric, I'd like to turn it back over to questions and answer.

Operator (participant)

Thank you, Mr. Mongeau. We will now take questions from the telephone lines. If you have a question and you're using a speakerphone, please lift your handset before making a selection. If you have a question, please press star one on your telephone keypad. If at any time you wish to cancel your question, please press the pound sign. Please press star one at this time if you have a question. There will be a brief pause while the participants register. We thank you for your patience. The first question is from Ken Hoexter at Bank of America Merrill Lynch. Please go ahead. Your line's open.

Ken Scott Hoexter (Analyst)

Great. Good morning. Claude, welcome back. Great to hear you again. I guess if I could just start out, given your outlook for mid-single-digit growth, can you maybe talk a bit about what you expect on the employee side a little bit? It, you know, accelerates it down 7%. Are there still more costs you look to pull out on the employee side? I guess on a resource side, it's amazing what we see on cost. So just wondering your thoughts there.

Claude Mongeau (CEO)

Jim, I'll let you answer this question, but we manage resources, and we manage them in line with volume, and we don't know where the volume will be, but we are, as we did in 2015, committed to keep our efficiency levels up. But, Jim?

Jim Vena (COO)

Okay. So, Ken, we work on the framework of looking at the operation to and be able to react quickly. So there's some things that are, as you've seen in 2015, we reacted in the right way, and, you know, it took into account where the business level was and where the efficiency and what kind of assets we need to operate. We see that we're gonna be able to react positively or negatively. Hopefully, we get surprised positively, but if it's different than what we expect, then we have some things going for us. We can, we'll do what we have to do with locomotives. And on the people side, we have an attrition rate that's a natural attrition rate that's running close to 8%.

So it gives us a hedge there that we'll be able to deal with on whether we hire or we don't hire, or we let the attrition handle itself as we, as we drop the number of people we need. So I think it's the same story as we've done in 2015 and the previous years, in 2016, Ken.

Ken Scott Hoexter (Analyst)

Thank you very much for the time. I appreciate it. Thanks a lot.

Claude Mongeau (CEO)

Thank you. Thank you, Ken, and thank you for your kind words. I'm, I'm really pleased to be back.

Operator (participant)

Thank you. The next question is from Fadi Chamoun at BMO Capital Markets. Please go ahead. Your line's open.

Fadi Chamoun (Analyst)

Yeah, good evening. And yes, great to have you back, Claude, on the call. So, question on the opportunities in the market. So, I mean, you keep sort of reducing the cost curve year after year, and obviously now you have a little bit of a tailwind from the Canadian dollar. I was wondering whether these factors sort of can help you go after markets or opportunities that would not have been the case before. I know you touched base on a couple of markets where you think you can sort of you know get some help from the Canadian dollar.

But is there other things that are not necessarily just a factor of the Canadian dollar, but also a factor of your cost curve and your service improvement, that you can potentially sort of begin to exploit, that you haven't yet sort of gone after them? Maybe you can answer that, JJ.

Claude Mongeau (CEO)

Yeah, JJ, yeah, JJ has his eyes on the future, you know?

Jean-Jacques Ruest (CMO)

Yeah, I mean, the tailwind of the Canadian dollar has also come in with a headwind of the reason why the Canadian dollar is down, is we suffer on the energy side of the commodity. So they came in as a couple, not separate. We, our role is really to exploit what the economy offers. The economy is not offering strong energy right now. It's offering a weak Canadian dollar. What do we do with that? The economy is still offered today, very cheap natural gas. So what do we do with that? There was an announcement earlier this month of AltaGas, who are starting to do more serious work about putting a propane export terminal in Prince Rupert.

This can only take place because the gas is North American gas, cheaper here than other places in the world, and there's also benefit from that on the chemical industry, plastics and the like. So we're looking for the strength where there is strength, and we want to be sure that we can help capitalize on partners, whether people wants to export, for people whose cost is influenced positively by the weak Canadian dollar. I mentioned the port, and the reason why I mentioned the port is because the Canadian industry, the Canadian economy is no longer as much manufacturing as it was 20 years ago, and we do a lot of services today, and many of these services are export services. You know, you could take a port as an export services. You could take a waterfront logistics warehouse.

We do, you know, container come in on one side, 40-foot, comes out the other side, going to, you know, into a different cities. Repack, pick and pack is also another export product. Maybe we can also exploit our CNTL fleet, which is Canadian-based, Canadian driver costs, Canadian overhead, into how we, how we exploit that in cross-border business and the like. So I think it's important to see what we have right now and how we exploit that, and not just focus on the fact that the sector is, is weak.

Claude Mongeau (CEO)

All right. Thank you, Fadi.

Fadi Chamoun (Analyst)

Thank you.

Operator (participant)

Thank you. The next question is from Walter Spracklin at RBC. Please go ahead. Your line's open.

Walter Spracklin (Analyst)

Yeah, thanks very much. And Claude, I'd like to echo everybody's comments. Great to have you back here. I guess my question is for JJ. You know, I'm getting a lot of uncertainty and concern, a lot of investors on the part of a lot of investors with regards to the outlook on the economy and the demand level in general. I know you mentioned that first quarter is going to be another tough quarter on a comp basis, but you've got a real dichotomy in your volumes, where you've got, it seems that the consumer is doing well, but anything industrial or bulk related is still struggling. When you look out beyond Q1 and you point to your slightly negative volume guidance, what, you know, are you building in a rebound in the economy?

Are you, do you think the consumer, are you building the expectation that the consumer holds in that bulk, you know, recovers? Is there anything that is in that slightly negative that would be, you know, anything different from the kind of trend that we're going on right now? Or would you consider it kind of conservative and still focusing on more of the same in terms of the rest of the year beyond Q1?

Jean-Jacques Ruest (CMO)

So maybe we can start with Q1. Q1, 2015, you remember, our volume was still very strong because, I guess, the economy had not yet fully recognized how, where energy was going to go. So we're still moving a lot of carloads of frac sand, crude, coal and iron ore. In our first quarter results, you will see that these four commodities are, you know, now, reality has set in. We had an iron ore miner shut down. We have some coal miners shut down. Crude by rail is moving at less volume. It's partly back in the pipeline, and frac sand. Obviously, you don't rail as much for crude as you did at exactly the same time. But the other segment, the manufacturing side, is doing okay. The side that has to get the benefit of cheap gas is doing good.

The U.S. consumer is doing good. The Canadian consumers, we're not sure. We're not really counting on that. Automotive sales and manufacturing are good. These are, at this point, at least for the first quarter, they're not really quite big enough to offset the big carload change in short-haul iron ore and the longer-haul carload of crude by rail and frac sand. We're not counting on a rebound of commodities. I'm not too sure anybody really is counting on a rebound of commodities. That's a little bigger than what North America can-

Claude Mongeau (CEO)

Yeah, that would be-

Jean-Jacques Ruest (CMO)

deal with at this point.

Claude Mongeau (CEO)

That would be a brave assumption if you were counting on it. So does that do the trick for you, Walter? Thank you.

Walter Spracklin (Analyst)

Thank you very much.

Jean-Jacques Ruest (CMO)

Thank you.

Operator (participant)

The next question is from Brandon Oglenski at Barclays. Please go ahead. Your line's open.

Brandon Oglenski (Analyst)

Well, good evening, everyone, and Claude, same from us here at Barclays. Great to have you back.

Claude Mongeau (CEO)

Thank you, Brandon.

Brandon Oglenski (Analyst)

It's an exciting time in the industry to be back to dealing with some pretty negative economic outlooks. Luke, I wondered if you could comment on the $6 billion shelf that you guys filed back in December or January. Is it common for you guys to file one that big? And I'm just wondering, are there big debt maturities that you guys are looking to refinance right now? I know you talked about a $2 billion share repurchase. Is this an opportunity where maybe that could be upsized throughout the year? You know, I saw you took the dividend up a lot. And frankly, is there any strategic alternatives that you're also thinking about here, just given some of the noise that's coming out of Calgary recently?

Luc Jobin (CFO)

Yeah, Brandon, okay, just to pick up on your question. The $6 billion, you know, you have to look first of all, it's a shelf that's in place for just a little bit over two years. So our financing requirements, just on the basis of maturities, over those two years, plus the financing necessary to fulfill our, you know, our stock buyback program and the likes, is significant. So in this year, we'll be looking to raise probably about $2 billion worth, and I would probably look at a number not too dissimilar in 2017. On top of that, obviously, keep in mind that, you know, a lot of our debt is financed in the U.S. dollars.

With the FX, obviously, this puts a little bit more pressure. So it's really with that in mind that we've put the shelf cap at $6 billion, just in terms of giving us a little bit more flexibility. Obviously, should, you know, some opportunities come along, we've always said that, you know, we wanted and we have a great balance sheet and that we would be prepared to use it. But, you know, there's nothing imminent, and I think it's just in times where there perhaps is a little more uncertainty in the marketplace, we'll be looking to make sure that we've got sufficient liquidity and that we can deal with our maturities and continue to support the business. Thank you.

Claude Mongeau (CEO)

Thank you.

Operator (participant)

Thank you. The next question is from Cherilyn Radbourne at TD Securities. Please go ahead. Your line's open.

Cherilyn Radbourne (Analyst)

Thanks very much, and welcome back, Claude. I wanted to ask how you're thinking about mix in 2016. I would think that with the difficult comparables in crude by rail and fracs, and in Q1 at least, the mix would be a headwind. But how are you thinking about mix for the full year as you start to cycle easier comp?

Claude Mongeau (CEO)

JJ, it's tough in the current environment to figure out volumes, so mix is even more difficult. But, JJ's on top of his game. What do you see out there?

Jean-Jacques Ruest (CMO)

So for what we can see, and not all, not at all of it is always very clear, it is likely that our RPM will be weaker than our carloads at this point in time. So if you're doing a model, RPM will probably be weaker than the carloads, at least this year.

Cherilyn Radbourne (Analyst)

Okay. Thank you. That's my one.

Claude Mongeau (CEO)

Thank you, so much, Cherilyn.

Operator (participant)

Thank you. The next question is from Jason Seidl at Cowen and Company. Please go ahead. Your line's open.

Jason Seidl (Analyst)

Thank you very much. And, Claude, welcome back from everyone here at Cowen. You know, you mentioned that if you adjust for FX and fuel, you guys met your low sixties OR guidance that you gave a while back. Looking forward, if you just normalize fuel and normalize FX, talk about the improvements that you would expect for CN, you know, beyond, I guess, some of this economic turmoil that we're seeing now.

Claude Mongeau (CEO)

I'll let Luke answer that one, but we certainly hope that the fuel price over time will be a headwind. That would be good for the business. We're not managing for a ratio. We're managing for profit dollars. But, you know, Luke, you want to take that one?

Luc Jobin (CFO)

Sure. I mean, you know, I think, Jason, the, leaving aside for a second, the, the fuel, side, which is obviously very volatile. I mean, what we're really focusing is on, you know, right-sizing the resources, managing tightly, to, to continue to, to deliver great results, but not at the expense of growing our top line and, and, you know, pursuing these opportunities that, that JJ pointed out. So, you know, I wouldn't, I wouldn't necessarily, look for something that has a five handle on it. I think we've, we've always said that, we were intent on managing the business well and, and for the long term. And, and I think we've achieved, you know, ex-fuel, the, you know, the target that we thought was, was reasonable.

Having said that, you know, we're always looking for opportunities for productivity improvement. I mean, Jim, Jim's always there on the prowl, and I think everybody in the organization is conscious of that need. So, you know, I would still say that we intend to stay the course, and we intend to be both opportunistic in the short term, but with an eye on the longer term. So we don't want to just, we're not gonna get medals by in the short term trying to achieve a lower OR at the expense of our ability to continue to grow the business and create value for both our customers and obviously our shareholders.

You know, it's the industry-leading ratio, and I think, you know, from that standpoint, you know, we continue to focus on excellence.

Claude Mongeau (CEO)

We clearly intend to continue to be the industry leader in terms of efficiency. Even though 2 percentage points of our ROR is due to fuel this year, 170 basis points was due to efficiency and other initiatives, and that was in a pretty difficult environment. So we're managing to maximize every lever, and, and we will continue to do that and lead the industry going forward.

Jason Seidl (Analyst)

You definitely had some impressive operating statistics. Gentlemen, thank you for your time, as always.

Luc Jobin (CFO)

Thanks, Jason.

Claude Mongeau (CEO)

Thanks, Jason.

Operator (participant)

Thank you. The next question is from Chris Wetherbee at Citi. Please go ahead. Your line is open.

Christian Wetherbee (Analyst)

Hey, thanks. Good afternoon, and again, welcome back, Claude. Good to have you on the call. Wanted to touch a little bit on pricing, if I could. Maybe as you think about 2016 and the outlook, putting aside the grain cap for a minute, just wanted to get a sense of kinda how you're thinking about pricing and maybe what the competitive dynamic might be looking like, specifically in Canada in 2016.

Claude Mongeau (CEO)

If I could say something before JJ gives you a more focused answer on your question. You know, it's quite remarkable. You know, you have CN that is leading the industry, achieving new records in terms of efficiency. You have CP, which over the last four years has done a remarkable turnaround and is in every core respect, in terms of operating metric, is getting very close to our level of efficiency. There's something to be proud here. We have the two Canadian railroads really leading the way in terms of performance. I hope that going forward, we will protect that profitability and use it to generate a capacity to invest in our networks and to, and to grow the business and grow it against trucks, grow it through innovation and not chase volume for the purpose of chasing volume.

It's precious that we are able to achieve this efficiency level, and it's incumbent on us to manage for the long term. JJ.

Luc Jobin (CFO)

Yeah, well said, Claude. Yeah, so, so Chris, as I said in my notes, we're targeting, including the impact of the Canadian grain cap, roughly 3%. We would definitely, at this point, see 3% as above inflation, inflation as we see it for 2016. And remember, the Canadian grain cap as well as some of these indexes that some railroad contracts are likely to stay weak because the crude and the diesel right now is still very weak. So we even think that the Canadian grain cap might be slightly negative for the 2015, 2016 season. So 3%, including these indexes, it would be, it would presage well for the railroad, for CN. That would be above inflation.

Christian Wetherbee (Analyst)

All right. Thanks for the time, guys.

Claude Mongeau (CEO)

Thank you so much for your question.

Operator (participant)

Thank you. The next question is from Steve Hansen at Raymond James. Please go ahead. Your line's open.

Steven Hansen (Analyst)

Oh, yes, good afternoon, guys. I think one of the clear distinctions between you and your closest competitor of late has been the direction of the CapEx budgets. I think you suggested CAD 2.9 billion, which is up roughly 7%, I believe. And I know you broke it out by some of the three major buckets, but I was just wondering if you could perhaps elaborate a little bit more on, on the need to spend that kind of capital, in this macro environment and, and what you're gonna get out of that, specifically.

Claude Mongeau (CEO)

I will let Nick give you some more color, but we manage for the very long term. We are a very profitable company. We have an opportunity to do the work at the right time. There is no better time to upgrade our infrastructure than now. We can do it cheaper, we can do it faster and more productively, and we can gain long-term advantage that way. That's our mindset. Much of the increase is because of exchange. We're assuming a dollar that will be in the 70-75 cents with the US currency, and the rest is long-term investment that we believe will pay dividends for many, many years to come. Every company has a different agenda, but we see the strength in our long-term view. Luc, you want to add some more color?

Luc Jobin (CFO)

Yeah, maybe just a couple of additional comments. I mean, I think, you know, we—if you look at our track record, we consistently look to CapEx, you know, in the range of, I'd say the, I'd call it, around 20% of revenues. Of course, there's a little bit of noise in there, as of late with the fuel surcharge, you know, disappearing from the revenue line. But nevertheless, I mean, I think what we see is we look, as Claude pointed out, we look to the longer term, and so we pace ourselves and, you know, we'll dial up and dial down on certain types of activities when we feel that the need arises.

So as an example, you know, we're actually gonna look to do a little bit more on our basic capital on the track, on the bridges, and so on and so forth, because it's a great moment to do so. And arguably, as we look to the short term, our needs for capacity investments are not as prevalent. So, you know, we tend to try to be opportunistic. The conditions are ripe, as I mentioned, and Claude reaffirmed, for us, you know, with the great balance sheet we have, we can be smart. We can actually do these things while people that are under pressure are going to look to reduce their capital budget in order to maintain their free cash flow. So we can still generate good, solid free cash flow and continue to invest behind the network.

And, you know, we talked about safety, we talked about the velocity of the network and the productivity of the network. And these are, you know, the reason why we clock in these performances are industry leading, you know, year in, year out, is that we're continuously mindful of reinvesting in the plant in a thoughtful way to deliver both the productivity and the service excellence. So, you know, I think that may strike some people as a little bit counterintuitive, because the normal tendency would be to go and cut CapEx. We take a different look at things, and we see this as an opportunity to continue on our journey to make this a great franchise for the long term.

Claude Mongeau (CEO)

If I could ask Jim there, you know, when you're looking at your pinch point and you're looking at investing and getting the permits and getting motion to solve issues, which we were in the growing environment last year, you get that momentum and that focus, and it's paying huge dividends. Maybe, Jim, you want to talk about some of those initiatives that we are leveraging as we speak and will continue into the next year.

Jim Vena (COO)

Listen, absolutely, Claude. You guys have done a great job of explaining why we, and where the capital envelope is. But, it takes a while for us to be able to get permitting, to get the authority, to be able to deal with the pinch points. And in every railroad, and in ours specifically, there's some points where if you spend the right capital at the right time, it increases capacity through the whole corridor, not just in one place. And that's exactly what we've been doing. And I'll tell you, you know, we spent a lot of money to double track up to Steelton Hill, and for a few miles of railroad, you start to wonder, what the heck are you doing?

I'm sure, Luke asked me a few times, like, "Man, that's a lot of money for that three miles of railroad." But we've noticed the advantages already. In this winter, through December and January, we've had events happen above and beyond what we normally would foresee, and, and the reaction and the recovery is so much quicker. So that's why it's, it's smart to spend the money in the right places at the right time and, and have a view of what it does over the long term. And what that specific expansion on the Steelton Hill did, it opened up capacity all the way from Winnipeg to Chicago for us, not just in that one little, pinch point.

Jean-Jacques Ruest (CMO)

We're building a competitive advantage.

Claude Mongeau (CEO)

Yeah. So it's, we think it's gonna differentiate us in the long term, and we feel it's the right time to do so. Thank you for your question, Steven. It's a very good one.

Christian Wetherbee (Analyst)

Appreciate it. Thanks.

Operator (participant)

Thank you. The next question is from Allison Landry at Credit Suisse. Please go ahead. Your line's open.

Allison Landry (Analyst)

Good afternoon, and Claude, great to have you back. I wanted to ask a question on grain. So given that last year's harvest, the Canadian crop, came in better than your initial expectations, while also considering the impact of depressed commodity prices and elevated inventories, how do you see grain shipments playing out over the course of 2016? And in other words, at what point do you think the grain has to move such that you would start to see positive year-over-year comps?

Jean-Jacques Ruest (CMO)

So thank you. It's JJ. The crop, you know, the final result of the crop side, the one that came out in December, we're actually showing that the crop was bigger than what we thought it was going to be in August or in October. And but right now, as we speak, the volume of grain that we move in Canada is slightly below last year. That is because probably, you know, the attractiveness of the export of the export price is not quite what is at the liking of the owner of the grains, whether the farmers or the grain company who buy from the farmers and sell overseas. So that's basically revenue that eventually will come through. It might partly come through in the second quarter or maybe before the next crop.

Remember, last year, the carryover was very small, and we had very weak revenue on Canadian grain for August and September at CN, because, you know, the inventory in Canada were very, very low. So some of this increased crop that we saw last year, meaning a little bigger than what we thought in the first place, might just turn out to be that we will finish this year, this crop year, with a higher carryover, and those revenue will come in maybe late in the year or to 2016-2017. But one thing is for sure, when grain is harvested, eventually it'll be sold, and in Canada, the population is such that it will be sold overseas. So you will get to the port. It's a question of time.

Allison Landry (Analyst)

Thank you.

Claude Mongeau (CEO)

Thank you, Allison. I look forward to see you on the West Coast again, for a trip, this year.

Allison Landry (Analyst)

Sounds good. Thanks.

Operator (participant)

Thank you. The next question is from Matt Troy at Nomura. Please go ahead. Your line's open.

Matthew Troy (Analyst)

Yeah, thank you. I wanted a question about intermodal. Quite a divergence, your growth, 5% versus your competitor down in the low teens. I just wanted to get a sense of, you know, what's driving that growth. I know you provided some detail earlier. Is it primarily highway to rail conversion, or is there some market share gain in there? And then, as an extension, you know, if I think about the margin profile of intermodal historically being diluted from a mix perspective, it was your largest growing category, and it's the largest portion of your traffic base. Have you reached a critical mass now where the margin in the business is better than average?

I just would like to understand, you know, one, where the growth is coming from ahead of peers, and two, is the margin profile of this business, should we think of it differently going forward? Thanks, and Claude, welcome back.

Claude Mongeau (CEO)

Then, it's a very good question. You're making a full impact with that one question. Let me say that for many years now, we've had intermodal's profitability very much in the average of our book of business. It's, you know, we have added a new approach that allows us to be profitable in that business. And a lot of the growth, JJ will give you some colors, but it's the building blocks of all the initiatives that we have put together over the last five years. The end-to-end innovation, the supply chain collaboration, the extension of reach, the chasing of opportunities, one container at a time. And we are in many markets with a great, great franchise, and that's what's allowing us to grow. But JJ, where do you see the growth into 2016?

Jean-Jacques Ruest (CMO)

Well, well, Matthew, will probably be more on the overseas side than the domestic side. Partly because the Canadian economy may be, you know, will only offer so much opportunity in 2016. But the overseas market is a bigger pie, and then you're familiar with our initiative in Mobile, Alabama. We hope that when that open up sometime in May, and the Panama Canal open up sometime in May, June, that Mobile will start to produce some fruit for CN. Also because the U.S. Midwest is a market that over the last many years, as Claude has mentioned, we've opened a number of terminals, either on our own line, like Joliet, Illinois, or with partners like Indianapolis. And as we opening more destination, we have more to offer to the shipping line.

So the opportunity, over the next little while, let's call it 2016, is maybe more on the overseas side, and the destination more in the U.S., U.S. Midwest. Earlier this, late in 2016, we had a new call to the Port of Halifax, and they produced some growth for us in the fourth quarter. I think they will produce some growth for us also in 2016. Some of those containers are finding their way in Canada, but some are also U.S. Midwest. And also late last year in the fall, we had Maersk, who joined the Port of Prince Rupert.

Obviously, they have strategies of their own to use that port to their advantage, because of the type of service they can get there that no other port can offer, the way DP World and CN provide create that service together. We also have some other line who start to do some costs do some business in Rupert by getting slot on others companies vessels, CMA and Evergreen. So the choice of options and the players coming into ports where we play is, you know, should do well for us. We do have some challenges in Vancouver with some terminal capacity. That will be because of construction taking place right now, so we'll see how that play out, especially in the next three, four months.

Hopefully after that, we will have clear sailing and have all the capacity we need. But roughly, it's about, you know, those different things, and all of those are tied in, as Claude mentioned, the supply chain. You know, offering just a good price because you have a good operating cost is not what attracts the traffic, because anybody can offer a good price. You know, it has to be a good price with a, be a better service than what others offer.

Claude Mongeau (CEO)

Yeah, and as the environment improves and as the consumer sector gets better over time, maybe back another year into 2017.

Jean-Jacques Ruest (CMO)

Yeah, on margin, on margin, we do have a very strong upscaling program. We focus on round trip economics. We focus on balance. We focus on having the right fuel surcharge for the business. And these are levers that typically, you know, they don't show up in same store price. They show up in our internal report that we call our round trip RCRs and the likes. Train length, train density, using the right car and the right port. A lot of small levers that generate big bottom line dollars.

Claude Mongeau (CEO)

Yeah. What I was saying is that we hope that domestic will pick up, eventually after overseas into, into the back another year or 2017.

Jean-Jacques Ruest (CMO)

Yes.

Claude Mongeau (CEO)

Thank you for the question, then.

Jean-Jacques Ruest (CMO)

Thank you.

Claude Mongeau (CEO)

Thank you, Matt.

Operator (participant)

Thank you. The next question is from Benoit Poirier at Desjardins Capital Markets. Please go ahead. Your line's open.

Benoit Poirier (Analyst)

Yeah. Good evening, gentlemen, and great to have you back, Claude. On the intermodal side, your car loads are up 1.5% quarter to date. So could you maybe give some color on what we should expect this year in terms of volume growth, given the soft economy, but also given the port expansion you just talked about? And maybe also discuss whether the weaker Canadian dollar favors Canadian ports over U.S. ports. Thank you very much.

Jean-Jacques Ruest (CMO)

Okay, so, we don't provide guidance for a business unit, one at a time. You know, the Canadian dollar, as I mentioned earlier, is when you look at ports, they are a service provider to the U.S. Midwest. And, you know, if everybody plays their card properly, they should have a cost advantage versus, you know, the competing ports. The opportunity is more on overseas than on domestic. And, the first three weeks of the year, you know, we would like to see more growth in the first three weeks of the year, but it's only three weeks. Remember, last year, the fourth quarter results shows already we finished the year very current. You know, Jim's team really clean out any backlog we had in any segment.

We were current, so we entered 2016 with no backlog in hand, and I think our customers on the retail side also you know are you know not necessarily replenish their warehouse right away. They're also looking at 2016 and wondering when is the time to stock up and put product in their warehouse. So first three weeks is only three weeks out of 52. We'll see how the rest of the years pan out.

David Vernon (Analyst)

Okay, thank you very much for the time.

Jean-Jacques Ruest (CMO)

Thank you very much.

Claude Mongeau (CEO)

Thank you. The next question is from Brian Ossenbeck at J.P. Morgan. Please go ahead. Your line's open.

Brian Ossenbeck (Analyst)

Great, thanks for taking my question, and, welcome back, folks. Just had a quick one on EPS, especially related to FX. Clearly, foreign exchange, Canadian dollar, U.S. dollar, has been a big driver of volumes, big driver of mix. And so, Luc, when you talk about mid-single digits growth for next year, EPS off the adjusted base, I was just wondering, is that attainable without a bit of a tailwind from FX? Or maybe you can just tell us how much of that growth you're expecting from the currency markets as you see them right now. Thank you.

Claude Mongeau (CEO)

Yeah, Dan. Luke, you wanna handle that one?

Luc Jobin (CFO)

Yeah, sure. Listen, Brian, you know, the guidance that we provided, of course, and we've laid out the assumptions so you can look at those. For FX, we're assuming, you know, a Canadian dollar to US in the range of $0.70-$0.75. So, you know, that's the range that we have assumed in our guidance. And of course, you know, we'll have to see how that goes. As a further, perhaps, just to help you out a little bit, I mean, I'll remind you that for every $0.01 of FX change, you know, that has an impact of roughly $0.04 on EPS. So, you know, it's with that in mind. Of course, there's still a fair bit of volatility in there.

I think currently the Canadian dollar is closer to $0.71. You've got, you know, forecasts all over the place. We have provided you with the range that we have for the full year, and that's $0.70-$0.75.

Brian Ossenbeck (Analyst)

Okay, great. Sensitivity is helpful, too. Thank you very much.

Claude Mongeau (CEO)

Thank you so much, Brian.

Brian Ossenbeck (Analyst)

Thank you.

Claude Mongeau (CEO)

Thank you. The next question is from Bascome Majors at Susquehanna. Please, go ahead. Your line's open.

Bascome Majors (Analyst)

Yes, good afternoon. You know, towards the end of the year, not just you guys, but a number of rails saw volumes close the quarter fairly weakly. And clearly there was some de-stocking there driving that. I'm just curious what you're hearing from your customers, you know, and maybe you could separate it by retail and intermodal and industrial. Where are they looking at their inventory levels today? Do you think the de-stocking continues well into the first quarter, or do you think, you know, we've done a lot of what we needed to do, and things could stabilize short term?

Claude Mongeau (CEO)

It's clear that, as you would expect, when things are uncertain, you know, people are trying to find the right level. In the last couple of months, the quarter, but in particular, you know, November, December, are weaker. We are generally constructive. You know, we may be wrong, but we think that it's, the things will stabilize and that the beginning of the year will continue to be difficult, but that things will stabilize in the second quarter and the back end of the year. But, J.J., you want to give a sense of, you know, what the customer feedback is in terms of that dynamic?

Jean-Jacques Ruest (CMO)

So, yes, so in an environment where, let's say if we were to talk about commodities, in an environment where price tomorrow might be a little better than the price today, the buyer of the product might not want to carry inventory if he thinks he can get, say, potash next month at $10 cheaper than this month. So that creates an impact on, you know, people, how much they want to gamble with inventory, because once they bought the product, they own it at that cost. But eventually, many commodities, you know, pricing are a lot lower, fairly low already. We're gonna hit the bottom, you know, depending on each segment.

But the buyer, whether he's in China or he's in North America, doesn't believe he can buy iron ore or potash at a cheaper price, which will eventually be the signal that as things start to reach bottom or eventually go back up, whether it's late this year or early next year, then they'll be tempted to buy a little more than what they need for the same reason as to why they may be tempted to deplete their inventory right now, because they think they can buy a little cheaper six weeks from now than currently. So in people who played with big inventories, it's how much they need and whether or not now is the price, the time to buy and stock up, or the time to buy less and de-stock.

I think we're not sure exactly right now where we're at, but we're close to bottom, potentially.

Claude Mongeau (CEO)

Very good question. Thank you.

Bascome Majors (Analyst)

Thank you.

Claude Mongeau (CEO)

Thank you. The next question is from David Vernon at Bernstein. Please go ahead. Your line's open.

David Vernon (Analyst)

Hey, thanks for taking the question. I think you talked a little bit about this on the intermodal side, but I was just wondering if there was some more granularity you could talk about in terms of helping to dimension some of the volume opportunity. You mentioned some pre-selling up in the West Coast ports, as well as kind of what you're hearing about or thinking about the Gulf. Have you had any kind of more in-depth conversations that would help us put numbers on either the amount that you've pre-sold on the West Coast or what you think could be coming in through the Gulf?

Jean-Jacques Ruest (CMO)

So I don't have specifics to offer on how much we pre-sold, but I can just remind everybody of the capacity that's gonna be available for CN. So definitely the Mobile rail yard will be ready sometime in the month of May. So we start from zero. So everything from there is an upside. We're a new player, the new kid on the block, if you wish, you know, in that part of the world. In the case of DP World, they've refined the construction schedule and they believe they can add an extra 50,000 TEU available, extra capacity available for sale sometime in the spring.

They believe also, based on the construction schedule, they will have another 50,000 TEU over and above the spring 50,000 TEU that will come out available for us to go and sell jointly sometime in October of this year. Then in Vancouver, where Jim is working extremely hard with our rail service operation on the South Shore, because some of the capacity on the South Shore of Vancouver today is not fully utilized. Obviously, you have lots of capacity in Halifax and Montreal. The investment, long-term investment made by our partners, whether the Port of Mobile or the guys on the Canadian West Coast, is basically the reason why we also invest. Because when we're in this long run, it takes time to deploy the assets.

The best time to build the ice cream, to build a ice cream shop is in the wintertime, because when you try to open up in July, typically it's chaos. We're building, we're building right now for the next cycle. That is the way the Chinese look at the market.

Claude Mongeau (CEO)

Yeah, I told you that JJ has his eyes on the future. He's looking at the ice cream down on his sideline.

David Vernon (Analyst)

All right. Well, thanks for the time, and, Claude, all the best for a speedy recovery.

Claude Mongeau (CEO)

Thank you. I'm trying to continue. It's difficult at first with the voice, but the brain is working very well, and the voice will get better over time.

Jean-Jacques Ruest (CMO)

Exactly.

Operator (participant)

Thank you. Our last question for today is from Turan Quettawala at Scotiabank. Please go ahead. Your line's open.

Turan Quettawala (Analyst)

Yes, good evening, everyone, and Claude, congratulations and great to have you back on the call.

Claude Mongeau (CEO)

It looks, Turan, like you were able to squeak in at the end, so.

Turan Quettawala (Analyst)

Yeah, just the caboose in here, right? I guess one, just one question on the domestic intermodal business here. JJ, is it possible to break down how much of the 5% growth came in domestic versus maybe the overseas? I'm assuming it's probably all overseas. And then also, you talked a bit about the Canadian economy here being weak. I'm wondering if you can give any color on whether you're seeing signs of broad weakness across the board, or is it still pretty much isolated in certain provinces?

Jean-Jacques Ruest (CMO)

The domestic intermodal was definitely much weaker than the overseas. I won't give you specific numbers. And you know, the cross-border is a bit of a challenge. You know, the competition with the truck and the cross-border is fairly stiff. You know, there's more driver than there was, and the fuel price is, the diesel price is not what it was years ago. And in some of the East-West, I mean, Calgary, Edmonton, Saskatchewan, they're not quite the booming economy today than they were 18 months ago, especially as it relates to how much capital investment there is there, and eventually, that find its way into even down to consumer.

So Canadian domestic intermodal business is a little weak right now, and it might be a little weak for a little while until we find a new, you know, a new level.

Claude Mongeau (CEO)

Thank you, JJ, and, I believe that, closes the question and answer periods for us. We try to stick to that one hour timeframe. Let me just, close by saying two things. You know, we're very proud of how we finished the year. It was not an easy year, but we were able to meet our guidance and deliver, nevertheless. We're entering 2016. It's still an uncertain environment, but we feel confident that we have the right agenda, the right focus, and the right team to deliver. On a personal note, I have to say five months is a long time, but it allows you to step back. I was so impressed by how the team reacted. The leadership team, first and foremost, they stayed connected, and they delivered as a team.

The broader team of CN. I must have received a couple thousand emails of very personal, supporting me, encouraging me. Many of you on this call, analysts and shareholders, reached out to me. I was looking forward to get back. I am very pleased. I could not resist coming on this call. I will work on my voice. I have the energy. I feel good about our franchise, and we are marathon runners. We're investing for the future. I hope to be part of it for many years to come, if you will allow me. Thank you, and be safe. We will see you or talk to you on the second quarter call.

Jean-Jacques Ruest (CMO)

All right.

Operator (participant)

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