Canadian Pacific Kansas City - Q1 2014

Transcript

Operator (participant)

Good morning. My name is Mike, and I'll be your conference operator today. At this time, I would like to welcome everyone to Canadian Pacific's first quarter 2014 conference call. The slides accompanying today's call are available at cpr.ca. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you would like to ask a question, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. I would now like to turn the call over to introduce Nadeem Velani, AVP Investor Relations. Please go ahead.

Nadeem Velani (AVP of Investor Relations)

Thanks, Mike. Good morning, and thanks for joining us today. I'm proud to have with me here Hunter Harrison, our CEO, Keith Creel, President and Chief Operating Officer, Jane O'Hagan, EVP and Chief Marketing Officer, and Before we begin, I want to remind you this presentation contains forward-looking information. Actual results may differ materially. The risks, uncertainties, and other factors that could influence actual results are described on slide two in the press release and in the MD&A filed with Canadian and U.S. regulators. This presentation also contains non-GAAP measures outlined on slide three. The formal remarks will be followed by Q&A. We would appreciate it if you limited your questions to strategic items, and if you had any modeling questions, please follow up with myself or Maeghan at Investor Relations after the call.

It is now my pleasure to introduce our CEO, Mr. Hunter Harrison.

Hunter Harrison (CEO)

Thanks, Nadeem, and thanks for joining us this morning. I trust that you've seen the press release, and I guess my comments are I'm glad it's over. I've been in this business a long time, and as most of you know, this is probably the worst operating conditions that I have ever been through in that period of time. But despite that, this group of railroaders came through with some outstanding performance, certainly in my view, given the environment and the circumstances they were dealing with. So we've got a lot of ground to cover today, so I'm going to confine my remarks and turn it over to Keith and Bart and Jane, and then I'm sure we'll have plenty of questions this morning. So Keith, over to you.

Keith Creel (President and COO)

Thanks, Hunter. Let me start by saying it sort of echoed your comments. One of the most challenging operating conditions I've ever experienced in over two decades of railroading. But I'd be remiss not to say I'm extremely proud of the CP team who worked tirelessly, and I'm talking all departments from headquarters, operations, finance, running trades employees, mechanical employees, engineering employees, craft officers alike, 24/7 just to survive this winter, to serve our customers' needs. We realize effectively our work's not done. I'm not going to be satisfied myself until all of our customer service needs have been met, and we're doing it in a positive way the way we were prior to what I would call a winter for the record books. On a positive note, we are making progress operationally.

Rest assured, we're seized with doing what we've got to do to restore normal service levels and fluidity across the network. I think it's appropriate, let me provide a little bit of color to the challenge this winter represented. For the naysayers or perhaps those that don't understand the gravity of this challenge this winter represented, let me start by saying yes, winter does happen every year. Let me provide a little bit of color to how challenging this winter was. We prepared extensively for it, but absolutely one of the worst, not normal, not even close to a normal winter. To put it in more perspective, in Canada, according to Environment Canada, it was the coldest December and January since 1950. That's seven decades. U.S.

Specific to Chicago, which is critical to our network, between the months of December and February, according to those that keep the records in the state, 67.4 inches of snow were recorded in Chicago, making it the third snowiest winter on record, matched by the third coldest winter on record, which is a very compelling point when it comes to operating a railway. From December through February, if we go up to North Dakota, 25th coldest on record. Minnesota, the sixth coldest on record. So overall, from December through February, especially all modes of transportation, not just railroads, if you're flying in planes, if you're driving on the highways, or trying to operate any kind of business with a mode of transportation, you were severely impacted by this extraordinary cold and severe winter. So again, I'd stress exceptional.

I would stress keywords like abnormal, creating operational headwinds that were, I'd say you could say, a headwind's probably an understatement. I could tell you now, running a railway, snow in large volumes and short time frames can be challenging, but you dig out of it. But sustained frigid temperatures like we experienced is crippling to an operation. Train length reductions of 50% is not uncommon to be able to run the railway safely. And the key there is when you get to temperatures for a sustained period, in Canada, if I want to talk Celsius, -25 degrees Celsius or lower, in the states, that's 16 below zero. For those of you that don't know how to do the conversions, that's rough numbers where it's at. It's cold.

You get to a point where you can't maintain your train brakes, you can't maintain air through the train system and the brake setup, or you can't operate the train safely. The only way to mitigate it is to run shorter trains, which means you consume crew assets, you consume locomotive assets, you put additional train starts out on the railway, and it consumes capacity, and essentially everything slows down. So all of your cycles on your locomotives, as well as your car turns, are prolonged and exaggerated, which saps capacity out of the network. Let's talk a little bit about Chicago.

I put a map in here to provide a little perspective because I know I've heard a lot of people probably will ask and are thinking, "How does Chicago impact CP as much as it has impacted CP?" Well, effectively, the way our franchise works, some of the challenges we deal with, a CP Bensenville yard is on an island to a point. When I say an island on the main line with Metra, you're talking a Metra that runs a tremendous amount of trains. In Chicago alone, between Metra and Amtrak, they operate over 1,300 trains a day. We're on a key corridor going into the city. Effectively, we've got four-hour windows in the morning, four-hour windows in the afternoon, and then every hour they run a pair of faster trains we have to operate our freight in and around and through.

The preponderance of our business coming in Chicago, and you see our two lines, be it coming from Milwaukee or coming from the Kansas City area, west of Chicago, goes to the belt. The belt is a bridge carrier. It's a switching carrier that all the railroads that operate in and around Chicago own part of, but effectively run it to the benefit of all the railways. So they do and command and represent a tremendous amount of workload. If the belt gets backed up, if the belt gets to the point where they're not able to process their traffic efficiently, then it's going to back up on the other roads. And that's what happened to CP in spades through the winter. Recently, even to the point that winter is over as far as the weather, the challenges associated with it are not.

Two weeks ago, it was not uncommon to come into this railway on a daily basis and be holding about 12 trains, which represents 12 train loads of cars and 12 train loads of locomotives in queue and line to get into the belt. I'm not being critical of the belt, that's just the operational challenges that we were facing. We've done some pretty extraordinary things with some of our partner roads to clear that backlog up, and I'm happy to say that it is eased. We've got a lot of the traffic that we had backed up all the way into Canada cleared out, which is a positive sign.

But again, on the car cycle standpoint, on the locomotive standpoint, until we regain fluidity, and I think we're probably still about four weeks away, you won't see normal cycle turns or normal velocity, normal capacity restored in the U.S. network into that time. So it remains a challenge for us as we go forward. Now, you're going to ask the next question, "Challenge, is it a challenge long-term? Is it an opportunity?" I view it as an opportunity. If we continue to do the same thing we've always done, and if you have another winter like we've had this past year, then you can expect similar results. We're taking this as momentum, as an opportunity to create a desire, working with our other roads, to try to get traffic out of Chicago that does not need to be in Chicago.

There's certain amounts of traffic, and this is 25% of the entire industry's volume that goes to this center. It is the largest interchange location in North America. Some of that business simply doesn't need to be there. So it serves this industry's interest, it serves CP's interest, it serves all connecting carriers' interests for us to work together to identify that traffic and route it to alternate gateways to create additional capacity within this greater Chicago terminal so that when and if these kind of winters occur, we mitigate the impact and we don't have a repeat performance from this past year. Moving to a couple of comments on legislated grain volumes. As Hunter mentioned or will mention and discuss, I'm sure, on this call and questions, the proposed legislative changes in Canada that we've dealt with are disappointing, to say the least.

The reality is this current grain supply chain, of which rail is only one component, just simply can't meet these extraordinary volumes over a short period of time. To put in perspective, this crop on the Canadian side is the largest grain harvest in Canadian history. It's 37% more than a five-year average. On an annual basis, normal demand for the two railroads to move in Canada to export is about 34 million metric tons. This harvest represented about 20 million more, or 50% more than the average on a five-year basis. So the bottom line is the supply chain from the field elevators to the railway to the port terminals can't handle this kind of volume, again, in a short period of time. Even in spite of the winter, in spite of some of these operational challenges and supply chain challenges, we've moved record grain volumes since last fall.

We were moving record grain volumes last fall, which got impacted by the temperatures that came in December and January. With the weather improving, we've regained momentum. We've moved 15% more western grain in February, even in some of the toughest winter challenges, and 20% more in March than the previous year. We're currently exceeding the minimum thresholds as well that are outlined in Bill C-30, which the government has imposed upon us. On the safety side, a couple of encouraging trends that are developing. I say this not to brag on the performance because I think one injury and one derailment is too much, but more to specify and highlight that the safety culture that we're driving continues to evolve and improve. Train accident frequency improved. In the toughest winter operational conditions, this railroad has experienced over 50% versus last year, which is phenomenal.

We recorded less than 1 train accident per 1,000,000 train miles. So that's not only an industry best, it's CP record as far as the first quarter, as far as any quarter, in fact. And on the same positive note, on the injury side, our ratios improved 14% year-over-year. Again, not to brag about this, but to highlight that our focus on driving a culture of accountability, leverage with investment in technology in the physical plant, is the way that we'll continuously drive improvement on the safety front, which is good for our business, it's good for the environment, it's our moral responsibility, and something we take very seriously at CP. So that said, I'll turn it over to Jane to comment more on the commercial implications of this quarter and what the opportunities are on a go-forward basis.

Jane O'Hagan (EVP and CMO)

Okay, thanks, Keith. In the face of extreme cold weather and tough operating conditions, revenue increased by 1% in the quarter. The impact of weather cost us about $75 million in the quarter, but we see upside in our growth initiatives and strong demand fundamentals across our portfolio. As network velocity continues to improve, we expect to make up this shortfall through 2014. I remain confident in our revenue guidance of 6%-7%. Renewable pricing came in above our target range of 3%-4%. Average revenue per RTM was up 6% with our focus firmly on increasing revenue quality. So turning to the lines of business, I'll report Q1 2014 revenue highlights on a currency-adjusted basis, but I'm going to spend the majority of my time providing insights on Q2 expectations. So starting with grain, in Q1 we were down 1% in revenue.

In Canada, the record crop presented an unprecedented demand for grain movement to export terminals. Despite ongoing severe weather early in the quarter, strong export deliveries to Vancouver helped drive positive year-over-year Canadian grain volume and revenue. Adverse weather hampered our U.S. grain movements, particularly through our Key Ellis in Chicago, while more fluid corridors serving the Pacific Northwest market remained flat versus last year. Overall, southbound challenges in our U.S. portfolio offset gains in Canada with volumes down single digits year-over-year. So the outlook for grain. Looking ahead to Q2, we have record levels of sustained grain demand across Canada, and we expect performance similar to the record levels set during the peak September to November period last year. Strong demand in the U.S., coupled with improved Chicago operating conditions, will provide opportunities for strong year-over-year volume growth in eastern U.S. markets.

So we expect high single-digit growth over last year in Q2. Turning to fertilizers and sulfur. In Q1, we were down 16% in revenue. The revenues in the quarter were impacted due to lower fertilizer shipments as a result of high inventory following a late harvest and a narrow application window, sulfur production impact, and challenging operating conditions that limited us from taking full advantage of volume following a recovery in the potash markets. This led to a Q1 RTM decline of 12%. As we look to the outlook, the demand for domestic fertilizer application remains very strong on excellent crop fundamentals in North America. We're optimistic we can take advantage of some of the upside through Q2 despite a compressed season. The fundamentals are expected to carry forward into the fall season with additional potential upside into the second half of 2014.

International potash prices began to stabilize and increase at the end of the quarter, that created certainty for buyers. Volumes are expected to rebound in Q2 with more favorable operating conditions, but are not likely to reach the record export levels we saw in Q2 2013. Now turning to coal. In Q1, revenue was down 2%. Our Canadian met coal volumes increased strongly in the second half of Q1 as we overcame supply chain-related challenges. Teck westbound volumes hit an all-time monthly record in March. Continued weakness in U.S.-originated domestic and export thermal coal demand, combined with supply chain challenges due to a harsh winter operating condition, led to a decline in U.S. coal. As a result, RTMs were down 4% in Q1.

For the outlook in Q2, despite some prevailing softness in seaborne met markets, we expect to see strong demand from Teck due to their diverse market base, their high-quality product, and competitive cost position. U.S. export thermal volumes are expected to fall off mid-Q2 due to customer netbacks no longer supporting those shipments. Domestic thermal volumes in the U.S. are expected to return as supply chains get reset, but the market dynamics continue to be challenged. Q2 coal volume is expected to strengthen through the quarter due to easier year-over-year comparisons. Now turning to intermodal. Q1 results, revenue was down 3%, but intermodal performance in the quarter was a highlight as we continue to improve the quality of revenue and grow our domestic business despite the volume impact from a contract we chose not to renew in international, the significant weather challenges, and the Vancouver trucker strike.

Domestic led the way with a 5% RTM increase in the quarter, reflecting our best-in-class transcontinental service and our Expressway growth. Cents per RTM and average revenue per car increased 2%, demonstrating our plan to target the segments and customers that drive the most value is in fact working. So for the outlook, we expect continued traffic gains in our domestic business as we sell our superior service and market capacity in high-volume corridors. The product consistency and reliability of our intermodal service will continue to generate interest from customers and segments who are looking for competitive alternatives and value a premium product. We'll continue to translate our service improvements to revenue growth where we have competitive advantage, we'll do pricing for value, and improve the operating income of the business. In industrial and consumer products, Q1 we were up 3% in revenue.

Challenging winter conditions limited our crude volume growth in Q1 with carloads slightly lower than Q4 2013. The ramp-up in frac sand delivered double-digit volume growth in the quarter. Average revenue per car and cents per RTM were driven by effects and changes in mix from increases on higher frac sand and crude. In terms of our outlook, the new Hardisty facility will start up in mid-June and will ramp up through 2014. This is new capacity in the heavy crude market, which will bring better balance to our franchise given it's less sensitive to crude spreads. The crude-by-rail model continues to be valued by our customers, and capacity buildouts are on track. We expect double-digit sand growth in Q2 as the sand facilities on our network in Wisconsin continue to ramp up from 33,000 carloads in 2013. Our industrial products group will trend with GDP.

In automotive, in Q1 our revenues were down 13% as adverse weather impacted automotive production and the supply chain. Chicago is a key hub for empties and connections to other carriers where congestion had a significant impact on shipments from Southern Ontario plants. In terms of the outlook, as service improves in and around Chicago, we expect to take advantage of improving velocity and car supply to handle backlog shipments. Our focus is on using our network and service to drive sustainable growth. We are aligned with strong automotive companies who are very competitive in their markets. In conclusion, like Hunter, I'm glad to see the winter months behind us. Demand is strong across all of our lines of business. We're delivering on our initiatives, and we are working and improving revenue quality.

We have a sales organization who's highly motivated by a new incentive compensation program that rewards profitable growth. It's early stages, and we should see solid results as the year rolls on. On that note, I'd like to turn it over to Bart.

Bart Demosky (EVP and CFO)

Okay, thank you, Jane. Good morning, everyone. It's fitting to say that in spite of the significant challenges you've heard described by Keith and Jane already, this was a record Q1 for CP, and I believe that does bode very well going forward. Operating income and net income were both up 17%. The resulting earnings per share of $1.44 was up 16%, and our OR of 72% was an improvement of 380 basis points year-over-year, which I see as a testament to the efficiencies and strong cost control the team continues to demonstrate. I didn't want to cover much in the way of the numbers, but there are a couple of items from an operating expense standpoint that I thought would be worth noting. In particular, we saw strong continued improvement in the comp and benefits area this quarter.

Efficiencies generated from both headcount reductions and lower pension expense more than offset the higher crew costs and overtime wages that we had to incur as a result of the harsh winter operating conditions. Purchased services also saw some dramatic improvement in the quarter. In spite of headwinds that we saw due to higher land sales and a favorable $9 million legal settlement last year in the same quarter, we were able to reduce this line of work by 9% on an FX-adjusted basis. The improvement was largely driven by insourcing initiatives, which have allowed us to reduce IT and third-party maintenance costs. That strategy is working very well. We did see an uptick in materials expense this quarter. We received a few calls on this this morning. It was really primarily due to higher winter-related freight car repairs.

But keep in mind that those costs are mostly recovered through higher AAR car billings for those repairs. So we will see a better run rate going forward. Let me just touch on one other thing, and that's enhancing shareholder value. As you may recall, I mentioned on our last call, my first call, that I don't believe in sitting on excess idle cash. I view it as something that could be a drag on shareholder returns if we could be deploying that cash effectively to drive higher shareholder returns overall. So consistent with that thinking, in March, we initiated a share buyback program, which I believe reflects our confidence in the long-term prospects of the company and our fundamental belief that this is a value-enhancing proposition for shareholders. In other words, even with the share price where it is today, we see ourselves as undervalued.

In conjunction with that program, we have also put in place an automatic share repurchase plan, which allows us to buy shares throughout our blackout period. So over the last few weeks, while we've been in blackout, we've continued to purchase shares. We also announced, as part of the program, our intent to repurchase about 1.3 million shares through private agreements. Simply, those enable us to purchase shares at a discount to prevailing market prices. For those of you who are familiar with those types of programs, you'll know that the counterparties tend to be Canadian financial institutions rather than institutional shareholders. Lastly, I'm also very pleased to highlight the ratings upgrade CP received from Standard & Poor's last week. They bumped us up from BBB- to BBB. We were also able to retain a positive outlook from Standard & Poor's.

In my view on it, this upgrade is really a reflection of our strong operating performance, the improved balance sheet that comes along with that, and a commitment from the company to financial discipline. So to that end, at the bottom of slide 12, you'll see it there. I have highlighted a couple of financial metrics that we are focused on. You'll see there in the continuous improvement mode. It's obviously not a complete list. There are other metrics that we steward to, but the intent simply is to show that we are committed to maximizing shareholder value while maintaining a strong financial discipline, and the company is certainly delivering on both those fronts. So with that, I'll conclude my remarks, and I'll hand it back over to Hunter. Thank you.

Hunter Harrison (CEO)

Thanks, Bart. Let me see if I can attempt to address some of the other issues that we were dealing with the first quarter that have got certainly potentially implications going forward. That's more some of the regulatory reactions that we've gotten from both Ottawa and Washington. First, let me talk a little bit about reaction in Canada. Taking all in, I'm proud to report right now that in spite of the fact of all the winter conditions and environment and unprecedented operating conditions, we're carrying 12% more grain than we were last year, and that was at record paces. So it's hard to prepare for a winter like this. But in spite of that, I think I could best describe it as we probably had a very knee-jerk reaction from Ottawa with due respect to the regulators.

Once again, with due respect, I'm not sure they understand really what they're dealing with. If you think about the interswitching, to put in interswitching, extend it to 160 km, and you take it north but not south so a U.S. carrier can come into Canada, but a Canadian carrier cannot go into the U.S. and it only covers three provinces, it makes very little sense to me. It has political syrup all over it, and I'm not sure what impact it's going to have. Number one, if you look at those three provinces, the only road other carrier that could come into our territory would be Burlington Northern. And I've talked to them several times, and they've got their hands full trying to handle U.S. grain, and it'll be a long time before they reach into our territories.

If you look at interswitching and the history of it and see how much interswitching is used, I think you would be amazed that the numbers are very, very small. Will it be less efficient? Yes. Do the regulators understand that? No. But once again, we had very little, if any, dialogue or feedback or interplay as far as suggestions of if anything should have been done to fine-tune the system. Now, am I an opponent of interswitching? No. If you want to have interswitching, that's fine. If you think interswitching encourages competition, maybe so. That's fine. But I can tell you this, that in those kind of conditions is when the strong really stand out. And so I'm not concerned. The main issue I have with interswitching is the rate.

If it's a regulated rate and it's a fair assessment of the cost to provide that switching, then I have no trouble with the background of interswitching. But just think about what's going to happen. I mean, here we have a situation where it's set up for a U.S. carrier to come into Canada, not for a Canadian carrier to go into the U.S. They're going to come up and take Canadian grain and take it south to the U.S., put it on a U.S. road, non-regulated, by the way, take it to Western markets, take Canadian grain to U.S. ports, take Canadian jobs away. I just, in the long run, don't think it's going to fly. So I think those things concern me. Well, I have a little concern. Do I lay awake at night about it? Absolutely not.

You're going to see us perform in spite of what reaction the regulators taking. And the same situation exists to a degree in Washington. There were some issues raised about service issues in Chicago. I think Keith has covered it very well, that, "Look, when you come to the end of the line, as far as you can go. If people won't take the traffic further, there's not a lot we can do about it." And with due respect, the regulators' reaction is to hold a public hearing, and people get up, and really, there's not any positive feedback. But I will tell you this.

Some of you are aware and remember that before I retired the first time, I promoted a type of commercial arrangement with other roads that was called routing protocol, that was to route cars, the most efficient route. I'm oversimplifying, but the most efficient route, which provides the best service for the customer and the lowest cost for the railroads. Our challenge would be able to how to split the pie up that was created. So with some of these conditions that have existed in Chicago, we have had some, I think it's fair to say, some encouraging dialogue with the other carriers. I've said to you many, many times, in fact, it wasn't 7 months ago or 8 on one of these calls that I told you that I was concerned about Chicago, that Chicago was fragile at best.

Is this the last time Chicago's going to get in this situation? No, probably not. In fact, we felt so strong about it that my former employer, that we tried to buy the Belt Railway Company of Chicago. They wouldn't sell it. We tried to buy the Indiana Harbor Belt Railroad. They wouldn't sell it. We tried to encourage a merger of the two in Chicago. They wouldn't buy it. So as a result, at that point in time, we bought a railroad that went around Chicago, which I think has probably put our competitor from the east in better conditions operating through Chicago as a result of recognizing those issues. All in, the ship is righted. It's sunshine and then Calgary.

In spite of this, a little rugged start here, I'm very comfortable going forward with the guidance that we have provided to you, and I don't see any need to change that. In fact, I'm more encouraged all the time. So with that little political byplay, I'll turn it over to Mike to see if there's questions from the group, which I'm sure there might be.

Operator (participant)

Thank you. If you would like to ask a question, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. As previously highlighted, please limit your questions to two. There will be a brief pause while we compile the Q&A roster. Your first question comes from Brandon Oglenski with Barclays. Please go ahead.

Brandon Oglenski (Director and Senior Equity Analyst)

Well, good morning, everyone, and congratulations on what was a pretty difficult period. Hunter or Keith, I just want to come back to the idea that there's some concern from investors that maybe the cost reductions have been too fast, too quick. Has that in any way impacted the recoverability of the network, or are you reducing volatility for CP looking forward?

Hunter Harrison (CEO)

Well, let me comment, and then Keith can kick in. This is in no way created any more volatility. The cost reductions that we have made have been made in a very appropriate manner. There's been no slash and burn, no obsession with headcount. It's been done through the basic model that we have, by service and control the cost and asset utilization. And we follow the same model now. Those that are trying to find a crack in the mortar here are absolutely wrong. And I think what it really does is it says even more that here's an organization that has maybe been accused of going a little too far to be able to produce the kind of results that this team produced in the first quarter in spite of what we've been through.

So no, I think that just bodes more strongly for the model than ever before.

Keith Creel (President and COO)

The only thing I would add to that is I'd add emphasis to it actually has shortened the impact or minimized the impact of what this winter would have done to this railway. You go back a year or two years ago, and we had 30,000 more cars out on line of road. We had more locomotives on line of road. We had the kind of conditions we've had. We wouldn't have been adversely impacted. We would have been crippled. We would have been paralyzed. So I would suggest this isn't about cost reductions. It's about asset turns. It's about right-sizing the level of assets you have against the business demands. And it has allowed us to maintain fluidity in those corridors where in the past we wouldn't have been. And it's mitigated even in those that we've been adversely impacted by. So it's accelerating the recovery.

It's not impeding the recovery.

Brandon Oglenski (Director and Senior Equity Analyst)

Well, I'm sure a lot of folks will remember a pretty nasty winter a couple of years ago this company faced. Speaking to Chicago, though, what can proactively be done here to clear some of this interchange traffic issues that seem to come up every year?

Keith Creel (President and COO)

Well, proactively, to Hunter's point, routing protocol. We just don't need to have, as an industry, cars in Chicago that don't belong in Chicago. I'll give you case in point. We got engaged pretty heavily and early with our customers, warning them what was going to happen in Chicago. Some listened, and I'm not being critical for whatever reason. Some listened. Some didn't. I can give you two energy customers, and I talked about this at the STB last week, two different results. One worked with us, and we routed around Chicago to their end destination. One didn't. The one that did, even in the face of this winter across this network, moved comparable year-over-year volumes. The one that didn't, we're dealing with potential plant shutdowns and having to curtail their end production. I'd make a case that one made the right decision. One didn't make the right decision.

So cases like that, when you multiply them, you get an opportunity to do something different that will give you a different outcome. So again, we're seized with looking at all our traffic, car by car, lane by lane. We've challenged the marketing team. I'm not interested in the long haul if it takes me into Chicago and it's going to adversely impact the operation. So if we've done that selfishly, shame on us, but shame on our competitors as well. We need to work with them and figure out how to create synergies for the customers, for car cycles, for locomotive cycles. We have a low-cost operation, both us and our competing and partner carriers, and we figure out commercially how to split the revenue. There's cost savings to be split up, to be realized. There's revenue implications that we all should be mature about and realize.

The end result is the customer is more satisfied. They get to do more freight. And you don't have the impact of winter the way it has impacted us this past year. So it's something we'll continue to work on going forward. There's no silver bullet to Hunter's point. This is about singles and doubles to keep winning the game, and that's exactly what we're going to do.

Brandon Oglenski (Director and Senior Equity Analyst)

Well, thanks, Keith Creel, we're falling out here.

Hunter Harrison (CEO)

Congratulations.

Operator (participant)

Your next question comes from Steve Hansen. Raymond James, please go ahead.

Steve Hansen (Managing Director and Equity Analyst)

Oh, yes. Good morning. I just hope you could provide some added color on this domestic intermodal franchise that you're now growing with some new service offerings in place. And I guess specifically, how long do you think it'll take to backfill some of the international business that you've strategically seeded?

Keith Creel (President and COO)

At the run rate now, the way it looks, Steve, we're talking the revenues on domestic will lap what we've lost in international by the end of 2015, if not exceed. Then the quality of the book because the contribution and the quality of the revenue is so much more positive in domestic versus international, it's going to be a much greater success story, bottom line, for the company.

Steve Hansen (Managing Director and Equity Analyst)

Okay. Great. That's helpful. Just turning to crude by rail quickly, if I may. Hunter, I think in the past, you've mentioned that the economics associated with some of the early-stage contracts in crude by rail were not maybe as favorable as you would have liked. Presumably, there's been a learning curve. You've got a new large-scale unit train facility coming on in short order here. I'm just trying to get a sense for how the economics might have changed for the business or if they have changed or how that learning curve has evolved.

Hunter Harrison (CEO)

Well, they've changed in those two ways. I mean, we continue to have growth with crude. And look, people have misunderstood me to some degree. Look, I love the whole crude just like anything else. It's just a fact that if you looked at the margins, they didn't qualify in my book of being the right quality. Now, Jane and team have worked very hard. And going forward, I think you'll see the quality of revenue improve there. And once again, if "the regulators stay out of it and let us that know how to railroad, railroad," then those issues will be behind us.

Steve Hansen (Managing Director and Equity Analyst)

Okay. Very good. Thank you.

Hunter Harrison (CEO)

Yes.

Operator (participant)

Your next question comes from Scott Group, Wolfe Research. Please go ahead.

Scott Group (Managing Director and Senior Analyst)

Hey. Thanks. Morning, guys.

Hunter Harrison (CEO)

Morning.

Scott Group (Managing Director and Senior Analyst)

First, just want to ask just a couple of follow-ups on the guidance for the year. Jane, the 6%-7% revenue growth, what's the FX rate you're assuming and just maybe the implications of the rate being at 110 right now? Then Hunter, last quarter, you suggested that maybe it could be as good as a 63 OR. I'm guessing that's tougher now after one Q, but maybe just kind of your latest thoughts on how good it could be this year.

Jane O'Hagan (EVP and CMO)

Well, I think I can answer your question on the FX pretty quickly. I mean, we're assuming an FX of 105. And as we move forward and look at the book, we're hoping that as this Canadian dollar stabilizes, our export-oriented traffic, and we'll assume that we'll see some additional traffic that'll move in the merchandise sector to various points within North America. So Hunter, I'll turn it back over to you then.

Hunter Harrison (CEO)

Yeah. Look, I hesitate to even put out numbers anymore. The staff beats me up as soon as I walk out of the room about being optimistic. And you can color my questions with optimism. Look, there's a lot of positive things going on here. Did we have a little setback with winter, but did we learn? Absolutely, we learned. So somebody asked the other day, "Is the potential there 'potential' for a 63?" Yeah, the potential's there. You don't always fulfill your potential. But yes, the potential is there. Yes, it's a matter of timing. Yes, there's a lot of moving parts. But I mean, so far, so good. I've been doing this a long time, and I hadn't missed too many numbers. So I know I've got a short track going here, but I don't plan on missing any more.

Scott Group (Managing Director and Senior Analyst)

Okay. That's helpful. Then maybe just strategically, just on the Chicago issue. So obviously, the EJ&E has been bought by CN, but Hunter, you talked about some other acquisitions you've tried to do in the past. Do you think those could open up again? And I know you've been one of the few proponents about more major consolidation in the industry. Does this issue in Chicago, you think in your mind, make that more likely, or are you more interested in kind of bigger transactions?

Hunter Harrison (CEO)

No, I think it does make it more likely. This is not something that I'm some Johnny-come-lately here. I've been saying this for 10 or 15 years. Someday, the whole industry's going to wake up about Chicago. If you go back in time, before previous mergers, by the way, Chicago was not a big interchange locale. It was far behind St. Louis and Kansas City. But what created all the business at Chicago? Well, it's just a shift of the business away from Kansas City and St. Louis and other points on the Mississippi and created a lot of business in Chicago because of the mergers.

Railroads still have this "what I call long-haul mentality." We saw some as we were getting into it with the commercial side of the business, we saw a lot of business being routed through Chicago that should have never gone through Chicago, that it's out of route, that it's more cost, that it's worse service, that it's less asset turns. But people that grew up in this industry, this long-haul division mentality, are one day going to learn. As you get further growth in Chicago, as the economy further picks up, Chicago does not have the infrastructure to handle the business going forward, particularly if you start talking about regulatory issues as far as hazardous commodities and those type things. There's got to be another place on the Mississippi to interchange traffic east-west.

Now, if you look at the amount of traffic that's interchanged east-west and you look at the various gateways up and down the Mississippi, I mean, I hadn't seen recent numbers, but Chicago is probably 10-to-1 over any other gateway on the Mississippi and is more than all the rest of them put together of St. Louis and Memphis and New Orleans and those type things. So yes, do I think there's going to be a point where people are going to need, have to look at other issues, which might be a merger? Absolutely. Because through a merger, you could still maintain competition and have a much better flow of traffic. And if everybody wasn't worried about the long haul, they wouldn't have it all routed through Chicago. So yeah, Chicago's going to get fixed. It's just a matter of time.

For some reason, we got to get battered and bruised in this industry before we wake up.

Scott Group (Managing Director and Senior Analyst)

All right. Thanks for the color, Hunter. Appreciate it, guys.

Operator (participant)

Your next question comes from Bill Greene, Morgan Stanley. Please go ahead.

Speaker 22

Hi. Good morning. Thanks for taking the question. Can I ask you to talk a little bit about how we should think about baselining traffic? We know that you lost some business by design here, but how should we think about the recovery? What freight didn't move in the first quarter that we can expect to move in the second and maybe third? And also, how much of the business is left that you may want to reset, if you will? So I think, Hunter, in the past, you've talked about maybe 20 contracts or so that you didn't like the margins on. Maybe having a sense for what that means on a net growth basis, whether you want to look at RTMs or traffic, would be helpful.

Hunter Harrison (CEO)

Bill, let me make these comments, and Jane and Keith might want to hear. But if you look, clearly, it's going to be a strong grain year throughout the year of the rest of the year. And there's a huge amount of carryover, so there's going to be pickup there. Most of our other bulk commodities look positive, not with a big carryover like grain. But when you look at autos, forest products, particularly lumber, most of that softness is a result of car turns. Cars got stuck in other carriers, and where they were making 15- and 20-day turns, we saw 40- and 50-day turns with the assets. So I think pretty well, if you look across the book, intermodal is not affected as much. And typically, what we think of is that the intermodal business you lost, you've lost. You don't carry it.

But I think the product that Keith and Jane have put together, the domestic intermodal, is very encouraging. Their staff just got back from Asia, and Jane, I think, was with them. And some very encouraging signs there related around something that's unique in this industry called service. And I think some people that had left said, "Have you got room for me to come back?" So I think we'll see some resetting. This is my view of some intermodal business. So if you look throughout the year, and one of the reasons that I'm as bullish as I am on the guidance is that I think there's going to be there's going to be plenty of revenue out there if we continue to execute the way we've been executing.

Jane O'Hagan (EVP and CMO)

Yeah. The only part I would add is that over the last year or so, Hunter has really had us focused on ripping apart the book of business and really looking at ways to improve the revenue quality, attacking the profitability by customers, profitability by lane. And as Keith indicated, part of our work will be to continue to look at that to optimize how we can move more, moving them on the most efficient corridors. But the one thing I will say is that to your question around contracts and those that Hunter has indicated that they're not quite the way that we'd like them to look, we've included that in our guidance. That's included in that overall view.

Speaker 22

Okay. That's helpful. Thanks. Bart, maybe I can just follow up with you on one question. When we look at the target leverage ratio you sort of talked about, it kind of suggests some very large opportunity to increase the buyback significantly, particularly when we consider some of the things Hunter's mentioned on asset sale potentials. So can you just talk a little bit about how you would envision sort of the scope or the capacity? Is it measured in the multiple billions here? Is that how you should think about the opportunity? Maybe some color there'd be helpful. Thank you.

Bart Demosky (EVP and CFO)

Bill, it sounds like you're pretty excited about buybacks in the future. I think we are too. The way I'd maybe characterize it is I look at given the way the business and the operations side of CP has continued to improve and will continue to improve going forward, we've started to not only repair the balance sheet but get it to a place where ultimately, maybe adding some leverage down the road makes sense. We're talking about using truly free cash and excess cash to repurchase shares. Now, I think what that does tell us is that going beyond the current $1 billion program, once we've fully executed that—and my view is we will, of course, fully execute it—we'll be in a position to have lots of opportunity to continue to repurchase shares going forward beyond that program.

It comes with being able to put leverage on the balance sheet, but it comes more from the great operating performance of the company and the cash that that produces. I can't give you any specifics today. This is a journey. We just got to this point, but it looks very, very promising from here.

Speaker 22

Bill.

Thank you for the time.

Hunter Harrison (CEO)

This is kind of a matter of an issue that we've dealt with called confidence, okay? So we've developed some confidence with the rating agencies. We've developed some confidence with the board. We've developed some confidence with people internally that thought this was unachievable, and I told them it was going to have to be a leap of faith. So to Bart's point, if we continue to have the operating performance that we have been having, I think you'll certainly see in the future step two and three to a buyback program.

Speaker 22

Very helpful. Thank you.

Keith Creel (President and COO)

I think I want to Bill, let me add one comment of color, something just looking at the way the business is flowing right now as well. Grain, grain, and more grain is the story Canadian side, the story on the U.S. side. From an RTM standpoint, though, even though winter has ended and we are making progress, it's sort of a tale of two stories. You're getting a lot of fluidity. You're getting train speed back. You're getting cycle turns back on the Canadian side. But we still have a drag with the impact of Chicago and sort of the ripple effect. What goes in's got to come back out. So we've got the backflow cleared up, but it's not normal state yet. Train speed in the states, and the worst of things was off about 35%-40% compared to last year.

Now, we're down to about 25%. So it's getting better, day by day getting better, but we still have to mitigate our expectations. So I would expect over the next month, probably flattish type RTM growth. You'd start to see toward the end of second quarter an increased RTM growth year-over-year and then strong third and fourth quarter based on the base demand across all those business groups that Hunter spoke to. So it's solid demand across all business groups, and that's what gives me confidence. That's what's given us confidence to maintain our year-end earnings guidance in spite of this adverse first quarter that we've had.

Speaker 22

Excellent. Very helpful. Thank you.

Operator (participant)

Your next question comes from Turan Quettawala, Scotiabank. Please go ahead.

Turan Quettawala (Director of Equity Research)

Yes. Good morning. My question is back on the regulation side, I guess. Hunter, you talked quite a bit about the regulators here. Are you concerned that maybe there'll be some other customers who will start to knock on the regulators' doors considering that the grain lobby has, I guess, met with some success here? And also, is the government becoming a little bit more conversational now, or is it still much more of a one-sided approach?

Hunter Harrison (CEO)

Well, I don't think there's a lot of customers that are going to be knocking on regulators' doors depending on where you're talking to. But look, some of us that live through regulation know that's not the answer to this. I hope the customers know and understand. And to some degree, it's been an educational issue with customers. And we've seen cars routed out of Wyoming, going to Toronto, for example, that go into Chicago, that go to another carrier, and that just doesn't make sense. Now, I think that I think this was you might describe it as a perfect storm as some of this came together. And there was a lot of pressure from customers and reaction from the regulators.

But I think that particularly in Canada, all this has to go through a CTA review once this legislation is passed where you have some people that, with due respect, understand the business a little better. And then we'll go through this five-year process of review that the transportation system goes through. And I think we have a lot of case to be made that, "Look, don't overreact. Don't have some, as I described earlier, knee-jerk reaction. Think about what you're doing." This doesn't make a lot of sense. Why do it in three provinces but not the other, okay? Why is it they can come into the U.S., can come into Canada, but we can't go? It makes no sense.

If you sat somebody down and said, "Here's what they've done," and they'd say, "Why?" Then you ask them, "Why?" and they don't have real good answers. So I think a lot of the rhetoric is going to calm down. I think we've talked all morning about the weather being behind us and operating performance getting better, and this too shall pass.

Keith Creel (President and COO)

Let me add a little color to that as well. I think that there have been some customers knocking on the regulators' doors specifically in Canada expressing concern about some of the legislation and some of the things that have been done because of the unintended consequences that could transpire. If you're a potash shipper, if you're a coal shipper, and you're a world supplier, you want to make sure that what's happening in Canada is not in your worst interest. You want it to be in your best interest. And sometimes these things happen. From a capacity standpoint, I'm not concerned about the commercial implications of interswitching. I'm concerned about the capacity implications.

If your objective is to increase capacity to move grain, which is what the rallying cry was for this legislation, then do you really need to do things that could impede your ability in sap capacity? If you start trying to put 100-car unit trains through 20- and 30-car interchange tracks, a designated interchange location specific to CN and CP in this country, you're going to have an adverse impact not only on grain movements but also on the existing business that moves through existing interswitch interchanges. So to me, you got to think about unintended consequences. I don't think there was enough consultation. I don't think there's enough understanding.

As I have in the past, and I'll continue to express concern to the regulators that make these decisions, they need to vet them, and they need to think a little deep and hard before they do something that creates overall adverse impact to the Canadian marketplace.

Turan Quettawala (Director of Equity Research)

Thank you. That's very helpful. And if I may ask one quick one, Keith, you talked about the second half being obviously a lot stronger here. Is there any sort of specific risk that comes to mind off the top as to what might change that in any way?

Keith Creel (President and COO)

I think the only thing that would change it is world economic meltdown. I just don't think it's in the cards. Even with that, we've got a lot of grain to move, a tremendous amount of grain let alone. If we were to move all the pent-up demand that's out there and really hit on all cylinders and crossed all i's and dot all t's, that's a compelling opportunity for this company.

Jane O'Hagan (EVP and CMO)

And there will be significant carryover of the crop this year as well to the tune of over 20 million metric tons. So when you factor that in, we'll be moving grain for some period.

Turan Quettawala (Director of Equity Research)

Great. Thank you very much.

Operator (participant)

Our next question comes from Chris Wetherbee, Citi. Please go ahead.

Speaker 19

Yeah. Thanks. Good morning. Keith, maybe just talking a little bit on the cost side. So when you think about sort of the $0.30-$0.35 of weather that impacted the first quarter, maybe it's about half of that coming from the expense side as you look to get the service ramped up over the course of the next 4 weeks or so. So are you thinking about sort of anything meaningful from a cost perspective being added into the second quarter? I guess I'm just roughly trying to get a sense, the cadence that's kind of ticking back up towards some of those longer-term 2014 targets.

Keith Creel (President and COO)

No. I would say that there's no home runs there. I think it's the railroad, and as we've experienced, train lengths are going up, train loads going up, train speeds going up, cycle turns are occurring, costs are coming down, overtime's coming down, terminal dwells coming down. As those things happen, they'll reverse and account for some of the downfall that we had in the first quarter, especially considering if you remember year-over-year, we did our whiteboard sessions mid-year last year. So the first half, the comparables, if it had been a normal winter, would be compelling. So we'll realize those synergies in the second quarter, and I'm already seeing it in the numbers, and we'll regain the expense that we've chewed into or overshot, I guess, in first quarter.

Speaker 19

Okay. That's helpful.

Keith Creel (President and COO)

I don't know if Martin.

Speaker 19

Can we think about resources?

Bart Demosky (EVP and CFO)

Sorry, Chris. Maybe I could just add just a couple of words. The insurance expense in the quarter related to the weather was about $25 million. So that's a number you could use to come out on a run rate going forward.

Speaker 19

$25 million of expense. That's helpful. And then, Keith, when you think about sort of resources, forgetting about headcount for the time being, you'd be thinking about capital resources, locomotives, etc., or actual sort of hard infrastructure assets. When you think about sort of what this winter has taught us, is there anything that you feel like you need to go to Bart to ask for as you look forward to the rest of the year as far as capital is concerned, or you guys feel relatively good about sort of the plans that you've talked about in the past?

Keith Creel (President and COO)

I would say if I went back and I had a crystal ball, I wouldn't add any more resources when it comes to locomotives, crews, and people. I mean, effectively, we maintain the fluid railroad overall in Canada. The place that really hurt us was Chicago. Like I said, if you've got 12 trains daily waiting to get in Chicago, am I really doing anybody any good having 15, 16, 17 in line to get in Chicago? That's just more additional locomotives, more people, more assets, more costs that once things normalize, that's going out of business sales as far as I'm concerned. The short answer is no. We've got a very robust capital plan this year.

We've got some strategic investments we're making to increase capacity over the long run that will allow us to drive train velocity, take out additional train starts, train lengths, and absorb incremental business at low incremental cost. I think we're right-sized, and I think we're on target. I wouldn't suggest that we need to change anything.

Speaker 19

That's great. Thanks for the time. Appreciate it.

Operator (participant)

Our next question comes from Ken Hoexter, Bank of America Merrill Lynch. Please go ahead.

Ken Hoexter (Managing Director and Co-Head of Industrials Research)

Great. Good morning. Hunter, you had mentioned in your previous position that it wasn't about the operating ratio, but at some point, you want to start growing revenues. But now that you've been here for a little while and seen the landscape change in the cost side, you mentioned kind of getting to sub-60. Is there kind of a, I know you didn't want to set a hard number before of a target, but do you still see that on the path given all of the bulk traffic on this network compared to what you moved before? And then do you still see kind of the outlook of at some point switching over to a stronger revenue growth and a less focus on the ramp-up on the cost side?

Hunter Harrison (CEO)

You're going to get me abused by the stamp here. Let me say this. I think that you're exactly right about what I've said previously. I still believe that I'd change it. I think we're probably seeing the light at the end of the tunnel with that strategy and a shift. I would suggest to you that we're going to talk about that a great deal at the Investor Day or days in New York in October, I think. I think we are approaching and to some degree, the industry is approaching a point where I think that you're going to see growth kick in. The economy stays stable, and I think you're going to see some growth further for a lot of reasons, the reasons that I've talked about before.

So yeah, I think we're maybe a year or two away from that shift where there will be a point that it's probably not in our interest to go necessarily lower. Now, that'll be a low point. It won't be 63. It'll break through that barrier. But yeah, I think that we're looking to the point where the real opportunity, particularly for a business that's capital-intensive and high-fixed costs as this one is, there's a point that growth can really kick in and give us a real boost to the next stratosphere.

Ken Hoexter (Managing Director and Co-Head of Industrials Research)

When you said break through the barrier, you mean the 60, or do you mean the 63 that you had mentioned?

Hunter Harrison (CEO)

63. Let's start with that, okay? If we get through that, then look, you can say 59 is just 1 point less than 60 or 4 points less than 63, but it's some kind of mental issue with certain people. So look, we have been involved. I've been involved with carriers before that have had operating ratios starting with fives that are clean quarters and work some aberration. So could I see a day in the future, and we're going to talk about more, that we will get to some of these artificial barriers? Absolutely. And when we wring all the cost out of this operation and get operating as effectively and as efficiently as this team would like to have, I think there's going to be a lot of opportunity for growth on the upside, which will maybe be the next wave of the future for us.

Ken Hoexter (Managing Director and Co-Head of Industrials Research)

Appreciate that. Then just you had mentioned before you wanted to talk about Ottawa and Washington, and I know you talked about Ottawa for a while. I'm not sure if you ever kind of moved it over to Washington and your thoughts on maybe the switching proposal or the returns proposal that have now come before the STB. Can you kind of switch over to that side a little bit and maybe throw out your thoughts there?

Hunter Harrison (CEO)

Yeah. I think if you look back, first of all, the STB went for a good period where they only had two sitting on the board. Now, they've got the third party. But I think that if you look back at history, if you look back at the numbers, they're pretty compelling. If you look back since Staggers in the 1980s of the day, and you look at railroads, financial performance, service performance, or whatever the case might be, and you say, "We're going to go back to the old days or mess with that model," you need to be very, very careful. We talked about interswitching in Canada. I remember the old days of reciprocal switching. Was it good for service? No. Was it good for cost? No. What was it good for? Well, I couldn't figure it out.

So I think that once again, like a lot of things, we've got a headline for a couple of days. Service is falling back in shape. And I think that I don't have and maybe I'm reading this wrong. I don't have concerns that Washington is going to do something that's not smart and appropriate for the railroads. And if they do, if they think about it or approach it, I think there'll be a lot more dialogue and input from people that know a little something about the industry rather than, once again, snapping off and putting some legislation in that makes not very much sense.

Ken Hoexter (Managing Director and Co-Head of Industrials Research)

Wonderful. Appreciate the insight. Thank you.

Hunter Harrison (CEO)

Yeah.

Operator (participant)

Our next question comes from Allison Landry, Credit Suisse. Please go ahead.

Allison Landry (Senior Transportation Research Analyst)

Thanks for taking my question. Hunter, referring back to your comments on there still being the potential to achieve a 63 OR this year, could you talk about some of the key levers that you could pull to make up for some of the setbacks in the first quarter? I know that you mentioned a little while ago that there's plenty of revenue out there. So do you think that the top line will have more of an impact than you initially expected, or will it sort of be a combination of that along with continued execution on the cost improvements that were already in place?

Hunter Harrison (CEO)

Well, I think that it's going to be more the same. We got a little setback here with the snow drifts that were higher in locomotives. But all the initiatives that Keith has put in place, some that were just getting kicked in, are going to get kicked in fully the rest of the year. James, forget new revenue for a minute. We got old revenue out there that we can bring back. I don't think there's no magic wand and no secret. Are there some other things going well? Yeah. I mean, there's some very encouraging dialogue, for example, in the U.S. on labor agreements. Very encouraging. Now, I don't know where it's going to end, but I think we'll be better off that way. I think there's some dialogue going on in Canada.

So I think it's just more of if you look at our metrics and see the trends that had been created. I think you'll see more of that. And so I think you'll see some similar combination to the setback in first quarter and going positive in the next three quarters. I think we'll see once we get car cycles back in some type of rhythm or tempo, if you will, that we'll see some pickup in the merchandise side, the auto side. And at the same time, we'll get back to the trends that we're tracking as far as the operating initiatives that Keith and his team have put in. And so I think it'll be a combination. But this is not a model that reacts just to the market and changes every quarter. Look, we got a model.

We got what we think are the values that make this thing tick and may work pretty well over the test of time. We get a level playing field here and a little snowmelt, and we'll get back on the same trends and track you saw for some period of time until the point, to Ken's earlier question, to the point where I think we'll be talking about at the meeting in fourth quarter about what is the shift that we see out in the future in the next 3, 4, 5-year plan, if you will.

Allison Landry (Senior Transportation Research Analyst)

Okay. Thank you for that comprehensive answer. I have a follow-up question for Jane. Just given the news this weekend regarding the Obama administration pushing back the Keystone decision again, has your outlook changed at all on your crude-by-rail growth trajectory, particularly as we look out to 2015? Could there be some additional room or upside to your 2-3x growth target?

Jane O'Hagan (EVP and CMO)

I'd say, Allison, that we've always built into our crude target, our guidance around 140,000-210,000 carloads, that we believed was aggressive. But as I've said many times, our forecast is not dependent on pipelines, not going ahead or in terms of pipelines moving forward. We believe we have a unique proposition that provides optionality, provides a clear alternative to get oil to markets where customers want to move it. So I think we feel very we feel our guidance is on track to that number. As I said before, our capacity buildups are moving as planned. We continue to make headway. But again, we believe that the pipelines are complementary to what we want to do as well. And so we're focused on our unique space, creating value.

As Hunter said, really focusing on getting the right combination of facilities and movements into our business and identifying where we can grow profitably.

Allison Landry (Senior Transportation Research Analyst)

Okay. Thank you so much.

Operator (participant)

Your next question comes from Thomas Kim, Goldman Sachs. Please go ahead.

Speaker 21

Thanks. I wanted to ask a couple of questions. The first one on the pricing side. To what extent were the pricing gains in grain, industrials, and forestry during the quarter from core versus mix? And then to what extent did FX impact the average RPUs?

Jane O'Hagan (EVP and CMO)

Well, I would say that each of the groups are different. But I would say that when you look at our grain pricing, clearly, when you look at the corridors that we moved, grain pricing was very strong. We took advantage of our opportunities where grain wanted to flow. And as I indicated last quarter, we expected that our yields in grain would be strong. Certainly, as I indicated before on the crude side, there were some impacts, some impacts from FX. But largely, a good degree of this book now originates from the Bakken, moves in U.S.-denominated currencies. When we look overall at what we're doing in terms of the pricing side, I've been very clear that pricing is a journey for us. And it's a combination of two things.

Number one, it's achieving our renewal targets of 3%-4%, which we've delivered on in this quarter, about that range. It's also really on taking a look and developing what is the right book of business for this network. As Keith indicated, certainly, our work is not finished in this area. We continue to work on core pricing, improving that opportunity. But again, a lot of what we're going to be doing in the future is not only assessing just that profitability but also working on the routing options that'll create the best efficiency that we can to continue to grow the business.

Speaker 21

Okay. Just in terms of setting our expectations for the second quarter, the momentum of pricing growth that we saw last quarter, is that, do you think, sustainable for Q2? And should we anticipate that sort of decelerating a little bit off of a higher base into the second half of the year?

Jane O'Hagan (EVP and CMO)

Well, I think that certainly, on the grain side, we use seasonal pricing. So we might see a little movement on grain pricing as we move towards in our regulated corridors. But I think overall, we're very pleased with the momentum that we've had on the pricing side. I'd reiterate our guidance for 3%-4% on our renewals. And as I said, the work that we've been doing on the book of business to get that right combination of yield and movements, I think that we could I would suggest that would be in line.

Speaker 21

Okay. Thanks, Jane. Bart, can I squeeze in one question just with regard to equipment rents? I think that was one area that you may not have detailed. So if I missed it, I apologize. But I think you provided pretty good color with regard to purchase rents and materials. And I was just wondering if you could just highlight or detail what helped contribute to the lower equipment rents in the first quarter.

Bart Demosky (EVP and CFO)

Yeah. It's mostly lower leased cars is the primary item along with some locomotive rental costs. Those are the two factors. We were down or we were favorable about 16%.

Speaker 21

Okay. These are not rental rates but the number of cars leased. Is that right?

Bart Demosky (EVP and CFO)

That's right.

Speaker 21

Okay. All right. Thank you.

Operator (participant)

Your next question comes from Jeff Kauffman, Buckingham Research. Please go ahead.

Jeff Kauffman (Managing Director and Senior Equity Analyst)

Thank you very much. Congratulations, everyone. One question for Keith. One question for Jane. Keith, in previous years, when we've had a lot of snow in Canada, we're thinking about getting past the snow. But we tend to have flooding in places like Saskatchewan as that snow starts to melt in the spring. Can you talk about some of your contingency plans, if that is to present itself this year, and what you're seeing right now?

Keith Creel (President and COO)

Well, I can talk about what we're seeing. What we're seeing is a slow melt in favorable conditions. So we do not anticipate short of some global warming that hasn't obviously happened as of late, any overwhelming of the waterways in our network that would have an adverse impact when it comes to flooding. Now, the Mississippi's always a wild card. But we don't see anything again right now on a positive standpoint that leads us to believe that we're going to have anything like we've had in the past.

Jeff Kauffman (Managing Director and Senior Equity Analyst)

Okay. Thank you. Jane, you talked a little bit about some of the stabilization in fertilizer pricing. Can you talk a little bit about how some of the currency swings, not just the Canadian currency but in some of your key export markets, are impacting competitiveness?

Jane O'Hagan (EVP and CMO)

Well, what we're hearing from customers is that we have not had any signals that this is having an impact on their ability to market their products in those markets. A lot of the customers that we talk about or that are part of our book are customers who lead in those segments. I think that what we're seeing specifically in the product side is that the demand fundamentals are such that the price is where the buyers are wanting to get into the market to basically because they've been out of the market, as you recall, last year, we had a period where we weren't moving much product. But again, the real focus has been on that they're basically high-quality, low-cost providers that do well in their segments.

I haven't heard anything that would be an indication that foreign exchange has been cited as a reason for any change in volume.

Jeff Kauffman (Managing Director and Senior Equity Analyst)

Okay. Thank you. And again, congratulations.

Operator (participant)

Your next question comes from Benoit Poirier with Desjardins Securities. Please go ahead.

Benoit Poirier (Managing Director and Senior Equity Analyst)

Yes. Thanks for taking my question. My first one, I was wondering whether you could provide more detail about the opportunity to monetize real estate. I understand that the $2 billion amount is more a 2015, 2016 story. But I was wondering about the potential for a portion of D&H and whether it should be realized this year.

Hunter Harrison (CEO)

The D&H?

Benoit Poirier (Managing Director and Senior Equity Analyst)

Yes.

Hunter Harrison (CEO)

I think, Benoit, you're right. I think that most of this book of opportunity with the real estate will be in the out-of-years, 2015, 2016. We're working hard to stamp in on the right model to best optimize these assets. I think we anticipate a closing on the DM&E this summer, probably late May, early June. And then there's still some activity that we talked about originally, strategically, on the D&H. But certainly, you won't see anything this year that impacts that. But I think in the out-of-years, when you're talking 2015, really 2016 and 2017, you'll see this really kick in and start to pop.

Benoit Poirier (Managing Director and Senior Equity Analyst)

Okay. Thank you very much. And just related to free cash flow, am I right to say that it was $70 million before dividend? And is the $1 billion-$1.1 billion target still achievable this year?

Bart Demosky (EVP and CFO)

Yeah. I think you're right on the pre-dividend free cash flow for the quarter. Yeah, we don't provide guidance on cash. But the general consensus in the market is about $1 billion-$1.1 billion of free cash before dividends. And we certainly wouldn't disagree with that.

Benoit Poirier (Managing Director and Senior Equity Analyst)

Thank you very much. That's it.

Operator (participant)

Your next question comes from Walter Spracklin, RBC. Please go ahead.

Walter Spracklin (Managing Director and Senior Equity Analyst)

Thanks very much. Good morning. Good afternoon, everyone. I guess I want to swing back to regulatory for a second but in a little bit of a different vein, Hunter. I know, as you'll have seen and you're well aware, Bill C-30 has a sunset clause attached to it. So it goes away soon. What really is, in my view, the more concerning and potentially concerning aspect of this, call it more hostile, regulatory environment is the review of the CTA. I think you're right. I mean, I completely agree with you that a lot of this stuff that came into Bill C-30 was very surprising. It didn't make much sense to me either. But I'm wondering if the politicians who have been listening to that as well believe that they could make different changes that reflect in the lobby by the grain customers.

I guess my question is, what could that be? Have you had your ear to the ground in terms of what new aspects they might be looking at if interswitching is not the solution? Is there other solutions they might come up with that we're not looking at right now that might, down the road, impact either your efficiency drive or the overall ability to deliver solid service to the customer?

Hunter Harrison (CEO)

Well, Walter, I was going to say it's a good question. It's a difficult question to answer. I would say this. First of all, I think you should split the grain customers out in two sections. You've got one, the large grain companies. And you've got another, the farmer. And in my view, with my ear to the ground and talking to a lot of people, that's potentially a lot of the friction. Look, for this industry - and I'm saying industry. This is not an announcement for CP - but the industry, to deliver grain at record levels in these kind of conditions, bodes well for the future. Now, the market tends to say, "Well, we don't want to hold grain store, grain carry, grain over." Well, sometimes you get these adverse effects.

I think that every, say, politician for a moment, every editorial, op-ed, whatever that I've read commenting on their actions to date have been rather critical. I hadn't seen a lot of people endorsing this if this is the way to go. I think that, for an example, there's issues with the revenue cap. Does the revenue cap make sense to me? Absolutely not. Who's going to buy equipment in the future? The grain fleet's getting old in this country. And the ownership is very diverse. And you don't build rail cars overnight. But how could a company go to its board of directors and say, "I'd like to buy a lot of grain cars. But I can't tell you anything about what the returns are going to be. I don't know what the cap's going to be. I don't know what the IRR's going to be.

I know nothing about it." It's not going to be very successful. So I think that there's some shakeout going on as we speak. There's people that are learning more about the system that have not paid attention to it. And have I been pleased with all the reactions? Absolutely not. Have I been pleased with the dialogue I've had with some of the participants? No. In the final analysis, I think that the right things will be done. I mean, I have not been able to get audiences with some of the people that are key players for whatever reason. But they don't want to talk. Well, if you don't want to talk, it's hard to have a dialogue and decide what the right model is if people don't want to talk.

Walter Spracklin (Managing Director and Senior Equity Analyst)

Do you think?

Hunter Harrison (CEO)

Well, I think this too shall pass and that we'll come back to our senses and get to moving grain and product through Canada like we should and let this political wave go away.

Walter Spracklin (Managing Director and Senior Equity Analyst)

Do you think there's any compromise solution where they relax a little bit on the revenue cap, it allows you to invest a little bit more in grain capacity, or something along those lines at all? Is the revenue cap though? Or is that just something off the table? It's not going to?

Hunter Harrison (CEO)

Look, I've heard feedback from some key people in the government, both provincial and federal, that are not all that pleased with the revenue cap. If you look at the revenue cap and you really peel it back, which I have recently, and it makes very little sense. So is there some compromise out there? Yes. Are there some considerations probably given to the elections coming up? Yes. I think once some of the political rhetoric dies down, and I think all of us have gotten smarter through this exercise, that yeah, I think there's probably some positive compromise. And I think that people are going to say, "What is this inteswitching 160 km? And what does that do for us in Canada?" All it does, from an efficiency standpoint, the carrier that's going to line all the business has to furnish the equipment.

And as I told you, I don't think my friends at Burlington Northern are going to be a participant for a while. They've got their hands full in the U.S. But in this system, they would have to give us cars at the border for us to take someplace, wherever, to then load, then to take back to them, and create other interchanges and exchanges. And it just doesn't make any sense. But once again, it's sometimes people making decisions that don't really understand the issues and problems. So I think it'll all shake out. My optimism is bubbling through here in the long run.

Walter Spracklin (Managing Director and Senior Equity Analyst)

Perfect. Okay. Switching gears over to Keith. First, I want to say the FRA accident statistics, boy, those were pretty impressive. I thought it was a typo the first time I looked at them. So great job given the conditions. But related to that, on the volume side, we did notice a significant revision, if you're to say, to what we were looking for, what consensus was looking for on the volume side after the winter impact occurred. And you provided some really good insights into Chicago and some of the, let's call it, structural challenges that you have with regards to the Chicago area. My question is, as you get lower and lower in your operating ratio, do you start to hit up against and you move away from, call it, operating efficiencies.

You start to hit up against some structural impediments that make it a little bit more difficult to address those operating or the operating ratio. Does that mean we might have to see some more capital invested in not in locomotives but more in addressing some of the structural constraints that might be on CP's network, be it in Chicago or perhaps in the west or anywhere on the network?

Keith Creel (President and COO)

Well, I would say the only structural constraint that we have in the network, given the level of business we face today, is Chicago. I don't know what the answer is to Chicago. If we could buy the Harbor Belt that's up for sale or the Belt if it's up for sale, then I would make a compelling case we could create some capacity for ourselves and for others. But outside of that, our capital spend, I think, is right-sized. I would expect it to be the same. We've got to be careful what we spend to optimize the network because I don't want to ramp up on employees and ramp up on those type assets just to lay them off when we get done. We've got a very robust and thorough 5-6-year plan that we put together since I've arrived here that I feel very comfortable.

Addresses our ability to bring on incremental, sustainable, profitable growth and, at the same time, maintain the leverage we need to maintain a controlled cost and produce a positive operating ratio.

Walter Spracklin (Managing Director and Senior Equity Analyst)

I guess my question, though, is, does structural cost become an impediment down the road as you get lower and lower?

Keith Creel (President and COO)

No. I mean, I'm only going to spend money where, in the lanes that I've strategically got growth. It's going to be profitable growth to provide a return to maintain that operating ratio. Short of that, I'd say the answer is no.

Walter Spracklin (Managing Director and Senior Equity Analyst)

Okay. Perfect. Thank you very much.

Operator (participant)

Your next question comes from Jason Seidl, Cowen & Company. Please go ahead. Seidl, please go ahead.

Speaker 18

Yes. Asked and answered. Thank you.

Operator (participant)

Your next question comes from Keith Schoonmaker, Morningstar. Please go ahead .

Keith Schoonmaker (Director of Industrials Equity Research)

Thank you. I'd like to turn to what seemed to be a couple of positive metrics, namely average train weight increased 6% and length is also improved. I guess at face value, this seems a little surprising in light of the extreme cold Keith mentioned. Was this just a function of mix in commodities that move in longer trains? Or could you add a little color, please?

Keith Creel (President and COO)

That's a function of train miles that we've taken out, train consolidations, using DP power, leveraging and optimizing DP where we could to maintain train length versus last year. And listen, that was definitely, definitely diluted with the weather. We've already seen incremental train length improvements, which are quite healthy just in the month of April, train length improvements, which are quite healthy in the month of April. And we're maintaining our train mile reduction. So it's a combination of all three. It's really not a mix issue at all. It's just our operating model taking hold and providing the leverage that it provides and the strength that it provides to move this business at low incremental costs.

Keith Schoonmaker (Director of Industrials Equity Research)

Great. Thanks. And quick quantitative question. How many locomotives and cars were online at the end of the quarter, please?

Keith Creel (President and COO)

We'll have to get back with you on that exact number. I don't want to give you a bad number. Nadeem, I'll get back to you.

Keith Schoonmaker (Director of Industrials Equity Research)

Very well. Thank you.

Operator (participant)

Your next question comes from Cherilyn Radbourne, TD Securities. Please go ahead.

Cherilyn Radbourne (Managing Director and Senior Equity Analyst)

Thanks very much. Good afternoon. I wanted to ask a broader question because it seems to me that the rail industry as a whole has lost some broader goodwill. I think that's with the general public, with customers, with regulators. I think that's tied to Lac-Mégantic and also the capacity issues in the first quarter as a result of winter. I just wonder if you think the industry is doing enough as a whole to reassure those stakeholders that, A, there isn't an underlying capacity issue, and B, that it's a safe industry.

Hunter Harrison (CEO)

Well, let me make an attempt at that. Number one, I think one of the problems is that we've talked about as an industry. This industry's made up of seven class ones. Some of them are doing some things strategically. Others are doing other things. And I don't think that the industry deserves to get painted with a broad brush. A railroad is not a railroad. It's not a railroad. That's one of the reasons that we have not necessarily participated in some of the industry initiatives. I think we'd like to think that we're trying to do everything we can to have a positive influence on the industry and customers and the public as far as understanding some of our issues. But they're difficult to deal with. Now, let's take what we have going on in Canada as we speak.

We've got a lot of pressure on one side to catch up and deliver grain. On the other side, we've got the regulators talking about Lac-Mégantic, for example, talking about, and they have just lowered the speed of trains. That's inconsistent. That's going to slow the network down. And we have not had, and I'm being very cautious when I say this. We've not had any derailment related to speed. We've had no derailment with crude related to speed. Lac-Mégantic had no issue with speed. Speed was not an issue. So I think maybe that some of us individually should do a better job of educating the public and the politicians and the regulators on the true bottom-line issues, the way to approach them, the way to deal with them, rather than, once again, to my earlier comment about a knee-jerk reaction. Yeah.

I think that to some degree, are we getting a little bit of a black eye, if you will? Yeah. Am I concerned about that? Yeah. We should do a better job of talking to people about what we're providing and what we're doing. It really kind of concerns me at times when people are talking about grain delivery in Canada. Guess what? You go to Vancouver on the weekends, there's not one grain company out there that's working through the weekend. Our employees are working 365, 24 hours a day, seven days a week. And if we stopped to take holidays off or the weekends, you would see major shutdowns, major grid locks. So we just hadn't done a very good job in that respect. And we hope to address that better individually as a company in the future.

Cherilyn Radbourne (Managing Director and Senior Equity Analyst)

And then just very quickly, could we get the EPS impact of the weaker Canadian dollar on the quarter?

Hunter Harrison (CEO)

On average, it's about $0.05 per $0.01 change. So it's annualized. Annualized, we got about $0.07-$0.08 this quarter.

Cherilyn Radbourne (Managing Director and Senior Equity Analyst)

Okay. Thank you. That's all from me. Sure.

Operator (participant)

Your next question comes from David Newman, Cormark Securities. Please go ahead.

Speaker 20

Just a couple of quick ones, guys. Just in terms of the headcount reductions that you've been tracking towards, has there been any change at all because of the weather? In other words, are you going to keep some bodies on a little longer just to kind of get through the Chicago congestion? And then I think you had a big nut for the IT side that you're going to reduce at the end of the year. Where do you stand on the headcount reductions? What's kind of the waterfall chart from here?

Hunter Harrison (CEO)

Well, this is kind of a work in progress. There's pluses and minuses. The headcount right now is about 4,980+ as we stand. You're right. We had planned this bubble with IT. I'm not sure if it's going to be as big a bubble as we initially thought. We're right on schedule in that regard. I mean, clearly, this organization had too many people. I mean, think about let's turn the page back. If you go back to 2011, the instructions here were to hire enough people to handle business, plus 25%. Now, I don't understand that rationale. We're working our way through that. There'll be some we've got some attrition taking place in certain places. We've had some people that don't like to work in snow and cold and windy conditions.

Speaker 20

No one does.

Hunter Harrison (CEO)

An outdoor sport. If they don't want to do that, now's the time to find out. So I think overall, we're in pretty good shape there along the plan.

Speaker 20

Hunter, is that sort of late this year? Was that the plan, or?

Hunter Harrison (CEO)

Yeah. I mean, the plan was, I think, that there was a bubble of about 300 people year-end. As I've said, there's a lot of moving parts. We've had a little bit of some challenges with the sap cutovers. So I'm not sure that bubble is going to be as big as we had initially planned. But if you're looking from a headcount standpoint, there's other opportunities that we didn't see when we publicized those numbers. So I think overall, the guidance we've provided in that regard, I feel very comfortable with.

Speaker 20

Okay. Very good. And last one for me on the. I know your network's not naturally aligned towards it, but obviously, a big opportunity in BC and Alberta in the LNG side in terms of moving construction materials, pipe, frac sand, things like that. Are you seeing any early business on that? Or what sort of potential opportunity could LNG be for CP Rail?

Jane O'Hagan (EVP and CMO)

Well, clearly, one of the things that we'd like to do as the model evolves and as you say, as the facilities get identified, is to obviously syndicate the crude-by-rail model that we have to LNG. And those discussions are in very, very early stages. But with respect to construction materials, I have a part of my organization, Canadian Pacific Logistics. And basically, what we do is we go out and look to work with companies to basically handle those construction modules. The discussions are early. But again, this is an area that, given the fact that we've had experience in moving wind energy, turbines, blades, etc., we move a lot of dimensional materials today. It'd be an area of growth for us as well.

Speaker 20

Very good. Impressive results in a very tough quarter. Thank you.

Operator (participant)

Your next question comes from John Larkin, Stifel. Please go ahead.

John Larkin (Managing Director and Equity Analyst)

I had a question as to whether or not any portion of the $0.30-$0.35 of weather-related impact in the first quarter could be tied to costs or foregone revenue associated with being compliant with the regulator's requirement to haul 500,000 tons of grain per week.

Hunter Harrison (CEO)

No, John. Look, as I said to the regulators, "Look, our interest is to haul as much grain as we can selfishly." That goes to the bottom line. It starts at the top and goes to the bottom. So I want to haul all the grain we can possibly haul. So effectively, there's very little, if anything, that has been done by the "regulators" that has impacted our operating strategy. Now, I'll give you one exception. For an example, some of the challenges that we face. Thunder Bay has had problems with ice and getting ships in and so forth. So when you can't get through Thunder Bay, the alternative is to go to eastern Canada to effectively, for us, Montreal and Quebec City markets. So we had customers literally begging to go to the long east. Well, that was going to start to jeopardize because they're only counting units.

They don't look at the length of hauls. And so we said to the regulators, "We've got this quandary. The customers want to go Long East, but that will impact your model about the number of cars." And the response was, "The law is the law is the law," which is a wonderful response. But we took a chance. And we hauled stuff to satisfy the customers to the east and have tried to serve those eastern markets with Thunder Bay having its problems. But that's some of what you get into. You've got the customer begging for one thing, the regulator asking for you to do something else. But with that exception, it's been kind of a non-event.

John Larkin (Managing Director and Equity Analyst)

Thanks for that. And maybe just one more question on the whole issue of Chicago. There's this project underway.

It's been underway for a number of years involving all the different parties that have a foothold in Chicago called CREATE. And in listening to Keith earlier, it sounded as if you believe that maybe CREATE isn't having that much positive impact. And that what would really work to solve the problem would be to route traffic completely around Chicago, that traffic that doesn't need to go into Chicago. Is that a fair assessment?

Hunter Harrison (CEO)

Yeah. I think CREATE was broke when it started. And it's been broke ever since. And it's created zero value, in my view. It's hard enough to get two railroads to agree on something much less seven or eight. And it's a bureaucratic machine that adds additional layers that provides nothing in return. So the issue with Chicago, when you really peel it back, is to take traffic out of Chicago that shouldn't be going there.

We're hauling stuff out of western Canada that is a perfect fit to go down the east coast of the U.S. But people want to drive it to Chicago. And so I've talked this is not some recent phenomenon with me. I've been in this I've talked about Chicago. I've talked about it for years. It's not going to get better. And CREATE, which I'm not proud to say we're a member of and tried to participate in, but with due respect to those 12 or 14 people in there in that room that are getting instructions from three or four different places, just creates more mud, in my view. Keith might want to comment further.

Keith Creel (President and COO)

Yeah. Hunter is talking specifically to the way we coordinate movements in and through Chicago, trying to get all the railroads to agree. And the best of times, it's a challenge.

And the worst of times, which we've just experienced, it's almost like pulling your hair out. So I would echo Hunter's comments about the value add of that central coordination office. Now, there have been some CREATE projects from a capacity standpoint that increased capacity, increased velocity on some of these belt railways, on flyovers. Some of those things that have transpired mitigated some of the impact this winter. But in spite of that investment, it's a compelling case that the only long-term solution to help mitigate the impact of this kind of weather in Chicago is to get as much traffic out of Chicago as we possibly can. There's only so much infrastructure you can add. People don't want you building in their backyards. You're landlocked in many locations. So I don't say it's run its course.

But it's pretty close to fruition from a capacity addition standpoint, on the CREATE standpoint. And I'll echo Hunter's comments on the coordination and the control in that central planning office. It's challenged at best.

John Larkin (Managing Director and Equity Analyst)

If 25% of the traffic hubs over Chicago, what percentage of that do you think is devertible to another routing?

Keith Creel (President and COO)

You know what? I'm not qualified to answer that. I can tell you that there's a percentage of the business or 40% of our traffic either originates, terminates, or passes through Chicago. If I could get 10% of it out, I'd make a compelling case. But it's a little bit premature for me to say yet. I haven't been here long enough to completely understand our flows. But rest assured, my objective is to get 100% of it out that I can.

John Larkin (Managing Director and Equity Analyst)

Thank you.

Operator (participant)

Harrison, there are no further questions at this time. Please continue.

Hunter Harrison (CEO)

Thanks, Mike. Thanks for joining us. We appreciate the support you've shown. We'll talk to you in July and make your plans for Analyst Day and fourth quarter.

Operator (participant)

This concludes today's conference call. You may now disconnect.