Canadian Pacific Kansas City - Q3 2015
October 20, 2015
Transcript
Operator (participant)
Good morning. My name is Aaron, and I will be your conference operator today. At this time, I'd like to welcome everyone to Canadian Pacific's third quarter 2015 conference call. The slides covering today's call are available at www.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'd like to ask a question, simply press star, then number one on your telephone keypad. If you'd like to withdraw your question, press the pound key. I'd like to introduce Nadeem Velani, AVP, Investor Relations, to begin the conference.
Nadeem Velani (EVP and CFO)
Thank you, Aaron. Good morning, and thanks for joining us. I'm proud to have with me here today, Hunter Harrison, Chief Executive Officer, Keith Creel, President and Chief Operating Officer, Mark Erceg, our Executive Vice President and Chief Financial Officer. 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 2, 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 3. The formal remarks will be followed by Q&A. In the interest of time, we would appreciate if you limit your questions to two. It is now my pleasure to introduce our CEO, Hunter Harrison.
E. Hunter Harrison (CEO)
Thanks, Nadeem, and nice to be back. I'd much rather be here with you than in Rochester. There are a few things I'd like to highlight on the quarter before Keith and Mark go in more level of detail that I think are noteworthy. I guess one was the pretty outstanding performance in less than a robust economy to achieve operating ratio again of breaking through 60%. We completed the transaction and the sale of the D&H, so that's behind us. As most of you are aware, we upsized the buyback. And I should, I'd be remiss if I didn't take a moment here to thank Keith and the team who carried on pretty admirably with my absence.
They might have done too good a job, but maybe I can come back and help them a little bit here. But I think most noteworthy, and we've been talking about this for some time in each company we've been, but our LR group was successful in signing an hourly agreement with the BLE in the U.S., which I think is quite significant. I think that, in my view, at least, that that will only lead to the UTU signing up, and that's kind of the patterns we followed before. And so effectively then, with a couple of minor tweaks, we'll have the total U.S. operation on an hourly comp basis, similar to the ones of you that have been following us for some time, similar to the Illinois Central agreement.
And, so that was a big, big breakthrough. And I think that will be a further influence to at some point in time, and this is one that I... It's hard to predict, but I think at some point in time, we're going to see a similar type arrangement, I would predict, in Canada. Now, we're before arbitration as we speak. I think we're expecting, and I don't think this is written in stone, but I think we're expecting fourth quarter, probably end of October, early November, a decision from the arbitrator on the running trades in Canada, which will basically put most all of the labor issues in Canada to rest. So I think that's a, that's a big move.
So, you know, it's really in these kind of economic times. I think it's clear that we've got the best product service out there in the market. I think we have reached a time where we are the most efficient, and the boom times are really coming when we can break loose and get Canada out of this recession and see a little direction on what's going to happen to crude. Then, we're going to have to buy a bigger safe for the funds. So with that, nice to be back. I'll be here for the Q&A, and with that, let me turn it over to Mark and or Keith and Mark. I guess, Keith, going to take the ball first.
Operator (participant)
Keith.
Keith Creel (President and COO)
Okay, thanks for the comments. Hunter, welcome back. Certainly, the true measure of a leader is what happens when he's not here, so we never felt like you left us, and this team worked extremely hard, given the economic headwinds we faced to produce these results, which I'm extremely proud of. Very strong operating performance across the board. Essentially, this is a quarter of controlling what you can't control with this operating model, converting it. The metrics provide some pretty powerful proof points across the board, but all key metrics showing improvement year-over-year. Dwell time, 19% better. Another reflection of our commitment to be focusing on our terminals this year to drive those costs down and improve service.
Train speed up 20% for the year, which effectively, if for those of you that were at our multi-year plan rollout last year, that is our end-of-year plan. With that said, we're obviously not gonna be complacent in that regard. I pulled the team together back a couple of weeks ago. Hunter, of course, as he always has, has challenged us. I challenged the team. We're looking at what's next, what's next from additional train speed improvements, so we can continue to turn our assets, not necessarily through significant spend, but more about process and execution, converting what we've already invested in. And also, it's opened up a very unique opportunity for us, given that we're much further ahead than we had thought to take a very strategic and hard look at our capital spend in the out years as we go forward.
There's quite a bit of discretionary spend in our multi-year plans, so certainly, rest assured, we're gonna be taking a look at that for 2016, 2017, and 2018. Throughout the quarter as well, we continue to allow our resources to match the reduced volume environment. Across the board, a couple of comments. Total workforce down 9% from a year ago. Overall, since Hunter started this journey a little more than 3 years ago, we're down just in excess of 5,900 employees. So quite a bit of improvement in that regard. That said, the railroad still is very well positioned to handle the growth when it bounces back. A nice proof point of that was September, when this company actually moved record amounts of crude and record amounts of grain, given the asset base that we have.
During the quarter as well, we reduced cars online by about 15%, and we've got over 400 locomotives stored, as we said today, which obviously is a significant delay to our capital requirements for the years going forward, as well as reducing our operating costs during our current times. Another very encouraging point I wanna say a few words about is the area of safety. This is an area that's critical to CP. It's critical to our customers and the communities we operate in and through. Our safety record continues to set new levels of performance. Train accidents improved 40% over last year's Q3 performance. And again, 8-9 years running of CP being the safest railway in the industry. But again, one derailment is too many. It's an area that we remain seasoned and focused on.
Turning the page to the revenue side, the 2% revenue growth year-over-year. Revenue performance was driven by effectively, 2% revenue growth on a -4% RTM. This was driven by +4% cents per RTM, as the currency and our price more than offset the negative mix and the lower fuel surcharges that we face. I'm not gonna go into detail for the segments, but let me highlight a couple of key drivers of the volumes. In the bulk, the grain was down as a whole, driven by our U.S. market, where our farmers continue to hold their crop, given the suppressed commodity prices, as well as the strong U.S. dollar. Coal, up 7%, but this is a tale of two stories.
Obviously, some headwinds in the Canadian franchise, which was down about 9% in the quarter with some of the, some of the pinpointed reductions of the mine shutdowns that Teck had, but that was more than offset by our strong U.S. coal performance. On the merchandise side, we did see some strength in forest products, but faced some pretty difficult compares, given, the key energy markets and obviously some headwinds there we didn't expect or could predict last year. Intermodal growth, you see a little bit, it's been muted by the winter, a weaker fall peak, a little bit lesser than what we expected. Obviously, there's increased trucking capacity in our short-haul lanes, which has given us some headwinds or resistance, and also we're being impacted by a slowdown in the Canadian economy. So obviously, there's a lot of uncertainty in the markets.
Times like this, again, I'll close with what I started with. This is an opportunity for us to take this operating model, focus on what we can control, provide the best service, we control our cost, operate a safe railroad, and win market share, even in the down environments, and put ourselves in a position when the economy bounces back, the base is reduced, obviously, and you're gonna see not just impressive results, but remarkable results from this operating team, this company, and this operating model. So with that, let me pass it on to Mark Erceg to provide some color on the financials.
Mark Erceg (EVP and CFO)
Thanks, Keith. You know, as I reflect on the third quarter, which is my second quarter here with the company, you know, I'd have to say the team performed really well, particularly in light of what was a very challenging demand environment, and I'm very proud and honored to be part of this team. As Keith mentioned, revenues were up 2%, with FX and price gains offsetting the impact of lower fuel surcharge revenues and weak volumes. And from an OR standpoint, our adjusted operating ratio came in at 59.9%, which represented a 290 basis point improvement versus a year ago, but perhaps even more importantly, you know, was the second lowest OR in the company's history.
And then from an adjusted earnings standpoint, we earned $427 million, which was up 7% versus a year ago. And adjusted EPS came in at $2.69 a share, which was up 16%. Now, in order to reconcile back to our GAAP EPS of $2.04 per share, there's a couple items that we need to cover. First, we did exclude a $128 million non-cash loss of $0.70 per share. That was related to the FX translation on our long-term debt.
As you know, and as we've talked about in the past, we're excluding from adjusted earnings per share the non-cash revaluation of US dollar-denominated debt on our balance sheet, which results from changes in the CAD, US dollar FX rate during the quarter. As you'll recall, during the second quarter, when this was a gain, we also excluded that from our adjusted EPS. Second, we did complete the sale of D&H South. That resulted in a $68 million one-time gain of $0.26 per share during the quarter, which, and also consistent with prior practices, was excluded from our adjusted number. Then finally, you may recall that last quarter, I indicated we were exploring ways to increase our financial flexibility going forward.
Consistent with that, we did decide during the third quarter to take out a series of privately held secured notes, and that resulted in us paying an early redemption premium of $0.22 per share during the third quarter. With the adjusted earnings per share to GAAP reconciliation now out of the way, let me provide some additional color on just a couple income statement items, and I'll do that on an FX-adjusted basis in order to try and keep things as simple as possible. Comp and benefits was $351 million this quarter. That represented an increase year-over-year of roughly 4%. Within that, lower stock-based compensation of $18 million and headcount reductions more than offset wage inflation and $24 million of higher pension expense.
Then turning to fuel expense, fuel expense was $162 million, which was down 45%, year-over-year. Lower volumes did account for $16 million of the reduction, and fuel productivity accounted for an additional $14 million. But lower fuel prices themselves did account for the lion's share of the reduction at $106 million. And then finally, fuel lag, which is a $15 million benefit during the quarter, more or less completes the reconciliation. Purchased services came in at $272 million. Now, that represented an increase of 8%. That increase was probably higher than some of you might have expected, but that was because we cycled up against some one-time capital credits and accounting adjustments, which were in the base period.
And then in addition, while casualty costs were low during the third quarter, they were even lower last year. And finally, we're no longer subleasing locomotives to another railroad, which temporarily lowered purchased services last year. The last P&L line item I should probably comment on is interest expense. Interest expense was up 24% in the quarter. You probably noticed that we've issued a series of debt instruments recently. We've done that to take advantage of what we believe is a temporary dislocation between our stock's current trading price and its long-term intrinsic value. So while we've dramatically lowered our share count, you know, that's come at the increase of higher, higher interest expense. The last area I should probably comment on is cash. Year to date, we've generated $979 million of free cash.
That's a 60% increase versus a year ago. The increase is primarily attributed to higher cash flows from operations, only partially offset by higher capital spending. While capital spending through the first nine months of the year is running ahead of last year, and we do continue to see pressure from a higher US dollar, we do remain on track to spend the $1.5 billion we did guide to at the beginning of the year. Although, as you heard, Keith mention, we are doing a bottoms-up review and looking at all discretionary capital programs going forward, and that might be reflective then in our thinking, you know, as we move into the, into the outer years. Now, I'm sure you've noticed, we've also been very active in the capital markets this quarter.
We issued $2.7 billion of US dollar-denominated debt. A small portion of that was used to fund the early redemption of several secured notes, which I spoke to just a moment ago, but the vast majority of that was used to repurchase shares. During the quarter, we'd repurchased 7.7 million shares for a little over $1.5 billion, and year to date, we've bought back 13 million shares at a cost of $2.6 billion. Now, the net result of all this activity is that we've increased our financial flexibility by removing restrictive covenants from secured debt. We've significantly reduced our weighted average coupon rate, while at the same time dramatically increasing the weighted average duration of our debt portfolio.
We've taken advantage of what we believe is a temporary dislocation in our stock price to aggressively repurchase our shares, all the while being mindful to protect our strong balance sheet and our BBB plus credit rating. With that, let me turn the call back over to Mr. Harrison or Mr. Creel.
E. Hunter Harrison (CEO)
Thanks, Mark. Let me just make one comment before we take questions about. I would expect that this review of capital. And just to give you one example, when we started this journey, I guess 3.5 years ago now, we talked about, for example, locomotives, that we were going to be able to take a hopefully a 3-4-year holiday on locomotive acquisitions. But Keith tells me now that that 3 or 4 years is probably going to extend to at least 18. So we're looking at, instead of 3 or 4 years, we're looking at 6 or 7 years.
If you kind of look at that across the board, and if you look at the discretionary spending and the catch-up capital, if you'll allow me to use that term, that we put in place, without affecting the condition of the physical plant and no compromise of safety and all discretionary sidings that we've caught up on, I would expect that we could see our capital spend come down potentially as much as $400 million. So pretty, pretty significant of the work that's been done in the past, that we'll just now start to begin to reap the benefits from. And with that, Aaron, we'll be happy to address questions the group might have.
Operator (participant)
Certainly. Thank you. If you'd like to ask a question, simply press star, then the number one on your telephone keypad. If you'd 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 the line of Scott Group from Wolfe Research. Your line is now open.
Scott Group (Managing Director and Senior Analyst)
Hey, thanks. Morning, guys. Welcome back, Hunter.
E. Hunter Harrison (CEO)
Thank you.
Scott Group (Managing Director and Senior Analyst)
So, it's been a while since we've heard from you, Hunter, and there have been some media reports. Can you just give us an update? I don't know that we need the history of where you were, but kind of where you are now and what—how active you are day to day, and how this kind of impacts your view and vision for CP over the next few years?
E. Hunter Harrison (CEO)
Well, I hope it's a non-event, Scott. I'm, you know, back on my feet. Most all of the medical issues of any significance are behind me. I'm very similar to where I was before, and I don't see any change in what I had, you know, we previously talked about, that the plan is that contractually, I'll be here till the middle of 2017. And unless, God forbid, some other issue kicks in, that's where I want to be.
Scott Group (Managing Director and Senior Analyst)
Okay, good to hear. And then, so we're in this period of weaker volume, which may or may not continue. And if we can't count on the top line as much anymore, how comfortable do you feel about or how low do you feel like you can push the operating ratio lower with things like lower capital, lower headcount, the new labor deals? How good could that get? Or is it that in a tougher revenue environment, there's not much more margin to get?
E. Hunter Harrison (CEO)
No, I think that... You know, I think it's starting to be reflective. This quarter starts to send some signal if you look at the bottom line performance, in spite of the fact of a weak top line. With the other things that you mentioned that are additive, I mean, if we just were focusing on OR, you know, clearly, we hadn't hit the wall. Are there— I don't know, the group's gonna get nervous if I say anything more, but I'm gonna say it anyway. There are probably two or three more points to pull out just where we are now. Now, you let the economy bounce back a little bit, and let's get back to, quote, "normal times," then it really gets pretty exciting.
So, you know, I think that we've always said, this model, does even better of controlling cost and producing results during soft, might be called bad times, than it does as everybody does well when, when things are robust with the top line. So I think that, that to produce the kind of OR now with that softer top line and, and with these other things of the labor agreements and headcount and the capital and so forth, it's, it's pretty exciting.
Scott Group (Managing Director and Senior Analyst)
Okay. All right. Thank you, guys.
E. Hunter Harrison (CEO)
Yes.
Operator (participant)
Your next question comes from the line of Fadi Chamoun from BMO Capital Markets. Please go ahead.
Fadi Chamoun (Research Analyst)
Okay, good morning.
E. Hunter Harrison (CEO)
Good morning.
Fadi Chamoun (Research Analyst)
Welcome back, Hunter.
E. Hunter Harrison (CEO)
Thank you.
Fadi Chamoun (Research Analyst)
So on the, you mentioned in the press release the ability to generate bottom-line double-digit EPS growth in varied economic condition. Should we understand that to extend into 2016, even without sort of a change in the underlying volume environment we're seeing?
Mark Erceg (EVP and CFO)
Yeah, I think the simple answer is, yes. You know, we have demonstrated an ability, even with revenue ton miles down, you know, the ability to increase train weight, train length, network speed. We've driven fuel efficiency lower by 5% this quarter. So there's still a lot of cost takeout that can be affected, and so we're very confident that, you know, next year will be at least another year of double-digit EPS growth.
Fadi Chamoun (Research Analyst)
Okay, great. And if we can look at the volume a little bit, as we, you know, looking into 2016, like, where do you see the opportunities to maybe grow the volume, and where do you see some of the challenges? I'm just trying to see, you know, if you feel that, you know, 2016 is potentially flat or slightly up volume or down volume. I'm not sure at this point if you're able to make any comment about that.
Keith Creel (President and COO)
Fadi, let me just say this: The only answer I feel comfortable giving you is I don't know. I mean, I don't know what's going to happen in 2016. I do see continued strength in some of the areas that we're seeing strength in now. Automotive, I believe, can be a strength force. Intermodal, I think, can continue to drive some growth for us. Canadian grain-
... First part of the year, strong. Latter part of the year, I don't know. I don't know what's gonna happen with the harvest, and I certainly don't know what the U.S. farmer is gonna do relative to when they're finally gonna move their product. So a lot of uncertainty, and again, I'll take you back to what we said before. Regardless of what the macroeconomic environment is, we're gonna focus on what we can't control. We're gonna rightsize our assets, we're gonna continue to convert, control the bottom line. You know, the investment, even if I scale up, and we will for next year, our capital investment, we still have to pay for what we've spent this year. You know, I look at the speed this morning, we hit 23.2 on the network.
That may be an all-time record for us, but rest assured, I've still got six or seven sidings that I haven't the benefit of coming online yet, that will come online in 2015, that I'm gonna be paying for in 2016. What I went through last week, we're leaving a lot of money on the table and a lot of opportunity and a lot of productivity on the table, just from executing day in and day out, what I call noise in the network. So take away the excuses, focus on locomotive reliability, focus on using the speed you've got, focus on maybe an age-old mentality in this company, where the engineering department may have been more of in a silo, not tied to speed.
Just effectively seasoning and making everyone very sensitive to what speed does for assets across the board, from the guy that's pounding spikes, to the guy that's pulling pins, to the dispatcher that's running the switches. There's incremental opportunity for us without additional capital spend to drive that bottom line. So long answer to your question, but again, I'm not too concerned with what the economy is gonna give me. I'm strictly, I'm very focused on what I can control relative to the bottom line, running this railway better day in and day out.
Fadi Chamoun (Research Analyst)
Okay, that's helpful. Thanks.
Operator (participant)
Your next question comes from the line of Brandon Oglenski from Barclays. Please go ahead.
Brandon Oglenski (Director and Senior Equity Analyst)
Yeah. Good morning, everyone, and Hunter, welcome back. Best wishes on-
Mark Erceg (EVP and CFO)
Thank you
Brandon Oglenski (Director and Senior Equity Analyst)
... on future out there. Keith, I hate to come back to the same question, it feels like the first two folks were asking here, but I mean, can we talk about recent trends? Because it does feel like the quarter started on an even softer note. Is there currently deceleration in demand across Canada and across some of your major markets, or should we not read too much in the negativity that we've seen in the last few weeks?
Keith Creel (President and COO)
I would say that, maybe the last few weeks is a little bit overstated because you've got Canadian Thanksgiving in there, you've got, some supply chain challenges on the coal side that we dealt with. But overall, yes, there's a little bit of weakness, certainly a little bit less than what our expectations are. But as far as looking at it, out at the balance of the quarter and the year-end, I mean, we've said second half, 3%-4% less RTMs. Are we closer to the 3 versus closer to the 4? I'd say, yeah, probably. But beyond that, I'd just be guessing.
Brandon Oglenski (Director and Senior Equity Analyst)
Okay, well, that's my fault, but I wanna focus on... Because you guys have driven a lot of EBIT growth here, just via FX, and we understand how that impacts the P&L. But you start to lap the significant change in FX next year, so you lose a little bit of that EBIT tailwind. I guess, are these cost initiatives that you're talking about, going to be enough to deliver double-digit earnings expansion? And, and I guess, can you talk about the buyback as well? Because you've, you've spent a lot on the, the buyback here. So how do we think about earnings growth in an environment where volumes could still be flat, maybe even negative, and without the benefit of FX like we've seen this year?
Keith Creel (President and COO)
Think about significant operational improvement, to Hunter's point, given the same or a little bit less. If you improve the operating margins 2-3 points, that's driving significant EPS, and I'll let Mark address the question on the buybacks.
Mark Erceg (EVP and CFO)
Yeah, the share buybacks, I mean, look, we had initial program out there this year for 6%, you know, authorization to be completed. We buy an additional 2%, and we've been buying our shares fairly aggressively in the marketplace, because as we've looked out and we've done our own intrinsic value modeling work, you know, we're very confident we're creating shareholder value over the mid and long-term horizon, which is how you have to think about these things. We're not really concerned with, you know, weekly movements in the stock price, but over the mid and long-term horizon, we're very confident that we're creating shareholder value through the actions we're taking.
You know, we are also going to make sure that we balance that with our desire to maintain a strong balance sheet, and we are committed to maintaining our Triple BB credit rating at this time as well.
Brandon Oglenski (Director and Senior Equity Analyst)
Appreciate it. Thank you.
Mark Erceg (EVP and CFO)
Yes.
Operator (participant)
Your next question comes from the line of Walter Spracklen from RBC. Please go ahead.
Walter Spracklen (Analyst)
Thanks very much, and glad to have you back there, Hunter.
Mark Erceg (EVP and CFO)
Thanks, Walter.
Walter Spracklen (Analyst)
My question, I guess, is on pricing, and Hunter, you've mentioned dynamic pricing at the last Investor Day in terms of encouraging volume, and you kind of assured us that that was more with an effort to gain share from truck. I'd like to ask you a bit about two particular areas, that is domestic Intermodal and Crude. Feedback we're getting is that you are being a little bit more aggressive on pricing, aligning it a little bit more with the dynamic pricing that you'd indicated at the Investor Day, and it is being a little bit more competitive with your rail competitor as opposed to truck. Can you help us understand what the pricing approach is there, and specifically, where it applies to domestic Intermodal and Crude?
Mark Erceg (EVP and CFO)
Yeah, I mean, I'd start off with, you know, there's a little supply and demand in there, number one. You know, number two, you know, we have talked about there, there's a point in time that, when, when you've got assets parked-
E. Hunter Harrison (CEO)
... when you've got human resources sitting at home, when you got a physical plant that's underutilized, your cost structure is such that it would say the smart thing to do is to move something. Now, there's a point you're not gonna get there. But, you know, as our cost base comes down, and so if we're at 57 or 58 instead of 68, you know, nobody thought about what we were doing when we were priced at 68. And you can damn sure afford to do it when you're down. Now, look, you know, I've always said that I think the market gives you the price. The market gives you the price, and you decide you want to be a player or not. Now, if the competition doesn't like what we're doing, they got a choice.
They can jump in the fray and play, or they can stay home. It's up to them. So, you know, that's, I think, just one example. Now, I would further say this: As we come out of these economic times, and as we talked about the four-year plan, clearly there's some leverage there, where if you can look at your business like other people, non-rail, look at it, like the automobile industry, and if you can afford to make the car cheaper and are higher quality for it, okay, but still charge the same thing and gain market share, you would jump all over it, and people would think it's a smart thing to do. You know, with rail, sometimes they kind of question that strategy.
We clearly, I think, articulated at the last analyst meeting that if we get our costs down, and we're pretty well there, to the pretty consistently in the starting with a five, that we can convert some of that to be more competitive in the marketplace to pick up top line. Now, if business comes back and we come out of recessionary times and there's higher demand, you know, we're not gonna give it away to give it away. If there's a demand out there, we're gonna strike the demand. I think you will see over time, where we effectively pretty well move away from contracts and get into tariff and are more supply and demand, and more flexibility and move rather than just sign some three-year contract, put it to bed, and go on to something else. And I think those have some opportunities also.
Walter Spracklen (Analyst)
So, is that to suggest that if the continued weakness persists, we might see year-over-year same-store core pricing less than the 3%-4% that you've been historically guiding? Or are you still comfortable with 3%-4% for going forward?
Keith Creel (President and COO)
Yes, 3%-4%.
Walter Spracklen (Analyst)
Yeah.
Keith Creel (President and COO)
Doesn't change it, Walter. The only thing I'd add to Hunter's comment, I'd remind everyone that, I don't see rail as my competitor when it comes to crude. My primary competitor is the pipeline-
Walter Spracklen (Analyst)
Right.
Keith Creel (President and COO)
-not rail.
Walter Spracklen (Analyst)
Yeah.
Keith Creel (President and COO)
So if I'm gonna be doing things to leverage this great service and low operating costs to win business for this railroad, that otherwise it would be in a pipe, I'd say it's the right thing to do.
Walter Spracklen (Analyst)
Yeah. Yeah, makes sense. Okay, thank you very much.
E. Hunter Harrison (CEO)
Thanks, Walter.
Operator (participant)
Your next question comes from the line of Alex Vecchio from Morgan Stanley. Please go ahead.
Alex Vecchio (Analyst)
Good morning, thanks for taking my questions and welcome back, Hunter. So with respect to the labor deal in the US, great progress there. I was wondering, Hunter, if you could just remind us if you were to win the same terms or similar terms with the other U.S. unions, how much margin expansion potential could result from that? And taking it a step further, I know there's, you know, still a lot of uncertainty about the Canadian side, but just remind us, you know, in a—if you will, in a bull case scenario, if you were to win the early agreements on the Canadian side, how much margin expansion potential would come from that?
E. Hunter Harrison (CEO)
Well, let me oversimplify this for you. Effectively, and there's a little bit difference between, maybe some would suggest a lot of difference between Canada and the U.S. here, but it focuses around fringe. Our fringe benefits in the U.S. are somewhere in the 43-44% range. I would say Canada, they're probably 15-17%. So there's a significant difference in fringe. And so effectively, and look, there's no secret strategy here. We've been very honest with the collective bargaining units going back 6 or 8 years when we started this. You know, we can take fewer people and pay them more if they can produce. So bottom line, what this does is takes, you know, you can look at headcount. I look at it more of the full cost.
It takes about 35% of the cost of the train and enginemen U.S. out of the equation. Lowers it 35%-40%. Now, in Canada, much, much bigger base to deal with, but not quite as much synergies there because the fringe benefits are, are so much lower, and that's basically, that's basically health care. So, but it's, it's a significant difference in move, and I think what we've experienced in the past with it is that, you know, the 35% is kind of a floor, and then it's the smarter you get using that type of operation that raises up the ceiling of how effective you can be there with it. But it's, you know, it's a mark on the OR.
Alex Vecchio (Analyst)
Okay.
E. Hunter Harrison (CEO)
Or-
Alex Vecchio (Analyst)
All right, that's help. No, that's, that's great color. That's helpful.
Keith Creel (President and COO)
Let me add one more comment to that, if I could, Hunter. This isn't just about the cost. You know, in today's labor environment, when the economy comes back, we all understand that, labor can be a challenge at attracting and retaining labor. So this is all about employee retention as well. You take an environment where the employees, although they may give up work rules, when they get predictability to their schedules, which is nontraditional in the railroad environment, they know they're gonna get a couple days off a week. They know they're gonna be making a lot more money. They got better quality of life. They got more money in their checking account. That's a powerful combination. In turn, what the railroad gets is lower cost, but most importantly, improved service. So yes, it drives the margins on a cost standpoint.
When the economy comes back and you're competing for service, and you've got predictable workforce, both in quantity as well as the service you provide day in and day out, that's how you truly win in the market share and drive the bottom line, operating ratio improvement and margin improvement in the company. So it's a tale or two stories that's powerful on both sides.
E. Hunter Harrison (CEO)
Plus, the one other thing I'd add. In today's kind of market, I mean, it's really significant. It provides job protection for the employee. Now, how many employees today, if you look at, the oil patch, would like to have a guaranteed job? You know, now we have to be very, very careful how we manage that, and that's why I'm sometimes accused of choking the horse a little bit, by not turning them loose with hiring, just freelance. But it really, to Keith's point, it's just a total different quality of life than the typical rail employee has been used to.
Alex Vecchio (Analyst)
Yep. No, that makes sense, and that's great color, guys. My follow-up, Keith, I just wanted to clarify something you mentioned earlier. Was the 3%-4% year-over-year decline and your comment that you'd probably be closer to a 3% decline in reference to the second half RTMs as a whole, or the fourth quarter, specifically?
Keith Creel (President and COO)
Second half, overall.
Alex Vecchio (Analyst)
Okay, great. Thanks very much.
Operator (participant)
Your next question comes from the line of Chris Witherbee from Citi. Please go ahead.
Chris Witherbee (Analyst)
Hey, thanks. Good morning, and welcome back, Hunter.
E. Hunter Harrison (CEO)
Thanks, Chris.
Chris Witherbee (Analyst)
Wanted to touch back on sort of the CapEx comments and some of your thoughts there. You gave us some sense of sort of maybe the magnitude of some of the savings that you could incur over the course of the next couple of years. How do we think about the duration of that? So is that sort of a one-year or maybe two-year type of dynamic for 2016 or 2017? Is it something that maybe you could see stretching out a little bit longer? And then when you think about sort of priority and use of cash, where you stand now with the buyback and the leverage, how do you think about sort of extra capital in the budget for 2016?
E. Hunter Harrison (CEO)
Well, you know, look, we kinda have a rule internally that says, you know, you don't ever spend precious capital until you've explored every operating opportunity you potentially can, number one. So, you know, I think that there's a lot this depends on. We're in a position today where we have effectively from a basic physical plant, safety, rail ties and ballast are all for close to catching up. Now, we're not disturbing those dollars going forward. Basically, what we're looking at is the discretionary spend that we've been doing with the sidings and so forth, and Keith, I think you mentioned earlier, still has 6 or 7 to put in service now. So that's kinda...
Now, if we were looking at a run rate of the business at the same level we're talking about today, you know, the percent of however you like to look at capital, as a percent of revenue or what, the most effective way, you could say that run rate would be, you know, pretty well the same. But once again, if we see, and we will, the economy bounce back and things come back, then there will be times that says, maybe we gotta spend a little discretionary capital to be able to handle this or get rid of this pinch point or whatever the case might be. But I think the order of magnitude is, and the message is this: the company, at a point in time, got way behind, and we paid our bills and caught up.
And so now we're kind of managing this year to year, so it'll be lower, but not anything that I can say to you it's always gonna be as a percent of revenue less than X.
Chris Witherbee (Analyst)
... Okay, that makes sense. And sort of priorities for capital when you think about 2016 leverage, buyback, those types of things?
Keith Creel (President and COO)
Yeah, I think what I would simply say is, you know, the first use of our discretionary cash is to support the business growth itself. We're hopeful that as the economy comes back, we'll need a little bit more working capital just to finance the day-to-day, you know, receivable balances. You know, secondarily, we put our CapEx to work, for high rate of return investment projects, like the sidings that Keith has alluded to, that increases the overall network speed and improves our services and our liabilities to our customer base. And then beyond that, you know, we've talked openly about the fact that our preferred way to return excess cash to our shareholders is through share buybacks, because we believe in the long-term intrinsic value of the company. We think we're creating value for our shareholders, through those actions.
Chris Witherbee (Analyst)
Yep. Okay, that's helpful. If I could squeeze one little follow-up here. Just when you think about sort of resource levels, I know what the volumes look like right now, and it's very uncertain how it might play out in 2016. But given that sort of uncertainty, how do you think about, you know, headcount and other resources as you're positioning for 2016, given that uncertainty relative to where we had finished the third quarter?
E. Hunter Harrison (CEO)
Well, you know, it's very hard to manage this business quarter to quarter. That's why we try to keep, you know, we're maybe a little more aggressive of saying we're gonna have a lower headcount, but we're willing to pay if we get caught, and we need to, we can pay some premiums to take care of the business rather than have somebody brought on for the longer term. You know, I think from a rolling stock perspective and so forth, you know, we're taking advantage of putting, we've got, as Keith said, the 400 or so high horsepower locomotives put up now. That represents about 40% of the fleet. That is something that's significant enough, and we know will last long enough, that that directly affects the headcount material.
And so they're a little bit different, but, but I think that maybe gives you a little flavor of how we look at it. I mean, we're not a company that says, "Look, freeze all spending," you know, you know, we didn't go through that with crude. I think one day, and we always said, look, we've never been opposed to the, and, or fought, lobbied against the pipeline. I think there's appropriate places for the pipeline. There's appropriate places for us, hopefully. And so, you know, we're gonna keep ourself in a position where if crude bounces back, if our bulk commodities handles back, that, then we can handle that. But, but to kind of do that on a quarterly-type basis, some organizations get pretty immature.
Chris Witherbee (Analyst)
That, that makes sense. Thanks for the call, guys. Appreciate it.
E. Hunter Harrison (CEO)
Sure.
Operator (participant)
Your next question comes from line of Tom Kim from Goldman Sachs. Please go ahead.
Tom Kim (Analyst)
Good morning. Thanks very much for your time here. Keith, I just wanted to follow up on your comments regarding crude pricing, obviously, versus the pipelines. I'm wondering, to what extent have you had to adjust pricing already in the third quarter, if it was reflected there? And maybe if you want to give us some guidance as to, you know, what your latest thoughts might be, for crude volumes in the fourth quarter and then perhaps some of the pricing, how you're thinking about pricing around that? Thanks.
Keith Creel (President and COO)
Well, I'd say this, there has been some second quarter, third quarter, fourth quarter, there'll be some strategic pricing relative to pipeline capacity and an ability to put that freight on the rail versus the pipeline. So yes, there has been some of that. Obviously, in a more robust environment, we'd be extracting a greater rate of return on the business. But I can tell you, rest assured, we're covering our cost of capital. We're making money. We're not doing this for practice, but again, it's revenue we otherwise wouldn't see on the rail. So I think it's the right thing to do. Relative to demand for the fourth quarter, obviously, the strength we saw in September, October, I don't think, and the spreads would suggest it's not going to be replicated in November, December.
It's certainly not as bad as it was, this summer, but certainly not as robust as it was in September.
Tom Kim (Analyst)
Okay, that's, that's very helpful. And can I just ask on the domestic intermodal side, you know, the second quarter was a little soft, and the third quarter showed a little bit more weakness. Can you give us a sense of, you know, when you would anticipate some of the domestic volumes sort of turning around or giving a little bit of guidance as to how we should be thinking about the, you know, the near-term outlook for that?
Keith Creel (President and COO)
Yeah, I think short term, you're seeing a reflection of primarily Canadian economy and excess truck capacity. I think from what I'm seeing, we pretty much hit the trough. I think you're seeing a little bit of stabilizing into this month, into the middle of next month as we go through this muted peak. And I think in 2016, as the economy bounces back a little bit, you're gonna see a little bit strengthening on the domestic side. But short term, I think it stays pretty close. I don't think it gets a lot worse and maybe a little bit of upside the balance of the quarter.
Tom Kim (Analyst)
Thanks very much.
Keith Creel (President and COO)
Thank you.
Operator (participant)
Your next question comes from the line of Ken Hoexter from Bank of America. Please go ahead.
Ken Hoexter (Managing Director and Senior Research Analyst)
Great. Welcome back, Hunter. Good morning, Keith, Mark, and Nadeem. Just to Keith, and maybe you can expand on your last comment there. Are you seeing it past that bottom and you're already bouncing? Because I'm just wondering into your 2016 comment, is that something where you see the economy bouncing? I guess maybe just going back to your original thought on the double-digit EPS outlook, is—does that include volumes being flat or down next year? ... or is that only on the cost side and you're kind of just looking at, I guess, at just on the cost side?
Well, again, I can't predict on the volume side. My strength and comments and my confidence is based on—I'm sorry, on the revenue side. My strength and confidence is based on the cost side and our ability to drive operating margin improvement, regardless of what the macroeconomic environment gives us. What I'm saying specifically a moment ago, though, I think we have gotten close to the bottom relative to domestic intermodal demand. I think we'll see a little bit of uptick through November versus where we are today. I don't think it's going to be significant, but I don't think likewise, we're going to see a lot of deterioration either.
Year over year, even in this down economic environment that we're in, people forget the fact that we've actually grown domestic intermodal over very strong compares from 2014 to 2013. So again, from a service standpoint, even in the face of macroeconomic headwinds, I think that speaks well of our operating model and the service we provide. So I think that same model is going to begin to drive the margins in 2016, regardless of the macroeconomic. And I say regardless, I'm not going to... If we have some huge economic downturn, I can't predict, and we'll have another discussion. But given what I'm seeing today, unless something gets drastically worse, I'm still very confident on the cost side, driving margins of that double-digit EPS.
Great. And if I could, just follow up on the, on the coal side. You threw out there that, obviously, and given Teck shutdown and the rolling shutdowns, it was down in Canada, but up in the U.S. Maybe you can expand on that in a bit, just given everybody else on the US side is seeing a downtick. Where was the growth from? And then maybe a little bit of outlook on Teck. What is expected from there? Are we going to continue to see maybe double-digit declines from Teck, or post the shutdown, do you think we're, you know, it's back to slight growth going forward?
Well, let's start with Teck. I can't predict. I mean, I obviously don't think I'm going to have a tremendous amount of growth given understanding the, you know, the environment they're working against relative to a depressed coal price on the world market. So I can't say there. I think that we're going to do what we can to help them stay competitive, driving their costs down so that they can continue to be a low-cost producer, and they can deal with these economic headwinds they're dealing with, and with the reduced commodity price, so that when it does bottom out and come back, that they're standing in a position of strength, which is going to benefit this railway.
What has given us an offset to the reduction in Teck on the U.S. side is not increased demand overall, but it's relative to our book of business. Last year, a lot of our coal effectively was covered under legacy contracts. We've got a couple of contracts here that we've repriced, as well as we've shifted the interchange locations of the gateways this coal is moving over. So we're benefiting from a stronger price. We're actually making money, not losing money, and at the same time, a longer length of haul, which is what's driving the increased revenues year-over-year to more than offset what we've lost on the Canadian side.
Was that new business that, or did you change the business to get the longer haul, or is it just how you're running it?
Keith Creel (President and COO)
No, it's not new business. It's actually a shift of contract. Some of that business was handled by one carrier that shifted to a different carrier. So same business, it's just handled over different gateways, longer length of haul and improved profitability.
Ken Hoexter (Managing Director and Senior Research Analyst)
Thanks for the time.
Keith Creel (President and COO)
All the things we do on the operating side as well. So actually increase those train sets, the size of those sets by making that shift in interchange location.
Ken Hoexter (Managing Director and Senior Research Analyst)
Got it. Thank you very much for the insight. Appreciate it.
Keith Creel (President and COO)
Thank you.
Operator (participant)
Our next question comes from the line of Allison Landry from Credit Suisse. Please go ahead.
Allison Landry (Analyst)
Thanks. First, Hunter, glad to hear you're back on your feet. My first question is more strategic in nature. First, can you comment on the cross-border intermodal conversion opportunity in terms of what you think the size of the addressable market is? And then secondly, how are you thinking about CN's partnership with J.B. Hunt? And would you consider partnering with an asset-based carrier at some point in the future in order to, you know, increase market share and build density?
Keith Creel (President and COO)
I would say on the J.B. Hunt piece, I believe CN's had a relationship with J.B. Hunt that, that predates their announcement. So with that said, cross-border, I think if our competitor has an opportunity with their service to compete, then we obviously have that same opportunity. I don't know the exact size of the prize. I would recognize that, you know, some of the, some of the currency headwinds that we've got may hurt as far as help, but it's something that we're looking at, relative to the opportunity. So again, we would consider anything that made sense relative to a partnership with an asset-based company, but at the same time, knowing what I know about that business, I don't significantly think that's moving the needle.
Allison Landry (Analyst)
Okay, great. And then, excuse me. My second question is on potash. So I think you guys are fairly positive on second half volumes, but with some of the recent production cuts that we've been hearing, what's your outlook for, you know, the fourth quarter and maybe into early next year?
Keith Creel (President and COO)
Well, I still think we're going to have a strong fourth quarter. It may be a little bit less than what I expected, maybe a little bit down, but still very strong. Going into next year, there's a lot of uncertainty, but I still think Canpotex is going to be positioned well for a strong year. I mean, we had a phenomenal 2015 shipping experience with Canpotex, shipping record volumes. I'm not going to suggest that they'll exceed that. I can't predict that, but I will say that I think it's going to be strong. But more to come on that. A lot of that's driven, obviously, by when they settle the price with China and how the world commodity prices respond to that, which we won't really know about until sometime in the first quarter.
Allison Landry (Analyst)
Okay, excellent. Thank you.
Operator (participant)
Your next question comes on the line of Thomas Wadewitz from UBS. Please go ahead.
Thomas Wadewitz (Managing Director and Senior Equity Research Analyst)
Yeah, good morning, and welcome back, Hunter. Good to hear your voice again, and also congratulations on the hourly agreement. I know that's a big deal.
E. Hunter Harrison (CEO)
Thanks, Tom.
Thomas Wadewitz (Managing Director and Senior Equity Research Analyst)
Let's see. So you made some comments earlier in the Q&A session about, you know, still room for OR improvement. I think you said, you know, there might be another 2-3 points. Is that including the U.S. agreement and what, you know, what could be, I think, in the past, you said maybe 75 basis points from U.S. hourly agreement, or would that be further upside to the 2-3 points?
E. Hunter Harrison (CEO)
I think it's further upside. You know,
Thomas Wadewitz (Managing Director and Senior Equity Research Analyst)
Okay.
E. Hunter Harrison (CEO)
Go- yeah.
Thomas Wadewitz (Managing Director and Senior Equity Research Analyst)
What kind of time frame do you ... Like, when you say that, is that possible you capture that next year, or you say, well, that's over a couple of years?
E. Hunter Harrison (CEO)
No, I think we start to, you know, it just doesn't kick in overnight, but it's, we pretty well control how quick we are able to adjust and get our people acclimated to managing a railroad in a different manner. So I would think that, you know, within a year, we'll be 80% there, and then, you know, as you go further, there's gonna continue to be opportunities, but you'll just be chasing after those opportunities for, you know, for a long period of time as you fine-tune the operation with other opportunities.
Thomas Wadewitz (Managing Director and Senior Equity Research Analyst)
Right. Okay. And then just as a second one, a follow-up, also, there was discussion on the CapEx, and you provided a pretty optimistic comment about maybe $400 million reduction in CapEx that was potential. It was unclear to me from the comments, is that something you'd apply to next year, or that's just kind of a broader comment? I'm, you know, is that like $1 billion in CapEx next year, or you don't want to be that specific yet?
E. Hunter Harrison (CEO)
No, no, I think it's, you know, I think, I think Keith and company are rerunning some of the numbers right now as we speak, so I would, I would hope and expect that, most of that, most, if not all of that $400 million, would be captured in the, in 2016.
Thomas Wadewitz (Managing Director and Senior Equity Research Analyst)
Right. Okay, great. Thanks for the time.
Operator (participant)
Your next question comes from the line of Benoit Poirier from Desjardins Securities. Please go ahead.
Benoit Poiré (Analyst)
Yeah, good afternoon, good morning, and welcome back, Hunter. Mark and Keith-
E. Hunter Harrison (CEO)
Good morning.
Benoit Poiré (Analyst)
If we, you can go back to the, your flexibility on the balance sheet, you end up with a net debt at close to 2.7. You previously targeted in a range of 2-2.5. Debt equity stands to 67%. So if you could provide more color about the flexibility and whether you could still ... How aggressive can you be in your share buyback next year, given the significant amount you've made this year, and also the asset sale that impact your latest two years' free cash flow?
Mark Erceg (EVP and CFO)
Yep, no, that's a great question. We talk, you know, on a regular basis with all the principal rating agencies. You know, we went to them very proactively a number of months back and said, "We think we have an opportunity to step forward and take advantage of what we think is a temporary disconnect between our underlying intrinsic value and the stock's current trading price, and we would like to access that by temporarily increasing our leverage ratios." They were very amenable to that. They understood the value we were creating through that transaction. They also understand our ability to de-lever if we need to, because of the cash generativity of the railroad. So we've been working in consultation with them as it relates to that.
Clearly, if we recast our 2016 and going forward CapEx budgets, you know, that'll provide us with additional funds to continue share repurchase as well, but we're gonna take it as it comes. You know, we're balancing the desire to create shareholder value through those repurchases, but also want to maintain a strong balance sheet as we've been doing over the course, over the last several years.
Benoit Poiré (Analyst)
Okay. Second question, the follow-up question, with respect to the potential CapEx reduction that could take place next year, is it something very temporary because of the volume decline, or it's something that could sustain, and we could see a $400 million reduction of CapEx a year in 2017 and 2018?
E. Hunter Harrison (CEO)
No, Benoit, it's not related necessarily, you know, to the business issues now, just taking a cut. So, you know, I think it's something that's sustainable, but as other opportunities come up and business bounce back and so forth, then we might have to reach in and increase and take away some of the $400 million or $50 million or whatever it might be. I don't think it would return to the levels it was before when we were in the kind of catch-up mode from previous administrations.
Benoit Poiré (Analyst)
Okay, perfect. Thanks for the time, guys.
E. Hunter Harrison (CEO)
Thank you.
Operator (participant)
Your next question comes from the line of Matt Troy from Nomura. Your line is open.
Matt Troy (Analyst)
... Yeah, thanks. Just a quick one. Positive Train Control. I was wondering if you could just give us a status update on where you stand in terms of the rollout. Obviously, the optics of a deadline in just over two months, something in, you know, being extensively covered in the press. But just wondering if you could just provide an update in terms of where you are, in terms of what you're required to implement across your network, and then perhaps what you see as the path forward, and what some of the contingency planning might be around the fact that, if Congress can't get an extension passed, there would be repercussions. Thanks.
Keith Creel (President and COO)
Okay, I'd just say that, you know, there's a lot of uncertainty there, except for the fact where we are certain is there's no way this industry is going to meet that mandate. So it's something we're all seized with. Obviously, we've done our job, or trying to do our job day in and day out, to make sure that Congress understands that in spite of a mandate that we can't meet, we've got a responsibility to run the railway safely. And if they force that date upon us, then we have no choice but to seriously consider not hauling those products that require us to have PTC in the first place, which is what we're positioning. We've certainly communicated that with Congress. We've communicated that with our customers. Obviously, that draws a lot of concern.
A lot of people, maybe some of the Congress members, don't clearly understand the products that we carry that enable them to drink clean drinking water, that produce the products that we consume day in and day out, that should we not haul it, that those kind of items could be in jeopardy. But with that said, this company has spent, probably, rough numbers, two-thirds of our total spend. We're well positioned. We've got to get the technology tested. It hasn't been for lack of effort. The territory effectively from the border down to Chicago, down to Kansas City, has to be covered.
We've got some testing that's in place now that we're going to do throughout the end of the year, and we'll continue to progress through that to 2016, 2017, with a view and an expectation that we can get this thing implemented. Now, that doesn't mean tested and reliable, that's a whole another discussion, but certainly implemented by 2018.
Matt Troy (Analyst)
Okay. Makes sense. Thanks for the detail.
Keith Creel (President and COO)
Thank you.
Operator (participant)
Your next question comes from the line of Jason Seidel from Cowen. Your line is open.
Jason Seidel (Analyst)
Thank you, and echoing everyone's comments, welcome back, Hunter, and hello to everyone else. Hunter, if I could just go back to your commentary, you know, sort of about the ability to bring on more revenue, maybe pushing the OR up a bit. Now, I, you know, I think I can do the math like everybody else. You know, I'd rather have $1.8 billion in revenues at a 65 OR as opposed to $1.5 at a 59. However, every time I think you say that, people think about the old days of railroading, where, you know, two railroads would fight over a 0.5% market share, and that would force pricing down in the long term. You know, is there anything you can tell us that, look, that's not going to happen again?
And my second question to that is, what is this related more around the move away from the contracts, and this is going to be more on the spot basis that you could be aggressive for extra business?
E. Hunter Harrison (CEO)
No, you know, I think it's, you know, I think it's our view of what's smart to do and look at. I can tell you this. I was not part of that old regime. I remember the days, but I didn't have any controls then. As long as I'm around, we're going to maintain a certain discipline and never get back into that type of environment again. And I just think it's, you know, to your point, you know, I sit down, and I talk about that, of would you rather be this size company with this and that?
And everybody agrees until they think we might do it, and they say, "Oh, my God, you wouldn't do that, would you?" And then if you don't do it, they say, "Oh, my God, you're going to do that." So it's kind of damned if you do and damned if you don't. I think that, as I've said before, many times, number one, we're going to be the most efficient carrier out there with the best service and the best product. And as long as we do that, that's going to put us in a good position. And then, how we react to the marketplace, given demand in the market and given what the market is, and, you know, I'm not going to spend a lot of money to go out and try to get business that's, you know, very cheap margins.
I think that you can rest assured that this company is going to be very disciplined with, with how we do pricing, and we've never been accused of being price cutters or the low-cost leader, or what. If anything, we've been on the other side of the ledger. I just think that you have to think about something. I get very nervous when I pick up the headlines, and it says some rail is raising rates 17%, okay? And at the same time, the next week, they're announcing a record quarter, and the next week, somebody's writing their congressman, okay? Now, we have a certain amount of discipline, more so in Canada than we do in...
Rails all the time get the questions in the U.S., "Why don't you raise rates?" Well, one of the reasons that we don't is this: You know, we have kind of an internal rule that says this: you know, if you abuse authority, you lose it. So there's some responsibility we have to manage that in a very disciplined manner, and I hope you can trust that we will do that.
Jason Seidel (Analyst)
No, I think that's the answer most people wanted to hear. And a quick follow-up, you sort of mentioned the government. Now, you guys have had your clashes in the past over a few issues. You have a new government there in Canada. Do you think this is gonna be a positive, negative, neutral, or sort of a wait and see?
E. Hunter Harrison (CEO)
Well, you know, if I had to guess right now, I think it's neutral, okay? You know, with due respect to my conservative friends in Canada, they might not call me a friend. They ain't done much for us. The Liberals didn't do much for us before the Conservatives when they were in, and now the Liberals are back in. They ain't gonna do a whole lot for railroads, and they don't need to do for it. Just leave us alone, give us a level playing field, and let us run our business, okay? I do wish they would take a look at their policies as far as grain, and why all of a sudden they think they have to regulate western grain and all that.
But I don't, I think they've got larger issues than to worry about the rails in Canada. Canada, right now, as I said, as an American citizen, Canada has the finest rail system in the world, the two best carriers in the world, and they ought to be proud of it if they take care of it. Now, I'll leave it there.
Jason Seidel (Analyst)
Well, thanks for your time, as always, Hunter.
E. Hunter Harrison (CEO)
Sure.
Operator (participant)
Your next question comes from the line of Bascom Majors from Susquehanna. Your line is open.
Bascom Majors (Equity Research Analyst)
Yeah, thanks for taking my question here. I just wanted to follow up on the balance sheet, Mark. Where do you see leverage landing for 2015 here on a debt to EBITDA basis? And how comfortable are you with maintaining that profile at or above the high end of your targets against the uncertain macro backdrop you're seeing into 2016?
Mark Erceg (EVP and CFO)
Yeah, right now, we finished the quarter at 2.75 times. You know, I would expect, if anything, to see that maybe, you know, you know, move in slightly. But with only, you know, 3 months to go, I wouldn't expect it to move materially from that point. I think the key is that, you know, we have worked very closely with the rating agencies. They understand what it is that we're doing, why we're doing, why we're doing that. They also understand that we're, you know, making sure we maintain a very flexible financial structure going forward. So, for example, you would have seen that we issued 100-year paper, you know, during the quarter.
In effect, you know, what we did, you know, through that transaction was we have, you know, traded out, you know, cost of equity, which is maybe called roughly 10% for an after-tax cost of debt, which is maybe 4.5%, and effectively locked in, you know, over 500 basis points of value, you know, for our shareholder base over a long duration. We've also been able to, as we said, extend, you know, move out the duration of our weighted average portfolio very significantly. It was about 13 years, not that long ago. Now it's more akin to 26 years. We also did our weighted average coupon rate down from, call it, 6.25 to 5.625. So a lot of things that we're doing, we think are very prudent balance sheet management.
Exactly where we'll end the year, I can't predict that, but I can tell you that we're committed to our Triple B plus credit rating agencies, you know, dialogue, and we're comfortable we'll manage against that.
Bascom Majors (Equity Research Analyst)
Well, I appreciate all that detail here. You know, just one housekeeping item related. Now, where do you see interest expense landing for Q4 after all the debt you raised in the third quarter? And, you know, given the higher debt balance and reduced weighted average coupon that you talked about.
Mark Erceg (EVP and CFO)
I think, maybe just see a straight mathematical calculation, given all the paper we've already issued, the coupon rates are outstanding. I think it's probably, you know, 125, something to that effect, but, you know, that's just a straight calc.
Bascom Majors (Equity Research Analyst)
All right, thank you for the time.
Mark Erceg (EVP and CFO)
Thank you.
Operator (participant)
Your next question comes from the line of David Vernon from Bernstein. Your line is open.
David Vernon (Senior Analyst)
Good morning, and thanks for fitting me in here. Question for you, Keith, on the fluidity you guys are seeing in Chicago as we're heading into winter. Do you think that, you know, the rail service levels through there are holding up at a decent level, and we're gonna avoid any risk, assuming a normal winter of another sort of network seizure, as we kind of look to the end of the year?
E. Hunter Harrison (CEO)
Well, if it's a normal winter relative to a reduced business demand, I would say the likelihood you're gonna see what happened in 2014 happen is minimal. That said, you know, it doesn't just take a weather event. Chicago, it's a very tenuous, sensitive place as it is. A major service interruption by any of the carriers can cause traffic bunching, dump into the belt carriers. It has a ripple effect across the industry. So I'm saying I look at it every day with cautious optimism, but I'm a realist, and I understand it doesn't take a lot to create some fragility there in Chicago. But again, normal winter, reduced traffic volumes, I don't see a great likelihood or chance of a repeat of 2014, for sure.
David Vernon (Senior Analyst)
Has there been any structural improvement through some of the work that's been put through there? Or is this just the better service levels, the result that there's just less volume, less crude flowing through the city?
E. Hunter Harrison (CEO)
There's been some. I mean, obviously, some of the dollars, the capital dollars that have been continued, that have been spent since 2014, is gonna increase OpEx to a degree. Does it move the needle? I'd say no. But between that, between a reduced traffic volume level and between, some coordination where the railroads are working better together in the playbook, so to speak, when things do get a little bit hairy, I do think you get a better outcome given the same circumstances.
David Vernon (Senior Analyst)
... Great. Thanks for the time, and congratulations on getting the costs down, the profits up while the volume's down. It's a good result. Thanks.
E. Hunter Harrison (CEO)
Thank you.
Operator (participant)
Your next question comes from the line of Jeff Kauffman from Buckingham Research. Your line is open.
Jeff Kaufman (Analyst)
Thank you very much. Thanks for squeezing me on, and welcome back, Hunter.
E. Hunter Harrison (CEO)
Thank you.
Jeff Kaufman (Analyst)
Thank you. A lot of my questions have been asked. Let me just follow up, one for Keith, one for Mark. Mark, you mentioned the interest expense calculation for four Q. If you bought back no more shares, what would shares outstanding look like in four Q?
Mark Erceg (EVP and CFO)
I think if I got it correctly here, the quarter end share count is around 158.7 million shares. Something to that effect.
Jeff Kaufman (Analyst)
All right. I thought that was the weighted average for the quarter, not the quarter end.
Mark Erceg (EVP and CFO)
I may be citing that. That's what's sticking in my head. As far as the actual share count on that day, I'd have to dig it out of a file.
E. Hunter Harrison (CEO)
Yeah, I'll follow up with you. It's in,
Jeff Kaufman (Analyst)
Okay. Yeah, we'll, we'll do that offline. Last question for Keith. Keith, I don't think anyone's asked about the expiration of the Softwood Lumber Agreement, and I was just kind of wondering what your thoughts were on that.
Keith Creel (President and COO)
Well, it just has expired, what, a couple weeks ago?
Jeff Kaufman (Analyst)
Yep.
Keith Creel (President and COO)
It was a year-long process. I don't know what's going to happen. I would say that hopefully, that presents an opportunity for us to move more softwood lumber across the border in the absence of the tariff, but I'm not exactly sure.
Jeff Kaufman (Analyst)
Okay. Hey, guys, congratulations, and thank you.
E. Hunter Harrison (CEO)
Thank you.
Operator (participant)
And your next question comes from the line of David Tyerman from Canaccord Genuity. Your line is open.
David Tyerman (Analyst)
Yes, just wanted to follow up on Hunter's comment about the 2-3 point OR improvement. So I was wondering what areas we should expect to see the biggest improvement. Is it labor, or is it other areas that you would expect to see improvement like that, or go into that?
Keith Creel (President and COO)
Essentially, it's all the above. It's effectively converting the operations, the synergies we create through the investment to running fewer train starts, fewer people, fewer locomotives, fewer cars, fewer mechanics needing to work on locomotives, fewer mechanics needing to work on cars. So across the board, lower headcount in headquarters, obviously. It's just—there's no silver bullet there. It's singles and doubles. It's working across the board. It's right-sizing your assets relative to the business levels with a much more productive physical plan, doing more with less effectively.
David Tyerman (Analyst)
Okay. Okay, so it sounds like if we were modeling this, pretty much every category could be improved somewhat?
Keith Creel (President and COO)
Well, you're gonna—I mean, you would see the things you would see, you'd see headcount down to a degree. You'd see train length up. You'd see train speed up. You'd see, if you looked at our daily numbers we look at, you'd see train count down and crew starts down. Those are the drivers that drive the bottom line and that actually drive the cost centers in the company. You'd see fuel improvement, less fuel consumed, fuel productivity up. I mean, I could give you about 15 or 20 things, but external, if you pay attention to train speed, you see improving, you see train length improving, you're seeing train rate improvement, you see fuel and productivity improvement, then all those other things are going to happen as a result.
David Tyerman (Analyst)
Okay. Very good. Thank you.
E. Hunter Harrison (CEO)
Thank you.
Operator (participant)
Your next question comes from the line of Steven Paget from FirstEnergy. Your line is open.
Steven Paget (Director and Institutional Research)
Thank you. Good morning. Welcome back, Hunter. One thing only for me. Anecdotal feedback is that there are two, only two railroads in North America that do what they say they will do, yourselves and the railroad in Montreal, and U.S. railroads aren't providing the same service. Customers are getting frustrated. Could this frustration with other railroads lead to some form of negative intervention by the U.S. government?
E. Hunter Harrison (CEO)
Is that the question?
Steven Paget (Director and Institutional Research)
Yes.
E. Hunter Harrison (CEO)
You know, I hope not. But I guess it could. You know, I'm not aware of so much of the sensitivity of some of those issues. I think the Surface Transportation Board, and not this last administration, but has not been very aggressive. In fact, if you look at what they've done or accomplished over the last, I don't care what period of time you want to look at, 10 or 15 years, with the exception of handling a couple of mergers, it's been a non-event. So at this point in time, I would doubt that they're equipped or would want to get into a fray like that. But I mean, I wouldn't rule that out.
I mean, certainly, we tend to forget, I guess, a couple of years ago, what we were going through in Chicago and with grain and other things. If, God forbid, we would go back into those times, then, you know, you would have people raising many issues again about those type things that we should be sensitive to.
Steven Paget (Director and Institutional Research)
Well, thank you. That's my one question.
E. Hunter Harrison (CEO)
Thank you, Steve.
Operator (participant)
The final question comes from the line of Turan Quettawala from Scotiabank. Your line is open.
Turan Quettawala (Director:Transportation and Aerospace)
... Yes, good afternoon. I guess most of my questions have been answered as well. Welcome back, Hunter.
E. Hunter Harrison (CEO)
Thank you.
Turan Quettawala (Director:Transportation and Aerospace)
One, one question only, I guess, on asset sales. Maybe you can give us a bit of an update on that. I guess that's the only part of the capital equation there that we haven't touched on today.
E. Hunter Harrison (CEO)
Okay, go ahead, Mark. Mark Wallace is here with us. I'll let Mark give an update on the portfolio.
Mark Wallace (VP, Corporate Affairs)
Sure. Hey, Turan, it's Mark. So, we're still working with our partners at Dream, you know, pretty aggressively. We've got, we've got about 12 or 13 projects underway. We're fast tracking two of them, in Toronto, that, that we're pretty excited about. You know, we're gonna, you know, we're gonna start seeing some cash from those probably in 2017. I mean, these, these are development opportunities that we're working on. You know, we do have a couple of properties that have flowed back to CP because they're not, they're not developable. So, we expect probably, you know, sometime in 2016, 2017 to see some higher land sales.
You know, how much right now, I'm not gonna quantify that, but you know, year over year, you should probably see start seeing an increase in 2016, 2017 in our land sale numbers.
Turan Quettawala (Director:Transportation and Aerospace)
That's helpful. Thank you very much.
Operator (participant)
There are no further questions, Mr. Harrison. Please continue.
E. Hunter Harrison (CEO)
Well, thanks so much for joining us. Once again, it's nice to be back, and I look forward to visiting with you in January, after we hopefully have experienced a very successful fourth quarter. Thanks.
Operator (participant)
This concludes today's conference call. You may now disconnect.