Union Pacific - Q1 2014
April 17, 2014
Transcript
Operator (participant)
Welcome to the Union Pacific first quarter 2014 conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero from your telephone keypad. As a reminder, this conference is being recorded, and the slides for today's presentation are available on Union Pacific's website. It is now my pleasure to turn and introduce your host, Mr. Jack Koraleski, CEO for Union Pacific. Thank you, Mr. Koraleski. You may now begin.
Jack Koraleski (CEO)
Thanks, Rob, and good morning, everybody. Welcome to Union Pacific's first quarter earnings conference call. With me here today in Omaha, Eric Butler, our Executive Vice President of Marketing and Sales, Lance Fritz, President and Chief Operating Officer, and Rob Knight, our Chief Financial Officer. This morning, we're pleased to report that Union Pacific achieved first-quarter earnings of $2.38 per share, an increase of 17% compared to the first quarter of 2013, and another all-time first-quarter record. Total volumes were up 5%, and the increase was broad-based. We saw growth in 5 of our 6 business groups, with particular strength in agricultural shipments, industrial products, and coal. The volume growth, combined with solid core pricing and a continued focus on safety, service, and efficiency, drove a 2-point improvement in our operating ratio to a record 67.1% for the quarter.
As you all know, this winter was one for the record books, especially in the upper Midwest. So we're proud of the efforts of the men and women of Union Pacific, who worked tirelessly to serve our customers despite these weather challenges and helped us to achieve a solid start to the year. So with that, let's get into it. I'll turn it over to Eric.
Eric Butler (EVP of Marketing and Sales)
Thanks, Jack, and good morning. In the first quarter, volume was up 5% compared to 2013, as solid demand made up for the challenging weather conditions in much of the country. We had strong gains in agricultural products, industrial products, and coal. We also saw volume growth in intermodal and automotive, and in chemicals, we were able to offset declines in crude oil with gains in other commodities to end up even with last year's strong first-quarter results. Core price improved 2%, which was partially offset by unfavorable mix and lower fuel prices to produce a 1% improvement in average revenue per car. Add in our volume growth, and we increased rate revenue by 6% to a first-quarter record of $5.3 billion. Let's take a closer look at each of the six business groups.
Ag products volume grew 13%, which, combined with a 3% improvement in average revenue per car, drove revenue growth up 16%. We continue to see strong demand for grain, with car loadings up 39%, driven by last year's strong harvest. The biggest gains were in grain exports to China and Mexico and wheat exports through the Gulf, and lower corn prices drove increased demand for domestic feed grains. Grain products volume was up 5%, driven by an 11% increase in ethanol shipments as refineries replenished low ethanol inventories. Shipments of DDGS grew 38%, driven by strong export demand, primarily from China. Food and refrigerated shipments were down 3% for the quarter as the winter weather impacted cycle times for equipment serving the produce and frozen food markets. Partially offsetting those declines were gains in import beer, where volume grew 3%.
Automotive volume grew 2%, though average revenue per car was down 2%, resulting in flat revenue for the quarter. I'll talk more, I'll talk more about the average revenue per car decline in a moment. First, finished vehicle shipments declined 3% as winter weather impacted shipments, and we had a couple of plants with unscheduled shutdowns. While automotive production was strong in the quarter, the severe winter weather contributed to year-over-year sales declines in January and February. Sales rebounded strongly in March, up 5.6%, thanks to improved weather and dealer incentives. We expect our finished vehicle shipments to rebound as the rail network recovers from the challenging weather. On the parts side, volume increased 9%, with strong production and over-the-road conversions driving gains.
The decrease I mentioned earlier in average revenue per car reflects a change in the way we handle per diem revenue on intermodal containers used by our customers for auto parts. As a result, in 2014, the per diem revenue is included in other revenue instead of automotive commodity revenue. Chemicals volume was flat for the quarter, with revenue up 2% on a 3% increase in average revenue per car. Industrial chemicals volume was up 7%, driven by strength in end-user markets such as shale-related drilling, paper products, and de-icing materials. Fertilizer shipments were up 7% for the quarter on strong export potash demand. Crude oil volume declined 18% compared to the first quarter of last year, with price spreads negatively impacting volume. Partially offsetting the decline was an increase in our barrel shipments to the Gulf Coast.
Turning now to coal, revenue increased 3% in the first quarter on a 7% increase in volume. Average revenue per car declined 4%, driven by mix and lower fuel prices. Southern Powder River Basin tonnage was up 2%, as demand from the cold winter weather and higher natural gas prices offset our previously reported contract loss. Colorado-Utah coal tonnage was up 13%, benefiting from the increased domestic demand as well as gains in West Coast exports. We continue to see strength from other coal-producing regions, where tonnage was up 25% for the quarter. In our industrial products business, a 9% increase in volume and a 1% improvement in average revenue per car produced revenue growth of 10%. Non-metallic minerals volume was up 18% for the quarter.
We continue to see strong demand for frac sand and shale-related drilling, which was up 22% over last year. Aggregate and cement demand were strong, particularly in Texas and California, driving construction shipments up 10% for the first quarter. Our government and waste shipments were up 23%, driven by a waste customer adding short-haul shipments in January and February. Additionally, the winter weather increased demand for salt, where our shipments were up 28% compared to the first quarter last year. Intermodal revenue was up 4% in the first quarter, driven by a 3% volume gain and a 1% improvement in average revenue per unit. Domestic intermodal volume was up 8% in the quarter, driven by strength from our traditional IMC customers, new motor carrier customers, and demand for new premium service offerings.
Headwinds from the severe winter weather were offset by business development and highway conversions. Our international intermodal volumes declined 1% against a strong comparison from the first quarter of 2013. The winter weather impacted consumer demand, and imports through the West Coast ports were down nearly 3% for the first two months of the year. Let's take a look at how we see our business shaping up for the rest of 2014. Our current outlook is for the economy to strengthen modestly this year. Last year's strong crops should provide opportunity for ag products in the second quarter, with anticipated strength in both domestic and export grain markets. The 2014 crop yields will be dependent on the weather. In food and refrigerated, we expect growth in import beer, but the drought in California could create a headwind for tomato paste and canned goods.
Automotive market fundamentals remain strong, with demand for new vehicles, easy access to financing, low interest rates, and low fuel prices all expected to drive increased sales. We should see finished vehicle volume rebound in the second quarter as we continue to recover from the winter weather. Most of our chemicals markets should remain solid throughout 2014. Crude by rail will continue to be impacted by spreads, a growing Gulf crude supply, and increased pipeline capacity. Lower inventories will continue to be a driver for our coal business in the second quarter. Weather conditions this summer will influence how things shape up for the full year. Industrial products should continue to benefit from shale-related activity, with increased drilling supporting growth in frac sand and pipe shipments.
Housing starts were off to a slow start in 2014, but they are still projected to exceed 1 million units, which we anticipate will drive demand for lumber shipments, and we think the strength in construction products will continue. Highway conversions and new product offerings should continue to drive growth in domestic intermodal. International intermodal should benefit from a continued improving economy and strengthening housing market. For the full year, our strong value proposition and diverse franchise will again support business development efforts across our broad portfolio of business. Assuming the economy cooperates, we expect to deliver profitable revenue growth yet again in 2014, driven by continued volume growth and core pricing gains. With that, I'll turn it over to Lance.
Lance Fritz (President and COO)
Thanks, Eric, and good morning. I'll start with our safety performance, which is the foundation of our operations. The first quarter 2014 reportable personal injury rate improved 3% versus 2013, progress achieved through our comprehensive safety strategy. The number of severe injuries during the quarter declined to a record low, reflecting our work to reduce the risk of critical incidents, our team's commitment to the Courage to Care, and the maturation of our total safety culture. Moving to rail equipment incidents or derailments, our first quarter reportable rate finished up 7% versus the quarterly record set in 2013. However, the absolute number of incidents, including those that do not meet the regulatory reportable threshold, decreased to record lows in each of the first three months of this year.
Looking forward, we expect continued improvement from investments that harden our infrastructure, expand, expand advanced defect detection technology, and enhance our ability to find and address risk. In public safety, our grade crossing incident rate improved slightly versus 2013. Driver behavior continues to be a critical element. To make continued progress, we're focused on improving or closing high-risk crossings and reinforcing public awareness. Severe winter weather conditions were a headwind to our safety performance during the quarter, most notably where our employees faced the brunt of below-zero temperatures and record snowfall. Even so, the team did a tremendous job addressing the risks. In addition to impacting safety, the most severe winter weather we've faced in quite a few years materially impacted our first quarter network performance. The impact was most evident in the upper Midwest and at interchange points with other carriers, particularly in Chicago.
Extremely cold temperatures and significant snowfall disrupted operations by limiting train size, curtailing switching activity, reducing the ability to mobilize crews to crew load change locations, elongating equipment cycles, and reducing fuel efficiency. Our dedicated employees did a great job battling difficult conditions while maintaining open channels of communication with customers and our interchange partners as we managed through the challenge. We responded by leveraging the unique value of Union Pacific's franchise. We adjusted transportation plans to use alternative switching yards and gateways. We realigned resources to where they were needed most and employed the use of our surge capacity. This included increasing our locomotive active fleet by about 600 units since last fall and increasing our active TE&Y workforce by roughly 550 since January.
While we mitigated a fair amount of winter's impact, our service performance fell short of our expectations, and we are working hard to achieve a rapid and full recovery. While that recovery is now underway, most of our first quarter operating performance metrics reflect the winter's impact. Velocity declined 7% as adverse conditions generated an 80% increase in the number of days with major service interruptions. These interruptions temporarily reduced operating capacity during the quarter, particularly in the Northern Region. The interruptions and subsequent limits on network capacity also drove a decline in our service delivery index, a measure which gauges how well we are meeting overall customer commitments. On a brighter note, we were able to maintain local service within a decent range, registering a 93.1% industry Spot and Pull.
This metric, which measures the delivery or pulling of a car to or from a customer, also reflects the tighter service commitments we introduced this year. In addition to surge resources, infrastructure investments have also improved our ability to recover after incidents, reducing their impact on the network. For 2014, we plan to invest around $3.9 billion, which is up about $300 million from our 2013 spend. We're purchasing 200 locomotives this year compared to 100 last year, in part due to future volume growth assumptions, as well as our Tier 4 emission strategy. We continue to invest in capacity across our network, including new capacity in the upper Midwest and in the South, that support expected growth.
Speaking of unit volume growth, for the first time in several years, we saw solid and relatively balanced regional volume growth. While severe weather impacted our ability to fully leverage that volume, we were still able to realize meaningful productivity gains. For example, the increase in regional TE&Y employees was less than our unit growth, despite the surge of crews we deployed in the north. Freight car dwell was up 12% for the quarter, driven by a 36% weather-related increase in the northern region. On a more positive note, we held locomotive productivity flat in the face of the headwinds. Our longer-term trend of improving locomotive reliability, coupled with effective utilization plans, should register continued gains going forward. Overall, we generated reasonable productivity improvement as our men and women applied their expertise to improve safety, service, and efficiency using the UP Way.
Our primary focus was serving our customers and keeping our employees safe during difficult operating conditions. The net result was a 2 percentage point improvement in operating ratio, something our team is very proud of achieving in a very difficult quarter. In summary, our full-year operating outlook for 2014 remains positive. We are confident we are on a path to restoring operations back to normal. We're focused on reducing variability in the network to drive service improvements, and we've made progress during the past few weeks. We will continue to work closely with our interchange partners as our recovery and that of the entire rail industry is conditioned upon interchange fluidity. As performance improves and as demand dictates, we'll adjust our resource levels accordingly, including moving locomotives back into storage. We expect to generate record safety results on our way to an incident-free environment.
As network performance improves and we utilize resources more efficiently, our ability to leverage unit growth to generate solid productivity will improve, and we will continue to make smart capital investments that generate attractive returns by increasing capacity in high-volume corridors while also supporting our safety, service, and productivity initiatives. As a result, we'll provide customers with a value proposition that supports growth with high levels of service. All combined, it translates into increased returns for our shareholders. With that, I'll turn it over to Rob.
Rob Knight (CFO)
Thanks, Lance, and good morning. Let's start with a recap of our first quarter results. Operating revenue grew 7% to an all-time record of more than $5.6 billion, driven by strong volume growth and solid core pricing. Operating expense totaled nearly $3.8 billion, increasing 3% over last year. Expenses include about $35 million, or roughly $0.05 per share, of costs associated with the severe weather conditions in the quarter. Operating income grew 14% to more than $1.8 billion, hitting a best-ever mark for the first quarter. Below the line, other income totaled $38 million, down 5% from 2013. Interest expense of $133 million was up 4% compared to the previous year, primarily driven by new debt issuances at the beginning of 2014.
Income tax expense increased to $671 million, driven primarily by higher pretax earnings. Net income grew 14% versus 2013, while the outstanding share balance declined 3% as a result of our continued share repurchase activity. These results combined to produce a best-ever first quarter earnings of $2.38 per share, up 17% versus 2013. Turning to our top line, freight revenue grew 6% to a first quarter record of just under $5.3 billion, driven primarily by 5% volume growth. Lower fuel prices and business mix each drove about a half point decline in our average revenue per car. Growth in our grain and frac sand volumes were positive mix drivers, but were more than offset by negative mix in automotive and coal.
Eric just pointed out the increases in lower ARC auto parts versus the decrease in finished vehicle volumes, which accounts for the negative mix in automotive. As for coal, we did see the benefit of higher ARC volumes, including our prior year repriced legacy business. However, this was more than offset by increases in lower ARC, shorter haul movements. Increased intermodal and waste shipments also contributed to the negative mix. Core pricing gains totaled slightly over 2%, continuing our pricing strategy of outpacing inflation. Slide 21 provides more detail on our core pricing trends in 2014.... As you recall, 2014 is a legacy light year, so we will not see the 1.5 points of legacy benefit, which we saw in 2013. We're also seeing the impact of lower inflation on that portion of our business that is tied to inflation escalators, primarily ALIF.
The table at the bottom of the slide takes a closer look at the quarterly ALIF escalator. As you can see, it rebounded only slightly from negative territory in the fourth quarter last year. While pricing is never easy, we continue to see solid core pricing gains above inflation on the business that we can touch in the marketplace today. Keep in mind also that the positive mix impact of new business or business returning to the Union Pacific franchise is reflected in our margin gains, but is not added to our core price calculation. We continue to be as focused as ever on pricing to market at rates that earn a fair and reinvestable return. Moving on to the expense side, slide 22 provides a summary of our compensation and benefits expense, which increased 3% compared to 2013.
Higher volumes, inflation, and weather were the primary drivers, offset by productivity realized by leveraging the volume growth. Total TE&Y increased slightly, though not at the same rate as our volume growth. However, this increase was more than offset by a decrease in employees associated with capital projects for the quarter when compared to 2013. For the remainder of the year, we would expect to see compensation and benefits expense to grow, but this will be largely dependent on how volume plays out. In addition, we still expect to see labor inflation come in under 2% for the full year. Turning to the next slide, fuel expense totaled $921 million, up 2% when compared to 2013, driven primarily by higher GTMs associated with increased volumes. Our fuel consumption rate was essentially flat on a year-over-year basis, with the weather having some negative impact.
Total fuel expense was tempered by a 3% year-over-year decline in average diesel fuel prices. Moving on to the other expense categories, purchase services and materials expense increased 9% to $607 million due to volume-related subsidiary contract expenses, higher locomotive and freight car material costs, and crew transportation and lodging costs. Depreciation expense was $464 million, up 7% compared to 2013, consistent with our prior guidance. Looking ahead, we now expect depreciation to be up 7%-8% this year. Slide 25 summarizes the remaining two expense categories. Equipment and other rents expense totaled $312 million, which was flat when compared to 2013. Higher freight car rental expenses was offset by lower container lease costs. Other expenses came in at $226 million, down $11 million versus last year.
Higher utility expense was more than offset by a year-over-year improvement in our freight and equipment damage costs, as well as lower environmental and personal injury expenses. For 2014, we expect the other expense line to increase between 5% and 10% for the full year, excluding any unusual items. Turning to our operating ratio performance. Pricing the business at reinvestable levels and moving it safely and efficiently continues to drive results. We achieved a record first quarter operating ratio of 67.1%, improving 2 points when compared to 2013. Longer term, we remain committed to achieving an operating ratio below 65% before 2017. We also remain committed to achieving strong cash generation and improving overall financial returns. Turning now to our cash flow. In the first quarter, cash from operations increased to almost $1.8 billion.
You'll recall that we expect a headwind of about $400 million this year due to tax payments associated with prior years' bonus depreciation. These payments will be reflected in subsequent quarters. We invested about $900 million this quarter in cash capital investments and also returned $363 million in dividend payments to our shareholders. Also, in keeping our commitment to achieve a dividend payout range of 30%-35%, we increased our declared dividend per share by 32% on a year-over-year basis. Taking a look at the balance sheet, we issued $1 billion of new debt in January, bringing our adjusted debt balance to $13.3 billion at quarter end. This takes our adjusted debt-to-cap ratio to 38.4%, up from 37.6% at year-end 2013.
We remain committed to achieving an adjusted debt-to-cap ratio of approximately 40% and a debt-to-EBITDA ratio of about 1.5 by year-end. We feel our current cash outlook positions us well to execute our cash allocation strategy. Our record profitability and strong cash generation enable us to continue to fund our strong capital program and grow shareholder returns. In addition, we continue to make opportunistic share repurchases, which play an important role in our balanced approach to cash allocation. As you may recall, our new repurchase authorization of up to 60 million shares over a 4-year time period went into effect January 1 of this year. Under this new authority, we bought back 3.8 million shares, totaling $683 million in the first quarter. This brings our cumulative share repurchases since 2007 to 110 million shares.
Combining dividend payments and share repurchases, we returned over $1 billion to our shareholders in the first quarter. It represents roughly a 45% increase over 2013, clearly demonstrating our commitment to increasing shareholder value. That's a recap of the first quarter results. As we look to the remainder of the year, a favorable economy and some help from the weather will combine with our commitment on core pricing above inflation and our ongoing productivity initiatives to produce continued margin improvement and record financial results. With that, I'll turn it back to Jack.
Jack Koraleski (CEO)
Okay, thanks, Rob. As we put this winter behind us, we're off to a good start for the year. As always, there's gonna be some challenges ahead, but we also see opportunity. In the weeks ahead, we'll be focused on restoring the fluidity of our network after the winter slowdown. We're absolutely committed to pursuing the excellent service our customers expect and deserve. It's a cornerstone of our ongoing success. Our value proposition to our customers depends on it. Strong service goes hand in hand with improvements in network and asset utilization that are so critical to our future. Another potential challenge for the entire industry is the uncertain regulatory environment, which is being played out in Washington, D.C., Canada, and Mexico. We're watching things closely on all fronts, making sure that regulators truly understand the importance of a healthy, growing rail industry.
We're also watching the weather and the economy very closely. There's still a lot of year ahead of us, so we'll have to see how the summer burn plays out for coal demand and how the 2014 crops will fare, everything from planting through harvest. As far as the economy goes, a lot can change between now and the end of the year, but at this point, we're seeing some signs of gradual economic improvement, and we're encouraged by the opportunities it presents. With the power and the potential of the Union Pacific franchise, we'll leverage these opportunities to drive record financial performance and shareholder returns this year and in the years to come. So with that, let's get started and open it up for your questions.
Operator (participant)
Thank you. We'll now be conducting a question-and-answer session. If you'd like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Due to the number of analysts joining us on the call today, we will be limiting everyone to one primary question and one follow-up question to accommodate as many participants as possible. Thank you. Our first question is from the line of Scott Group with Wolfe Research. Please proceed with your question.
Speaker 5
Hey, thanks. Morning, guys.
Jack Koraleski (CEO)
Morning, Scott.
Speaker 5
Wanted to just first ask about the yields, particularly on the auto and coal side. If I'm understanding this right, as finished vehicles start to grow again, as weather gets better, should we start thinking about auto yields growing again? And then on the coal side, with yields down 4% year-over-year, they were just so strong in first quarter last year, up 16%. Was there anything unusual, like any liquidated damages last year that you didn't have this year, that's driving that? Because I'm just not sure how to model coal yields going forward.
Jack Koraleski (CEO)
Okay, Rob?
Rob Knight (CFO)
Yeah, Scott, let me talk about the autos first. As Eric mentioned in his comments, there was a process change that affected some per diem treatment on some containers that basically accounts for all of the decline in the autos ARC. On top of that then, as he also pointed out, the mix shift of fewer finished vehicles and more auto parts also had an impact on ARC. So we don't give guidance on what the mix is gonna look like or what the ARC is gonna look like by commodity line, and we don't do it, by the way, as a company. But directionally, yes, if we see growth in finished vehicles outpacing the growth in auto parts, you would expect that trend to move in that direction.
We're not giving that specific guidance, but you're thinking about it right. On the coal, our coal ARC was down 4%. Roughly half of that was driven by mix. I mean, your traditional mix that you might see, that's a greater movement of shorter-haul coal moves and less shipments of the higher, in some cases, repriced coal business. And the other half was made up of lower fuel prices, drove lower average per car on the ARC line. And year-over-year, you're exactly right, there was a small, as you call, we pointed out, it was roughly $15 million of liquidated damages last year that did not repeat this year, that at this point, I don't see that trend continuing throughout the year.
That had a little bit of an impact on our coal ARC line as well. That piece was about 1.5, if you will, of the 1.5% of the 4% decline.
Speaker 5
Okay, that, that's very helpful. And then just wanted to, you know, take a shot at the long-term margin guidance. So if I look historically at the first quarter OR and then the full year OR, the full year typically is about 3-4 points better than the full than the first quarter. So, and you had weather in Q1. So that, I mean, it feels like we're on a run rate this year around 64% for the OR, and that's just so much, so different than the sub-65 in 2017.
So I'm not sure if the long-term guidance is just really stale, or is there something that you're telling us that we need to be thinking about or worried about the next three quarters that's gonna dramatically change the trajectory of margins?
Jack Koraleski (CEO)
Hey, Scott, our guidance is below 65 before 2017, not in 2017. Rob, why don't you fill in the blanks on that?
Rob Knight (CFO)
Yeah. And Scott, I mean, we hope you're right. I mean, there's a lot of things that have to play out. I mean, we certainly hope that the economy cooperates. Fuel prices, as you've heard us speak many times, can have a, an impact directly on the margins and the operating ratios. So as we've said all along on this financial improvement journey over the last decade, you know, we're not looking at the sub-65 as an endpoint, and we're not going to slow down. We're going to get there safely and efficiently as we can, and if all the stars align, the economy cooperates, and we move in the direction that we hope everything happens, you know, we'll get there as soon as we can.
Our best look at this point in time is that that looks to us like it's sometime before 2017.
Jack Koraleski (CEO)
Okay, thanks, guys.
Operator (participant)
Our next question comes from the line of Chris Wetherbee with Citigroup. Please proceed with your question.
Speaker 5
Thanks. Good morning. You know, maybe just a quick question on the volume pace. As you came out of the first quarter, things obviously ramping up, it seems like there was probably some pent-up demand here that's carried into the second quarter. How do we think about sort of how long that lasts and maybe the pace of activity here? And how much is sort of still yet to be moved that wants to be moved, and, and kind of when can you catch up, do you think?
Jack Koraleski (CEO)
Yeah, I think you're exactly right, Chris. I think as we moved towards the end of the quarter, we were catching up from some of the issues in the early quarter. But, you know, our volume outlook is still fairly decent for the year. So Eric, you want to-
Eric Butler (EVP of Marketing and Sales)
Yeah, Jack. Yeah, Chris, as Jack said, clearly, there was some catch up, particularly when you think about the difficulties that the winter had on the automotive business, and then even coal utilities, there was a strong coal burn, and so there was some catch up there. You could also think about our grain business and the grain harvest. There's a natural processing in the first quarter, shipping the record corn harvest that we had in the fourth quarter. But like Jack said, I'm pretty optimistic about a slowly strengthening economy for the balance of the year. A slowly strengthening economy across our book of business will have positive impacts. Plus, we continue to have a strong value proposition, and so we're optimistic for the balance of the year.
Speaker 5
That's great. That's very helpful. And on the coal side, when you think about the inventories of the utilities that you're serving relative to those length of haul differences that I think showed up here in the first quarter, how should we think about that? Is there any imbalance there where it might suggest you have stronger volumes continuing to those shorter length of haul utilities? Any sort of color you could give there would be helpful.
Eric Butler (EVP of Marketing and Sales)
Yeah, I would say there's no kind of balance in and out. Inventories are quite low, as you probably know. They're about 21 days below what would be considered normal, so they're quite low, but there's no kind of imbalance between short and long haul that would have a mixed change for the future.
Speaker 5
Okay, great. Thanks very much for the time. I appreciate it.
Operator (participant)
Our next question comes from the line of Ken Hoexter, Bank of America. Please proceed with your question.
Speaker 5
Great. Good morning, and great job working-
Jack Koraleski (CEO)
Good morning, Ken.
Speaker 5
Through the weather. Just to follow up on the short haul freight that you've gained, it seems like a lot impacting the mix. Can you talk if there's any long-term impact on margins? And really, is this long-term business, or is this because some competitors are having infrastructure issues, and as they fix that, some of that reverts back to a different network, or is this more permanent business in nature?
Jack Koraleski (CEO)
You know, it really kind of depends on the individual markets, Ken. For instance, the short-haul move that Eric referenced on the waste product is a customer of ours that just historically had, had last year had moved for nine months, and this year really picked up volume in the first. So that's kind of an ongoing issue for us. Rob, you want to hit any more of the-
Rob Knight (CFO)
Yeah, Ken, I would just say, I mean, your, your question is hitting right on the, the reason why you've heard me many, many, many times say we're not giving guidance on, on average revenue per car, because mix is always a part of our business. And when you look at as diverse as our franchise is and as diverse as all of our commodity groups are, mix is rather normal. But as you also are questioning in terms of the margin, you know, just because something has a short haul, lower average revenue, revenue per car, doesn't mean it has a lower margin. So, you know, we're not afraid of that at all. We're pricing and moving the business as efficiently as we can, driving our margins, which in fact, we've done. We did that in the first quarter, even with this negative mix impact.
So, mix will always, always be a part of our business, but we're focused on improving our margins regardless of length of haul.
Jack Koraleski (CEO)
Yeah, as Rob said, if we can get our reinvestibility threshold met, we're happy to take the business.
Speaker 5
That's, that's great insight. Thanks. Just a follow-up on the locomotive side, and I guess demand side overall. As you noted, demand kind of creeping in a little bit on a gradual improvement. If we start seeing it a faster pace of improvement, what's your thoughts on your ability to handle it, to take the capacity, access locomotives, your infrastructure's ability to handle it? Maybe it's a Lance question in terms of scalability and of the infrastructure and available capacity.
Jack Koraleski (CEO)
Absolutely, Lance?
Eric Butler (EVP of Marketing and Sales)
Sure. So Ken, we feel pretty good about fluidly handling the volume that Eric's bringing onto the network. If you think about where we are right now, the first quarter was, what? 179,000 seven-day carloads. We've publicly said we think our network can handle 195,000+ with a very good, excellent service product. So we're looking forward to that volume. Of course, it's dependent to some degree on exactly where it shows up, but you know we've been putting capacity into the network in anticipation of that, and we feel pretty good about handling the volume.
Jack Koraleski (CEO)
Our first quarter was pretty balanced, so we like that.
Speaker 5
And similarly, access to locomotives to handle that, is that infrastructure still available?
Eric Butler (EVP of Marketing and Sales)
It is. If you think about how many locomotives we have left in surge right now, it's a little over 300, and that's bearing in mind that we brought in, what was it? 600 locomotives since the fall, with a large portion of those not driven by volume, but instead driven by trying to overcome winter's impact.
Lance Fritz (President and COO)
... So we've got surge resources that'll be able to handle it.
Jack Koraleski (CEO)
As we spin up volume and our operating stats improve, we'll actually be sucking some power out of the network and putting it back in storage. That's right?
Speaker 5
Appreciate the time. Thank you.
Operator (participant)
The next question comes from the line of Bill Greene of Morgan Stanley. Please proceed with your question.
Speaker 5
Hi there. Good morning. Thanks for taking the question. Rob, I wanted to ask you about pricing. When we see this inflation metric start to rise a bit, is it logical to think that the core pricing headline starts to rise as well? Is it as simple as that, or is there another element there that we have to keep in mind?
Rob Knight (CFO)
I mean, that part of business that is tied to the ALIF, and there are timing differences, and as you've heard us comment many times, they're not all the same. Those contracts and those pieces of our business that are tied to the ALIF have different time frames of when we, they trigger. So you take that into consideration. But directionally, if ALIF, if, if inflation increases and as ALIF, in fact, you know, reflects that, that part of business that is tied to ALIF will increase, yes.
Speaker 5
Right. And then, as we look to next year's a legacy, it's got more legacy in it, right? So as we look to next year, this should have a pretty good directional trend.
Rob Knight (CFO)
Yeah. Next year, Bill, as you've heard us say several times, we've got roughly $300 million of revenue, which tends to be sort of front end of business that we will compete for in the marketplace, but it's about $300 million of legacy revenue next year.
Speaker 5
Great. And then, on inflation, yeah, I think in the past, you've talked about seeking to offset it with productivity, but if it's gonna run this low, is there a chance that our productivity actually causes our... So, not the cost related to the volume growth, but rather just the fixed cost base and the productivity, can that actually cause this cost number to go down?
Rob Knight (CFO)
You know, maybe Lance might make a comment on this as well, but I would say potentially. Again, as you, what you're referring to, Bill, as you know, is, you know, we set to price the business to market, achieve a successful above-inflation sort of pricing environment, and then in, in addition to that, offset, and we challenge ourselves to offset all, but if we hit 50% of offsetting, inflation through productivity, that's a great model. And to your point, with low- and in a lower inflationary environment and a positive volume environment, that gives us more options to, to, to do as well as we can on that.
Lance Fritz (President and COO)
That's perfect. Rob's absolutely right. Mirroring what Rob says about our drive to an improved OR, we don't set a limit as just offset inflation. We look for efficiency and productivity every day through the UP Way.
Speaker 5
That's great. Thank you so much for the time.
Operator (participant)
Our next question comes from the line of Jason Seidel of Cowen and Company. Please go ahead with your question.
Speaker 5
Good morning, guys. It's been well publicized that your western competitor has had some major, major service issues, and it seems like you guys probably got some freight from them. How much, how much did that really stress the system in the first quarter, you know, when you throw on top the winter weather and everything else?
Jack Koraleski (CEO)
You know, Jason, if you look at our issues in the first quarter, it was 99% winter. The additional volume and whatever we've taken on, either of our own bringing onto the network or anything that might have been diverted, on a temporary or permanent basis, basically just would have been handled easily by our resources, our infrastructure, the investments we've made in the past. So it did not. The additional business did not stress our network. It was just really the impact of winter weather and the impact that it had, not only on Union Pacific, but broad-based throughout the industry on our interchange partners.
Speaker 5
Okay. Jack, this is a broader question. I asked this on another call, the other day. You know, we've had issues with Chicago as an interchange in the rail network the entire time I've been an analyst. I mean, obviously, it was greatly exacerbated this quarter with winter weather. And I know there's been projects around, like the CREATE project, to try to improve that, but what's really just holding the rail industry back from all getting together and really just trying to fix this interchange once and for all? Because it seems like, you know, this is something that would benefit, you know, six of the seven Class I's going forward.
Jack Koraleski (CEO)
Yeah, my perspective on that, Jason, is CREATE still is a blueprint for how we can significantly improve the throughput in the Chicago area. But each railroad has its own issues that it's dealing with as well. And so for our—in our world, you know, we're making investments, we're planning, we're working together. Having the centralized operating control group in Chicago helped to mitigate some of the winter weather, but there's lessons learned here, and I'm sure that as we come out of this first quarter experience, we'll learn from that. The industry will learn from that. We spent a lot of time working with our interchange partners on throughput and volumes and things like that. How can we handle things more fluidly? Our ability to divert to different gateways, depending on the individual interchange partner, those kinds of things.
So, I think there'll be lessons learned from this, but I still fundamentally think the investment and the strategy identified in CREATE holds a lot of potential for us. Lance, what do you think?
Lance Fritz (President and COO)
Yeah. Absolutely, Jack, and there's something that the participants in CREATE have been public about, and that is, since the start of CREATE, we've taken half a day out of the time it takes for a car to transfer through Chicago, side to side, end to end, which is real progress. That's down by about a third. And this year's winter was epic... and in the absence of CREATE and the Chicago Planning Group and the coordination that the interchange railroads undertook, it would have been a much worse outcome. Clearly, lessons learned, but it was effective.
Speaker 5
Lance, where, where do you think that number can come to? You said it's down by a third. I mean, can you get down by another third?
Lance Fritz (President and COO)
So, think about it like this. We've got 17 capital projects already in place, complete. There are 20 that are in design or underway. And so, you know, each one of those is gonna help. So there's still a fair amount of upside in terms of reducing the time it takes cars to traverse.
Speaker 5
Okay. Gentlemen, I really appreciate the time, as always.
Lance Fritz (President and COO)
Thanks, Jason.
Operator (participant)
Our next question comes from the line of John Larkin with Stifel. Please proceed with your question.
Speaker 5
Hey, good morning, gentlemen.
Lance Fritz (President and COO)
Morning, John.
Speaker 5
Wanted to focus on the rail cost escalator chart that was in Rob's section of the presentation. And if you look back at the trailing four quarters, that's pretty tempered inflation, and I would have thought with the labor cost escalation built into your contracts, that certainly over time, you would have seen more than an average of, you know, less than one, which I think it probably works out to be there. Anything that's going on there that we're missing? And how would you expect that to continue over the next four quarters?
Rob Knight (CFO)
Yeah, John, I think you're gonna see it continue to be low for the next four quarters. And you recall that our labor inflation, which, as you know, the way the ALIF works, it's a market basket of inputs from the industry. But the labor inflation for us, we called out that we think it's gonna be less than 2% this year. So that is a, you know, big piece of what's in there. And so it is driving and has been for quite some time now the reduction in that ALIF number. So it lines up, and over time, it does what it's intended to do. You know, from quarter to quarter, there might be some timing issues, but it's done its job over a multiple quarter, multiyear period.
Speaker 5
Okay, and then maybe just a follow-on on the timing of the restoration of complete fluidity in and around Chicago and in the northern end of the network. One of the executives giving testimony at the STB last week suggested that Chicago should be back to normal completely within four to six weeks. Is that in keeping with kind of your expectations, and will there be any meaningful impact on the EPS line during that restoration period?
Rob Knight (CFO)
Hey, Lance, why don't you handle the, the outlook?
Lance Fritz (President and COO)
Yep. Okay, John. So we are, very encouraged by what we see happening on our network right now. We're confident that sometime in the second quarter, we will be back to normal. We're working to make that as soon as possible. And in terms of, Chicago interchange, that's a difficult question for me to answer 'cause it's dependent on how quickly the networks of interchange railroads come up to speed. What we see right now is real solid improvement as we've exited winter.
Rob Knight (CFO)
Yeah, so we're hoping it won't be a material. You won't see a lot of it in the second quarter from a cost perspective, but it really depends on how it plays itself out.
Speaker 5
Thank you.
Operator (participant)
Our next question comes from the line of Rob Salmon of Deutsche Bank. Please proceed with your question.
Speaker 5
Hey, thanks. Good morning, guys.
Lance Fritz (President and COO)
Morning.
Speaker 5
Rob, with regard to the incremental margins, as I'm taking a step back and kind of listening to what I heard on the call, it's clearly mix worked against you guys. There was a lot of incremental costs associated with winter weather, which meant the network wasn't probably wasn't running as fluidly as it could and constrained train lengths. Should I think about the Q1 64% incremental margins as being a low for the year and expanding from there?
Rob Knight (CFO)
You know, Rob, we, as you know, we don't give that level of guidance, but I, as you heard me say many times, for us to get from where we are today to our sub-65, and we're not gonna slow down to get there at any particular time, we're gonna get there as efficiently as we can, assumes that we're gonna get a 50% kind of number on incremental margins from here to there. There can be lumpiness from quarter to quarter, depending on volumes, weather and other issues, fuel prices and other issues. So, you know, we're gonna keep doing as, as well as we can, but we have—I've shied away from giving specific quarterly guidance on that incremental margin number, other than to get to our sub-65, we've got to continue to make good progress.
Speaker 5
Okay, that's fair, but we should think about the network running more fluidly, and that should obviously help overall operational performance, I would imagine.
Rob Knight (CFO)
That would be a plus, absolutely. And then we'll see what volume, how volume actually plays out.
Speaker 5
No, that's fair. I’m not sure if this question should be directed toward Lance or toward Eric. I noticed in the network productivity section, one of the slides you guys were calling out about 4% volume growth in the north. And as recently as a couple of quarters, that had been down on a year-over-year basis. Clearly, your primary competitor in the west has been having a lot of challenges in that region. It looks like the TE&Y headcount increased about 6% year-over-year. Is this 6% growth with regard to expectations for future volume growth, or just handling current traffic?
On a side note of that, can you give us a sense if you guys are seeing incremental competitive wins in the north, what type of traffic that's coming on, if it's coming on, on the manifest network or unit train network?
Lance Fritz (President and COO)
Yeah, I think what you saw in the TE&Y buildup of 6%, Rob, was basically the impact of winter, where we flooded the northern region with extra labor, to help us work our way through the winter process, and it's not necessarily a reflection of what's happening, in the north on an ongoing basis. Lance, you wanna?
Rob Knight (CFO)
... Is that okay?
Speaker 5
Yeah, that's perfect.
Rob Knight (CFO)
Are you good with that?
Speaker 5
Yeah. Yeah, yeah.
Rob Knight (CFO)
And then the other thing is, when you think about our northern region, think about that's where the grain is, that's where frac sand is, you know, intermodal is sitting there, and also our coal business. And so those were all some fairly decent volume gains, just intrinsic in the business itself.
Speaker 5
Appreciate the color. So it sounds like more units are in there. Thanks.
Operator (participant)
The next question comes from the line of Allison Landry of Credit Suisse. Please proceed with your question.
Speaker 5
Thanks. Good morning. I just wanted to follow up with a question on coal, and specifically the growth in Colorado, Utah coal versus Southern Powder River Basin. So, you know, you mentioned 13% tonnage growth in Colorado and 2% in SPRB. Was that a function of weather or easy comps? And how do we think about sort of the relative tonnage growth with respect to these two origins for the balance of the year?
Rob Knight (CFO)
Okay, Eric?
Eric Butler (EVP of Marketing and Sales)
Yeah, so if you think about Colorado, Utah coal, there was some easy comps year-over-year. We do continue to expect in the outlook to see Colorado, Utah coal being a good source for export coal as the export coal opportunities strengthen in the future. But I think if you think about it going forward, Southern Powder River Basin growth will probably outpace Colorado, Utah growth going forward in terms of upside opportunity.
Speaker 5
Okay. And is it fair to say that the SPRB has a longer length of haul?
Eric Butler (EVP of Marketing and Sales)
It depends on the origin destination pair, but that's probably not an unreasonable expectation.
Speaker 5
Okay.
Eric Butler (EVP of Marketing and Sales)
But it depends on the origin destination pair.
Speaker 5
Got it. Okay. And then just I had a couple of questions on the frac sand business. You mentioned the volumes were up over 20% in the quarter. So I was wondering if you could talk a little bit about the sustainability of this pace of growth over the next couple of years as new mines continue to come online in Wisconsin. And then, you know, could you give us a sense of how much of the frac business you are originating and terminating on your own mines, and maybe which shales you're delivering the most frac to?
Eric Butler (EVP of Marketing and Sales)
Yeah. So we're very excited about our frac sand franchise. We think we have the premier origination franchise, and we think a significant portion of the new mines that are coming online in the Wisconsin, Minnesota, Illinois region actually are coming on our franchise, or at least access our franchise. So, we're pretty optimistic about the longevity and the outlook from that standpoint. At the end of the day, it's really going to be drilling that really drives the consumption of frac sand and the drilling trends in terms of longer mines, longer drilling, deeper drilling, deeper horizontal, more fracking, all are pointing to significant continued growth in frac sand consumption.
One of the interesting trends in Texas, in particular, for Permian Basin and Eagle Ford Basin, I think in January, I don't know if the February, March numbers have come out, but in January, Texas hit an all-time record of production of oil, in terms of records going back to the early 1980s. So as long as those drilling trends continue, you'll see the frac sand demand continue, and we have the premier frac sand franchise.
Speaker 5
Okay. And I would imagine that has a pretty good length of haul from Wisconsin to Texas. Is that correct?
Eric Butler (EVP of Marketing and Sales)
You know, it traverses north-south. It's not as long as some east-west moves, but, you know, it's a pretty good part of our franchise.
Speaker 5
Fantastic. Okay, thank you for the time.
Operator (participant)
The next question comes from the line of Brandon Oglenski with Barclays. Please proceed with your question.
Speaker 5
Yeah, good morning, gentlemen, and congrats on a relatively good quarter here. You know, Rob, I wanted to come back to the discussion on pricing, because I feel like there's a lot of maybe misunderstanding around the core pricing gains. You know, obviously you had higher levels of gains last year, but actually we're seeing better margin expansion this quarter. Can you just expand on your comment about how the new and incremental business is not necessarily captured in your metrics?
Rob Knight (CFO)
Yes. I mean, you've heard me say this many times, but, the way we calculate price at Union Pacific is how much price did we yield in a particular time period against our entire book of business. I'm very proud of the way we calculate it, because it's the most conservative way of looking at it. What I pointed out is that... So what that means then, if we bring on a new piece of business or business that we haven't had for, you know, over a year let's say, that business might come on at great margins, of course, because we're very focused on bringing it on at the right margins, at the market level pricing. But it wouldn't show up in new price. I mean, it wouldn't show up in a year-over-year calculation of price. You're exactly right.
When we point out that our pricing was up 2%, and you know all the headwinds we faced, low legacy, number light, and the ALIF impact, the reason we were able to expand our margins is we were able to leverage the business, leverage the new volumes that came on, and as new business came on, we are confident we're pricing it right, but it doesn't show up in the pricing number, but it shows up in our margins.
Speaker 5
... Right, and that's what we should really be focused on to see how you're delivering on the pricing front, right?
Rob Knight (CFO)
Well, yeah, I mean, clearly, pricing is a tool along with productivity and other things that we do. But at the end of the day, margin expansion is clearly the ultimate driver or the ultimate answer.
Speaker 5
All right, well, thank you. And hopefully, I can just get one follow-up in here, for Lance. Lance, I think you did state that, you know, the network is designed for 190-195 thousand units, I believe. You know, that's about 5% from where you've been running, the last few weeks. Does that signal that we need a lot more CapEx going forward, or are there any structural constraints in the network that make it tough to get to 200,000?
Jack Koraleski (CEO)
No, Brandon, you know, what we typically say is 195-200,000 7 days we could handle fluidly. We say that because in 2006, we peaked at a number about like that, a very different service product at that time, and since then, we've improved processes, we've invested capital, we have more surge capacity, and that's what gives us that confidence level. From the point of view of handling the volume that Eric's team is bringing on right now and for the rest of the year, absent some acute areas where maybe we've got a very specific capacity constraint, we feel very good about being able to satisfy that with a high service product.
Speaker 5
Well, thank you.
Operator (participant)
Our next question is from the line of Bascom Majors, Susquehanna. Please proceed with your question.
Speaker 5
Yeah, good morning, guys. You know, there's a lot of regulatory balls in the air, the STB, particularly relative to just a few months ago. And you also mentioned some things developing in Canada and Mexico earlier in your comments. I was just hoping if you look at all of these at once, could you help frame what, in your mind, is the greatest long-term concern for you? And perhaps additionally, you know, what's more immediate that you're looking at today that could impact you, fairly soon?
Jack Koraleski (CEO)
You know, that's a fairly broad question, and so we, we treat each of those as a very serious issue, and we look at them very carefully and closely. So we're watching what's happening with the Neague proposals, the service hearings, the Canadian-directed agricultural shipments, the Mexico reform. So, in each of those cases, we have teams of people looking and working very hard to ensure, as I said in my opening remarks, that everyone understands the importance of having a viable, growing and healthy rail system that's paid for by private investment and not taxpayer dollars.
So while we consider each one of those to be a very serious and a concerning development, it also gives us the opportunity to position all of the great things that, that not only Union Pacific, but the entire rail industry has done by the constant reinvestment and investment of capital dollars to build the transportation infrastructure in this country and, and actually throughout North America, that there is today. So we, we take them all one by one. If you look at, you know, the new discussion around revenue adequacy, it's gonna be an opportunity for us to point out the benefits of what's happened so far, the investment that's been made, the importance of having decisions, if we're gonna change things to recognize replacement costs, those kinds of things. The service hearings, I think, went well.
I think it positioned us well to tell the story of how, even though it was a difficult quarter for the industry, the capital investment made it a lot better than it probably would have been if it had happened 5 or 10 years ago. In Mexico, we've been working very hard to make sure the government understands the importance and the development and the volumes that have improved since we took on our concession in partnership with the FXE. And that if they look at the throughput and the development of transportation within the country, it has certainly helped to grow the Mexico economy, if you look at all the investment from the automotive industry and things like that.
So we look at these as every one of them, while it's a serious issue, if it were to go awry, it gives us a great opportunity to talk about all the good things that have happened. And so we're not afraid of them. We're willing to step up to the plate and participate in each and every one of them to make sure our story gets told.
Speaker 5
Thank you for the thorough answer. That's all I've got.
Operator (participant)
Our next question is from the line of Walter Spracklin of RBC Capital Markets. Please receive your question.
Speaker 5
Thanks for that. Good morning, everyone. I guess my first question here is for Lance. You know, with all the difficulty you had in the winter weather, you still managed to keep your headcount under good control here and, you know, didn't really need to resource up significantly to add any redundancy. So that's quite impressive. But I'm just wondering, is that reflective of what could have been a lower headcount if you didn't have the weather? And how should we look at your headcount as you go through the year and the year this year?
Jack Koraleski (CEO)
So, Walter, we think about headcount resourcing for the volume that shows up, where it shows up, so that we can maintain an excellent service product. I, I won't look backwards and guess at what it would have been if winter hadn't happened. Going forward, the right way to think about our headcount is exactly as Rob states. With productivity, we should be able to keep headcount growth lower than volume growth, and I feel pretty confident we're gonna be able to do that.
Speaker 5
Okay, so there's no nothing that distorted that in the first quarter, that you're going to significantly drop headcount now in the second quarter or anything like that?
Jack Koraleski (CEO)
... That's correct.
Speaker 5
Okay. Second question now. As you alluded to in a, in a number of different ways on your ag business, a lot of volatility. You mentioned weather, you mentioned, you know, related to that, the significant drought from last year, the unpredictability of that. If we look at the current trends in the first quarter, carloads, it seems to be off to a very good start, not only on a, on a comp basis, an easy comp basis, but also on an absolute basis.
I'm just curious if, as we model this out in future years, given how important the ag business is, when we look back at historical average levels, be it on carload or overall crop size, is there any reason why your carload volumes would be any different from an average run rate level historically? Or is that how we should look at it? Might we need to revert our 2015 ag estimates downwards to reflect perhaps a very healthy 2014 haul?
Jack Koraleski (CEO)
Eric?
Eric Butler (EVP of Marketing and Sales)
Yes, so Walter, as you recall, last year or 2012 going into 2013, there was the drought, which significantly impacted our volumes last year, same time, first quarter. So if you look at year-over-year, the fact that there was a record corn harvest, you know, that the harvest started in October, and the volumes are moving through the first quarter of this year, clearly is the primary driver behind the volumes that we're seeing. There was some, as we said, stress in the grain network on our competitors, so there was some small portion of incremental volumes we had, assisting the market due to that and those challenges that they had. But again, that's rounding. The bigger issue was the record corn harvest, a pretty good bean harvest, pretty good, wheat harvest.
In terms of going forward in the future, again, the weather will determine the yields, will determine the production, and that will determine the volumes that move during the harvest season.
Speaker 5
Okay. If I could sneak one last one in here on the regulatory standpoint, I heard all your commentary. Perhaps you could give us, if to the extent you know it, the next few catalysts for any potential changes or regulatory... In other words, are we gonna stay within the confines of the STB and their actions, or could there be any other occurrences that might impact the STB's any changes the STB might make on the regulatory front?
Jack Koraleski (CEO)
You know, at this point in time, as we look at it, the regulatory model is based on railroads being allowed to earn their rate of return and be revenue adequate. We don't see a lot on the legislative front. There is the railroad antitrust bill that has been introduced but has seen no action. So we haven't really seen a lot on the regulatory front, other than what's happening in the STB.
Speaker 5
Right.
Jack Koraleski (CEO)
Actually, as we look at the STB hearings, they're taking a very measured and thoughtful approach to it, so we're in good shape.
Speaker 5
Okay, that's encouraging. Thank you very much. That's all my questions.
Operator (participant)
Our next question is from the line of Justin Long with Stephens. Please proceed with your question.
Speaker 5
Thanks, and good morning. We've been hearing a lot lately about a tightening truckload environment, and you would imagine this should bode well for intermodal pricing as we progress throughout the year. Do you think you will be in a position to get better intermodal pricing in 2014 versus what you've seen in the past few years?
Eric Butler (EVP of Marketing and Sales)
Eric? As we say, we continue to price to the market, and we are continually focused on taking advantage of strong demand. As you mentioned, the CSA is having an impact on trucking capacity. It had an impact in the winter because of the safety concerns. There probably were some trucking capacity that self-selected themselves out of taking trips during the most difficult portion of the winter weather because of the concern of the risk with the CSA. But we continue to think that the intermodal opportunity is strong, trucking capacity is tightening, and we continue to think that that's a good outlook for our book of business.
Speaker 5
Okay. Thanks, Eric. And maybe as a follow-up to that, how much flexibility do you have to move pricing in intermodal? Have you already established your rates for this year, or do you have the ability to raise rates throughout 2014 if the market and demand continues to move higher?
Eric Butler (EVP of Marketing and Sales)
You know, as we've talked in the past, a portion of our business is in different segments, some in long-term contracts, some in one-year contracts that rotate or come up throughout the year, some in instruments that you can change on a relatively frequent basis. Our intermodal business has that same kind of profile, and as we have opportunities based on demand and market prices, we'll take them.
Speaker 5
Okay, great. I appreciate the time.
Operator (participant)
Next question comes from the line of Keith Schoonmaker of Morningstar. Please proceed with your question.
Speaker 5
Yes, thanks. I think my question is for Eric. Eric, your comments remain quite positive on the 2014 economy, and I want to ask you about chemicals in particular, given the sea change in U.S. natural gas economics from fracking. Would you share any new developments or your expectations for what industries within chemicals might lead rail volume growth, and if you think this will come on next year or further into the future?
Eric Butler (EVP of Marketing and Sales)
... Yeah, I think we've said several times in the past that with the relatively low natural gas prices, you know, futures are still, I think, around $4.50 or something like that. You're seeing a lot of plastics development coming on, a number of different plants that have been announced for expansion. I think we've said in the past, in previous earnings releases, that most of those will come on 2016, 2017, but we continue to see strong upside opportunity from that. Our fertilizer business we continue to see a strong upside opportunity in our fertilizer business. So fertilizers, plastics, industrial chems, we think are a long-term positive outlooks.
Speaker 5
Thanks, Eric. I guess just a quick follow-up on the Mexico discussion. I mean, given this business is handed off to your U.S. assets rather than your own operations in Mexico, and I recall the Ferromex ownership stake, can you comment on how you believe your franchise would actually be affected if the bill proposed became law? I mean, is this just a bad precedent for other jurisdictions, or would this, in itself, have material impact to UP?
Jack Koraleski (CEO)
You know, I think overall, if you look at our franchise, the Union Pacific franchise, the business that's moving into and out of Mexico, it's not gonna really change materially, our ability to deliver goods both to the border and also to take them from the border and deliver them throughout the U.S.
Eric Butler (EVP of Marketing and Sales)
Rob?
Rob Knight (CFO)
I think you've heard us say this before, but our interest in this is we don't wanna see something that erodes commerce in Mexico. And we think one of the unintended consequences of what, you know, the potential bill is, is that it would create less commerce in Mexico, because we, as you know, the only railroad that crosses the six border crossings in and out of Mexico. So we just like to see commerce continue to grow and volumes continue to want to cross the border both ways, and, you know, we're ready to handle it.
Speaker 5
Yeah, agree. Seems like a big step backwards from recent progress. Thank you.
Operator (participant)
The next question comes from the line of David Vernon of Bernstein Research. Please proceed with your question.
Speaker 5
Hey, good morning. Just two quick questions maybe on the growth outlook. Eric, the intermodal weeklies are looking pretty strong right now. How much of that is the Santa Teresa opening versus maybe some just straight organic conversion versus share take?
Eric Butler (EVP of Marketing and Sales)
So we did open our Santa Teresa facility in April 1 of this year, and we think that that will be a strong lever for us for that market. That market, I think we've, we've talked publicly that that new ramp has about a 250,000 lift capacity. If you think about it, our domestic intermodal business is 1.6 million units. So we are seeing strong growth with our products and services across the board. Certainly, the new product offerings from Santa Teresa will add to that, but we're seeing strong growth across the board.
Speaker 5
So should we think that Santa Teresa, the opening of that terminal, is gonna continue this growth kind of through the year and it laps? Or is this more, I guess I'm trying to figure out if the current strength is more of a temporary thing that should ebb as the weather sort of eases up and other rail service improves, or if we should be expecting these higher upper single digit growth in intermodal going forward?
Eric Butler (EVP of Marketing and Sales)
Yeah. So the current strength is the strength that we're seeing across our book of business. When a ramp opens up, there's a gradual ramp up, and there's gonna be a gradual ramp up in Santa Teresa. The current strength in our intermodal business is depending on a growing, the strength, slowly growing economy and our value proposition, and that's an across-the-board opportunity for our book of business.
Speaker 5
Great. Maybe just as a separate question, are you guys seeing any development of terminals for handling heavy crude by rail, either in the western, specifically, like California refineries or down in Texas on your network?
Eric Butler (EVP of Marketing and Sales)
Yes, we have spoken before. There are a number of different terminals that are under development, both on the West Coast, and to an extent, also on the Gulf Coast. We're working actively, and part of our strategy is to strengthen our franchise. We cannot direct when and where crude oil will flow. That's determined by spreads, but our franchise wants to... We will ensure we have a franchise to land it when and where it wants to flow, long term.
Speaker 5
Would you think that those Western refineries might have perhaps a little bit of a cost advantage via rail relative to the Gulf?
Eric Butler (EVP of Marketing and Sales)
Not really sure what you're asking. When you say cost advantage, you mean lower rail, rail costs?
Speaker 5
Yeah, lower distance to move from Western Canada down to the West Coast.
Eric Butler (EVP of Marketing and Sales)
It'll be market-based, and we'll price to take advantage of the value of our franchise, whether it's going to the West Coast or to the Gulf Coast.
Speaker 5
All right, thanks.
Operator (participant)
Our next question comes from the line of Ben Hartford, Robert W. Baird. Please proceed with your question.
Speaker 5
Hey, good morning, guys. I think a question for Lance. If I look at cars online, cars online are call it 10%-12% above trough levels of last year. As we think about volume growth accelerating and kind of a crosscurrent of the network normalizing into the third quarter, how should we think about the asset requirements of the network going forward? I mean, can we continue to think about cars online falling as they were through all of last year? Or should we think about those 2013 levels as the trough, and now that we do see volume growth accelerate,
... that, that growth number should lag, but we won't quite pierce and, and fall below the best levels realized last year. Can you provide some perspective there?
Lance Fritz (President and COO)
Sure, sure, Ben. As I look at car inventory on our railroad right now, the large majority of the growth year over year is about winter impact, and I'm expecting that portion of inventory to ultimately bleed off as we're able to interchange it off to, other carriers, or ultimately get it to a customer on our own railroad. There is some amount of that growth that's, driven by unit volume growth. And, what I really look at and care about is, car productivity, as opposed to the absolute inventory number. The absolute inventory number is important for me as a, as an overall indicator, but what we really try to drive is, good utilization of the cars that are on us.
Speaker 5
Okay, that's helpful. Thank you.
Operator (participant)
Our next question comes from the line of Don Broughton of Avondale Partners. Please proceed with your question.
Speaker 5
Good morning, everyone. Real quick, you talked about wage inflation. Looking at the comp benefit line, obviously, wage inflation 2%, what are the other puts and takes? Performance bonuses we hope you earn, pension tailwinds, what else is gonna be pushing and/or pulling that line in 2014?
Eric Butler (EVP of Marketing and Sales)
Yeah, Don, the on that line, a big, a big offset, if you will, to wage inflation has been the pension expense, the pension side of the equation, and that's been the reason why I say that our labor line for the full year expected to be below 2%.
Speaker 5
Okay, fantastic. So the wage inflation actually is higher than that. It's just that the actual line itself will come in at under 2%.
Eric Butler (EVP of Marketing and Sales)
That's correct.
Speaker 5
Thanks, Rob.
Operator (participant)
Our next question comes from Jeff Kauffman of Buckingham Research. Please go ahead with your question.
Lance Fritz (President and COO)
Thank you very much. It's been a long call. Most of my questions have been answered. Just kind of one quick one on the locomotive CapEx you spoke about. With the Tier Four locomotive standards, this is the first time I think we're using exhaust gas recirculation to meet the standards, and the experience of the truckers with this was we ended up with more expensive engines that were not as efficient. What are your thoughts on the locomotives post the Tier Four standard, and does this change the economics for you in terms of thinking about natural gas as an alternative fuel in the long run for the locomotive fleet?
Eric Butler (EVP of Marketing and Sales)
Lance?
Lance Fritz (President and COO)
Sure. So, first thing to note is, we have a couple of Tier 4 test units that are on us, wired up, so that we can fully understand what the OEM involved, what the economics and what really the overall performance metrics of those units look like. It is not certain, what efficiency impact a Tier 4 locomotive is gonna have, in relation to a Tier 3. I know the OEMs are working very hard to make, fuel consumption rates roughly equivalent, and, so there's more to follow there. And in terms of will a delta in that make a fundamental difference in the LNG economics, the answer is that's probably a minor impact. The major impact is, utilization, infrastructure costs, and a couple other elements.
Speaker 5
Okay. Well, Lance, thanks so much. Guys, congratulations.
Eric Butler (EVP of Marketing and Sales)
Thanks, Jeff.
Lance Fritz (President and COO)
Thank you.
Operator (participant)
Our next question is from the line of Cleo Zagrean with Macquarie. Please receive your question. Ms. Zagrean, your line is open for questions.
Speaker 5
Hi, thank you. My first question relates to pricing. Could you clarify for us how much of your book is specifically tied to ALIF or another inflation cost measure, and how much is able to take advantage of improving demand fundamentals, as, for example, in intermodal?
Eric Butler (EVP of Marketing and Sales)
Rob?
Lance Fritz (President and COO)
Yeah, I mean, roughly a quarter of our business is tied to an escalator, ALIF the major driver, of the escalations that we use. And I would just, I would also then add to that, Eric responded earlier to the intermodal question of, you know, what capability does he have to take pricing up throughout the year? And we've got a mix of long-term contracts, we've got a mix of short-term contracts, we've got a mix of annual quotes, if you will. So we look to take advantage and, move and price to market, wherever we can. We don't give specific guidance by commodity as to how much we can touch within a particular time frame, but across our entire book of business, we look to price to market where we have the opportunity.
Speaker 5
Would you be able to comment what verticals are offer most opportunity this year, in your opinion?
Eric Butler (EVP of Marketing and Sales)
No, we don't - we won't get into that.
Speaker 5
All right, thank you. And then my second question relates to crude by rail opportunities, specifically tied to the Permian. Would you be able to share with us what kind of growth or infrastructure development projects you are looking for there to enable you to take advantage of production growth, and what kind of commitments you are looking for in the supply chain to commit your capital to developing that area?
Eric Butler (EVP of Marketing and Sales)
Yeah, as we've said previously, the Permian Basin has great pipeline coverage, and that's where most of the production growth has taken place in the state of Texas. So if you look at our crude by rail volumes from the Permian, they actually have decreased significantly. We've said that in the past, and they're really nominal. And going forward, there may be some spot opportunities for crude by rail in the Permian, but the Permian has great pipeline coverage, and we don't expect that to be a driver of any crude by rail volumes going into the future. It is a driver of our drilling materials volumes like frac sand and pipe.
Speaker 5
So you're not contemplating maybe laying some new rail into California refineries, or that's more science fiction than feasible future?
Eric Butler (EVP of Marketing and Sales)
Yeah, so we are, as I mentioned before, looking at strengthening the destination franchise for crude by rail into California. At this point in time, we, the market is suggesting a lot of that will be sourced from Canada or the Bakken. There are those in the market who believe that Permian will go to California. If that happens, we'll be prepared for it, but I think the market today is suggesting the majority of crude by rail in California will come from Canada or the Bakken.
Speaker 5
Thank you very much. Really appreciate it.
Operator (participant)
Thank you. At this time, I would like to turn the floor back over to Mr. Jack Koraleski for closing comments.
Lance Fritz (President and COO)
Well, great. Thank you, everybody, for joining us on the call today, and we look forward to speaking with you again in July.
Operator (participant)
Thank you. This concludes today's conference.
