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Canadian Pacific Railway Limited (NYSE:CP)

Q4 2013 Earnings Call

January 29, 2014 11:00 am ET

Executives

Nadeem Velani

E. Hunter Harrison - Chief Executive Officer, Director and Member of Safety, Operations & Environment Committee

Keith E. Creel - President and Chief Operating Officer

Jane A. O’Hagan - Chief Marketing Officer and Executive Vice President

Bart W. Demosky - Chief Financial Officer and Executive Vice President

Analysts

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

Fadi Chamoun - BMO Capital Markets Canada

William J. Greene - Morgan Stanley, Research Division

Keith Schoonmaker - Morningstar Inc., Research Division

Benoit Poirier - Desjardins Securities Inc., Research Division

Ken Hoexter - BofA Merrill Lynch, Research Division

Steven P. Hansen - Raymond James Ltd., Research Division

Allison M. Landry - Crédit Suisse AG, Research Division

Christian Wetherbee - Citigroup Inc, Research Division

Brandon R. Oglenski - Barclays Capital, Research Division

Scott H. Group - Wolfe Research, LLC

David F. Newman - Cormark Securities Inc., Research Division

Turan Quettawala - Scotiabank Global Banking and Markets, Research Division

Jeffrey Asher Kauffman - The Buckingham Research Group Incorporated

Donald Broughton - Avondale Partners, LLC, Research Division

Thomas Kim - Goldman Sachs Group Inc., Research Division

Jason H. Seidl - Cowen and Company, LLC, Research Division

Walter Spracklin - RBC Capital Markets, LLC, Research Division

Operator

Good morning. My name is Aaron, and I'll be your conference operator today. At this time, I'd like to welcome everyone to Canadian Pacific's Fourth Quarter 2013 Conference Call. The slides accompanying today's call are available at www.cpr.ca. [Operator Instructions]

I'd now like to introduce Nadeem Velani, AVP, Investor Relations, to begin the conference.

Nadeem Velani

Thank you, Aaron. Good morning, and thanks for joining us. I'm proud to have with me here today Hunter Harrison, our CEO; Keith Creel, President and Chief Operating Officer; Jane O'Hagan, EVP and Chief Marketing Officer; and Bart Demosky, our EVP 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. We would appreciate if you limited your questions to strategic items and if you could have any modeling questions, please follow up with Investor Relations after the conference call.

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

E. Hunter Harrison

Thank you, Nadeem, and welcome to everyone. We've got a lot of ground to cover today, so I'm not going to be redundant with the presentations that the -- my colleagues are going to give you, but just suffice it to say that I was extremely pleased with the quarterly and annual results. I think we exceeded most expectations. I think that -- I think we've assembled now our team of railroaders that is second to none in the world. And I think that as we go through the presentation today and talk about guidance for the future, that it will give you even more confidence in what this team has got the ability to produce.

Let me just highlight one thing that I was extremely pleased with that took place right at the end of fourth quarter and right the first of the year as we brought on a new Executive Vice President, Chief Financial Officer, Bart Demosky, who came to us from Suncor.

We did extensive searches all over North America for a longer period of time than I would like to have done but he was worth the wait because I'm convinced now we could not have gotten a better candidate. It just so happened that he happened to be a neighbor here in Calgary. He has hit the ground running. He's a quick learner. As you will see by his presentation today, he's getting a grasp of the business, and he's become an integral part of this team. So welcome, Bart, to the team. Nice to have you.

And with that, let me turn it over to Keith, who'll make a few comments on the operating results.

Keith E. Creel

Okay, thanks, Hunter. I'm just going to highlight some of the key points of the quarter, some of the things we're most proud of and save [ph] maybe an extension of questions for the Q&A talk. Overall, very impressed with the operating team's performance in the fourth quarter, in spite of some pretty tough comparables that we did have the counter impact, last year fourth quarter 2012 with the happy hour due some of those things that you put into play, Hunter. So the bar is raised for us this year, but this team has met, exceeded those challenges.

We drove additional improvements in train length, weight and fuel, again in spite of the comparables and in spite of the weather challenges, which kicked in, in spades, in December. Strong volumes in the first 2 months helped drive a lot of the operating leverage with RTMs up significantly about 9%. Until mother nature started throwing some curveballs at us in December. We did have some headwinds there that we had to deal with which limited some of the productivity gains and impacted the service offering. So a little bit of impact on the operating efficiency side, as well as on the revenue side there in December. But in spite of that, we closed the quarter very strongly, not losing any ground to a record performance in third quarter at a 65.9, it's something we're very, very proud of that this operating team produced.

Some of the leverage key highlights there, fuel continued to improve dramatically year-over-year by increasing our train lengths in these locomotives, faster and aggressive on the fuel conservation side, 7.8% improvement versus 2012. A little bit more excited that we closed the gap to fast becoming best-in-class 2012, we're about 12% behind best-in-class, third-best in industry, 2013, we closed the year out only 4% off of best-in-class and second-best in the industry. Rest assured, we've got line of sight to be best-in-class by the end of 2014.

On the safety side, another very encouraging story, fourth quarter, best fourth quarter, best quarter overall safety performance on the train accident side in the past 3 years, about 20% improvement over 2012. And more importantly, we -- as we told the market back at the end of the first half of the year, some of the challenges we had we are confident with our investments to technology to our fiscal plan improvements, as well as our culture changes, driving rules, compliance and safety, we would see a benefit. We closed that gap. We finished the year just a little off almost flat with 2012, which was a record year, so very encouraging. A lot driven by making [ph] that momentum into 2014, having so far a very encouraging safety performance from the derailment standpoint, accident standpoint in 2014.

So that said, 2014, another strong year, much still left to do, more to come. We've invested quite a bit in 2013 in sidings, which came on late in the year, we're going to be able to convert and expect this operating team to convert that in 2014, taking out additional train starts, driving some more velocity improvements and more locomotive productivity improvements, train weight and length improvements.

And focusing on our yards, I'll remind you the whiteboard sessions we did last year, those kicked in certainly in spades second half comparable-wise, though first half we did not have the benefit of those. We will realize the benefits of those operational improvements with train small reductions and all the benefits of that first half of 2014. And as we look at '14 from a capital investment standpoint, we're going to continue to strategically invest in our network to increase the reliability, to increase the safety or investment in CTC, we're investing additional steel, we're investing in additional 11 sidings by the end of the year, with a focus instead of bringing all those sidings on toward the end of the year, we're going to pick the one strategically to give us the most bang for the buck from a velocity standpoint, from a service reliability standpoint and concentrate our assets and resources to bringing them online based on that sequence in priority through the year. So we'll start to see some of those gains a little bit earlier than we would have otherwise.

So with that said, very, very excited about 2014 and about the abilities and the opportunities that are out there.

I'll turn it over to Jane to comment on how she's going to convert that in the marketplace.

Jane A. O’Hagan

Good morning. I'm pleased to announce that we delivered 8% revenue growth in 2013. And specifically on the quarter, we continue to improve the quality of revenue and to deliver on our growth initiatives, giving us a record revenue performance with 7% growth over Q4 2012. Our average revenue per car was up 6%, and our renewal pricing came in above our target range of 3% to 4%.

Demand remains strong, but as Keith indicated, volumes softened toward the end of the quarter as the entire supply chain was impacted by poor weather conditions experienced across North America. For 2014, we are targeting 6% to 7% revenue growth.

As further guidance, I'll note that a $0.01 drop in the value of the Canadian dollar versus the U.S. dollar has a positive annualized revenue impact of about $35 million.

So turning to 2013 highlights of the business, I'll report revenues on a currency adjusted basis. So let's start with grain. Our Q4 results, our revenue up 5%. With the exception of Western Canadian crop estimated to be 79 million tons or 27% higher than the previous record, we had a strong export program moving 12% more grain through Vancouver in Q4 2013 than in 2012. Our carload decline of 1% reflects lower demand in the U.S. Midwest relative to Q4 2012 when we had a significant increase in the volume we shipped to domestic U.S. markets we traditionally don't serve. Average revenue per car was up 9%, as pricing gains were achieved in both Canada and the United States.

Our outlook. We see a return to normal U.S. condition combined with a record crop and strong demand in Canada that will present upside opportunity through 2014 for our entire grain franchise.

Now turning to fertilizers and sulphur. In Q4, we were down 9% in revenue. But despite global market uncertainty, our export products volume increased strongly against the relatively weak Q4 2012. Domestic Fertilizer weakness resulting from a late harvest and a small application window offset gains in products export. The international potash market prices began to stabilize at the end of the quarter.

So as we look to the outlook, there are strong demand fundamentals for domestic fertilizer application as both farming comps and grain prices are up, and because demand was constrained during the fourth quarter. The return of cooperation between Russian potash producers creates greater price certainty and this stability sets the stage for international buyers to purchase with a lot more confidence. We expect this development will drive a recovery and export volumes similar to the experience in the first half of 2013.

As we turn to coal, Q4 results revenue was flat year-over-year. As I advised last quarter, met coal exports drove an increase in our Canadian volume, while a decline in U.S. coal traffic related to continued weakness and electric utility demand presented. The decline in short-haul thermal traffic and the increase in longer coal export met coal resulted in a 6% increase in the revenue per car.

As we look to the outlook, tech [ph] hold a strong position in the met export coal Market both with respect to market diversity and in cost performance, and the increased capacity is expected to translate into volume growth for CP's Canadian franchise. U.S. volume growth is uncertain as questions remain about turnaround in the domestic and export demand with thermal coal.

Now let's turn to Intermodal. Q4 results revenue was 3% lower year-over-year. But I consider 2013 Intermodal performance to be a success. As by year end, we had improved the quality of the revenue, close the revenue gap created by facility closure services continue and book of business rebalancing. As I look towards the outlook for 2014, I want to reiterate that we're growing in the right lane, with the right customers, a line to our service capability and our network strength. We're taking the advantage of our service improvements by growing where we have competitive advantage, where we can price for value and improve the operating income of the business.

We expect Intermodal revenues to be down for the year, reflecting in part the OOCL business that is shifting to CN. But we will meet the same Intermodal challenge in 2014 that we successfully addressed in 2013 to continue to improve the operating income we generate from this business and to fill any revenue gaps that appear .

The overall book of business will continue to change, both as international contracts shift between carriers and as the composition of our domestic book changes. Our book will remain strong as we continue to focus on the segments and on the customers that drive the greatest value to both parties.

Now as I turn to industrial and consumer products, our Q4 results, we were up 18% in revenue. We moved 25,000 carloads of crude in Q4 for a total of 90,000 carloads for the year. Our Q4 RTMs were up 20% due to gains in crude oil and increases of frac sand originating from mines that continue to ramp up their volume.

As I look to the outlook, our crude oil customers have confirmed they continue to value rail service and facility development and the expansion is evidence of their commitment. Our capacity build-outs are proceeding at a more measured pace, and we continue to see increasing volumes of heavy crude moving with different economics and drivers of demand than the lighter Bakken crude we predominantly move to date. We will continue to mitigate our risk by advancing growth in careful stages that accommodate investment, the market commitments of our customers and choose those that provide good margins.

While we carefully build the capacity to handle consistent term volume, we also have the capability to move volume that responds to the movement of spreads. We have announced 3 new frac sand facilities on our network in Wisconsin. The new capacity will produce high-quality product and will be phased in throughout the year. Our other industrial products will trend with GDP growth.

So in conclusion, I'm looking forward to 2014. Our operating team has set the table for us, and we will now sell service with sustained profitability. While we have some revenue headwinds from Intermodal and automotive contract shift, I'm confident that we can deliver revenue growth of 6% to 7% in 2014. We're starting this year off with a new marketing and sales organization that we rolled out in Q4, and we're kicking off next week with the new incentive compensation program that will reward profitable growth. The team is focused. We're up to the challenge. And with that, I'm going to turn it over to Bart.

Bart W. Demosky

Well, thank you, Jane, and good morning, everyone. I thought I'd maybe just start off by reiterating a couple of things, and first and foremost, just how excited I am to be on board here at CP. Hunter gave some very kind comments at the beginning there, and I'm looking forward to being up to the challenge. It's a great opportunity and one I'm really looking forward to. I'm also excited to be here on the call with all of you today. It is only day 18 for me, so I am going to keep my comments at a fairly high level and focus on 3 things.

First, I'll just cover a few of the key metrics for you. I did want to spend some time on operating expenses because that is such an important part of the story and the value contribution here, and there's continued great work going on there. And then I am going to touch on free cash flow. I know that's an area of interest for many of you, so I'll provide you with a few comments there.

So just to kick things off, it was a very, very strong quarter. Adjusting for significant items, our operating income was up a full 45%. Net income was up a full 51%, resulting in EPS of $1.91. And we had an all-time operating record of 65.9%, an improvement of a full 890 basis points year-over-year.

Now there were -- there are a couple of below-the-line items that I did want to draw your attention to. One is other charges. That typically has a run rate of about $3 million in a quarter. We were impacted by foreign exchange this quarter. So in the quarter, that cost us about an additional $3 million. And then if you look at CP's effective tax rate, it came in to just over 28% for the quarter. And that was higher than our guidance that we provided previously of 25% to 27%.

Two things happening there. One was the B.C. tax rate increase that occurred earlier in the year. And then on a good news story, of course, we're seeing higher revenues in the United States, which is positive but it does attract a higher tax rate.

On to the operating expenses side. I am going to speak from the perspective of an FX adjusted basis. So just keep that in mind as you listen to my comments. In Q4, foreign exchange did have a positive impact on our revenues of about $43 million. Likewise, it increased our expenses by $29 million. And a couple of metrics to leave with you: in total, for every $0.01 the Canadian dollar depreciates, it increases our annual revenues by about $35 million, Jane had covered that earlier, and our expenses by about $20 million.

Another good rule of thumb is for every $0.01 change in the exchange rates, that equates to about a $0.05 change in EPS for us. And for reference, we have set our guidance for the year using a $1.05 exchange rate. So we do have a tailwind right now to start the year.

We saw continued improvement on the comps and benefits side this quarter. And that's despite higher stock-based comp volumes. But that was more than offset by significant efficiencies that were delivered. Stock-based comp headwinds, to be frank, those are quality comps because that means all shareholders are winning. And year-over-year, it was only a $9 million headwind. But sequentially, it was about a $25 million drag.

Going forward, just to give you a guideline, you can expect our stock-based comp sensitivity to be about $850,000 of additional expense for every $1 increase in share price.

Now before I wrap up on comp and benefits, I should note that as a result of a higher discount rate, but also very, very strong portfolio performance, we experienced a 15% return on a portfolio basis for pension assets in the year. And as a result, we are expecting pension income of $52 million in 2014 versus an expense of $45 million in 2013. As you all know, pension accounting, it is a complex -- it is complex, with lots of variables. But at this point in time, we would expect to be in an income position in 2015 as well, and we're guiding right now to about $50 million in income.

In terms of the balance sheet and pension impacts, you will note that we now have a pension asset recorded. That would be the first time in a long time for the company, I would expect. This represents an improvement or a movement, I should say, from an $800 million deficit position in 2012 to a surplus in '13. A couple of factors driving that. One, I mentioned already, which is the favorable discount rates and the very favorable portfolio returns. But also we did have some planned changes and there were significant prepayments made in previous years. We are just running the numbers right now from an actuarial basis. But at this point, we believe that we no longer have a solvency deficit.

On the fuel front, the 7% fuel productivity improvement that Keith mentioned more than offset higher fuel prices that we saw and the higher volumes we experienced in the quarter. The increase in material expenses primarily was due to volume, and there was some seasonal weather impact in there as well. Equipment rent continues to be a very positive story with productivity more than offsetting volumes that increased in the quarter. And purchased services, a significant decline in this quarter, and there's a couple of things going on there. On the efficiency side, in-sourcing initiatives drove lower IT costs, and we're going to continue to see benefits there, as well as third-party maintenance costs. And we also benefited from a bit higher land sales than we would normally experience but also lower casualty costs in the quarter.

I am going to close over the comment on free cash. In 2013, we generated $530 million of free cash, that's after dividends. And that's in spite of our CapEx ending the year just slightly higher than the $1.2 billion we guided to. The company is clearly in the strongest cash position and free cash generation position in its history, which makes me feel pretty good as CFO about my timing on joining. And for anybody who knows my background, I'm not a fan of sitting on idle cash. So while I'm not in a position today to guide you on our use of cash plans beyond those already outlined, I can say that we are taking a very close look at our options, and I'll be discussing those with Hunter and Keith and the board in very short order. So we should be back relatively soon with some plans there.

With that, thank you very much. Great to be on the call. Looking forward to meeting as many of you personally as I can. And with that, I'll hand it back over to Hunter.

E. Hunter Harrison

Thanks, Bart. I'll just start here. So let me kind of pull all this together and talk about a little guidance for 2014, and I trust you've seen the numbers, but on the revenue front, we're talking about 6% to 7% year-over-year revenue increase. And I know there's going to be a little probably discussions on that, whether that could be described by some as maybe a little conservative. But I think there's a lot of moving parts right now that we don't really have our hand wrapped around very good. One is that what's the Canadian dollar is going to do. Bart described to you some of the volatility associated there, what's going to happen in China, although I think that will have -- if there is a negative impact there, it won't impact us maybe as it does others.

On the cost front, we expect to breakthrough 65%. from an operating ratio standpoint, that's effectively a full 2-year plus ahead of the 4-year plan. And I think that we look for earnings growth in excess of 30%, which makes me even more enthusiastic about where I am with the organization and this looks like it's going to be a long, good run, and I'd hate to leave in the middle of it. But that will be determined, as Keith makes faces at me in the background here. But I think that a couple of other things that you probably have questions about online. Let's talk about a little bit about on the -- clearly, we, as Keith mentioned, we had some impact from weather conditions here in Canada, on a year-over-year basis. And really it was the last 3 weeks of December that caused the major part of the issue. But I would hasten to add that, that -- those issues continue into January. And they're in a location, basically, it's Central Canada and the Midwest. So we kind of cut the network right in two. But in spite of that, we have made some changes in the operating plan and I think Keith and his team are dealing with that very well.

On the headcount front, the number stands today at about 4,750 thereabouts. I would certainly expect by year end '14, we would clearly break through 5,000-plus, there's a request there. But that will be a very, very positive bit. And then we're having some challenges, but you always do with some SAP turnovers. But when we get those issues resolved, that's got some very positive impacts to us additionally on cost control efforts.

So with that, we'd be glad to address the questions you might have.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Tom Wadewitz from JPMorgan.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

I wanted to see if you could give a little commentary around the target, I guess, the 65 award target. You had alluded to that in the third quarter Q&A session that you thought you would maybe be at 65 or a little better in 2014. And you're sticking with that. But now, you've got a swing of $95 million or roughly year-over-year in pension. I'm guessing, on third quarter, you didn't have quite the same visibility to how helpful that swing would be. So what are maybe some of the puts and takes around that 65? And do you think that maybe that's conservative given the pension tailwind that you have?

E. Hunter Harrison

Tom, I think, if you look at the release, it actually says 65 or lower. Do I expect to do better than 65? Yes. What's the probability of it? We could debate that, but if somebody said, "Look, I think you're going to do 63," I wouldn't argue with that a lot. But at the same time, as I've described earlier, we still got some issues out there. I don't want to say at this point what it's going to be. I know if this first quarter continues like it is, and I hope it's not, we're going to have some catching up to do in the next 3 quarters. So I guess the best thing I can say to you is, as Keith described, all the operating metrics are falling in place. We have one significant labor contract to resolve this year that expires year end with the Teamsters for the running trades here in Canada. I can tell you that we're in some informal negotiations with the running trades in the U.S. and it's hard for me to put probability on maybe we can make some breakthroughs there. So if you characterize the guidance as conservative, I wouldn't debate that. I mean if we go back 2 years, people said we couldn't get there. And now, we're conservative. So in the future some time, we're going to get this right. We'll get this balanced up.

Thomas R. Wadewitz - JP Morgan Chase & Co, Research Division

Okay, great. And then the second question, I guess either for you, Hunter, or for Keith. Can you maybe run through the timing of some of the bigger initiatives there? What's going to have a bigger impact on the operating improvement? I know, Keith, you mentioned that you had some sidings that came on pretty late in 2013. You've got some that are maybe pulled forward in 2014. Maybe how big that is in terms of driving operating improvement in cost side? And then maybe some of the other big drivers? I'm sure there's a lot. But if you could highlight a couple of the biggest ones and maybe the timing when they really have an effect, that'd be helpful.

Keith E. Creel

The short answer to that question, I would say that the things, the capital investments we made in the network last year that we've got on late in the year, of course, that's going to have a meaningful impact in our ability to get to that mid-60 number. So we'll start converting that immediately. After weather, I mean, that's the challenge, Tom. When it's 40 below 0, it's hard to run long trains and long trains are which you build the network for. So once we get out of some of these challenges mother nature is giving us, you'll start to see us maintain [ph] -- now will we have quantum leaps like we had last year versus the previous, I would suggest no. But still, steady consistent gains on train length to train weight and taking out additional crew starts will help us on the headcount issue and help us on the productivity and help us convert that revenue opportunity that's out there, especially on the bulk side. And then the other things we're going to do to invest money I mean the real gains to that, well, they'll come second half and they'll come in pieces. They're not going to be any big, again, quantum leaps, but steady, slow progress, they keep helping us drive improvements in the metrics and sustaining the story towards that mid-60s number.

E. Hunter Harrison

Tom, I guess the one thing I would add to that is that, and I know it's difficult for you to -- but it's always -- to put in your model. A lot of what we're seeing right now is we're going through learning curves here. We're going through culture shock and culture change. If I look around this table of the senior team that effectively reports to me. All of us effectively, with the exception of Jane and Peter Edwards, all of us have been here less than 2 years. In Bart's case, 18 days. So we're going to gain a lot more knowledge. As we gain that knowledge, we're going to be able to impact change more with the operating officers in the field. And so, there's a lot of runway left here going forward. But I think that's a big one that gets overlooked, and I happen to think that the real success of the businesses are the people. And this team is getting there, like I said earlier, better and better, stronger and stronger. I expect that we will be -- this is just a little in term, [ph] goal, I think by the year end, we'll be out in the lead as far as deficiencies, from OR, low-cost here, however you want to describe it. So there's a lot of runway left here, barring any issues that we can't predict.

Operator

The next question comes from the line of Fadi Chamoun from BMO Capital Markets.

Fadi Chamoun - BMO Capital Markets Canada

Hunter, you've said in the past consistently that once you have better service, you get a shot at more volume. And now that you've had sort of some time to go to market with improved service, can you share with us a little bit about some of the opportunities you see out there in some of the segments? And how quickly do you think you can convert that service into growth in the next couple of years?

E. Hunter Harrison

Yes, I think there's several things there, Fadi. Number one, as I've talked to that before, I mean, people are resistant to change, number one. So you really got to differentiate yourself from the competition and give people a real reason to make the change. And I think we're in pretty solid ground with our bulk book of business. That's all about efficiencies. And the more efficient we get, the more we get all of it. But our real focus and so we're going to focus on being very efficient with bulk. But the real opportunities that I see are domestic Intermodal and the non-bulk business, or what we refer to as merchandise. In my previous experiences, you've got to go out there and prove yourself in the marketplace for 1.5 years or 2 years before you start to really gain momentum with some of those changes. So I think we'll see some of that kicking in, in '14. But I think the out years of '15 and '16, we'll really see about the ability, now some of that is restricted to some degree because people have contracts, and I think we're going to be probably in the areas that I've just described with domestic and merchandise, we'll be moving away from anything of what might be described as a longer-term contract, I mean anything. Number one, I don't know that we'll do that many contracts. But if the customer wants to do a year contract, that's fine. So I think the opportunities are still there, and I think, to some degree, we're all going to be meeting in, I think, it's next week.

Bart W. Demosky

Monday.

E. Hunter Harrison

With the sales being where I -- the easiest way I could describe this is a little bit of a shift away from a market-driven organization to a sales-driven organization, where we hope we're going to go to commission sales or that book of business I've described of the domestic Intermodal and merchandise. To my knowledge, no railroad has ever done that really. So we're going to give people opportunities to go out and sell. In real successful organizations, the people who make the most money are salespeople. You give them the products to sell. So all of those things being said, I think that this is not just a cost take-out story.

Fadi Chamoun - BMO Capital Markets Canada

Okay. Just to be clear, these new services, particularly on the Intermodal side, have you seen market share improvement as a result of these services directly yet? Or you're basically saying that this is early stage?

E. Hunter Harrison

Well, probably all of the above. We've seen some market share shift, particularly domestically. And we focused on that, that is much better margins. I think the international is going to be pretty soft this year for the industry. The margins are not as good. There's going to be more pressures on it, given that if there's issues in China, in Asia. But I think also that we're going through a period where some big names are putting us through what they call a trial period. And Keith had spent a lot of time hands-on with that, he and Jane and Mike. So I think we're seeing the opportunity. If we can produce and do what we say we're going to do, that we're going to see gains there rather quickly. Now we're not going to go out there and buy business. It's going to be quality revenue and people, they want a quality service and are willing to pay a fair price for it, that's what we're going to go after.

Fadi Chamoun - BMO Capital Markets Canada

Okay. That's helpful. Maybe one on the top line also for Jane. So you said 6% to 7% this year. You seem to be sort of confident with this outlook. Can you share sort of where do you see the opportunities to do better than that coming from in terms of sector specific? And also this sort of area of risk in that outlook, where do you feel that the biggest opportunity and the biggest risk are going to be like in the next 12 months?

Jane A. O’Hagan

Well, I think that, Fadi, obviously, the fundamentals that we have involved for the record Canadian crop and the fact that potash is back and that we expect that, with the depressed pricing, that this is going to drive our sales, is a key part. But I think to Hunter's point, we're also using service to drive growth in our bulk book and driving greenfield development as we've done in grain and as we've done in potash. I think in merchandise, obviously, we are ramping up our frac sand. We've seen that impact come into Q4. We're online with our expansions in crude. But at the same time, I'd say that we're not going to be going as quickly. I think that to Hunter's point, there's lots of things that we need to watch in that marketplace around risk, around cars. And so, we're going to be choosing this opportunity. We feel we've got good line of sight to our guidance. But choosing those that create good sustained profitable return. And I think that the other thing to add to Hunter's point about our sales force, we've also added a retail component to our sales plan. And I think that's going to give us the additional coverage that we need to continue to build that merchandise side. So with the economy at this point in time and our line of sight to our initiatives, new sales organization, focusing on selling and getting at that possible growth, our challenge is to go as hard as we can. So we feel that we have pretty good visibility to where we need to go with that guidance.

E. Hunter Harrison

Let me add something before we go to the next question. I made a mistake a while ago, and I was trying to be humorous. And I've already gotten a couple of calls from people who misunderstood my comments. My plans are not changing about when I'm going to leave the organization. The plan is to do like we've always did, that sometime in the 2016 time frame and not locked into that number, but that I would -- that would be probably when we would look at the exit strategy of me leaving and Keith taking over. So don't misinterpret my enthusiasm earlier that I'm walking out tomorrow because I've got all I need, that's not the case. So I'm going to be here for a while. Next question.

Operator

The next question comes from the line of Bill Greene from Morgan Stanley.

William J. Greene - Morgan Stanley, Research Division

Hunter, something that you touched on in some of your remarks as just as it relates to labor. I'm wondering if you can offer a little bit of a framework in terms of what's the scope for change there? Can we see something like you achieved at Illinois Central? Is that not even up for discussion? What sort of opportunities do we have to kind of have another step change function in productivity there?

E. Hunter Harrison

I mean, first of all, I think that we're talking with the organizations in the U.S. and it's no secret. And I think they have, I think it's fair to say, that they approached us, and we're interested. We have entered a dialogue with them, very similar to the type of agreement that most of you has been aware of in the past that we made a breakthrough at Illinois Central now. Keep in mind that the U.S. is a much smaller portion of our operation. So to the degree that, let's just say, we hit that then we could get an improvement of maybe 30%, 35% on the U.S. P&E front. Now is that a big breakthrough? Yes. I think maybe bigger even, Bill, is that we've already started to try and attempt to enter a dialogue right now for the negotiations that end year end because it's likely to wait till midnight, the light of day until anybody really gets down to business. And so we want to avoid disruption. We want to avoid anxiety on the employees' part, on the shippers' part. And so one of the things that we're doing, and Keith is leading this effort, so he might want to add to this comments, because we're trying to enter a dialogue with the employees and talk to the employees, tell them what we're trying to accomplish, why we're trying to do it, what we'd like to be able to do, what do they want, and so we're trying to do this in a refreshing different way than a typical rail contract. So Keith, if you've got...

Keith E. Creel

Yes, I'll just add to that. It's more of a grassroots type approach. We're certainly trying to engage the senior leadership of our running trade unions in conversations ahead of time prior to negotiations normally opening which would be towards the end of the year. At the same time, we're going to do a very good job of getting out on the ground with our employees and with our members explaining what's important to us and digesting and taking back a 2-way communication, what's important to them. With an idea that if they understand what we need and we understand what they need, there's a happy medium to be made. So we're going to be focused on that. We've got some cautious optimism. I think it's important that we do understand our employees and our employees understand us. So hopefully a more favorable agreement will come out of it and there's nothing else more positive morale environment will come out of it.

William J. Greene - Morgan Stanley, Research Division

That makes sense. Hunter, I also have a follow-up on something else you said before. So we'll see where the OR ends up in '14. But I think everybody would acknowledge that the pace of change has been just breathtaking. So when you think about achieving ultimately, whenever that happens, whether it's '14 or early '15, sort of industry-leading OR and cost structure, what sort of the next ramp for the organization from there? Is it just more OR? Or do you really just have to start driving the growth using that low-cost structure to drive the revenue to industry-leading growth rates as well? How do you think about that shift from once you've sort of achieved that goal?

E. Hunter Harrison

Well, as I've said many times over my career, I mean the objective is not to get to 58, when you have this cost capital-incentive business, somebody comes in here with a $1 billion worth of business, but the OR is going to be 56, I'm sure you're not going to turn that down. So we're going to, in a material way, try to develop what we call controlled, sustainable profitable growth and grow the business appropriately. But at the same time be as conscious, as cost conscious, as aggressive as we've always been. And if we're successful, which I have every reason to believe we will be, in converting the service and going to the market, then we'll be rewarded with that growth and that can even open up other opportunities for us.

Operator

Your next question comes from the line of Keith Schoonmaker from Morningstar.

Keith Schoonmaker - Morningstar Inc., Research Division

Continuing on right-sizing but maybe switching to assets, could you update us on your thoughts on magnitude and timing of the $2 billion or so of the real estate portfolio you now may consider as superfluous?

E. Hunter Harrison

Keith, I think that we're working very hard on the approach we should take there and the right model, and I would -- my guidance would be that I don't think we will see significant movement in '14 with that $2 billion as we've described or in that kind of range. I do think there will be some opportunities for a little line here or there. But I think it will probably be, at least, into '15 and maybe '16, gain this full momentum until we convert that and monetize those assets.

Keith Schoonmaker - Morningstar Inc., Research Division

And I guess, Hunter, maybe you mentioned a preference for a strategic question, so let me ask a big one. Do you think more mergers will take place in North America? And what would it take for this to happen?

E. Hunter Harrison

Well, let me qualify by saying, I'm probably on an island by myself when I give this answer. I do think there will be consolidations in the future. I don't -- I'm not suggesting it's going to be in the next 2 or 3 years, but I do think, given capacity issues at each point, environmental concern, you're not going to build any more railroad, that really if you look at the U.S., for example, you split up East and West, you got 2 in the East, you got 2 in the West. And a merger across the Mississippi River is not going to impact the competitive environment. I think there's a model that you presented appropriately which suggests to the shippers that they could get -- there could be more efficiencies that way, they could have lower cost, the carriers to do better. If mergers were allowed, I think there's a model that we had that said, if somebody thinks they're captive and they don't think that we're giving them the right service or the right price, then you'd have to allow brand x to come in to provide that. So I do think there will be consolidations in the future and to try to talk about the timing. But I think in the -- I don't think we'll go another 5 or 6 years without some consolidation.

Operator

Your next question comes from the line of Benoit Poirier from Desjardins Securities.

Benoit Poirier - Desjardins Securities Inc., Research Division

Keith, maybe the question is for you. You previously expected RTM kind of in the mid single-digits for Q1. Obviously, it's going through a rough start. What is your expectation right now for Q1? And is the softness only due to weather issues?

Keith E. Creel

Hello, Benoit. Absolutely, the softness is 100% due to weather. It's not because of opportunities, it's because of the challenges. And I'm going to be optimistic on this. I -- we've got some catch-up to Hunter's point. I don't expect that January, February -- February is like January, then we're going to have a pretty challenging March to do it, but I'm very confident in this team's ability to deliver that single-digit RTM growth -- mid single-digit RTM growth. So unless March is similar to January and February. We've got an opportunity in March to play catch-up, and I think we're going to finish strong.

Benoit Poirier - Desjardins Securities Inc., Research Division

Okay, very good. And would it be possible -- guys, my second question is related to crude by rail. Just to provide an update on the guidance. I think the latest one was either to double or triple the number of carloads from the base of 70,000 by the end of 2015. And obviously, we've heard very positive comments from NSC, KCS with respect to the heavy oil. So I just want to know where it's going on your side.

Jane A. O’Hagan

Yes. I think that if we talk about crude by rail, as I indicated, we move 90,000 carloads. And our current guidance was for 140,000 to 210,000 by the end of 2015. At this point, we don't see a reason to revise our guidance, but there really are a lot of factors, as I said, that can impact us along the way. We continue to watch those factors that could influence the development and the pace of that business, including pipelines, including the impact on tank cars, infrastructure at origin, at destination. But the expansions that we have line of sight to that we've announced are going as planned. So we feel confident. But, again, I just want to put it in context that crude is about 4% of our book. So, again, it's an important thing for us to just watch all the risks.

Benoit Poirier - Desjardins Securities Inc., Research Division

Okay. And I know that you're not happy from a pricing standpoint. So should we expect a better profitability as you ramp up volume and you negotiate better contracts?

Jane A. O’Hagan

Absolutely. I think that we're going to be making -- looking for all opportunities, obviously, upgrade the quality of the book, but also, looking for ways to incent and ensure that in the crude product that we're incenting the use of safer cars and newer cars as well in that process.

Operator

Your next question comes from the line of Ken Hoexter from Bank of America.

Ken Hoexter - BofA Merrill Lynch, Research Division

Keith, can you talk a bit about -- you mentioned the sidings and you talked a bit about CapEx. Maybe some thoughts on future CapEx. Are you looking for more growth investments in there? Is there any catch-up in terms of the way some of the network was structured? Any thoughts on the capital spending side?

Keith E. Creel

I would say -- when you say catch-up, maybe not the same challenges that we had in 2013 and '14. It's more about optimizing the network. It's more about strategic investments in sidings. We're not congested, but we're pushing up against opportunities to actually run longer trains, more longer trains, and take out train starts. So that's pretty much what the game plan is. As far as quantum of capital, I don't see much of a change. It's going to stay in the range of where it's at now on a go-forward basis. Maybe a little bit of uptick, somewhere between $1 billion, $1.2 billion, $1.3 billion, $1.2 billion to $1.4 billion. I mean, that's the range, nothing huge or no big opportunities or things that's going to be driving that. We're going to be focused on CTC. On the capital investment side, operation-wise, we're going to be focus on siding investments and some tweaks to some of the yards finishing out multiyear plans. Some we're going to spend in St. Paul, as well as a little bit at Chicago. And it's all just incremental investment anything that's monumental.

E. Hunter Harrison

The biggest call on the capital, right now, and I think that will continue for the next year or 2 is that we have some -- a few weak links in the network that we're going to get the basic fiscal plan and propel it to where it ought to be. And so rail-ties and balanced [ph] investment which, worse case, is you buy a little early, that's going to be the focus. We're going to have a kind of a recess here with leads on the mechanical side, and with acceptance of these few other projects like SAP, a little [ph], and then Keith mentioned the society extensions and those things that pretty well represents where we'll be capitalizing going forward.

Ken Hoexter - BofA Merrill Lynch, Research Division

Great. And just a follow-up, I guess, on Jane on 2 of the commodities on grain. Just in down -- last quarter and just understanding what the record crop, how do you see the building and similarly, on Intermodal, just given the loss business you mentioned and your focus on the domestic push, can you -- any concept on profitability of that shift from the international more toward a domestic push and what that does in terms of shifting lanes?

Jane A. O’Hagan

Well, I think, that -- let me attack the grain first. I think that when we look at the focus of this organization and what we've been doing, this record crop presents us lots of opportunities to basically move grain more efficiently. What we're doing out there is we're obviously offering as many multiple destinations as we possibly can. We've ran a very robust program at Thunder Bay, and we're continuing to create diversity for our grain shippers across the entire franchise. I think that what we've demonstrated in last year is that we can be nimble in making those markets. Because last year, the impact that we had with drought situations was we moved a lot of grain to markets that we didn't traditionally move. So I think when I look at old look, I think that we're going to move grain more consistently. I think this is going to be one of the crop years where we don't have the pickiness that we've had in the past. We'll probably have some large carryover. And with an average crop, we're going to see strong movements of grain throughout the entire year. I think as we talk about Intermodal -- as we look at the Intermodal business and we think about the margins, we've been clear before that domestic has a much better place for us in this business. The beauty of the service that we're providing is our operations team has created something for us that is really second to none in the industry. And what this is doing is these contracts open up and as these opportunities open up in place, it gives us the ability to go in and price for that value, knowing that, that service is something that no one else can touch. So again, that's part of the strategy for 2014.

Operator

Your next question comes from the line of Steve Hansen from Raymond James.

Steven P. Hansen - Raymond James Ltd., Research Division

Just a follow-on question to the crude barrel question asked earlier. I was just curious whether or not you can give us a sense or indication for whether there's any other large crude oil terminals being contemplated here in Canada. There's obviously been some large announcements over the past 2 or 3 months that changed the outlook quite dramatically, and there's been a lot of suggestion that there might be more coming. I'm just wondering whether or not you could confirm or not. You've been discussing the concepts with some of the majors in Canada here on the E&P side.

Jane A. O’Hagan

Steve, just to give you some color on that, as you know, the pace at which this develops with the lights and the Bakken was much faster. As we look to develop the terminals in Canada, clearly, we're dealing with producers, we're dealing with refiners. So I can indicate that there is interest largely within -- on our network. But again, because this business is competitive, what I encourage you to do is to watch our carloads. The format that we've used in the past is to continue to work with those players that are investing in their cars, investing in their terminals, investing for the long term. So I would just tell you to stay tuned.

Steven P. Hansen - Raymond James Ltd., Research Division

Okay, fair enough. And just a follow-on question to the previous grain question as well. Can you help us understand what the pinch points might be in the system to move some of this grain that's -- the line across the Prairie, again, monster crop, much of it's still stranded in the Prairie. They expected carryover is also going to be at mammoth levels. I think it's going to reach -- they carryover would be bigger than the last since 1979. I'm just trying to understand, as we move through the nontraditional grain moving pattern, how the limitations might shape up. Is it carloads? Is it core capacity? Is it locomotives? Where are the pinch points in the system to move the grain?

Keith E. Creel

I'd say, right now, the immediate answer to that, the largest pinch point is weather. That's certainly impeding the supply chain's ability to run as efficiently as we were before. Locomotives and cars, if you don't have letter rights, you can't optimize that. That way, you're going to bumping up against port capacity. You got to match elevated capacity to railroad capacity to support capacity. I mean, that's it. You can only shift as much as you can load up onto a ship, and now the ports have spent money, invested the time and effort, they're working as partners and supply chain increase their capacity. And as we do that, with the weather on our side, you'll see us matching the railway capacity, locomotive and car capacity against that port capacity.

Operator

Your next question comes from the line of Allison Landry from Crédit Suisse.

Allison M. Landry - Crédit Suisse AG, Research Division

On the pension side, so given your comments that CP is no longer in a pension-deficit position, I was wondering if you could give us an update on the cash contributions that you'd previously outlined, which I believe were in the range of $100 million to $125 million for '14 and '15. And then, stepping up from that in 2016, do they go to the 0 from here, or are they significantly reduced? How do we think about that?

Bart W. Demosky

Allison, feel free -- you can follow up with us after the call if you'd like. But overall, I'd say nothing changes at this point. We'll continue at -- you have to look at it over a 3-year basis. So at this point, we would continue with the contribution.

Allison M. Landry - Crédit Suisse AG, Research Division

Okay. And on the -- in terms of cash flow. Free cash flow conversion tripled basically to just over 50% in 2013. And as we think about continued margin improvement and sort of flattish CapEx, it seems that this number could easily rise to north of 70% in 2014. And I was wondering if that's a fair way to think about it. And what does that imply for the magnitude of a potential buyback or dividend hike?

Bart W. Demosky

Yes, Allison, it's Bart here. So we don't guide on cash flow. But one of the things I could tell you is, looking at some of the analysts' reports that are out there, they're kind of calling for that $1 billion to $1.1 billion range of cash flow for us in -- that's before dividends in 2014. I wouldn't argue with that very much. When it comes to dividend growth or buybacks, we're factoring in the future improvement of the business, the margin growth and the better operations when we look at our future cash flow projections. That will be part of the input into what I'll be talking about with Hunter and Keith and the board here. I'm sure it will impact our decision-making around how we utilize some of that excess cash, but I can't tell you today exactly what that's going to look like.

Operator

Your next question comes from the line of Chris Wetherbee from Citi.

Christian Wetherbee - Citigroup Inc, Research Division

Yes, question, Keith. You mentioned sort of where you stand relative to fuel efficiency and the progress you've made so far. When you think about sort of train length and weight, where do you feel like you are in the process? How much more do you think you can improve? So what inning are we on, on those 2 metrics specifically?

Keith E. Creel

I think there's probably -- when we get all the sidings done, and this is going to take a couple of years to get it done, but there's still another 10% or 15% improvement on both those measures to be driven by converting DP and long sidings and longer train.

Christian Wetherbee - Citigroup Inc, Research Division

Okay, that's helpful. And then, Hunter, just -- when you think about some of the longer-term targets that you guys laid out back in December of 2012, you're clearly closing in on that on a much earlier pace. Do you give us sort of newer -- new updated targets at some point in 2014? Do we just sort of think about sort of lower end of your previous OR range? I just want to put some context around how we should be thinking about sort of the longer-term opportunity beyond '14 and into '15, 16 and beyond.

E. Hunter Harrison

So -- right. We're very sensitive to what you're saying and we've grown over this plan. And so I think the plans right now, if somebody can correct me here, if I just outline, but we plan on having an analyst meeting in September of this year in the New York area, I think. And my sense is that we will develop at that point a new plan and probably come out with a 5-year plan, which updates everything and makes it easier for you to look at the future.

Operator

Your next question comes from the line of Brandon Oglenski from Barclays.

Brandon R. Oglenski - Barclays Capital, Research Division

Keith, I wanted to follow up with you on the volatility in the business inherent with winter. Obviously, you had some challenges in December, but it looks like you guys have a little bit more robust operating plan that allowed you to have a pretty good outcome even with those challenges. So as we look forward, should we look for less earnings volatility in the fourth and first quarter? What are some of the steps you're doing to mitigate those impacts?

Keith E. Creel

So I mean, when it comes to winter, the impact essentially is train lead. That's what really hurts you, or that's what your headwind is, so to speak. So you just got to try to railroad smarter. You can't push the envelope. You got to make sure you optimize the DP. You got the right configuration, you got the right distance between the locomotors, you got the right blocking, tackling going on in the terminals. And I'm not going to suggest we're perfect. We're far from perfect. I see mistakes, and we learn from mistakes on a daily basis. But we are getting better. We're trying to mitigate the impact. And part of the other key to this is not flooding the network with cars and locomotives that you can't move. Because it's -- there goes an analogy. You think more is better, but actually, less is better when you get to these kind of situations. Because if you've got more equipment out there that you're trying to move and you're trying to force, and you've got more than you can really effectively process through your terminals on your main line with these challenges, you're just going to drag the whole network down and mess everything up. So that's the focus. It's all about blocking and tackling, and that's how you mitigate or minimize the impact to the bottom line.

Brandon R. Oglenski - Barclays Capital, Research Division

Appreciate that. And Bart, I know you're new in the job here, but looking at the leverage profile of the company and given the changes in FX rates and interest rates right now, how do you think about the credit profile of CP and what you'd like to do with the balance sheet from a debt perspective?

Bart W. Demosky

Yes, sure, Brian. I'm actually in the middle of looking at all of that right now. What I'd say from the early indications are that, clearly, the quality of the balance sheet is better than the current ratings of the company. So I just talked with all the rating agencies yesterday to get a sense of what their needs are and sort of timing around when their reviews would be. But I suspect it's quite positive. Leverage targets are something else that we're looking at, but -- and so I can't give you full details. I think, as we come through this quarter, I'm going to get those plans in place and be able to start talking about it more fully. But as the operations continue to improve and we pay down debt -- and we have just recently bought out a long-term capital lease as an example of debt paydown -- we may have opportunities to manage leverage, whether that be a debt issuance and taking advantage of the current low rates, or doing something else. But it will be in conjunction with the whole operations and business plan rather than something that's unique or off on its own.

Operator

Your next question comes from the line of Scott Group from Wolfe Research.

Scott H. Group - Wolfe Research, LLC

So someone asked earlier about better service leading to market share. And I want to ask you about better service leading to better pricing. And I'm wondering if that's something that's starting to happen. So I think, Jane, you mentioned that renewals came in above the 3% to 4% target, which I think is a change, and I'm wondering if we're kind of finally at that catch-up point where we can start seeing some better pricing. So just some thoughts on there will be great.

Jane A. O’Hagan

Scott, I think, what I would start off by saying is that given what Hunter said about change and culture, the last year, we spent time just ripping apart our book of business and addressing the quality of revenue. We made some tough choices. But again, this is a journey. It doesn't happen overnight for us. I think that we're never going to be finished because this is something that we're going to be looking at as the quality of service improves and as that service drives us to be able to offer different products to different customers. We've upgraded accounts, we've upgraded lanes that needed to be addressed. To Hunter's point, we have transformed many of our pricing mechanisms to move ourselves away from contracts and to get to tariff where we can give ourselves some more flexibility to go after all the various components of price. And I think the other thing that we've taken a really strong effort at in pricing is that there's all the other components that go in as well around supplementals and demurrage. And we've been standardizing that, forcing those terms. So when you couple that with the approach that we have to get people out selling service and not price, backstopping what we've done with higher renewals above our 3% to 4%. We feel we're on the journey, but we're never going to be done.

Scott H. Group - Wolfe Research, LLC

Do you feel like you're in some ways priced at a discount right now? I mean, should we be expecting that -- the renewals to kind of stay above this 3% to 4% range, or are you sticking with 3% to 4% as the realistic target?

Jane A. O’Hagan

At this point, I think what we'll do is stay with the 3% to 4%. I mean, obviously, what we need to do each and every time is understand how the business offering that the ops teams had set the table for us with commands value in that customer supply chain and extract that value accordingly. So I think that, as Hunter indicated, this is not something that you'll accomplish overnight. But it's something that we renewed our focus, we've done a tremendous amount of work over the last year, and we're going to keep pushing on the same front.

E. Hunter Harrison

Let me just give an example, and this is what fits with our strategy. I mean, as we lower our price, our cost, excuse me, and if our price, let's just say, stays at 3% or 4%, the margins continue to improve. We can't turn that kind of business down. But at the same time, we're going to extract the value out of it. That's one of the reasons that we're more domestic oriented from an Intermodal standpoint. Number one, the price for domestic is significantly better than international, number one. And just -- and it's also lower cost. So we don't have to build big facilities. You don't see domestic trailers or containers sitting on in hubs for 6 and 7 and 8 days. That's an international scheme, and domestic want to turn it over quickly, turn the asset, move it. And that's the high-quality customer, and it's the different style customer that has to fit with us. So we're going to try to hopefully play to our strengths. Now I'd like to do everything we can internationally. So right now, it just -- it doesn't fit given where the market is.

Scott H. Group - Wolfe Research, LLC

That makes sense. And just one other for you, Hunter. Just -- what's your latest thoughts on where the headcount can go from here? And how much of the purchase services savings that you talked about a year ago, how much of that you think you'd realized yet and how much more to go?

E. Hunter Harrison

On a gross basis, I mean, I think we're probably -- on that purchase service, we're probably 60% of where we can be. The headcount issue -- and I don't like the term, I don't want to lock us in to a number that says we're not going to make a this decision to get to some number. But having said that, everything in, if things play out going forward as we think they will, we'd have tremendous growth. The number can -- and as I've talked about before, can approach, 6,000 [ph]. Now -- and once again, we're positioned there to be able to handle that probably 85% or 90% through attrition. We had a lot of people, I think, around the organization that were waiting for buyouts. Well, I don't -- I'm not a buy outer, okay? So some people learned that they were waiting for something that wasn't going to come. So they decided to move on. So we're going to get this organization rightsized. We still have productivity gains to be made. Just to Keith's point a while ago, about -- 15% with train starts and fewer locomotives and all those things. So there's a lot more runway in every one of these metrics. I don't know any of them we've run out of.

Operator

Your next question comes from David Newman from Cormark Securities.

David F. Newman - Cormark Securities Inc., Research Division

Just looking, once again, just on the price insight. It would seem to me, by, sort of, segment that the biggest opportunity would be in the domestic Intermodal mixed merchandise. And giving -- given what's going on in the trucking side of the regulations, and hours of service rules, et cetera, is that going to be the area that -- where the biggest bang for the buck, I guess, on pricing? And if you look at the bulk side, getting down to annual contracts, is that going to be more flexibility on the pricing role? So I guess, if you look at segment-by-segment, where do you think the pricing could be the most meaningful?

Jane A. O’Hagan

Well, I think, to the point that Hunter made previously, I think that when you look at the merchandise sector and you look at the domestic Intermodal, the margins are there. There's truck competitive business that when you look at the service offering that we put into the marketplace, when we compete against other rail and we compete against truck, we have an opportunity to tap into that margin. And that's exactly what our strategy is. I think that when you go forward on the merchandise side and you look at, over the years, the fact that in some areas, we're not getting our fair share of the wallet of some of our customers. We have the opportunity to sell them a broader range of service, but we do that as that service improves. I think with grain, there's always a portion of the book of business that's gonna be regulated, which, in Canada, is about 60%. But there's 40% that we have here that is commercial. And our U.S. franchise is commercial as well. I think that one of the things that we've seen post-CWB is an opportunity to see grain moving in different corridors. And we have the opportunity to work with different companies to find ways to get that grain to market and where we can extract some price for that value of service. So I think, overall, again, it's a journey. But I would say that would be sort of directionally be correct in those areas.

David F. Newman - Cormark Securities Inc., Research Division

And just a quick out on -- and so the revenue caps that you have on the grain side, there have been some discussion about potentially removing those. Is that just wishful thinking, or do you think that will -- that could actually happen at some point here?

Jane A. O’Hagan

I mean, I think that there was a long time that none of us, who had been in the business, ever thought that we would see the single-best selling go away or the monotony of the CWB. I mean, my view would be is that a fully commercial network, when you look at having a record crop, you start to look at some of the efficiencies you want to build in. It would make some sense given the fact that grain is becoming a much more global market. But I think, at the end of the day, that this is a regulated sector of the business. Government will have a key part in determining what that framework would be, but I think that when we start to see our ability to respond, there certainly are given the fact that our U.S. franchise is right across from many of the high throughput elevators we have in Western Canada, that there could be some benefits to looking at that certainly, and we've had some discussions of same.

David F. Newman - Cormark Securities Inc., Research Division

And final one, just -- the receptivity of the -- of your bulk customers to moving towards annual contracts, is that something they're welcoming as well? And obviously, it would give you a bit more flexibility on your pricing, I would imagine, as well.

Jane A. O’Hagan

Well, I think it depends. I think that when you look at our potash business, we've been pretty clear in our coal business that we have long-term contract that basically provide escalations that covers us, certainly, to get those -- to get the pricing in market. But also, the fact that we have productivity that where we spend or we create benefits, we keep that. I think the grain business has always worked on a tariff basis. I think that some of the opportunities we have on the fully commercial piece to tune up those tariffs and have them responsive to what the supply, demand is are opportunities for us as well.

Operator

Your next question comes from the line of Turan Quettawala from Scotia.

Turan Quettawala - Scotiabank Global Banking and Markets, Research Division

Maybe I'll ask one for Bart, just on the free cash flow here. Bart, obviously, understood on not one on cash here. But I'm just wondering if you can give us any sense on maybe a balance between buybacks and dividends, especially considering where the stock is at today.

Bart W. Demosky

Good morning. It sounds a little bit like a broken record, but it's a bit early to comment on that. We're getting our hands around how much there is going to be, and then we'll have a good discussion and certainly make decisions on that. I have to sit down with Hunter and Keith and the board on it. So...

E. Hunter Harrison

Yes, let me just -- because it's a little unfair to Bart. But I think I've said to you and I think the board is very sensitive to these issues. They're very sensitive to the fact that we have farther exceeded the plan, that we're way ahead of schedule. I would think that by, at this next call, end of next quarter, we'll have some pretty definitive responses to what we're going to do and how. Now there are some tricky issues here with our ownership shift. For example, right now, when -- the proxy account says that the ownership were going to U.S. and Canada was 50-50. Now it's about 80-20. Well, people in the U.S. aren't crazy about dividends because of the tax refund. People in Canada like dividends. So we've got to take all of that and put it in the blender. But I feel pretty confident that we're going to come back to you with something of a positive nature there and how aggressive it is and what size and all that is just being determined. Bart's modeling is going through some of it now. And -- but I think it's something that will be positive in the future.

Turan Quettawala - Scotiabank Global Banking and Markets, Research Division

That's great. And maybe I can ask one for Keith quickly here just on the weather. Keith, just if you look at the whole network here, is the weather a bigger challenge in January than it was in December, or was December worse? I know it's not good, but I'm just kind of wondering on a relative basis.

Keith E. Creel

I'd say it's equal. It's about the same. I mean, across the whole network, we're impacted at the last 2 weeks of December, but that's 2 weeks versus, I got, 4 weeks in January. And I've got it across probably 2/3 of the network. I mean, good in Chicago. I've been to Chicago earlier this week, it's -- and I've lived there for 7 years. It's never been that cold. Snow all over the place. St. Paul, same story. I mean, we're not short on challenges, but I'm not going to be long on excuses either. We're going to execute, and we're going to make up.

Operator

Your next question comes from the line of Jeff Kauffman from Buckingham Research.

Jeffrey Asher Kauffman - The Buckingham Research Group Incorporated

Keith, can you talk a little bit about where you are on a capacity basis in Vancouver and the port's ability to handle your growth in Intermodal or wheat or potash? And what roles CP plays in terms of helping to build that growth?

Keith E. Creel

Well, I guess you got a couple of different destinations there, they're a couple of different stories. Deltaport, which is TSI, which is where we're Intermodal, the preponders [ph] in Intermodal is coming and going out. CP's not the same size player as CN, but I can tell you now they have their challenges. And those challenges are compounded by what shipping companies do. When they're slowboating across the oceans, they feel the need -- they don't hit schedules and you have 5 ships that show up on a 2-day span that should have been over a 5-day span, then you're going to get hunched and you're going to create capacity and take away needed capacity to defluid. So I would say, they're not long on capacity at Deltaport. So some impact there. If you ship to the inland, if you go up to Vancouver, and you talk about potash, Neptune, they spent some money. And Neptune did expand capacity. So potash and coal there, I think, as long as weather cooperates and as long as our partners, we're not the only ones using the facility. They remain fluid, we remain fluid, I think we're okay with capacity. As you go to the grain side, for the export terminals, they, too, have spent money invested. Some of these challenges they're still subject to, wind, rain, they're trying to mitigate that. So from a growth standpoint, I think that they're getting better. I think that as we get better, we can match up and we'll consume that capacity, and there's some room to grow on both side, both for the railways as well as for the farmers, as well as the potash shippers and the coal shippers.

Jeffrey Asher Kauffman - The Buckingham Research Group Incorporated

Okay. And, Jane, follow-up. Given all the improvements in service, I know you don't always play nice in the sandbox. But I was a little surprised to hear about some big contract losses on Intermodal and Auto. Can you talk a little bit about the competitive environment? And with your service product improving, what's the primary reason for a little customer switching?

Jane A. O’Hagan

Well, I'd say that the rail business at the outside is the competitive business. And we're obviously going to be pricing at a level and with that value of the service we provide. And by and large, I expect railroads of others to do the same thing. I think that, basically, when we look overall, I think it boils down to price. Some people are focused on the value, others are focused on the cost. I can't give you a specific example. But I can tell you that, with respect to the service that we provided to the major contracts that we have discussed that we chose not to price to, this was not a service issue. This was a pricing issue. And at the end of the day, we're going to work with those customers that see the value and where we can earn a fair and reasonable return.

Operator

Your next question comes from Donald Broughton from Avondale Partners.

Donald Broughton - Avondale Partners, LLC, Research Division

All my questions have been answered.

Operator

Your next question comes from Thomas Kim, Goldman Sachs.

Thomas Kim - Goldman Sachs Group Inc., Research Division

If I could just follow on, on the comment on price. Just given that CN still has an OR advantage, are you beginning to see them use that a little bit more aggressively even outside of Intermodal?

Jane A. O’Hagan

I mean, I can't talk to a specific example. I mean, that's a question you're going to have to ask CN. I think that what -- we have our own game plans. We price for value. We need to look at what we do to increase the operating income in the book and build [indiscernible] quality revenue.

Thomas Kim - Goldman Sachs Group Inc., Research Division

Okay. And then just with regard to the new incentive scheme for the sales force, now there seems to be a general tendency for sales to focus on revenue. And, obviously, there can come the -- sort of risk that they push volumes over freight rates. I'm just wondering, to what extent the new scheme has measures in place to protect the pricing integrity? And, for example, do you incorporate a margin as part of the overall incentive as well?

E. Hunter Harrison

Well, the answer is yes. Number one, if the carloads that show an efficient margin that we have determined, you don't get accounted for it. So the first -- the first prize here is you got to be profitable at this level, number one. And then, there are some issues about it's effectively only new business. It's not business that we've had before. And then, if it meets that criteria of profitability and new with some qualifications for prevailing conditions, both up and down and windfalls and so forth, then they will receive a percentage of profitability of that unit. And again, it's a pretty simple method for people to go out and sell price -- I mean, sell service under a disciplined environment.

Operator

Your next question comes from Jason Seidl from Cowen and Company.

Jason H. Seidl - Cowen and Company, LLC, Research Division

When I'm looking at sort of your revenue per carload on the grain side, I mean, I know there's a lot of moving parts, especially with -- what could go export. What should we be looking for on that line item on a year-over-year basis?

Jane A. O’Hagan

I think that it's difficult to predict. And I'd indicated last quarter that I would've expected that the revenue per carload would've been impacted by some of the regulated grain because of the fact that we do work to a maximum revenue entitlement in that segment. But I think the fact that we have 2 different grain franchises and that there is a commercial component in and that we've been nimble in the market, we've been providing options. I'd be inclined to think that we're going to probably see yields in and around that same area.

Jason H. Seidl - Cowen and Company, LLC, Research Division

Okay, that's fair enough. And, Hunter, going back to sort of the new sales structure. How is that going to impact maybe sales and their relationships with operations because sometimes, those 2 sort of bang heads in the past in the rail industry?

E. Hunter Harrison

Well, that's our job. I mean, this is a team. Everybody's got a part to play. The operating guys provide the service, Jane and her team sell the service and we make a buck and everybody's happy. And anybody that can't be a team player, then they've got to find another team to play on.

Operator

Your next question comes from Walter Spracklin from RBC.

Walter Spracklin - RBC Capital Markets, LLC, Research Division

Question on the revenue guidance, 6% to 7%. I'd like to decompose that a little bit. I think I heard Keith mention mid single-digit RTM growth. And my question, I guess, is to Jane with regards to mix because hearing you on the renewals coming in above the 3% to 4%, and when I look at yield, and this is on a revenue per revenue ton mile basis, just noting that it was 0.9% in the year and 1.8% in the quarter. Just curious whether mix is at play here. I know you've got a lot of moving parts with regards to significant increases in grain, some declines in Intermodal and so on. How should we look at mix playing itself out in 2014 in the kind of an order of magnitude on a revenue per revenue ton mile basis?

Jane A. O’Hagan

Well, I think that if you look at Q4, when we talked about mix, we had a lot of moving parts. And I'd slice them to the extent that I can over each and every quarter in 2013. To remark on the impact of long-haul crude volume, when we have any shift that takes place in the short-haul thermal volume, and I think that the other area that we always have impact, given what we saw over the last year, given the fact that we were in and out of the potash business, these are all things that impact our sense per RTM. I think that when you look at a go-forward basis and think about that mix, again, what we're going to see is, if our plans come to fruition, which we fully expect that they will, crude oil is going to continue to play an important part of the book. That's obviously going to impact the RTM, given that length of haul. I think that grain, we're seeing that on positive on an arch basis given all the various outlets that we have. So it's really hard to predict, but I think that's where we're going to see it, Walter.

Walter Spracklin - RBC Capital Markets, LLC, Research Division

Okay. And then my second question is on a little bit of a disconnect between operating income implied by your guidance and then the EPS growth. If I take your revenue growth and I grow it at 7%, put a 65% OR, the EPS growth is somewhere lower, and I'm wondering if you built in into your estimate any significant change in your capital structure through debt repayment. Is it a U.S. dollar phenomenon where you're paying less U.S., the impact of the higher Canadian dollar, debt refinancing, or is it -- is there a share buyback at all built into your guidance for 2014?

E. Hunter Harrison

Let me -- Walter, I think you have to look at the variability in those numbers. We're saying that OR is at 65%, but it could be lower. At the same time, we're looking at the revenue and it could be lower or higher. Well, you pick different numbers in there of the likelihood and the profitability and you can get several different answers on the EPS, given what they -- you give each one of those. But I think they all fit within an appropriate range.

Operator

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

E. Hunter Harrison

Okay. I'm sorry about the duration. We took too long on the call, but we had a lot of questions, and I wanted to try to address all of them. So we look forward to the next opportunity to visit with you. And hopefully, the weather conditions will be a little better and we'll have even better results. Thanks.

Operator

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

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