Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)

Union Pacific (NYSE:UNP)

Q1 2014 Earnings Conference Call

April 17, 2014 8:45 a.m. ET

Executives

John Koraleski – Chief Executive Officer

Eric Butler – Executive Vice President of Marketing and Sales for Railroad

Lance Fritz – Executive Vice President of Operations – Union Pacific Railroad Company

Robert Knight – Chief Financial Officer and Executive Vice President of Finance

Analysts

Scott Group – Wolfe Research

Chris Wetherbee – Citigroup

Ken Hoexter – Bank of America

William Greene – Morgan Stanley

Jason Seidl – Cowen & Company

John Larkin – Stifel, Nicolaus & Co., Inc.

Rob Salmon – Deutsche Bank

Allison Landry – Credit Suisse

Brandon Oglenski – Barclays Capital

Bascome Majors – Susquehanna Financial Group

Walter Spracklin – RBC Capital Markets

Justin Long – Stephens Inc.

Keith Schoonmaker – Morningstar

David Vernon – Bernstein Research

Ben Hartford – Robert W. Baird

Don Broughton – Avondale Partners

Jeff Kauffman – Buckingham Research

Claire Ouzagareen – Macquarie

Operator

Thank you for accessing Union Pacific Corporation's first quarter earnings conference call held at 8:45 AM Eastern time on April 17, 2014 in Omaha. This presentation and the accompanying materials include statements that contain estimates and projections or expectations regarding the Corporation’s financial results and operations and future economic conditions. These statements are forward-looking statements as defined by the federal securities law.

Forward-looking statements are subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in the statements. The materials accompanying this presentation include more detailed information regarding forward-looking information and these risks and uncertainties.

Operator

Greetings and 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 formal presentation. (Operator Instructions) It is now my pleasure to turn to introduce your host Mr. Jack Koraleski, CEO for Union Pacific. Thank you, Mr. Koraleski, you may now begin.

John Koraleski

Thanks, Robin, good morning everybody. Welcome to Union Pacific’s first quarter earnings conference call. With me here today in Omaha are 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 quarter record. Total volumes were up 5% and the increase was broad-based.

We saw growth in five of our six 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 but especially in the upper Midwest. So we're proud of the efforts of the men and women of the 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

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 grains in agricultural products, industrial products and coal. We also saw volume growth in the 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.

Corporate improved 2% which was partially offset by unfavourable mix and lower fuel prices to produce a 1% improvement in average revenue per car add in our volume growth and we increased freight 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.

At products volume grew 13%, which combined with a 3% improvement in average revenue per car throws revenue growth up 16%. We continue to see strong demand for grain with carloadings up 39% driven by last year's strong harvest. The biggest gains were in grain exports to China and Mexico and wheat exports to the Gulf. And lower corn prices drove increased demand for domestic feed grains. Grain product volume was up 5%, driven by the 11% increase in ethanol shipments as refineries replenish low ethanol inventories.

Shipment to BBG's grew 38%, driven by strong export demand primarily from China. Food and repurchase shipments were down 3% for the quarter as the winter weather impact the 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 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 that our finished vehicle shipments to rebound as the rail network recovers from the challenging weather.

From 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 revenues instead of automotive commodity revenue.

Chemicals volume was flat for the quarter with revenue up 2% on a 3% increase on average revenue per car. Industrial chemicals volume was up 7%, driven by strength in end user market such as shale related drilling, paper products and the icing materials. Fertilizer shipments were up 7% for the quarter on strong export potash demands.

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 prior shipments to the Gulf Coast.

Turning now to coal, revenue increased 3% in the first quarter on a 7% increase in volume. The 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 and higher natural gas prices offset our previously reported contract loss.

Colorado, Utah coal tonnage was up 13%, and benefitting 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.

Now in industrial products business, a 9% increase in volume and a 1% improves 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. And 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, while shipments were up 28% compared to the first quarter last year.

Intermodal revenue was up 4% in the first quarter, driven by 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 the strong comparison from the first quarter of 2013. The winter weather impacted consumer demand and imports to the West Coast ports were down nearly 3% for the first two months of the year.

Now take a look at how we see out 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. 2014 crop yields will be dependent on the weather.

In food and refrigerator, we expect growth in import beer, but the draught in California could create a headwind for tomato paste and canned goods.

Automotive market fundamentals remain strong with demands 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 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 in 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 preposition and diverse franchise will again support business development efforts across our broad portfolio business.

Assuming the economy cooperates, we expect to deliver profitable revenue growth yet again in 2014, driven by continued volume growth and corporation's gains. With that I'll turn in over to Lance.

Lance Fritz

Thanks, Eric, and good morning. I'll start with our safety performance which is the foundation of our operations.

The first quarter of 2014 reportable 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 a 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 advanced defect detection technology and enhance our ability to find and address risks.

In public safety, our grade crossing incident rate improvement slightly versus 2013. Driver behaviour continues to be a critical element. To make continued progress we're focussed 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 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 mobility 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. 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 active locomotive 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. And 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 in 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 pool. This metric which measures the delivering 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 a 100 last year, impart 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.

And 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 cart 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 for restoring operations back to normal. We're focussed 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 interchanged fluidity. And 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 that generates solid productivity will improve and we will continue to make smart capital investments that generate attractive returns by increasing capacity and high volume quarters while also supporting our safety, service and productivity initiatives.

As a result we'll provide customers with a value preposition 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.

Robert Knight

Thanks, Lance, and good morning. Let's start with the 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 totalled nearly $3.8 billion, increasing 3% over last year. Expenses include about $35 million or roughly $0.05 per share of cost 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 totalled $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 to 2014. Income tax expense increased to $671 million, driven primarily by higher pre-tax 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 our 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.

Both in our grain and frac sands 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 per coal, we did see the benefit of higher ARC volumes including our prior year re-price 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 totalled 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 point and a half of legacy benefits 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 All-LF. The type table at the bottom of the slide takes a closer look at the quarterly All-LF 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 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 re-investible 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, but 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 labour inflation come in under 2% for the full year.

Turning to the next slide, fuel expense totalled $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 come 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 service and materials expense increased 9% to $607 million, due to volume related subsidiary contract expenses, higher locomotive and freight car material costs and crude 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% to 8% this year.

Slide 25 summarizes the remaining two expense categories. Equipment and other rent expense totalled $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 re-investible levels and moving it safely and efficiently continues to drive results. We achieved a record first quarter operating ratio of 67.1% improving two 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 the 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 payment to our shareholders. Also, in keeping our commitment to achieve a dividend pay-out range of 30% to 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 yearend '13. 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 yearend. 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 repurchased authorization of up to 60 million shares over a four-year time period went into effect January 1st of this year. Under this new authority, we bought back 3.8 million shares totalling $683 million in the first quarter. This brings accumulative 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 45% increase over 2013, clearly demonstrating our commitment to increasing shareholder value.

So that's a recap of the first quarter result.

As we look to the remainder of the year, its favourable economy and some help from the weather will combine with our commitment on core pricing above inflation and our on-going productivity initiatives to produced continued margin improvement and record financial results.

With that, I'll turn it back to Jack.

John Koraleski

Okay. Thanks, Rob.

As we put this winter behind us, we're off to a good start for the year. As always, there's going to 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 on-going success.

Our value proposition to our customers depends on it. Strong service goes hand in hand with improvements in network in 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 fair everything from planning 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.

Question-and-Answer Session

Operator

Thank you. We'll now be conducting a question-and-answer session. (Operator Instructions)

Our first question is from the line of Scott Group with Wolfe Research. Please proceed with your question.

Scott Group – Wolfe Research

So I wanted to just first ask about the yields, particularly on the auto and coal side. So if I'm understanding this right, as finished vehicles start to grow again as whether it gets better, shall 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.

Robert Knight

Yes. Scott, let me talk about the autos first. As Eric mentioned in his comments, there was a process changed and affected some per diem treatment on some containers. It basically accounts for all of the decline in the autos' arc. On top of that then, as he also pointed out, the mid shift of finished vehicles and more auto parts also had an impact on arc. So we don’t give guidance on what the mix is going to look like or what the arc is going to 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. If you might see, that's a great 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 every car on the arc line. And year-over-year, you're exactly right, there was a small, as you recall we pointed out. It was roughly $15 million of liquidity. The damage is last year that did not repeat this year. That at this point, I don't see that our trend is continuing throughout the year. So that had a little bit of an impact on our coal arc line as well. And that piece was about 1.5, if you will, of the 1.5% of the 4% decline.

Scott Group – Wolfe Research

Okay. That's very helpful. And then I just wanted to take a shot at the long-term margin guidance. So if I look at historically at the first quarter OR and then the full year OR, the full year typically is about three to four points better than the first quarter, and you had weather in 1Q. 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 that if the long-term guidance is just really still 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 going to dramatically change the trajectory margins.

John Koraleski

Hey, Scott, our guidance is below 65 before 2017, not in 2017. Rob, why don't you fill in the blanks on that?

Robert Knight

Yes. 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 for the economy cooperates fuel prices as you've heard us speak many times. It can have an impact directly on the margins and the operating ratio.

So as we've said all along on this financial improvement journey over the last decade, we're not looking at the sub-65% as an endpoint and we're not going to slowdown. We're going to get there safely and efficiently as we can. And if all the stars line, the economy cooperates and we move in direction that we hope everything happens, we get there as soon as we can. But our best look at this point in time is that it looks to us like it's sometime before 2017.

Scott Group – Wolfe Research

Okay. Thanks guys.

Operator

Our next question comes from the line of Chris Wetherbee of Citigroup. Please proceed with your question.

Chris Wetherbee – Citigroup

Thanks. Good morning. 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 last and maybe the pace of activity here? And how much is sort of still yet to be moved and wants to be moved and kind of when can the catch up do you think?

John Koraleski

Yes. I think you're exactly right, Chris. I think as we move towards the end of the quarter, we were catching up from some of the issues in the early quarter. But our volume outlook is still fairly decent for the year. So Eric, you want to …

Eric Butler

Yes. Chris, as Jack said, clearly, there were some catch up, particularly when you think about the difficulties that the winter had on the automotive business. And then deep in coal utilities, there was a strong coal burn, and so there was some catch up there.

You can 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. Slowly strengthening economy across our book of business will have positive impacts. Plus, we continue to have a strong valued proposition. And so we're optimistic for the balance of the year.

Chris Wetherbee – Citigroup

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 the 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 we might suggest you have stronger volumes continuing to the shorter length of haul utilities? Any sort of color you could give there would be helpful.

Eric Butler

Yes, I would say this. Those kind of balance in and out. Inventories are quite low. As you probably know, there are 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 mix change for the future.

Chris Wetherbee – Citigroup

Okay. Great. Thanks very much for the time. I appreciate it.

Operator

Our next question comes from the line of Ken Hoexter with Bank of America. Please proceed with your question.

Ken Hoexter – Bank of America

Great. Good morning. Great job working through the weather.

Just a 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 as they fix that, some of that reverts back to a different network or is this more permanent business in nature?

John Koraleski

Yes. 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 last year had moved for nine months, and this year really picked up a volume in the first. So that's kind of an on-going issue for us.

Rob, do you want to -- do you have any more with the …

Rob Knight

Yes. Can I just say -- I mean your question is heading right on the reason why you heard me many, many times, say we're not going to get guide this fund on average revenue per car because mix is always a part of our business. And when you look as diverse as our franchise is, as diverse as all of our commodity groups are, mix is rather normal.

But as you also are questioning in terms of the margin, just because something has a short haul lower average revenue per car doesn't mean it has a lower margin. So 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 be a part of our business, but we're focused on improving our margins regardless of the length of haul.

John Koraleski

As Rob said, if we can get our re-investability threshold met, we're happy to take the business.

Ken Hoexter – Bank of America

That's great insight. Thanks.

Just a follow up on the locomotive side, and I guess demand side overall. You noted demand kind of creeping in a little bit on a gradual improvement. If we start seeing, I guess, 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 questions in terms of scalability of the infrastructure and available capacity.

John Koraleski

Absolutely. Lance?

Lance Fritz

Sure. So Ken, we feel pretty good about fluidly handing the volume that Eric is bringing on for the network. If you think about where we are right now, the first quarter was, what, 179,078 car loads. We've publicly said we think our network can handle 195,000 plus 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.

John Koraleski

And our first quarter was pretty balanced, so we like that.

Ken Hoexter – Bank of America

And similarity access to locomotives to handle that? Is that infrastructure still available?

John Koraleski

It is. If you think about how many locomotives we have left in surge right now. It's a little over 300. That's bearing in mind that we brought in what was at 600 locomotives since the fall with a large portion those not driven by volume, but instead driven by trying to overcome winter's impact. So we've got surgery resources that will be able to handle it.

Lance Fritz

So as we spin up volume and our operating stats improve, we'll actually be seeking some power out of the network and putting it back in storage.

John Koraleski

That's right.

Ken Hoexter – Bank of America

Appreciate the time. Thank you.

Operator

The next question comes from the line of Bill Greene of Morgan Stanley. Please go ahead with your question.

William Greene – Morgan Stanley

Hi there. Good morning. Thanks for taking the question.

Rob, I wanted to ask you about pricing. When we see this inflation metrics 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 though that you have to keep in mind?

Robert Knight

I mean that part of business that is tied to the All-LF and there were 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 All-LF have different timeframes of when they trigger. So you pick that into consideration. But directionally, if inflation increases and as All-LF in fact reflects that, that part of business that is tied to All-LF will increase. Yes.

William Greene – Morgan Stanley

Right. And then as we look … next year is 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.

Robert Knight

Yes, 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 frontend a business that we will compete for in the marketplace. But it's about $300 million of legacy revenue next year.

William Greene – Morgan Stanley

Right. And then on inflation, I think in the past you've talked about seeking to offset it with productivity. But if it's going to 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 a fix cost based in the productivity. Can that actually cost the number to go down?

Robert Knight

Lance could comment on this as well. But I would say, potentially. Again, as what you're referring to, Bill, as you know is we set the price the business to market, achieve a successful above inflation sort of pricing environment. And then 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, we're in a lower inflation area environment and a positive volume environment that gives us more options to do as well as we can on that.

John Koraleski

That's perfect. Rob is absolutely right. Mirroring what Rob says about our drive to an improved OR, there's -- we don't set a limit as just offset inflation. We look for efficiency and productivity everyday through the UP way.

William Greene – Morgan Stanley

That's great. Thank you so much for your time.

Operator

And next question comes from the line of Jason Seidl of Cowen & Company. Please go over with your question.

Jason Seidl – Cowen & Company

Good morning, guys. It's been well publicized that your competitors had some major, major service issues, and it seems like you guys probably got some freight from them. How much do that really stress the system in the first quarter when you saw on top of the weather, and everything else?

John Koraleski

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 on to 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 or infrastructure of 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.

Jason Seidl – Cowen & Company

Okay. And Jack, this is a broader question. I asked this on another call the other day. We've had issues with Chicago as an interchange in the real network, the entire topic been an analyst. I mean obviously it was great exacerbated this quarter with winter weather. And I know there's been projects around, like they create a project to try to improve that. What's really just holding the rail in street back from all giving together and really just trying to fix this interchange once and for all? Because it seems like this is something that would benefit sixth or the seventh class once going forward.

John Koraleski

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's stealing with as well. And so in our world, we're making investments. We're planning. We're working together having the centralized operating controlled group in Chicago help 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 spend 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 and Create holds a lot of potential for us. Lance, what do you think?

Lance Fritz

Yes. 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 a 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. It'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.

Jason Seidl – Cowen & Company

And Lance, what do you think that number can come to? You said it's down by a third. I mean will it keep down by …

Lance Fritz

No. So think about it like this. We've got 17 capital projects already in place, complete. There are 20 are in designer underway, and so each one of those is going to help. So there's still fair amount of upside in terms of reducing the time it takes cars contributors.

Jason Seidl – Cowen & Company

Okay. Jim, I really appreciate the time as always.

John Koraleski

Thanks, Jason.

Operator

Our next question comes from the line of John Larkin with Stifel. Please go ahead with your question.

John Larkin – Stifel, Nicolaus & Co., Inc.

Hey, good morning gentlemen.

John Koraleski

Good morning, John.

John Larkin – Stifel, Nicolaus & Co., Inc.

I wanted to focus on the real cost escalator chart that was in Rob's, actually in the presentation. And if you look back at the trailing four quarters, that's pretty tampered inflation. And I would have thought with the labor cost, the escalation built in your contracts that certainly overtime you would've seen more than an average of less than one, which I think it probably works out to be there.

Anything that's going on there that were missing? And would you expect that to continue over the next four quarters?

Robert Knight

Yes, John. I think you're going to see it continue to be low for the next four quarters. And if you recall that our labor inflation, which as you know the way the All-LF works is a market basket of inputs from the industry. But the labor inflation for us, we think it's going to be less than 2% this year. So that is a big piece of what's in there. And so it is driving and has been for quite some time now the reduction in that All-LF number.

So it lines up, and overtime it does what it's intended to do. From quarter to quarter, there might be some timing issues. But it's done its job over multiple quarter and multiyear period.

John Larkin – Stifel, Nicolaus & Co., Inc.

Okay. And then maybe just a follow-on on the timing of the restoration of complete fluidity in and around Chicago in the northern -- into the network. One of the executives giving testimony at the STB last week suggested that Chicago should be back in 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?

John Koraleski

Hey, Lance, why don't you handle the outlook?

Lance Fritz

Yes. 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 because 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.

John Koraleski

Yes. 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.

John Larkin – Stifel, Nicolaus & Co., Inc.

Thank you.

Operator

Our next question comes from the line of Rob Salmon of Deutsche Bank. Please proceed with your question.

Rob Salmon – Deutsche Bank

Hey, thanks. Good morning guys.

John Koraleski

Good morning.

Rob Salmon – Deutsche Bank

Rob, with regards to the incremental margins, as I'm taking a step back and kind of listening to what I heard on the call, it's fairly a mix work against you guys. There's a lot of incremental cause associated with winter weather which meant the network wasn't -- probably wasn't running as full as it could in constrained train lengths.

Should I think about the Q1 64% incremental margin as being a low for the year and expanding from there?

Robert Knight

Rob, as you know, we don't give that level of guidance. But as you heard me say many times, for us to get from where we are today to our sub-65, and we're not going to slow down to get there in time. We get there as efficiently as we can.

As soon as we're going to get 50% kind of number on incremental margins from here to there, there can be lumpiness from quarter to quarter depending on volumes of weather and other issue, fuel prices and other issues. So, you know, we're going to keep doing as well as we can. But I've shied away from getting 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.

Rob Salmon – Deutsche Bank

Okay. That's right. But we should think about the network running more fluidly, and that should obviously help overall operational performance, I would imagine.

Robert Knight

That would be a plus. Absolutely. And then we'll see what volume -- our volume actually plays out.

Rob Salmon – Deutsche Bank

Yes. It's fair. I'm not sure if this question should be directed towards Lance or towards 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 it 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, it increased about 6% year-over-year. Is this 6% growth with regard to expectations for future volume growth are just handling current traffic? And 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?

Eric Butler

Yes, 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 want to -- is that okay?

Lance Fritz

Yes, that's perfect. Yes, yes.

Eric Butler

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 and our model is sitting there and also our coal business. And so, those were all some fairly decent volume gains just intrinsic in the business itself.

Rob Salmon – Deutsche Bank

Appreciate the color. It sounds like more unit train there. Thanks.

Operator

Our next question comes from the line of Allison Landry from Credit Suisse. Please proceed with your question.

Allison Landry – Credit Suisse

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 mentioned 13% tonnage growth in Colorado and 2% in SPRB. Was that a function of whether or easy comps? How do we think about sort of the relative tonnage growth with the respect of these two origins for the balance of the year?

John Koraleski

Okay, Eric?

Eric Butler

Yes, tonnage. When you think about Colorado-Utah coal, there was some easy comps year over year. We do continue to expect in the outlook to see a Colorado-Utah coal being a good source for export coal as the export coal opportunity 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.

Allison Landry – Credit Suisse

Okay. And is it fair to say that the SPRB has a longer length of haul?

Eric Butler

That depends on the origin and destination pair. But that's probably not an unreasonable expectation. But it depends on the origin of destination pair.

Allison Landry – Credit Suisse

Got it. Okay. And then just -- I have 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 talk a little bit about the sustainability of this pace of growth over the next couple of years as new minds continue to come online in Wisconsin. And then could you give us some sense of how much of the frac business you are originating and terminating on your own minds? And maybe what shales you're delivering the most active?

Eric Butler

Yes. 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, 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 fracing all are pointing to significant continued growth in frac sand consumption, on those the really interesting friends in Texas in particular for Permian basin and Eagle Ford basin, I think in January I don’t know, the February March numbers have come up but in January Texas had an all-time record of production of oil in terms of record just going back to the early 80s. So as long as those drilling trends continue you'll see the frac sand demand continue and we have a premier frac sand franchise.

Allison Landry – Credit Suisse

And I would imagine that has a pretty good length of haul from Wisconsin to Texas. Is that correct?

Eric Butler

Turbos [ph] is north, south, it’s not as long as some east west moves but it is a pretty good part of our franchise.

Operator

Our next question comes from the line of Brandon Oglenski with Barclays.

Brandon Oglenski – Barclays Capital

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. 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?

Robert Knight

Yeah, I mean you have heard me say this many times but the way we calculate price at Union Pacific is how much price do we yield in a particular time period against our entire book of business. I am very proud of the way we calculate it because it’s the most conservative way of looking at it. What I pointed is that, so what that means that if we bring on a new piece of business or business that we haven't had for over a year let’s say, that business might come on at great margins, of course we’re very focused on bringing on at the right margins at the market level pricing. But it wouldn’t show up in the new price, I mean it wouldn’t show up in the year-over-year calculation of price.

So you’re exactly right, when we point out that our pricing was up 2% and all the headwinds we faced, low legacy number light and All-LF impact, the reason that 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 are pricing it right but it doesn’t show up in the pricing number, but it shows up in our margins.

Brandon Oglenski – Barclays Capital

And that's what we should really be focused on, to see how you are delivering on the pricing front, right?

Robert Knight

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, the ultimate answer.

Brandon Oglenski – Barclays Capital

Hopefully, I can just get one follow-up in here for Lance. Lance, I think you did state that the network is designed for 190,000, 195,000 units, I believe. 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?

Lance Fritz

No, Brandon, what we typically say is 195, 200,000, several days we could handle fluidly and we say that because in 2006 we peaked at a number about like that very different service product at that time and since then we improved processes, we’ve invested capital, we have more surge capacity and that's what gives us the 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.

Operator

Our next question is from the line of Bascome Majors with Susquehanna.

Bascome Majors – Susquehanna Financial Group

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 these all at once, could you help frame what, in your mind, is the greatest long-term concern for you? And perhaps additionally what's more immediate that you're looking at today that could impact you fairly soon?

John Koraleski

That’s a fairly broad question and so 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 Needling [ph] proposals the service hearings, the Canadian directed agricultural equipments, the Mexico reform. So in each of those cases we have teams of people looking at 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 tax share dollars. So while we consider each one of those to be a very serious and concerning development it also gives us the opportunity to position all of the great things 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 actually throughout North America that there is today.

So we take them all one by one, if you look at the new discussion around revenue adequacy it’s going to 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 that were going to change things to recognize replacement costs, those kinds of things. The service hearings, I think well I think could position 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've been if it had happened five or 10 years ago. In Mexico, we've been working very hard to make sure the government understands the importance in the developments 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, well, it's a serious issue if it were to go it right, give 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 each and every one of them to make sure our story gets told.

Operator

Our next question is from the line of Walter Spracklin of RBC Capital Markets.

Walter Spracklin – RBC Capital Markets

I guess my first question here is for Lance. With all the difficulty you had in the winter weather you still managed to keep your headcount under good control here and 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've been a lower headcount if you didn't have the weather? How should we look at your headcount as you go through the year and the year this year?

Lance Fritz

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 won’t look backwards and guess that what it would've 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 are going to be able to do that.

Walter Spracklin – RBC Capital Markets

So there is 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?

Lance Fritz

That’s correct.

Walter Spracklin – RBC Capital Markets

Second question now. As you alluded to in a number of different ways in your ag business, lot of volatility. You mentioned weather, you mentioned 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 comp basis, as 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?

Eric Butler

Walter, as you recall last year or 2012 going into 2013, there was the drought which significantly impacted our volumes last year, the same time first quarter. So if you look at year-over-year the fact that there was a record corn harvest and 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 are seeing. There were 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, those challenges that they had. But again that surrounding the bigger issue was the record corn harvest was a pretty good bean harvest, pretty good wheat harvest and 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 harvest season.

Walter Spracklin – RBC Capital Markets

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 going to stay within the confines of the STB and their actions? Or could there be any other occurrences that might impact the STBs, any changes the STB might make on the regulatory front?

John Koraleski

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. And 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 and so we haven't really seen a lot on the regulatory front, other than what's happening in the STB and actually as we look at the STB hearings, they are taking a very measured and thoughtful approach to it. So we are in good shape.

Operator

Our next question is from the line of Justin Long of Stephens.

Justin Long – Stephens Inc.

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 think you will be in a position to get better intermodal pricing in 2014 versus what you've seen the past few years?

Eric Butler

As we said we continue to price the market and we are continuedly focused on taking advantage of strong demand. As you mentioned the CSA is having an impact on trucking capacity, had an impact in the winter because of the safety concerns that probably were, was some trucking capacity that self selected themselves out of taking trips on the most difficult portion of the winter weather, because of the concern of the risk with 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.

Justin Long – Stephens Inc.

Maybe 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

As we have talked in the past, a portion of 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 the same kind of profile and as we have opportunities based on demand and market prices we will them.

Operator

Next question is coming from the line of Keith Schoonmaker of Morningstar.

Keith Schoonmaker – Morningstar

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 US 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

I think we have said several times in the past that with the relatively low natural gas prices, futures is still I think around 450 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 said in the past and in previous earnings releases that most of those will come on in 2016, 2017 that 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 long-term positive outlooks.

Keith Schoonmaker – Morningstar

And I guess just a quick follow-up on the Mexico discussion. Given this business is handed off to your US 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 effective if the bill proposed became law? Is this just a bad precedent for other jurisdictions or would this in itself have material impact to UP?

John Koraleski

I think overall if you look at our franchise, the Union Pacific franchise, the business is moving into and out of Mexico, it's not going to really change materially, our ability to deliver goods about to the border and also to have taken from the border and deliver them throughout the US.

Robert Knight

You heard us say this before but our interest in this is we don't want to see something that erodes commerce in Mexico and we think one of the unintended consequences of potential bill is that that it would create less commerce in Mexico. But as you know the only railroad that crosses 6 border crossings in and out of Mexico, so we just like to see commerce continue to grow and volumes continue to one across the border both ways and we are ready to handle it.

Operator

Next question comes from the line of David Vernon, Bernstein Research.

David Vernon – Bernstein Research

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

So we did open our Santa Teresa facility 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 talked publicly that, that new ramp has about 250,000 less capacity, if you think about our domestic intermodal business is 1.6 million units, so we are seeing a strong growth with our products and services across-the-board, certainly new product offerings from Santa Teresa will add to that. But we are seeing strong growth across the board.

David Vernon – Bernstein Research

Should we think that that Santa Teresa opening of that terminal is going to continue this growth through the year and it laps? Or is this more -- I guess I'm trying to figure out of 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

So the current strength is, the strength that we are seeing across our book of business, when ramp opens up there is a gradual ramp up and there is going to be a gradual ramp up in Santa Teresa. The current strength in our intermodal business is depending on slowly growing economy and our value proposition and that’s an across the board opportunity for our book of business rate.

David Vernon – Bernstein Research

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 California refineries or down in Texas on your network?

Eric Butler

As we have spoken before, there are number of different terminals that are under development both on the West Coast and to the extent also in the Gulf Coast. We’re working actively and part of our strategy is to strengthen franchise we cannot direct when and where crude oil will flow, that’s determined by strength that our franchise wants, to, we will ensure we have a franchise that landed when and where at once they flow.

David Vernon – Bernstein Research

Would you think that western -- those western refineries might have perhaps a little bit of a cost advantage via rail relative to the Gulf?

Eric Butler

I am not really sure what you are asking, when you say cost advantage you mean lower rail costs?

David Vernon – Bernstein Research

Yeah, lower, just to move from western Canada down to the Western –

Eric Butler

It will be market based and we will price to take advantage of the value of our franchise whether it’s going to the west coast or to the Gulf Coast.

Operator

The next question comes from the line of Ben Hartford of Robert W. Baird.

Ben Hartford – Robert W. Baird

I think a question for Lance. If I look at cars online, cars online are call it 10% to 12% above trough levels of last year. As we think about volume growth accelerating and the cross current of the network normalizing into the third quarter, how should we think about the asset requirements of the network going forward? 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 fall below the best levels realized last year? Can you provide some perspective there?

Robert Knight

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 am 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 an overall indicator but what we really try to drive is good utilization of the cars that are on us.

Operator

The next question comes from the line of Don Broughton of Avondale Partners.

Don Broughton – Avondale Partners

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 going to be pushing and/or pulling that line in 2014?

Robert Knight

On that line, a big offset if you will to wage inflation has been the pension expense, pension side of the equation and that’s been the reason why I say that our labor line for the full year is expected to be below 2%.

Don Broughton – Avondale Partners

So the wage inflation actually is higher than that, it's just that the actual line itself will be -- come in at under 2%?

Robert Knight

That’s correct.

Operator

Our next question comes from Jeff Kauffman of Buckingham Research.

Jeff Kauffman – Buckingham Research

Most of my questions have been answered. Just one quick one on the locomotive CapEx you spoke about. With the tier 4 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 4 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?

Lance Fritz

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 with 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 four locomotive is going to 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 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 couple other elements.

Operator

Our next question is from the line of Claire Ouzagareen with Macquarie.

Claire Ouzagareen – Macquarie

My first question relates to pricing. Could you clarify for us how much of your book is specifically tied to AII-LF or another inflation cost measure? And how much is able to take advantage of improving demand fundamentals for example, in intermodal?

Robert Knight

I mean roughly a quarter of our business is tied to an escalator, AII-LF being the major driver of the escalations that we use. I would also then add to that, Eric responded earlier to the intermodal question of what capability does it to 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 with any particular timeframe but across our entire book of business. We look to price to market where we have the opportunity.

Claire Ouzagareen – Macquarie

Would you be able to comment to what verticals are offered most opportunity this year in your opinion?

Robert Knight

No, we don’t get into that.

Claire Ouzagareen – Macquarie

And then my second question relates to [indiscernible] 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 it to take advantage of production growth, and what kind of commitments you are looking for in the supply chain from a pure capital to developing an area?

Eric Butler

As we have said previously, the Permian basin has great coverage, pipeline coverage and that's where most of the production growth has taken in the state of Texas. So if you look at our crude by rail volumes from the Permian they actually had decreased significantly, we have said that in the past. And they are 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, 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.

Claire Ouzagareen – Macquarie

So you are not contemplating maybe laying some new rail into California refineries or that's more science fiction than feasible future?

Eric Butler

Yeah, so we are, as I mentioned before, looking at the destination franchise, for crude by rail into California. At this point in time, the market is suggesting a lot of that will be sourced from Canada or the Bakken. There are those in the market we believe that Permian will go to California. If that happens we will be prepared for it but I think the market today is suggesting majority of crude by rail in California will come from Canada or the Bakken.

Operator

Thank you. At this time, I would like to turn the floor back over to Mr. Jack Koraleski for closing comments.

John Koraleski

Well, great, thank you everybody for joining us on the call today and we look forward to speaking with you again in July.

Operator

Thank you. This concludes today's conference. You may now disconnect your lines at this time.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Union Pacific's CEO Discusses Q1 2014 Results - Earnings Call Transcript

Check out Seeking Alpha’s new Earnings Center »

This Transcript
All Transcripts