Canadian National Railway's (CNI) CEO Claude Mongeau on Q2 2014 Results - Earnings Call Transcript

Jul.21.14 | About: Canadian National (CNI)

Canadian National Railway Company (NYSE:CNI)

Q2 2014 Results Earnings Conference Call

July 21, 2014 4:30 PM ET

Executives

Janet Drysdale - Vice President, Investor Relations

Claude Mongeau - President and CEO

Jim Vena - Executive Vice President and Chief Operating Officer

J.J. Ruest - Executive Vice President and Chief Marketing Officer

Luc Jobin - Executive Vice President and CFO

Analysts

Benoit Poirier - Desjardins Capital Markets

Brandon Oglenski - Barclays

Cherilyn Radbourne - TD Securities

Scott Group - Wolfe Research

Walter Spracklin - RBC

Chris Wetherbee - Citi

Fadi Chamoun - BMO

Bill Greene - Morgan Stanley

Ken Hoexter - Bank of America Merrill Lynch

Jason Seidl - Cowen & Company

Keith Schoonmaker - Morningstar

Allison Landry - Credit Suisse

David Tyerman - Canaccord Genuity

David Vernon - Bernstein

Donald Broughton - Avondale Partners

David Newman - Cormark Securities

Operator

Welcome to CN Second Quarter 2014 Financial Results Conference Call. I will now like to turn the meeting over to Janet Drysdale, Vice President, Investor Relations. Ladies and gentlemen, Ms. Drysdale.

Janet Drysdale

Thank you, Patrick. Good afternoon, everyone. Thank you for joining us. It’s a beautiful day here in Montreal. We’ve certainly got some great results to share with you. I would first however like to remind you of the comments that have already been made regarding forward-looking statements. With me today is Claude Mongeau, our President and Chief Executive Officer; Jim Vena, our Executive Vice President and Chief Operating Officer; J.J. Ruest, our Executive Vice President and Chief Marketing Officer; and Luc Jobin, our Executive Vice President and Chief Financial Officer. (Operator Instructions)

It's now my pleasure to turn the call over to CN's President and Chief Executive Officer, Mr. Claude Mongeau.

Claude Mongeau

Thank you, Janet and thanks to all of you for joining us this afternoon. We indeed have very good results to announce and we plan to take your questions and delve a little bit deeper about both the quarter but also the look for the balance of the year.

If I focus my comments on Q2, we’re very pleased that we’ve had a very swift recovery following what was a tough winter condition. And we did exactly what our customers would expect in terms of getting those supply chains back in sync. Our core metrics are all in line or better than last year. Jim will give you more details but service and productivity are doing very good.

We moved all-time record volumes for the second quarter and that helped us resync those key supply chains. We dealt with the backlog of traffic from the winter and are meeting robust growth opportunity across our customer base. J.J. will give you more color and details about that but we did during the quarter deliver double-digit volume growth and to be more specific 14% per revenue ton miles which is probably the best indicator our volume and 11% for carloads.

Specifically, we have the record second quarter for grain. And this is one supply chain that we’ve been working hard to resync and I’m pleased to tell you that as I speak today in the middle of July, our Canadian grain supply chain is fully back in sync.

During the second quarter, we moved 70% more grain than last year. We’re moving record volumes, spotting every week the last couple of -- in fact for the last two to three months. Now we’ve been moving in a range of 6500 spots or carloads in our Western grain operation. That’s an absolute record. And as we stand today, we only have about week of orders outstanding, all the ship lineups at the waterfront port are at normal level and our overall supply chain is fully back in sync.

For the full year, we should be delivering an all-time record in terms of grain volume, well above an average in the range of 25% more than an average crop is what we will be doing. That should help having carryover stocks that are in the range of 80 million tons or maybe only 6 million tons more than an average carryout as we close the crop year.

All of this is possible because we’re balancing operational and service excellence, that’s our agenda. We clearly show that we are delivering growth at very low incremental cost, our operating ratio at 59.6% is an improvement over last year. Luc will give you the core elements of our results but it is solid financial results in terms of revenue expenses, free cash flow. And he will also give you a little bit more details about the outlook for the balance of the year, which is very solid for another strong year in total.

We’re trying to stay ahead of the game looking to next year. We have good growth outlook, staying ahead of the capacity curve, investing through the summer. And we’re doing that because it matters to us to stay in sync with those customer supply chain and help our customer win in their own market.

With that, I will turn it over to Jim.

Jim Vena

Okay, Claude. Thank you very much. Why don’t we turn to the operating highlights page. And let me start off by thanking CN’s dedicated team of railroaders for their hard work and solid execution which drove a swift recovery from the winter-related challenges that we faced in the first quarter.

Overall the network is fluid and our key operating metrics are in line or better than last year, particularly given the significant increase in workload. On the year-over-year basis, revenue ton miles as Claude mentioned were up 14% in the second quarter. That’s a full 10% increase versus our fourth quarter 2013, which is our prior quarterly peak. To come out of Q1 and deliver volumes at 10% above peak speaks to the focus and dedication of the CN team and our commitment to our customers.

Let me highlight the year-over-year 4% improvement in train productivity and 5% improvement in locomotive utilization. We are focused on putting a strong volume growth to work for us by running longer and more efficient trains. Those efforts paid off nicely in terms of employee productivity which hit a all-time record in the quarter with an almost 12% year-over-year improvement in gross ton miles per employee.

I’m very pleased also with our fuel efficiency performance. We reported a 5.5% increase in gross ton miles per U.S. gallon of fuel consumed but recall that the comparable would be because we had a negative account in adjustment last year. The fuel efficiency came in at 3% better for the quarter which is still an outstanding performance. We will be facing some tough comps though going towards the second half of the year and we’re working to be -- finish off the year at 1.5% betterment.

Now in terms of velocity and dwell, we’ve improved significantly versus Q1 but were lagging little bit from last year, obviously bringing on 14% increase in volumes as part of that. Traffic mix in the capital programs has also played a role. We have a number of capital programs occurring underway which will help us going forward but we have work to do.

I’m very pleased with the operating performance in second quarter but there is no ifs and or buts that we’ve got a lot of work to do to try to increase the velocity and speed even with the metrics that we were able to deliver in the second quarter.

We can turn over to the next slide on balancing operational and service excellence. This is very important about what we do and what we’re trying to achieve as a railroad. So the objective is pretty simple. We need to stay excellent running the railroad while at the same time continue to improve service that we offer our customers.

All that though is centered around our employees. They are key and employee engagement is important. We’re continuing to push decision-making to the front line and of course making sure those employees have the tools and training to make the right decisions.

We’ve just opened two new training facilities, one in Winnipeg and on July 7th, the one in Chicago. We modernized our curriculum and we've improved our on-the-job training. From the service side, we continue to make progress with respect to our end-to-end supply chain approach. We’re as focused on driving improvement to -- in our customer-centric metrics as we are maintaining our operating discipline.

They go hand-in-hand. We’ve already made meaningful progress in our intermodal and bulk segments and I'm very pleased that we’re slowly starting to rollout our iAdvise initiative to merchandise customers. iAdvise improves in the connectivity between the yardmaster, the customer service rep and the customer and provides our frontline operating folks with the visibility and awareness needed to better meet customer expectations and it’s at the right level. It’s at the frontline people doing the day-to-day work that serves our customers.

On the capital front, we’re continuing to invest for growth and productivity. In particular, we’ve got a number of programs targeting greater Winnipeg and the Winnipeg-to-Chicago quarter in an area that you heard me speak about that we have specific issues that we've identified that we need to get fixed in the next 18 to 24 months. And we’ve got a good plan to get ahead of it.

We’re also continuing to invest in AC locomotives. This year and next year and the following year we’ve got a plan in place and orders in place for this year and next year and what we bring forward. And of course, safety is the foundation of everything that we do everyday. We're going to continue to work all levers via technology, process or safety culture driving improvements.

We continue to invest in technology with the announcement last year of extra funds of $10 million on technology and processes. And with the CM campus in Winnipeg and in Chicago, we are going to continue to drive the safety culture and drive improvements in both our metrics.

So to wrap up it up, both solid operating performance in Q2, but like always more work to do, never satisfied with where we are. So over to you J.J., just keep that business, will you?

J.J. Ruest

Thank you, Jim, and especially thank you for the 14% revenues on mile growth. We will walk you through our second quarter performance, then we will do the commercial outlook, and then conclude the yield management. We are pleased to report record revenue for the quarter a $3.1 billion and a year-over-year growth of 17%.

The breakdown is as follows. Volume and mix produced 11%. Same-store price was just under 3%. Recall that same-store pricing is defined as shipment with the same customer, commodity, care type origin and destination and reflects about 75 of our traffic. There was very minimal impact from fuel and exchange contributed 4%.

Now we will go to the highlighted market and as usual I will do that on a FX adjusted basis. Petroleum and chemical continued to be impressive forcing a 12% revenue growth. This was driven by increased crude carload about 31,000 in a quarter versus 17,000 last year. Canadian crude is accounting for roughly 60%. We have continued ramp up of new loading facilities as well as new customers receiving location. We have strong butane, propane, gas and diesel related to tank capacity on the TransMontaigne Pipeline and the reversal of the Cochin Pipeline.

Metals and minerals revenue gained 14%. We moved 21,000 carloads of frac sand, 46% carload growth. We handled our first unit train of sand to Western Canada that will become a new trend over time. We had higher volume of semifinished steel reflecting share gains and improving North American demand for automotive and energy sector. Short-haul iron ore carloads were down 10% as we were bottlenecked by the frozen Great Lakes in April, resulting in very slow start of the iron ore selling season.

Forest product revenue was up 4% on flat carload. The U.S. housing start increased our lumber and panel shipment to United States. This was offset by a lower offshore export of lumber due to lack of CN’s car supply to Port of Vancouver. Pulp and paper revenue remains payable.

Coal revenue was basically flat. We had lower volume of Canadian met coal and petroleum coke for export, which was due to weak market condition overseas. This was offset by a doubling in shipment of short-haul U.S. utility coal for domestic restocking and from domestic share gain.

Grain and fertilizer reported the biggest gain. Revenue grew 31%. Canadian grain revenue achieved an all-time high for export volume, 50% more than last year. Our U.S. grain revenues were also very strong, up 24% and we handled strong product shipment partially to United States.

Automotive revenue increased a good 10%. We have strong demand for finished vehicle, which was finding supportive in the quarter by improved PBX car supply. Intermodal revenue grew a solid 15% and export volume were very strong for CN at Port of Montreal and Vancouver as a result of new business and at Port of Rupert due to the change in deployment of vessel capacity.

On domestic we continued the solid growth in retail, which was mitigated by lower revenue for wholesale. Our coal supply chain revenue increased 25%. Other revenue which was 4%, we lost basically one full month of sailing with the iron ore vessel fleet due to heavy highs back in April.

Now turning to the outlook, I want page 10, the demand is solid. Starting with intermodal, we see a concentration of growth at a Port of Vancouver, Rupert and Montreal. Currently with the short-term diversion of U.S. West Coast traffic to the Midwest, our West Coast port capacity is sold out for month of July and August. In Canadian domestic, we are balancing price and volume growth, but leave no doubt we have a very strong domestic service offering.

In bulk, we will continue to move last year’s record Canadian crop in advance of the new harvest. We also see good things in our U.S. grain volume as well as in potash. Thermal coal volume will remain strong driven by ongoing agility of restocking and by share gain. Offshore coal export will remain depressed.

In merchandise, demand for crude by rail will remain on the upward trend. Receivers capable of handling unit train volume will generate significant demand for. I'm also constructive, more constructive on the pricing trend for crude by rail new contract and the value of that business to CN.

Metals and frac sand demand looks solid. We are adding to our fleet sentimentally 500 units to beat more of the U.S. housing start demand. We are also improving our intermodal model at Prince George to move more Asia lumber export overseas.

Moving to price and capacity yield management becoming increasingly important in the way we do business. The North American rail capacity is getting snug. Pricing should be influenced by both the value of our service and the intrinsic value of capacity in of itself. We use same-store price as a better reflection of all pricing action taken. We continue to focus on inflation plus pricing which we define now as 3% all-in, including coal, grain, the full book of business as it should be. We find revenue per car and cent per RTM to be weak measure of price and yield as they are generally primarily driven by change in mix.

We prefer using better decision tool. Revenue to cost ratio for customers private care, contribution per car day for CN provided railcars and round-trip revenue through cross ratio model for antimodal, our focus in on upscaling not just adding volume.

In conclusion, there was solid demand pretty much across North America. We are growing faster than the economy at mid to high single-digit carload growth and we are focused on getting value for our service and for our capacity with disciplined inflation plus pricing and with capacity yield management. Luc?

Luc Jobin

Thanks, J.J. Starting on the page 13 on the presentation, let me walk you through the key financial highlights of our second quarter's performance. As both mentioned, these very strong results demonstrate our quick recovery from the first quarter's weather-related challenges and solid growth momentum into the second quarter. As J.J. outlined revenues were up $450 million, or 17% to slightly over $3.1 billion.

Operating income was over $1.2 billion, up $216 million or 21% versus last year. Our operating ratio was 59.6%, an improvement of 130 basis points over last year as we grew the business at low incremental cost. Now this represents a record for second quarter operating ratio and it weighs in as our third best quarterly operating ratio performance ever.

Other income was $2 million versus $28 million in 2013. Last year's result included in the quarter a pretax gain of $29 million on the exchange of an operating income. Net income for the second quarter is $847 million, up 18%. Foreign currency translation contributed to a favorable impact on net income of $28 million or $0.03 of EPS in the quarter. So the reported diluted EPS reached a $1.03, up 23% versus last year. The adjusted diluted EPS also stands at a %1.03, in this case up 24% versus the prior year.

As I mentioned 2013 adjusted results did include the property gain which I referred to earlier and deferred income tax adjustment of $5 million relating to a change in provincial corporate income tax rate.

Turning to Page 14, operating expenses were $1,858 million, up 14% versus last year or 10% on a constant currency basis, as we continue to tightly manage costs. At this point I'll refer to the expense changes in constant currency.

Labor and fringe benefit costs were $560 million, an increase of 10% versus last year. This was the result of three elements. First, an increase in overall wage cost of $38 million, or about 8 percentage points. This is the product of wage inflation of about 3%, overtime for about two percentage points, and a 3% increase in our average headcount versus last year.

So, Jim and his team certainly delivered double-digit manpower productivity in the quarter. This was partly offset by higher capital work being performed in the quarter versus last year for approximately 4 percentage points. And the second element is a higher stock based compensation expense in this quarter versus last year. Now this represents $40 million of the variance or 8 percentage points.

The third element is a favorable variance of $9 million of 2% points in pension and benefit expense. This was the result of the pension expense being lower by approximately $20 million, which offsetted increase benefit costs in the quarter versus last year. Purchased services and material expenses were $390 million, an increase of 11% or $39 million.

The key drivers here were the 14% higher volume in the quarter, along with some leftover winter related costs. As such, repair and maintenance expenses were up $11 million or 3 percentage points, as were material cost in the quarter. While the intermodal trucking and transloading expenses were up 2 percentage points, as were crew accommodation and utility costs in the quarter.

The fuel expense stood at $484 million, up $54 million or 13% versus last year. Higher volume represented an increase of 13 percentage points in the quarter, while an increase in price drove the remaining 5 percentage points. Fortunately, fuel productivity was approximately $20 million favorable, on account of a 3% improvement in the quarter. While an additional 2 percentage points of the variance relates to a one-time unfavorable inventory adjustment that we incurred last year.

Equipment rents at $84 million were $12 million higher than last year or 18%. This is mostly attributable to higher equipment leasing cost and more car hire expense in the quarter. Casualty and other costs were $83 million, $14 million or 22% higher than last year. The increase here was split about evenly and resulted from higher costs related to environmental matters and higher property tax.

Turning to free cash flow on Page 15. We generated over $1.2 billion of free cash in the first half of the year, an increase of $482 million versus last year. In comparison to last year's -- in comparison to year-to-date results last year, cash from operations benefited from higher earnings, lower income tax payments and better working capital. This was partly offset by higher net investments activities for $50 million in the quarter.

Some of the favorable working capital variance however, is partly the result of timings, so we may not net off quite as well on that dimension by year-end. Meanwhile, our balance sheet remains strong with debt and leverage ratios within our guideline, which bodes well for continued support for the business and shareholder distributions going forward.

Finally on page 16, our outlook for 2014. We’re pleased with the swift recovery, we achieved from a challenging first quarter. Our entire second quarter's performance was strong from a revenue, service and operating standpoint. This is a fine demonstration of our ability to grow faster than the economy and do so at low incremental cost. We have good momentum and we continue to be optimistic with our prospects for the balance of the year.

Now while we clearly have our work cut out, we have the potential in the second half of the year to reach the overall earnings growth performance achieved in the first half. Given this perspective, we’re raising our annual guidance and so we are now aiming for solid double-digit EPS growth in 2014, over the 2013 adjusted diluted EPS of $3.06.

We’re also raising our guidance for free cash flow to now be in the range of $1.8 billion to $2 billion. Meanwhile, we’re maintaining our capital investment program at $2,250 million.

So in conclusion, CN team remains as committed as always to delivering superior results for our customers and shareholders, as we continue to unfold our strategic agenda in 2014 and beyond.

On that note, back to you, Claude.

Claude Mongeau

Thank you, Luc and thanks to the team. I think, it’s fair to say when you look at these result that our business agenda is maintaining its strong momentum. We are delivering high service level to meet our customer demand. Our supply chain mindset is a key differentiator and its helping us outpace the economy and our peers.

We have a disciplined approach to investment. We’re looking to support growth, productivity, and safety. We’re doing on a consistent way trying to stay ahead of the curve and it’s paying dividends. The goal is to create solid value for both our customers and our shareholders and I think our Q2 results and the Outlook that we’ve just provided you for the balance of the year is proof to that.

With this, Patrick, we will be happy to take questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) The first question is from Benoit Poirier from Desjardins Capital Markets. Please go ahead.

Benoit Poirier - Desjardins Capital Markets

Hi. Could you maybe provide more color on the crude by rail following the announcement made by KCS and Global Partners for the new terminal in Port Arthur? It seems a very nice opportunity for you. And more specifically I’m wondering, how conservative is your guidance of 150,000 carloads for next year and also what we should expect in the second half? Thanks.

J.J. Ruest

Thank you, Benoit. Its J.J. Maybe starting with the guidance, we may do better than the guidance, but want to put that in the context of the yield accrued. Crude is to pay, it’s win the railroad just like any other commodity, so that's as important as exceeding the guidance on volume. Regarding the announcement of the new terminal on the KCS, this is not the only new terminal, but there is inbuilt in the Gulf or Alberta. But it just add up to the size of that pie, right.

It makes a bigger pie for -- in the present case. Canadian crude, that’s where we participate to go down the Gulf. And we do have connection with KCS over, I call it Springfield. Some of the people call it Cockrell. And time will tell how the business shape out, but just -- just more of a bigger pie for everybody to participate.

Benoit Poirier - Desjardins Capital Markets

Okay. Thanks for the time and congratulations for the result.

Claude Mongeau

Thank you.

Operator

Thank you. The next question is from Brandon Oglenski from Barclays. Please go ahead.

Brandon Oglenski - Barclays

Yeah. Well, good afternoon, everyone and congratulations on the good results here. I guess, my questions for Claude or J.J., obviously, this year you’re seeing a lot of ramp up in grain markets. You’ve won some intermodal contracts from your competitors as well as on the auto side. But when we start thinking about 2015 and 2016, how sustainable is this mid-single-digit type of carload growth. Isn’t that going to start lapping some very difficult comparisons? Do we see maybe a year of pause in 2015 on the growth and are there some pretty robust pipelines behind this?

Claude Mongeau

Let me take that. I think we are seeing a robust pipeline of growth across all of our lines of business or I would actually say for the most part across our lines of business. Definitely energy markets will continue to be a strong source of growth into 2015 and beyond. Grain should have another strong year next year because as I said earlier while we will finish with a carryout of 18 million tons that is still a 6 million ton more than an average.

Add to this a new crop and the need to move it, we should be moving record volumes of grain well into the spring and even summer of next year. We have good growth in intermodal, good growth in automotive businesses. We have solid growth in merchandise winning with our customers, one carload at a time. So I don’t see 2015 as a year of pause and it’s tough to lap strong growth year-over-year but that’s our agenda. And we’ll give you more contouring color on that outlook when we close in on the year. It’s a bit early to call it more precisely at this point.

Brandon Oglenski - Barclays

Appreciate it. Thank you.

Operator

Thank you. The next question is from Cherilyn Radbourne from TD Securities. Please go ahead.

Cherilyn Radbourne - TD Securities

Thanks very much and good afternoon. I would be curious to know given how strong your execution has been since the spring arrived and to what degree you think some of the acrimony between the rail industry and the grain industry has started to dissipate here?

Claude Mongeau

You know that. I think you have to put things in context there. As I said before, I think some stakeholders and certainly the government reacting to those stakeholders we lost perspective in the winter with the grain situation. We were hitting record volume last fall, even the minister of agriculture was saying that we were doing an adequate job at moving this record crop.

The winter was very difficult but when you look at the entire winter at the end of it with the strong March performance, we came in with volumes that were only 2% less than an average winter. And since then, I mean, we are hitting absolute record. I said earlier 70% more Western grain during the second quarter and we will finish the year in total with 25% more grain than an average year.

I think the facts are speaking to the reality. And I’m hopeful that ultimately the facts will shape policy and it’s certainly shaping the relationship we have with our customers because as we speak, I think we have as I said earlier, we don’t have a week of outstanding orders. That means we are meeting all the demand and there should be room to store the grain when it’s harvested especially so that it’s expected to be harvested late this year because of the late planted crop. So we'll do our work and hopefully people will see that and shape policy accordingly.

Cherilyn Radbourne - TD Securities

Thank you. That’s my one.

Claude Mongeau

Thank you, Cherilyn.

Operator

Thank you. The next question is from Scott Group from Wolfe Research. Please go ahead.

Scott Group - Wolfe Research

Hey, thanks. Afternoon guys. So wanted to ask a little bit about the pricing. J.J., it sounds like maybe that’s a lever you’re going to start pushing a little bit more aggressively. And just wondering how quickly do you think that starts to show up in the numbers and do you think that you can get another point or two of pricing and still maintain kind of this volume growth well above the rails?

J.J. Ruest

It is two things that we’re focused on, focusing on, one is pricing as measured in same store price and the other one is yield, which you will not see in same-store price as we do upscaling because upscaling turn out to be new business. It doesn't get measured in same-store. And that the two of them are very relevant to driving an operating ratio that I think we have today.

And we’re of the view of pacing ourselves doing this progressively and working on the two lever as opposed to just one lever. And I think overall, I think capacity in North America, I mean railroad may have different opinion or opinion that they see publicly or not so publicly but capacity is getting real tight and capacity just in itself has more value today than it had after the recession and we’ve been into a recovery now for five years and railroad have been investing billion of dollars including ourselves.

But there is some pinch point that from time to time show up after weather issues or other issues, which I think are pointing to the valued capacity and eventually that reflects in your renewal and that reflects also in which business fit best into a given railroad which I call upscaling. So over time but steady Eddie on the way up.

Scott Group - Wolfe Research

Do you think -- when do you think this starts to show up in the numbers?

J.J. Ruest

Again over time. We still have this Canadian grain thing to digest up to August 1st and there’s some lingering effect in August. And after that we’ll -- after that I think you’ll only see so much in same-store price and the rest hopefully you’ll be able to see more on the bottomline of the company.

Scott Group - Wolfe Research

All right. Thanks a lot guys.

J.J. Ruest

Thank you.

Operator

Thank you. The next question is from Walter Spracklin from RBC. Please go ahead.

Walter Spracklin - RBC

Thanks. Good afternoon everybody. Just a follow-up here. Clearly with the higher volume that you're getting on your system and the higher demand, J.J., is doing a good job know as Scott was indicating of repricing that capacity that you have using the bottom decile group of customers. This question I guess is for Jim. As J.J. is doing that, on that side, what -- how are you looking at the capacity on your side in terms of being able to handle this growth?

You mentioned that you still have some work to do in the velocity side. Is there any risk that we start to see in the back half, some cost creep or are you still confident that we can get some good operating leverage here or is it perhaps the CapEx question where you go into Luc and rather than an expense creep you might -- you might come back and ask for a little bit more capital. How do we look at that kind of capacity utilization and the constraints you’re having on that end?

Jim Vena

I think the way you asked the question, you just quite hit it all, Walter. So it’s a great way to frame it. First of all, do we have some areas where I’d like a little bit more capacity, yes. But we try to plan capacity out, so that we don’t get to the point where we’re so restricted that we have an issue in the short term.

You can’t spend enough capital for winter. And I’ve said that a number of times and you’re going to have some issues whether you like it or not. But we have some areas that we’ve identified that we have to work on. We’re working on, on this year. We spent capital last year between Edmonton and Winnipeg and in fact they’ve worked out real good through winter in that area.

We will continue to invest and as I mentioned earlier between Winnipeg and Chicago because we see growth in that lane, plus the type of traffic. Second piece is -- and what you won’t be able to see is a certain percentage, let’s say 4% or 5% go onto the trains that you’re running already. Trains have got the room to grow. We bring in AC locomotives, invest on them. That allows us to put more on the trains especially in Edmonton to Chicago. So we do all that and then the mix.

And I think the biggest problem I could have is as J.J. tells me that we’ve got another 14% next year. And I don't see anything that will stop us from being able to handle that kind of business if the market is there for us to bring it in. It’s always a challenge. And when I talked about the velocity is, last year, Q3 we basically set a record on most of our numbers. It's topped the match that with the matching business and what we have.

Now, I don’t if we’ll get right through the numbers, we are going to work real hard to try to get to the numbers, and that’s kind of people we have. We’ve got people front line, working to try to get that last mile, that last car on the train make it a little bit bigger, Walter. So hopefully, I answered the question.

Luc Jobin

Walter, it’s Luc. Just to add a little color on the CapEx side of things. Obviously, again, I mean, I think we are trying to invest the money wisely. We are trying to anticipate the needs. This is not something that would push us above our sort of range. We’ve always been looking at 18% to 20% of revenues for CapEx. So I would expect those going to stay in that range. We are certainly adding more rolling stock. I mean, if you look at just the locomotives, we’ve actually secured about 500 more locomotives since the back end of the recession. We’ve got a pretty aggressive plan to continue to do that as the business is there.

And as Jim pointed out, on some of these infrastructure requirements, we work at it over time. So we’re on to some of the areas that we feel are creating opportunities for improvement and we are flagging some more for the future. So it’s a matter of pacing ourselves, but the good news is the business is out there and I think we’ve got a good plan to address it both in terms of operating performance and capital investment.

Walter Spracklin - RBC

Great. Thank you very much.

Claude Mongeau

Thank you, Walter.

Operator

Thank you. The next question is from Chris Wetherbee from Citi. Please go ahead.

Chris Wetherbee - Citi

Thanks. Good afternoon. I was just thinking about sort of the guidance and putting in the context for the second half. As you are coming out of 2Q and volumes are running very well, the network is clearly running very well outside of maybe a slight deceleration volume as you move into 3Q and 4Q. What is there anything that maybe shows up that could decelerate the pace of growth? It would seem like you’re entering into the back half really with the strong tailwind here. And I’m just trying to get a rough sense of putting that solid double-digit EPS growth and the context for the back half.

Claude Mongeau

I think the best way to think about it is we finished the first half with roughly 17%, 18% EPS growth. We are working out to repeat that in the second half, but that’s what the Luc signed up for. And Jim and J.J. will try to beat it.

Chris Wetherbee - Citi

All right. That’s helpful. Thanks.

Operator

Thank you. The next question is from Fadi Chamoun from BMO. Please go ahead.

Fadi Chamoun - BMO

Yes. Actually my question was asked, but maybe for J.J., on the intermodal side as we go into the back half of the year, you obviously had a very strong first half with some diversion from the U.S. coast maybe and some sort of above average growth. How do you think about the back half of the year being more normalized growth rate at this point, or is there anything else going on, on that front?

J.J. Ruest

Thank you, Fadi. We are still constructive about the second half for intermodal, again more coming from the Port of Vancouver, Rupert and Montreal because of things that we’ve gained earlier in the year will carry us through the full calendar year. Your comment about the divergence from the U.S. Midwest, the labor situation on the U.S. West Coast, we didn’t get a whole lot of benefit of that other than the latter part of the month of June. So the impact of that is really going to be the third quarter.

And as I said right now, we have more coming at us than we can handle. So that’s not a -- it’s a good and bad problems to have. All in, there is nothing that says the second half should be hitting a wall or what not. Overseas is going to be strong. Situation in the U.S. eventually will get its self resolved. What we are really after is permanent business, not just transient business. And domestic has some pockets of positive and some pockets of negative and we will work with that, because in the end what we are really after is something sustainable but profitable. It’s helping out what you’re looking for.

Fadi Chamoun - BMO

Sure, thank you. Maybe you can just give us what was the growth in the domestic intermodal in the quarter?

J.J. Ruest

I don’t have the specific numbers, but the growth was much stronger on the overseas than it was in the domestic, whether it’s revenue or units.

Fadi Chamoun - BMO

Okay. Appreciate it. Thanks.

Operator

Thank you. The next question is from Bill Greene from Morgan Stanley. Please go ahead.

Bill Greene - Morgan Stanley

Hi, good evening. J.J. or maybe even for Claude, to some extent, I am curious what your view is on the idea of service. So when we look at CN for years, your service was kind of second to none for sure in Canada and you guys won a fair amount of shares through that service level. Now you are making it harder for CP to catch up on OR with this performance here in this quarter. But as that gap narrows and the service levels, if they are approximately the same, do we have to worry about any traffic that’s on CN that is perhaps not naturally on CN so that it would naturally want to go back to CP of service and costs were similar. Is there a segment of the business so to speak at risk over the next few years, or is that not really the case at all?

J.J. Ruest

I think the business that we have is natural business for CN. We worked hard over the years to have true end to end supply chain approach and customers are -- that business model is resonating with them. We keep making headway. We compete against trucks. We compete against ships. We compete against pipeline. We compete against all the railroads in North America, including CP. And our goal is to outpace our peers and outpace the growth rate of the economy. And I think our outlook for growth for the balance of the year in my comment about 2015 support the notion that we see that continuing or anticipating for the foreseeable future. So you don't win business on an operating ratio, you win business because you have the right franchise, the right mindsets and the right business agenda, and we think we have all of that.

Claude Mongeau

And in the market where capacity is a little tight, we don’t need to go after every piece of business.

Bill Greene - Morgan Stanley

Yeah, fair enough. Okay, great. Thanks for the time. Appreciate it.

Operator

Thank you. The next question is from Ken Hoexter from Bank of America Merrill Lynch. Please go ahead.

Ken Hoexter - Bank of America Merrill Lynch

Great, good afternoon and congrats on the nice results. But just digging into maybe J.J. a little bit of the outlook. Can you talk about your timing of maybe some new crude by rail activities coming out on the heavy Canadian side? And then similarly, on the coal side, I think you threw out there that you expected it to remain or you are seeing that it continued to get weak given where global pricing is, can you maybe delve into that a little bit as well? Thanks.

J.J. Ruest

On the coal side, the export coal is weak, is even weaker now than it was earlier in the year and we don’t necessarily see a whole lot of positive signs, especially on the pet coke and/or the met coal. On the domestic coal, I mean, people are restocking and we had this one-time share gain early in the year, they stay with us for the full year.

And on crude, these are major projects. Actually we’re getting pictures this week of some of these big construction sites and it takes time. So the big ramp up again, people will work hard to try to do everything they can. I am talking in Alberta here in the north, but there are still areas of winter from time to time to wrap up this construction site before the coming winter. So I mean, we constructive on crude. The market is moving towards units range, bigger block of origin, bigger block of destination and I think we are staying to our guidance, may exceed that and we want to be sure that where we move is at decent yield and it pays its way on the railroad.

Ken Hoexter - Bank of America Merrill Lynch

Thanks.

Operator

Thank you. The next question is from Jason Seidl from Cowen & Company. Please go ahead.

Jason Seidl - Cowen & Company

Hey, guys, it’s Jason. Real quick, J.J. you talked a little bit about the real strong growth on the frac sand side, but you mentioned that there’s going to be unit train, that seem like it was new business going to Western Canada, started here in the back half of the year. Can you give us a little color on that and can that grow beyond on unit train?

J.J. Ruest

So there is unit train activities today in the United States, where people who buys sand receive large block, meaning unit train quantities. Not the case yet in Canada. Obviously, the market though sees all kind of efficiencies in moving bigger block, I would say unit train would be big block, right. And we moved our first big block unit train in the second quarter.

And there is a trend where the big buyer of sand would like to receive bigger quantity at the time. And just like crude, this will eventually move to kind of a different distribution model where people spend a lot of money at the receiving end with loop track or big receiving track that they receive large quantities, which is a sign of volumes going to go up. And if these LNG terminals in the Prince Rupert and Kitimat really goes ahead, it really speaks to how much sand we required in the Northern B.C. and in Alberta.

So it’s a trend about growing and is also a sign of how much money, capital money our customers are investing because they believe the business is there long term.

Jason Seidl - Cowen & Company

Is there any difference in the length of haul on that business than the U.S. business?

J.J. Ruest

No. We’re talking Wisconsin to Alberta and maybe one day Wisconsin to B.C., but today it's really Wisconsin to Alberta.

Jason Seidl - Cowen & Company

Okay. Great. And then follow-up question. You also mentioned little bit about a recovering housing market in the U.S. I mean, we’ve seen some mix data here -- down here in the States. And just wondering what would you guys are seeing that tells you, you got to order some center beams here.

J.J. Ruest

Yeah. What I’m saying is even though the housing starts in June were down, and we are struggling with meeting the demand. So in a way it’s a silver lining to us the housing starts are running up too fast because we’re not be able to keep up. So our fleet is -- in the second quarter, it was basically fully deployed and our customers elected to because the supply was tight, elected to ship more to the U.S. long-haul and to the short-haul to Vancouver by truck.

So we are getting more equipment so that we can participate more to the U.S. housing start. And we’d like also it’s about a little more in the Asian export via Vancouver. The ship is center beam from B.C. to Vancouver and you load the container, as well as do some of that right at the middle or closer of the middle from our Prince George intermodal terminal.

So, I think the relationship between U.S. housing start and CN Caledon lumber is maybe a little tighter what people thought because in June we really had very little reprieve in our order book.

Claude Mongeau

In fact, I would say in number we still have quite a bit of inventory on the ground that we have to clear over the next several months. So, we’re constructive about lumber movements and the same story with panels, which is basically the same market.

J.J. Ruest

That’s right. Thank you, Jason.

Jason Seidl - Cowen & Company

Well, thank you, guys as always.

J.J. Ruest

Thank you.

Operator

Thank you. The next question is from Keith Schoonmaker from Morningstar. Please go ahead.

Keith Schoonmaker - Morningstar

Yeah, thanks. J.J, I think you mentioned that heavy crude was about 17% of quarterly crude volume, if I heard that correctly. Could you comment on trends and length of haul within the crude franchise and maybe what you expect in the next year to two?

J.J. Ruest

The heavy crude, my comment on heavy crude was we are roughly about 60%. I think in the second quarter 60% of our crude was heavy crude.

Keith Schoonmaker - Morningstar

60%, 6-0?

J.J. Ruest

6-0, yeah.

Keith Schoonmaker – Morningstar

Okay. Yes. And then trends on length of haul, if you don't mind?

J.J. Ruest

Trends of length of haul, I think it was second quarter, as far the same length of length of haul I think, from the first to second quarter. I mean, crude itself is long-haul business, no question and it’s more and more into unit train of block. But the average length of haul, I think it's probably stable for a crude business, stable as in the recent past.

Keith Schoonmaker - Morningstar

Thanks.

J.J. Ruest

Thank you.

Operator

Thank you. The next question is from Allison Landry from Credit Suisse. Please go ahead.

Allison Landry - Credit Suisse

Thanks. Good afternoon. I just wanted to ask a balance sheet question. Your adjusted debt to EBITDA came down a little bit in the second quarter to about 1.6 from 1.8 in the first quarter. And I was just wondering if you would consider adding some leverage here to potentially increase your share buyback program ahead of the October expiration of the current program?

J.J. Ruest

Yeah. I mean, as such we don’t have a specific plan to kind if unduly leverage up. I mean, we continuously look at the balance sheet, as I mentioned earlier, it is in a pretty good shape. So we’ll look at, we’ll review our policy for stock buybacks and dividends as we get to the back end of the year. Our stock buyback program expires in October, late October, so that will be providing some input, some update on that, probably when we report our third quarter numbers.

And the dividend, we will reconsider as well in terms of next years plan and probably report back on that sometime early in the New Year. So, good balance sheet, yes clearly some flexibility there. But we shouldn't expect a major departure in the way in which we’re thinking about the balance sheet. So, no significant leveraging up overnight kind of thing.

Allison Landry - Credit Suisse

Got it. Thank you so much.

Claude Mongeau

Thank you, Keith. It’s the same team, steady Eddie, but delivering strong cash flow and solid shareholder value.

Operator

Thank you. The next question is from David Tyerman from Canaccord Genuity. Please go ahead.

David Tyerman - Canaccord Genuity

Yes, good afternoon. A question on the intermodal. In the intermodal, you commented that you’re balancing price and volume growth on the domestic. I was wondering if you could provide a bit more explanation there and particularly in light of CP touting this area as an area of major growth. I don't know if it’s impacting you or not.

Claude Mongeau

So the domestic intermodal and we are talking the Canadian domestic intermodal is where us and our competing railroad from Calgary offer similar service. And the area, where the service overlap the most is Toronto, Calgary, Vancouver, back to Calgary, back to Toronto. And in that corridor, it’s fair competitive service wise and price wise. We are focused on getting a fair value for service.

And in some cases all the effort that we put in are deemed to be not worthy of a small price increase. And in those cases sometime we may have to take the pass for the bigger picture. So by and large, we are focused on the yield and upscaling. And in some cases, we may or may not meet the competitive offers out there if there is some, when there is some. We want to balance price with volume and it’s very important to our midterm game plan here.

David Tyerman - Canaccord Genuity

Okay. That’s helpful. Thank you.

Operator

Thank you. The next question is from David Vernon from Bernstein. Please go ahead.

David Vernon - Bernstein

Hey, guys. Thanks for taking my question. J.J., could you comment a little bit about how the contract was structured for the heavy Canadian crude by rail? Are those U.S. dollar-denominated and how do you think that the demand should trend as we see the currency separation beginning to develop here as the U.S. dollar is appreciating? Thanks.

J.J. Ruest

When we ship something for the U.S., we view ourselves as a U.S. railroad and we price in U.S. fund. When we ship something into Canadian city from a Canadian city, we see ourselves as a Canadian railroad and price in Canadian. So, domestic movement, Canadian funds, cross-border movement, U.S. funds and the dollar does what it does, sometime it’s up, sometime it’s down.

David Vernon - Bernstein

Do you think, though, that if we started to see the U.S. dollar continue to appreciate that could help create some demand for that heavy crude?

J.J. Ruest

I’m not sure how it links back to heavy crude. I mean, crude is really a U.S. dollar-denominated world market anyway to start with. So I wouldn't necessarily make whole lot of tie-in between exchange rate and how crude move by rail.

Claude Mongeau

I would agree with that. I think that our opportunities to continue to grow in the energy market is really linked to, I means, it’s a sea change. The shale plays, the new movement of crude by rail, all these markets are looking for transportation opportunity and some of them need infrastructure. And it’s more about how the infrastructure is coming into play that we see the growth coming up than moving it week-to-week or month-to-month of the Canadian exchange rate.

J.J. Ruest

Yeah. It should not be confused here with like paper or some of the other commodities which are truly Canadian based from beginning to end in their costs and different market place.

David Vernon - Bernstein

All right. Thank you.

Operator

Thank you. The next question is from Donald Broughton from Avondale Partners. Please go ahead.

Donald Broughton - Avondale Partners

Good afternoon. Thanks for taking my question. I just want to kind of get inside your head a little bit and think about -- understand how you think about strategically. The service issue being had by a couple of your U.S. counterparts in particular. Has it really changed the way you think about how you operate the railroad, how you’re hiring employees, how you operate the interchange with them, how you invest in your rail or is it more a -- look this changes the way we’re going to interact with our customers and what we see is the opportunities for volume, the opportunities for yield. Is that one or the other predominantly? How do you think about that?

Jim Vena

Don, if you get inside my head, you would look out three to four years and you would see us finding ways to say ahead of the curve on service initiative, stay ahead of the curve on capacity investments, stay ahead of the curve on shaping safety and our ability to be seen as a backbone to the economy. And if you stick with me and I have a good access to how we’re thinking, you would see that we have a bright future and are looking to ride our agenda and it’s not about what our competitors are doing this week, it’s about where we see the market three to four years from now.

Luc Jobin

And Don, just to add a comment, it’s Luc. I mean, I would say that certainly given the infrastructure advantage we have in the Chicago area, this is a pretty lasting advantage that we’re going to leverage as much as we can and that’s very difficult for others to get around that. So I think it bodes well from an infrastructure standpoint.

Claude Mongeau

If you need to go to Chicago, you can ride on us.

Donald Broughton - Avondale Partners

Thank you.

Claude Mongeau

Thank you, Don.

Operator

Thank you. Our last question is from David Newman from Cormark Securities. Please go ahead.

David Newman - Cormark Securities

Good afternoon gentlemen.

Claude Mongeau

You squeezed in David.

David Newman - Cormark Securities

Nice quarter. So beside pricing improvement from top grading some of the areas and I would assume that’s probably like intermodal, crude by rail, mix merchandise, whereas it’s obvious where you can do it. Is there other areas like where M&A would make more sense? So are you getting a little tight and a little bit snug? You've got 2 billion in free cash flow that you have coming at you, certainly lots of cash. Your balance sheet is in great shape. You did a great acquisition years ago, obviously, and certainly in Northern Alberta, some of the short lines that has helped. Is that starting to enter your thinking in terms of maybe there's other areas rather than deploying CapEx, you might look at some M&A?

Claude Mongeau

Our core strategy is leveraging our franchise on an organic basis. And in addition to solid volume and good pricing, we are -- and that’s tied to capacity and there is nothing like being challenged to focus on all the levers and there is a new trend, it’s about looking at the bottom line opportunity, how can you get yield by focusing on how you leverage that volume to get the business at lower cost.

So not just price and volume, it’s also bottomline focus through yield initiatives. And if you do that consistently and outpace the economy and accommodate that business at low incremental costs, you can as we did over the last five years deliver solid results for your shareholders. We have the balance sheet, a strategic opportunity create themselves, there are also part of the scope of initiatives, the plan is organic growth and we’ve got the tools and the ability to act on plan B if an opportunity creates itself.

David Newman - Cormark Securities

Very good. And may I just squeeze one in? I mean, is it the obvious areas, international, intermodal, crude by rail, mixed merchandise, is that the areas where we’ve all heard comments about international intermodal being lower margin? Is these sort of the areas that you are looking at to sort of top grade?

Claude Mongeau

I would say that we have opportunity across all of our businesses, more than the ones you just mentioned.

David Newman - Cormark Securities

Okay.

Claude Mongeau

And all of our businesses are solid profitability. It’s true of overseas. It’s true of domestic. Obviously, intermodal is a little below the average of the overall book, but in our case, it’s fairly close to the average profitability of our book of business. We look to upscale. We look to create yield. And we look for balance. And we do that across all the commodities we serve.

David Newman - Cormark Securities

Very good. Congratulation guys. Great results.

J.J. Ruest

Thank you.

Claude Mongeau

Thank you. And that’s a good question to close it. Again, we are constructive about the balance of the year, very proud of our second quarter results. And those results because we have a very strong team of committed railroaders that are focused day in, day out to serve our customer needs and that’s what we will do for the balance of the year in order to deliver solid results and meet what our new guidance. And we look forward to report on that success in our Q3 call. Thank you.

Operator

Thank you. The conference has now ended. Please disconnect your lines at this time and we thank you for your participation.

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