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Genesee & Wyoming Inc (NYSE:GWR)

Q2 2014 Earnings Conference Call

August 1, 2014 11:00 a.m. ET

Executives

Matt Walsh - Senior Vice President-Corporate Development

Jack Hellmann - President, Chief Executive Officer, Director

T.J. Gallagher - Chief Financial Officer

Michael Miller - Chief Commercial Officer North America

David Brown - Chief Operating Officer

Analysts

Chris Wetherbee - Citi

Jason Seidl - Cowen and Company

Rob Salmon - Deutsche Bank

Bill Greene - Morgan Stanley

Justin Long - Stephens

Tyler Brown - Raymond James

Allison Landry - Credit Suisse

Operator

Ladies and gentlemen thank you for standing by and welcome to the Genesee & Wyoming second quarter 2014 earnings call. (Operator Instructions) As a reminder, today's call is being recorded.

With that, I'll turn the conference now to Mr. Matt Walsh . Please go ahead sir.

Matt Walsh

Thank you for joining us today on Genesee & Wyoming's Q2 2014 earnings call. Please note that we will be referring to a slide presentation during today's call. These slides are posted on the Investors page of our website, www.gwrr.com. Reconciliations of non-GAAP measures disclosed on this conference call to the most directly comparable GAAP financial measure are likewise posted on the Investor’s page of our website.

We will start with the Safe Harbor statement and then proceed with the call. Some of the statements we will make during this call which represent our expectations or beliefs concerning future events are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, which provides a Safe Harbor for such statements.

Our use of words such as estimate, anticipate, plan, believe, could, expect, targeting, budgeting or similar expressions are intended to identify these statements and are subject to a number of risks, uncertainties and other factors that could cause actual results to differ materially from our current expectations, including, but not limited to, factors we will discuss later and the factors set forth in our filings with the Securities and Exchange Commission.

Please refer to our SEC filings for a more detailed discussion of forward-looking statements and the risks and uncertainties of such statements. We cannot assure you that the forward-looking statements we make will be realized. We do not undertake and expressly disclaim any duty to update any forward-looking statement whether as a result of new information, future events or otherwise, except as required by law, and you should recognize that this information is only accurate as of today’s date.

On the call today, we have two speakers: our President and CEO, Jack Hellmann and our CFO, T.J. Gallagher; as well as our Chief Operating Officer, David Brown and Chief Commercial Officer, Michael Miller.

I will now turn the call over to our President and CEO, Jack Hellmann.

Jack Hellmann

Thank you, Matt and welcome to G&W’s second quarter earnings call. As always, we will start our call this morning with safety.

On Slide number 3, you will see that we completed the second quarter of 2014 with an FRA reportable index of 0.5 injuries per 200,000 man-hours. We're leading the rail industry in safety and making great strides in our performance. However we continue to see opportunities for improvement.

Now let’s turn to Slide number 4 and an overview of the second quarter of 2014. The bottom line is that our adjusted diluted EPS was $1.12 which was in line with our guidance. Given the $0.02 per share positive impact of the newly started Rapid City, Pierre & Eastern Railroad which included a one-time tax benefit, our diluted EPS was essentially at the midpoint of our guidance of $1.10.

From a revenue standpoint, we were approximately $10 million ahead of our guidance, of which half was from the RCP&E and half was same railroad revenue. Of the increase in same railroad revenue, our North American traffic in metals, agricultural products and Class I overhead was better-than-expected, while our petroleum products traffic was lower-than-expected due to tightening crude oil spreads.

From the expense standpoint, we reported an adjusted operating ratio of 73.4% which was a bit higher than our targeted 73. The main reason was roughly $3 million of additional expense due to two severe washouts -- one in Canada during the spring fall and one in the Southeast US, due to a thunderstorm that dropped 22 inches of rain in 24 hours. In addition, our mix of business was slightly unfavorable due primarily to higher volumes of lower rated Class I overhead traffic and less petroleum products traffic.

Slide number 5 shows that our adjusted diluted EPS increased 11% over the second quarter of last year. The slide also quantifies the underlying EPS impact to two key items that affected the comparative periods namely a $0.03 per share impact of currency and a $0.03 per share impact of the washout expense. The bottom line is that the earnings power of our business remains quite strong.

Now I’d like to turn to Slide number 6 and discuss some of the key developments in our business over the past several months. First, we’re pleased to report that on June 1, we successfully started up the RCP&E. Our operating team blanketed the railroad on the cutover weekend and did an outstanding job of creating a seamless transition of new employees, equipment, facilities and training programs, all for the benefit of our new customers.

From a business standpoint, customer demand on the RCP&E is strong and the current harvest in South Dakota is expected to be very good. However given lingering congestion in the North American rail network, our biggest challenge thus far has been achieving a consistent cycling of locomotives and cars to and from the railroad in order to clear a grain backlog that is only building with the new harvest. We're working closely with our customers and connecting railroads to ensure the RCP&E becomes fluid and consistent.

A second key development was that our finance team completed the refinancing of our senior credit facility, which extended our debt until 2019, reduced our interest expense and added a new revolver that presently has approximately $600 million of availability for acquisitions and investments.

Third, we restructured our Atlas construction subsidiary and relocated it to Jacksonville, Florida where we expect Atlas to work collaboratively with the G&W commercial team for new industrial development projects.

A fourth key development is that we've now completed construction of a 25 km rail line in the Labrador Trough to serve a new iron more mine owned by Tata Steel Minerals Canada. Upon receipt of the necessary permits from the Canadian and provincial governments, we expect to commence shipments in the third quarter of 2014. Recall that the rail line connects to a major new iron ore mine, that is targeting over 4 million tons per year of output and will serve as the internal raw material supply for Tata Steel Works in Europe.

Fifth, we continue to evaluate multiple acquisitions and investment opportunities in G&W’s footprint. We are actively looking at projects in all of our core markets worldwide.

Now please turn to Slide 7 to discuss recent negative development with two iron ore customers in Australia. One small mining customer IMX, exhausted the reserves at its Cairn Hill mine and closed down in June. G&W has not invested in any rolling stock for this customer and therefore we will only lose track access income paid by another rail company who operated over our track.

The second mine, Francis Creek in the Northern Territory of Australia is a larger iron ore customer who has just announced plans to close its mine temporarily due to both the low price of iron ore as well as permitting delays for the mine’s planned expansion. In this case, we have two trains sets in service that will either be part or redeployed after this November. Unlike most of our iron ore business, our contract for this mine only has limited take or pay protection as the mine was operating under a legacy FreightLink contract until the startup of the planned mine expansion.

Based on discussions with the customer, the mine is expected to reopen in late 2015 although we believe this will be dependent on the global price of iron ore. Meanwhile our other Australia iron ore mines continue to ship at normal levels.

In reflecting on where our business stands at the midpoint of 2014, I would highlight three key points. First, our North American business is quite strong, although we're carefully monitoring the fluidity of the overall rail network and its impact on our car supply and traffic. Second, our Australian shipments are showing weakness for the first time in recent memory due in part to the 30% plus drop in the price of iron ore this year.

And third, the acquisition and investment landscape holds a range of interesting opportunities for us in all of our core markets.

And with that, I’d now like to turn the call over to our Chief Financial Officer T.J. Gallagher. TJ?

T.J. Gallagher

Thanks, Jack and good morning everyone. Slide 8 shows the revenue bridge between the second quarter of 2013 and 2014. Revenues increased a total of $13.9 million or 3.5%. Excluding a $6.5 million negative currency impact and a $5.5 million contribution from the RCP&E, same railroad revenues increased $15 million or 3.8%.

Moving to Slide 9 and freight revenues. Second quarter freight revenues increased a total of $16.9 million or 5.6%. Excluding currency, same railroad freight revenues were up $17.1 million or 5.8% and the RCP&E added $4.9 million.

Let’s move the discussion to commodity on Slide 10. Our same railroad carloads were up around 5% which was ahead of our guidance of 3% to 4% largely due to strong volumes of lower rated Class I overhead traffic.

Here are the highlights. Agricultural products traffic was up 4500 carloads, or 7% with strong traffic in North America partially offset by weaker traffic in Australia. Coal traffic was up 9000 carloads or 11% primarily due to higher steam coal demand in our Midwest and Ohio Valley regions. Metallic ores traffic was up 2400 carloads or 14% primarily due to higher volumes of iron ore shipments in Australia. Metals traffic was up 3600 carloads or 8% primarily due to higher steel volumes in North America.

Petroleum products traffic was down 3300 carloads or 12% primarily due to weaker crude oil and LPG traffic in North America. Auto and auto parts traffic was down 2000 carloads or 21%, primarily due to railcar supply issues as well as the loss of a customer contract in Canada.

And last, other commodity traffic was up 7100 carloads or 40% due to stronger Class 1 overhead traffic. Please note that we expect this overhead traffic to moderate later in the year.

Now moving from freight volumes to freight pricing on Slide 11. Same railroad average revenues per carload decreased 0.8%. Excluding the impact of changes in the mix of commodities, changes in fuel surcharges as well as the depreciation of the Australian and Canadian dollars, same railroad average revenues per carload increased 1.9%. Average revenues per carload were negatively impacted by change in customer mix within the other, metallic ores and waste categories. Our same railroad North American core pricing increase was approximately 3%.

Now turning to Slide 12 and non-freight revenues. Non-freight revenues declined $3 million or 3%. In the quarter there was a $1.4 million negative impact due to currency and a $7.3 million decrease in rail construction revenues primarily from our Atlas construction subsidiary which has been restructured and no longer focuses on municipal transit projects. This decline was partially offset by a $5.1 million increase from all other non-freight categories but primarily from higher switching revenues.

Slide 13 shows the adjusted income from operations and adjusted operating ratio for second quarter of 2013 and 2014. Our adjusted operating ratio was slightly higher at 73.4%. Two factors that negatively impacted the OR were currency and washouts which impacted the OR by approximately 30 basis points and 60 basis points respectively. The reason why currency impacted the OR is that Australia has a lower operating ratio than the rest of G&W and with the weaker Australian dollar there was less contribution from Australia and therefore slightly higher OR.

Numbers and guidance on Slide 14. Let me refer you to our earlier safe harbor statement that noted that these statements are subject to a variety of factors that could cause actual results to differ materially from our current expectations. These statements represent management’s expectations regarding future results as of today August 1, 2014 and we do not undertake any obligation to update this information.

For the third quarter 2014 we expect revenues in the range of $420 million to $430 million and an operating ratio of between 72% and 73%. Net interest expense in the third quarter is expected to be approximately $13 million and we expect G&A of approximately $42 million. Our effective tax rate should be around 36% and diluted shares should be 57 million. The bottom line is that we are expecting third quarter diluted EPS between $1.15 and $1.20.

Slide 15 contains additional information for our Q3 guidance. We expect freight volumes to increase around 7% to 8% in total and 5% on the same relative basis. More specifically we expect other commodity group carloads to be up primarily due to strong Class I overhead traffic. We expect coal volumes to be higher due to continued strength in steam coal demand. Minerals and stone, agricultural products and chemicals and plastics, are also expected to be higher primarily due to the contributions from the RCP&E.

Petroleum products carloads are expected to be flat year over year as weaker crude oil volumes are offset by growing NGL traffic. We expect our same railroad average revenues per carload to increase about 1%, excluding the impact of changes in commodity mix, FX, and fuel surcharges. We expect North American coal pricing increases to be approximately 2% to 3% and fuel prices are expected to average $3.40 per gallon.

Last, we expect the revenue impact of the Australian mine closures to be approximately $2 million.

Moving to Slide 16, our updated guidance for 2014 is unchanged at a range of $4.15 to $4.35 per share with the key changes outlined on slide 17.

Let me start with the positives. First, coal volumes are stronger we thought back in April given greater inventory replenishment and overall stronger demand. Second, we executed a new credit facility in conjunction with the RCP&E transaction that in addition to providing a large revolver results in overall lower interest expense. We now expect interest expense to be $4 million lower than in our guidance from April.

Third, the Us harvest appears to be quite strong and should benefit our agricultural products traffic. The upside of the larger harvest, however, has not been factored into our guidance because of rail network congestion and car supply.

On the negative side, there is the impact of the Australian iron ore mine closures which we anticipate will have a $5 million revenue impact over the course of the second half of the year. We also expect crude oil and NGL traffic to be weaker. The reduced crude oil traffic is related to the narrow WTI LLS spread and the weaker NGL traffic is primarily related to a slower ramp up of a customer expansion.

I will close with Slide 18. Our balance sheet remains strong and as of June 30, our debt to capital was 44% and we had approximately $600 million of revolver capacity available to fund future potential acquisitions and investments.

And with that, I will open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And the first go to Chris Wetherbee with Citi.

Chris Wetherbee – Citi

I guess I just wanted to touch on trends in Australia, you commented a couple times during the call about the price of iron on and I guess typically thinking about sort of how the business works. It's been a little bit immune from some of the volatility in the commodity prices, the pace of volume that is, I guess I just want to roughly sense – are you changing the way we’re thinking or should we change the way we’re thinking about sort of the volume potential of Australia, to see continued pressure on commodity prices, is there anything more risk or is this just more of a one-off situation with these mine closures?

Jack Hellmann

Well based on – I mean these are both in the iron ore market and you really need to think about them on a case-by-case basis. So the first mine is one that we knew had a limited life in that we chose not to serve with equipment and just to receive track access for it. And so in that, that’s smaller mine, it was simply a question of time before that track access stream went away, the question was when and it was expedited by the fact that price of iron ore dropped there. But in generally speaking, the mine was exhausted, so that's one fact pattern.

The other fact pattern – and each fact pattern for each mine is different because the cost structure of each mine is different. So the mines that are currently -- the major portion of our iron ore traffic is much more competitive in global market and they’re still shipping at normal levels which is the last thing I commented on. The fact pattern at the top on the other iron ore mine is - was a situation where the mine was completing at one reserve and it was moving into the next one. It was having difficulty with environmental permits being approved in a timely fashion and the price of iron ore was low. And so they took the opportunity to temporarily close down and are going to wait – they’re going to continue to ship through about November and then they’re going to reassess where they are as to whether or not they -- whether or not they reopen late in 2015 or not. While they’re saying they will reopen, we believe that, that may or maybe not be the case and that it will be dependent on the global price of iron ore.

But in terms of the other iron ore that we serve, it continues to be shipping -- those mines continue to be shipping at normal levels, in fact some of them are increasing, you can see that in our monthly carload numbers that were actually up sequentially because the mines mostly in South Australia where we serve 10 mines across four operating areas, in our narrow gauge traffic and then another large mine on the standard gauge traffic are all competitive and continuing to ship.

Chris Wetherbee – Citi

Okay, you feel pretty good about sort of the rest of that book of business outside these –

Jack Hellmann

Yeah, exactly, so concentrations to this up, that’s right. Now to your point, let me continue all of your questions, because – we talked about Australia but I didn’t talk about Canada which is we’re talking about -- now when you think about our Canadian iron ore business, our biggest investment is with the Tata project that I just talked about, and that is proceeding as planned. And it is rather unique in that it’s part of the steel supply chain rather than for Tata rather than directly exposed to the spot market. So that’s a different type of -- when you look at fact patterns within each discrete mine, this one's a little bit different.

Now in Canada, one of our smaller customers, it’s not material, so we don’t talk about it – it hasn’t been producing all year due to the lower-price of iron ore. But interestingly several other new projects in that geography are proceeding in the region and have signed future off-take agreement. So there are a lot of new developments in the market but generally speaking other than the two in Australia, it’s been business as usual for us.

Chris Wetherbee – Citi

I guess maybe a quick follow-up just thinking about the RCP&E and you think about some of the Midwest congestion that we continue to see slowing down the overall industry network. How long do you think it takes to kind of get that back up and running? I know obviously we have a new grain crop coming and it’s not going to make it easier for you, but just want to get a rough sense of how you think about sort of the ramp up of speed and fluidity on that piece of the network?

Jack Hellmann

Listen why don’t I turn it over to – why don’t we start with David Brown, our chief operating officer, to talk a little bit about what we’re experiencing on the RCP&E in the context of that broader network congestion and how it's affecting the fluidity of our locomotives and railcars on and off the RCP&E. And maybe you could start by framing the issue, we can then speak to over time how long run – and some sense of what we think it’s going to take to improve the fluidity to handle what -- to your point there's a very large crop there, you’ve got a backlog now and there's a large crop. So David, do you want to speak a little bit to the RCP&E startup and flow of equipment.

David Brown

Sure, Jack. So it was a start up for the railroad in June 1 and we have progressively seen that our overall operating measurements are improving. As with any start-up it takes a lot of management time and focus, attention and we certainly have seen an impact from the continued congestion on the Class 1s, especially across that region and over to Chicago .And as you see the Class I measurements around velocity improved, that would indicate that we will see the same type of improvement on RCP&E as the fluidity and basically the cycle times of cars and locomotives improve. So we have seen extended cycle times for both cars and locomotives and that has had an impact on the fluidity of the RCP&E. We see that continuing to improve, nominally sort of each week and that's getting better and we expect that to continue as we go through the harvest –movement in this particular harvest and we think that we’re going to be really up against this harvest through the rest of the year. We know it’s going to take a lot of attention and focus on continuing to improve transit times, cycle times for equipment and locomotives.

Chris Wetherbee – Citi

Any impact to the contribution from RCP&E, as you think about it, is it meaningful or is it just more of sort of getting it up and running so it’s not going to have that big an impact on kind of the financial contribution?

Jack Hellmann

Chris, I am not sure I quite followed – so we gave guidance for the RCP&E when we announced the acquisition and closed it, and nothing has changed there. I think the challenge we have is, we have a better harvest than we thought but we recognize that with the network congestion and fluidity issues that Dave just spoke about, capture some of that upside is to be determined.

Operator

Our next question is from Jason Seidl with Cowen and Company.

Jason Seidl - Cowen and Company

When you look at the fluidity of the class 1 network, obviously we had some issues probably starting with late last year and was exasperated by weather now, I guess why it was coming back decently, what’s built into your guidance in terms of how quickly they recover, I am just curious about how much in terms of extra expenses are you expecting because the system is –

Jack Hellmann

Yeah I mean our guidance is built based on the status quo today and it captures within it the car supply constraints that we are experiencing. So there definitely has been a drag on our business in many of our regions, Canada in particular but also in some of our other regions, from lack of car supply. That is built into the guidance. Another way of saying what I said is we would be doing better if the car supply was better and the system was more fluid. Michael, would you add anything to that or –

Michael Miller

No, I think that’s correct, Jack. I mean the real challenge for us is estimating what the upside potential is and kind of knowing when the improvements will occur. Our goal is just to be well prepared for it as the cycle times improve and car supply becomes better, operationally we just want to be ready to react, so we can capitalize on any upside potential but it is built into our guidance based upon the current network activity levels.

Jason Seidl - Cowen and Company

You’ve assume status quo and if they start improving that’s potential upside.

Michael Miller

Yes.

Jason Seidl - Cowen and Company

Jack, in the quarter, you guys talked about sort of repositioning the Atlas construction, can you talk a little bit about any cost that might have been associated with that move in the quarter and sort of what the outlook is like for them now going after new business?

Jack Hellmann

Michael, well I will speak to the number, there is about a million bucks that we spent in the relocation that came through in the quarter, now that’s behind us and I think there might be like a couple hundred thousand more that will come through in the third – TJ, will find that out – de minimus, it’s not way significant. The more important is the positioning of the business. Michael, do you want to talk a little about that?

Michael Miller

Yes, Jack, we are trying to basically reengineer the business instead of additional processes and focus on some markets that we feel are more suited for our corporate strategy .We're looking very closely how we link those to our industrial development commercial efforts and quite honestly our pipeline for the back half of the year is very robust but as we reengineer the company we need to make sure we’ve got the detail processes in place, that’s been our key focus looking forward into the third quarter. But we do feel like we had a revenue gap coming into this year, we’re going to work hard the next six months to try to close that and we feel pretty good about what the pipeline looks like.

Jack Hellmann

Hey Jason, one other comment on the cost of the restructuring of that - that is included in the business development and related costs that we call that as sort of a one time item that we back out of our adjusted earnings, so we’ve already done that.

Operator

Our next question is from Rob Salmon with Deutsche Bank.

Rob Salmon - Deutsche Bank

As a follow up with regard to the Atlas restructuring and kind of refocus on the markets that you guys are targeting. Is this more to kind of help drive better underlying industrial development across Genesee network or is it to kind of optimize and improve the Atlas margins?

Jack Hellmann

It’s focusing on industrial development. No, the margins are what they are to construction business, it’s a low margin business period. It’s more -- I don't think it has intrinsic economic characteristics that make it particularly relevant to a railroad other than that can help us win new business on our railroads, so that’s how we think about it. This is commercial – it has the commercial tool and that’s why I turned to our chief commercial officer to answer the question, that’s because how you’re using it.

Michael Miller

Just to add a little color to that. I mean one of the key drivers for us on the industrial development side is to be able to get projects to market and being able to offer a design, build, construct operate type model, we feel like we’ve strengthened our position there. So we’re hopeful that we will see this help drive additional industrial development opportunities across the goal line faster for us.

Rob Salmon - Deutsche Bank

And TJ, shifting gears to the guidance, with regard to the Australian headwind that you called out in the back half of the year, in the second quarter it sounded like you were talking to about 2 million. Was that -- is that just the IMX and we should be thinking about it as loss kind of non-freight revenue, or is there some sort of reduction in the Francis Creek volumes which should be flow through as well.

T.J. Gallagher

It’s a little of both but it’s two-thirds IMX, one third TR.

Rob Salmon - Deutsche Bank

And with that non-freight piece I would imagine that just flows through to the EBIT, is that how we should be thinking it or is there a slight offset on the operating expense line?

T.J. Gallagher

Think of it as extremely margin, yes.

Jack Hellmann

Almost all of it, there is a little increase – because there is trains on another of your track [ph] but essentially it’s the track access is straight income.

Rob Salmon - Deutsche Bank

And then as I am thinking about the overall class 1 network fluidity, the network hasn’t been where anyone would like it to be right now, but if I am thinking from a Genesee & Wyoming perspective, clearly there is loss revenue associated with that, because the car cycle isn’t where it needs to be, is there also any sort of incremental expense that you guys were getting hit with, that we should be thinking as we are modelling in the near term, or is it primarily loss revenue which is kind of the way we are thinking about it?

Jack Hellmann

It’s mostly loss revenue, but David, you want to speak that a little bit on the operating side. I mean there is something, that’s why the incremental cost, I think it’s mostly revenue.

David Brown

No, I agree, Jack, there is some cost implications around slow interchanging and – things like car hire are impacted somewhat but again we watch the class 1 reported measurements and those are good indicator to us as to how things are improving and we expect some improvement in our overall cost and certainly like Michael mentioned there will be upside opportunities from a top line standpoint.

Operator

And we go to Bill Greene with Morgan Stanley.

Bill Greene - Morgan Stanley

Hey, Jack, can I ask for your thoughts on the guidance and what I'm getting at is it feels like we’re kind of keep pushing some of the growth into the future, so if you think that the second quarter guidance which you met we pushed some growth to the back half and now with the third quarter guidance a little below consensus, so kind of these are pushing the back half in the fourth quarter, is there a risk on our fourth quarter or certainly maybe were overestimated the long-term growth?

Jack Hellmann

That’s two questions, one is on the year, whether there's any timing differential. I mean it is what it is, it’s built from the bottom up as to what our best expectations are based on the moving parts that we identified in coal, and petroleum products and iron ore. So there is a higher growth rate -- there's an easier comp in the fourth quarter to drive -- that certainly drives a good chunk of the growth rate. The third quarter outlook is broadly consistent where I would've expected to have bee four months ago, three months ago. So although the internal part may be different as life changes sequentially. The big picture ends up being overall for the year it depends on where your last guidance was.

Bill Greene - Morgan Stanley

And longer-term you feel okay about 15 to 20%?

Jack Hellmann

Absolutely, absolutely, I mean you can look at -- if you want to look at a quarter as the - what core earnings growth is – you’re unexcited by 11% growth rate, I think is the genesis of your question. And if you look at the impact of currency which is about 3% and you look at the impact of the loss outlook is about 3%, you are about 17% and then if you figure the fact that we actually didn’t have a very good mix of business in the period. So you could be doing better than that. You’re essentially -- you should be delivering right down the middle of that.

Bill Greene - Morgan Stanley

Let me ask you a question on pricing as well. So I realized -- that the rail industry is providing substandard service now and it's a little hard to ask for price increases when your service levels aren’t up to snuff. On the other hand we are seeing chokepoints around the system where capacity is getting tight, is pricing perhaps one of the tools that we can use in ‘15 to try to limit some of this volume growth, because we’re going to need more capacity in some parts of the network here, I realized services has got to get better too but to some extent it feels like we've got it maybe slow some of the growth rates in some parts of the network in order to get it back to normal?

Jack Hellmann

I am going to let Michael Miller, our chief commercial officer speak to that philosophically and we probably don't want to go too far into that talking other people’s network, we got to focus on our own. But go ahead, Michael.

Michael Miller

Yeah, I would think it is safe to say that we feel very comfortable with our network capacity and we’re not in a position right now within our networks that we couldn’t take on incremental traffic without much concern. But with that said we are going to continue to focus on pricing and we do feel like it’s an opportunity for us to capture market value where the service is better. Clearly our pricing is tied directly to the class Is and we will follow along that to some degree but I feel comfortable that we have enough capacity, we’re not going to be pricing business away from our railroads.

Bill Greene - Morgan Stanley

Okay, Jack, one point of clarification on your slide 6, you say you’re evaluating acquisitions worldwide in the footprint, is that to suggest you don't want to go outside the footprint?

Jack Hellmann

I guess that’s kind of a elusive statement, isn’t it? It means it mostly in our footprint or directly adjacent there too, but yeah our preference is always to be in our footprint. That level of generality gets me a little bit of wiggle room to be right next door but not in it. But generally speaking we always prefer to have -- those opportunities that are in our footprint, contiguous is always the best because the economic typically are the most attractive but we’re active in every market in which we currently have operation, there are various projects that we’re working on and just remains to be seen which ones will, will and won't happen.

Operator

Our next question is from Justin Long with Stephens.

Justin Long - Stephens

I wanted to follow up on the iron ore question earlier and just to ask how we should be thinking about metallic core volumes over the back half of the year and into 2015, do you expect consolidated volumes in that commodity group to start moderating sequentially or given the growth we should see from other customers can we still see this commodity group trend flattish or maybe up?

Jack Hellmann

Well so with respect to the third quarter given that we had a ramp up in 2013, we see metallic ores flattish, slightly up maybe and from a full year perspective it’s been a great year, traffic is up about – around 8%. We haven't guided into 2015 but it gives me an opportunity to mention for the question that someone is going to ask is if the iron ore mine closures has $5 million impact in 2014, what does that mean for 2015? The simplest way to think about is that the aggregate revenue from these two mines is about $20 million of which $5 million that we felt this year as one mine shutdown in June and the others continue to ship until the fourth quarter, so therefore the 2015 impact is going to be about $15 million. And if you assume about a 50% incremental margin which is what we usually do, that will get you to about 10 to 12% impact in 2015.

Justin Long - Stephens

And then second to that I wanted to ask about the NPRN that came out last week regarding and tank car regulations. but I know nothing is final on that but could you just talk about how this could potentially impact your business based on looking through that document and some of the things that have been proposed?

Jack Hellmann

David, do you want to talk a little bit about it since you have been on point for this topic.

David Brown

Sure, Jack, it really has little effect on our overall operations and we don’t supply cars, so car owners supply cars and class 1s are much more involved in overall types of cars that are going to be deployed according to that. NPRM, as far as speed and other restrictions of braking requirements none of that really is – it makes any difference for any of our properties that are currently operating build sites of the commodities that inflammable are included in that notice. So it’s not going to have much impact.

Operator

Our next question is from Scott Drew with Wolfe Research.

Ivan Yi - Wolfe Research

Good morning guys, this is Ivan Yi on Scott Drew [ph]. Going back to Australia are all of your iron core contracts take or pay and with the $5 million revenue loss expected in second half be much different without take or pay?

Jack Hellmann

The remaining contracts are yes.

Ivan Yi - Wolfe Research

The second part, meaning you’re expecting a $5 million revenue loss but you have limited take or pay protection with this contract correct?

Jack Hellmann

That's right. If you did have it you would be doing better than what we just articulated, but we don't have it because they are in between mines, so you had a legacy contract that lasted from – a business that we previously acquired that lasted through the mine which is -- which will be running through November and then there is another deposit right next to it but the one for which the permitting issues exist and then -- new contract would exist for the development of that deposit, which would be on different contractual terms than the legacy contract.

Ivan Yi - Wolfe Research

And just quickly on Grace Harbor any update there on the potential crude by rail development?

Jack Hellmann

I think the short answer is it’s going to be slow, there is a lot of – Michael do you want to give an update on various processes out there.

Michael Miller

I think that's an accurate reflection, it’s going through the permitting process, environmental impact study, so it’s going to continue to be a slow process.

Operator

And we’ll go to Tyler Brown with Raymond James.

Tyler Brown - Raymond James

Jack, we have seen you guys execute on RCP&E, I you think one of your competitors recently bought some lines from NS, I was just curious on your thoughts related to those class I spend, do you guys think there's a reacceleration here, although it’s kind of more one-off deals

Jack Hellmann

More one-off deal, that’s not where our focus is right now. I mean obviously if there are attractive opportunities to present themselves we take a careful look but in the sort of population set of opportunities that’s not even – that’s kind of on a one off basis that we think about it.

Tyler Brown - Raymond James

I just noticed that the purchase services particularly in Australia seem pretty low but was there something going on there and can you give us some help for what you're expecting the OR to be say in North America and Australia in Q3?

Jack Hellmann

Sure the amount that went down is primarily related to insourcing of maintenance of equipment in Australia. If you recall in 2013 we insourced our minerals and waste -- operations which was previously outsourced, in 2014 we insourced the maintenance of equipment, so that’s really the difference in purchase services. With respect to OR, the OR in Australia in Q4 we expect to be around -- Q3 around 73% and that’s due to number of factors timing of maintenance of equipment expenditures, the Australian mine closures, we mentioned, that we have also had to develop this quarter. We do expect that Australian OR to turn to more normal seasonal high 60s for the fourth quarter .

Tyler Brown - Raymond James

TJ, again you guys are on track to get to that call it mid to high 2 leverage ratio by the end of the year, I'm just curious how you think about the ‘15 allocation slate. I know you guys are focused on M&A, your growth CapEx but if those prove elusive are you looking to turn on a big buyback or would you be looking to pay down more debt?

Jack Hellmann

We will evaluate that as the time comps, when the time comes. Right now obviously we don't have buyback in place but I would say right now based on the number of acquisition and investment opportunities we have, the probability is weighted towards capital deployment rather than shrinking our capital base. But obviously there could be a fact pattern which realizes precisely what you said, it'll just depend on how life plays out .

Operator

Our next question is from Allison Landry with Credit Suisse.

Unidentified Analyst

This is Danny on for Allison. Just wanted to shift away from crudes to NGL a bit, I know you mentioned that you have an NGL customers that’s ramping up slower than you anticipated. Just wondering if you could help us think about the size of that opportunity and whether it could eventually drive overall growth in petroleum products, if you have any other NGL customers do you expect to ramp up over the next few quarters?

Jack Hellmann

The customer I am referring to is the major NGL fractionation plants in Ohio that we’d spoken about in the past year. They initially opened last August with one fractionation train, they are in the process of installing the second and third trains. And the reference run for ramp up is by getting the additional units online and processing in ’15 but lower-than-expected which is not unheard or uncommon with the new plant of this size.

Michael Miller

There is still other projects in the pipeline, we feel like we start to be coming on in the fourth quarter this year, early first quarter next year. The big key here is increasing of the input and takeaway capacity into these fractionation facilities but we do have couple other facilities that will be coming online relatively soon and they will be ramping up as well, so we feel pretty good about our development opportunities in both Utica and the Western Marcellus markets.

Unidentified Analyst

And then just thinking about it in the context of overall petroleum products volume, is it something that -- are these projects that could push the overall petroleum products volume growth up or is that something where – it’s still going to be driven by crude spread over the next few quarters?

Jack Hellmann

So our petroleum products business around now is roughly a third -- third NGLs/LPG and a third other. So it’s sort of balanced right now, so depending on how we should use those one third size components grow or stay flat or shrink the crude oil given the spreads, may not determine hopefully the overall growth rate in the commodity group.

So one third is definitely growing at a rapid, more rapid cliff but that may either be disguised or amplified depending on mostly what's going on on the more volatile component which is the crude component. That’s why you look at the guidance in the third quarter – our NGLs are ramping up pretty nicely in the third quarter but our assumptions on the crude are offsetting that, so you probably won't be able to see it unless the spreads continue to widen.

Operator

And we have a question from the line of Phil Greene [ph] with Macquarie.

Unidentified Analyst

You have highlighted M&A and investment as the key area of focus this quarter, could you tell us more about it, maybe more detail on opportunities to invest capital on the base additional 250 million a year that you mentioned an attractive rates, would you like to comment on trends that could act as a tailwind, I am thinking maybe strict restriction for the class 1 road or the regulatory burden for the short lines, as a result of all of these proposed regulations in the US could help, since these are pushing the railroads platforms to acting an environment that is natural for you, or any other trends across your global footprint that you like to highlight for us.

Jack Hellmann

I would just say that -- there's a wide range of opportunities ranging from outright acquisitions of companies or traditional M&A type opportunities as well as opportunities for deployment -- deployment of capital for equipment in markets like Australia and so there continue to be some large projects that we’re working on in all of our markets and I wouldn't -- and I wouldn’t yet publicly opine on what any of the impacts of regulation might be on others and how it might impact our M&A strategy. I would just speak to the realities of the present which are -- we see the population set of both traditional M&A coupled with the potential to deploy equipment for certain customers.

Unidentified Analyst

And my follow up relates to the tax credits, I am surprised that we haven’t heard a question about it so far but I have recently at the industry gathering that there is possibility for it to be made a permanent change and maybe that is why we have seen the delay in passing under a temporary extension framework, are you more or less confident in getting this extension and – as the year goes by?

Jack Hellmann

There is a majority of -- a majority of the house and a majority the U.S. Senate support -- cosponsored this short line tax credit and so you have a very strong bipartisan support for the tax credit, the issue is always which piece of legislation it might find itself attached to, because it’s too piece of legislation in its own right, the conventional wisdom and I don't have any better information than the conventional wisdom would be the in a lame-duck session of Congress post November election is the time when some kind of tax extenders bill can be brought forth to vote and given the bipartisan support ours is a lot that -- tax credits is a logical inclusion in such a bill. Having said that we – and we’ve had similar expansions coming – three times, four times, from the base bill, so that is not uncommon at least the past practice but it could find its way into another bill as well time will tell but it’s got – it’s unusual in that it has such broad support and so lacking in controversy relative to other bills in Congress.

Unidentified Analyst

Do you still expect it as annual renewal – a permanent tax grant cut?

Jack Hellmann

typically what’s happened historically has been made -- you'll have a year like this one where we haven't had it for the year and it gets retroactively approved, so there's a catch up and then then if it happens for example later this year you’d have a catch up a -- one-time catch up for all 2014 and introspectively in 2015 you would have for ensuing years with the two year renewals, with the three year renewal, obviously carry through 2016. Over time I think there's a number of members of Congress who'd like to see this in a more permanent form given this relates to the long-term infrastructure investments and for companies seeking to make long-term capital planning decisions it would make sense for it to be embedded in a piece of transportation legislation that has a longer time horizon to it. and but whether that’s logical outcome come, something else happen remains to be seen.

Operator

We have no further questions in queue. please continue.

Jack Hellmann

Thank you very much for joining us on our second quarter earnings call. We are now concluded.

Operator

Ladies and gentlemen this conference is available for replay, it starts today at 1 PM Eastern and will last until September 1 at midnight, you may access the replay in anytime by dialing 800 475 6701 or 320-365-3844, the access code is 309989, those numbers again 800 475 6701 or 320-365-3844, the access code is 309989. That does conclude your conference for today. Thank you for your participation, you may now disconnect.

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Source: Genesee & Wyoming's (GWR) CEO Jack Hellmann on Q2 2014 Results - Earnings Call Transcript
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