Canadian Pacific Railway's (CP) CEO Hunter Harrison on Q1 2016 Results - Earnings Call Transcript

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Canadian Pacific Railway Limited (NYSE:CP)

Q1 2016 Earnings Conference Call

April 20, 2016 09:00 AM ET

Executives

Nadeem Velani - Investor Relations

Hunter Harrison - CEO

Keith Creel - President & COO

Mark Erceg - CFO

Analysts

Chris Wetherbee - Citigroup

Fadi Chamoun - BMO Capital Markets

Scott Group - Wolfe Research

Walter Spracklin - RBC Capital Markets

Tom Wadewitz - UBS

David Vernon - Bernstein

Ken Hoexter - Merrill Lynch

Jason Seidl - Cowen and Company

Justin Long - Stevens

Turan Quettawala - Scotiabank

Benoit Poirier - Desjardins Capital Markets

Allison Landry - Credit Suisse

Steven Paget - FirstEnergy

Bascome Majors - Susquehanna

Jeff Kauffman - Buckingham Research

Operator

Good morning. My name is Blair and I will be your conference operator today. At this time, I would like to welcome everyone to Canadian Pacific’s First Quarter 2016 Conference Call. The slides accompanying today’s call are available at cpr.ca. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. [Operator Instructions]

I would now like to introduce Nadeem Velani, VP, Investor Relations, to begin the conference.

Nadeem Velani

Thanks, Blair. Good morning and thanks for joining us. I’m proud to have with me here today Hunter Harrison, Chief Executive Officer; Keith Creel, President and Chief Operating Officer; Mark Erceg, our Executive Vice President and Chief Financial Officer.

Before we begin, I want to remind you this presentation contains forward-looking information. Actual results may differ materially. The risks, uncertainties and other factors that could influence actual results are described on Slide 2 in the press release and in the MD&A filed with Canadian and US regulators. This presentation also contains non-GAAP measures outlined on Slide 3. The formal remarks will be followed by Q&A. In the interest of time, we would appreciate if you limit your questions to one.

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

Hunter Harrison

Thank you, Nadeem. Thanks to everyone for joining us this morning. I am extremely pleased with the results of the quarter. I have been doing this for a long time and I have some appreciation for what it takes to achieve an operating ratio which was a record for us. It is 58.9, particularly given the soft economic conditions that we are faced with. So real congratulations to go out to Keith and his operating and marketing teams for producing these type results in very difficult conditions.

And then I guess it really bodes well for the future in that when we see the economy strengthening a little bit it will come back. It is just – it is not a case of if, it is when. It is certainly going to put us in a position to have some really record results that you have not seen before.

We have announced a new share buyback program and increase to our dividend and more on that later from Mark and so once again just congratulations to the team for a job well done, particularly those who help us that are shareholders and so with that let me turn things over to Keith for a little more granular look at what we experienced in the first quarter.

Keith Creel

Okay, thanks, Hunter, thank you for the comments. I echo your remarks. Overall I'm extremely proud of this operating team and this operating model demonstrates the power of this model. You see the metrics. At the end of the day it is all about solid execution about what I consider the best [Indiscernible] in this industry to produce our best ever first quarter operating ratio.

In this current very demanding environment that we are living in today it is all about focusing on and controlling what we can. It is leveraging this operating model to succeed. The metrics you see certainly speak for themselves. Double-digit improvements, [speed], locomotive productivity, car miles per day, train length and fuel efficiency both improving by 5%. So all fruits of the hard labor and the execution day in and day out while we improved service and delivered for our shareholders.

We surpassed our operating targets that we set back at our multi-year plan for 2018. Certainly train speed, velocity, key to our success but we are certainly not stopping there. In fact last week myself and Hunter we had the senior operating team in Chicago for three days discussing our next level of operational improvements focusing on how to execute better, how to lower the cost, how to improve safety, and also improve service for our customers.

Also with an eye on the future we continue to grow and develop our team, preparing for the eventual transition with Hunter and me next year. We got some organizational changes that we approved yesterday with the board of directors that what we will be announcing today. I will go ahead and brief our shareholders on effectively what we are going to do right now. We operate with three regions. We have a western region and eastern region and a southern region, each run by a senior vice president of operations.

Effective immediately we are going to consolidate those three regions to two. There will be a West region and an East region. Of course the US operation will fall under the guidance and the direction and leadership of the eastern region. We got Guido De Ciccio, who is currently the Senior Vice-President of the Western Region, and will remain the Senior Vice President of the Western Region. Tony Marquis, who is the Senior Vice-President of the East will pick up the US operation. Each of those from a development standpoint and from a coverage standpoint will get a vice president. So we are going to take two of our talented general managers from [Indiscernible] Steve Nettleton will be in the east, located in St. Paul, and in the west, Mr. Mark Redd will be vice president located in Winnipeg.

We feel very confident with that operating team. It is going to allow me the capacity and time to continue with working with them to continue to improve this operating performance as well as focus, spend energy and time developing the other parts of the company be it the marketing team as well as, working with the finance team and the balance of the support staff at CP. So very excited about that; again effective immediately.

Robert Johnson in turn will become the executive vice president of operations. Robert is going to move from St. Paul to Calgary, again effective immediately. So with all those changes we feel very, very solid team – very solid team. We will continue to drive and improve our record performance.

On the revenue side obviously a very demanding environment. Freight revenues for the quarter were down 5%, but that is effectively in-line with our expectations. And our comps are going to continue to be a challenge heading into the second quarter particularly with the bulk commodities negatively affecting volume and mix. Lower fuel prices and a weaker US dollar certainly puts further pressure on the yield in the near-term as well.

So that said the Canadian economy though on a positive note appears to be stabilizing and recessionary fears seem to be subsiding. So we do feel that the second-quarter is going to be the bottom. Q3, Q4 obviously are going to be stronger on a demand standpoint. Q2 last year I will remind you very strong, [Indiscernible] as far as demand in April then it eased off in May and June. So we got some pretty challenging comps in the second quarter to workagainst this year.

But with that said this railroad is running to Hunter’s point better than it ever has. We set up a strong foundation. So when these volumes do come back that is when you truly see the leverage and the power of this operating model that kicks in and springs back with some pretty dramatic performance bringing that revenue to the bottom line.

So with that said let me past it on to Mark and I will let him provide some more color on the financial performance.

Mark Erceg

Thanks, Keith. Let me start this morning by quickly walking you through a few of our first quarter financial highlights. As expected, we did face a challenging demand environment as both Hunter and Keith commented on, but in keeping with what Hunter has always taught us we did take a very hard look at the levers within our control and we pushed exceptionally hard to find efficiencies and take out non-value added costs, which allowed us to produce a record OR of 58.9%, a 430 basis point improvement versus year ago.

And while I realize that I made a similar comment last quarter, I still think it bears mentioning that because fuel surcharge lag added nearly a point to OR achieving a sub 60 OR in the first quarter, at least in my own view, is particularly impressive.

Moving to a few specifics, operating expenses were down 11% as reported and down 15% on an FX-adjusted basis. And since FX remains volatile I will be speaking on an FX-adjusted basis for the remainder of my commentary. I should also mention that we provided some slides in the appendix to give you some additional details, which you might find helpful.

So with that understanding comp and benefits were $329 million this quarter that is down 16% versus last year driven by lower headcounts, lower stock-based comp and positive pension income. And for all you financial modelers out there two quick reminders related to comp and benefits going forward that you might find helpful. First pensions will be a $22 million benefit next quarter that is versus a $33 million benefit this quarter because as you may recall we had a one-time $11 million pension related gain, which we recognized during the second quarter last year.

Second stock-based comp is likely to be a significant headwind in the second quarter because based on last night’s closing price we are already facing roughly $30 million of incremental costs on the quarter on a year-over-year basis.

Turning to fuel, fuel expense was $125 million, which was down 41% year-over-year. Lower volumes accounted for $11 million of the reduction, and fuel productivity accounted for an additional $9 million and as with last quarter lower fuel prices themselves accounted for the majority of the decline at $67 million.

Purchased services declined 13% to $221 million largely due to casualty costs and efficiency savings. Land sales despite relinquishing the Arbutus Corridor to the City of Vancouver for $50 million, were actually a headwind during the quarter given the $60 million of land sales we recorded during the first quarter of 2015. And since we are discussing land sales, I should take this opportunity to mention that we remain on track for total land sales of approximately $75 million this year, which is in-line with our guidance and we expect that this level of activity with continue for the next several years as we work to monetize our significant real estate portfolio.

Moving below the line, other income and charges reflect the change in value of the US dollar denominated debt on our balance sheet. Interest expense was up 35% to $124 million due to the additional debt we issued in 2015 to repurchase shares and our effective tax rate, excluding the FX translation on US dollar denominated debt came in at 27.5% on the quarter but because of our ongoing tax planning efforts, we now expect a full year effective tax rate of 27.25%.

Bringing everything together, reported net income came in at $540 million, but if you remove the non-cash gain of $181 million on US dollar denominated debt and [only] adjusted diluted earnings per share you would see that they were up 11% at $2.50 per share. So all things considered this is a very strong quarter and because we remain confident in our ability to deliver meaningful increases in both free cash flow and shareholder value going forward we are as Hunter indicated earlier implementing a new share purchase program and increasing our quarterly dividend by $0.15 to $0.50 per share in order to continue returning significant capital to our shareholders.

Since the start of 2014, we have returned $5.3 billion to our shareholders, $4.8 billion was in the form of share purchase and a little over $0.5 billion were returned via dividends. During that same time period and net of shares issued under our stock plans we have seen shares outstanding reduce by 22.4 million shares or 12.8%.

Our most recent NCIB application is currently under review by the TSX, and we hope to receive approval and be back in the market over the next couple of weeks. And with that let me turn the call back over to Hunter.

Hunter Harrison

Thanks Mark and Keith for those very helpful presentations. And with that Bliar we’ll be happy to answer questions the audience might have.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] The first question comes from the line of Chris Wetherbee from Citi. Your line is open.

Chris Wetherbee

Hi, great. Thanks. Good morning everybody. I wanted to ask a question just sort of on the outlook for this year, so a couple of moving parts, we have currency kind of coming back the other way. Some tough comps I guess in the next month or so Keith that you highlighted, but fantastic operations from the business and as you think about that maybe an improving Canadian economy how should we think about the potential for double-digit EPS growth this year and sort of what the sort of prospects are for the business?

Hunter Harrison

Well, Chris that is a – it is a good question and one that we talk about internally a lot given the moving parts that are taking place right now, but bottom line all in I think we are still very comfortable with the guidance that we have previously provided and it is always something makes the change there. We have obligation to certainly disclose that and you all will be the first to know but second-quarter it is clearly going to be challenging to us but third and fourth look much better in our crystal ball. So I think all in I'm pretty comfortable right now with the guidance that we have previously provided.

Chris Wetherbee

Okay, that is helpful. I appreciate it and if I could sneak one follow-up, just thinking about the sort of the cap structure a little bit when you think about your buyback and maybe what you guys are comfortable with, so getting about 5% of the shares outstanding, how do you think about sort of where you want to be in terms of the capital structure now that M&A is off to the side, how should we think about that?

Keith Creel

As we sit here today we have finished last calendar year on 2.8x of leverage with the 5% share buyback that we announced today and assuming that that is affected by the end of the calendar year, we will be probably around 2.7 coming to that effect. That places us comfortably as an investment grade company, which is something we have always said is important that we are committed to.

We obviously have the opportunity to kind of revisit that as the year unfolds, as both Keith and Hunter indicated, we expect Q2 to kind of be the bottom. So as the third quarter and the fourth quarter start diving around and if we see some additional momentum out there we can obviously go back and revisit that decision that is similar to what we did in 2015. If you recall in ’15 we bought about $2.7 billion worth of shares but we did that in two tranches.

We came out initially with a program that we later upsized and certainly that is something that we could consider and have available to us this year as well.

Operator

The next question comes from the line of Fadi Chamoun from BMO. Your line is open.

Fadi Chamoun

Okay, good morning.

Hunter Harrison

Good morning Fadi.

Fadi Chamoun

So I wanted to sort of ask a bit of a bigger picture question, now with sort of the M&A on the backburner or whatever you want to call it behind us a little bit, how should we think about what comes next, like are there things that you can do outside of class one mergers that would maybe improve the CP network connectivity with US consumer and industrial kind of activities, which is probably a good source of growth for you longer-term. And maybe also refresh us on what kind of margin opportunities you think you still have ahead of you, at CP right now after all the improvements you have done so far, it looks like there is some room to keep growing there, but if you can sort of put some quantification around that it would be great?

Hunter Harrison

Well, let me address it at this point. Number one, Fadi we are continually looking for opportunities strategically for this organization to grow and take advantage of our strengths. Now having said that, we just got cut off with the past with M&A activity, but look that is not the end of the world. There is other opportunities for this organization that we will be continually exploring and for obvious reasons, I can't get into the level of detail of what they might be at this point.

More on the – if I understood the question right, more on the margin side, operating margin or operating ratio is going to [Indiscernible] I think that if you go back to originally the four year 2018 plan where we kind of basically said we are not obsessed with the operating ratio and we would like to convert that to growth and we no more got that out of our mouth and then we got slapped upside the head with crude, which made us kind of refocus on the next steps. But I think that if you look at this operating model we have got, I think that you are looking at an organization right now that has gone from not by my estimate but others, particularly the media that has gone from where it is the first in a rather short period of time.

And I get asked the question all the time, what is the difference here. We operate on the – all operate on the same gauge, effectively the same locomotives, same signal systems, what makes one railroad different than the other, and I continually turn back to the strength of this organization and others that I have been associated with and it comes down to people.

And I think that I was extremely delighted to spend three days with Keith’s team and look at the bench strength that he just announced that he has brought into the organization and blended with a glue that has held this organization together and the new players that have come in I think that if we see a little bit of step up in the economy, we are really positioned to take advantage of it and I think we get nervous when I start talking about how [Indiscernible] we go, but certainly if you break down the 58.9, that is not the ultimate. We can get if that is our desire is to low as we can go, we can certainly get to the mid-50s.

Keith Creel

If I could add a little color to that Hunter, this operating team, effectively gets stronger everyday. We are not perfect though Fadi, obviously this is an outdoor sport and I will tell you, I can get up every morning and find as many things wrong as I want to find wrong, but this is about teaching and developing. So I have got the best coach in the world I have worked with for two decades and continues to be a coach.

I have obviously developed a lot of those skills myself. I certainly don't hesitate to teach and develop and that is why this operating team came together [Indiscernible] the chemistry, the remaining general managers, the superintendents we have across this railroad are all solid operating officers, and getting stronger everyday. The difference now we have got a service we are putting out in the marketplace combined with a marketing team that in their own they are maturing and developing with a level of accountability, a level of professionalism.

This market has caused them to get stronger. Certainly they understand the pressure they are on under to perform. We have got a lot of visibility with our compensation system, with our commission system that we put in I guess a year and a half ago. Certainly we know the [Indiscernible] are the ones that are making lemonade out of lemons and we know the ones that are and the ones that aren’t.

They don't earn their [kith] and they don’t jeopardize the team. They don't stay in the company, and that is our obligation to the shareholder. That is our obligation to the customer. But what they are doing now that I am extremely encouraged with that CP never did before we talked about this converting service. Becoming part of our customers’ supply chains, part of our customers’ business offering, help them grow, so that we can grow with them to a point this past quarter, we did over 3000 cold call sales.

3000, I bet CP never did 3000 cold call sales in the last decade. So that is how hungry this marketing team is and as a result of that we have got customers that never experienced CP, we have got customers that are under their own pressures to control cost that are taking advantage of this low-cost transportation service we can provide. So, if you look at the RTMs, we are down, obviously but if you look at the industry – relative to the industry we are down one of the least.

We are doing quite well. That said that this service that we are selling to me is gaining traction. So to Hunter’s point when this market comes back the opportunity for growth, the opportunity for return, to drive strong EPS growth for the future it is strong. It is extremely strong. It is very encouraging. So this story is not even close to done Fadi.

Fadi Chamoun

Great, thanks for the great color. I wanted to also just follow up how do you think about second quarter volume, is it sort of your best guess at this point, is it consistent with what you saw in the first quarter as far as decline or maybe a little bit worse?

Hunter Harrison

Yes, year-over-year it is a little bit worse. Right now we are running around 7% from an RTM standpoint, but that is going to get a little better next month. My best guess I think we will finish the quarter about 6%, and then we will pickup obviously in the third quarter and the fourth quarter.

We have got some opportunities. There is a lot of grain out there that stopped moving especially on the US side. At some point those firms have got to move their grain to make room for the crop that is coming in. So I'm confident that as we start to see or the farmers start to see how the crop is coming in they go to make room for it. We are going to start moving that in the third quarter. So there is some opportunity for tailwinds to help us in the second half for certain.

Operator

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

Scott Group

Hi, thanks. Good morning guys.

Hunter Harrison

Good morning Scott.

Scott Group

So, Keith wanted to follow-up with you because you have talked a couple of times about some visibility to the back half of the year getting better and maybe what gives you outside of grain and the inventories what gives you confidence in the second half pickup in volumes and maybe if you could talk specifically about what end markets you are seeing improvement in or expect improvement in in the second half?

Keith Creel

So grain is part of it. Scott, obviously there is some opportunity there. Automotive for us is doing well. We are being awarded with additional business because of the service, number of products. With the housing starts in the US, pulp and paper, we are moving more, which is a positive.

I do think at some point domestic intermodal there is a lot of capacity out there, but we are starting to see some gains. Our quarter performance is better than our year-to-date performance. So that is getting better. Obviously we still have some challenges there, but overall I think that I feel confident given we are sort of getting out easy. We are walking out or crawling out of these recession fears. I think that that turns to our favor. On those market fundamentals and the service we are going to continue to grow the business.

Scott Group

Okay, and then also if you could just talk about the pricing you had in the first quarter and what kind of pricing – maybe the price and mix impact in the first quarter and then what kind of price you guys are expecting for the year?

Keith Creel

Now the price and mix as we stated on the chart for the first quarter was 1%. So effectively a lot of that is – fuel is going to continue to be a headwind for us. The help from FX is going to become a headwind for us as well in this quarter. We certainly lack any benefit from that in the third quarter, but overall pricing if you exclude grain, pricing came in close to 3% for the quarter and we expect that to be maintained for the balance of the year.

Operator

The next question comes from the line of Walter Spracklin from RBC. Your line is open.

Walter Spracklin

Thanks very much. Just wanted Keith on that pricing Keith, is some of the bulk customers that I want to zero in on bulk and intermodal here, bulk customers seem and feel like it is some of the pressure they are getting is less cyclical, more structural, when you are coming up against renewals amongst some of your bulk customers are you getting the pressure now on pricing that would pressure that down below that 3% that you are guiding, are you still able to get that kind of 3% plus or inflation plus even with core customer or bulk customers that are seeing some of those structural headwinds?

Keith Creel

Yes, there is obviously some headwinds out there, Walter. I'm not going to suggest there is not. But overall we are able to maintain that pace. It is a very conservative number. We've always maintained that a conservative approach for delivering service and providing value. The key is converting that volume service and teaching and educating the customer how they're actually saving money, not actually spending more money.

That's been key in some of the contract negotiations we've had as of late. There is more particular customer that we just want a contract with that effectively that's how we sold it. Our cycle times are network or speed or route effectively and this is a car owner, is about a half a day shorter than the competition. If you can put that to the bottom line into car savings and their capital cost savings as opposed to rate savings is pretty compelling. It wins the argument every time, you just got to get a team out there that is educating and understand how to sell that in the market place.

Walter Spracklin

Okay. And just a follow-up here, looking back I guess Hunter you had reaffirmed your guidance. If I look at your assumption for foreign exchange when you set the guidance, it's about $0.04 lower than where the CAD has moved. I think this sensitivity and again you can correct if I'm wrong, it's around $0.08 to $0.10 per penny. So, I think looking at about a $0.35 to $0.40 headwind versus that core assumption.

Do you have buffer in your guidance that gives you comfort to reaffirm that, is there something that's changed in the first quarter that came in a little bit better or you're looking into the back half of the year and its feeling a little bit better about your guidance that will allow you to offset that sensitivity on the foreign exchange side.

Hunter Harrison

Yes, Walter, I'll just clarify them on the sensitivity. We do give a disclosure in the back of the presentation, but when we give our guidance back in January, the dollar was closer to 1.45, I think its 1.26 today. And for that that $0.20 swing of $0.15 to $0.20 swing range, it's about a $0.05 sensitivity on EPS annualized. So, just a real token of the same numbers.

Mark Erceg

Walter, at your further. 1) As Keith mentioned earlier, the cost were coming down every day as we speak. So, that's turning the other direction, I think it's safe to say that from a bulk standpoint, we feel a little better than we did when we did the original forecast. Now any record setting, but given that there were some doomsday projections out there. For example, with our largest customer tech, and that situation has improved. We think the Part A situation will stabilize and improve. So, there is a lot of puts and takes, but I think we're still all in pretty comfortable with the bottom line net.

Operator

The next question comes from the line of Tom Wadewitz from UBS. Your line is open.

Tom Wadewitz

Yes, good morning.

Keith Creel

Good morning, Tom.

Tom Wadewitz

Keith, you talked about you're taking some steps to, you mentioned organization changes and going from three regions to two. And you guys are always focused on continuing improvement. How do we think about the levers, I guess in simple terms, I think of train lanes with something you've expanded a lot car miles per day velocity. Those are some of the matrix over the last couple of years you've driven hard again.

Are those still the right matrix and are those the things you're still focused on or as you revisit, are there other things that we should be thinking about and that you're focused on to drive improvement and cost and productivity?

Keith Creel

Yes, on those are certainly key matrix for us that kind of quantum leaps that we produced over the last three years obviously. You don’t have so much opportunity there. So, we'll see more continued improvement, but not those kind of quantum leaps. But the real focus, if you think about where we actually can save a lot of money, it's a highest cost in its which is our turn overs. So, lot of discussion last week about leadership, about process management, about taking additional cost out of the terminals, just by being better operators and railroads.

Another phase we're about to kick in, I think it's going to be a game changer for us, both on the marketing side as well as on the cost side, managing assets is trip plans. We're on the verge of implementing trip plants in the market place, where we'll have car measures to the hour, delivering from we pull the customer till we deliver the products. So, essentially that does two things, for the marketing team, they can sell the service, they can tell the customer holding in hours, when we're going to get a product from point A to point B, which else then playing better which adds value in the market place.

And from the operating side, when you're measured against that every single cars opposed to just the train, it's a whole another level of expectation, it's a whole another level of performance. So, it's part of the chapters of how we become better operating railroaders and how we roll out this operating plan. And that drives out significant synergies and cost.

And finally, one other point I'm extremely excited about, we're rationalizing the physical plan. You'd be amazed how many main tracks switches we still have out there that effectively are paying there for their keep so to speak, that we put in over the years. Different operating philosophy, we think you can do more with the less, obviously our predecessors thought more was better. Well, more cost a lot of money. And more when you got mainline switches in that you don’t need, they're also safety challenges.

Every switch that's in the main lines a potential [indiscernible], which obviously is not in any of our best interest. So, we're effectively going to eliminate what we went through last week in excess of 300 main line switches and about the same number as far as back tracks and yards. And taking out about 70 miles of track which can be cascaded and obviously minimize and reduce our future capital call. So, there is still so much left to do here Tom that it can have extreme confidence and our ability to continue to drive cost out of this operating network.

Hunter Harrison

Keith, let me add to that just a minute. We talked about already that look the M&A activity for now is dead, we understand that. I still not to believe that in the future someday it's going to take place where it's going to happen. But and whereas some people missed it here was this, the real opportunity for rail to make a huge breakthrough, market share was viz-a-viz the competition, the truck, is that we have to provide a service that is consistent that we can quote to the customer. Alone we try to make the sales call today and the customer wants to know what the service is from Toronto to Texas. I don't want to get too specific here.

Well, what we're telling is what we can do in Chicago. Lead and want to know about Chicago, everyone's wants to know about the Texas. Well, if you got two or three roads involved, you cannot provide a consistent service or commitment to the customer. And when you can provide that, at the same time guard against and have the appropriate amount of regulation in place, then you are going to see rails like quantum leaps with market share gains and bring a lot of things that are on the highway with our friendly competition the truckers, that ought to be on rail, that will be if we can ever break through this whole issue with consolidations and mergers.

Tom Wadewitz

Okay, great, thank you for that. Just as a follow-up, Keith, I know you've been asked about or Hunter you've been asked about market fair bid and optimism on second half. What about within specifically domestic and international intermodal, would you expect those two to pick up and if so is that just an economy view or is that piece of share gain again in both domestic and international intermodal?

Keith Creel

From domestic, it's both Tom, I think the economy is good, the economy is going to help us a little bit but share gain certainly from truck most specifically. We got some initiatives that we put into play that haven’t -- there is now starting to bear fruit that I'm confident, it's going to help us a second-half versus the first. International, it's sort of a wild card. We had a pretty strong start to the year before the Chinese New Year but things have fallen off a bit since.

We are starting to see some signs of increased demand of from the West so that's a big question, Mark. I feel much more confident about the domestic piece but we are going to do well in the marketplace. We are doing somethings from a service standpoint from a marketing standpoint, so that we can create a lot of success in that international space as well. We expect a lot of that to unfold next year. So, stay tuned on that front.

Operator

The next question comes from the line of David Vernon from Bernstein. Your line is open.

David Vernon

Hi. Thanks for taking the question, Mark. Just a couple of follow-ups for you. As far as the timing of the repurchase and any additional debt, are you expecting to get that done this year and is that going to be from operations and more leverage? And the second kind of question on just on the modeling side, should we be expecting any dollar savings from the consolidation of the operating divisions from three to two?

Mark Erceg

Yes, let me take the first part of that. As we sit here right now we do have our applications in, those tend to get turned around in relatively short order. So, we would think just within a matter of weeks we could be back out in the market buying shares. As it relates to your question about whether or not we need to raise an incremental debt to affect that, I think the short answer is no. We did finish the quarter with a fair bit of cash on hand, higher balance than what you've typical have seen.

That's because during the overtures that we were making, we obviously suspended any share repurchase activity. So, we are holding a much larger cash balances. And then during the course of the calendar year, we are very confident that we are going to generate close towards $1 billion of free cash flow. So, between self-generated cash and the cash we have on hand, we are confident we can buy those 5% of to the shares as part of the new NCIB program by the end of the calendar year without having to take on any additional debt.

We are still on the year around 2.7 times leverage. Now as both Hunter and Keith indicated that the second half ends up being stronger. We will always have the opportunity to go back and pick a second bite at the apple and revisit that program. But at this point we don't have any expectation, I mean, raise any debt. That maturity ladder we'll see it, we are really not going to meet that maturity until 2018. So, we are in really good shape as far as the balance sheet is concerned.

David Vernon

And then the second part of the question was really around any dollar segments or [indiscernible] in terms of financial benefits from consolidation of the operating divisions.

Mark Erceg

I know. Not material, no I wouldn't say that. It's not about saving M&A those kind of cost. This consolidation it's about affecting the development of the team and just being better railroaders and executing.

Operator

The next question comes from the line of Ken Hoexter from Merrill Lynch. Your line is open.

Ken Hoexter

Great, good morning. Your employees were down kind of double digits, your car loads down about 4%. How do you feel about headcount now? And Keith you intimated that was still more room to go. But you also restated employees. Maybe you could just walk us through what was there and any difference that means to targets or how we should think about that going forward?

Mark Erceg

Well, on the employee side, we got it we said a 1000. There is an opportunity we see maybe increasing that maybe 1300 year-over-year. So, I think that's the difference. What is the second part of the question?

Ken Hoexter

Just to walk through difference. Because you restated, does that change your targets as far as what you plan on reducing and then how do you feel about headcount now because Keith you said there is still room to go. So, does that change your targets in terms of headcount that you could continue to take on?

Keith Creel

I will let Mark speak to the financials, but the room to go to clarify my answer is yes we do see an opportunity to go around 1300 instead of a 1000.

Mark Erceg

Yes. At there, it indicated we thought we could be down a 1000 employees by the end of the second quarter. We're on phase four of that and then we think there is some additional reduction that made beyond that that Keith just alluded to. So, maybe in the 1300, 1400 range. You will notice that workforce numbers have not changed. We did make a slight adjustment to some of the other numbers that we provide that was done to drive consistency in our approach.

We had been using mid-month numbers instead of end-month numbers for certain types of conventions and certain employees were you classified as part-time and full-time. So there is a little bit of thing and there that we want to clean up and we've done that but the workforce numbers haven't changed at all and it has in effective the commitments we made this year.

Ken Hoexter

Yes, that's helpful.

Mark Erceg

And we'd run some of the attention when we were talking about the M&A activity we did not use the slice and burn and cut off the world and get rid of jobs and so forth. Well, none of that's taken place but it looks like these are our friends in the East are both adapting our plan and they are consolidating divisions and closing terminals and taking the headcounts out and I am saying that the letter from a senator get -- raising issues about it. So, it's not a level playing for you.

Ken Hoexter

I appreciate that thought. Just, you talked about using price, Hunter, a while ago for improving flows and days of the week. Just want to understand as you look back on that, has that filled up or are you still working to balance that out and is that still something that gets discussed every now and then in terms of the price for balance?

Hunter Harrison

I think that’s kind of maybe say two or three of this model that Keith talked about earlier with what we call the true plans. When you develop that type precision and the customer can depend on it, then you can then take advantage of some of these day of the week pricing and the leveling or workload out. We are not there yet, where we'd like to be but it's just another opportunity with them, through and when out the three bit, we'll get to when we can.

Operator

Your next question comes from the line of Jason Seidl from Cowen and Company. Your line is open.

Jason Seidl

Thanks, very much, operator. Some quick ones here. Guys, you talked about obviously looking into the back half of the year, can you give a little color on maybe the export coal outlook given that now it seems that China isn't that bad and might be doing some work -- infrastructure projects? And the second quick one is are there any thoughts on the new proposal to build a new train line around Chicago by a private party? I think they said it was going to be like $8 billion to try to alleviate some of that congestion, I know you've been a big proponent of trying to do some out of the box thinking things to help Chicago out.

Keith Creel

Right, let me take the first question before I turn it over to Hunter to elaborate on the out of the box. On the coal side to your point not as [indiscernible] what we thought. Certainly, we are helping them win in the marketplace I think by giving them great service, we are lowering our cost but from a demand standpoint we think we'll probably finish flat. There is an opportunity for upside yes but we're not assuming it. But we do think flattish volumes compared to 2015 year end.

Hunter Harrison

Well, I don't know about Chicago, I'll share this with you. In our former some of this team that our former employer, we bought the railroad around the parameter of Chicago and we damn sure didn’t pay anything close to $8 million dollars like I think it was like 300,000 and it was probably one of the things that is getting a lot of credit for today. And they were also recently was a group of well-respected retired executives from the rail industry that were put together by all the rails to [indiscernible] like better term the Chicago issues in congestion.

And they were just asked to look at what if you looked at it didn't weren’t concerned about what uniform you had on, just an interest of getting traffic through Chicago, what would be the appropriate way to do it. And I think the information I have is they came up with some excellent plans expect some of them have big prize tag and some of the rails didn’t. If this gets public and it's going to be a big project, say we are going to get forced into it, so all of a sudden the committee get disbanded.

So, people got to get serious about Chicago, when we had the discussions based on either merger, it just doesn't matter what CP does. We are such a small player, it's only 5% of the business, so who cares. Well, there is a lot of people who care in Chicago and in my view the industry never wake up quick about Chicago or someone is going to do it for us. So that's my --.

Jason Seidl

Now, Hunter, in some past calls you mentioned that you would probably be willing to try to purchase the both railroad and run it for the other railroads and if you didn't do a good job you said they could buy it back off of us. Is that an option that you still might want to explore?

Hunter Harrison

Absolutely. We will buy one, we will buy both we will buy Chicago and give them a hell of a deal but I don't. There is not many takers out there and I wonder why.

Operator

The next question comes from the line of Justin Long [ph] from Stevens. Your line is open.

Justin Long

Thanks and good morning. I wanted to ask about returns. There is always a lot of focus on the OR but looking at your ROIC, do you have a target for 2016 to even share and also as you think about deploying growth capital on the business going forward, what's your typical ROIC hurdle?

Keith Creel

Yes, we do have internal hurdle that we use to strain and then evaluate all capital projects that we have. It's actually a very sophisticated allocation process that we use. It probably isn’t surprising given the fact that in '14 and '15 we spent about $1.5 billion in each of those years on CapEx. This year as Hunter indicated because we have done a lot of the catchup work that was required. We plan to spend more like 1.2, so there should be a significant amount of CapEx reduction that we're seeing from this year going forward which should allow us to generate more cash that we can return to our shareholders.

That said we haven't typically disclosed our internal verbal rates to folks externally. We don't think that that's necessarily appropriate. We do adjust that for different types of risk profile depending on what the type of project is and we go back and do very diligent reviews in order to make sure that we've actually keep those target levels. I will comment though that our adjusted ROIC has nearly doubled from about 8% to 15% over the course of the last couple of years, something we are very proud of and something we are going to expect to see continuing from this team.

So, we don't disclose those numbers but I can assure you that we will get it very closely. We also make sure that when we are out there purchasing shares, we are doing it at a value that makes a lot of sense for our shareholders on a long term basis.

Justin Long

Okay, thanks. And maybe one quick follow-up. I wanted to add follow-up on the volume outlook. You talked about expectations for second quarter volumes but looking at the full-year, is your outlook still for a volume decline in that 1% to 2% range?

Keith Creel

No, we said RTMs, in an RTM basis, closer to 4% or 5% and I think that's where we are going to come in. I mean obviously there is some upside opportunity but I feel very confident with that number.

Operator

The next question comes from the line of Turan Quettawala from Scotiabank. Your line is open.

Turan Quettawala

Yes, good morning. Thank you for taking my questions. So, Keith, just to clarify that 4% to 5% RTM decline, is that Q2 or are we talking about the full-year there. Sorry.

Keith Creel

That's full-year.

Turan Quettawala

Okay, got it, thank you. And I guess some other quick clarification here on the employee side -- sorry go ahead. So, on the employee side I think you are talking about a 1000 to 1300 deduction here, but you are coming in down about 1800 on Q1. So, can we just expect that to go up I guess in the second half of the volume, is that the way to think about that?

Keith Creel

No, you got capital work, the capital work through are going to do, you will see engineering employees that typically aren't working in the first quarter that would be deploying our capital ties, rails, steel, that type of work during the second to third quarter. So, that first quarter number obviously will roll down and then finish the year. Year-end will be around at 1300 number.

Operator

And the next question comes from the line of Benoit Poirier from Desjardins Capital Markets. Your line is open.

Benoit Poirier

Yes, thank you very much. Looking on the intermodal side, obviously you improved a lot, your cost structure. Could you mention the opportunities for renewal some intermodal contract this year and what's up for renewal and what is the opportunity?

Keith Creel

Okay, [indiscernible]. This year we actually have one that we are negotiating now which we feel very good about. Quantum is not a huge contract. It's obviously one that we care about but we feel good about that. Next year much more opportunity if I remind you to go back two or three years ago, I guess it is it's been three years; time flies fast. We are forced to walk away from the particular contract which is very large intermodal ship or domestic or international intermodal that we certainly expect to be appearing for the business next year.

So, that contract would come up second quarter of 2017, is when it would be [indiscernible] or go into effect. So, again that could be a difference change for certainly. We got to improve service, we got a lower cost structure. The market is going to set the rate and if we can make money and it earns its cost to capital it's a good business decision for us, then I am sure that we are going to win the business.

Benoit Poirier

Okay, that's great color, Keith. And also you mentioned in the announcement that you see signs of stabilization within the Canadian economy and the global markets. I was just curious what are the key elements you see that support kind of a stabilization?

Keith Creel

What I am seeing when I say stabilization like the coal piece, that was a big question mark for us. Some of that uncertainties taken out obviously. Potash, right now we are not moving a lot of potash but those contracts have not been settled which I know, yes. But Canpotex is very bullish and it's fully expect to maintain their guidance for the second half. So, you are not seeing that tonnage moving now, you'll see it in the second half. And again I'm an optimist on the grain side if we have a normal harvest.

On the Canadian side then you are going to see pretty strong great movement in the second half and if we have a normal or maybe a little better than normal harvest on the US side, we have in everything that's pinned up in storage, you are going to see some upside there as well. So, those are the main levers that I see as an opportunity for us and continue the domestic intermodal side, our services winning market share. That's very encouraging especially in this very challenging environment.

Operator

The next question comes from the line of Allison Landry from Credit Suisse. Your line is open.

Allison Landry

Thanks. So, trying to put everything into context, should we be thinking about 2016 as a bottom for EPS and maybe if you could help to frame how you are thinking about the longer term earnings power of the company when volumes do come back, just given what you've been able to do on the cost front and the inherent operating leverage that you spoke to earlier?

Keith Creel

Yes. I would suggest that the 2016 would be the bottom assuming economy comes back which is what we're assuming. So, if we get modest GDP growth with this operating leverage we've created, then you are going to see stronger EPS growth. Long term still feel confident that we can with a little bit of help from the economy double our EPS maybe not in to 2018, it might be in 2019, but it certainly within the realm of possibility given with the economy turns a little bit favorable for us instead of against us.

Allison Landry

Okay. And then Keith, maybe during initial thoughts on what you would want to accomplish on the marketing front, one for leadership transition happens and maybe if you could talk a little bit about some of the areas where you think you can drive topline growth over the next few years and sort of comparing across that with what you outlined back in 2014 outside of crude by rail?

Keith Creel

Yes. A lot of on the marketing side is developing the team even more. So, obviously with all my operating responsibilities I have not had the same amount of time remotely close to spend where the marketing team which I intend to do. So, developing them from a leadership standpoint developing their ability to sell our service to convert that service and discussions with customers working within to help better integrate CP with the customers to effectively drive more value for the customer which is going to mean more value and revenue for CP topline.

We talked about our diversification strategy trying to become a merchandise railroad as much as we are a bulk railroad. That plays right into that story line. So, we're going to continue to have discussions with customers like the one I talked about earlier where they are car owners they have got significant capital cost in the cars and if I can get out of and move in faster using the benefit of my shorter network versus my competitor in these key marketplaces, if I'm reliable and do what I say I am going to do, I am going to convert that business.

So, all those things are going to help us continue to drive the topline and obviously with this operating team it's going to be brought down to the bottom line.

Operator

The next question comes from the line of Steven Paget from FirstEnergy. Your line is open.

Steven Paget

Good morning. My question looks back to two or three years to the information technology or IT overall that CP carried out and maybe we could just get your perspective on what you did, how you did it, why you did it, and what the results have been.

Keith Creel

I mean, I would tell you that that's actually a fairly large project that we review regularly with the board. The last update that was provided then was just a number of weeks ago. That was a very large project and it effectively went away from having a lot of contracted services to bringing those things in house. We had set a rate return threshold that we were able to deliver against as part of that project and it also give us lot of additional system capabilities. So, we have been monitoring that project. We would say that it delivered against all the vectors that was designed to hit against and we're very happy with the outcome.

Mark Erceg

Yes, and I would add Steve, "capability" and "reliability." If we don't have good data if we don't have good systems to make decisions with around the railway with day in and day out. If our systems crash, we can't get our report -- give us gauges on how we're doing across the network on a day-to-day basis. It's challenging. So, since we've in-sourced it, we have our own people, we've been able to develop our own skill-sets, our own win strength and our own level of accountability; the results have improved dramatically. And it lowered cost. So, again, it's win-win situation for us.

Steven Paget

Thank you Keith, and Mark.

Mark Erceg

Thank you.

Operator

And the next question comes from the line of Bascome Majors from Susquehanna. Your line is open.

Bascome Majors

Thanks. Hunter, you talked earlier about the benefits from a share gain perspective of a more integrated Transcon real network. Getting to that point was clearly I guess a lot harder than you guys and many of us anticipated with the experience within SC what changes or has the changes where you think the appetite from, beat other rail stakeholders of Washington is a little more conducive to getting a large scale merger through.

Hunter Harrison

Well, I guess the person, I guess yesterday we got plugged about the rules we have a process since the Staggers Act of 1980, which effectively be deregulated the industry, where it was mandated to the service transportation board to make decisions on mergers. And as soon as the mergers comes up in we want it to become a political process instead of a process that had been mandated effectively to the Surface Transportation Board of our Congress.

Now, my view is this, if Congress does not want mergers why they don't create a wall that say they can't have a merger. So, we what if we hear first of all, we heard, well first of all we heard well it's a fact they're going to be with the customers who want. Well the last statistics asphalt, was that the customers voted in favor of the merger. Now, I think the most of the customers now recognize that this transaction was procompetitive. Okay, clearly it introduce more players and so this is not gown or what?

I mean, on the quote-big-bore is already transaction was poor competitive to be clear it introduced more players and so this is not going a lot I mean one of the "big 4" is already kind of change their stance to a gree and said mergers can be a wonderful thing. If you can have one service from coast to coast. It's just the timing I am not sure when the timing is right. People will come to their senses.

One of the other ones made comments that said if you looked at their comments in 2011 and 2013 it said mergers was their salvation. It's the way they created all their success but today they don't want any more mergers, little selfish. So, I think that we thought we had a model that opened up competition that brought introduced more competition into gave an opportunity to have better service to the customer and create some shareholder value. We thought that was all good but other people see it differently.

Look, its going look I am not worried about my legacy of creating some lasting merger that's not what I am about. I am much more about create shareholder value. Is it frustrating? Yes, it's frustrating. But I would predict post Harrison; it's going to happen. And it will be and it will happen and it will work very well. A lot of people were against the transaction some of the customers that I have visited with and what they were against was not mergers they were against how mergers were executed in the past. So, people didn't execute very well and they lost equipment and they didn't know what was in their systems and they played havoc with the customer, then they don't want any merger. But it's kind of like I used to say it, I used to hate to get a spanking for something that my sister did. I, there's only so much we can do. So, it's going to happen, we just have to develop a little patience which I'm not really in doubt with but it will happen one day soon.

Keith Creel

Yes, let me. If I could add to that, Hunter. Business ends and service end doesn't care the argument, potentially survive a wheel. I don’t care what railroad you run, we are all faced with the challenge that trade revenue is going to double over the next ten years in Chicago. It's not going to change, so we can stick our heads in the sand today but our plan will be around ten years from now, so the problem is not going away so we certainly have to solve it for the betterment of the industry as well as the US economy and the Canadian economy both are connected.

Operator

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

Jeff Kauffman

Thank you very much. Keith earlier you talked a little bit about some of the opportunities, taking switches out track out could you give us an update on the capital program looking out next few years where you are on a locomotive storage basis, where are you in terms of that siding extension program and rather than focusing so much on the cutting maybe talk about the opportunities on the capital projects side and what you think that spending looks like over the next few years.

Keith Creel

Yes, in the locomotive side that we are in extremely good shape we have with the productivity we've improved, speeds we have improved we have got somewhere around 600 locomotives that are stored. So, I can take a capital holiday well 2018, 2019 before we go back in the market on locomotives is what we expect. As far as the sidings extension program, we have all of our key lanes for the demand that we have today. Were caught up and we've installed long siting we have put in order magnitude of the last three years somewhere around 30 siding extensions additions.

Now we have a plan in line with the multi-year plan based on demand based on growth that we can obviously kick back in if and when it comes. And it will come it's just the matter of timing. I just don't know the answer to the when piece. But in the meantime even part of what we have assumed that we will stand by what we are doing taking these switches out and cascading this material that reduces our demand as we optimize the network in pace with the business at a lower cost, because we are going to be able to cascade those assets. So, short-term we have got a more reliable plant, it's a safer plant that requires less maintenance, long term as we grow and expand for business then it's going to be lower cost.

Jeff Kauffman

Okay. So to tie it all together, Keith, where do you think the capital budget is for this year and what do you think you need to spend based on the growth plan you are envisioning over the next couple of years?

Keith Creel

Well, I think over the next couple of years you can see it's very similar to where it is now. In the out years you might see it pickup adding those sidings, doing that kind of work 100 million, 150 million over a magnitude I guess it all depends on where the exchange rate is we are talking about conversion with Canadian and US dollars. A lot of that material we buy in the US, the new stuff so over magnitude that's where it's at. We expect the model similar numbers over 17 compared to 16 and maybe 18 and 19 it uptakes a couple of hundred million.

Operator

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

Unidentified Analyst

Good morning, this is Eric, I'm for Brandon. Thanks for taking my question. I just wanted to follow-up on grand real quick. You mentioned the potential for a normal harvest, is that your expectation right now or is it still too early to tell?

Keith Creel

Well, that's what we always assume in our models. It is too early to tell. There is no assurance of one of the harvest but certainly that's what we assume. We think that's irrational and paid and sanctioned to put in our business demand models.

Unidentified Analyst

Okay and then I guess how have your operations changed to go with backlogs on that network, similar to 2014, as the stock power reduction kind of coincides with a new harvest.

Keith Creel

Well, obviously we'd rather be moving over the 12 months of the year, not condensed and consolidate. So, yes, it will create some congestion when the farmers all want to move it at the same time. It's not just us, it's also hanging out to our partners in the business. But what we've done since then, actually last year and this year which has been received extremely well in the marketplace. We have dedicated trains where we sell dedicated capacity to our customers.

So, it's sort of a take or pay thing, they commit to us and they get the assets, certain percentage of our overall fleet. It's around 50% of the fleet. They get dedicated assets, they can plan on the product they need to move. But at the same time if they lock those assets up and they don't move the products then we get a payment for that as well. So, we both have skin in the game. And I think another thing that a lot of people don't realize, it's happened since 14, especially in the Canadian side.

Our partners in the business, the green companies have spent significant capital to help some other congestion issues on the West Coast port, which given the same size crop obviously there are still going to be some challenges and they got to I think work closer with us to work 24/7, 7 days a week, the same way we do. But if they do that given their capacity that they've created match that up with our dedicated train which reduces cycle times, you are going to see capacity for the railroads to move much more gray at a lower cost.

Operator

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

Hunter Harrison

Thank you. Thanks, Blair. Let me make a couple of comments. First of all it's with mixed emotions that I kind of looking at the twilight or into my career. And one of the reasons why is which you heard today, I mean, this organization that we collectively have put together has some exciting challenges ahead of us that are known they can step up to. I think they are clearly going to establish themselves even deeper as the number one railroad in North America. The thing that Keith has talked about today building the main stream the new opportunities with trip plans.

The achievement that have been that we talked about today in the operating ratio with some of the other things were achieved without some of these tools that we are talking about today. So, this group is extremely bullish on the future rightfully. So, and I just will have a few more years ahead, I mean to be a part of it. But I fail retirement once and I came fail again. So, but I am excited to watch from the sidelines what this group produces and I still reserve the right to if they don't perform like they can and should. I might have a few tip from the [indiscernible] as the shareholder.

So, thanks for joining us and we look forward to seeing some of you this afternoon at our annual general meeting. Thanks.

Operator

This concludes today's conference call, you may now disconnect.

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