Canadian National Railway's (CNI) CEO Claude Mongeau on Q1 2016 Results - Earnings Call Transcript

| About: Canadian National (CNI)

Canadian National Railway Company (NYSE:CNI)

Q1 2016 Results Earnings Conference Call

April 25, 2016, 04:30 PM ET

Executives

Sam Forgione - VP, IR

Claude Mongeau - President and CEO

Jim Vena - EVP and COO

Jean-Jacques Ruest - EVP and Chief Marketing Officer

Luc Jobin - EVP and CFO

Analysts

Cherilyn Radbourne - TD Securities

Ravi Shanker - Morgan Stanley

Jason Seidl - Cowen

Fadi Chamoun - BMO

Ken Hoexter - Merrill Lynch

Walter Spracklin - RBC

Brandon Oglenski - Barclays

Chris Wetherbee - Citigroup

Justin Long - Stephens

Allison Landry - Credit Suisse

Brian Ossenbeck - JPMorgan

Tom Wadewitz - UBS

Turan Quettawala - Scotia Bank

Scott Group - Wolfe Research

Bascome Majors - Susquehanna

Benoit Poirier - Desjardins Capital Markets

Operator

CN's first quarter 2016 financial results conference call will begin momentarily. I would like to remind you that today's remarks contain forward-looking statements within the meaning of applicable securities laws. Such statements are based on assumptions that may not materialize and are subject to risks described in CN's first quarter 2016 financial results press release and analyst presentation documents that can be found on CN's website. As such, actual results could differ materially. Reconciliations for any non-GAAP measures are also posted on CN's website at www.cn.ca. Please stand by. Your call will begin shortly.

Welcome to the CN First Quarter 2016 Financial Results Conference Call. I would now like to turn the meeting over to Sam Forgione, Vice-President, Investor Relations. Ladies and gentlemen, Mr. Forgione.

Sam Forgione

Thank you, Patrick. Good afternoon, everyone, and thank you for joining us today. I'd like to remind you all of the comments already made regarding forward-looking statements.

With me today is Claude Mongeau, our President and Chief Executive Officer; Jim Vena, our Executive Vice President and Chief Operating Officer; J.J. Ruest, our Executive Vice President and Chief Marketing Officer; and Luc Jobin, our Executive Vice President and Chief Financial Officer.

In order to be fair to all participants, I would ask that you to please limit yourselves to one question.

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

Claude Mongeau

Thank you very much Sam, and thank you all for joining us on this call. I think it's fair to say that there is a lot to be proud. We are coming again with very strong results in what is more difficult volume environment. J.J. will take you through the contour but we're leveraging hard diversity, the diversity of our franchise we're chasing every carload.

We're holding our own but the overall volume is down 7% or 9% depending how you measure it but in that context we are responding very swiftly on the resource side and then in terms of efficiency. Jim will give you the detail, but across the Board, we're setting new levels of performance in terms of efficiency and network throughput.

We put it all together. We're doing this with a view to maintain that balance because we service and cost efficiency. Our service has never been better. We need that to help our customers succeed in the marketplace.

We're also maintaining our focus on safety. We've had very strong safety results during the first quarter and we want this to continue going forward. In terms of the - very important operating ratio, we've established a record for the first quarter with 58.9%.

This is a clearly industry-leading performance. If you take the same geography as the industry in terms of out of book real estate gain. So very good performance. We're very pleased in that regard and so you put it all together.

Luc will take you though this, but our EPS is up around 16% to $1 and our free cash flow is very solid at around $584 million, while around very good results, solid performance by the team.

And I'll let Jim, J.J. and Luc take you through the details. Jim, over to you.

Jim Vena

Well Claude, listen, thank you very much. I think a lot of hard work.

Lot of things that helped us, but overall a good performance by the railroad running on a day-to-day basis. And I think it is fair to say the team continued to build off the results in previous quarters and we delivered very strong results in safety, expenditures, service and in operating excellence.

The results are shown on the slide and we've put a little note at the bottom that talked about a mile, the winter. So you can discount them a little bit. There is no differential, but the winter helped us, but nevertheless, the trends were more productive by 8%. Their speed was improved by 10% and locomotive workload improved by 5%.

In our yards, they were more efficient by 9%. In a time, our real car spent in a yard dropped by 15%. The result all in was better locomotive utilization, better car utilization, less cars online, more gross tons per employee, more cars switched per hour worked and precipitated a clear indicator of network performance with a car velocity improvement of 15%.

So overall, satisfying results with everything that was given to us with the volume, the winter and the productivity that the whole team worked on.

You can flip over the next page. I just want to reiterate and really nothing - not a big change and not a change I guess at all of what our - what we're trying to deliver on. Our agenda of operating and service excellence has built on a foundation of safety first.

We want to deliver a safe, fast, dependable service, executed by the whole team and at all levels of the company while continuing to drive efficiency across the Board.

Just before I pass it on to J.J., so for us it's all about making sure we're balanced. We react quick. We're nimble in the changing conditions and I think the whole railroad show at how we can be nimble at times when things change with us and we react as quick as possible.

So J.J., over to you a little more detail on where we are.

Jean-Jacques Ruest

Well, thank you Jim. Jim, you're very humble, it's a great solid quarter with a team 58.9% operating ratio, so kudos to the operating team at CN.

Overall the first quarter revenue went down 4% from last year and is broken down as follows. Volume and mix reduced our revenue by 7%. The calls in RTM were down 7% and 9% respectively. February was our best month, but March was soft.

Crude by rail, coal and frac sand continue the significant decline. On the positive side, we benefited from the derived demand coming from U.S. consumer spending, from the manufacturers that use natural gas based feedstock, from vehicle purchased by consumers and from the new housing construction.

Same-store price was up 2.5% all in. If you remove the Canadian regulated grain and other legacy index agreement that have a long fuel and supply fuel component, price was up 3%. The fuel surcharge application lowered our revenue by 5% but exchange increased our revenue back by 6%.

Now let's turn to some of highlight of the last quarter. Revenue derived from housing stock remained the bright spot and area of the growth from last year for CN, accounting for close to 15% of our overall book of business. This would include lumber through U.S., storage B title, plywood, containerize household goods for the domestic overseas and other construction material.

With a weaker Canadian dollar, the Canadian forest product producers are in a strong position and so is CN. We had strong vehicle purchased by consumers, it does not matter where vehicle is manufactured whether it's Europe, Asia, or the NAFTA region. The CN network of auto support facilities in every major cities where we have rail network gives us a very high market share what the consumer buys from the dealers.

Our automotive business unit was up 18% with an impressive 20% carload growth. With a collapse in energy markets, Brent crude purchased by the course of refineries was very cheap and affordable and there is also ample pipeline capacity to go around. Those two things are making crude-by-rail economies broadly unattractive.

Our crude-by-rail volume dropped by half to 14,000 carloads, for the more relevant aspect of the crude story is a prevalent incremental rail capacity pricing that brought crude-by-rail to become the least profitable for the unit train business.

The downturn in oil and gas capital program also impacted our steel, cement aggregate and frac sand business. Frac sand was down 45% in volume to 13,000 carloads in Q1.

Our frac sand business is now largely related to natural gas drilling as oppose to shelf oil drilling. Domestic intermodal revenue grew 4% driven by volume in our Canadian door to door retail service.

If you exclude the impact of the NS Triple Crown restructuring and the related loss volume, our overall domestic volume was up 7%. International intermodal started up very strong in the quarter, but in March we had a decline on the West Coast business as in the Canadian and other U.S. West Coast port, mostly export falling off but also a pull back on import.

On the east coast, Halifax was very solid and grew more than 50% in volume in the quarter. All in for the quarter, international volume was up 1% and revenue was down 1%.

Our grain operation was in excellent shape last winter. Canadian grain revenue was overall flat the last year with better carload volume but lower regulated pricing. U.S. grain was impacted by the strong U.S. dollar, therefore our overall U.S. grain volume was down 13%.

Lower natural gas price have supported a 7% carload growth for manufacturer of petrochemical plastics, hydrogen fertilizer and other natural gas liquid the list which I've just listed here is based on natural feedstock.

The retreat of coal continued, our coal revenue ton mile was cut by about half versus last year. Coal is now only 3.1% of our total book of business, the lowest exposure of the coal of any railroad.

Now looking ahead, we expect coal, crude and frac sand to continue their volume decline till the bottom is found, hopefully later this year in the case of crude and sand and late in 2017 in case of coal.

Canadian grain would also be weak till the next harvest come up this coming September. The economic environment continued to be uncertain, but we will exploit the positive forecast in the manufacturing sector and the rail demand derived and the related rail demand derived from housing start to consumer spending.

We are also very well-positioned to export the huge potential of the mid 2017 expansion from our West Coast port terminal partners. In regard to automobile, the rail operation will be ready soon and both Maersk and Cosco have announced New Panama cannel, all water service that will stock in mobile to start from June.

The plastic environment remained constructive for the rail industry, although a bit weaker and we expect to broadly produce pricing above inflation, I would say in the 2.5% range all in. We still have legacy index pricing that have a long fuel lag component that required a reminder of this year to be digested.

We anticipate the Canadian grain cap to be above plus 1% this August and the market is also dealing with the capacity pricing experiment of one of our competitors. We're actively supporting our shippers a logistics partners for whom the weak Canadian dollars and/or the achieve energy is a coverage of corporate advantage to explore. Example of that would be the Canadian port, the forest product mill, the aluminum smelters, the automotive assembly plant, the petrochemical complex under refineries.

In conclusion, we at CN continue to invest in a way for future, our strength lined portfolio diversity and our best-in-class profit margin operating ratio and in our solid Chicago solution right in the heart of the continent.

Luc will give you the financial color of our first quarter results.

Luc Jobin

Okay, thanks very much J.J.. Starting on Page 12, then let me provide you with the highlights of our very solid first quarter performance. Revenues were down 4% at just under $3 billion. Fuel lag was a revenue tailwind of $16 million in the quarter however when compared with last year’s lag it represents a headwind of $41 million or $0.04 of EPS.

In spite of facing a challenging revenue environment however, operating income was up 14% versus last year at just over $1.2 billion. Our operating ratio as Claude mentioned was 58.9%, a record level for our first quarter. This represents a 680 basis points improvement over last year.

Net income stood at $792 million up 13% and the diluted earnings per share reached a dollar up 16% versus last year. The impact of foreign currency was $57 million favorable on net income or $0.07 of EPS in the quarter.

Turning to expenses, we once again made excellent progress in the quarter in terms of safety, productivity and cost management while maintaining superior service. Intense focus on right sizing resources given the lower volume drove operating expenses down 14% versus last year at just under $1.75 billion.

Expressed on a constant currency basis this is a 19% improvement. At this point I’ll refer to the variances and constant currency. Labor and fringe benefit cost were $590 million, a 16% decrease from last year. This was the result of two elements. First, overall wage cost decreased by 9% as wage inflation was more than offset by lower overtime and a reduction of nearly 10% in average headcount for the quarter versus last year. Sequentially, the average headcount was also down 4%.

The second element contributing to reduce labor cost was a lower pension expense for $51 million. Purchase services and material expenses were $408 million, 14% lower than last year, as lower volume, cost management initiatives and favorable weather help to reduce material costs, repairs and maintenance and crew accommodation, as well as utility.

The fuel expense stood at $235 million or 40% lower than last year. Price was $109 million favorable. In addition lower volume accounted for $23 million of the improvement and fuel productivity advanced by 2%, depreciation stood at $307 million, 1% lower than last year.

This was a function of asset additions offset by the impact of depreciation studies and other minor adjustments. Casualty and other costs were $112 million which was $55 million lower than last year and for the most part attributable to lower accident related costs.

Moving onto cash, we generated free cash flow of $584 million in our first quarter. This is $63 million higher than in 2015 and mostly the result of higher cash generated from operating activities. Capital expenditures were essentially flat with last year of $469 million.

Finally our 2016 financial outlook, we remain constructive in terms of CN’s prospects for the year notwithstanding the fact that we continue to experience high volatility and weaker conditions in a number of commodity sectors.

The pace of North American industrial production is also slowing down considerably. Fortunately however prospects are still favorable on the consumer side of the economy and this should continue to support moderate growth in housing or moderate and intermodal sectors.

We now estimate that this will translate into a decline of our annual cargo volume in the 4% to 5% range versus 2015, while pricing will stay ahead of inflation.

The strengthening of the Canadian dollars to the U.S. exchange rate and the evaluation of oil prices however are clearly different from our regional expectations. These factors when combined with more modest-strength demand will make things more challenging for us in 2016.

Accordingly, we are revising our original guidance and so CN now aims to deliver 2016 earnings per share in line with last year's adjusted diluted EPS of $4.44. On the capital front, we remain committed to reinvesting in our business to support the safety, service and efficiency of our network. Therefore we maintain our capital investment program for the year which after adjusting for our revised currency assumptions now stands at approximately $2.75 billion.

Furthermore, we continue to focus on sustainable value creation and rewarding our shareholders with consistent dividend and share buyback returns. CN's annual dividend was increased by 20% earlier this year, while we are gradually moving towards a 35% dividend payout ratio. In addition, our current share buyback program is approximately $2 billion.

So despite of more challenging environment in 2016, we are focused and committed to managing the business in a manner that protects earnings while not compromising our long term competitiveness.

And on this note, back over to your Claude.

Claude Mongeau

Thank you, Luc. Let me wrap up the - there is a lot to be proud as I said at the outset our results were very solid during the quarter. We are leading the industry if you look at it in terms of a run rate basis.

Luc communicated our revised guidance the challenges are in front of us. The volumes are weaker and also the assumptions that are the framework against which we provide you a consistent and transparent set of assumptions.

It's also a currency and fuel prices and generally the economic growth. This is just a world out there that we have to face to. And things are turning from a tailwind of shock absorber to a somewhat of a – as rare win as we look forward to the balance of the year.

So, we are working out but we are responding swiftly. We are focused on doing what we can to protect profitability and to continue at the same time building for the long term future. That's why we are holding the line in on our investments. For safety, for service, for efficiency and we are constructive the prospects are out there. It's just the question of running the Marathon with the view to avail competitiveness over the long term.

With that I will be happy to take questions with the rest of the team Patrick.

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from Cherilyn Radbourne from TD Securities. Please go ahead.

Cherilyn Radbourne

Thanks very much and congratulations on your performance.

Claude Mongeau

Thank you, Cherilyn.

Cherilyn Radbourne

In terms of your volume outlook, maybe you can give us a bit more color and a bit of a ranking in terms of some of the more important deltas. It sounds like it's crude, frac sand, coal, but also perhaps international intermodal.

Jean-Jacques Ruest

So it's J.J., Cherilyn. It is crude, frac sand and coal definitely. For the second quarter it would also be Canadian coal. You also remember last year we had an iron ore mine that shut down in the summer, so we still have some of that.

And currently as we speak, it is also the OSM, international business of Canadian West Coast. That’s a phenomenon that started in March 5, but February was strong and we believe that this is only a phase, it should come back sometime in the middle of the second quarter based on customers integration to us but also based on may be what the U.S. economy term is and eventually and what not.

So OSM is just maybe a phase where full pricing and crude is something more steady.

Cherilyn Radbourne

Great, thank you. That's my one.

Operator

Thank you. The next question is from Ravi Shanker from Morgan Stanley. Please go ahead.

Ravi Shanker

Thank you. Good afternoon, everyone. J.J., if I can follow up on something you said, did I hear you right when you said that you thought coal would bottom in late 2017? Because that would probably be a little later than some people expect. Can you talk about where you're seeing that market, please?

Jean-Jacques Ruest

As I said our coal revenue in the first quarter were close about 3.1% of the total book of business, so already our exposure is quite a bit less than those. So you go to start from that starting point. We know what their next three quarters look like and our sense is that some of exports and in terms of U.S. consumption, U.S. at least utility that we serve, we might see some further erosion in carload in 2017.

So, I think the consensus by railroad is, there will be some further weakness from 2016 and after that it’s a question of crystal ball and where you’re at. Again remember we start coming about 3% book of business at this point.

Ravi Shanker

Great, thank you.

Operator

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

Jason Seidl

Afternoon, everyone. I guess my one is going to be around the pricing side. You say expectations remain above inflation. But what's the feel for it going forward? Is it weakened somewhat? Or are you still confident that pricing's going to hang in there, maybe even moderately improve if trucking capacity tightens?

Claude Mongeau

J.J. can add to this but it is a tough world out there for our customers and it is a shrinking buy in terms of volumes. In that context, we have to do everything to help our customer win in the marketplace. But we provide good service and so it's incumbent on us in the industry to put that pricing. But right now it is shrinking buy and it's tempting to do incremental capacity pricing or things like that.

We intend to put the car book of business and we think the value of our services should allow us to continue to price ahead of inflation. That's what we've done at 2.5% or not different than other railroads to provide you things to pricing information and we hope to keep it at that level for the balance of the year. J.J. do you have any other color?

Jean-Jacques Ruest

Yes, one of them is this issue with trucking capacity which is right now - than say 18 months ago but that's a cyclical thing right eventually trucking capacity was tighten up again. We don’t necessarily believe what happened in 2016.

Then we have the phenomena of divesting these index pricing which has a fuel component, Canadian grain cap, that's nothing to take into account – we’re eventually will be cyclical and typically the average contract we get, we do get 2%, 3%, 3.5% of price increase and we have this little phenomena of capacity pricing which if the capacity is coming from the highway maybe it can work out but if it comes from one railroad to another it has a bit of a dilution effect.

So I think we have very good customers, a long-term business and not only that we intend to keep that business that's what we have done here in the last 12 months and we keep that - this year is about 2.5% but in future years inflation plus thinking to account what we just said, you know trucking capacity which is cyclical and some of these index so cyclical.

Jason Seidl

And J.J. how do you view your cost inflation going forward are you around that 2% mark?

Jean-Jacques Ruest

Luc, maybe you talk about rail inflation -

Luc Jobin

Yes, if you look at rail inflation it's probably running just a little bit around 2 and probably some of the commodities are running below 2. But on the other hand in terms of wage inflation that's running probably closer to 3. So that's the world we are in, so J.J.'s description of inflation cost is in the right thing.

Jean-Jacques Ruest

And taking into account an operating ratio of 58 versus 2.5, versus the 3, we're working on different scale dollar and I think on materials, there is some price material maybe Jim you want to say something about how effective our capital program is right now.

Jim Vena

Sure. Just two things, one is we always have wage inflation. We know what our contract is, we know we have to work against. That's why it so important to us and we will continue to drive to make sure that the trains are more efficient, the yards are more efficient, we get more out of the each person that comes to work by being more efficient, but on the – and that leads me into the capital program.

So the capital program 2.75 with the adjustment of the exchange and when we say that we wanted to make sure that we had the number. And one of the comments we had was, we think that we have better use of the dollars in the time when the volume is off a little bit and that's what exactly what we've realized.

We've been able to be out there in the first three and half months and productivity that we get and the amount of infrastructure that we've been able to put in and renew is substantially better for the same amount of money and that's what we want to continue to do at this time J.J.

Claude Mongeau

Very good. Thank you so much Jason.

Jason Seidl

Thank you as always guys.

Operator

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

Fadi Chamoun

Yes, good afternoon and good quarter, guys. But looks like you may have a little bit of headwinds in the coming quarters. I have a question on incremental pricing, J.J. You mentioned that on the crude by rail side, have you seen this anywhere else in terms of the business that you have? And what is the risk that you think this could roll into some other categories of business that you got?

And maybe a quick one for Luc, the 51 million pension income in the first quarter, how should we think about the run rate for the next three quarters on that?

Jean-Jacques Ruest

There are two questions in that.

Claude Mongeau

We will allow you for that one and a half question - J.J. quickly on.

Jean-Jacques Ruest

Yes. I did brought it up on the crude-by-rail. It is now what we call incremental capacity pricing, the pricing on crude-by-rail in the train is if you are on the buying side of those services, it's fantastic deal.

And I think it's potentially because some time when things are predicted to be huge volume wise, you actually had so much expectation than when the market is not growing as much as you hope, you may tended to overact and cut the price and see if you can make it up in volume and see if you can make the product move.

Railroad is a demand derived industry. We don't create demand. We feed demand. And I think crude-by-rail is an example of that. It doesn't matter how you go. The product can move in a pipeline it will and all you're doing by going very low, it's just making the business pretty unattractive. So right now crude-by-rail, the volume is weak, will get weaker and the pricing is not the greatest.

There is some of that happening in other segments, is up to some extent. There's really no loss of volume with it, but when the car is lost and another one we made it up with another one, so you trading a car for car and that's kind of not going anywhere type exercise. Luc?

Luc Jobin

Yes. Fadi in terms of the pension expense as we disposed to you guys in the last call we expect to have a tailwind of about $150 million for 2016 versus 2015, so that's the number that you should really be using and obviously it is not spread out evenly through the year, so you have to look back to last year and what's going on. And we'll be providing some input or some update on that as we go file our actual evaluations at the end of June.

So stay tune, we'll update the number but 150 as the tailwind is the right number to use for the full year.

Operator

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

Ken Hoexter

Great, good afternoon. Wanted to follow up a little bit on that. Luc, the average cost per employee was down about 2% year over year. Are there any special things in that? Maybe you can walk us forward in your outlook now on flat earnings. Is that solely on the volume side? Or is that on this, on whatever you have in the cost per employee as well? Can you walk us through how we should think about the cost per employee going forward? Thanks.

Luc Jobin

Yes. Well as I mentioned, I mean, you got to separate what's going on the pension side from what's going on the headcount. Wage inflation as I mentioned earlier is running at about 3%. We are managing very closely the headcount and so we were down about 9.5% in the first quarter versus last year, so that's about 2400 fewer employees in our service. And then, the entire team is focused on improving productivity and getting more out of the workforce.

So these are the key drivers and so its back down productivity wage inflation, we certainly also working very hard to reduce overtime, so that's another weaver that we're pulling and that's really what you should be factor, again there is a continuing to push as we have last year obviously when we get into the second half for the year we'll be confident against the lot of the improvement we made last year, but we feel pretty good about our ability to continue to push and get great operational improvements while at the same time you're balancing the service dimension. So that's my best guidance for you.

Claude Mongeau

Thank you, Ken.

Ken Hoexter

Thanks, Claude.

Operator

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

Walter Spracklin

Thanks very much, good afternoon, everyone. Just wanted to focus here on your new volume expectation for the remainder of the year. As you indicated you're reflecting the continued weakness in some of your bulk commodities. When you forecast that out for the rest of the year that's implied in your guidance, are you effectively taking a view -- maybe you could give us some more color on the relative optimism on that new view based on your revised guidance.

In other words, are you just looking for a continuation of the current run rate level? Or are you building in any back-half recovery that's already in your numbers? If you could give us a little sense of what level of conservatism or optimism you're building into your forecast, perhaps by each of those merchandise bulk and intermodal segments, that would be very helpful.

Claude Mongeau

Yes. I would say J.J. always tries to put the church in the middle of the village. So J.J. you want to give more color?

Jean-Jacques Ruest

Walter, its J.J. If we look just kind of look to next three quarter we kind of give the second quarter as maybe the toughest of the treats of a volume partly because what I've just talk about grain, grain, we'll have to wait for the next crop on the Canadian side and also because obviously the intermodal is little slow right now and it will need to ramp up sometime in the next couple of weeks before when this thing starts.

So, what are the some of the positive side? As I've said, anything that's to do with U.S. housing start, and I mentioned the list of commodities, actually a benefit from that on the CN side, manufacturing the vehicle on the container input but also on the finished vehicle side. Right now, even North American assign the plan, their inventory on ground is basically for the whole industry, North America is a target meaning we know about some backlog, so we're moving what's producing, but every time they produce a vehicle that tends – arrive intermodal container business.

And then we have the consumers, U.S. consumer, Canadian consumer, so intermodal, locomotive, manufacturing side or serving the dealers. Some of our customers had lock the fact, energy is very cheap, because natural gas is a feedstock and I mentioned some of those commodities, so its probably a long list of items and suppose to say we're going to be moving a lot of whole account with one given account, or we'll be going to be moving a lot of crude with two refineries which was maybe the stories of 20 months ago.

Walter Spracklin

Okay. Thank you very much J.J. Thanks Claude.

Operator

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

Brandon Oglenski

Good afternoon, everyone, and thanks for taking my question. I think, Luc, in your prepared remarks, you did talk about the strength of the consumer in North America. But J.J., I just wanted to follow up with you. Intermodal, not just for you guys, but the industry, is down, I don't know, let's call it 5% to 8% here to start off April. What's going on your retail customer side? Should we read this as more negative for the economy, or is this a destocking issue? How do we think about it?

Jean-Jacques Ruest

I think its –Brand it’s a good point meaning that maybe CN is little more transfer than another, but the staffs what the industry show over the last four weeks of intermodals in North America and in Canada are weak, and the West Coast are week.

So it's kind of main in industry phenomenon and I think partly its because the way we have all of our specifically a fairly good start to the year and including February for Chinese New Year was a different five this year and we never quite get a link from Chinese New Year which will happen at some point later in this I got to believe retailers behavior and maybe keep all the way to kind of slid up there supply chain.

But I think broadly there's an issue here's to on February and this February is bit stealing forward and now we're into stage where people are relooking at their stock and deciding how much they really need.

So I won't call at this is CN stories, but the thing that when you look at the staff especially the last four weeks Canada, U.S, West Coast, East Coast, there is a bit of a slowdown, I think we all experience that should come back some time during this spring.

Brandon Oglenski

Okay. Thank you.

Operator

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

Chris Wetherbee

Thanks, good afternoon. Was wondering if you could talk a little bit about the impact of the Canadian dollar from a customer perspective. If you're seeing anything at this point yet in terms of impact on your customers, particularly with some of the export business into the US. Or when maybe you think you would see that. How much does the currency need to affect the terms to see those lows change?

Claude Mongeau

We see obviously markets to balance out, so yes, over time exports from Canada, you would expect that to be positive with the dollar where it is, but it takes a while to kick in, J.J. likes to take of the services if we add the lower cost services at ports or trans loading activities. We have opportunities to move more goods to the supply chain that goes through Canada.

So we have to take advantage of the opportunities everywhere they are. And they are adding up in total. But at the end of the day it doesn't move. There is always a lag and its only then little bit less than a year at the dollar is quite a bit lower. J.J., do you anything to add.

Jean-Jacques Ruest

Yes. There's always a lag, because its take a little time for keyboard to turn around and secure more of the sales of the U.S. account versus an overseas account or domestic account. But that Canadian port, the Canadian West Coast that will limit on the capacity today, but by 2017 when they're at lower capacity the dollar still $0.18, we should be able exploit that to get business to the U.S. Midwest.

Canadian sawmill, Canadian aluminum smelters, these are plan which are most of the cost are in local currency and therefore we do have a cost advantage now. If you look at some others like assembly plants or petrochemical plants is a higher proportion of their cost which in U.S. front, despite the fact their plants in Canada.

But its - margin we do have an advantage now versus when the dollar was at par. These are just some of the examples of how some of these things play in some of these different sectors.

Chris Wetherbee

Okay. I'm thinking there's a little bit from the reversal for us, so maybe if we see a reversal in the currency, it might not see as of that potential benefit come to fruition. But I guess it takes some time to see.

Claude Mongeau

Yes. Short term high shock absorber impacted in terms of conversation that Luc will explain that to you in terms of the movements of goods, these things don't adjust as quickly. And that dollar is still much lower that it was on the year 15 months ago, at $0.80 in terms of trade are good and the favor of Canadian exports.

Chris Wetherbee

That's very helpful. Thank you.

Operator

Thank you. The next question is from Justin Long from Stephens. Please go ahead.

Justin Long

Thank you and congrats on the quarter. Intermodal seems to be a focal point for the business going forward. I wanted to ask about intermodal margins and where they stack up relative to your other businesses today. Looking ahead, how do you anticipate intermodal margins will be impacted as you start to factor in the port expansions and the opportunity for growth in the US domestic intermodal market?

Claude Mongeau

You know, we've been having a modal and intermodal for years now that is balance end-to-end approach and our intermodal margins are – there are not at the top of the list n terms of the profitability but they are – very much in the middle of the back.

So, the growth opportunities in that business are very favorable to long term profitability and we want to keep it that way. I mean Jim and his team are focusing on end to end service. We are working with our partners that supports not just to provide good service but also to provide efficiency gains in our loading up the cranes, lining up the cars so, that we are as efficient as possible.

And if we keep doing that, that’s what we need to maintain a secular long term growth opportunity and intermodal that's our strategy. It has been working and we see it continuing for the foreseeable future.

Justin Long

Okay, great. I appreciate the time.

Operator

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

Allison Landry

Thanks, good afternoon. With volumes down a bit more than you originally thought and currency and fuel moving the other direction, do you think that you can still drive year-over-year margin improvement for the balance of the year? And I know that you talked about driving some incremental efficiency gains. Wondering how to think about all the puts and takes with respect to the OR.

Claude Mongeau

Yes, as I said there is famous OR is very closely watch metric. I think Luc will comment more Allison, but I think it's fair to say that we have a pretty good start to the year with very significant improvement in the record operating ratio at today's level the fuel prices and with all of the initiatives we have to offset the lower volume.

We see a good opportunity for margin improvement in 2016 that's for sure. Long term our goal is to stay in the dealership position that we’ve been holding for a long time. On that key metric we don’t only focus on it because we tend to watch to - to focus on all the pieces including cash flow and return on capital. But at the rate we're going, we want to stay in a leadership position.

Luc, you add a few - put color.

Luc Jobin

No, I think we provided pretty well for - it’s all about – it's an end result it's not - we don’t start when we are working away back and all of us keep pushing the envelope and Jim and his team everyone around the table to find what the most efficient way we can do things, while at the same time in terms of protecting the service and longer term growing the business.

So, we have a great start. You should expect us to continue to have industry leading operating performance and that's ultimately translates into operating ratio but I mean that's just – it's just a way we look at the business and it’s not the driving force. So stay tune but the number should be good for the year.

Allison Landry

Thank you.

Operator

Thank you. The next question is from Brian Ossenbeck from JPMorgan. Please go ahead.

Brian Ossenbeck

Hi, good afternoon, thanks for taking my call. I had a question on -- Claude, you mentioned the overall volume pies could be shrinking, reference to customers that are under some pressure and we've heard some comments about the environment being more competitive.

So are there any -- I was wondering if there's any contracts, probably thinking more on the international intermodal side? Or anything else that's really coming up for bid throughout the rest of this year?

Claude Mongeau

We are such a good service the rail industry in general that it's very important to protect and profitability with the good pricing and that’s our thinking. At the same time you have to react competitive pressure and that’s what we are doing to keep the business that we have no burden.

On the international front our larger intermodal accounts that been renewed, J.J. and we don’t have any large control until next year. So, we are focused on delivering the business that we have at this point and we feel confident about the future.

We have a very good service and good end to end supply chain approach and our network reaches not deep into the U.S. from the three coast. So we think we are a great partner in that field and as a comparative market out there we'll just have to earn the business that deal passionately.

A – Jean-Jacques Ruest

Yes Brian, we have contracts every year for renewal so, one should – I mean that's just normal part of business. It’s not a risk of just how things do and as Claude said most of our major contract for the units have turned out and as to what might happen next year it is all speculation that we – that's what we hear from our old customers.

Operator

Thank you. The next question is from Tom Wadewitz from UBS. Please go ahead.

Tom Wadewitz

Yes, good afternoon. Wanted to see, J.J., you referred a couple times to the capacity coming on. Just wanted to see if you could run through the different capacity events in 2017 and frame the size of the Mobile, Alabama this year so we have a sense of the size of those and also your best sense of the timing.

Jean-Jacques Ruest

Okay. So if they can run roughly the three major ones so, one is Prince Rupert, Dubai Port. The capacity will add is in a range of 500,000 TEU that will come up roughly in July 2017. And we believe about 95% of this 500,000 TEU capacity is for rail in and out.

The GCT global container in the Vancouver also has capacity expansion in the rail side about a similar amount. It's probably 500,000, I mean 600,000 TEU. That rail capacity - being rail loading it's all railed all for rail and that’s a historically in Vancouver is market share roughly is two-third – one-third 70, 30 between us and the rail road’s – us been a dominant player that we give you a sense of how much capacity is available for us to go in market and mostly market in the U.S.

And in mobile Alabama, the terminal is expanding at the virtual discharge for the rail operation that they’re building right now will come in operation I think last is early June sometime in the next 30 days here. And the capacity that we are targeting there is eventually as we able to reach as much as 20%, 25% what is just charged by the ship.

So today all ship discharge will be 100% trucked in, trucked out. Cosco and Maersk are the first companies who - should be start as up to a single who offered a service and offer some pricing to do kind of mobile and north and then we’ll see how successful they are in helping us and helping turn off operator to enter.

So in the case of more dealers you start bring new so, it will find before we get our lights under us.

Tom Wadewitz

If you get 25% of mobile what is that translate to roughly?

Jean-Jacques Ruest

So the mobile capacity today is I think what is charged in the range of 200,000 to 150,000 TEU. Their aspiration is to have the bigger terminal and attract more discharge all in whether its rail or truck. There is only one terminal.

So we would like to get to a point where a core of the terminal, as terminal is growing is moving out of the terminal by rail that might take a little time because we need to prove the service just like we did back then in Rupert and also in return on Vancouver.

Tom Wadewitz

And what was the GCT timing in Vancouver, I didn't catch that.

Jean-Jacques Ruest

July 2017, mobile is month of June of this year.

Operator

Thank you. The next question is from Turan Quettawala from Scotia Bank. Please go ahead.

Turan Quettawala

Good afternoon. I also had a question on intermodal. Prince Rupert obviously been a great growth driver for you guys over the last few years, but certainly in the last quarter it's been a little bit weak. J.J., maybe you can give us some color as to what's going on there. Is it more of a temporary issue, you think? Or is some of that market share going back to the U.S.?

Jean-Jacques Ruest

So it was strong earlier in the year because of Rupert then its slow down at the same time and again if you look at the statistics of the U.S. West Coast or some of the four tracker magazine or some of the - in Wall Street Journal, I think we all have seen a slowdown on the import in the West Coast especially in March.

We’ll more still have Rupert because Rupert is a rail kind of a long haul, it doesn’t have the local market and Rupert is also separate to a point like other ports and off the challenge of exports related to U.S. dollar because a good deal of the export from Rupert actually were coming from U.S., Midwest.

So we’re working through that with our major customers in Rupert. They are historical one like engine or the newer ones like Maersk and everybody is attending here to make full use of the capacity that we selectively have at Rupert.

So goal is to get it back to where it was and I think it will probably mean also you would think that U.S., West Coast will also get stronger from where it is today, we may have bit of an industry phenomena thus of the Rupert, I don’t think it’s a Rupert phenomena.

Claude Mongeau

Yes, and I would say Turan you’re right that on a year-over-year basis it's down but on a run rate basis Rupert is still about 700,000 TEU. On an annual basis the cost is functioning well, it's a question of end demand picking up so that we can regain momentum.

Turan Quettawala

Great, thank you very much. That's my one.

Operator

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

Scott Group

Hi thanks, afternoon guys. Wanted to go back to the pricing discussion for a second because as I think about it, in like the past 10 years or so, I'm not sure I really remember you guys ever guiding to pricing of 2.5%. I feel like we've always been in this 3% to 4% range.

So I want to understand, is this something that is a temporary issue because of RCAF and grain and once we get through that we'll be back in 3% to 4%? Or do you guys see that the environment has changed? And you mentioned the competitive environment a few times on the call. Do you think we're just in, for the foreseeable future, in a little slower pricing environment? Can you clarify some of your competitive pricing comments, if that's truck, if it's the other rail in Canada or -- and then what segments you're seeing it in

Claude Mongeau

Scott let me repeat it what I said earlier. I think rail as an industry we had a very good service and at the end of the day we move what the demand is out there and so with good service and with the right demand framework, I think it's incumbent on all of us to keep pricing that allows us to reinvest in the future and to be disciplined in how we go about things.

And we think that's the goal for everybody. Right now the shrinking part maybe makes it a bit more tempting to try to do incremental capacity pricing but we are want to defend our business and in the end you are trading four quarters for dollar.

So we think it is hopefully temporary. We provide you very detailed information about our pricing performance on a same-store basis, it’s come down a little bit. Some of it as J.J. has said it is because of fuel and regulated grain, some of it is because of having to respond to a competitive pressure. And we hope that as fuel goes back and as the industry focus on discipline pricing, that we should go back up in more towards the range that we use to be delivering. But we will react to the market and just have to see how it goes. Thank you for your question.

Scott Group

Thank you, guys.

Operator

Thank you. The next question is from Bascome Majors from Susquehanna. Please go ahead.

Bascome Majors

Thanks for taking my question here. I believe you mentioned that the capital budget cut was entirely FX-driven. Can you go back and confirm that's what you said? Is there an opportunity to shift out some of the growth capital expenditure? Would it make sense to do that if the demand environment continues to be as pressured as it is in the near term here?

Luc Jobin

Yes Bascome this is Luc. Just to respond to your question essentially the lion's share of the decrease is a function of the revised exchange rate. There is a little bit of productivity in there as well which we’ve been - as Jim pointed out, we have been doing extremely well in the productivity front and so there is a little bit of that as well.

With respect to the outlook for the year, we are pretty well focused on fulfilling this plan. It doesn’t have a whole lot of investments which are - what I would call chasing growth, we are focusing on hardening the infrastructure, we do have some commitments around rolling stock which obviously are not things that we can change lightly, PTC is a major category where we have stepped up the investment and we are committed to fulfilling the regulated mandatory implementation.

So in the scheme of things, I wouldn’t look for significant reduction in CapEx. We take a long view of our CapEx. We think it's exactly a good time to be having our infrastructure and we can see the benefits are coming so loud and clear velocity is fantastic, we can maintain great service, the safety numbers are all showing the right signs, so all of these things and Jim is getting some very good working blocks for the engineering team to get on the track and work in addition to reasonable commodity prices.

So, it all makes sense and frankly this is typical of us taking a little bit of a longer view on things and not just trying to chase the next part, something that the whole team looks at very closely, so we don’t take free cash flow and CapEx lightly but we are pretty committed to this envelope.

Claude Mongeau

Yes, it's in best way to say it is a long term Marathon and we’re building for the future. So we are holding the line on our CapEx until further notice. Thank you for the question.

Bascome Majors

Thank you.

Operator

Thank you. The last question is from Benoit Poirier from Desjardins Capital Markets. Please go ahead.

Benoit Poirier

Good afternoon, gentlemen. My question is on the petrochemical. There's a lot of talk, excitement about the opportunities in the Gulf Coast. I was wondering if you could provide more color about the size, the timing of the opportunity with the implication for CN.

Luc Jobin

So the excitement on the petrochemical and Gulf Coast is typically related to new plastic plants that are being built either the ones that there were yesterday running flat out or the ones to be built. And it takes a few years to build these big plants. You need to build first in cracker and then the plastic plants.

So this is not like tomorrow but the trend looks like because of the cost. The cost of making plastics in the gulf right now are in Louisiana, Texas. Some of them are close to CN line, some of them obviously are not close to CN line.

Across this you can export to the world, you can make products and sell it here but also you can compete with other countries. So typically it may not mean a lot of rail business because the product that's producing in the gulf, most of it will want to go receive and that's why partly we benefit in mobile Alabama with these new unrecognized service because one of the thing that the shipping line are targeting is when they go to Panama Canal, first up is Houston and the reason they like Houston more today than in the past is because they’re going to get lot of polyethylene plastic export in container.

And then we go to mobile, and then - go to some other cities. So the plastics story might be as much as an oversea international business, as an export. So you truck to the port or maybe shortly rail shortfall. So you lower plant and send it where storage and transit, you get it out of there, you send it to a place we're going to bag it, the container gets lift, goes to Houston and then goes overseas..

Benoit Poirier

Okay. Thank you very much for the time.

Claude Mongeau

All right thank you very much Benoit. And thank you all for joining us on this call. As we discussed we had a good start to the year. We remain constructive about our prospects for the full year even though there are some challenges out there. We are managing the business for the very long term. But we are also nimble in responding swiftly to make sure we protect profitability to benefit our shareholders at the same time as we continue to deliver solid service, so that we can help our customers in what is a difficult period.

That's what you can do and that's what we plan to do. And we hope to see you at the end of the second quarter. Be safe and see you then. Thank you.

Jean-Jacques Ruest

Thank you all.

Luc Jobin

Thank you.

Operator

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

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