Canadian Pacific Railway's (CP) CEO Hunter Harrison on Q3 2016 Results - Earnings Call Transcript

| About: Canadian Pacific (CP)

Canadian Pacific Railway Ltd. (NYSE:CP)

Q3 2016 Earnings Conference Call

October 19, 2016 11:00 AM ET

Executives

Maeghan Albiston - AVP Investor Relations

Hunter Harrison - Chief Executive Officer

Keith Creel - President and Chief Operating Officer

Nadeem Velani - Vice President and Chief Financial Officer

Analysts

Scott Group - Wolfe Research

Fadi Chamoun - BMO Capital Markets

Ravi Shanker - Morgan Stanley

Walter Spracklin - RBC

Chris Wetherbee - Citi

Tom Wadewitz - UBS

Ken Hoexter - Merrill Lynch

Brandon Oglenski - Barclays

David Vernon - Bernstein

Brian Ossenbeck - JPMorgan

Justin Long - Stephens

Benoit Poirier - Desjardins Capital Markets

Jason Seidl - Cowen & Company

Keith Schoonmaker - Morningstar

Bascome Majors - Susquehanna

Brian Konigsberg - Vertical Research Partners

David Tyerman - Cormark

Operator

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

I would now like to introduce Maeghan Albiston, AVP Investor Relations, to begin the conference.

Maeghan Albiston

Thank you, Mike. Good morning and thanks for joining us.

I'm very proud to have with me here today Hunter Harrison, our Chief Executive Officer; Keith Creel, President and Chief Operating Officer; and Nadeem Velani, 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 two in the press release and in the MD&A filed with Canadian and U.S. regulators. This presentation also contains non-GAAP measures which are outlined on Slide three. The formal remarks today will be followed by Q&A. In fairness to all participants, we would request that you limit yourself to one question. If we are unable to get to your question today, I would be happy to follow up after the call.

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

Hunter Harrison

Thank you, Maeghan, and good morning to everyone. Thanks for joining us.

I am going to limit my remarks this morning as I kind of step back in my role and allow Keith and company here to carry this story forward. There are a couple of things I would though like to bring to your attention.

A couple of people we should recognize and congratulate is certainly Nadeem Velani, who you all know who is now --was I guess short-term interim CFO, I am proud to report to you that yesterday the Board approved it permanent, so now Nadeem is CFO. So congratulations, welcome. Most of you know Nadeem. I know he will do an outstanding job and certainly the thing I look forward to the most which possibly as some of you look forward to is some stability. And also congratulations to Maeghan who has been propping up Nadeem through the years and now she gets her opportunity to shine. So Maeghan, congratulations on your new position.

A couple of comments about the quarter before Keith and Nadeem take over. Very pleased from an operating ratio standpoint, I think that if not it is close to a new record for quarter performance. I think the thing that I would call to your attention the most that excites me about that is the foundation really that that builds for the future. We did, I was a little disappointed that we missed consensus I guess about a nickel, but we don't control consensus and I think effectively that story is the grain story. There was all lot of and still is all lot of hype about the crops in Canada. I personally think the crop is there but it has certainly been a late harvest. Most of it has been blamed on the weather and there has been some wet weather, but at the same time my personal observations are it is a little bit of softness in the markets. As you see the markets turn worldwide and get a little more aggressive, the wetness of the weather might be near as challenging a factor as it has been so far.

So if the grain had been like a lot of us were predicting, I think we would have been right in line with what we expected. And I think it is a case that most of the conventional wisdom is that if the grain doesn't move fourth quarter it will carry over into first quarter of 2017 and give us even a stronger start there. So I really think that this OR of 57 and a fraction, 57.7, is going to send some signals to potential guidance and what we are looking for in this organization in 2017.

We have reached a point where if you go back about four years now, conventional wisdom, the pundits and others said we couldn't get to 65 in four years. They were wrong again and I think that Keith has put together and almost has completed an outstanding team to carry this organization forward. A couple of us are going to be leaving the organization but we are still going to be supporters and advisors if needed. So overall, I was very, very pleased with the outcome and look forward to more results like this in the future.

With that let me turn this over to Keith and team to get more in the detail and granularity.

Keith Creel

Okay. Thank you, Hunter.

With that said, this quarter, third quarter, was all about again controlling what we can control and doing it well. We obviously faced some challenging environment when it came to the volume, but I am extremely proud of what this team did as they matched it with an outstanding operating performance, which again demonstrates the strength of our operating model driving productivity metrics as you see the slide there at all time highs both in weights, lengths, fuel efficiency, record levels for the company. If not industry best right at industry best as well while at the same time driving improvements in the service levels which is what we converted in the marketplace and critical importance to us.

The most encouraging part though is increased operating leverage and momentum as the volumes recover in the fourth quarter and they are starting to recover as you saw yesterday in our RTMs release that came out last week possible inflection on volume. It reflects that now the grain supply chain so to speak or the shipments hit their peak volumes, which I expect to continue exiting kind of catastrophic weather through the balance of this year. And as Hunter said, what we haven't moved in the third quarter will carry over into 2017. So it is not lost revenue, it is just revenue that is pushed forward. So the foundation is there for continued margin improvement as we move forward to Hunter's point.

On the service side, I am extremely pleased also to advise, Hunter had mentioned in the last call that we were on the verge of implementing thrift plans, which again for those of you that may not have been on that call, a measure of the car from the time a customer leases it by the hour to the time it gets to destination, it is a commitment we make to the customer. When we measure our success, the expectation is 90% or better on a daily basis. This was an extraordinary effort by the team, Ray in service design, Mike in the IT team and the operating team working together. But, this created some pretty extraordinary results; the superintendents have gotten very engaged.

In a very short time, we have gone from implementation to the last two weeks exceeding over 90% on a daily basis which again bodes well, is an excellent tool for service excellence. It is going to give our marketing team a product to go out and sell. We will be talking about selling service to go with a customer, explain to them what we can do for them in lines of cycle time, explain to them how our shorter network in key markets can lower their transportation costs and help them win in the marketplace while we do the same.

And on the asset utilization side, the cost control side, that is an even more exciting piece. It makes us very transparent because we become better railroaders making connections in our terminals, running our terminals better, faster asset turns, which obviously equals lower cost.

I mentioned also in the last call from a productivity standpoint and initiative we were going to go after this year on increasing our grain train lengths. We have had some success in that. We have moved up. Second quarter to third quarter increased from about 11% at this point up to 124 cars per train with an objective to get to 134, which obviously is a pretty significant productivity improvement, which is going to allow us to take out train starts and again improve fuel efficiency as we go forward and increase asset times and lead more grain.

Sustainability, that's another key area we talk about. It's not enough just to do this quarter-to-quarter. As Hunter said, building a team to sustain the success as we go forward as we shift this engine that we created low cost high service to grow top-line. Hunter and I spent last week with our superintendents and our general managers we brought them together, took them off the property, spent three days in tents teaching them how to become better railroaders. Some of the gentlemen, some of these ladies obviously have never had an opportunity in their career to spend three days with Hunter. So it was quite an eye-opener for them. But it gave me a chance as well as we worked with them not only to teach, but to assess and build on the strength that we have built for that bench as we get deeper. So extremely pleased from sustainability of people development front as well.

Let's speak a little bit to the revenues. Obviously a little bit less than what we expected driven primarily by the grain as Hunter had mentioned being pushed forward, down 9% RTMs, 6%. We had 3% reduction in carloads, but that's obviously to the RTMs down more than the carloads, it is a reflection of the declines at our long-haul crew traffic and weaker grain volumes. Fuel surcharge hurt us about 2%, but on a positive note as we go into Q4, the impact of fuel surcharge will be negligible.

Price was roughly 3% excluding regulated grain. Some of that though was offset by the areas of business showing strength which are lower cents for RTM, Canadian coal, export potash, U.S. grain, corn and soybeans were strong, so obviously each of those on the commodity side have a lower cents for our team as we ship more of it.

In the fourth quarter we expect a flattish RTMs driven by larger than anticipated the Canadian grain moving forth, taking longer to ramp up as we explained. So that is going to drive us to a flattish Q4 as far as an RTM basis. But the worst is behind us. We are continually improving service, we are setting the foundation as I said setting us up well as we head into 2017 and beyond for quite a bit of success margin improvement and EPS growth.

So with that, I'm going to pass it on proud to say to our newest CFO of CP, Mr. Nadeem Velani, to provide some color on the numbers.

Nadeem Velani

Thanks, Keith, and thanks Hunter for the confidence that the two of you have shown in me. I am extremely excited for the new role and look forward to being part of the team for the long-term helping drive value for both our shareholders and customers. Thank you.

We can turn to the third quarter financial performance slide. As Keith mentioned, the top line was challenged this quarter with revenues down 9%. Operating expenses on a reported basis were down 6%, but if you remove the one-time gain we had last year from the sale of the D&H South, operating expenses were actually down 12%. So a pretty good performance all in.

A few of the major items worth mentioning on the expense side, comp and benefits was down 16% versus last year driven by lower headcount and positive pension income. It was offset partially by wage inflation of approximately 3%. Also worth highlighting the change in share price added $26 million on the quarter and hurt the operating ratio by roughly 170 basis points. We had a strong run-up in the stock this past third quarter.

On the fuel side, expense was down 15% year-over-year driven by lower volumes, lower fuel prices and an improvement in fuel efficiency. However, in the quarter fuel revenues decline faster than price and the net impact was a $22 million headwind from the lag impact. So that was certainly a headwind that we faced this quarter.

On the purchase services side, a few of the highlights. It was down 16% to $228 million largely due to lower crew hauling costs and fewer contractors. We also conducted a review of our network strategy this quarter so this resulted in a $15 million favorable adjustment to liabilities that had been accrued for the discontinuance of certain branch lines. Land sales in the quarter were $5 million and as we look ahead to the fourth quarter, we still have a significant amount of land sales which we estimate to be approximately $50 million.

All in, our third quarter operating ratio was 57.7%, an improvement of 220 basis points from the adjusted operating ratio of 59.9% in 2015.

So moving below the line, a few things to highlight on the other income and charges. This includes a $46 million charge from the change in non-U.S. dollar-denominated debt as well as a $25 million charge related to illegal settlement. Interest expense was up 13% to $116 million due to the additional debt we issued in 2015 to repurchase shares as well as the use of our commercial paper program.

I want to point out the effective tax rate was adjusted to reflect change in traffic mix as well as other tax planning initiatives. So we mentioned it last quarter, but we trued up the tax rate to 26.5% year-to-date. In the quarter it was actually 25.2%. As we look forward, we expect to have a sustainable 26.5% effective tax rate.

Lastly, adjusted income for the quarter came in at $405 million or $2.73 per share. We did complete the NCIB program that we announced in Q1. We returned $1.2 billion to shareholders this year at an average price of $175 per share and over the last three years it is worth noting we have purchased roughly $6 billion as part of our repurchase program.

At this time, we don't intend to upsize, instead we will be focusing on strengthening some of our key rating metrics. Our net debt to EBITDA metric for example is at 3x, some of the natural delevering should put us closer to 2.7 by the end of the year. However, long-term, we talked about our targets being the 2x to 2.5x range. Now that being said, if the market opportunity were to present itself, we may reconsider that position.

So clearly lots of puts and takes on the progress but when you take away some of the noise from fuel, stock-based compensation and a few favorable items as well, the business was running closer to a 56 operating ratio. As we head into Q4 with the land sales I mentioned, will probably bring the OR down to the low 50s. If you exclude the land sales, we should exit the year at about a mid-50s run rate. That sets us up very well if volumes in 2017 reflect positive.

With that, I will pass it back to you, Hunter.

Hunter Harrison

Thanks, Nadeem and Keith for those enlightening presentations. And with that, Michael, we will be glad to take questions from the group.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Your first question comes from the line of Scott Group with Scott Wolfe Research. Please go ahead.

Scott Group

Hey, thanks. Not Scott Research yet, we are working on it. So I know you guys don't typically break out price versus mix but we haven't seen it negative before. So maybe, Keith or Nadeem, can you give a little bit more color on that and break that out for us and kind of how you are thinking about that price going forward? And also mix going forward as kind of some of the volumes start to improve a little bit?

Keith Creel

I will let Nadeem add comments I guess here, Scott, but as far as I am concerned, what you can expect going forward, the 3% to 4% stick stays the same. Maybe in this environment it is closer to 3%, I am not exactly sure. We will look at that as we go into 2014. But what is driving the negative mix now, again, we think about the Canadian coal that is moving strong, we think about potash moving strong second half at a higher volume than we would have been moving it last year. We think about U.S. grain, the PNW. That grain competing with [VN] [ph] obviously. We have raised the rates on that, tariffs have gone in, but in the third quarter we didn't see the benefit from that.

So, as we go into the fourth quarter that will sort of offset itself, come in flattish and then in first quarter of next year, we were able to with the MRE, take up the rates 4.8%. So on the Canadian grain side; we will see a positive inflection as well. So that explains it from a mix standpoint. That is pretty much what drives that. I don't know if Nadeem can add any more color than that, but I think that pretty much captures it.

Nadeem Velani

No, I think you've got it, Keith.

Scott Group

So just to follow-up kind of quickly as you think about the fourth quarter, Keith, you said kind of flattish RTMs. Given some mix and price, what does that kind of imply for fourth quarter revenue?

Keith Creel

I would say flattish, yes.

Scott Group

Okay. Perfect. Thank you, guys.

Keith Creel

Thank you.

Nadeem Velani

So, Scott, just keep in mind, we got a bit of a headwind with currency in Q4. Fuel will be relatively flat all things considered where we are today. So some of the elements are changing, but that is what would change the sense for our camp.

Scott Group

Okay. Thank you, guys.

Keith Creel

Thank you.

Operator

Your next question comes from the line of Fadi Chamoun with BMO Capital Markets. Your line is open.

Fadi Chamoun

Yes. Good morning and congratulations to both Nadeem and Maeghan.

A couple of things just sort of looking into the next few quarters, if you can give us even a high level thoughts about what do you think 2017 looks like on the volume side, some of the things you think will work for you and maybe if there are any headwinds we should be thinking about?

And also you mentioned exiting 2016 at sort of a mid-50s operating ratio run rate. Is that volume dependent? What kind of volume you need to see in 2017 for that to sort of play out? And I am assuming 55% is an over the year kind of target.

Keith Creel

Let me take a stab at this, Fadi. As far as volume in 2017, I mean we are still doing a lot of work putting that all together, but the things that I think are positive for us obviously the compares in 2017 on crude will diminish and that is still a little -- our book of business getting more that we will be able to stop talking about it which is a positive thing. The first half last year if you remember had very weak potash volumes. I think that is a strength for us in 2017.

As far as the operating ratio performance, the mid-50s when we say volume dependent we are going to be flattish Q4, you can expect I think flattish if not some upside in the first quarter of 2017 barring a horrific winter, which I pray about every night. I think we can have modest volume growth in 2017 with a much improved operating base. And you are going to see some earnings growth in 2017. We are optimistic about it. FX as well may be something to think about in Q1 of 2017.

Fadi Chamoun

Okay. Thank you.

Operator

The next question is from Ravi Shanker from Morgan Stanley.

Ravi Shanker

Thanks. Good morning, everyone. Just wanted to dig a little bit deeper on the grain move. What level of confidence do you have that this actually happens as you expected given the fact that I think there was a bunch of snow over the weekend I believe in certain parts of Canada, which kind of makes this harder. And you did put out a fairly somewhat extraordinary press release I think last week where you put out this grain scorecard to make sure that everyone is really delivering on this throughout the supply chain. So again, what level of visibility do you have that this grain gets moved?

Keith Creel

I obviously don't have a crystal ball, but everything I am seeing; I am seeing and hearing nothing that takes me away from being bullish about grain versus last year. I was in Ottawa two weeks ago and met with the Minister Garneau. Except Canada there's numbers around 70. The consensus is 72 to 74. The issue that we have been dealing with, with the delayed harvest in Alberta, I think it is 80% caused by the moisture is a real issue. I think it is causing from a quality standpoint more blending which is done in the prairie so to speak so it slows down the process of getting into the railcar. But overall the supply chain is doing well so far.

As I said, it is fully charged now. We are going to have to keep an eye on it and part of the transparency is exactly that on the grain car that we are producing. We were criticized heavily back in 2013 and 2014 for not doing our part, which in fact is not correct. At CP specifically, we moved more grain in 2013 and 2014 at that point than we ever had. What we have learned though to make sure that we are all on the same sheet of music, this supply chain has to work in concert to grain companies both at the port elevators that load the grain, offload the railcars and in the field where they load the grain have to work 24/7 the same way we work 24/7 to optimize the supply chain.

So we feel that by being leaders and being transparent and just stating the facts and not rhetoric as we go forward, all players will see that. I think all players will work together to improve on these efficiencies and if things do go south on us, at least the farmers and at least the government clearly understand what can and can't be controlled and if it is things that we can't control, our voice is, our opinion is that they will do the prudent thing and act on fact, not on rhetoric and speculation.

Ravi Shanker

Got it. Thanks for the color. And just as a clarification, Nadeem, did you say in the fourth quarter you are going to be doing a mid-50s OR ex land sale and a low 50s OR including that?

Nadeem Velani

Correct.

Keith Creel

He said it loudly.

Ravi Shanker

Got it. Understood. Thank you so much.

Operator

The next question is from Walter Spracklin from RBC.

Walter Spracklin

Thanks very much and congratulations both Nadeem and Maeghan, well-deserved.

I guess and Keith you mentioned on the crude how it has come down a little to a low level run rate. There is a lot of noise in that number with the wildfires and so on. What is a run rate we should plug into our model with regards to crude just on a base level as we look out to 2017 would you say?

Keith Creel

Walter, I would be guessing. I know we are going to finish this year somewhere around 30,000 car loads versus 95,000 last year. And if I guessed it would be a little bit less than that. That is probably where I would guess. I just don't know exactly where to put the pen yet.

Walter Spracklin

Okay. And then the negative mix effect from that lower should -- there should be much less of a negative mix effect on your yields in 2017, is that right?

Keith Creel

That is correct. That is exactly correct, Walter.

Walter Spracklin

Perfect. Okay. Thank you very much.

Keith Creel

Thank you.

Operator

The next question is from Chris Wetherbee from Citi.

Chris Wetherbee

Thanks, good morning, guys.

Keith, I was wondering if you could comment a little bit on the competitive dynamic you know from a rail perspective and also from other modes of transport perspective. I think you have some shots on goal for some big contracts coming up here over the course of the next several months. Kind of wanted to get a sense of maybe how that was progressing?

And then just maybe broadly speaking how do you guys are feeling your positioning is kind of going into the end of this year and the beginning of next year given how lean the operating system has gotten; it seems like things are running well on the network. Just want to get a sense of how we should be thinking about that?

Keith Creel

Yes, I would say from shots on goal, number one the most important thing to stay focused on is we are not going to make bad business decisions. We are selling service that is exactly what we are going to do. In key lanes, we've got a superior network. We've got shorter routes, we've got faster cycle times if we do our job putting that service in the marketplace and selling that compelling value to our customers I think that is puts us in the game for those shots on goal, but more to come on that. Obviously, again, I'm not going to make a bad business decision. This team works too hard to produce what we produce but certainly we have a compelling product out there so we are definitely in the game.

I would think, some of the things we have done too if you think about some of the business that we have not secured as of late, again that speaks to the discipline when it comes to price discipline, when it comes to selling service and actually improving the quality of our revenue as opposed to chasing bad revenue. So again, stick with us there. More to come on that, but I think we are in, in good stead.

Chris Wetherbee

Okay, so no real change in the confidence level around some of these bigger intermodal contracts that may be coming up, that is all stuff you are working on at this point?

Keith Creel

Yes, we are approaching them with cautious optimism I guess is the best way to say it. The things I will say though let's not talk about those contracts, in the areas that you see strength in our intermodal business specifically is more share coming off the highway. That cross-border domestic intermodal service we put in last year has grown dramatically and it has become very accretive and very beneficial for us. So it speaks again to the service, it speaks to the franchise and it speaks to what we are doing, we are not just going after rail share, the bigger opportunities are out there on the highway which we're trying to capture and put on the railway.

Chris Wetherbee

That is helpful. Thank you. Appreciate it.

Keith Creel

Thank you.

Operator

The next question is from Tom Wadewitz from UBS.

Tom Wadewitz

Yes. Good morning and congratulations to Nadeem and Maeghan, very well deserved. So it is great to see that.

Wanted to see, I know you got a question along these lines earlier in the call, but just wanted to make sure I am understanding it right. You are saying like a 55, 56 type operating ratio in 2017 that is a reasonable expectation if you get I think Keith you said modest volume growth. So would that be something like 2% to 3% volume growth, is that the right framework?

Keith Creel

No, Tom, just to clarify, we haven't indicated -- we will get back to you on January as to when we give our guidance for 2017. I guess my point was in the back half of the year here as we -- this quarter and as we close out Q4, we will be exiting with a mid-50s type of OR, low 50s in Q4 if you want to include the land sales, the but mid-50s excluding. That is where we are set up. We will get back to you on where we think the top-line looks like and the various puts and takes for 2017, but it is too early to talk to that at this stage.

Tom Wadewitz

Okay. So you wouldn't say that is wrong. It is just you don't want to go down the path of being too specific on guidance for next year, is that what you are saying?

Keith Creel

You can expect margin improvement. We are just not exactly ready to tell you -- guide to where we think it might be yet.

Nadeem Velani

There are puts and takes with pension, with some of the volume outlook, with obviously we will see where currency lands and a few other things that we are going through the planning cycle as we speak. And so it is October, we will get back to you in a few months.

Tom Wadewitz

Thank you, Hunter. I appreciate that. So on the volume side for next year, can you just give me a sense of how much conviction do you have or how much visibility? It seems like you've got leverage to some of the segments where there is good reason for optimism, potash, grain, the global met coal seems pretty strong and your domestic intermodal is showing some traction. But how much visibility and conviction do you have that those segments can drive some volume growth when you look to 2017?

Keith Creel

I would say you summarized it. As far as conviction, I mean obviously don't know what the economy is going to give us. I think this slow growth is sort of the new normal, but I think we've got slow growth, we've got superior service and we are recapturing market share that I think we should benefit from that, Tom. Those are the areas that you summarized our some of the exact areas along with merchandise that we expect to see some wins in the marketplace.

Nadeem Velani

Last January, think about the bulk franchise and the commodity prices and how we were kind of getting penalized for how negative the commodity outlook was. Well, I would reverse that right now and that is kind of the strength of our conviction on the top line, 40%, 45% of our business is bulk. And I think we have a lot more visibility there than say energy now. At the same time, energy has become such a low component of our business that it is going to be almost insignificant once you get past the first quarter in terms of the comps. So we are setting up well with intermodal has turned positive here in the last several months, merchandise, autos and forest products and some of the key merchandise lanes. But, again, it is a difficult uncertain environment, but we feel pretty good about how things have transitioned the last several months.

Hunter Harrison

Tom, I think I would add this. I think the thing that we don't really understand and know and all of these other things that Nadeem and Keith had mentioned are very positive. But I think one of the things that I give a lot of thought to is what is going to happen in November for the election. And that could have big, big impacts both plus and minus and we are just going to have to see how that shakes out. I mean it has got impacts on freight, it has got impacts on environmental issues and there is a lot of things that can swing with what takes place in the election. I'm not picking a candidate, I am not telling you what the outcome is going to be, I am not that smart, but there is more to come on that.

Tom Wadewitz

Right, right, okay. Great. That makes sense. Thank you for the time.

Hunter Harrison

Thanks Tom.

Operator

The next question is from Ken Hoexter from Merrill Lynch.

Ken Hoexter

Good morning. I will also echo congrats to Nadeem and Maeghan.

Keith, maybe you could delve into the employees which are now down below 12,000. And when you think about the operating expense and your operating ratio going forward, you've dropped from 17,000 that was a big program that you and Hunter kind of focused on initially. Are we done on that side, or do you still look at that with your whiteboard sessions and say, hey, there is still room for more efficiency gains on the comp and benefits side?

And then just a minor one, depreciation also actually went down sequentially. Just wondering is that a new level as you retire equipment or anything or anything on the expense side?

Keith Creel

On the people side, obviously, we are not going to make the same quantum leaps we have made over the last four years but we are never done. You can always expect productivity improvement. So I would say marginal improvements there, not quantum leaps but certainly you can expect us to become more productive and more efficient as we invest in physical plant, we speed trains up. We mixed in sidings, we reworked yards. There are several initiatives that I've talked about that haven't been fully implemented both on the engineering side as well as the operating side that will drive the different additional synergies and manpower savings as we go forward. So that will be incremental change but always expect incremental improvements, we are not finished there.

Nadeem Velani

And Ken, yes, it is a fair run rate going forward on depreciation.

Ken Hoexter

Thanks. Keith, just a follow-up on your statement there on your steps to implement the trip plans. Is that something that there is future efficiency; is there tail from that program that we should see over the next few quarters?

Keith Creel

Yes, you will see additional car velocity, you will see car miles per car day go up, you will dwell time go down, you will see operating cost in the terminals improve as we make connections. Yes, that is incremental step change but it is all part of the story that will continue to drive incremental productivity improvements on cars, locomotives and people. It hits all three areas.

Ken Hoexter

Is there magnitude or CapEx impacts on that?

Keith Creel

No CapEx.

Hunter Harrison

Positive.

Keith Creel

Yes, obviously to a point, it defers CapEx when you come to replacing equipment when you are not having to replace as much of it I guess. But as far as anything material, you can expect the same on the CapEx side the $1.1 billion to $1.4 billion is what we see for the next few years at this point.

Ken Hoexter

All right. Appreciate the time. Thanks.

Operator

The next question is from Brandon Oglenski from Barclays.

Brandon Oglenski

Good morning, everyone, and congrats as well, Nadeem and Maeghan.

Hunter, I don't know how many more conference calls we have you. So I want to ask a longer term vision of the industry of you if you don't mind. There is a lot of capital going into disruptive technology modes for transports, a lot of talk about platooning and autonomous or semi-autonomous for trucking. And how does the railroad industry adopt to these future changes or potential changes? We also see a lot more growth in e-commerce versus traditional retail. So where do you see the industry going especially with the implementation of PTC? Is there hope for single crews? Obviously, there is a big pushback against mergers last year that we all know quite a bit about. But what is the future if trucking or on-highway or other modes of transport become that much more competitive? What does the railroad industry do going forward?

Hunter Harrison

Well, you know that my answer is going to be different than others so it is not going to be the conventional wisdom. But I would say this, the rail industry needs to wake up and before others and go back to the basics that is where we need to strengthen. This is not about technology, this is about we've got a lot of basic things to do. Positive train control is not positive train control, okay? It is an acronym that people don't understand. If a car rolls out of a yard and rolls into the side of a train, positive train control has nothing to do with it. It was a political reaction; there is a lot in my view, a lot of time and money wasted in those efforts.

I just think that as we look at and analyze for example some of the actions that take place, our view is that most of them are human behavior and we don't spend much time on human behavior. We spend much time on technology and driverless trains and those things. I think the whole issue can be addressed with there is there is nothing like a safe manual. And until we wake up to that, there was a well respected individual in this industry going back 70, 80 years ago, I wasn't here then but the record reflect, but one of the statements he made was that their strategy was to get rid of people at all cost. What a hell of a thing to say.

So, whatever influence or efforts I have if any in the future, it is going to be for us to really look inside and see what is taking place and happening. And we talked about computer, computer assisted dispatching and different things and at the same time you look at the article next to it, and it talks about hacking and terrorism and who is going to get into the computer. And I think if we are not careful, we are going to lead ourselves to places we don't want to go.

Brandon Oglenski

Thank you.

Hunter Harrison

[indiscernible] will love that, but that is the way I see it.

Operator

The next question is from David Vernon from Bernstein.

David Vernon

Good morning, guys, and thanks for taking the question. I guess as you think about the mid-50s OR heading into next year, if we see sort of a flat volume environment, do think you can still sort of make some forward progress on the OR or do you think that it will be more of a flat outlook for that?

Keith Creel

I would say, David, if you think about with some of the puts and takes, we can't control the volume environment. What we can control is the cost and service and that is really what we focus on. So if you look at some of the deposits we had this year with land sales and pension and so forth, you factor some of that out, we are not going to need volume to drive operating improvement, we are not going to need volume to drive margin improvement. There is still opportunities ahead of us on that front. So if we finish this year in that 57, 58 range full-year and we were closing the back half of the year below that, you can expect us to see some sequential improvement. We have talked long-term about how we still have opportunities to improve the operating ratio volumes, independent of volumes, so just like we have done this year.

David Vernon

Thanks for that. And then maybe just on the domestic intermodal side, obviously, the sequential improvement in that volume growth, is there something you guys have made changes into in terms of the schedule and the way you are marking that that should lead us to think step up will annualize? Or is this just you hit the market at the right time with some services? Can you give us a little bit of color on what is driving that inflection on the domestic intermodal?

Keith Creel

Yes. We targeted and implemented a new service in a market that we weren't serving cross-border domestic so that market from Toronto, Montreal Toronto down to Chicago. Some more again taking trucks off the road, utilizing our cost advantage and our service advantage. So as we go forward, I think that fuel is going to adjust. I think at some capacity we will tighten up and I think that bodes well for an even strengthening domestic intermodal proxy in 2017.

David Vernon

So that domestic intermodal…

Hunter Harrison

Let me add, I think this group will benefit very, very well in the area of the domestic intermodal that you raised the question. When you see interest rates rise, people don't pay a lot of attention today to carrying costs of inventory and safety stock and those things with interest rates where they are. You let interest rates go back to where they were in the late 1970s, early 1980s and carrying costs are 45% and watch the person providing the service capture the business.

David Vernon

All right. Thank you.

Operator

The next question is from Brian Ossenbeck from JPMorgan.

Brian Ossenbeck

Hi. Thanks for taking my question. A lot of the softness that you talked about here into the end of this year in this quarter was the delay in grain. But I wanted to ask about more so on the coal side is running about down 7% year-to-date in carloads. I think last time we heard an update on there was finished flat for the year. It seems like it would imply a pretty hefty amount of volume in the fourth quarter. So just wondering if that is still a possibility and then is there any type of upside you would see with -- working with your big mining customer to take advantage of some of the upward move in price on the [seabore] [ph] market for met coal, maybe not this year but next year?

Keith Creel

Let me say this. On the carloads, that is a little bit misleading. You've got to understand the franchise itself, the carloads are down significantly year-over-year on the U.S. side, short-haul coal the biggest proponents of the business or a big chunk of business is actually tech export coal which is running at a pretty strong run rate now. So don't get to mislead by the carloads. We will still finish from a tonnage standpoint flat if not up slightly over last year in 2016.

Given that they are running at close to peak volumes, we are not assuming a huge upside next year, marginal growth, but certainly some growth on coal overall. And then from a compare standpoint, you get over, you lap the carloads, you put your carloads decreases on the U.S. side from a carload standpoint.

Brian Ossenbeck

Okay, great. Thanks for clarifying that. And like I said just is one quick one on capital structure. Nadeem, you mentioned a bit about leveraging buybacks, but regardless, that dividend which you just raised recently, maybe you could just give us a feel for the Board's thinking of that for the longer-term. When we look at the yields versus yourself and the rest of the peers not in Canada but across the broader group?

Nadeem Velani

I don't want to speak for the Board. I think it would be more appropriate for Hunter and/or Keith to speak to the dividend versus buyback. I would just say that we have recognized that our dividend was quite low, our yield was I think 0.7% and the Board recommended a pretty significant change -- increased that by I think 43% in April/May timeframe which was done. The stock was trading at a pretty low value in the spring. We took advantage of that with our buyback and we have been very clear that we plan to invest back in the infrastructure or back into the business. But beyond that, we will return the cash to shareholders. I think our free cash generation is very strong this year and it will be stronger next year.

And so with that, it is going to be somewhat -- we are not going to I think change our tune on how we distribute cash or the quantum of how we distribute cash other than to say we are going to be sensitive to what the stock price is. We are going to be sensitive to our shareholder desires. I think our shareholders' composition has increased to the highest it has been since I have been here in terms of our Canadian ownership. We are getting close to 40% and that is going to have an influence in what the Board decides. So I think those are kind of my overall thoughts and maybe Hunter can offer a bit more insight there.

Hunter Harrison

Yes. Nadeem answered the question, and then, he turns it over to me. But I would say this; we face the same questions every year. The first call on cash is back in the company, is where we need to spend it on the basic infrastructure of the company of rail ties, ballasts, locomotives or whatever, we will. Now we have done, this team has done a pretty darn good job in controlling capital spend and improving asset utilization. So our capital spend has been down so there has been more cash.

Given the -- Nadeem I think mentioned earlier -- given the rationalization of some of the operating yards, there is going to be some pretty positive free cash flow coming out of our subsidiary that we do a joint venture with called Dream. So I think it will be down to what is the most effective, efficient way to return those efficiencies to the shareholder and I think there will always be some debate between buybacks, dividends, special dividends or whatever.

I think if I had to make a guess, I think in the future and it gets into tax policies between the two countries, but I think my personal view is maybe we were a little light on dividend mix and maybe the dividend will increase a little bit as opposed to we have been stronger in the past on buyouts, on buybacks. We will be -- I think we will always be very sensitive to the intrinsic value of the franchise going forward and we are not going to buy back to buy back but if that is a value proposition and it is the best place to spend for the shareholders, then we will do it.

So, we have all of those things at our disposal and given the environment we are in and the various tax policies and the mix between Canada and the U.S. ownership as well as other probably 20% of our stock is held outside of Canada and the U.S. So, all those things will be there, but I guess the positive thing is as long as we keep operating like we are and I am convinced we will do that and even better, those will be great issues to debate.

Brian Ossenbeck

That's right. Okay. Thanks a lot for your help.

Operator

The next question is from Justin Long from Stephens.

Justin Long

Thanks and good morning. I had a couple of quick ones. First on land sales, so you gave an expectation for the fourth quarter. I wanted to see if you had any initial expectation for 2017 land sales? And then secondly on auto, we saw some sequential weakness in the quarter so I was wondering if you could just provide some more color on that business and how you are thinking about the progression of auto in 4Q and into next year?

Nadeem Velani

So on land sales, Justin, I would just say they are lumpy. I would say that we have opportunities ahead of us. We have had ongoing land sales the last several years and as part of our strategy to again monetize assets that as they become redundant and so forth, we have this opportunity with Dream that Hunter spoke to. Again, we will get back to you in January with a view on where land sales will fall in for the year. But at this point, I would assume 100, 110 that we are from this year will probably be a bit of a headwind into next year is probably a fair assessment.

Keith Creel

I think on the auto weakness, the best way to describe that is again more about the discipline story. We are not going to chase business, some business we just can't make the numbers work on. We are focused on quality revenue, which is what we are actually realizing the business we retained we are going to make a buck to be paid for the sphere of service that we provide and we are going to leverage the strength of our franchise in the lanes that we serve best which is exactly what we are doing. So that is the story on the auto side.

Justin Long

Okay, fair enough. I will leave it at that. I appreciate the time.

Keith Creel

Thank you.

Operator

The next question is from Benoit Poirier from Desjardins Capital Markets.

Benoit Poirier

Hey, good morning, gentlemen. Thanks for taking my questions and congratulations to both Maeghan and Nadeem. So very happy.

And just one question just was wondering if you could provide an update Nadeem on the pension benefits, whether you are still expecting kind of $90 million this year? And when you look at the current discount rate, I was just wondering what type of headwind it could represent for CP going into 2017? Thank you.

Nadeem Velani

Thanks Benoit. So, right now we have a tailwind for this year about $80 million, $90 million for 2016. We will get back to you in January. I hate saying that with all these questions, but I think at this stage if you look at where discount rates, they are down about 60 basis points from where they were earlier this year. But on the positive side, our asset returns are very strong. If I had a crystal ball and if we tell you where we are today, it is going to be actually a tailwind for 2017, so not a headwind for us on that front. Again, we will have more color in January depending on where discount rates end up and how asset returns finish up for the year, but at this stage it is going to be a tailwind for us.

Benoit Poirier

Very good color, Nadeem. Thank you.

Nadeem Velani

Thanks Benoit.

Operator

The next question is from Jason Seidl from Cowen & Company.

Jason Seidl

Thank you, operator and congratulations to both of you with a new roles.

I wanted to get back to Keith on the pricing front. You mentioned probably at the low-end of your historical range at 3%. Given the market, do you feel this is going to be a bottom especially on some of your truck competitive traffic should we look at 2017 to be potentially stronger on the pricing side?

Keith Creel

I do think it has bottomed out. Obviously, we've got to wait and see how strong the market is. I don't know exactly where to put the pin but I would think it is fair to say I think it is bottom. The 3% [indiscernible] that see strength of the economy.

Jason Seidl

Okay. That is fair enough. Just also a clarification, I think you guys I think, Nadeem, you were talking about 4Q. Was that expectations for flat revenue and volume, did I hear that correct?

Nadeem Velani

Yes. That is correct, flattish revenue and volume, that is correct, on an RTM basis.

Jason Seidl

On an RTM basis. Fantastic. Gentlemen, thank you for the time as always.

Keith Creel

Thank you. Take care.

Operator

The next question is from Keith Schoonmaker from Morningstar.

Keith Schoonmaker

Yes. Thanks. A quick follow-up on the gap between intermodal unit growth versus RTM growth. You mentioned on domestic that this was from the expanded cross-border traffic into Chicago. But could you elaborate a bit on the 16% RTM growth in international with flattish carloads there? Thank you.

Keith Creel

Yes. We are growing over Vancouver both export and import with our existing customers which is longer length to haul. It drives more RTM.

Keith Schoonmaker

Vancouver into the Midwest, is that correct?

Keith Creel

Yes, Midwest and Eastern Canada as well both Chicago market, Montreal, Toronto.

Keith Schoonmaker

Is that a major win or simply just growing with existing?

Keith Creel

Yes. It is existing shipping lines, leveraging our service and growing in their marketplace which obviously benefits us.

Keith Schoonmaker

And one more, has it grown markedly because of the failure of Hanjin or is this just secular growth?

Keith Creel

It is excluding Hanjin. Hanjin has really had no impact at all to us so maybe that is upside for us, all of that still has got to shake out. We are partnered with Hyundai, which obviously is another Korean carrier but at this point we see no material change or benefit plus or minus from the Hanjin situation given the minimal revenue we've inputted.

Keith Schoonmaker

Right. Okay, thanks very much.

Keith Creel

Thank you.

Hunter Harrison

Let me add something about something to be careful of and watch. It is not something that necessarily the industry is proud of but our RTMs when you are looking at RTMs from an intermodal standpoint, they are not a real good reflection of actual RTMs because a lot of those trailers and containers we don't actually give weights on them. They are estimated weights estimated by the customer and so when you look at an RTM for a container as opposed to a boxcar, the accuracy leaves something to be desired there.

Operator

The next question is from Bascome Majors from Susquehanna.

Bascome Majors

Thanks. Let me reiterate the congratulations for Nadeem and Maeghan here.

Just wanted to clarify a bit on your comments earlier about the buyback and the cash flow priorities. Can you confirm from a repurchase standpoint, are you going to continue to repurchase shares with cash flow and just not add debt to do it? Or will you be starting to diverge that cash flow to actively deleverage in addition to doing so by growing EBITDA?

Nadeem Velani

Bascome, our NCIB was started back in May of this year. What I have said is it wouldn't be our recommendation at this point to upsize. We worked hard to get our credit rating to an investment grade. We have built up some leverage above our natural comfort zone of 2x to 2.5x. We are going to generate a lot of cash over the next several months. We will delever closer to 2.7. As we generate additional cash we will probably get closer to the 2 to 2.5 range is where we would like to be.

Again to Hunter's point, it is going to be dependent somewhat on the intrinsic value and where we see opportunities to maximize our use of free cash and do the right thing for shareholders. We are not saying that we are not going to buy back shares. We do think we are still in that growth cycle; we are still the fastest EPS grower were in the industry. And we are not signaling anything there differently. So I would just say that be patient. We are not changing our philosophy on returning cash to shareholders whatsoever. We are just going to make sure we do it in the most prudent manner.

Bascome Majors

Understood.

Nadeem Velani

Thanks Bas.

Operator

Next question is from Brian Konigsberg from Vertical Research Partners.

Brian Konigsberg

Hi, good afternoon. Thanks for taking the question.

Coming back to some of the very early comments, Hunter, you initially talked about the grain market when you are saying things have been delayed, you think part of it is obviously the weather but also some actual market weakness or softness as well. Can you just provide a little additional color around that and Keith maybe how you are incorporating that into the confidence level you talked about?

Hunter Harrison

I think if you go back that we have done and spend a lot of time on and analyze the supply chain, the pipeline or whatever and you say why are some of the problems created? One of the things you will find is here we are sitting now with record levels if you believe the market and I want to be able to believe because if you are not dealing with facts, you can't be accurate, that there is a bumper crop out there. But it is not moving. We've got assets in place. We've got people in place. There is expenses associated with those and the excuse is of the pipeline and we are all part of it is well, there is some weather.

Well, look, I think if you look at the world markets and what people are paying for grain if that price went up and I'm not an expert on that and I don't follow it daily but it is a little soft and if it gets better they would figure out a way to get the grain out of the field and get it to market.

What happens to the inefficiency is when you sit here every day we sit is a missed opportunity to move grain. If the market breaks loose and the price goes up and the weather dries up, then everybody is going to want to move the grain at the same time. Now we are going into the holidays and we've got Thanksgiving in the U.S. and we've got Christmas in both countries and we've got shutdowns and then we wake up in January and somebody says -- oh the grain is not moving.

So I think as we really look at the facts and Keith and company have spent a lot of time with the grain traits and customers and there has been an overall, a cooperative effort and I think this situation is improving. And I think all of us to some degree, reputationally, there is much more appreciation maybe for what is being done this year than maybe there was to go back to Keith's point, in 2012. So what I'm saying is the price of grain worldwide has impacts on the pipeline in Canada and people sometimes don't make the connection.

Keith Creel

The only thing I would add, Hunter is speaking exactly to the message on motivation to move the grain, pricing capacity and what we are losing by not shipping the peak capacity earlier than we have. As I said last week, we did hit peak capacity. We've got to make sure that the supply chain is going to be able to sustain at and barring some atrocious winter and I am assuming, I am taking Canada at their word and I'm taking the consensus the grain company some are higher, some are lower. But in general it is north of 70, which is more the grain than we moved last year. I wouldn't say I'm bullish but I'm confident that the grain is going to be there to move and land is going to dry out, the supply chain is going to succeed. I know that to Hunter's point, the grain companies would work closely with some of them are more progressive than others, some of the bigger players in the industry have invested hundreds of millions of dollars to improve throughput capacity on the West Coast. Extremely proud to the partnered with those folks.

Our dedicated trains, which were I think very innovative in the industry and innovative in Canada are sold out as well as in the U.S. So again, I don't have a crystal ball, but I am taking Canada at their word and I am taking the grain companies and their word. They are putting money where their mouth is and I am expecting a nice harvest and I am expecting the supply chain to sustain and this new partnership to work well for us and I think we will move record amounts of grain in this shipment year again versus last year.

Brian Konigsberg

Great, that is helpful. If I could just add one follow on. Nadeem, just on the share count, so you did buy back another slug of stock but I would have thought that your share count would have ended lower. Was that just a case of being weighted toward the end of the quarter? And I guess on that point, maybe you could provide where the shares ended Q3 at?

Nadeem Velani

Yes. We ended at 146.3. So it is just timing in terms of the purchase. We utilize a grid that basically tries to maximize how much, buying at the right price, so we will accelerate it when it is lower, the stock had moved up, it pulled back and so forth. So some timing of purchases changes we were probably more aggressive earlier in the quarter. We ended up 146.3.

Brian Konigsberg

Got it. Thanks.

Nadeem Velani

Thanks Brian.

Operator

The last question is from David Tyerman from Cormark.

David Tyerman

Yes. Good morning. Just a quick question on CapEx. In 2016, it looks like so far you are running a little above the $1.1 billion. So is that still the number for the year and any thoughts for next year preliminary?

Nadeem Velani

Yes, we had one project that was a higher level than we anticipated and effectively we are going to be at 1.2 this year. Just a little bit more color in the MD&A as well. I would say that as Keith described, 1.1 to 1.2 is where we see things currently over the next several years. It can be somewhat dependent on currency of course, a stronger U.S. dollar does hurt CapEx -- our CapEx spend. So outside of any dramatic changes there or any volatility there, 1.1 to 1.2 is fair number for us.

David Tyerman

Okay, thanks. And congratulations Nadeem and the same to you, Maeghan.

Nadeem Velani

Thanks David.

Operator

I will now turn the call over to Hunter Harrison.

Hunter Harrison

Thanks Mike. I was sitting here reflecting as I was listening to this dialogue, and I think it is worth spending just a moment to reflect back when some of us walked in here this team four years ago and what we found and what we said and what has happened. And I think it gives some indication of what you can maybe expect in the future. But as I went out in the field and visited with customers first of all, I was advised not to do that because I might be assassinated.

But one of -- there were three things that were issues. One, we clearly had to get the cost under control. And we were at that point somewhere around an 81% operating ratio. That was some weather reflected bad year but normalized at so it was 78 or whatever it was.

We were getting horrible criticism about grain handling and what we were costing the farmer in Canada. And reflections that our service was just atrocious and our service was bad, but the problem was even when it was brought to our attention, the recovery time to fix those problems was almost unbearable from the customer standpoint. Well, today -- and at that point we said here is what we are going to do.

Here is what we are going to try to accomplish and it met with a lot of skepticism from the markets and from a lot of you. And rightfully so. But the cost has come down from 80, thereabouts, and now we are debating about God forbid mid-50s and at that time, people couldn't even spell 6 much less 5. So cost doesn't appear to be an issue.

Keith as he has talked on the call a good deal and the team on the grain side have turned the situation around. I think it is safe to say that from wearing a black hat, they have taken a leadership role in moving of grain in Canada which we are all internally very proud of.

I think the third thing that we had to improve and the one that I was concerned would we get there in my tenure here? And that was trip lengths and that was service. And as Keith indicated to you earlier in the call, we are there. It is implemented even beyond my level of expectations and they are pretty high. We had a couple of days last week that we were over the 94 level. So we don't hear things about costs, we don't hear much about grain. And I guess the proudest is I don't get as many calls from customers complaining about the service. And so those three things were probably the key in this our organization being able to improve market cap and reward shareholders and those things that you know hopefully rather than I.

So it has been a very pleasant, pleasing experience and I want to congratulate this team for those accomplishments. And the only other comment, I would have I am a little bit jealous here this morning. Everybody is congratulating Nadeem and Maeghan about their new positions. Hell, I am leaving and nobody is congratulating me. So, have a good day. Thanks.

Operator

This concludes today's conference call. You may now disconnect.

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