Genesee & Wyoming, Inc. (NYSE:GWR) Q4 2017 Earnings Conference Call February 8, 2018 11:00 AM ET
Matt Walsh - Executive Vice President, Global Corporate Development
Jack Hellmann - President and Chief Executive Officer
T. J. Gallagher - Chief Financial Officer
David Brown - Chief Operating Officer
Michael Miller - Chief Commercial Officer
Chris Wetherbee - Citigroup
Allison Landry - Credit Suisse
Bascome Majors - Susquehanna
Justin Long - Stephens
Jason Seidl - Cowen
Scott Group - Wolfe Research
Ken Hoexter - Merrill Lynch
Brian Ossenbeck - JPMorgan
Ladies and gentlemen, thank you for standing by. And welcome to the Fourth Quarter 2017 Earnings Conference Call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time [Operator Instructions]. As a reminder, this conference is being recorded.
I would now like to turn the conference over to your host, Matt Walsh. Please go ahead.
Thank you for joining us today on Genesee & Wyoming's Q4 2017 earnings call. Please note that we will be referring to a slide presentation during today's call. The slides are posted on the Investors page of our Web site, www.gwrr.com. Reconciliations of non-GAAP measures disclosed on this conference call to the most directly comparable GAAP financial measure are likewise posted on the Investors page of our Web site.
We will start with a Safe Harbor statement and then proceed with the call. Some of the statements we will make during this call, which represent our expectations or beliefs concerning future events, are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, which provides a Safe Harbor for such statements.
Our use of words such as estimate, anticipate, plan, believe, could, expect, targeting, budgeting, or similar expressions are intended to identify these statements and are subject to a number of risks, uncertainties and other factors that could cause actual results to differ materially from our current expectations, including but not limited to, factors we will discuss later and the factors set forth in our filings with the Securities and Exchange Commission.
Please refer to our SEC filings for a more detailed discussion of forward-looking statements and the risks and uncertainties of such statements. We cannot assure you that the forward-looking statements we make will be realized. We do not undertake and expressly disclaim any duty to update any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by law, and you should recognize that this information is only accurate as of today's date.
On the call today, we have four speakers: our President and CEO, Jack Hellmann; our Chief Financial Officer, T. J. Gallagher; our Chief Operating Officer, David Brown; and our Chief Commercial Officer, Michael Miller.
I will now turn the call over to our President and CEO, Jack Hellmann.
Thank you, Matt. And welcome to G&W's earnings call for the fourth quarter of 2017. As always, we'll start our call this morning with safety. On slide number three, you'll see that G&W completed 2017 with a safety index of 0.83 injuries per 200,000 man-hours. Our safety results flipped in the fourth quarter of 2017 and as a result, we're disappointed to relinquish our position as the rail industry safety leader for the first time in nine years.
Keep in mind that each of the injuries embedded in our safety statistics as an incident that has negatively affected the colleagues’ well being and we have no greater priority than to get our people home safely after each shift. As we enter 2018, where we are doubling safety initiatives at all of our railers, terminals and trucking operations and expect to regain our leadership position in the coming year.
Now turning to slide number four. In the fourth quarter of 2017, we reported diluted EPS of $6.81 and adjusted diluted EPS of $0.77. As shown on the table, we had a number of items impacting the quarter, including $372 million tax benefit in the United States, resulting from the tax reform there and $9 million benefit in the UK from a negotiated buyout of the deferred consideration associated with the 2015 Freightliner acquisition. Adjusting for these and other smaller items, we reported $0.77 of adjusted diluted EPS compared with our outlook of $0.75.
Looking at the bottom of slide number four, you'll see the components of our Q4 variance versus the guidance. At a high level, revenues in North America, Australia and UK/Europe, were consistent with our outlook with any variances related to the mix of business and/or operating cost.
In North America, other than weather-dependent commodities, such as coal and agricultural products, our Q4 carloads were stable and core rates were up approximately 3.5%.
Our income was about a penny lower than plan due to higher claims expense. In Australia, we were right on plan, supported by higher spot coal tonnages, despite Glencore industrial action issues in their new South Wales coal mines, which have now been resolved. In the UK/Europe segment, our adjusted income was $0.04 behind plan for two reasons; the first was the mix of lower rated contracted revenue versus spot revenue in our intermodal operations; second, with an unusual number of service failures that resulted in higher maintenance expense and that were penalty fees. Overall, the business outlooks for both bulk and intermodal rail in the UK has improved significantly and our focus is on operational execution.
Now, I'd like to turn the call over to our CFO, T. J. Gallagher, to discuss the fourth quarter in detail and then I will return to speak to our 2018 outlook. T.J?
T. J. Gallagher
Thanks, Jack, and good morning, everyone. Turning to slide five and result. Our adjusted diluted EPS were $0.07 lower than last year, but recall we had $0.10 from a take or pay contract in Q4 2016. Excluding this take or pay contract, our earnings were up roughly $0.03 per share, which is described in the table at bottom of the slide. First, North America is down roughly $0.02. In summary, higher operating expenses, primarily fuel and claims, more than offset strong freight pricing. UK/Europe was approximately $0.07 higher than last year due to Pentalver and the UK operational restructuring that improved performance.
Finally, there were a number of other items, primarily the impact of the share offering in December 2016, which totaled negative $0.02.
Now, let's get into the details of each segment, starting with North America on slide six. Fourth quarter revenues decreased $2 million or about 1%. Excluding the $10 million take or pay contract and acquisitions, same railroad revenues increased 1% as stronger minerals and stone, pulp and paper and chemicals and plastics revenues, were partially offset by lower coal revenue.
Now, moving to carloads on slide seven. Our North American same railroad traffic was down 3.2%, primarily due to lower coal and agricultural product shipments. Coal shipments were down primarily due to lower shipments in the Midwest. Q4 2016 was a tough comp for us and in Q4 2017 we had a mild early winter weather. The decrease in agricultural products is largely due to the drought in South Dakota, as well as and one large competition in our Midwest region. Other significant negative variances include lower scrap metal traffic, primarily in the Southeast U.S., lower petroleum products traffic in the western U.S. and chemicals and plastics, which was impacted by lower ethanol shipments.
Significant positive variances were minerals and stone, pulp and paper and lumber and forest products. Our minerals and stone traffic benefited from stronger aggregates and frac sand. Pulp and paper volumes increased due to increased container board traffic in multiple regions with the strong peak season last quarter and traffic moving from truck to rail. Finally, lumber and forest products traffic was higher, primarily due to strong finished lumber business in the West Coast.
Now moving to slide 8 and pricing. Our same railroad North American core price increase in the fourth quarter was around 3.5%, which was a little better than expectations. The table on the slide bridges this core price increase to our reported average revenues per carload increase of 5.7%. As you can see on the slide, we had favorable changes in customer mix, primary in coal and agricultural products, commodity mix, as well as higher fuel surcharges and a stronger Canadian dollar.
Now, let's turn to slide nine and North American adjusted operating income. Adjusted operating income, excluding currency was down $12 million, primarily due to the recognition of the take or pay shortfall in Q4 2016. Excluding the take or pay, operating income was down $2 million. And the big picture here is that the incremental margins from our revenue growth was more than offset by higher net fuel cost due to the lag in fuel surcharge recovery and higher incidents and claims expense.
Now, let's turn to Australia on slide 10. Australia revenues increased in Q4 of $14.1 million or 23.1%, primarily due to GRail-related revenues. Same railroad revenues increased $2.5 million due to the stronger Australian dollar and higher metallic ores revenues.
Now slide 11, Australia adjusted operating income increased $8.5 million, excluding currency, primarily due to the GRail acquisition, stronger metallic ores, and stronger agricultural products.
Now the UK/ European operations on slide 12. Revenues increased $42.9 million in the fourth quarter or 32.3%. Excluding FX and the Pentalver acquisition, same railroad revenues decreased $5.4 million as growth from the UK intermodal, and aggregates in Poland and the UK was offset by the ERS restructuring.
Now slide 13. UK/ European adjusted operating income increased $5.1 million year-over-year, excluding FX, and our same railroad adjusted operating income increased $3.3 million. The increase in operating income is primarily the result of the UK operational restructuring.
Now, I'll give the call back to Jack for an overview of our 2018 guidance. I'll then follow with the details.
Let me refer you to our earlier Safe Harbor statement that noted that these statements are subject to a variety of factors that could cause actual results to differ from our current expectations. These statements represent management's expectations regarding future results as of today, February 8, 2018, and we do not undertake any obligation to update this information. Jack?
Okay. So turning to our outlook for 2018. On a consolidated basis, we’re expecting pretax income growth over 10% and adjusted diluted EPS growth over 30%. The higher growth rate in EPS is primarily due to U.S. corporate tax reform, which reduced our consolidated book tax rate to approximately 27%.
Now turning to cash flow, which is significantly higher than net income at G&W. In 2018, we expect adjusted free cash flow attributable to G&W to grow over 25% to $350 million and adjusted free cash flow attributable to G&W before new business and grants to grow over 35% to $370 million. Please note that these adjusted free cash flow numbers include an allocation of the cash flow of our Australia operations to our 49% joint venture partner in Australia. In other words, the adjusted free cash flow numbers that I just referenced are the amount 100% economically owned by G&W and therefore provide a measure of cash that could be available for our discretionary purposes.
Assuming no acquisitions or major investments and that our free cash flow is used to repay debt, we project net adjusted debt to adjusted EBITDA of 2.25 times at the G&W parent level at year-end 2018. In North America, in 2018, we see a favorable outlook for freight shipments with the exception of coal and agricultural products, which are more weather dependent and we expect to benefit from a tightening truck market and higher diesel fuel prices. Note that we recently completed our J.D. Power Customer Satisfaction Survey with an overall score of 7.98 out of 10, the best score we've received since we started the survey 10 years ago. So we believe we’re well positioned to add market share from our customers.
In 2018, we're targeting North American revenue growth of 4% and adjusted operating income growth around 7%, which we think should be supported by good macro fundamentals. Finally, North America, I should highlight that we should maintain strong bipartisan supports for an extension to short line tax credit. Included in the comprehensive set of bill that emerged last night is a one year extension of the short line tax credit retroactive to 2017. If passed by the house and signed by the President, the impact to G&W would be a tax benefit of roughly $0.45 per share recorded in 2018 earnings.
If the bill passes, our efforts will then be on extending the tax credit for a longer period or making it permanent, so that certainty is consistent with our planning for long-term infrastructure investments; potential opportunities for longer-term extension and clearly the expected federal infrastructure bill and possibly other bills that have tax elements in them. In Australia 2018 where we have a controlling 51% G&W Australia with Macquarie Infrastructure owning 49%, our outlook is for modest growth but we see a strong new business pipeline. For example, we are investing in new coal wagons to support our growing spot coal tonnages in New South Wales, with the added expense of new hires in the first half of the year and the revenue benefit from this incremental capacity flowing through the second half of 2018.
Meanwhile, one of our iron ore mine customers in South Australia stopped shipments in October 2017 in order to develop a significant expansion project should have a more clear view of future shipment levels later in 2018. Finally, we are adding to our Australian overhead expense in 2018 in order to enhance our commercial capabilities and better position ourselves for several other new projects that could come online in 2019 and thereafter, including the longer term increase in coal tonnages associated with our GRail acquisition that we expect to start in 2021.
In the UK/Europe segment in 2018, our outlook is steadily improving across the business. In rail, container flows from ports to our inland terminals have regained more consistent fluidity. We are wining new bulk customers and we are positioning ourselves for growth and infrastructure project work. In addition, we continue to gain traction and cross selling rail, terminal and road services. Finally, we see opportunities for further cost reductions and operating efficiencies. Overall, the UK business climate is good and our focus is on operational execution.
Outside the UK, our Polish business is stable and ERS has been restrictured to a profitable core franchise. In financial terms for the UK/Europe segment, we are targeting revenue growth of 21% or 5% same rail road growth, excluding currency. Adjusted operating income is expected to increase 21% in 2018, but the growth rate in adjusted operating income is actually closer to 64% on an apples-to-apples basis over 2017, as a new accounting standard requires that we separate certain components of our net pension expense, which will show $9 million of pension income below the operating income line in 2018.
Finally, we continue to actively evaluate acquisitions and investments across our global footprint of railroads, and have approximately $400 million of capacity under our revolving credit facility, as well as significant free cash flow generation. One new transaction that we announced yesterday with the minority investment in a company called Cargomatic. Based in Long Beach California, Cargomatic is the technology platform they connect shippers with truck carriers with a focus on short haul markets. We see direct applications of the technology to extend our service at terminal and transload locations across G&W’s rail footprint in the U.S. and abroad.
And now, I would like to turn the call back over to T. J.
T. J. Gallagher
Now turning to slide 16 and more specific guidance for 2018. As you read through the details on the slide, note that our full year expected book tax rate is 27%, reflecting the impact of the recent U.S. tax legislation. Also, the recent change in the presentation of pension cost from the U.S. GAAP effective for 2018 has a significant impact on the results of our UK/Europe region. Although, the change in presentation is EPS neutral, it has the effect of moving operating income below the line, as Jack noted. In our case, $9 million of net earnings on UK pension assets, which have historically been recorded as contra UK labor expense, will now be shown below the line. This $9 million is shown on the slide.
Note that when we report results over the course of 2018, the 2017 amounts will be reclassified to match this new presentation requirement. Last, given the partnership in Australia, we expect to record non-controlling interest of roughly $10 million to reflect [MIRA’s] 49% ownership interest in G&W Australia. The bottom line is that we expect 2018 diluted EPS in the range of $3.70 to $3.90 with diluted shares at $63.2 million and adjusted free cash flow to G&W of $315 million, an increase of 26% year-over-year. Adjusted free cash flow to G&W before new business investments and grant funded projects is estimated to be $370 million, which is a 37% increase year-over-year.
As a side note, our cash tax rate is expected to be approximately 13% or roughly one half our book tax rate and we expect this cash tax rate to remain stable for the next five years underpinning our strong free cash flow.
Now, let’s move to slide 17 and an overview of the operating segments, starting with North America. In North America, we expect revenue growth to be around 4% and operating income growth of around 7%. The operating ratio should improved 90 basis points from 75.5% to 74.6%. We expect carload growth around 2% and core freight pricing around 3%. Although, our bottom up budget process yielded a core rate increase around 3% with the higher fuel prices and the tight truck market, we hope this is a conservative outlook. The big picture for North America is that we expect growth in most commodity groups and strong freight pricing, partially offset by lower freight related revenues that are more customer-specific including the $3 million take or pay recognition that we had in Q1 2017.
Among the key freight revenue increases our minerals and stone due to stronger aggregates in play, metals with stronger finished steel products and as well as the new customer coming online, pulp and paper with expected market share gain given the tight truck market and stronger finish lumber shipments in the specific North West with the new customer ramping up.
Now Australia on slide 18. In Australia, we expect revenue growth of approximately 7% with roughly one half of that due to FX, we also expect strong coal volumes from Glencore and highest spot traffic, following the delivery of additional coal wagons mid-year. This growth is partially offset by lower agricultural products traffic from smaller grain and cotton harvest, as well lower metallic ores revenues. Our lower metallic ores revenues outlook for 2018 is down due to the shutdown of a mine last October.
As Jack mentioned earlier, while a short term negative, this mining customer is currently raising capital to expand operations and is planning to restart production at much greater volumes than what they had been running at previously. We expect Australia operating income to be up around 3%. Partially offsetting the revenue growth are higher costs as we continue to build out the platform for future growth, as Jack noted.
Now, let’s move to UK/Europe on slide 19. In our UK/Europe region, we expect revenue growth around 21% with the majority of that growth coming from the full year impact of Pentalver, which is roughly $60 million and FX with the stronger British pound adding approximately $50 million, assuming current exchange rates. Same railroad revenues, excluding FX, increases around 5% with growth from intermodal and aggregates, as well as from new steel and aviation fuel contracts, partially offset by decline in coal.
Moving to UK/Europe operating income. The table highlights the impact of the change in the presentation of pension cost on operating income. On the same accounting presentation basis, UK/Europe adjusted operating income is expected to increase over 60% to $34 million, reflecting the full year impact of Pentalver and improvements in UK operations, which yields a total 95.5% OR. However, with the change in presentation, $9 million of operating income is moving below the line and therefore our operating income guidance for 2018 is $25 million and the OR is 96.7%. As a reminder, the change in accounting presentation for pension is EPS neutral.
Let’s move to slide 20 and CapEx. We expect our core capital to increase $80 million, primarily due to the timing of certain 2017 projects being completed in 2018.We expect a small increase in grant funded projects in 2018, and we also expect capital for new business investments to be around $40 million, which includes new coal wagons to support our spot coal business in New South Wales and expansion of our container storage terminal at the London Gateway port, as well as various track upgrades in North America to support new customers and to increase existing customer traffic.
Now slide 21, and free cash flow. We have reorganized our adjusted free cash flow calculation to simplify the presentation. Starting on the top, we have reported net income to which we had non-cash items and changes in working capital to get net cash provided by other activities. Then we subtract an allocation of the Australian cash flow to our joint venture partner MIRA. The net of these two is effectively operating cash flow economically owned by G&W. Note that the allocation to MIRA assumes that all cash flow is distributed whether or not it is actually distributed, because actual distribution may vary year-to-year.
So from the operating cash flow, we subtract core CapEx to get adjusted free cash flow to G&W before new business investments and grant projects. For the subtracting grant projects and investments, you arrive at the bottom line adjusted free cash flow to G&W. We see adjusted free cash flow to G&W growth of 26% and adjusted free cash flow before new business and grants growth of 37%.
Now let’s go to slide 22 and first quarter guidance. We expect revenues of approximately $575 million in Q1 and operating income of approximately $92 million. Net interest expense in the first quarter should be approximately $27 million and we expect D&A of approximately $71 million with an effective tax rate around 27% and diluted shares of $63 million.
The bottom line is that we are expecting first quarter diluted EPS of approximately $0.75. Keep in mind the deep seasonality of our UK/Europe business. The business is normally breakeven in Q1, and with the change of the presentation of pension costs, we expect an operating loss of $2 million for segment in the Q1.
If you move to slide 23, we have a bridge from Q1 2017 through Q1 2018, starting with the $0.53 of adjusted diluted EPS we reported last year. First, the lower U.S. tax rate increases earnings by approximately $0.13, which is partially offset by higher net interest expense. In North America, we have $0.03 decrease due to the Q1 2017 take or pay recognition, but this is offset by $0.10 increase from Freight revenue growth and operational improvements. Australia is relatively flat year-over-year in Q1, and we expect about $0.03 of higher earnings from UK/Europe.
Now, let's finish up with the balance sheet on slide 24. We ended the year with net debt to cap of 37%, net adjusted debt to adjusted EBITDA of 2.8 times and $400 million of revolver capacity. With respect to Australia leverage, Australian debt was 3.2 times at year-end 2017 and we expect that to reduce to 2.9 times by year-end 2018.
And with that, I'll open up the call for questions.
[Operator Instructions] Your first question comes from the line of Chris Wetherbee from Citigroup. Please go ahead.
I want to dig in a little bit on the UK/Europe, and just given understanding maybe you've little bit more specific what happened in the fourth quarter. And I think the projection is for turning the corner a bit on profitability in 2018, maybe some of the steps Jack you guys have taken to get comfortable with that the customer mix is right and you have the cost structure right to address the business opportunities you have there?
There continue to be -- we have a new leader in the UK/Europe who continues to make changes, and it's been headed very nicely in the right direction. The business environment is very good. And all the C change types of shifts to the organization that had to happen are complete. And so now it's all about execution and we were disappointed in -- we thought we would do better in the fourth quarter than what we did. We have some service execution problems, which were a combination of some equipment failures. And you recall in the UK network, if something trails and you delay the passenger network, it cost you a lot of money and that cost us something like $1 million in the quarter. And so that really hurt. And so that is not acceptable and is being -- so that continues to be addressed and is easily fixed.
With respect to the revenue, the revenue is a little bit trickier. Part of its correlated with fact that you have the service failures. They didn’t pick up as much volume as they otherwise would have. But in effect there, what you’ve got is contracted box revenue, which is real stable and it’s the conveyer belt of containers at a lower rate. And then you fill excess slots with spot containers.
And in this particular quarter, the skew was more towards -- its very hard to predict, which way it’s ultimately going to be, it depends on when ships arrive and the like. And so in this particular quarter, the skew was towards the contracted revenues rather than the spot move. But overall it feels -- the business feels good. I was just in London two weeks ago. And while there is still changes that we could make to run thing better, I mentioned to you, we think there is still more operational efficiencies. It’s all about execution now. The right people are in place to execute. They’re getting the right support to make it happen. And this has turned the corner.
So I think as we enter 2018, we feel like the trajectory for the businesses is solid. There is a lot happening in that UK market also on the -- in terms of some of the -- one of the incumbent has been struggling, and that’s allowing us to pick up new contracts, some of which T.J listed and more of which we are bidding on right now.
And so we're cautiously optimistic that that growth rate there is actually going to -- it is going to step up a little bit here going forward. So we feel like we're in a good spot there. And you would have liked the fourth quarter to have been a bit better, but there is nothing going on there that’s not -- that can’t be managed.
May be follow up two quick questions on the North America side of the business, incorporating was a little bit better in the quarter and the outlook for three as you go into 2018. You talked a little bit about the North American pricing environment. You don’t have as much exposure, picking up a little but you certainly have competitive exposure. So if you could talk a little bit about pricing dynamics in North America? And then in terms of the M&A dynamic within North America, obviously one of the big class ones I think is going through a pretty significant structural review. So can you talk about may be potential opportunities? I know you don’t want to get specific but just broadly, how it feels compared to maybe how it felt previous years in the U.S. specifically?
Why don’t we start with pricing and with that for that, I will turn the call over to Michael Miller. We are in somewhat of an unusual period right now and that there is some macro fundamentals that have been leaning against us quite some time now that are starting to move the right way. And so we're tentative but cautiously optimistic that we can push harder.
With regard to pricing, as we look at '18, we obviously had a good quarter in the fourth quarter with pricing. And we have a pretty good amount of our business exposed to truck competition. So as that market has tightened and as fuel prices increase, that certainly puts us in a position to get more on the price side. As T.J mentioned, we have 3% built into our 2018 forecast. We probably believe that’s a little conservative.
The only hesitation we have is some of our growth commodities in 2018 are some of our lower rated commodities. So it’s going to be a mix play in there. But clearly on the truck side, we are very close to our customers. We're seeing -- and if you look at our pulp and paper business in the fourth quarter, you saw a little uptick there and that is really driven by modal conversions. So we do feel like we’re going to see a pretty good year ahead of us with regards to pricing.
T. J. Gallagher
With respect to M&A activity, we continue to be active in multiple markets and transactions of various sizes, including some of the ones you that you’ve -- you can assume the first potential transactions announced that we’ll take a careful look and where we’re contiguous in a good fit, that's going to be -- hopefully will be more competitive. But the variety of things we’re looking at is it’s not in a dimensional but there is many things we're looking at right now.
So it’ll get you focused in one specific opportunity here?
T. J. Gallagher
No, we have stuff always moving simultaneously.
Your next question comes from the line of Allison Landry from Credit Suisse. Please go ahead.
I wanted to ask if the North American networks were impacted at all by some of the service issues that made across ones we’re seeing, whether it's related to implementation of PTC that's slowing down some of the bigger guys or the changes at CSX and even congestion at [HCN]. Just curious to know if that was a volume or cost headwind for you guys during Q4?
Why don’t we tag that from a few points to be able to try commercial and then operating point of view. So we’ll start with the Michael commercial and then Dave operational.
Allusion, I would say, we certainly felt some of that payment Q4, and we certainly felt some of it early in this first quarter. Some of it was not just what you talk about congestion PTC that was likely weather events that also impacted there. And as you know when the networks are running tight or when there is things like PTC work or construction work and a ice storm hits the Southeast, it has a ripple effect across and network.
So we’ve have clearly experienced some of that in the quarter. It certainly impacted some of our carloadings in the first month. But we believe we can call some of that back. And we're seeing consistent improvement across the network. So hopefully as we come out of winter, we’ll see the network running relatively fluid.
Do you want to comment in our customer survey, in addition to G&W scoring at a historically high level, it was interesting because the Class 1 railroads scored as the highest they’ve ever scored in the last decade that we've been doing it. Do you want to make any observations on that? It was a bit of a surprise to us given what was going on more broadly in the rail.
Yes, the survey has been going on for the last 10 years, and it typically hits around early fall right before peak season. So you get a flavor of what the customer feels and sees in the network. And quite honestly, the scores were as best we've seen in 10 years. So we felt pretty good about it. We felt what we've experienced in December and January was just the combination of things, whether volume peak PTC, and those things will pass.
We think all the Class 1s are working to get their service products up. And obviously with the volume outlook for '18, we're going to need good fluidity through the network to capitalize on it.
That's very interesting…
Dave, do you want to add anything -- we're not all in one room. We spread out here. Dave, do you want to add anything operationally?
No, I think Michael covered it very well. I would just add that ours local operating teams are generally very nimble around service variation. So that combined with the fact that we do have very good working relationships with inter-chain partners, particularly the Class 1s, it gives us capability to adapt pretty quickly to these variations, whether it’d be weather or PTC implementation or some others structural or organizational change on one of the Class 1s, we get adapt quickly.
Just as my follow question, in terms of -- and this is sort of more modeling, but in terms of the assumption for the share counts to increase in '18 versus where it was in Q4. Could you remind us if how much you left on your buyback authorization or if it was completed?
T. J. Gallagher
The buyback authorization that was I believe September of 2015, we've not executed any of that.
So that was 10 million shares. Is that correct?
T. J. Gallagher
That’s not what we thought about, I don’t even –
Yes, $300 million…
And so presumably that’s not incorporated into the guidance?
T. J. Gallagher
Do you think that if you weigh all the options from an M&A standpoint, and I don’t know maybe this is a question on the valuation levels that you’re getting for potential deals. How are you thinking about transaction versus buybacks and the returns?
T. J. Gallagher
That’s a totally fair good question. That options has to be on the table given whatever we look at, even when there is interesting acquisition opportunities. When you look at the attributed free cash generation of this business, when you do the math on these numbers and you see that the core business is growing up $5 a share of cash earnings, you have to take a careful look at that as a good alternative in terms of being free cash -- being free cash accretive to the business.
We're not looking at it right at this movement, because we’re seeing a lot of interest things that where we think we can create incremental value that could potentially do better than that. But your point is well taken as a serious consideration.
Your next question comes from the line of Bascome Majors from Susquehanna. Please go ahead.
Your commodity mix differences relative to the larger rails really worked against you on the top line front in 2017. And if we look at your guidance for the first quarter with respect to volumes, and North America down 1% up 2%, it kind suggest that that makes tailwinds probably with you in a very near-term here. When you guys think about the pacing of the year, when do you think some of these mix differences could shift in G&W’s favor? And what commodities or timeline should we look at to drive that shift?
Bascome, if you look at the biggest difference this year for G&W versus -- and again we’re posting on North America versus the Class 1, was coal and frac sand, including the intermodal, which we don’t have a significant amount of. Those are two big variables here. So from a mix shift, I think proportionally there is more ag with Class 1s than there are for us. So I think -- Michal do you want to add?
I think on the timing, Bascome, obviously, when you look at some of places we have good exposure for growth, like pulp and paper, they obviously a pretty steady line of more facilities. So we saw a nice peak in the fourth quarter, simply because of ecommerce buying. So I think we're probably backend weighted in the year where we see some significant lift. But obviously, it depends on fuel, it depends on truck capacity, it depends on truck pricing, which we all think are headed in the right direction. I think we’re just looking at Q1 as we’ll gradually walk in as the year progresses, we’ll see how stronger position we can have in those markets for growth. So there is no definitive timeline. But I do think we’re poised for nice growth in the back half of the year.
T. J. Gallagher
Bascome, let me add little more color. Probably the biggest negative carload we expect to see this year is in the other category, which is probably -- we expect to be down roughly 10%. Again, a lot of that’s overhead traffic and empties, so it's relatively low rated stuff. But from a volume standpoint, we would be probably close to 2.5% despite less empty traffic moving over our network, so that's a really big economic driver. The other one that we see down this year is petroleum products, and that's really more due to a single customer in Canada. And by enlarge we see pretty good growth across most of our commodity groups.
Michael, do you want to speak a little bit to what we're doing with some other customers in the southeast paper. And we're doing some unusual things, because we think there is a lot of traffic to be had. We're not satisfied with our current growth rate until we’re pulling out all the stops to get it up. And so do you want to walk through some…
Clearly, from a market share standpoint over the last three to five years, we’ve seen a shift from rail to truck, in the pulp and paper business. When you look at the percent of business, we’re handling out of each mill location that we serve. So we had stepped up our focus on trying to provide a higher level of customer service and more proactive approach to that. So we have embedded people to help make better decisions on moving transportation. We've deployed visibility tools to try to get better visibility of empty pipelines to give our customers the certainty they’ll have a cart to load.
So there is a lot of things we're doing. And that size under the Cargomatic announcement, things we’re doing to try to improve our technology platform, our customer service platform to make us a more viable solution in truck competitive markets where we know the service is important, visibility is important and consistency is important. So we're doing a lot there to capture business. We’re in the early innings of it. But we certainly believe there is going to be additional opportunity for us as we continue enhance that service platform.
Thank you for the comprehensive answer there, and it dovetails perfectly into the other thing I want to ask about, and that's Cargomatic. Is this a response to any particular competitive threat that you see to your business? And I guess from the [offensive] side, what part of the customer wallet does this let you capture that you are getting before? Thanks.
It's offense not defense. It's extending our supply chain further than where our track ends. So it's pretty simple in that regard. And when you think of Cargomatic, I don’t want you to think we’re suddenly thinking we can get into a venture capital investing, because that's not the case rather we see technology platform that we can help roll out and drive customer traffic across our rail internal assets.
And so Michael do you want to speak to some of the places where we’re actually looking at rolling it out first. It's an app. I mean you can think of it as like Uber for trucks and as kind of the last mile beyond our rail terminals.
You guys probably know the technology, its first-mile last-mile dray, it’s kind about application. But clearly, if you just look at it on the surface, it’s got application in our UK and Australian intermodal franchise, that’s an easy fit for us to bundle that up with our rail service or couple it with our trucking service. But really in North America what we’re looking at as how do we take and bundle it into our rail and trainload network, and simplify that multi-modal touch point for our customers and make it more seamless. Obviously, there’s shipping by rail and it has to be transloaded, you got multiple touch points there.
So our view is that we can simplify that process and streamline it for our customers. There’s opportunities to pick up additional business, make it easier for our customers to use rail and extend our reach beyond just where our rail tracks go. So for us, it’s really as much as investment is a partnership to actually drive new business to our network.
T. J. Gallagher
So the goal here is to drive value across G&W infrastructure, it’s not the investment per se in the company. Having said that, obviously, we want the equity in that business to appreciate and the success in driving it across G&W’s network by definition will enhance the value of the equity investment that we made.
And at the center, this is the customer. I think we will be very clear that anything we're trying to do on this enhanced customer service levels, whether it’s technology or people, we’re focused trying to improve our customer touch.
Your next question comes from the line of Justin Long of Stephens. Please go ahead.
Just to start may be with the follow up question on North America, I wanted to ask about the car load guidance for 2018. And can you just help us understand what’s you’re baking in for coal and ag on a year-over-year basis. I know overall you guided for 2% volume growth. But I'm curious what that number would look like if you stripped out those more weather dependent commodities and just looked at your expectations for the underlying demand environment.
We see ag relatively flat year-over-year. And that assumes a normal harvest in South Dakota and the rest of our agricultural areas.
So that’s again 5 carloads in ag. And then coal, we actually see coal improving, just a couple of percent, so in line with our overall common growth expectations. So those two commodities as we see 2018 today don’t materially change the overall consolidated North American number.
But clearly, there is a lot of risk around those two commodities, weather, currency global supply, natural gas prices. So I think our position is, we have to wait and see certainly, days for those two commodities.
And secondly, I wanted to get a little bit more color on the guidance for Australia. From a volume prospective, you're assuming a pretty substantial reversal looking at the first quarter guidance versus what's implied for the rest of the year. Could you just talk about your expectation for volume or revenue growth in coal for 2018? And on the OR in Australia, I'm also curious where you expect to exit the year once the revenue catches up to the extent ramp you're expecting in early '18?
So let me just see the carloads first. So from a carload basis, with Glencore recovering to a level that’s not impacted by industrial action like they saw last year in the new spot tons, we see around 20% increase in coal volumes. Keep in mind that where they fell -- or Glencore fell short last year, that shortfall was protected by take or pay contracts, so 20% up in coal. And in terms of the exit year run rate, it's going to -- I don’t have an exact number, but it's going to be at least 150 basis points lower. And keep in mind that Q3 and Q4 are two strongest quarters. Q1 and Q2 are weakest quarters in Australia.
So something closer to the low 70s to exit the year in Australia?
And if you get -- you got to remember, you've got a pretty big customer that's not shipping right now. And so if you get that customer and/or some of these other customers coming online, this is a business that gets back into the high 60s, it's one new piece of business away from that. We had greater than expected success in the spot coal tonnages, you’re not quite seeing it right now just because the grains off, mine is not shipping right now because it's looking to expand. And we intentionally added some overhead, which I can assure you, we don’t do lightly, that's in anticipation of being able to add further growth. But the core business can go -- it can go into the high 60s pretty comfortably.
Your next question comes from the line of Jason Seidl from Cowen.
Jack, just want to focus in a little bit on the acquisition front. Do you think at least on the rail side, there is more acquisitions here for you in North America or aboard?
As of this moment in time, talking strictly about acquisitions rather than equipment investments, definitely North America.
That’s what I figured. Also want to touch back on Cargomatic, because I've covered you for almost 20 years now, and it's a bit of an unusual investment. But I do see the desire to want to tie into the rest of the rail supply chain, and I guess this does pretty good on the transload and on the dray side for you. But I guess why Cargomatic, what drew you to them? How many companies like Cargomatic did you explore? And is this the company that actually generates any cash?
Well, why Cargomatic was, because first and foremost, our organization knows the entrepreneur -- a very successful entrepreneur that runs it and he’s well known to us. He’s smart, he’s knows what he is doing and he’s a great partner. And so when you’re making the investment in an idea, the people you’re investing are the most important thing and that's how we thought about it. So I would frame it with respect to the positive attribute to this investment and why it's a good fit for us.
But in terms of the technology, I mean there is an awful lot more that we are doing now today. For example in the G&W, if you actually looked at the G&W operating budget for North America, we've probably got extra $4 million of incremental expense layered in related to various technology projects we're doing. Couple of million of that is related to the customer, enhancing the customer experience, as well as enhancing some of the flow of operational information, which for internal use. So there is both an internal and an external component.
So I think Cargomatic is just a logical manifestation of all the ways that asset intensive businesses can be enhancing the customer experience and managing their businesses more intelligently. And whether we’re investing in our own internal capabilities, so we’re investing in a third party could speed us along as the case of Cargomatic. I think it’s just a natural evolution of the long-term role we play in the supply chain. So I think I’d leave it at that.
Jack, as you look at that evolution, if you look out a few years. Are there places where you envision Genesee & Wyoming investing in automation to help the rail space along? Because obviously people are looking at trucking on the automation side, but not a lot of people are talking about the rail side.
Notably, I mean most of -- the way I would think about some of -- our connectivity to more autonomous vehicles is going to extending our reach beyond what it is today. So most of the thing we’re looking at now are looking at physical infrastructure assets that are irreplaceable, that are economic by definition, that are logically a part of the long-term supply chain regardless of the degree of autonomy in it. And we’re looking at those capabilities that can enhance flows across that valuable physical infrastructure. And so I mean that pure and simple is how we think about it.
Your next question comes from the line of Scott Group from Wolfe Research. Please go ahead.
So just on the short line credits, can we just clarify is it retroactive for '17 only or do you get it for '18 as well? And are you hearing anything in terms of likelihood of the house, following that…
So it is retroactive to 2017. So to the extent that it was passed and signed that gets you probably end up with it -- whenever the President put his penned down, it’s the period in which it would be recognized as a onetime item. It is one year for now and for us -- so we took the probability of the house. You’ve got as good information as I do in terms of what the probability is. I think I mean the information I have this morning was it looked like it was likely, but there is some other issues on the table that are being considered at the same time. But as of this morning it look pretty likely.
So our focus then of course is all the congressional support that we have, they don’t -- and its vast. I mean its majority is in the house of senate. They know this is about U.S. infrastructure and they hate the fact that it keeps getting piece pushed year-after-year retroactively, because you can’t make long-term capital investment decisions with any degree of uncertainty unless there is something that’s in place for an extended period of time.
And therefore, the congressional push is to turn this into something that is long-term and that’s why likely places for it to end up or any kind of infrastructure bill that emerges or perhaps some other bills that emerge to the house some tax component to them. But it’s actively on the radar screen of many in Washington with respect to U.S. infrastructure policy. So I would say for now the highest probability outcome is one year followed by another hard push to find the long-term solution.
But just on clear to your answer, it’s only retroactive. You don’t get it prospectively for…
Only getting for 2017, that’s one year. It’s one year. So it will be recognized in 2018 calculated based on 2017 -- I wasn’t clear.
Back to Australia for a second. So if I think back to the Analyst Day when you guys talked about double-digit revenue growth and pretty meaningful margin improvement, I think that was after the mine shutdown it happened. So is there a step back somewhere else in Australia or is this just a timing issue of you always knew '18 was not going to be in line with the long-term guidance and you’re still confident in the long-term guidance you have laid out?
We're still very confident though, nothing has changed in Australia other than you haven't had as much of a grain harvest. And we've added some expense in order to expand the business. The long-term outlook is unchanged.
Is there a timeline for when you think that mine reopens?
Yes, in my remarks what I spoke to was with certainty in the second half of 2018, we've got equipment that's being delivered that will increase our stock hold tonnages in the second half of 2018. In addition, there are multiple projects we’re working on with that single mine being one illustration of it with which we’ll have clarity over the course of the year. And so our outlook actually is pretty good for late 2018 and into 2019 based on what we're looking at right now.
There is a lot projects out there.
And just last question. So a different version of policies questions about M&A and valuation. So just given where some global rail valuations are. How do you think about the balance of buying assets versus potentially selling assets? I am just curious your mindset is at this, Jack?
Well, I mean, I think if we ever feel that there is an asset that's more valuable to someone else than it is to us, we’ll obviously take a careful look at that. So I mean that goes without saying an effect. And then beyond that, the question is in terms of the things that we’re evaluating. We’re always in tandem given the valuation to G&W and the free cash flow generation to G&W, we’re having to carefully consider our own shares and in tandem with what other opportunities we're looking at. It's always a consideration that has to be put on the table simultaneously.
Your next question comes from the line of Ken Hoexter from Merrill Lynch.
Jack, can you talk about the asset you wrote down in Australia, and does that change your outlook on the growths potential there?
The assets in Australia are low density grain lines that -- or in South Australia, they don’t have very much that moves to over them. Basically what's happened is the collection system for grain has been consolidated, there is some super silos. And so it became increasingly illogical to be running some short haul moves to those silos, instead we're taking the long haul move from the silo. And so the free cash flow pick-up from that’s actually positive, because you no longer have to maintain that low density track. There wasn’t shipping on it anyway. And then you just consolidate with the customer efficiencies from that super silo to the port.
So it's not -- although its branch -- most of the business we had was on the mainline, most of those branch lines are marginal lines that don’t generate a ton of free cash flow, including on the Eyre Peninsula. I mean there are other lower density lines, so we have to -- only look at it and make sure it's clear and positive free cash flow on them for the long-term. Otherwise, you do what we did there on the lines there and shut it down. From our standpoint, it was a non-event because it was in conjunction with transaction that -- a long term contract that we signed with Glencore. It was just a matter of time before they consolidate all the volume to a single site, which they mount down and then that was the end of the line.
And then your thoughts on or maybe on the operating ratio in the U.S. Was this impacted by your safety or the miss steps you talked about earlier? And I guess then looking at your full year target in the low ’80, I would have -- if that’s just still not progress in Europe or what’s holding that back in terms of getting into the ’70, may be you talk a little bit about your operating ratio target.
In the case of North America, it’s in directly related to the core safety performance in the fourth quarter, basically the bulk of that $3 million to $4 million that T.J identified is hitting the insurance deductable on two derailments, that’s what it is. It’s as simple as that.
T. J. Gallagher
So in terms of pushing that OR on a consolidated basis, close to 80, really if you look at each operating segment, because it’s really best to look at the operating ratio of each segment because then you can see the drivers more clearly. But on a consolidated basis, our OR was impacted about 40 bps negatively, because of the pension accounting change, we move $9 million below the line. But then stepping back Australia Jack mentioned, we’re one contract resuming our new contract away from being closer to high 60s low 70s, that moves you down.
UK/Europe continue on its trend with the opportunities in the infrastructure space in the UK, as well as you gaining market share there, that’s going to help. And then in North America, it’s just again steady growth incremental margins. All those three things working together puts you down there.
And I guess just one more, may be a vision picture for Jack. With the Cargomatic now you got obviously we're talking about it in Europe and Poland, the safety impacts in the U.S. Does it feel like you’re getting stretched at all in terms of the different regions pulling you in different directions? Maybe just your thoughts on your ability to kind of -- all these things I think you -- whether it’s the weather in Australia and impacting the network at all.
I don’t -- the answer is no. It doesn’t feel stretched all, because we got really strong teams running every single region. In fact, I would say that we feel as strong as we felt right now in a long time. We’ve just through about 2.5 to 3 year period where we've had one thing after another. And it certainly feels like things are turning upward right now, which you can see manifest in the projections financially.
And with respect to safety, I think the takeaway there is safety is never fixed. And we're still the safest railroad in the world and we will resume that mantle in 2018, but it has to be a constant, constant commitment and focus in order to sustain at levels that we think should ultimately be zero reportable injuries. We've got dramatically improving performances across our UK business. We did have two steps back in North America, but that is readily fixable. The culture is down.
And I think the fact that we’re open about it is why here it's more -- when we have a step back when we talk about it, because without talking about it do not accountable and you don’t jump on it. And so that's why we’re so transparent about talking about it. And there is nothing intrinsically broken and there is nothing -- I don’t think. In terms of being stretched, you had a management that’s strong as it’s ever been right now. So I feel really good about where we are right now.
Appreciate the time. Thanks.
Operator, we have time for one more question.
Okay, that question comes from the line of Brian Ossenbeck from JPMorgan. Please go ahead.
So I just had a couple of quick follow-ups on Australia and then on taxes. It is helpful just kind of thinking about the one customer starting and what that might mean for margins. Are you able to do something similar with the investments in the wagons and other new projects or overhead rather that you’re bringing into the system, and able to -- some sounds like CapEx, some sounds like ongoing OpEx, where you hope to leverage later. So anything you can provide to help parse that out in terms of the effect on 2018, would be helpful?
In terms of 2018, just the macro -- the biggest macro drivers to think about are, grains down, a single mine that we’re shipping for nine months of last year is down, and filling chunk of that, a good chunk of that hole is the back half of 2018 coal tonnages from incremental investment in wagon. So in simplistic terms it’s that. And whether we make additional investments in equipment to generate additional incremental income, that is entirely possible. Whether we win new contracts that are either in our backyard on our network or elsewhere within our network, that too is also possible.
Depending on the location of where those projects take place, it will be more or less capital intensive. Off our core network in relative terms might be a little more CapEx relative to incremental cash flow. On our network typically, you have your maximum cash flow. I think that's probably covers it.
And then just a quick one for T. J. on -- you don’t get the extenders for the 45G. Is there anything meaningful coming through on the carry over credits from prior years?
T. J. Gallagher
No, we have -- given the number of unused or extra tax credits that we have on our balance sheet from prior years, the incremental credits from 45G is extended would be used in subsequent years not this year. So the passage of it wouldn’t affect this year’s book or tax book or cash taxes.
So the main point there is we got enough credits to it over the next five years, and this passage gives you another year.
I think there is not extended than with similar…
The four or five years [multiple speakers]…
Okay, that concludes. Operator, you can review the replay instructions.
Thank you. Ladies and gentlemen, this conference will be available for replay after 1:00 p.m. Eastern Time today through March 8th. You may access the AT&T Teleconference replay system at any time by dialing 1-800-475-6701 and entering the access code 439093. International participants dial 320-365-3844. Those numbers once again are 1-800-475-6701 or 320-365-3844 with the access code 439193. That does conclude your conference for today. Thank you for your participation and for using the AT&T Executive Teleconference. You may now disconnect.