Q2 2019 Earnings Call
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Operator todays conference is scheduled to begin momentarily until that time your lines will again be placed on hold thank you for your patience.
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Good morning, My name is Adam and I'll be your conference operator today at this time I'd like to welcome everyone to the Canadian Pacific's second quarter 2019 conference call.
Oh slides accompanying tainted in today's call are available at www.
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Our dot C.A.
All lines have been placed on mute to prevent any background noise.
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Chris remarks, there will be a question and answer session.
If youd like to ask a question simply press Star then the number one on your telephone keypad and if he would like to withdraw your question press the pound key.
I'd now like to introduce Megan Alison a VP investor relations and pensions to begin the conference.
Go ahead.
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Good morning, everyone and thank you for joining us today.
Before we begin I want to remind you that this presentation contains.
Looking information and 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 Mdna, that's filed with Canadian and Us regulators.
This presentation also contains non-GAAP measures, which are outlined on slide three.
With me here today is Keith Creel, our President and Chief Executive Officer, Nadeem, Velani Executive Vice President and Chief Financial Officer, and Jon Burke Executive Vice President and Chief Marketing Officer. The formal remarks today will be followed by Q in may and in the interest of time, we'd appreciate if you limit your questions to two.
It's now my pleasure to introduce Mr., Keith Creel. Thanks Megan.
Good morning.
Listen the team in our streamlined proud to sit here. This morning represent our 13000 strong CP family.
We get to share and discuss the record setting quarter for this company.
Ross a record setting and it's a mix of record second quarter Records are all time Records records for revenue.
EPS all time record for workload on GTN is on the network train length Records train weight Records locomotive productivity Records.
Fuel efficiency records and most importantly.
Quarterly safety record when it comes to you know we had a very challenging first quarter to bounce back the way this company's bounced back.
To regain the momentum that sets us apart from the Industrys most specifically.
And our train accident ratio the way, we run the railway safely everyday.
Speaks to the commitment.
Into the potential that this company represents.
An all time record as well on personal injuries for the company. So certainly.
The culture when it comes to safety is strong and getting stronger certainly we're extremely extremely focused on and proud of.
No this kind of performance demonstrates what a mature precision scheduled railroading.
Company around by the best team of Railroaders industry can produce.
That said, we talk about the records something even more encouraging.
Because this pursuit of operational excellence is something that I call. It a journey, it's not a destination.
Maintaining a constant.
Pursued a constant constructive tension in the organization even in the face of record volumes when we're focused on making sure that we keep our assets.
Right sized at the peak.
To accommodate and to allow for any kind of softening or muted demand that we might face as well as our normal seasonal demands that.
Come down in July this team is doing that.
Within that quarter, taking out locomotives and taken out headcount that's associated with those locomotives reducing us.
Down almost 10% and our locomotive fleet alone.
So with that being said.
The quarter was not without its challenges we talk about the things that went well I can tell you. This quarter, we faced unprecedented pressures from the Mississippi River much like our class one partners when I say pressures the pressures did not let up the duration of the floods that we experienced this year.
40, 50 years, if you go back through history.
You are going to be hard pressed to find anything that was that prolonged in the impact to this railway in their team I tell you.
The men and women that run this railroad day in and day out are inspiring they battled the floodwaters that kept the railroad open as long as they possibly could yes, we had to re routes and trained yes. We had some additional operating expense tied to a little bit of capital expense tied to it in some foregone revenue.
But for us to be able to sustain that kind of pressure and bounced back the way. We did again speaks to the test with the strength this team.
Switching over to the commercial side.
I'll tell you we continue to make progress that's encouraging as well we laid out a plan at our Investor day in October .
We told the market, we told our shareholders, we told our investors that we have.
A unique set of opportunities that weve worked hard.
The set up we accrued created the capacity and developed a strategic plan that converted in the marketplace and that is what's fueling this pace of growth that is unprecedented in the industry and a time a leader demand across the macro economy.
We call it sell felt we call it unique opportunities that allow us to be counter to what the balance of the industry is experiencing and thats what youre seeing in these results.
You read about our press release during the quarter of Yang Ming.
That's one commercial success that John will talk about the specifics of and yes, we're super excited about the partnership.
And absolutely excited about the revenue and what it's going to do driving earnings and growth in.
2020, and beyond but from an operational perspective, I'm equally as excited because what it allows this company to continue to reduce setting its self apart from our competition.
Setting a new standard for service in our partnership that specific what I call. The third leg of the alliance.
Which is hapag Lloyd Ocean network experience and now will be in 2020, Yang Ming allows us to continue to.
Fine tune and create an industry best service that will get you.
From Shanghai to Chicago with the lowest owned dog dwell time that can't be matched by our competition.
Whether its us west coast or other Canadian alternatives into the Midwest markets with our fastest transit time and our shortest routes.
And our reliable capacity at something Thats compelling in the marketplace and it's something that we'll continue to make a strong difference in our operational ability to continue to drive margins.
And operational excellence within the organization.
To add benefit to that as well the problem Riyadh.
Hmm, Hyundai which is.
It's a customer that CP currently enjoys a partnership with.
They made a strategic decision as well effective spring of 2020. They are joining the aligned so that volume now currently calls on Syn term on the south shore, which CP service that volume will shift the deltaport will be handled by our partners. The GCT will be moving on the shift with the alliance, which again gives us another step incremental improvement takes out complexity.
In the terminal takes out additional cost of them and improves efficiency and velocity.
Just as a proof point, we think about this.
I would go back.
Year, and a half ago.
The share GCT Deltaport had gone down about 20%.
For CP and the balance for our competitor with this new contract that comes on line in January we're going to be about 65% to 70%.
Of the product that's being discharged on the docket GCG again, enabling that reliable service industry best service into the Midwest.
So when you think about all these things you put them together.
What does it mean, what does it mean for our customers what does it mean for our shareholders and our investors. Its a solid proof point that when we say we're going to do something we do it. It says that sustainable profitable growth is it's not just a catch phrase. It's it's woven into the DNA of how we run this business.
And when you do it and do it well.
In the live and die and breed by that principal due to say you are going to do you don't try to be everything to everyone. But those that you serve you serve the best and you deal with this kind of culture in this kind of disciplined these results are possible.
And it allows you to grow this company now and into the future and as excited as we are about 20.
19.
The opportunities that John and the team put together for 2020 in 2021 from an investor standpoint.
We certainly expect not only in 19 to meet our guidance, but to carry strength and momentum in the 2020 in 2021 as well.
That's going to bode well for anybody to invest in this company as well as our employees as well as our customers the perfect trifecta.
So with that I'm going to turn it over to John to provide some more color on on the commercial side and after they deem covers the financial performance then we'll open it up for questions.
Alright.
Thank you Keith and good morning, everyone.
So total revenues were up 13% this quarter to 2 billion with six out of our nine lines of business being up double digits in revenue.
Our teams are up 6% FX was a tailwind of 2% and fuel was flat.
On the pricing side as expected, we continue to land in that 3% to 4% range.
Now taking a closer look at our second quarter revenue performance on the next slide.
Ill speak to the results on a currency adjusted basis.
So as Keith spoke to it was an extremely strong quarter for the bulk portfolio grain was up 11% Canadian grain and grain products delivered a record second quarter up double digits.
And both April and May were a record month for volume and from a tonnage perspective. This was the third biggest quarter of all time for CP and grain.
Feeding in Canada is now complete and as of right now, we expect new crop to be in line with the past couple of years.
Additionally.
We project Carryout stocks to be normal, but certainly more heavily weighted on the canola side.
All this to say, we expect there to be good volumes of grain to move this fall.
As a reminder, the new regulated grain pricing for CP, taking effect on August Onest, we will be 3.7%.
But in contrast, us grain volumes were down double digits as the PGW export market continues to be challenged due to the lingering trade dispute with China.
We are watching us grain markets closely, though because with the flooding and tough growing conditions that have emerge across the central and eastern us actually this might present, a pretty good opportunity for CP grains into these areas that are expected to be short production.
Moving on to the coal business as a result of maintenance outages at both Port and mine Canadian coal volumes decreased this quarter.
However, in spite of the supply chain challenges in Canada, we actually saw fairly strong movements of thermal coal in the us and our revenues were up 5%.
The demand environment for met coal remains strong and we continue to expect a strong back half of the year.
On the potash front Q2 was an all time record quarter for volume and revenue as strength in our export potash outweighed weakness on the domestic side.
That weakness being the result of flooding and again poor weather conditions in the upper Midwest of the United States.
But in spite of it.
The weakness on the domestic side and certainly some tough comps we have coming into the second half of the year on potash with strong global demand and it's still a very healthy pricing environment.
We expect the opportunity for upside as we move into the second half of the year.
On the merchandise front, the energy chemical and plastic portfolio had another strong quarter with revenue growth of 22%.
The growth included another strong quarter of Lpgs plastics refine products all moving on our energy train in Vancouver.
Excluding crude Sep volumes were up 9% and revenues grew three or 13%.
On the crude by rail as expected we came in at around 25000, carloads or approximately 160000 barrels per day.
As production curtailments began to ease in the fundamentals begin to improve.
Although crude by rail remains variable, we expect volumes will continue to increase as production and curtailment balanced stabilizes and our new contracts and existing customers continue to ramp up the second half of the year.
And the MMC volumes declined 9%.
Largely driven by our Frac sand, however, revenues were only down 2%.
Consistent with what I've spoken about a number of times in the past we are executing a surgical strategy to re hone our frac sand from the Permian basin to the Bakken This market diversity yields higher revenue per carload single line haul efficiencies and improved margins.
We currently have two unit train facilities in service and we are adding a third unit train facility in this region by the end of the year.
In automotive.
Certainly despite a weak north American demand environment.
CP revenues were up 12% on the quarter, we continue to see success, driven by Globus and the opening and ramp up of our Vancouver auto compound that we've spoken about.
As a reminder, this is only a portion of the global business with the full contract coming online.
To us in 2020.
This combined with continued growth at Vancouver give us confidence in this sector well into next year.
And finally on the intermodal side of the business overall revenues were up 11%.
Both domestic and international volumes were up low double digits.
In fact, despite some softening in the retail sector domestic revenues were a record in Q2.
On the international side of the business, we continue to excel in the market and execute our playbook.
Most recently I'm very pleased that CP was named best logistics provider in rail at the Asian freight logistics and supply chain Awards in Hong Kong.
And further as Keith mentioned preparations are well underway with Yang Ming for our 2020 onboarding of their volumes.
Which will move through GCP deltaport, leveraging our capacity not only at the port of Vancouver, but also at our capacity at our inland terminals across our network.
We're also excited as Yang Ming around.
Taking full advantage of our fastest routes into Chicago Toronto in Minneapolis.
So look I am I am extremely pleased with the efforts of the team.
The sales and marketing team in collaboration with the operating team to deliver this quarter.
So while theres no doubt theres theres uncertainty in the macro environment and some softness in some of our lines of business.
Between the combination of our strong bulk franchise, coupled with new business that is moving now and new business that will be starting up in 2020.
I have a high degree of confidence that we will continue to deliver the growth that outpaced the industry.
The CPG team is focused and we are collaborating with our customers to create efficiencies.
And convert opportunities in the marketplace with that I'll pass it over to the name.
Thanks, John and good morning, as Keith noted this was a strong quarter by virtually any measure.
When we reported in April I was encouraged by how the volume and operating trends were recovering from a challenging quarter challenging winter.
Those trends continued throughout the quarter and led to strong revenue growth John detailed as well as very strong cost control. The end result was a Q2 operating ratio decreased 580 basis points to second quarter or 58.4%.
Ignoring the impact at last year's Labor disruptions had on the award in Q2, we still saw an improvement of 440 basis points year over year.
Adjusting for land sales depreciation and stock based comp we saw incremental margins of about 90%.
Taking a closer look at a few items on the expense side as usual I'll be speaking of the result on an exchange adjusted basis.
Comp and benefits was up 8% or $28 million versus last year.
The primary drivers of the increase were increased stock based compensation of $20 million, resulting from the higher share price as well as higher head count.
Fuel expense was flat year over year is increased volumes were offset by decrease price and record Q2 fuel efficiency of 0.93 gallons per thousand gpms.
Materials and equipment rent expense were both flat year over year.
As expected depreciation was $183 million an increase of 5%.
Purchased services was $265 million, a decrease of $23 million or 8% primary driver behind the decrease was a land sale of $17 million, which we guided to on our Q1 call.
Decrease rolling stock costs and other operating efficiencies was a further tailwind. Additionally, the casualty line under purchase services reverted back to historical levels.
Rounding out the income statement adjusted income increased by 33% and adjusted EPS grew 36%.
Below the line them note that there was an 88 million dollar income tax recovery related to changes in the Alberta corporate tax rate. This benefit was excluded from normalized earnings and we'll have a negligible impact to our 2019 effective tax rate.
As the benefits are phased in over the four years, we will start seeing more meaningful benefits to our effective tax rate.
Turning to the next slide our leverage in the quarter came in at 2.4 times adjusted net debt to adjusted.
EBITDA within our target range of two to 2.5 times.
In may we repaid our debt maturities, which we refinanced early in March.
With the strong operating performance and growth the last two years worked our way back into our target leverage range.
While capex increase sequentially given Windsor flooding in network investments, we will keep our capital spending within our guidance of $1.6 billion.
Continue to take a balanced approach to shareholder returns in May we meaningfully increased our dividend by 26, 7.5%. This marked the fourth straight year, we have raised our dividend as we gradually move towards our targeted payout ratio of 25% to 30%.
On the share buyback front.
As of the end of Q2, we have completed nearly 70% of our current share repurchase program at an average cost of roughly 270 to $272 per share.
We will remain opportunistic and disciplined in our deployment of capital.
Combining this discipline with our strong operating performance, we delivered in ROI see of 16.8% for the last 12 months.
This will undoubtedly be the strongest.
Our royalty in the entire industry, which is a tremendous achievement by the CTP team.
The railroad is operating as well as about as I've ever seen it and our team of Railroaders is getting stronger and deeper each day.
We continue to watch the demand environment closely and should the macro environment change, we will continue to adapt our cost base quickly.
As Keith mentioned, we are confident in our full year guidance expects to deliver another set of strong results. When we speak again in October .
With that I'll turn it back to Keith the Rep to wrap things up.
Thanks, David and John No just to wrap up looking for Deb.
Lots, we've made about our tough comps in the back half of the year.
The tough comps or what happened when a company performance.
We're realists, we are going to stay humble we're going to stay focused we understand that the man environment is not without its challenges.
But you can be rest assured this team's going to be focused disciplined and committed and confident to delivering our guidance for the year.
These results are a testament to the power of our operating model and CPC ability to execute operationally financially and commercially all at the same time.
That being said, let's open it up for questions.
Thanks.
Certainly if you would like to ask a question. Please press star one on your telephone keypad and if he would like to withdraw your question press the pound key as previously highlighted please limit your questions to two there will be a brief pause, while we compile the Q and a roster.
And your first question comes from Chris Wetherbee of Citi. Chris Your line is open.
Hey, Thanks, good morning, guys.
Good morning.
Maybe wanted just to pick up on that comment about the second half and the comps that you guys see if you could talk a little bit about some of the key commodity groups you feel most confident about in terms of maintaining the mid single digit.
RPM growth as you've faced some of those tougher comps and if there is some sort of demand sluggishness, maybe what are the areas, where potentially you could see that kind of flow through just kind of curious about what your outlook is there on the volume side.
Chris I can start off this is John .
You know look we turned in a really strong Q2 in the bulk side of the business and I see that tailwind continuing I'm as I mentioned.
You know, we're kind of in the grain trade off a little bit right now in July , but I expect upside as we move through the quarter in the grain.
You know the potash demand environment continues to be.
Strong we're certainly some some weakness in the domestic side, but we think that picks up through the quarter and the export side continues to be very strong.
Hi Tech is a it for the most part sold out Q through Q3.
So we'll continue to see some some tailwind there.
You know our year over year comps as it results to international intermodal, we still have a I think some some upside as I look through Q3 in that space are sorta. Despite some of the challenge that others are are facing we haven't seen the blank failings with our with our customers in that area.
So I'm I'm positive on all that space I think you know we've we've out matched the industry on the auto sector here now for the second straight quarter, and frankly, I think that trend continues as we move in to Q3 also and then.
On the crude side and yes, it's it's a variable in there there's certainly some moving parts that need to be worked out here, but.
The contracts are in place and we're actually I think more optimistic today than we have in that that these issues are going to get resolved and there could be significant upside in crude by rail.
Okay. Okay, that's very helpful on down.
Last quarter to deem I think you were pretty constructive about your potential for the award in the second half of the year, even facing a more challenging comps than you had here.
In Twoq.
Could you speak a little bit to sort of how you're feeling after getting the second quarter done obviously really strong performance you mentioned very high incremental margins. It doesn't appear that there is anything sort of blocking that as we move into the back half of the year, but if you could put some color around that would be great.
Let me let me set this up for Canadian were still convicted Chris but over to you they do.
Yes, I think Chris I mean, we're doing what we say we're going to do in terms of as Keith noted that's that's a.
You know our conviction comes from that comes comes from a network that's running as we mentioned as good as we've ever seen that it comes from that what's in our day in DNA of strong cost control and.
You know not to not getting low than a false sense of confidence, but but in times like this where where you see oh.
Bit of softness you can start putting assets aside for proactively.
And the only adding resources, where necessary so same level of conviction in the back half.
Yes, we have some tough comps, but we feel very good about what we can do from a cost control point of view and those incremental margins.
Well it will add to the bottom line.
Yeah, that's the fundamental demands Chris that that drove the preferred to second half of last year exist.
The second half of this year with even more pent up demand so to speak in an ability for us to execute.
Given our investments.
You know I think about the Green fleet alone are we talking about investing in our Hopper fleet efficiencies, we get from that we'll just start to begin to realize it would operate capital efficiencies meaning.
Fear about orders, meaning more velocity with the fleet, meaning I don't need as many cars that moving the same or more green with fewer cars were looking at doing things with our potash fleet to to respond to surging demand our record demand with our customer and partner in Canpotex run a 200 car potash trains to Vancouver, and even to a point we're testing with you Pete over Portland, We ran 188 car train just recently, so we're going to continue to push the envelope.
Squeezing what we can't have our assets.
To do more with less all within the monitor precision scheduled railroading is we continue to deliver service and as we do that cost come down capacity increases velocity improves.
It's just a different space, they operate and with with the same or better demand.
In the second half you should expect better performance, which is exactly what this team is focused on produce.
Helpful color. Thanks for the time appreciate it.
Thanks, Chris.
Your next question comes from Walter Spracklin of RBC capital markets. Please go ahead.
Thanks, so much good morning, everyone.
I guess coming back to to keep your your comments about how you know how much more improved.
You know the handling is the complexity is improved I look back at your just eyeballing. The last few years going from second quarter to third quarter Youve done anywhere from.
We'll see some are railroading and Canada is a lot easier and you've done anything from 200 to 600 basis points quarter sequential.
You know you talked about 100 basis points on the year is something that you generally target but.
Gosh everything looking at it here given.
The item as Keith you mentioned it suggests that you could be well above the 100 to 200 that.
Improvement year over year on the or and then when we go into the next year.
With with Yang Ming coming in in the end the lower complexity of everything consolidating Deltaport again. My question I guess is where are we beyond the 100 to 200 that we've typically come to expect an operating ratio improvement on an annual basis.
Walter I Love your optimism in your belief in the model.
Part of this the art of the possible you.
We exceeded our expectations they have in the past, but you're talking about quantum leap.
In areas that we made quantum leap and it's just hard to keep setting a world record mild redoing. It every year.
So we're going to continue to improve.
We're going to sweat our assets there are puts and takes and we're going to drive in spite of.
The headwinds that we face in these areas, where we're going to get incremental margin improvement for the next several years given the business that I see laying on the railroad and.
You could say there is some conservatism in our guidance, we feel we need to be responsible and guide to what we feel confident that we will be able to deliver but at the same time I don't want to be over exuberant and.
And mislead and create.
Bar, so high that we disappoint, that's I don't want to de motivate my team either so rest assured you got a team here you've got a leader in a leadership team that will push this envelope in a responsible constructive way.
And we expect and we hope to exceed your expectations, but I can't tell you that.
I see 200 basis points of opportunity given all the moving parts that we see out there and all the things that may or may not happen with winter.
Good I make a case, where everything goes our way euphoric case, I'd love to be able to control that I can't say I've got to be reasonable and I've got to be responsible in what my guidance is and I see.
Confidently ability to get that kind of basis points, but I'm not willing to extend this to the two not yet I want I want to wait and make it happen instead of.
I assume thats going to happen I, just don't think that's responsible way to handle it well.
The stock based comps.
It's probably the biggest headwind in terms of so it's a first class problem and certainly something that our shareholders will complain about in terms of that headwind but.
That adds a bit of a challenge when when when looking at year over year.
Fair enough I appreciate that and going now down to the EPS level I know your longer term double your double digit for the should long term double digit double digit obviously, a very specific wide range consensus is moving up now into that mid teen.
Mid might you know after this go into the mid to high teen are you comfortable that kind of progression I mean, you did 36% in the second quarter.
You know if you are you comfortable with that trend as you demonstrated very strong second quarter results that the that expectations go up into that mid teen mid to high teen range.
I'd Echo what what Keith as.
Conveyed on the ore side.
I think it's fair to.
We want to be able to to deliver on what we are committed to we've kind of.
You know talked about the double digit low double digit type of range.
You know call it conservative or what have you.
Just mindful of the things we can't control.
Which is a you know things that these countries curtailments and if the stock continues to run that could be a headwind then and if you have some sort of weather disruption in December or what have you. So so we're mindful that there is still a long ways to go.
We're confident in our ability to.
To grow double digits.
I don't want to get into that to the weeds of what level of double digit. So I'll just leave it at that sure. Okay. Appreciate it great quarter guys.
Thank you.
Your next question comes from fighting Shimon CMO.
Please go ahead.
Good morning, Thank you.
John You could you you mentioned pricing in the 3% to 4% range.
Is this pricing kind of broad based so you're seeing the strength across all the segments.
I'm, particularly curious about the intermodal market the domestic intermodal markets, we are seeing some.
Eating in the freight demand environment, I guess and.
So Keith if you can speak to that please.
Yeah.
You know fatty so at items was you actually were talking earlier. This morning, I was I'm quite pleased with the discipline. The team has been able to show in the results were producing on the pricing front really now going over the last year quarter by quarter.
So we we landed in that upper end of that range again, and as I look at the renewals pushing into into Q3, I think I feel pretty confident that we're going to be able to sustain that.
Certainly as you called out Theres some areas where.
There's some weakness or little more challenges than others.
We have seen.
As you said some weakness in the domestic sector.
Particular retail.
Type business that being said the pricing is held in there also pretty decent maybe towards the lower end.
All of that range specific for that area.
I would also just call out.
Particularly for Q2, we we did see some pretty positive mix.
Point point and a half in that base it had to do.
With some of our less of our longer haul crudes, we have some shorter haul crude that that took place that impacted that and then frankly, just some of our new business pricing has been has been quite strong that we brought on this year.
Okay great.
Great color. Thanks.
The second question I had is the I mean do you are you feel Verde a positive obviously about the.
Opportunity to grow well into 2020, and then I've got a few few a new business awards.
The two have already communicated.
Is the is the Capex outlook.
A kind of.
Continuing to be in the $1.6 billion range into a 2020 do you see that creeping up and as it related to that maybe to nadeam. The free cash flow conversion like net income to free cash flow conversion has been just about 55% I think on average for the last few years can you talk about kind of the leverage that you have to kind of improve that as we move into the next two to three years.
I understand there's some improvement in the margin obviously, but is there anything else maybe on the Capex side that is unique that you can highlight that could help improve cash flow performance. Thanks.
Okay thought if I can I'll take yeah.
Take the capital question I'll, let nadeem expand on the free cash flow so.
When it comes to our capital on below the Answer's no creeping along the same discipline in running the railway its the same disciplined approach on.
Managing capital so as we talk about the formula what's the art of the possible how do you get sustainable low cost growth.
You create capacity you sell to the strength of your network you selling universe capacity you have it when you sign up new customers to grow the book revenue you're in lock step with.
The capacity or the capital that's required to create that capacity to be able to deliver the business because if you don't.
Jeopardize the entire operating model success across every line of business. So the business that we signed up for 20 and 2021.
The assets, we need being a locomotive being.
Remodeled remanufactured, the surgical citing here siding there.
CTC here, they're CTC their inspection truck care inspection truck there all that's in the plan. It's all baked into the plan. So you will not see a big swing and our capital envelope as we bring on this additional business in 20 and 21 and in fact after 21, you'll start to see our need for capital based on what we see today taking into account the growth.
Actually the diminishing come down not go up.
Right and and perfect segue to my second question there crowded.
Well, we did where we invested.
Where we continue invest the opportunities right now on the covered hoppers on locomotive modernization, what we did with with Aeolus yard and and we will do in a in Minneapolis as well to to support our service to support our growth agenda.
Those things start tailing off and I think the the next leg of the story is going to be a very positive one from a from a free cash.
Conversion point of view so.
If you look in that once we get past the investment in the covered hoppers.
In that 2022 kind of timeframe.
You'll start seeing.
Free cash conversion in more in the 75% to 80% kind of levels and so I think that that is something that's somewhat overlooked.
I think thats going to be a very impactful story to TCP and what we can deliver so.
I think you're right you're right on in terms of what we can achieve and where where theres next opportunity. So.
Thank you I appreciate the color and great quarter. Thanks.
Excuse me.
Your next question comes from Allison Landry of Credit Suisse. Please go ahead.
Good morning. Thanks.
I just want to go back to that to the question on the RCM guide and asking a little bit of a different way, but if I'm.
Just doing the math to get to call it four or 5% for the full year I mean, basically on a sequential basis second half our T.N. needs to increase somewhere in the low double digit range versus the first off that's a much bigger sequential increase then leaves really seen historically, so maybe putting the tough year over year comps decide how can we think about the sequential ramp in our T. ends in Q3 and Q4, maybe based on the the commodities that you talked about earlier and your response to I think Chris asked the question, Yeah, potash grain crude et cetera.
I mean, Allison we're up 2.7%.
Year to date already.
I don't think we need double digits to get to mid single digit so.
No question only about not year over year.
So.
[noise] sequentially right because the back the tough comps in the back half so I'd point out to John's comments on the strengthen in bulk areas like potash.
You're going to see a ramp up in crude which is going to support a strong sequential RCM growth. So you're going to see a pickup in tech coal I mean, the coal itself month today, we're talking about some of the softness we see.
The growth we experienced in the second quarter Allison was in spite of actually shipping less coal due to some supply chain challenges, it's not a demand issue. It's just working out some noise in the supply chain, which is working itself out we're realizing in the third quarter. We have ship month to date more than we did.
Last year, so all those things.
You know with the three three and a half percentage year to date number the second half.
Sequentially do you can you can be at it a little bit north of the mid single digit and you're going to come to the math that we're coming to then it's not hard to get there.
Okay, all right. So it sounds like you guys are pretty confident there Keith I think in your prepared remarks, you talked about the you know basically hitting a record for workload in terms of Gtlds on the network, where where do you think you are from a capacity or resource standpoint, obviously that they really strong incrementals in Q2, it seems like the networks in great shape, but if volumes and workload gross per se you know at what point might you need to layer back in some resources specifically on the headcount side. Thank you.
Well the only the only place that we're not capacity constrained were capacity contain we're trying to be unlocked staff as locomotives. I mean, we said that all along we've got more than adequate track capacity terminal capacity, we made some strategic investments in Calgary that we'll realize.
This year through the fourth quarter, we just.
Converted what was an old hump yard into a very productive switching yard or we didnt finish that until first week of January so we have any realized.
The benefit of that in the fourth quarter, but again locomotives that said we're training we're hiring in lockstep with our demand to make sure we've got the running.
Running trades employees ready to pool and operate the locomotives and we're bringing the locomotives online as we re manufacture them in lock step with the demand as well. So the game is not to be long on assets. We've got the right things the right parts moving in the pipeline to be just on spot with assets when it comes to track and terminals.
Oh, we're not there at all and in fact our capacity.
Our flexibility our ability that.
To handle surges is drastically improved we've got more capacity than we've ever had in partnership with GCT at Deltaport are southshore is working extremely well we are hitting records with with our green partners, they're creating capacity it demonstrates the flutie the network, we're talking about record volumes.
We put more stress on this network than has ever been put on this network in its history and its 138 year history in year over year, we increased train speed by 5%.
That just tells you there's resiliency in this network and if you're an investor you don't need to get worried about this company getting into a trap, we're playing a catch up capital game, we're overcommitting, it's a surgical.
Execution of the strategic plan, we developed two years ago in lockstep in partnership with our customers protecting our customer service protecting our investors Trust and our employees Trust. That's what we're doing day in and day out and Thats why we have so much conviction and confidence in our guidance.
Great. Thank you guys.
Thank you.
And your next question comes from Ken Hoexter of Bank of America Merrill Lynch. Please go ahead.
Hey, Greg Good morning, and congrats on a solid quarter, Keith and team just the employees. How do you think about the trends as you grow in Riyadh costs should it stay mid low to mid single digits with volumes and your thoughts on the impact to the DLR with with the employee base.
Yes on the employee base like this year.
Yes, so youll digit RCM is 1% to 2% head count we're up a little bit right now with capital work you did speak that have come down sequentially and will be that 1% to 2% on a mid single digit rtms and best way to gauge, where we were kind of pre hiring and getting our people up in.
Anticipation of the crude contract the Alberta government started here in July so we've we've kind of pre hired for that.
So that was already in the in the cost base as we speak.
So.
Steve You are ahead on employees then because of it.
Yes.
Okay and then my second one is on the crude by rail just given what you were just highlighting that theme on the on the Alberta as commitment that shifted that potential. So I know that wasn't in your commitment for volumes, but maybe talk about what you expect to be the outcome or what you're seeing so far when negotiations and where do you see crude by rail volumes trending going forward.
Yeah. So I you know what I'm pleased with the progression of those discussions with the Alberta government Ken.
We're seeing a good expression of interest from a number of shippers in terms of.
Commercializing if that's right term that capacity.
There's efforts are underway with with the major producers and the government to try to find a workable solution you probably read about it and I'm sure.
Around.
The production levels matching.
Curtailment and if they can prove that thats going into a railcar.
They would get that sort of equal relief.
So those discussions are ongoing my guess is probably.
You know at least another couple of months, maybe more of a Q4 story of in terms of resolution and getting ramped up but all that being said.
We did about 25000 carloads.
In in Q2, I can see that jumping up to 30000 carloads with the potential for upside as we as we look at Q3.
So we've got a fairly steady ramp up.
Of us that's coming on line as we move forward here.
I think the only thing I'd add 10 is listen this is a space where a realist it's been volatile it's been unpredictable.
But I would agree with John .
You know I'm cautiously optimistic and I see.
The parts moving in a favorable direction for a favorable resolution I mean, the fundamentals are we've got a lot more all being produced in pipeline capacity to take it away and there is a demand forward in the market.
We just got to work through this and we'll continue to work in lockstep with the government.
To get this to get this issue resolved and I think you'll see.
Fourth quarter.
Some robust demand, it's going to be in the marketplace, which which will represent some of the upside if all of the things.
Workforce and all the things line up right and mother Nature's good to us than.
There is a bit of optimism in the fourth quarter.
But all those things have to happen, but again, there's more fours lining up going against as far as trying to get this resolved in the crude space.
Great. Thanks for the time guys.
Okay.
And your next question comes from Tom Wadewitz of EUV, Yes, Tom. Thanks go ahead.
Hi, Yes, good morning, and congratulations on the strong execution in the quarter.
Wanted to ask you if you could give me kind of a high level frame, perhaps John or Keith on share gains this year and how you might I don't know if share gains right term, but new new business, let's say and what the revenue contribution is if you kind of put it together for this year.
Or maybe at a high level and how we think about that in 2020 whether that.
Revenue contribution from new business would be.
Larger or similar or just kind of you know some high level frame on it.
On the new business impact.
Well I think it's it's a good indication of Tom why you see what we've been able to do in Q2 and our confidence as we look into Q3 and in Q4 you know.
We've got we've added dollars Grandma, we've built an auto compound.
We've we've seen significant upside with with K plus S. As they continue to ramp up.
Potash the bulk.
Remained strong that albeit not new but I think we're performing well in terms of our share in those spaces also we've talked and I have talked quite a bit about wanting to further develop and grow our transload business I can tell you we've had quite a bit of success.
As you look at in the eastern markets.
With with refined fuels business growing strong through trans load.
Our Hamilton steel facility has has grown double digits in terms of that throughput.
You start, adding all those things up I just I just looked the other day, we've added about $35 million of annualized new business with our short line partners. So far this year.
So that's sort of low hanging fruit that that's been out there for quite some time and you put a little focus to it and that sort of singles and doubles started add not.
So I think those are some of the things that are that are helping propel us today and as I look into next year and in 2020 of course, you got the Yang Ming and the further auto opportunities that we've spoken about.
As Globus has an even fully ramped up yet.
You get the G. Three terminal opening up next year and we've got a project for refined fuels with Suncor that we've spoken about publicly that'll that'll start up next year.
And again you got.
We forget about this business, but CAPL assesses a is really ramped up well and you know they expect another big step function of growth as we look into 2020.
You start putting all that in into a blender and it becomes pretty compelling story.
Well, let me ask you a little bit there. So just do you think it's a bigger impact this year in terms of the revenue contribution from new business or.
Bigger impact this year the next year or is it kind of similar next year or how would you just frame the magnitude.
I think it frames a magnitude of mid single digit.
Our team growth and double digit earnings.
Competence, Tom that's probably the best way to summarize it.
Oh, okay.
Okay. Thanks.
Yeah, and then I guess the second one just on keep can you add a little more to your comment on Hyundai when times and what that means that they are changing and is there kind of.
New business for you on the volume side with Hyundai or that's primarily efficiency or just maybe build a little bit more on your comment that you started at the beginning of the call.
Yes, I think it's I think it's both I think its growth in volume for Hyundai I think that.
It's also efficiencies and I'll say this and explain it. So there is served its interim through all the consolidation.
Or the shipping industry over the last several years, where they landed.
With their partners.
They were benefited they haven't realized the same cost synergies that some of the competitors have and although we have Paul.
All other business out of Vancouver, the size of the pie has been reduced because they've been at a cost disadvantage.
Oh, so move forward to 2020.
They sign up with the alliance, they're enjoying industry best service.
They're going to enjoy industry best cost they won't be at a disadvantage anymore and we firmly believe that is a result of the cost advantage in the service improvements they are going to grow in the marketplace and when their ships get fuller than our trains get fuller.
So its a quality revenue problem.
Our opportunity for us and at the same time anytime we can take complexity out of precision scared railroad you minimize the moving parts the remaining parts move faster the dwell.
On the dock is going to be lower the trains are going to discharge.
Larger in on time, we're frequently it allows me to minimum assets faster my crew costs are going to be optimized my.
My equipment cost could be optimized my velocity is going to be optimized decrease capacity and it just hits you across every business unit incrementally because it's moving in some of our highest density.
Corridors. So it's a positive positive positive then I guess just as excited operationally is not only does it allow us to enjoy the benefit now it allows us to sustain constant improvement as we go forward and as we become better Railroaders and as we get better.
Through our investments into our execution not executing operating model day in and day out it's a win win not just for intermodal.
But for CP and for all of our business lines that go through Vancouver, given it's such a key gorder for this railway.
Okay, great. Thank you.
Thank you Tom.
And your next question comes from Scott Group of Wolfe Research. Please go ahead.
Hey, Thanks, good morning, guys.
Got anything.
No. It didn't wanted to ask a follow up on the guidance do you think that we maintain double digit earnings growth in third and fourth quarter.
Yes, I didn't hear the last part in what.
Do you think we maintained double digit earnings growth in third and fourth quarter I understand full year, and we don't want to get into the double digit for strong double digits I'm, just trying to isolate second half of the year.
I certainly expect that.
That's fair representation in Q3 Q4, it may be a little bit difficult im not going to give you quarterly guidance.
On the T.S., but.
Looking at.
What Q4 was a it was an all time record.
EPS number for the company.
Okay that makes sense and then.
Keith.
I don't know if im a little early to ask this but but I think that the 10 year Tech contract comes up next year. It's the first time sort of this management team has an opportunity to take a look at that contract do you think there's big opportunities either from an operating or pricing or just a lot. So sophocles opportunities with that contract since it's been 10 years.
[noise] comes up in 2021, so you are a little bit early Scott, but rest assured it's not something that we're not thinking about.
Listen here's the strategy at this company, it's our objective.
To become integral into the companies that we partner with their success because when they do well, we do well we want to be part of their supply chains were part of the reason that tech is able to enjoy.
Reliability in the supply chain low cost producer and win market share and rural markets were part of the Formula So as long as we continue to play that role we continue to be good.
Supply chain partners, we originate the coal.
We have access.
Two.
Neptune access to west shore.
We're going to continue to be.
A key player strategic player in create compelling value. This is going to be hard to walk away. So when you talk about huge opportunities to me the opportunity is to strengthen the partnership and help them grow when the market space quantum leap.
In productivity listen, we're always going to push.
To make things better and if we can knock out some of that noise I'm, making the supply chain more reliability in partnership with the terminals at the coast as well as in partnership with the terminals that load the cold and we do our part of the middle than yes, theres opportunities.
But as far as quantum leaps no as far as improving and protecting that revenue stream and helping them succeed in the world marketplace. I think we're very confident in our ability to be able to do that.
And that's what gives us confidence that that Goshen, Dave we just.
We just got to make sense.
When you make sense in your part of what helped the company succeed in the marketplace, it's hard to walk away from that.
Okay, great. Thanks for the time guys.
Thank you thanks.
And your next question comes from Brian Ossenbeck.
Hi, JP Morgan.
Please go ahead.
Hey, good morning, Thanks for taking my question.
John I, just wanted to come back to your comment on.
The mix kind of it's been been strong this quarter a couple of points as you mentioned I can just elaborate little bit on what was driving that sound like crude was a was a significant source, but also maybe a mix of new business. So if you could elaborate on what do you expect to maintain that that's sort of quick in the back half of the year and how much of that is reliant on continued ramp up in crude.
Yes, so I, we definitely saw less long haul crude Kansas city more shorter haul over some of our western gateways and noise that had a material impact.
Now some of the new business in the crude by rail space that we brought on has also come on as I mentioned that at at very strong pricing levels.
Though I look at it like this Brian as I look at Q3, and Q4, I think that moderates I am not sure we see that that that mix tailwind like we had in Q2 at some of this other longer haul crude ramps back up.
Okay. So Kurt is the biggest yes. It is.
Okay. It is yes.
And just another question for you John on the Canadian Hills, the mandates now.
Got it and effective June 2021, little bit later than expected I think youve typically referred to that is sort of upside outside of the guidance, but now it's been.
Delayed a bit even past the 2020 outlook.
Do you think actually having that in place will create any sort of.
Yeah shift as people start to get ready for that and maybe assess with it actually means for the business better than we had had something approved.
So the side or is it still too early to think about any impact from that thank you know I think having that certainty in the marketplace now.
Is is good.
No. We've we expect it to be somewhat of a.
Capacity sort of crunch driver when it when it is applied in now that we know sort of a locked in dade. We can have those frank discussions on when we get into the renewals and and what our pricing looks like between now and then and with the expectation that.
When the LDS do do come about how thats going to change and impact to the marketplace. So.
All in all I think putting a line in the sand now and having clarity actually that that's sort of helping us out.
Okay. Thank you very much.
All right.
Your next question comes from Seldon Clarke Deutsche Bank. Please go ahead.
Hey, guys. Thanks for the question I'm, just getting back to the outlook for margins in the back half of this year you call that incremental margin of 90% in the quarter.
Which as well on your longer term.
Uh huh.
No it wasn't us.
Oh I'm sorry.
Yes.
Restate that if you can get walk down a little bit somehow.
I apologize so just wanted to ask about the outlook for margins in the back half of the year and a little bit of a different way you called out incrementals of 90% in the quarter, which is obviously well above your kind of longer term range is 65% and you know you talked about pre hiring employees and you had some tailwinds from mix in the quarter. So just kind of given all those moving pieces, how should we think about your core incremental margins in the back half of the year.
Yes, I mean, when we guide to incremental margins, we've talked about that 70% to 75% level, we're comfortable with that I mean quarter quarter could it change could be a little bit lower in a little bit higher yes, somewhat dependent on the mix of business as well and and just how things are operating so I think.
On the whole were still confident with that 70% to 75%.
Okay, even with some of the headwinds from the pre hiring in the second quarter, you still expect that to kind of step down and there's enough there were enough.
Positives to get that up to 90.
I mean, yes, if you take out the pre hiring it would have been closer to 100%.
So that that pre hiring was done in Q2 that that was in the numbers, we just reported right.
Right, Yeah, that's kind of what I was asking why let's step back down again or just.
Well again it depends on on the.
Quarter over quarter, there's there's other costs and other things that that vary between quarter to quarter right. So.
You know if you hit 100% one quarter doesn't mean, it's going to be that favorable forever. So that's why we guide on a full year basis not quarterly.
Got it Okay, and then just kind of a longer term question on all our just given everything that's going on in the industry as well as the PSR it feels like the.
Theoretical floor that management teams are willing to put out there as have the high fiftys for all our.
But just given like what you guys have done the last several quarters and you know I think around margins that 90% range and you know your core and core margin at 70, 75%. What do you think the ultimate Flores for rail ours over the next several years.
Well I'd say via some you know Rob.
I'm going to speak to what I've got good line of sight to on what I know and.
Obviously, I can't control at all and some things could.
We have a little shorter bid or actually overachieved, but I see an ability.
Annually to improve with our business mix and the growth that we're going to.
To bring online with cheer him with partnerships.
Organic and inorganic growth.
A point of year for the next two to three years, so I see this.
Good one annually from sub six the art of the possible.
Mid fiftys.
Okay. That's really helpful. I appreciate the time.
Thank you.
And your next question comes from Ben Wyatt Carr Yang from two Chardan capital. Please go ahead.
Yes, thank you very much and congratulations for the good quarter.
John just in terms of forest product, obviously, a very good performance when we look at the revenues up 8%.
It seem a big discrepancy versus the industry could you maybe talk about what are the key drivers a year and in terms of forest products and what you see kind of a four in the second half.
Yeah, you know, what we've actually seen quite a bit of a success than in two areas. One is.
Our pulp business has been quite strong.
So thats sort of a derivative of our growth and in our international business that has allowed us to to grow the pulp business for export back out of Canada.
So we've seen good success in that space and then in our team has been focused really on asset utilization of our Centerbeam fleet. So you know the the lumber market has has no doubt been challenged but I think weve targeted into the marketplaces that that we do see sustainable business and then really focused on asset utilization with our partners into those marketplaces.
There is no doubt as I look into Q3 and Q4, there's going to be some headwinds in that space certainly we get the sawmill curtailments that are somewhat ongoing.
In in BC. The good thing is that has less impact on us and frankly, because a big part of our network in the west is trans load origin Transload.
It gives us.
We've actually got a little bit of insulation from some of that impact.
So I I do expect that Q3 and in Q4 in the in the forest products space will certainly be more challenged on the in the lumber space.
But we will see little we're certainly going to try to sustain it as we look at it into our pulp business.
Okay, that's great color and maybe a high level question for four key when we look at the strength of the Canadian dollar obviously right now at 130 still in line with the guidance Youre assumption for the year. So no material impact on the bottom line, but does it influence the way some of your customers think about their business strategy and is there a certain level where the Canadian companies.
Could become let's say.
Having more difficulty or more competitive issues a key.
Well I mean, it's the same fundamental that exists.
A lower Canadian dollar generally.
It's going to favor the Canadian producer because it gives them a little bit of advantage reach in the marketplace on exports as long as that is there.
I don't see a whole lot of change you know if the Canadian dollar were to get.
Remarkably stronger then could you see an impact maybe.
But I, just don't see that as a possibility or probability in the immediate future.
Okay, Okay, perfect Thats, great color. Thanks for the time.
Given the off take care.
And your next question comes from having Shanker Morgan Stanley . Please go ahead.
Oh, Thanks morning, everyone.
I know a lot of focus on crude by rail in the near term, but if I were to ask you a longer term question in terms of the conversations you're having to customers and the constant delays you are seeing in new pipeline projects is this still viewed as a like a three year opportunity or are you, having constructive conversations for longer term contracts and seamless volumes extend beyond that initial window.
Well I'll, let John add color you'd like to Ravi, but discussions when this all started that would have been two to three years is based on pipelines that.
Those expectations have been far mess.
There is so much uncertainty with the pipelines with three to four to five year discussion as possible. So I think.
It extends to tell a bit I still believe the pipelines will be built they there's too much of a critical need there's just a lot of noise in a lot of hoops in obstacles to get through but they will calm so.
There was a bit of a tail to our two to three when we started this thing, but it's not going to be a forever tail.
Which I continue to remind John and in the commercial team, we're making 30 40 years asset decisions at this company.
Certainly not that kind of tail.
And we're not going over extend.
Our capital over extended.
Our company based on a four or five year opportunity on a 30 or 40 year decision.
Yes, Robbie Keefe Bang on we you know our discussions just frankly with the producers. These contract lengths are lining up in a three to five year range.
Got it.
And kind of where do you kind of mentioned that long term outlook I think youre. Your pure is maybe looking at some growth opportunities beyond just the core railroad business, Yeah Board acquisitions, and such can you just give us an update on the award to your M&A pipeline or non renewed growth pipeline looks like and if there's any potential activity there.
Yes, the shortest update is given our opportunities our own unique story CP, we're not interested.
In pursuing a strategy to buy trucking companies were Railroaders, we're going to continue to play to our core strength does that mean that we won't look at partnerships does that mean that we won't take strategic steps to make sure that our customers have a level playing field and continue to win market share based on the strength of our service.
We will do that but as far as mine trucking companies, we're not in the market.
Understood. Thank you.
Thank you Greg.
And we have no further questions at this time, so I will turn the call back over to Mr., Keith Creel for closing remarks.
Okay, well to wrap this up I want to thank everyone for their time. This morning for your interest and for our shareholders. Thank you for your trust and your vote of confidence.
We've had a phenomenal quarter, it's behind US now it's in it's in the past we're looking forward working.
Focused on our convictions to make sure that we continue to meet or exceed.
Our customers expectations, the second half of this year as well as our shareholders.
So with that being said, we look forward to.
The share in our third quarter results later in the year.
Thank you.
And this does conclude today's conference call you may now disconnect.