Canadian Pacific Railway Ltd

TSX:CP

Earnings Call Transcript 2018-Q4

[Operator]

Good afternoon. My name is Jesse, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Canadian Pacific's Fourth Quarter 2018 Conference Call. The slides accompanying today's call are available at www.cpr.ca. [Operator Instructions]I would now like to introduce Maeghan Albiston, AVP, Investor Relations of Pensions, to begin the conference.

[Maeghan Albiston, Assistant Vice President of Investor Relations]

Thank you, Jesse. Good afternoon, everyone, and thank you for joining us today. Before we begin, I just want to remind everyone that this presentation will contain forward-looking information and that actual results may differ materially. The risks, uncertainties and other factors that could influence actual results are described on Slide 2 in our press release and in MD&A materials that are filed with Canadian and U.S. regulators. This presentation also contains non-GAAP measures, which are outlined on Slide 2 as well.With me here today is Keith Creel, our President and CEO; Nadeem Velani, Executive Vice President and Chief Financial Officer; and John Brooks, our Senior Vice President and Chief Marketing Officer. The formal remarks will be followed by Q&A. [Operator Instructions]It's now my pleasure to introduce Mr. Keith Creel.

[Keith E. Creel, President, CEO & Director]

Thanks, Maeghan, and welcome to the call today. I think it's appropriate, let me start by thanking our 13,000 strong CP family that produced the results that this leadership team has the honor to discuss with our shareholders and with our investors today.As you can see from the release, by every financial measure, literally every financial measure, this has been a record year both on a quarter basis as well as a yearly basis. Specifically for the fourth quarter revenues, $2 billion, a CP record, up 17% versus the fourth quarter of '17. A 56.5% operating ratio, an all-time quarterly record for CP. Adjusted EPS grew 41%. From an operating and [ fixed ] perspective, the results were equally impressive, we handled record GTMs, record RTMs at our network this quarter, while we continue to drive improvements across all of our key operating metrics, train feet were up 3%, terminal dwell was down 6%, fuel efficiency improved 3%, which is an industry best. And most importantly, above all else, we executed safely, driving personal injury improvement by 14% and train accident improvement, 31% versus the fourth quarter of 2017. So with that said, on a full year basis, 2018 was a best ever year for the FRA personal injuries at CP, as well as the 13th consecutive year that CP has reported the lowest train accident frequency ratio in the industry.Now, beyond the immediate financial [ pith ] of the fourth quarter, 2018 was also a very meaningful year across the organization from a sustainability standpoint. As I highlighted back in our Investor Day, for those that truly understand our CP story, it's a compelling one, we've got the service, the cost structure, the capacity to grow in a profitable and stable way. 2018 is an absolute proof point of these stats and stays. So record performance in 2018 was undeniable, an example of what our operating model can produce. We grew the top line to record levels by bringing in all new customers while we grew our existing loans without compromising our ability to provide capacity and deliver the service they deserve and that we committed. The results [indiscernible] showing low incremental cost. Put these 2 key elements together, the natural byproduct is our best ever operating ratio and record earnings. And again, from a sustainability point in 2019 and beyond, what continues to build my confidence in our CP story is again fact-based. We've got a committed team of first-class railroaders who know what it takes to execute a precision railroad model. This is a team that continues to get stronger as we challenge each other in the status quo. Rest assured, this is not a team that I'll allow to get comfortable and complacent.What we do and how we do it takes the right talent. They have to be aware of the correct way, motivated and inspired to make it happen for our shareholders, customers in the North American economy. We continue to build and deepen relationships with our 13,000 strong CP family. Most specifically, it was a busy and a very successful year in the label front. Not only ratifying our long-term deal with the TCRC Running Trades earlier in the year, but concluding 2018 with the ratification of a full year deal with Unifor in December before it expired.The change we've driven is not that easy. We certainly have not got them all right, but I'm pleased with the progress that we continue to make. The deals we signed provide mutually beneficial terms that will support our growth strategy while we provide CP, its employees and our customers, with the stability and the certainty we need to continue to execute and grow over the next several years.And I think as a side note, it's also important to remind ourselves, our next major labor contract in Canada doesn't come due until 2021, which gives us a significant meaningful quiet period as we continue to focus on deepening relationships even more at our company.Speaking of the guidance, we entered 2019 with tremendous momentum. Rest assured we're poised for another record-setting year. As you've read in our press release, we're targeting mid-single-digit RTM growth, double-digit EPS growth for the third consecutive year. We did it in 2017, we did it in '18 and we're confident that again in '19, we'll meet or exceed those expectations. I've never been more confident in this team's ability to deliver. We're never more excited about the potential for this franchise as we continue to write the next chapters of success of our CP story.And so that said, I'm going to hand it over to John to bring some color to the markets before Nadeem wraps up and elaborates on the numbers, and we'll spend the balance of our time for some robust and meaningful Q&A. Over to you, John.

[John Kenneth Brooks, Chief Marketing Officer & Senior VP]

All right. Thank you, Keith, and good afternoon, everyone. The total freight revenues were up 18% this quarter to what Keith said, a record $2 billion, with record growth across every line of business for the second straight quarter. RTMs were up 9%, fuel and FX were tailwinds of 3% and 2%, respectively. And as expected, same-store price continues to be strong, finishing at the upper end of our targeted 3% to 4% range. The pricing environment continues to remain healthy.As Keith stated, 2018 was a tremendous year for CP as we executed our disciplined strategy to deliver sustainable profitable growth. And look, it didn't happen by accident. On the backs of our industry-best service, we had a plan, we picked our partners and we executed with precision in the marketplace. In October, we outlined at our Investor Day, CP's unique strengths that enable us to offer creative solutions to our customers, including our energy train from the Alberta Heartland to Vancouver, our new and expanded transload facilities in major centers such as Vancouver, Minneapolis, St. Paul and Hamilton, and leveraging our landholdings to create new auto compounds at Vancouver and Wolverton. We are executing our strategic playbooks, utilizing the principles of PSR and, frankly, the results speak for themselves.Full year total revenues were up 12%, to a record $7.3 billion. And at the risk of repeating myself again, revenues were up in every line of business on a full year basis.So let's take a look at fourth quarter revenue results on the next slide. I'll speak to the results in a currency-adjusted basis. Starting off, as expected, grain was sort of a tale of 2 stories. Canadian grain volumes were up 7%, surpassing last year's record levels. This was partially offset by continued weakness in our U.S. grain portfolio where volumes were down 18%, largely as a result of decreased shipments to the U.S. P&W.So look, as we enter 2019, we expect continued strength in Canadian grain through the first half of the year, given solid crop inventories and strong regulated pricing. And in the U.S., although January is off to a pretty decent start, we expect ongoing uncertainty in these markets.Strong export volumes from both Canpotex and K+S marked our fourth consecutive record-setting quarter for potash, with revenue finishing up 24%. We had an all-time record year in potash and we see opportunity as we move into 2019 as global demand remains strong.The energy and chemical plastic portfolio saw revenue growth of 46%. While certainly crude was a large contributor to ECP growth with approximately 25,000 carloads moved in the quarter, I would highlight that excluding crude, ECP revenue saw strong growth of 26%, driven by LPGs, biofuels and refined fuels. As we head into 2019, we expect continued momentum in this line of business. Based on the strength of our service, our energy train continues to create opportunities in the marketplace.We've entered into a new multi-year agreement with Suncor, providing service from the Edmonton area to their expanding Vancouver export terminal. Also in the ECP space, we recently entered into a new multi-year agreement with a new customer to deliver refined fuels into the southern Ontario market. This business leverages freed up capacity with the closure of our Expressway operations. As many of you will recall from our Investor Day where we spoke about this, the Expressway terminal is strategically located with direct highway access and distribution to the Greater Toronto Area.So moving on, as expected, forest products were up 12% as we continue to leverage our Vancouver, Toronto and Montréal transload capabilities. The automotive business unit revenues were up 4% on the quarter in spite of weaker demand environment in this space. At the start of 2018, this was an area that I highlighted potential headwinds for the year. So I'm pleased to report total revenue finished up 11% on the year as our new team focused on leveraging our strong service and customer partnerships to grow our share in this market.Heading into 2019, we see growth in this sector as we continue to attract new business to our network. Construction of our new Vancouver auto compound, which has Ford as our anchor tenant, is on track to be completed in Q1. This facility brought on by utilizing our existing strategic landholdings, provides our automotive customers with a new option in the Vancouver market.So finally, on the intermodal side, revenues were up 11%. On a full year basis, I'm extremely pleased with the strong growth we've had in both domestic and International intermodal. On the domestic front, we had a record year over -- on top of a record year, and I expect continued growth as we move into 2019. In Q1, we'll onboard our newest domestic intermodal customer, Dollarama, to our already very strong retail book of business.Additionally, this team, I can tell you, is laser-focused on continuing to leverage our demand management tools to create new valuable capacity on our existing train starts. We are confident that this will drive more over the road conversion to our intermodal trains.On the international side, we're also projecting growth in 2019 as we leverage our service and the capacity brought on by GCT at Deltaport, to grow with both new and our existing customers at the Port of Vancouver. And I'm also pleased to announce that we have recently extended our transportation agreement with our largest intermodal customer, Hapag-Lloyd.So let me wrap things up now. As Keith commented, we accomplished a lot in 2018, and I am extremely pleased with how this team is maturing or delivering results and strategically executing our playbooks in the marketplace. The demand and pricing environment, as we see it, continues to be healthy and I'm extremely encouraged by the energy and momentum we have coming into 2019 and the opportunities I see ahead.With that, I'll pass it to Nadeem.

[Nadeem Velani, Executive VP & CFO]

Thanks, John. An outstanding report. I'm proud to announce record results for the quarter. Total revenues were up 17% or 15% on an FX-adjusted basis, driven by RTM growth of 9% in the quarter. These revenues are coming on at a high incremental margin, as evidenced by our fourth quarter operating ratio of 56.5%, an improvement of 350 -- 370 basis points year-over-year.As our numbers illustrate and Keith highlighted, the railway is performing extremely well and we have strong momentum as we continue to drive productivity and grow at high incremental margins.Taking a closer look at a few items on the expense side. As usual, I'll be speaking on the results on an exchange-adjusted basis, which is shown on the far-right column of the slide. Comp and benefits expense was up 10% or $34 million versus last year. A few specifics behind that number. Higher headcount support increased volumes along with wage and benefit inflation were drivers behind the increase. Although key item to note, although the share price declined during the quarter, stock-based compensation was only a $2 million reduction from 2017 levels, as higher accruals were booked for long-term compensation as a result of the strong performance and future outlook.Fuel expense was up 22%, primarily as a result of higher fuel prices and increased volumes. This was partially offset by improvements in fuel consumption, up 3%, driven by improved train utilization from higher volumes. This was a record Q4 fuel efficiency of 0.956 gallons per 1,000 GTMs and record annual fuel efficiency of 0.953 gallons per 1,000 GTMs. Our investment in locomotive modernization and our commitment to the principles of precision scheduled railroading were drivers behind the record numbers.Purchased services and others was $250 million, an increase of 1%. As previously highlighted, we had a land sale closed in Q4 for a gain of $35 million. However, this land sale was partially offset by a $20 million contingent claim in the quarter.Moving below the line, interest expense was $2 million lower or $6 million lower excluding FX. The reduction is primarily driven by savings from our debt refinancing in Q2 of 2018.Adjusted net income improved 38% overall, while adjusted EPS grew 41% to $4.55. To put that EPS figure in perspective, that is greater than CP's full year EPS in 2012 prior to the transformation, which is pretty incredible to think about how far we've come.Moving on to full year results on the next slide. This record fourth quarter performance rounds out a record year for CP. The plan is clearly working. For the year, revenues grew 12% and adjusted operating income grew 15% compared to 5% revenue and 6% adjusted operating income growth in 2017. Our full year adjusted operating ratio was 61.3%, which is a 110 basis point improvement over 2017, demonstrating our ability to grow volumes at a low incremental cost. This led to adjusted income growth of 25% and the benefits of a lower share count from our share repurchase program helped us achieve EPS growth of 27%.Moving on to free cash to wrap things up. 2018 cash from ops increased by 24% and free cash flow increased by 47% to nearly $1.3 billion. Shareholders are being rewarded as we remain opportunistic in our share buyback, taking advantage of all that's holy in the equity markets. We have completed around 40% of the buyback program we announced in October at prices below where we are currently trading. Additionally, a 15.5% dividend increase in May marked the third straight year the dividend was raised.Our approach to capital remains disciplined. In spite of currency headwinds and our opportunities for growth, our capital spend finished in line with expectations. As mentioned in our press release, we plan for the same level of capital investment in 2019.When we give guidance on capital spend, rest assured, we have a well thought out and detailed internal planning process. You should not expect negative surprises from us.Nowhere is that discipline more evident than in our adjusted ROIC, a record 16.2%. To put that figure in perspective, when we started this journey in 2012, our adjusted return on invested capital was just shy of 10%. Now, it's the industry best. As I told you at Investor Day in October, we're focused on generating quality returns for our shareholders, driven by our strategy of sustainable, profitable growth, while controlling cost. I'm extremely pleased with our performance, particularly in the back half of 2018 when we separated ourselves from the pack and demonstrated what a precision scheduled railroad with the best team in the industry can deliver. There's a great deal of momentum at CP and we're extremely excited for what's ahead in 2019.And with that, I'll pass it back over to Keith.

[Keith E. Creel, President, CEO & Director]

Okay. Thank you, John. Thank you, Nadeem, for that color. I think we'll just take a moment of our time to open it up to Q&A and a robust discussion. So over to the operator.

[Operator]

[Operator Instructions] Your first question comes from Ken Hoexter with Merrill Lynch.

[Kenneth Scott Hoexter, Managing Director and Co]

Keith, maybe you can just delve into a little bit, or John. At the Analyst Day, you talked about the potential for committed contracts in the year ahead based on things that were expiring. Maybe you can talk about the progress in negotiations as you built into that 5.5% RTM growth into 2019.

[John Kenneth Brooks, Chief Marketing Officer & Senior VP]

Well, Ken, I can tell you, we're deep into those, every one of them across those business units we spoke at Investor Day. I can tell you, it's probably too early to get into too many details on it, but I think the neat thing you got to remember as part of the -- a lot of those opportunities set us up for 2021 and beyond. So a lot of that, that revenue and that opportunity aren't included at all, as you look at our 2019 guidance and where we expect to be. So a lot of that, I would consider, are sort of a future upside.

[Keith E. Creel, President, CEO & Director]

But more specifically, in 2019, Ken, I'll draw attention to what we really couldn't say back then, Loblaws closed and renewed, Canadian Tire closed and renewed, Hapag-Lloyd closed and renewed, Dollarama closed, renewed. Those are all pretty meaningful proof points of our confidence in our story, revenue story at CP.

[Kenneth Scott Hoexter, Managing Director and Co]

Are those all ones that renewed or those are not new wins that you had talked about from competitive...

[Keith E. Creel, President, CEO & Director]

Dollarama is new. Revenues in Hapag, Canadian Tire and Loblaws all closed and renewed which were -- we were in the negotiating process, obviously, during that time.

[Kenneth Scott Hoexter, Managing Director and Co]

Got it. And then just as my follow-up, Keith, you kind of came out with some harsh statements in terms of what the government was looking at into the Port of Vancouver and progress. Maybe you can kind of follow-up a little bit in terms of where your performance is at, at the port and what you think kind of drove that investigation.

[Keith E. Creel, President, CEO & Director]

Okay. Well, harsher words, Ken, mine, I think were -- I tried to be fact-based and maybe a little bit pointed but I think I was fair to the hardworking employees of this company that have created record service levels and capacity in that whole corridor. We went through some challenges and the capacity constrained corridor at the point back in the fourth quarter and into the beginning of January. We had to take measures to protect our overall health of our franchise, that's a key corridor for us, obviously. We have a lot of customers that are serving that corridor. We've got not only the carload side, the chemicals, we've got the grain, we've got the potash, we've got the coal, so it's a key corridor for CP. And when we get to a point where we see certain business lanes with equipment tied up for a number of days waiting to get their destination in a capacity-constrained location, we have a responsibility for all of our customers to take the appropriate surgical actions to make sure that we mitigate that damage. And we also took immediate action, not only to curtail some of that pressure but to do some things ourselves to help our competitor recover quickly in that corridor because again, we have entered into agreements. We can meet the greatest competitors, but in that corridor, we create capacity together. So when one succeeds, both succeed and we think that's the right thing to do, not only for our shareholders, not only for the corridor, but overall, for all of the business that goes into and comes out of Vancouver. So long answer to your question, things have recovered quite nicely, I think, for both railroads. I saw it as an episodic event. It's something that I think we responded well to, and we're going to go through the process. I think the CTA acted a bit prematurely. I think it will go and the facts will speak for themselves and I think that it all comes out that everything that I've said, not only what I said but what the facts prove to be true. CP is in good shape in that corridor, the wells are the lowest they've ever been. Our service is better than it ever has been, and it's driving a lot of these results. So again, the rhetoric will pave the way, the facts will get out on the table and CP is going to bode well when the facts stand on their own.

[Operator]

Your next question comes from Chris Wetherbee with Citigroup.

[Christian F. Wetherbee, Vice President]

I wanted to talk a little bit about the guidance. So mid-single digit on the RTM side. Presumably, pricing is additive to that when you think about the top line. And you've given sort of a double-digit EPS growth, which is, I know, a convention you've used in the past. Can you help us sort of square the circle here to a degree? Maybe talk a little bit about the operating ratio, some of the moving parts there, give us a little bit of sense sort of where in that double-digit stack EPS potentially could be. It seems like obviously higher than 10% but just trying to get a sense -- a better sense about where that might shake out.

[Nadeem Velani, Executive VP & CFO]

Well, Chris, I'd say that certainly, we have strong confidence in the volume outlook. Some of the unknowns, we'll see what happens with fuel prices, which had been pretty volatile. It could be a headwind on fuel surcharge. That being said, it's a nonevent from an operating income point of view, for the most part. Currency, we've given you our guidance, which would be pretty consistent with 2018. So at $1.30. So assuming that comes true, at current levels, potentially there's a little bit of upside but that being very volatile the last 3, 4 months as well. So we've been very positive in terms of our pricing outlook in our cents per RTM, very evidenced by Q4 results, where cents per RTM were extremely strong. And the renewals and the pricing environment that John spoke to has been very supportive. So everything I've pointed out there for us, with the exception of fuel surcharges, could be additive to revenue growth. We're performing well. Our precision schedule railroading model and our approach towards sustainable profitable growth has helped with our incremental margins. You should expect our operating ratio to improve. We're not going to back off that approach of continually lowering that, and we believe it would be a disappointment if we weren't best in the industry in terms of the operating ratio. Certainly, the back half of 2018, we were far above the best in the industry, and we plan on staying there. So all that to say, some of the negatives in terms of the macro environment, where we are in January, depending on which headline you read, the sky can be falling every now and then. And it could -- we think it's prudent at this point to provide the guidance we've provided of 10% or double-digit EPS growth. So do we feel confident in that number? Yes. Do we want to give you more visibility than that? Let's say, not at this point. The last 2 years, we've been able to outperform and update our guidance accordingly. I'm not saying that, that's what we'll do, but we'd rather be conservative and rather put out numbers that we're going to achieve than the other way around. So all that to say, I'm not going to give you more color than what we did in terms of our guidance.

[Christian F. Wetherbee, Vice President]

Okay. No, that's super helpful. I appreciate the color. One quick follow-up. I just want to make sure I understand where CBR, crude-by-rail, sits in the RTM outlook. Most of that, I believe, is take-or-pay. I just want to get a sense. Are you seeing any impact on that business based on what differentials have done over the last month or so?

[John Kenneth Brooks, Chief Marketing Officer & Senior VP]

Chris, we hit sort of this 100,000-unit run rate here in fourth quarter. My expectation is we hang around there into Q1, and then we've got some upside as the year goes forward. I do think certainly some of the actions that have taken place here, most recently in Alberta, have created some -- I don't know if it's unintended consequences, potentially uncertainties in the marketplace. We've seen, I would say, some sets slowing, some new additional business slower to come on. Overall, the volume -- the base volume has held in there. But it's something, obviously, we're taking very seriously, we're watching very closely, and we have stayed in sort of constant dialogue with the province.

[Nadeem Velani, Executive VP & CFO]

And, Chris, our guidance reflects conservative Q1 crude volumes.

[Operator]

Your next question comes from Steve Hansen with Raymond James.

[Steven P. Hansen, Senior Vice President]

Just very quickly on the labor front. How are you feeling about the employee count through the year? The faster growth has obviously been quite strong through Q4 and even into early part of Q1. How do you feel about the hiring front for this year? And how should we think about that in our modeling process as you think about incremental operating margins and leverage?

[Keith E. Creel, President, CEO & Director]

Yes, I think you should still assume some incremental productivity improvement. So based on mid-single-digit RTM growth, I think it's fair to assume posting additional increase in headcount overall. There's still meat on the bone.

[Steven P. Hansen, Senior Vice President]

Okay. Very helpful. And just a follow-up on the crude commentary then. It sounds like some of the spread closures that have happened might mitigate some of the shorter-term upside to that. But as you look into the contracted volumes for the balance of the year, should we expect the cadence to improve slightly or improve -- I'm trying to get a sense for that run rate for the balance of the year. Just purely what's contracted?

[John Kenneth Brooks, Chief Marketing Officer & Senior VP]

Yes. So Steve, I think my expectation would be, as we push into Q2, we make a move towards a 120,000-car annual sort of run rate. And then we'd push into the back half of the year. We'll see what sort of upside that presents. I think the key here is we've set ourselves up well with the right partners. There's a lot of investments that have taken place, not only at CP, but with our partners. We just want to make sure we've got a level playing field in the marketplace to sort of drive so we can all reap the benefits of our efforts to date. And again, I'm confident that we're seeing that. But right now, I'm cautious until the whole thing gets worked out between the curtailment and certainly the government's interest in providing their own crude-by-rail service.

[Keith E. Creel, President, CEO & Director]

I think they're looking for that whole thing. The government, I know they have the best of intentions, but the reality, some of the unintended consequences, I don't truly think they understand. Put yourself in oil companies' shoes. How do they plan? How do they do contracts? How do they plan their resources? Put yourself in the railroad's shoes where capacity is critically important to what we do and how we maintain our business model and our service for all players in those market spaces that deserve that multi-capacity. If we committed capacity, committed capital, for instance, to locomotives based on projected growth, which unintended consequence gets impeded or curtailed as a result of these actions, don't think that I'm just going to spend the money, don't think that if the money spent and invested in locomotives, if we have other areas of opportunity and demand by customers that we're just going to hold it in case. We've got a commitment and responsibility to those customers to maybe redeploy those assets. And then you wake up 6 months from now and you say, wait a second, what happened here? Railroad, we need locomotives, we need capacity, we need people or you're hurting the industry, you're hurting the province. Well, you know what, I don't want to hurt anything. But I think we've got to think a little bit further out. We've got to think about unintended consequences, and I think there's a piece of that, that's either not understood or has not been considered. That's going to come into play.

[Operator]

Your next question comes from Walter Spracklin with RBC.

[Walter Noel Spracklin, Analyst]

On the capacity, I want to ask a question on capacity. You had alluded -- or you indicated mid-single-digit volume growth in your guidance. If you do see higher volume growth than expected, what would you say is your current capacity? How much more could you handle? And at what point do you start to see cost creep as you reach some of your upper capacity limitations?

[Keith E. Creel, President, CEO & Director]

I think it all depends on your terms. As we said in the past, we certainly can handle capacity. We could double it if we have to. I mean, if you look at the RTM growth that we have, I mean, it's conservative. So worst case or best case, however you want to put it, we can handle double the RTM growth and not be capacity-constrained as long as it's not double and stacked up, I guess, in one corridor. As long as it's spread out the way we manage our business, there's no one pinch point that creates huge concern.

[Walter Noel Spracklin, Analyst]

That's great. And now, perhaps moving over to pricing. Could you delineate between what was core -- I think you said at the upper end of the 3% to 4% range. I just want to make sure I heard that right. But going forward, is there any impact on that you're seeing from truck rates coming down or anything that could lead to a price pressure given the competitive environment that wasn't prevalent in 2018?

[John Kenneth Brooks, Chief Marketing Officer & Senior VP]

Yes. So, Walter, look, we were right at the top end of that on a same-store basis. Our renewals were a little better than that based in Q4. Those contracts actually pushed 4.3, 4.5 type numbers. As I look into Q1, I think for the most part, we're off to a strong start with sort of similar type numbers. We're obviously staying close to our wholesale customers that give us a good read on the trucking market. We're staying close to our customers and what they're seeing in terms of their demand environment. And as it stands right now, with what I believe is prolonged tighter capacity, I think that pricing opportunity continues. And then, Walter, we get back into the back half of 2019. And then you start to introduce the ELDs and that potential mandate coming on early in 2020 and what sort of effect does that sort of bring into place, all of which, I think, supports a continued robust pricing environment.

[Operator]

Your next question comes from Tom Wadewitz with UBS.

[Thomas Richard Wadewitz, Managing Director and Senior Analyst]

Wanted to see if you could lay out the -- what you think is the likely pass on the curtailment in Alberta? Is it -- I mean, I guess you're implying maybe, John, with your comments that the curtailment fees and you get up to $120,000 run rate. Is that the right way to view it? What are some of the puts and takes on the way things might play out given what you know today, given what you think might change on the government actions there?

[John Kenneth Brooks, Chief Marketing Officer & Senior VP]

You put me in an area of the ultimate guesswork, Tom. Guessing what -- between free markets and governments, the output is tough. Look, if the spread stays where it is now, at $8, $10, I think, I saw today, there's going to be ongoing pressure. I think the government has said they're going to revisit curtailment sort of on a monthly basis. February, I believe, requirement is the same as what January is. So I think right now, we expect a little bit of that ongoing pressure to continue through February. I would say for the most part, the crude shippers in our terminals though are bullish that this is going to get itself sorted out, and we're going to get back to sort of the heavy demand profile that we had leading into it. In the midst of all this, we moved, I think, close to 80 crude-by-rail trains last month. And I think we're going to do similar type number here in January. So I expect that sort of run rate to continue, and then we'll -- as we've got some additional opportunities coming on in Q2, we'll go from there.

[Thomas Richard Wadewitz, Managing Director and Senior Analyst]

So does your comment on Q2 going up to 120,000, that assumes that the spread widens out? Or does that happen even if you stay at $8 to $10 a barrel spread?

[John Kenneth Brooks, Chief Marketing Officer & Senior VP]

Look, if this stays at $8 to $10, there's probably going to be some challenges. Look, we've purposely structured the right contracts that have some backstops against the business for us. So it's not like there's nothing if those contracts don't start up, but our expectation right now in terms of resource planning is to have those start up as we come Q2. Now, the other thing is those aren't going to just all click in overnight on April 1. There's going to be a ramp-up period through Q2 to build ourselves up to that run rate. The other interesting sort of, I don't know, unintended consequences, the right way to look at it, but we've actually seen quite a bit of an uptick in activity out of the Bakken as a result. And my energy team is somewhat deep into those opportunities now, assessing that, that potentially again, we'll take a very disciplined approach as it relates to any sort of capital or people or locomotive needs to handle that business. But actually, that could present either further upside or a backstop if some of this is delayed in coming out of Alberta.

[Operator]

Your next question comes from Brian Ossenbeck with JPMorgan.

[Brian Patrick Ossenbeck, Senior Equity Analyst]

John, just a follow-up where we left off on the Bakken. Obviously, the spreads have come down pretty significantly since October. But I know you've been pivoting some frac sand into that region to take up some of the capacity you left when that crude-by-rail dried up. Does that limit you in any way from turning that back around, putting some capacity back in the ground if that market were to pick up, as you just mentioned?

[John Kenneth Brooks, Chief Marketing Officer & Senior VP]

No. I think it's an area, and Keith can comment on it, that we've got pretty strong capacity in that area. You look at it, our U.S. grain has been significantly off, right, and certainly, the China tariffs have limited the flow of our soybeans out of that region. So frankly, if we can backfill that with frac sand and a little bit of Bakken crude, that might actually fit our resource planning for that area quite well. And the team has done a heck of a job rehoning our frac sand. And certainly, it's an area that we see some headwinds in 2019 as in-basin sand continues to fill some voids in the Permian. But we've been successful. I think we had about 15% of our frac moving into the Bakken a year ago, and we're moving close to 50% of our frac sand into the Bakken now. So it's been a pretty successful story for us.

[Brian Patrick Ossenbeck, Senior Equity Analyst]

All right. Maybe just a quick one on the margins. Going back to Investor Day, we're looking at 100 basis point of improvement year-over-year through 2020. Clearly, you're looking at some good operating leverage from better volumes. What are -- on the operating side, though, and productivity gains, what are some of the specifics that you're targeting there to help drive some of that improvement?

[Nadeem Velani, Executive VP & CFO]

Well, certainly, operating leverage is something that -- in this kind of volume environment that we're describing that will be supportive, we've made some very strategic investments very recently. For example, in Alyth Yard here in Calgary, where we spent probably $40 million, $50 million of capital in the fourth quarter of 2018 to optimize not only that facility but some of the blocking and some of the work up in Northern Alberta and Edmonton area that's going to be kind of benefiting from that investment here in Calgary. So that's going to help us -- allow us to improve our train speeds, improve our train length and, overall, our ability to move through the yards more much more effectively and improve our overall labor productivity as well. So there's a number of these items that are going to be helpful. One thing I'd point out from a headwind point of view, our guidance doesn't assume any landfill. So that's about a $40 million headwind, about 40, 50 basis point type of headwind to the OR. But yes, we certainly expect to improve the OR irrespective of that. So some of the other things we talked about in terms of robotic process automation, some of the benefits from our investment in locomotive modernization, et cetera. So rest assured, the pipeline of productivity opportunities are still plentiful.

[Operator]

Your next question comes from David Vernon with Bernstein.

[David Scott Vernon, Senior Analyst]

Nadeem, similar kind of question. But I think at the Investor Day, you were laying out an expectation for something like a 75% incremental margin. And it sounds like things worked pretty well, but you kind of fell short a little bit on what that incremental would have been. Can you talk about what maybe didn't go as well as you would have liked in the quarter and how that kind of relates to the outlook for an incremental margin guidance you gave last fall?

[Nadeem Velani, Executive VP & CFO]

Well, I wouldn't say that there's something that I'd point to that didn't work out well. Maybe you and Maeghan can compare notes after the call, but -- in terms of your calculation. We certainly see in excess of 70% incremental margins in the quarter. We had some onetime negatives as well that I pointed to during my comments. For example, we had a contingent liability in purchased services of $20 million that was accrued. And there was also some higher accruals for stock-based comp that was in the tune of $15 to $29. That's probably where the differences lie between our calculation and maybe where you're seeing things...

[David Scott Vernon, Senior Analyst]

I take out the landfill as well. So...

[Nadeem Velani, Executive VP & CFO]

Right, right. So I think those are probably the key figures. And depreciation is something that we back out as well. And so I don't think there was anything there that I would apologize for or any excuses to be made. We're very confident in our incremental margins and in excess of 70%.

[David Scott Vernon, Senior Analyst]

Okay. But that was excluding the depreciation on landfill?

[Nadeem Velani, Executive VP & CFO]

Right, excluding landfill and stock comp. Yes.

[David Scott Vernon, Senior Analyst]

All right. And then maybe just as a quick follow-up, any commentary on what you're hearing from customers on the export coal outlook would be great. Obviously, with all the concerns about global slowdown, I'm wondering if you're hearing anything from Teck about sort of demand for metallurgical coal off the West Coast, North America?

[John Kenneth Brooks, Chief Marketing Officer & Senior VP]

No. Things look pretty strong. We just recently updated our projections with them in line with what our guidance is and our expectations are for 2019. Teck -- it's an efficient pipeline, and they've got a long-standing strong book of existing customers. And actually, they seem pretty -- I don't know if bullish is the right word, but expect a pretty stable 2019.

[Operator]

Your next question comes from Matt Reustle with Goldman Sachs.

[Matthew Edward Reustle, Senior Equity Analyst]

Just back to the cost side. Nadeem, you mentioned land sales. Are there any other cost headwinds that stopped you from achieving the sub-60 OR that you've had as a run rate for the second half of the year?

[Nadeem Velani, Executive VP & CFO]

Fuel surcharge is always one of those unknowns, right? So when fuel surcharge comes on at a 95%, 100% kind of OR, that can affect the math. That's something that always points to stock-based comp. We expect the stock to go up. We've seen it come up since year-end, and our expectation is we'll execute on our plan and that the stock will continue to increase over the course of the year, and that will create some headwinds on comp and benefits. A couple of things I'd point out to.

[Matthew Edward Reustle, Senior Equity Analyst]

Okay, understood. And then, Keith, if you step back and just compare the demand environment today to where you were at the Analyst Day, are you seeing any slowdown in your end markets besides -- you guys mentioned the uncertainty around crude, but besides that, are you seeing any change in tone or shift from customers versus where we were just a couple of months ago?

[Keith E. Creel, President, CEO & Director]

No negatives [ in and of itself ] except for, obviously, concern in and around the crude space. So that's the greatest degree of uncertainty outside of the macro environment uncertainty we have with all the rhetoric that's going on about what may or may not happen in the U.S. But no material impact. We still have very optimistic and robust demand reports from our customers. Until and unless I see consumer confidence really take a hit and consumer spending really slow down, I don't see it. Now, obviously, the big concern remains for us the grain U.S. piece. There's some uncertainty in that, but that was there in 2017 as well. We think we found the bottom, but who knows. We'll see what happens in the second half of the year. But at this point, outside of those couple of places, we see underlying strength in opportunity, optimism and no pessimism yet.

[Operator]

Your next question comes from Fadi Chamoun with BMO.

[Fadi Chamoun, Managing Director and Analyst]

Just a couple of clarifications. So John, you mentioned the backstop in the crude-by-rail contract. I'm just trying to understand like the take-or-pay and the backstop. I'm assuming if you move -- you prefer to move the volume but if we do end up in kind of spread remaining uneconomical, what is this backstop relative to moving the volume? Do you recover your fixed cost? Do you -- like how should we think about that relative to moving 100,000 carloads a quarter -- a year?

[John Kenneth Brooks, Chief Marketing Officer & Senior VP]

Yes. So you're right, Fadi, I wouldn't characterize it as take-or-pay. As typical with our contracts that have what we call a minimum volume commitment, we also have sort of the give and the get, the commitment we ask them to make has a liquidated damage associated with it. So that's what we would have as part of these contracts. And as we've -- certainly, we'd always prefer to haul the traffic and earn the full revenue, but if we don't, the backstop, the liquidated damage and those liquidated damages are designed to underpin and support whatever investments we've made towards that particular contract.

[Fadi Chamoun, Managing Director and Analyst]

Okay. But there's no way for us to kind of think about it in terms of number. Is it recovering half of what you would have made moving the volume or more than half? Or kind of -- any range that you can hang on that?

[John Kenneth Brooks, Chief Marketing Officer & Senior VP]

Fadi, it's kind of tough. And part of the issue is it varies a little bit from contract to contract, depending on the origins and the destinations and certainly the customer and the amount of other business they have relative to it. I guess my only guidance would be, be assured that if we brought on locomotive to support a contract, we've made sure that financially, whatever we got out of that contract, if nothing moves, would support those capital investments. I have to leave it at that.

[Fadi Chamoun, Managing Director and Analyst]

Okay, great. One other clarification. So it looks like you untapped resources quite a bit in the back half of 2018. I think the headcount is just under 13,000 kind of exiting the year. Is that the kind of workforce you think is needed to handle the 5%? Or should we think that number goes up a little bit as well as a year ago in the context of the RTM guidance?

[John Kenneth Brooks, Chief Marketing Officer & Senior VP]

Sure. So you might see a very small increase. As Keith mentioned, kind of, if we're doing mid-single-digit RTM growth, maybe low single-digit headcount growth. But one thing to keep in mind is it's usually a long lead time, as you know, to hire and train, et cetera. Last year, first half of the year, we were ramping up a lot of training but there's nonproductive workforce. We had some stops and starts with the labor disruption and a very difficult winter. So there was some noise in the 2018, certainly the first half of the year. I would expect, at this point, a very small level of hiring in that 1% to 2% right now type of number, Fadi. And you won't see the same dynamic in terms of the nonproductive workforce. So all these, as you know, you've been around long enough, but the attrition is always there in your back pocket to support you. And attrition's always there. It's something you need to replenish. So we're always hiring, but we're not going to over-hire. And I think we've done a good job of being able to forecast and plan and not get caught, whether it's from a people resourcing point of view or from an asset resourcing point of view. And so we feel good about the visibility we have between the volumes and what we're resourcing to support that.

[Operator]

Your next question comes from Ravi Shanker with Morgan Stanley.

[Ravi Shanker, Executive Director]

The first question, can you give us a sense of what do you guys see in terms of the impact of trade and tariff headlines internationally and the -- any impact you've already seen in the International Intermodal business in terms of people building up inventory in 2018 that could potentially lead to an overhang in 2019 or any sign of nervousness that you may see a decline in ordering in 2019?

[John Kenneth Brooks, Chief Marketing Officer & Senior VP]

Yes. So Ravi, I guess I think we did see a little bit of a late Q4 surge in international volumes as a result of the tariff. But I could tell you this, my team convinced me to take my January numbers and February numbers down a little bit, and we haven't seen that happen at all. The volume continues to be, I would say, where we expect it or slightly stronger. I think the thing I'd point out is, part of this depends on the partner that you pick or associate with in that space and the operating performance you have for that business. And at the end of the day, we're secure in that area. We have no major contracts coming up for renewal. We just renewed Hapag-Lloyd. They've been a very strong performer. The ONE business continues to grow with us. So we expect a tailwind to continue despite some of that rhetoric and noise. And then as I look ahead, and this goes back to some of the earlier questions, there's opportunities for us to grow in that space as we move along in 2019 and into 2020.

[Ravi Shanker, Executive Director]

Got it. And just to follow up -- thanks for the additional detail in the slides this time. If I could just ask you on Slide 10, where you have the pie chart on your merchandise breakdown and energy, chemical is 47%, do you have a sense of what that number was 12 months ago?

[Maeghan Albiston, Assistant Vice President of Investor Relations]

I don't think it moved materially, Ravi, but I can follow up with that number after the call.

[Operator]

Your next question comes from Allison Landry with Credit Suisse.

[Allison M. Landry, Director]

Maybe just first going back to the comments about -- Nadeem, your comments a couple of questions ago in terms of rightsizing the resources. And Keith, I think you mentioned earlier being able to handle 2x RTM growth. Should we take this to mean in terms of there being some latent capacity in the network, if the macro does unwind maybe sooner than expected, will it take a little bit longer to rightsize resources? Or is that a nonissue, in your opinion?

[Keith E. Creel, President, CEO & Director]

That's a nonissue. If any of that were to happen and these opportunities were to reverse, so if you just railroad adjust and rightsize resources the other way quicker than anyone else in this industry. We keep our finger on that routinely, daily. It's part of the DNA. It's molded in our blood. We breathe and eat it on the planning process, be it going up, be it going down. Well, I'll make a case in a down market, and I'll say this with firm conviction, this railroad will do better than any other railroad in this industry.

[Allison M. Landry, Director]

Okay. And then as my follow-up, I wanted to ask a little bit about the U.S. regulatory environment, and specifically, if you have any thoughts or insights on the potential regulatory implications of PSR in the U.S. given the change in Congress and the Transportation and Infrastructure Committee. Do you think that the misunderstood notion that PSR is cost-cutting in a CapEx reduction strategy, along with maybe the fact that more rails are revenue adequate versus years passed, does this add a layer of risk from the regulatory standpoint that maybe the industry and the market hasn't seen in a number of years? And how worried are you about that? And how worried should we be?

[Keith E. Creel, President, CEO & Director]

Well, I think we have to be cognizant there's always a risk and you have to manage that. And I think you manage that by educating the regulators as well as the customers with the facts. You can look at our case in point, Allison. I mean, we started this journey with PSR in 2012. We fixed the engine. It's run like a sewing machine and we're a growth engine now. We're not a transformation engine. So we're sort of going through the cycle and continuing to evolve. We continue to improve. We're not perfect, obviously. But at the end of the day, I think by and large, talk to our customers that may have resisted the change in the onset, those are happy customers today because we've created precious capacity that's allowing those customers that are partnered with us to go to the marketplace. You look to some of the rhetoric and some of the concern about investment in infrastructure, we've never invested more money. You look at our safety record, it's never been better. So if you want a case in proof that PSR works, if it's executed properly, there's a case study out there. With that said, I know and I respect the other CEOs of these railroads. They understand some of those nuances. I see what the STB is doing. The STB is asking questions. They're trying to learn, trying to get educated. And I also believe that with a proven voice based on facts, if they think that action is necessary, then they'll act. But the reality is it proves itself out. I mean, CSX again, I don't have to advocate for CSX. The results advocate for themselves. They implemented PSR. There is obviously growing pains. Change is never easy for anyone. But at the end of the day, they created capacity, created service. And by and large, if you talk with the customers overall, I think they would support those statements. So again, if it's fact-based and we educate and try to curtail some of the rhetoric and just speak the points, the fact and point to the experience, I think that's going to outweigh the rhetoric that's out there and balance and offset the risk.

[Operator]

Your next question comes from Seldon Clarke with Deutsche Bank.

[Seldon T. Clarke, Associate Analyst]

Just in regards to your volume guidance for this year and just the different opportunities you laid out for growth, how resilient do you think mid-single-digit volume growth is next year in a more sustained macro slowdown?

[Keith E. Creel, President, CEO & Director]

How resilient?

[John Kenneth Brooks, Chief Marketing Officer & Senior VP]

How resilient?

[Seldon T. Clarke, Associate Analyst]

Yes. I mean, just like could you give us some context around like some of the different opportunities that you see that are more insulated from -- if we continue like hovering around 1% GDP growth? I'm not talking about a recession or anything like that, but just maybe what the opportunities are that are less macro sensitive versus like the typical industrial production carloads that Class Is move?

[John Kenneth Brooks, Chief Marketing Officer & Senior VP]

Yes. Well, certainly a big part of our business remains our bulk franchise. And I expect for the most part, our grain business would fall in that category. Although we set record -- had a record year in potash, I think all the signals remain very strong in that marketplace, as I already spoke about. I think Teck is, for the most part, expecting a pretty strong 2019. So that part of the business is pretty stable, and I look for growth opportunities there. We've already spoken about the crude-by-rail and we're where we expect ultimately that to go. Then you sort of layer on -- we've got a proven track record in our domestic space. We've been growing at close to double digits the last, now, 2 to 3 years in that area. We're going to layer on Dollarama, which will be now a significant new member to our strong retail portfolio in that book. That's going to provide a pretty nice tailwind and I think pretty much insulate us from any downturn that could affect domestic. I spoke about international. And then I still think we've got some tailwinds, certainly in the first half of the year around ONE, and we expect growth with our existing customers. Really, I have to go down the list, and I feel pretty good, unless the sky completely falls, that we're going to be able to achieve that guidance.

[Seldon T. Clarke, Associate Analyst]

Okay, that's really helpful. And then just last one for me. Do you have a target for free cash flow this year?

[Nadeem Velani, Executive VP & CFO]

Yes. We should see -- we don't have some of the land sales that we achieved in 2018. So you should see kind of marginal improvement in overall free cash. So around $1.3 billion in 2018 to see a modest increase in that kind of low single digits.

[Seldon T. Clarke, Associate Analyst]

Okay. Even with -- I guess you have a little bit of a headwind from CapEx?

[Nadeem Velani, Executive VP & CFO]

Yes. I mean, modest.

[Seldon T. Clarke, Associate Analyst]

Okay. Was there any -- I guess the CapEx that you guided to was all gross, and then the difference between -- obviously, net of the land sales. But is that -- is there any investments that were pushed out or delayed or anything like that? Or is it just strictly the land sales that makes the difference?

[Nadeem Velani, Executive VP & CFO]

It's really the land sales. Yes.

[Operator]

Your next question comes from Scott Group with Wolfe Research.

[Scott H. Group, MD & Senior Transportation Analyst]

So is there any way to just quantify the size of Suncor in the Domestic Intermodal contract? And then on this no land sales in 2019, have we sort of run our course on real estate? Or are we just being conservative?

[Nadeem Velani, Executive VP & CFO]

I'll let John speak first.

[John Kenneth Brooks, Chief Marketing Officer & Senior VP]

Yes. So the Domestic Intermodal opportunity with Dollarama was a $30 million to $50 million opportunity. The Suncor opportunity will phase itself in through 2019 and carries with it some developments that are really sort of in the barest maximum fruit as we get into 2020. It's probably a $20 plus million opportunity near term growing -- doubling as we get into the out years.

[Nadeem Velani, Executive VP & CFO]

The land sales got -- sometimes it can very difficult to predict what -- they're still lumpy, and you're dealing sometimes with some government and these are councils that can be difficult to move along, as we've seen in the past. So difficult to predict some of the smaller land sales. As far as the larger pieces, one key item that -- one key area that we had originally highlighted as an opportunity is part of the longer-term kind of divestiture. We might target to utilize for, in general, kind of railroad ops that could create a good tailwind for our growth strategy going forward. So we've revisited that book of business to see what makes sense today and what makes sense with our current growth strategy and profile of business. So we still see opportunities on that front, but they're longer term. So that's how I'd categorize our forecast on landfill.

[Scott H. Group, MD & Senior Transportation Analyst]

Okay, that's helpful. And then, John, if I could just ask one, just quick last one on crude. So at what level of volume run rate would the liquidated damages kick in? Meaning, if we're in a 100,000 run rate and we go to 90,000 run rate, do we get liquidated damages on that 10,000 shortfall? Or is it we need to see a more material dropoff before liquidated damages kick in? I just want to understand like at what level we're really protected at.

[John Kenneth Brooks, Chief Marketing Officer & Senior VP]

Scott, it's contract by contract. So it would be really -- well, it would probably be confidentially wrong, #1, but really difficult to sort of guide you to that, other than to say, again, we've built these on the premise of supporting any sort of resources that the company has had to acquire to support it. So it is not dependent on that, but we would be backstopped on those fronts.

[Scott H. Group, MD & Senior Transportation Analyst]

But are those contracts running above those levels today?

[Nadeem Velani, Executive VP & CFO]

Scott, I mean, some of those contracts haven't even kicked in yet, right? So some of these -- so that's the difficulty in answering it as well.

[Operator]

The last question that we have time for today comes from Bascome Majors with Susquehanna.

[Bascome Majors, Research Analyst]

Yes. Keith, about a month ago, you negotiated some updated employment terms and compensation with the board. You've clearly -- the performance of the business has been really great as of recent and looks forward to carry it into 2019. Can you just give us a little color on what led to the revisiting of the employment terms? And it's just the whole agreement wasn't filed. For any investors who were worried about how long you're going to be at CP, kind of some of the commitments that you had made to the firm and related to that agreement.

[Keith E. Creel, President, CEO & Director]

I guess in simple terms, number 1, the material terms of the deal relative to how long I'm committed to CP has not changed. I'm committed on my current contract through first quarter of 2022. I'm telling you right now, I'm having a great time. This is something magical that we've created with this team and with this opportunity leading this company. So I have no intention to do anything any differently. And relative to my compensation, I think it was just the recognition of some shareholders' concern as well as the market criteria out there that if we're going to be the best-performing railroad, it's probably pretty fair that myself as well as my team are compensated fairly relative to the market. So that's all it was, is closing the gap between what I currently make with the market. And in light of that, it wasn't only I. Obviously, I'm the only one who gets [indiscernible], but we took steps as well to recognize the record performance of this team, mid-level management-wise, senior-level management-wise, across the board. This isn't just Keith Creel. This is a collective effort in this entire company, and we're taking steps to make sure to protect the talent that's making this happen.With that, I guess we're going to wrap the call up. I want to thank everyone for their time this afternoon. Certainly, as you have the opportunity to digest these results, I think you'll share in our confidence. If you have anything to clear up, you can obviously reach out to Maeghan and her team, and they'll be happy to provide any more detail that they can.With that said, have a safe and productive afternoon. We look forward to reviewing what we believe will be very strong first quarter results as well when the time comes. Take care.

[Operator]

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