Canadian Pacific Railway Limited
Q4 2020 Earnings Call Transcript

Published: 28 Jan 2021

[Operator:]

Good afternoon. My name is Jason and I will be your conference operator today. At this time, I would like to welcome everyone to Canadian Pacific's Fourth Quarter 2020 Conference Call. The slides accompanying today's call are available at www.cpr.ca.

[Chris De Bruyn:]

Thank you, Jason. Good afternoon, everyone and thank you for joining us today. As some of you are aware Maeghan is at home with two new beautiful twin baby boys and I'm happy to report that everyone is doing well. Before we begin, I want to remind you this presentation contains forward-looking information. Actual results may differ materially. The risks, uncertainties, and other factors that could influence actual results are described on slide two in the press release and in the MD&A filed with Canadian and US regulators. This presentation also contains non-GAAP measures outlined on slide three. With me here today is our President and CEO, Keith Creel; our Executive Vice President and Chief Financial Officer, Nadeem Velani and our Executive Vice President and Chief Marketing Officer, John Brooks. The formal remarks will be followed by Q&A. In the interest of time, we'd appreciate if you could limit your questions to one. It is now my pleasure to introduce our President and CEO, Mr. Keith Creel.

[Keith Creel:]

Hey good afternoon. Thanks Chris. I appreciate the opening comments. Let me start my comments by thanking our CP family, 12,000 strong team of railroaders that I'm honored to serve and lead and produce with daily. Their grit, their resilience, that they've demonstrated and continue to demonstrate that the toughest times in '20 and this week, progressed through '21 enable these results. It's without those collective efforts none of this would be possible. So certainly a debt of appreciation in particular to the operating employees, their heroic efforts day in and day out to keep the North economy moving in its time of exceptional need. Again, it's inspiring to step out every day, to put your own life at risk to protect the livelihoods of others, to protect the livelihoods of our fellow employees, the communities we serve and our customers, again, very inspiring. So I'm super, super proud of the team, I'm super proud of the body of results that we're going to get to, to discuss today. In speaking of that pride, we talk about pride a lot at CP. We talk about sacrifice a lot at CP. Contribution, certainly not a shortage of opportunities to sacrifice in this industry, nor demand for peoples' contributions.

[John Brooks:]

All right, so thank you, Keith and good afternoon, everyone. So as Keith said, RTMs accelerated in the quarter and finished positive, up 2%. Total revenues were down 3% to 2 billion. FX and fuel combined to be about a 3% headwind and pricing gained further momentum while mixed results were negative. I'm very pleased though, with how volumes have steadily improved through the quarter. We're up over 9% sequentially. Continuing the trend we saw in Q3 and I frankly believe that we have hit the inflection point through this pandemic and the issues faced in 2020 and we will continue to gain momentum and see positive volumes as we move into 2021.

[Nadeem Velani:]

Thanks, John and good afternoon. Keith mentioned these were tremendous results that our team of 12,000 railroaders delivered in a very challenging environment, and I'm honored to present them. We overcame the financial impact of a pandemic and still delivered the low-end the guidance we presented a year ago. This should not go unnoticed. It wasn't easy, but it's the only company in our industry to continue to provide guidance throughout 2020. It shows the confidence we have in our business model and our team's ability to execute. This team does not make excuses when faced with headwinds. We focus on controlling what we can control. We have a culture of accountability that starts from the top and we are paid to execute and deliver and that's what we will continue to do. Now getting into the results overall, the operating ratio decreased 310 basis points to an all-time quarterly record of 53.9% driven by strong operating efficiencies including record train lengths and weights, improved casualty performance and lower fuel prices. Taking a closer look at a few items on the expense side, comp and benefits expense was up 9% or 37 million versus last year. The primary drivers of the increase were higher stock based compensation of 15 million, the onetime bonus paid to frontline union employees Keith mentioned totaling 17 million and a continued pension headwind for current service costs. Fuel expense decreased 58 million or 26%, primarily as a result of lower fuel prices. This year, we achieved full year record fuel efficiency, helping us to avoid 40,000 tons of CO2 emissions. Materials expense was up 10% or $5 million as a result of higher repair materials for track and operations and increased volumes. Depreciation expense was up - was 197 million an increase of 11% as a result of higher asset base. Purchase services was 197 million a decrease of 97 million or 33%. The main driver of the decrease is the gain related to the true up of our existing ownership percentage in the Detroit River Tunnel for a total of 68 million. The remaining decrease was largely driven by lower casualty costs on the quarter. Moving below the line, other components of net periodic benefit recovery were effectively flat, with lower discount rates offsetting higher amortization of actuarial losses. Income Tax decreased 37 million or 16%, primarily as a result of a onetime tax recovery. This has been backed out of adjusted earnings. Branding out the income statement, adjusted diluted EPS grew 6% to a record $5.06 in the quarter. Moving on to full year results on the next slide, the fourth quarter performance caps an impressive year for the CP family. Our full year operating ratio was a record 57.1%, a 280 basis point improvement year-over-year, as we continue to demonstrate our ability to improve margins and deliver the best OR in the industry. Adjusted income grew 5% and a record adjusted diluted EPS increased 7%. And we achieve this all while achieving record safety performance. As we look forward to 2021. Our guidance assumes high single digit RTM growth, CapEx of 1.55 billion and double digit adjusted EPS growth. A few specifics to call out, you should model an increase of approximately 30 million in comp and benefits from pension current service costs largely as a result of a lower discount rate at year end 2020. Similarly, depreciation is expected to be approximately $45 million higher in 2021 as a result of a larger asset base. But as I said earlier, we are paid to overcome headwinds. And we see and we see further opportunity to continue improve margins in 2021. And I fully expect us to continue to lead the industry on that measure. Moving on to free cash to wrap things up, 2020 cash from OPS decreased by 6% to 2.8 billion and CapEx came in slightly above the guided 1.6 billion as we pulled forward certain capital projects in order to leverage the economic recovery in 2021. We have a disciplined approach to capital investment and the strong returns we're generating are evidenced by an adjusted ROIC of 16.7%, also an industry best. As we go forward, we expect to bring the capital envelope down in 2021 given the pull forward I mentioned and anticipate to spend 1.55 billion. Free cash came in at 1.2 billion. As we continue to grow earnings and remain disciplined on capital, you can expect to CPs free cash conversion continuing to improve both in 2021 and beyond. I think another area we differentiate ourselves from our industry peers is that despite the volatility we all enjoyed this year, we continue to reward shareholders. We paused our buyback early in the second quarter given the uncertainty in credit markets, but in June with confidence in our outlook combined with the strength of our balance sheet, we resumed our buyback. Ultimately, we completed 90% of our latest share buyback program at an average price of $369 per share, significantly below current prices. In 2020, we returned $2 billion to shareholders through share buybacks and dividends. And just this morning, we announced a new 2.5% buyback program. We also announced the proposed five to one share split that will be presented to shareholders that are 2021 AGM. We think this is an appropriate step to enhance liquidity in the stock and provide better access to ownership for a wide range of investors. Our balance sheet remained strong with leverage of 2.5 times net debt to adjusted EBITDA. So let me wrap up by saying 2020 was a challenging year and CP demonstrated resilience in the face of significant uncertainty. We're able to provide guidance to the investment community throughout the year. And we'll continue to provide transparent and achievable guidance as the uncertainty lingers. This is a team that sets a high bar and has a track record of overachieving. If you look back at the first four years that Keith, John and I've worked together in these roles, the company has delivered a CAGR of 16% EPS growth. Our ROIC has also improved from 14% to 16.7% during that period. And I can tell you, we're not done. We're all excited about the opportunities ahead of us. If we can deliver the lowest operating ratio and best revenue performance at a pandemic, it's extremely exciting to think about the art of the possible as the economy recovers in 2021 and we benefit from operating leverage. Its why don't worry about headwinds. So with that, I'll pass it over to Keith to wrap up

[Keith Creel:]

Thanks for the color John and Nadeem. Exceptional, that's the word I think about, an exceptional year, it's enabled by an exceptional group of railroaders at this company to set us up for an exceptional 2021. We're ready for the year. We've got the momentum, moving into '21 wins at our back. This team is ready to produce. So with that, let's open it up for questions.

[Operator:]

Thank you. Your first question comes from the line of Chris Wetherbee from Citi. Your line is open.

[Chris Wetherbee:]

Hey, thanks. And good afternoon guys. Maybe wanted to sort of dig into the RTM growth outlook a little bit deeper. So I think as you mentioned, there's sort of an inflection that's been going on here, so I guess maybe if you could help us sort of highlight maybe some of the specific biggest opportunities that you see whether it be on the intermodal or otherwise, as you look at 2021. And then can you also help us a little bit with the cents per RTM to if you don't mind? Just there are some FX headwinds I think you will be facing to some degree, so just want to kind of get a sense of how that might translate relative to total revenues. Thanks.

[John Brooks:]

Yeah, so maybe, Chris, I'll start on the cents per RTM a little bit. I think looking back at Q4, we did see a little bit of mix. We had a really strong bulk quarter long haul, Vancouver grain long haul P&W grain. As I said, record potash that created a little bit of headwind overall on that front. We're facing that cents per RTM negative VRCPI on the regulated grain at least through August of 2021 looking ahead. We did lap some pretty big LDs from last year Q4, as it relates to our crude by rail business. And we'll face a little bit of that, I would say, at a declining rate, as you move through 2021. And as you mentioned, and we'll get to some point where we start lapping that - the fuel, and ultimately FX headwind that we've - we faced in the cents per RTM. Looking at the volume, we're excited. This year is going to be a big year for CP in terms of a lot of the projects that have been under development. Really the last couple years a number of them have come to fruition, but we've got a quite a number of them that are really just starting to ramp up and hit their full potential. As I mentioned, the automotive space continues and it looks to be a really solid tailwind for us not only in terms of volumes, but also cents per RTM. The Glovis business, frankly, is looking to be about 30% bigger than we anticipated. We've got our Schiller Park compound that we're just on the verge of starting to get some volume running through that facility. We've taken a dormant facility in Calgary and filled that up with FCA and others and of course we've had a ton of success in our in our Vancouver auto compound. So I'm quite bullish in the automotive sector. But really as I go down the list, I expect big things in the bulk franchise. We should continue to sustain what you've seen in grain and grain products. Our biofuel plants are back running at 97% to 100% capacity across our network. We've got a couple facilities actually in biofuels and also frac sand that had shut down during the pandemic that are coming up and I expect to give us a little bit of a tailwind in those areas. The ag nutrient side is I think quite exciting for 2021. Canpotex has pretty ambitious growth rates for us as we continue to enjoy that business. Our general fertilizer business particularly with Mosaic looks particularly strong. So I am bullish across the board and that's without even getting to the full ramp up of our Maersk business and then as Keith mentioned the opportunities that we're going to see Saint John in 2021.

[Chris Wetherbee:]

Okay, that's great answer. The only clarification just on the cents priority, I'm going back to that. Does that sort of mean flattish, maybe slightly negative on that, just kind of curious?

[John Brooks:]

You know what, I think to start 2021 may be slightly negative and then an inflection, I think Chris, has you move towards the back half of the year.

[Chris Wetherbee:]

Perfect. Thanks for the time.

[Operator:]

Your next question comes from the line of Tom Wadewitz from UBS. Your line is open.

[Tom Wadewitz:]

Yeah, great, I - let's see, I don't know if I can ask you to add a touch more color on the kind of the grain comment that I guess Chris was hitting on. I don't know if you want to count that as a question or not. But my primary question is on the crude business, it seems like I guess the Keystone XL getting cancelled again and DRU ramping up in second half. I'm wondering if you see - you would expect to see some indications that there might be more interested in additional DRUs or more optimistic look on crude. I know it's pretty a volatile business. But I guess that's, kind of the primary question. And I don't know if you mind adding a quick - a little further thought on the grain revenue cap impacting first half?

[Keith Creel:]

Yeah, thanks. I'll take I'll take the DRU view and then I'll let John speak to the grain piece. So Tom, to your point, the answer is yes, we do think that the administration actions, the executive order, the pipeline that bodes for more strength and more potential demand for crude. We think it creates more support for scaling up and expansion of the DRU, so we're bullish on that opportunity. And then overall, although we still see the short-term, not long-term, eventually, pipeline capacity is going to catch up, we just think there's a longer tail on it now. So we think there's going to be a space for some potential upside in both spaces. And again, the most exciting part about the DRU as that scaled up is that tradable business that's going to be part of our book of business on a go forward. It's protected, its pipeline competitive, we're talking about 10-year contracts, so it's environmentally positive. So again, across the board, that DRU piece is really, really exciting for us. And given that the facility that's being built now is going to come online midyear and we exclusively serve it in Hardisty and its scalable, it can go up to twice as large as it's coming out of the gate at. That's pretty exciting. It's really exciting.

[John Brooks:]

And Tom, just to come back to your grain question, so just on the regulated Canadian grain, we've got the headwind on the VRCPI. So we'll manage that like we do every year our regulated grain rates and then actually we expect that to inflect and turn positive as we move into the new crop year.

[Tom Wadewitz:]

Okay, thanks for the time.

[John Brooks:]

Alright.

[Operator:]

Your next question comes from the line of Ravi Shanker from Morgan Stanley. Your line is open.

[Ravi Shanker:]

Thanks. Good evening, everyone. Keith, I think you said that on the OR side, you're targeting well over 100 basis points improvement, maybe you or Nadeem can kind of give us a little bit more of a walk there. A, does that mean - what's well over 100, is it 150 or is it 300? Sorry, I know I'm being a little bit greedy here. And maybe kind of how do we think about some puts and takes here? I know you mentioned depreciation, but any other big items to keep in mind?

[Keith Creel:]

Ravi, you got to tell me what the spreads are going to do in crudes, you got to tell me what the crop year is going to be next time around. If you could give me those numbers and a few other inputs, I could land on that OR number, but I feel confident and better than 100 points for sure. I don't know if I'm going to commit to three, but it's going to be somewhere in between. Nadeem do you want provide some color?

[Nadeem Velani:]

I don't think there's too much more to add than that. I think, Ravi, you look at some of the opportunities of what we've delivered in the last few years with volumes actually declining. And if you listen to John, and what we believe as far as our RTM growth. I think we are very bullish on the volumes and we've seen the volumes return and we have a lot of initiatives that John mentioned are ramping up, in addition to things we're doing today. So with a volume increase in a low-cost basis, the operating leverage that this team has shown we can deliver on at a cost structure that's entering 2021 so low, we feel very good about what we can do from an operating leverage and incremental margin point of view.

[Keith Creel:]

Yeah, I think I already coined last week is a double nickel, we're not going to commit to a double nickel in '21, but we certainly have our line of sight. It's in our crosshairs would be the best way to say it.

[Ravi Shanker:]

Understood. Thank you.

[Operator:]

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

[Fadi Chamoun:]

Thank you. Good afternoon. Three quick points, just clarifications related to each other. First, what is the FX that you are baking into the EPS guidance? Second, the energy cents per RTM was 5.9 in the fourth quarter, which I thought was pretty big drop from the trend we saw in the first, second and third quarter, if you can talk to that as well and kind of talk to us through how does that look like going into 2021? And overall I mean, related to that mix cents - cents per RTM, you're saying RTM growth, kind of high single digit, let's say, 7% to 8% that's kind of what you mean. When you include FX and the mix issues like does that number kind of stay around the same? Does it go up? Like, are we - is the mix overall for fiscal 2021, would be positive or neutral?

[Nadeem Velani:]

Sure. So Fadi, let me start and John can add - jump in. FX, we're looking at around current levels or around 128 level through the year. So could there be upside or downside. I just point out that FX it has a translation impact, but the reason that the Canadian dollar is strengthening is supportive to us. So that means that the Canadian economy is recovering in a positive manner. And it means that typically commodity prices and namely crude is improving. So sure, it can be a translation headwind, but net-net, it's an overall positive. It helps our balance sheet as far as our leverage metrics and as far as our US dollar denominated debt, it lowers our CapEx spend and like I said, it helps overall our volumes. If you look at - to your point on the crude cents per RTM, so as John mentioned, we lost some liquidated damages in Q4. And so you see the impact of that in the cents per RTM on crude. We talked about that likely will continue through the year, especially if you assume a certain level of crude, we've been very conservative in our view. So I think if you get the benefits of spreads, widening, if you get some of the longer-term benefits of production ramping up, I think we could have further upside on crude volumes, which again, will impact our cents per RTM, right. So we'll have less liquidated damages, but we'll be moving more business which again, is a positive. Net-net with currency it is to Keith's point going to be somewhat dependent on what fuel prices do from cents per RTM point of view. But I think you'd have a modest decline is where we're seeing things as we stand here today. If fuel surcharge ramps up that can be kind of neutral.

[Fadi Chamoun:]

Okay, very helpful, thank you.

[Nadeem Velani:]

Yeah.

[Operator:]

Your next question comes from the line of Walter Spracklin from RBC Capital Markets. Your line is open.

[Walter Spracklin:]

Yeah, thanks very much. Good evening, everyone. I guess, I want to go into the OR question and with the double nickel target. I know Keith, when you came over to CP you had a model that you'd executed on before and you were looking forward to executing it on at this organization and certainly have done so. My question though I guess is, are you in unchartered territory now in terms of new improvements, and how much of OR improvement now is going to come as a result of technology? I noted in your appendix, you've got a few slides on technology. I'm sitting at home not being able to go out with the pandemic and I've been going through your LinkedIn profile. You got some pretty interesting videos on some of the technology that you're implementing both from a safety standpoint and from an efficiency standpoint. So is this now, new territory? How much is technology going to have to play a role here in getting your OR improvement down further, just any thoughts on that would be helpful?

[Keith Creel:]

Well, I would like to say that we certainly have in our mind all that opportunity. Walter, it is new. Given that we're just at the point the exemptions we got for Transport Canada using the portal and using the Coldwell technology that's literally two months old. So we'll continue to grow in that. It's going to be incremental change. It's going to be incremental benefits of protecting our margins and its part of the formula allowing us is it's just a natural outcome of running our business as long as we bring on sustainable profitable growth, those are key words, those aren't just catchphrases. You got to bring the right business mix; you got to make a buck doing it. And it's got to fit your network. You can't overstretch your network and create some kind of congestion that that jeopardizes your ability and destroys your cost structures or drives additional capital expense. There's a fine balance that has to be managed. We've got a commitment to our customers. Asset terms matter, velocity matters, all those things that a PSR formula is truly baked upon, it's foundational and you got to respect that. But if you layer on technology, on top of that, whenever you can improve the safety, performance and we prevent those realms, every time we have them. Number one it's a challenge. It's our social responsibility. It's a challenge our social license. It's certainly nothing that we desire to occur. So everyone we could prevent is a positive there. But from a dollars and cents standpoint you're talking millions of dollars, every time you put a mainline trainer most times that you put a train on the ground, it tracks speed that's a lot of money. And it's a lot of adverse impact to the network fluidity given the way we run the business, because essentially, it's like capital. We got a lot of planes flying around Pearson Airport or O'Hare with nowhere to land and they're burning fuel and burning dollars and taken out efficiency and consuming capacity. So these technologies - that's the approach that we're taking, they've got to be practical, they've got to be executable. I'm not going to be bleeding edge. We're going to develop technologies that we can convert, not talk about for four or five, six years, convert the data to make it a safer, more reliable, more efficient, lower cost, better service railroad. That's what we're doing with our Coldwell technology. That's what we're doing with our big data analytics and algorithms that we use to have more predictive analytics to allow us to identify mechanical defects before they become an issue with the train. That's what we're doing with our broken rail detection that we've created ourselves our home-built solution to that challenge, where we don't have CTC that we're deploying. We've got about four subdivisions that we've completed. By the end of this year, we'll have 11, and we're doing it at a fraction of the cost. So again, those are all part of our pursuit of operational excellence. It's just part of consistently getting better at what we do. Becoming better railroaders and leveraging technology, not to hit a home run, but just to consistently hit singles and doubles, and those singles and double add up to runs and you start adding those runs up and you start winning ballgames.

[Walter Spracklin:]

Pretty exciting stuff, I appreciate the time.

[Keith Creel:]

Thank you, Walter.

[Operator:]

Your next question comes from the line of Allison Landry from Credit Suisse. Your line is open.

[Allison Landry:]

Thanks. Good afternoon. So your - the main competitor you've been talking about scaling up the business and focusing on yield management. I would think this is a clear positive for CP, but maybe if you could speak to your thoughts just on the overall pricing environment and whether you think maybe there's a structural acceleration here that's taking place as a result of not only these actions, but just the fact that that rail service probably is getting better. Any thought there would be great. Thank you.

[John Brooks:]

Yeah. Thanks, Allison. You know what I do. I think this feels a lot like the environment we faced back in, I guess it would be 2018 where we saw a I think, pretty strong year across the board and the rails on pricing. Just the volume growth that I see out there and literally as I look down our list of commodities, I think there's pricing opportunities in just about every one of those sectors. I can tell you we've been very creative in how we've approached managing this capacity and working with our customers around surge, equipment, but capturing the price for the value of that that service. Q4 renewals were quite strong. I would say on the upper end of the targets, we traditionally talk about that and I'll remind you my sales team is largely compensated on their ability to deliver price and to have that price disciplined. But I would maybe close by saying it's not a flavor of the day at CP. It is been, since I've taken this role under Keith's guidance and working with Nadeem, our effort is been around pricing day in day out for the capacity we have and the service we're bringing to the table. And that's not going to change. I was wildly pleased with how we performed in the face of a pandemic. And now with some tail winds, I can tell you there's a lot of focus to do the same as we move into 2021.

[Allison Landry:]

Okay, thanks, John.

[John Brooks:]

Yeah.

[Operator:]

Your next question comes from the line of Ken Hoexter from Bank of America. Your line is open.

[Ken Hoexter:]

Hay, great. good afternoon. Just to clarify Nadeem to Ravi's answer there, you include - you're including the gain from the asset sale, you're not normalizing it out. So when you talk about 100 basis points, Keith, you're talking about on the 571 right, I just want to clarify that before I ask my main question. But the question I had was, go ahead.

[Nadeem Velani:]

So yes, Ken, I mean we reported a 571 OR. We would expect to improve off of that. That's where you get to the double nickels that Keith was talking about. We're not saying on an any sort of adjusted OR.

[Ken Hoexter:]

Perfect, thanks. And then given the Maersk and intermodal growth and all the scale that you're talking about in RTMs, can you just talk maybe, John, about your thoughts on the capacity out west? Or I don't know Nadeem, if you think there's need for siding or capital deployment, you talked about keeping CapEx the same, but maybe talk about how that's going to be deployed? Thanks.

[Nadeem Velani:]

Yeah, I mean, specifically, Ken, looking at port capacity out in Vancouver, I feel - we feel quite comfortable with the relationships in the direction that that GCT and DP World between the Deltaport between Vanterm and Centerm to handle the business. We've got a new train, pair and design that will - I think we're super excited about how we can compete in the market from Vancouver into certainly day in day out Toronto in eastern Canada, but as we grow our business into the Minneapolis market, with the capacity, we've added in our Shoreham intermodal terminal, and also into Bensenville that we're going to have quite a product. And you lookout east and Keith mentioned this, we are - the Port of Saint John embarked upon about a $200 million modernization project and that's going to quickly step their capabilities up to 300,000 TEUs annually, but we've got line of sight in working with the port and the province, and then frankly, all stakeholders out there to get that port up to an 800,000 TEU facility. So I don't see capacity at the terminals being an issue. And PSR railroading and all the things we've talked about, I think we feel quite comfortable around our product to deliver inland from those ports.

[Keith Creel:]

Yeah, Ken, let me add a bit of color on the line capacity. We're not in any location constrained from line capacity. With that said, part of our normal cadence of doing business every year we're spending what I call capacity capital dollars, surgically investing in strategic sidings, we've got a list based on delays, based on velocity, based on capacity across every corridor, they're prioritized based on the return. And we've continued to invest to create that additional line capacity, that if we don't need it from a business level and we have it, we return it to asset terms. So you think about 2020 when everybody else is cutting capital, we didn't cut our capital we spent more capital in '20 than we ever have in the company's history. So rest assured we've got some capacity in our back pocket to execute on these contracts and these contracts when it comes to service. We talk about the cost destruction when you over commit to railway, talk about the reputational destruction when you over commit to railway when we go and negotiate these contracts. I'm at the table with John. So all these contracts, these major contracts that we're committing, I've got a commitment to my customers that exists with us today. And we're putting our word and our reputation online with those new customers. And the commitment I make to each and every one of them is I'm not going to oversell my railway. I know the value that it destroys for the customer as well as for this company. And that is not going to happen on my watch at Canadian Pacific.

[Nadeem Velani:]

And I'll just add, Ken, that from a capital point of view, many of these deals, we ended up doing that requires capital, we partner with our customers to co-invest. So there's - we both have skin in the game, we both have a certain level of return and conviction and it tends to be a long-term deal. So John knows from me and my team, the expectations as far as what the returns need to be. And I think that that's added to what you see the output of ROIC close to 17% that we put that discipline into the process. We don't need the practice of moving it as Keith says, it's - it has to have the - generate the right return.

[Ken Hoexter:]

Thanks Keith, Nadeem and John. I appreciate it.

[Operator:]

Your next question comes from the line of Steve Hansen from Raymond James. Your line is open.

[Steve Hansen:]

Yeah, good afternoon, guys. Thanks. A question for John on the grain opportunity, John, you're coming off a record year that should be congratulated. But the bar is now higher. Ag fundamentals do look really outstanding right now, which I think plays in your favor for '21. But I think I was most struck by your comments on the number of new elevators that plan to come online for your 8,500 model. Could you maybe just elaborate a little bit on where those elevators are coming for? You referred to network development, but I'm just trying to get a sense for your confidence in those coming on this year and your ability to push higher in the '21 here? Thanks,

[John Brooks:]

Steve. I think what a lot of folks maybe don't sometimes understand in our ag franchise is we've been the leader of developing these big high throughput elevators. And what we're doing now is less about adding new dots on the map in terms of elevators, but more working with our grain shippers to now reinvest in other elevators to expand them to our 8,500 foot model. And as I said, we've got 31 of those active today. In the coming year, we're going to add 15. So that's 15 I think the numbers would break out Steve, the three new ones coming online and 12 existing elevators that'll be expanding to the 8,500 foot model. So that means 56 car facilities, 112 facilities, expanding up to two handle 134 plus cars. That converting ladder tracks and the loop tracks across the prairies. That's adding sightings outside of facilities, so trains can get off our main line. It's allowing the ability to keep our power on our trains when they land at origin so they can be quickly loaded and launched. And when I say quickly loaded that's under 12-hour load times. It's adding that next level of efficiency across all of our elevators. And then when you combine that Steve with the investment in the covered hoppers that becomes a powerful thing. And frankly, that's what gives me the optimism when you spread that across Canadian franchise that continues to grow in terms of yields and production. And frankly, quite a bit of headway across our US franchise to develop it. It also to meet the growing demand that we think is going to have a continued tailwind for exports up the P&W. That's what gives me so much excitement about the ongoing growth of our grain franchise.

[Steve Hansen:]

That's great color. Thanks.

[Operator:]

Your next question comes from the line of Jon Chappell from Evercore ISI. Your line is open.

[Jon Chappell:]

Thank you. Good afternoon, everyone. Keith at the very beginning I thought it was interesting your comments on proving the naysayers wrong. As good as the years you had. Everyone thinks that at a certain point you hit a ceiling. So as you think about not just '21, but also beyond that are there other CMQs out there? Are you chasing big fish like Glovis and Maersk contracts or is it just basically taking this capital envelope that you continue to spend in blocking and tackling with the current network and the current group of customers and just trying to keep taking share from the service that you provide?

[Keith Creel:]

Well, I'd say yes. I'm not aware of any CMQ like opportunities. I would say that we keep a strong financial position or keep our balance sheet strong and powder in our pocket so that we can be opportunistic if one of those comes up. And in the meantime, it's about building out this network that we have. We've just began to do this great work with the CMQ and all that potential to realize that potential. And I firmly believe I've said this before, I made a comment that success breeds success. When you're working with some of these big players like a Maersk, you're working with some of these automotive companies, you're working with a Glovis, you're working with competitors, they have competitors. And if you're helping become part of their success story, that gives them a competitive advantage in their marketplace, then their competitors are going to say, wait a second, I've got a match that, I've got to try to develop some of those same synergies. So again, that gets to picking your partners and picking your partners wisely, we're never going to be everything to everyone, but rest assured the partners that we partner with, we're going to give them a service that gives them an experience that allows them to compete in their space, and allows them to take share and through that we'll grow with them. So that's the strategy. John's got a list of opportunities. Still, these things don't happen overnight. These big what I call pendulum swingers, momentum creators, they take several years in the making, it's not something that's going to happen overnight. We announced just recently, I guess it was last quarter as well, about our intentions to build out our facility or transload facility in our terminal in Vancouver. Rest assured there's already been discussions that that announcement has enabled and there's some before after, where they're going to be customers that come in there, they're going to create capacity and create commerce for Canada as well as CP at the same time and that's the two-to-three-year timeline, before we get to that point and beyond. So again, the one thing we are blessed with, besides the greatest railroaders in the world in a franchise, in the lanes we run in that can't be paralleled by our other rail competitor. Because we run short link to fall is plenty of land currency to convert and grow in our own footprints without having to get into wars with municipalities or trying to buy land that may not be obtainable. I can grow in Vancouver, I can grow in Calgary, I can grow in Toronto, I can grow in Winnipeg, I can grow in Chicago, I can grow in Montreal, we have landholdings contiguous to every one of those terminals that can create customer solutions and that's exactly what we're about the business is doing. So you can continue you'll expect to continue to see that playbook play itself out at this company for the years to come outside of any kind of acquisition we might participate in.

[Jon Chappell:]

Great, thank you, Keith.

[Operator:]

Your next question comes from the line of Jordan Alliger from Goldman Sachs. Your line is open.

[Jordan Alliger:]

Yeah, hi, I just had a couple cost questions. I'm curious on the purchase services side and just was wondering is that sort of snapped back to more normalized ranges as a percentage of revenue, post this quarter? Then maybe if you can just touch a little bit on sort of your thoughts around cost per employee or wage inflation as we move through next year? Thanks.

[Nadeem Velani:]

Sure, so a couple things to add. Yeah, we would expect purchase services to get more normalized, absolutely. We get the benefit of the Detroit River Tunnel this quarter, which is outside, absolutely. Cost per employee. So based on our high single digit RTM growth, you should expect kind of low single digit employee increase. And on the cost side I mentioned a $30 million impact from current service costs related to pension. We'll see how we perform the suite. We have comp tied to our performance and our STIP or our annual bonus paid out is going to pay out at a very high level this year, meaning for 2020. So we accrued at a very high level. So hopefully, it's at the same level that means we're executing. If not, then that would be a tailwind. Stock based comp, same thing. We're the best performing rail stock in 2020. We had significant headwind from stock-based comp as a result on the mark-to-market of the stock price. Hopefully we have the same problem. I'm sure shareholders won't complain. So that's somewhat dependent on again, how we perform and how the market performs as far as CP stocks. So if we have another strong year then it'll be neutral. And you would expect the cents per RTM to be similar levels, if we - if our stock doesn't have the same level of increase then you should assume the cost per employee to come down a bit. So those are the elements.

[Jon Chappell:]

Thank you. Thanks so much.

[Nadeem Velani:]

Inflation relatively - yeah, no problem Jordan, inflation, I would assume about a 2% type of level as well for our overall inflation.

[Jon Chappell:]

Thank you.

[Operator:]

Your next question comes from the line of Brian Ossenbeck from JPMorgan. Your line is open.

[Brian Ossenbeck:]

Hey, good evening, thanks for taking the question. Maybe one for you, Keith, when you talk about being part of success for the partners in your shippers, service and growth and capacity, I would say part of that, but you have a couple of extra slides on ESG. A few reports and ratings just came out. Is that angle or is that initiative really starting to resonate with some of your customers or partners? Is that more on a short-term basis where you've got their attention? Or do you feel like you've really started to form some partnerships that maybe are being driven by this factor above and beyond what you normally provide for them?

[Keith Creel:]

Yeah, that's an area that obviously is becoming more and more topical every day and more - its importance is growing, it's growing stronger, it's not demeaning at all and it is part of the cell cycle. It's part of the discussions that John and his team are having with our customers, because our customers obviously have the same concerns we do about the environment. And when they can see, the rail is an opportunity to partner with and again, that's why it's important in my mind that we take a leadership role in this space. We're proud to talk about - we announced our hydrogen hybrid battery locomotive that we're developing. So I've got a - we're blessed with a team of very intelligent, talented engineers, led by Dr. Mulligan that they've created their own lab, they're developing a hydrogen fueled locomotive for the rail industry. That's a game changer. There's hydrogen solutions out there in Europe not for freight though, more for passenger. So is it robust enough, strong enough? So the challenge is how do we do that? Well, it's a challenge they've taken on and when you take that kind of a leadership role and it's not just again, semantics or words, its actions. I've been in the lab, I've seen the hydrogen fuel cells they've created create electricity and power and electrical motor, I've seen the locomotor. They're in the process of converting. A year from now we'll have power locomotor maybe a year and a half at the most we'll have a power locomotive in Calgary, this could be switching customers using hydrogen. And it's not our objective to get into the locomotor producing business. It's our objective to prove what's possible, to prove out the concept, and then go to the OEMs and say, listen, here it is, this is what it looks like, make it better, create a solution for the industry because this industry needs that. So those are all spaces that our employees get behind and we get behind it. And it absolutely is becoming part of not only what we do and who we are, but how we sell. The other one thing I'll comment to you that we're super proud of, literally, within another four weeks left we'll finish completion of our solar farm in Calgary. If you've ever been to our corporate office, it's a converted rail yard. We're blessed with a big footprint, physical footprint. And we said hey, how can we innovate here? And why are we burning fossil fuel created energy? Why don't we create our own? So why don't we build a solar farm? We've built the single largest solar farm about to complete. I would suggest, outside of commercial space in Canada we'll be I think the only corporate office that's 100% zero carbon footprint fed run in our power, run in our lives, run in the business that we do at our corporate office. That's something again, we're extremely proud of. It's great for the environment. It's great for our employees, and it's great for society.

[Brian Ossenbeck:]

Thank you, Keith.

[Keith Creel:]

Thank you, Brian.

[Operator:]

Your next question comes from the line of Scott Group from Wolfe Research. Your line is open.

[Scott Group:]

Hey, thanks, good afternoon guys. Nadeem, I want to ask on CapEx and free cash flow. So it's below 20% of revenue this year in the guidance Do you think that's sort of the new normal and then with CapEx down and earnings up what's realistic for free cash flow conversion this year and longer term?

[Nadeem Velani:]

Thanks Scott. So yes, I mean, our capital spend when we look through the next three years, it's in that range. Coming down a bit over in 2022 and into 2023 as we roll off investment of the hoppers, so we'll have less hoppers in '23 and that'll be our final year. So you'll probably get down to about the $1.5 billion CapEx level at that point outside of any other major investment that - but nothing upcoming that's in our pipeline as we speak. So certainly, we do feel that our free cash generation is going to - conversion is going to improve rather dramatically as we increase our income and CapEx comes down. I think we're kind of in that 3%, 3.5% level right now. Do we think we can get to 4% and approaching 5% over that timeframe? Yes.

[Scott Group:]

What's that metric you're referring to, sorry?

[Nadeem Velani:]

Free cash - our free cash yield.

[Scott Group:]

Okay, perfect. Okay.

[Nadeem Velani:]

Our free cash conversion approaching 80%.

[Scott Group:]

Super helpful, thank you, guys.

[Nadeem Velani:]

Thanks, Scott.

[Operator:]

Your next question comes from the line of Justin Long from Stephens. Your line is open.

[Justin Long:]

Thank you. Good afternoon. I just wanted to ask one about the 2021 guidance. Nadeem, could you talk about any gains on sales that are baked into that guidance? And then as we think about the first quarter, anything directionally you can give us to help think through the DLR that you're assuming within the guidance as well?

[Nadeem Velani:]

Not to get too much into quarterly OR guidance, buy you just expect a sub 60 OR. And obviously, Q1 is a bit more challenging with the weather, with the seasonality on volumes, with some of the stock-based comp payments that occur. So that's natural - naturally will improve from there and get - well, if you want to get to the numbers, we're talking about you could probably do the math, but I would expect Q1 will be the tougher kind of year-over-year comp. And then as we - sorry, your second question?

[Justin Long:]

Any games on sale in the 2021 OR guidance you gave?

[Nadeem Velani:]

Yeah, they are - I mean, we didn't give OR guidance, but I would say that we do expect some level of gains on sales. We do have a couple of projects, we'll see if they close or not. But our EPS guidance of double digit EPS growth does not necessitate any level of gains on sales.

[Justin Long:]

Okay, that's helpful. Congrats on a great year. Thanks.

[Nadeem Velani:]

Thank you.

[Keith Creel:]

Thank you.

[Operator:]

Your next question comes from the line of Brandon Oglenski from Barclays. Your line is open.

[Brandon Oglenski:]

Hey, good evening, everyone. And thanks for taking my question. I know it's been a long call, but I do always love the enthusiasm that you guys have. It shows through in the results. I guess Nadeem, coming off from Scott's question on cash flow, is this the time to be having a healthy discussion buyback versus dividend and is the thought process changing there at all?

[Nadeem Velani:]

No, I mean, we - I'd say that we've had a bit of a more balanced return in the last call it three years. We've been increasing our dividend. And I think that we have been pretty transparent in terms of our goal of getting a payout ratio closer to 25%, 30%. We've been the fastest dividend increaser in the industry the last five years. I think we will be named to the dividend aristocrats fund S&P Canada. Starting next week, we'll enter that. So we're making headway. The problem is - first class problems, I guess is our EPS is growing, like I said, close to 16%, the last four years. So we're mindful that we want to - that our shareholder base has also changed and there's an increasing due that - they want a bit more dividend and we're trying to have a balanced approach. We've also been very mindful that our stocks been underpriced. There's other rails that that may not execute as well, but they get better premiums. And so it's been an opportunity to continue to buy back our stock cheaper, which I think our shareholders have been very pleased with. I think we bought back close to $10 billion of stock over the last since 2014 at half the - half of today's price. So it's been a good opportunity to have a balanced approach. So we are also price dependent. So bottom line is you can expect this to continue to increase the dividend probably at a faster pace to get to that 25% to 30% payout ratio. But we will still continue to have share buybacks as our natural opportunity and course of returning cash to shareholders in that around 3% level.

[Brandon Oglenski:]

Thanks Nadeem.

[Operator:]

Your next question comes from a line of Benoit Poirier from Desjardins Capital Markets. Your line is open.

[Benoit Poirier:]

Yeah. Good afternoon, gentlemen. A quick question Nadeem, could you maybe provide some color about the capital envelope for share buyback this year, and maybe also to provide some color on the opportunity to deploy the available 1000 acres of excess land in terms of how many year or maybe more specifically about the cadence in 2021? Thank you.

[Nadeem Velani:]

So our buyback, I mean, we for the most part, complete our buybacks. This is the first time we didn't do a - complete an NCIB since we've been at CP. So we announced the 2.5% program. I'm not sure how much it's going to cost. The market's volatile. So it's dependant on what your expected stock price is going to be Benoit, that's going to drive really the math of it. So we will - we constrain ourselves to not push our leverage more than two and a half times. We want to make sure that we protect our balance sheet as Keith talked about earlier. So if the stock gets too expensive, we will hold back. And we also stagger our buyback decisions and our dividend decisions, partly for that reason as to give us a bit more visibility on that decision making and a bit of time to see how the market is reacting. So that's how we think about it. I won't tell you what we are expecting to pay because I can't predict the stock price. On the land question just Can you clarify? I didn't fully hear the entire piece of the question.

[Benoit Poirier:]

Well, you've been quite good over the years to leverage the available real estate. And I still - there are still 1000 acres of available land that you could leverage down the road in the future - in the years ahead. So I was just curious to have maybe more color about the opportunities you see in 2021 to leverage this excess real estate Nadeem?

[Nadeem Velani:]

Sure. So we do have a number of transload and investments that are - we are in the midst of across the property. So whether that's Vancouver, Southern Ontario, Chicago, just completed some transload work in Montreal as well. So that's kind of an ongoing basis. Now, there's a lot of - that's a lot of land the 1000 acres. So we'll see what comes up, but it'll - that's enough land for a long time. But as far as selling land, we have a little bit of opportunities, it's somewhat dependent on the market, somewhat dependent on interest out there, we're not actively - usually actively looking to sell land until - unless there's an operational aspect to it that we could benefit from or that can - used as an opportunity. So right now, I think there's a little bit of land available that we're getting some active interest and that's why I said we may have some land sales in 2021 the magnitude of which - I mean, in the range of 25 million to 50 million type of range is what could occur, but again, we're not counting on it.

[Benoit Poirier:]

That's great color. Thanks for the time.

[Nadeem Velani:]

Thanks Benoit.

[Operator:]

Our next question comes from the line of David Vernon from Bernstein. Your line is open.

[David Vernon:]

Hey, guys, two questions for you John on the end market side. First, whether a closure the Dakota Access pipeline would be material for your guys' crude by rail franchise? And the second question is really about Saint John and opening up that intermodal flow. I'm curious to know what type of the inland ports, the steamship lines you're looking at for that traffic? Is it Canada bound traffic? Is it US bound traffic? And then how do you think about the margin profile on that project? Because I imagine there's going to be some trade imbalances as you start to initially launch that service.

[John Brooks:]

Yeah. No, David. Dakota Access, yeah. No, we're watching it closely. We do ship Bakken crude out of North Dakota and obviously, if something happened with that pipeline, we think that would generate an opportunity, of course, there's been a lot of noise around that pipeline for a number of years. We've been able to generate some pretty I would call stable crude by rail business out of North Dakota. But I think certainly there is an opportunity for upside if they would move towards shutting it down or putting it on the sideline for a certain amount of time. As it relates to Saint John, I can't be more excited about the opportunity. And it's just not the import export business that we've talked about extensively in that ramping up, but it's also the domestic intermodal opportunity in and out of the Maritimes there. Again, our competitors enjoyed that Atlantic Canada market really without another competitor for quite some time. Certainly there's a lot of capacity on existing trains that are running there today. I don't have a lot of concerns relative to the initial margin play. There's a ton of upside to add a number of incremental cars into those train movements from Saint John over to Montreal. I think what we see initially the - maybe a little bigger mix going down into the US in the Chicago market. But I would say as it balances out, it'll be Canada, it'll be Montreal, it'll be Toronto. There might even be a little bit of moving into western Canada. But principally Chicago, Montreal and Toronto is the key markets.

[David Vernon:]

Alright, thanks very much. That was very helpful. Thank you.

[John Brooks:]

Yeah.

[Operator:]

We are now out of time. I would now turn the call back over to Mr. Keith Creel.

[Keith Creel:]

I think I want to thank everyone for their attention, their questions. Thanks for sticking with us this afternoon and allow us a chance to share our exciting story. As I said in the beginning, we had a phenomenal exceptional 2020, set us up for an exceptional '21 and we certainly expect to overachieve. Stay safe. Thanks and we look forward to talk to you to share our first quarter results in April or March, April. Take care.

[Operator:]

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