Oct 13, 2016
Executives
David Baggs - VP, Treasurer and IR Officer Michael Ward - Chairman and CEO Frank Lonegro - CFO Cindy Sanborn - COO Fredrik Eliasson - Chief Sales and Marketing Officer
Analysts
Tom Wadewitz - UBS Danny Schuster - Credit Suisse Rob Salmon - Deutsche Bank Ravi Shanker - Morgan Stanley Ken Hoexter - Merrill Lynch Brandon Oglenski - Barclays Brian Ossenbeck - JP Morgan Christian Wetherbee - Citigroup Bascome Majors - Susquehanna Scott Group - Wolfe Research Jason Seidl - Cowen Ben Hartford - Robert W. Baird Cherilyn Radbourne - TD Securities David Vernon - Bernstein Scott Schneeberger - Oppenheimer Justin Long - Stephens Walter Spracklin - RBC Capital Markets Suneel Manhas - RBC Capital Markets Brian Konigsberg - Vertical Research Partners
Operator
Good morning, ladies and gentlemen and welcome to the CSX Corporation Third Quarter 2016 Earnings Call. As a reminder, today’s call is being recorded.
During this call, all participants will be in a listen-only mode. For opening remarks and introduction, I would like to turn the call to Mr.
David Baggs, Vice President, Treasurer and Investor Relations Officer for CSX Corporation.
David Baggs
Thank you, Sherlyn, and good morning, everyone and again welcome to CSX Corporation’s third quarter 2016 earnings presentation. The presentation material that we’ll reviewing this morning along with our expanded quarterly financial report and our safety and service measurements, are available on our website at CSX.com under the Investor section.
In addition, following the presentation, the webcast replay will be available on that same website. This morning, our presentation will be led by Michael Ward, the company’s Chairman and Chief Executive Officer, and Frank Lonegro, our Chief Financial Officer.
In addition, Cindy Sanborn, our Chief Operating Officer; and Fredrik Eliasson, our Chief Sales and Marketing Officer will be available during the question-and-answer session. Now, before I turn the presentation over to Michael, let me remind everyone that the presentation and other statements made by the company contain forward-looking statements.
You are encouraged to review the company’s disclosure and the accompanying presentation on slide two. This disclosure identifies forward-looking statements, as well as the uncertainties and risks that could cause actual performance to differ materially from the results anticipated by these statements.
In addition, at the end of the presentation, we will conduct a question-and-answer session with the research analysts. With nearly 30 analysts covering CSX and out of respect for everyone’s time, including our investors, I would ask as a courtesy for you to limit your questions to one primary question and one follow-up question.
And with that, let me turn the presentation over to CSX Corporation’s Chairman, and Chief Executive Officer, Michael Ward. Michael?
Michael Ward
Thank you, David. Good morning everyone.
Yesterday CSX reported third quarter earnings per share of $0.48, compared to $0.52 per share in the same period last year. Revenue declined 8% in the quarter, consistent with an overall volume decline of 8% which included a 21% decline in coal volume.
Turning to operations, safety performance remained strong and service levels continue to meet or exceed customer expectations driving further network efficiency improvements. In addition, CSX further reduced structural cost in the quarter and aligned resources levels to lower volume while retaining the ability to flex those resources with demand.
Continuing to match resources to demand, combined with our ongoing initiatives to support network fluidity forming the foundation to maximize future merchandise and intermodal growth opportunities. As significant cost savings partially offset the impact of lower volume and the changing business mix, operating income declined $92 million year-over-year to $841 million.
At the same time the operating ratio increased 70 basis points year-over-year to 69.0%. Before I hand the presentation over to Frank, let me thank our employees, customer and suppliers for their skillful planning and tireless efforts working together to manage the effects of Hurricane Matthew over the weekend and through this week.
Times like this remind us of the paramount importance of safety for our employees, customers and the communities we serve, as well as the critical importance of the service we provide for American businesses. Now I'll turn the presentation over to Frank who will take us through the third quarter results and fourth quarter outlook in more detail, Frank?
Frank Lonegro
Thank you, Michael and good morning, everyone. Let me begin by providing more detail on our third quarter results.
As Michael mentioned, revenue was down 8% or $229 million versus the prior year, driven primarily by lower volumes. Total volume decreased 8%, which impacted revenue by about $220 million.
In addition, fuel recoveries declined $63 million in the quarter, but was offset by strong coal pricing from an improved service product. Same store sales pricing for the third quarter was up 2.3% overall and 3.6% excluding coal.
Other revenue decreased $9 million driven mainly by lower incidental charges versus the prior year. Expenses decreased to 7% versus the prior year, driven mainly by $112 million in efficiency gains and $53 million in lower volume related cost.
Operating income was $841 million in the third quarter, down 10% from last year. Looking below the line, interest expense was up slightly from last year with higher debt levels partially offset by lower rates, while other income increased $11 million.
And finally, income taxes were $260 million in the quarter, with an effective tax rate of about 36%. Overall net earnings were $455 million, down 10% versus the prior year and EPS was $0.48 per share, down 8% versus last year.
Now let me turn to the market outlook for the fourth quarter. Looking forward you will notice that the outlook reflects our adjusted market alignments.
As released in our third quarter earnings, we are now referring to our markets as shown on this slide, which is consistent with how we are managing the business. The previous food and consumer market is now part of agricultural and food products, waste in the fly ash business have moved to chemicals and the equipment business now resides in the renamed metals and equipment market.
Reclass volume, revenue and RPU information for the last three years are available on our Investor Relations webpage. In 2016, CSX's fiscal calendar includes a 53rd week.
And as such we will be reporting a 14 week fourth quarter. When taking the full quarter into account with an extra week versus the same period last year, we expect volume to be roughly flat.
However, on a 13-week comparable quarter basis, we continue to see a soft but stabilizing industrial economy with volume down year-over-year. In addition to the standard view we provide each quarter, which on the slide shows expectations for the 13 week comparable period, we have included a red, yellow, green designation to the far right, which shows the full quarter impact of the extra week on volume expectations.
That said the market comments to follow reflect expectations on a 13 week comparable basis. Automotive is again expected to grow as light vehicle production remained strong and new business continues to ramp up.
Agricultural and food products is expected to be neutral, the record grain harvest will drive year-over-year gains. However market dynamics for ethanol remained challenged near-term for CSX due to increased movements in storage in the Gulf region.
Export coal is also neutral as we are seeing some near-term increase in meteorological demand, driven by reduced Chinese supply such that volume should be similar to last year's levels. We expect our full year export coal tonnage to be around 25 million tons.
Chemicals will be down with continued weakness in drilling related products, especially crude oil due to low crude oil prices and unfavorable spreads. This impact more than offsets growth in core chemicals and the continued ramp up of new fly ash business.
Domestic coal will again be down however, in the fourth quarter we will cycle the start of the pronounced market weakness, which took hold in the fourth quarter last year. While the excess supply of natural gas continues to provide a price point that favors gas burn over coal, the easier comparables will moderate the rate of decline we have seen over the last several quarters.
We expect domestic coal tonnage to be relatively stable to what we saw in the third quarter. Intermodal will decline as we continue to cycle comparative losses in international in the fourth quarter.
Additionally as we previously reported, we will continue to cycle some short-haul traffic loss in the domestic market, which began in the third quarter. Absent to this we continue to experience strength in the domestic segment driven by our strategic network investments that support highway-to-rail conversions.
Minerals will be down in the quarter as we cycle a strong period last year that benefited from an extended aggregate shipping season in the north due to mild weather late into the year. Overall on a comparable 13 week basis, we expect volume to be down mid-single digits.
Low crude oil, natural gas and other commodity prices, as well as strength in the U.S. dollar continue to challenge the rail marketplace.
Although the impact of these factors is beginning to moderate as we move through a full year of this external climate. When we report earnings in the fourth quarter our GAAP numbers will include the full 14 weeks of volume in revenue.
Again a preview of 14 week volume expectations has reflected to the far right of the slide, which in total represents about flat volume year-over-year. When we report next quarter, we will provide a breakout of volume and revenue for the final week of fiscal year, which is a holiday week to facilitate year-over-year comparisons.
Turning to the next slide, let me talk about our expectations for expenses in the fourth quarter. As a result of aggressive cost actions we have achieved over $340 million of efficiency gains year-to-date and now expect full year productivity savings to be about $400 million.
Looking at the fourth quarter, the drivers for each expense category are shown on a comparable 13 week bases versus the prior year. Separately at the bottom of the slide we have provided guidance for the incremental cost associate with the 53rd week this year.
In addition, we will be cycling $48 million of restructuring cost in the fourth quarter, which impacted labor and fringe by $37 million and MS&O by $11 million in the prior year. Looking first at labor and fringe, we expect fourth quarter average headcount to be down slightly on a sequential basis.
Although not to the same level we saw in the third quarter. Labor inflation is expected to be around $30 million in the fourth quarter, which we expect to be more than offset by continued efficiency and volume related cost savings.
Similar to this quarter, we expect a headwind in the fourth quarter of about $40 million versus the prior year, driven by higher incentive compensation. As a reminder, in 2015 we saw incentive compensation decrease in the second half of the year.
As sharp declines in the energy markets coupled with broad based commodity and dollar impact drove CSX’s financial results will below our initial expectations. MS&O expenses expected to be relatively flat to the prior year with continued efficiency gains offsetting inflation.
We expect fuel expense to decline the fourth quarter, with the higher cost per gallon year-over-year reflecting the current forward curve being more than offset by volume related savings and continued focus on fuel efficiency. We expect depreciation in the fourth quarter to increase around $15 million versus the prior year, reflecting the ongoing investment in the business, partially offset by the favorable impact of an equipment life study.
Equipment and other rents in the fourth quarter are expected to be relatively flat to the prior year with the benefit of improved car cycle times offsetting higher freight car rates and the increase in volume related cost associated with automotive growth. Finally, fourth quarter expense will also be impacted by the extra week.
And when we report earnings in the fourth quarter, we will provide detail to help you better understand the impact of the 53rd week. Now, let me wrap up on the next slide.
With macroeconomic and energy headwinds impacting most market, CSX once again delivered solid financial results in the third quarter. This success is driven by pricing for the relative value of rail service, driving efficiency gains and aligning resources to the softer demand environment, which partially offset an 8% volume decline this quarter.
To mitigate the weak demand we have taken significant cost actions this year, resulting in year-to-date efficiency savings of about $340 million and right sizing savings of around $200 million. We continue to pursue structural cost opportunity across the network and now expect full year efficiency savings to be about $400 million.
Looking at our expectations for the fourth quarter, as I mentioned previously we expect volume to be relatively flat to last year, which includes the impact of the extra week. We remain intensely focused on pricing to the value of our service and expect our strong cost performance to continue into the fourth quarter.
We will also be cycling an $80 million property gain from the prior year, which was below the line in other income in addition to cycling the $48 million in restructuring costs. As a result we expect fourth quarter earnings per share on a reported basis, including the impact of the extra week to be flat to slightly down versus the earnings we reported last year.
With that let me turn the presentation back to Michael for his closing remarks.
Michael Ward
Thank you, Frank. As you heard today CSX is continue to drive results for shareholders in this dynamic business climate by aggressively managing cost and delivering record efficiency savings.
The men and women of CSX are working relentlessly to safely, efficiently and successfully serve our customers. As we continue to manage through the current macroeconomic and energy environment we are simultaneously focused on positioning CSX to maximize opportunities going forward.
The transformation into the CSX of tomorrow requires growth and increased profitability at our merchandise and intermodal businesses, while preserving the business value of coal as it becomes a smaller part of CSX going forward. With that focus we’ll continue to drive earnings growth and margin expansion for our shareholders as we redeploy capital to further improve the network, support new technology solutions and automation and enhance merchandise and intermodal operations.
With continued population growth as well as the challenges facing the trucking industry, we remain confident in the long-term secular growth prospects for domestic intermodal. In support of that vision we continue our multi-year strategy to add network capabilities and new service offerings.
This strategy supports improved profitability and the ability to serve ever more service sensitive freight. As we look to the future our core earnings power remained strong and the CSX of tomorrow will continue delivering compelling shareholder value as we further progress towards the target of a mid-60s operating ratio longer term.
And now we’ll be pleased to take your questions.
Operator
Thank you. We will now be conducting a question and answer session.
[Operator Instructions] Our first question comes from Tom Wadewitz with UBS. Your line is open you may ask your question.
Michael Ward
Good morning Tom.
Tom Wadewitz
Good morning, Michael, good morning everyone and congratulations on the really strong results on the cost side obviously good execution. Wanted to -- on that topic just wanted to see if you could offer some thoughts about the run rate the $400 million you’re talking about this year is very strong and see stay well what is the pipeline look like and what is the run rate look like going forward is that something that you can potentially sustain at $300 million or $400 million in 2017?
How would you -- can you offer some thoughts on the pipeline and how much is already done and what you can offer looking forward? Thanks.
Cindy Sanborn
Okay, Tom good morning this is Cindy. Here’s how I think about this year and going into next year.
So when we as a company started looking at how coal was becoming less and less of our product mix or service product mix, we took a real hard look at how we needed to use our network differently to drive efficiencies, to drive margin expansion from the cost perspective. So a big portion of what you have seen here this year is looking at structural changes in the coal fields and we’re lapping those this month actually when we shut down Erwin and Corbin and so those would not obviously repeat going into future years.
But we’re also have looked at driving density both on our routes, on our coal routes and density on our trains in terms of train link and while we are lapping some of the big steps that we were able to take with train links. We do see other opportunities for that it does require investments so the timing of it becomes contingent upon those investments being coming to provision.
And then there is a traditional productivity that we look at and have over many, many years and technology is a huge part of that so we’re streamlining, streamlining to align with our core network, our network of tomorrow. And so when I think about that type of technology or that type of productivity.
I see next year looking a little bit more normalized in terms of run-rate around offsetting inflation around $150 million. But we don't put any upper limits on productivity.
We are going to address and bring in everything we possibly can. And I think particularly technology lever is an exciting one for us both in terms of mobility and utilizing machine vision.
And then other areas around predictive analytics to help us be more liable with our assets. So I think you'll see us we pulled a lot forward into this year, which is part of what you're pulling on.
I think we'll see a more normal year next year, but we are not leaving anything on the table.
Tom Wadewitz
So the 150 you mentioned that’s a reasonable number to look at or that's kind of the core and you would expected to be beyond that?
Cindy Sanborn
That’s a reasonable number to look at based on the investments we're going to make coming to provision.
Tom Wadewitz
Okay, great. Thank you.
Operator
Thank you. And next question comes from Allison Landry with Credit Suisse.
Your line is open. You may ask your question.
Michael Ward
Good morning, Allison.
Danny Schuster
Hi, good morning this is Danny Schuster on for Allison. How are you doing this morning?
Michael Ward
Good.
Danny Schuster
So last year you had on a net basis a couple of pennies of one time benefits. So I guess I was just trying to understand if earnings are flat to slightly down in 4Q this year.
Does that imply that core earnings are actually starting to grow? And should we see that trend accelerate with continued cost reductions, moderated coal volumes, export coal pricing for the next few quarters?
Thank you.
Frank Lonegro
Hey, Danny it's Frank. We try to do this some insight into Q4 on a reported against a reported basis, so flat to slightly down to try to give you a sense of some normal seasonality in the business quarter-over-quarter, as well as perhaps a little bit of conservatism around what the impacts of the hurricane are ultimately going to be.
So we try to give you some clarity there. And I think what you're going to continue to see us do, as Cindy mentioned is continue to focus on a great service product and the productivity as well as strong pricing for the value of the service we provide.
So the thesis will remain the same going forward. So I think we will try to give you some sense of where we'll end up the quarter and obviously that gives you some implication for the year and thinking about next year as well.
Danny Schuster
Great, thank you Frank.
Operator
Thank you. Our next question comes from Rob Salmon with Deutsche Bank.
Your line is open. You may ask your question.
Rob Salmon
Hey, good morning, guys. Frank with your prior comments you alluded to incorporating some of a hurricane impact on the fourth quarter.
Can you give us a sense of what's baked into the model? And then aside related -- actually different question, but we saw some really nice improvement in the intermodal RPU last quarter.
Could you talk about your pricing initiatives within that segment and how much of that improvement was kind of the lapping out of some of the shorter length default business?
Frank Lonegro
Right so really three parts there I'll tackle the financial piece of the hurricane and kick it over to Cindy and let her talk about the hurricane impacts and then obviously Fredrick on the intermodal side. We're still early in the process of understanding the impact of the hurricane.
Cindy will talk about where we are operationally. We do have something modelled in there, but it's really just an early estimate until we get everything back up and running.
And we do the tally and we really don't have a good number for you this morning. We'll be out in early November and we'll certainly have all of the things tied up by then and we'll give you sense of the impact then.
But let me let Cindy talk about the operational piece.
Cindy Sanborn
Yeah as far as Hurricane Matthew, I think both from a preparation and recovery, our employees have done an outstanding job managing through a storm that was highly impactful in terms of the amount of territory that was affected. And so as of this morning, we are open on our core route on 995 albeit with the use of generators to provide power to our assets that require electricity crossings, and signalling systems with generators.
And commercial power still not back we'll still be nursing those generators until we can get commercial power back. But opening that route is very, very important to us, it's part of triangle of core operations.
We do have yet still some branch lines that are out. So unable to serve those customers as of this point, but we see good equipment availability and energy around getting those routes restored as well.
And I think our impacts are going to be some will be capital, some will be operating expense. And then within that operating expense we'll see some cycle time impacts from the storm.
But truthfully I am extremely pleased with where we are considering, where the hurricane affected us and how quickly we've been able to come back.
Michael Ward
And Cindy on some of those secondary lines the water has not even peaked yet. So until it does it's hard to even get in there and assess the damage really.
Cindy Sanborn
Yeah specifically in and around Lumberton North Carolina, we still have our railroad under several feet of water. And it's going to be days before those flood waters recede and obviously is affecting the community as well.
And restoring service in all of these areas we feel like helps the communities recover as we bring in supply. So there is still quite a bit of work to do.
Fredrik Eliasson
And then in terms of the intermodal question we are continuing to get some price in intermodal obviously not as much as we have in the past because of the excess capacity that's out in the marketplace that is offset by what we're seeing on a fuel side. But we are also seeing some positive mix in the portfolio.
Part of that is some of the short haul business that has shifted over. So overall we're pretty pleased with the performance we’ve seen from an RPU perspective in intermodal business.
Rob Salmon
Well thanks so much for all the color and congrats on a great quarter and managing through really tough backdrop as well as even navigating the hurricane.
Michael Ward
Thank you.
Operator
Your next question comes from Ravi Shanker with Morgan Stanley. You may ask your question.
Michael Ward
Good morning, Ravi.
Ravi Shanker
Thanks good morning, everyone. So as a follow-up to that pricing question, your all in same-store pricing continues to remain above inflation which is great, but it has been sequentially declining a little bit.
So how do we think about that in the fourth quarter and beyond? I mean what's the floor for that number, is at this level is that inflation?
And does the bounce in export coal help you at all starting next quarter?
Fredrik Eliasson
Sure so in terms of overall same store sale pricing we're obviously very transparent. What we're doing there each and every quarter you'll have an opportunity to see that in the fourth quarter.
There is clearly more difficult sale environment and it's been there for a period of time as we see a significant amount of excess capacity. Our focus continues to be to price the value that we provide our customer to be able to continue to reinvest.
We have an improved service product year-over-year that is very helpful. And what we are trying to do is to sell through this trough so to speak and sale that kind of the long-term access to a network and the capacity that we have.
Specifically to export coal, I think we've been very transparent over the last couple of year that as the market has gone tougher since 2012 we have been taking our prices down to obviously optimize our own portfolio, but also to help strategically with some of the producers. We do have the ability to touch those contracts on essentially quarterly basis or some of those are index.
And so with the uptick and the benchmark that we've seen here which obviously gives us an opportunity to leverage that uptick which is good news.
Ravi Shanker
Great, thank you.
Operator
Thank you. Our next question comes from Ken Hoexter with Bank of America Merrill Lynch.
You may ask your question.
Michael Ward
Good morning, Ken.
Ken Hoexter
Great, good morning, thanks Michael. Just wanted to talk, you mentioned to Tom earlier about increasing car lengths and maybe more investments.
Cindy is this something you need to make additional CapEx and spending on to be able to get even longer train lengths, is that something that you're starting to peak out or is there still additional room for productivity improvement?
Cindy Sanborn
Yeah, Ken. So I would say that we are making investments I've been talking the last couple of quarters about our route from Nashville to Cincinnati that we were investing in this year, that that would be in service as if the third quarter.
So it is in service and we have seen some good improvement in link there. We were restricted to based on sidings to about 6,500 feet on that corridor.
So it's that type of investment that we will continue across there about 12,000 feet. So moving forward, we have identified locations to continue those types of investments.
But as you relieve the pressure on the corridor that we just did, then you now find that you're meeting up against some other impacts on other corridor. So that's where we'll be looking and are looking in the process of assessing and or building to continue to improving train length.
Frank Lonegro
And Ken one other thing on CapEx, what Cindy is referring to is absolutely what we're going to do going forward it's a reallocation of capital within that longer term guidance that we've spoken about previously. So as you go into 2017 the things that are strategically aligned in terms of the network of the tomorrow highly automated railroads, service excellence, et cetera.
Those are going to be within the compliance of the normal capital process. And as you size that next year I wouldn't think of that as being incremental investment versus reallocated investment within that portfolio.
Ken Hoexter
That’s really helpful, thanks, Frank. Just Fred a follow-up if I may, on coal your thoughts on utility on where inventory levels are this is really interesting just given I don’t know maybe the extended heat that we had here, but is there stabilization going on a domestic side and your thoughts are we at an inflection points perhaps where I don’t know if inventory levels have come down far enough far enough or if net gas pricing is high enough you maybe just throw us some thoughts on the domestic side?
Fredrik Eliasson
Sure so clearly the hot summer has been helpful the cooling degree days has been very helpful especially in the South we’ve seen significant reduction in the inventory levels, I think in the South in terms of days burn we’re down to from 150 a year ago to somewhere around 100 now. And even in North we have come down a little bit, I would say though overall that they’re probably still slightly above where they would like for them to be, in certain places they are less, certain places they are more, but they’re probably still a little bit above where they would like it for them to be.
But it is good news that we’re starting to see that and also to your point about natural gas prices they have come up a little bit, that’s also helpful. But generally though we do need to see those natural gas prices closer to 350 or above to make really meaningful impact and we’re excited where we’re heading we’ll have a much better view I think as we get into the fourth quarter and early next year in terms of what coal will do for 2017 not just on the domestic side, but also on the export side.
Ken Hoexter
Thanks for the thoughts. Appreciate it.
Operator
Thank you. Our next question comes from Brandon Oglenski with Barclays.
You may ask your question.
Michael Ward
Good morning, Brandon.
Brandon Oglenski
Hey good morning, Michael and thanks for taking my questions. So when I look at these efficiency numbers, they are pretty big.
When we’re talking [indiscernible] $300 million to $400 million in efficiency this year, that would equate I don’t know maybe greater than 3% on the operating ratio to 300 basis points. So I mean is that the type of improvement that investors should be thinking about as we look into ‘17 and beyond can we start to see 100-200 basis points improvement annually and the operating ratio if these efficiency targets hold and you get to a more stable or maybe even a growth environment?
Cindy Sanborn
So I think as I said before we had a pretty extraordinary year this year, which you’re referring to which is part of our views on how our business mix has changed with a less reliance upon coal. And so there are some structural takeout that we put in place that can’t repeat because it is structural around the coal markets.
But going forward we have lapsed for this year some of our train link initiatives. But as I mentioned in the last question we see opportunities going forward, we see productivity available to us that we traditionally have around streamlining again around our core network, which is part of our network of tomorrow.
But I think run rate wise looking into 2017 it would be more of a $150 million offsetting inflation kind of number to face off of after having such a strong year this year. But we don’t stop thinking about ways to improve our efficiencies we understand that as our business mix changes, have to make our merchandise and intermodal our service products more profitable and from a cost -- and the operating department has a huge lever we have to pull on the cost side to make that happen.
So we’re going to continue to look for those opportunities and drive it forward and I will say adding to that that we also are going to serve our customers effectively to provide a very good service for them that allows Fredrik to grow the business and price the business.
Michael Ward
Brandon one other thought is in terms of your allusion to growth there as we grow especially if we grow in class merchandise business in automotive and intermodal I mean you are going to see incremental margins that really pull on the operating leverage point. So in addition to the productivity line you should see the benefit of that again if the economy is cooperative for us longer term.
Cindy Sanborn
Yeah I should add we do see capability of adding growth in pretty much any market without adding cost back one for one. So we do see great leverage there.
Brandon Oglenski
Well I guess I don’t want to be too critical here, but if what you’re doing is offsetting inflation next year let’s say on the productivity side this is going to come off as critical but how is the CSX of tomorrow any different than grow to 65 by 2015, which we heard in 2011? It just sounds like it’s going to be a struggle to get a lot of operating ratio improvement unless something changes on the demand side or am I thinking about that wrong?
Cindy Sanborn
I mean, I think there is no -- everything on the table has been for as long as I've worked here. And we are continuing to make sure that there is any opportunity we have we're going to take advantage of.
So I think to your point it may seem not as strong as this year, but our objectives are to not just look at 2017 by itself, but also continuing into the future and drive operating margins on the cost side. And we're coming off a strong year.
We think we can offset inflation next year, but we are not going to leave any opportunity out there on the cost side.
Michael Ward
Brandon this Michael, I mean obviously productivity is going to be key and as Cindy said always strive to do more than what she is talking about. But growth does have to be a critical component as we move to the mid-60s operating ratio.
We've got already tempered economy here for the last two years and clearly growth has to be part of that equation. And we think with the service partners we have Fredrick's team can grow it once we see any signs of vibrant in the economy, but that is part of the equation.
Fredrik Eliasson
Yeah I mean Brandon we're confident in our ability to get to the mid-60s operating ratio. The timing of that is going to depend on the rate of decline in coal obviously.
But continuing to focus on value pricing for the service product that we provide to our customers continuing to have productivity offset inflation. I mean you do get margin expansion by doing that year-over-year.
Brandon Oglenski
Okay, appreciate it.
Operator
Thank you. The next question comes from Brian Ossenbeck with JPMC.
You may ask your question.
Michael Ward
Good morning, Brian.
Brian Ossenbeck
Hey, good morning thanks for getting me on the call here. So question on the coal network and rationalizing that further, obviously you made some actions with Erwin and Corbin that you're going to lap here pretty soon into next year.
So what are you looking at when it comes to being able to take the next steps? Is it just coal volumes getting to a certain level, density is perhaps getting a little bit higher when you factor in some of the point-to-point pricing.
So just kind of your thought process in how you -- what will you think just generally on timing for some of these initiatives to keep initiatives to keep moving in the coal fields?
Cindy Sanborn
Well I think we are going to serve our coal customers well. And that is Fredrick and I work and our teams work on that to make sure that we are available and capable of providing service to our coal customers.
As things changed within the coal field even more than they already have, we will take the steps that we need to take to structurally change along with those changes. So we are prepared to continue to look there, but it's a profitable business for us and we intend to stay in that business where the customers are for as long as they are there.
Brian Ossenbeck
Okay, thanks Cindy. Just Michael one follow-up on the growth that you mentioned.
Port of Savannah was out maybe a couple of weeks ago now announcing a large expansion of the rail terminal there. It looks like they're going to double the capacity longer trains to facility.
Is that volume starting to be spoken for attracting customers or do you really need to see the Port finish the complete expansion sometime in 2020 before that we really start to drive some more volume on your network? Thanks.
Fredrik Eliasson
Sure this is Fredrick, so what we're seeing and have been seeing is a continued shift towards more East Coast internationally intermodal coming in versus West Coast. And as a result the ports are clearly making investment not just Savannah, but other ports as well.
And we are as well to make sure we can serve that. And that is attractive business that we want to get more of.
And as we see additional investments come online we'll have an opportunity. In the Savannah case we certainly have grown our business significantly there already.
And we expect to continue to see that going forward. But that is true for the other ports as well.
Brian Ossenbeck
Okay, thanks Fredrick.
Operator
Thank you. Our next question comes from Christian Wetherbee with Citigroup.
Your line is open. You may ask your question.
Michael Ward
Good morning, Christian.
Christian Wetherbee
Good morning, guys. My question is on CapEx, just kind of wondering as we look at the year-to-date progress so far towards the $2.7 billion number.
There is still a lot left to go here, but I don't think you're kind a taking that 2.7 number down. I'm guessing that locomotive pull forward from 2017 might that will be backend weighted and might be part of that sort of $1 billion plus that I think you're targeting for the fourth quarter.
But just wanted to get a rough sense of maybe how we think about this number? And maybe thinking a little bit longer term to a previous question Frank you said it's sort of a reallocation and sort of where you're spending the capital.
What is the right number to be thinking about of that reallocated capital is it a percent of revenue, is it an absolute number in the mid $2 billion type of range? I just want to get a rough sense of maybe how to think about that?
Frank Lonegro
Sure, hey Chris, Frank. So, on the 2.7, that is what we call our managed capital number, as part of that you’ll have two things in there, you’ll have the $300 million that we pulled forward from the seller financing of next year into this year and paying off locomotives as delivered.
The other piece which will show up in other financing activities so not in the property additions line will be $300 million for paying off engines that we took delivery of last year. So, your 2.7 is again, we’re trying to be very transparent with you in terms of the capital dollars that we’re spending this year, although you do have some geography differences on the cash flow statement.
In terms of 2017, when you think about where we are, we are looking very hard at infrastructure and equipment given the environment that we’re in and given the network of tomorrow strategy that we have. What we have been talking about is normalized five or ten year view in retrospect for CapEx we generally spend somewhere between 12% and 15% of that capital portfolio on return seeking investments.
But we’re looking forward to doing on a going forward basis is to increase that allocation to more like 20% or 25% of the capital portfolio. So, not looking to necessarily increase capital based on the strategy, really looking to reallocate to make sure that we’re focused on the things that are going to drive the value in the future.
Christian Wetherbee
Okay, that’s helpful. I appreciate that color and then the follow-up just sort of in the context of capital allocation across sort of the spectrum.
When you think about next year, debt levels relative to share buybacks how does share buyback kind of pay into the long-term plan?
Frank Lonegro
Sure. It’s part of the balanced deployment of capital certainly the primary focus of capital is going to be to reinvest in the business for a reliable railroad in accretive type investments.
Secondarily would be the dividend piece and obviously we are looking hard at that since we took a break this year on the dividend, but we’re going to look hard at that next year. And then looking at where we are on operating cash flow next year and sizing buyback program that generally we talk to you about in the end of the first quarter of the given year.
So, I think that order is important for the investors to keep in mind, and realizing that the environment that we are in now is perhaps quite a bit different than the environment that we were in 2015 when we increased the dividend by $0.02 and announced the two year $2 billion program that will complete by April of next year.
Christian Wetherbee
Okay, that’s very helpful. Thank you for the time, I appreciate it.
Operator
Thank you. The next question comes from Bascome Majors with Susquehanna.
Your line is open, go ahead with your question.
Michael Ward
Good morning, Bas.
Bascome Majors
Hey, thank you, good morning. Frank, I want to drill down on another answer on the margins and cost side.
Given the cost take out that you have achieved over the last several quarters, that’s been a while sense since we’ve had a year where you went from a big revenue decline to potentially return to growth and your best incrementals of the resent years have been around 50% on the margin side. I am just curious not necessarily saying that revenue will return next year, but when it does return given the takeout you’ve done what kind of incremental ballpark are you thinking about in the business?
Frank Lonegro
When you look at what we’ve done on the cost side, certainly that sets up incremental margins that are probably better than what they have been historically, but as I’ve alluded to in the answer to the earlier question it really depends on how the business comes back. If it comes back in areas where you’re adding a box car on to an existing train, an intermodal container on to an existing train, an auto rack on to an existing train that’s really where you’re going to get the incremental margins and the operating leverage that you’re referring to if it’s something that’s on the box side of the business, which is going to be a new train start.
The incremental margins are going to essentially be what the absolute margins are in that business by and large. So, I do think we’ve set ourselves up for a good run as the economic improves and as volumes comes back especially on the class side of the business.
Bascome Majors
Thank you for that. And just a bit of a housekeeping on your cost guidance for 4Q, the MS&O guide of flat year-over-year that signaling a pretty significant Q-over-Q growth maybe 12% or so.
And I know you have the extra week but that’s maybe 10 points or so above the typical sequential growth there. Can you just help us understand what’s driving that beside above and beyond the extra week?
Frank Lonegro
Yeah, there is a few things on the sequential side to think through given that we have got some incremental bulk business on the export side, the grain side and the automotive side; we have got additional engines in freight cars in the mix relative to third quarter. So, clearly that’s going to impact MS&O line on the materials and supply side.
We are expecting normal seasonality in terms of normal winter, we didn’t see necessarily as much of that last year, but we’re expecting this year just given what we understand the winter to hold, there is a normal seasonal shift between the third quarter and the fourth quarter as we stop the construction season as it gets too cold and too icy to work up North. So we do have that and then there’s normally on the technology side as annual hardware software maintenance contracts come due so we have that just in terms of seasonality.
And then we’re usually a little less fuel efficient as we get into the fourth quarter and we’re going to pull on everything as you’ve seen us do already this year, but as we set up a more normal fourth quarter that’s how we see it going. The other thing to think through is a lot of the hurricane side expenses to the extent that hit the OpEx line are going to hit here.
So we got a little bit of piece in there. And then when you look at the productivity as we’ve targeted about $400 million it implies about a $60 million run rate for the quarter and that’s a little less than what we have seen in the third quarter.
So you add all that up and it’s going to be about flat on a year-over-year basis.
Bascome Majors
Thank you for your time.
Frank Lonegro
Thanks Bascome.
Operator
Thank you. Our next question comes from Scott Group with Wolfe Research.
Your line is open.
Michael Ward
Good morning, Scott.
Scott Group
Hey, thanks good morning, guys. Wanted to just go back to coal for a second, Fredrick do you have the inventory levels for the North?
And then on the met side how quickly do the export rates reset higher and can you just kind of frame what that opportunity is and maybe how much of the export rates dropped over the past five years? And kind of order of magnitude how much do you think that they can rebound?
Fredrik Eliasson
Sure in terms of the inventory levels we use Pyra data so in the North we went from about 95 days of burn, at this time last year we’re down to 90 now and in the South 150 down to 102. So significant improvement, but as I said earlier still above what I would consider target level at this time of the year.
But this target has obviously changed little bit more little more difficult these days because it depends on lot of where the utility is in the dispatch order, et cetera. To your question about met obviously it’s come down significantly and I don’t have a number that I think we’ve shared before, but it is a significant adjustment and you’ve seen that play out in our RPU line since really since 2012.
And as we now sit here and we’ve seen the benchmark go up to 200 from 90 to 50 I think it was in the third quarter that is an opportunity for us to leverage. And our contract have evolved overtime to be essentially quarterly or based on an index that is tied to the benchmark.
Scott Group
Okay. And then just lastly for Frank I know we’ve got big incentive comp headwind in fourth quarter, third quarter should we be thinking about a similar large headwind in the first half of next year too or do we kind of moved to more of a normalized incentive comp run rate on a year-over-year basis ‘17?
Frank Lonegro
Yeah, more normalized.
Scott Group
Okay perfect. All right thank you guys.
Operator
Thank you. Our next question comes from Jason Seidl with Cowen.
Your line is open.
Michael Ward
Good morning, Jason.
Jason Seidl
Thank you, operator. Good morning everyone, I guess I’ll piggy back a little bit on that coal question, when you talk about more normalized target levels where would you put those target level in both your southern and northern regions?
Fredrik Eliasson
Well as I said in the past we have used the targeted days burn somewhere around 55 in the North, 70 in the South. However I do think that I could be a little bit misleading these days because of the fact that utilities are situated very differently in terms of where they are in the dispatch order.
It was easier to give those target levels in the past when you were the base load. Now it varies really by utility-by-utility, but the good news is we made significant in-roads especially in the South and we’re getting closer to a more normalized level and there are utilities and we’ve seen this year over the last three months that clearly are below where they want to be, but we still have several utilities that are significantly above.
Jason Seidl
Okay. And when you look at sort of that 350 bogie you brought up with natural gas, if we are well above that for a considerable amount of time what percent of the business do you think of your coal business is going to be positively affected by that?
Fredrik Eliasson
Yeah so if you look at where we were here this quarter we had about 58% of our business either came from Illinois Basin or Powder River Basis. We saw a pretty significant shift towards Illinois basin within that number.
And we have said publically that when it is 350 or above that part of our portfolio so 58% of portfolio is essentially in the money. And that will allow for a significant increased utilization of those plants.
Now there is a lot of other factors that plays into that. Clearly whether the plants are located makes a big difference.
As you all know that the natural gas prices are 350 is Henry Hub price. It is very different in certain parts of our service territory.
But as a general rule I still think that holds pretty well in terms of indication over the plants that we serve become more competitive.
Jason Seidl
Thank you and that was very helpful. I guess my follow-up question is going to be on the pricing side, when you look at intermodal merchandise still well above your cost inflation, but it did decelerate on a sequential basis.
How are you thinking about sort of that truck competitive market going forward? It looks like we've had a little bit of uptick on the spot side here and with ELDs coming up.
What are you guys looking for in ‘17 on that market?
Fredrik Eliasson
Sure, I mean it is clear that we've had a tough market for an extended period of time now in terms of excess capacity. And it does impact not just intermodal business, but certain markets within our merchandise business as well.
Generally shorter haul also generally lower contributory traffic that are more susceptible to being switched over to truck. As the market turns and it will turn we see new orders of truck of Class A trucks have come down significantly 30% 40% year-over-year , year-to-date.
We know ELDs will be coming in by sometime in the second half of next year. And if the economy continues to expand and unemployment stays low that should lead to a much better environment as we get into late ‘17 and that will be helpful.
So our challenge to our team right now is to sell that improved service product that we have sell through this kind of trough and sell the long-term access to our network that allows us to continue to reinvest in our business.
Jason Seidl
Fredrik thank you for all that color and everyone thank you for your time as always.
Operator
Thank you. Our next question comes from Ben Hartford with Baird.
Your line is open, go ahead with your question.
Michael Ward
Good morning, Ben.
Ben Hartford
Hey, good morning all. Cindy could you talk about when you would anticipate a trough in the employee count, is there any sort of visibility to that during the fourth quarter or in the early part of 2017?
Frank Lonegro
Hey it's Frank. What we did was we guided to down slightly sequentially, but also put a bit of a qualifier on that one given the fact that we were probably down more than slightly sequentially from Q2 to Q3.
So we're continuing to look across the board at all areas of resources whether it's train and engine crews or folks in the rest of the operating department and folks on the G&A side, I mean which you’ve seen is and across the board approach in terms of overall productivity as well as on the resource side and challenging the need for every dollar and every vacancy when it comes up we're taking a look at it and making sure whether or not we need to fill that. So I think you're going to see us focused, although the magnitude of the decreases on a year-over-year basis are obviously going to get smaller and smaller as we go forward.
But you'll continue to see us look very hard at resources. Cindy you want to add anything to that?
Cindy Sanborn
I think you hit it.
Ben Hartford
Good. And then Fredrick if I could ask you just more of a conceptual question on the volume side, volumes over the past 10 or 15 years have been flattish to even down, obviously coal the coal headwind have been noted.
So as we look forward the economic environment uncertain if we use industrial production growth as a guide. Do you have confidence or any sort of visibility to volume growth more closely approximating even whatever U.S.
IP growth ends up being as coal as we transition away from coal given the volume growth opportunities longer term on the intermodal side. Or is that 10 to 15 year trend of kind of flattish volumes in the business.
Is that still a pretty appropriate bogie to think about over the three to five years?
Fredrik Eliasson
Yeah, I think absolutely. I think that if you look at long period of time if you take out the coal business you just look at the correlation between IDP in our merchandise business it has correlated pretty well where they probably with a slightly underperformed IDP over an extended period of time several decades.
As I think about 2017, right now and obviously we are in the middle of our planning season and getting a lot of feedback for our customer, if you take out our coal business and also the crude-by-rail business which is energy related, if you take that out and we look at the rest of the portfolio our merchandise and our intermodal business we feel pretty good about what the portfolio can do here after a very tough period of time. And then we have pretty good confident that based on the economic indicators we’re seeing right now based on the feedback from the customer that we can return to more normalized growth environment next year in our non-energy businesses.
We will have a much better sense of the energy businesses as we get through the fourth quarter, but we are encouraged by what we are seeing in terms of our initial planning assumptions right now.
Ben Hartford
Okay, great. Thank you.
Operator
And your next question comes from Cherilyn Radbourne with TD Securities. Your line is open, you may ask your question.
Michael Ward
Good morning Cherilyn.
Q - Cherilyn Radbourne
Thanks very much and good morning. One of the things that really stood out in the quarter for me was just the year-over-year improvement in labor efficiency, just given the volume decline that you were facing.
Just wondering if you can give us some practical examples of how you are continuing to generate that labor productivity?
Cindy Sanborn
Hi, Cherilyn thanks. I think one of the better examples would be our longer train initiatives so looking at density of trains and being able to operate the same number of cars with in fewer chunks.
I think we also are utilizing technology to help us as well and being able to automate processes. So those are probably two of the bigger examples I could give you.
Frank Lonegro
And make sure just in terms of sort of raw orders of magnitude the 3,900 or so positions that we were down year-over-year, the majority of those and this is both the efficiency side as well as the volume variable side come out of the train and engine mechanical and the op support side of the business, but engineering, intermodal, G&A are also down year-over-year I mean we are down across the board in terms of resources on a year-over-year basis. And I think you are going to continue with perhaps the exception of technology as we really go into the highly automated railroad part of our strategy, I mean pretty much every group is trying to be as lean as they can.
Cherilyn Radbourne
Great, Thank you. That’s all for me.
Operator
Thank you. Our next question comes from David Vernon with Bernstein.
Your line is open, go ahead with your question.
Michael Ward
Good morning, David.
David Vernon
Good morning, guys. Thanks for taking the question.
Congratulations on the productivity here, this is obviously been the big part of the story this year. As we think about next year and the growth being a little bit more in the scheduled network businesses around merchandise and intermodal.
Should we be thinking that the incremental fall through on that businesses could actually be a little bit better than maybe we have seen the incremental margins on average run in the past?
Frank Lonegro
Yeah I think with the expenses that we have taken out in the scheduled network and sort of across the board that obviously sets us up for incremental margins that are healthy and perhaps a little bit better than they have been in the past. So, yes, this is the answer to the question.
David Vernon
Excellent. And then maybe just kind of if we think about the business in the couple of years let’s say if we’re kind of flat in volume, obviously the productivity has been a big of it, but how should we be thinking about the sort of organic earnings potential in the business over the next couple years?
Do you mean is it possible to continue to pull out cost and grow for a few years or do you think it’s going to be a little bit more of kind of holding the line just in kind of a flat growth environment?
Frank Lonegro
I think you are flat on volume and don’t have any mix impacts associated with it, it’s really going to be what we’ve been able to do in the past which is we’ll continue to offset inflation with productivity, we’ll continue to have value pricing that will fall to the bottom-line and the combination of those two things. We’ll provide margin expansion on a year-over-year in the environment that you mentioned.
David Vernon
So you see, you actually expects a little bit of sustainable earnings power even if there was a little even we’re in a flat volume environment?
Frank Lonegro
Correct.
David Vernon
Excellent. Thanks very much for your time guys and congratulations about the great quarter.
Frank Lonegro
Thank you.
Operator
Thank you. The next question comes from Scott Schneeberger with Oppenheimer.
Your line is open, go ahead with your question.
Michael Ward
Good morning.
Scott Schneeberger
Thanks, good morning. Automotive remains an area of strength for you, just curious how sustainable do you think it is just from an end market perspective and also you sight new business ramp ups in the slide deck.
What type of contribution should we think about over the coming quarters there? Thanks.
Fredrik Eliasson
Sure, so, obviously auto has been at a pretty high level here this year in terms of production I think the latest estimate that I've seen is about 79 in terms of production. We're more closely tied to production and the sales.
And next year the latest estimate that I have is a slight increase to about 18 million vehicles and so that's helpful. We have onboard some new customers this year that has helped.
And the contribution of that traffic is very attractive. And it has been great journey for the automotive market overall coming out of recession.
But it is probably fair to say that at the moment it looks like we're hitting that high watermark so to speak. We don’t see necessarily coming down significantly from that.
We think we're going to move more inline what we're currently seeing. But obviously we're being nimble there as well and to adjust our resource level whether it's up or down.
But right now the best estimate is for relatively flat environment for 2017.
Scott Schneeberger
Great, thanks. And then Cindy just following up on efficiency savings so we can infer here that you're looking for maybe a base level of 150 as we look out into ‘17 as we look at our models and think about kind of the cadence through next year.
Is there anything special to keep in mind down that front or it's just a progressive build? Thanks.
Cindy Sanborn
Yeah, I don't think there is anything specific that would cause you to want to put different values and for the different quarters. It will be pretty much across the board even.
Scott Schneeberger
Thanks.
Operator
Thank you. Our next question comes from Justin Long with Stephens.
Go ahead with your question, your line is open.
Michael Ward
Good morning, Justin.
Justin Long
Thanks and good morning. So my first question was on coal.
There are a lot of people that believe industry coal volumes will be up next year. I know you said 4Q whether it will be important in terms of how things play out in 2017.
But just assuming normal weather patterns, do you have any high level directional thoughts on how your coal volumes could trend next year?
Fredrik Eliasson
Well I guess the only directional comment that I would say is that it looks like by the end of this year over a five year period we would have lost about $2 billion of coal revenue. And this year alone probably in excess of $0.5 billion.
So based on what we're seeing right now, we think next year's decline will be significantly less than that. But beyond that, I really do think I want to stick with what I said earlier which is that we'll have update for you when we do the fourth quarter earnings call both on a domestic side and on the export side.
Because I think I think we'll be in a much better position as we are in the process of gathering our information from the utilities the 40 to 50 utilities that we serve. And I think that's the best way to give you guidance is to take the input that we get from them.
So that it's a lot more accurate than trying to speculate at this point.
Justin Long
Got it. But you seem to imply with your commentary that directionally you think it will be down next year.
You're just not willing at this point to quantify that?
Fredrik Eliasson
Yeah, I think that's probably directional what I'm trying to say. I think that clearly the fact that natural gas prices are come up is helpful, it is still not at 350.
Inventory levels are still above what they should be. And we only have about 1 million tons or so that probably will come out next year in terms of plant closure.
So that number is getting a lot smaller. But nevertheless I think as we look at the crystal ball right now, that is probably a safe place to be.
But as I said a cold winter natural gas prices move up above the 350 mark. And that picture can change very rapidly.
Justin Long
Thanks, that's really helpful. And one quick follow-up I wanted to ask on pricing.
Fredrick I believe you said you were still getting price in intermodal. But could you say if your intermodal pricing is above inflation or given the truck competition we're seeing.
Are we seeing below inflation price increases in that intermodal business?
Fredrik Eliasson
We've historically given you the breakdown in the two categories that we have merchandise and intermodal combined in all end. I think we'll stay at that level.
Pricing is a critical part for us in order to continue to reinvest in the business and especially in the intermodal since we put so much of our incremental capital towards intermodal. So being able to have the traffic at contributory levels we continue to push prices is a critical part of that strategy.
And we are getting positive price exactly where it is. I think we'll keep those buckets that we have in place today.
Justin Long
Okay, fair enough. I appreciate the time and congrats on the quarter.
Operator
Thank you. And next question comes from Walter Spracklin with RBC Capital Markets.
Your line is open, go ahead with your question.
Suneel Manhas
Good morning, this is Suneel Manhas stepping in for Walter Spracklin. So just circling back you mentioned how your East Coast volumes are seeing a bit of a bump and just wondering how much of that volume bump is coming to the Panama Canal?
And are you seeing shifting of buy patterns, and how should we think about that impact moving forward? Thanks so much.
Fredrik Eliasson
Sure, so this is Fredrik again. We have seen the shift for an extended period of time, that we see more of our international cargo coming in on the East Coast porch.
We have not seen a significant change in the amount of volume coming in since the Panama Canal got widened. What we are seeing that there are some bigger vessels coming in, but generally it is not necessarily adding capacity.
They are reconfiguring the strengths, there are fewer vessels and we’re also seeing some realignment with vessels that before came through the Suez Canal that is now coming through the Panama Canal instead. But we are -- so there’s not significant change, but the pattern has been there for a long time and we do expect that pattern to continue that we will be more and more of that volume come through the East Coast porch.
Suneel Manhas
Got it, okay thanks so much. Appreciate it.
Operator
Thank you our final question comes from Brian Konigsberg with Vertical Research Partners. Your line is open, go ahead with your question.
Michael Ward
Good morning, Brian.
Brian Konigsberg
Hey, good morning guys thanks for taking my question. You guys covered quite a bit of ground, just question on inflation it sounds just on the commentary in regards to efficiency, do you still expect it to remain pretty muted next year in the realm of 1.5%, but just looking at the labor, some cost incremental you’re talking about for Q4 that’s running around 4% probably includes a little bit extra from the extra week.
And then just metal prices have been strong maybe rolling up a little bit now, but is the expectation you were still going to be living in a pretty muted environment into ‘17 despite some of the indicators that say it could be a little bit higher?
Frank Lonegro
Yeah I think on the inflation side we have been in a little bit of a muted environment here in the last couple of years. When you start thinking about the inflation more broadly, as well as GDP and IDP potentially going up there could be a little bit of a pressure on the upside, there is a little bit of nuance in the second half of the year before they were infringe inflation that you’re picking up on which is wage accruals that came up starting in the middle of the year.
So there’s that in there rather than a sort of a core external inflation run rate that’s out there. But I think what you’re hearing from us is regardless of what inflation is we’re going to do our level best to more than offset that with productivity.
So I think having something in that 150, 175 range for inflation next year is probably a good start in place and we’ll offset that with productivity.
Brian Konigsberg
Great. If I could just follow a real quick one just on the intermodal and the expectation that I guess pricing does firm a little bit later next year has supply in trucking comes down and ELD go into place does that assumption -- does it require improving demand for you to see improving pricing in that business or if we ran it just kind of where we stand today does that make it a bit more challenging?
Fredrik Eliasson
Yeah, I mean it really is supply and demand picture so if you have ELDs and other regulatory constraints put pressure on the supply side clearly additional growth in economy is also helpful. And if you remove one or two of those it’s going to prolong the period where we see this excess capacity.
So we’re obviously following this very closely and hoping for an economy that picks up more than we currently expect that could be very helpful both in terms of our volume initiatives, but also in terms of pricing.
Brian Konigsberg
Understood, great thanks guys.
Michael Ward
Thank you we’ll see you all next time, next quarter. Thank you.
Operator
This concludes today’s teleconference. Thank you for your participation in today’s call.
You may disconnect your lines.