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Genesee & Wyoming Inc (GWR)
Q3Â 2018 Earnings Conference Call
Oct. 30, 2018, 11:00 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Ladies and gentlemen, thank you for standing by and welcome to the Q3 2018 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, instructions will be given at that time. (Operator Instructions) As a reminder, this conference is being recorded. I'd now like to turn the conference over to Matt Walsh. Please go ahead.
Matthew O. Walsh -- Executive Vice President, Global Corporate Development
Thank you for joining us today on Genesee & Wyoming's Q3 2018 earnings call. Please note that we will be referring to a slide presentation during today's call. These slides are posted on the Investors page of our website www.gwrr.com. Reconciliations of non-GAAP measures disclosed on this conference call to the most directly comparable GAAP financial measure are likewise posted on the Investors page of our website. We will start with the Safe Harbor statement and then proceed with the call. Some of the statements we will make during this call which represent our expectations or beliefs concerning future events are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, which provides a Safe Harbor for such statements. Our use of words such as estimate, anticipate, plan, believe, could, expect , targeting, budgeting or similar expressions are intended to identify these statements and are subject to a number of risks, uncertainties and other factors that could cause actual results to differ materially from our current expectations, including but not limited to factors we will discuss later and the factors set forth in our filings with the Securities and Exchange Commission.
Please refer to our SEC filings for a more detailed discussion of forward-looking statements and the risks and uncertainties of such statements. We cannot assure you that the forward-looking statements we make will be realized. We do not undertake and expressly disclaim any duty to update any forward-looking statement, whether as a result of new information, future events or otherwise except as required by law. And you should recognize that this information is only accurate as of today's date. On the call today, we have three speakers, our Chairman and CEO, Jack Hellmann; our Chief Financial Officer, TJ Gallagher and our President of our North American Operations, Michael Miller.
I will now turn the call over to our President -- our Chairman and CEO, Jack Hellmann.
John Hellmann -- Chairman & Chief Executive Officer
Thank you, Matt, and welcome to G&W's earnings call for the third quarter of 2018. As always, we'll start our call this morning with safety. On Slide number 3, you'll see that we completed the first nine months of 2018 with a safety index of 0.9 injuries per 200,000 man-hours. The safety results are short of our industry-leading standards and we have launched a series of initiatives to further enhance our safety focus going forward.
Turning to Slide number 4, which compares third quarter results to our guidance. In the third quarter of 2018, we reported diluted EPS of $1.16, and adjusted diluted EPS of $1.23. So we ended up around $0.08 per share above the midpoint of our guidance. In North America, our business was strong and our incremental margins of 65% exceeded our typical expectation of 50%. With volumes about 4% ahead of guidance, the diluted EPS contribution from North America was roughly $0.13 per share, better than we expected. In Australia, we are slightly behind plan due to lower than expected coal volumes. The reason for the Australian coal shortfall is primarily due to a typhoon in Japan that affected coal purchases as well as a third-party derailment on the open access network in New South Wales that also impacted shipments. Finally, in the UK and Europe, our results were roughly $0.04 per share below our plan due to a combination of ongoing operational challenges at the Port of Felixstowe, as well as the impact of the locomotive driver shortage. The UK driver shortage recently emerged due to a rapid increase in retirement, as well as hiring pressure from passenger services. We are actively hiring and training drivers in the UK right now, not only to fill the immediate driver need but also to handle a commercial pipeline that continues to build.
Now let's turn to Slide number 5 with some general comments. In North America, several items are worth noting. First, North America traffic was uniformly strong in the third quarter with a 9.4% increase in traffic and carload increases in 12 of 14 commodity groups. The volume strength was due to both demand and model conversion. While the growth rate seems to have slowed in October, business is generally good, although agricultural export shipments are being negatively affected by the lack of purchases from China. Second, we took a direct hit from Hurricane Michael. In October, the hurricane directly hit the Florida Panhandle and our Bay Lin Railroad of Panama City causing significant damage to our buildings and resulting in thousands of trees down on the tracks of our Florida and Georgia railroads. All of our rail lines have been reopened for service and our focus now is on working with customers as they come back online, as well as assisting the rebuilding efforts of our employees who lost their homes in the 155 mile per hour winds. From a financial standpoint, we will reach our insurance deductible in the fourth quarter and expect to experience lower revenue due to damage to our customers' facilities. We expect the lost income from the hurricane to be recoverable under our business interruption insurance policy in 2019. Third, two short line railroad leases in Canada are expiring in the fourth quarter of 2018. Since our acquisition of RailAmerica nearly six years ago, we've been planning to return a portion of the Goodridge (ph) in Exeter and the Southern Ontario Railway to Canadian National. These lease returns are taking place in the fourth quarter, although we will retain small operations in each of the two geographies. On an annual basis, the net impact to our income statement will be positive with an increase of approximately $6 million in operating income, as we have been amortizing the assets to lease expiration and expensing all track infrastructure costs. At the same time, our volume will decline approximately 27,000 carloads per year in North America. I should note that while we have other small leases that could expire in the coming two years, there is nothing material. Fourth, I'd like to comment on the U.S. short line tax credit. With 262 co-sponsors in the House and 56 co-sponsors in the Senate, we've once again built tremendous bipartisan support for the short line tax credit.
The annual benefit to G&W is approximately $36 million per year or about $0.60 of earnings per share. Three outcomes are possible after the November 2018 mid-term election. One, no extension of the credit; two, another one-to two-year extension, or three, a permanent extension. We will be pushing hard during the lame duck session between the election and January 3 to achieve an extension, but after that we will need to restart from scratch building co-sponsors for new piece of legislation and the new Congress. Fifth, I'd like to note that we do face some operating uncertainty with respect to the implementation of precision scheduled railroading by our Class 1 partners. While there may be a long-term benefit to the fluidity of the Class 1 network, there is the risk of interchange disruptions for our short lines.
Now let's turn to Australia and Slide number 6. Despite shipment disruptions in the third quarter and delayed steam coal shipments in the fourth quarter that will spill into 2019, Australian business continues to be well positioned for growth into next year. In New South Wales, we have a new train set that is now serving spot coal volumes and a second train set that is arriving at the end of the fourth quarter. The consistent high quality of our Australian teams operating performance is generating good customer demand for spot coal shipments and we expect to translate this into long-term contracts in the months ahead.
Now turning to the UK/Europe. In the third quarter of 2018, our UK/Europe adjusted operating income was roughly $2 million or 35% better than last year excluding our now divested ERS business. While below our third quarter plan, we are in fact making good progress in the UK optimization program. It's been well executed. The streamlining of the UK management team and the consolidation of our support functions is progressing and technology investments continue to be implemented. One significant area of our optimization plan that may change relates to the return of excess locomotives and wagons that were underutilized due to operating efficiencies. We previously indicated that we will be returning the leased equipment and thus far have incurred $6 million out of the total of $29 million of estimated charges. However, due to strong commercial demand for our services that we believe can be secured under long-term contracts, we may be redeploying all or a portion of the excess equipment to new business. A decision that we expect to make in the short-term and could avoid over $20 million of charges. Finally, as a result of growing demand for our services and the locomotive driver shortage, a key focus for our UK operating team right now is the hiring and training of new locomotive engineers.
Finally, I'd like to turn to our investing activities in our share repurchase plan. We continue to actively analyze acquisition and investment opportunities in multiple geographies, as well as to evaluate investments in our own shares. In mid-October, we completed our previously announced $300 million share repurchase program at an average price of $76.70 and our Board recently approved an additional $500 million share repurchase program. We expect to execute the new repurchase plan opportunistically as we evaluate the intrinsic value of our shares, the relative attractiveness of acquisitions and investments, as well as our leverage profile and overall business conditions. I should note with our current leverage at 2.7 times net adjusted debt to adjusted EBITDA, we have the capacity to pursue both investments and share repurchases simultaneously. While we will be managing through some issues in the fourth quarter, our commercial outlook is good in all three G&W geographies and our earnings are on a favorable trajectory after a strong third quarter.
Now, I'd like to turn the call over to our CFO, TJ Gallagher, to discuss the third quarter results and fourth quarter guidance in greater detail. TJ?
Timothy J. Gallagher -- Chief Financial Officer
Thanks, Jack, and good morning, everyone. Please turn to Slide 8. Our adjusted third quarter diluted EPS increased $0.42 per share or 52%, primarily due to strong growth in North America as well as the impact of U.S. tax reform. Australia was slightly weaker and same railroad UK/Europe was up $0.03. ERS, which was sold in June, contributed $0.05 per share last year, primarily due to a couple of large one-time items. I will cover the details of each segment over the course of the presentation. So let's get started now with North American carloads on Slide 9. Traffic for the third quarter increased 9.4% year-over-year with strength across most commodity groups, the largest of which were in metals, which increased approximately 9,700 carloads or 29% due to stronger shipments with our steel-making customers as well as stronger outbound pipe shipments. Coal, which increased roughly 9,500 carloads or 16%, primarily due to stronger steam coal shipments in our Midwest and Northeast regions. Agricultural products, which increased 3,400 carloads or 7%, primarily due to stronger export soybean meal in the Pacific Northwest. And last, minerals and stone, which also increased 3,400 carloads or 6%, primarily due to stronger aggregates, cement and clay. In the appendix, we have included a comparison of our U.S. carloads to U.S. Class I traffic for the first nine months of the year. Excluding intermodal traffic, our U.S. carload growth was 3.3 percentage points higher than Class I growth, primarily due to stronger coal, metal and other consumer-related commodities such as lumber and waste. Now let's turn to Slide 10 and North America pricing. Our North American core price increase in the third quarter was around 3.5%. As you can see from the bridge on the slide, we had adverse customer and commodity mix shifts, which were partially offset by higher fuel surcharges. The unfavorable changes in customer mix were primarily in coal, where we had a new customer start-up in 2018, and agricultural products, which had a shorter average length of haul in 2018. The adverse commodity mix includes a relative increase in lower rated commodities such as coal and Class I empty traffic.
Now turning to Slide 11 and North American revenue. Revenues increased $36.8 million or 11.5%. As you saw on the carloads and pricing slides, we had strong growth across many commodity groups as well as strong pricing and higher fuel surcharges. The largest freight increases were in metals, pulp and paper, minerals and stone, and coal, with all remaining commodities adding another $7.6 million. The higher switching revenue is from a new iron ore customer in Canada and higher revenues from our port terminal railroad in Savannah, which had stronger intermodal volumes and Corpus Christi, where we had a new petroleum products customer start-up. Now moving to Slide 12. From an operating standpoint, our North American business performed very well. With 65% incremental margins, net of higher fuel surcharge revenues, our adjusted operating income increased $19.6 million excluding currency or 23.6%. Now let's turn to Australia on Slide 13. Excluding FX, revenues increased $1.4 million or 1.9%, primarily due to higher coal and minerals and stone revenues, partially offset by lower drought-impacted agricultural products and lower metallic ores.
Slide 14. Excluding currency, Australia adjusted operating income was roughly flat with higher expenses due to training additional locomotive drivers for new business. Now let's turn to UK, European operations on Slide 15. Excluding FX, same railroad revenues increased $9.1 million or 5.6%, primarily due to UK Rail performance and higher aggregates in Poland. The UK Rail increase is primarily due to strong intermodal pricing and new bulk contracts. Now, Slide 16. Excluding currency, UK/Europe same railroad adjusted operating income increased $2.2 million with these increased roughly split one half to restructuring savings and one half from the stronger intermodal pricing. As a reminder, both Q3 2018 and 2017 results reflect the change in pension accounting, which reduced operating income by $2.2 million in the quarter and increased the operating ratio by approximately 120 basis points.
Now let's turn to Slide 17 and updated Q4 guidance. Let me refer you to our earlier Safe Harbor statement that noted that these statements are subject to a variety of factors that could cause actual results to differ from our current expectations. These statements represent management's expectations regarding future results as of today, October 30, 2018 and we do not undertake any obligation to update this information. First, North America results are expected to be roughly $0.08 lower than our prior guidance, primarily due to Hurricane Michael. We expect that our business interruption impact of roughly $0.04 will be covered by insurance. However, we don't expect this insurance recovery to occur until 2019. So there is a timing impact in the fourth quarter. In Australia, we now expect results to be $0.02 lower, primarily from delays in coal shipments.
Finally in the UK, we expect Q4 results to be $0.04 lower, which is the same level of underperformance as in Q3. The bottom line is, we expect Q4 diluted EPS to be approximately $0.90. With that, please turn to Slide 18 in the details for Q4. We expect fourth quarter revenues in the range of $555 million to $575 million and operating income in the range of $97 million to $102 million. Diluted EPS is expected at $0.90 with 58.9 million shares outstanding. Carload growth in North America is expected to be around 5% with strength in coal and metals. In Australia, we expect volumes to increase 10%, primarily due to easier coal comps despite the lower updated forecast. And in the UK/Europe, our volumes are expected to be flat. So let's finish up with the balance sheet on Slide 18. We ended the quarter with net debt to capitalization of 37%, net adjusted debt to adjusted EBITDA of 2.7 times and over $600 million of capacity on our revolver. And with that, I'll open up the call for questions.
Questions and Answers:
Operator
(Operator Instructions) First question is going to come from line of Jason Seidl with Cowen Securities, please go ahead.
Jason Seidl -- Cowen Securities -- Analyst
Thank you, operator. Hey, Jack, hey TJ, hey, Mark. Wanted to focus a little bit on the commentary about the growth above the Class I, obviously ex-intermodal, well above their growth rate. What's the outlook for that continuing within the industry as you look across your business lines?
Timothy J. Gallagher -- Chief Financial Officer
Well, if you turn to the appendix, we provide a commodity weighted variance on the far right column. So you can see where the 3.3 percentage points of outperformance comes from. Coal is the biggest part and we've said all along and have been saying for years that our growth, because we touch so many of the Class Is, east, west, north, south, and our volume growth should be roughly equivalent to the average across the Class Is, but for a different mix. Now we've got a different mix for coal, we have a different mix for ag and those weather-dependent commodities can swing things up or down. With respect to the other underlying commodities, our growth in North America is slowing, but still positive. Our growth in Q4 is expected to be 5% versus 8% to 9% in Q2 and Q3. So we expect growth to continue. But it is moderating. There remains uncertainty around ag with respect to tariffs, but overall the economy still feels good, but softening just a bit in terms of growth. Michael, any other comments?
Michael Miller -- President, North American Operations
No, I think you're right on TJ, I mean we've experienced over the last three or four years is just a natural slowing in the fourth quarter, just the inventory reductions, planning, finish off the year with lower inventories for our customers. The other thing that plays in our favor is we do have a little more truck competitive exposure on our commodity bases. And with higher fuel prices, tighter truck competition, those set us up very well to capture more business. So I think from our standpoint, we look to kind of continuously push forward on where we have been on this growth trajectory and look for some stability coming out of the grain business once the Chinese tariff kind of works itself out. Historically, we would have shipped a lot more grain in the fourth quarter, but that has been slowed just because of the tariff issues.
Jason Seidl -- Cowen Securities -- Analyst
So would you just say the --
John Hellmann -- Chairman & Chief Executive Officer
Jason, just a couple more observations. And with respect to, if you look at again Slide 21, you can see about 2/3 of outperformance is coal, a piece of that is a new plant that we're serving, so that's structural, a piece of it is weather related, so that's going to be more variable, and so it's been -- it was a hot summer. So, we benefited from that, the stockpiles have been low and benefited from that. So there is a piece that's structural and a piece that's going to move with the weather. If you look at minerals and stone, you see that frac sand comment, that's because we don't handle very much frac sand and so some of the fall-off that you've seen from the Class Is shipping from north to south since we weren't handling much of that to begin with, that's why you've seen the relative outperformance. Let's see what else is worth commenting on there. Michael already talked about the truck competitive lanes (ph). So that's probably sufficient. I don't think we forecasted beyond what you see here on a nine-month basis in terms of that where the relative differential is going to be. We just haven't done the analysis in terms of where we think they're going to be versus where we are going to be yet. So I don't think we can answer precisely, your question, but hopefully that provides enough color.
Jason Seidl -- Cowen Securities -- Analyst
No, Jack. That's good color. And I guess on the -- you mentioned the weakness, that sounds like most of the weakness is going to be in the ag front in 4Q related to the tariffs, is that correct?
John Hellmann -- Chairman & Chief Executive Officer
Well, there is a little, I mean in relative terms compared to what we previously had been seeing. Yes, the ag is weaker, but it's still I think quarter-over-quarter roughly flat and so it's not going to be declining. It's just not going to be as strong as we thought, because there's not much shipping out the door to China. I think the other area before I kick it to Michael is the lumber and forest products is pretty flat right now after very strong shipments is in the ton shipping and I think our outlook for lumber quarter-over-quarter is -- after good growth is pretty flat embedded in our outlook. I don't know if there's any other, TJ, you want to comment on anything else?
Timothy J. Gallagher -- Chief Financial Officer
The other trends are -- remained, although may be slightly less pronounced.
Jason Seidl -- Cowen Securities -- Analyst
If I could sneak one more in here. On pricing, 3.5% same-store, that's a pretty good number for the industry. Obviously, you referenced you're more truck-competitive. We've seen the spot market on trucking come down, but it seems like the contract market is still doing really, really well. What your observation is going forward and being able to extract pricing and some of those truck-competitive lanes for '19?
John Hellmann -- Chairman & Chief Executive Officer
Michael, you want to speak to that?
Michael Miller -- President, North American Operations
Sure. Yes, I think we still believe structurally truck count -- truck capacity is going to continue to be tight. You know we really focus working with our customers to price to that market and I think the fact you haven't seen contract rates drop is pretty much true that in '19 you're still going to see truck rates continue to be relatively strong. So we feel like we have still an opportunity to price into that market. In cases, we've even worked with some of our customers, lock in a few longer term deals with some really inflationary plus adjustment factors just to guarantee capacity. So I think we've done a pretty good job and feel like '19 will be relative basically in line with '18 for us. And as the service product for the network gets better and better, reliability gets better and better that also offers an opportunity with price.
Jason Seidl -- Cowen Securities -- Analyst
Okay. Thank you for the time as always, gentlemen.
John Hellmann -- Chairman & Chief Executive Officer
Thanks, Seidl.
Operator
Next, we'll go to the line of Chris Wetherbee with Citi. Please go ahead.
Chris Wetherbee -- Citi -- Analyst
Yeah, hey, thanks. Good morning, guys. Wanted to touch base a little bit on the UK and -- UK, Europe and Australia. And just maybe think a bit more conceptually around operating leverage in those businesses. So Jack, I think, you talked there, TJ about a couple of cost pressures that are popping up, I think, in both areas, mostly around labor. But it sounds like there is still a good revenue opportunity. So just want to get a sense as you look at the '19 how do we think about the leverage there, we kind of get North America and you can -- see that in 3Q results. But what can we get out of both of these businesses?
John Hellmann -- Chairman & Chief Executive Officer
Yeah, I mean the short answer is they are different. The Australia is going to look more like the US, it's chunkier. In terms of -- the incremental volume comes online at a higher incremental margin, whether it's on our network in South Australia and the Northern Territory or whether it's out in New South Wales with increased spot coal tonnages and so you do -- the needle gets moved with higher margins just based on the nature of that business in Australia. Cost pressures in Australia are mostly self-imposed training drivers for future growth. We have added some commercial capabilities as well in the G&A side of things that have been cut back after the reduction in Australian business. So we've been investing for growth and we think 2019 and beyond we're going to start seeing that. You can see that we've invested in two new train sets. There's various other projects around that hopefully will bring to fruition as well. With respect to the UK, you're going to be -- it's quite -- not quite as chunky. The incremental margins aren't quite as good and so the operating ratio tracking down into the low 90s over time. It is still the logical play to think about that, but not quite the step function-type benefit that you see in North America. Well, I guess you saw at this quarter North America you see how fast it can move just when the volume goes up. Australia is the same, UK a little bit less.
Chris Wetherbee -- Citi -- Analyst
Okay. And then does that sort of still hold in the dynamic of maybe sort of this wage dynamic with the locomotive drivers that you're going to see for next year in UK, Europe?
John Hellmann -- Chairman & Chief Executive Officer
Yes, I mean you're going to -- so we're expecting to have some cost pressures in the fourth quarter. I wouldn't be surprised if we had some cost pressures in the first quarter of 2019 on the driver issue there. But that's also being led to increased commercial activities where we're going to be adding some new business as well. And so I think over the -- you're going to continue to see the -- as those drivers come online, there's a number of guys that are being trained that are coming online. We are hiring new people. We are trading new people. I think you'll see working itself through by the second quarter.
Chris Wetherbee -- Citi -- Analyst
Okay, that's super helpful. And then, just wanted to ask a little bit about your perspective on buybacks versus deals. This is a question that's come up a bunch, and just kind of curious, obviously $500 million new program sounds like you -- from a balance sheet perspective, you have capacity to maybe do both in the future, but as sort of you look at your opportunity set in front of you today, how are you thinking about that leaning -- sounds like leaning a little bit more buyback, but if could you put some color around that would be great.
John Hellmann -- Chairman & Chief Executive Officer
Yeah, you know we're pretty balanced in our approach, you can see the proof is in the putting and we've been buying shares, right. So -- but that doesn't mean we haven't been looking at other investment opportunities. There are some interesting things out there. Thus far, that value opportunity has not been superior to our own shares and therefore we've been buying our shares and we've gotten approval for a significant new share repurchase program to retain that optionality going forward. But we are -- we look at it in a balanced -- we look at it in a very balanced way and you'll see us continually -- continue to probably opportunistically dollar-cost average into the stock at various levels. You can see where we just completed the last $300 million and we'll balance that with other acquisition and investment opportunities. And so balance is the word that I would take away from that.
Chris Wetherbee -- Citi -- Analyst
Okay, that's helpful. Thank you. Appreciate it.
Operator
And next, we'll go to the line of Ken Hoexter with Bank of America Merrill Lynch, please go ahead.
Ken Hoexter -- Bank of America Merrill Lynch -- Analyst
Hey, great. Good morning. Jack, just a follow-up on the buyback real quick, just while we're on that subject. But is there a timing that you're putting on this one is, should we assume or I guess, TJ, should we assume this is a 2019 start-finish event?
John Hellmann -- Chairman & Chief Executive Officer
TJ?
Timothy J. Gallagher -- Chief Financial Officer
Hey, Ken. So there is no fixed end date on this, and I'll just remind you that although as a different business environment, we launched the $300 million program in 2015. So, it took a roughly three years to complete. So there is no fixed deadline whether it's one year, two year, three years. As Jack mentioned before, it's one of our balance and being opportunistic as we evaluate acquisitions, investments as well as our own shares.
Ken Hoexter -- Bank of America Merrill Lynch -- Analyst
Alright, that's helpful. So just I wanted to follow up on your -- Jack, you've made some opening comments on UK that you might keep some of the equipment instead of divesting it, where are you seeing that business ramp-up and maybe you can talk about the opportunities and your margin outlook on the UK/Europe business?
John Hellmann -- Chairman & Chief Executive Officer
Yes, you know I mean we are -- I can't be too specific, but just because you're -- we're in an open access environment there and we're bidding on some large contracts where we think we're pretty competitive. So there is some very logical places where that equipment which may find a long-term home, and when those are the sorts of things we would announce when they're consummated, but it looks like what was going to be a parking of equipment. Now on a probability adjusted basis rather than just realizing those lease savings, which is what we are anticipating doing and returning equipment, we may be deploying them under a longer-term -- under a long-term deal to move some freight. So I can't be more specific than that.
Ken Hoexter -- Bank of America Merrill Lynch -- Analyst
This is in the UK, not Europe?
John Hellmann -- Chairman & Chief Executive Officer
Yes. No, it's all we can't say, I am talking only to the UK. That's right.
Ken Hoexter -- Bank of America Merrill Lynch -- Analyst
And I guess was this all the coal business that you would shut down or is that completely different. This is ...
John Hellmann -- Chairman & Chief Executive Officer
Yes, this is -- this is most -- from an economic standpoint, you're mostly talking about locomotives.
Ken Hoexter -- Bank of America Merrill Lynch -- Analyst
So the business could be any type of product. It's not related to the cars. Okay.
John Hellmann -- Chairman & Chief Executive Officer
That's right. Yeah, you're not limited to necessarily with the cars directly.
Ken Hoexter -- Bank of America Merrill Lynch -- Analyst
And then so would this -- if you have the equipment, then does that add to your leverage -- your operating leverage outlook on new business gained, just want to try to understand if this is -- how significantly you could ramp up on margin?
John Hellmann -- Chairman & Chief Executive Officer
It's embedded commercial growth that -- if we're deploying that equipment to new business by definition, it's new commercial growth at a favorable margin that's superior to the economics that we showed you in terms of what we would benefit from by returning the leases. So, yes, it's got a good incremental margin on business that earns its cost of capital.
Ken Hoexter -- Bank of America Merrill Lynch -- Analyst
That's helpful. And is there, again, same thing as time frame, is that something we should look at fairly soon or is that something that comes in ratably over 19, 20?
John Hellmann -- Chairman & Chief Executive Officer
Well, it depends on which piece of business it is. The decisions -- decision-making processes are in the relatively near term and if they come to pass, you'll see us announcing.
Operator
And we have a question from the line of Allison Landry with Credit Suisse. Please go ahead.
Allison Landry -- Credit Suisse -- Analyst
Good morning. Just wanted to ask another question on the UK. There's been a litany of issues since you acquired Freightliner, most recent with locomotive driver shortage and some of the things have not been in your control and I heard your comments earlier about the strong pipeline of business, but I guess sort of thinking about the full year EBIT for UK/Europe now expected to be 20% to 30% lower than what you thought back in January along with underperformance in '17 and I think 2016, like how do you or how can we get comfortable with the long-term returns on the business?
John Hellmann -- Chairman & Chief Executive Officer
I mean, I think everything you said is true, the business is underperformed since we acquired it and there always seems to be -- there always seems to be a reason, right. Once it was the collapse of the coal market, another time it's been congestion in ports, as the liner companies -- as the container shipping companies consolidated and changed their ports of call, there always seems to be something. And so we're just focusing on -- we've got a great restructuring plan in place. The places that were coming up short, this case driver shortages, we're just going to be fully transparent on what they are and what the financial impact is, there's a lot of positive progress being made in the turnaround of the business and we remain optimistic. As you can see embedded in the numbers, even though we're short of where we wanted to be, directionally the business is headed in a good direction and we expect to continue to do so. And so I think from your standpoint, I think it's show me, don't tell me and that's why I'm not laying out a long-term vision here, I'm going to keep showing you how we're chipping away quarter-after-quarter and eventually we'll have the credibility for you to see that long-term path.
Allison Landry -- Credit Suisse -- Analyst
Okay, that's fair. And then I also wanted to ask a longer-term question related to precision railroading and just if we can assume, it's at some point successfully implemented across the Class Is and I would think the sort of obvious potential benefits for you guys would be M&A, costs on lease opportunities, but just curious to hear your thoughts on if you think there is a material cost opportunity at G&W where you could see the North American OR get down in the low 60s, for example, if the Class Is get to the mid to high 50s. So just wondering if you could help us think through that and then maybe if there's any less obvious implications from TSR that we should be considering?
John Hellmann -- Chairman & Chief Executive Officer
Sure. I'll tackle just first comment. Number one is my tongue in cheek answer is to remember that in precision scheduled railroading, we are a precision scheduled shock absorber, because we are short line and we take it when it comes and we play the hand we're dealt very well where lower density lines, our costs go up, we are able to deliver the traffic, help out the customers and help facilitate the transition. So just keep that in mind, that's why when we caution that there can be adverse side effects, that's what we're talking about. In terms of anything that enhances the fluidity, the overall rail network is beneficial to movements by rail and can ultimately be beneficial to us. Our greatest operating leverage doesn't come from -- we've been unlike Class Is that are constantly adjusting their cost structures, which have been in place for very, very long periods of time. Our cost structures have been built from the ground up over time and our biggest source of leverage isn't going to be finding overhead cost take outs, which we don't have very much. It's going to be from the volume that flows across our network and the price, driving and across our fixed asset base and realizing the types of incremental margins that you saw in the third quarter. With respect to precision scheduled railroading and the recent efforts by a couple of our Class I partners, maybe I'll kick it to Michael and let him make some observations.
Michael Miller -- President, North American Operations
Yes, I think our view of PSR is, if it's going to happen, let's just go ahead and get it over with. We believe that last two, obviously last year CSX implemented a pretty substantial move with their PSR and we suffered do that in the Q3 and Q4. But if you look at that, they've seen pretty good growth year-over-year now and the railroad is running very, very well. Our other two Class Is that we deal with here that are going through the implementation of a balanced approach to PSR, we've been working very closely with them as they implement it, hopefully that will mean a little less disruption for us, but we do believe long term as the North American network becomes more scheduled, that gives more reliability, more predictability of service, which ultimately drives more volume. We will actually have to engineer our business around what the schedules look like. So as Jack mentioned, our calls may go up a little bit to begin with, but over time we'll work to get those back to the levels we think they should be. But long term it's going to be more volume, more predictability, more reliability, which means we can price higher for the service. And I think long term, it's a great thing. But for us we think it will be a little bit of growing (inaudible) here with the two partners that are implementing it now, it maybe a little bit less than we experienced last year, but that remains to be seen.
Allison Landry -- Credit Suisse -- Analyst
Okay, excellent. And then so just any sort of early phases of those two carriers, any disruptions that you've seen so far?
Michael Miller -- President, North American Operations
Yes, we've had a little bit of disruption, it's been more spot related, I think the implementation has been more focused in certain geographies. So it's been very confined to a couple of properties that we had and interchanged with those partners, but obviously I think they're ramping up that implementation now. We'll see how that goes.
Allison Landry -- Credit Suisse -- Analyst
Okay. Excellent. Thank you.
John Hellmann -- Chairman & Chief Executive Officer
Thanks, Allison.
Operator
And next we'll line of Matt Reustle with Goldman Sachs. Please go ahead.
Matt Reustle -- Goldman Sachs -- Analyst
Yes, good morning, thanks for taking my question. Just going back to North American incremental margins, but very strong quarter and if I look at your guidance and back of the hurricane impact, it looks like you'd be open up the high 50s again in the fourth quarter, is there anything with the pricing environment which is supporting higher incrementals above that kind of 50% midpoint that you've talked about in the past?
Timothy J. Gallagher -- Chief Financial Officer
It's really hard to see, I mean, look, it's favorable, but in every quarter when we look at our incremental margins, in addition the price is always freight mix which plays into that. So still 50% is the right starting point to think about and then it's going to bounce around from there, we did -- 65% is kind of shows you what we can do. But in any given quarter, there's always going to be some things that will make it different.
John Hellmann -- Chairman & Chief Executive Officer
We can give you an hour long answer to that by commodity, by lane and depending on the mix, you could come up with 10 different answers. But I think based on kind of a statistical sample of all the lanes we serve and where stuff normally shakes out, 50 is generally proven to be a really good number for a really long time, sometimes it's very obvious. I think last quarter we had a bunch of one-time costs that you can see it clearly. So we try to break it out, so you could see this quarter as clean and easy one to see to the extent that rate increases are higher than normal. It's probably going to be a little bit higher to the extent that they're a little lower, it's going to be a little lower, but I think as a rule of thumb and in terms of forecasting our long-term business, that's the margin that we use.
Matt Reustle -- Goldman Sachs -- Analyst
Understood. That's very helpful. And then, just when you talk about the pockets of slowdown that you're seeing and I know that's very isolated, is it essentially all tariff related when you look at where you are seeing areas of slow down?
Timothy J. Gallagher -- Chief Financial Officer
Well, there is certainly -- I'm not going to go and say with that degree of specificity. I can't say we sat in a room full of customers at an event out on the West Coast about four, five days ago and there were one out of 20, we're happy with the tariffs and 19 out of 20 we're unhappy for various reasons, whether it's higher input costs to their products or whether it was export markets, where economic logic was no longer prevailing and there were de facto embargos on products being implemented in Asia. So there's certainly intangible flow on effects through the totality of our customer base, so that's being impacted adversely by the tariffs. In terms of trying to quantify how that's affecting, I mean it's certainly not affecting our -- the inventory levels of lumber which are flat period-over-period. The strong dollars probably -- the strengthening of the dollar is probably the most broad effect overall, which is some of our currency-sensitive commodities probably are finding a home externally as much as they otherwise would is clearly it would be better if the tariffs weren't in effect for much of the economy.
Matt Reustle -- Goldman Sachs -- Analyst
Understood, thanks for that.
Operator
And next, we'll go to the line of Brian Ossenbeck with JPMorgan. Please go head.
Brian Ossenbeck -- JPMorgan -- Analyst
Hey, good morning, thanks for taking my question. Maybe just following up on the business outlook. Can you give us a refresh of the industrial pipeline -- industrial development pipeline rather, how it's changed over the last quarter, I think last time you gave us an update which was helpful. There was some stuff that was moving ahead in, call, the next six to nine months. So just wanted to see if it had a change in terms of timing or scope of opportunities?
John Hellmann -- Chairman & Chief Executive Officer
Yes, so, hey, Michael, do you want to take that. Maybe talk a little bit about what's come online like rebar and stuff and then talk a little bit about other things that we're seeing in the pipeline and where it's coming from.
Michael Miller -- President, North American Operations
Yes, I would say we've seen a few of our customer projects come online, new steel mill in Oklahoma, rebar products. New feed mill, it's come online. I will tell you, I probably haven't seen a more robust pipeline, not any huge projects, but a lot of kind of middle-sized projects 500 to 1,000 carloads, in some cases, up to 3,000 to 5,000 carloads per year. I would say probably over the next six months, we'll probably have another four to six projects come online. So the pipeline for us is really robust right now. There's a lot of capital investment going in either through expansions or new additions of capacity. For us right now is just a matter of making sure we slow down any churn, so we actually recognize all that additional carload growth is going to be coming online over the next six to 12 months. And there's even projects out there that are two to three years out, so we feel very good about our industrial development pipeline and as long as the economy continues to kind of move forward, we feel very confident that you will see two or three of these projects come along every single quarter coming online and adding new carloads to the franchise. And there are cross commodity sectors. There is really no -- we had a big lumber mill come online in the Pacific Northwest last year, the steel come online, feed mills coming online, we're looking at plastic facilities expansion, so it's really across the board.
Brian Ossenbeck -- JPMorgan -- Analyst
Okay, got it.
John Hellmann -- Chairman & Chief Executive Officer
You probably got -- what is interesting about it is how broad based it is to Michael's point. You heard TJ in his remarks. I don't think -- we don't speak to every project that comes online, but whether it's a new mine up in Canada that's opened. You saw that go into our non-freight revenue, there was the plant -- there was the new facility down in Corpus for handling, I think, petroleum products that came online. So you're -- it provides nice support for the underlying volumes and you're just seeing a it. But what's interesting about it is that it is so broad based. It is in over -- if you look back over the last five, six years, there was always an area whether it was energy at one point entire or whether it was different commodities and different time frames, where it was always skewed one way or another, it's very broad based right now.
Brian Ossenbeck -- JPMorgan -- Analyst
Got it, it's very helpful. Sounds like no real bubbles in there that you can see and then it's also no real slowdown in terms of confidence or timing because of the tariffs or the strong dollar, anything else like that?
John Hellmann -- Chairman & Chief Executive Officer
Right. We'll say hopefully no bubbles, right.
Brian Ossenbeck -- JPMorgan -- Analyst
Okay, fair enough. And then just one more on growth and maybe more on partnerships. CP had an investor event, recently highlighted doing more business with short lines is way to grow our merchandise. So I guess it's been a year -- little over a year since you did the Ohio Valley agreement with CP, so maybe if you can put that into context how it works, what's been good, bad expected about that partnership. And if you think the -- if you share their view that that's another way to add some more volume on the network going forward.
John Hellmann -- Chairman & Chief Executive Officer
I think the most important takeaway from that specific project was the speed with where -- it was the fastest we have ever seen a Class 1 railroad move on a new project. From the time we sat down to talk about it, to the time that we got the deal inked, it was -- in rail terms, it was lightning speed. I mean it was a couple months from consummation of idea to execution, which is a precedent that we'd like to think and continue for the industry overall. The volumes have not yet ramped up for that project, even though there is a specific market that we expect to emerge in the coming months. Michael, you want to speak to that a little bit, it isn't moving the needle yet at all, but it's expected to.
Michael Miller -- President, North American Operations
Yeah, we've only kind of tested the market. We've had a couple of shipments come in for test to make sure the trends at the facility. They're converting a fairly large chunk in their business into this area, so they want to make sure it's right. So we feel good about the service product. We look forward to starting to come online probably the beginning of next year of any material volumes. With regards to the second part of the question, we are look working very closely with other Class 1 partners to look for ways we can extend their reach into markets that make sense for them. Whether it's a -- another intermodal opportunity or whether it's you're providing haulage service or even just providing more switching coming off some of our short lines, so they can avoid going to a classification yard. I think we're looking at all of those options. And as I said in the past conference, this is a team sport, so our job is to play together as a team and make sure we provide the best supply chain solution for our customers. So that's really kind of where we are. If there's something we can do to help add value to their supply chain, our value to our customer supply chain, we're looking at all those options.
Brian Ossenbeck -- JPMorgan -- Analyst
Okay, great and just one last quick one on the UK. Any lasting impact from the IT issues that happened at Felixstowe port? Any longer term divergence maybe for a quarter or part of '19 or is everything back to -- approaching back to normal? Thank you.
John Hellmann -- Chairman & Chief Executive Officer
Yes, I mean economically the traffic that wants to move by rail will move by rail. So I wouldn't be worrying about permanent divergence there. We have stepped in with our trucking fleet and handled some extra -- some flows that are due to some of the disruption at the port. Many of the issues have extended on a bit longer than expected, but we do expect them to what we've been expecting it for a while, but this quarter is where they're currently telling us that it will all be ironed out. I think on the last call, we said that it had been ironed out and then we got a surprise a couple weeks later, so it continued on -- it's an IT system issue there. I wouldn't be concerned about a long-term divergence and new patterns of freight movements emerging there, what economically wants to move by rail will move by rail there. And there's a lot of hunger for that for the supply to be provided from our intermodal service.
Brian Ossenbeck -- JPMorgan -- Analyst
Okay. Thanks lot for your time. Appreciate it.
Operator
And we have a question from the line of Diane Wang with Morgan Stanley. Please go ahead.
Diane Wang -- Morgan Stanley -- Analyst
Hi, thanks for taking my questions. I have a macro question for the 20% of business outside of North America. GWR (inaudible), you guys have a lot of company-specific initiatives in the UK and in Australia. So how do we think about the potential impact on GWR from a no-deal Brexit and decelerating growth in China. And what levers do you think you can pull to mitigate, any headwinds?
John Hellmann -- Chairman & Chief Executive Officer
Yes, in terms of no-deal Brexit, say it's a terrific question. There isn't much business that we handle in the UK that is traded with Europe. So that's the main thing. These are -- the intermodal traffic that we're handling is largely intermodal trade with Asia and then exports being distributed from there. So in terms of what's flowing, roll on roll-off type stuff that's going across the channel, that's not us. I mean in terms of specific concerns about impacts, while we're -- I mean the currency movements, probably the biggest thing to keep your eye on because of its impact on the British consumer. The depreciation of the pound, and the implicit undermining of the purchasing power of the British consumer would be one of the variables that could affect products consumed in the UK and therefore implicitly our intermodal flows. So I think from where we sit today amid this uncertainty, that's the macro variable. It's not practical -- not at the practical implementation level, it's that macro variable that I think is the one to watch.
Diane Wang -- Morgan Stanley -- Analyst
I got it. And then what about the Australia business and any impact from China?
John Hellmann -- Chairman & Chief Executive Officer
I'm not sure to answer that one. Because I mean what's the specific question, if -- be more specific in the question, I'll hit it.
Diane Wang -- Morgan Stanley -- Analyst
Just decelerating growth in Australia and the impact on let's take whole, right now that you guys have a lot of fixed shipments?
John Hellmann -- Chairman & Chief Executive Officer
Sure. So if you look at our coal price -- if you want to talk about -- I mean it depends on the commodity how you divert it, coal Australia equal is steam coal, Japan, Taiwan, South Korea and some of the new spot moves are headed to China. The vast majority of that business is under long-term take-or-pay contracts. It's very stable. That's why you don't see, when volumes dropped quite a bit like if you compare this quarter profits to last year and then you looked at the coal volumes, you'll notice that the profit was about the same, but the volumes are very different. That's contractually structured that way and so I don't -- in terms of slowdown in China on our steam coal, I'm not sure that that's necessarily something that we'd be concerned about except in the spot market and then whatever overall impacts are on-demand for steam coal in Asia. And everything else, it's all -- whether it's China or any other consumer, other commodity, just watch the commodity prices and those commodity prices can affect the relative competitiveness of some of the mines that we serve whether they be manganese, copper or iron ore and lower prices makes our customers less happy, lower Australian dollar makes them more profitable. So there's -- as those variables come together, that impacts the relative competitiveness of our customers.
Diane Wang -- Morgan Stanley -- Analyst
Great, that's very helpful. I'm just squeezed to one in here on coal in North America. Can you remind us what is your split of coal at the different regions like PRB (ph) versus Eastern and what nat-gas prices they's competitive to that?
John Hellmann -- Chairman & Chief Executive Officer
Yes. So the last time I took a hard look at those numbers, PRB was around 50%, 60% and then the remaining 40% to 50% sort of split between Illinois Basin and Northern App. So those numbers are going be directionally correct. $3 gas -- natural gas prices is kind of like the rule of thumb, that's sort of a good number to think about in terms of competitiveness. And I think natural gas prices are north of that or they've been north of that. So that's been helpful along with the warm midwest winter we had -- warm midwest summer that we had.
Operator
And we have a question from the line of Scott Group with Wolfe Research. Please go head.
Scott Group -- Wolfe Research -- Analyst
Hi, thanks. Good morning guys. And best wishes to Dave Brown. TJ, can you just clarify the $0.08 change in the fourth quarter guidance, is that for North America, is that entirely the hurricane or is there anything else there?
Timothy J. Gallagher -- Chief Financial Officer
No. It's mostly, I mean more than half of that is the hurricane, there's a little bit of, as we talked about earlier, our expectations for ag in Q4 are little lower than we expected and so there's a little bit of lower -- relatively speaking lower AG expectations, but the bulk of it's the hurricane.
Scott Group -- Wolfe Research -- Analyst
Okay. In terms of Australia coal, just to follow up on that last question. So you've added some coal sets, we are getting some more spot coal, if for whatever reason that spot coal business goes away, when do the Glencore contracts revert to you, is that 2019 or 2020?
Timothy J. Gallagher -- Chief Financial Officer
2021.
Scott Group -- Wolfe Research -- Analyst
2021. Okay. So we've got some time there.
John Hellmann -- Chairman & Chief Executive Officer
Yeah. But what happens -- But you are right analytically, if you are thinking about risk and residual risk and things of that nature, that's the ultimate backstop for any capital deployed.
Scott Group -- Wolfe Research -- Analyst
Okay, makes sense. One more for you, Jack on the buyback. So I think you said balanced and opportunistic, you were pretty aggressive with the $300 million and the stock today is lower than it was in the third. So why not more, I guess, aggressive in terms of utilizing that is something change in terms of leverage targets, does it maybe are we getting closer to M&A again. Maybe I just want to understand the language your tone change or maybe I'm misreading?
John Hellmann -- Chairman & Chief Executive Officer
I'm not sure to answer that.
Timothy J. Gallagher -- Chief Financial Officer
The bulk of the shares were while the average was 76, 70 and you saw from the purchase through the end of Q2, the average price was in the probably $2, $3 below that, which means the last bit was above that, but I don't think there's -- I mean just as you've asked the question, Jack and I, were looking at each other and I think you know the way we've executed that plan and the way we look going forward is -- remains balanced. It remains a function of M&A and investments is also a relative leverage. So it's -- nothing has really changed.
John Hellmann -- Chairman & Chief Executive Officer
You'll see us structurally buy more when we think it's relatively cheaper. I think you can say that unequivocally and you can also -- and so -- anyway. So I think you can -- I think that's the case. We also don't think we're smarter than anybody else are smarter than the market and so dollar-cost averaging is -- can be a wise way to manage one's way through or share repurchase plan. And as evidenced by the volatility on our own stock and no news over a two-week period, you know you see that kind of movement, you want to -- you know that's when you want to hit it hard, is when you see something like that when the structural cash flows are looking pretty sound and then you see movements like that. That's pretty -- that opens up a nice door of opportunity there.
Scott Group -- Wolfe Research -- Analyst
But am I right in thinking though that this year is a change in thinking of more willing to use the buyback more generally and does that naturally make you more disciplined or more picky as it relates to M&A?
John Hellmann -- Chairman & Chief Executive Officer
No, I mean I think our level of picking this has been the same all along. And so it's -- I think it's the lack -- it's the fact that our leverage is -- to the extent you're hearing a change in tone is because we've delevered so much from our key -- free cash flow that we're capable of doing both right now. So I think that's probably the answer to what you're putting your finger on.
Scott Group -- Wolfe Research -- Analyst
Okay, great. And then just last thing real quick, with the 71 OR (ph) in the third quarter, does that change the think the long-term 72 OR target for North America?
Timothy J. Gallagher -- Chief Financial Officer
I know we never throw out an OR target just because you can see structurally what happens when the volume comes. And so the volume assumption will dictate where the OR ends up and will we be afraid to do a transaction of business that had a high 70s OR that earned a great return on capital, we wouldn't hesitate to do a transaction like that. So we've always shied away from -- we look at return on invested capital and the OR is an answer that it's all four based on where the volume ends up.
Scott Group -- Wolfe Research -- Analyst
Perfect. Thank you, guys.
Timothy J. Gallagher -- Chief Financial Officer
Sure.
John Hellmann -- Chairman & Chief Executive Officer
Okay, well, we've reached the top of the hour. And so that -- therefore, that concludes our call. We thank you very much for joining us. Operator, please read the replay instructions.
Operator
Ladies and gentlemen, this conference will be made available for replay after 1:00 PM Eastern Time today until November 30th at midnight. You may access the AT&T Replay Service at any time by dialing 1800-475-6701 and entering the access code 439197. International participants may dial 1320-365-3844. Again, those numbers are 1 (800) 475-6701 with the access code 439197 or internationally at 1320-365-3844. That does conclude our conference for today. Thank you for your participation and for using AT&T Teleconference service. You may now disconnect.
Duration: 62 minutes
Call participants:
Matthew O. Walsh -- Executive Vice President, Global Corporate Development
John Hellmann -- Chairman & Chief Executive Officer
Timothy J. Gallagher -- Chief Financial Officer
Jason Seidl -- Cowen Securities -- Analyst
Michael Miller -- President, North American Operations
Chris Wetherbee -- Citi -- Analyst
Ken Hoexter -- Bank of America Merrill Lynch -- Analyst
Allison Landry -- Credit Suisse -- Analyst
Matt Reustle -- Goldman Sachs -- Analyst
Brian Ossenbeck -- JPMorgan -- Analyst
Diane Wang -- Morgan Stanley -- Analyst
Scott Group -- Wolfe Research -- Analyst
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