EFTA01371096

31 October 2017 Railroads Canadian Rails Profit and pricing discussion All Class I railroads are solidly profitable in North America, with the companies under our coverage universe (CP, CNI, CSX, NSC. UNP) reporting an average ebit margin of 36.5% in 2016. This makes sense to use given the consolidated nature of the Class I industry, price discipline, and capital intensity needed to maintain an efficient railroad. There is some variability in the performance, however, with the Canadian rails achieving superior profitability relative to the U.S. rails. 'Figure 24: Class I rail operating ratios (opex as a of revenue) 2010-2019E 85% 80% 75% 70% 65% 60% 55% 2010 2011 2012 2018 2014 2015 2016 2017E 2018E 2019E -4-05X -4k-NSC -41b-UNP — Drturfalre ant, arlipii.101WIS One driver of profit variation is yield differentials (i.e. revenue per unit or carload). For example, if we look at CNI, which has the lowest operating ratio (OR), 34% of its total traffic in 2016 came from its highest yielding end markets, compared to just 30% for CSX, which had the highest operating ratio of the Class l's in 2016. As you can see below, the companies with a larger percentage of revenue coming from higher yielding carloads typically see a lower operating ratio. While this does not entirely account for margin differentials (carloads are not created equal from an incremental margin standpoint and average length of haul needs and # of touch points need to be considered, which we discuss later), higher yields do translate to higher fixed cost leverage. Hunter Harrison's Precision Railroading model has helped CP and CN1 achieve beau in-class operating ratios. Deutsche Bank Securities Inc Page 15 CONFIDENTIAL - PURSUANT TO FED. R. CRIM. P. 6(e) DB-SDNY-0064285 CONFIDENTIAL SDNY_GM_00210469 EFTA01371096