CSX Corporation (CSX) Earnings Call Transcript & Summary

Great. Good morning, and welcome to day 2 of BofA's 27th annual transportation and industrial conference, in virtual format. I'm Ken Hoexter, BofA's air freight and surface transportation and marine transportation analyst. Welcome, and good morning. First up on day 2, we've got Kevin Boone from CSX Corp., the Chief Financial Officer, EVP. Also joining is Bill Slater, Head of Investor Relations. Kevin has been CSX' CFO for a year now since May of 2019, although joined interim back in October, having joined back in September of 2017 during Hunter's PSR revamp. We welcome CSX for its 12th consecutive year and now 17th time in the 19 years we've been hosting the conference. Among many other companies, but CSX withdrew its guidance for 2020, holding its CapEx to the low part of its $1.6 billion to $1.7 billion target range. So with that, I'm just going to toss it over to Kevin for a couple-minute intro, and then we'll jump into Q&A. [Operator Instructions] But Kevin, with that, let me turn it over to you for some intro thoughts.

Thank you, Ken. Really appreciate it. Happy to be here. I certainly wish we are sitting in Boston together in person but glad we are able to participate in this year's virtual conference. I'm probably lucky this is not a video conference. It's been over 2 months since I've had a haircut. So glad you made this not a video conference for this time. We're all obviously adjusting to this new normal in these unprecedented times, and that applies to how we're approaching our business today. It's important that we pause for a moment and thank our employees and the railroaders out there that go to work every day to ensure essential goods are being delivered to all of us. Our top priority continues to be the safety of our employees, and we are taking the necessary steps to protect all the hard-working CSX employees who are keeping the network fluid. We are equally committed to maintaining the best-in-class service. Our customers have come to expect CSX service, and it is a testament to the quality of our team as service has actually improved during this disruption period, an amazing accomplishment when you consider the significant changes we have had to make to the network as we adapt to the significant declines in volumes. We also expect to emerge from this downturn a stronger company as the current environment allows us to reevaluate all aspects of our business. This includes all costs. As you know, Ken, there are things we can do from a cost perspective that are temporary and then there are those things that we can do that which we can carry forward as the volumes return. We are very much focused on attacking those traditional costs that we can carry forward as volumes recover. At the same time, the operating team is putting us in a position to not only differentiate our service in the current market but, just as is important, to be there for our customers as the volume returns. While it's still too early to call the shape or speed of the recovery, our hard work over the last few years has positioned CSX well to weather the current environment. In addition to more than doubling our free cash flow conversion, we have a strong balance sheet, more than $2.5 billion of cash and short-term investments and industry-leading free cash flow generation. Nothing changes how we approached our business today. We will continue to get more efficient while offering our customers best-in-class service, which will allow us to convert more volume to rail. We are using this period, and we will emerge from this even a stronger company than we were before. That's all I got, Ken. Maybe we can start with the Q&A.

Sounds good, Kevin. So maybe just jumping right into that. And by the way, my kids have been dying to give me a haircut as well, so I definitely hear you. And I don't think that's going to happen. But maybe diving in with the -- your thoughts on the costs side, maybe talk about what is variable when you think about as you move to cut some costs during the downturn and, you mentioned, as things recover. So what kind of operational costs can you pull out on a more permanent basis when you think about that? I don't know if you want to walk through labor, MS&O, fuel, rents and the like in terms of kind of talking about variability and such.

Yes. Maybe that's the best place to start. Obviously, the most variable cost that you can think of is our fuel expense. And we've done a great job. Jamie and team and the operating team has really focused on the fuel efficiency over the last few years, and we're setting records for ourselves there. And we'll continue to do so. Obviously, with fuel prices down today, the impact is a little bit less, but I would expect over the medium, long term for those costs to recover as well. So probably the most variable cost we have out there. And if we're running less trains and less volume, fuel expense should come down and be fairly variable in that scenario. Probably on the other side of that is depreciation. I could probably talk for an hour about depreciation. As you know, we have group life accounting, which is a little bit unique to the railroad industry and utilities and some others. But essentially, what group life accounting does is we've had -- over the last 3 years, we've eliminated almost over 1,000 locomotives from our network either through a sale or scrapping or just writing off. So during that time, we've gotten great value while we've done that, and we've decreased our active locomotive count by almost 50% during that time. So our capital intensity has dramatically declined, when you look over the last 2 years and the amount of cars we need to run the railroad. All those things have come down dramatically. Obviously, given the dynamics of group life accounting, the depreciation expense remains there over time. We didn't -- given we -- as we went along, we took these assets out of the network. We -- those continue to depreciate on the balance sheet today. So I would look at -- when you look at us and you look at our depreciation, I would look at our CapEx spend, which we've done a phenomenal job of becoming more efficient. Probably it's a bit underappreciated when you look out over time on what we've been able to do there, and I'll probably talk about it a little bit more when we go through the questions. But we're getting a lot more efficient on our CapEx spend today. We've made huge gains there. And we see a lot of opportunity to get even more efficient there and reallocate dollars to high-return projects that we see going forward. So depreciation a little less variable, although I would argue that you should look at our CapEx spend. And when you look at the spread of depreciation versus CapEx versus the industry, we have the lowest spread out there. So our free cash flow conversion is obviously impacted by that, and that's why you see some strong free cash flow conversion on that side. When you turn to MS&O and labor. First, starting with labor and you look at our labor workforce. About 1/3 of our labor workforce is T&E, which is obviously highly variable. If we're not running the trains, generally, that T&E workforce will come out. So we'll see some benefit there. We have other operational workforce, like the engineering side where you still have to maintain the railroad, the track, the maintenance, the inspections. While we'll look for opportunities there, that's probably a little less variable. And then you have the G&A side as well, and so we're always looking for opportunities to become more efficient and find savings as well. So we'll look at every aspect and really with a view towards a recovery and how we can leverage some of these things that we're doing today where the costs do not need to come back. I can tell you Jamie has been out in the network the last few weeks, and he's continuing to find opportunities out there where we don't believe we'll have to bring back costs doing things differently, provides an opportunity to really take a fresh look at how you are -- what you're doing operationally. When you don't have as much volume going through the terminal, you can really look at operational efficiencies that -- gain that you expect to hold while -- when the volumes return. A bit on the MS&O side, it's -- as you know, it's really everything else. It's there are some highly variable costs when I think about lift costs that we pay for a lift. Those will come out one for one. And then they have fixed costs like real estate taxes that really don't move in the near term with volumes coming down. So it's a bit of a mixed bag there. But again, it's going after things that we have traditionally thought of as fixed, maybe our utility spend. We spend $60 million a year on utilities, traditionally probably not been a cost we've focused on, probably said that's not really that variable. But we're looking at those things today and really trying to understand better what costs potentially we can lower and sustain, most importantly, as we come out of this pandemic impact.

So overall, would -- yes. No, that -- it definitely covers it in detail. Would you simply put a kind of number of 60%, 65%, 70% of kind of things that you look as variable or is it just taking each one of those and breaking it down?

Yes. I don't think we're going to guide for the second quarter OR. I think in the reality, given the significant declines, if those continued through this quarter, I think that's -- we'll hopefully see some auto business start to come back here over the next few weeks as those turn back on. But certainly, I wouldn't expect those to go to 3 shifts which they were doing prior to the pandemic impact. But if you look at it, we're not going to set any records in the second quarter, that's for sure, on the OR side. And I think when you look at the model, it's -- I think it gets easier. It's -- it gets harder to offset the volume declines as they accelerate. So for instance, in the first quarter, we saw revenue down 5%, and we are obviously able to offset that. Our expenses were down 7%. I wouldn't expect our expenses to be down more than our revenue in the second quarter. But with that said, the opportunity as the volumes return, I would expect significant leverage particularly coming out of that as the volumes increase. So we all -- saying all of that, to expect -- I would expect a 6 handle, more than a 5 handle, on the second quarter OR certainly given where everything stands today.

Yes. No, that's helpful. So even with volumes down, what, 21% quarter-to-date, down 23% this past week, you're suggesting kind of it can still be in the 6s. But let me ask you about that volume side. Are you looking for -- given the auto companies are looking to reopen around the 18th, but they've got to move volume in order to prepare for that. Are you starting to -- obviously, we haven't seen it in the volumes yet, but are you starting to prepare to see that volume increase? Or are there other factors that you still see stay closed that keep the volumes at this down 20%-plus level?

Yes. We're starting to see, I will say, at this point, very small car orders starting to come through for some of the plants that are starting to open up. But you have to remember it will take them a couple weeks to ramp up and then to produce their first car, and the car has to sit out there to be inspected and those things. So this will be a slow ramp. And then when you think about -- they're focused on protecting their workforce as well. So the likelihood of them going back to 2, 3 shifts in the near term is fairly low. I think they'll take it very slow, see how it goes and do all the things that we're trying to do to protect our employees as well. So it's going to be a slow ramp, but going -- certainly going from 0 to something is helpful, and there's a lot of other markets that had impacts from our metals business across the board, plastics business. So the autos returning certainly will start to help, hopefully, on a sequential basis our volumes as they ramp back up.

So let me just understand. You withdrew the guidance, and we're talking about, obviously, what's going on with volumes. What kind of opening do you need to see before you gain confidence to reset those targets? Is it stability? Do you wait until fall, until there's a full reemergence and elimination of shutdowns? I just want to understand your thoughts on what you need to see before you kind of reengage in providing that outlook.

Yes. I don't know. We don't -- we haven't sat around here talking a lot about when we're going to guide again, to be honest with you, just given the dynamic market. And I'm not sure we're going to be in a position by the end of the second quarter or even the end of the third quarter to do that. It's such a dynamic, changing market. Is the pandemic going to spike back up in the fall and winter? Certainly, we're not going to be the ones who make that call or have any more insights into that than anyone else out there. What we can do is just be transparent with what we're seeing on a weekly basis. And as you know, the -- our volumes come out every week, and we'll put some context around that and whenever we get a chance. But I don't -- and certainly something we'll start discussing later on in the year, but it's not something that we're actively discussing today, is when we're going to guide again. We're just focused on running the business as best we can and reacting to this really dynamic market right now.

So let's go back to some of the costs you noted. Given the volumes are down 20%, maybe you can talk a little bit about head count. You talked about the variability of costs before. It was down, what, 7% at the end of the quarter. How do you and Jim think about this in terms of opportunity to make additional structural changes?

Yes. When -- I'm just talking to -- Jamie returned from a trip out to the field and going through with the field management out there. He continued to identify jobs and things that, in his opinion, even when the volume comes back, we won't need. So those are the opportunities that we're identifying today, and they end up adding up to a lot, hopefully, over time as we take a fresh look at everything. When there's not a lot of volume going through the terminals and on the network, it really allows the team to take a pause and reevaluate everything. And that's kind of what we're seeing today. We made significant gains, obviously, reacted to the volume on the T&E side. We do have reserve boards, which allows our employees to stay on benefits for a longer period of time, but it also allows us, at the same time, to react if the volumes come back quickly. We can call those employees back within 48 hours, which gives us a lot of flexibility in the model. As you know and having followed the rail industry for a long time, I think we're a bit guilty as an industry of not being able to react to the positive volume when that comes back strongly. And so that's we really have an eye towards that, being able to be there for the customers when the volume returns and, I think, hopefully, differentiating ourselves in the market when that happens. So we're doing everything with an eye towards being able to service our customers as the volume returns. In fact, despite all of these changes over the last months, we've seen our trip plan performance set new records, which is just amazing. When you think about all of the train starts and other things that we've done to the network to react to the lower volumes, to have our trip plan compliance setting records at this point is unbelievable.

Yes. So just I'm going to jump around to different subjects given we -- kind of the time frame we've got, and I appreciate you taking the time to do this. But Jamie recently noted you had 2,000 locomotives in service, down from 4,000 when PSR began. What's your operational number now? How many do you have stored? You were talking about kind of thinking about depreciation over the long term. So just understanding your fleet and your operations on the locomotive side.

Yes. Today, we're below 1,900 active locomotives with obviously the severe volume declines that we're seeing today. That would put us at almost around 1,500 in storage. And I certainly don't see us -- or talking with the operations team, we don't expect a need for all 1,500 of those locomotives. So we're going to have to continue to evaluate that over time. But that obviously gives us a lot of opportunity to grow into that fleet, wherein we expect volume to come back and we expect to grow over the medium and long term. So from a capital standpoint, it gives us a lot of runway to grow into that, which is a great place to be right now. But we have 200 locomotives that are sitting there ready to go at a moment's notice, which gives us a lot of flexibility to react should the volumes surprise us to the upside, which I certainly hope they will over the next few months.

So flipping to the top line. The pace of the spread between you and your eastern peer is at a relative record gap since I've followed the 2 companies, almost a 10-point differential. From your point of view, is that NS focusing on its yield-up strategy and pushing away volume? Is it you taking share? Maybe any general thoughts or commentary on specific markets? And maybe you could hit on some of the major ones like coal or intermodal as you work your way down.

Yes. I think I can't speak to NS and their strategy necessarily. We're always focused on what we're doing and, quite frankly, focused on the truck conversion opportunity because that's the -- that's who we view as our major competitor in the market. That's where the growth opportunity over the medium, long term really lies for us. So we've seen a lot of -- I think what you're seeing in our volumes -- and we had a lot of momentum, quite frankly, in January, February and parts of March until the -- we saw the autos fall off. And quite frankly, we're beating our internal estimates on volumes before the pandemic impact. But what you've seen is a lot of opportunities to work with our customers converting, getting more of their wallet share, converting truck share back to rail with our performance and our service that we've provided over the last 2 years. They're starting to buy in. They're seeing it. They're seeing the consistency month after month, quarter after quarter and, hopefully, year after year. And the more time that passes where we continue to show the strong performance, I think they are more and more confident to give us more business. So that's what we're seeing there. And I think we're at the forefront of that trend this year and, quite frankly, late last year as well. That will be hard to see right now, obviously, with the volume declines, but that will -- we expect that to return. As the volumes come back, you'll start to see that trend again, but it's really the winning current customers' wallet share, finding new customers, truck conversion opportunities we've seen. Breaking it down by market, when you look at our merchandise business, that's really where we have focused over the last 2 years. You've heard Jim talk about. You've heard Mark talk about it. That's really where we believe there's a large opportunity for freight conversion from truck. And quite frankly, it's great business. It should be moving on the railroad today. And so that's when -- where we've been focused. We've also seen some -- the intermodal business, we think that's a long-term grower for us above GDP. Our network is -- on the intermodal side is the best it's ever operated. We have a channel partner that was out there on their last -- on their first quarter call that said it was the best service they have ever seen and truck like. And so as we see demand come back, we expect to win in the market. And then on the coal side. Coal has its own dynamics, when you look at it. We obviously have more export coal than our eastern peer. And so those dynamics play out there, exposures in the South. We probably have a little more southern exposure than our direct peer as well. So those dynamics have played out where we've seen a little bit of a volume difference here in the first quarter as well. But those are really the -- I think, the dynamics at play here where we're seeing some nice wins from current customers and new wins from customers that haven't traditionally used rail.

That's great. So you look at it more as a competitiveness versus the truck side, yet again it's amazing to watch that spread widen to the levels we haven't seen. So 2 questions on that, that are coming in. One, we hosted a call yesterday with [ Puerto Valena ] in New York and just want to understand. There was a -- maybe a little bit of a weak outlook on international intermodal in terms of what's going to hit the shore just given what's going on, obviously, with our economy. What are your thoughts on the -- maybe you can balance that out between international and the domestic side. And then when you hit on the domestic side, the question will be just how do you think about the loose truck market, particularly in the East, given fuel being so cheap. And how is their competitive nature versus rail? Obviously, you mentioned the best service, but how is that stacking up just given the looseness of the market and their -- the increased competitiveness with cheap fuel prices? So one on the international side, one on the domestic.

Yes. Certainly, on the international side, well, we're tracking the sailings and obviously seeing the blank sailings and down volumes. That will be dependent on how China, obviously, rebounds and then, as a carry-on effect, how the U.S. consumer rebounds from this as well. So in the short term, probably still see some pressure there as we get in the back half of the year. I think that's to be determined at this point what those volumes look like. I'm hopeful that the U.S. consumer can rebound and we can see some volumes return, but that's probably too early to call at this point. Then on the domestic side, look, we have long-term partnerships with our channel partners and customers there. And I think they understand the value proposition that we're bringing to the market. I would certainly say the truck market is loose today, no doubt about it, but that can tighten up very quickly. And so they like the predictability, the consistency of what we provide out there in terms of our service. And so I think that's a value proposition to our customers. So we still think in almost all cases we still are a cheaper option. And certainly in this market where our customers are looking to save, preserve cash, we're a great option for them to do that. So those discussions continue to happen. And we would expect intermodal to continue to take share from truck over the long term even despite some of the truck weakness that you've seen today. We also have, obviously, the fuel surcharge that is helpful in a down fuel environment, where the customer gets to participate in that as well from a pricing standpoint.

Just real quick on crude. It's a very small part, but a question came in. Just what's your exposure to crude by rail?

Yes. At this point, in the current environment, it's really less than 1%. So not a big piece of our business today, a little bit less than some of our peers out West. So not a huge factor for us.

Yes. And when you think about technology investments, one of your peers talks about inspection portals, autonomous track inspections. I know CSX has talked about a couple of different developments. Where are you on technology? You mentioned Jamie making moves to cut costs. What other things are you doing to more permanently look at your cost structure there and add more technology options?

Yes. It's probably something that we should be doing a better job of highlighting, quite frankly, because we do feel like we're on the cutting edge of all the technology developments that are going on in the industry, quite frankly. And when I look at my spend from a capital perspective, over the last 2 years, we're spending more capital on some of these initiatives than we ever have over the last -- if I compare that to the last 5 to 7 years. So certainly, our capital investment on innovation and driving some of these benefits has certainly stepped up quite dramatically, when I look over the last 2 years. When I look at it, the track inspection, we have 3 cars today that are out on the network. We're investing in 2 more this year. We are covering over 300,000 miles with those inspection cars. And I think that probably is reflected in our safety numbers, quite frankly. We've obviously set the standard in safety here recently. Train accidents, all those factors are coming down. And I think that's part of the driver there is some of the technology that we've spent on, including the track inspection cars. We have -- we'll have, by the end of the year, 3 car inspection portals that we're investing in. I think you've heard our -- some of our peers talk about the portals. We're also investing there and see great benefits over the long term. And we'll continue to develop the algorithms and -- related to that and learn from that process. So we're really excited about that. They're sitting in outside of Waycross right now. And so we're learning a lot every day about that technology. We're looking at -- we have investments in crew intelligence, which it provides more efficiency in predicting availability of our crews, which traditionally has been a problem for the industry. Predictability of who's going to be available where we might have bottlenecks in the system is going to be really, really helpful as we manage the network. Yard intelligence, when I -- you think about automating yards and telling crews how to operate, what's the best way to switch the cars most effectively in the yard, those things are things that we're going to invest in over the next few years. And I think they're going to pay off very well. We also -- in this environment, we've also accelerated on our test pilots with our -- with tablets in the field. This allows the crews to not have to go into the building, check in. So from a safety perspective, it eliminates the human-to-human interaction, which is obviously important in this environment. But it also saves the time for those crews having to go in the building, check in, fill out the paperwork, all of those things. So we see big benefits, from an efficiency standpoint, from introducing those. And you have the rule book there. You have all these things that make it easier for them to do their job on a daily basis. So yes, I think it's something we'll probably try to highlight a little bit more going forward because we probably haven't talked about it enough, but we have a number of initiatives ongoing. And when I think about our capital program, there's a lot of machine and equipment that we are going to continue to introduce that will make it a lot more efficient to realize a lot of benefits on the capital spend side when we're laying down track and ballast and all those things that we can -- we believe we can automate over the long term.

So Kevin, if I were to sum up, it looks like you're looking for permanent costs while quickly adjusting some of the variable costs. On volumes, you're taking share. As volumes come back, you see more opportunity given what you were seeing in January and February. You're looking more for a kind of 6 handle for operating ratio, which would not be a surprise, I think. For this quarter, I think we're in the mid-60s. But you took some liquidity steps. I don't know if you want to throw in any final thoughts on liquidity or CapEx, which you've talked about at the low end of your target range, or anything else you want to kind of wrap up with if that summation is somewhat kind of...

No. I think [ a couple of comments ]. CapEx side, we did say we're going to come in at the low end and there's a number of factors. We're -- the productivity levels that we're seeing out, when you look at our $1.6 billion of approximate spend, about $1 billion of that is going into the infrastructure. And we're seeing huge gains in terms of labor efficiency out there in the field as we're putting down the track. We're able to run longer blocks. We're learning a lot out there. But we're generating double-digit productivity levels on a year-over-year basis, which I've been very happy to see as we were monitoring those. So -- and we're also able to use those savings and put them into projects, like I mentioned before, on the automation side which have very good, high returns for us over the long term. So that's an exciting part. I think, obviously, the capital base is much lower. We're having -- need much fewer locomotives to run our network than we needed 3 years ago. So that will be a sustainable long-term benefit from a capital spend perspective. We're also seeing somewhat of a slight slowdown from some of our contractual work, as you can imagine, as we're protecting our workforce and a lot of the outside contractors aren't on site today, but that's really a small number. Where we're focused on is really, from a procurement side, finding lower costs out there. Commodity prices are down. We're going back to our vendors and asking for some benefit of that. And so there's a lot of opportunities that we're driving that you're starting to see in our CapEx numbers which is a benefit. Then on the cash flow side, I really -- I think we talk about this all the time, but that's the measure where I think we're very differentiated in the -- not only within transports but within industrials broadly. Our ability to generate a lot of free cash flow, which has manifested in about -- over $2.5 billion in cash sitting on our balance sheet right now, gives us a lot of optionality going forward to return cash to shareholders and to make investments. So we're in an enviable position in terms of our cash position. And so that gives us a lot of opportunities to really capitalize on that, I think, when we look out over the next year and beyond that.

If I can just squeeze one in, as we just did the wrap-up, but just to clarify on the volume shifts. You're not suggesting that it's strictly share gains from a peer. Obviously, you mentioned a lot on intermodal and winning stuff off the truck, but just to clarify: It's not seeing contracts swapping around. It's through increasing of transport business and current customer business. Is that how you would qualify it? Or has there been anything [ significant ]?

That's been our focus, work with our existing customers; how can we win more wallet share; and then identifying new markets, new customers that traditionally haven't used the railroads and going -- really going after those as well. Look, we compete day -- every day, obviously, with our direct peer, but we also compete every day with truck. And so -- and truck is a much larger market, we believe, to go after incremental volumes. So that's where we focused our attention over the last year. Mark and team have done a lot of work breaking down those markets, understanding where the opportunities are and, quite frankly, having discussions that we never have before with existing customers and new ones. We're providing a service level and visibility to the service that they've never seen before, which I think is just helping us win in the market. So that's -- yes, I think that's really the driver of what we've seen over the last, call it, 6, 9 months.

Sounds great. Hey, Kevin, truly appreciate you taking the time. Bill, thanks for being on the line as well. And everybody, next up, we're going to have Union Pacific at 8:40. So feel free to dial back into that or Webex into that presentation. And Kevin, Bill, appreciate you taking your time and your thoughts today. Thank you.

[ Thank you ] very much.