CSX Corporation (CSX) Earnings Call Transcript & Summary

Let me continue the transportation track here with our next rail, CSX Corporation, and we are very pleased to have with us CFO, Kevin Boone. Kevin, thanks so much for joining us. Before we kind of kick off the content, let me read a disclaimer. Please note that this webcast for Morgan Stanley's clients and appropriate Morgan Stanley employees only. This webcast is not for members of the press. If you are a member of the press, please disconnect and reach out separately. For important disclosures, please read the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. And of course, for the audience, if you have questions for Kevin, please, input that in your webcast browser, and I can read them on cam.

With that, Kevin, thanks so much for joining us. It looks nice outside, and kind of almost seems like everything is normal again. So maybe if we can kick off with kind of your view on how you see the world right now? Obviously, it's been a tail of, I'd say, 2/3, if you will, the way you divide the OR. Does it feel like things are coming back in normal? And I think that, that ramp has some visibility to refining?

Yes. No. First of all, thank you for having me. Obviously, the first time doing the Laguna Conference. I've been there on the other side. So it's -- unfortunately, my first time is going to be virtual, but we've got some pretty good weather out here, as you mentioned. In terms of the trends, as you -- as we all saw in the second quarter, we saw a significant decline in our business, where we peaked in June. May and June, we were down 26%. Followed by a fairly rapid recoveries, some volatility that we've probably never seen from a volume perspective. Operationally, we did a great job. Had some bumps along the road, trying to get some people back when the volume came back quickly in July, but we're mainly through that, and seeing some good performance out there. Jamie has gone back out in the network really, still finding some opportunities. He's out there today, actually ahead of this hurricane. So we'll be watching that closely as that kind of flows through our network and watching that. But where we see volumes today, and this is -- you see it in our weekly carloads as we've seen intermodal really start to strengthen here. You followed the truck market, Ravi, and that's really gotten tight here, and we'll probably get into that a little bit more. Month-to-date, double-digit year-over-year increases in our intermodal business. On the merchandise side, we continue to see a little bit of recovery off the bottom, down that low-single-digit, mid-single-digit range. Month-to-date, so seeing some strength there. It's pretty obvious that there's low inventories out there across the consumer products. My son can't get a bike still, so he's having to ride his sister's bike right now. There's a lot of products out there, lumber, other things. They're still having to get restocked. So we're seeing a little bit of that. I think the big question for me and for us, as we're looking into -- later in the fourth quarter and the next year is once the restocking is done, are we going to see some continued recovery in the economy and which will carry us through into 2021? So that's somewhat of an unknown. I think we're more encouraged that some of this restocking has the legs hopefully, into the next year. And that will continue to carry us. And so we'll see how it goes. Coal obviously remains a challenge. We'll start to lap that. Later next year, probably the first time that I'm somewhat optimistic on what coal could look like year-over-year as we move into 2021. Just given the comps, right? We're down so much. We've seen such a material impact globally to demand, given the pandemic implications. India is a big export market for us. Obviously been very, very impacted. So we think there's an opportunity that we could be at the bottom. We'll see where the commodity prices go. That's obviously, influential for our export business. And then on the domestic side, we saw some pretty low natural gas prices earlier this year. And hopefully, we're not going to go lower than that. And hopefully, there's a little bit of upside there. So we're watching that closely. But there's an opportunity, there's probably as much opportunity in the next year as there is a risk from these levels that we've seen in a long time.

Got it. Adam also has always been a glass hospital guy. So let's hope he's right about that [indiscernible].

I don't know about that. I think it's been pretty balanced around here. It's all about setting expectations internally, too.

Got it. That's fair. Maybe I can follow up on your comment on the inventory side. Obviously, it's no surprise intermodal's coming back first, because the consumer kind of has been strong on the industrial side of things. Do you have a sense from your customers kind of where they are in terms of that inventory people? Kind of what innings they are in, both on the consumer side as well as on the kind of merchandise industrial side? And maybe kind of what innings are we in, in terms of this recovery? And kind of what does that slope look like? Is it a case of, we had a slow recovery off a bottom and suddenly the curve inflects higher? Or do you think it just continues the current [ path ]?

Yes. I think we're living in the world of anecdotes right now, but we're talking closely with our customers. A lot of -- there's still a lot of uncertainty. I mean we have the election coming up. What does that mean post-election? How will spend levels really look? But taking -- before all of this happened, we were having real discussions with customers around -- concerns around driver supply, those issues that were really front of mind, and I think you're really seeing -- with a lot of trends, we've seen those really accelerate here in this period. And I think the driver shortage trend. You've probably seen with the pandemic, that really accelerate that dynamic that we have a lot of great customers concerned about. That's why they are talking about more rail service, quite frankly, with us, ones that we hadn't been customers historically. So seeing some of those trends play out here. I was just on a call with the Atlanta Fed the other day, and we had some trucking companies on there, and they're basically saying, despite bonuses, raising wages, they're seeing -- they continue to see supply come out of the market. So I think that's encouraging for us. I think people are going to continue to see the opportunity that rail provides. Jamie, and what they've done on the intermodal side, we have a completely different network in terms of how we serve the customer. Transit times are a lot faster. Reliability is up. We have a channel partner. One of our major channel partners out there continues to say that our service is truck-like. That's important. That helps us. That helps us win new business. So I think we're at the really early stages of that trend. And if anything, the pandemic is really, I think, accelerated those conversations or will accelerate those conversations, given some of the shortages we've seen. From a trend where we are today, you follow the truck market as close as I do, it's really tight. And what we really would like is that to continue in the fourth quarter and first quarter. I think that will help bidding seasons heavy in those couple of quarters that will help it with our discussions with the customer. When you look at our business, we started the industrial recession in the beginning of 2019. So we're almost 2 years into this kind of declining environment. So there's a lot of opportunity if things start to normalize. If the economy comes back for us to continue to win share, I'm sure we'll get into what our opportunities are from a market share perspective a little bit later. But we're pretty optimistic on all the things that we've done. We're set up well to really capitalize here.

Got it. And just a follow up on that on the truck point, intermodal point. And there's no question that a tighter truck market is going to be a tailwind for you, kind of just given your overlap in that business. What is your go-to-market strategy there? Are you -- like is your message to customers now, we'll take as much truck conversion as you can give us because kind of volume is our friend at this point, given where you are in your [ PSR ] strategy? Or are you looking to kind of maximize price and kind of maybe try and focus on that or focus on the returns rather than go after as much volume as possible?

No. I think when we discuss our strategy internally, I think a balanced strategy of both price and volume is a sustainable, long term, successful strategy, and that's what we're looking to do. Our service is much, much better than it ever has been. So we expect to get price in that environment, and particularly in this environment, as things tighten on the truck side. So we want to get paid for the service we're providing. We want to grow with our customers. And those discussions, I think sometimes customers are still surprised that we're so adamant. We want to grow volume. Jamie's created so much capacity and his operating team out there, where we have the ability to grow into it, whether extending our train length, which we've done -- we've been very successful as you've seen sequentially here off the second quarter. So we got plenty of capacity out there, and it's -- we know incremental margins are very healthy as we put more volume through our fixed infrastructure. We had the train starts. All these things are at levels where we have a lot of ability to leverage the network that's out there. We talk about 20%, 30% capacity in our network out there. So plenty of room to grow, plenty of opportunity for us. We're excited. Hopefully, this market continues to turn in the right direction. But we're -- I think we're still cautiously optimistic here, given all the things we're seeing. Certainly feels a lot better than it was in the second quarter.

Got it. Maybe shifting gears, talking about the incremental margin point you just raised, because you've been saying in the last couple of conference calls that your cost structure can't be variable on the way down and fixed on the way up, because it kind of doesn't work that way, which is a point. I really appreciate it. I really get that point, and yet at the same time you guys kind of have -- and your peers have been pretty good at not bringing back capacity at the same rate that volumes are coming back. So how do you think about that incremental margin range in the back half of 2020 and so couple of years? I think in the past, you guys, kind of on a sustained basis, have done high 60s, 70s, even kind. Are we looking at that level of incremental margins, do we do better? Do we do worse, given that you already have such strong starting point on the OR side? And how do you think about that?

Yes. I'm not going to break any news today and provide guidance on incremental margins. What I said on the second quarter call is as we improve sequentially, hopefully, off the bottom, I expect very, very strong incremental margins better than what we were, obviously, doing in the second quarter. And that's -- that will hopefully be reflected in the overall OR margins that we'll start to see in the third and fourth quarter. So I'm -- everything that I've seen quarter-to-date is playing out that way. When you think about our fixed cost structure, depreciation, G&A, which we continue to drive even more efficiencies there, seeing a lot of opportunities there. There's a lot of things that we took the opportunity to look at in the second quarter. I think, at one point, we had a list of 50 different initiatives that we were evaluating. Not all of those are things that we're going to be able to drive this year. They might have 2, 3 year, but we really tried to accelerate those items, whether it's looking at our vehicle spend, maintenance, our leases, looking at whether we need to be in some buildings, getting out of those. I mean the list goes on and on. Our data center, on the technology side, how can we be more efficient? Technology is a huge, huge spend for us. On the engineering side, Ricky and his team, under Jamie, has done a fantastic job. And that's not only on the OE side, it's on the capital side, too. And I think that gets a little bit lost when you talk about the railroads, we have a huge capital spend every year, and as we can get more and more efficient there. That's a lot more dollars, either that we return to shareholders or we use to accelerate some of our investments, whether it's in automation. A huge -- we kicked off a huge exercise on the automation side. They evaluate every opportunity we have out there, and kind of prioritize it, like we never have done before. We're still going through that process. But we talked about automated trains all the time. There are so many other things from an inspection perspective. Even on the G&A side, that are -- you can get in the hundreds of millions of dollars over the long term, that are opportunities for us to drive cost out of here, including how we put capital in the ground out there using data analytics to analyze where we should replace track and do that in a much more data-driven way. I think there's huge, huge savings opportunities using automated equipment to take labor out of the process and probably do the functions a lot more reliably. It's a huge opportunity. So a lot of those things, we took a step back as a team and say, let's really accelerate some of these things. Let's look at it. Let's all have a buy-in from a leadership team of what we want to prioritize. Quite frankly, we didn't always prioritize the things that we didn't look at returns and what prioritize the things that have the highest returns, and let's drive those here in the near term. So I'm really, really excited about all the work we've done there. We don't have all the answers today, but we have a lot of drive, and we have a lot of momentum here internally to kind of look at that.

Got it. Can I just follow up on that because I think that's a very important point, and I think it's kind of an overlook part of the CSX story and even things about -- when we think of CSX, you think of OR, you think about strong operations. I don't think you think about technology and automation just yet. So you said hundreds of millions of dollars of opportunity, over what period of time are we looking at here? When does this kick off? Is this something that we can realistically see in the next 2 to 3 years kind of -- or are you planning to have an Analyst Day where you kind of open to come on a little bit on the tech and investment side? And how do you think about that as an incremental cost opportunity for you guys, now that you've already taken out a lot of the kind of low-hanging fruit and your OR is already kind of in the mid-high 50s on a sustainable basis?

Yes. I think we probably have done a real good job of communicating externally on all the things we're doing on the automation technology side. We have a significant spend even in 2020 on a lot of initiatives that we're driving today that are -- when you look at our dispatching system, meat pass planner, when you look at our fuel efficiency, technologies that we're still investing in. They're kind of across the board. And when I talk about hundreds of millions, that's over a number of years. And what we're trying to do is layer these things in because the end state goal might take 5 years, but there's steps along the way where you can realize a lot of savings. In our dispatching system, how are we going to layer that in? It's a 4-, 5-year process, but there's savings along the way as we turn things on that we can realize in the near term. So what I'd like to build, and I think what the team is building up to, is building a cadence every year where we see savings dropping through from these initiatives. And I think it's also important, as we look back at what we've been -- where we've been successful and where we haven't been successful, is to make sure the whole company has support around these things. And so we continue to invest in them over 5 years. We've had a lot of starts and stops. When I've looked over the last 10 years, where we've had an initiative, had a lot of support and for one reason, another, that dropped off because the dollars were reallocated somewhere else. So it's important, for us as a team, to all agree that these are our priorities, and we're in the process of doing that. And we also have to decide is the technology there today or do we think it's going to be better in 3 years. And maybe it makes sense to reevaluate in 3 years. But the inspection side is a huge, huge, huge opportunity, and it takes out labor obviously costs longer term. It can make our railroad safer, which is our #1 priority. When you look at all of the things, machine can find things that the human eye can't. And the pace of -- the amount of opportunities we have to inspect using some of these cars and technologies that we have, it's infinite versus sending a human out there to look at the track every several times a week. So really, really excited about that. When you think about the automated terminals, really, we're on the forefront of that. But how can machine learning help us sort and plan for our trains in a more optimal way? We've introduced some technologies on our crew planning. That's really where, as you know, when we fall short, it's usually because of the crew shortages that we have. So how can we predictably determine where we're going to be short crews, so we're hiring in the right places. And maximizing the vacation planning for those things that happen all the time out there. So we're getting a lot better on that using the technologies. But we're in the first innings, honestly, of that process. But the most important stage is getting the buy-in from the top-level down, and letting everyone know this is a priority for us.

Got it. Speaking of crew shortages, kind of shifting back there in the near term here. I think the Service Transportation Board kind of sent a letter to the CEOs of all the Class 1 rails kind of -- is pointing off that if volumes are coming back, let's make sure that service standards stay high as the volumes come back. Obviously, it wasn't a comment at you, but maybe kind of if you can share your side of that, kind of where do you think that came from and what are you doing in response to that?

Yes. I think the industry as I mentioned before, that the volatility that we saw from the severe declines and then off the bottom in July, it was challenging. It was challenging for people to get people back to work off a furlough, given all the environment out there with the pandemic. I think we all -- the return to work was a little bit slower than what we probably were thinking at the time around July period, probably wasn't helpful as people were taking final vacations and the school starting back up. All those dynamics, I think, caught the whole industry flatfooted a bit, but we caught up really quickly. We've recalled a number of further employees. We're [ doing ] a lot better right now when you look at our trip plan compliance versus what we were doing in the second quarter. So we're pretty pleased with how we've improved off of that. Are we where we want to be? Absolutely not. Jamie has high expectations. We still have some ways to go. He has aspirational goals there that have a lot of runway for us to improve from there. But I think they realized, the challenges that occured, some volatility that we've never seen before in our business. And I think our -- hopefully seeing the results now and what we're able to do.

Got it. And just kind of maybe closing the loop here on the OR side. I mean you guys understandably had a 6 handle in your OR in 2Q, which was a pretty remarkable outcome given how tough things were. I don't think it's you stretch to say that probably goes back to 5 handle in 3Q. And you've been kind of pretty clear with the incremental margins that kind of bring back costs lower than volumes. But were there any lumpy items on the cost side, where you guys kind of did emergency cost cuts or like delayed some cost actions, where you may actually have some tougher sequential cost comps in 3Q versus 2Q?