CSX Corporation (CSX) Earnings Call Transcript & Summary

All right. Good morning, everybody. Next up, we have CSX, very happy to have Kevin Boone, who's the CFO here with us today. Lots obviously going on in the news this week and a cyclical volume recovery underway. So Kevin, I don't know if you have any opening comments or remarks or I can just start hitting you with questions?

No. I appreciate you having me. It feels full circle. This was my first conference when I joined CSX 3 years ago. So I was just reflecting on that this morning. It's obviously been a challenging year. I guess the good news is we're almost through 2020. So yes, let's go to the Q&A.

All right. I'd love to start with the Pan Am. I know that you -- there's not much you can discuss regarding that. There's still the regulatory approval. Maybe you could just sort of frame for us the -- as much as you can, just sort of the strategic rationale? You guys have talked a lot about entrenching yourself in customer supply chains. So is that sort of the main driver behind this? Is there -- or the economics sort of sufficient from a single whole line perspective? What's -- how do we think about CSX engaging in this acquisition?

Yes. I mean, first and foremost, we did an incredible amount of work, as you can imagine. We have a great team on the finance side, operations. Every part of our business due diligence on this transaction, and we obviously saw a lot of value in it. That's why we're here today and made the announcement this week. Jamie went up to the network. Really did a lot of -- he high-railed the whole network, really got a sense on what the opportunities might be there. We think from a customer service perspective, there's a lot of opportunity to add a lot of value there. And there are some investments we can make to grow the business over the long-term as well. So as Jim says, when you can touch water, those are very, very valuable assets. And so we see a lot of value there over the long term, medium term. And they have a great team that we -- they helped us understand the opportunities that exist and what we can really do in the network, and we think there's some very good growth. If you look historically, they've been able to grow a little bit faster than our -- what we've been able to achieve. So we think the growth profile is attractive for us. And we're excited about what we can do on top of that.

Is this like a sort of, what's the right word, a template for how to think about -- I mean, obviously, you want, what we've said before, just getting deeper within the customer supply chains. Is this sort of a bigger lever going forward? Obviously, Pan Am is the largest regional rail. I'm not sure how many of those are out there like that. Is this is more of a one-off? Or do you think that sort of short line M&A in general is a catalyst for CSX, but also just the U.S. Class rises to really start to chip away at the volume that's been lost to truck over the last couple of decades. How do we think about it?

Yes. I think Pan Am was probably more of a unique situation in terms of short lines. I don't think you could look for us to be big buyers in that market necessarily over the next few years. There are assets that come up that are unique and are fit, we'll certainly look at those. But I wouldn't read into anything there in terms of more transactions on that side. We're always looking at ways where we can strengthen our core franchise, offer more value to our customers. If there are things we can do, we do them today with our TRANSFLO business. We do it with our auto business, where we have some value-added services as part of the move that we offer. And so as to your point, if we can get more embedded with our customers, get that business more sticky, that's what our customers more and more want from us. We'll look at those things. Warehousing all those things are impossible. We have a great real estate franchise. We can leverage in that as well.

Okay. Are you guys still in the process of selling any branch lines? Or is that sort of largely over? I think Jim actually said at RailTrends a couple of weeks ago that he's like, look, we're -- well, we're probably not sellers. We don't want to cut our fingers off, we want to grow. So is that a fair characterization that there's not much to do as far as sort of rationalizing the network going forward?

Yes. I think that's right. There are really -- there are real reasons why we sold off some of those short lines the last 2 years. I think they -- from a strategic standpoint, they made a lot more sense in others' hands. We probably don't see as many opportunities going forward for that. And quite frankly, our operating team is best-in-class. And rather than have more railroad to run because we think there's a lot of value that can be created there.

Makes sense. All right maybe just sort of skipping around it, I just wanted to talk about the current volume trends. It seems like every week, the quarter-to-date year-over-year growth rate gets a little bit better. And I think, obviously, intermodal has been a driver. You've seen sort of upticks in other parts of the business. Could you just maybe sort of talk about if there's any commodity types or end markets that are trending either better than you initially expected or worse? And then we can sort of segue that into maybe thinking about the 2021 volume outlook?

Yes. Certainly, when you look at intermodal, that's been obviously in the high single digits around 9%, 10% that we're trending right now. It's a testament to what the consumer market is doing right now. We talk about low inventories, the restocking that's taking place. My youngest son won't get his bike from Santa this year because there's no bikes available. But we have -- there's a lot of replenishment. We think -- I think Mark talked about it at the last conference, we probably see some continued momentum into the first quarter. We'll see beyond that where the economy goes. But there's clearly a lot of restocking. You could see the poor data, I know you look at that all the time. It's -- we're hitting record days of volume here on our intermodal side, despite all the things that we've done over the last 2 years when we rationalized some of the lanes. So it's a testament to what we've done. Now we're handling more volume than we ever have. So it makes me -- I think when we look back, we did all the right things before and really optimizing the intermodal network and what Jamie was able to do, creating this point-to-point network was pretty incredible. And I think it's paying huge dividends right now. On the merchandise side versus third quarter, we're, certainly in certain markets, starting to see some stabilization, I would say, chemicals. You see the carloads. Those are trending up. The metals and equipment, a little bit better trend there. Again, these things -- the volatility right now is pretty uncertain. We just went through Thanksgiving. What does that mean for the pandemic? And what -- I just saw Los Angeles had a shelter in place by the Mayor there. So what does that mean for business activity? Even at 2 or 3 weeks out from now, it makes it incredibly challenging. We have to go into 2021 right now. So we're thinking a lot about what that looks like, and it's -- we were summarizing all the macro analysts out there and what their forecasts are. We have some that are forecasting high single-digit industrial production growth and some that are down mid-single digits. It's -- I've never seen it so wide in terms of what the expectations are out there. So it makes it hard to predict going into next year, what is the second half of 2021 really, really look like? How quick do we get the vaccines out and those kind of things? What we have been looking at a lot is in the trailing 4, 6 weeks trend and what does that really imply on a go-forward basis when you overlay the seasonality. And right now, if you look at that and you can do the math as well, it's kind of that mid-single-digit revenue growth for next year. We'll see where the next 2 or 3 weeks trend and -- but we have to adapt. I know from Jamie's perspective, it's incredibly difficult when you overlay, we have a lot of employees out, almost 200 employees that are out related to COVID right now, and they have been in pockets. And we're having to adjust the network and to really work around that. Incredible amount of challenges he's had to work through this year on that side. And it's hard. And it's hard to predict where things are trending. But it's nice to see now here in the fourth quarter that we have some stabilization in some of these markets. Clearly, first quarter is probably a little bit difficult comp because you will remember, we didn't have the pandemic impact until really late in that March -- month of March, and it started with the auto franchise really first coming off and coal was probably a little bit of a headwind in the first quarter, but then the comps get...

Comps get easy.

In the second quarter. And then what does the second half look like? From there, are we going to get another uptick in the economy? And how does that play out? What I do know is, we're 2 years into an industrial recession. This all started in 2019, if you remember. And so when the economy recovers, I think we'll participate in a very meaningful way.

Maybe staying on the topic of merchandise, you guys have outlined this for a while, just in terms of the opportunity longer-term to -- because of the better service and improved time metrics and trip compliance that you really can start to chip away at gaining share from truck. And it seems like you guys have been able to do that for several quarters. It's just been masked by everything, just volumes being down so much. But when you think forward, and I don't know if this is a 2021 or beyond that type of sort of framework. But can you grow merchandise 1% or 2% better than the industrial economy? Is that something that could happen based on the share gains or contract wins that you've seen so far? Could that happen in 2021? Or is that too optimistic?

When you hear Jim and Mark, absolutely. That's what we're trying to do here. When you talk about the truck inversion expanding the addressable market, utilizing the better service, which opens up new business for us. That's exactly what we've been keen on. So if you listened to Mark last conference, to Jim, that's the goal. We want to change the growth trajectory of what we've been able to do in the past and get on a new trajectory going forward. Now what we can't control is the economy. We can't control how much IP grows next year. But we have every -- we have aspirations to grow above that. There's no question about it.

Okay. Is it -- I mean, I would imagine, at least the truck -- the tight truck market is probably helping those conversations. But like longer-term to really penetrate merchandise that is currently going on truck that should economically move by rail, what needs to happen? I think at recent sort of industry conferences, the main things that shippers focus on are, of course, reliability, consistency, reduced variability. They want to know where their freight is. And they want more proactive sort of outreach and solutions from marketing customer service. So when you -- obviously, you've had the service improvement in terms of on-time performance as well as improved trip plan compliance. But is that enough? What's the next big thing that you think needs to happen to really start to move the needle as far as those share gains?

Yes. First of all, when I reflect on what's happened with the truck market here in the last several months is, similar to a lot of other mega trends when I think about e-commerce and the Amazon growth that you're seeing in their business and other things, we had this driver supply that's been out there, right? And I think what we've really done here in this market and with COVID and everything you probably accelerated that trend where the driver shortage is really playing out here. And you're really seeing it. We have a number of customers that have come to us and that are more long-term thinkers and said, "Hey, we're really worried about this over the next few years that we're really out in front of it." And what you -- I think what you're seeing is really not being pulled forward here on that side. So it's certainly, I think, an opportunity for us going forward to continue to convert that business as we move forward. So I think we're pretty excited about that.

And what about -- so as far as like the tracking and tracing and customers wanting that visibility. I know you guys have your platform ShipCSX. Could you talk about how far along you are in developing that and rolling it out to customers? Is there sort of further improvements that need to happen? So if you could just talk about sort of that platform and then your sort of marketing efforts towards that visibility to give to customers?

Yes. I think we're on the leading edge of -- certainly from a ShipCSX and given the trip plan compliance visibility to our customers where they can literally track their freight through our network is pretty cutting edge. And I oversee, obviously the capital budget, and we've spent a lot of dollars there. And I think it's going to pay off. Customers want that visibility. It keeps us honest. It keeps the customer honest. There's accountability on both sides. And it helps us identify additional opportunities when they are able to see that. We can -- for new business, we can literally go in and show them our performance on a lane in a credible way and say, this is what we do today, and this is what we deliver for other customers. That, I think, really, really helps the customer acquisition discussions and driving more volume. When you talk about reliability and the opportunity to continue to really capture more customer share, first of all, I think they need to see it for a period of time. And I think we're showing them that today. Our team, Bill pointed out to me, he looked back when we first started trip plan compliance in 2017, over -- around 20% of our loads over 2 days or great are late. Today, that number, when you look at the magnitude of the misses, we count every miss as a miss, right? When you look at the trip plan compliance, no matter if it missed 2 days, 3 days, 4 days or 1 hour or even 5 minutes, it all accounts the same in that number. But when you look at the over 2 days late, that's gone from 20% to low single digits today. And so that variability in our -- in the business is really, really shrunkier and that customer experience has gotten significantly better. But you have to prove it over time. In these markets, where truck's tight and we can prove that we have a good, reliable service, they're going to reflect on that, I think, as a customer and say, I feel confident and I can give CSX more business going forward.

All right. Maybe switching just to the cost side or maybe back up. So it seems like, at least from what we can tell right now, volumes, hopefully, will be positive in 2021. Obviously, still a lot of uncertainty. But thinking about what you guys have done as far as structural cost reductions and even sort of since COVID started uncovering different opportunities and ways to improve efficiency and train length and train weight, et cetera, et cetera. I mean, so as I put all that together and sort of barring an economic shock, I mean, is it feasible to think about a mid-50s OR in 2021?

I knew you were going to go there.

I have to ask.

I knew you were going to go there. Well, first of all, I don't want to get on -- what we're really trying to do is grow operating income at a very high returns, right? And so -- and I hate to -- I know others have said this before, but we're certainly not turning away 60 OR new business with the goal of hitting a 55. As Jim will say, he'll tell you today, like we can get to 55 today. But our revenue base is probably -- looks different, lower. So the goal is to grow really profitably. And it goes without saying, probably going forward, growth is going to be a bigger contributor of that operating income growth than it probably has been over the last 3 years. And we have a lot of confidence that, that can really play out. But it goes without saying also that we have incremental margins that are very, very good. When you look at third quarter, who would have thought 3 years ago that I would tell you, we had a quarter where intermodal contributed the most to our revenue in our history on a percentage basis, and coal, the least. And yet we hit a record OR in the quarter. That's -- I think that's fundamentally changed the game, and it's all a testament to what we did with the network and what Jamie and his team on the operating side have really done. That incremental intermodal revenue drops through at a very, very good attractive margin. And we're pretty proud of that. So going forward, of course, I think it is going to be volume-dependent going into next year. We feel confident if revenue is higher than what we expect, and incremental margins are going to be very, very attractive. There are always things that we have to offset in any given year. Inflation will be slightly higher going into next year than it was this year, but still probably lower than the 3 to 5-year average. You have depreciation, as you know, always a headwind. Our CapEx is above depreciation. This is our industry phenomenon. Fortunately, our CapEx is not as much above depreciation as others. So maybe a little bit less of a headwind long term. I'd like to point that out as well. And then we have things like real estate taxes that are based on our profitability. And so the profitability has gotten meaningfully better. It goes up on a lag basis. So we'll have to offset all of those. So before we get started, we have to offset some of these costs, and we think we can do it with some productivity. But certainly, it's a volume story going forward. We're planning, we have to build in some -- on the Op side, some variability in terms of hiring. We're starting to look to hire to backfill some attrition. So if that volume does surprise to the upside, we're there to really handle it, as you know. And when volume surprises have happened in the industry, we have a history of not really handling that really well. And so we want to disprove that this time around.

So that's I think a good sort of line question. So I'm not like -- I mean, is it -- are you finding it difficult, whether it's just related to the spike in COVID or volumes coming back, is it getting more challenging from a hiring standpoint or recalling employees from furlough? Like you just mentioned, like do -- how much do you sort of need to get ahead of the attrition? And what could be strong growth next year, so that you're not caught short? So maybe if you could just -- or talk about how to think about labor? And then the service metrics have deteriorated a little bit. I don't know if it's sort of related to some of the employees that we were talking about that sort of are going on in clusters, if there's anything there? Or if it's just pure volumes? So maybe if you could talk about all of those things?

Yes. We certainly -- on the COVID side, we will have spikes in different areas, and it's a huge challenge. You can't move employees around. If all of a sudden an area like Birmingham has a spike in COVID cases, it's not like you can take employees from another area and move them in to run the railroad. It just doesn't work that way. The union contracts don't allow for that. So it inhibits our flexibility there. So Jamie and team to move this amount of volume that we are right now, given all the challenges is a testament to everything. When you talk about the service metrics, I think we've taken this year -- we're tweaking, right? We're looking at train length as a trade-off between speed and are there some cases where you want to make that trade-off? I think the numbers will show that that's probably the case in some instances. It's gotten us a chance with the lower volume to really tweak the network. And Jamie and his team really looked at that. And I think it's really paying dividends right now. We have expectations that we'll get better, no question. Are we satisfied where we are today? We aren't. We have aspirations to get better and better. And we think we have clear line of sight to that. These COVID problems are challenging. From a hiring perspective, look, these are attractive jobs, well paid jobs. I think it's always -- I think the biggest challenge is the lead time to get a conductor or an engineer qualified. So from start to finish, it's months of training to get qualified on the railroad. So you have to anticipate that. So you will have to hire for 6 months ahead. And that's what we're thinking about right now. We have a 6% to 7% attrition every year. So we need to get ahead of that as well. And overall, we're -- you could be up -- according to some of the IP estimates, you could be up high single digits or others where you could be down mid-single digits, it's incredibly difficult to manage from a resource perspective. But we're talking more about as a team being prepared to really react to that upside surprise if it comes.

Okay. Maybe just turning to CapEx. Any sort of initial thoughts on 2021? Do you expect it to sort of -- your sort of overall level of spending to remain kind of flattish? And what longer term, like, as you guys start to chip away at share gains from truck and grow volumes, what's the right level of CapEx to sales or on a GTM basis without sacrificing growth? I know there's -- you guys have a lot of capacity that has been built in with the PSR implementation. But how do we think about that short term and then longer term?

Yes. We'll give the official guidance maybe here in January, we'll talk about that. But what I've always said about CapEx and what we've been trying to do over the last year, since I've been in this role is really putting a lot of rigor around the projects, having accountability on the back end, looking at the returns, does it make sense? How are we prioritizing the highest return projects? As an organization, I don't think historically, we valued when we come in and really been successful on a capital project versus saving money on the OE side, which obviously reflects in our operating performance from an income statement perspective and the things that you look at. But really, it's getting that -- Jamie's highly focused on it on his side is on the engineering side, we've gotten -- when you look at our performance there and our cost per TIH, Ricky's team on the engineering side has done a fantastic job. And what we've done is with the lower volume this year, we plowed that back into the railroad. When we had less volume, we decided to accelerate some of the capital that we needed to do there, and we'll continue to do that a bit here going forward. My goal is to avoid the volatility in our capital, particularly on the maintenance side. So we feel pretty good about these levels, a little bit step-up in the locomotive rebuild program, not huge, probably going into next year, some step-up in bridges. But really, nothing on the maintenance, the core infrastructure spend that you see there. We have pretty good line of sight over a multiyear period, whether it's the railroad, the locomotives, all that core infrastructure. Where we really also focused on is using some of that savings and really accelerating some of our technology spend. We'll spend more on automation next year than we did this year. And I would like to do that more and more going forward, using some of the savings that we drive on the maintenance side, on the core capital and redeploying it on the technology side. So highly focused on that. We've been looking at that for the last 6 months, really going to try to accelerate that. If there are opportunities to pull forward, we have plenty of cash. If we find opportunities with very high returns, I'm more than willing to spend the capital. But I feel pretty good about the levels that we're at with no major spike coming in the future.

Okay. I mean, just on the topic of technologies, this has come up in pretty much all the rail fireside chats that I've done, CN talks a lot about their automated inspection portals. Keith has talked about it, doing it a little bit differently than in the way CN is doing it. Where are you guys on things like that as far as like the portals or the automated track inspection or predictive maintenance? Where is CSX in that? And what makes sense as far as your network as -- when we're thinking about different technology investments?

We do it all. We're doing it all. You talked to Jamie, we have the inspection portals. We have -- we're adding another one in Waycross. We're creating the algorithms. We're really working through that. We feel like we're in the leading edge of all of these technologies and adapting them on the inspection side, huge, huge improvements. And when I look at the inspection side on the track side, it's really going to help us over the next few years, deploy our capital in a much more efficient way. I'm incredibly excited about that. When I think about $1 billion of capital we're putting in, in our railroad. And if we can use data in a more impactful way where it identifies where we really should be replacing it, I -- what I know today is we're probably repricing some rail too early, right? And if we can get better at that at identifying where the opportunities are there, there are savings there to go after. From an automated train perspective, Jamie will tell you that he believes we'll be the first in the industry to be able to run a train from 0 to 0 as they call. And the first benefits of that will be further fuel savings. We think there's still a lot of opportunity on the fuel side. Even though we're best-in-class in the U.S., which we like to point out from an ESG perspective, it's a huge opportunity to go to customers and say, we're the most efficient railroad in the U.S. There's a lot of pressure from investors and others to -- for people to meet their emission standards and those things. We're the solution when we have those discussions. So we have every expectation we're going to be -- continue to be leaders there. And we're spending more and more capital, as I mentioned, on technology every year. I know Jamie and the entire leadership team is challenging us, bring us ideas. We got to prioritize things. We're willing to make multiyear investments to get the opportunity. When you think about inspection, that's multiyear investments. We're investing in our dispatching system today. That will have big benefits over a multiyear period. So I just went through a technology discussion on the cloud and the migration on the cloud, we're looking at those things over time. Those have really substantial benefits to us as well. So there's a lot of momentum on the technology side in all parts of our business that I think you'll see us really leverage over the next few years, but they're not necessarily next year savings. They're the things you have to invest in overtime in order to really get the real value.

Okay. Maybe I'll sneak one last one in. Just any thoughts on capital allocation, buybacks versus the dividend? Obviously, you guys are spinning out quite a bit of free cash flow, and that probably only gets better. So if you could just sort of talk about how you guys are prioritizing after Capex, obviously?

Yes. We have a history of liking both. We have a history of -- if you look out the last few years of raising our dividend. These are always Board discussions that we go through every year. But I'd point back to history on the dividend. And then certainly, returning cash to shareholders has been a priority for us, and that will continue to be our priority. If there are investments we can make that have very high returns, we'll do that as well. We have -- we're fortunate enough to have a lot of cash on the balance sheet. And we expect we'll continue to generate really high levels of free cash flow, which, as you know, we continue to highlight as a differentiator versus our peer group.

[ Cheap as ] on a free cash flow basis, right?

That's right. That's right. Hey, you're listening to me.

Yes, exactly. All right. Kevin, thank you so much. This was great. I hope your meetings go well the rest of the day, and really appreciate you taking all the time with us. Take care.