CSX Corporation (CSX) Earnings Call Transcript & Summary

Good morning, everyone. Welcome to our next session with CSX. I'm Scott Group, the transport analyst here at Wolfe. It's May 26, 9:10 Eastern Time in the morning. Really happy to be joined by Kevin Boone, CFO from CSX. We're going to jump right into questions. I'm going to start with a few. Please type in questions as you have them.

Kevin, maybe just start with an update on what you guys are seeing so far in the second quarter. Volumes are tracking up 31%, 32% quarter to date. How are volumes doing relative to plan? What segment is doing better? What segment is doing worse than expectations?

Yes. First of all, thank you for having me. Hopefully, this is one of the last virtual conferences we'll have to experience. As you can see, I'm in the office today. And we're welcoming back a lot of people into the office over the next few months. August 1, we'll hopefully be back at 100%. So excited to get everybody back in the office and interacting. In terms of what we're seeing today, I would characterize the market as supply-constrained growth. You can see supply channels are struggling to ramp up production. Autos is obviously one area where everybody is highlighted in their struggles to get parts and particularly the semiconductor issue continue to impact their business. But we're seeing it across almost every area, employment, finding good people to ramp back up production. And fortunately enough, we've gotten ahead of it with some of our hiring efforts, and we'll continue to get ahead of it because we do see strong demand continuing. When I think about areas where we're seeing strength, no surprise, intermodal continues to be very, very strong. Our network serves almost 2/3 of the U.S. population, and we're benefiting from that. Seeing a lot of truck conversion there. Quite frankly, probably what's constraining a little bit of that growth right now is a drayage availability on the truck side. So very, very tight truck market today, and I'm sure we'll talk about that more in the conversation here. The metals market, another area where we're seeing a lot of strength. Again, those companies, those customers are ramping up production, and we're benefiting from that as well. Really, you remember in the first quarter, the chemical industry, particularly in Texas, got hit pretty hard by the weather. We've seen that really bounce back here and are seeing good -- really good demand in the plastics area, other areas. In fact, I was talking to one of our largest customers a couple of weeks ago. And by his estimates, it will take them about 12 to 14 months just to get back to normalized inventory levels. So it's a long, long path for them to replenish inventories from here. And so we see a lot of optimism even going into next year. On the downside, obviously, I highlighted autos. When you look at the impact there, 75% of our auto plants that we serve year-to-date have been impacted by supply shortages and have been shut down at least a week or if not longer. On the extreme side, we've seen in one of our plants, I think, will be shut down for almost 15 weeks by the end of this quarter. We think that starts to normalize in the third, fourth quarter, but that's TBD, and we're watching it closely. Again, when you look at inventory levels at the dealers, they're very, very low. So we think this is a timing issue, and we'll start to see, hopefully, some of that volume start to pick back up in the second half. We think there's probably opportunity that to work through the summer furlough periods that they generally have, if those parts are there. So we're watching that into July and August, when we typically see a slowdown that perhaps they might be looking to ramp back up production. And those are the challenging areas, really supply-constrained growth at this point. And I would say the fluidity within the transportation sector is not great. We've certainly had our struggles with COVID, and we're coming out of that. And we'll talk a little bit about our service metrics, I'm sure. But everybody is struggling to catch up here, and we think we'll continue to see improvement going forward.

Okay. Great. So you guys have guided to double-digit revenue growth for the year. Is the market so supply-constrained where there's just not enough volume to move and there's potential risk to the double-digit revenue guidance? Or do you guys feel, hey, our volumes are really good this quarter even despite that and pricing is good and yield is getting better and all that, and we still feel very good about double-digit revenue growth?

No, I feel pretty confident about the double-digit revenue growth. Obviously, double digits has a wide range. But yes, we feel very confident there, and that there will be continued growth in the next year. Obviously, the comps this quarter are particularly easy. We started having a pretty robust recovery in the third and fourth quarter. But even despite that, we think we'll have some pretty healthy growth going into the back half of the year. You touched on a little bit yields. I think on a year-over-year basis, we'll really start to benefit the revenue growth outlook. It won't be the headwind that we've seen in the last few quarters. And so that's a positive as well.

So do you -- should we expect yield trends to inflect positive here in the second quarter?

Yes. There's a lot of -- we've got a month to go, but certainly won't be the headwind that we saw in first quarter. We'll see a pickup into the second quarter probably trending positively depending on the mix. And then in the second half, I'm very, very confident that you'll see some RPU growth continue on easier comps there and the headwinds from coal, obviously, won't be there into the second half as well.

Right. And then maybe just getting a little bit more granular. How about yield trends, excluding the impact of fuel? Clearly, fuel is going to be positive going forward. Do you think we can get some underlying yield inflection, excluding fuel?

Well, if you look out at the last 2 years, certainly a very, very challenging market. 2019, we went into an industrial recession followed by a pandemic, not the most -- not the easiest environment to go out and ask for price from customers. Sitting here today, it's a much, much different market. Trucks are tight. All the competition is there, but we're also feeling early stages of inflation. And like everyone else, we want to stay ahead of that. So we're having those conversations. Not every contract comes up for bidding every month. So there is a little bit of a lag. But I would characterize the environment as much healthier than it has been, and we'll continue to price the value in our service as that continues to improve. What I know is customers are looking for capacity out there, and we're hiring ahead of that. We're getting ready for it, and we're ready to move more freight and to have those conversations. So I'm optimistic. Again, these things happen on a lag basis. I think probably more of the impact carries through to next year as we have those discussions with our customers. As you know, Scott, some of our contracts are tied to inflation adjusters. So we'll see that. When you think about areas like intermodal and other areas, that will -- you'll start to see some impact of that as well as we've been in a very, very low inflation environment. Quite frankly, we benefit from a little bit higher inflation. Obviously, you don't want that to get overheated, but a little more inflation is a good thing for us.

Right. And so if I'm hearing you right, you actually see opportunities for pricing to be even better in '22 than what you're seeing in '21?

I think there's always a lag. If you have contracts that come up periodically through the year and as those are implemented, those carryover through the next year. So as we have those discussions, we should see some carryover into '22.

Okay. Can you just help give us a little bit of color or thoughts around the operating ratio trends? They typically improve, I don't know, 300, 400 basis points from first quarter to first quarter -- first quarter to second quarter. Is that the right way to think about margin seasonality? And any thoughts on margins operating ratio for the full year?

Yes. You remember the first quarter, a particularly challenging quarter for the rail industry and the transportation industry as a whole with the weather impacts that we saw. I think you'll certainly see improvement from first quarter. That's not where we see our margins long-term trending. So a lot of opportunity there. I don't think it's unfair, your characterization. We'll see how the rest of the quarter plays out, but you'll definitely see some improvement there. And as the revenue starts to drop through, we'll see a very, very solid incremental margins on that.

Okay. Just give us an update on service levels and how the network is doing right now? Clearly, the year-over-year service metrics are under pressure for everybody, you guys included. What -- when do you -- are you seeing some signs of underlying improvement here? What do you need to do to get service levels better? Is this a big -- is this having a big cost impact to service right now? Just couple of thoughts on service.

Yes. I think when you look at all the challenges that we had, COVID -- fortunately, our COVID numbers now are coming down. Just unexpected absenteeism is, I would say, still at higher levels than we would expect, but I anticipate that will start to come down too as we exit the pandemic. So those are very, very positive developments that we've seen in the last couple of months. Obviously, the weather in the first quarter didn't help us, and we dug our way out of that. On our carload side, when we look over the last 2 weeks, we're trending above that 70% level on Trip Plan Compliance, which is a great start. Not back to the levels we were pre-pandemic, but we're -- certainly the second derivative is looking very favorable there. And then on the intermodal side, we're at that 90% level. We'd like to get into that mid-90s, and I have every confidence that we will. I talk to Jamie every day. We're starting to backfill some of those hotspots where we saw lack of labor and lack of crew availability. So we're starting to see those new recruits, new hires start to drop through and qualify out there in the field, and that will continue to happen over the next few months. So we're getting ready for the fall peak and all those, hopefully, additional demand that we'll see into the back half. And are there additional costs? Certainly are. Over time -- you're certainly seeing the higher levels over time than we did last year. So with additional hiring, I would hope to see that come down at some levels. When you think about car hire and dwell time and -- those numbers are up at levels that we would hope would start to come down. So we do see some cost opportunities as we start to see the network more fluid. We also -- from a customer perspective, as they get back up and running, more fluidity from them where we're seeing more consistent movements through our network will be helpful as well. So as the supply channel will kind of recovers, as we are -- can anticipate the flows from the western railroads as we all get improved, I think you'll see the benefits start to drop through as well.

Those service-related costs you mentioned overtime and other things, are those any better in the second quarter than what we saw in the first quarter? Are they worse? Is it similar? Any thoughts?

No. I think you see some improvement. I mean, for one, we're not dealing with the weather impacts that we had, which created a lot of overtime spend, other areas where we had to catch up. So things are improving, and we've seen month-over-month improvement.

And where do you think that -- what's the target for where Trip Plan Compliance should be for where train speeds or dwell time should be? And when do you think you'll get there?

Yes. I think Jim has always said that mid-90s level for intermodal is kind of where we want to be. And then we want to be above that 80% level trending into those mid-80s long-term would be a great place to be, we think, which would be a differentiated product and really help us compete with truck longer term. So those areas, that's where we're targeting. Again, I think we'll see a sequential improvement through the year. Jim has had a lot of discussions with Jamie on his expectations, and Jamie is very confident that we're going to get it back. I'm not going to put a line in the sand on where we're going to reach those targets, but we feel pretty good going in the second half that things will get materially better.

Do you feel like you need to add a lot of headcount to get it better? What...

I think it's a lot about getting the headcount in the areas that we need. We've seen -- we struggled a little bit here in the Gulf. So we're having a lot of hiring and a lot of new recruits that are going to go down to the Gulf and qualify there. So it's really, in a lot of ways, redistributing our headcount to the areas we need going forward. There's always attrition. We generally see 6% to 7% attrition. So we need to offset that and probably add a little bit of headcount on top of that. We're not talking about a dramatic headcount increases to handle this additional volume. We still have the same story that I've talked about for the last 2 years. We'll see good incremental margins on more revenue. So still remain very, very confident in that, but we want to be there if the volume comes. We've seen so many times for this industry. And when the volume is over, let's call it, 3% or 4%, the industry struggle to handle it, and we want to change that narrative a bit.

So that's where I wanted to go next, right? I mean it's very clear in listening to the rails that there is more of a renewed focus on growth. And I guess, a couple of things here, it's an industry that is -- certainly, the U.S. rails have struggled to grow over the last 10 years or so. Why do you think that's been? What's going to change that's going to let you guys actually start growing volume? And just -- is it a problem that just as we want to start growing volume, the industry is dealing with these service issues? Do you think that this is just a -- are we sort of ruining the chances of really attracting trucking volume to the network right now?

Yes. I think Jim and I were just talking about this the other day. When you look at our service and if we hadn't done all the changes that we implemented, we were running precision scheduled railroading. I can guarantee we wouldn't be operating at the levels we are today and probably the whole industry wouldn't be. So this was a little bit of a saving grace, given all the challenges we had with the pandemic and having workers not available and then you add in probably one of the most severe weather impacts that the industry has seen in a long time. And we're still moving freight. I can't say that, that happened very well in periods like 2014 and other periods. So it's relative. Do we feel great about the service levels we're at today? No. Do we think can be a lot better? Absolutely. But we went through one of the most difficult periods that we hopefully will ever experience from that level. I'm optimistic as the other railroads continue to improve, that's going to help us as well. We work as a network and half of our business interchanges with another railroad. And so as they get better, it's going to help all of us, I think, go after this market share opportunity that we continue to highlight. So why haven't we been able to grow? Jim and I and everybody will tell you, it's because of our lack of service. The customers haven't trusted us with their freight historically. And that's where it starts. We don't want to change that narrative. We want to win the confidence of the customer. We want to deliver a good service product. And I think there's other challenges that are going to really serve as tailwinds for us. Driver shortages are not going to go away. It's really -- you pull forward that problem probably by 3 years with the pandemic. You think about the tight labor market today, they're going to -- there's going to be struggling -- they're going to struggle to get new hires in there and replenish their workforce. You also look at what we've traditionally done as a railroad in terms of our tools that we offer customers, the way we analyze data to find new opportunities, all those things were changing today, the way we use technology. You can argue that the industry has been very, very behind, other industries and adapting technology and really adapting to what the customer needs. And so we're working on a lot of those tools today. And we think that's going to drive more volume to us. And then we've talked about this a lot, but extending our reach to network, there's a lot of ways we can do that. Quality, which I'm sure we'll touch on, is one way. Pan Am is another. But there's many other partnerships that we're working with is how do we reach more customers and where our physical railroad goes today. We don't touch every customer. So how do we reach those customers, and those are big opportunities for us. And a lot of that we'll do through partnerships. Then I'll say the final piece, which we've probably been less focused on, but we're highly focused on it today is we're really leveraging a lot of our real estate portfolio and our partnerships and getting more industrial development along the railroad. Unfortunately, over the last 3, 4, 5 decades, more and more customers then see the value of locating on the rail, and we're trying to change that narrative. We have industrial development sites. If you want to put in more production, we've got a place for you. Here's the value of having rail access and all those things. E-commerce, where we're working with a lot of the e-commerce players that locate a warehouse on us. You want to have that optionality. You want to have that ability to move freight on the railroad going forward. So all those -- that's probably a longer lead cycle, but we are seeing some early signs of progress and really starting to see some good wins on that side as well. So all those things, I think, are different than when you look at the last 10 years.

Right. When you talk about half the business interchanges and we're all sort of on one network, I mean, is this -- is that the argument for why maybe M&A is starting to make sense in this industry?

Well, I think -- look, Jim talked about this. He got probably more questions than we expected on this topic on our last earnings call, quite frankly. I think there's been a lot of, obviously, efficiencies created through M&A, and Jim touched on that. But there's no argument around that. There's efficiencies to be gained. You can create more operating leverage, all of those things occur through M&A. So that's no secret and why that's worked in the past. And we're obviously watching everything that's developing right now. And again, better we are able to work with our partners and move freight through our networks, the better the customer experience will be, the larger the opportunity for us to go out and take share from truck. And we have this great environmental advantage right now, too, which is really, really playing well with our customers today. It's the first -- we're leaning into that very, very hard, and our customers care more this year than they did last year. And they're going to care more next year, too. And so we're investing in a lot of technologies, too, to continue to get our efficiencies up and fuel efficiencies there. And that's a huge benefit for us going forward as well.

Okay. Let's talk about Quality Carriers acquisition. So I think we're sort of trained to think we like rails and we get -- we're skeptical when rails buy trucking assets. Maybe talk through the rationale of the deal? And what does success look like with this transaction?

Yes. I think -- let me take you back to how we got here. We started a group about 2.5 years ago. I was fortunate enough to be part of that, a data analytics group where we were going to get more visibility to all the freight that's moving averse to the railroad today. What's moving on truck, trying to understand all those freight flows. And as part of that exercise, as we understood the markets more and more, certainly we saw a lot of this chemical business that we thought, given the length of haul, given the attributes, obviously, very, very good business for us today, probably some of our best business that we move from a margin perspective. And what we're trying to -- we're scratching our heads, why isn't more of that coming to us? And in many cases, we saw -- while we don't really physically reach that customer, we don't touch them, we don't -- there's not a service product today that really exists that gives them the option. And so we looked at all the assets that were out in the market, and Quality, obviously, is the leading #1 player in the industry. It's still a highly fragmented industry out there, and their footprint really overlaps with ours. And there was an opportunity to start to have a discussion. And so we worked over almost 6 months -- 6 to 7 months working with quality and going through their book of business, working with Randy and his team and coming up with a new service product that we think we can introduce to the market, and that's how customers really, really want today. There couldn't be a better market to introduce new service into today. And so taking a step back, we went to the customers. We asked them, is this something that would be interesting that something that you would potentially adopt? And the overwhelming response was, yes. I think we surveyed the top 30 customers. And the response was, when can we get started. And then when you look at this, it's really a unique business. There's a lot of qualification that goes into, a lot of safety training, a lot of product quality issues, very, very sticky. The customer doesn't want just anybody moving this kind of freight. If there's contamination issues, it ruins the freight. And so there's a lot of specialization that we really liked about this business that we, quite frankly, can learn on -- learn from on our side of the business. So we think -- and that's why we thought ownership really made sense. There's things that the customer requires to make sure that they're comfortable that their freight is going to be moved and the quality is going to be out there. And when we look at the opportunity, I talked about this is we believe it's hundreds of millions of dollars over time. That's not going to happen day 1. That will happen over time and -- but it also solves a lot of the issues that quality is -- and the trucking -- truckers are, quite frankly, struggling with today is on the driver retention side. They have well above-average driver retention rates today and have done a great job and actually are yielding up drivers here recently. And I think that's obviously differentiated versus the rest of the industry. But what we allow them to do is we take long-haul truckers off the road and allow them to get home at night and move 2 to 3 loads a day, put it on the rail and go home at night. And we think that's going to improve their driver retention rates and ultimately their underlying growth rate. What does success look like? Success looks like if it drives more of our volume to the core railroad and the underlying -- more volumes of railroad. Yes. That's what success looks like. That's the reason we looked at the asset to begin with. We're not in the business of just moving everything. It's got to fit into the core network, the core railroad, what we do. And we think we're highly optimistic that we'll start moving some freight in the third quarter, and that will continue to ramp up sequentially into next year.

And so when you talk about hundreds of millions of dollars of opportunity, that's what you're talking about, hundreds of millions of dollars of potential revenue that could go on the railroad from here?

Right. What we do know is from the current book of business that quality has today, there's freight that can be converted over to rail. But we also know they're about 15% of the market today. And so there's a lot of other freight that's moving, not only quality that allows us to go after as well.

And what's the total pie you think that you're going after here?

I think it's approaching -- yes, I think that's approaching that $1 billion level now. Will we convert all of that? I think that's a bit optimistic, but you can imagine the returns on this acquisition look quite attractive at much lower levels. And so we have -- Randy is signing up for a target. And so there will be targets around this. So the team is all aligned and driven to look at converting more volume over. And by the way, this product offers a nice cost savings to the customer. So in an environment where you're seeing considerable inflation from a customer perspective, here's an option where they can go back and say, I'm delivering some cost savings to the customer.

And why couldn't you just partner with them like BN, JB Hunt kind of contract?

Let me be clear. They're -- we're open for business. So we'd love to partner on every rail opportunity there. So I mentioned in my opening comments that this is a unique product, requires a lot of training from the trucking side, a lot of product quality issues. And so from a uptake -- I think, from a customer perspective, knowing that there's a 1 person to go to, 1 representative that can follow their freight through the network and from a quality perspective, I'm sure that it's going to be delivered at the expectation or at the level that they expect was really, really important. So I would look at this as more of a unique opportunity. Certainly, not -- I don't have a long list of trucking companies sitting on my desk right now that we're looking to go after. That's not the case. I would characterize this as a very unique opportunity and a unique segment of our business.

So we shouldn't be thinking about the next thing is the quality for grain or something like that that's next?

I don't see it today. Look, we'll always look at opportunities. If we think that we can create value more and push more volume onto the rail network, we'll look at those opportunities. But no, I think we're pretty focused on integrating quality and really making that successful.

Okay. Just a couple of questions that came in just the last couple of minutes. How does the current regulatory environment affect your decisions regarding headcount adjustments and potential reductions in labor? And if you want to more broadly open that up to just how you think about the broader regulatory environment right now?

Well, I don't -- we're not looking to reduce headcount right now, given the growth outlook we see. So we're hiring. We're resourcing to the levels that the customers require and trying to stay ahead of that. I think we've done a great job of starting the hiring process in the fourth quarter and kind of seeing what we thought was a recovery coming ahead of us. And it takes a while, unfortunately, to qualify a conductor. And so that's why we started at earnest in the fourth quarter and continue to have about 2 classes a month right now going through the pipeline. So we're reacting. We want to serve our customers. There is a challenged supply chain right now. Trucks are challenged, all those. And we're all interconnected in ways which create challenges for us. You look at the ports, you have a lot of ships still waiting off the coast on the West Coast, trying to get in. So we're not seeing balanced flows through our network, and those are challenges. Jamie is certainly up to meet those challenges, but we'll continue to see that hopefully improve through the back half of the year. And we'll be ready to handle it, but we're reacting. We're doing everything we can. The other thing you have to -- when you're hiring, you got to make sure safety is the #1 priority, and we're prioritizing that to make sure everyone that we're putting out in the network is properly trained and qualified. And so you have to make sure you're considering all those factors as you bring on people.

And then just lastly -- go ahead.

And then the regulatory environment, look, I don't think a whole lot has change on that side. We continue to work closely with them and here to serve our customers.

Okay. And then just lastly, someone's asking to the extent you can, can you just clarify your comments around margins and the seasonality? Should we just -- they're asking, should we take the normal seasonality or is it potentially better than that, given that 1Q was impacted by weathers and -- weather and fuel and things like that?

Yes, I'm not going to put a fine point on that. There'll be improvement. We're pretty confident in that. I think we said that normal seasonality is 300 to 400 basis points. Obviously, I'll be disappointed with 300 basis points, but I'll leave it at that.

Okay. All right. Great. Thank you so much, Kevin. We're going to wrap there. Really appreciate it. And everyone, we're going to get going in about 2 minutes with Keith Creel from Canadian Pacific. Thanks again, Kevin.

All right. Thanks, Scott. Appreciate it. Thanks.