CSX Corporation (CSX) Earnings Call Transcript & Summary

All right. Good morning, everyone. This is David Vernon with Bernstein, covering transports and airlines. Welcome to day 2 of our 37th Annual Strategic Decisions Conference. We are pleased to be joined by Jim Foote, CSX President and CEO. We are going to be talking a lot about the railroad business here for the next hour or so or 50 minutes anyway. [Operator Instructions]. If there is -- I think that's pretty much the only thing that we have to worry about in terms of meeting logistics. With that, I would like to welcome Jim to the conference and ask you to maybe to kick us off with a little bit of state of the business overview. How are things work running on the railroad these days? I'll hand the mic over to you.

Well, first, David, thanks so much for the opportunity to be here today. As we were just discussing, I can't wait to get back when we're doing these things live and in person, but we're almost there, I hope. CSX is dealing with the recovery, let's call it that. It's interesting times, challenging times for everybody in the transportation and logistics business. Across the board, there's pent-up demand for just about everything that's been disrupted by whether it was the pandemic, the ice storms, the polar vortex, you name it. We seem to have encountered just about everything as we here in South Florida get ready for hurricane season. So just kind of what we do, but the railroad under the circumstances is running well. Clearly, we've had pockets of issues from a service standpoint as things came back so fast, so quick, all while we were continuing to have a number of employees who were unfortunately off with the virus and quarantining and everything else. But we're digging our way through it, as everyone is. And trend lines over the last month, couple of weeks are very, very positive for us. And we hope that this strong economy and strong demand environment continues across the board.

Well, as you think about the pace of this economic recovery, is there anything that's working better than expected, worse than expected as you're thinking about it from a commercial standpoint?

Better than expected, worse than expected, all of the above, David. Clearly, the consumer economy has been strong throughout this period of time. Intermodal business continues to be -- we don't have a peak anymore. We just have a constant peak. And I think everybody involved in that supply chain, whether it's the manufacturers, overseas or domestically; the shipping companies; the ports; the vessel operators; the railroads; the trucks; the draymen, you name it, I think under the circumstances, have responded extremely well in North America to keep everybody in what's vitally important, like toothpaste and diapers. So -- and then on the other hand, clearly, we expected a reasonable recovery in the automotive sector and started to get back to what we thought were going to be really, really good numbers. Obviously, every number is good versus last year. But kind of looking at versus '19, getting back to those levels, pretty strong numbers. And then who foresaw this chip shortage, where we've had probably about 75% of the auto plants on our network who have experienced some shutdown -- extended shutdown or more. So it's strange times, but I think everybody is doing a really good job to try and keep up and make sure the economy keeps functioning and growing. And the case numbers keep going down, which makes it easier for us. And so it's a mixed bag of everything, and we're dealing with it.

And as you think about the auto business maybe under delivering relative to what true demand is, where -- what are the other sort of 2 or 3 markets where you think there's going to be a stronger-for-longer kind of commercial outlook for CSX?

Well, stronger-for-longer, in that case, again, there's pent-up demand. Everybody wants to buy a vehicle. I was just talking to someone the other day who said the auto salesmen here in South Florida are getting laid off and told to go home because they don't have any cars to sell. People are still going to want to buy a car someday. Plastics demand still remains strong. And it's going to take a while to recover from the devastating impacts of the ice storm in Texas and down in that region of the country. And again, people are still going to want to make things and buy things. So those are areas where you could reasonably say we'll get that business back some day. And especially in this environment where truck capacity is so tight.

Okay. And let's talk a little bit about the mix that you're seeing on the railroad right now. Obviously, very, very heavy intermodal. Carload traffic, maybe a little bit constrained because of some of these issues we talked about in terms of chip shortages, the recovery of the chemical fleet. Like how is that going to translate into sort of earnings opportunity for you?

Well, we always have the mix issue associated with more intermodal versus the carload. On a revenue per unit basis, clearly, intermodal is at a lower revenue per unit. And so if you measure it that way, that's a challenge. It's not a unique challenge because we've had the longer-term change in our mix associated with the downward trends in domestic coal. So that's just the kind of the new norm. The good news is, prior to this, starting in '17 and '18, we did so much work to reconfigure, reengineer the intermodal network, changing some of the methodologies that had been used. And as a result, while that didn't necessarily have a big impact on the revenue per unit, it certainly improved the overall profitability in that business segment. So we're really excited about the long-term opportunities for us to continue to grow intermodal volumes.

Okay. Since you mentioned the c word, I feel like I have to get at least one coal-related question in here. As you think about that ongoing long-term decline in the domestic coal business, you guys have done a tremendous job managing through what I would have thought would have been maybe a little bit more stranded cost in the business. How should we think about that going forward? Are we at a point where the profitability of the other sets of traffic has gotten to a level where we can deal with it? Or is there still maybe some lingering concern over fixed cost absorption issues with the declines of coal?

Well, the decline in coal seems to be -- again, it fell off a cliff in the East, and I guess it fell off a cliff in the West, too. But it's been reasonably stabilized for now a couple of years. Our export business still, excluding utility coal to Europe, there still continues to be demand, and that demand should continue. So we'll still need the infrastructure and it's a very good business for us. So we have the infrastructure in place, which clearly -- we clearly won't be wearing out the rail as fast as we used to. So we'll moderate our capital spend on that, and we can manage through that, I think, very well.

Okay. And if you could indulge us with some thoughts on sort of your views on which types of traffic are more and less beneficial and how that's maybe changed in the last couple of years. I know it's a question we usually ask when we get a chance to sit down together. The relativeness -- the relative attractiveness of intermodal versus carload, merchandise versus coal and maybe if there's been any changes in that in the last couple of years.

Well, no, all traffic is good, let's say that. All business is good. And we're in a great position right now to have clearly a lot of -- we freed up a lot of capacity across the network to be able to bring on volumes without having to worry about big upticks or big variances in the capital spend to do it. So I think, again, from a marketing perspective, my intense focus has always been here and elsewhere on the carload business because it's very, very good business. And we know from a competitive standpoint, as we target converting a lot of the business that used to move by rail that now moves by truck, we know that the shipper is paying a premium price to move it in a truck. So it's not a question, it's not a strategy to go out and discount your rate in order to get the business. It's a strategy to go out there and prove you deliver the product reliably in an area where the shipper, the customer is already paying a premium price to move it. So it makes a lot of sense for us to continue to focus on that carload business. It's the hardest part of the railroad to run. It's a lot easier to go from terminal to terminal. From an operating perspective, you're not handling cars, switching cars, humping cars, doing all the necessary work that's associated with sorting out the cars as they move across the network. But it's very good business for us, and it fits really well into our long-term strategy.

So as you think about extracting those extra carload opportunities, what is the -- can you talk about tactically how you're going about doing that maybe today versus how CSX might have done it before the regime change and the introduction of PSR?

Well, I think if you're -- again, your mindset needs to change that you're not a commodity. Transportation in that segment, transportation is not necessarily a commodity that trades just based back and forth on price. It's a service business. So I think anybody that's running a business, if you have your opportunity to say, do I want to be in a commodity business that I really don't have any control over what the price is, it is what it is. Or I want to be in a service business, where I can provide a really good premium product and extract more value there, that's the first area is the concentration on the whole mindset around what it is you're doing and how you're selling it. So we've worked very, very hard on that. And we'll continue to do that. We'll continue to try to run the railroad better and better and better and more reliably. That's the key, reliability is what everybody wants. And some of the things we're doing strategically. We're very excited about the fact that they've put -- built out capacity for plastics transloading on the East Coast, Charleston, Savannah, you name it; metals transloads, those types of things, paper. And now with the marriage of Quality trucking into CSX, that's exactly what the strategy is there is to leverage our joint -- our singular expertise in these 2 markets and put together new joint service products that will move more traffic by rail. So a lot of different strategies ongoing.

So I want to talk a little bit about that quality thing since you brought it up, I'll pull it forward a little bit here. Can you talk about the rationale for buying a trucking business? And I'm just sort of giving you the question as I've gotten it from some investors, why buy a trucking business when you got a 60 OR in the railroad business, why do you want to go buy a 10 OR in the trucking business?

As I said, in this circumstance, it's a strategic alignment between 2 companies. Chemicals is a big, big, big portion of our business, which we do extremely well in. In many circumstances, we can't get to the end customer, we can't get to the origin supplier of the product. So -- and they have similar issues with -- and again, this is long-haul trucking business, over-the-road long-haul trucking business in an environment where there's driver issues, there's all kinds of issues associated with that, where we can both continue to grow in our respective markets. We can both continue to improve the overall products that we can offer in the market. And really, the only way to do that is by consolidating the 2 companies together. So it's much more strategic than just say, I want to be in the trucking business. It's all about combining the 2 services to create a better service that sells well in the marketplace.

So as you think about that expansion into the horizontal adjacencies of the chemicals value chain, right, are there other industries where you're looking to replicate a similar approach, whether it's grains or you mentioned metals before, but it didn't sound like that was an investment you guys are making. But as you think about that sort of expansion across outside of the railroad segment of the value chain to maybe some of the adjacent services, is that going to be part of the growth algorithm going forward?

Yes, David, it already has to a degree, but much of that has been kind of homegrown or on a much -- the only reason this one hits the radar is because it's on a larger scale. As I said, we either partner with or do it ourselves, whether it be steel transload facilities that needs to be trucked to its end destination market, but we can provide as reliable service on an end-to-end basis as really the truck can, plus leverage the inherent cost advantage that we have. But in order to do that, you have to be aligned either at origin or destination or both in order to be able to provide that service product. So much of that business migrated away from the railroads. And I use this analogy all the time. When somebody was building a new facility over the last 10 years or 15 years or we go back 20 years, it used to be, they go like, oh, we want to -- where do 2 railroads meet? And now they want to know is finding a piece of land at the intersection of Interstate 65 and 80. And in a large -- to a large degree in this transportation market, the railroads became irrelevant. So we are working our way now that we have a much, much, much faster and more reliable rail product to try and get back some of that share that moved away from rail.

And as you think about talking about this with investors, it is going to bring a bit of a margin headwind. And obviously, it's optics. And if you're not -- if you're going to be generating the cash flow, that's the one thing. But how do you feel like investors' receptivity to this -- to what could be a margin dilutive investment? And how do you think about kind of talking through that with investors?

Well, people like you who understand, yes, you just said it, it's optics. And it's a challenge for us to make sure that we communicate clearly. Yes, it's about growing operating income but in cash flow. And I can focus on having the lowest operating ratio in town and shrinking my operating income and cash flow, I don't know that any investor that would find that necessarily an intriguing investment thesis.

No. But it just is one of those things where we've seen this with a couple of the other railroads where -- one you're intimately familiar with, Canadian National, they've similarly diversified in some ways, creates some optics on the OR, and there can be this negative perception of either failing execution or something missing. And I'm just wondering if you've had those conversations with bigger investors yet and what the feedback has been.

Again, everything associated with these changes -- somewhat changes in strategy. It requires that you recognize the issues and address the questions. And so we'll have to do -- Bill's responsibility was to make sure that everybody thinks this is a great, fantastic idea. And if they don't, it's Bill's fault. And so -- but again, I'm more excited about, hey, let's try to offset that dilution by adding a ton of new business to the railroad, which is the overall reason we're doing it, which offsets that. That's going to be a big challenge for us. But I mean, we'll communicate it. I think we're probably in the early stages, communicate what the railroad operating ratio is. Hey, if anybody is really interested, this is what it would have been, except for the trucking, that kind of thing. But I hope we can eventually mature and migrate away from that a little bit. I'm reasonably familiar with what CN did, and we did it for years and years and years on a smaller scale and nobody even noticed. It was a great idea, bah, bah, bah. And then -- but when you step up and you do something that is bigger in scale, it shows through a little bit more. So shame on us if we can't articulate that because it's -- as I said at the beginning, it's positive to operating income and cash flow, and I think that's what everybody's going to be excited about.

Okay. One of the other areas that we've talked about or that you guys have made some efforts in, in terms of expanding the reach of the network with Pan Am Southern. Can you give us an update on kind of where that is? I know I've been reading through the regulatory filings. Like what's your expectations on that front?

We're just in the early stages of seeking authority to complete the transaction from the Surface Transportation Board. And I'm confident just because of the positive nature of it. Clearly, it improves the overall rail transportation network, especially in the New England region. It's a great thing for that area of the country to have a company of this size come in and provide end-to-end seamless rail service to those customers. And if you've seen all of the responses to date, whether it's from first shippers and then regulatory -- or the governmental entities, federal, state, local, it's been extremely well received. So -- but we'll work through that sometime -- let's hope we get the approval sometime early next year, and then we can begin to implement our integration plan.

As you think about -- so there have been a couple of other transactions where we've seen -- actually assets that were short lined in the past now coming back into the sort of the Class I fold. Is that just a [ rain ] endorsement of rail demand? Or how should we be thinking about that, right? Because typically, I'd always sort of thought of the opportunity to short line a lower density section to track as lower capacity, lower density, not enough traffic there. Is this a good signal that there is a building demand tailwind for rail over the next decade? Because obviously, buying an asset like this is not a short term strategy, I wouldn't think.

No. And I think we have begun to unlock the benefits of rail versus the highway by, number one, having a strategy to, number one, have a quality of service product out there that can sell in the marketplace. When the rails were spinning things off, it was like, oh my God, first of all, hey, guess what, if we spin this off, we can lower our operating ratio. It must be a great idea. Let's get rid of a big chunk of our company. Why? Does it make economic sense? Does it improve operating income? Does it improve cash flow? No, but it lowers our operating ratio. Hell, yes, let's do it. Because everybody loves that story. Nobody ever focused on of the financial implications of what that meant. And now that we run the railroad as well as we do today, we can do it just as well or better than a smaller regional railroad can, plus we have the wherewithal to be able to improve upon it, where they couldn't. I mean there's no way that a small regional railroad like a Pan Am could make the capital investment in the systems technology that we have to be able to communicate and provide visibility and seamlessness to them doing transactions that we can. And that's kind of today -- in today's marketplace, technology is a big, big deal. Customers don't want to pick up the phone and call a traffic department for [ Kipski ] to find out how to ship a railcar. They want to go online, find out what it is, find out what the service is, click and go and just like they do today with the truck. So we're going to compete against the truck. We have to behave like the truck. We have to have the technology like the truck. We have to have a toolkit that's equivalent to the truck. And we can do that today, whereas it's much more difficult for a smaller company to make that kind of capital investment. So we bring a lot of benefits to it. Again, the customers in that region have transformed amazingly away from their legacy businesses into new growing businesses. So it's a really exciting opportunity for us to not only add on the business of the Pan Am, but even -- and grow it in the future.

Okay. Let's talk a little bit about the pricing environment. Can you give us a sense for how are things on the contract renewal front, how are conversations with customers?

Conversations with customers. Customers' conversations are always the same. I want to pay less and you want to charge more. And -- but it's -- the market is what the market is. So a tight truck market who is our primary competitor, who was -- is stretched for capacity for whatever reason. They can't get a box, they can't get a driver, whatever the reason, it makes for an easier conversation with our customers. So -- but as you well know, our contracts are not -- we're not dial a rail. It's a longer-term relationship with big producers. So we both work together mutually to find a happy price point that keeps the customer in the market, make sure that the customer is competitive and he can grow his business because if he grows his business, I'm going to move more business. So it's helpful, but that's why our pricing is much more linear than sawtooth in nature.