CSX Corporation (CSX) Earnings Call Transcript & Summary

Afternoon, everybody. Welcome back to Deutsche Bank's 2021 Transportation Conference. My name is Amit Mehrotra. I'm the Transportation and Maritime Shipping analyst here at Deutsche Bank. We heard this morning from Union Pacific, Canadian National, Kansas City Southern. I'm very pleased now to welcome CSX and Kevin Boone, former CFO and now Executive Vice President of Sales and Marketing. I also would be remiss if I didn't mention that Kevin was recently named by the Jacksonville Business Journal as the -- one of the region's Ultimate Finance Executives. So big congratulations on that achievement, Kevin.

So to kick things off, there's no prepared remarks. We're just going to go to Q&A, so we appreciate that, Kevin. Obviously, CSX is showing good volume growth when the rest of the industry is struggling up 5% or so this quarter to date. I think I was looking, in fact, CSX is the only U.S. rail to see growth versus 2019 on a quarter-to-date, basis on a year-to-date basis, not much, but well above U.S. competitors. Can you just give us a sense of what's playing out? Are you seeing some of the benefit from the chassis issue at your main competitor? Are some of the targeted growth initiatives that you've pursued kind of playing out, pure market share gains, all of the above? If you could just talk about the overall volume picture, explain some of the relative outperformance, especially in light of kind of what appears to be just significant overall network congestion and constraints?

Yes, sure. Well, first of all, thank you for having me again, wish we were in Chicago sitting together. We thought earlier this year, things would be -- we'd be in a much different place right now. So we're obviously working through challenges that, quite frankly, we didn't think we're going to have 2 or 3 months ago. COVID numbers are up. That's challenging the network again. We're managing through it. But you mentioned, we have a lot of strength in our business. One of the things I would highlight and you highlighted as well is the intermodal side. And I think that's a testament to our operating team, quite frankly. We've been able to keep the terminals open. We've been able to keep them, to a large degree, fluid. And our only challenge has been takeaway capacity on the drayage side, but we've done a great, great job there. And I would like to refer to it as the best intermodal service out there. I think we have the premier franchise when it comes to service in the East, and it's really showing up in the numbers. And pretty proud of that, work with Jamie all the time, and we're highly focused on that. And that's why we're seeing the great growth. With that said, challenge is getting boxes out. The growth could be more than what we're seeing today. No question about it. Chassis has been an issue. If there are more boxes and more chassis and more truck capacity to take away the boxes, we would be seeing more volume. It's not a demand issue right now. And that's really across most of the markets. Auto is the one area where we all know is challenged. I feel like every month we go in and we find out new information that's going to push back the recovery further. Probably everybody saw the IHS update yesterday, further cuts to production levels in this year. We think the volume is coming. It's just gotten delayed to 2022. And in some ways, it's probably a blessing for the supply chains out there that auto is not running full out right now because that would only stress the whole transportation sector more. But we do expect that to come back. When I think about steel, metals, our paper products, all those remain very, very strong today. And quite frankly, probably demand is outstripping transportation's ability to meet all the demand. So all my conversations since taking over this new role are with customers and a large majority of them are focused on how can I get more capacity, what are you guys doing to add capacity, and so we're being as transparent as possible with the customers. We're doing everything we can to be able to bring on all that volume growth. We certainly want to serve it. And working closely with Jamie and his team to really go through that and identify those areas where we need more crews and more people running the trains. The coal business probably came back in a way that we didn't anticipate. I don't -- any one of our customers couldn't have told you that we'd be seeing this level of demand, these level of commodity prices, natural gas near $4. And then you see met, and obviously, the benchmarks overseas at a very, very supportive level. So those are areas where we're -- those are bulk trains. We've got to have the crews to run those. It's not about putting cars on the back of an existing train. It's either you run the train or you don't. And so those are some of the challenges that we're facing today and really reacting and trying to resource as quickly as possible. I'm focused on maximizing what we can do in the next year and having those conversations with customers about what demand looks like in the next year, so we can plan ahead. Be transparent with us. We'll be transparent with you on our challenges near term. But we have every intention to grow, and these secular trends that we've talked about for a long, long time, are behind our back right now. The wind is behind our back. When you think about ESG and the benefits there, I can't tell you -- I bring it out proactively with customers, but our customers are bringing up with me all the time. They have the pressure to reduce their emissions and they realize the benefits of rail. The tight truck market is certainly something that we can all debate if it ever goes away. I was just on a call with a number of truckers earlier today, and there is no light at the end of the tunnel. They see challenges persisting for a long time. Their ability to attract and recruit talent is tough. They're having to raise wages. They happen to do some extraordinary things to get people back in the trucks. And quite frankly, they aren't very successful at it right now. And so that just amplifies the conversation with our customers where they want to move more and more volume over to rail. Our ability to recover, I think, will be stronger than truck. Our ability to replenish our workforce will be hopefully quicker and will be there next year. And so that's why we're having those discussions today. A lot of cost inflation on the truck side, and that's only going to benefit that discussion in there. They're looking for ways to offset a lot of that cost inflation from the truck side and we're certainly a first alternative to do that. Service reliability. While we've been challenged right now, our service is still well above levels that we -- before we started this whole transition. And so we will leverage that. Our conversation is harder right now given that they would like more capacity, of course, but they -- I think they understand the long-term reliability of what we're able to deliver. And that's really risen to the top here, given all the challenges they've seen in truck and they don't see that going away. So it's been good, gotten out there in front of a lot of customers and just having these conversations, let us know, so we can plan. It takes 4, 5, 6 months to qualify a conductor. So we need to know ahead of time where those needs are coming, so we can resource in a way to handle all that demand.

Can -- I want to talk about service. But since you mentioned coal, I can bring that up first. When we think about export coal, domestic coal shipments and talk about the impact to yield. I mean, should we see coal yields inflect in the back half of the year? Obviously, the comps are relatively easier. But just talk about sequentially how you see coal yields trending? And then I want to get back to service for a second because it wasn't that long ago where coal was a big tailwind, and then it turned into a massive headwind. And that's good while it lasts, but there are questions about whether to capitalize it given the secular decline over time. And so one of the things I wanted to ask about is when we look at other railroads and their service advisories and maybe some of their channel partners, their advisories, there's just a lot of ingate closures, it's a mess out there, closing entire lanes, major lanes for several days, if not a week. I feel like you guys have kind of side-stepped out a little bit. And I'd like to get a little bit more color. I'm sure you're metering some of your volumes as well. But talk about kind of how you've been able to manage that, I think, kind of better than the industry and where some of the holes are in terms of how you guys are managing service?

Well, the easy way to manage is have the best team in the industry. So we have the best operating team that can adapt and react to, quite frankly, a nonfluid market right now where things come out at us at different points. So it's really -- I would point, number one, to just the team. On the intermodal side, we've obviously leveraged the reservation system to where we need. And we have -- we've done very little of this metering demand. We've done very little, maybe a little bit in Chicago here and there. But otherwise, have been able to handle the demand, trying to work with our customers to come in and get those boxes and move them out. These intermodal terminals were never built to store containers for 15, 20, 30 days. And that's the reality of what we're dealing with right now and having to do some extraordinary things, moving boxes around, stacking them, multiple lifts within the terminals to really try to react to that. So that's really been a challenge there. You asked multiple questions. On the coal side, in terms of yields, what we're going to see on the international side, obviously with the benchmark prices moving up, a bit on a lag, but we'll see some benefit to that. So that's going to be a tailwind as we move into the back half of the year on the international side, if I pull that apart. Then when I look at my domestic business, right now my southern utilities are -- stockpiles are very low. We're trying to replenish those. We are having -- we are resourcing up crews, so we can continue to deliver that. Are we underserving demand right now? Absolutely. I expect that to get better as we trend through the year and then into next year. But my guess is we're probably going to be replenishing those inventories well in the next year, in the southern utilities. But the domestic side could be length of haul issue. So depending on if we're going to the northern utilities or southern utilities, that's where you're going to see the big differential in the yields. But I don't see a drastic change there as far as that goes. But overall, there's no question we're trying to be transparent with the customers, telling them when we expect crews to qualify where we are having challenges and just being transparent around it, and I'm giving them insight into when we think some of these issues will be resolved. We're doing extraordinary things, whether it's attendance bonuses, signing bonuses, referrals, all those things to recruit and attract talent, and we're having some level of success. We're starting a class every week now. So every Monday, we're having a new class start to hopefully get at that 100-plus hires a month until we think we've really met the demand that exists out there. So it's on me and my team to identify what that demand looks like in the next year and then work with Jamie and his team to resource up and make sure we have the crews in place. We want to handle it. There's a lot more that we could be handling today if we had full visibility coming into this year and really solve everything that was going to happen.

I want to talk about mix for a minute. When I look at kind of first half volumes versus the same period in 2019, it's basically exactly flat, but there's been a notable shift. I mean, intermodal is up 12%, merchandise is down 5%. That difference is kind of even more pronounced in the most recent quarter. And it's obviously showing up in overall yields. I mean, yields average revenue per car for the company is down 5%, given that lower contribution from intermodal. How much of this is an issue? In your mind, it seems like more and more of the incremental growth is coming from intermodal. I know you guys are trying to proactively counter that with the quality acquisition, for example. The question, I guess, it's a very fixed-cost business. The revenue intensity per carload is actually coming down over time. Do you think that's just cyclical? Or is there kind of proactive things you can do like the quality acquisition that kind of helps mute that mix down effect, so to speak?

Yes. I don't think this is a secular trend or anything that's fundamentally happening. I think it's a reflection of the disruption in the supply chains right now. When you think about our auto business, starts and stops at all the plants we serve, that has a lot of downward effects on the steel industry and other markets that we see. I would say the consumer market has probably been more consistent in the demand and then in the flows, and that's why you've seen it more consistently show up in our volumes over time. And quite frankly, with all the great -- all the changes we made in our intermodal network over the last 3 to 4 years, it really set us up well to handle this influx of demand that came our way. On the merchandise side, that's really been largely lack of some crews in areas, particularly on the bulk business where we're resourcing up and we'll handle it. But there's plenty of demand on the merchandise side right now. I have full confidence we'll start to move it more and more as we qualify conductors. But -- and you talk about it. Who would have thought with those trends that we're seeing versus 2019, obviously we're able to drop that through at a healthy margin, right? And when you look at merchandise on average, it's -- the RPU is 4 to 5x that of intermodal and yet we're still able to convert that business and realize a great return on it, as you saw in the second quarter.

How are you -- so just on that point, obviously, trade capacity is constrained right now. You're having to pay more. How have you guys been able to do that in terms of convert that intermodal volume that obviously comes with some extra costs? It's not unit train volume that obviously has nice margins attached to it. Talk about how you've been able to kind of offset some of those headwinds that the other players have been dealing where those results are sort of higher intermodal growth?

How we've been able to handle the influx?

Yes.

Yes. It's -- well, what we see a lot of it is coming from the ports. So it's a continuation of -- the eastern ports have more capacity, obviously, than the westerns and we've been a real beneficiary of that, having that fluidity at the ports and be able to move it inland. Again, it goes back to the team, the operating team and a lot of focus on that, a lot of getting ahead of it. And doing things differently if we need to and adapt. It shows the capacity that we've always talked about within the -- in the network and running a lot -- in some cases, running -- extending some trains and doing those things that bring on the capacity without really going into our crew base a lot. It's where we -- you got to have new train starts in that bulk business where that really depletes the crew base quite a bit. And so that's where we really seen our challenges more so than on the intermodal where we have capacity on the existing trains to add stops to the back of the train and keep running.

And I wanted to talk about new business opportunities. I mean, first, just update us on the Quality Carriers acquisition. Have you taken out all the billion-dollar opportunity yet? I mean, how is that going? Just give us an update on that. And if you just follow the money there, it's quite a compelling acquisition if you're able to drive 5% to 10% uplift in your chemical carloads over time as a result of this deal. It seems like it's quite compelling. But just talk to us about how that is? And I know you led a team kind of that looked at these types of opportunities and quality came out of that. Are there any other kind of adjacencies or segments that are equally compelling or interesting to you, if you can talk about that as well?

Yes. Well, first of all, I'll update on Quality. I think we're more confident in our decision to acquire Quality now than we were 3 or 4 months ago when we announced it. We closed here on July 1. It's been a really, really smooth transition. They're obviously facing the constraints in the market as well, and we're working together. There couldn't be a better time to go out and have a discussion with the customer right now on how we can create more capacity for them. And so we've got a number of live customer engagements we're working on with Quality, which will bundle, Quality's trucking capability with our rail service, in most instances right now with our TRANSFLO capability as well. And these are -- we're going to do it in a thoughtful, methodical way, to make sure we did it right because people are looking at us and looking at those first few moves and making sure that it works. So that's -- we're taking it relatively slow to begin with, and we expect to ramp it up pretty significantly with some relatively small investments in the next year. Getting incremental equipment right now is slower than we would have had hoped earlier in the year. So we're probably seeing 6 to 9 months of lead time on some of the incremental equipment, which will help us continue to grow this business. These aren't huge investments, but they're important for us to kind of bundle the services together. But Randy and his team have done a phenomenal job. And our sales team right when we closed, went down there and they had just an endless list of customer opportunities where they're moving freight today and they can't meet the demand. And so -- are there ways where we can work together and the customer has confidence that in situations where they get into critical inventory levels that we can emergency truck it? That's important for them right now, just bundling that entire service together. It's not about price right now, it's about capacity for many of our customers are just looking at anywhere for capacity and to replenish these inventory levels out there. And they really look at it as a longer-term fix, not something short term, where we're going to move it over the rail and then move it back. We're not really interested in that. They're really more interested when they see a value proposition where they can do it cheaper. And so we'll continue to invest in that. And things can be going better on the cost synergy side, which we really didn't embed into the model. We're seeing some opportunities that we thought were there, which are good to see. But we'll see this really probably ramp up in the back half of next year as we get the equipment, utilize that and continue to ramp up and have discussions with the customers, but it's going really, really well.

Any other adjacencies -- I mean, I know you guys are obviously very big landowners. I know that's been a focus for you in terms of developing the real estate along the network. I think you hired maybe someone to take charge of that, head of real estate or something like that. But talk to us about, one, are there any kind of quality like, not necessarily in the trucking space, but something that makes sense that can drive idiosyncratic growth outside of the market? And just on the real estate side, how aggressive are you going after that opportunity? And what's the update there?

Yes. First on -- the other adjacent business that we have is TRANSFLO and we have a lot of resources around that, and that really extends our network. It provides an ability to touch customers that we don't physically touch as a rail network. And Arthur and his team are really focused on -- now that we have customers out in the market looking for additional capacity, it's a huge opportunity for us to have those discussions. Sometimes we can use a Quality truck with that TRANSFLO service, but we'd like to partner with everyone out there to really final mile it to the customer location. In terms of leveraging our real estate portfolio, we did bring on Christina last year. She's been great, bringing a lot of new ideas. We really have -- what we want to do is encourage investment along the railroad. And so we have shovel-ready industrial sites. When you think about the pandemic and when you think about all our customers reevaluating their supply chains, we want to be the first call when they're considering new manufacturing, new warehouses in the U.S., put them on -- put them on a CSX rail-served location because, one, it solves the truck issues that are probably not going away. And we probably haven't been as focused on that in the past before the last 3 or 4 years, and we really, really want to encourage industrial development along the railroad. That's really important to us. We ready to have -- we're willing to have a different discussion with the customer around that because we value that. It's a long-term investment. Some capital is really important. When you think about tens of millions of dollars of investment or hundreds of millions of dollars of investment along the railroad, that makes that business quite sticky, and we like that. So we've really invested more resources into that group, are highly focused on it and looking for ways where we can extend the network. It's really just extending the reach of customers that we serve today and how do we -- through TRANSFLO, through Quality, through other partnerships, how do we do that. So we're having discussions on a weekly basis with customers that are building warehouses, other things like locate them on a railroad, locate them on CSX. And here are the benefits and here are the opportunities that that provide going forward. So that's really what we're focused on in the current environment.