CSX Corporation (CSX) Earnings Call Transcript & Summary

My name is Garrett Holland, senior analyst covering transportation and logistics at Baird. We are very pleased to have CSX Corporation participating in our Industrials conference this year. From the company, we have, Jim Foote, President and CEO; Bill Slater, Head of Investor Relations. And so we're just going to go ahead and dive right into the Q&A. But if anyone participating on the webcast has a question, please submit it through the portal, and I will relate it to Jim.

Jim, clearly, no shortage of things to discuss in this type of environment, but maybe to start on volume -- in the wake of the volume disruptions that we saw in the third quarter. Where are you seeing some incremental recovery here in Q4? How are your volumes tracking relative to your thoughts at the onset of the fourth quarter? What categories are doing better or worse at the margin?

Well, first of all, thanks a lot for the opportunity to be here today and talk to you. So we'll dive right in. Not a lot has changed. Demand continues to be very strong across just about every one of our commodity segments with the exception of auto, which everybody knows what the issues there is. There's no sense of me talking about it. And the challenge is clearly not the demand and market strength. It's all the other noise that's going on at the same time in terms of the transportation supply industries challenges as well as our challenges associated primarily with trying to hire people in the midst of all of this. So our outlook is still on track. And we wish we had the capability right now to move more.

No. That's helpful. And to pick up on that point on the supply chain congestion, what are the keys in your view to really getting past this issue? And I know CSX has been very active, controlling what you can, adding new container yards, storage capacity and repositioning equipment. Has that helped improve fluidity across your network? And are you seeing any indications that give you confidence that we're past the worst of the supply chain congestion? And importantly, there's a path to normalization ahead.

Yes. There's a tremendous amount of focus on the intermodal segment of the railroad. But the rest of our merchandise customers, our coal customers are equally as challenged just simply because whether it's warehousing, trucking on either end of the piece, whatever it might be, problems with our customers, them having the difficulties in hiring. So it's across the board. So we've tried to address everyone's needs to the best that we can. In the merchandise segment, consolidating trains wherever we can. The key is to make sure that the core network continues to operate fluidly. Sometimes that leads to last-mile, first-mile challenges associated with making sure we have the crew to get the train out of the terminal and across the railroad because if the railroad slows down, it just adds problems. Your need for -- if the railroad slows down, your need for cruise goes up. So we can't let that happen. And sometimes that's frustrating for the customers. They think we're doing something to short them, but it's just trying to keep everything operating the best we can. The fluidity of the network is getting back to -- continues to improve slightly each and every week, each and every month. And so that's a lot of hard work on everybody's part. In the intermodal area. Some of the things we're doing, I guess the new term is pop-up ports, trying to find relief valves where there's congestion, same thing to keep the terminals, port terminals operating. I can't let those plug up. So we have to find alternative places to put the boxes in the event that the customer -- the beneficial cargo owner can't accept it. So we're doing that. And a lot of the work that we've done in Chicago in terms of making sure we have capacity is not necessarily because we're challenged. We've, I think, done a pretty good job throughout the year. But everybody knows, guess what happens every year in December and January in Chicago? It gets cold. It snows, it ices up. And so we're looking ahead there to try and make sure we have the flexibility with relief valves in terms of off-site storage yards, et cetera, with reach stackers or whatever it might be necessary to be able to handle that volume if we are, on top of everything we're faced with, get struck with a difficult winter.

No. That's helpful. And I know you must rather have the volume, but the intermodal storage and premise and use charges as well as demerge were higher in the third quarter. Do you see these changes -- these charges changing customer behavior? Or do you still expect them to remain elevated here in Q4? Just interested to hear what you're seeing from your customer base.

Well, we'd like to see them go down. Because if they go down, that means the fluidity is up, and we're not having the congestion in the terminals. It's interesting to note that I think it's correct to say that the railroads early on in this process were somewhat were criticized for what was viewed as somewhat predatory tactics in imposing these charges. Well these charges have been there for years, decades. And now to see like the ports putting in similar types of charges, it's somewhat indicating that we're just trying to do the best we can, and there has to be some incentive there to get it out. So until the velocity of the entire network, and I don't mean CSX, but the entire transportation network, stabilizes and begins to improve, which I think it is, you'll probably see those charges stay elevated and then trend down as we move into next year.

No, that's helpful. And to pick up on your point about the ports. Obviously, the eastern ports have benefited from very strong import growth. And until recently, have been outperforming, I would say, the West Coast ports from a fluidity standpoint. Interested if you could talk about the longer-term growth opportunity, that import volume is for CSX as well as some of the longer-term benefits you see from the infrastructure investment outlined by the administration lately?

Yes, the East Coast ports, it's a heck of a franchise, and it's something that people have talked about for a long period of time. Going back to the expansion of the Panama Canal, getting the larger vessels to be able to come around. So that trend line of, man, I don't know what -- it wasn't that long ago. At least it was still in my career when about 90-some-percent of everything that came in, came in through the West Coast. And we've always talked about how that shift would occur, driven by -- first of all, strong demand along the East Coast ports. It makes a lot of sense for a lot of people. If it's something that's going to be consumed, New York, Philadelphia, Baltimore and on down the line Atlanta to bring it in the East Coast port than it is to take it off and run it all the way across the country. So that shift has been ongoing for a long time, coupled with, again, something that's been in the works for many, many years. The shift in manufacturing from solely in China, down around into Vietnam and Thailand and now more and more into India, that favors the Suez route. So those 2 combinations of the Panama, a general shift in the way people view the supply chain and the Suez, has driven port expansion along the East Coast. I mean you look at what those people down there in Savannah are doing. The Port of Georgia, it's -- I was just there, I guess it was last week, phenomenal, phenomenal expansion with more planned in the future. Port of Virginia, some of the work that they've done over the last few years, Baltimore now with the new tunnel. Work that's been done in New York, New Jersey over the last few years. So there's capacity. There is the ability to expand capacity with the East Coast ports, couple that up with the shifts in trade flows. Couple that up with the fact that the railroads in the East Coast now, I think, run obviously better. The railroads in the East run better than they did 5, 10 years ago. So it's -- everything is lining up for us to have the continued strong volumes out of the East.

That's very helpful. And given the congested state of freight markets, along with ESG considerations, shippers should be more interested in rail transportation than ever. Help us understand how quickly we can unlock that rail conversion potential? And your thoughts on the maturity of the intermodal opportunity in your Eastern franchise.

The intermodal opportunity and the carload opportunity from a truck conversion standpoint, our channel partners in the East talk about enormous opportunities in the East to grow volumes. So from an intermodal perspective, domestic intermodal perspective, that's very positive for us. We just talked about the opportunity on the international side of the intermodal business, but the carload side of the business, 66% of our business, is where I've always talked about where the real opportunity lies. The paper guys, the steel, the plastics producers. All of those people are putting their product -- same product that they put in a railcar today, putting it in a truck -- 2 or 3 trucks, in order to move it. And they would prefer to put it on the railroad. So it's up to us to, number one, get our service levels back to where they were in 2019, which were record-setting in just about every category and then improve from there. To me, it's not getting back to 2019. 2019 is the base. 2019 is the base camp in order to climb this peak and achieve greatness. And that's what we're working extremely hard on, every single day is to accomplish that.

That's great. And then just to maybe wrap up on the demand side. Do you view as the disruptions that we've seen in '21 is deferring volume into next year? Or just how would you characterize the strength of demand and the improving visibility as you see it today?

Normally, I would always say, I've never seen the business come back. Everybody -- maybe when you got a corn stored on the ground in a Walmart parking lot someplace in Iowa, it's eventually going to move. But most of the time, people figure out a way to run their businesses and get their products to market. There's probably lawn furniture sitting in a warehouse someplace that was supposed to be here for the May sale. Well, they'll sell that next year. But automotive clearly is going to improve. It's a well-known issue that all of the manufacturers are working on to solve, all of the chip producers are working on to solve. And all you need to do is drive around. There's no cars in the lot. People want cars. So they want to buy cards. They want to buy new cars. In fact, good luck trying to go buy a car at sticker price. They mark them up about 10%. So that's going to happen. I think what we've seen due to a lot of issues, whether it be the Delta variant, whether it be congestion throughout the world in transportation, whether it be part shortages, it's going to get better. And that has caused everybody's forecast, I'm sure you guys as well, to take your expectations for this year down and move them up for next year. So we'll follow along with that. We're planning on hiring and hiring and hiring to the extent we need to be ready to be able to handle that. Shame on us for not being able -- ready, but we never saw these kinds of difficulties, never expected these kinds of difficulties. And we're looking at revamping and changing our entire way we approach, hiring employees to the jobs they might want to work as opposed to the ones they don't want to work. And I think across the board, most people are going to get comfortable with interacting with the businesses that they buy products from by using a kiosk more. We can't switch box cars using a kiosk. So we're going to leverage technology where we can, but we still have a need, a very strong and vibrant unionized workforce. And we're working with them to try and make sure that we get ahead of the issue.

That's great. Just wanted to cover a couple of questions on pricing. Obviously, the flip side of congested freight markets are rising transportation costs. That seems to be a tailwind for your business. What are some of the initial trends that you're seeing as you work through early repricing here in the fourth quarter? And with truckload markets still rising double digits next year, help us understand the pricing and yield opportunity a bit longer term.

Well, we have more longer-term relationships with our customers in terms of how we set rates over a period of time, whether it's 2 years, 3 years. They got it shorter than it used to be, 5 years, 6 years. It gives you a little bit greater visibility as to what you want to do. And so rail pricing is a little -- or is less volatile and, say, dial a truck. But it's always better to be discussing what you think is a fair rate this year versus -- next year versus this year, however you're looking at it, in an environment where demand is strong for your product. And in this situation, everybody is trying to figure out this -- again, the newest equation, what is inflation, how much, how long. And I think Kevin talked about that on our last call, how we have a big portion of our portfolio that rolls over in the fourth quarter and the first quarter. So that's when we'll be trying to, again, set a fair rate that takes into consideration all of these factors.

No. That's helpful. And you're clearly investing in the franchise, and I think you were vocal earlier in the year about your desire to get ahead of demand and add more employees and understanding that's been a challenge in tight labor markets. But what are your thoughts on the need to add a similar amount of labor for next year as you look to outpace the attrition in the workforce?

Well, again, I mentioned earlier, our performance in 2019. We will move from a volume perspective, I try to never look at versus last year because it's just insanity, other than when I'm talking to my boss is the Board of Directors and telling them, "Hey, we're up 25%. We're doing really great." But we'll move more freight this year under these challenging circumstances than we did in 2019. So we need to get back to that point in terms of hiring. The one thing is we have a reasonably, I think, high attrition rate, not as high as some companies when I hear, now that we've gotten into a whole new area of recruiting, I never realized that some companies had 100% turnover every year. I don't know what I'd do if that was the case. But -- so I'm not worried about us hiring too many people just simply because of the attrition rate. We can manage -- we can easily manage the appropriate amount of employees to the need to move our customers' products. So right now, it's -- all hands on deck full speed ahead, trying to get more -- trying to come up with new creative ideas to hire people. And I'll worry about that with Jamie Boychuk and Kevin and Sean Pelkey about making sure that we have everything in place to balance the need against customer demand, operational needs and the financial performance of the business.

And to that quest to get staffing to where you want it in the wake of a vaccine mandate, which is now tied up in courts. Just interested if you could help us make some sense of it all, how are you preparing for compliance? And what do you think the final impact will be for your workforce and the industry supply of labor?

Well, it makes me nervous, obviously. Here, on the one hand, I'm doing everything I possibly can to train -- hire employees. And we're not unique in there that there are people out there that say that they're not going to get the vaccine. So there's a lot of different factors at play. Obviously, we're watching all of the circumstances as they play out, whether it be, oh my God, the ongoing litigation between railroads and unions, the ongoing litigation between states and the federal government, other non-rail customers who are expressing their concerns over all of this. But at the end of the day, it's my obligation to make sure that the company is in compliance with the federal regulations, whether they be executive orders or orders -- or regulations put out by OSHA, and we'll be in compliance. That's the way our business operates. We're kind of used to that. We work with the FRA. We work with the Department of Transportation. We work with everybody. So we scratch our heads and say why. But at the end of the day, we're working diligently to come up with sound policies that meet the needs of all of the regulatory bodies and tries to address fairly and reasonably the request of our employees. And that's about kind of what we always do, and that's what we'll do in this case.

Fair enough. And you talked a little bit about the trip plan compliance. Intermodal side, very strong back, I think, within your targeted zone. But in addition to the labor element, is there anything else? What are you working on to restore the car loan performance to 2019 levels or better as you noted?

It's clearly just the employee issue, the ability to hire employees. We have -- still have locomotives, excess locomotives. We have track capacity. We're making strategic investments to increase fluidity. The more our velocity number goes up, the more our dwell number will come down. And that just means you're moving more freight and need less asset to do it. And when velocity is down and dwell is up, our customer service metrics are not good. So whether you are focused on trying to provide a good quality product to our customers, which is what you're always doing, you want those numbers to go in the same direction as if you wanted to reduce costs. Adding -- putting in more railcars, it's just going to -- anything that you do that would slow down the network. It's like at rush hour if you just told everybody, nobody can -- because of COVID, everybody's got to drive in their own vehicles. So let's double the amount of cars on the highway, and let's see how much faster we get there. It would just create havoc and chaos. So it's always this balance by focusing, but our #1 focus is on those customer service metrics. And I guarantee it, if our customer service metrics are good, our operating performance, as it relates to efficiency, will be better.

No, that's my next question. I know your primary focus is on growing operating income, restoring those service metrics. But how would you dimension -- I know the idea is not to push the OR to an extreme low. But how would you dimension the efficiency opportunity and a continuous improvement spirit at CSX after significant gains in recent years?

By running the network, again, more fluid, whether that be through the use of technology. As an example, just the technology focus on how we inspect the track, how we inspect the locomotives, getting rid of the number of slow orders we have on the railroad because we have predictive maintenance versus reactive maintenance, finding things that could go bad in the middle of the night during the day instead of waiting for something bad to happen. All of those things improve -- will improve the overall efficiency of the company and improve our throughput, and will continue, as I said, create efficiencies. And so this game is not over in any way, shape or form. We do have inflation now every year. So we have to do that stuff just to stay where we're at. The easiest way to improve the operating ratio is to grow the top line. And so that's our primary emphasis.

I just had a question from the audience. How do you think about managing the mix of your volume growth? Clearly, the quality carriers deal helps a bit, but your thoughts on actively managing that mix, giving growth outlook going forward.

We like all of the business. Clearly, there are different margins in different commodity groups in different business segments. But we are very, very active in 2017 and 2018 on the intermodal side. And we would -- and we are now in a position to be able to reap the benefits of the improved margins in that segment by all the work we did before. So I'm very happy to move as much intermodal volume as we can.

And on the -- back on the investment topic, the proactive strategy has served the company very well. In addition to the labor initiatives, some of the technology, what else would you highlight as the investments that carry the most strategic value today that will provide so much optionality, say, 3, 5 years out?

I think that our initiative that we talk about all the time. Again, there's -- we're way behind in the arena of the real deployment of technology. We're not thinking about getting into the metaverse, but let's try and get up to the first phase here first. And so technology is always going to a play, a factor as we go forward. And so each year, we've kind of spent marginally a little bit more in that arena. And I think that, that moving into the way people do business today from a customer relationship standpoint, speed to market is critical as well. So a rational deployment of our capital in those 2 areas, modernizing our customer-facing tools, ShipCSX, but more than -- clearly more than what we're doing today. And leveraging technology are -- every project in those 2 areas that we look at has a very good payback. And we'll put money into the railroad where we need to. We're lucky that we don't need to and won't for a while, but we're putting some sidings in down in the southern part of our network today because it, again, increases fluidity on a critical component of our network that's got growth opportunities. So you got to stay ahead of the game. You can't be reactive. You need to be proactive.

That's great perspective, Jim. And we thank you for your time. With that, we're out of time on the webcast. But special thanks to CSX, Jim, Bill and everyone online for joining us today. And we hope you have a great rest of the conference. Thank you.

Thank you.