CSX Corporation (CSX) Earnings Call Transcript & Summary

Good morning, everyone. Welcome to the third session here of Barclays' 39th Annual Industrial Slide Conference. I'm Brandon Oglenski, Transport and Airline Analyst. And I'm very excited to have up here next, CSX and Mr. Kevin Boone, EVP of Sales and Marketing. And Kevin, you've been with the company since relatively 4 or 5 years now.

Yes, 2017.

And a lot has changed since then.

A lot has happened.

I think you went from an IR role, into the CFO job and now Head of Sales and Marketing. So it'd great to get your insight. And also, it wasn't that long ago, you were on the other side here as an investor. So great to get your view from this side now. But before we get started, as in years past, we do have audience response questions. But unfortunately, we don't have the little clickers here in the room. So if you want to participate, we have 6 questions on CSX. If you just scan the QR code, you'll get those on your phone. And you can also, I believe, type in the question there, I'll read it right here on the iPad. I'll just keep the profanity down. And also, if you just want to ask a question, we'll get the mic runners here.

So Kevin, thank you for being here. I think we've gotten a lot of questions here before we talk specifically about strategy at CSX, but rail volumes have been weak now for 3 quarters on and during the pandemic. January and February started off pretty tough. Can you tell us how things are trending right now in the first quarter?

Yes, sure. Well, first of all, it's great to be here in person, not only as another Zoom call. When you look at the start of the year, and I think we talked a lot about this on our fourth quarter call, clearly, Omicron was at the peak. That happened very, very quickly even relative to Delta. We saw the COVID numbers just spike in a matter of a couple of weeks, and that was disruptive, as you can imagine. And those numbers can be concentrated in terminals and it makes it difficult if they're evenly spread across your network, probably easier to deal with, but the concentration really makes it difficult from an operating perspective. And on top of that, the weather, as we got into late January and February, were challenging as well, probably more challenging than what we saw last year. But where we stand today, I'm encouraged we're seeing our headcount numbers recover from COVID and probably seeing the best active employee accounts on the T&E side that we've seen in a long time there. And so there's a lot of optimism in terms of what we can do going forward and eventually handle more volume as the customers continue to recover.

And do you mind putting that in the context of your 2022 guidance?

Yes. I think largely things are on track, a little bit slower start in 1 month, but 1 month doesn't make a year. We still are looking for, obviously, the recovery in the auto sector. That's the big one that we still see some significant declines on a year-over-year basis. Obviously, the comparisons into the second half get a lot easier. And on top of that, we do expect recovery. It's long time coming. The demand is clearly there. If anybody try to buy a car right now, it's 6-, 9-, 12-month lead times to get those new autos. So we know the demand exists there, and that's a big opportunity. And the auto sector touches a lot of other sectors as well, steel, plastics, others. And so we would expect that to really carry through to some other markets that we serve.

And for a conference like this not just for transports, but broader industrial, I think big questions here for investors around supply chain constraints. Where do you see those today? And I know you're talking about your labor force being out with COVID. More broadly, where do you see the pinch points in the supply chain today?

Well, you cover the trucking industry, we're still seeing that at our terminals, Chicago, others we're seeing still excessive dray of containers in our yards. We're having to do some extraordinary things to use trucks to get them off our yards and keep it the fluidity going. Lack of chassis. That's still a problem. We'll expect some of those chassis to come into the market second half of the year that should help alleviate it. But when you look at our domestic intermodal business today, it's not growing. And it's not growing because we don't have the capacity. It's not growing because the trucks and the containers and the chassis don't exist to really stimulate that growth. So looking forward to that really changing here in the second half of the year, and we expect that to improve.

And so sorry, is that a driver issue or equipment issue, too?

I think it's everything. It's equipment. Chassis is probably the most pronounced issue right now. I think the driver issue is more on the long haul. But I would expect the drayage opportunity to come back from a driver supply a little bit more positively than on the long-haul side, which I think is going to be challenged for a long, long time, which is a good thing for us.

Right. And I want to get back to this, but also on the inventory side then, do you view your customers as being proper inventory levels? Are they under inventory right now? Do we need to see a restock?

I think we're still in the restocking phase largely. I know the inventory numbers are being watched closely. But what we see coming in even from the ports right now, there's still a replenishment happening. And in some cases, given just the just-in-time nature of the market right now, that actually can hurt us sometimes when you think about a customer having a project, the construction project and needing the lumber or needing whatever materials they need, they are paying excessive truck prices to get it to the site, so they don't slow down the labor there. And so I think we'll see some normalization, which actually is helpful for us as inventory levels replenish to a point where they're comfortable with another day of dray or another day of transit time with the rail.

Okay. And then on inflation, which has obviously been high, how does this impact your cost structure, but more importantly, your pricing as well?

Inflation, as long as it doesn't slow down the economy is a really good thing for the railroad. We're the lowest cost option, ground solution for our customers. And it's, quite frankly, stimulating a lot of conversations we wouldn't normally have with our customers where they're willing to get a lot more creative and shifting -- potentially shifting more business over from truck to rail just because they're looking for ways to offset a lot of cost pressure that they're feeling. But certainly, when we look and come into this year, the -- or we even look at last year, -- we started off the year in a pretty low inflation environment and that rapidly changed as we got in the second half. And the customers are passing through price. They expect that conversation to be had with when we're having that something they're surprised by, and we're having to cover our costs that we see, obviously going up in this environment. So it's been a positive move. We don't get to touch all of our contracts all at once in any given year. but we're certainly looking to recover the cost inflation that we're seeing in our business.

Okay. And one here from the audience, and I think for a near-term focus. Any update on Curtis Bay, when will that reopen? And what's the impact on the first quarter?

Yes. You've seen it in our volumes. We've been able to start direct loading at Curtis Bay. So we plan to do that until we can repair it. We're making a decision over the next week or so on what option we're going to select. There's opportunities for us to increase the capacity at Curtis Bay given the issues we had. So we'll look into that going forward, but probably at a minimum, 6-, 9-month or up to a year project for us, but we didn't -- we'll be able to ship at least 50, probably even greater percent of what we were able to do before with the new direct loading that we're doing.

Okay. And roughly, how much of this business does it -- how much does this reflect of your total business?

Yes, it's just relatively small in the grand scheme of things. Our domestic business is our largest part and then export. And we have other options that point those carloads at other terminals. So we've been able to largely make up for that.

Okay. And then before we get into the Commercial strategy, we didn't, I believe, guide to a specific OR this year. Can you talk to some of the puts and takes on that, especially in an environment where you should be seeing acceleration in pricing, right?

Yes. I think nothing's changed in our business model. We're focused on leveraging growth and that means a fairly positive incremental margins. What we're seeing in the current environment, we're investing ahead of the growth to some degree, where we have 500-plus trainees and out there getting qualified right now that are unproductive, you can say, because they're not moving freight today. That's an extra cost that we're carrying. If -- I just talked to Jamie yesterday and we're probably carrying about 150 locomotives more than what we would normally need in this environment, and that's related to the crude issues that we're having out there. So as our crude issues improve, we would expect the locomotive count and a steady state to come down. And rule of thumb is probably every train is costing you about 4 T&E employees on a daily basis because you're paying the cost of the manufacturer and all the maintenance related to the locomotive and the active count right now. So if we put that back into storage, you save cost and then obviously the cost on the headcount come into play, but we think that mostly equals out as we get out into the second half.

Right. I think if we go back to last year, you guys came out pretty vocally saying, look, the volume is coming, we need headcount to handle it. While a lot of your competitors were saying maybe the opposite. And I think your volumes have recovered the most of many in the industry. I think part of that is because you've had headcount. Can you talk about that dynamic of labor?

We looked at this closely, and we were talking with our customers, we saw trends on a daily basis. And we -- to your point, early last year, we saw the issues. We saw probably attrition rate at higher levels than we had seen historically, and then we started to go out into the market and looking for trainees and it wasn't as easy as it normally had been. And so we were transparent about it on I think it was the fourth quarter call in January last year. And I've been happy to sit here today and say we're filling all our classes. So we're -- we may -- we turned the machine on. It took a little bit longer than what we thought, but we're highly successful right now, and we've got over a lot of trainees out there. And so we think we're ahead of the curve. And I think this is a race to add capacity into the market. And I think we're going to be in a really good position as we get into the back half, whether it's relative to truck or other modes of transportation, they really talk to customers and say, we have capacity. Let's take advantage of that, and we're where can we add new service for you.

Okay. And I think this actually relates well to a question that just came in, quarter-to-date volumes are down 3%. Service metrics are lagging. How are these metrics coming now versus where your expectations were? And I think you guys actually provide some on-time metrics quarterly. Is that correct?

Yes. Yes. Those aren't when you look at trip plan compliance, what kind of the customer measure, it's not where we want it to be today. But I think we see a good path to getting back to those 2019 levels and then exceeding those from there. It's a relative game right now. The truck is not reliable. The rail is not as reliable as it should be. So you're seeing disruptions across the supply chain. Customers aren't as fluid as they normally are. They're having to deal with disruptions in their business. It's every week that we get on a call, going week and it's this auto plant. That's not going to be active or producing autos this week. And so we're having to adjust. And I think as you see the supply chain balance and you create a little bit more ratability throughout the network, that's going to be extremely helpful. I know Jamie talks about it all the time. With me, it's, "Hey, we can get more consistency of the freight coming to us, it really helps us." And I think we're starting to see the early signs of that. Not only were we disrupted in January, our customers were disrupted pretty heavily by this new latest variant that we saw.

Yes. And I think all of those lines we got another question here, too. Just given the softer 2 months of the quarter, were there opportunities to take out some of the above normal costs you originally guided to sticking from the fourth quarter? But I think some of this is just the labor, right?

Yes. What we said on the fourth quarter call is we expect expenses to be relatively flat in the first quarter, and a lot of that is related to our hiring initiatives. And those will start to normalize as we qualify people and they're moving freight. That will be a bonus. I talked about the extra locomotives we have out there that I think will normalize and there's the overtime costs and all those things that will normalize as we get through the year. And so all those things are pretty much in line of what we expected other than maybe a little bit more weather and the Omicron impact probably lasting a little bit longer.

Okay. Can you talk about quality carriers and the rationale behind that acquisition? And I bring it up because we've had some interesting back and forth, north of the border Montreal on their prior trucking acquisitions. So does it make sense for railroad to own those assets in that business?

Yes. I think it's important to understand how we got the quality. It was a lot of work on understanding the freight flows that existed that were adverse to the rail and what was moving over truck in the eastern part of the U.S. and what we saw and arguably our best franchise, the chemical franchises, there was a lot of freight moving in the Eastern United States. Long haul, that's not moving over rail. And we asked the question, well, why is that? Because rail is obviously the most cost competitive, and we do a really good job from a reliability perspective. And what we continue to see is, while we don't reach that final customer, we don't physically -- the railroad doesn't go there and that the question, well, is there an asset? Is there a solution that can allow us to grow the pie and quality happened to be an asset in the market. At the same time, we were doing all this analysis. So the stars align, so to speak. We did a lot of work with Randy and his team looking at their current freight flows and what the market looks like and we all came to an agreement. Yes, there's a big opportunity there, and we're seeing it through our customer discussions today, they're excited about it. They need more capacity. They're looking for one solution. It's hard to put together a transload, on top of a truck, on top of the rail. And now we can do that for them. And that's really a solution they're looking for. And we're also introducing the ISO tank into the intermodal network, and that will come on in the second half of the year. That's a more seamless solution that we can offer the customer. When you think about a transloading solution, there's probably a longer lead time. It's weeks and months to put that together for the customer, but we're getting a lot of momentum. There's a lot of customers that are coming to us. We're starting to do some of those things. We want to do it in a way where it works and when the network is functioning very fluidly so we can take that on because you get one shot with a customer to prove that you can do it consistently and reliably. Customer, it doesn't -- one day extra transit time, doesn't really matter to the customer. It's creating the pipeline for the customer that's reliable that they continue to have the manufacturing plants producing and that's what's important to them and they realize the cost benefits, the ESG side of it is huge with these particular customers. And so that's been a great discussion topic that's really driven a lot of conversations and a lot of more willingness to, quite frankly, explore these ideas.

We know it's dilutive to the OR, though, correct?

Trucking margins are dilutive to the OR. I would say my expectation, and we're seeing this today, the core business is doing very, very well, as you can imagine. That the returns are going to be accretive. And then when you look at the conversion, when I'm looking to convert something that quality is doing today and over to rail, the incremental margins on that are very, very good.

And how much of the business day has been converted?

Very little, very little. And you look at -- sometimes I joke, I wish quality was bigger. And so obviously, a relatively small asset in the grand scheme of our business. But that doesn't mean there's going to be a large opportunities. It will take -- I think you'll see a lot of momentum build in the second half of the year and then into the following years.

And I'm asking this because I think it gets to a broader topic strategically Commercial side. And I asked this of Union Pacific earlier, it seems U.S. rails historically were maybe more risk averse. Does this signal a new strategy at CSX, where you're going to go take lead on opportunities, take risk with capital. Is this the expectation going forward?

I don't think it always takes capital. It's letting our partners know we're willing to do things we're able to react quickly. If you see, the market has changed so dramatically and customers are looking for solutions and they're looking for them quickly. And I'll give you an example of that. The Georgia Savannah port came to us and said we're having this issue at our terminal, and we have all this congestion. And we were able, in a matter of weeks to put up a new solution that goes all the way in Atlanta for them and really solve a problem that they had. And we think that business can stick long term. Traditionally, CSX probably wouldn't have been in a position to really capitalize on that. And I think we're just going to have to think differently as an industry, whether it's working closer with Union Pacific and BN and others to be able to capture those opportunities that maybe we weren't able to do because we've moved so slowly before. And quality is an asset we bought. What we also want to show the market is, hey, we want to do these things. We don't have to own it every time, hey, if you're a partner and you have some chemical business that you want to transload with us, we're open for business. And that's changing the mentality of our customers. They say, we're not always viewed as the most forward thinking in terms of providing new solutions, new opportunities for them, and we want to be thought that way.

Okay. Any questions in the audience here? Just raise your hand. All right. On intermodal, you said you're not growing the business right now is...

Domestic side. The international side has been great, as you can imagine, and the domestic side has been more challenged with some of the trucking challenges that have occurred.

But I guess what's exciting you long term there? And have you won contracts? What's the strategy to grow that business?

What's exciting is, I think relative to the industry, we've done a very, very good job. So while domestic intermodal hasn't been a big growth driver over the last few quarters because of all the challenges I suggested, we've outperformed the industry, and we kept our terminals fluid. We think there's a lot of capacity we can continue to add. We think the service product is going to continue to get better and even more truck like than what it has before. And we think we have the best service product out there and it's showed up in our volumes. There's no question about it. That's what excites me. And all of the factors that are going on when you think talk about the environment, when we talk about cost inflation, all these factors are a tailwind for us today.

How do you get the service to a level where you can really start expanding the business, I guess?

I mean, we're hitting the high 80s today. And so we're not that far from the 90s, which is where we consider a truck-like reliability. And so we're there. We were there in 2019 and really saw a lot of positive momentum. So we're not far off from that as we recover the crew issue.

I think it might be a question here.

Kevin, can you provide an update on the Pan Am deal and just where that stands? Any way to quantify how that's going to impact you guys and just any feedback from the STB after the hearing?

Yes, if we had the opportunity, we had a 2-day session where we got to present to the STB. And I think that went quite well, 100% or we had no customers that are opposed this transaction. And now they're reviewing it post that 2-day session and we expect an announcement, I think, April 21, and we would hope to close June 1.

I guess what's the strategic rationale though for Pan Am?

It's within our reach. It's a single-line service into a market that we think is going to have a lot of opportunities. There's port access. That's very attractive. That we saw, but it's a market that has had, quite frankly, challenging rail service for a long time. It's a great consumer market. We think there's a lot of growth opportunities. When we look at the core businesses that exist there. We think they're above average growth relative to our overall network. So those are very, very attractive for us.

Okay. And I guess talking about intermodal, is this a lower-margin business than your average book? Or is that not the case?

I think the profitability profile has improved dramatically. When you think about the ability to grow that business, adding another container on to the back of an existing train has got very, very positive incremental margins. And so while the core -- the overall business might not be as profitable as some of our merchandise franchises, I think the incremental margins look pretty similar in a lot of ways.

Okay. And outside of chemicals, intermodal, what other market opportunities are you guys pursuing?

We're pursuing opportunities across our franchise merchandise, we talk about it all the time and all the work we did about understanding the truck market today on the chemical side, converting more chemicals, and that's not just through the quality acquisition, we think there's a lot of opportunities with plastic exports, other things that are happening on the East Coast that we're really participating in. That's a good growth driver for us. And when you look at where we are in terms of just order fulfillment right now, we're not fulfilling the order or the demand that a lot of our customers on the paper and packaging side, the side, chemical side. So that's a big opportunity in the near term to get those order fill rates up to levels that we have historically done and then get to that 100% where they're willing to give us even more of their wallet share.

And do you think this is a long-term opportunity to convert?

We do. And certainly, adding in the transloading, we have our transload business that we recently put a new leader on top of that and highly driven to really expand the reach of the railroad, not only in the chemical market, but other markets. And because we know there's a lot of freight out there, as I spoke to. And it's -- sometimes you need the transloading combined with a truck to really reach those customers and markets, okay? And that's a little -- it really -- it takes relatively low capital to do it. It's a couple of forklifts and some land in some cases.

I wanted to talk about capital because you brought that up a couple of times that you don't necessarily need the capital to get these growth projects going. And I think you guys have said long term, we should expect CapEx at or below 15% of revenue, is that right?

We haven't guided to that. That's where you've seen historically. When you look at what we see our needs on the core franchise and from an infrastructure standpoint, I think we're in a really, really good place. We don't see any big spike in capital needs from that perspective. We're going to look at any project that has a really high return. And if it exists, there's nothing today that would be hundreds of millions of dollars that's out there that is an opportunity. But if that came along, we certainly have the balance sheet and the cash to do those things. And my hope is we'll see more of those opportunities, where you can get 20%, 30% returns for some capital investments that are will stimulate growth and even more growth.

Yes. And I know we have a couple of other railroads at this conference, too. But historically, the Canadians have demonstrated better volume expansion but with relatively higher capital investment in the business. Now maybe there's unique circumstances there, but it just seems to me that the more you're willing to risk on the capital side, that seems that drives better volume outcomes, and shareholders aren't necessarily negative on those outcomes.

Yes. I think from a rail infrastructure perspective and Jamie, and we've been saying this for a long time, is we came into a rail network that had a lot of head of investments in terms of double track in a lot of areas, which gives us the ability to grow into that. So we think we have the opportunity to do that. We're adding some sidings in the Gulf region to help out with some capacity additions there that I think will be beneficial to our growth, particularly on the chemical side going forward. But we think we have a pretty robust infrastructure right now that allows us to grow into it without a lot of incremental investments. We have a lot of locomotives stored. As I mentioned, we probably have 150 too many out in the working today. So that gives you an ability to grow long term with those assets as well. So I feel comfortable from a core railroad infrastructure that we're well positioned and that there's not a capital model coming. And like I said before, there's investments in cars or other things that we can do that are going to stimulate more growth, we're very open to it. We're not going to constrain growth.

Okay. I mean I know you guys are active with PNM, but we've had bigger M&A in the rail sector in the last year. How do you guys view the landscape changing with the CPK issue deal potentially closing, do you view M&A as a longer-term thesis in this industry? Or do you think it's actually gotten harder now?

Well, I think further Class 1 M&A from here is a nonstarter, particularly in this environment, never say never. Decades, the world changes down the road. But yes, I think that's probably not happening. And I think that's probably a consistent view by everyone today given just the regulatory backdrop that we're in today. But then when you think about KCS, Canadian Pacific, obviously, is there's very little overlap in our networks. We think there's opportunities to work together. And whether it's creating business from Mexico and new lanes and new opportunities, we're excited to have those conversations and create great service for the customers and open up new markets for them.

I mean, I hear from shippers to, especially on the intermodal side that they would rather deal with 1 carrier than 2 or 3. So longer term, though, is there a value you think, in an east-west merger hypothetically?

Jim, I'll defer to Jim's comments on this. He's talked about this at length at conferences, mergers over time, and there are a lot of Class 1s that have emerged over the last several decades has created a better rail network and more efficient, single-line service is more efficient when you're not having to hand it off and do those things. So there's a lot of benefits to it. And I think you have to recognize those when you look at the history of the rails and what got us here to having the best world-class rail system that we do benefit from and the industry's benefit from here in the U.S. So there's a lot of advantages to it.

Okay. And as we're running out here, I guess, Kevin, what's most exciting for you in the new position heading sales and marketing?

Yes. I mean when you look at the opportunities and the backdrop that we're in today, I don't think there's a more positive backdrop from a growth perspective than we see in my time following the railroad industry and talking to Jim, I think he would agree with that, and he's been doing this a long, long time as well. When you think about the environment, when you think about truck challenges, when you think about the potential for onshoring, when you think about inflation, which has been low for a long, long time, now picking up, these are all factors that really help our conversations with customers. And it's going to -- it's stimulated new conversations. And quite frankly, as I mentioned before, their willingness to think differently. And that's what we need a little bit from them is, "Hey, I've moved this freight traditionally on truck, but I'm more willing to look at your intermodal franchise or I'm willing to work at transloading and doing other things to really benefit my supply chain by using rail more." And I think we're there. And it's exciting that now that we're through this next variant, hopefully, knock on wood, that we'll be out there having these discussions in person with customers, and they're receptive. I would say, 3 years ago, probably not a receptive in a low inflation environment. Things are going well. They don't really need to look for alternative solutions, but now they do. And that's something that we have to capitalize on it and be more nimble and be more willing to work closely with operations and find those solutions.

Well, Kevin, we're out of time, unfortunately. But thank you so much for coming down.

Thank you.

Good to be in person again.

Absolutely. Thank you.