CSX Corporation (CSX) Earnings Call Transcript & Summary

CSX, Kevin Boone, Executive Vice President, Sales and Marketing. Welcome back, Kevin, good to see you.

Thank you.

Kevin's got a couple of quick things -- then we'll get right into questions.

Yes. I just quickly wanted to introduce. So I have Arthur Adams here in the audience with me. He runs our merchandise business. He's part of an excellent team on our sales and marketing team. And then I also have Matthew Korn joining me from the IR side. So great to be here, new venue, new locations. So we'll get to it.

Okay. Fantastic. So maybe just give us a macro update volumes pretty flattish to start second quarter. How are volumes doing relative to your expectations and outlook for -- as we head to the second half of the year, what commodities do we think get better, what do we get worse sort of open into question to some of the demand side of things?

Yes. I don't think anything has really changed from our last quarter and what we said publicly the last few weeks, continue to -- you see our volumes. Those are relatively in line with what we were expecting. Certainly, there's more demand out there than what we're meeting, but we're hiring aggressively to get to those targets. We're really committed to looking at everything we can do from a workforce perspective to make sure that we can meet the demand that exists. And we're really excited about all the trends, quite frankly, that are driving more opportunities for us to take share in the market, whether it's inflation right now and given that we have the low-cost opportunity in the market versus truck, it's real selling point today. ESG, we'll talk about I'm sure a little bit more. ESG is alive and well and customers are highly focused on it. They want to drive more and more freight to the railroad, to meet their short-term and long-term objectives when it comes to carbon emissions. And we're all seeing some of the pressures that are on every industry from a reporting standpoint with the SEC now getting involved, and we really fit well in that equation. And then you're seeing some of the near shoring and Arthur also runs our industrial development team, and we've had some huge success there recently that will mean that some nice growth that we'll see in 2024 and 2025 as part of some new investments that customers are making on our network that will deliver growth for us. In terms of the trends in the year, auto, we expect to continue to recover. There's a number of finished vehicles on the ground today that need to be moved, whether it's on our network or on the Western carriers. And so we're highly focused on that. I think that will continue to improve as we get through the year. We all know where the volumes exist today or where the inventory is at the car dealers, and so that needs to be replenished. Coal, we did see down volumes in the first quarter, and there was a number of factors that contributed to that. We had the Curtis Bay outage that should come back online in September. But we also saw some disruption at some of the major mines that we serve. And we also saw some strike impact on one of the mines that we also serve. And so some of those things will start to ease as we get into the rest of the year. We're also seeing some reinvestment in the -- and their producers' capabilities. So we'll hopefully see some favorability there, although it's week-to-week. We're seeing producers have some issues even this past week that we're going to have to work through, and we're highly focused on getting as much coal to our Southern utilities and other utilities that really need it to get them through the summer. So working almost daily with those and trying to find new sources and opportunities for them to meet their needs. Then on the merchandise side, we talked a lot about this today is demand is almost across every market. It's outstripping the cards that we were able to deliver to the customers today. And so we're focused on that. How can we spend these -- get the cycle times to where we were in 2019? And that's largely going to come through the hiring process that we're working diligently to solve. Then the intermodal. And our international remains strong. We see good strength through the summer. I think beyond that, as normal, we don't have a whole lot of visibility. But with the potential strike or potential labor disruption on the West Coast, we think the East is still going to continue to win share, and we're part of that, and we've done a great job, the last 2 years are really serving that market, and you've seen it in our growth rates. And then I finally say, on the domestic side, on the intermodal side has been largely equipment issue. Chassis still remain a problem. We see some coming into the market in the third and fourth quarter. And we think, along with that, we'll see some volume opportunity. We're also seeing container investments, and those are starting to hit the market as well. So hopefully, we'll see some upside there where we really haven't been able to participate in the growth that's been available, quite frankly, given the demand.

Okay. Great. So I'll start with questions. So guidance implies we see year-over-year inflection positive volumes in second half of the year. You've guided to double-digit revenue growth for the year, double-digit operating income growth. Anything changing in terms of any of those?

No, I think overall, nothing has changed. You'll have moving parts, obviously, but nothing has really changed from that guidance.

And so you and all the rails have said, we think in the second half of the year, we're going to have better service levels and with that will come better volume. We're now 1 month away from the second half of the year, are we seeing enough today that gives us confidence in that view of second half is going to be what we want it to be?

Yes. I think we're certainly confident that we've bottomed here, and we see the healthy pipeline of our hiring efforts that have, quite frankly, been a 2-year endeavor once we identified that there was going to be a labor shortage issue and things were slower to ramp up than we had liked. Getting people in the classes in the middle of some COVID outbreaks, whether it was the Delta variant, Omicron certainly slowed the things down, and we didn't anticipate all of that. But we feel relatively that we'll see some sequential improvement, hopefully, month-over-month as we move into the back half of the year. I would say summer is always a challenging period from a vacation, unplanned absenteeism that we'll have to move through. And then hopefully, we'll see some really good volume or really good momentum as we get into the fall and winter in the back half of the year.

And that sequential month-over-month comment, is that a employee comment? Is that a service comment? Is that a volume comment? Or maybe it's in all 3 comments?

I think it's all 3. I think they're all interrelated. So as we get more employees, we should see some better performance on the network.

And how sure are we that this is truly just a -- an employee problem?

I think we're highly confident. I talked to Jamie on a daily basis and when you look at, it's not a locomotive issue. We have locomotives. In fact, we have probably more in the network today than we really need based on the volume. And so we think we're good there. We've made incremental investments on the network, quite frankly versus where we were in 2019. So that should help us handle more volume going forward. So it's really a people issue.

And so I think the goal is to get to what 7,000 T&E employees?

And then grow...

And then grow from there, but we need to get to 7. Where were we first quarter where are we as we speak today?

Yes. I think in the midst of the Omicron breakout, we kind of -- we hit a 6,250 below 6,300 number. We're approaching that 6,700 number today on active T&E and active adjusts for -- if you have people out on COVID or if you have them out on other issues.

And when -- so when do you think we get to that 7,000?

I think we said in the back half. Jim doesn't want to put a number on it. Everybody heard Jim speak at the STB hearing. We don't have a magic ball in terms of if it's September 22 or it's October 21, but we're doing everything we can to get there as fast as we can.

Okay. Near-term question on margins, we typically see 300 to 400 basis points sequential margin improvement first quarter, second quarter. Anything that you want to flag positively, negatively as we think about just near-term operating ratio?

Yes. I think everybody has seen where diesel prices have gone. That's -- we have a fuel surcharge that obviously offsets that cost pressure, but that always puts pressure on your margins where they are, but it's operating income neutral from that perspective. So it's just optically a higher OR given those dynamics. We do have -- I think we talked about a large gain that we'll have in the second quarter. But absent that, I think nothing has really changed from a seasonality perspective. Generally, the second and third quarters are going to be our best-performing quarters from a margin and revenue growth perspective. On the last quarter call, I think we -- I believe we said expenses will largely be flat. So it's all about the revenue that we put on top of that cost base. And we're largely in line with where we thought we'd be quarter-to-date.

So play out that normal seasonality and then factor in fuel that's taken another?

Yes, I think so. And then the other seasonality impact that wasn't there that is there today, it's Quality. Quality doesn't have as much of a seasonal change quarter-to-quarter. So you might not see Quality margins improve from first quarter to second quarter like you traditionally will see with the rail core asset.

Okay. By the way, if anyone has questions, raise your hand. Just wait for the mic 1 second.

A couple of questions on the coal business. I'm curious both on -- first on the coking coal, there's been a couple of new mines there south and is ramping up. I'm curious, are you winning that business and in this pricing environment what that could mean for your business, if you're actually seeing volume growth there and your ability to service those ramps in growth? And on the thermal side, talk about your domestic export mix, I would imagine your customers are trying to move more tons to export market, given higher netbacks and domestic pricing and what that can mean for you in that shift for your business and profitability?

Yes. Let me start with the thermal side. We're highly focused on making sure our Southern customers, and any other customer, quite frankly, domestically gets through the summer. And inventory levels are very low, and we're working with the producers to make sure that they appreciate that. There's a robust export market for that coal as well, but we want to make sure that's protected. They have contracts in place and that is moving effectively to make sure we get through that. So that's a day-to-day exercise for the team, but we're.

Stockpiles, can you talk about that a little bit?

The stockpiles are at very, very low levels, in some cases, single days.

So if we have a hot summer, there's going to be some -- it's going to be a problem?

It could be a problem. And we're -- yes, we're concerned about it. We're having discussions actively with all the producers as well as the utilities and making sure that we're not the bottleneck.

So this start interrupt, this might be a market where you would typically favor the export from -- because it's more attractive, but we've got to make sure that we're doing everything we can to...

I think that's right. Certainly, our customers probably are the producers would make more money in the export market than they will domestically with their contracts. But we've got to make sure that customers today are served. And then we get them through summer and then we start replenishing the inventory levels that are really, really low. We've had a lot of our utilities have to idle some of their utilities right now to preserve those coal volumes or coal stockpiles for the summer. But eventually, they're going to start burning the coal, and we want to be prepared for that. So day to day, it's a challenge. But you mentioned, we're seeing strength in the export market, too. You mentioned Leer sales specifically. That has come online, that will give us more capacity. We're hiring, getting more crews. We are short crews in some of those areas, but we do see some volume growth opportunity beyond that, and we're actually seeing some other producers think about additional capacity coming online within our network, which will be good into 2023. On the met side, clearly, demand is incredibly strong. Again, with Curtis Bay outage, that's impacted some of the export volume that we'll see. So some bottlenecks at the export facilities at the terminals, but that should improve into the back half of the year as well. So we would expect volume growth to continue there. Year-to-date, our volumes versus 2019 in coal are down 25%. And I would say the market demand is higher than it was in 2019. So that's an opportunity to catch-up as we go. Mix on the export side, I think you asked about that as essentially 75% met, 25% thermal. And that's not because demand on the thermal side is lower. It's just -- there's not as much capacity right now to send into that, the export market.

So coal is maybe the most obvious example of where you're not -- the volume is not in line with the demand. If you were to take a step back for the overall business, how much sort of pent up, if that's the right word, demand is or how much volume are you missing because you can't actually handle it? And I'm thinking about if the underlying demand softens, how much could you be okay in that kind of environment because you still have an opportunity to sort of catch-up?

Yes, I think, as a baseline, we look at 2019 as the closest year that was somewhat normal. And we'll all remember in 2019, it was an industrial recession that occurred. So even versus 2019, probably an easy comparison, we're still down volumes overall. Our intermodal business is up from those levels, but every other part of our business is essentially down. And that's not because the demand is not there. It's because we haven't been able to meet that demand with the current network or some other disruptions. Obviously, auto has had their issues in ramping up production. But I can go around every market and domestic intermodal has been held back by chassis and container shortages and truck availability ironically. That's really held us back. We would be moving more domestic intermodal today if those problems were fixed, and we expect those to start to get better as we get in the third and fourth quarter. Coal we covered. On the merchandise side, Arthur's world, we have many of our different business lines that are in the 60%, call it, order fill rates today. Those traditionally have been in that 80% to 90%-plus area, and that's where we plan to get back to, but order fill order rates having gone down. And in fact, in some markets, we've seen over the last few weeks, demand has actually gone further up. And so we're working as quickly as we can to get those cycle times on those car fleets at the levels that we saw in 2019 so we can serve that demand. So -- and then the auto business, we know where that stands right now, production is choppy. We have some facilities that are on 1 week and then they're off, but we're seeing a lot of inventory on the ground that we need to start to move as an industry. And I think that will take us even through the summer when they have their seasonal shutdowns, there will be enough inventory to kind of carry us through and volume for us to move.

David, you have a question?

Yes. If I could just go back to coal for 1 sec because I think if we do have brownouts or blackouts across regions of the country, there's going to be a lot of finger pointing. Is it finger going to be pointed at you? Or is it at the coal mines because they're not producing enough? Like, who's going to shoulder the blame when -- if and when we have power issues?

Yes. I think the direction from my boss, Jim, is we're going to prioritize those coal moves. And so the producers have had issues. The 1 mine in particular that serves a lot of these utilities has continue to have issues. That's been public, and that made stockpiles already low when they weren't able to operate for a while, and now they're having growing pains getting production back up and running. So it's not going to be our issue where we're concentrated right now. We're going to do everything in our power to move that volume when they have it.

Maybe let's broaden that answer just broadly from a regulatory standpoint. So obviously, lots of focus from the STB on rail service issues. What -- we've seen there requiring more data transparency from you. What else do you think that they can or should be doing to regulate service? And then more broadly, like what are you worried about from a regulatory standpoint with a more active STB right now?

I think we got to remember, we're aligned, 100%. We want to -- we absolutely want to move more volume. We're absolutely investing not only capital but in people to do that. So our interests are aligned. I think a lot of people are frustrated. Supply chain is broken. We're not where we want to be on a labor workforce. Most of our customers aren't there where they want to be on their workforce. We're seeing a lot of inconsistency in volumes as it moves through our network because customers can't produce at a level that's consistent. So our hope is the customers get more ratable, that helps our network, but it's across the board. And we've had a lot of discussions, obviously, with STB. We're going to share even more information and be transparent around it. The workforce has changed in a lot of ways that I don't think anybody anticipated. But we have seen some other companies come out and say they -- maybe they over hired. And some of that stress might actually help us hire and replenish our workforce even quicker here. So I'm hopeful. We've got a lot of people and resources up against solving this problem. And I'm confident that we're going to recover and then start to grow and take share like all the members of the STB want us to do. They want us to take share from truck. They want us to do what's best for the environment, which is putting more freight on the railroad.

And what about from a pricing standpoint? We're in an environment where you have -- where we don't have enough capacity, which usually suggests that we should have -- suggest we should have pricing power. What are you seeing from a pricing standpoint? Are we continuing to see that accelerate? Is a softer trucking spot market are having any impact on pricing trends that you guys are seeing?

Yes. I think first of all, when we came into the year, I don't think we envisioned inflation where it is today, and we have to react to that. So inflation expectations have gone up. And as part of that, we've got to make sure we cover our cost. And so I think it's safe to say we've seen some pricing momentum to make sure we're staying in lockstep with what's going on in the world. And we'll continue to look at that. So when we were in the fourth quarter, inflation expectations were different than when they are today. And so we'll have to look at that when those contracts come up for bid, and you have to look at supply/demand. In terms of the truck markets, I've read all the reports. I see what's going on in that market. We're not really seeing it. I think some of that is because diesel prices are so high. And so the -- really, the value proposition that rail offers versus truck is probably stronger than it was before the spot market came off a bit here. So we're still seeing strong opportunity both across intermodal and merchandise, quite frankly.

And so if we are in this environment of high oil prices, high gas prices, high corn prices, high commodity prices everywhere. And we don't have a fix in Russia, Ukraine. What is the volume opportunity as you think out over the next 12, 24 months? And then are their investments -- are your customers making further investments given this commodity environment? And how are you -- once your service is where you want it to be, how are you positioned to capitalize on this?

Yes. When you look at where commodity flows today, traditionally, Ukraine, Russia markets, whether it's from ag, coal and other markets have served Europe. And most of our exports, whether it's wheat and other things have gone off the West Coast or sort of Asia, China. Now if that all shifts over the next 12 to 24 months, that would imply there's opportunities for us to potentially out of the East Coast, meet some of that demand that is being lost by Russia and Ukraine no longer being able to serve that market. And so we're working with our customers, having those discussions actively. I think it's probably a little too early to tell. I think there will be some investments that will be needed if we want to start exporting, for instance, we don't really have a wheat export franchise on our network today. That's a West Coast opportunity that exists for them today. Does that shift at the margin and give us opportunities? We're having those conversations, we think that there -- the way the market is trending today that there could be an opportunity, and we'll work on it. Customers need to make the investments. We'll make investments where it's -- where we see if it's appropriate. But it's more of an opportunity than a risk. That's for sure.

And which of the areas which the commodities where you're seeing the customers maybe make the most investment?

Mainly on the ag side. It's probably where that really lends itself. Steel side, probably you can see some implications there as well. And then on the coal side as well, although there's not really any incremental supply. I'm sure there's some supply that would love to hit in Europe today, but we're really not able to do that.

Right. Intermodal, we've seen some big shifts in market share western part of the country. I think that's an opportunity for you guys. You guys have less share of domestic intermodal in the East and Norfolk. What's in your mind, the opportunity for domestic intermodal share gain?

You've seen our product has really been successful over the last 2 years with -- and is manifested in outgrowth versus the market. We're pretty proud of what we've been able to do on the intermodal side. In terms of the growth we've achieved, we really continue to run a fluid network. That's kudos to Jamie's team; and Marcelo, who runs our intermodal ops team over there. They've done an amazing job, and that's really let us grow not only the international business, but hold our own on the domestic side, even with the challenges on the chassis and container issue. I think whatever happens in the West, I think there's probably opportunity to open up new lanes potentially as business shifts from the BN and UP, but we interchange with both the Western partners and we just want to move more domestic intermodal freight through our network, and we're working closely with both of them to find new markets, new lanes. We're working on our own lanes, whether it's the I-95 corridor, where we don't see a lot of volume today, but I think there's a big market from Florida to the Northeast. We're really working hard to grow that franchise.

Quality. How would you grade that acquisition so far? What's the opportunity? It's not obvious to me yet that we're seeing truck freight convert to rail freight like we thought would happen. When does that happen?

Yes. I think discussions have been great with customers. We've had equipment issues in terms of extended equipment time. We have the ISO tanks coming in, in the third and fourth quarter, which I think is going to be a really big opportunity for us. The core business is doing spectacular. It's doing extremely well. Well above our bull case scenario. You're right. I think from a rail conversion opportunity, it's been a little bit slower than we would have liked. And a lot of that comes back to the equipment. And quite frankly, a little bit of the network as well, when you do it and when you introduce a customer to a new product, a new service, you want to make sure you deliver on that. And so we've been really thoughtful about when we're going to bring on customers that we can deliver the service that they expect, which is truck-like service when you're converting truck to rail and doing it in a really thoughtful way. So nothing's changed. I think customers are more excited than ever about the opportunity. And quite frankly, in that particular area of our business, they're more focused on ESG than our average customer out there. We have those conversations with them more than others, and they're probably feeling whether it's from an investor perspective or from their customers, more pressure to deliver on those. So I'm more bullish on our opportunity to convert volume over the next year, 2 years from truck to rail.

Pan Am, how much revenue, how much earnings, we're just about to lap the sort of margin headwind from Quality? How much of a margin headwind is Pan Am, if at all?

Yes. I think less than a point to revenue growth. This is a relatively small asset to start. We think there's huge opportunities. Arthur's working on those on a daily basis as we bring it on to open up new markets. I'll be disappointed if we don't see well outsized growth versus our core business there. So we're really, really excited to bring that on. Sean mentioned on our last earnings call, it will be basically neutral to earnings as we have some integration costs and other things through the back half of the year.

Okay. So some -- again, cosmetic hit to operating ratio?

Yes, it's very, very small notes.

And so we did Quality last year, we're doing Pan Am this year. Should we expect more of this going forward of these sort of tuck-in types of deals?

I think we're really focused on integrating these assets and seeing those through. We'll always be opportunistic if there's something that really makes sense. But these 2 assets were really, really unique. And so we're not actively out there in the market pursuing other opportunities at the moment, but we'll always look at things as they come up.

Big picture, I think all the rails have been over the last 6 months, 12 months trying to tell a message, a story of, we want to grow volume. We're still going to get our inflation plus pricing and natural. As that happens naturally, I don't know maybe it's not the goal, but naturally, the margins will improve over time as that happens. Does anything about what we're seeing right now from a service standpoint, from regulatory heat right now. Does that in anyway change how you think about the longer-term growth algorithm for your business of volume plus price plus margin gets you to sort of double-digit earnings growth? Anything changing how you think about that?

That's the goal and consistently doing that over time. And we've discussed these many times. The railroad industry hasn't shown the volume growth. That's the difference. And how can we deliver that. And I think all the external factors have never set up as well for us to really achieve that and some of the things we're doing internally by thinking differently. How do we put a service together, whether it's transloading as part of that, to reach more customers and take share in the market as some things that we've are doing new today? Quite frankly, we weren't thinking about before. And we're thinking long-term. Arthur and I just got done reviewing every market, 3-year strategic plan now because we want to be building on that into next year and not doing it at the end of the year and really being thoughtful of how we layer in these opportunities and where are the customers that really have the big chunky business to convert over from truck to rail.

Okay. One more from the audience and I'll take one, then we got to wrap.

Yes. I apologize not to beat this issue so much, but just a follow-up on the discussion on calls, I was just thinking about it. It's interesting in India for these export tons, the same issues in India, they're having blackout, brownouts, hospitals are being shut down. Europe obviously has their power prices. I'm just trying to understand your comments a little bit more. Are you -- I don't know why CSX wouldn't pursue a policy to maximize your profits if those tons were more profitable on the thermal side? Are you getting a directive from the government to do this? Or this is your own decision? It's just someone will confused on that front. Obviously, there's been a war on call here, capital spending is down 80%, 90%, perhaps you need some days like that to reinvest in the sector. So I'm just trying to understand those comments.

No. We're making sure the customers that have had a longstanding relationship with us, continue to obviously have the coal that they need to run their business through the summer and working with them. The producers understand this as well. Many of the utilities we serve are going to be around for a long, long time. And they understand the importance of that. And we're not -- we don't have the ability to redirect coal. It's not our decision we're making. It's between the producers and the utilities. But they do have contracts in place, and they need to be getting their fair share.

They are in the contracts?

Yes, that's right. And so we're -- but we're highly focused that we're not the issue in terms of them getting the volumes that they need. We can't help what the producers do. If they have issues and temporary shutdowns because they run in their issues, but we're going to focus on moving the trains when they're full of coal.

Just to wrap up. Shareholder returns. We finished the quarter with $1.9 billion of cash socks under some pressure. Any thoughts on...

Well, market is under pressure.

Yes. Yes. Well, but the -- do we -- are we opportunistic right now? Or are we saying, "Hey, we got to watch what the markets telling us and so maybe we're not going to be as opportunistic right now?

We've always proven, I think, with the exception of when we were going into the pandemic, and nobody knew what that was going to be like, and I was the CFO at the time we were trying to do how many months of cash do we have on the balance sheet to pay our employees if we didn't get paid by customers. But outside of that, we've always proven opportunistic in down markets. And we had the strongest balance sheet we've had in a long, long time. We're at the lower -- we're beyond the lower end of our credit rating. So we feel like we're in a very, very good place to continue to -- first, we're always going to focus on capital and making sure our railroad is being reinvested in every year. And then the outcome of all of that is a lot of cash flow that we can distribute to shareholders.

Okay. We went a little long, but we're going to wrap there. Thank you so much, Kevin. That was great.

All right. Thank you. Appreciate it.