CSX Corporation (CSX) Earnings Call Transcript & Summary

Okay. Good morning, I'm Brandon Oglenski, airline and transport analyst here at Barclays, and welcome to Day 2 of our 40th Annual Industrial Select Conference. Happy to have everyone here in Miami Beach. I'm very happy to be kicking off today with CSX and joining us from CSX, Joe Hinrichs, President and CEO of the company. Joe has been with CSX, I think, since September of last year. So I know we have lots of great topics to touch on here.

26, September 26, yes.

But like yesterday, if you were in the fireside chat, we're going to do the audience response questions real quick. Pick up that little keypad in front of you. Do you currently own CSX, [indiscernible]. And thank you for participating, we share this data.

I'm a [indiscernible].

Unfortunately, we don't give you a CEO in [indiscernible].

I'm just kidding. But it's true.

All right. Question #2. What is your general bias towards the stock right now, positive and negative or neutral? [Audio Gap] And then Question #3, please. In your opinion, through cycle EPS growth for CSX will be above peers, in line with peers or below peers? [Audio Gap] All right. Well, Joe, thank you for coming down. Welcome to Miami.

Yes. Thank you.

I definitely want to ask some very CSX-specific questions, but I don't want to be blind to the current media environment involving railroads and certain accidents in Ohio that has gotten a lot of attention. And I'm not asking anything specific about that. But from your perspective at CSX, do you see any significant changes in safety or regulatory requirements that could come from this?

It was definitely going to be a heightened sensitivity to anything safety-related in the railroad industry, and we'll be having a number of conversations with DOT and FRA and the like. I think you'll -- once the NTSB comes out with their findings, which will be the fact-based data around what actually happened, we can then respond as an industry and as a company to what we're seeing and what happened. We've already taken a number of steps at CSX to get to learn from this and make sure that we're -- everything that we have is functioning properly and we're -- and our processes are in place. I would expect there'll be some discussions certainly and also then some outcomes that will lead to enhanced safety in the railroad industry. And most of those things, I think, can be worked out between the industry and the different departments that's -- in a way that's good for everybody.

Okay. So any significant changes in capital or...

It's hard to tell. I mean most of the things the Secretary [ Bridges ] listed in his letter are not -- would not be significant changes to capital. I mean, there's already a planned conversion of the cars to tank cars to another new level. That's already planned in the outer years. So if it's pulled ahead a little bit, that's something that the industry can handle. A number of other things are more process-driven, et cetera. We'll have to see what the technical analysis and what the technical experts have to say about electronic braking and those kind of things. So I wouldn't necessarily believe there's a huge capital outlay in the near term, but we'll have to see where we get to.

Well, I appreciate that and I know we want to focus on your new role here at CSX. And can you just give the audience some perspective here in context? You did a long career at Ford, came to CSX. And just to provide some context from the investor perspective, a lot of folks when they see a new rail CEO, they say, all right, is that a person from an operating background? That's the person we want to run a railroad. So I'm not saying that folks are skeptical, but what does your background bring to CSX?

Yes, sure. I mean, first of all, unlike, I think, any CEO in rail history, I was a customer of rails for decades. Actually, 20 years ago, ran the organization inside Ford globally that manage all logistics and transportation spending, et cetera. We got to know the railroads pretty well then. So that's a unique perspective, I think, that I get to bring to this role. But I grew up in manufacturing. I grew up in the operations side of the auto industry. I've had every job you can have in the operations side. I'm an engineer. So I have a great appreciation for the operating side of the business. And what I observed studying the rail industry and scaled railroading and everything that's taken place the last 5 years ago is really bringing lean thinking and lean optimization concepts to the rail industry, which have been going on for decades in the auto industry and a number of other industrial industries. And so that lean thinking and that lean training is applicable no matter where you are. Waste is waste, no matter it's a service organization or a product-driven organization. And importantly, I have a great appreciation for the men and women that actually do the work. Having worked in our -- like 7 different manufacturing plants throughout the Midwest, having run the manufacturing operations for Ford globally and having done 4 national contracts with UAW on the labor side, I have a great appreciation for the actual employees who are out there in the field doing the work. And that's a really important part of what we're trying to do at CSX is make sure that our employees realize they're the most important part of what we do because they provide a service to our customers, they pay us for it, which has not been a strength of the railroad industry. So there's a number of things in my background, I think, that actually carry over nicely. And I can tell you, talking to customers, they very much appreciate having somebody in this role that actually is going the other side of this relationship for a long time.

Yes. You went off there with lean concepts. What do you see happening at CSX today that you think could be better in the future?

Well, we've -- since I joined the company, we've really been focused on reminding people of what the 5 guiding principles are to railroading. At the start, it's about improving safety, controlling costs, improving asset utilization, improving the employee experience, engaging employees and then improving customer service. Nobody really argues with those 5 principles. And we've made a lot of progress in improving safety. And certainly, the industry and CSX have made a lot of progress in controlling costs and asset utilization. What I found in the rail industry and what we continue to see is there's a disconnect between the relationship between the employees to do the work out there moving the goods from Point A to Point B and the companies. And we want to make that better. And then you know over the last several years, especially our customers do not feel like they've gotten the service they paid for. And so our view has been these 5 principles still are relevant. These need to be more in balance and we need to make sure we're prioritizing our employees and our customers. Any service organization is driven by its employees. And if our employees are feeling inspired to motivate, appreciated, they're going to help us provide better service to our customers. And so our focus has been on reengaging with our employees, solving problems that are real for them, helping them make it a better experience, listening to them, making sure they know how important they are and then focusing all that energy on serving our customers better. And as you've seen from the data lately, our operations are running the best they've ever run and our customer service data is the best we can see in our history and the data that we have and customers are giving us that feedback. So that cycle is working. At the same time, of course, we're controlling our costs, and we're not putting in more assets. So our view is we've got to have these things in balance. And what's happened is PSR and these things have gotten a bad name, not because the principles themselves are flawed at all. It's how they were implemented and how people were treated while they were being implemented and how people felt were customers prioritized, they didn't feel that way. Where employees treated with respect or they talk to or they explain why things were changing, not necessarily. So there's a number of pieces here. But for me, if you bring it all together, if you can get your employees really feeling like they're part of the team and filling appreciated value, they'll provide you the service that we need for our customers, which will then, in turn, allow us to have the conversation with our customers about, okay, what more can we do together.

And Joe, this is a different message because I've been covering rails for 17 years and I think you're the first CEO that leads talking about engaging frontline employees. Of course, everyone talks about, but it feels like this is a big priority for you. You mentioned you went through 4 contract cycles at your former employer. What have you seen coming into the rail industry that maybe has been neglected or overlooked in the past?

Well, it goes back to what I just talked about. I mean, there was tremendous distrust between the employees and the unions and the railroads. I mean, that was exacerbated by a 3-year process to get to a contract agreement on a 5-year contract. So it expires at the end of next year. So it's coming back at us again. And so one of the ways we've approached this is just to reengage with our workforce, make sure they understand that we know how important they are, that they're the ones creating the value by moving the goods for us safely from Point A to Point B. And so I go out every -- almost every week in the field and visit with employees. We go unannounced, we don't tell them we're coming. We just show up. Jamie Boychuk, our EVP of Operations, usually goes with me. And we just talk to people. How are you feeling? What's working? What can we do better? And we're getting great feedback around, hey, they told us about our attendance policy. They gave us examples of where it wasn't fair. We fixed that voluntarily. We just did the right thing. They told us that this paid sick leave issue, why it's important to them. And so we've resolved that with 6 of our unions, and we led the way in the industry in that. We're just working through the issues. They want to know how we can do a better job of scheduling and making things better. But at the end of the day, the employees provide the service and we can't be fighting with ourselves inside the industry. And all this negative attention that's been brought in the industry in the last 6 months or so with the threat of a strike, the contract negotiations, Congress having to get involved, the paid sick leave issue, now this derailment is getting in the way of us really working well with our employees and our union leaders to create a better experience to serve the customers better. Our investors will be rewarded for that, because you can see it in our numbers. I mean just look at the data. The CSX operations right now are running as fluidly and running as well as they have at any time. And we believe that has a lot to do with, of course, our operating model and our team. But also the reengagement with employees and helping them understand what role they play in making this successful.

We've all heard about the paid sick leave issue. And I have seen 5 or 6 agreements come across specific to CSX. Can you talk about what you've done there because I think that is unique to your network? Is it not?

Yes. Although this week alone, both Union Pacific and Norfolk Southern have announced agreements with it. Union Pacific with 2 and Norfolk Southern yesterday with 1. We sat down in December after the contract was ratified or voted on by Congress and sat down with our unions and said, okay, if we're serious about this issue and it means something to our employees, let's sit down together and listen to each other and find a collaborative solution. And what we've been able to do is just listen to each other and say, okay, well, we reallocated 3 days that we already had off that had to be preapproved to now be allowed for use for sick leave. And then on the 4 additional days, we talked with our union partners about how can we get efficiencies in our operations, not take money away from our employees' pocketbooks. But how can we get work together to -- we know there's all kinds of things we can do to be more efficient and we have ideas around that. And we reached agreements on those things to help pay for the paid sick leave in a way that was helping the company get more efficient, but not affect the employees themselves. And again, we can't take any one of these things out of context to say that's the solution. But it's the feeling and it's the momentum of solving problems of creating a better experience that allows you to have a better environment. And so -- and a lot of these things are self-reinforcing. So let me give you a example, Brandon. So we're just looking at data. And if we look at the data every week, we get together as a leadership team and go over with all the numbers of the business, we go over the trends, we go over everything. Last year, at this time, we had on average, 200 C&E employees or conductors and engineers who were stuck at a location over 30 hours. That's 200 people who are really upset about they can't get back home, they can't -- they're not getting paid the higher wages by working. They're frustrated. This year, at the same time, it's 50. So that's how -- so there's 150 less people getting stuck somewhere. Now why is that? Because our network is running a lot better. And we have more manpower that's helping it run better. When the network runs better, it's like the airline industry, you don't get people stuck in the wrong places and you can't do anything about it. So what does that mean? Well, that's 150 people every day who are not upset, who are not -- who can go back to work after they have the rest period. So these are examples of how this becomes self-reinforcing. If we can get all these things right and the network runs well, the experience gets better for the employees, which then leads to better service, better capacity and better costs, frankly, because the cost of having someone sit somewhere for 30 hours. So this is how it all fits together. And I think people have misunderstood these things. I get a question all the time, well, you gave paid sick leave is going to increase your cost? No. Because the network running well is our biggest cost lever. And that's what we focus on.

We have in your third point here on employee -- or sorry, customers and focusing on the customer. It is pretty clear in the new STB data we've had for the past year that your on-time delivery rates are well above the industry average. What's driving that outperformance?

Well, I think there are several things. I mean, first of all, this was done years ago, but our operating model, the implementation of railroading has done at CSX was done extremely well, and it's a very well-run railroad when it has the people and it has the people working together. That's the first thing. We have a great team, and we've put an increased emphasis on it. And since the day I got here, I get asked all the time from people, what do you look at when you wake up in the morning because we have all kinds of data? The first thing I look at is the injury and accident report. And what happened in the last 24 hours, did anyone get injured? Do we have a report on that? Were there any accidents? And the second thing I look at is the customer service data, trip plan compliance, customer switch data, on-time arrivals, on-time originations, all these things. And I talk to Jamie probably every day about these numbers. And he and I -- and we've been really putting an emphasis on velocity and dwell are measures that are important because they're in service of our efficiency, but also more importantly, they're in service of our customer service. And so there are means to an end. If we go really fast the wrong direction, we didn't -- the velocity looks good, but we didn't see anything meaningful to our customers. So what we focus on is prioritizing the customers. And we've seen -- I mean, we are seeing tremendous progress in those numbers even before we started getting the additional head count on because people were focused on it. They were paying attention to it and they were understanding this is where we're going to put the emphasis points. And I'm really proud of the results we're seeing in the -- the first 6 weeks of this year, we're at levels we didn't even achieve back and we were running well in late '19, '20 that were much higher now on these customer-focused metrics. So really proud of that. Customers are telling us they're seeing it and they're feeling it. And that's where we want to be.

Okay. And if we can queue up Question #4 from the audience response system. And if you guys have questions, just raise your hand, we'll get you a mic. Question 4. In your opinion, what should CSX do with excess cash, both on M&A, larger M&A, share repurchases, dividends, debt pay-down?

So -- yes, you guys sitting on our Board meetings, I see. We will always look for opportunities for M&A if they make sense. The challenge with this industry is there's limited opportunities, right? The Pan Am acquisition, we're investing heavily in that to bring that railroad up to our level of standards for quality and safety of the network. But that was a great example of kind of bolt-on M&A, if you will. Quality Carriers was another great example, specialty chemical truck, better margins than typical trucking business. But importantly, an opportunity for us to introduce a new product, a new service to chemical customers intermodal with ISO tanks, which is really going well and it's early going so far. Obviously, we do a lot of share repurchases and that's been the bulk of our activity. And will probably still be the bulk of our activity going forward, given that we expect to continue to have excess cash. We've just raised our dividend 10%. Our balance sheet is in really great shape. So I think that in reality, you're seeing that we don't really need to address the balance sheet. And then on internal investment you're seeing, we're actually raising the capital deployment in our business every year. One, to make sure that our network as it expands like with Pan Am is continuing to be at the levels we wanted to. And also, we have a number of initiatives on technology deployment. We're taking our data to the cloud from datacenters, we're implementing a lot of new technology features for safety, et cetera. You'll see continued technology investment for growth, but also for safety and for efficiency. But you'll see that continue. But clearly, we'll look for M&A activities. But right now, the bulk of our excess cash will go to share repurchases.

Well, and want to come back to the M&A issue. But on capital investments, do you think maybe in the past railroads have been a little bit maybe light on spending relative to the opportunity set?

It's really hard for me to tell. I really can't -- I wasn't here, so it's hard for me to answer that. I know -- I looked at the data because you always want to -- the data can set you free and you can learn a lot from it. We're actually investing more in our network now than we were before scheduled railroading, even though we took a lot of rail out. We took a lot of hump yards out. We took a lot of things that cost a lot of money to upkeep. We're actually investing more capital into our rail network today than we were even prior to the implementation of scheduled railroading. All I can say is where we feel really good about the health of our network and we feel really good about what it's delivering from a safety standpoint, from an efficiency standpoint. And our commitment is to maintain that or even enhance it so that we can continue to feel good about our network. Obviously, what's happened in the last couple of weeks has highlighted the need to make sure that all of our equipment, all of our technology is working for safety and for the communities that we serve.

Can we queue up question #5? In your opinion, what multiple of 2023 earnings should CSX trade?

Higher than it is today.

If there's not [indiscernible] option.

I'm not going to -- yes, I'm not going to -- it's not for me to say. One of the feedbacks we get often is, if you can really demonstrate the ability to grow volume, we've been demonstrating -- we're still in a good pricing environment. If you can really demonstrate that you can leverage this operating model to grow profitably, that will affect the multiple. And that's our plan for this year is to grow the volume ahead of GDP.

Yes. And I want to talk about growth. And I want to focus near-term too, if we can just for one question. But it appears import activity really slowed down in fourth quarter. I think it's still very slow…

It's still slow, yes.

Right now, what are you hearing from customers? Are we destocking in the economy right now?

Yes. So there's no question the international intermodal business is down significantly. It's just like it was in the fourth quarter, starting out the first quarter of this year that way as well. We're hearing at the second half story. We're hearing from the shipping lines that that's what they're hearing and seeing as well. We're being told it was a lot of destocking. The inventory was built up in destocking. I think there's also some nervousness around where is the economy really going. So we'll have to see with that. Domestic intermodal has picked back up a little bit for us lately. Thankfully, we're seeing very strong start to the year on the merchandise side of our business. Coal has been strong. And a number of other sectors have been improving in the industrial side of the business. Auto for us has been down so far this year, largely because a number of our key customers have had production issues or have had units on hold for quality issues. But we have every expectation that auto will pick back up and will be strong for us for the full year. So we feel really good about the merchandise side. I think intermodal is going to be a second half story on the international side.

Well, can we touch a little bit on pricing as well? Because it's been a huge topic for this conference across industrial.

Sure.

Transportation was a big source of inflation for a lot of supply chains. But obviously, you guys have a lot of labor costs now that you didn't have even a year before. So how do you approach the pricing?

So pricing discussions so far this year have gone well. Actually, they've been supportive of what we've said was we expected to happen this year. I think a number of things. One, the customers understand that we have inflation. They've seen their wage agreements. They understand we have inflation. They're experiencing inflation themselves, so they understand that. Second of all, it's a much easier conversation to have when you're delivering the best service to them you've delivered ever. So they're appreciating that and recognizing that. And they know -- I believe that they know -- I know I've talked to 20 some CEOs of our major customers. They know how committed we are to this, to improving customer service. So so far the pricing environment has been supportive of what we expected starting the year out and I don't expect that to change. We obviously saw a lot of pricing last year. And metallurgical coal, export coal pricing has been elevated for the start of the year. We'll have to see where that ends up for the full year. But we feel good about the pricing environment we're in right now.

Well, and can you talk to -- I think most railroads are challenged to provide a margin outlook this year. But what's -- so I'll try to get it out of you. What's the longer-term view on the operating ratio and margins? Is that not the right focus?

Well, I mean there's nothing, again, data and metrics, they're not inherently bad. It's just where do you put all your emphasis points. And so the operating ratio is important. It's not a perfect metric because in the denominator, you get things like fuel surcharge or demurrage storage costs or met coal prices to spike up that don't purely identify how the operating side of the business is doing because those things are not controlled by how well the railroad is running. But nevertheless, it's an important number. And we won't shy away from it. It can't be the endgame. The endgame is to provide a solution and provide a service to the customers that they're willing to pay for that allows you to make an attractive margin because you have a cost structure that's supportive of that and you have value being created for your customers. So the operating vehicle is a way of looking at that, but it's not the only way of looking at that. And so from our perspective, it's again it out balance and about keeping all these things in context together. So you look at our numbers, we look at operating income, operating ratio. If you look at the customer service data, you look at our cash flow, of course and then our cash earnings after we take the charge for the capital, all these things are important. Now our belief is we continue to run the railroad really well. We continue to engage our employees and help us run the railroad really well and safely. We serve our customers really well. We can grow the business. And the incremental margins on this business when you grow it in the right way, are very attractive. So all that being said, we should be able to demonstrate over time an improving outlook for our business. But it needs to be driven by growth in volume that's justified by how you're serving customers with that and then getting the incremental margin from that. Because there's only so much more you can squeeze out of the operating side of the business going forward.

Appreciate that. And I guess longer term, what are the most exciting growth verticals for you? And maybe with the context that U.S. rails historically have probably underperformed GDP on volume.

No question. If you take coal out because coal has been a little...

Yes.

I mean certainly, intermodal is an opportunity for growth. It has been. CSX has demonstrated significant growth over the last several years on intermodal. That will continue to be a focus because truck conversions are important for a lot of reasons. Obviously, we have the capacity to do that. It's good for the environment, it's good to get the trucks off the road to the infrastructure for taxpayers and everything else. Intermodal is an opportunity. I mean we'll see where coal goes over time. We know that -- we know where coal is going over time. And on the merchandise side, our industrial development team has done a really good job of getting a number of big wins. So we have a number of the new auto plants being built in the Southeast, whether it's the Ford plant in Tennessee, Rivian plant in Atlanta, outside Atlanta, VinFast in North Carolina or some big steel Nucor, other things are all on our network. So we're going to see over the next couple of years some chunky increases opportunities with us, given some big wins we've had lately, including Chemonics, things going on. So we're really excited about that. So the merchandise side still has opportunity to grow largely because of a lot of the industrial development work and the onshoring going work on in America is largely focused on the Southeast, which is where we're strong and where we have a good presence. So we see a big opportunity there. But coal will obviously, over time will be in decline. So we have to offset that in other parts of the business.

Can we queue up Question #6 for the audience, please? What do you see as the most significant share price headwind for CSX, core growth, margin performance, capital deployment or execution?

Well, I'd like to say the execution piece, we already know we can do well. Growth is the biggest challenge because we haven't demonstrated it as an industry and you all agree with that. We haven't demonstrated an industry we can do that extended over the time period. We also have demonstrated we can give consistently strong customer service to our customers over an extended period of time. So they're related to each other. I mean our margin performance is already good. Obviously, our capital deployment, I think, is a good -- we have a really good strategy there. And I feel good about our execution. We're working on our strategy development, spending more time on it than we probably have in the past. But we need to demonstrate to our customers, to our investors, to all of you that we can profitably grow the business the right way.

And you mentioned bolt-on M&A might play a role here. Obviously, Quality Carriers, Pan Am in the past. What do you look for in potential acquisitions?

I mean the first thing we look for is obviously can -- is there something we can bring to it to add value, like Pan Am for example, we can bring the strong operating leadership and performance in the operating model. Second thing is can enhance our current business? Can it supplement like Quality Carriers can bring intermodal to our railroad -- rail network and it can expand our footprint to serve more customers or even our current customers better or differently. So those are the first things we look for. And obviously, it has to be an attractive price for obvious reasons. We don't want to just waste capital. But we're not -- I want to be clear, we're not out spending a lot of time looking for M&A opportunities right now. We're focused on bringing Pan Am up to speed and executing on our strategy this year and showing that we can demonstrate to our customers that we're going to keep being there for them so we can grow with them.

Okay. Then last question #7. I know I got a minute left here, Joe. But does ESG play an active role in your investment decision related to CSX? Yes, it does positive. Yes, it does negative? Or no?

That's obviously for the investors. But ESG is a very important part of the railroad story and it gets lost sometimes. The STB Chairman Marty Oberman and others have been really out front, like saying, listen, if the railroad networks can get the capacity up, provide the service, get more business on the rail network, it would be good for the economy and good for the environment. And I agree with that statement, and we're working hard to make that happen.

Well, Joe, just a few seconds left here. How do you want investors to look back in a couple of years? What's the metric you want to be measured against?

Well, obviously, volume growth and income growth and the margins that go with that are important for any business like ours. I also want us to look back and say that we did it the right way to make it sustainable with a culture, a leadership behaviors and a working together environment that was focused on the customer and did it the right way so it's sustainable through the cycle and also through management teams, where we can continually show that we can grow the business by serving customers the right way with our employees.

Great chat, Joe. We can keep going but...

Thank you, guys. Appreciate it.

Thank you.