CSX Corporation (CSX) Earnings Call Transcript & Summary

At Baird, we're very pleased to have CSX participated at the Industrials conference this year. From the company, we have Joe Hinrichs, President and CEO. We've also got Matthew Korn from Investor Relations. We're going to dive right into Q&A. But if anything, on your mind, feel free to raise your hand or shout it out or we've got the iPad system, and we shall work that into the conversation.

So Joe, why don't we start by -- maybe give us an overview of the ONE CSX initiative. I think that's a [ hallmark and Colin card ] for year 1 of your tenure as CEO. What is that program? What is that trying to accomplish? And how does it translate into results for shareholders?

Yes. Thanks, Garrett, and thank you all for being here. I mean our view -- and actually, just for the transparency, ONE CSX was actually rolled out about 6 months before I got there, it was based off of the learnings from [indiscernible] when [ Alan Wally ] was CEO. And of course, I worked for Alan for the 7 years he was CEO. So had a lot of familiarity with it. But for us, what it means is trying to bring everybody back on ONE team and everybody working together for the same goals. And when I came to CSX and did all the research and talked to people about what was going on in not just the industry but in CSX, summer before last, I found that there was a lot of anxiety and a lot of angst around all the relationships that were going on and felt if we could bring everybody together and focus on what the objectives should be, we could really make a difference. So ONE CSX is really -- we talk about like just first of all, focus on our employees, ONE team, making sure our employees feel valued, appreciated, respected, included and listened to, say it over and over again because we have to. All those words mean something. Because frankly, what happened over the last several years, the implementation of scheduled railroading COVID, a 3-year contract negotiations. It took a long time during a high inflationary environment. All those things brought about a breakdown in relationship between the employees and the company across the industry, but also at CSX. And so we felt that as a service organization, if we didn't bring the employees along and get them back engaged what we're doing, we couldn't achieve the goals we're trying to achieve, which is really focused on engaging with our employees, bringing them back into the relationship of ONE team focused on safely serving our customers well. And we're in business to serve our customers. So we keep reminding people that. And then all the other stakeholder relationships, unions, regulators, government officials, media, Amtrak, I mean other Class I railroad short lines all those relationships are important. That's why ONE CSX is about bringing everybody together on ONE team to serve one purpose of serving our customers and ultimately profitably growing the business.

That's great. And the year quite quickly, we faced a number of headwinds in this operating environment. I guess, what are some of the underappreciated things that you're proud of from year 1? And what are the priorities for the second year now?

I'm really proud of the momentum we have on the customer service side of our business. I was a customer, I think many people know, I was a customer for decades in the auto industry and never felt like any of the railroads prioritized service to the customers. And we've really made that a priority, and we focus on that every day. And we've really motivate our employees and our team to leverage our very strong operating model to work together to serve the customer. And that has differentiated us in the marketplace, differentiated us with our customers. And I'm really proud of that progress. When you -- I'm proud about how we brought the team and how we've been able to develop a leadership team that's really working well together, complementing each other well, which then cascades through the organization. I would say the other thing is I'm just really appreciative of our employees and the engagement we have with them. We do surveys every quarter with them. Our employees gave us 3,600 written comments in March; 3,200 in August. I've read all of them. It's a ruling process, but it's important they feel that people are listening and that we're responding and connecting with our employee base because we're a distributed employee base, 22,000 people, but 90% of them are not in headquarters in Jacksonville, so they're out in the nation, 26 states plus Ontario and Quebec. So really focused on that. I think the opportunity, if you want to ask the other question is we had 3 fatalities on our network this year, and that's not acceptable. That will never be acceptable. One is not acceptable. Two of those were trainees, and we've done a lot to address that situation. The last couple of months, knock on wood would have been a lot better, but we got to keep making progress there. With the customer service side, we have a lot of momentum. We've been gaining some share on merchandise. The customers are giving us strong feedback. The General Commerce did the survey in the spring of intermodal railroads, we were #1 by far by the customers, not by anybody else. The FDB released us from the only Class 1 in the U.S. from all the extra reporting in the spring because of what they were hearing from customers. So these are the feedback [ loops ] we look for to say, is it working? our customers seeing a difference with CSX.

The network is performing very well. You just had EVP and COO, Mike Cory joined the team. I guess what does he bring to CSX and how does he help extend that momentum?

Yes. I mean I'm really excited with Mike joining the team. He's been here a little over 6 weeks now. I knew from the moment I started talking to Mike that he was the right partner that we need on the operations side to bring our teams together. Mike brings 40, he jokes with me don't say that number, but 40-plus years of experience, he was there at CM through all of the implementation of scheduled railroading, but also saw the good and bad, the growth and what it did to the network, but also some of the behavioral and other issues that came from how things were implemented. So he's really come in. He was -- like me, he was retired for a couple of years, and he's come back to do this because he wants to do it because something -- he was so excited about. No one's ever -- we talked about, no one's ever used -- leverage a scheduled railroad and the efficiencies and the margin that comes with that to deliver great customer service and engage with employees and create a culture that people want to be a part of like that's the trifecta. And of course, the investors will be rewarded for that. And so he was like, "I want to do this, too." This is like what we've always dreamed about. So he's brought a lot of energy. He's been a great team member for all of us. Kevin Boone, our Chief Commercial Officer; and Mike, I moved them right next the office, right next to mine. There's a lot of energy. We spend a lot of time together every day and really just about bringing that team work. Mike brings a really sense of -- and where he is in a stage of his career, he wants to give back and he wants to teach and train and develop, and that's really, I think, what our operations team needs right now.

Great. And investors want to see growth from the railroads. How do you leverage the strength of PSR into better railroad growth over the years ahead.

Yes. The one thing I've learned is studying the railroads before I joined and then having many years, everybody uses the word growth in every conversation. They have every presentation, every event. Why haven't we been able to deliver it? Well, my thesis, our thesis has been that we haven't delivered service that is acceptable or even good enough for customers to even be motivated to talk about growth. Yes, we have some cyclical things like coal and other things that have hit us just say on the East, but except for this year, coal is up. But at the foundation of the -- our view is the foundation of any discussion around growth has to be we give you a reason to want to grow, and that's what the customer service. We have industry-leading service levels, but we know there's a lot more we can do. We're not anywhere satisfied with where we are. We know we can get better. And it's not just in did your car load or did your intermodal train get there on time, but also were we there when you need us to load empties. That's really important to customers or -- and get -- we need to reduce the standard deviation of outliers. So if we get there 90% of the time, but the other 10% or 5 days late, that's a huge problem, right? So it's not just on the averages, we've got to narrow the standard deviation of our performance. There's so much opportunity there. But the foundation to talk about growth with the customers, we've got to motivate them to want to do business with us again. And we gave them every reason not to do business with us for a long time, even though we have cost advantages, ESG advantages, all these things. Because I know, I was in the auto industry. If you go back, I read engine plants and transmission plants 15, 20 years ago and we moved all our engine transmissions by rail. That never happens now. As an example, frames, sheet metal, in the auto industry used to always move by rail. None of that use by rail now almost, [ unless come ] from Mexico. So why? Because we weren't reliable enough, we weren't -- we didn't have repeatability. They couldn't count us. You shut that plant down one time and never happens again. So we have to demonstrate that we can give a reliable, repeatable service level that gives people confidence that they can trust us for the long term and then motivate them because we have benefits we do give on the lower cost, better emissions, et cetera. And I think we can -- we're starting to demonstrate that with CSX. We're starting to have some of those conversations. And then, of course, we have to be able to compete with truck and [ essentially on ] intermodal side, which means, again, that reliable service, that predictability, and we have to make doing business with the rails a lot easier. The whole customer experience, we don't have visibility, we don't give the kind of visibility that people are looking for. So we have to create that. The experience dealing with the railroads. We have to make that better. We get to watch a lot of this because we own quality carriers, the largest specialty chemical trucking business. It's a big business, almost $1 billion in revenue last year. And we get to see what it's like on the trucking side to compete. And with a great company, well run, [indiscernible] is a great job running it. And we can see the opportunities that we get better, how we can serve the customers better.

That's great. I guess, give us some insight to the long-term strategic planning process at CSX. Obviously, the operating foundation is critical. But what do you see is the growth potential, the financial algorithm, how were you and the team frame it?

So I think the -- I'll start with the financial algorithm. I think the financial algorithm is pretty well, understood it, just we have to demonstrate we can deliver it. We have healthy margins in our industry. You know that we need to maintain an operating leverage an operating model that continues to sustain that. There's significant incremental margin in our business if you can add to existing trains add volume. So if you look at it, we have a healthy margin structure. We need to protect it with our -- by leveraging our operating leverage of our operating model. We need to demonstrate volume growth. How does that come? Some of it can come from just the economic cycle itself. Some of that comes from industrial development. We're very fortunate to be in the south -- have a significant presence in the Southeast United States, where there's a lot -- where most of this industrial development is happening. It's real. Over the next 2 to 3 years, you're going to see a lot of that. And then because we have -- the returns we have, we do a lot of returns to shareholders, especially CSX through buybacks. So you can see if you can get that volume growth that we need to prove we can deliver through customer service, we can price above inflation and leverage our operating model to have strong margins and with a strong return to shareholders, especially in buyback, you can see significant EPS growth over time, which is what we have demonstrated without the volume growth. Now we need to demonstrate all of that with the volume growth, and I believe we can do that.

I'd love to get your perspective on current affairs as well. Demand in the fourth quarter as you see volume trends relative to expectations and just perspective on the freight cycle and the broader economy.

Yes. When you look at it, CSX so far in the first -- through the first 3 quarters, we were able to grow merchandise volume with IDB basically flat. Industrial production basically flat. And that was share gains, and it was also order fill rates going up and being able to really demonstrate we can serve our customers. We're actually ahead of that pace a little bit in the fourth quarter so far, which is encouraging. If you think about what we've seen trending through the year, domestic intermodal has started to come back which is good. International intermodal has stabilized at a lower level, but at least it's not going down anymore for a number of months. That's a lot of volume, not as much revenue, but a lot of volume. So encouraged by domestic intermodal trends, and if we can say, I wouldn't say encouraged, but we're at least pleased to see that international intermodal has stabilized. We'd love to see it coming back stronger. But for now, I don't -- we don't see that coming back for a while. On the merchandise carload side, we had a little blip with autos because of the strikes. But for the year, we've seen strong growth in autos. We anticipate that will continue. If you think about it, other big sector of our group, coal has been really strong this year. We had a really strong last couple of months. It continues to be strong, both in pricing and exports, but also in volume. The chemical franchise, which is our largest customer base, has been down for a year, we started seeing that -- those orders -- order rates drop in the fall of last year. They've now started to come back a little bit. Admittedly off of easier comps year-over-year, but we've seen some trend positive on the chemical side. Aggregates, grain harvest looks to be strong in the Midwest, aggregates have been strong. But forest products, paper pulp board, stuff tied to housing and whatnot has been a little soft still. But the phosphate and fertilizer has been a little hit and miss. Lately, it's come back a little bit. But -- so it's kind of a mixed bag, but encouraging signs. Our domestic intermodal continues to increase. Chemicals have come back a little bit. And those other franchises like autos, coal have been strong throughout the year and continue to be strong.

So demand may be stable or bring us up to speed on the inventory restocking dynamic. Are we there yet? Is destock over?

We've been talking about inventory destocking for a year now. It doesn't take a year, I don't think that destock inventory -- you hear a lot about retailers talking about maybe not the greatest upcoming holiday season. I think the best evidence of that, of course, is what's happening on the imports, right? The international intermodal business, you heard Maersk came out last week with their commentary. So we're watching that very closely. So it looks like the consumer is spending money because GDP continues to grow, but more on services than on goods, the opposite of what was happening during COVID. So we'll see how that destocking plays out and also just where the overall demand levels are for goods. But it's fascinating to watch because we're also seeing metals tied to with auto production is up. So it is a mixed bag. But the thing is, will the consumer get back into purchasing goods versus services, that's going to be one we're going to watch very carefully. Encouraged by domestic intermodal business showing signs of life now for several months in a row growing, but we're going to have to watch it. So I'd say it's not a bad environment. It's not as great as it was a year ago or maybe a little over a year ago with all the supplemental revenue and all the fuel surcharge revenue that we got. But it's not a bad environment. And frankly, it can go up from here if the economy can show some industrial growth over the next several years, which we think will happen just from the industrial development projects in the Southeast.

I guess to what extent would you attribute that momentum on the volume side, just a better coordination and service for CSX. Tell us how Kevin and Mike and the ops team are working together to build the customer pipeline and get those fill rates up?

Yes. Well, it bought tear to my eye yesterday. You would love it. They had the sales and marketing team and the operations team had all their leaders from 2 or 3 levels of the organization together because we had a leadership meeting on Monday morning. And Monday afternoon, all day Tuesday, they were getting together going over every market how are we working together, what are the opportunities, where are the customer touch points that we need to get better at. I mean it was so much energy. I popped my head in there a few times. It was wonderful. This was my dream to see these groups working like this together. So we've definitely gained business because of that. We've gained some share on the auto side, for example, because of service. The customers have told us that. We need to keep getting better. And as you know, Garrett, a lot of these things are set up contractually. So a lot of our customers -- people think, all your service is better, why aren't you getting more share? Well, because a lot of these are contractual relationships. And they're over time. So you have to demonstrate that you are more worthy, and they want to do business with you. And then over time, you can have those discussions when the contracts come up. But I'm very encouraged by how the teams are working together and how they're looking for opportunities and listening to our customers. We have a big initiative going on with each of our customer segments asking them how they measure us, how they look at us and how do they determine if we're doing a good job or not. Not how we look at ourselves and we learned some things from that. And we're adjusting our our measurement systems and some of our priorities based on that discussion.

The shipper base has validated the service and partnered with you with more site development along the network, when do those projects come online? What's the volume tailwind there?

Yes. I think so we start in the second half of '24, but it's really a '25/'26 story. I mean the capital is going in. So it's happening. I mean, the Rivian plan outside Atlanta, the Ford plant outside of Memphis, the Hyundai plant in Georgia, the VinFast plant in North Carolina. These are being built or what Novelis is doing and [indiscernible] is doing. So we've won a lot of good business that's those assets are being built, they're happening. So we have a good time line and good visibility into that. And I think Kevin Boone said that could be 1 to 2 points of volume just from the industrial development, given what we see. And there's 500 projects. We talked about the big wins because the -- but it's a little bit of everything, which is great. Aggregates has been a big part of it, actually, believe it or not, because a lot of construction projects going on. So we're excited by that but it's going to be more of a '25, '26 story. And so our challenge is going to be in '24 to continue to win business by executing better, by being a better partner and see how the economy evolves. And then start -- and then when these things kick in, they become additive. I'm really encouraged, though, because we picked up a lot of auto business this year, and we've been able to deliver it with a really good service. The grain harvest is picking up. We're delivering really well on that. Our coal business over the last several months picked up significantly. We've been able to deliver on that. So people ask the question. The natural question is, can you handle it? Will you be able to deliver these levels of service when the volume returns? Well, by different sectors, we're seeing that happen, and we're able to deliver at the levels we've been delivering at service. So I'm encouraged by that. I believe we have the capability to do that.

So service is good, network is performing well. How do you get paid on the pricing side? Help us understand those discussions with shippers as you look to maintain that positive price/cost spread.

Yes. I mean, it's been a -- there's no secret to anybody. It's been a pretty high inflationary environment for a couple of years. Our labor contract is known, so we can talk about that. Obviously, it's a big part of our cost inflation, but also rail ties and everything else that goes with it. We haven't been able to price above inflation as much as we were probably a few years ago, but we're still able -- it's been in a supportive environment. There'll be some catch-up over time, again, because these are contractual things that are set up over time. But we've used the word supportive, but definitely, the pricing environment has been supportive. It's not the same bump that it might have been 2 or 3 or 4 years ago, but still it's healthy. I think as inflation starts to subside a little bit, predictions for next year are down from this year, of course, we should see a little bit more contribution from that. But we feel really good. Our teams tell us that, "hey, it's a lot easier to have these conversations with customers about pricing when you're delivering service they haven't seen before." And when you're delivering better service than the other options. So we want to stay in front of that. It makes it for a much healthier conversation to talk about growth and/or pricing. But there'll be some catch up over time, given what we've seen. We have to get better also because we've been so focused on the service improvements of demonstrating some efficiency improvements as well along the journey. Mike has been a big help in helping us look at that so that we can also help offset some of these costs.

On the intermodal side, to what extent has ample capacity in the truckload market made pricing more challenging?

Yes. It's interesting. We don't do a lot of spot pricing and a lot of spot competition. A lot of our stuff, as you know, is handled by the IMCs and it's more contractual. But we're not exposed to it as much as people think we are on the intermodal side. Now it's still something you have to keep in mind, and you have to be competitive with. But generally speaking, our pricing in the intermodal side has not been too different because again, we've got these longer-term relationships and longer-term -- and we're providing much better service, which, again, is part of that conversation. But we have something we have to watch. I mean, both diesel prices and also trucking prices combined. You have to make sure it's a good value proposition for the customer. But we haven't been exposed to it too much. No, it hasn't been supportive of getting a lot more pricing to be sure, but it hasn't been -- we don't do a lot of smart stuff.

And CSX has been very active and was one of the first to get aggressive on the hiring side. How much more capacity do you have in the network today given your labor position and equipment and your ability to just layer on volume without more cost?

Yes. I mean I think you have to separate are you adding trains or are you adding 2 trains. Adding 2 trains, we have a lot of capacity. Our train length really hasn't changed for -- average train length hasn't really changed for the last 3 or 4 years, actually and we have capacity. We've been putting in sighting, we've been investing in the network. So we're actually -- of course, we have the new interchange point coming with CPKC and Myrtlewood, Alabama, very excited about that. We're putting in side longer sidings. We think our physical assets have a lot more capability. We got to make sure the engine -- the locomotive engine availability is there, of course. Our biggest challenge still remains having all the right people in the right places all the time. While we've gotten close to where we want to get to in total head count, we're still 4 or 5 key locations now where we want to be. So we're still doing some hiring. We're also anticipating further attrition, and we're staying ahead of it. But I feel really good about the capacity we have and also the way the team is working together. I've said this many times, I think it's underappreciated in this industry, how much discretionary effort there is out there in the workforce. I came from a world where people were tied on assembly line. So you were kind of cadence to the work effort. If your employees are against you, they can slow the whole thing down, either they're upset or distracted or anxious or they can slow the whole thing down. If they're motivated, they can really help the place run and we're trying to get to that place where everyone is feeling motivated in part of the ONE CSX team.

And to that point, I guess, how do you grade or where do you see more opportunity for productivity improvement as velocity, fluidity? What are some of the metrics on your dashboard that you check daily?

Yes. So we -- so I look at Trip plan compliance. Well, first of all, look at safety always first, because that's most important. And in fact, the last couple of months, we've made a lot of progress there. But then I look at Trip plan compliance, on-time originations, what we call CSD, which is last mile, first mile, and then you look at the velocity. Velocity and [indiscernible] are in service of those other metrics. I joke all the time. If we just take a training around back and forth between yards really fast, don't do anything. We can make our velocity and [indiscernible] look really good, but we need to achieve anything. So it's really about service to the customer. So we start there. But those are the things we look at. And then you got to look at your car count and you make sure your engine count is where it needs to be and then fuel usage and other things like that. We have a lot of data, so much data in this industry. And a lot of it gets published which is shocking to some of us come from other worlds, the exposure level we have of all the data. But the reality is that our network is running well, but we know there's still a lot of opportunity and we haven't reached anywhere near our potential.

So when you think about drivers for improving return on capital, operating ratio, maybe less of a focus going forward. What are they? Is it really volume growth? Or is there anything you can control?

Well, we definitely can always find efficiency. So the biggest way to help margin is lower cost with the same kind of revenue, right? So we always work on that. We've had some pressure with inflation we talked about, but we can get better. But yes, the incremental margins on this business are significant. So when we deliver volume growth by earning the right to do that with our customers through our service levels, it will have a very -- a good impact on our business.

And obviously, service has been missing, the missing link through the cycle. I guess what gives you confidence in the resiliency of the service today and as demand inflects that it's still going to be there?

Yes. And like I said earlier, I've already seen in pockets because when the coal business goes up, it's that -- those lanes have got to be able to respond and they've been able to respond. When auto business goes up, they got to respond. So we're seeing the ability to respond. So I'm encouraged by that. I also just encouraged by the motivation and the talent of our team and how we're working together as ONE CSX team. All the things we're doing is building momentum on how we work together to be able to serve our customers better. And we've had examples where we can demonstrate we can turn it up and still deliver the service levels that we want to. I think one of the biggest challenges we'll continue to have in our industry is keeping the manpower levels where we want them to be because just getting harder and harder to find people that want to do and have the lifestyle of a railroader and want to do the kind of work that we have. So we have to make that more attractive to make it a better environment people want to be a part of. I think that's underappreciated. 10 years ago, there was a -- there was a long line to get a job at CSX. Now we're recruiting people to give -- to come to CSX. And that's true for the whole industry. So we've got to be better at that. It starts with the culture we create and the environment we create for our employees. But I feel good about the capability. And again, we got to demonstrate that, but we want to be able to do that hopefully soon.

Is there anything on the technology investment side that can extend the service advantage and...

There's a lot. I mean, we're going to talk about this more next year. I think I don't want to give away some of the fun. But there's a lot of opportunity in technology to be a part of the solution. This is not an industry that's really been able to or even often embrace technology as much as it could. Some of that is the current FRA, other things have been a little bit of a roadblock on some of implementation of things, but also just historically because of the network effect of the business, it's hard to get things done. But technology needs to be, can be and will be a huge part of the story going forward. Everything from how we serve our customers and how connected we are with our customers and the visibility, but also safety and a track level at the community level, but also just efficiency of what we do. Everything from the joint venture we're doing with CPKC on hydrogen locomotives to automatic track inspection to a lot of things. There are a lot of things that happen in our business that we accept that technology is readily available today that can help solve that problem. It's not going to invent anything. We have an environment today where we still run into things on our network. Our trains going to figure out how to run into things that technology exists to avoid that. We can't stop the train in 10 feet. It's too big. This is physics. But you can know. So there's a lot of examples of things we're working on that, that we can be better as an industry and we can be better at CSX and technology can be a big part of that.

And so is that just the remix of the capital spend budget? Or what do you think for capital spend?

Yes. We've been watching that. I mean you know our capital spend has been going up, but our revenue has been going up, too, and plus we had the Quality Carriers acquisition. We've been investing in ISO tanks for intermodal solutions for chemical customers. We had the Pan Am acquisition, which we're putting money into that. We've got now the MNVR, which is the new interchange point, putting money in the [indiscernible] There have been some unique things driving some of the capital. But we've been staying pretty steady. If you look at our capital spend as a percent of revenue, we've been pretty steady. I don't see that percentage changing dramatically over time. Yes, the numbers are going, but our revenue is growing, too. And I'm really proud of the way our network looks right now, and we're going to keep that up. The vast majority of our capital spend goes to that. So yes, there's going to be some investments, but I think we can manage it within the kind of percent of revenue type spending we've been doing for a number of years.

I guess we're running up on time. But as you think about the range of outcomes for next year, how do you build and embed flexibility in the operating plan so that you can adapt to stronger demand or an extended drag?

Yes, that's the challenge because of back to manpower, right? On the capital asset side, we have the assets. If demand goes up and if it goes down, we'll obviously have to -- we could put some things on side. The manpower planning is the biggest challenge. It's hard to predict next year as that economy. I think we all know that. Could there be some upside, could be some downside. If there is downside, we'll adjust our cost structure appropriately and we'll do what we have to do. But on the T&E employee side, we want to protect those because that's what we need on the upswing, the conductors and engineers that drive our trains, it takes 6 months to train. On the economy side, we're watching all the things I talked about, and we're going to have to see if there's ability for the economy to sustain a little bit more growth. Predictions for IDP next year are negative. So a big portion of what we do is tied to industrial production. But of course, we've been able to demonstrate our ability to outgrow that this year, and that will be our goal for next year as well.

Well, it's a great update. Special thanks to CSX. Joe, thank you for being here.

Thank you all for being here. Appreciate it. Thank you.