CSX Corporation (CSX) Earnings Call Transcript & Summary

Good morning, everyone. Welcome to Day 2 of Barclays 41st Annual Industrial Select Conference. I'm Brandon Oglenski, airline and transport analyst. And kicking it off today, I'm really excited to host CSX. Joining us from the company is Mike Cory, VP and Operating Officer; as well as Kevin Boone, Chief Commercial Officer. And just like yesterday, but before we jump into the questions, we're going to do the audience response as to hear for those in the room. [Operator Instructions] You currently own CSX? Yes, overweight; 2, market weight; 3, underweight or no. Okay. Question number two. What is your general bias towards CSX right now? Positive, negative or neutral? And now, we know your answers.

Positive.

Good. That's pretty favorable. And then question number three, please. In your opinion, through cycle EPS growth for CSX will be above peers, in line with peers, or below peers? And thanks, everyone, for participating. [indiscernible] after the conference. All right. Well, gentlemen, thank you so much for being down here and start the morning here.

I don't know where to start. Mike, welcome back to railroading.

Thank you, Brandon.

Haven't seen here in a couple of years, but welcome to the U.S. So maybe we can start there. Like what's been your experience in the first few months on the job in Jacksonville?

Sure. It's -- I've been around a while. So it's not like I'm learning how to railroad. It's a different railroad than what I'm used to. CN was very linear. You -- I say it all the time, if you go 1,000 miles, you do some work, you're another 1,000 miles. Here it's every 150 miles, there's a customer that -- or a yard or a facility or something that we touch. And so to get my head wrapped around that, it's been good because it's important. I understand what businesses the traffic flows, but what the customer demands are. Really good team, very young, new to their positions. So the opportunity to teach and start to build that brand at CSX is -- and if that was important to me coming back, has been great. And there's just a lot of opportunity that I'm really excited about.

And anything on the operations side that you saw that was better than what you've experienced before or something that you wanted to change right away?

There's always things that people do, and this is why it's important, respect culture when you go somewhere. There's things that they do that, yes, they may slightly have been a little new, a little bit more smooth, whatever the case. But the organization, the structure of what we were doing in operations wasn't what I was used to. We're really focused on developing the people around us so that everybody understood their accountabilities, had the clear direction of what they're supposed to do. They had competencies or we built them with them, and you can see the CN folks that are out in the crowd. We focused really big on building people up and developing them. So that's really the big opportunity here. But at the same time, there's opportunity [ brand new ] trains, for faster trains, for interaction with some high-cost, mates like our engineering department, that's a $3 billion construction company that we could do a lot more in terms of tying them in with the [ station ] folks to save money, do better work. There's -- it's the regular opportunities that are out there that I've -- that we've always seen, but really doing it through people, developing them, so that when I'm long gone, they're continuing to do it. That's the goal.

Appreciate that. And I definitely want to keep this focused long term, but Kevin, just want to ask about first quarter trends and volumes because we saw, yourself and everyone else in the industry had. Pretty difficult January from a weather perspective. Where do you see underlying demand right now? And have you seen the recovery since January?

Yes, you're right, January was tough. Mike -- we've experienced it every day. When you have a football game shutdown and we're delayed in Buffalo, it's pretty bad out there. But it hit the southern part of our network pretty hard too, which is they're not used to. So...

Yes, it hit like just east of the Mississippi, right down to Nashville and Alabama where it hasn't happened before. So it set us back a bit, but...

But I think when you see the volumes, and obviously, we report them every week, you'd see that we had a really nice rebound across some of our core franchise like chemicals, forest products, we're starting to see a rebound that were really underwater last year and really got hit hard, largely from destocking in my opinion. I think it was underappreciated how much supply, how much inventory was in the system with all of the new challenges that we've had over the last few years with a couple of it in the supply chain. And I think that had to run its course and it's largely focused on of course in some of our major markets. And that encourages me, even if we don't see a big pickup in the economy, that just a normalization, back to run rate demand means some growth for us, and that's what we guided to do. So some of our core franchises, like I mentioned, chemicals, forest products, those areas, metals were quite encouraging what we're seeing. Second derivative, maybe a little bit better than normal seasonality, what we would expect coming out of the fourth quarter and the first quarter, we're seeing that today. Even the international intermodal, obviously, on a much easier comp, but we are seeing a lot more activity there. And on the domestic side, we've talked about it late last year, we're pretty proud of what we're able to do during COVID and what that product service looks like today and it continues to be positive for us. So we'll see what all of the things that are happening later this year with the election and other things that are coming, hard to predict what fourth quarter looks like. But early on, we're encouraged. We're probably running in some of these areas a little bit higher than planned. The only 2 that I would say are a little bit slower autos. And that's just a couple of the quality holds there, but we think that's deferred revenue, not loss of revenue for us. And then on the ag side, the southeastern crop was a little bit stronger than normal. And so we haven't seen those movements into the Southeast like we normally would. But that -- our team expects that to start to ramp up in the second quarter still. No market that I see right now is really declining, if they're all stable and improving.

And how can you help us put this in the context of your annual guidance this year for low single digit to mid-single-digit volume and revenue?

Yes, I think there's a lot of mix issue. When you look at our business, there's a lot of volatility that comes along with the export coal side of our business. Every year, we want to come in with a conservative assumption. We're quite happy with where coal prices [ we see today ]. So we'll see if that holds for the rest of the year. That wasn't necessarily our assumption, not that we have a better insight than anybody else, but that's what we want to assume, manage the business that way. And we're seeing a lot of robust demand right now actually for the international side. And then you have fuel surcharge. Diesel prices were a little bit lower. They've ticked up above 4 now. So we'll see if that holds. That's a big factor in terms of revenue growth. And then just the overall mix within the business, if we do see intermodal come back, which we expect, and maybe have a little bit higher growth than maybe the rest of our portfolio, that would be a negative mix to our business. But we'll expect a healthy pricing as the service continues to improve. We're really leaning into that. So nothing's really changed from the algorithm that we've talked about for so long and price above inflation.

Yes. And if we expect the last couple of years, you and your competitor in the East, probably create a little bit of a valuation discount to the rest of the group. I think some investments are concerned about that outlook for coal. Can you dig a little bit deeper into your coal business? How much is that exploded into metric.

Yes. I mean if you look at it now, I mean, our domestic business over the last 10 years is down significantly from where it was or much more heavily aligned to the international business. And we're seeing opportunities when we see weakness in the domestic market to push it in the international market. We have an asset like Curtis Bay, which is very strategic for us. It allows us to have a lot of flexibility. It's very strategic with our customers and we leverage that quite a bit. So our domestic business is much less, I would say 2 years ago, we were hearing from customers all the time, hey, you're ready for shutdown is coming. I think that narrative has changed quite a bit in the last year. When I went to the last conference, the Coal Rodeo, they call it. I was quite surprised to hear a lot of the customers talking about deferring shutdowns of some of their coal-fired plants, particularly in the Southeast, just given all the data centers and other activity they're seeing. And they're worried about just being able to serve on all the demand that's going to be there over the next 5, 10 years. So -- we'll see. Coal is a very, very reliable source, particularly in winter months and summer months, and I think customers have realized that. When we come into this year, there might be a little bit of downside. We're seeing that in our volume today, [ for domestic side ] but that's moving up on the international side. We do have minimums with a lot of our domestic customers, given what happened in the COVID period, and we expect them to shifting into meet those minimums.

So coal is powering AI?

Yes, it seems like it.

On the positive -- well, and again, exports actually favorable right now?

Very favorable. Yes. I mean you see the benchmark prices, they're down from the peak, but they're very, very supportive of our business and our customers are making a lot of money.

And what's the range of pricing outcomes and the sensitivity to export coal prices on new contracts?

We don't move in tandem. We obviously have minimums that will move down in their caps. The caps have been rising given what we experienced over the last few years. But where we are today with that coal, Australia now above 300 is a very, very healthy price for us, and we participate -- and they're doing very well, and that's what's happening right now.

Okay. And the end market was different going into globally.

India is a big market for us. When you think about from the met side of the business, we touch everywhere in the world. We're seeing a lot of growth in India. That's a big market.

Okay. And -- so Mike, Kevin has been telling investors for a while now, we have this industrial development process at CSX. How do we locate customers on the network and then these long-term projects that are now coming online ['24] level, how about the volume impact. But how do you work together with his team in planning capacity?

In a variety of ways, Brandon. The one thing that we make sure of is, we have a clearing house, and that's our services, I think they have to reports up to me yet. At a very early stage the information is brought forward with Kevin. Kevin and I, whether its everyday, but for sure, every week, we have absolutely the leadership team are going through any of the new business that's coming, but it's getting dissected in with the people that design the plan. And then that's coming back through me. So if we see -- and then that ties to locomotives that we need, that ties to people that we need, that also ties to us talking about how we're actually going to deliver the service, that's probably the most important thing. But through various parts of the organization we're connected at the very end Kevin and I.

Yes, the industrial development side is probably the easiest work because as there's a long lead time, right? It takes a year or 2 to build these facilities. So that's the -- this planning the cyclical side and being connected on where do we think we could see supplies upside, right? And where are those corridors in staying connected there. And our teams are working closer together than they ever have and sharing that information with the time. I wish our customers knew what fourth quarter looks like. They're asking us, and a lot of them they don't. But we know where we could be surprised and making sure we're resilient in those areas.

And the more I learn and the more the team learns about the capacity we have, we're able to feed it also back. So it's a cycle or a circle. Not one of the -- we're out there as well right down on the ground floor our managers are working with the local marketing department. First of all, the deliver of the service we should, but also to get insight as to what else may be available, and then we feed that information to them.

And from a resource perspective, how are you thinking about headcount and labor, especially managing to the new agreement...

Yes, it will cost us a few people, no question. However, right now, we're pretty comfortable with what we have. There's a couple of locations we're still trying to hire and attract and that's throughout. That's not just the conductors, that's other signal department people, so on. And there's definite areas where the money has come into whether it's Amtrak or somebody else, and they're able to attract it. And we see that smoothing down or cooling off. And so from an asset perspective, we're good on locomotives. We're good on people. The key is to stay close with Kevin. And again, industrial side, we have a long lead time before we have to go out and do anything. In the other areas, we're working hard to create that efficiencies. So we do -- we are able to match the attrition, naturally happens, but at the same time, provide something to Kevin and the team to go out and sell.

One of your competitors said, inflation this year, mid-single-digit levels. Is that something you're seeing as well?

Yes.

Yes. I think we said inflation is coming down versus last year.

Yes.

Particularly on the PS&O side and other areas. You know what our wage inflation looks like, right, very visible, 4.5% to the union in July, right? That's already baked in. But it is less than what we've seen until we see it decelerating. And hopefully, the Fed sees that, too.

And for me, Brandon, my goal is to not optimize much, whether it's rail, whether it's other components, locomotives, and that's through efficiency.

Okay. And Kevin, coming back to the industrial development project, I mean those projects have started delivering volumes as you expect...

It is. Yes. I think we'll really start to ramp up in '25, '26, but we'll see some second half of this year mainly. And these facilities can take a year or 2 to really ramp up the full production. But we're in the very early stages of that growth -- a big factor...

And could you walk through some examples of what's coming online?

Yes. I mean on food processing, we have a plant coming on this year on that side. On the steel side, we have a number of opportunities over the next 3 years that you'll see coming online for us. We're very excited about on the EV battery side. I know there's a lot of debate around how that evolves from here with some of the weakness in EV sales recently. But we've got Apple on the ground on the CSX network and obviously, one of the biggest facilities that has been announced since [already sale is in the ground ], right? I don't think the capital is being spent kind of -- its going to happen, and we're excited to be able to serve it. It's going to be a big opportunity. But really across the gamut, you can see more development, I would say, on the forest products. The packaging side, we're seeing new facility starting to come online. We did over the last few years, a lot of consolidation and now they're building larger facilities. So it's something that I advise you, as you highlighted, our team has been very focused on even at the senior levels of how we really identify these projects and make sure that we're front and center in getting them. And I think we'll share through this year how we've been successful in how we -- there's not really even a good data source out there that tracks us. And I think we're creating the first one that will really give you a sense of where all the activity is happening. It's happening in the Southeast, happening in our network in the Midwest, it's happening in Texas. Those are the centers of development, and we're fortunate to have 2 of the 3 in our network.

And how is this impacting your longer-term view on volumes? I think in the past, you've said we should add maybe a point.

Yes. I think aspirationally, we said a point to 2 points. I think the bigger factor is when you look at largely what our inability to grow as the rail industry was every year. We're having to offset this industrial decline, sitting down on our railroad every year. And hard to grow when you're having to offset that is going away, and I think they're going to start netting up rather than that being a detractor from our growth every year, and that's going to be an additive. It's huge. It's a huge opportunity for what we see in the business for decades.

And by the way, if there's any audience questions, raise your hand and we'll get you a mic. In that context, Kevin, what's the outlook going forward on pricing? Has that algorithm changed for CSX or the industry?

No, as I mentioned, I don't think anything has changed. Obviously, in places coming down, so we were highly successful last year and I think for a lot of the costs that we were experiencing that are really [indiscernible] we recognize when our customers are getting priced that we should participate in that, especially in our service product is getting better and improving, and we have aspirations, and I know Mike sees a huge amount of opportunity for that -- continue to get better, and we'll sell through that. There's a lot of value we turn their assets that they own. There are other things that we do that puts a lot of value. So I don't think anything has changed. I know there's been a lot of focus on that from an investor standpoint. But there's no question the environment basically is very different than last year, but it's still above average trend of what we saw prior to the inflation stuff that occurred over the last 2 years.

David.

Merchandise network for [indiscernible]

I can start with -- for me, I'm not used to seeing that much compaction with customers, especially the merchandise, as you say. So we -- our focus, first of all, is to deliver the service to [indiscernible] keep the business. But the longer trains allow us to have less movement along the network, so speeding things up. The ability to reduce our yard dwell, our connection standards. We're really focusing on that because, again, -- we want to work with the customer, so they don't need a buffer supply. So we have the exact amount of cars, and it could be upwards of 5% for some customers that we take out of the fleet. That creates fluidity, but it's strong. All of our major facilities are at full working capacity. And really, the last month has been -- last month in a bit has been a little difficult as compared to my first couple of months because of weather and a few other incidents that took place. But overall, it's strong and it's fluid, and we have more capacity there to do more there.

Mike, can you talk about the rail connections you guys are building interline agreement, I think CP had -- both you and CP had a big announcement last year. Operationally, how does that manifest?

Well, it's still ahead of us, Brandon. We haven't got the STB approval, but I mean we're able to now and Kevin could speak to it better than I, but we were able to hit in markets that we couldn't before using our connections with CP and our partnership. But it's like any interline agreements that we enter into that the opportunity to go further to get our customers to different markets, that's something that this does. And like I said, Kevin would speak to that, a lot of these will get us to a market that we haven't had access to. And from a market we haven't had access from.

Yes. Clearly, the Mexico market is a big one that we're targeting with this strategic alignment with the CPKC. And auto is a huge -- we have a lot of auto facilities down in the Southeast and [indiscernible] in the parts, that's all getting trucked today. It's a poster child for truck conversion. And we think we're going to be able to deliver a pretty compelling product and service for those customers and can deliver a lot of value, and we're pretty -- we're excited about it. All those facilities are on us because it's also opportunities go from east to west as well. So we'll look at those. Teams are working together. I actually just traded messages with my counterpart over there, and we're getting back together, but our teams have been working. We got a large pipeline of opportunities working with customers. And we'll hopefully get that up and running here in the fourth quarter. We'll see with the approvals in all the regulatory. We're working on the capital side of it, make sure it's fluid and running well when we're able to deliver the service. I'd also add Pan Am -- we're really starting to get that acquisition. We're starting to see that. The capital pay off there and the pipeline there is growing significantly for that business, and we're pretty excited that, that's going to bring incremental growth there in the back half of the year, as that really starts doing well.

Okay. If I could, Brandon, just -- and also the relationship between Mark and Keith and our operating team, we work very closely in sync because we do the same thing. We've worked together for a long time. My experience anyway is with CN and CP. So I'm looking forward to that just to think the same way, and that's important. And Pan -- and the Kevin's point the Pan Am finally got up there a few weeks ago, and we've done a tremendous amount of work to bring the level of ability up there to where it needs to be, so from track refurbishments. But we actually had the whole team together, and we've come up with a very solid operating plan where we been able to even move some of the capital we have planned in certain areas to other areas, and at the same time, speed up the traffic and again, go after the asset utilization and reduce what we need. That's been a good news story, and Kevin is building on it.

And Kevin, maybe an update on Quality Carriers, maybe focus on how you did by trucking company for 2021.

Yes, it's been more than a couple of years at this point. Yes. So it's -- look, it's focused on our largest market with our chemical market, right? And when we step back and take a look at chemicals, it's probably one of those markets where largely, if we serve it and we serve the facility that they want to reach probably are getting involved there, right? There's not a lot of truck work in those leads where we -- we get the lion's share of that. And so the idea around Quality Carriers was how do we extend the reach of some of our most profitable business, how do we reach customers that we traditionally haven't been able to reach. And obviously, [indiscernible] is a intermodal product, I will -- it's cut off with Randy the other day. We're seeing that really start to take traction. We're working with some of the largest customers in that segment that are now growing as we turn the calendar. We love look at option on that side and so across the product is very exciting. And adoption, I think the great thing about Randy's business, and they do a phenomenal job. It's very sticky. Also that creates challenges when you're introducing a new product and you need adoption from some of the largest players and we're starting to get that traction. I think January was our highest month from an intermodal and that continues to be an upward trajectory. So we're excited. It gives us another seat at the table when we're discussing with our customers. A lot of times they're bifurcated. They have people on the procurement side to handle the trucking side and then they handle the rail and those who aren't talking all the time. Now we get [ seat at ] the table and we have create new one, we can do with the rail side of it. So even on the merchandise side, I think it creates opportunities to really -- because that relationship is even greater. So I'm very happy. The core business is doing very well. It's held up much better than every other trucking company that I can think of in terms of their pricing and their ability. And I think that's a testament to that team and new product that [indiscernible]

And maybe bigger picture on intermodal as well. Historically, a lot of rail management teams have said, it is a lower margin business. We can get some volume, but maybe -- best contributor to the bottom line. Is that the view of CSX Corp -- [indiscernible] we heard from [ David ] yesterday that rail service has improved quite a bit there.

I mean when you look...

Couldn't agree.

When you at Michael, tell me we're running too short a train intermodal side, and when you think about putting things on the back of intermodal train, the incremental margins are very, very healthy. So really leveraging what [indiscernible] is really only the fuel, which is minimal, like dream for, right, for that incremental move in the list of booking costs, which we have great leverage in that area, too, with our -- what we've been able to do from a terminal perspective. I know it's only going to get better with some of the leadership we have over there today. So it's partly of our growth. Merchandise is part of our growth, and so obviously you see those in our business. But intermodal is going to -- we expect to outgrow our merchandise...

I bring to you a question #4 for the audience, please. In your opinion, what CSX to do with excess cash? Bolt-on M&A, larger M&A, share repurchase, dividends, debt paydown or internal investment?

Sounds like we're one of the few doing share repurchases this year.

And did you guys guide to a level?

We didn't, but I think you can expect -- we've been pretty consistent over the last few years. . Can we have question #5, please. In your opinion, what multiple of 2024 earnings CSX trade? Thank you. And then last question, number 6. What do you see as the most significant share price headwind for CSX? Core growth, margin performance, capital deployment or execution and strategy? And Mike, you did allude to CapEx, I think, guide to what, $2.5 billion spending this year, give or take. What are the opportunities to get more efficient on the capital side?

Just our process within our engineering function. We just brought in a new Vice President of Engineering, I've worked with him many years. We're looking so closely at that because its just -- that's the big chunk of the capital that we spend here. And that also involves the operating team. We can -- we have to have solid positive blocks, which we haven't done. We have to make sure the work we do is quality work. We have to make sure the inspections we take are bringing back information that we need to change the way we do the job, the components we use, it just has a lot of opportunity to -- because we get more out of that capital spend in that sense. But every other piece of capital, do everything we can operationally first, before we go out to get it. And we have a very good network in terms of capacity and the ability to run fast.

One thing. We only have a couple of minutes left, so maybe we can summarize here, but -- when I looked at your annual outlook, and I think you guys are moving away from operating ratio, which I applaud because EBIT margins are just easier to discuss. But same outcome, you guys didn't necessarily commit to better this year. What should investors expect from a profitability perspective when we add all this up?

When you look at our ability on incremental margins and nothing and that story has changed. There is some volatility this year, particularly in the first half. We're going to lap some storage revenue that's going away. But by the second and third quarter, that's fairly largely behind us. Obviously, export coal pricing is a factor, high prices last year, right, but we'll be lapping that as well. I think as you see into the second half as Sean talked about this, you'll see those incremental margins really start to hopefully shine, and with all the things Mike is working on, I think you'll see that impact as well. We're quite optimistic, and I saw on the last question, I think the biggest challenge with core growth for us, I need to send that slide to my team. We're pretty excited about all the things that we have going on and what we can control. We obviously mid of an environment where we have cyclical businesses that we can't control, but we -- I'd be more optimistic about our pipeline and our share opportunities across different industries than I ever have been. I am seeing more collaboration with our Class I partners than I ever have since I've been here. That's encouraging. I think we're all leaning in together. And that -- there's debate out there, we're leaning in, and growing for that come at the sacrifice from ours, quite the opposite. The more we're able to grow the business the better our margins are going to be. That's how it works. We have a lot of fixed costs in our business, and that hasn't changed. So I'm always surprised, Brandon, if we talk about growth, everybody thinks we're talking negatively about margins. That's just not the case. Sean can show you the math. Certainly, it's -- they work hand-in-hand. And I think growing margins and growing our business are kind of hand in hand and we like that. We want to be compared to the best industrial transportation companies out there. That's why we look the margins. We want to be benchmarked to those over time, and we're excited about some of the things we're seeing, and I couldn't be more excited to be working with Mike here, and our teams are sharing and collaborating like they never have been before.

Kevin and Mike, unfortunately we're out of time, but really appreciate talking. Thank you.

Thank you.