Norfolk Southern Corporation (NSC) Earnings Call Transcript & Summary

Okay. Good morning, everyone. Welcome to Day 2 of the 13th Annual Wolfe Research Virtual Global Transportation and Industrial Conference. I'm Scott Group. I'm the transport analyst here at Wolfe. I am -- you are stuck with me all day. We've got a jam-packed agenda. We've got all of the rails doing fireside chats today. We've got 2 -- we've got a rail regulatory panel, we've got the -- one of the Board members from the STB, we've got a rail shipper panel. So we've got a pretty comprehensive view of the rails today. We've got 2 LTL panels, 1 with public carriers, 1 with private carriers. We've got XPO Logistics. We've got a truck technology panel talking about electric and autonomous trucks. We've got a truck brokerage panel with Echo Global Logistics, Landstar and Transfix. We've got a freight tech panel. We also have DSV today. So we've got a full agenda. Thanks, everyone, for logging in. Just as a reminder, we're using GoToWebinar for all of the panels and fireside chats. And the way it's going to work, hopefully, everyone will be -- hopefully, myself and all of the companies will be on video. I think that's better than just doing audio. In terms of questions, I'll be moderating all day, but if you have any questions, submit them. It should be pretty clear how to submit questions. I'll be filtering them, so ask appropriate questions. But certainly, if you have good questions, I'll make sure that they get asked. I just want to thank all of our companies for participating in this virtual conference. I thank all of our clients for all your support. Really excited about the agenda today. I thought we had a great day yesterday with airlines and trucks and multi-industry companies and should be another good day today. I should also mention, we do have a couple of -- or at least 1 other multi-industry company, Stanley Black & Decker is also going today, that looks like aid on the industrial side. And then we wrap up tomorrow. We've got a couple more on the trucking side and then a couple more on the multi-industry side. Okay. Why don't we -- we're 2 minutes ahead of schedule, but I think that's okay. Why don't we -- Grace, why don't we launch Norfolk Southern, and we can get going. Nothing wrong with starting a little bit early, get us ahead of schedule. So really happy to have Norfolk Southern kicking off the conference. We've got both Mark George, the CFO; and Alan Shaw, Chief Marketing Officer. Mark, Alan, hopefully, you guys are 6 feet apart in that room close enough it looks like. And Mark...

Objects are farther apart than they appear.

Okay, good. Mark is going to kick us off with some couple of quick opening comments, and then we're going to go right into Q&A. Thanks, Mark, for being here.

Thanks, Scott, for hosting us. Alan and I are both delighted to be with you, and we are here in Atlanta together, although as you can see we are maintaining a safe distance. Just a couple of words before we get started with the fireside chat and we'll start with our safe harbor. We will have forward-looking commentary today, so I encourage all who are listening to view our recent SEC filings. Where you'll see a discussion of our risk factors. Moving on to the business, while the economic and market disruption from COVID has forced us and most companies to revoke guidance for 2020, we left our 60% OR target in place for 2021 waiting to understand the slope of the eventual recovery. We felt it was just too early to push out that goal. We continue to be very aggressive on the cost side during this journey to be a 60% OR company. Our immediate challenge is trying to balance current volume realities while retaining the agility to react on a recovery. Speaking of those volume realities, quarter-to-date volumes through last week were down 30% including a challenging mix. Coal is down 55% quarter to date, merchandise is down 34%, and Intermodal is down the least, at 22%. Now RPU in each -- ex fuel, in each segment is again looking solid like we showed in Q1 of last year. However, the mix and the volume declines -- I'm sorry, Q1 of this year. However, the mix and the volume declines along with the declining fuel surcharge in this quarter will create overall net RPU headwind that implies revenue could decline in line with or more than volumes this coming quarter. But our positioning for the long-term is really great. Our TOP21 strategic plan is paying dividends, as you would have seen from our Q1 results, where we had 11% cost reduction on 8% volume declines. Our team is nimble with crew starts down in May, matching the volume declines that we have. Service levels and availability to our customers are the best they've been in the history of the railroad. And that has helped us as we've recorded our 13th consecutive quarter of RPU improvement. We have an outstanding franchise with the best channel partners in the industry and we are poised to leverage the recovery when it comes so we can deliver considerable incremental margins. And most importantly, we've got an inspired and dedicated workforce that is committed to safely transporting goods that keep America running. And they are doing it without interruption during this pandemic, and that is awesome to observe. So with that, Scott, we are ready for Q&A.

All right. Fantastic. That was really helpful, Mark. And again, just a reminder, anyone listening in, we've got a lot of people on the webcast. Feel free to submit questions, and I'll make sure we get to them. So there's 2 things I want to follow up on, just based on what you said, Mark. First, when you talk about the 60% OR for 2021 and you say it's just too early, is this something where you -- where it's -- you realistically have still have visibility and line of sight to that for 2021 or is this just, "hey, like, we just don't know but it's -- we don't know. So it's too early to even cut it". And maybe just some color on like what level -- is it really just the magnitude of volume recovery that we're going to see that we're going to need to get there? And how much of that volume recovery do we need to see? Is it -- do we need to just stabilize here? Do we need to recover? Maybe just some color because at least for now, you're sticking with it, but I just want to understand, is this, we're sticking with it because we just don't know anything else?

Yes. No, that's a fair question. And it makes sense to drill into that given where we are with the volume declines and the collapse we're seeing in the overall marketplace. But look, we are still very focused. We've got an entire organization that's been motivated and inspired to try to get to the 60% by 2021. And we just -- we know that it's a question of when and not if, but we think it's a little too soon to push that out because, frankly, there's a lot of prominent economists, including the Fed. Nobody agrees and nobody can predict what's actually going to happen on the recovery. So given that, we feel it's better to just wait a little bit, see what the recovery shape is going to look like and focus on trying to drive this organization forward while people are still motivated. But yes, look, it's going to require quite a bit of a volume recovery. We're going to have to get close to pre-COVID levels in 2021. We built a plan -- when I came back -- when I came in at the end of last year and I looked at the path to get to 60% by 2021, it was clear that it was constructed in a different volume environment than what happened at the back half of last year. The back half of last year, we had a big volume drop off, and it wasn't clear that, that 60% in the old path would be attainable. So the whole team got together, we sharpened our pencils. We had proven to ourselves actually that we were more successful on the cost side. So we reconfigured the model and rebuilt it with a good clear path to get to 60% that was far less volume reliant. And unfortunately, we're sitting here going into the year with real confidence, we got a path to 60% by 2021, even if we had a few points of revenue difference from what we assumed. But these levels, it would be tough if it stayed down here, for sure. We wouldn't get there. But we're going to need it to come back quite a bit. And then if it does, we'll be on target to get there. If it doesn't, we'll be in touch with you and let you know what the revised timing looks like. Scott, I think the key thing is it's a speed bump, if anything. We're still committed to get to 60%.

Understood. So it sounds -- oh, go ahead, Alan.

Yes, Scott, you know well, all you have to do is look at an effective 230 basis point improvement in OR in the first quarter on an 11% volume decline. And then the actions that Mark and our ops team took with our locomotives and our capital structure and our capital plan for this year is highly reflective of the fact that we're adjusting, and we're adjusting very quickly. It's very difficult for us to tell you what's going to happen in 2021. We're just trying to figure out what's going to happen for the remainder of this quarter.

No, that's fair. So I mean, ultimately, it sounds like the message is "we'll see if we can get there in '21. We're hoping we can, if volumes recover. But ultimately, is it '21 or '22? We'll find out over the next several months and years. But we're getting there, it's just a question really of when".

Perfect. Perfect summary.

Okay. And so now let's try and focus a little bit near-term and maybe one for you, Alan. So volumes are down 30% quarter-to-date. Do you think at this point -- I'm going to be asking all the rounds this, do you think at this point that volumes have bottomed? And what's your outlook as you think about the different commodity segments over the rest of the quarter?

I do believe volumes are bottomed, Scott. Right now, we're tracking around 107,000 units per week. We've done that the last couple of weeks. I think the incline is going to be rough. It's going to be uneven. I think through kind of where we are in each of our markets -- our auto plants reopened this week with very limited production. The sustainability of that production is going to be highly dependent upon consumer demand and consumer confidence to go out there and buy automobiles. We're also going to have puts and takes and fits and starts with us associated with the suppliers as they're ramping up just-in-time as well. Greater increases in automotive would potentially happen after auto plant shutdown during the month of July. So I mean we're going to be looking at August or September before we see a meaningful ramp-up in auto. There's a lot of, say, steel that's already forward positioned next to the auto plants. And so it's going to take a little bit longer for the steel markets to recover after manufacturing and after auto picks up. In international or in intermodal, we're going to see probably some downturn in volume over the next couple of weeks. We've got some pretty good visibility in the blank sailings. 25% of the capacity has been pulled out of the West Coast, about 20% is out of the East Coast. And with coal exports are -- pressured India, seems like they're starting to take coal. However, now they're getting ready for the monsoon season. So that's going to be an issue. The Chinese market is still impacted by import restrictions. So that's going to be a very slow recovery. And then domestically, we're going to enter the summer with stockpiles at about 125 days in natural gas prices at extremely low levels. And so we don't see an upturn in domestic utility coal anytime soon. So hopefully, that provides some color.

It does. Just a couple of follow-ups. You mentioned auto is starting to reopen, but we won't see the real recovery until after the July shutdowns. Are you -- so it sounds like you're still expecting the typical July shutdowns to happen this year. Those are not going to get skipped this year because they were already shut down earlier?

We've heard of 1 who is potentially going to skip that. But for the most part, going forward, auto production is going to be highly dependent upon demand.

Sure. And then you said that Intermodal is likely to get worse over the next few weeks based on blank sailings. And -- so I think -- and I'm going to tie this into the mix comments that you were making earlier, Mark. So it sounds like -- and clearly, we could see we're having a challenging mix this quarter. Do you think as the quarter -- the rest of the quarter plays out, if intermodal is going to be getting maybe a little bit worse than what we're seeing right now and then that would imply some of the other things getting better maybe on the merchandise side, including autos, that the mix headwinds that you're seeing now start to abate a little bit as the rest of the quarter plays out?

If anything, that will be on the margin, Scott, I think. Don't put too fine of a pencil on this, I would -- I want to underscore what Mark said. In each of our 3 business units, the revenue per unit, ex fuel, is lining up pretty closely with where we were in the first quarter. A little bit more pressure in coal. As we had talked about how the export contracts, we're going to start to see the impact as we move through the second quarter because the Australian premium low-vol coal price started, really, to decline in April. It actually hit its high point in March. And so there's a little bit more pressure on RPU within coal. The rest are hanging in there, ex fuel. However, what you see is that intermodal was down, 22% down, the least. Our auto franchise is down 92%. Merchandise is down 33% and coal is down about 55%. All of those things equate to negative mix. And even within Intermodal, our Triple Crown product is designed for the auto industry. And so that's down very significantly, and that's the highest RPU business that we've got within Intermodal because it has a drag component to it as well. And then don't overlook the impact of fuel surcharge. We were down by $23 million year-over-year in the first quarter, and fuel surcharge revenue in the second quarter could be down 3x, 4x of that.

Okay. So just -- all helpful. Just a couple of follow-ups there for you, Alan. You've talked about coal just a bunch. So can you -- sometimes you give us some sense of utility coal trends, Northern, Southern utilities, which has mix implications. So do you have any view there? And then on the met prices, so they've taken a step down since the quarter. Do we see that show up in the RPU in the second quarter or does that have more of a third quarter impact as benchmarks potentially reset?

Right now, Scott, utility coal volume is down about 66%. Recognize that we're comping to our highest coal volume quarter of the year last year, and I believe also our highest coal RPU of the year last year. So that's going to put more pressure on year-over-year comps. Export is down about 1/3 right now. And domestic met, as you can imagine, associated with the impact of the steel industry running at about 50% capacity is down about 40%. Domestic met is relatively high rated. And so that has an impact on the RPU as well. You asked about export met. As we noted, March was a pretty high month for the underlying benchmark price. It was about $155 per metric ton. It dropped about $40 down during the month of April and then it dropped a little bit more now. Right now, it's moved up and down. But right now, it's at about $119. And so there you can visualize some pressure. There's a little bit of a lag in how that plays through our contracts. And so you'll see more pressure in that environment in May and June and then as you move through the third quarter.

Okay. I think we got all that. Okay. So let's go back to Mark for a second. So I want to understand just a couple of things on the cost side here. So when we look at the April headcount data that came out, headcount was down 18% year-over-year in April. It was down, I think, 19% in March. So I guess, I'm wondering why you're not being more aggressive on the headcount to the extent you can right now. And is there potentially a timing issue here where we'll see more aggressive headcount reductions in May as -- in response to the volume environment that obviously got a lot weaker as April played out.

Yes, Scott. So look, we're continuing to make really good progress on the cost. The headcount, as you mentioned, came down again in April, high-teen levels. We're matching our crew start reductions with volume right now in the month of May. We've taken out 30% of our crew starts to kind of match the volume. The question is when do you actually reduce the headcount or you leave those people on extra board and able us to flex when volume comes back. So I think that's the bigger issue we have is making sure that we have that flexibility to add back the capacity when the volume returns. But we are continuing to make progress. You heard about our Lynwood yard closure in North Carolina. We're going to take out 85 people there with that yard closure, that's between $10 million, $15 million of savings. So we're continuing to push hard, frankly, on all the levers while making sure that we don't leave ourselves naked when volume comes back. Remember, there's a long history in this industry where railroads struggle when volumes surge a little bit. And that happens either because we went too deep with T&E resources or inadequate number of locomotives or network congestion because we can't handle it when it all comes back at once. So we're really mindful, especially with this type of downturn that has prospects to come back rather quickly. So we're trying to balance all of this, keeping the resources out the ready. We're looking at reserve boards, which is an interim step. You don't get all of the savings of furloughs when you just cut down -- cut down T&E starts, of course, you get a little bit more of the savings if you put them on reserve board. So it's something we're certainly looking at. Incremental savings are not that significant compared to just keeping them as extra boards. But we continue to examine it all, and we're going to continue to flex based on the prospects of the recovery. And that's why we're in close communication with Alan and his team who are in close communication with our customer base to understand when things are starting to turn and how quick they might come back. So that's really the key, Scott. It's just trying to maintain some level of flexibility and trying to find that right balance.

Are there -- you mentioned the reserve boards a couple of times. Are you using that or is that something that you may use going forward?

We may. Right now, we're doing I think a good job balancing effectively extra boards along with furloughs. Extra boards, they come with some form of guaranteed payments. So it's -- when you shift over to reserve boards, you eliminate at least the guaranteed payment portion. But you still have all the health and welfare benefits. So you don't save all the costs like you would with a furlough. So we're trying to push really more into the furlough when we are comfortable things -- volumes won't come back, at least not as quickly. So right now, we think we're effectively balancing between those other two, but we are looking and examining reserve boards as well.

Sorry, I apologize. But this is a new term to me. Explain the difference between extra board and reserve board. I'm not sure I'm following.

So an extra board is essentially the difference between a crew start. When we reduce our crew starts, but we don't reduce the person, they go on the extra board or the reserve list or the bullpen, to use a baseball term. But there's still -- while they're not being paid for the trips per se. They're being -- there are some form of guaranteed payments that they do have every other week. Now when you go to a reserve board, you're basically on the hook for the health and welfare benefits. And obviously, when you go to furlough, that's when you have the full cost reduction, although there are still trailing health and welfare benefits that continue for several weeks.

So if I understand this right, the furloughs has the biggest reduction in cost immediately then the reserve board and then the extra board has sort of the least reduction in cost in the second quarter, but, arguably, would position you sort of for the best incremental margin on the way back up. Is that the right way to think about it?

That's correct.

Correct.

Okay. And then 1 more follow-up on this discussion...

Scott, just to put a finer point on it for you. So you might have an extra board that -- when people move on to the extra board or into the bullpen because you're just not starting the trains, you might save 40%, okay? If you move them into a reserve board, you might save 50% to 60%, max. And then obviously, when you move into furlough, that's where you save 100%, although like I said on a little bit of a time delay.

Okay, that makes a ton of sense now. Okay. And then -- so 1 of the other follow-up just on the labor side then is just on the comp-per-employee side, and that was an area that was -- had a little bit more upward pressure than we were expecting in the first quarter. Given this extra Board issue, is that an area where you think -- or any color you can give us on comp-per-employee trends right now?

Yes. So Q4 to Q1 -- let's just address that question that you've got. That is driven really by 2 things, primarily. It's the timing in which you have a sense of a sense of accrual true-ups. And in the case of Q4 and Q1, they move in the opposite direction. We had a big write-back in Q4 for incentive accruals. So that depressed the comp per employee, because we had less incentive payouts. Q1, you start getting on to a normal accrual again. So there was a big -- there was a shift there. And then secondly, Q1 every year, you're going to restart the payroll taxes with the new calendar year, FICA and the such. So that was kind of the Q4 to Q1 jump you see. Going forward, you'll probably see that those are going to be flat to modestly up the balance of the year. Generally, it's not a metric that we manage to. We're focused on the absolute spend which is going down, quite obviously, and we're focused on the employee levels, which are going down. But the net of those 2, there can be sometimes sequential dislocations in that ratio because, as I mentioned, health and welfare costs can lag behind when an employee is furloughed, you still have their health and welfare costs. So that can distort the ratio a little bit. And that becomes really noticeable during times of significant changes in force levels. And it may look different depending if the reduction was through attrition versus furlough. And certainly, the timing in a quarter plays a role as well. And then year-over-year, don't forget, you're always going to be facing that ratio inflation, 3%, 3.5% merit or scope -- sorry, merit inflation rates. And then employee mix, frankly, for us this year, it's still a factor through Q1 because we have much fewer conductor trainees than we did last year in Q1. And that -- we lapped that now here in Q2. Okay.

So lots of moving parts, but if I'm hearing correctly, maybe comp per employee on a year-over-year basis, up less than the second quarter than maybe the first, and partly because you're lapping that conductor training issue.

Spot on.

Okay. Now the other thing -- we talked a lot about labor productivity. So train productivity, some of the rails right now actually have train starts down more than volumes, and you're sort of matching 1 for 1. Is there an opportunity to start getting some train productivity with train starts down more than volumes or is the reality, when volumes are down 30% not down 20% that it's just tougher and don't really expect that.?

Yes, I mean we've been exceeding on -- for about 8 months, 9 months now, our train starts in excess of volumes on the way down. And we've been doing a very, very good job at that. 30% gets a little tough. You need a little bit of time to readjust it, drive more productivity and have your crew starts down further than volume when it's down 30%. But the team is -- again, they're nimble, they're looking at things. I'm certain that on the way up, we're going to see more productivity make an appearance here. I don't know if you have anything to add on that.

Yes. I think we've done a very good job of keeping our train starts in line with our volume decline while actually improving our service product. And that's an important thing, Scott. You talk a lot about yield and you can see our differentiated product, and you can see that reflected in our margin strategy on our yield performance.

Right. So let's follow-up there, Alan. So clearly, there's been some market share losses, be it to truck or to CSX, over the past several months. Do you think that -- we'll see the continued impact of that all year. But do you think that there's incremental market share that you might lose as you continue to pursue yield growth or do you feel like we've stabilized on the market share trends and it will just be more -- we'll continue to see the impact of what we've really lost, but nothing incremental. How are you thinking about market share? And where is your focus right now? Is it still on yield? Is it now more of a balance? Just some thoughts there.

Yes, Scott, we've talked about it. We are fierce competitors. We also understand that our focus is on revenue and revenue quality. And we've performed pretty well over the last 4-plus years and comps on revenue. And we're going to -- we're committed to continue to do that. And we are going to continue to focus on long-term revenue and revenue quality not near-term volume gains, right? Because that's what drives value for our shareholders. Reckon that's what drives value for our customers as well. There are always puts and takes in volumes and we see that with respect to truck and we see that with respect to the motor competition as well. We also understand that we've got some unique features of our franchise. Last year, at this time, 60% of our -- or pardon me, are coal volume was in the utility franchise. And that's down about 66% right now. We've got a very strong ethanol franchise and with forward-positioned plants. And so when energy markets are weak, that it impacts outbound ethanol and inbound coal. We also serve more integrated steel mills than any other railroad in North America. And frankly, more U.S. vehicle production than any other railroad as well. So all these things are having a market impact on our volumes that aren't necessarily related to a share shift to truck.

As well as the Hoosac Tunnel collapse.

The Hoosac Tunnel collapse. So there's a lot of things going on. The important thing is that we understand it. We've got great visibility into our markets, into our customers and into our drivers. And so we're looking through these numbers. We look at the AAR stats on car loans every week, just like you do. We are going to be determined not to make a bad decision based on some misleading signals.

Okay, so we're not going to overreact right now and pivot away from the focus on yields and margins?

Just Scott, it's revenue and revenue quality over the long term, not near term volume. And you can see that reflected over the last 3, 4 years in RPU and revenue for revenue [ time up ]. It's been a great strategy and it's delivered a lot of gain for our shareholders.

We've just got a couple of minutes left. I'm just going to -- last 2 that are coming in from online. Talking about, for you Mark, CapEx. So we reduced it to $1.5 billion this year. Is that sort of a sustainable run rate? Does that go back up next year? And then someone asking about with significantly fewer, less volume and train starts and all that, does that have an impact on your sort of rolling stock maintenance expenditures as well?

Yes, they're somewhat interrelated. So let me tackle first the CapEx. We went low here, 25% reduction year-over-year significant. We got together as a leadership team early in the year when we started to see our own volume, pre-COVID, start to show weakness. That was a catalyst to reexamine CapEx levels into this year. And obviously, as COVID was evolving, we stacked hands again and said, "You know what? We got to pony up and go deeper". So that's what we did. There is going to be natural pressure for this to come back up and to elevate from these levels. My goal is to try to keep a lid on it to the extent we can. And limit the growth. Hopefully, my goal would be, I'd like to see revenue outgrow CapEx from this point in time forward and really just put a lot of scrutiny on every project and make sure that we have a strong, robust dialogue on every dollar we spend. So there's going to be some tension in the organization. It's going to want to absolutely go up. I'm going to try to keep a lid, to some degree. And again, I'd love to be able to see revenue growth outpace CapEx and instead pivot away from this percentage of revenue fixation that we've got and focus really on what's needed. And then, yes, rolling stock inventories. I mean, clearly, if we stay down -- sorry, rolling stock maintenance costs, if we stay down at these levels, for a prolonged period of time. Yes, absolutely. You need less maintenance. But if this is a temporary trough, I'm not sure it's going to provide any meaningful opportunity. But certainly now, if this is a step change down in volume levels, then yes, we will see lower maintenance costs.

Okay. And then the final question, and hopefully, quickly, someone's asking, can you characterize Claude's role on the Board? And would you -- can you -- would you say he is any more or less involved with the management team than any others on the Board, if you have any insights there.

Actually, yes. Claude is a -- he's not just an outstanding board member in his fiduciary -- sorry, in his oversight role, but he's also acting, to some degree, as a consultant for us. And he's giving great advice and great insight to the leadership team. When we have presentations and when we talk about as a management team, what's happening with the Board in the market, what our objectives are as we're rolling out PSR. He's providing great insight and great wisdom from his own experience. Personally, I will tell you, I spend time having dialogue with Claude as CFO -- with him as a former CFO, gaining his knowledge and insight. So he's also providing a real valuable role as an in-house consultant.

I would say that on a whole, we have a very active and very engaged board, indeed. And they've put out very attainable yet difficult targets, and they hold us and Jim and the rest of the executive team accountable for hitting that. It's great to have Claude onboard because he's got some experience, as Mark noted, that's very relatable to Mark. And so there's been great synergies there. Overall, we've got a very engaged board.

Okay. I think we got to wrap it there. Thank you so much, Mark and Alan. I really appreciate it.

Yes, Scott, thank you.

All right, guys. If you guys want to roll over right now, we're going to be heading to the fireside chat with CSX. I'll be there in a minute.