Norfolk Southern Corporation (NSC) Earnings Call Transcript & Summary

Hey, everyone. It's Jason Seidl from Cowen. Welcome back to Cowen's 13th Annual Global Transportation and Sustainable Mobility Conference. We are honored and pleased, once again, to have Norfolk Southern presenting. With us from Norfolk Southern as presenters are going to be Mark George, EVP and Chief Financial Officer; and Alan Shaw, EVP and Chief Marketing Officer. Gentlemen, I know you have some comments in the beginning, so why don't we start off with you guys.

Jason, thank you for the invitation to join you and our investors today. It's a pleasure to be here. Mark and I are excited about this, although I'll tell you I missed my early fall trip to Boston, maybe next year. We're looking forward to it. Mark and I will make certain forward-looking statements today. As you know, those are subject to risks and uncertainties. And I would invite you and the audience to take a look at our annual and quarterly statements filed with the SEC for a full discussion of those risks and uncertainties. If you'll advance, I'd like to talk to you about what we're seeing in the markets and increasing optimism as the third quarter has unfolded and we move into the fourth quarter. So our intermodal volumes are now at above pre-COVID levels. And it's really been led by our domestic product which has benefited certainly from the Amazon era. It's benefited from tightness in the truck market. It's benefited from the inventory replenishment and just low capacity with truck drivers. And we have a very strong service product as well. I'm going to talk about that in a little bit, which gives us some confidence to innovate into that arena. International has really started to pick up over the last couple of weeks as import activity has been very strong. And even on the East Coast, export activity has started to pick up as well. You can see within our merchandise network, we're pretty close to pre-COVID levels right now. That has been driven by the improvements in automobile volumes. Inventory levels in automobile, finished goods, finished vehicles remains very low by historical standards, down about 26% year-over-year. So we expect continued strength there. As we've talked about, that's also pulling product through the supply chain. So you're seeing coil, steel, metals and -- metals business picking up as well. We're seeing plastics pick -- volumes pick up as well, both driven by the auto franchise, consumer markets and the housing market. Auto -- or plastics prices at this point are at a 52-week high. And we're seeing a flush of that product coming our way as well. And then you've got the energy-related markets. We're comping up against some pretty hefty headwinds within our crude oil franchise. Volumes sequentially improved every quarter in crude oil last year. And right now, our crude oil volumes are down about 90% year-over-year. There still is a soft demand within the gasoline markets, and so that will impact light crude volumes for us. Spreads aren't really conducive to a lot of crude-by-rail to the East Coast, but we may see some heavy crude as the fourth quarter progresses. And then within coal, our utility volumes in August were over double what they were in May. So we're seeing improvements there. And we're starting to see a little bit more export activity into India and into China as well. So while coal remains pressured and in a secular decline, we are seeing sequential improvements within that franchise. We'll turn to the next slide, and I'll talk a little bit about our service product. And you can see that train speeds have remained kind of steady for us as volumes have improved through August as has terminal dwell. And throughout all of this, we want to remind everyone that we've rationalized 2 hump yards, and we did it while continuing to deliver a very strong service product to our customers. That's allowed us to start seeing highway conversions, that's allowed us to pick up some share, and that's allowed us to put some innovative new products out into the market, such as the recently announced intermodal product between the Southwest and the Southeast with both BN and UP and recognize those are the 2 fastest-growing regions of the country. And then I'll close with a slide on our -- one of our -- our outlook, and then turn it over to Mark. Even before the pandemic, we were seeing changes in the supply chain due to the Amazon era. And with the pandemic, we've seen a much deeper disruption to the supply chain. It's a profound reorientation of how goods are moving. Frankly, this creates a huge opportunity for Norfolk Southern because we firmly believe there's going to be greater risk aversion in inventories going forward. And we believe that inventories are going to be held closer to the ultimate consumption market. And that's the environment and that's the geographic location in which we operate. It also will support a robust demand for intermodal. And we've got the most powerful intermodal franchise in the East. We're aligned with the best channel partners out there. And we've got strategic and strong access to every East Coast port. And we've got the capacity. The capacity has already been put into the ground. And so we're putting out a very good service product, we're attracting new business, and we're adding it into an existing network. And what that does is it creates a lot of operating leverage, which creates a lot of benefit for Norfolk Southern and for our shareholders. We're going to continue to innovate, and we're going to continue to look for products that we can put into the market that bring us closer to the consumer-oriented and the consumer end of the overall economy. We'll be doing that in both intermodal and in industrial products. And within the entire economy, as a result of the pandemic, we think there's going to be more reshoring and onshoring. That's going to benefit Norfolk Southern as well because we sit on top of about 2/3 of the consumption within the economy. We think that those products are going to be manufactured closer to the end use. We also have the best-in-class industrial development franchise, and that's going to help us cite new manufacturing facilities on our franchise, which is going to support further growth for us. We've got a very strong merchandise franchise. You've heard me talk about the diversity and the resilience there. We set a record for merchandise revenue in 2019 and 2018 and in 2017 as well. We serve more U.S. vehicle production than any other railroad and more integrated steel mills than anybody else. So we're pretty confident about where we're headed in that franchise. Overall, we're continuing to make changes to our operating plan as we continue to look for opportunities to deliver efficiency and productivity. Personally, I've been out with 8 of our 9 operating divisions over the last 5 weeks talking to them, our operating team, about how marketing and ops can work more closely on driving improvements in productivity and service and in revenue growth. We're going to continue to do it based on data. We're going to make data-driven objective decisions on what's best for Norfolk Southern and for our shareholders. We're going to continue a no-surprises approach to PSR in which we're collaborating with our customers, our short-line partners, with our port partners on ways to improve our efficiency and their efficiency while preserving a platform for growth. So we're going to continue to be focused on those initiatives, we're going to be data-driven, and there will be no surprises. Mark?

Yes. So go to the next slide, which is Slide 6, and let's talk a little bit about our productivity trends, in particular, our quarterly T&E productivity. You can see this is the chart we've shown before. Going back to 2015, we were retaining 3% productivity increases each quarter. And as you can see here, we really saw a step change acceleration in productivity as we launched PSR in mid-2019. Now 2 notable points I want to address here. First, you can see the effects that the pandemic-related volume decline had on the second quarter productivity from that 29% decline in GTMs. Now despite that anomalous volume decline and productivity dip, the Q2 productivity levels were still at historically high levels, which shows the amount of change and structural improvement that's been driven into the business since the PSR launch. Second and more important is the third quarter data point. It's trending very well, as you see on the chart. We're having good success bringing volumes back onto the railroad, leveraging our existing resources, which [Audio Gap] the second quarter call. In fact, both July and August, we drove crew starts down by 10 points more than the volume decline year-over-year. So a pretty good story, and that productivity is a result of absorbing volume on existing trains as measured by train weight. If you go to the next chart, you'll see here's a snapshot of train weights by quarter since the beginning of 2019. You'll see in the third quarter, we increased train weights to around 6,900 tons per train. That's an 11% improvement since the beginning of 2019. And what you're seeing here is the success of adding incremental volume into existing train service, whether it's intermodal or merchandise volume. We're leveraging the capacity dividend we created with our PSR-based TOP21 operating plan, running a fluid railroad with fewer but bigger trains. Now remember, this improvement has come despite headwinds from less bulk freight, including coal. And I'm sure everyone knows the story with coal. You saw it on Alan's slide, his first slide, but it is down disproportionately, about 33% year-over-year, and that obviously poses headwinds to average train weights. However, the team has been able to overcome and offset this by fitting the rebounding volumes that we've seen here in Q3 on a train plan that was downsized for the pandemic. And as business has returned here in the third quarter, we've avoided the addition of new trains. So it's a good story on productivity. And if you move to Slide 8, I'll just take a second here. Let me give you a brief update on capital. We continue to be in very good shape with the balance sheet. We've got about $1.2 billion in cash after the dividend payment that's scheduled for tomorrow. Total liquidity stands at $4.7 billion in an economic environment that's actually improved from what we started to see in April and May where everyone started to tighten up a bit. So we still -- we feel very good about our liquidity. And I will say we are still committed, however, to our dramatic reduction in capital expenditures in 2020. We've reduced our budget to $1.5 billion while keeping the physical network in good shape, while advancing the locomotive modernization program that we have underway and also protecting our near-term revenue opportunities. So we're scrutinizing the dollars we invest. That's a priority for us. And I'm very proud of our team and how quickly we reacted to help deliver a more constrained CapEx budget this year with the onset of the pandemic. So with that, Jason, Alan and I are open to questions.

Okay. Fantastic. I think we -- I'm able to conduct the IT movements here behind the scenes. So I have a few of my own prepared questions, and then we're getting a bunch in from investors. So I'm going to try to balance it, so people can sort of get what they want asked. I guess this can go to Alan. Alan, when you look at your yield-up program and you look at sort of your competitor, CSX, beating you out there on the volume side, do you think that yield-up program is part of the reasons why you trailed them on the volume side? Or do you think it's something else?

Yes. We talked about this, particularly after the first quarter. And we highlighted that there are a lot of issues that were going on that were impacting Norfolk Southern more than maybe some of the other rails. That included our utility network. We have a larger percentage of our coals in our utility network than some others. It included crude oil, I mentioned. It included ethanol, it included NGL. So there's a lot of pressure on energy markets which we faced. We also knew that some of these issues, we were going to overcome them as the year progressed. And you can see improvements in our volumes at basically since the middle of the second quarter since about week 20 in mid-May. Look, we understand that we operate and we are defined by that $800 billion-plus truck and logistics market. And that's where our opportunities are, that's where we're positioned, and that's where Norfolk Southern excels. We're going to continue to excel in that consumer-oriented market. And we are confident that, that's where there's going to continue to be long-term growth and long-term demand in the U.S. economy.

Let's talk a little bit about that market because, clearly, truck rates have been off to the races the past month or so. And this week, it's probably not going to get any better with Roadcheck having been decided. How much has that helped you guys? And how much that we've seen on the rebound on the intermodal side or maybe in some of your merchandise traffic can be just attributed to the demand function out there in the marketplace?

Jason, I think it's helped quite a bit. What you're seeing is that spot rates are pulling contract rates up. So that's going to offer some long-term support in that market. There's not enough demand. I talked a little bit about the supply of truck drivers, which has been impacted by increased drug testing. And it's been impacted by higher insurance rates. And so these are all kind of like secular drivers that are going to continue to put pressure on truck capacity. We're also seeing kind of an attempt to inventory restocking. Retail inventory-to-sales levels in July were the lowest on record. And then overall inventory levels in August were even lower than July, even though sales weren't up. We don't have the final census data. But I think you're going to see a continued pressure there as well. Then you got like PMI is positive, durable goods is up 11.4%. So there's a lot of demand out there for our product and the space in which we compete, which is within that truck market is pretty stressed.

If we could just flip a little bit, I'm going to stick with intermodal, and then I have a quick question for Mark, and I'll grab some from the clients. But on the international side, we've seen a lot of shifts in sort of global supply chains. A lot of people move to sort of Southeast Asia away from China. That's pushing [ freight less ], which means it's going to come to the East Coast or it's going to come to the Gulf. How do you see your share of international modal -- intermodal over time?

Well, over the last 10 years, we've seen that profound shift that you talked about from -- on our volumes from West Coast originations or terminations to East Coast. We think that will continue. Right now, there's a lot of business going in through L.A. Long Beach. And a lot of that is getting transloaded into 53-foot containers, which benefits our intermodal franchise. And as I talked about, we just launched a couple of new services from the Southwest into the Southeast, which is helping as well. But we've got great access to all of the East Coast ports. We're aligned with a lot of the capacity in the vessel strings that are hitting the East Coast right now. We're starting to see improvements in export activity through the East Coast as well.

Perfect. Thanks...

We've got the best intermodal franchise in the East, and we're going to leverage it.

Great to hear. Mark, I wanted to follow up on one of the comments you made. You talked a little bit about CapEx this year. I know you don't have a budget for 2021. But given how low it is for 2020, directionally, how much of an upswing should we expect for next year?

Yes. It's a fair question, Jason. I mean we clearly went low by taking out $500 million this year. My goal is sort of want to go up from here, and my goal is to keep the increase as small as possible. Regardless of revenue, I want -- obviously, I'd like to see revenue grow at a much faster rate than our CapEx and decouple this percentage of revenue guidance that we've lived by in the past. So I think we'll probably see a modest increase, but I'm not going to put a fine point on it yet.

Okay. So a modest increase is what we should expect?

Yes.

Okay. Okay. Let me grab some questions here from the audience for you, gentlemen. Can you see a scenario in which headcount growth is flat or close to flat sequentially 3Q versus Q2 despite the improvement in volume?

Yes. I can see that scenario.