Norfolk Southern Corporation (NSC) Earnings Call Transcript & Summary

Really excited about the next session that we have, which is Norfolk -- which is with Norfolk Southern, the second railroad that we have presenting so far today on Tuesday here. From the company, we got a great lineup, we have Mark George, who's the EVP and Chief Financial Officer; and Alan Shaw, the EVP and Chief Commercial Officer. Gentlemen, welcome. Thanks very much for joining us. We appreciate you coming to the conference virtually here. We wish we were in Miami. Unfortunately, it's a lot colder here and probably even where you are, too. But let me turn it over to you. I think you have a couple of things that you want to run through, and we'll leave plenty of time for Q&A. [Operator Instructions] So with that, I'll turn it over to you guys.

Thanks, Chris. Yes. We've got a few slides we'll go through with you. Before we get into that, just a quick reminder, we will include certain forward-looking statements in our presentation today, which are subject to risks and uncertainties, as noted in our 10-K. I plan to speak to adjusted 2020 results. Please refer to the non-GAAP reconciliation posted on our website under this event. Specifically, recall in the first quarter of 2020, we launched a rationalization of our locomotive fleet by 703 units, which resulted in a noncash charge of $385 million. And then in the third quarter, we disclosed a $99 million noncash impairment charge related to an equity method investment. I will speak to full year results, excluding both of those charges. So if you go to Slide 3, 2020 clearly brought significant challenges to our country, our economy and, therefore, our industry and our company. But despite the Q2 economic shutdown and resulting 26% decline in volumes, it did not interrupt our continued focus on driving productivity in our company. With full year volumes down 12%, we managed to reduce costs by 14% and improve our operating ratio by 30 basis points. We idled 4 humps in the year, 2 of them in the second quarter during the height of the pandemic. We rebaselined our train plan, and then leveraged the returning volumes in the second half with strong incremental margins of 78% in the third quarter and 67% in the fourth quarter. We did this by growing our trains longer and heavier, allowing for the liquidation of over 700 locomotives while driving fuel efficiency gains each quarter of the year. By the way, that smaller locomotive fleet required less material and maintenance expense. Workforce was 18% smaller in 2020. And putting this into context, in 2015, we had over 30,000 employees. While in 2020, we ended with just over 19,000 employees. So we are a much different company and far more productive. So the result was strong margin expansion in 3 of the 4 quarters last year with consistent OR reductions of between 230 and 240 basis points. So with that, let me hand over to Alan, who will now cover 2020 market changes and our expectations in 2021 for those same markets.

So we had talked, Chris, on our fourth quarter earnings call about how we exited 2020 with a lot of momentum. Recall that our revenue ex fuel surcharge in our intermodal franchise was up 11% year-over-year in the fourth quarter. So we are clearly back above pre-pandemic levels within intermodal. And we pivoted to growth during the quarter in our industrial products less energy segment. Energy continued to be pressured. As we moved into 2021, we saw that momentum carry over into January. And we were really pleased with the broad-based strength that we had, frankly, in all of our markets. In January, intermodal came out really hot. The housing market is about as strong as we've seen in over a decade. Automotive production in 2021 is projected to be above 2019 levels. Metals prices are close to all-time highs and retail inventory levels remain near all-time lows. And so you've got some strength in markets, and then you've got this inventory replenishment cycle that, frankly, were just starting, which gives us a lot of confidence as we move through 2021 and is what gave us a lot of confidence to guide to 9% revenue growth for the full year. I will tell you, you can see a dip in our volumes as February has unfolded. That is all relating to winter storm activity. We've had a number of disruptions to, frankly, our network and our customers' networks, the drayage community and our customers' abilities to process through February and, frankly, it's only getting worse this week with the storms that have just recently hit Chicago, the Northeast and the Mid-Atlantic area. So you should expect to see pressure in volumes as we move through February. It is projected to get above freezing in Chicago by this weekend. And so our recovery cycle will start at that point. It doesn't change anything about our outlook for the remainder of the year, but you should expect to see stuff pushed into the second quarter and to -- into the third quarter. Next slide, please. Again, as you just kind of walk through our markets, we see strength in merchandise. That is merchandise activity has been increasing in each of the last 8 months. We've got an unrivaled intermodal franchise, which faces consumer activity in the east and is positioned up against the fastest-growing segments of the U.S. economy. And then within coal, we've seen some improvements in export thermal coal demand. So there, what you're going to see, you see strength in volumes. It's accretive to our margin targets. However, as you know, export thermal coal has a lower RPU than overall export coal and overall coal RPU. And I'll turn it back over to Mark.

All right. Thanks. So look, we do feel good about our 2021 outlook. As you heard from Alan, markets, in general, are showing buoyancy driven by increased manufacturing and consumer activity. Our 2021 planning model has strong intermodal and merchandise segments propelling us to high-single-digit volume growth, which translates into that 9% revenue growth that Alan just mentioned. Intermodal leads the way. Merchandise will grow solidly, although we do have coal declining, even if there are periods of strength during the year with coal as we're seeing here in the first quarter. So with this top line momentum and our ability -- I think proven ability to leverage our resources, we expect a run rate -- to get to a run rate OR in the 60s with 300 basis points of OR improvement this year. And I'll just mention that that's not the end point. We'll be going into the 50s after we hit 60, and we're going to continue to narrow the gap with the industry. With regard to capital allocation, we expect capital expenditures to approximate $1.6 billion. We raised our dividend last month in conjunction with increasing our dividend payout ratio to 35% to 40% of net income. And as we demonstrated in 2020, we are committed to protecting liquidity while returning remaining cash flow along with capacity from financial leverage to our shareholders. Going forward, we're going to continue advancing productivity initiatives and bring freight onto the railroad more profitably than ever. We know there is more improvement to be made across the organization, and we will execute on our commitments to drive efficiencies and create long-term, sustained value for our shareholders. So thanks for your attention, Chris, and we are now ready for Q&A.

Fantastic. Well, guys, thanks so much for running us through that. I thought that was very helpful. So I guess maybe starting off with the shorter term. So the weather impact is interesting. It's something that we've been talking about really all day today at the conference. So maybe you could help us sort of put a little bit more of a framework around what's going on. I mean last year, there clearly was a fairly clean first quarter from an operating perspective around weather. This one is less so. Any way your -- any sort of a perspective or benchmark you can kind of give us to what this might look like from a weather impact perspective relative to what we've seen in years past?

Yes. Chris, I'll cover that. You can certainly see it in the volumes. And the first one to suffer the impact has been our intermodal volumes. And you've seen those are down about 10,000 units from previous weeks. And that really is a function of drayage capacity. Really, what you -- what we saw about 1.5 weeks ago as the storms hit is our trains continue to operate and our intermodal terminals continue to operate, but street activity just effectively ground to a halt. A lot of that was because localities would not allow trucks out onto the highway. So like it's not for a lack of trying by anybody. And so you get this imbalance in assets, and that's created some issues. And now the weather that's moving its way across the U.S. has impacted operations within Chicago. I was up in Chicago last week. And I woke up and it was like 2 degrees. And that's Fahrenheit, that's not Celsius. And it's -- it really makes it -- things just operate slower in the cold. Cranes operate slower. It takes longer to get air on trains, you have to run shorter trains. If you have a lot of snow activity, sometimes you can't double stack because the snow impedes your ability to put container on containers. So it really does sap the capacity in a network. The good thing is we are continuing to be productive, we're continuing to operate every day. Frankly, hats off to our operations team, to our intermodal ops team and to our business partners for getting out there in this severe weather because any work we can get accomplished today is work we don't have to do tomorrow. We're going to keep moving. It's going to warm up and volume will recover and rebound. It's just we're seeing a winter's worth of weather in about a month, whereas you harken back to like 2014, it started getting cold in December and lasted through March. We haven't had that. This is just -- it's isolated and it's acute in the month both of February.

Got it. That's helpful. It strikes me that before we started to see some of the last week or so of challenging weather, your volumes in the first quarter actually seemed to be trending actually quite good relative to what I felt like your full year guidance would suggest, understanding that the first quarter was not the easy comp, right? In 2Q and certainly in 3Q is where the comps get significantly easier. So can you put a little context around what you're seeing from a demand perspective? Because like I said, I think through the first, call it, month and week or so of the quarter, it felt like you guys were running up almost 5%, which was -- I thought a good start to the year.

Yes. We were all pretty happy with our start to the year and our -- frankly, our ability to handle that kind of growth. That, and as I've noted, I think we saw broad-based strength. And it's scenarios, frankly, where we weren't really anticipating commodity prices, which has certainly improved over the last couple of weeks. Lumber prices are up 47% just in the last 3 weeks, reflecting the strength in the housing industry. When I was in Chicago, we were with a metals customer and his point to us is metals is the new toilet paper. Everybody wants it, but nobody can get it, right? And so there's a lot of demand out there for that. And that's reflecting of the auto industry. And with that, it also pulls plastics. So our plastics volume was really strong. Corn prices have held up. And so our ag volumes had been very strong as well. Thermal export coal, we've got some pretty good visibility that that's going to be solid for us through the first half of this year. Beyond that, no one's making any predictions because a lot of it has to do with the exchange rate and then the trade tensions between Australia and China. But there were a number of factors that led us to deliver really solid growth in January. There hasn't been any demand destruction associated with this weather. And so once we recovery -- recover, pardon me, our customers recover from this and frankly, the whole North American rail network does, too, we're going to be back towards that level of growth.

But we probably still have another week to go.

Yes. We absolutely have at least another week to go. We'll have another week to go before we get into decent operating conditions from weather, and then it's...

We need to catch up.

Yes. It's going to take some time to unwind all the delays and the bottlenecks and the network associated with this.

Okay. Okay. That certainly makes sense, and that's helpful. Auto is obviously a significant franchise for you guys as well. We've been hearing about chip shortages impacting potential production at some of the OEMs. I don't know if you have a perspective on what you're seeing on the auto side. The comps get very, very, very easy in another quarter. But before we get to that point, do we think that maybe the outlook there has been somewhat diminished? Or is that maybe not such an issue for you guys?

Chris, I think it depends upon your time frame. I will tell you that the semiconductor issue is more troublesome, more acute in the next couple of weeks than we had seen a couple of weeks before. I was asked about it on the call, and we noticed that it was somewhat problematic. It's become more of an issue with some of the plants that we serve. And so you can see that in our auto volumes. But I'll also note that the plants that we serve are making SUVs and trucks and van -- transit vans. And so our customers, our OEMs are -- they're capitalists. And so they're going to do everything they can to hit the demand for those high-profile, high-margin vehicles throughout the year. And so it will push some auto business into the second quarter and into the third quarter, but I'm confident that they're going to make that up throughout the year. So we remain very solid in our outlook for the year in terms of near double-digit growth in intermodal and automotive and in industrial products' synergy.

Okay. Okay. No. That certainly makes sense. It sounds like the demand hasn't relented at all in those end markets anyway.

No. I don't think it has. The only thing that's happened is that finished vehicle inventories has declined.

Yes. Yes.

Right. So...

[ Puts energy further ].

Right. And so what you're going to see is you're going to see that move up or production move up. And in some cases, what we're seeing is as the automakers are effectively making almost the entire vehicle and just waiting for the semiconductors to insert those chips when available. And so you're not seeing as much of an impact on the metals market as you would normally expect because, in some cases, production has slowed. In other cases, they're continuing to produce, and they're just going to wait for that final component.

Okay. That's helpful. And then just thinking about sort of the mix dynamic and maybe how that's reflected in revenue per carload as we see this year progress. So obviously, some pretty big headwinds to mix in RPU in general in sort of parts of 2020. You were kind of moving in the right direction. Fourth quarter was better than at least we had expected. And I think the trajectory might be still positive as we move, getting better sequentially in 1Q, and then ultimately, easier comps in 2Q. Has anything around that changed with what you've seen in terms of the makeup of the demand so far that's kind of come through in 1Q? And maybe what is at least temporarily impacted due to weather? Or are we still on that same path of sort of gradual improvement as we get into 2021?

Yes. I'll take it broadly and then I'll dial down into markets. We still are expecting overall RPU to be negative in the first quarter. Part of that is mix, part of that is fuel surcharge comps year-over-year. As I think about where some of the growth is occurring for us in the first quarter, export thermal coal is a great example. It's accretive to our margin targets. It is a lower length of haul than our export met. And so it doesn't carry that same sort of RPU as export metallurgical coal. And it's generally a lower RPU than our U South volume as well. And so we'll see what happens as a result of this weather. We start to see improvements in commodity prices, natural gas, which would be supportive of export coal. We'll see how much stockpile gets burned down at our utility franchise as a result of this. But I can tell you, even they are trying to determine what their target stockpile is in an environment in which they're not baseload. And it's generally going to be lower than what you would expect out of a baseload plant. And so there will be some inventory overhang that has to get worked off even if coal generation is improving. With respect to our intermodal franchise, as that continues to be a growth driver and you see even a little bit more international volume for us this year, that will have negative implications for RPU mix as well.

Okay. Okay. Got it. That's helpful. And just as you think about some of that coal dynamic, I think I heard you that the -- there's export thermal coal going out as it stands right now, so there's some demand kind of coming back for that business. Does that have a positive impact on the way we think about coal yields?

No. That would have a negative mix effect on coal yields.

Okay. On an all-in basis.

Yes.