Norfolk Southern Corporation (NSC) Earnings Call Transcript & Summary

Okay. Afternoon, everyone. Sorry, we're a few minutes late. It is Scott Group, transport analyst from Wolfe Research, kicking off the afternoon session of our 14th Annual Global Transportation Conference. It's Tuesday, May 25, it's now 1:05 p.m. Eastern Time. Really happy to have Norfolk Southern joining us today. We've got Mark George, the CFO; Cindy Sanborn, Chief Operating Officer; and Alan Shaw, Chief Marketing Officer. Thank you, guys, for being here. I don't know if you have any opening comments you want to make or if you want to get right into questions.

Scott, we'll be pretty quick here. We've just got a few slides to share with you to get our story out there.

Fantastic.

Thanks for the opportunity to present today. A quick reminder. Presentation will include some forward-looking statements subject to risk and uncertainty, as noted in our 10-K, and we'll speak to 2020 results that exclude those 2 noncash charges we had last year, $385 million for 703 locomotives in the first quarter and $99 million cash impairment -- noncash impairment charge related to an equity investment in the third quarter. There is a non-GAAP reconciliation posted on our website under this event. So if we go to Slide 3, Scott, we've made tremendous progress on productivity ever since we launched our TOP21 operating plan in the third quarter of 2019. GTMs per employee were up 16% through the first quarter of 2021, and we posted an all-time record OR of 61.5%, a 340 basis point improvement over that same time span. Apart from last year's economic shutdown in Q2, we made meaningful year-over-year and sequential improvement, and we're proud of the progress we've made to date and we're not finished. There are many operating initiatives at the root of this improvement, some of which Cindy will talk about in a couple of minutes. But our strategy of technology innovation and implementation is also a key driver for our productivity improvements. And if you flip to Slide 4, you'll see we're making real progress here. We're putting real-time data and mobile technology into the hands of our customers and employees, and we're enhancing both our internal and external business processes. We are truly in the midst of a digital transformation with investments in technology that are really expected to drive the next phase of improvements in 5 key areas: service, quality and experience; driving growth; improving sustainability; improving operating safety and performance; and, of course, productivity and efficiency. With that segue, Cindy, why don't you talk about our productivity trends and service metrics?

All right. Thanks, Mark. We've made significant progress on a number of productivity initiatives since the launch of TOP21 in the third quarter of 2019, as you see on Slide 3. Train length and train weight grew an impressive 14% and 15%, respectively, while workforce and locomotive counts were both down 22%. We iterated on train plan changes over the last 2 years, while closing or converting 6 hump operations. That has enabled us to build out our trains longer, while reducing locomotive counts and dramatically increasing workforce productivity. These are all core PSR concepts. And we remain focused on driving more productivity ahead. In the meantime, we do take very seriously network performance as we contemplate and implement changes. So let's now take a look at our current network fluidity metrics on Slide 6. Regarding terminal dwell, we've seen a steady sequential improvement for 11 consecutive weeks with the latest weekly reading at its best so far this year. Train speed has shown some sequential improvement as well as we continue to focus on improving car velocity for our customers and our shareholders. There's still more work to do, and it's an absolute priority. And I'd like to turn it over to Alan for a couple of slides from him.

Scott, I'm going to point to Slide 7, just briefly. Our volume levels have been largely consistent this year, except for the dip that we had in February associated with the weather impacts on our network and the whole supply chain ecosystem. They rebounded very quickly as we exited the weather impacts and have been really fairly consistent since, despite some of the disruptions that we've seen from, say, the automotive industry and the semiconductor shortage. And I'll close with Slide 8. We firmly believe that we are well positioned to serve the fastest-growing segments of the U.S. economy. The economy -- or the recovery for us has been led by our unrivaled consumer-oriented franchise. Late last year, we started to see improvements in the industrial sector of our franchise. And then this year, we've gotten some -- somewhat of an unforeseen strength in our energy markets as well. And you look at GDP, Purchasing Managers' Index, housing, inventory levels, commodities markets and a really tight truck market, and it all kind of supports our growth projections for the year. While export coal is a strength for us. We continue to point to a secular decline in the domestic thermal market within our coal franchise and so we're cognizant of that. And just in closing, we believe that our leadership and sustainability are resonating with our customer base in the markets we serve, and our growth numbers are validating this point. We're confident in our ability to franchise -- pardon me, leverage our franchise, our approach and our sustainable low carbon transportation alternative to help our customers compete in a global marketplace, provide them with a platform for growth and grow our margins. With that, we'll close and turn it over to you for questions. Scott?

Okay. Great. Thank you, guys. So let's start near term, and then we'll get longer term, bigger picture stuff. So just volumes are up 33% quarter to date. What's doing better than you expected, what's doing worse than you expected? How is overall 2Q tracking relative to the plan?

What's doing better than we had forecasted, Scott, has been the export market. We've talked about thermal as a strength. We started to see some improvements in the export met market. Now that's -- the indices are looking a little healthier than they had been. That recognize that the indices are kind of based right now trading on news, instead of actual trades. So we'll see how that goes. There's a lot of geopolitical concerns going on there in the export market. So that's a volatility that could be on the horizon for us. Where we're clearly not performing the way I thought we would and where I missed was the impact of the semiconductors. It's been greater than we had anticipated. I think volumes probably hit a kind of the low level a couple of weeks ago in our automotive franchise. They had dropped like 30% sequentially over a couple of weeks. We started to see some improvements in the automotive network, but it's still pretty far away from where we think it should be, and it very well could be into the fourth quarter before we hit the run rate for automotive that we had anticipated.

Okay. And so when you add up the moving -- the parts of export better, auto is worse, you've guided to 9% volume growth for the year. How is -- or revenue growth for the year. How is -- how are you feeling about that guidance? Do you feel like there's upside potential? Are there more risks, upside? What do you think?

We're confident in it. We're delivering it. There are risks, which I've identified with the thermal market, with geopolitical tensions, with equity markets really high. Mark, you want to talk about this quite a bit.

Yes. I mean look, the momentum is there, Scott, in the marketplace. I mean the volumes are there. We're seeing it. We were very early on with confidence in the top line outlook for the year. I think we were the first ones.

And we were unique.

Very unique. And everyone has kind of come up to see the market after us. The only thing, frankly, that I think can derail this geopolitical chasms that start to emerge or imagine a scenario where equity markets really do tank and that has a secondary impact of consumers tightening, businesses tightening and suddenly, the GDP contraction starts to reemerge. But barring any of those kind of events, we still feel really good about the year.

We've got a great franchise that's -- it's really at the face of the consumer-oriented economy, and that's the fastest-growing segment of the economy right now, and we anticipate it will be in the next year as well.

Just a reminder for anyone listening, if you have any questions, type those in and we'll -- I'll make sure to ask those. So on the yield side, we've had 4 straight quarters of negative yields. Do you -- should we expect that yields finally inflect positive starting in the second quarter? And then I know fuel is certainly going to be -- start turning into a tailwind. How should we think about yields excluding fuel as well in the second quarter?

So we do expect that we're going to see improvements year-over-year in RPU starting in the second quarter. We highlighted some issues in the first quarter. With respect to yields and our approach to the market, as you know, we've got 24 consecutive quarters of RPU ex fuel improvement year-over-year in merchandise and 17 in Intermodal. So that's a -- that doesn't just happen, right? And that is -- that's execution of a strategy, a long-term strategy across market inclines and market decline. So we're very confident in our ability to price to the value of the product that we're delivering to our customers.

And Alan, when you think about yields ex fuel on a consolidated basis, do you think those would be positive as well? It looks like mix is trending positive this quarter with merchandise up 35, coal up 40. So it would seem like we've got some positive mix on top of prices. Is that right?

Yes. We'll see some positive -- we do have positive mix. We do believe that we'll have year-over-year RPU growth in the second quarter. I want to remind you though, Scott, and I know you've got this model, is that within coal we've got negative mix. As thermal coal export is the one that's leading the growth that's relatively low RPU compared to export met coal. Although within Intermodal, we've got positive mix just because of the super-heated LTL market. So there's a couple kind of crosscurrents going on there. But we do anticipate that we'll deliver positive RPU growth year-over-year in the second quarter and for the full year.

Okay. And Mark, on the operating ratio side, so we had a strong first quarter. We typically see good sequential improvement, give or take, 300 basis points from first quarter to second quarter. Is there any reason to think we should be outside of that normal seasonality, either positively or negatively? Any discrete items you want to highlight for us?

Well, I think more than discrete items, it's just the fact that normal seasonality doesn't apply anymore. I mean since the pandemic last year, it's really upended the traditional seasonality on a year-over-year or quarter-over-quarter basis. I mean we really entered a recovery in June of last year, and it's been kind of a linear increase since then. But then as Alan showed earlier on his slide, it's been kind of flat, so we've been level-loaded in terms of volumes here other than February. So because of that, I don't think you should be modeling perhaps the traditional seasonality profile as much as the way we're looking at things are a little bit more sequential. Since we came out in June of this pandemic, we've really shifted our focus internally on trying to absorb that incremental volume while limiting additional incremental costs. That's the way we're trying to manage the business right now. So aside from that, getting to your specific questions, we did talk about the fact that purchase services was a low quarter for us. We can expect to see that kind of ramp a little bit more here in the second quarter for the balance of the year, driven in part by some engineering spend, but also IT, in particular. A lot of those investments are kind of back-loaded. And then fuel will also represent a growing headwind as we exit the first quarter with surcharge on a little bit of a lag, mitigating that more in the third quarter.

Yes, it's all about potential upside or downside to the revenue guidance. Mark, I'll ask you about the OR guidance, 300 basis points as guidance for the year. How are we feeling there?

Again, I think we feel good about the guidance, we really do. The top line, that confidence that we have in the top line, it carries right through to the OR guidance because we've got our hands on -- a handle on cost, and we're not concerned by any adverse trends there.

Okay. Let's bring Cindy into the conversation. Cindy, just give us an update on what you've done so far year-to-date in terms of continued limitation of PSR. And what, if anything, is left for you guys to do on the network side on the cost side?

Great, Scott, so as we came out of fourth quarter of 2020, and we really had a very volatile first quarter with January kind of warmer and maybe a little bit more fluid in January, and then a really challenging winter, which took demand down, volume down and then pivoted right back up in March. So what we've been doing is pressure testing the footprint of terminals that we've laid out with our conversions that I spoke to and so forth. And we're starting to see some good momentum on the dwell side, and you see that, and I spoke about that. So part of what we've been doing here in the last couple of months is just working into the footprint we've got and improving our service product for our customers. But going forward, I mean, we're continuing to look at train size. That is still an opportunity for us, where we see about 10% of our trains operating at 10,000 feet. So we know that's not going to be everything at 10,000 feet, but we see some opportunity there. And I had talked publicly about siding extensions that are underway in a couple of areas on our network that will actually also help us moving forward. As we continue to progress, I mean, we will also look at terminals. There's always opportunities there as we take advantage of the volume that we're seeing and how can we handle it most efficiently from a car velocity perspective. And then locomotives, which kind of pivots back to train length and taking full advantage of our locomotive fleet and making sure we're fully utilizing it and getting fuel benefits with it as well, which has also been, from a utilization perspective, a positive story here over several consecutive quarters. So we've got ways to go. And it felt good to come out of the first quarter and get some consistency underneath our feet here.

So I guess how do you balance that? It sounds like there's more opportunities to take things out but you also want to get the service product better. How do you accomplish both of those at the same time?

Yes. It is -- it's very -- you've got to be very nimble with it. Looking at our labor productivity. We also look at the productivity that we can get in our yards and terminals. And how can we continue -- some of it's tweaking in some places and some things are going to take some investment that will be a little bit more longer-term issues. But we've really been focusing most recently on getting our service performance back because that's -- we really needed to come out strong after where we finished March. So that's taken some priority here and appropriately so. And we will continue to have a priority, but we will work on making sure we continue labor productivity in general, and there's opportunities there.

So I guess on that labor productivity point with headcount, do you think headcount needs to start moving higher from where we are? I guess we've got the levels through April. But do you think it start -- needs to start moving higher? Or can that continue to creep a little bit lower from where we are right now?

Well, I've talked a little bit about working on train size and also terminal efficiencies inside terminals. And we have been hiring. We've just let attrition kind of help us go down -- help us slowly move down where we see those opportunities. I think our biggest headwind as we go forward is we've been challenged to hire people as many others have in places where we do need it because it's not a broad-based hiring plan. And so we will -- we are having some difficulties there. That is my one concern as we head into the summer months. But we have seen some attrition, both in those that we've hired leaving earlier than we expected or finding that it's not kind of the work that they want to do. And also getting people in the door to begin with. But if we -- to do this right, it's a little bit of a mix of hiring and a mix of productivity. And I think I feel better about the productivity piece and a little bit more concerned about the hiring piece. And I think it will be a headwind for us going to the summer.

A headwind just in terms of your inability to hire, not that we actually -- okay.

Yes, yes. Absolutely. Yes. Yes. Thanks for clarification.

Okay. So we've got a bunch of questions coming in. Just on the service point, is there a velocity miles per hour that you're targeting that you want to get back to and a dwell time hours that you're targeting?

Scott, train velocity is somewhat composition of mix. And when we've seen coal run like coal's running, looking backwards, which is kind of hard to really set a target. So I wouldn't say a target, I think we still have opportunity to improve. And on dwell, we've had some moments we're further below 20 hours. We need to continue to get there and stay there. I think that's -- and improved from there, but I think that's a good target for us. And there's a lot of great work going on inside our terminals and our manifest terminals to get to that point, and we've seen some good days around that. We just need to put that together into weeks.

Okay. And this is a long question that somebody asked, but I'm going to read it. Congestion has been an ongoing problem for most rail networks in the last year. One of the things we continually hear from some of your service partners is that when they provide you with information related to upcoming equipment needs and potential network challenges based on planned customer volumes, your systems and model do not lend themselves to network responsiveness. What are you going to do to become more responsive to this criticism as rail -- and then as retail and manufacturer customers and your intermodal partners embrace digital technologies that offer predictive capabilities? Hopefully, that made sense. I don't want to reread that.

Yes. I'll talk about what we're doing with the intermodal terminal, Scott. We've seen issues where -- with contractor, labor force availability has been impacted by the lack of labor availability in the warehousing market, right? And that's created a draw on that capacity for us. So we're revisiting our -- many of our lift contractors and putting in service level agreements in there. There are -- we've had to go out and get -- acquire more chassis as street dwell has increased. We are digitizing our intermodal footprint but with the rollout of optics, which is a terminal -- Intermodal terminal optimization system for us. And one of the things that's helped us do is load our intermodal trains much heavier and much longer, which allows us to handle more volume with the same amount of resources. And in effect, interjecting resiliency as a shock absorber into our network without any capital. So there's a number of factors that we've had to work on internally within our intermodal footprint in order to accommodate these shocks to the entire supply chain. Because as you know, the drayage network is very stressed. The warehousing network is very stressed. And the international community is pumping volume into the United States as quickly as it can because inventory levels -- retail inventory levels are at historic low.

Okay. I think that makes sense. Now I mean at the end of the day, there's a lot of these questions that I think are geared towards, right, the rail industry hasn't grown volume in a long time, the U.S. rails. And are we -- do we feel confident that we can start growing and sustaining volume? Do we have the service product to do so? And then -- so maybe along those lines, another question that came in is your thoughts on CSX's acquisition of Quality Carriers. And do you feel like that's an area where you guys would look to target specialty trucking as a growth avenue and maybe as a means to sort of help attract some volume to the rail growth?

Let's talk about 2 of the points you made there. Number one, rail's inability to grow. If you look at it in total, that's the case, I think you have to pull it apart and you look at us compared to 2011. And our coal revenue has declined from $3.5 billion to $1 billion, right? And revenues have kind of stayed flat, right, during that time period. It would be mathematically impossible for us to lose another $2.5 billion worth of coal revenue going forward. Intermodal is a proof point for the rail industry. That's the best service that the rail industry puts forward as the Intermodal product, and that grows 6% to 7% a year over time, at least ours does, right? So we're very focused on improving the quality of our product and our merchandise network. We're focused on targeting that $800 billion truck and logistics market. One of the ways we can do that is a consistent, reliable service product. You don't need speed. You also layer on top, a lot of these technology initiatives that Mark talked about, right, the ease of doing business and the customer-facing technology. That unlocks growth potential for us. We -- with respect to your second point, you ultimately want to provide a product to your customer that -- we talk about the simplicity of truck, coupled with the efficiency of rail. You can do that by partnering with others in the supply chain community, and we've been pretty successful at doing that. That's our focus.

And from -- and I would just add from a capacity perspective on line of road in terms of the network, building out the trains, we still know we have some opportunity there. We can make some investment in siding capacity so that we don't have to put train starts on as a part of volume. And then when it's time to do -- put train starts on, we can do that. We have, in our case, right now, we've still got locomotives in store. We've got -- and we would have to hire up, but we can accomplish that. So I feel like, I'm like Alan, I mean, it's a story that has a lot of detail in it. That includes capacity on the line of road, which I feel really good about.

But you don't feel like you need to start acquiring trucking assets?

No.

No, we don't feel like we need to own the assets.

We could partner.

We could partner.

There are plenty of folks out there who are better at first mile, last mile than we are, and we can partner with them.

Mark, a couple of quick ones for you. So cap per employee was up, I think, 11% in the first quarter. How should we think about this cost item going forward the rest of the year?

Yes. So the way I would think about it, Scott, is probably flat sequentially, the balance of the year. Put it that way, I think that would probably equal growth in the high single-digit range for the balance of the year. But just think about it in dollar per employee as kind of flattish.

Okay. And then with the focus on technology that you mentioned, is there a capital implication there? Or should we think about CapEx, $1.6 billion, does that sort of stay steady the next few years from here? Or does that start moving higher?

Well, I think CapEx will grow, but our goal, and we've been talking about this for the past year, is really to see revenue outpace -- revenue growth outpace the CapEx growth. So we've been funding our technology investments progressively over the past few years as PTC investments have wound down. We've replaced it with projects that will actually generate a return.

So CapEx as a percentage of revenue should continue to fall and cash conversion should continue to improve.

That would be the goal, yes. But I wouldn't commit now to saying CapEx will remain flat at $1.6 billion, which was the premise of your question.

Okay. No, that makes sense. Alan, what about the pricing environment? I know we talked about yield, but what about underlying pricing? The truck market is super tight, rates are up a lot. It feels like every time we get to this level of truck rate increases, we start seeing rail pricing in that -- give or take, that 4% kind of range. Is that what you're seeing right now?

Scott, you and I have talked about price for 6 years, right? And so my viewpoint on that is we're going to take a sustained approach to this. We're not going to introduce the chase a spot market. We're not going to introduce volatility into our top line. As you know, the average duration of our contracts is over 2 years. So every year, we're touching about 50% of our business. The rate, we're doing a little bit better than our rate plans so far this year. But again, that's -- it's going to be end of 2022 before we really start to see it manifest itself throughout all of our deals.

Okay. Someone is asking, how are you handling ESG as it relates to the coal franchise as it impacts the environment and emissions?

Well, coal, as you know, is about 8% to 9% of our revenue base. We're focused on things that are important to our customers. I think more broadly, we're focused on ESG. That's become increasingly important to our investors and our customers, and frankly, our employees. And rail has a wonderful narrative relative to truck with respect to ESG. I've talked about targeting that $800 billion-plus truck and logistics market and how we have an unrivaled Intermodal franchise in the East, which lends itself to -- very easily to truck conversions. And then I also talked about our efforts within our merchandise network to take business off the highways as well. So we have a very positive and somewhat unique ESG story in the rail industry.

Want to go back to operating ratio for a second, longer term. So next step is the 60% OR. It feels like you're on track to hit that at some point this year, maybe as soon as 2Q, we'll see. Some of the rails are talking about mid-50s, even some now low to mid-50s ORs over the next few years. Any structural reason why that's a place where you can't get to?

Well, remember, our goal here has been to narrow the gap with the industry because we do recognize we were behind them all. And actually, I'll just point out, I think we did a damn good job there in Q1, narrowing the gap to, I think, 10 basis points maybe, call it a rounding error, but we had a very good first quarter. I'm not saying we're done. That gap may reemerge because of dynamics that were -- existed in the first quarter. But we've -- we made really good progress. And as we guided, we can and will go lower than the 60%. But our goal is really just to narrow the gap at this point. We're not going out there with long-term goals. Our objective is to create tremendous shareholder value, first, through fixing our margin profile and then through growth. And I'd rather say that it's not sequential. I'd like to be able to get growth and margin expansion at the same time. But right now, our focus is to narrow the gap while harvesting this growth opportunity and drive shareholder value that way.

Okay. And then my last question, then we need to wrap. We should just address M&A. Just your thoughts on M&A broadly, if we -- if this CN-KSU deal now goes through, I guess, do you think that this leads to further Class 1 consolidation? What's it going to take for maybe you guys to change the view of it is now time for M&A.? I know your view has been it's not, but what would cause you to change that view?

I mean honestly, Scott, we want to just focus on our business and focus on driving our organic operating performance. We're following the news. I mean it's evolving daily, and we don't want to get into speculating on those hypotheticals right now. We've got a lot of work to do organically to get our railroad where we want it to be. There's just no sense in us commenting on other people's deals.

We're going to get 4 or 5 different versions of that exact answer over the next couple of days.

Yes, you are.

Okay. All right. I think we've got to wrap there. Sorry, we were a few minutes late. But thank you, Mark, Cindy, Alan. I really appreciate that, just as always. Thank you, guys.

Thanks a lot. Take good care.

Okay, guys. So we're going to get going in about 2 minutes with our next panel. Our trucking panel with Covenant, US Xpress and Sts Express. Thank you, guys.