Norfolk Southern Corporation (NSC) Earnings Call Transcript & Summary

Hey, afternoon, everybody. Welcome back to Deutsche Bank's 2021 Transportation Conference. My name is Amit Mehrotra, I'm sure everybody's sick of me saying by now. I'm the transportation and shipping analyst here at Deutsche Bank. We heard this morning from Union Pacific, this afternoon from CN and KCS. We just heard from CSX. And now I'm very pleased to welcome Norfolk Southern, rounding out our rail day here at the conference. Joining us from the company, we're very fortunate to have Chief Operating Officer, Cindy Sanborn. Chief Financial Officer; Mark George. Cindy, Mark, really appreciate you joining us today. Lots to chat about. I think you guys have some prepared remarks, there you are. I can see it now. I know I think you guys have some prepared remarks. Thanks again. I'm going to hand it over to you, and then we'll get it right into Q&A.

Okay. Thanks, Amit. Good afternoon, everyone. We've got some presentation materials that are posted on our website. So we would encourage everyone to go on there and open it up as we'll be referencing those specific slide numbers. Some typical housekeeping we'll just start off with and that -- we're going to have also on those site and available here are some reconciliations of non-GAAP measures to comparable GAAP measures. We will make certain forward-looking statements, which are subject to risks and uncertainties, could differ materially from actual results. So refer to our quarterly and annual reports that are on file with the SEC, for those discussions and what we view as the more important risks and uncertainties. So with that, if we look and go to Slide 3, is it? Yes. And Amit, as you know from our second quarter call, we reported a solid set of results here, which included record performance for net income, earnings per share, operating income and operating ratio for which we delivered an all-time best 58.3% in the quarter. We saw a dramatic year-over-year improvement in both revenue and volume, up 34% and 25%, respectively, and that outpaced an 11% growth in expenses, resulting in great leverage for us in the quarter. Importantly, and as we shared with you, we are very focused on improving sequentially. And then you can see evidence of that focus in our results as we held expenses flat quarter-over-quarter on a 5% increase in volume and 3% -- sorry, 6% increase in revenue. And of course, we're very pleased to finally break through that 60% operating ratio floor here in the second quarter. You see significant year-over-year and sequential improvement in the OR, even though 200 basis points of that improvement was from an outsized land sale in the quarter, but still excluding that outstanding performance in our operating ratio here in the second quarter. Now as you know, a key element of our operating ratio improvement comes from continued productivity, then we've been driving that since the launch of our TOP21 operating plan, which we started in the third quarter of 2019. And as you see on Slide 4 here, workforce productivity has been a strong driver of our improved performance over the past 2.5 years, and that continued in the second quarter. GTMs per employee were up 22%, and you can see a corresponding 660 basis point improvement in the operating ratio. Our workforce is actually 8% smaller than it was a year ago, handling 25% more volume than we did a year ago. And in fact, our workforce is down 23% since the launch of our TOP21 operating plan. So we remain committed to drive further productivity improvements into the business. And you'll hear some of the house from Cindy today, and that will continue to help us drive our operating ratio down as we move towards narrowing the gap with our rail peers. And if you turn to Slide 5, you can see we started 2021 really with 2 solid quarters, and we've achieved record first half results, including a sub-60 OR for the first 6 months as well as record EPS. Expense growth has been limited to only 3% on 13% volume gains and 15% revenue growth. So -- and this performance through the first half has really translated into a very strong free cash flow that you'll see on Slide 6, where we also had a record through the first half, and that was aided in part by very strong operating cash generation, but also modest property additions through the first half of $627 million. And all of this translated to a 99% free cash flow conversion through 6 months. And the strong cash generation and the spending restraint afforded us significantly higher shareholder distributions through 6 months, exceeding $2 billion and an increase of $807 million versus prior year. And that's thanks in part to 2 dividend increases that we had this year as well as a meaningful increase in our shareholder repurchase activity. So with that, let me turn it over to Cindy, where she'll walk us through some of our PSR-related productivity measures and some of the other topics we're working on.

All right. Thanks, Mark. I'm on Slide 7. We reported another quarter of double-digit improvement in train weight and length, both of which are now at record levels. And we did this with a much smaller pool of resources compared to pre-PSR. For example, our active locomotives are down by 20 points on the slide, and the workforce, as Mark mentioned, is 23% smaller than when we first launched our TOP21 operating plan in July of 2019. Over this time, we've made a number of strategic changes to our network, including the conversion of 6 hump yards into flat switching. In addition, we made tactical iterations of our train plans frequently, fostering our ability to build out longer trains while reducing locomotive counts and dramatically increasing workforce productivity. Of course, technology is also a big factor in our gains, and you can see that on Slide 8. We are getting better and better as we streamline internal and external business processes to enhance our product, service -- customer service model as well as operational efficiencies. As we've talked previously, investments in technology are expected to drive the next phase of improvements in 5 key areas as we enhance our competitiveness with trucks, to gain a larger portion of that $800 billion truck market that you've heard Alan talk so much about. Those 5 areas are service quality and experience, driving growth, improving sustainability, improving operating safety and performance and, of course, productivity and efficiency. So now turning to our service metrics on Slide 9. You can see that while we still have work to do, we are making steady sequential progress on our fluidity metrics this quarter as we recovered from several operational disruptions in June. Through simplification of our plans, consolidation of our resources and technology-driven process changes, we've resumed improvement and are committed to further progress for our customers, allowing opportunities to take on additional traffic with the same or fewer resources. Importantly, these operational enhancements provide a tremendous benefit to our fuel efficiency programs, as you see on Slide 10. And there's still plenty of runway ahead, which we're attacking from multiple angles, including our continued DC to AC conversion of our locomotive fleet, implementation of -- and utilization of energy management technology and also maximizing horsepower efficiency. Those are just a few examples. And just last month, we've established a new organizational alignment with ownership of fuel efficiency across the entire company and accountability of our progress through a collaborative strategy with mechanical, transportation, network planning and many others as we strive to make a lasting impact on our company, customers and community. It's not just about saving dollars, it's about doing the right thing for the environment. Turning to Slide 11. From environmental stewardship to the safety and development of our entire team, we are committed to bold leadership and deliberate action. In just the last few months, we've taken our industry-leading sustainability efforts to new heights as we became the first North American railroad to issue green bonds. In addition, we established a science-based target for greenhouse gas emissions reductions that is consistent with the Paris Agreement on climate change, and earlier this month, released our 14th annual report on corporate responsibility, where we articulate our 5-pillar sustainability strategy to set measurable company-wide sustainability goals with clear action plans. Our momentum and resolve on fuel efficiency, as an example, gave us confidence in establishing the science-based targets announced last month. Sustainability is a core competency of ours and one we will leverage as we move forward to grow profitably. With that, I'll turn it over to Mark to wrap up with our outlook.

Thanks, Cindy. If you turn to Slide 12, this is where we're going to just talk a little bit about our 2021 growth outlook. We do expect that the current economic momentum will continue through the balance of the year. Favorable conditions still persist in the consumer and manufacturing sectors. And the stage, frankly, is set for continued growth in the balance of the year. In part, thanks to the tight trucking environment but also a very strong energy demand from the red hot economic activity. Of course, there's always going to be some uncertainties to consider. We are closely watching these, in particular, the semiconductor shortage as well as other supply chain disruptions within our market sectors. Regarding coal specifically, despite near-term upside in export thermal markets, our utility coal continues to be in secular decline. We've got unit retirements we're dealing with as well as limited coal availability. But overall, more positives than negatives for the second half of the year based on the current economic outlook. And the feedback from our customers is very positive. They are increasingly confident about the current demand environment. So net-net, we feel good as we look to the back half at 2021. With that, Amit, we are ready to take some questions.

Great. Well, thanks, Mark. Thanks, Cindy. That was super helpful and comprehensive. So I want to start where you left off Mark on the volume picture, no surprise. But your volume growth quarter-to-date is on the plus side of the camp, but quite a bit below your closest competitor. If you look at kind of what you're doing quarter-to-date, year-to-date versus where you were in the same period in 2019, it's also quite a bit below. I know you guys are dealing with some idiosyncratic issues like the chassis repairs, et cetera, et cetera. A lot of that is coming from intermodal. But just talk about kind of where you're seeing the biggest differences on the relative underperformance in volume, if you'd characterize it as that? Is it transitory market share losses that you expect to get back once maybe the service level and the chassis come back? What's behind the -- if you can just talk a little bit about that volume discrepancy.

Sure. Sure, Amit. Well, one thing I can tell you what it's not. It's not merchandise. Merchandise, we're actually doing quite well. We're up 8.5% quarter-to-date and outpacing the industry actually. So it's a good area for us. I think where we're really seeing the gaps as intermodal and in coal. Let's start with Intermodal. I mean we've got clearly a distressed supply chain, and that is actually being exacerbated by the chassis repair issue that we have. We've been very upfront about that. There is additional growth to come as we get the chassis fleet back up and running, and it is coming back up. We've made good progress on repairing the faulty fleet that is out there, but there is still more work to do. And look, there's continued pressure from the drayage community and that puts pressure on our volume. So assets are not turning as quickly as they need to on rail, and that impacts our entire network, including what's going on in the street. So that said, we've seen considerable growth in our premium LTL market. And we are supporting that with the available chassis at the expense of the nonpremium traffic. So we are triaging a bit to make sure we protect that premium segment. But look, at the end of the day, we'll get back on track with the chassis, and I think you'll see better intermodal performance progressively here as we close out the year. Now on coal, we were kind of clear about this on the earnings call that there are some maintenance outages that have impacted some of the demand on our coal. We were heavily impacted by that starting in late June, and those continued through July. So that certainly has put an impact on us on the coal side. And then coal availability is down and franchise differences do make an impact, I think, when you're looking at us here. But year-to-date, we are -- our coal business year-to-date, we're up 22%. And that's, I think, 6 points ahead of where our Eastern peer is. So year-to-date, it's a good story on the coal side quarter-to-date is a little bit more where you see the issue that you've raised.

And I think -- go ahead, Mark. Sorry.

No, I was going to say, but we're confident because our customers are confident that things are going to continue to get better in the market as we close the year. Go ahead, Amit.

Yes. And I want to talk about kind of the OpEx cadence. I mean as revenue becomes a little bit more clearer as we progress through the quarter, I mean, it looks like you're obviously still going to see year-on-year revenue growth, maybe sequentially a little bit down. You've kind of talked about this low 60% OR level for the back half, I think, is what you mentioned. How do you think OpEx should trend sequentially relative to that sequential trend in revenue? Do you have opportunity to maybe lower it a little bit? Or is that just going to be what drives the deterioration of the OR in the third quarter relative to what you did in the second quarter?

Well, look, I think from an OpEx perspective, the big variable is going to be fuel, the sequential movement on fuel. I think we've been pretty clear on comp and ben, you see our headcounts kind of going sideways to leaking down a little bit. So I think you should be able to figure that, between comp and ben knowing now that you've got some incentive headwinds that I've given you some guidance on. Most of the other OpEx lines we're hoping will hold a little bit more sideways, although there will be some pressure on purchase services that we've talked about and some pressure on equipment rents as well. But aside from that, it's really more about the composition of some of the revenue change that we've made. I mean the fuel surcharge, bear in mind, we've raised our guidance on the revenue by 3 points. So when we get kind of a little more granular and specific for you. We raised it by 3 points. About 1/3 of that raise, Amit, was from the fuel surcharge. Now that covers increases in fuel expense, albeit on a lag but there's really no drop-through on that. The other 2/3 is really a combination of higher accessorials than we originally had budgeted and then also a mix toward coal, a higher mix towards coal. And those 2 elements, that 2/3 brings pretty good drop-through, really good drop-through actually. But when you blend it all together with a 1/3 that has essentially no drop-through, you're just going to have incremental margins that are a little bit lighter in the back half than what we enjoyed in the first half, especially considering that the accessorials themselves will likely diminish in the second half from what we enjoyed in the first half, hopefully, as the network and the fluidity of the overall infrastructure starts to improve. Does that give you a little bit of the color that you're looking for?

Super granular. Super helpful. And I wanted to talk -- just sticking on the volume side for a minute. I guess it was recently reported that you guys are reopening the Greencastle Intermodal facility. I know when that was shut down back in 2019, it was kind of a temporary move or at least that's what it was discussed to be. Just talk about what -- why you reopened that, what that gives you in terms of better fluidity and better ability to maybe execute on some of the demand growth you're seeing?

Yes. I think Cindy and I can talk a bit about that. I mean this is a move, obviously, to help the fluidity in the overall network. I mean it will take a lot of pressure and congestion out of, is it the Richmond?

Rutherford.

Rutherford facility. So that's really the main purpose of that move. But Cindy, why don't you talk a little more about it?

Yes. I mean I think that's essentially it. I mean it gives us more capacity and capability of landing containers on a footprint that is built for that purpose. So we've -- as you mentioned, we felt like we get to this point here at some point, and we're here. But I also think there's other actions we're taking in the intermodal space to try to solve the volume that we're seeing and being able to handle it as efficiently as we can. We talk about the chassis a little bit. But I think when you look at Landers or facility at Landers, it's in Chicago, we've got some opportunities to improve our stacking efficiencies to gain some capacity there. We've acquired some parking off-site and reconfigured our latch space in general and acquired some parking off-site. So we're doing a lot of things. Greencastle is just one to give ourselves a capability to manage the volume in this very constrained and lumpy supply chain set of challenges that we find ourselves in.

Yes. And I guess you've had a lot of things thrown at you this year. I mean, starting with the weather, you had obviously some derailments in the second quarter, congestion ongoing. You've had the chassis issue that's pretty idiosyncratic to Norfolk. But just talk about how comfortable you are with the operations today, update us on the chassis issue? How many of that 5,100 have been kind of fixed and back in service. Just give us an update, kind of state of the network, so to speak.

Yes. So I'll start with chassis. Just to kind of start at the high level, we secured about 80 vendors to help solve this repair that needed to be made, and they were across about 15 different locations on our network. We're approaching -- about 2/3 is complete with a target to be complete about 75% at the end of the month. But then it gets a little harder as you get to the stragglers and some of the stragglers are not actually on our network. So we will continue to make progress, but probably not the step functions that I'm calling out here right now. And also for reference, I think we were about 45% complete when we spoke on second quarter earnings call. So you can see the real progress we've made this month. I will also highlight that we're acquiring an additional 1,100 chassis, which we should start to see coming -- being available on September 1, and we'll be completely on site or on property by the end of the month. So there's a lot of relief coming towards the chassis situation that we find ourselves in. Yes, a little more broadly than that, how I feel -- I mean, I am excited and energized really by the opportunity to continue to improve our operation, which our customers both need and expect as well as doing it with strong amount of productivity. Working in any part of the supply chain that we're in right now with all of its challenges, it's added a little degree of difficulty, but we are making improvements. We're not anywhere where we need to be. This is also an outside sport, right? So tropical depression that's passing through town here also adds a little bit to the complexity. But I think we're creating opportunities to overcome these challenges more profitably than we ever have. We've accomplished a lot in 2021 so far, and we're continuing to find opportunities and setting ourselves up nicely for 2022 and beyond. And I'll highlight a few things that I see. We're hiring where we need to. That's been a real topic. It's really about managing our workforce. And we knew going in that we had productivity opportunities that we needed to take on. So we're going to need to replace one for one in terms of attrition, but we did need to hire in certain points in our network. So we are doing that. We are doing that in some cases, finding ourselves in a very constrained labor market. So that's a headwind for us in places, but we are really also seeing productivity and allowing attrition to help us realize that productivity. And that's really the best way to manage it without having to furlough people. You just simply don't hire and allow that productivity to be generated by natural attrition. We're continuing to get faster and more productive inside our terminals. I talked about that on the earnings call, too. And that feels really good. We're seeing about a 2-hour improvement in car dwell in our terminals from Q2 to Q3. We're also doing a nice job of handling the surge of bulk traffic when I say surge of bulk traffic as we've looked at what we thought our composition of business would look like, we thought it would be more weighted towards intermodal and manifest versus bringing on bulk trains in coal, in particular. And as you know, coal is a more resource-intensive service product. So I think we've done a really good job of bringing that on. There's still opportunities to make that more productive. The other thing I'll highlight, like the third item or fourth item I'd like to highlight is on the capital front, we've got good work going on both physical work and planning on siding extensions to allow us to continue to grow train length and our DC to AC conversion of our locomotive fleet, which gives us a much stronger tractive effort per unit in our locomotive fleet. So those conversions are also in progress. And we're still making some organizational moves as well as planning moves to streamline and simplify our network as we either we manage it as well as how it's -- how the plan is laid together. So hey, we've got a long way to go. We're going to take the improvement that we're seeing, but not be satisfied with where we are. And that's kind of where I see the network at this point.

Just one comment on the chassis thing and just to clean up a little bit. I think the new chassis that Cindy spoke about are coming on at the beginning of the year, not at the beginning of next month, beginning of '22.

That's right.

So just want to get that out there.