Norfolk Southern Corporation (NSC) Earnings Call Transcript & Summary

I think we can get started here. This is our last session of the conference over webcast. So it's for people that are listening, my name is Amit Mehrotra. I'm the Deutsche Bank Transportation and Maritime Shipping analyst. I couldn't be more excited to have Alan Shaw, President and CEO of Norfolk Southern here, 90 days in the job, but 27 years at the company. So it's going to be really great. We have Mark George, the Chief Financial Officer; as well as Luke Nichols, the recently appointed Investor Relations Officer. So thank you all for joining us. Alan, I think you have a few slides and then we'll get right into a lot of Q&A.

Yes. Amit, thanks for hosting us. As you noted, we brought the A team, so we're ready. So I'm going to start with a little housekeeping I will make forward-looking statements. They're obviously subject to risks and uncertainties and actual results may vary. So I'll invite you and our listeners to take a look at our quarterly filings with the SEC for more information on our risk factors, and also all these slides will be out on the web.

Great.

We -- in the second quarter, we delivered record revenue and record second quarter EPS. So from that standpoint, it's a really solid quarter. We understand we could have done better if we had a better service product because. We certainly could've handled more volume, more revenue, and our cost structure would have been better. And so our margin profile would have been substantially better. We've really focused on 3 areas in order to address service. And I'm going to talk about all 3 of those. But effectively, it's resources in the form of crews, it is operating plan and its leadership. So I'm going to talk about crews here on this slide, this is Slide 3. We took a -- we were at our trough in terms of qualified T&E members about midpoint in the first quarter. We decided to aggressively start hiring crew members in December of last year when I became President. And -- let's say, it takes 4 or 5 months once you get them on the property to get crews trained and qualified. And so what you're starting to see as we move through the second quarter and into the third quarter as our qualified crew members have started to reflect positive. And at this point, we're over 260 qualified crew members higher than we -- and that's net of attrition, than we were at our trough in the middle of the second quarter. I think what's also encouraging for us is the fact that our pipeline for the conductor trainees remains really strong. We've got well over 800 in our training class now, again, it will take 4 or 5 months for those folks to become qualified to work productively and safely. And you should expect, and we always do, relatively high attrition in that class because it's a route away game. It's 24/7, it's outdoors, right? And so it's not for everybody. And we try to expose the trainees to that environment during the training class. So if they decide this isn't the right lifestyle for them, they make that decision during training instead of when they're out on the property. So good -- Really good progress there. The second thing that we've done is launch TOP|SPG, a new operating plan. And let me be really clear about that, right? That is about optimizing our most precious resource, which is crews. It is designed to improve service, improve productivity and improve growth by creating a road frame plan that optimizes our crew base. It absolutely follows the principles of PSR, which is serve your customers, manage your assets, control your costs, work safely and develop your people. It's a balanced plan. And when we talk about balanced within the rail industry, what you ultimately want is in any given terminal the inbound trains and the inbound locomotives matched the outbound trains and outbound locomotives because if you don't have that, then you're going to be redeploying assets in a nonproductive way whether that's crews or locomotives. And so we've really enhanced the balance in our network. And we'll probably -- I'm sure we're going to talk about TOP|SPG more in Q&A, and I'll get into that a little bit more. We also drove simplicity in our network as well. As we took a look at our train plan, we found that it makes sense that we had a lot of train originations bunched during a pretty short time period in that 24-hour window. And so we took advantage of the 24-hour window, spaced those around -- and you can do that. You can change the spacing of your trains if you run more direct point-to-point trains instead of having a lot of intermediate stop-offs. And so that's created more space and room to operate on our network, which has reduced overall train lease for us by 40%, which is pretty remarkable. I mean that's going to be a great lift of our productivity and our resiliency and our ability to execute on a daily basis. Consistent with the principles of PSR, it's an iterative plan, right? We're going to put a plan in place. We're going to measure compliance, measure execution and we're going to continue to look for opportunities for improvement. And we've just recently implemented some new changes into our intermodal franchise. And really, what we're doing here is we're seeking signals from our customers as to where our customers see strategic growth opportunities. What are lanes where they think they can really grow if we provide a consistent, reliable service product. And so in those cases, we're enhancing our service offerings. We might be launching more trains in a day, but we're not going from 2 terminals in Chicago to 2 terminals in Eastern PA, train is leaving from one of the terminals that Chicago is going to go one of the terminals in Eastern PA, right? And so that creates density, which allows you to launch more trains from that terminal, but not have more train starts in total.

That's what you're doing right now, right, in terms of changing destinations and consolidating?

That's exactly right. Right. So -- by launching trains more frequently from terminals, if a customer misses the 6:00 a.m. drop-off at the intermodal terminal, instead of waiting till the next day, the customer might be able to meet the 4:00 p.m. drop off at that terminal. So clean your terminals more frequently, should help with terminal congestion and will absolutely provide a better service product to our customers. Now as I noted, we're not doing this with any additional crew starts. One of the ways we're doing that is we're, again, looking for signals from our customers and we're not finding a lot of strategic growth opportunities in some of the lanes that we serve. We're not growing. And so in those lanes, we might still offer that same product. But probably less frequent in a given week. And so you can redeploy those crews, you can redeploy those locomotives as railcars towards higher growth opportunities. And it really is -- for us, it's consistent with our approach for yield up, which is effectively where we were seeking market signals on where to best deploy our assets. We're going to -- we're pivoting and taking a really fresh look at our merchandise network as well. And we've got a longer-term strategy on our bulk operations network, which is unit trains. That will take more time. We have some sidings that we need to complete. And you've heard us talk over the years about our siding strategy that Mark and his team are leading. Our AC to DC locomotive conversion certainly helped support our long train strategy as well. And frankly, we're going to need to get inside of our customers' capital budget cycle because they will absolutely, in many cases, need to make adjustments to their unloading or loading capacity to handle longer trains. Ultimately, customers are looking for bushels of corn or tons of coal. So less trains but delivering the same amount of volume or more upside is beneficial to both the customers and us. And so I'm encouraged by our start there. We're going to get a lot of support from that. As we implement this, as I noted, we're going to be intently focused on execution and compliance to the plan. And that's really where leadership comes in. And in March of this year, we onboarded Paul Duncan, who's our Vice President of Network Planning and Optimization. And we took the daily dispatch out of transportation and had to report to Paul because it was very important to me that the folks who are designing the road train plan are responsible for dispatching the road train plan on a daily basis. We also made a change, as you know, within the last couple of months in our VP of Transportation and put Floyd Hudson in there. Floyd has done a remarkable job he's on a lot of leadership and really driven daily execution into our plan. And what that allows is you've got Paul's team focused on the plan, the dispatch of the plan. Floyd's team is completely focused on the execution of the plan on a daily basis. But frankly, what you want in PSR is for the folks in the field, the transportation team to show up every single day and know exactly what they're supposed to be doing that same day. And it probably ought to be static. It will be the same thing they were doing the day before and the day before, that builds that muscle memory. And then what you get is once you have high compliance to the plan you've got a good flow of metrics and data, you start to look for opportunities to tweak, but that's driven by the central planning team. And then in advance, you identify what success looks like and how you're going to measure it. And if it's successful, you implement it elsewhere. If it's not successful, you want something and you -- we look to innovate in another way. So as a result of this, as a result of the crews as a result of the plant chain as a result of the improvements in our operations leadership, you've seen some pretty meaningful results in our network fluidity. And our train speed is at levels that we haven't seen in over a year. And our terminal dwell is now at the best levels that's been at this entire year. So we're certainly encouraged by the progress there. It's not where it needs to be, and we're not going to stop until it gets to where it needs to be. As I think about the network performance a slow network is costing us revenue. There's no doubt about that. We can handle a lot more volume if we're moving faster. There's also a friction cost associated with a slower network, right? You spend more money on recrews, right? If a train is supposed to get from Chattanooga to Atlanta, and because of a slow network you can't get all the way there before the crew times out, crews have got hours of service, then you have to call another crew go out and pull that train into the destination terminal. Those are, frankly, crews that I would much rather use on a scheduled road train. With the improvements that we've seen in our leadership and our plan, you can see some pretty substantial improvements in our overall recrews. That's a friction cost that as our network speeds up we're going to shed. And also, as our network speeds up, it's going to help locomotive utilization, it's going to help car utilization. It's going to help fuel efficiency as well. The other thing that we always look at is our customer-facing networks. And here, you see a remarkable improvement over the last 4 or 5 weeks in customer -- in our customer-facing metric and our merchandise network. So we're delivering improvement -- market improvement in relatively short order. And our customers are noticing too. They're talking to us about transitioning more business back to Norfolk Southern. I've talked to the CEOs of 2 of our channel partners. I've talked to a CEO of one of our bulk customers. They're seeing the improvement. They're gaining confidence in our ability to handle their business. And so they're talking about shifting business back to us. It takes time. right? I want you to be really clear about that. We'll go to the next slide. Our volume is a bit kind of stagnant, I'll say, sequentially over the last couple of weeks, there's a lot of puts and takes. The coal network is running really well for us. And demand is -- for BTUs overseas is particularly high, and frankly, domestically as well. Auto is being impacted by overall North American network fluidity we share a pool of cars, multilevels in there, that handle the automobiles. They're not spinning fast enough. And so we in other words, aren't able to take advantage of all the volume opportunities that are out there. Our corn and our grain network is running really well. The boxcar network in ag and forest products is running slow, that needs to move faster. And as that moves faster, we'll have more carrying capacity and the ability to have a more business. Intermodal is a kind of a headline issue for us when you see a pretty significant drop in our intermodal volumes. It's important to understand where that's coming from. That's in our international business, in many of the steamship lines that we're aligned with are choosing to truck business out of East Coast ports to basically short-haul destinations because they want to get their boxes back to Asia because of the...

And truck pricing is down, too.

Yes. Right. And so what that does for us is we don't have that short haul international volume, that's also a positive mix impact for us on the top line, right? So it's a drop in volume. We don't see that level of drop in overall revenue. As I noted, our domestic customers are seeing improvements in our service and talking to us about shifting business back to us. Our outlook for the remainder of the year remains relatively strong as I talk to our customers and our marketing team does their visibility into the demand environment is pretty good for the next 45 to 90 days. And as you and I were discussing earlier, even with demand starting to soften a little bit, we could still grow into this demand environment as we improve service, which we're doing. The U.S. light vehicle production is supposed to improve 18% year-over-year in the last half of this year. That's going to pull more multilevel business for us, but it also should full plastics. They should pull -- it should pull metals and it should pull glass for us. Consumer activity is a little bit weaker. And so those markets are a little bit softer. As I look at intermodal, we've talked about the dynamics there. And then coal, is really strong for us, particularly export. And we're now seeing something that I've never seen in my 28 years at Norfolk Southern, which is producers are now shifting business into the export thermal market instead of export met. Typically, export met is priced multiples higher than export thermal. Now export thermal is about $100 a metric ton higher than export met because of the energy issues that are going on over in Europe. And so that's -- that is, I think, the met price decline will have an impact on our overall RPU sequentially, but there's still a lot of demand out there. And frankly, demand is going to be limited by overall coal supply. So as I close and before we get to the questions, I want to just take a couple of minutes and talk a little bit longer term. We've got a franchise that is built for growth, right? We serve a majority of the consumption, the majority of the manufacturing in the United States. We face the fastest-growing segments of the U.S. economy, and we've got the premier intermodal franchise. And then you take a look at our customers and whether or not you're talking about intermodal channel partners or you're talking about manufacturers, you're going to talk about energy producers or food producers. Our customers are generally market leaders in their space, and they're aligned with us, and they've aligned with us because they've got faith and confidence in the quality of our franchise and our vision on where we're going to take this. We are going to compete based on operational excellence. We're going to provide a consistent and reliable service product that allows our customers to build their supply chains around and allows them to grow. We've got a talented and dedicated team. We are going to use the sustainability advantage of rail relative to truck to our advantage. That's not something that came into the logistics calculus 3 years ago, but it's certainly front and center right now for the decision makers. And we're going to leverage technology. And we're going to leverage technology to be more productive, and we're going to leverage technology to make it easier to do business for Norfolk Southern because we know that the markets that we're serving are becoming more consumer-oriented, and our own customers, their preferences for logistics services are being defined by their own B2C experiences. So I'm very confident about the progress that we've made on both leadership and our operating plan and our resources specifically cruise, and I'm extremely confident about where we're headed.

Great. Perfect. That was wonderful. And I really appreciate the detail on SPG because I think when I listen into that, it feels like there's some real PSR principles that are being implemented. And I want to talk a little bit more about that and you -- for you to provide more color on that because if I go back several years, we were sitting in Atlanta, and the yield up strategy came up. And I think that addressed a lot of issues of the previous decade where maybe chasing volume over price and trying to fix that revenue per revenue ton mile dynamic and go after price. You've certainly done that. If you look at the yield development over the last many years. It feels like now TOP|SPG is a reflection of tangible structural network adjustments, and you gave a little bit of example of that. But hoping you can go a little bit further in terms of talking about the lead times involved in implementing some of those strategies. And then also think about hump yards and hump yards are kind of thought of where cars go to die, so to speak. And I want to understand a little bit more why it makes sense to bring those back? What does that give you in this whole TOP|SPG kind of journey?

Sure. So when you joined us in Atlanta, I think that was during Investor Day in early 2019, correct?

Correct. Yes.

And in 2019 and late June about the same time period, right, we implemented TOP21, which was a new operating plan design, really implementing a lot of the principles of PSR. And since that time period, we reduced OR by 530 basis points, right? We increased EPS by 27%. We hit our OR target of 60 and we returned $10 billion to shareholders either through stock dividends or share buybacks. So we've been on our PSR journey for a couple of years and we've delivered really strong results. PSR is about incremental and continual improvement. And TOP|SPG is part of that. Our network has changed over the last couple of years, there's no doubt. And by that, I mean, our traffic flows and, frankly, the physical plan of our network. Over the last couple of years, we have closed or we've idled hump operations at 7 yards, right? And as we looked over where we are and where our flows were, and frankly, what our service product was, I wasn't satisfied. And so I asked our team to come up with a new operating plan that makes us even more efficient, makes it much more simpler, makes it more balanced. And I've talked about that. We got our terminals are more balanced before TOP|SPG, I would say, of our 15 largest terminals, about 4 of them were in balance in terms of inbound and outbound locomotives and crews. Now about half of them are. So we've really made a step function improvement there. Our train meets have been reduced by 40% as we de-conflicted the network. That makes it much easier to get across line of road. We need to recognize that crews are going to probably be our most precious resource for a while. And so we need to make sure that we're optimizing our crew base. In the second quarter of this year, we delivered record train lengths and we delivered record fuel efficiency in a pretty poor service environment. So just imagine how well we can do when we're running well right? And so we've been implementing PSR principles over a number of years. I've been personally involved in that, and TOP|SPG, I think, is another step function for us. And you saw the improvement soon we got that implemented. When we talk about hump yards, I want to make it perfectly clear, we were still doing switching, flat switching at Macon and at Bellevue. Every railroad has got hump yards, right? Every railroad has idled hump yards just like we have. And it makes perfect sense. Hump yards were built. Some of them -- some of the hump yards were built in the 1950s. But if you look at the traffic mix for rails over the last 20 years, merchandise volumes, which are the ones that use hump yards, has decline. And so it makes sense to take a look at, again, managing your assets, PSR principles, look for opportunities where you don't need an asset.

But I guess the question I had regarding that is -- it's really a question about congestion. So if I look at Norfolk's Cars-On-Line, almost 175,000. It's about 40,000 more than your direct competitor, CSX. And you do less non-intermodal volumes than they do. Well, the question I have is that does Norfolk have kind of a congestion issue and does the hump yard actually exacerbate that condition?

I'm sure you're aware that that's a non-GAAP metric.

Yes, many ways of looking at it.

Okay. And so I'm also sure you're aware that we measure it different from other roads. And I'm sure you're aware that when a car that's delivered by NS to one of our customers, it is sitting on the customer side and behind the customer gate, we still include that in our account, okay? So apples-to-apples, don't do that. I wouldn't do that, right? Look at trends over time. And I think if you index it back to early 2019, you'll see that in assets Cars-On-Line have been very flat. And frankly, what you've seen over the last couple of weeks as we've implemented TOP|SPG, is that number has come down. Let's go back to the hump dialogue, right? It is perfectly reasonable to assume that using gravity and using technology is a lot more efficient than using crews and locomotives. So if you've already got business going to the yard, it's hump capable, so you don't have to incur any additional investment, and you've got the density of volume in the multidirectional flow, then turning to hump operation on works. And it's working for us. Take a look at our dwell at Macon, and you can get those numbers on a weekly basis. It's gone down 18% since we resumed hump operations. So it helps with service. It helps with saving. It helps alleviate congestion.

Okay. And so when we think about the crews side of it, so those charts are very compelling in terms of the inflection you've seen in crews. And there's obviously much more to come on that side. Can we talk about what level we need to get to for you to see a little bit more fluidity? And by the way, we've seen a little bit of green shoots. I would say there have been some weeks that I've been worried about it where I stepped back and said, "Hey, this is kind of interesting." And it's a little bit spotty, but we've seen some signs of inflection. Can you just talk about where those signs of inflection are coming from? And when do you think we get to the point where crew or labor availability is not much of an issue for the entire industry for Norfolk Southern as it has been?

Yes. We definitely are showing improvement. And then you just go back to the last 5 or 6 weeks since we've gotten the right leadership, the right plan in place and additional crews. As crews come on board and they continue to, as I noted before, we have over 850 conductor trainees in our current class. As they mark up and become qualified and we continue to iterate our plan, you're going to continue to see improvements. Having kids go back to school helps, too, because people are less likely to take vacations right now and as we move into September. And so that will help with crew availability as well. It's not linear. I wish it were, and I wish I could just extrapolate what we've done so far. It doesn't work that way. We will continue to see improvements. That's going to provide a lift to our volume. I think that's going to be targeted towards the fourth quarter of this year. And I think it will be as we move through the fourth quarter and the next year when we start to hit our service targets, which is 2019 levels. So that's months away, but we are seeing improvement now our customers -- more importantly, our customers are seeing it. Our customers are talking to us about shifting business back. But I want you to think about a merchandise customer. So a merchandise customer right now, this is the third week of August, right, so she's probably winding up her rail shipments for the month of September right now, scheduling them. And she's doing that based on cycle times on Norfolk Southern probably over the last 6 to 8 weeks, which is when we started to see improvement. So we're now starting to get to the point where our improvements are showing up in our customers' metrics as they make their monthly decisions on volume. It's going to take time. It really will. Volume return is going to lag the service recovery.

And one thing you guys have done a good job is kind of actually keeping the operating cost structure pretty constant despite some of the service and volume challenges, I would say. But I assume this part of the process is you're also adding more assets to -- you're adding more resources to address some of the service issues. Can you just talk about the resources you're adding to address some of these and when those can come out as a result of some of the labor relief you're going to get over the course of the next few months?

Sure. It's really critical in an operating environment to do a robust diagnosis of what's going on in your network and understand what the leverage points are. I think you know this, but in my 28 years at Norfolk Southern, I spent more time in operations facing roles than I have in either market -- customer-facing or in the finance department, right? And so it's important to me. I'm attracted to that. I'm drawn to it. I'm out in the field, talking to our team almost on a weekly basis, both the operation supervisors and the craft employees. And I'm also in our network operations in every morning. So I get a sense of what's going on. For us , it's a crew issue. Now if you take a look back to say, 2014, could have said, "Yes, there are absolutely issues associated with locomotives." That's not the case now. That's -- and frankly, that's a good thing. And so that informs our decision about what assets to put in place. And we're not throwing a bunch of locomotives at this issue because that's not the issue. It's getting that network sped up through crews, through leadership, through the operating plan, through our own personal involvement in this thing, that will create much more capacity and much better utilization of all of our assets.

We're seeing some of the sort of challenges, certainly not Norfolk specific, but even CSX, which was the earliest adopter of PSR, have equally challenging service metrics. So there's something going on in the East Coast, whether it's the international intermodal volumes, the volumes that are stacking up at the ports or the labor challenges. What do you -- when you think about the Eastern network, not just you, but also CSX, what are some unique challenges that are happening in the East that are impacting the service metrics a little bit?

Well, as you noted, we operate it at a supply chain ecosystem. 50% of our business either originates or terminates on another railroad. And then all of our intermodal business is probably going to involve a warehouse or a drayage component at some point in it. So if those aren't working well, if the [indiscernible] lines don't have the chassis, if the warehouses are full, the drayage community isn't running well or if the national box carpool or the national multilevel pools aren't operated well, that's going to have an impact on our service. But I'm not using that as an excuse, right? I'm personally committed to getting the service thing fixed. I'm personally committed to competing based on operational excellence. So I'm driving accountability into our organization. And we're focused on the things that we can control. There's a lot of self-help here for Norfolk Southern through leadership, through crews through operating plan, and you're seeing the results of that.

Yes. And I hope you don't take this question the wrong way because it's not meant to be taken that way. But there's a lot of people right now that can help you accelerate that process that have decades of experience with PSR, whether it's [ Jim Bena ] or [ Sami Fami ] or other people that have a lot of experience that would be willing, I think, to come in on a 3-month, 6-month consultancy basis to accelerate to help the existing team. I've asked this question to Union Pacific as well in the past. But how do you think about your -- the potential of bringing somebody in just like CNS has in the form of [ Matt Harris ] to serve as a consultant that can help that execution or accountability part of the TOP|SGP?

Yes, I'm going to pull every lever it takes. We brought in somebody. We brought in Paul Duncan from another railroad. And you see the impact that he's had on our franchise. We changed out our VP of Transportation, you see the impact that that's had. Now we understand PSR. We improved OR 530 basis points over the last 3 years, 27% Improvement in EPS. And so we understand the principles. We understand what to do, and I am personally committed to getting this thing fixed. And we're going to pull on every single lever that it takes.

Great. Sounds good. And then the other question I had, so it looks like the stars are kind of aligning for 2023. You have service fixed fuel prices still expected to stay quite high. So there's a lot of economic incentive to move on the rail. You've got a huge intermodal franchise which obviously benefits where the growth is coming from. When we think about 2023 and having all the ducks in a row, so to speak, a lot of this TOP|SPG implementation done -- or being implemented. What do you think the opportunity is? I mean, is there a big catch up here as we think about 2023 where a lot of the inefficiencies that the industry is seeing now could reverse and you just really have a great opportunity just to put up some big numbers?