Norfolk Southern Corporation (NSC) Earnings Call Transcript & Summary

Good morning. So next up -- we continue our 30th Annual Transport Conference. Again, thank you for taking the time out of your day. I'm Ken Hoexter. Next up, we have Norfolk Southern who we welcome to our conference for the 19th time in the 22 years we've hosted the event. From the company, we've got Alan Shaw, President and CEO, having taken the CEO role just about a year ago, May 1. Certainly an adventurous year, a tumultuous one recently. We welcome them for the fourth time participating in the conference. So thank you, Alan. Also with Alan in the audience is Mark George, CFO, joining us for his third time. I believe Ed Elkins is here, hiding behind the pole, Chief Marketing Officer, for his second consecutive conference; and Luke Nichols all the way in the back. So I guess he wants you to ask them the tough questions on your way out. We truly appreciate the [ greatest ] participation and partnership with NS over the years. So Alan, thank you. Let me start with that. So I think I'm going to turn it over to you. I think you've got some opening remarks, giving an update, market update, but I would just throw out, before you even get started, just these last few weeks, it's been great to see. We've been highlighting it on our weekly -- last week just seeing the service levels rebound. I think that's a few weeks ahead of your kind of June target. So that's a tremendous ramp up. And so even the Chairman had some positive comments about the way you've been handling this and moving forward. So with that, let me turn it over to you for the intro.

Yes, I wrote those down.

What's that?

I wrote those down. You've already said something nice about -- you got to write it down. Well, thanks for hosting us today. It's always a pleasure to visit with you. And this is frankly, a good opportunity for us to talk about what we've been doing this year with respect to the ballasting and more importantly, also what we're doing with our strategy and how they interrelate. I will make a couple of forward-looking statements. Those are obviously subject to risks and uncertainties. And so can I invite your audience to take a look at our filings with the SEC on our website and this presentation for more info on our risks. Let me start with East Palestine. It's been about 3.5 months since the derailment. In the immediate aftermath, I made the commitment, we were going to do what's right, and we're going to do more than less. And that means more involvement than less involvement with Norfolk Southern on helping the community recover, more involvement than less on the environmental remediation and more involvement than less in my own personal involvement with this. I was there in the immediate aftermath. I've been back almost every week since. I'm going there tonight. I'll be awarding -- I personally endowed a couple of scholarships at the high school, and I'll be awarding those tomorrow at a school assembly. What's important is we're making progress there. We've contributed over $34 million to the community, whether that's the school system, whether that's local businesses, whether it's families. And that's just a start. We made a lot of progress on the environmental remediation. We moved over 40,000 tons of soil off-site and over 17 million gallons of contaminated water. There's more work to be done on both of those. We've established and are working with 2 attorneys general from Ohio and Pennsylvania on long-term funds to address some of the things that folks in the community have expressed to me as real concerns. And that's property valuation assistance, that's health care and monitoring -- or health care and it's also long-term water monitoring. So we're addressing those issues. We've got about 300 NS employees and contractors who are there on a daily basis. And I'm really proud of the progress that they've made, and I think the community recognizes it as well. And what I see is that when those employees go home, they typically want to go back, and I've actually heard examples of boys cutting vacations short so they can get back up to East Palestine. And that tells me 2 things, Ken. That tells me, #1, they know we're having a positive impact on the community and helping the community recover; and two, we're getting positive feedback from the community as well. So we're doing the right things and we're taking a longer-term view in our approach to this. And that's really consistent with that unique strategy that Norfolk Southern laid out last December that Jim Overman talked about, right? That's our approach, long-term value creation. And it's a balanced approach. In the past, you could rightfully accuse some in the industry of really focusing on short-term operating margins by cost control at the detriment of long-term growth opportunities and long-term EPS growth opportunities as well. And we did the math, and we laid that out pretty well at our Investor Day. It's a balance between service, productivity and growth. And it's more about long-term value creation through top-tier revenue and EPS growth, a commitment to industry competitive margins and a balanced and disciplined capital approach. And it works. And we saw it work in the fourth quarter. We saw it work in January, where our service was near or at 2-year highs, and our volumes were outperforming seasonality. And candidly, we had an awesome January. I mean we really exceeded our expectations on the top line and on the bottom line in January. And then we had some issues on February 3, and that's what we're working through right now. But as I think about our response in East Palestine, in that long-term approach, it reconfirms my commitment to our strategy because I think taking a long-term view when you're [ rearward ] is the right thing to do now. And we're going to be focused on the long-term best interest of our customers, our shareholders, our employees and the communities we serve. We made 2 consequential decisions in the first quarter that I knew were going to have an impact on our service product and an attendant impact on our revenue, and that was based on feedback from the community to take the soil up from underneath the tracks, that's our double main line. As you know, it's our premier corridor. It's our busiest corridor. And we went from double mainline to single mainline at restricted speed in early March. We expect that, that work will be done in early June. That will have an impact. That's not the only thing that needs to get fixed, there's no doubt. The other thing that had a near-term impact was after a couple of derailments in early March, I asked our operating team to get really conservative on our train makeup rules. I wanted to make sure that we were really conservative on our [ Conses ], and I wanted to reengineer our [ Conses ] by train symbol, by line segment and build capacity back. And we've done that. But when we went really small in early March, you will have seen our cars online rise, and you can see it right here. That congested our network. And it primarily congested our network and our merchandise network because that's where we really had to look at this. And in fact, right now, our intermodal network is running pretty darn well. It's not exactly where we need it, but it's in really good shape. And the issues that we're seeing right now are primarily isolated to our merchandise network. Ultimately, these new train makeup rules are going to help us. We're using more distributed power so we can run longer trains. And ultimately, it will mean improvements to our cost structure and our service product and our capacity. Those rules are now all in place. Right now, what we're doing is just modifying some slightly. And what you can see is that as you noted in your opening remarks, we're seeing train speed get better. We're seeing terminal dwell get better. We're seeing cars online get better. And I know you look at the weekly volume figures, they're getting better sequentially as well. So it does prove that service sells. I mean we make one product and it's service, and we sell one product and it's service. So we're going to provide a really good service product. That's how we're going to compete going forward, and we're going to make sure that we remain focused on industry competitive margins and a balanced capital approach.

Thanks for that, and maybe just to jump in on 2 of those points, right? One which is service came down after East Palestine, and glad to hear all the steps you're taking to improve, remediate, work with the community. I think you also said recently, don't expect that service until June, yet we're seeing that velocity pick up before your second mainline is fully operational. What is -- how are you able to do that? What's leading that? Maybe add a little bit more thought to that.

Very good. So what we're doing is we're working through that backlog or that backlog of cars of inventory on our network. So pay close attention to cars online. As we start working that off and that built up because we got really conservative initially on our train makeup rules. As we start working that off, that's improving our service product. We will not be where I'm comfortable with service, which is hitting our service targets until the third quarter. Second main -- bringing back that second mainline will help, working off this backlog is probably a bigger issue. So I would invite you to continue to pay attention to the cars online number.

So I believe that ran into what you just, I think, wrapped up with, which was car -- volumes, right? So carloads are down about 8% midway through the second quarter, a bit larger than what we had built in. You were mentioning maybe seeing some of that sequential improvement, look for that going forward. Does the volume improvement follow that service improvement? I presume it does, but maybe scale?

Yes, it does because right now, candidly, we're not handling all the demand out there in the automotive network and in the steel network primarily. And as our assets turn faster, because we worked off that inventory, because our dwell is going down, the cars online are going down, then we'll pick up more within that merchandise network. And the intermodal network, Ken, it's -- our service is pretty darn good, and it's more of an issue with overall demand. But even there, we're starting to see some sequential improvement there as well. And I was talking to Ed this morning, and I think maybe what we're seeing there, although J.B. Hunt will have a unique perspective on it as well is that, that inventory drawdown may have kind of hit a level where it's no longer going on. We'll see. Debt market remains stressed. I can tell you there's a lot of uncertainty, right, with the consumer, particularly with higher interest rates and a weak housing market. And frankly, when you move into a new house, you buy a lot of stuff, durable goods, and that's what we ship. And there's not a lot of activity now in the housing market. So that's having an impact as well.

Yes. No, we're definitely seeing that and it seems -- I mean it sounds like from Walmart, we might have found that floor on inventories. But from our truck shipper survey, it's still -- I mean it came off all-time highs, but it's still extremely elevated levels. So I agree. Hopefully, we're starting to work that down or chip away the -- let me go near term for a second, just because here we are midway through the second quarter, and I know a lot of people want to talk near term, and then we'll talk some big picture questions. But yields were pulled back a bit from fourth quarter to first quarter. You've got -- yet they're still up 8%, I'm talking sequentially pull back. But you've got fuel surcharge, highest levels last year. A year ago, you've obviously got a tougher comp. So how should we think about pure pricing? A number -- all the rails used to give, don't give any more. So how do we think about the underlying outpacing -- a fight against rising inflation here in this environment versus what could be an optical continued pullback, I presume, in terms of [ RCs ], revenue per car?

Yes. When you look at yields, the other impact, in addition to fuel surcharge, is the unwinding of intermodal storage revenue, right? And that just tells you that the supply chain is getting better and more fluid. And so as intermodal storage revenue declined, we actually picked up share from truck in the international market in the first quarter. I would tell you that our pricing has been -- was pretty good in the first quarter. It's a little bit better than what we had thought, and that's primarily in the export coal market and in the merchandise market. It's really tough to forecast the export coal market right now, but I -- the prices are down pretty significantly from where they were this time last year, the indices, but they're still at pretty elevated levels, enough to pull in and attract more production, which will be good for us. I think pricing within merchandise will stay pretty good as our service improves. We really try to price to the value of the product that we're providing. And there's a lot of reasons customers want to use rail, capacity, sustainability, and it's more cost-effective than truck.

They want to and they definitely need the service to be there it seems like in order to get the volumes. Well, we'll talk about that in a minute. Let me knock off my last near-term question, right, which you always love, the near-term operating ratio, right? So typically between 1Q, 2Q there's about a 70 basis points average improvement. This quarter -- this time, obviously, given the different issues, first quarter deteriorated about almost 260 basis points, reversing a normal trend that had been kind of flattish. So does that make hitting your target easier in terms of given the harder starting point? Or are there still overhangs from the events going on that still drag it and the service levels?

Yes. I think with what's going on, on us, and then what you've kind of seen in the macro economy since the pandemic, normal seasonality really hasn't held that much in the rail industry. Recognize in the first quarter, as I noted, we had a great January. It was fantastic. We're going to -- so we had 2 tough quarter -- 2 tough months in the first quarter. We'll probably have 3 tough months in this quarter. You'll be able to see it and watch it with the weekly metrics. As volume improves, the service improves, we'll unwind some of those service recovery costs, and we'll bring more revenue onto the network. But we're still dealing with lower fuel surcharge revenue, and we're still dealing with lower accessorial storage revenue services. And so yes, I think the second quarter is going to be -- it's going to be tougher in that perspective.

So we just finished with the Chairman, as you mentioned, and obviously, a big thing he's talked about is employees, highlighted you're improving service, your dedication to keeping the employees. You still noted, I think, that on the call, about 25% of crew regions were short back in December. And then in the first quarter, I thought you mentioned that it was as high as 1/3 of the regions were short on crews. How are you doing now? And how should we think about that going forward?

Our pipeline of conductor trainees is close to a record high. We can continue to -- compared to where we were last year where we felt like we had to hire for almost every location, we can really now become a lot more surgical and a lot of it's in the Midwest. So we're really focused on hiring in the Midwest. A lot of our conductor trainees are targeted for the Midwest. And in some areas, we've got enough flexibility because of the hiring that we've done over the last couple of years that we can apply go teams and temporary transfers to help us in areas where we continue to be short. Ken, we moved -- we went into this year knowing that we had to invest in resiliency. We knew -- even though our service was really good at the end of last year and great at the beginning of January, we knew we weren't resilient and that we needed to build that so we could handle shocks to the system, and that's what we're doing right now. So that's part of our long-term strategy.

So that's actually a perfect segue into my next question. You talked about the analysis of makeup of train rules that you adjusted. Maybe dig into that a little bit more. What does it mean? What have you changed? What does that mean for train lengths? What -- the efficiency of the network? How do you think about that?

So it really is about the locomotive configuration within the train, enhanced use of distributed power. It's about the placement of loads and empties within the train. And then there are some cars that have end-of-car cushioning devices as well, which you have to be particularly careful about where you put those cars in a train. And so as we noted, after the Springfield, Ohio derailment, I asked my team to get really conservative really fast because we were just in a position where we had -- we couldn't afford something like that, right? I needed to take the long-term view. I knew it would have a near-term impact, but I had to take the long-term view on this thing. We did that. We put the capacity back in as we've remodeled everything, and you're starting to see the results from the service product. Ultimately, it's going to help us because it will give us the opportunity to run longer trains because we've increased our use of distributed power by like 50%. I want to be clear. It will not have any negative long-term impact on our cost structure, our service or our capacity. And in fact, it will help.

So how then -- we had another rail talk this morning about now being 100% on time in terms of origination, like that's the plan and a focus on the plan. How does Norfolk think about that? Because you never -- did the full PSR kind of adoption, it was always our own way of doing it. How then do you view? What's important for Norfolk in terms of the schedule and running the operation?

Yes, getting back on plan is where we are now. That's what we're focused on. We've made a lot of strides on decongesting the network, and you've seen it with the cars online. And now the team is really intently focused on running to our plan. I mean that just makes a lot of sense, right? Then that provides a better service product. You can play in your assets whether it's locomotives and crews a lot better -- crews like it better too because they know when their next train start is going to be.

That kind of eliminates my next question is, what has Paul Duncan made to change the operating plan? So it sounds like it's still just maybe these minor adjustments in terms of how you set up the infrastructure, whether it's more distributed power, more...

Paul came in early last year. And since then, I've made a complete refresh of our operating team with a focus on service and safety. And this is the same team that delivered exceptional service for us last year and the beginning of this year. I always think about service and safety as a combination of leadership, plan and resources. We invested in the resources last year. We -- Paul put in TOP|SPG, that balanced plan that had really good results for us. We've got the right leadership in place. Now it's about tweaking the plan and really focusing on running to the plan and executing the plan on a daily basis.

Okay. Let's go back to your December Analyst Day where you set a few targets, right? So volumes over GDP. I'll just refresh everybody who might not recall them all, right? So GDP -- so now you're talking about 2% to 4% volumes, revenues over volumes, operating income over revenues and EPS above operating income or effectively double-digit growth. So here we are 5 months later, the backdrop has maybe clearly changed from the starting point. What are your thoughts on those targets?

Yes. To be clear, those are long-term targets. I'm fully committed to those. Yes, we have a unique opportunity at Norfolk Southern because of our franchise. We serve 60% of the consumption. Every day, about 100 million consumers wake up within 50 miles of one of our intermodal terminals. We've got the most powerful intermodal franchise in the East that faces the fastest-growing segment of the U.S. economy. We serve more than half of the U.S. light vehicle production. We've got a wonderful franchise that's built for growth. And then you combine that with a lot more onshore that you're seeing in the Southeast and the Midwest because of energy security concerns and rule of law, there's a lot of opportunities for growth at Norfolk Southern above kind of, I would say, industry level over the long term. And that is the basis for our new strategy, is to provide a good, safe and reliable service product and drive longer-term growth. That will allow us, as we continue to focus on productivity -- and I tell the team all the time, we are going to focus on productivity. Everyone does it, including our customers. So embrace it. We're going to focus on productivity, disciplined capital deployment, Mark is going to make sure of that, and that's going to drive top-tier EPS and revenue growth, competitive margins, for us.

I want to come back to the margins in a second, but I want to hit on the CapEx one, right, especially because of what you just talked about, some of the near-sourcing, energy, rule of law needs of just bringing business back here. Your CapEx is now about $2.1 billion or 17% of revenues. After your launch of PSR principles, it went down to 13% for a few years. It's now climbing back to 17%, 18%. Is that the right level for the rail going forward? Does that -- CSX earlier this morning talked about, given that near sourcing, a lot of opportunity, to go get more industrial sites and develop given the growth that's coming your way. Is that built into that kind of 70% target? Or do we see that creeping up over time?