Norfolk Southern Corporation (NSC) Earnings Call Transcript & Summary

Okay. Welcome back, everyone. Sorry, we're a couple of minutes behind schedule. Really happy to have Norfolk Southern back at the conference. We've got Alan Shaw, President and CEO, Alan. Good to have you here. Alan's got a couple of slides he's going to show, and then we will get right into questions. So I'll pass it off to you.

Thanks, Scott. I appreciate the opportunity to speak with you today. We were on a scheduled railroad. So we got to get back on schedule here. So today, I'm going to make some forward-looking statements, which are certainly subject to risks and uncertainties. Scott, I would invite your guests and your audience to take a look at our SEC filings, take a look at our website and take a look at our presentation for greater detail on our risk factors. Let me just start briefly with East Palestine. I was there last week. As you know, I've been there almost every week since, I was there in the immediate aftermath. And I go back and 2 functions, right? I want to listen to the community, find out what we can do well, what we can do to support them and also monitor our work and our progress. And I'm really pleased with the progress that we're making. We're making a tremendous effort and move on the environmental remediation. We've moved off over 46,000 tons of soil. We've moved off over 18,000 -- or 18 million gallons of water. We're investing in the community. We've committed over $35 million so far in community assistance and investing in the community to help it thrive. And that's just a start. I can tell you that the tone and the feel and the community has changed dramatically within the last 100 days, and that's a result of Norfolk Southern's response. We said we were going to do the right thing here. And we said we're going to be focused on the long term. And we've made promises, and we've kept our promises. We've got more work to do. But we approach this in much the same way that we approach our long-term vision for Norfolk Southern, focused on the long term and focused on a response that 5 years from now, 10 years from now is going to make the folks in East Palestine and Norfolk Southern, and frankly, the industry proud of our response. We are safe railroad. Last year, the number of derailments on Norfolk Southern was the lowest in 2 decades, and we can do better. And last year, the employee injury rate on Norfolk Southern was amongst the industry's lowest and the lowest in a decade and we can do better. And so what you've seen from Norfolk Southern is an internal focus as soon as we got the preliminary results of the NTSB investigation, which said the NS train crew did everything they were supposed to do. There were no track defects and the wayside detectors were working. We announced a 6-point safety plan. And you also see us lean forward on an external view as well because the NTSB is focused on a railcar that no railroad owns, and that touched 3 railroads before it got to us. And so I've been on the hill, having really constructive dialogue with senators and congressmen and women on rail safety legislation. And I can tell you, in the Vance, Brown Bill and then the Johnson, Sykes Bill, there are a lot of things that make a lot of sense. And you've seen me kind of step forward ahead of much of the rest of the industry and say, we're willing to support a lot of this stuff. And I can tell you the -- what's in those bills right now would not be too overly burdensome for the rail industry or our customers. I think it's -- our response at East Palestine and the feedback that we've getting from the community there reconfirms my commitment to that unique strategic plan that Norfolk Southern laid out last December at our Investor Day. We talked about an operation -- a customer-centric operations driven service model with a balance between service, productivity and growth and no longer just a near-term over focus on operating margins. But more of a longer-term focus on top-tier revenue growth, top-tier earnings EPS growth on industry competitive margins and a disciplined capital deployment. We think that's the best thing for Norfolk Southern. And so we charted a new course in the industry. We've got a unique franchise that allows us to really lean forward into this because of the strength of our intermodal franchise because we serve 60% of the consumption in the U.S. economy because we serve more than 50% of the U.S. light vehicle production. I've got confidence in our franchise. I've got confidence in our customers, and I've got confidence in our team. And that allows us to take a longer-term approach. And that longer-term approach is emblematic of what we did in East Palestine. It's working. We've got proof points on our strategy as well. We were running really well late last year and in January of this year and we were delivering really good results. We did have some -- we have had some service issues as of recent because of 2 very consequential decisions that I made to pull up the tracks at East Palestine and remove the soil. I recognize that's our mainline corridor between Chicago and Eastern PA and New York, New Jersey, and we went from a double main to a single main running at a restricted speed. And after the Springfield, Ohio derailment in early March, I talked to our operations team, I said we need to get really, really conservative on our train make-up rules, reengineer every train over every line segment to make sure that we're running appropriately. We've done that with -- when we pulled back, it created a lot of congestion on our line as cars built up because we were running much smaller trains. We're now working off of that congestion. And you can see that in the cars online Norfolk Southern. We're chewing through that backlog of freight. As a result, terminal dwell is improving. And as a result, train speed is improving. I'm really confident in our trajectory and I'm encouraged about where we're going. I can tell you that the new train make-up rules will actually enhance our productivity because it increases our use of distributed power. So it's actually going to help our cost structure in the long run, it will help our service and it will help our capacity. And as a result, guess what, when you got a better service product and you're a service organization, you've got more demand for your product. And so as our service product is improving, our volumes are improving as well. Now certainly, there -- and I'm sure we'll get an opportunity to talk about it. There's a lot of uncertainties out there. But I'm pleased to see that the volume metrics are moving in line with what you're seeing on a weekly basis with respect to the improvements in the service metrics.

Awesome. Thank you, Alan. So I'll start with some questions, but we -- it's great to see a packed room here. So as people have questions, raise your hand, we'll get you involved. So let's start on East Palestine. So when do you expect all of the track remediation work to be done and reopen the double track, when does that happen?

So we're working with the Ohio EPA and the US EPA on that, and they continue to do testing. We had originally thought that we're going to have it all back in early June. Now it looks like early July is going to be the date. That will come with some additional cost. I think it's also important to note that the bigger issue for us on enhancing service is working off of that backlog of cars online, which is what we're doing right now, and you're seeing those gains.

So I guess do you feel like you showed the slide, we're seeing -- starting to see some improvement in the service metrics. Have we seen enough that service metrics have sort of definitively bottomed at this point?

Yes, I'm very confident in the trajectory that we have. I'm never going to give you an absolute, but I can tell you that we're on the path forward to getting service back in the third quarter.

And then once we get to July, do you think we see sort of a step function in service metrics that we look at every week.

I'm not sure that we'll see a step function. What I think we're going to see is continual improvement. Now it's not necessarily linear or week to week. But as you've seen over the last -- since last couple of weeks, basically since early April, we'll continue to make improvements as we work off that backlog. And so I would invite you, Scott and the audience, to really pay attention to the cars online on Norfolk Southern. Once we chew through that congestion on the network, it's really going to enhance our fluidity, enhance our ability to spin our assets and enhance our ability to pick up more business, particularly in the merchandise network.

And so if I look back before the derailment, right, early in 1Q, your service metrics were really good. I guess how quickly can we get back to that ultimately is what we're trying to understand. And you talked about maybe some smaller trains, maybe I think you used the word conservative with train make-up. Do we need to add a lot of people ultimately to get back to the service we had in January? Or do we have the resources? And do we take the January resource as we get through the track work and we sort of get back to where we were in January. Does that make sense?

Yes, it does. Let's start with service. We've got a good service product in intermodal. We really do. The train make-up rules really impacted our merchandise network. Our service product in intermodal is not where I want it. It needs to get better. But we've got a good product right now, and we're delivering that for our channel partners. So I think you're going to have the opportunity to talk to our Hub Group and J.B. Hunt. It's in the merchandise network. We've got to speed that up. we've got the resources. For me, service is about leadership, resources and plan. My first year as CEO, it's only been a year. We've overhauled the entire operations leadership at Norfolk Southern with a focus on safety and service. We put in the new plan, top SPG, a balance between service, productivity and growth. And we've got resources. We're going to continue to hire for resiliency in a couple of areas on our network. As we communicated last December, we needed to build resiliency this year into our network. So I think that what we're going to see is gains in the merchandise network, some slight improvement in intermodal. And I think in third quarter, we're going to be back to where we were in January. And that's the proof point for our new strategy is our January results were really, really good.

And is your expectation as the service improves, the volumes come with it? Or are we in this freight recession and service can get better, but the volumes don't necessarily come with it.

Yes, there's like a lot of murkiness out there. I'll tell you, I think that in the intermodal network, we're running really well, and we're handling everything that's out there. I think there is some potential that the inventory destocking has ceased. We'll see, right? I'm not ready to call that. And certainly, there's a lot of uncertainty with respect to the consumer in the second half of the year, right? So let's see where that goes. Right now, we could absolutely handle more business in our merchandise network as our velocity improves. And I think you would see that, we will see that in automotive, and we'll see that in metals as well. So it's kind of a 2-part. We've got a good service product in intermodal. We're handling everything that's out there and merchandise as we continue to improve, you're going to continue to see improvements in our merchandise volumes.

So I understand, intermodal the volumes are being constrained by demand right now, whereas merchandise, there's more demand than you're handling, merchandise volumes are being constrained by service. So as service gets better, merchandise is where you'd expect to see the volume.

And we've got a good product in our intermodal franchise. And in fact, we started taking and we continue taking share from truck in the international markets in intermodal.

And so overall, volume is down about 7% quarter-to-date. How is that just relative to what you were planning for? What segment is doing better, what's doing worse than what you thought?

As we talked about, I think that we've got opportunity for enhancements in our volumes, particularly in the merchandise network and specifically in automotive and in metals.

And -- just one just quick follow-up on East Palestine. So on the Q1 call, you talked about $387 million of sort of onetime costs. Is that -- should we expect that sort of each quarter as we go on, there'll be some insurance recoveries that come in and that $387 million just trends lower throughout -- over the next quarters, years. Is that basically how to think about it?

One thing is certain, that number is starting to change, right? That was our best estimate at the time. We've announced 3 funds that we're working with the Attorneys General from Ohio and Pennsylvania to handle long-term water monitoring, long-term healthcare and property valuation. That will change that number. You're also going to see that number change as insurance claims come in. And certainly, that does not include any third-party recoveries either. Recall that in the first quarter, we noted that the cash outlay so far is $55 million. So we haven't even hit the floor of our 2 insurance steers. So there will be a timing differential between when we recognize the estimate and when we start to get the cash from the insurance companies and any third-party recoveries.

And I'm guessing there have been costs not remediation costs, but just you've had challenging service, you've had weak volumes. I'm sure there's been some -- but you wouldn't call onetime cost, but there have been costs. Is there any way to just quantify how much of that we saw in Q1? I'm guessing Q2 will be even worse because it's a full quarter of it. Q1 was just half a quarter.

Yes. When you're not running well, you're not providing a good service product that has consequences. It has consequences on the top line and it has consequences in the expenses. And I think we've talked in the past about a good run rate of service recovery costs of, say, $40 million a quarter, right? So there's a lot of incentive to run a good railroad, which is why we announced this new plan where we're going to be resilient and provide good service over time.

And I mean I think you've been pretty clear. It sounds like Q2 is going to be tough.

Yes. It will, right. Let me get to that. Thank you for bringing that back up. Yes, we had an awesome first -- we had an awesome January. And we exceeded our expectations on the top line and on our margins because our service product was so good, and we were outperforming normal seasonality on our volumes. Obviously, we had 2 tough months in the first quarter. We'll have 3 tough months in the second quarter. We're not taking our eye off the ball on getting service back in the third quarter and taking advantage of the unique growth opportunities on our franchise.

And just so we can sort of help set some expectations like do you think you did a [ 65 ] sort of underlying adjusted OR in Q1. Do you think we -- can we see any improvement from that from Q1 to Q2 as seasonality would suggest or given everything going on, maybe it takes a step back. Any directional color you want to give us.

Yes. As you know, we don't give quarterly OR guidance, although I understand why you're asking. I think going from 2 tough months to 3 tough months would indicate kind of where that's headed.

But your -- you would be the second quarter from a service volume, and I'm guessing that OR earnings standpoint, second quarter is the trough and we start to recover from that.

I will tell you that second quarter will be the trough for service. What happens with volume and all those other financial metrics is going to be impacted by the macro.

Okay. Yes. Maybe there are a lot of -- I want to think about the yield environment a little bit. There are -- there's a lot of puts and takes. We've got fuel, we've got met coal prices, we've got base pricing and mix. There's just a lot of -- there's a lot of puts and takes. How should we think about yields, revenue per carload in second quarter, either year-over-year sequentially? How should we think about that?

Yes, Scott, you and I have been talking about the importance of price for, what, about 8 years, right, back in my previous role. We get it. And we're really focused on pricing to the value of our product over the long term, and you've seen us demonstrate that ability. I think as you talk about year-over-year comps and where we are now, we're going to be unwinding some higher fuel surcharge revenue. We're going to unwind accessorial charges. That's going to be some headwinds, export coal prices are lower than they were this time last year. That's a headwind. We're seeing I'd say, negative mix within the intermodal franchise as we're actually picking up share from truck and international, which as you know, is lower rated than domestic. And we're getting really good pricing particularly in our merchandise and particularly in our coal markets, which will help to offset some of that.

Good price, but it sounds like mostly everything else is a headwind to yield right now.

Yes.

Okay. And when I think about underlying pricing, it feels like you guys as an industry, maybe underpriced versus your own inflation last year, we got surprised [ middle ] of last year with inflation. So from my point of view, maybe there's some potential catch-up from a pricing standpoint. We've obviously got truck rates coming under pressure. So there's puts and takes. Can pricing accelerate from what we're seeing right now? Or is it, hey, truck markets here, it's bound to start to decelerate some. How do you think about underlying price from here?

A lot of cross currents. As we talked about, I think we're getting better price in the merchandise network than we thought we were going to do entering into the year. And as our service continues to improve, I'm very confident that our team is going to deliver on that. We got to understand what the market is in the truck market. And certainly, the export coal indices are going to have an impact on price as well.

How should we -- what's the sensitivity? What sensitivity can you give us on those export met prices now in the sort of lower 200? How much of a -- and if we take this met price and hold it, how much of a revenue headwind should that be?

Yes. I think this time last year, if -- right now, the export met is probably around 245, 240. This time last year, is maybe double that, right? And so there is a headwind. You're also probably going to see some positive mix within coal, recognize that there really is no very little demand right now for domestic utility volumes. And as additional metallurgical production comes online. I think we're looking at additional 5.4 million tons of metallurgical production in the United States this year. That's got to go somewhere. The steel -- domestic steel market will soak up some of that. You'll see a lot more going export, which means we'll probably handle a lot of that. And so that will be some positive mix, although in an environment where the underlying price for that commodity is going down.

And so just based on the met price should coal ARPU takes, I guess, somewhat of a step down from Q1 to Q2 and then maybe one more step down from Q2 to Q3. Is that a fair expectation?

Yes, I think ultimately, it's going to be dependent upon mix within there. But certainly, the underlying price in individual segments is kind of following that trajectory.

And then how about like the intermodal storage piece. It's a little bit tougher to see it for you guys you embedded within Intermodal. CSX has talked about a $300 million headwind for the year. Is that a ballpark fair expectation for the headwind for you guys?

Yes, probably order of magnitude, maybe a little bit lower for us.