Norfolk Southern Corporation (NSC) Earnings Call Transcript & Summary

Let's kick off day 3 at Laguna. With arguably the most exciting kind of idiosyncratic story in the space right now, Norfolk Southern. Very happy to have with us, newly appointed CEO, Mark George and COO John Orr. Gentlemen, thanks so much for being here.

Mark, congratulations. I know it's been less than 48 hours but -- and obviously you're very well known to the investment community. But any early thoughts on kind of how would you like to make the role your own? Kind of any -- what would you do the same, what would you do differently?

Thanks, Ravi. It's great to be here, and it's great to see all these familiar faces too. We're really excited, John and I, about moving forward right now. I mean, obviously, we've been in the news for all the wrong reasons in the past week. But I am super proud of our Board for moving very swiftly and very decisively and very quickly so that this is just a speed bump, and it's not a continuation of all the distractions that our organization has been dealing with for the past 18 months. So I'm really happy about that regardless of who the appointment was in those cases. In this case, it's me, but I'm just happy, we got this behind us quickly. We can get the organization focused moving forward. We've got a lot of momentum inside of Norfolk Southern. I think you've all seen the weekly progress that John to my left here has made since his arrival. It's been immediate and consistently progressing forward. And I am thrilled because look, I've been here for 5 years inside the company. We can talk about the fact that I spent 30 years inside of another industrial conglomerate United Technologies. And I've seen the world operate differently without a whole lot of patience for anything other than excellence on the operations side. A high-quality oriented organization that we had a quality system in place for my 30 years whether it's Six Sigma or ACE, that concept existed, and that's what I was bred with. And the tolerance for poor performance inside of rails has always bothered me. And the fact that now we've got a real operator with 40 years of experience, you started very young, I know, but with 40 years of experience, we've seen everything, has seen everything that's been broke and has been able to fix it. And we now have that legitimate operator, I'm thrilled with, because we can't have patience for anything other than excellence. Because if you're not excellent in the way you serve your customers, they have options and we've suffered from that over my first 4.5 years. So thank you, John, for coming on and making the impact that you and your team are making. I know it's not a one-man show.

No.

But I think that's kind of the biggest story in short order. The difference that one leadership change can make, I'm really blown away by it.

Got it. I'm going to pepper John with a bunch of questions, but maybe just one follow-up to you and just wrap up what you were saying. It has been a distracting 18 months for the organization. How do you turn the page? How do you kind of make a fresh start, especially kind of through the organization? Obviously, like you said, very decisive action at the top of the company, but how do you going to permeate that through the organization?

Yes. Look, I'll be honest with you, this -- the 18 months has been brutal for our organization, for our employees. Nobody wants to work with a name card with a company who is infamous right now. whether it was the derailment, the PR crisis, the GR crisis, the environmental crisis, being in the news for all the wrong reasons, they're eager to move forward with pride. And Norfolk Southern has a very long history of being successful, and we want to get great again. We really do as a company. So people are excited that we're now turning the page. We're moving forward. And I think that's the main focus is to harness the best out of everybody. And with John and John's leadership, maybe talk a little bit.

Yes, if I could just add, I think. Just -- I'll frame it in the last 6 months. We've been churning through a change in organizational realignment for the 6 months, even as I came in, in the midst of the proxy issues. All through that leading operations with confidence and capability and creating that accountability structure was really key. And just over the last 7 days, the last 5 days, our team has been well practiced with dealing with exception management and driving performance with the common purpose of serving the customer at the best cost and closing the gap to our competitors. This -- I was really proud of the team when this news broke and the hype, they recognized this could be distracting, immediately all of them, including -- led by Tim Livingston, Senior Vice President of Operations went out to the field, engaged our employees on safety. Safety is the key to everything. It's the value that we drive every decision that stabilizing force allowed us to just work through, last thing we wanted was somebody to get so distracted, they got hurt or caused a disruption within the community or within the organization as a derailment or something like that. And as they saw the press and they saw the Board reaction and of course, Mark is well known in operations. We have a lot of great debates and great discussions, but they were stoped if I could put it in California terms and we're still -- we're really excited. And to a person, they have already moved on, moved up, and are energized.

Great. So let's talk about the path forward from here. But maybe starting with a little bit of a step back. When you kind of came in, like you said, kind of a few months ago in the middle of the proxy battle, a, what did you find and b, what were customers telling you they needed to see to kind of come back on the railroad.

The nice thing is, let's start with the customers because Ed is 10 steps away from me in the office. Mark, was 30 and now he is 40, so I'll get more steps in, but we're tight, we're very tight, the 3 of us. And I was less worried about that and more worried about the actions and deeds and deliverables I could provide Ed to have a better narrative. As we got more momentum starting with on-time performance in our terminals, really focusing on the merchandise cost structure and capability structure, that started this first churn of improvement. The second churn was increasing standards and capabilities and visibility. That allowed us then to see the proof of what we're doing, especially as we moved to higher standards and capabilities we didn't erode our service product. In fact, our intermodal composite improved. It notched up a couple of points. And we started to improve our merchandise on-time deliveries. And then we started to hear from the customers. And then we saw the customers vote with their actions. We started to get more spot moves. The capabilities that we created to have locomotives in the right place at the right time, the right cars being used, less cars per load allowed us that capacity that we created from a car, a resource and then an over-the-road component and they voted with their products. So we saw -- I saw that through their actions, Ed and I talked about it. We have -- Ed and I are -- 3 times a week have a structured ops commercial meeting, where we talk through any issues, we talk through what's coming up, and we energize around how to build that top line growth. And of course, then I'm focused on the bottom line in context with that. So I think that's the most critical piece that we're doing and focusing on what I do, and that cascades into the value proposition for the entire organization.

Got it. I'm going to come back to top line and growth in a second. But when you think of the continuous improvement in service product, is that just implementing best practices? Or do you need to invest in the network to kind of get it up to that level as well?

Yes, there are some things that we don't have to invest as much as we thought coming in like locomotives and resources, we've really got a discipline around that, and even structurally changing how we view locomotive distribution, horsepower per ton, cranking that down, like I describe an 8 burner stove. So those are things. But then I look at how do I consolidate assets, create world-class facilities to minimize downtime as we increase our safety composition of wheels and safety appliances on cars, for example. So yes, there will be investments, but there'll be investments with a high ROIC. And that's the P&L link between Jason Zampi, whom we call Jay-Z, and Mark and me and the team. So yes, but it will be tailored, really bespoke capital investments, but certainly not for capital for capacity unless it's something new and emerging.

I'd say, Ravi, we've had a lot of low-hanging fruit with just some process changes and some focus by operations. John has quickly harvested that, there's been a 3-month payback on bringing John into the company because we immediately took out all of our port service-related costs in the second quarter, just with the process changes that John brought in. And then there's more of that. As John talked about, whether it's a 6-burner stove or I think he's more like a hip-hop DJ, mixing records. But it's that stuff, he's grinding it out. The costs are coming out. And yes, there will be bigger stuff that has to get worked on to get the next layer of productivity and expense reduction in 2 and in 3 years, that we have to start forward planning for now, whether it's a little bit of investments in our yards or whether it's sidings, things like that, we'll focus on. But right now, what I love about it going back to my quality analogy, they're looking at processes and standards. And the other thing I want to point out that John has done, which I love, is he set up these war rooms, okay? And that's analogous to kind of this relentless root cause analysis. When you have issues, in a quality organization. When you have issues, you drill into the processes to understand what broke down and then what process changes you need to fix it permanently. He's got these war room set up with these guys behind and girls behind these huge screens, identifying the issues, what the root causes are and how to permanently fix them. And we haven't seen that. And I'm thrilled because that's what I've been looking for and waiting for, for my 5 years, and he's brought it in, and I'm just thrilled.

Got it. I just want to clarify that we have Jay-Z here. We have a hip-hop DJ here, but Beyonce will not be making it today. So when you think of that $250 million kind of cost opportunity, can you remind us kind of how far are we into this? What's the time line to delivering that? And what could be potential for upsizing that?

Yes. I am really excited on how we're progressing along that front. And you see it in the bottom line. I would say we're tracking very well on that, and I'm confident that we're going to meet our commitments.

We got $250 million. Roughly half of that has kind of already been harvested because we took out those poor service-related costs I've talked about. And the rest is absolutely on track for this year. And then next year, we've got another $150 million that we got line of sight to.

Got it. And maybe kind of last question on this topic. You mentioned that customers are rewarding you almost immediately with spot business. Usually, it takes a little bit of time for service improvements to resonate with customers and kind of have that convert. So do you feel like you made those conversions early? Or is there like more -- how much of a pipeline is yet to come in terms of kind of being rewarded for those improvements you're making?

Well, I think it's hard to really differentiate between what was pent up and what is now a reaction to better service at first. Now we're seeing that. We saw that a couple of months ago, that pipeline pent-up service-related volume was cleaned up. And as we see now that it coming on board, I think what's important is we're grabbing it, and we're able to leverage it, now we're able to -- now start to frame out with some relative certainty what is the resource allocation for that? How do we structure our planning around that, our costing around that. And I think as we go, what I see is in the most service-sensitive lanes, like automotive and intermodal, we're seeing growth. And we have less cars. We're fixing our cars more quickly, so we have more in service. We're able to pull out bad leases and expense in those environments. And if you can gain in a soft truck environment in those service really sensitive competitive lanes to truck, then that to me that's a testament to what we're doing is the right thing. And we're also seeing it in merchandise and spot moves for agriculture and fuel and things like that. But I would say that I'm confident now it's really about the service.

Yes. Got it. Just on that note, let's pivot to growth. Clearly, you're seeing a nice acceleration in volumes from 2Q to 3Q. How would you characterize the demand environment out there right now? I think there's been some focus on maybe volumes being good, but mix being a headwind. So kind of anything puts and takes to keep in mind for 3Q and 4Q?

Yes. Actually, we started the quarter really well. I mean July and August from a revenue perspective, we're running ahead of our own plan. So we're really excited. I would tell you that, that overage has been eaten up a little bit in September. We've seen some moderating compared to our expectations, largely in a couple of discrete markets like auto and steel. So we're keeping our eye on that, but I think we're fully on track for the third quarter because the great headwinds -- sorry, the headwinds we have in September are really offset by the great tailwinds we saw in July and August. So we're going to keep our eye on it as we go into Q4. Hopefully, the volume pressures are -- abate going into Q4. But yes, mix has been a headwind for sure throughout the year. And unfortunately, it's continuing here in the third quarter, and I expect that those mix headwinds will continue to exist in the fourth quarter, too.

And we're not just sitting back hoping things change. We're creating actions. And Mark and I were the executives really in charge of driving the intermodal reservations and we put that in place a week ago, Monday. And it's running in parallel now. We start to see the expectation of more disciplined gate activity, forecasting train length, now really harvesting value, and cost reduction in our intermodal facility. So we're doing whatever we can, all that we can, to make sure that cost structure is in the right range and everything is on the table. And so as we churn through these next developments we're really making sure that we're doing everything we can to control costs, control that mix issue from a bottom line perspective. And I'm excited because as the market changes and truck tightens up and those headwinds become pretty significant tailwinds against a very, very disciplined structure.

Got it. On that point, Mark, you're definitely not the first company to talk about auto and steel being a headwind July, August, September time frame. What are you hearing from your customers? Is it feels like a short-term inventory balancing type softness? Could you think it can continue in 4Q? Or what are they telling you?

I mean it's demand related. And yes, the inventory destocking is really what's driving that. I think it's hard to say we've got to talk a little bit more with our auto customers to see how long they expect it to happen, but I do think the destocking is at risk of lasting throughout the fourth quarter. But we'll see. And I think that has a direct impact on steel, too. So we just have to keep our eyes on it.

Got it. So apart from these couple of end markets, volumes have nice momentum. The service product is improving. The net result should be price. So what are you thinking in terms of the kind of -- I don't necessarily care about 3Q, but kind of the medium-term outlook on price, especially in an environment that's still inflationary with the new labor contracts. So can you just talk about kind of your algorithm for getting price over inflation.

Yes. Look, I think in merchandise, we're doing a sensational job driving price in excess of inflation. We're well ahead of our own internal budgets on that, and the team has done a great job. I think intermodal, unfortunately, three years into a freight recession, we're a victim of spot rates in the trucking market, which have not come off the bottom yet. They seemed to have stabilized, but they're still stabilized at a relatively low level, so we're waiting for a recovery there, where hopefully, intermodal price can then -- will follow for sure, we know it will. So the timing of that, we just don't know, if it's within the next 3, 4 months, and we start to enjoy that going right out of the gate in 2025, or if it's going to take a little bit longer. We'll see what the Fed does, and we'll see how the economy reacts there. And then, of course, our coal pricing is also tied to indices and those have been a little weak. And then honestly, with fuel coming down, our surcharge revenue follows. So that's -- all that kind of shows up in RPU in addition to the mix that I talked about. So we got to put it in the whole mix master, but I would expect similar kind of pressure as we go through the rest of the year on RPU.

You definitely have like a DJ set. I mean he's mix master.

I call him DJ Kelly.

But just a follow-up on that. How do you think of the volume versus price dynamic? I mean obviously, you have a much better service product. That's probably not going to be cheap to kind of put out there. So it is a very competitive environment, and you obviously have a very strong peer. The truck market continues to be very competitive. So are you willing to walk away from volume to protect price? Or kind of how do you think of that balance?

I mean these are unit-by-unit decisions that get made oftentimes. And we want to be smart about it. We want -- for incremental volume growth, we really want it to be accretive, so we want it accretive to our OR. But at the same time, we want it to be attractive and sustainable business, and we want it to be business that John can move, that doesn't create disruption. So we really go through a great enterprise-wide kind of decision-making process on this stuff. So go ahead.

Yes, I would add. We demarketed some of our intermodal lanes quite a number, and yet we grew intermodal. So in some cases, it moved our customer to where we were, and it's a win-win. And in other cases, we're able to use the capacity for other things, whether it's merchandise through that corridor or it's intermodal from somewhere else. And you could probably have the same thesis with reservation system, you're going to chase things away, but actually just create quality and you create winning solutions and certainty, and that's what customers want. Certainty and pricing follows certainty, pricing follows the win of the wind, because they're able to take out costs for car hire and handling costs and labor as well. So that's what we want. We want everyone to win within our ecosystem and help our customers be as competitive as they can be within their own space because of our reliability and our service quality.

Got it. Mark, you started talking about the noise over the last 18 months. Unfortunately, there may be another one coming up in the form of the potential East Coast port action potentially as soon as end of this month.

There you go again, East Coast, West Coast.

So just on that note, kind of what are your thoughts on that? Are you seeing any diversion away already? Or kind of how are you planning for that?

I'm not sure we're seeing the diversion away already, but we're somewhat neutral on it. I mean, we've always been largely geared towards moving the West Coast-oriented or originated product. But I think we've shown the nimbleness now to where -- when the product moves to the East Coast, we handle that just fine to. There's puts and takes on where it lands on our network. Either way, we have no problem moving it. So it's not really a big focus internally for us. Would you add anything there?

Yes, I would say we've got great trading partners with the Western carriers. Really sophisticated interchange in Chicago that it works. Obviously, we don't want disruption in the U.S. economy. We don't want any kind of inflationary pressure in the macro, but whatever the world gives us, we were able to respond. And we showed that in Baltimore when the bridge disruption happened. We, within 12 hours, Ed, Mark and I got together, restructured commercial proposition with some of our biggest customers, reengineered our supply chain overnight, and we were really, really effective in continuing that export for the U.S. coal. And as Baltimore came back with relatively short notice in supply chain terms, we're able to pivot back and it did a lot of good things. And the one thing that I would say that this East Coast, West Coast issue might give as a kind of a golden nugget is that we learned more about our own capacity and capability in the coal supply chain that we're now leveraging and it will be a permanent improvement. Much like the issues that we hunt -- with Hunter and CN back in the day, we learned so much about our labor organizations when we had unfortunate disruptions, and we're able to extract value on an ongoing basis. This is the same thing here. We'll learn more about our capabilities and our ability to interchange more effectively, our abilities to pivot, and be more responsive in the market, and really what our capacity really is.

Got it. So maybe just to tie all that up together, how would you like to be judged? Is it a single metric? Is there a bunch of metrics? Is it revenue growth? Is it EBIT growth? Is it OR? Is it cash return? Kind of what's the philosophy there?

I think it's a composite of different metrics. Definitely, right now, we are out of balance with the industry. We have got to get our profitability back in line. That is our principal focus right now. We've got to get our operating ratio back in line in the same ZIP code as our peers. And we're committed to do that. We fell out of balance. But I think we've demonstrated here that we're making the moves in the right direction. Ultimately, we've got to start driving revenue growth to drive the bottom line growth. It's dollars and cents that you deposit, not percentages. So we have got to focus on earnings growth in dollars. And earnings growth in dollars will generate a lot of free cash flow, which then allows for share repurchases to help drive EPS growth at a faster rate than the profit growth. So that's kind of the algorithm. And then at the same time, you've got to also look at ROIC. We've got to be smart in the way we invest our capital. And we've got to drive returns higher as a percentage of invested capital. So I think you got to look at everything. But right now, we are going to be a little imbalanced focusing on restoring our profitability. Do you have anything?

I would say the only heavyweight metric I look at is safety. The performance of the organization, our social license to operate, our reputation is so important, and everything is driven through safety. And I would say then the rest, you're right, Mark. It's really a mosaic of information that we -- that manifests in 4 or 5 key metrics that we look at. There's no one metric that I think outweighs the rest. Otherwise, it gets into a vanity metric. And it's for that sake rather than the organizational health. But I look at asset, network, and customer those on a kind of a 2 x 6 every day, and I'm watching how we're performing with our terminals and with over the road. I'm watching from that, how is our car per mile, our HPT for available course and then the customer composite. And that gives us a good indication of where we are. But man, we're under the hood on everything. We are into the weeds on contracts, on capability, on cost, on service, on people and development, the speak-up culture that's leading and how we're driving safety and performance and how we're really reinforcing that safety enables performance. And as Mark said, manifests in so many other ways in the financials, whether it's direct or it's a little lagging, and that's some of the things that I'm really excited about, those lagging financial implications into the latter part of this quarter and next.

And I think you got to be careful about cherry picking and looking at certain operating metric and say, "oh, geez, their dwell just spiked." Look at the end of the day, John and his team may make some very tactical decisions in the course of a couple of weeks that may have an adverse impact on dwell to accelerate the network in other areas that are of high priorities. So that's why he looks at the mosaic and there's a lot of data out there, but there's also sometimes a lot of decisions that are behind investing in one area at the expense of another, to accelerate for the longer term.

Yes. And that's the cool thing about it, we just brought on a new CIO, Anil, he's dialed into operational value. We're looking at a single -- what I call a single source of truth, Hunter may have called it Data City back in the day, but I'm not trying to plagiarize from Hunter, but I learnt a lot from the man. And as we're building out a single source of truth, now we can peel back every layer, not just me but a train master in the field. That was the magic that Keith Creel brought to CN. He said he could mobilize the entire company to get information. He then unselfishly said, I want everybody to have that same capability and really leveraged up on what Hunter said about getting data and Data City, use it, and drive it. And so we've had a lot of talks with Anil and he understands the importance of that. He's on board. And I think we're going to see some really good capability developed from that as well.

This is a big deal. We don't have that today. We don't have those disciplines today inside the railroad. And I believe that's going to unleash a lot of opportunity going forward. So I'm really excited that John shining a light on it. In fact, when I first joined the company 5 years ago, I spent a lot of time with Claude Mongeau the former CEO of CN, who happens to be on our board. And he was speaking exactly about Data City and explaining how Hunter would almost sit in the control room and be on the phone with all the various branches pointing to data and asking the train masters, what's going on with this train, what's going on with that train. We have a lot of data today. I wouldn't say that we have good clear access to it in the right kind of data lake system. And that's where I think John shining the light on and we're pointing Anil to it and saying, we have to prioritize our IT investments right now toward what's going to provide the greatest return, and we are turning off a lot of other nice little projects that have a lot of promise for the future, but maybe they're not going to have the kind of leverage that this Data City will. So that's, I think, the other thing I would leave you with is we have to do a lot more prioritization of our investments, which means turning off some other things from people's wish lists because they're just not as important.

It sounds like a great stop for another Investor Day kind of just to shine some light on that. With that, maybe we can squeeze in 1 or 2 questions, anyone has in the room, there you go.

Good morning. You alluded to this a little bit earlier with the productivity comments and the focus on OR. But can you just walk through the path to sub-60? How much is internal initiatives, how much is the macro maybe being a little bit more helpful?

Yes. What we talked about is that path to sub-60. You're going to require the kind of modest revenue growth, 3%, 3.5% per year. While we're working on these productivity initiatives that are going to unleash $550 million of savings, okay. That's going to get us down into the lower 60s, call it 63. But we know that there's going to be a secular recovery in the industry and the market, okay? And when that comes, it's safe to assume you're going to get another couple of points that would get us probably more in the 5%, 5.5% range of top line growth. And when that recovery comes, that's going to get us below 60 because we're going to have tremendous incrementals from that volume. Given all the work that John and his team are doing, the incrementals on growth beyond the 3, 3.5 are going to be really attractive.

Got it. With that we finished our time. Mark, John, you are I think again it's been one of the most exciting kind of turnaround stories in the space in the last kind of 6 or 7 months or so. So I think everyone is focused on what you're doing. So congratulations again and we'll be focused on this.

Thank you very much. Take care.

Thank you.