Norfolk Southern Corporation ($NSC)

All right. Afternoon, everyone. We're going to get going with the next session. So we've got transports the rest of the day. By the way, I'm Scott Group, the transport and airline analyst here at Wolfe. So for our next session, we've got Norfolk Southern. I know it says Jason Zampi, CFO, to my far left; but also Mark George, CEO from the company, is here as well. So Jason, Mark, thank you, guys, for being here.

Glad to be here, Scott. Thank you.

Thanks for having us.

We're going to jump right into questions. I've got a few that I want to get to. And then if you have additional questions, raise your hand. So I think -- I guess we'll start on the merger. Let's get an update. You guys resubmit -- you and UP resubmitted the application late April. I guess we should expect to hear from the Board probably end of next week, if they deem the application complete. Maybe just take a minute or 2, where are we in the process? What in your mind were the key enhancements you guys made to the application? And any sort of expectations that you have for next week?

Yes. So where we are in the process is kind of like you laid out, we had resubmitted the application, like you mentioned. I think we expect to hear next week -- I mean, the deadline would be technically the 29th, but it could be before that, that we learn what the STB does, which is we expect a full acceptance. And then there's a whole procedural schedule that they follow with hearings and then environmental reviews. And then that gets you -- that gets them to the point of final decision, where they have 90 days after they close the docket to publish their final decision. So when you add it all together, we've said publicly first half of 2027, I think, let's be real, this is not going to happen in the first quarter of 2027. So it's sometime in the latter part of the first half, which means probably the summer months, that we learn. It could be May, it could be June. But ultimately, it's up to the STB how long they take. The good news is that when we get acceptance of the application, the STB is going to publish their schedule. So we'll get a sense of how long this is going to take to play out. So we can stop speculating at that point and we'll have something to work off of.

Okay. Obviously, a lot of...

You asked about completeness? .

Yes.

We think this is really complete. We think this is more fortified than the original application. And let me explain why. Not only did we answer the 3 things that the STB wanted, we responded to those fully, and we believe, in full satisfaction of their request. But we chose deliberately to almost redo the math using traffic data that was provided by the railroads. So we're the first merger application who's ever taken the full data set from all the railroads to project the future, as opposed to the sample data, which is the way everyone has done applications in the past and the way we did it initially, to project the impacts. And that's a big deal. That's a big deal. Because the good news is it kind of validated where we were coming out. It actually -- we actually have more, we think, more conversion doing the math that way. We maybe lost a little bit of the merchandise conversion, but actually got more intermodal conversions in the second submission. But the data is irrefutable now. And that took a little bit longer. I mean we had to run all of this data through, just like we did the first time, through all of our modeling. So it added a little bit more time to the resubmission, which is why it took us until April. But we feel as though we're taking away any potential argument that the other roads might say about the, well, I know this is a sample data used, but this isn't really accurate data. This is their data. This is the full data set. So we feel as though it's a much stronger application, more defendable with the data. And we went into even more articulation of the public benefits and enhanced competition. Go ahead.

A lot of comments from all the other rails, right, maybe none of them surprising, that they're saying it's incomplete still. But anything -- any of the public comments from rails or other stakeholders that give you some pause of, hey, maybe we missed this or maybe we missed that? And then I'm sure you love hypotheticals, but in the hypothetical world where we learn next week they've deemed for the second time it's incomplete, like where do we go from there? Does that sort of put an end to this or not?

No, I'm not going to get into hypotheticals. We think they're going to accept it. I don't know if they ask for more information. But if for some reason that scenario played out, we'll deal with it at that point. But -- what was the first part of the question?

Any of the comments [ concerning ] you in any way or surprising you?

No, we responded to that. We think that people are somewhat grasping at straws right now. They're reopening things and arguments they made the first time that the STB ignored essentially, but they're opening it up again. So we're not too concerned nor are we surprised. I think the other roads that are in opposition to this would love to just stretch this out and drag it along. So they'll use whatever tactic they can.

Right. And I was just saying because last May, we were sort of -- at our conference, we were dancing around the M&A conversation a little bit without really able to get into specifics. So at our conference [ at least ], maybe first opportunity for you to talk about it from this standpoint, right? There are, at its core, 2 key requirements for a merger. One is it has to be in the public interest. And two, now under the new rules, it has to enhance competition. So maybe just if you could just touch on those 2 pieces. Why is it in the public interest? How does this enhance competition?

Yes. That's -- it's easy. I mean on the public interest side, I mean what we're doing is massive in terms of trying to convert freight from the highway back onto the railroad, where it belongs, frankly. Heavy fleet belongs on the rail infrastructure. There's reasons over decades after the interstate highway system was built out why freight has migrated. It's just convenience. But as passenger vehicles have filled up the highways, it's becoming less and less comfortable and more and more risky. So what we do is if we can take, like we projected, 3.8 billion miles of truck traffic, off of the highway system, we're talking about reducing injuries -- I'm sorry, reducing accidents by about 1,750 per year on the highway system. We're talking about reducing fatalities on the highway system by about 65 million -- 65 per year. So that's a public interest. I think there's also an affordability angle here, right? The truck is more expensive than the rail network. So we are going to save consumers money by shifting traffic back on to the highways. It will be cheaper, it will be more convenient as well. So the public interest stuff that we've laid out is absolutely real. And I think in terms of enhancing competition, as soon as we announced this, you saw how the other railroads started to work together. So the competition is already enhanced. In fact, we've lost business because they've decided to compete differently. I mean let's face it, this industry, the rail industry has been a little bit lazy, and a little bit -- since I've joined 6 years ago, I kind of had the realization, "Oh my God, I joined a utility." There wasn't a lot of spryness to try to compete aggressively and to perform at levels that your customers expect. So we're seeing a spryness now in the industry just by the fact that we've announced this merger. So I think frankly, this is -- the enhanced competition is taking many forms. Another thing, just by coming together, we're going to now offer single-line rail service compared to interline. That is huge. And when you look at the facts, where single-line rail service exists versus interline, customers are -- there's a 44% higher market share for rail on the merchandise side, okay? That's 144% on the intermodal side when there's single-line traffic compared to interline, the share's 144% larger than single-line -- than interline alone. So the competition benefits are significant. And ultimately, at the end of the day, we're trying to do this for customers. And I know people have been out there saying customers didn't ask for this. This is all about Wall Street. You guys didn't even know I was having these conversations. This wasn't for you. This is for the customers because of those stats I just laid out. The customers are demanding better transport service. They've been moving away from rail to the highway. So the only way to reverse that trend and to give customers what they want is to get together and work on single-line options for them.

So just to follow up, like, obviously, people can disagree. I think the public interest case you're making seems pretty clear, right? I think on the enhancing competition relative to truck, I think pretty clear. I think where there's probably more debate is on the enhancing rail-to-rail competition, right? And I understand you made your point, hey, look, you've seen competitive response from the others. And that's sort of, by definition, we're enhancing competition. Do you have a sense, is the Board looking at broad competition, including truck competition, when we have to enhance competition? Or is the Board going to sort of look more singularly at intramodal rail-to-rail competition with that enhanced competition? Is it clear to you which way they are going to look at this?

I think when you go back to 2000, I know there's a lot of people that are saying, no, no, no, the Board intended back then, 25 years ago, that this was intramodal, that this is really just focused on enhanced competition within the rail space, okay? The reality is the Board, whatever they were thinking at the time, they deliberately decided not to define it, okay? And I think it was the wisdom of the Board back then to not define it, to know that when something comes up, it gives them the flexibility, depending upon the market dynamics at the time, to interpret it appropriately. So here we are 25 years later, 25 years later, the markets have changed dramatically. Rail has been pummeled by truck. And now this Board gets to decide how to define enhanced competition. And I think that they're smart. I think that they're wise. I think that they're going to be progressive looking enough to see that we have to look at the broader ecosystem, and it's not just intermodal. That said, even within rail, we believe we are enhancing competition because, again, look at the responses, they think they can compete and go bless them with partnerships. They're taking share from us rail-to-rail share movements. We're going to try to compete with single line, and there is rail-to-rail conversion from single line. So absolutely. And then the committed gateway pricing is another enhanced competition feature. So we believe we're responding to it both ways.

Okay. That all makes sense. And I remember reading in the Board ruling about the CPKC merger, "Our job is not to protect one rail relative to another," right? So maybe other rails complaining, maybe that doesn't matter so much. I think what -- maybe what shippers have to say, what unions, other stakeholders have to say, so maybe just touch on that. What are you hearing from those other stakeholders positively? What are the negatives you hear from other stakeholders outside of the other rails?

Yes. I think we do a lot of talking with customers, we do a lot of talking with other constituents as well. I would tell you, let's break it down. You talked to our intermodal partners and those shippers, the [ beneficial ] cargo owners, they're all excited. They see the benefit for this. They see the fact that they can go into single line versus interline. So it's all really good. I think when you get down to some of the merchandise shippers, they're hearing the noise from the others, and they want to talk about that with us. And then when we have the dialogue and we open our eyes to what the prospects are, that whether it's a grain shipper in Ohio who now sees, hey, I can move uninterrupted into Texas on single-line service, that's a new market that I don't serve today. Or someone in the Midwest who wants to ship feed to chickens in the southeast that would have had to go through watershed so, therefore, they don't even bother competing in the Southeast. Or steel customers who now we can tell them, you can serve markets in the West on single-line service. Their eyes open up, and they understand and they see the potential, and they get really excited. So it's a slog. We have to go through and explain it one by one, which we're doing. And when we do, there's a lot of enthusiasm about it.

Yes. Makes sense. And then as part of the merger process, I think the Board needs to consider downstream effects. One thing that just wasn't clear to me, when you guys laid out like the synergy targets, is there an assumption -- inherent assumption that this is the only merger? Or is there an assumption that there's 2? And if there are 2, like how would that change the merger synergy assumptions that you guys have laid out?

Yes. I think the rails have -- the other rails are basically -- kind of made their case, right? We kind of know what their intent is. And there's one in particular, who's not publicly traded. So therefore, they're going to behave in a certain -- they've come out and said that they're going to behave in a certain way, which is to not do a merger. So I think you could probably assume that what we've gone out there with is assuming that there is no follow-on. But otherwise, I can't really speculate. They're all on the record individually. If they were all publicly traded, I might have my own prognostication. But they're not.

Right.

And I think too, just to put a finer point, the revenue synergies are really -- we feel confident with or without a follow-on merger that those are attainable. You think about the portion of that that's coming from the truck market and how large that truck market is compared to the rail. So I mean there's plenty of business there for conversion.

And not offering up specific concessions, is that a realistic outcome in your mind, Mark?

What do you mean? We've offered up all sorts of concessions.

You're talking about the gateway pricing and all that.

Yes. I mean gateway pricing, we've offered jobs for life guarantees, open gateways. So we've put concessions out there. And we'll see how this whole process evolves over the next year or so. But it's not like we haven't put concessions out there.

Okay. Fair. So maybe -- well, unless -- if there are other merger questions, we can get you involved. But maybe let's turn to just the business today. Maybe, Jason, I'll let you take a few here. Just volumes up about 3% quarter-to-date. What's doing better than you thought? What, if anything, is worse than you thought? Just give a little bit of a demand update.

Yes, sure. So first quarter, I would say, was kind of bumpy from a volume perspective, right? January started off pretty good. February was kind of really impacted by a lot of the winter weather storms. And then March really picked up. And we've sustained that momentum here into April and May. So we're around 140,000 units a week, and this is now, I think, the 11th week in a row that we've been at that level. So we're seeing some pretty good volume momentum there. And that's translating to the 3%, you mentioned that quarter-to-date perspective. I think a couple of areas that are probably better than we expected. I would put chemicals in that bucket. Really kind of those energy markets, whether it's NGLs, frac sand, petroleum products, those are coming in better than we thought. And then I think coal is better than where we expected it to be. The third one, and there's puts and takes in all of these, but the third is domestic intermodal. International is still pretty weak, but domestic has come in better than we were expecting. So I think there's a lot of positive things out there. I think as a whole, we're -- I'd kind of categorize it as cautiously optimistic. Things that we thought might have been better, if you look at the housing market, I think we were hoping maybe for some rate cuts and for the housing market to kind of take off, that has a big impact on our business. We're obviously not seeing that, and that's probably not going to change here in the near future. So it's something to watch out there. And then I think the last piece is just the -- we know what happens with fuel prices. Do we reach a point that at some point that starts degrading demand out there? So we're not there yet, but that's something we're keeping an eye on. So definitely some puts and takes, but there's some favorable things we're seeing in the business for sure.

Okay. And that strength in domestic intermodal is in the face of losing some of the share that we did from the announcement of the merger. So it's a pretty good story. And I think we've been all tracking, everybody in this room, a little bit of what's going on with IPI and some of these manufacturing leading indices, and maybe that is starting to show up a little bit on the production and manufacturing side. So we're cautiously optimistic, as Jason said.

And then you just mentioned the domestic intermodal strength, and it seems to me, if I just take a step back, we've got this environment right now of rising truck rates, high fuel, rail service levels generally pretty stable. This feels like it should be a very good backdrop for certainly intermodal, but maybe the broad sort of rail market. Are we -- do you think we're starting to see evidence of this in terms of share gain from truck? We've been talking about it for so long and it feels like we haven't had it.

What is it, a 4-year freight recession, unprecedented in history may be coming to an end? Whether that's a function of the evacuation of excess supply of trucks finally or if it's temporary because of what's happened with fuel pricing, hard to say. We are in an unusual spot with this war and with what's happened with fuel prices. Right now, it feels good. If the war ends in the next couple of weeks and fuel prices start going back down over the next couple of few months, does that dynamic still persist or does it reverse back to where it was? Hard to say.

I think the key there, just to add on what Mark said, there is really, can you retain those customers? And that's through you pointed out service, right? And that's kind of the linchpin of that whole thing. So however, these shippers are attracted to us in the first place, we're ready to serve it. But it's -- that good service levels that will maintain it and keep them on rail for the longer term.

Jason, just a quick near-term margin question for you. You guys talked about 200 basis point sequential margin improvement Q1 to Q2. How are we trending relative to that given the volumes? Could it be even better? I don't know.

Yes, I'd say we talk about that historical seasonality, 200 basis points. First quarter has some higher costs from comp and ben and incentive comp, payroll taxes, things like that. And then normally, we see -- we do see an uptick in volume moving from first to second quarter. So that is happening. That's good to see. And I think we've got a lot of productivity initiatives underway that are really -- have taken hold. Over $500 million in the last 2 years and another $150 million planned this year. So that's all baked into that. The real wildcard here is fuel. And I talked on the quarter-end call, I think the price we're paying at the pump in March was up over 40%. In April, it was up 80% year-over-year. So that is a really significant headwind. We don't see that coming down anytime soon here at least. We're halfway through the quarter now. So that is a significant headwind. Even with all that, we still feel good about the 200 basis points of OR improvement.

This wouldn't do anything to change like the cosmetic impact of fuel, but I asked this to one of the other rails on earnings, I'll ask too, like, I don't really understand why rails have 2-month lags on fuel surcharges. Truckers are 1 week, FedEx, UPS are 1 week. Why are we still doing 2-month lags?

Well, with intermodal, we're on like a 2-week lag, okay? So I think it's really the other commodity groups. So that's a legacy. A lot of those are individually negotiated. And it tends to average out at about 2 months, right? .

That's right.

You want to...

Yes. No, you're absolutely right. 60% of our fuel surcharge revenue is based off our intermodal volumes. And like Mark said, that's only -- that's a 2-week lag. And that's really due to the fact that it is competitive with trucking and we're matching what they're seeing there from a price perspective, so the customer can really choose which mode makes the most sense given all those economics. But the rest of our business, merchandise and coal, that's more on a 2-month lag. It's really based on what the customer needs. And at this point, we think that that's sufficient to address the market and the lead time for a lot of these customers.

At the end of the day, it all evens out, right?

Sure. Right. Jason, if fuel sort of stays here, what's the OR headwind to the year from fuel? It's just cosmetic OR, when the earnings impact is immaterial.

Right. So I think the way we're thinking about it is it was a pretty significant OR headwind in first quarter, will continue to be a headwind in second quarter. But as we move through third and fourth, again, assuming that fuel stays at this -- based on this forward curve, should switch to a tailwind in the third and fourth quarter. But overall, a bit of a headwind for full year.

And so when you add it all up, do you -- is there a path to full year margin improvement, you think, in 2026?

Yes. I think a couple of things to factor in here, when we think about what we're facing this year. So we've talked about pretty significant inflation this year. We've got wage rates going up another 3.75% starting July 1 on the back of 4% last year. So we had significant wage inflation. Health and welfare rates are really high, insurance premiums, all those things. We had some pretty significant land sales last year that we're not planning on this year. So those are some headwinds we've got going against this. On the good side, we've got productivity. I talked about what we've already achieved. We've got another $150 million of productivity. And I'd classify that as structural productivity, not volume dependent. So those are all good. Now on top of that, you throw in fuel. And I think that, again, if you use that term, it's a big wild card, and we'll see how that plays out. But I think what we're super focused on, and you've heard us talk about safety, service and this cost discipline, and we're really kind of showing how we're achieving that. The cost envelope that we've laid out, we feel like we are going to control what we can control. Fuel price is something that it's a bit out of our hands. But what we can control from a fuel perspective is fuel efficiency. And really proud of what the team, the ops team has been able to do there, 5% improvement last year on top of 3% the year before that, hit a record in first quarter. So really, building on that momentum from a fuel efficiency perspective, and there's no better time to have it at fuel prices like this. So long story, lots of puts and takes, but we see a path there.

Okay, great. There's one question in the back. Maybe if you can -- while the mic's going there, I'll ask one more. I want to talk about pricing. If I look in Q1, and I get there's mix involved here, but yield ex fuel up 1% in total, merchandise yield is ex fuel flat. I feel like for so long, like pricing was sort of the constant in this industry. And I really feel like since the pandemic, the amount -- price relative cost has been underwhelming to me in rail. Like, can we get back to a sort of 3% to 4% type or maybe even more, I don't know, but can we get back to that kind of yield growth again? What needs to happen? It feels like it's been the missing -- the volumes have been -- are positive. Labor productivity you're talking about has been good. Like it feels like price has been sort of the missing link, missing piece.

Yes. I mean when you go back to pandemic, Scott, you're also talking about going back to where the catalyst of where the truck recession started as well. And you really have to break our business down. Intermodal pricing is highly competitive with truck. So that is the governor ultimately on intermodal price, is what's happening in the truck market. So that was going down for a while, and then it was -- it's flatlined for maybe the past year, year plus. But there hasn't been any traction. Now finally, we're starting to see that come up. And I think you would acknowledge you saw a little bit of that show up in the fourth quarter and now again a little bit more in the first quarter. So let's -- you got to look at that. Then you got to look at the coal business, which those are index driven. And we, during the pandemic, or leading up to and during the pandemic, we had very significant gross up in energy prices that we all enjoyed. And since then, met coal pricing in particular has been coming down at a steady decline. That's just math. And okay, we think we've probably lapped that now and we've stabilized and maybe there's a path up on coal pricing, especially, not just on the export side, but even on the utility side. In time, with all this utility coal demand, as contracts reprice, there's probably upside there. So then that leaves you with the balance, which is merchandise. That's the one thing that hasn't changed, to your point, we continue to give very good core pricing in merchandise. There's been no change in that trend line going back a decade. We get solid core pricing in our entire merchandise book of business. It gets dwarfed sometimes in certain years by mix within merchandise. So that's why when you look at RPU changes, even within merchandise, it may look flat, but it's because core pricing might have been up 3%, but mix ate it all the way. So I think the thesis looking forward is a little bit better on the overall book. Mix is always a player. And at some time, mix is going to be helpful as well. Like right now, I think we're seeing some favorable mix. But so I don't like to talk about price in one thing. You really got to break it down into those 3 components and then recognize, even within a commodity group, mix can play a role.

But it sounds like -- so intermodal has been -- truck rate's going up, that clearly should be good for intermodal. Coal has bottomed and maybe hopefully you're going to start to see a little bit of upside from here. We'll have to see what the indexes are. And merchandise you're saying you're getting good price, and there's mix fluctuations. Maybe it was a headwind, but maybe going forward it's a positive.

Maybe.

There was one in the back and we're getting down on time, but please.

Yes. I was just going to ask if there's like a rule of thumb or level that you think about with diesel prices or with fuel surcharges where you -- like the phone starts really ringing off the hook. Like if there's like, I don't know, just sort of a disaggregation line where intermodal really cuts towards your product?

I would kind of say when oil is at $80 a barrel, $85 a barrel, you're in a sweet spot, where I think usually the highway prices are a little bit more supportive of getting back on to rail, yet not so high where it's starting to destruct demand for the consumers. When you start with oil getting closer to $100 a barrel, obviously, it's an even better compare for us, highway versus rail. But you have to get worried about what's the broader impact on the consumer. So that's why where we are today, we're in a little bit of a shaky spot with oil where it is. If it stays here for a prolonged period of time, we have to be worried about demand destruction. We like where it is in terms of intermodal conversion. But long term, we have to keep our eyes out. So I kind of say that $80 to $90 a barrel range has kind of been the sweet spot historically.

Thank you.

All right. I think we do have to wrap it up. Mark, Jason, thanks so much. This is great.

Thank you. Take good care.