Union Pacific Corporation (UNP) Earnings Call Transcript & Summary

Thank you all. Very interesting lunch speaker. And so we're going to kick off the afternoon, stay on time here, with Union Pacific Railroad, a large railroad in the U.S. And Jennifer Hamann, the CFO, she's going to walk through the Union Pacific story, at least frame the company for us, and we'll dive right into Q&A.

All right. Thank you, Dave. So good afternoon, everyone. Before I start, I would like to remind everyone that I will be making some forward-looking statements. These statements are subject to risks and uncertainties. So please refer to the Union Pacific website and SEC filings for additional information about our risk factors. So to help set the stage for today's discussion, I want to provide a little insight into how we're looking at 2020 while at the same time, recognize the great work that the team did in 2019. Given the challenges we faced this past year, we're extremely proud of our overall results. Historic flooding in the Midwest and a weak freight economy provided tough hurdles as we implemented our new operating model, Unified Plan 2020. In spite of these obstacles, for the full year, we reported earnings per share of $8.38, a 6% increase versus 2018. Through the implementation of Unified Plan 2020 and our G55 + 0 initiatives, we achieved a record $590 million of productivity, driving significant costs out of our network. These cost savings helped produce an all-time record operating ratio for the year of 60.6%, an improvement of 2.1 points versus 2018. Turning to the value we created for our shareholders. 2019 was another year of both strong cash generation and cash returns to our shareholders as free cash flow after capital investments totaled nearly $5.2 billion, resulting in a cash flow conversion rate equal to 87% of net income. Our dividend payout ratio for 2019 was just over 44% as we distributed $2.6 billion to shareholders. Finally, we repurchased 35 million shares of our common stock at an all-in cost of $5.8 billion, reducing our full year average share balance by 6% versus 2018. The combination of dividend payouts and share repurchases in 2019 totaled $8.4 billion of cash returned to our shareholders as we continue to recognize the importance of providing strong returns for our owners. Now let's look ahead to 2020, where there are obviously a few macroeconomic factors at play impacting our coal, sand and intermodal markets. However, we have confidence in the opportunities we see to grow our business. And with a more efficient service product that is also more reliable and consistent, we feel we're in a great position to leverage these new service gains to compete in both new and existing markets. Let me highlight a few of those growth opportunities. A more consistent and reliable service product allows us to better compete in the highly truck competitive food and refrigerated markets. This includes opportunities to move fresh produce in our expedited coast-to-coast refrigerated service as well as within the beer markets. These are part of our continued long-term penetration gains in that business. We also see continued strength in the plastics market. With plant expansions coming online and continuing to come online over the next few years, we are well positioned to grow with new and existing customers. We feel our plastics network with its robust storage and transit and export capability separates us from our competition. Lastly, with our intermodal business, while the international market currently has its challenges, we're still actively seeking ways to grow. An example is our participation in the development of the new Butler Intermodal Terminal in Central Iowa. This terminal provides an alternative to larger Midwest rail hubs and gives shippers a cost-competitive solution to reduce trade's truck miles, most importantly, allow the customers to find new rail solutions with Union Pacific. Looking now at our current guidance for 2020. As we discussed on our fourth quarter earnings call, we expect to see slightly positive volumes on a full year basis. This view takes into account expected declines in coal and sand as well as tough year-over-year intermodal comparisons in the first quarter. We plan to deliver at least $500 million of productivity savings in 2020, with a sizable portion coming from further label productivity as we continue to find ways to improve efficiency. Coming out of fourth quarter, where volumes were down 11% and force levels were down 17%, we expect 2020 force levels should be down 8%, plus or minus for the full year. When evaluating force levels, I think it's important to consider the potential volume cadence for 2020. As we have stated, we expect volume to be more second half loaded this year. So while we will continue to be more than volume variable with our cost structure, we need to ensure that when volumes strengthen, we can continue to provide an enhanced service product that provides value for our customers. Pricing gains in 2020 should again exceed our inflation dollars. Our pricing strategy, which is integral to achieving our 2020 and long-term return objectives is supported by the strong service product we're providing our customers today. In total, achievement of our volume, price and productivity goals should result in another strong step down in our operating ratio. And while we don't anticipate a fuel tailwind like we experienced in 2019, we believe we should close out 2020 with a full year number that looks more like a 59% operating ratio. Finally, our guidance for capital allocation remains unchanged. We will continue investing in our business in order to ensure we have a proper foundation for future growth, and excess cash will then be returned to shareholders through dividends, payments and share repurchases. Wrapping it all up, these actions will contribute to another year of strong cash generation and margin improvement as we look out to 2020. We're taking another positive step forward on our path towards our longer-term target of a 50% operating ratio. And so with that, Dave, we'll take your questions.

Excellent. Thank you very much.

Thank you.

It's been a very interesting ride for the railroads over the past 15, 16 years in what we have called the rail renaissance period. And the way I describe it from a high level is it was a repricing story for the first 7 or 8 years and then it's attack the cost productivity story. But now I'm starting to hear a little bit more from some of the rails on the service side of things. How does UP think about service? How do you measure service? And where do you see service playing into your longer-term objectives?

Well, I think service is definitely very important for us. It's important for our ability to both be productive, as you mentioned, in terms of what we think that a more reliable service can also be more efficient and cost less for us to provide to our customers. But it's also important for us to be reliable and consistent to attract customers and keep the customers that we have moving on the railroad. We know we've got to be competitive. The trucks are very competitive. They offer different advantages that are generally -- particularly if they've got a team driver, they're going to be faster than rails. But we think that when you think about the cost advantages that we can provide, the fuel efficiency we can provide, you combine that with a product that becomes more reliable, we think that kind of doubles down on the attractiveness of rail.

And you mentioned specifically truck is competition. So I'll go there on intermodal briefly. The price discrepancy between truck and rail on your routes in the western half of the U.S. is typically much higher than those on the eastern rails. So have you seen much the way of share loss to truck over the past year? Or has that cushion been enough to allow you to hold on to the intermodal volume more than some of your eastern counterparts?

We've certainly seen our business, particularly on the domestic intermodal side, be impacted by the fact that the truck market has been a little bit more price competitive and particularly when you think about spot rates, where they have excess capacity. And I think I've seen things probably in some Stifel articles about 90-plus percent kind of fill rates, that ability to pick up those extra loads, that has certainly had an impact on our business. And you see the trucks compete, not just with our intermodal product, but some of our industrial products as well. If you think about lumber, that's a pretty truck competitive market for us in the I-5 corridor.

Okay. And tying that back into service that we talked about, Hub Group was up here earlier commending your service improvements year-over-year. And is the service tougher in intermodal than it is in the other products, whether it's ag products or industrial? And do you measure service any differently? Or are those networks set up differently for service in terms of either speed or on-time performance?

Sure. So you've seen us report a Trip Plan Compliance number over the last several quarters. It's a composite measure. And you've seen that increase pretty dramatically in 2019. Into 2020, we are now going to split out and create 2 different buckets, one that's kind of the manifest in autos category and then another number that is an intermodal specific category. Because to your point, intermodal customer does have a little bit different view of the world and a little bit different standard in terms of what they're willing to accept from an on-time reliability. And so you're going to see from us going forward that we are measuring that giving out 2 measures. And I'd say our intermodal service for the last few months has been right around that 80% kind of range, which is, we think, a good sweet spot for where our performance needs to be.

And then back to the competition in the other commodities that you guys haul, which is more rail competitive. You only have mainly one competitor that you deal with. So how do you tug back and forth for customers in those lanes that are seemingly not as competitive as the intermodal market?

Well, then that's where the reliability and the consistency can really come into play in terms of the cost structure for our customers. So a lot of our customers own their railcars. And so to the extent that we're able to turn those cars more reliably and get more cycles out of them over a 30-day, 60-day, 90-day periods, then that gives them the ability to reduce their fleet cost, and that's going to be more cost competitive for them. You've maybe also seen us talk more about, we're trying to do some things with technology. We just introduced an API suite for our customers to be able to get connected to us, to be able to ask for railcars to be placed or spotted, make changes relative to intermodal terminal reservations and a few other things. So we're trying to make ourselves and set ourselves apart also, not just in terms of the actual product that we're delivering but how the customer is able to see that end-to-end and the flexibility they'll be able to see from us.

And when you think about the network over the past number of years and the customer base because a lot of the rails, the customers located near the rails, they need rail service. Have customers moved away from the rails for any reason or toward the rails for any reason? And does that put your network in any sort of imbalance? Or have you created new lanes? Or are you thinking about other lanes to get closer to the customer?

Well, I mean, when you think of -- kind of going back to intermodal first, then that's kind of the nice part about intermodal is that they have the truck option, so they don't have to be right next door to our facilities. We do obviously try to locate our intermodal terminals in places that are convenient from a highway access standpoint and places that make that easy in and out in terms of the customer access. But we're always -- in fact, we have a team within our marketing and sales group that's devoted to looking at issues like network access, industrial development, helping people either access, what we call a team track. So that might be a track that's shared amongst a number of different industries and just maybe have some warehouse capabilities around it for transloading of materials or it can be a dedicated facility on one of our rail lines. So that's work that our team is kind of doing all the time. We also have a real estate group that works up and reports up to the finance team that's actively going out and trying to site develop and work with customers to put up new facilities on our line. So that's -- well, those are kind of longer term in terms of bringing those to fruition. That's work that's just kind of going on all the time.

And then as you think about the UP network, do you think about it as one fluid network for all commodity types? Or is it kind of a network of networks where you actually have a separate track system for intermodal versus chemicals or auto or other?

No. I mean we think of it as one network. We do within that network, I would say, offer some different train services in terms of you have your intermodal service, which is your more premium network, the higher speeds versus some of our more bulker manifest, but that's one thing that we're doing probably a little bit differently than what we had before, before Unified Plan 2020, is more mixed freight trains because we're looking at what's the most efficient way to get a customer's freight from point A to point B. And in the past, where we may be less willing to put some lumber cars on the back of a grain train or mix it in with autos or chemicals, you're seeing us do more mixed manifest. You're seeing us do more setouts and pickups along the route to help build longer trains and create more efficiencies that way. So there are different schedules, I would say, that address some of the different time requirements of different freights. But it's all still one network, and we're just trying to find the most efficient route for the customer.

And has that shown up in any of the numbers that you track, whether it be cars per train, if that's an important metric? Have you seen the trains increase in length on average, 10% since you started that program?

Well, we've certainly seen our train length increase. I think in the fourth quarter, we reported our train length was up to 8,200 feet. And I think that was up double digit from where it had been a year ago. And that's hard when you think about the fact that we were able to build that train length in an environment where volumes were down. So you're obviously always balancing how quickly do I need to get the freights [ forward ] for my customer versus being able to hold that carload to build the train length. So I think that shows some of the great work that the team has done, not just from how they're able to manage the network, but also how they're planning some of the scheduling and the pickups. So I think that's been a big thing. Obviously, freight car velocity, which is something we didn't talk about prior to rolling out Unified Plan 2020, has also increased through the year, and that's really that indicator of how quickly are we moving that freight car across our network. And that's a much more relevant measure for our customers versus what we used to talk about more with the train speed, where depending on what train it was on, that really didn't mean a lot for the customer. But now if they're seeing what kind of average mileage am I getting on my freight cars on a daily basis, particularly when they own that asset, that's much more meaningful for them.

And then if you factor in dwell times in the network, is there any kind of point-to-point transit time improvements that you've seen in terms of maybe, on average, it was an 8-day transit, now it's a 7-day transit?

Yes, I mean, I don't have any specific numbers to quote you. But certainly, when you see how our freight car velocity has improved, those door-to-door transit times have improved as well within that.

So say, I'm a bulk shipper or a chemical shipper, and you come in to meet with me and you see the BN walk out of the room. What are you going to come in and say that as a reason I should use UP over the BN for that business?

Well, I think if you're a bulk shipper or -- well, let's start with the chemical shipper because we do have a much more differentiated network. We have the largest number of what's called storage and transit spots. So if you're a plastic shipper or somebody who produces intermediate chemicals, we've got great areas within our network for you to take those and hold those. That's a part of our network that we think differentiates ourselves. We also have the Dallas to Dock initiative that we put out, maybe 2 years ago, where with all the new plastics development that has come into the Houston Gulf Coast, we can take those to a packager in Dallas and get those ready for export, using excess intermodal containers that are there going out via the West Coast. So I think we've got some product offerings that I would say are different from a chemical shipper standpoint. If you're dealing with a bulk shipper, again, I think it goes back to the reliability and the car velocity. And we're -- the way that we're running our network today, you're going to get more turns on your assets.

And you mentioned plastics, and that was one of the growth areas, a few growth areas in the rail volumes last year, and you just mentioned also plants opening up in Texas being one of the reasons for that. But I guess, digging further into that, where do you see the continued demand for plastics? Is that something where you have a competitive advantage in that market, if that's going to be a market that's growing faster than the overall economic?

Certainly. I mean when you just look at layout our rail network across the Texas Gulf Coast region versus where the plant expansion is going, it's like a hand in the glove. It fits very well together, where we serve already a lot of those customers. So they know us. It's not like we're new to them if they're just doing an extension to an existing plant or doing a new greenfield facility. And so it's a relationship that they're comfortable with. We're obviously very comfortable with, and we've been able to be very successful in picking up that new business as it's come online.

And then another growth area that was talked about on the call was these ag products are in theory is a growth area given the China-U.S. trade relations and a stipulation for increased export activity on the agricultural grain side. Can you talk a little bit more about that and your expectations as we move over the next couple of years for how the UP network is set up to handle that volume and the levers that it would allow?

Sure. Well, we serve the grain belt. So you think about Iowa, Nebraska, Kansas, Missouri, Illinois. Those are the territories that produce a large portion of the U.S. grain and grain supply. And so to the extent that you're going to have China become a larger purchaser of those, that's going to draw more of those crops out for export, either through the Texas Gulf Coast ports or out to the West Coast and PNW ports.

Since you brought up China, let's talk about the coronavirus. What are your customers saying? What are you hearing? How could that potentially impact the network, mainly from the intermodal side, but also from other commodities that you move in and out?