Union Pacific Corporation (UNP) Earnings Call Transcript & Summary

All right. Good morning, everyone. For those who don't know me, I'm Tyler Brown, senior analyst here at Ray J. I cover the transportation sector as well as the environmental service sector. But this morning, I'm really excited to have Union Pacific with us. Presenting today is Jennifer Hamann, the company's recently appointed new CFO, after a long tenure from Rob Knight; Brad Stock is from Investor Relations. So UP has been coming to this conference for some time. I think a lot of us kind of know who Union Pacific is, one of the largest railroads, obviously, in North America. But really, a railroad with a really proud and long history and really a fantastic franchise, really on the West Coast and into the U.S. Gulf Coast Also there's kind of a brewing story. We're knee-deep in a PSR implementation with a long time railroad veteran, Jim Vena. They've done a really fantastic job. And quite frankly, we're pretty excited to see what this railroad can do, particularly if we could just get a little bit of volume. So with that, we're going to do a presentation, a few questions and then a breakout. But with that, I'm going to go ahead and turn it over to Jennifer.

All right. Thank you, Tyler, and good morning. You kind of gave the summary of my presentation right there. I agree with everything you said. So before we start, I would like to remind everyone that I'll be making some forward-looking statements today. 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. 2019 was a solid year for Union Pacific. As we implemented our version of Precision Scheduled Railroading called Unified Plan 2020, we did so in an environment that was challenged by weak volumes and historic weather events. In spite of these headwinds, for the full year '19, 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. In terms of the value we have 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 our net income. Our dividend payout ratio for 2019 was just over 44%, as we distributed $2.6 billion to shareholders, and 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 returned to our shareholders as we continue to recognize the importance of providing strong returns for our owners. In fact, if you look at our track record over the past 10 years, we've returned $51 billion to shareholders through a combination of share repurchases and dividends, while at the same time, seen our market cap increase almost threefold. Of course, the foundation of Union Pacific's earnings power and cash generation is our great franchise and the diverse markets we serve. For those of you who are familiar with Union Pacific, you know that our franchise is the envy of our peers. And with the implementation of Unified Plan 2020, we've really now positioned ourselves to leverage our franchise opportunities. Our network includes 32,000 route miles through 23 states in the Western 2/3 of the U.S., supporting a balanced mix of 3 strong business groups and over 10,000 customers. The diversity of our franchise and the access it provides to a wide variety of markets is what separates us from our competition. From strategically located manifest terminals to an extensive system of automotive distribution centers and intermodal terminals and unparalleled access and port coverage along both the West and Gulf Coast, we are positioned to compete in the markets of today and tomorrow. Additionally, we have the industry's best access to Mexico with border crossings at all 6 major gateways. Cross-border trade with Mexico continues to be a long-term growth opportunity for Union Pacific. And even though we have a 26% ownership stake in the FXE, our business is actually split fairly evenly between the 2 Mexican rails. In 2019, volumes in and out of Mexico represented about 11% of UP's total volume, with autos and intermodal leading the way as the largest segments of our Mexico portfolio. And as it has in the past, our strong franchise will continue to provide us with a wide range of opportunities to grow with existing customers and penetrate new diverse markets. Now I'd like to spend some time highlighting where we see some of those growth opportunities in 2020. The more consistent, reliable service product that we are providing as a result of Unified Plan 2020 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. And we are investing for growth in these markets through the purchase of over 300 new generation refrigerated box cars which we just started bringing online in late 2019. We are deploying a winning combination of better service and assets to support long-term penetration gains. We also see continued strength and opportunities in the plastics market. With plant expansions 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 the investments we've made in storage and transit facilities and related export capability, separates us from our competition. Our Dallas to Dock service solution is a prime example of how using innovative ideas to cross service products can generate new business opportunities with existing customers. We introduced this product in late 2018 and are already seeing our packaging partner invest to grow the business. Another growth example is with premium, and specifically with international intermodal. And it's our participation in the development of the new Butler Intermodal Terminal in Central Iowa. In the past, containers would have either shipped via rail to Chicago and then backhaul drayed to Iowa, or some business would just use trucks the entire long haul route with no rail participation. Now with Union Pacific's new service, a container from Los Angeles is shipped to Council Bluffs, Iowa on an existing UP intermodal train and then placed in UP manifest service to interchange with the Iowa Northern railway. Net-net, for the customer, the product arrives in roughly the same time, but without the costly use of truck for the long haul or the dray. Better yet, there's an opportunity to reload the backhaul move with export grain. This new service demonstrates Union Pacific's willingness and ability to think differently and offer new services within the framework of our existing service network. Now beyond the franchise, another area where we believe we can separate ourselves from our competitors is through technology enhancements that deliver a better customer experience. Union Pacific is the first railroad to offer a suite of external application programming interface, or API, services to our customers. This communication channel allows the free flow of data between a customer system and Union Pacific's, giving customers direct access to their supply chain data. Using APIs, customers and supply chain partners not only have enhanced shipment visibility, but they can interact with the data and take action on their rail shipments. APIs are reducing manual work and streamlining business transactions by giving customers a new way to do business with Union Pacific. We've already rolled out 13 API services, with more to come in 2020. We believe these services enhance our ability to be more deeply embedded in a customer supply chain and provide value, and we're really just getting started. We know that improving customer interactions through technology needs to be a priority at Union Pacific. Switching over now to our operating results. First, I do want to make a couple of comments on safety, which is the bedrock of everything we do as a company. Simply put, our 2019 results were not good enough, and we know we need to improve them. We are partnering with our craft professionals to first identify risks and then to mitigate them. I'm confident that we will make gains in 2020 as we work to eliminate incidents on our railroad. As we reported in our fourth quarter results, we made substantial improvements across most of our operating metrics in 2019, through the implementation of Unified Plan 2020. As you look at January 2020 numbers shown on the slide, comparing those to January 2019, you see similar improvements are continuing across most of the metrics. 1 month of data is a little bit tough to compare because the volume picture in January, though, is quite different this year from last year, but you do see ongoing improvements in locomotive productivity as well as improvements in freight car terminal as well. Broken out on this slide for the first time is trip plan compliance by intermodal and the combined groups of manifest and auto. We will use this reporting structure going forward as we believe it more accurately reflects the different expectations of those networks. As shown on this slide, we've made substantial progress with our intermodal service product, which greatly improves our ability to be competitive in these markets. The manifest and autos number reflects the difference in traffic mix year-over-year as well as some impact from the hump yard closure we noted in our fourth quarter call. Overall, we continue to drive out inefficiency and improve the reliability and consistency of our service product. Now if you turn to look at our efforts to increase train length. Increasing train size remains one of our main focus areas to improve our productivity as well as our reliability, and we continue to make excellent progress in early 2020 despite current volumes. As you can see, we have increased train length across our system by 17% or over 1,200 feet since the fourth quarter 2018. And this includes incremental improvement in January of this year as we work to further optimize our network. In a few minutes, I'll also discuss the capital investments we're making to support this initiative. Another area we continue to push for productivity is in fuel consumption. We recognize that by reducing fuel consumption, there is a benefit to all of our stakeholders. We feel we have a unique opportunity to not only reduce our own carbon footprint, but that of our customers. Rail offers a fuel efficiency option that is up to 4x more efficient than truck. And through more efficient operations and improved fuel management systems, we believe we can even further widen that gap. As we move through 2020, you'll hear us talk more about how Union Pacific is dedicated to being a positive force in building a sustainable future for everyone. We know we have a role to play, and we're very excited about that potential. We are supporting our efforts for train length and fuel consumption, in part through our capital plan. Overall, we are targeting base capital spending of $2.95 billion, with an incremental $150 million for strategic siding extensions in 2020. About 80% of our planned 2020 capital spend is replacement spending to harden our infrastructure, replace older assets and to improve the safety and resiliency of our network. We will make no new locomotive purchases in 2020, although we will continue to modernize our existing fleet. And targeted freight car acquisitions, specifically the refrigerated box cars that I just discussed, will support both replacement and growth opportunities. Spending on positive train control continues to ramp down, but our dollars in 2020 are focused on interoperability testing and enhancements to our energy management systems to reduce fuel consumption. Finally, as I discussed earlier, we plan to spend an incremental $150 million on strategic siding extensions to increase train length capability in targeted locations. This represents about 40 projects that will support our efficiency initiatives by increasing the number of long trains we can operate in each direction, thus reducing demand for crew starts, speeding freight car velocity and improving service reliability. Our engineering team is off to a great start on these projects, and we look forward to leveraging the opportunities this opens up on our network. Finishing up here with a look at 2020 volumes. The year is obviously off to a challenging start with volumes down 10% year-over-year. Now we came into the year expecting tough comparisons in international intermodal as a result of the 2018 pre-shipping ahead of the 2019 tariffs. But we didn't have a good line of sight or really had even heard much about the coronavirus impact. We are really just now starting to see the impact of the virus on our first quarter volumes as the Lunar New Year was extended and factory production in China is slow to ramp up. How that ultimately plays out, however, is a little still to be determined as we can't predict the full extent or timing of the production lull. What I can state confidently, however, is that U.S. consumers are continuing to buy TVs, build houses, drive cars, et cetera. So when the impact of the virus is behind us and production ramps back up, we'll stand ready to move the goods. We also expected there to be headwinds coming into the year from coal and frac sand. This shows up within our bulk line. And coal in particular has been impacted this year by the extremely low natural gas prices, which, when combined with increased stockpiles due to a mild winter, have led to a 30% decline in those loadings on a year-over-year basis. And grain is also down 13% year-over-year, contributing to the declines in the bulk line. Industrial, however, does continue to be our bright spot, up 2% year-to-date. Our chemicals line and specifically plastics continued to be strong. Construction materials in the South continue their positive trend as well, and we're winning new business in this arena with our improved service product. So while the macroeconomic factors aren't necessarily lining up in our favor today, we have confidence in the opportunities we see to grow our business with a more efficient, reliable and consistent service products. To wrap up, our guidance for 2020 is unchanged. We expect slightly positive volumes on a year-over-year basis. Pricing gains are expected to exceed our inflation dollars, and we're looking for at least $500 million of productivity savings again in 2020. The achievement of these goals should result in another strong step-down in our operating ratio to a full year number in 2020 that looks more like a 59% operating ratio. And 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. Excess cash will then be returned to shareholders through dividend payments and share repurchases. At the end of January, we actually issued $3 billion of new debt as we continued to move toward our established leverage target of 2.7x debt-to-EBITDA. The proceeds will help pay off debt maturities in 2020 and funded our recently announced $2 billion accelerated share repurchase program, which is part of our progression to complete our $20 billion 3-year share repurchase plan that concludes at the end of this year. All in, what I've talked about today should contribute to another year of strong cash generation and margin improvement as we take another positive step forward on the path to our longer-term target of a 55% operating ratio. So with that, Tyler, I'll turn it back over to you for questions.

Sure. So if we have any questions in the field, happy to take those now. I have a question. Maybe I'll take a gander here. So a little bit going back to the volume. It's been a couple of years of, frankly, fairly tough, well particularly last year, tough volume environment. But when we -- and kind of this goes back to what I was talking about at the beginning. But when we do start to see that volume kind of come back to the system, you are running significantly more fluidly, headcount's come down, the cost structure has gotten better. I mean how should we think about the incremental margins when volumes do kind of get on that positive side of the ledger?

Yes. I mean we obviously don't give specific guidance on that. But we think they'll be very strong. I mean, we have, to your point, we've got great fluidity on our network today. And more importantly, we have capacity on our network today. We've got the crews that we can readily deploy. We have locomotives stored. We have freight cars stored. And the network itself has great capacity. So -- and when you think about the slide about the train length, just adding cars to trains is a great way to further build train length and have great incremental margins. And so that's the power that volume has for us. And the fact that we've been able to make the progress we've had without volume really speaks to the strength of Unified Plan 2020 and that further potential, to your point.

[indiscernible] talk about the rail cars [indiscernible]?

So do I need to repeat the question?

Yes, yes, you go ahead.

Okay. So the question is about freight cars and how do we think about buying versus leasing. And what was the other part?

[indiscernible]

Okay. So with our freight car fleet, actually, if you look at the cars that are moving on our network today, somewhere between 60% and 70% are either owned by -- or leased by our customers. So it's become a smaller part for us personally over the last many years. What we've really tried to focus on are investments in cars that can have multiple uses. So if you think about tank cars, those are kind of single use cars, and so we want the customers to own those. We own more gondolas for grain. We own some box cars, containers for intermodal products. And we want to make the best financing decision relative to whether we lease or own. And it's also somewhat predicated on what we see to be kind of the life of our use of that asset. More likely than not, it's probably the best financial decision for us to purchase the cars, particularly if we think we're going to use that car for its full life cycle.

Maybe coming back a little bit. You actually mentioned this in the very beginning of the deck about free cash flow conversion. So there's a big story across really the entire rail system about, let's call it, the quality of EBITDA, free cash conversion, however you want to define it. Historically, you had run, let's call it, free cash conversion in the 60% range. So free cash flow to net income, common definitions. Today, you're closer to 90%. Part of that, it's PSR. We're not buying locomotives, all of those types of things. But as we think about the next few years, is this kind of a sustainable, call it, conversion rate? Or would we -- would that maybe jog up or jog down or how should we think about that?

Yes. I mean we would certainly think that over the next few years -- and kind of going back to the capital comment, again, PSR, Unified Plan 2020, our version of it, has created capacity on our network. We're not buying new locomotives. We're buying a few freight cars. We're kind of on the margin. We are continuing to invest. But that said, we have said that long term, we think that our capital spend is going to be less than 15% of our revenue. And we think that -- we're very confident in that. And again, within that, we've got a lot of room to grow. So tying that back to free cash flow conversion, we think those should stay high. Certainly would look to push those up as we can drive operating income across our network with some volume growth.

Then maybe -- yes, go ahead, sorry.

[indiscernible]

So the number that you're referring to -- the question is about headcount and our guidance relative to headcount. So we have talked, our guidance for the year is that our headcount should be down 8% plus/minus on a full year basis. That's not just attrition. I think our natural attrition rate is a little bit less than that, maybe in the 5% to 6%, 7% kind of range. So it would be a little bit ahead of attrition. But it really is going to be volume dependent. And kind of our view of that is, again, here in the first quarter, volumes down 10%. We're continuing to see a decline in our overall headcount numbers. That's going to turn. We -- would be part of our plan as we get to the back half of the year and we start to see our volumes grow. And so when we get to the end of the year, that's why we kind of think net-net, we'll be down about 8% or so. But that's through more productivity. If you think about our target for at least $500 million of productivity in 2020, a big part of that has to come from our labor. That's our largest expense line. For us to get to a target like that, we have to continue to be very productive with our workforce.

And maybe sticking with headcount. So how should we think about the ability for you to handle volume growth? One of the, call it, issues, I suppose, with the rails has been big moves in volume to the upside and to the downside have been somewhat hard to handle. You guys have done a great job of handling it to the downside, quite frankly, I think, better than most would have expected. But when volumes do come back, assuming they don't surge, how do you bring T&E folks back? And how fluid can that be?

Right. So obviously, the more lead time that we have to be able to understand what the volumes are looking like, the more fluidly or seamlessly we can handle that. That's not always the luxury of things. So there's really a couple of different things. One is, we do right now have furloughed employees. So they no longer have a direct employment connection with them, but we've trained them, they're still in a furlough status. And the jobs that we have, a train and engine man at Union Pacific, are very good paying jobs, and sometimes some pretty remote parts of the United States require high school education, you don't need a college diploma. And so even though people have maybe gone on and started some other temporary jobs, we usually do a pretty good job of being able to call people back from furlough. Now we need to take them through a little bit of training to get them requalified, but we can put them back to service pretty quickly. And we're using more simulator training, and that helps us speed that return to service process. We're also working to shrink the amount of time that it takes us to hire and train a new train and engine person. I think, historically, we used to say that's about a 6 months time period. We're looking to close that down. I think now we think we've got that maybe closer to 5 or 4 months. And obviously, the more that we can cut back on that training time frame, the more nimble and flexible that we can be to the upside. But as it sits today, I think we feel very good about our ability to recall crews. And again, when you think about the focus and the attention that we're putting on long trains and continuing to build that train length, I don't need to add a crew to do that.

And maybe I'll -- we've got maybe a couple of more minutes, but -- and maybe I'll be a little nitpicky. It's kind of our job.

That's fine.

But you guys have decided not to disclose some additional metrics around pricing. And I'm just curious about the thought process on that. Is there a -- my assumption is pricing is still going to outpace inflation dollars. But is there any sort of signaling? Or how should we take that? And I'm just curious about the move to discontinue that.

Yes. So first of all, and you said it, I mean, and it is still our stated guidance that we expect our price dollars to be in excess of inflation. So we are still stating that. Well, we announced, I think it was at the end of the third quarter, that we're not going to talk about anymore is report a quarterly all-in price number. And really, as we looked at things, we found that we were -- had become over time the only railroad that was still giving that guidance. And in talks with our marketing and the sales team, they were starting to get a lot of pressure. And of course, pricing, they're always getting pressure, right, from the customer. But when we would talk at an Analyst Conference or an earnings release and say our all-in core price for the quarter was 2.5%, and then they're out sitting in front of the customer, and they're saying, here's the deal for you and it has a 5% increase in year 1 and then 3% increases in other years, that made that -- what was already going to be a tough conversation a much tougher conversation. Why are you pricing me above the average and those kinds of things. And so we've got a lot of discipline and rigor in our pricing process. You've heard us talk about the fact that every carload on our network needs to be reinvestable. And so we're still doing all the math and all the analytics, and putting all the rigor in it behind the scenes, but we're just not going to talk about that publicly.

Okay, fair enough. I think we're about out of time. I appreciate it. Thank you.

All right. Thank you very much, Tyler.