Union Pacific Corporation (UNP) Earnings Call Transcript & Summary

Okay. Welcome back, everyone. Really happy to have Union Pacific back at the conference. Jennifer Hamann, CFO, looks extremely socially distanced right now. Thank you for being here, Jennifer. Appreciate it. And I know you've got a couple of quick slides that you want to walk through. And then we'll jump into Q&A. A lot of people logged in. So if you have any questions, make sure to submit them, and I'll make sure we get to them. Thanks, Jennifer.

Okay. Thank you, Scott, and good morning to everyone. Before we get going, I should mention that the presentation slides are up on our website as well as an updated presentation book or pitchbook. On Slide 2, we have our cautionary information. I want to make sure and remind everybody that I will be making some forward-looking statements today. Those statements are subject to risks and uncertainties. So please refer to the Union Pacific website and our SEC filings for additional information about our risk factors. So starting out on Slide 3. As you all know, Union Pacific delivered very strong financial results in the first quarter of 2020. Despite volume declines of 7% and a positive business mix and our pricing actions, we were able to limit our revenue decline to only 3%. We demonstrated our ability to being more than volume variable as our expenses decreased 10%. This enabled us to grow our operating income 9% and earnings per share of 11% to $2.15 a share, and we also delivered an industry-leading operating ratio of 59%, which included an impressive core margin improvement of about 3.8 points. And this improvement was largely driven by strong productivity, $220 million and really, expense control, I would say, across the board as well as improvement in all categories of our key performance indicators. And ultimately, we do view the first quarter as a proved statement for the long-term potential of Union Pacific. If you look now to Slide 4. As I discussed on our first quarter earnings call, our balance sheet and liquidity position are strong. We have a cash balance today of around $2.5 billion, and there are additional levers available at our disposal was necessary. The bond market continues to be open to us. And we have not drawn down on our $2 billion credit revolver, and we also have up to an additional $400 million available under our receivable securitization facility, which is about 50% drawn at this time. We're in a very strong position to navigate these uncertain times. And as we demonstrated in the first quarter, our cash generation is strong with a free cash flow conversion rate of over 90% and although we did suspend our share repurchases as we were prioritizing liquidity, we do plan to maintain our industry-leading dividend payout ratio. If you turn to Slide 5. This is an update in terms of our second quarter volumes, which are currently down 23% as we see the ongoing anomic impact of COVID-19. Unfortunately, there are a few business lines that have not been negatively impacted. Our bulk business is down 19% as coal continues to be a significant headwind, down about 30% quarter-to-date, frozen and refrigerated beer, and feed and animal proteins are all seeing significant impacts from the pandemic. On the positive side, however, grain is actually up 8% as we've seen improvements in export grain as China has started to produce -- excuse me, started to purchase some beans in Milo. Our industrial business is down 16% as we're seeing softness across the board. The largest driver, however, is the impact of low crude oil prices, which is impacting our petroleum shipments as well as sand. Construction in the south continues to drive positive increases in rock shipments, although there is some uncertainty about that trend continuing as we watch how the pandemic impacts both state and local budgets. The biggest decline has been in our premium business as the impact of the auto plant shutdowns and overall consumer demand has led to a 30% decline. Autos are down 85% quarter to date. However, with plants starting to reopen, there is some light on the horizon there. The positive impact to those volumes is expected to be slow, however, as we look for production to ramp up over a period of time and for the OEMs to work through their current inventory levels. And of course, ultimately, consumer demand will be a big driver of those production levels. Both domestic and international intermodal continue to be down around 16% for the quarter, I would say we do have one bright spot here, and that's on the parcel side as consumers continue to use e-commerce to purchase goods. And on the international side, though, we're continuing to watch some of the blank sailings and expect some further load weakness as -- before things potentially improve there. And so I would say, as the country begins to reopen, we do look forward to seeing some improvements in both autos and other commodity lines but there's still obviously a lot of unknowns in terms of the pace of recovery and what that overall impact is going to be on consumer spending. On Slide 6, though, I do think it's important to point out that while the current state of the business is challenged, that has not deterred our business development efforts. While it's tough to see in the current volumes, we are securing some very nice wins in the marketplace and our enhanced service product and improved cost structure has armed our team with a fantastic product to sell and customers are taking notice. We've seen wins so far across a number of our business lines, examples of that are tomato pastes, sweeteners, steel, and recycled glass just to name a few. And then we've also recently won some pipe business that in the past have not met our return threshold. But with our improved cost structure and better service product for the customer, it now nicely fits within our return portfolio. And despite some of the major economic headwinds that are right now present in the premium sector, we've secured new business there as well, both in auto parts as well as domestic and international intermodal. And all of these wins really give us the optimism that we feel about our long-term future and the future of our franchise. If you move to Slide 7 now. As I mentioned, these wins are being driven by service product that has never been better. And we continue to see improvement in our key performance indicators in the month of April. The only metric in the month that declined versus last year was workforce productivity. And this really reflects the difficulty of matching our workforce to that steep decline we've seen in the volumes. And as you can now see weekly on our investor website, we continue to make substantial improvements in freight car velocity as it's currently running around 227 miles per day. And additionally, we've seen significant improvement in freight car terminal dwell. Most importantly, though, our customers are seeing improved service products through increasing trip plan compliance numbers. In the month of April, intermodal was at 89%, while manifest and autos improved to 77%. And this improvement is really tangible for our customers and demonstrates the overall goal of Unified Plan 2020. And while some of these measures benefit no doubt from lower volumes, we are taking the necessary steps to improve efficiency and the reliability of our network. Turning now to Slide 8. As we deal with the severe decline in volumes, we are continuing to take steps to reduce costs and rightsize our resources. And I'd say a good indicator of that success is in our continued increase in train length that we have produced in the month of April. Train length for the month increased to just over 8,500 feet as we continue to update our transportation plan including yard and local schedules to meet customer demands, while also balancing both the resources and assets to the decline in volumes. Capital investments on those siding extensions are contributing as well. Recently, we did make the announcement that we've temporarily closed shops in North Little Rock, DeSoto, and Denver, in order to control expenses and recognize the decline in volumes. And those facilities though stand ready to reopen when volumes return. I would say we're rapidly adjusting our resources to meet the decline, but we are also being careful to make sure that we have a good supply of antimony resources, both in terms of locomotives and employees. So to wrap it up on Slide 9. The guidance that we laid out on our first quarter earnings conference call remains unchanged. We did remove full quarter -- or excuse me, full year guidance for volume, headcount, operating ratio, and share repurchases. For the second quarter, we said that volumes would be down around 25% or so. And with current quarter volumes down 23%, I would say we're right in the ballpark there in terms of what we were anticipating. I would -- we'd also say and stress that we continue to pull every lever possible to reduce costs. But even with those activities, it's unlikely that we can improve our second quarter operating ratio on a year-over-year basis with that level of volume loss. On a full year basis, we still expect pricing gains to be in excess of our inflation dollars, and we look for $400 million to $500 million of productivity. We also very -- feel very confident about our solid free cash flow, and look for that to be able to be deployed for our capital spending, although reduced a little bit by $150 million to $200 million, maintaining their dividend. We just announced our second quarter dividend, but continuing with the suspension of the share repurchases. As we're dealing with the impacts of the pandemic, we have an unwavering commitment to improving safety and efficiency in service and really are looking forward to the long-term prospects of the company. And before I turn it over to you, Scott, I should also give a shout out to the men and women of Union Pacific. They have been deemed essential workers and certainly the work that they are doing to keep our railroad running safely and efficiently and moving the goods that are necessary for the U.S. economy and the supply chain, that hard work needs to be acknowledged and recognized. So hats off to them as always. So back to you, Scott, and we'll open it up, I guess, for your questions and questions of others.

Okay. Great. Thank you, Jennifer. And [ touch down ], I think you can pull those slides down. I'll start with questions if there are any that people want to submit, go for it. We've got some time for Q&A. So maybe, Jennifer, volumes down 23%, any way to give us maybe some perspective on revenue. We heard from a couple of the other rails this morning that, that revenue is going to be down at least as much as volume, potentially more than volume implying. So rev per car sort of flat to down. Maybe if you have some thoughts for us there.

Yes. We don't give revenue guidance, Scott, and I'm not going to start that today. But we are putting available lot on our investor website now. We started this couple of months ago, I guess, now in terms of putting out revenue ton-miles, I think that's a helpful indicator that people can look at and monitor, and it lines up against our 3 business teams and people know what the ARCs are of those business teams. And then obviously, you also have a little bit of pressure in terms of the average revenue per car with fuel surcharge and lower fuel prices. So I would say just look at all those things and take them into combined factors as you think about it.

Is it at this point, over halfway through the quarter and not asking for how you think the rest of the quarter plays out. But is it clear halfway through that there's a -- there's an obvious sort of mix, either a tailwind or headwind based on the mix of traffic that you're seeing right now?

Yes, I mean, again, I would point people to the RCM data, but just thinking about -- and I'm not going to talk year-over-year, but just thinking sequentially, certainly, in the first quarter, we had industrial products, that part of our business, which is our highest ARC business. It had -- it actually grew on a year-over-year basis. Industrial products in total was up, I think, 3% in the first quarter. You look at that business line now, and it's down substantially as is the rest of our business lines, but they certainly have the impact of the crude oil and the lower petroleum and sand pulls in there as well. So there's certainly an impact on that industrial products. And then I would also point out within the premium line, with autos down 85%, that's going to be a headwind for us as well.

Okay. I think that makes sense. So let's talk about work -- the slide that you had with all the operating metrics, everything favorable year-over-year. The one negative was workforce productivity, down about 5%. I guess that's just a natural thing that happens when volumes are down over 20%. Do you think -- is that something that, that -- does that gap start to improve in May? Or is there more headcount that's coming out right now? When do you think that, that workforce productivity has potential to turn positive again?

I'm not going to make a call on either the gap or when it might turn positive. But as I stated, we are continuing to take action to try to rightsize things. It's just tough to keep up. We are continuing to furlough [ pois ]. Certainly, the actions that we took with some of the shop closures that I've mentioned about the management actions that we've also taken in terms of our unpaid leave and salary reductions. So I think we're being pretty aggressive, and we're going to make sure that we try to stay on top of it.

Okay. And then how about on train starts if you have an update there?

Again, I would say we're being more than volume variable, and we've reduced our train starts at a faster rate than we've seen volumes decline, but it's hard to keep up with that, quite frankly. And there's -- you start to reach some limits because and I think that's why it's important. We -- when we show our productivity measures, we also show those trip plan compliance. So you've got to make sure that you're keeping the customer satisfied and then you're keeping that service product up. And so you've got to be balancing both things. And while you could maybe do more to pull back train starts at some point, that's going to have an impact on your customer service product. And so we want to make sure that we're not pushing too hard on 1 and causing problems for our customer on the other side.

Okay. That makes sense. So when you look at the headcount numbers, just -- I don't know if that -- I guess that does not include anyone on extra boards or reserve boards. Are you guys doing a lot of that? Is that a number that you can share in terms of how many people are on those boards right now?

No. I mean we have furloughed a large number. We are keeping some. I wouldn't say it's a large number necessarily in what we call the AWATS position, so the alternative work and training schedule, that allows them to keep their benefits, and we have them come in a couple of days a month to stay current on their training. I would say that's not a significant number within the total furlough status. But I -- just as a reminder, when we furlough somebody, they are allowed to get their benefits for a period of 4 months. So there is some ongoing expense related to folks, even once they're putting what I would call the true furlough status.

So we should think about it with furloughs that as at least initially may be in the second quarter, that the headcount starts to come up, but if you're still paying benefits that there's some -- the comp per employee number has some upward pressure on it.

It was a little bit...

Temporary and for those 4 months that you're talking about?

Yes. Yes.

So is there any way to help us to sort of connect the dots then between -- so train starts down even more than volumes, but help us connect the dots between sort of train starts and overall sort of OpEx and how much the train starts are a function of what -- I guess it’s just the way the question of like how much is a variable cost in the quarter and how much more fixed? So any way to sort of help us connect those dots?

Yes, I mean, as you know, we've not given precise things. I mean as I think about our cost categories kind of at a high level, the most volume variable part of that is going to be our fuel expense. I would -- comp and benefits is probably #2 in terms of volume variable. So you've got your train engine crews, which is a big part of our overall workforce. It's probably somewhere between 1/3 or more of our total workforce. And so that's a very volume variable piece for us. You've got our mechanical and engineering group, where we've taken a lot of steps when I mentioned the shop closures, those are by and large mechanical employees. And then the management employees are a smaller subset of the group. So I would say we've taken action across all of those categories here in the second quarter, that are going to move that needle, probably not to the extent the volumes have moved, but we're certainly going to take some -- we certainly have taken action there. And I would say, it's probably also fair to know that it's a small part, but some of those shop closures there's a little bit of capital impact for that because some of these locomotive shops and the car shop, they did some capital and some OE work.

Okay. And if you want to maybe provide some perspective view, you've said now today and you said it at some recent conferences, it's unlikely to see the OR improve in the quarter. But when you talk about it's unlikely, it doesn't sound like there's dramatic step backwards in the OR when you say unlikely, right? Am I thinking about that right in terms of the way you're trying to message this?

I guess I'm not trying to size it the one word. It's unlikely that it's going to improve. But I guess, don't read that as an order of magnitude. We're certainly going to have some benefit from fuel. Fuel has been kind of the one good guy. That's a tailwind for us this year that we weren't anticipating. But everything else, unfortunately, is a headwind for us. And so those are things that we're just not going to be able to overcome in this volume environment. So we'll see how the quarter plays out.

Okay. And then just that point about fuel, is there -- we had a lag benefit in the first quarter. Is there another sort of sizable benefit this quarter either from the lag benefit or just some sort of the difference we're seeing in highway diesel versus sort of heating oil prices? Is that a meaningful factor right now?

So we're going to continue to see, as you know when diesel prices come down, we've got about a 2-month lag relative to our surcharges. And so that dynamic continues. To your point, there has maintained a little bit of a wider gap than historically present, although I don't think it's changed that dramatically over the last couple of months, but a gap that's probably given us a little bit of tailwind in terms of the on-highway diesel fuel. It's not a huge thing. I'd much rather see volumes back up and a different dynamic overall in the marketplace than the bit of tailwind that we're getting from lower fuel and all surcharge lag.

Okay. One of the things we heard earlier today was that as some of these auto plants are starting to reopen that rather than run unit trains for autos we're able to sort of put them into the manifest network. So as volumes in this part of the business start to recover, we don't necessarily need to add train starts back. Is this an opportunity? And I'll extend it beyond just autos that at some point, hopefully, we'll get back to pre-COVID volume levels. But is there a chance that maybe the train starts never get back to pre-COVID levels again, just because we're taking an opportunity to sort of make this a some structural changes here?

Well, I'd point you to our train length that we've been talking about, we wouldn't be able to have achieved the levels of train length that we're operating now at over 8,500 feet. In the last year to 18 months, if we weren't already doing some of those combinations. So I don't see it as necessarily a big shift in what we have been doing. But certainly, to your point, it gives us the ability to further keep that work up and give us a few more carloads to do it with. And so we'll continue to do that. And you've heard us say, too is, as volumes start to come back, we would look to generate very positive incremental margins, and we would look to narrowing the resources back at the same level that the carloads go back.

The train length trajectory, is that easier to get up when volumes are growing? Or is that easier when volumes are shrinking right now?

No. I think Jim or Tom or any of the operating team were here, they'd say it’s absolutely easier when the volumes are growing because the thing that we could do as you know as we could just continue to hold cars for some period of time and then launch a really long train, but if we did that, you'd see both our terminal dwell times increase, which they've not been continued to drive dwell down or you'd see an impact in our customer service metrics, and you've seen that continue to improve. So it to me shows that we've really done a great job from a transportation planning standpoint to be able to work out where -- what are our head ops that we need to meet, how can we appropriately route and combine different sets of business to get the train length stuff like that. So no, it would be much easier for us to do that if we had more volumes to do it. But it gives you optionality. And so right now, our options continue to be constrained as you see volumes come down.

And what do you think is a good goal here targets? So let's just say in the third quarter, I'll make it up, but volumes recover, 5% or something, again, just making up a number. Is the goal to keep headcount and train starts flat? Would you want to grow it just through 4%? Or what's the right way to think about sort of the incremental margin that we can get as volumes start growing again?

Yes, I mean, obviously, I'm not going to size that. Again, I think incremental volumes as we start to see volumes grow, can be very positive for us. But like anything, it will depend on where the volumes come back from. We're -- if you see a big surge coming off of the West Coast in terms of intermodal, certainly, that will give us a great opportunity to increase train length across our sunset corridor and drive volumes there. But if you have everything, if coal is still down substantially, you're not going to have as much opportunity in those corridors. So we feel like we've got a lot of optionality in terms of the work that the transportation team has done in creating long trains that bypass terminals we also feel very good about just, obviously, the overall fluidity that we have, the resources that we have available to us. And so we just need to stay flexible and nimble and I welcome the opportunity to sit here and talk to you about volume growth and the great things that that's doing for our network and for our franchise.

Someone just submitted a question sort of longer-term in nature about, onshore -- the -- can you talk to the importance of on-shoring production for Union Pacific, including Mexico. So I guess, the moving parts of -- you've got a domestic business, you've got a Mexico business. And obviously, you touch the West Coast ports. So would you view on-shoring as a good or bad outcome for UP? And is it something, frankly, that you think is a big theme that's going to take place over the next few years? Or do you think maybe people are overhyping it right now?

I think we certainly don't know yet, right? And so for people to state affirmatively that it's going to happen, I think that we just don't know that yet. I think certainly, you could see some goods come back onshore that are deemed kind of mission-critical when you think about some of the medical supplies and things of that nature, that's probably not an area that we participate in that much, other than maybe on the intermodal side of the world. Where you could see the bigger impact, coupled in if you saw some heavy industrial manufacturing come back. That would be a great opportunity for us. If they site a plant somewhere in the Western United States and then we get to all the raw materials into it and then the finished products out. We'll certainly be happy to work with any customer. If they're looking to do that and have those conversations if the business moves to Mexico. We obviously have a very strong franchise into and out of Mexico with access at all 6 major border crossings and the 26% ownership in the FXE. So we'll wait and see what happens. I don't see it necessarily as a detractor or a positive as it just depends on what might happen. And obviously, where the plants would go up, you would think there's probably a better chance they would decide it in the western half of the United States just because less density of population and more land space to do that, but hard to really say.

Okay. That's fair. Longer term, so on the operating ratio, when I look at a sub-60 in the first quarter, which is usually the lowest and the worst OR of the year. To me, it suggests a run rate approaching mid-50s, right, on a -- in a more normal environment, so not this year, but as we get back to, hopefully, some more normalized volume revenue in '21, '22 is -- do I -- should I take that first quarter OR is a sign that the mid-50s OR that you've been talking about for a few years really is possible?

Well, we've always thought it was possible. Otherwise, we wouldn't have put the target out there. We've been...

Or better said, sorry to interrupt. Should I take that as a sign that maybe that we're sort of effectively on that run rate once we get back to that normalized volume revenue level?

Well, again, we've not put a date on it. But as you've heard us say, I think we said it at earnings, and I said it again today, we absolutely view that 59 that we put up in the first quarter is a proof statement of long-term potential. And we've talked about that long-term as being getting to the mid-50s kind of an operating ratio. So we're very confident that we have the ability to get there. We have a line of sight to get there. There needs to be a different point dynamic than what we're experiencing today, obviously. But that's where you hear us be very bullish and very optimistic about the future. We're going through a very tough time right now, as is everybody. We just need to manage through that and make sure that we're -- we still have the resources at the ready. And then we really look forward to that dynamic changing, both from a standpoint of the efficiency and the productivity that we've shown that we can do as well as that service product, the ability to win in the marketplace.

Any signs of a change in the competitive dynamic with BN getting any better, potentially getting worse in a tougher volume environment? Or would you characterize it is more of the same?

I would quite just characterize it is more of the same, no real change.

Okay. And operationally, anything that you see that they're doing to sort of replicate some of the things that you guys are doing really well right now?

I would say we've not really seen anything. We interchange a lot of businesses with them. They run on us. We run on them from a track address perspective. And I would say we've not seen any market change in their behavior over the last many months.

Okay. And then we're running out of time. I wanted to ask just quickly CapEx. So we're below $3 billion of revenue this year -- sorry, $3 billion of CapEx this year. Hopefully, not $3 billion of revenue.

Scott, I don't want that to make a headline.

So below $3 billion of CapEx, do you think we can stay here for the next several years? Or is this sort of a one and done? And realistically, it's got to get back up above that level going forward?

Well, I think we've shown a really good track record of being disciplined with our capital spend, and we obviously have the longer-term guidance out there, stay below 15% of revenue. $2 billion-ish is what we consider kind of the amount that we need to invest annually, kind of to keep the lights on. You add a few hundred million on top of that in terms of some of the investments to modernize the locomotive fleet and freight cars and those kinds of assets. Beyond that, it's where we can invest for productivity or growth that that's available to us. So we're going to be very judicious with our capital spend. I think the great thing about PSR and some of the investments we're making this year are clearly being seen in our productivity and our train length initiatives. And then I would also say, it does create latent capacity for us when you consider the yards that we've closed, the assets that we have stored, those are all things that we can deploy going forward with very little incremental capital.

Okay. All right. I think we got to wrap it there. Thank you so much, Jennifer. I appreciate you doing this and be well.

Thanks. You too, Scott, take care.

Thank you.