Union Pacific Corporation (UNP) Earnings Call Transcript & Summary

Everyone, welcome back. This is Jason Seidl from Cowen. We're continuing day 1 of our conference here with Union Pacific. We are thrilled to have Lance Fritz, CEO; and Jennifer Hamann, CFO, with us today. We're going to do some Q&A but after a brief update by Lance and Jennifer. So I'll turn it over to you, guys.

Thank you, Jason. It's a pleasure to be here this morning, and thank you for hosting us. I've got some prepared comments, as you mentioned today. They have accompanying slides. You'll be able to just go along with us. And we also have an updated pitchbook that you should have access to. Before I start, I want to remind everybody that there are -- I'll be making some forward-looking commentaries. Those statements are subject to risks and uncertainties. So please take a look at the UP website and our SEC filings for additional information about our risk factors. So going to Slide 3. Although I don't plan to recap our second quarter performance, it is important to reiterate our view that our results are another proof statement of the company's transformation through Unified Plan 2020. The team did a fantastic job of reducing our cost structure while maintaining a high level of service in the face of volume decline of historic proportions. So turning to the third quarter. The chart on the right really does an excellent job of demonstrating how severely our volumes fell off in April and how quickly they've been coming back beginning in June. Third quarter-to-date, our volumes are down 6% versus last year. Driving our volume recovery has been premium, up 4% versus the third quarter of 2019. Our Intermodal business has been very strong this quarter, up close to 8%. While international is improving and has been bolstered by a recent business win, it still remains down versus last year. Parcel and truckload, however, have seen double-digit growth in the quarter, driven by e-commerce and inventory restocking. Demand is at or near peak season levels. Automotive volumes are down 11% versus last year, but still a significant recovery from where they were at the bottom of the second quarter. And while inventory levels remain low, we continue to watch demand as the U.S. light vehicle sales forecast for 2020 is projected to be around 13.6 million units, which is down about 20% from last year. Our bulk business is down 11% as coal continues to be down more than 20%. However, we've seen sequential improvement across the other business lines: beer, driven by imports from Mexico; and grain, driven by exports, are both up versus last year. So ex coal, our bulk business has recovered nicely. Finally, our industrial business is down about 18% as it continues to be challenging by economic impacts from the pandemic and energy crisis. Sanding crew remains significantly depressed while other commodities like industrial chemicals reflect the current economic slowdown. A bright spot has been lumber, which is paced last year and reflects the strong housing market. In addition, our industrial business was slightly impacted by Hurricane Laura. However, our team did an excellent job of restoring service to that area in recovery. Going to Slide 4, as I mentioned earlier, our operating team has been presented with some substantial challenges this year. Sharp changes in volumes can be very challenging for our rail network. However, the operating team continues to produce results in both service and efficiency, helping to deliver business wins in the marketplace. Over the past month or so, our intermodal service product has been challenged with a sharp increase in demand on the West Coast as well as across the entire supply chain. Over the past several weeks, we've seen that service improve and is trending in the right direction. We remain committed to providing our intermodal customers with a high level service product. We continue to make improvement in trade line. As we are currently just under 9,000 feet as we update transportation plans in order to handle the increased volumes, our operating team continues to strike the appropriate balance of rightsizing assets with customer commitments. The improvements you see across the rest of our key performance metrics demonstrates that we're not just combining trains and cutting assets at the expense of our service product. Our optimism for the future has never been higher. With a reliable service product and a reduced cost structure, we're seeing new markets open up for us. And given that what we've accomplished during some pretty difficult times, it only gives us more confidence for what we can achieve in the future. Going to Slide 5. Since March, much of our focus has been on responding to the challenges presented to our company from the pandemic. That said, we understand our railroad is a reflection of society, and it's imperative that we continue to push and drive change that makes all of our lives better. At Union Pacific, we recognize the importance of delivering value for all of our stakeholders. As you are all probably aware, the United Nations has adopted 17 sustainability development goals with a target date of completion by 2030. While we believe Union Pacific plays a role in all of them, we've placed a focus on 7 of those goals. Today, I'll quickly highlight 3 actions we've taken in this arena. At Union Pacific, we believe education is an essential foundation for improving the quality of life. Recently, we announced an innovative partnership with the University of Nebraska at Omaha. It removes the financial and scheduling barriers that have traditionally discouraged employees from seeking higher education. In a nutshell, what we've done is bought credit hours and made them available for free to all of our employees for continuing education. The response so far has been outstanding as more than 800 employees already expressed interest with many already in the application and enrollment process. We're excited to see how it enhances our workforce as we move forward. We're also taking aggressive steps to remove barriers for women in the predominantly male-dominated rail industry. Women make up approximately 5.5% of our total workforce, which represents one of our biggest diversity opportunities. That's why at the end of May, we announced a goal to double that number to 11% by the end of 2030. Last year, our customers cut 25 million metric tons of greenhouse gas emissions by choosing rail over truck transportation. In March, we announced our intention to set science-based targets to help us further reduce our emissions. We recently submitted our proposed target for verification, and we anticipate publishing that target in the near future. This is an important step towards a more sustainable future. Wrapping up on Slide 6. Our guidance remains unchanged from what we discussed during the second quarter earnings call. Volumes are playing out relatively consistent with our expectations, and we still expect volumes for the full year to be down about 10%. We expect to exceed $500 million in productivity for the full year, and our long-standing guidance around pricing has remained unchanged. Together, these expectations for volume, price and productivity should produce year-over-year operating ratio improvement on a full year basis in 2020. Longer term, our guidance to capital expenditures of less than 15% of revenue and dividend payout ratio of 40% to 45% and, ultimately, a 55% operating ratio remain intact. As you've heard me say many times, Union Pacific is well positioned for a future of long-term growth and excellent returns. So with that, Jason, I'll turn it back to you for questions and answers.

Thank you, Lance, and thank you for updating us on where UP is at and also some of your longer-term goals. I want to commend UP on that, especially on gender equality. I always thought that women were sorely underrepresented in the supply chain and the women I've worked with over the years within transportation. I've always been extremely impressed with them, and I think we could just all benefit from their inclusion even more. I want to jump a little bit to PSR, which obviously, is on everybody's mind. Can you give us an update on how the implementation is going at UNP?

Yes. So a lot of the significant lift in terms of fundamentally changing the transportation plan and then finding specific large-scale asset redeployment or usage opportunities is in place. And at this point, we're looking for ways to continue to tweak the plan and find additional opportunity to improve the service product and improve the efficiency and reliability of the service product. So things like -- I think you're going to be seeing us take some actions in the intermodal space. We've got investment going on up in Chicago in G2. We've got investment going on down in Houston between Englewood and Settegast and we're looking for additional investment to take place in L.A., all with an eye towards kind of tweaking, if you will, our intermodal service product and product lines. We continue to look for ways to more efficiently manage our carload business in North Platte, Nebraska, where we have side-by-side yards, and it's our largest switching operation. We think it's the largest yard in the world. We used to use those side-by-side yards as omni-direction, West Bound used 1 yard or 1 hump and East bound used another hump. We've consolidated those humping operations into one. So East and westbound used the same humping operation. That's only available to us by an excellent work that the team at North Bled has done to take their car dwell down to typically below 20 hours of a car, and that opens up capacity for us to use in ways that we hadn't been able to use it before. So that's happening all around the network. It continues to happen. One of the biggest things we're doing is making sure that decision levels are driven all the way down into the front line; that our frontline leadership and teams have the ability to control their destiny and look for ways to improve the service product and take out decision-making layers. We've done that. And we're really pushing hard to help the local teams realize both the power and the accountability that they have to make that service product safer, more reliable, more efficient.

Yes. And the only thing I'd add to what Lance is saying is train length, obviously, has been a big part of our story as well. You've seen us continue to make excellent improvements there. Did a great job in the second quarter when volumes were shrinking dramatically. And now, you've seen us capture the benefits of that. And sequentially, those volumes are improving, and that's another area of investment. We're putting siding extensions in and a number of corridors that will help to further facilitate that growth.

Excellent. I'm going to stick a little bit on the intermodal side here. When you look -- intermodal volumes have been sort of in this recovery mode. What's brought about the recent recovery? Has it been just pure demand? Has it been truck pricing on the rise over the past, call, 1.5 months? What's driving that, if you can look deeper into it?

Yes, let's parse that out a little bit. I'll start by bifurcating intermodal and talk about international and domestic separately. International is just really all about the origin supply chain and China getting to be normal again through the second quarter and demand showing up to varying degrees in the U.S. So that's improved the pace of imports hitting the West Coast. Now only a portion of that turn into containers that are -- international containers being railed inland for distribution. A lot of times, those port containers turn into transload opportunity for board domestic containers moving out of the L.A. Basin or wherever the port district is. So we've seen a recovery in the international intermodal product. I think the inbound volumes are going to be higher in terms of boxes landed at the port than the volumes that we're going to see as international containers going inland because of that transload impact. In terms of domestic, there's a couple of different things happening. The first thing that's really juiced up demand is e-commerce in the parcel side of the world. So our parcel customers, and in your mind, you think that's UPS, FedEx, perhaps Amazon can be lumped in there, to an extent. Their business is booming, and we're seeing demand through those service products really, really strong, which is good. We've also seen, to your point, Jason, the truck market tighten up. And that's reflective of restocking after retailers having destocked even in the environment where there were large-scale lockdowns or self quarantines or shelter-in-place. There was still some amount of retail going on, but the supply chain was almost completely disrupted. And so I think a fair amount of destocking occurred, and we're starting to see a fair amount of restocking. It's been occurring over the last couple of months, handful of months. And it's interesting to us. I had a conversation with one of our very large customers yesterday in the, call it, the agricultural space, proteins, feeds, and they're a big truck user. And they see truck tightness almost in like a wack-a-mole way. There will be a particular lane, a particular area that it's very tight. It gets remedied, but that just creates a tightness somewhere else. And this customer also referenced what we've also heard, and that is in today's world, it's pretty hard to get drivers through school, graduated and into a cab of a truck. I don't know how long that lasts, but for whatever reason, the unemployment benefits and the adder or whatever it is, all of the things that have made truck workers supply tight periodically, that looks like that's current now, too. So that's what we experienced. That's what we're saying.

And of course, we've also won some new business, which is a testament to the work that the team has been doing, both from Kenny's side in terms of going out and beating bushes and talking to our customers about the value that we've added and then offering excellence side in terms of really driving reliable products. So across all 3 sectors that Lance mentioned, international, domestic and parcel, we've had business wins. And so you're seeing that volumes going up too.

Yes. I want to add one little anecdotal reference and that is Kenny, our Chief Commercial Officer, has reminded me that our lower cost base is turning into commercial wins in markets that we historically weren't winning at. And specifically in shorter haul business, we're across the carload and, to a lesser degree, in the intermodal product, we're winning business in a 400-mile range, which has been historically a difficult range for us to penetrate.

Well that's going to be interesting as we go into the next question. We had a ports call not too long ago with the Executive Director for the Port of L.A. was on and he was worried about losing up to 15% of his business because of, obviously, issues in the West Coast, some changes in global supply chain trade patterns. How do you view your long-term intermodal growth with that versus maybe -- is international going to shrink a little bit? And then will you pick up on the domestic side because your service product is much better and you have a lower price -- you have a lower price point because you reduced your cost basis?

Yes. There's a lot going on in the international side. I think it starts from sourcing, where China still is, of course, a monster source of product imported into the United States. But you've definitely, through the pandemic and even before, we could see that shifting over into Vietnam, Malaysia and some other sourcing areas. And that has been an impact on what's the most efficient routing to get it into market in the United States. So there's a little bit of that going on. There is a little bit of an issue with Port of L.A. and Port of Long Beach, having to deal with community relationships and elected officials who don't necessarily view inbound intermodal as a competitive advantage for their communities and instead are focused on other things that periodically, are increasing the cost of doing business through some of those ports. Now I know both the Executive Director at Long Beach and L.A. I know them both personally and they're very much focused on trying to do everything they can to make their ports competitive and the most attractive competitive option on the West Coast and be able to compete effectively against alternatives on the East. To that end, we've been working with both to create more visibility in the extended supply chain from Asia, all the way to destination in the United States and chunk out the responsible areas for each participant of the supply chain, create a little bit more visibility in performance data, and then hold each other accountable and help each other achieve best-in-class performance along that supply chain. That's underway. The tool is in place. The KPIs are largely developed and being implemented. And now it's all about the hard work of making sure that we're performing well enough to make the L.A., Long Beach cherry to look like the best place to bring imported product in the United States.

Lance, you mentioned a little bit about the shifts in the sourcing on the global supply chain. You mentioned Southeast Asia. We've seen some go to Mexico as well. Now you guys interchange with every single interchange point in Mexico. Is that going to be a longer-term benefit for you?

Yes, it should. We love it when Mexico sees foreign direct investment and an increase in production. We're very pleased with our franchise and its access into Mexico. We enjoy about 70% of the rail cross-border traffic to and from Mexico, and it's balanced between the 2 large carriers in Mexico, the FXE and the KCSM. But I still look at Mexico and think we're under-penetrated. There's markets where we should have a greater share of the outbound and inbound like along the [ key borders ]. And so we're working very, very diligently to secure that business.

And why do you think it is that you're under-penetrated in Mexico? What's the impediment there?

Well to a degree, it can be some of the complexities that occur at the border in terms of getting product in and out and the fact that in the trucking world, you can have a trailer sit and dwell for a little while. It's not optimal, but I think they treat that a little bit more -- they're not quite as aggressive at making sure their assets are moving as we are globally as an institution. I think, also, part of it is some of the same stuff we see in the United States, that transportation management systems frequently are oriented towards truck as the natural mode and that means rail has to really work hard to make sure we're as easy as we can be to do business with and take impediments from using us off the table. We're winning. We're seeing some penetration as it starts with a more sophisticated larger manufacturers, but there's huge opportunity there.

Okay. That's great. I want to switch over a little bit to western rail competition. Many times in the past, you guys have said that there was increased competition, and it was a little bit more difficult. Where does that stand right now between you and the BNSF?

BN has always been aggressive, very capable competitor. They compete very capably in coal, in the grain world, really, across the spectrum of their book of business. What I'm very pleased about is both what Unified Plan 2020 is done to our cost structure to enable us to compete and earn good margin in those markets. And then second, the fact that our franchise is shaped differently than the BNSF, and it gives us a little more opportunity to diversify our product portfolio than I think they have.

So as you look at the BNSF, and I'm not asking you to talk for them here, but like as you lower your cost structure because of your PSR initiatives, they're the sort of loan holdout on PSR. Do you think that they'll announce that they're doing PSR? Would that surprise you, I guess, is a better way to put it?

Yes, Jason, I'm not sure. And I'm not sure that it's fair to say they're not adopting elements or maybe PSR in its entirety. One thing that's different about the BNSF is that they don't have the same opportunity to tell their story publicly that a publicly traded company like Union Pacific does, right? We get to do that on our quarterly earnings calls. We get to do that in forums like what you're holding here today. And they typically are kind of out of that world. So I think there's a little more opacity in terms of what they're doing. Now I don't know any more than you do, right? I don't pretend to understand exactly what's going on in their world. But I do see them taking more aggressive action on their cost side. We could see that in what they did file in the second quarter. And I welcome if they were to go down the road of pursuing a PSR model. That means they would look at the world through the similar lens that we do, and I think that probably would be helpful.