Union Pacific Corporation (UNP) Earnings Call Transcript & Summary

I think we're live and recording, so we'll go ahead and get started. Thanks for joining us, obviously, in a different format this year, virtually, but nonetheless, still looking forward to a great conference. And kicking it off from a transportation and logistics perspective, I'm Ben Hartford, I have been covering the space at Baird for 15 years. Certainly excited and honored to have Union Pacific here to launch the transportation-related portion of the segments here over the course of the next 3 days. So I'm going to turn it over to -- it's my pleasure to have Jennifer Hamann here as well. She has been in the CFO seat for about a year now. I'm going to turn it over to Jennifer and the team. They're going to run through some prepared slides, and then we'll jump back over into my portion of the Q&A, and we'll get started. So Jennifer, I'll turn it over to you.

All right. Thanks, Ben, and good morning, everyone. The slides that are accompanying my prepared comments this morning are going to be shown on this webcast, but you can also find them on our website next to this webcast link. Before we start, of course, I want to remind everyone I will be making some forward-looking statements. These statements are subject to risks and uncertainties. So please refer to the UP website and SEC filings for additional information about our risk factors. So if you look at Slide 3, this gives you a summary of the highlights from our third quarter results. We delivered a strong financial performance in the third quarter. Despite volumes being down 4%, our revenue declined 11%, we put that together to produce an all-time quarterly record operating ratio of 58.7%, and it was our first sub-58 -- excuse me, first sub-59% quarter. During the quarter, we did an excellent job of controlling cost, as volumes rebounded from the lows of the second quarter. Put some numbers around that sequentially, as third quarter volumes increased 19% from the second quarter, our fuel adjusted operating expenses only increased 11%. We also delivered strong net productivity of $205 million in the third quarter at $610 million year-to-date as our operating teams continued progress on train length initiatives, balanced with an improved service product, led those productivity gains. Third quarter train lengths increased to just below 9,000 feet, and we're continuing to push that initiative, as October finished up another 100 feet more to nearly 9,100 feet. In addition to train length, we made significant strides across our other key metrics. The team delivered all-time quarterly records in terms of both locomotive and workforce productivity as we added the volume very efficiently. In October, both of these measures have improved again as workforce productivity was 1,050 daily miles per full-time equivalent employee and locomotive productivity was 142 gross ton-miles per horsepower day. The only measure that did not improve in the third quarter was our intermodal trip plan compliance. And this really reflected the impact that was seen across the entire intermodal supply chain from the sharp West Coast volume increase. We exited October, though, with some very good momentum and, in fact, October, we achieved an 83% on-time performance in terms of intermodal trip plan compliance. Throughout the third quarter and into October, our manifest network remained fluid and on time, demonstrating the flexibility and agility we've created in our operations. As the operating team leadership transitions from Jim Vena to Eric Gehringer over the next few months, our objectives and our confidence in achieving those objectives are unchanged. We will leverage our great franchise and our PSR implementation to deliver a safer, more reliable and more efficient service product for customers. If you turn now to Slide 4, this shows you our volumes fourth quarter to date, which are running up 4% year-over-year, as we continue to see growth in our premium sector, and I would say, improving sequential volumes in both bulk and industrial. If you look a little deeper at each business team, premium is currently up 12% versus the fourth quarter of 2019 as we continue to see growth in our intermodal business, up 14%. While we do have an easier comparison versus fourth quarter 2019, intermodal lines continue to be strong, led by e-commerce and restocking as we enter the holiday shopping season. [ Businessmens ] also contributes to our strength in this area. Our bulk business is flat, as coal continues to be a headwind, down around 17% quarter-to-date. However, that is being offset by strength in export grain as grain and grain products are up 18%, and we expect to see grain continuing to be strong throughout the quarter. Finally, our industrial business is down 8%, demonstrating some sequential improvement but at a somewhat muted pace. Energy markets continue to be challenged as crude and sand are down 40% and 30%, respectively. On a positive note, a strong housing market is driving strength in our forest products line of 11%, while industrial chemicals and plastics have made sequential improvement. If you look now on Slide 5, as we are transforming our operating model, we are providing our customers with a more reliable and a consistent service product; while at the same time, reducing our overall cost structure. This combination is opening up new markets and opportunities to secure new business. As you've heard both Lance and Kenny talked to, we're winning in the marketplace. While the uneven nature of our volumes this year has clouded the impact of our business wins, they are now starting to become evident in our volumes. As we've mentioned before, we have secured new volumes across a number of our business lines: grains, tomato paste, sweeteners, pipe and both domestic and international intermodal, just to name a few. Our marketing and sales organization is excited about the product they have to sell, and these wins only increase the optimism we have for the long-term potential of our franchise. Turning now to Slide 6. At UP, we recognize the importance of delivering value to all stakeholders. United Nations has adopted 17 sustainability development goals with a target completion date of 2030. While Union Pacific clearly has a role to play in all 17, under the direction of our CEO, Lance Fritz, we are focusing on 7. Let me quickly highlight some actions we've recently taken in this arena. We believe education is an essential foundation for improving the quality of life. In July, we announced an innovative partnership with my Alma Mater, the University of Nebraska Omaha. It removes financial and scheduling barriers that have traditionally discouraged employees from seeking higher education. Response so far has been outstanding as more than 1,000 employees have already expressed interest with almost 400 in the application and enrollment process. We are also taking aggressive steps to remove barriers for women in the traditionally male-dominated rail industry. Today, women only make up about 5.5% of our total workforce. But by 2030, we have a goal to double that representation to 11%. Additionally, we recently set a goal for 40% minority representation in Union Pacific, also by 2030. That's an increase of 11 points from where we are today. We believe our company's performance is improved and strengthened by a diverse and inclusive workforce. Finally, year-to-date through September, our customers have cut 16 million metric tons of greenhouse gas emissions by choosing rail transportation over trucks. We see rail transportation and our network, in particular, as being uniquely situated to help support a sustainable future. So wrapping up now on Slide 7. Our thoughts really on the fourth quarter and full year 2020 are unchanged from what we discussed at our October earnings call. We expect fourth quarter volumes will be up low single digits, which would be our first quarter with positive year-over-year growth in 2 years. Given this outlook, we expect full year volumes to be down 7% or so. Our full year expectations for productivity to exceed $700 million, and our long-standing pricing guidance is unchanged. We expect the total dollars generated from our pricing actions to exceed rail inflation costs. These expectations for volume, price and productivity should produce a record 2020 operating ratio. In fact, we expect the full year operating ratio to improve by roughly 1 point and start with a 5. In terms of cash generation and cash allocation, full year capital expenditures are projected to come in around $2.9 billion, and we will continue providing strong cash returns to our owners through our dividend and share repurchases. Longer term, capital expenditures below 15% of revenue, a dividend payout ratio of 40% to 45% of earnings and, ultimately, achieving a 55% operating ratio remain the vision and objectives for our company. So with that update, I'll turn it back to you, Ben, for Q&A.

Great. Thank you. Great summary. Jennifer, I just want to kind of start from the top and focus on kind of 2 key items at the beginning. The third quarter results, specifically, from your standpoint, the stock's reaction and kind of just sizing it up in relation to what expectations were during the course of the third quarter, I think the key points or the key focal points were the mix, some of the headwinds in the third quarter. I mean execution on an absolute basis was very, very strong, but maybe you could just talk a little bit about the dynamics during the third quarter and how the model executed relative to your expectations. Because, obviously, there was a little bit of disappointment, I think, once the results came out, but it seemed to be more positioning than anything. Could you talk a little bit about some of the mix dynamics that you experienced during the third quarter and how you think the model did respond, did execute amid, obviously, the Unified Plan and so on and so forth?

Sure. Well, I mean, I think kind of at a high level, when you think about volumes down 4% year-over-year and our expenses were down 11% -- or excuse me, down 12%. I think that alone is kind of a proof statement to say, we did a really good job controlling our costs. I think when you look at it sequentially, it's even more of a historic comparison when volumes sequentially increased 19% and our expenses only increased 11%. So I mean, again, we have said, I think, very consistently that our goal as the volumes return to the network is to control those costs, not bring them back at a one-for-one and provide a really strong service product for our customers. Because we know that's necessary to be able to grow in the marketplace and, ultimately, really drive returns and drive better margins, drive more cash to the shareholders. And I feel like the third quarter really is another in what has been, I would say, a series of kind of proof statements throughout 2020. Obviously, with some big bumps along the way in terms of what happened with volumes, that set us up very well to demonstrate that. So we felt very good about that performance. I think to your point, Ben, some of the noise around that, when you think about, again, volumes down 4% and our revenue down 11%, but that yield is tough to overcome through cost cutting. But again, I think we did a good job with it. And I think it shows our opportunity ahead as volumes can return back to a growth mode which we're hoping to see here and expect to see in the fourth quarter.

Sure. Obviously, COVID has had effects on businesses that are completely unforeseen through the course of the year, right? I think could you just spend 1 final minute talking about some of those dynamics in the third quarter? I guess, specifically within Intermodal, and some of the points of focus about -- well certainly, ocean freight volume came back in a fairly big way late in the second quarter and then there were some anecdotes of labor constraints. And maybe you can talk a little bit about the interplay between the rail yard operations and finding some of the labor, specifically in the third quarter that I think was in no small part COVID-related. And then could you also wrap in the application of surcharges and how you see that mechanism? Was it effective in the third quarter? How do you think you'll use that going forward as we graduate beyond this COVID environment as well?

Sure. So I think it's been well documented what the challenges were in the Intermodal supply chain as the volumes came back as quickly as they did, and it really was across that whole supply chain. When you see volumes drop off so suddenly and, of course, everybody is tightening down on resources; obviously, we furloughed employees, we parked locomotives, we parked freight cars. And then to see it spike back up as quickly as it did, I think we were well positioned in terms that we had cars -- railcars positioned close to the basin, near to the basin. We had the ability to call back crews very quickly and did, but it's still -- you've got to restart that engine and the flows were very imbalanced and that caused some headaches as well. But when I look at it and I think about historically, how I think we probably would have handled that quick snap up and down in volume versus how we did with our PSR mindset and with the new agility that our operating team has, I think we did a really fantastic job. I'd say, the month of July and into August were probably a little rocky from our customers' perspective, from a service standpoint. But then we pretty quickly got our footing, we got the assets in place. We didn't over resource, which is important, and we've been providing a really strong service product ever since. And I think pointing to the 83% intermodal trip plan compliance that we achieved in the month of October, further solidifies that because the volumes haven't come back at all. They're staying strong on the intermodal front. And we're handling that business on demand today. In terms of your surcharge question, we did put surcharges in place. We still have surcharges in place. And that really is to help protect some of the capacity. We have programs with some of our domestic intermodal customers where they commit to giving us so much volumes over the course of the year, and we commit to giving them box availability. And that's really what the surcharges are about, is helping protect those customer commitments. I think they achieved what we wanted them to achieve. It's really about better control of the flows. And I think that they were successful in that. We'll keep them in place as long as we think we need to relative to the demand environment.

If we could touch on Jim's departure now kind of 2 fronts: One, just from an organizational standpoint. Obviously, he's had a tremendous amount of success in a relatively short period of time, getting you guys on this journey. Can you talk about some of the things that we can't see, the organizational setup? I think you talked about the transition in leadership and that, I think, is around until midyear, but can you talk about what he's done beneath the surface? Where do you think Union Pacific is as it relates to the organization being in a position to push forward with regard to PSR as he moves on?

Yes. Thank you for that question, Ben. So as you said, Jim is going to be with us through midyear next year, and during that time, he's going to continue to work very closely with Eric Gehringer. Eric is going to step up into EVP of Transportation role. Eric is a great individual that I'm excited to be able to introduce investors to over the course of the next several years as he's working with the company and leading our operations department. He and Jim have really been working side-by-side over the last many months, really ever since Jim came onboard here at Union Pacific. And I see that transition going extremely well. They are very much aligned philosophically in terms of what we need to do going forward. Jim and he have been working very closely in terms of going around the organization, viewing the operations, talking with people, and I think that's the piece that maybe people look at Jim. He certainly was the headline name in many ways relative to our PSR implementation. But one person can't do all that work, as you know, and so it's been done across the organization, across the management team and across the workforce, quite frankly, in terms of putting together a list of initiatives. Train length, certainly, has been a big part of what we've been doing. But focusing on the freight car velocity, focusing on how we can reduce the dwell in our terminals to be able to generate more throughput and to be able to deliver that strong product to our customers. They have been spending a lot of time with the front-line managers, helping them understand what the PSR mindset means for them. You may have heard us say this, Ben, PSR, the kind of the common terminology is Precision Scheduled Railroading. Internally at UP, we call it pretty simple railroading. Don't complicate things, keep things simple, run the operation. And so I feel very confident in the management team that we have here, in Eric's leadership, and think the transition is going very well so far. And of course, Lance is continuing to direct the overall focus of the company in terms of how we can be more productive, how we can grow and how we can continue to improve our margins overall.

Sure, sure. Some of the tactical changes that are still to come under Eric's leadership, could you address -- you touched on train lengths, I think you're 9,000 feet. Now that's up about 30% or so over the past couple of years. What's the end game in your mind in terms of -- is there a number -- is there a defined number or is there a defined kind of period of time before you reach a point of maturity as it were -- as it relates to elongating the trains?

Yes. I think that's the exciting thing about it, Ben. We're constructing 15,000-foot sidings. So when you think about the fact that we're at 9,100 feet in terms of our max average train length, that says, we still have a lot of [ tender ]. Technology does not limit our ability relative to building train length. It's really about the transportation plan and the service we're providing to our customers as well as the volumes to be able to build that density. We've built out a number of sidings this year. We have more plans to construct next year. So we feel very good about that physical footprint that we're managing with. We'll continue to invest in that. I don't know that we know the limit of what that can be. It has to be kind of a composite look in terms of what are all the factors that are available to us. The footprint, physical infrastructure isn’t going to limit us. It's really going to be dictated more by the volumes that are coming on, where they're coming on and how we're able to design the transportation plan around that to have that long train length as we meet our customers' demands.

Okay. From a hump yards perspective, is there a defined number in terms of how many are left to be reduced? And maybe in that vein, you could talk a little bit about North Platte and the decision to keep one while flat switch on the other side. What's the perspective there as it relates to hump yards across the network?