Union Pacific Corporation (UNP) Earnings Call Transcript & Summary

Hi, everyone, and welcome to our next fireside chat with Union Pacific. Representing the company today, we have Jennifer Hamann, CFO; and Eric Gehringer, who's SVP of Transportation now in his role is going to be changing here shortly, as many of you have heard. Jennifer and Eric, thanks for being here. Really appreciate your time. Wish we could do this in Nashville. But looking forward to having this discussion. Jennifer, I'm going to open it up to you to make some prepared remarks. And then after that, we'll go to Q&A. [Operator Instructions] So with that, Jennifer, I'll turn it to you.

All right. Thanks, Justin, and good morning, everyone. We'll start off with our customary slide that shows that we have some forward-looking statements that we might be making today, and so those statements are subject to risks and uncertainties. So please refer to the UP website and SEC filings for additional information about our risk factors. And these slides that accompany our presentation can be found on the investor website next to the webcast link for this event. I'm excited to have Eric with me here today. In a couple of minutes, I'll have him introduce himself to you all and provide an update on our operational performance so far in the fourth quarter. But first, let me start with a quick recap of our third quarter performance. Beginning on Slide 3, this gives you a summary of the highlights from our third quarter, where we delivered strong financial results despite volume declines of 4% and a revenue decline of 11%. In this environment, we did an excellent job controlling costs as volumes rebounded from the lows of the second quarter. To put some numbers around it, sequentially, as third quarter volumes increased 19% from the second quarter, fuel adjusted operating expenses increased only 11% to produce an all-time quarterly operating ratio of 58.7%, which was our first sub 59 quarters as a company. Strong productivity gains of $205 million in the third quarter were key to driving that operating ratio improvement. In fact, year-to-date productivity totaled $610 million as the operating department continues to progress train length initiatives against an improved service product. If you turn now to Slide 4 and our fourth quarter carloadings, volumes are staying pretty steady in the 160,000 7-day carloading range, and that's been in that range for, I say, the past several months. For the quarter, volumes are currently up 3% year-over-year as we continue to see growth in our premium sector and improving sequential volumes in both bulk and industrial. Looking a little deeper at each business line. Premium is currently up 11% versus fourth quarter 2019 as we continue to see growth in our intermodal business which is up 14%. Intermodal volumes continue to be led by e-commerce business and inventory restocking as we enter the holiday shopping season. Business wins across auto parts and both international and domestic intermodal also are contributing to strengthen this area. Our bulk business is down 1% as coal continues to be a headwind, down around 19% quarter to date. However, that it is mostly being offset by strength in export grain as grain and grain products are up 17%. Business wins in commodities like specialty grain, sweeteners and tomato paste are elevating volumes for us as well. Finally, our industrial business is down 7%, demonstrating some sequential improvement but at a more muted pace. While energy markets continue to be challenged with crude and sand down 20 -- excuse me, 40% and 25%, respectively, a strong housing market is driving our products line up 11%, while industrial chemicals and plastics have made sequential gains. Again, we won a business in commodities like recycled glass, steel and industrial sand. In the face of macroeconomic headwinds, our marketing sales team is using a more reliable and consistent service product, combined with a reduced cost structure to go out and win in the marketplace. Our optimism for the long-term potential of our franchise has never been greater. So with that, let me turn it over to Eric for his remarks.

Thank you, Jennifer. I'm excited for the opportunity to introduce myself and provide some thoughts on my vision for Union Pacific's operating department going forward. I've been with Union Pacific for 15 years, starting my career in our engineering group, holding various positions until I was named Chief Engineering Officer in early 2018. At the beginning of 2020, the mechanical department was added to my responsibilities, which was dear to my heart given my aerospace engineering background. Then I move to my current position as Senior Vice President of Transportation. I've been fortunate to work with Jim Vena since he came to the Union Pacific almost 2 years ago. And I'm appreciative of the opportunity to continue to receive his guidance and mentorship through the end of June. While more recently, I've been experiencing PSR through the lens of train operations, over the past 2 years, we've also been transforming the engineering and mechanical departments. From being more efficient with our track time to maintain our infrastructure, to how we service locomotives to turn the asset faster, we are applying PSR principles in every facet of the departments. Under Lance and Jim's mentorship, the entire leadership team has been immersed in this way of operating since we began our journey in early 2018. Shifting gears to current operations on Slide 5, we're providing an update to our key metrics for October. As you can see, we once again made improvements across nearly all of our metrics. You'll note that locomotive and workforce productivity made sequential improvements from the third quarter as we continue to use those resources more efficiently. Those improvements were spurred by continued improvement in train length as we made a 100 foot sequential improvement in October to almost 9,100 feet. This improvement was made with sequential volumes essentially flat as we [Audio Gap] we continue to update [indiscernible] our customers with an enhanced service product [Audio Gap] [ in the quarter ] and remain so in October. During the earnings call, we discussed the challenges in intermodal with the rebound in traffic we saw on the West Coast. As we noted then, our service product has recovered strongly, as evidenced by the 83% on-time performance we achieved in October. As I look to the future, we have a full pipeline of productivity projects across the operating department that's [Audio Gap] Served I see as critical to our success. Safety. Everything we must -- we do must be done with an eye, doing our work safer. Train length. We will continue to push train length to be more productive and provide a better service product to our customers. Terminal rationalization. Our terminals must be as efficient as possible to improve the reliability of that service product. Asset management. We must be judicious with our resources and turn them quickly. And finally, technology. We will leverage technology whether using the PTC platform or new technology to drive productivity and efficiency. I'm proud of our entire operating team and their achievements during the challenging year. In fact, we're acknowledging the outstanding work of our agreement professionals have done throughout 2020 to ensure the safe, efficient and timely delivery of freight to our customers with a bonus. We could not have achieved what we did in 2020 without their support and commitment. As we look ahead to a strong finish to the year, we're excited about our opportunities in 2021 to provide our customers with a safer, more reliable and more efficient service product. With that, I'll turn it back over to Jennifer.

Thanks, Eric. So finishing up on Slide 6. Our thoughts 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 will 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 expectation for productivity is 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 a point and start with [ five ]. In terms of cash generation and capital 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 that 55% operating ratio remain the vision and objectives for our company. Finally, I also want to highlight the agreement bonus that Eric just mentioned. As we announced last week, we're providing monetary recognition to our agreement professionals in the form of a $1,000 bonus paid in December. Our agreement employees have been on the front line of the pandemic, providing an essential service to our company and our country. Quite literally, these employees kept our country moving when we needed it most. They went above and beyond to take great care of our railways and our customers. For that commitment, we'll be paying approximately 31,000 employees, a onetime $1,000 bonus, including taxes, that will add around $37 million to our compensation and benefits line in the fourth quarter of 2020. The value of women and men of Union Pacific provided in 2020 far surpassed our expectations. So this recognition is incredibly well deserved. So with that, Justin, I'll turn it back to you for the Q&A.

Well, thanks. I appreciate all the color that you provided. And Jennifer, maybe a follow-up first with a question for you. All the guidance sounds like it's being reiterated. So this quarter, has there been any major surprise, either positive or negative as you look across the business? Or would it be a fair characterization to say that trends have been fairly in line with your expectations?

Thanks, Justin, for that question. Yes, I would say, overall, the things are trending basically in line with how we expected. We had expectations with the intermodal business, the e-commerce parcel was going to continue strong in the quarter, and that certainly continues to be the case. We also expected grain to play a bigger role in the fourth quarter. We've seen it strengthen through the third quarter, and that's absolutely continuing here in the fourth quarter. But we are seeing some sequential gains on that industrial side, which is encouraging. Still very muted more it was prior to pandemic. But we are starting to see housing starts looking a little bit better some of the lumber products. But the industrial side of the business still is pretty muted. Obviously, coal continues to be a significant headwind along with petroleum and frac sand. But I would say that was very much expected coming into the quarter.

Okay. And Eric, I'd love to ask you a question as well, and it's great to meet you even if it's virtually. And I know there are a lot of investors that are eager to hear from you and meet you as well. So I wanted to ask about PSR implementation at UP. Obviously, it was -- it's off to a very successful start. Jim's leadership has been an important piece of that. So the main question, I think, investors have, just to be direct, is that sustainability of this success as this transition plays out. So from your perspective, what's the message to investors to give them confidence that the foundation of PSR has been built, the blueprint has been laid, and we'll see continued success and a smooth transition into next year.

So thank you for the question, Justin. That's a great one. I want to be just crystal clear that everything -- the strategies we have, the actions we've taken, they will continue. When you think about what Jim has shared in the past, he’s been an absolute driving force to evolve the way that we look at our business, obviously, with the clear sight on asset and productivity. When I think about moving forward, though, you've also heard Jim say that -- although he was that driving force, his mission was to empower our team to evolve in their mentality, to embrace the PSR tenets, and that's what we've done. You see it across the entire Board within every department we've been operating that we are focused on those 5 tenets of PSR. And I don't expect that to change a single bit with his departure in June next year.

And from a high level, as you think about the productivity opportunities in 2021, what are the kind of key areas that you would highlight, Eric?

So the 3 most important ones to me after safety are going to be train length, balancing, and then we look at our assets, specifically around locomotives. So all 3 of them individually, collectively, they all drive the same result, which is less crews, less locomotives, less cars. That doesn't mean that we're going to put that less priority on our service product, that needs to maintain its very strong position, but we'll continue to push those 3 areas because they directly drive bottom line productivity.

Yes. And Justin, as you -- I know you're familiar with it. So we completed -- I never get this number exactly right, [ close to ] 28 or so on the siding projects that are enabling the train length initiatives so far in 2020. We've got more than we'll complete before year-end. And then we've got more that we're going to be starting and working on in 2021 and completing in 2021. So when you hear Eric and others talk about continuing that train length story, part of that is driven by these capital investments that we're making, but then they're also obviously doing a lot of good work around the transportation plan and just looking at ways to be more creative and combining more trains to further drive that train length.

Yes. And I'll just add to that, Justin, when we think about train length, and Jennifer just mentioned at the end, when I say balancing, that's what I really mean is, yes, we can make infrastructure investments and we are. But even beyond just the capital investment, we also have opportunities to just take our existing trains, given their current length and look for every opportunity that complement. So a very common one is when we have trains leave a coal mine, we have the ability once they reach our railroad to combine 2 of them in their transit all the way to Chicago. It's those types of process improvements and that continued evolving of the mindset that says, we can run longer trains, then you would see me continue to reinforce on a daily basis.

And I know the opportunity to run longer trains is going to vary based on the commodity and where you are in the network. But just generally speaking, how much room do you have to go on that front? I mean is there another 15%, 20%? Just if you look at the average across the network, how much more can train lengths improve?

So we have this conversation frequently with people because it usually comes in the form of what physical limitations are there. Now there are physical limitations in our infrastructure. We do have to make investments in that. But I wouldn't even put a number on it at this point, Justin, because we're pushing ourselves to not even feel in any way constrained that there is an upward bound. Instead, we're just going to continue to safely but consistently push that envelope. And I hope that it's much longer than it is today.

So I think the conclusion is that this is a multiyear trend, not just a 2020 and 2021 trend as volumes bounce back. Is that fair?

It's 100% fair. And you know that it's going to go beyond that because part of our ability to grow train length, it depends on mix. And so as we see changes to our business, we're going to continually ask ourselves, okay, is there the ability to grow train length as a result of that change in the mix.

Yes. And I would just go back and say, one of the great crude statements that it's not just about infrastructure or volumes even is the way that we grew train length in the second quarter when our volumes were down almost 20%. So that's where really kind of the process that Eric touches on and the transportation plan plays a role. And so you've got -- just kind of think about Rubik's cube that we're continually twisting and reshaping and finding ways to grow that trend.

And Eric, you mentioned your background in engineering. I wanted to ask about that. And as you think about stepping into this new role, how do you feel like that could help you in the continuation of implementing PSR? And just from a technology standpoint as well, what do you see is the opportunity there? Will we see UP invest more in technology under your leadership the next couple of years?

Yes. It's a great question. So I really want to be crystal clear at this, that since the very implementation of PSR, I'm not involved in it. Yes, I was in the engineering department, but we were applying the PSR tenets of engineering just as we do in transportation. When we think about -- and I'll just stick with some of the examples we mentioned, the signing construction projects. If we think about how we're doing that in the last 2 years versus historically, we're delivering those projects twice as fast and about half as much cost. That's straight out of the PSR handbook that says, how do you take an asset base and deliver it faster with less cost or said differently, do more with less. Now when I had the opportunity to take mechanical, the same thing applied there. We applied PSR tenets obediently with my leadership. So an example there is, if I think about our locomotive inventory, part of the cycle on a daily basis of a locomotive is getting serviced, right? It comes into the terminal. It has to be serviced with fuel and cleaned and brought back out. When we think about that operation, we focus considerable amount of time to driving that down and make double-digit percentage improvements in that area. That directly correlates to a smaller fleet. So there again, applying PSR [ growth entire ] last 2 years. And then in the last 7 months with transportation, I've had the opportunity to just pivot from that and apply that same mentality to our transportation product, and you'll see me continue to do that. Now regarding technology, it will continue to be a driver of productivity and try to be probably with a greater driver of productivity in the long term. When I think about some examples, we've talked about our ITR, which is our Intermodal Terminal Reservation System. That's a technology that allows our customers to get improved visibility, and it also allows us to plan more appropriately our asset base for the incoming demand, whatever that may look like. And then in our PSR strategy, we have to be very good at our assets. You also will see technology in some of our autonomy or semi-autonomous equipment. There's continues to be more and more advancements in that area. So when we think about how we maintain the railroad, how we renew the railroad, there's massive opportunities to drive that to more of a machine-based operation versus a more human-based operation.

And I was just going to add, Justin, so under Eric's leadership in engineering group, one of his, I'll call, areas of focus was really that productivity side and applying technology to it and working with suppliers to develop a number of new maintenance of a machines or strings of machines that could both be more safe because we really have less people, could be quicker, less track timing consumed and just improve the overall productivity. And so that's work that he started and continues to be underway.

That's helpful. And just thinking about the OR, you have this longer-term goal of getting to a 55%. I know you haven't put a time line around that. It sounds like that's maybe something you would address next year if we can all get together for an Investor Day. But as you think about progressing towards that 55% OR, do you feel like you need to see revenue growth in order to hit that target? Or do you think the productivity opportunity and continued pricing above inflation is enough to get you there?

Well, Justin, I think you probably are very familiar. When we first put out the target of the G 55, the G was for growth, and that was put out several years ago. And unfortunately, our volumes have not grown since then. Although, we have made substantial progress towards that goal, and it really has basically been on the back of price and productivity. So I think in my mind, it's all about trajectory. I think if you can get all 3 legs of the stool moving together at the same time in terms of volume, price and productivity, there's a greater trajectory forward in terms of making progress towards that goal. If you're going to have 1 of the 3 or 2 of the 3, that's going to impact the trajectory, but if -- none of that does change our commitment to be able to reach that. In an ideal world, we'd be pulling on all 3 levers and getting there in short order.

Makes sense. I wanted to ask about peak season. Obviously, the freight market has been very strong. I think expectations across the board were for a strong peak. Curious what you're seeing out there today. And then just from a service perspective, I know there were some disruptions in the third quarter related to congestion. Any risk of that in 4Q and into year-end as peak season kicks in?

Yes. I mean I'll start and Eric will probably want to add on a little bit. As I mentioned earlier, our volumes have really stayed pretty steady over the last several months, I'll call it, since kind of the August time frame in that 160,000 7-day carloading level. The mix has changed a little bit as grain has started to play a bigger role, but intermodal continues to be up. So we still think there's going to be some peak season volumes relative to intermodal, but we're already operating that at a pretty high level historically for us. And if you talk to the parcel folks, they have seen because of the e-commerce shift, obviously, very strong loadings over the last many months since we kind of came out of that initial pandemic shutdown. So I think if you think about our volume guidance of being up low single digits in the fourth quarter, that's all fairly consistent with what we're seeing today in terms of our overall carloadings. But Eric, do you want to maybe touch on the service side?

And Justin, we had closed the quarter to 77% in our Trip Plan Compliance that we reported at the end of October that then got to 83%, which was evidence of our rebound coming out of the surge. Since that time, we've maintained that level. So I don't expect anything to change going down. And it will continue to be a major emphasis to your point as we come into what we've historically called peak season because we would have -- need to be exceptionally consistent during that period.

And one question we're getting a lot is just on the inventory restocking that needs to occur going forward. Do you have a view on how long that will last? Is that into the first quarter of next year? Could it be beyond that? What's the feedback that you've heard from your customers?

Justin, so certainly, we do believe the inventory restocking is still alive and well. In fact, anecdotally, I can tell you, we've got a big furniture store here in town and one of the anecdotes that we've heard recently is that they normally have, call it, 4,000 refrigerators in stock at any one point in time. And more recently, they've got like 400. So I think in terms of how long you going to have the tail on that restocking really depends on the consumer. We're obviously going into the holiday shopping season. Is the consumer going to stay engaged? I know retail sales just came out today. I think they were a little bit lower than what was expected, but still up year-over-year. So that's, in my mind, is how long that tail lasts is how the consumer stays engaged. Consumer balance sheets, I think, are in much better shape than they were coming into the pandemic. But certainly, the jobs, there's still a lot of people that are not at work. I think there's questions around, are we going to get a third stimulus package, all of those things are going to play into that mosaic in terms of how long we see that tail. But I do think that there's substantial opportunity still ahead of us in the near term.

And how do you think about the industrial sector headed into next year as well? I mean obviously, retail and the consumer has driven this recovery so far, industrial has been weaker. Do you think we're on the cusp of that changing? And next year, maybe industrial fares better than retail and the mix implications of that could be positive. So I would love to get your thoughts around that too.

Well, to the last part that you mentioned there, Justin, certainly the mix implications of that could be very positive for us. How that’s going to actually play out is obviously too soon to call. As I look back at some of the industrial production numbers, we were kind of entering into a slowdown relative to industrial production through the back half of 2019. I think that was reflected in our carloadings. And then when I look ahead at some of the projections for 2021, if you take out the second quarter, which is obviously the pandemic comparison, it's pretty muted overall. And I think even still in negative territory in the first quarter. So that is where our carload lines have been more muted. I think customers are a little bit less conviction right now in terms of where they're going to put those capital dollars. So I think that kind of remains to be seen. Certainly, if we can get some stability relative to the virus and the vaccine and see some better trajectory there and maybe some [ real proof statements ] going forward in that regard. That will help, but it could be muted, at least certainly to start 2021.

And then on mix, just sequentially going into the fourth quarter, you mentioned overall carloads have been pretty stable here recently, but the mix has changed a little bit with grain picking up. I know grains higher RPU, I think it tends to be a higher-margin percentage versus consolidated levels. So do you expect mix to improve in the fourth quarter relative to the third?

I think sequentially for the reasons that you just stated, Justin, that we should see a little bit of improvement on the mix side. Certainly, we still have the headwinds of less petroleum and frac sand, but the grain does help a little bit from a mix perspective.