Union Pacific Corporation (UNP) Earnings Call Transcript & Summary

Okay. Good morning, everyone. Welcome to Barclays 38th Annual Industrial Select Conference. I'm Brandon Oglenski, airline and transportation analyst. And we definitely miss being in Miami Beach right now, but I know we'll make the most out of it virtually this year, and we'll definitely be back down there next year. But kicking off the transport track this year is Union Pacific. I'm very happy to have Jennifer Hamann, Chief Financial Officer, joining us today. And I'm sure most of you are aware with UNP. But for those that aren't, it's one of North America's largest railroads, about $20 billion in revenue and an impressive 58.5% OR in 2020, which I'm sure we'll talk more of. And Jennifer has quite an illustrative career with the company. She was named CFO just early last year, but she has held numerous positions in finance. A lot of you remember, she was in IR as well as sales and marketing. And just before I hand it over to her, in years past on in Miami, we do have an audience response system. Those questions are still live. So if you're watching the webcast, there's a survey section on the screen. Please fill those out. That's just about ownership and sentiment. The more participation we get, the better data we have. And again, if there's any questions from the audience as well, there should be a question link. It will e-mail me directly. We can read that while we're chatting here with Jennifer. So Jennifer, thank you for joining us. Really appreciate you coming to us virtually.

You bet. Thank you very much, Brandon, for having me, and good morning, everyone. We were just chatting before we came on. I really wish I was in Miami because it was negative 26 when I woke up this morning in Omaha. So very chilly start to our week here. Before I start, I would like to call attention to our updated pitch book, which can be found on our investor website next to the event webcast. As my opening comments, we'll refer to the material found on that slide deck. Additionally, I would like to remind everybody that I will be making some forward-looking statements, and 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. Before turning the page on 2020, I would like to briefly recap our performance there. The team really delivered outstanding results in the face of significant challenges. For the full year, volume and revenue declines of 7% and 10%, respectively, were mitigated by $780 million of productivity and solid core pricing to produce an all-time record adjusted operating ratio of 15.5% and a decline of only 2% to our adjusted earnings per share. In particular, our fourth quarter performance demonstrated the potential of our franchise when we can leverage all 3 profitability drivers: Volume growth, productivity and pricing. This produced an all-time quarterly record adjusted operating ratio of 55.6%, and that gives us great momentum as we're beginning 2021. Turning to the first quarter. We're about halfway through. And to date, our volumes have been relatively steady, up 1% overall. However, over the past week or so, that extreme winter weather I just mentioned is having an impact on some of our volumes. Quarterly volumes are led by our premium business, up 6%. Intermodal is up 10% in the quarter as low inventories, e-commerce strength and business wins drive this growth. Within our premium line, automotive is down 9% as we are seeing the impact of the semiconductor chip shortage. At this point, our expectation is that auto production will be recovered through the course of 2021, but we're watching it, of course, very closely. Strength in export grain continues to drive the recovery we've seen in our bulk business, which is currently flat overall, but grain and grain products are up 20% in the first quarter. This is being offset by continued declines in coal, which is down 16%. Industrial volumes, while continuing to improve sequentially, are also down year-over-year, 6% year-to-date. And we continue to see strength, though, in forest products, which is up 14%, driven by the strong housing market. Our Industrial chemicals and plastics are also recovering nicely, up 5% on the strength of our plastics franchise. Those positive trends, however, are still being more than offset by continued challenges in petroleum products. While our overall volume picture is dependent on the economy, the team is focused on using our enhanced service product to win new business and outpace what the market provides. Already in 2021, we have seen wins across a number of commodities: beer, pipe, automotive and domestic intermodal to just name a few. And this is demonstrating the additional opportunity that an improving economy presents to us and our ability to compete and win new business. Two of the wins in that domestic intermodal space were directly related to our mutual commitment program and the reliable shipping capacity it provides to our customers. And as you heard both Kenny and Eric discussed on our earnings call, we're rolling out new products like our pop-up Intermodal Terminal in the Twin Cities of Minnesota. While we're starting out small there with current capacity of roughly 20,000 annual loads, we have future plans to build that out to over 5x that volume. This demonstrates our ability to get new products to market quicker and more efficiently than in the past. As evident by metrics found on Page 28 of our pitch book that's online, the operating team had a very strong January as we continue to make strides towards operational excellence. Train length continues to be strong, driving further improvements in locomotive and workforce productivity. A key number to point out for January is that our intermodal trip plan compliance was 89%, demonstrating the strong service product we are fully capable of providing to our customers. That said, we have seen Mother Nature impact us here in February with Arctic temperatures, ice storms and heavy snow impacting a significant portion of our network. In fact, last night, we announced intermodal gate closures in order to help mitigate the impact of our network as we work through these challenges. The experiences of the past 2 years, however, give us great confidence that we'll leverage our operating models and navigate these challenges quickly and efficiently, mitigating the impact to our customers. Shifting to our ESG efforts. Last week, we announced that our science-based targets to reduce greenhouse gas emissions in accordance with the Paris agreement were approved by SBTi. Our target is to reduce Scope 1 and 2 greenhouse gas emissions by 26% against the 2018 base by 2030. This is a very important step for Union Pacific and our sustainability journey. Additionally, for many years now, we have participated in the Carbon Disclosure Project. We recently received a grade of A-, which we're very excited about, in climate disclosure, demonstrating our leadership in this area. Additionally, we also received a supplier engagement rating of A, indicating we are effectively engaging suppliers on climate change. UP firmly understands the role we need to play in the fight against climate change and are committed to being a leader. Wrapping up here with our 2021 guidance. Our thoughts on the first quarter and full year 2021 remain unchanged from what we discussed at our fourth quarter call. We still expect first quarter volumes to increase in the low single-digit range with a full year outlook of 4% to 6% growth. This outlook includes the impact of ongoing coal and energy market headwinds. With productivity, we expect to generate roughly $500 million in 2021, and our long-standing pricing guidance is also unchanged. We expect the total dollars generated from our pricing actions to exceed rail inflation costs. With these assumptions for volume, productivity and price, we expect to be in the range of 150 to 200 basis points of operating ratio improvement in 2021. Longer term, our guidance of capital expenditures of less than 15% of revenue; dividend payout ratio of 40% to 45% of earnings; and ultimately, that 55% operating ratio, remain intact. So with that brief update, Brandon, I'll turn it back to you for Q&A.

Okay, Jennifer, I really appreciate that. So it sounds -- maybe I'm mischaracterizing this, but maybe the first quarter a bit softer because of some of these issues, both with weather and some in-market exposure in autos that you were speaking about? Is that correct?

Yes. I mean we're -- we had a strong January. If you looked at our carloadings as well as our operational performance, February is when we started to see some of the impacts from the chip shortage and now the weather is impacting us. Those are kind of transitory issues, and we'll work through those. I think things are supposed to warm up here in the Midwest, at least starting tomorrow, some of the activity in the southern part of our network I think is going to continue for a couple more days. But it is one of those challenges. Unfortunately, railroading is an outdoor sport, and it's something we face annually.

Okay. And I don't mean to be too picky on the quarter, but does this mean a little bit of additional cost in the first quarter than maybe we had been thinking?

I mean, certainly, the challenges from the weather will drive some additional costs. So it's something that needs to be factored in, absolutely.

Okay. Well, I guess, more importantly, though, it was a little surprising I thought on the call. You guys did provide quite a bit of detail in your financial guidance for 2021, unlike years past. I guess, what's really leading to the confidence to put out that outlook this year as opposed to years past?

Brandon, I don't know that we've put out that much more guidance. I think where we probably put a little more and technical around was certainly around the volume piece. And I think it's important from our standpoint -- because everybody's got their view of the economy, their view of what's going to happen in the world near term, long term through 2021. So we thought it was important to be pretty clear about what we were basing our expectations on and what that looked like. And then people can either choose to say, "Yes, that sounds reasonable to me," or "I think you're being too conservative. I think you're being too optimistic," whatever the case may be. But in my mind, that really is kind of the linchpin in terms of how we see 2021 is what that volume picture is. So that's why we did give maybe a little bit more information there.

Okay. And then you did guide to 150 to 200 basis points of margin improvement or operating ratio improvement as you just reaffirmed a second ago. I guess what -- you mentioned volume productivity pricing as all being critical to driving improvement on your margin. Is there one of them that is driving more confidence this year than maybe in years past?

Well, certainly, if you look back over our more recent history, Brandon, we've not had that volume piece. We have done, I think, a very good job, in fact, an excellent job, I would say, on the productivity front in the last several years, $1.4 billion in 2019 and 2020. We've been very disciplined for a long period of time on a pricing standpoint, making sure that our pricing dollars are yielding above our inflation dollars. The piece that's been a little bit lacking has been that volume piece. And that's where I point back again to the fourth quarter and what we were able to produce in the fourth quarter where we got a little bit of volume growth and had just an excellent quarter.

Okay. On productivity, because I think you called out about $0.5 billion of expected gains this year. Is that right?

That's correct. Yes.

I think your headcount is down an impressive -- almost 30% if we go back just a couple of years. What's your ability as you get that volume growth this year, and your expectations is that you will, that you can really leverage the network without adding back a lot of resources and more specifically headcount?

Yes. I think we feel very good about that. Again, when we talk about that $500 million of productivity, I think we see opportunities across really all cost categories to do that. But certainly, the biggest bucket in terms of our cost is our headcount. Labor and wages is our biggest cost category. So for us to get to that $500 million, we have to continue to have strong workforce productivity. And you saw us in the fourth quarter sequentially grow volumes, and our headcount actually went down just a tiny bit, and there were some seasonal things there. But at the 4% to 6% kind of volume growth that we're guiding to for this year, I would have every expectation that we should be able to hold our headcounts fairly flat. There may be some seasonal variations. But through the course of the year, I think you get to end of year 2021, if we're in that 4% to 6% range, you'll see headcount pretty flat.

And do you think you can do this while maintaining or even improving service outcomes?

I think that's a must, Brandon. That's why one of the things that I think we've been pretty consistent about in showing to our shareholders, talking to our customers about is those 6 KPIs that we're launching and then train length kind of on top of that. And you've got to keep each one of those moving together. You can't sacrifice one for the other. You maybe heard us talk about it. If we were just managing to train length, what you'd like to please see happen is that our dwell times and our terminals would grow because we're holding cars to be able to build that train length, and it would have a knock-on effect to our trip plan compliance. So if we can keep all of those metrics, and that's what we're very focused on, moving together, that says that that's kind of a wholesome environment for us where we think we can really hit the sweet spot of not only producing great operating ratios and driving more of that growth to the bottom line, but also attract more business to our railroad.

Yes. Well, I mean, I'm sure you can remember periods in the past, like in the early 2000s and prior periods when volume comes back, we usually see -- or at least historically, you've seen railroad service deteriorate. So I guess what has changed now that gives you this confidence that, hey, we can bring back the volume, not a lot of resources and keep productivity and service metrics higher?

Well, I think we've demonstrated that in the third and fourth quarters of this past year. And I think when you look at the last, call it, 2.5 years almost now that we've been implementing PSR, we've hit some certain service challenges like the flooding that we had in the spring of 2019, like the volume kind of sharp falloff and rebound that we had in 2020. And yes, there's a little dislocation in the network as you spend things back up. But by and large, we've been able to very quickly deploy our assets, get the network humming again. And so I think we're building a track record that would say that we have that ability to do that. And we have to watch it, and that doesn't mean again that there might not be some temporary dislocations. But I think our customers are seeing that's it's a much steadier product. And there's just much more resiliency in the network that we have today.

Yes. Well, I mean we definitely hear this from you and your other railroad peers, but then if we talk to intermodal customers, they'll tell you that there's some service disruptions. And maybe it's more terminal-related, equipment-related, potentially drayage. But how can you help, looking in that supply chain ecosystem, your one link and a long chain. How can you help those service outcomes in the future as well?

Yes. I think that's where visibility through that supply chain is just critical so that everybody understands what's coming at them and at what expected time and that there's a high degree of reliability with that. I think you've heard us talk about our intermodal terminal reservation system that we've deployed. That gives us a much greater window to when our customers are bringing freight to us. And then it also gives the customers a better window to know when they're going to get on that train and that their trip is going to be starting with us. And it's helping us reduce the dwell times, both on the in-gate side as boxes are coming into our ramp. And then we're also very focused on reducing the dwell times on the out-gate side and that helps keep that fluidity so that you have the ability when the train comes in, that you have spots to be able to land the boxes so that people can come in. You're right in saying that, that whole intermodal chain continues to be just a little bit dislocated right now. You're seeing more and more of the boxes that are coming inland through the West Coast ports being transloaded. And so now it's looking for a domestic chassis, domestic container instead of coming inland in an international container. And so that's causing some, what I view, as kind of transitory shortages. But I think if we can work together, continue to communicate and continue to improve those lines of communication and visibility, I think that's going to be the best solution going forward.

I mean, are there any investments you can make on these lines? Or are you making?

So we've been talking with -- and I think you may be heard us talk about this with the ports trying to get better visibility to their data to understanding what ships they're unloading, when they're unloading them, trying to encourage more on-dock loading instead of the drayage activity that's occurring there. We are building more and more user interfaces with our customers, APIs that are helping them see better into the transit times that we're providing them. But it's going to take a whole industry effort. And I don't know that we're quite there yet in terms of that broader discussion going on.

Okay. And then last one on productivity. I do want to talk about intermodal again from a volume perspective. But why not put a timeline on the 55% or better OR target that you guys have had out there for quite some time now?