Union Pacific Corporation (UNP) Earnings Call Transcript & Summary

Good morning, everyone, and thanks for your patience to start this day. My name is Garrett Holland, Senior Analyst covering transportation and logistics at Baird. We are very pleased to have Union Pacific participating at our industrial conference this year. Joining us from the company are Lance Fritz, Chairman, President and CEO; Kenny Rocker, Executive Vice President, Marketing and Sales; and Brad Stock, who leads Investor Relations for the company. Management is going to review some prepared remarks with slides, and then I will return for Q&A. So now we'll turn things over to the company for the opening presentation.

Thank you very much. This is Lance. So I'm going to go fairly [Audio Gap] I'm going to be making some forward-looking statements. Please refer to our SEC filings with the UP website to see more information on our risk disclosures. As a refresher, last month, we reported our third quarter results, a very good quarter. We produced third quarter records in operating ratio, operating income, net income and earnings per share. These results were achieved through basically the entire team working tirelessly to overcome some issues from mother nature and then some COVID-related impacts to the business. We continue to implement PSR. We continue to go after productivity. We see that in things like train size, and we've got plenty more opportunity left. The global supply chain disruptions and mother nature have placed some real pressure on our network throughout 2021, negatively impacting our service metrics. You can see freight car velocity and freight car terminal dwell continue to trail last year's metrics and have lowered our trip plan compliance measures, which negatively impacts our service to our customers. While we've shown improvement from our reported metric lows in August, there's still plenty of work to be done. We're also taking action to help the global supply chain from working 24/7 on the West Coast ports to offering incentives to ingate containers on weekends, to improving the dray driver experience on our intermodal ramps with UPGo app. Union Pacific is leading the change in providing solutions to ease supply chain solutions (sic) [ disruptions ]. Despite current challenges, the team continues to generate some workforce productivity and drive train length improvement. As we continue to build longer trains and improve productivity measures, we have every confidence that we're going to heal the network and deliver for our customers as we close out the year and move into 2022. So I'm going to turn it over to Kenny for a business environment update.

Appreciate that, Lance. Turning to Slide 5. Here's an update on the current volumes in the fourth quarter. We're showing you both year-over-year and sequential 7-day comparisons so far in the quarter to see what is happening in the markets we serve. Compared to last year, fourth quarter volumes are down 4%, led by a 15% decrease in premium and partially offset by gains in both industrial and bulk. Sequentially, we have seen our volumes decline 1% on a 7-day basis. In our premium markets, year-over-year volumes continues to be challenged by the global supply chain congestion and the semiconductor chip shortages. On a sequential basis, premium was down 4%, driven primarily to lower international volume as ocean carriers shift their business to local warehouses on the West Coast to reduce turn times and make the most of their assets. Our bulk business is up 7% versus last year and up 3% sequentially. Natural gas prices are driving demand for more coal shipments. At the same time, a strong grain harvest is increasing grain shipments sequentially in the fourth quarter. Finally, industrial was up 10% versus 2020 and down 1% sequentially. We have seen consistent volumes across most industrial market segments, and we're encouraged by the steady demand in those sectors like steel, industrial chemicals, plastics and forest products. I feel bullish on the opportunities in front of us as the market demand remains strong. It's going to take some time for the global supply chain disruptions to get ironed out, but we're doing our part on what we can control to help ease the congestion and work with our customers to find solutions. Slide 6. I want to reiterate that our goals have not changed from what you all heard at our Investor Day. For the commercial team, it's all about growing with our customers. We will continue to leverage our network efficiencies to deliver a more reliable service product and win new business, most notably from trucks. We are transforming our entire organization to have a growth-focused mindset with customer centricity at the forefront. It is critical that we continue to make improvements with how we do business with our customers. And lastly, we're making key investments to expand our network reach into new markets. This is evident with the new pop-up intermodal facilities in the Twin Cities in Southern California and Inland Empire. We're also looking forward to the new containerized grain transload at the Global 4 facility in Chicago that's opened in January 2022. I'm excited about all the opportunities we have in front of us to grow. And with that, I'll turn it over to Lance.

Thank you, Kenny. At our third quarter earnings conference call, we laid out the revised 2021 [Audio Gap] here on Slide 7. As Kenny discussed, while volumes have been challenged to start the fourth quarter in our premium business, we're encouraged by the strength in our bulk and our industrial businesses. We continue to target full year operating ratio improvement in the range of 175 basis points or so, although that continues to be stressed with fuel prices that continue to rise in October and a volume picture that was a little more muted to start the quarter than we had expected. We're committed to closing out 2021 in a strong position and poised to deliver record results. Wrapping up on Slide 8. Union Pacific continues to make strides towards our goal to achieve a more sustainable future. Starting with investing in our workforce, we're taking action to further diversify our workforce across multiple fronts: increasing gender diversity to 11%, doubling in essence what it was last year; and minority representation to 40% by 2030. To hold ourselves accountable to these targets, we'll continue to provide quarterly updates on our progress towards these diversity representation goals. With regard to championing environmental stewardship, it will require action across a number of fronts to make real and lasting change. In a few weeks, we plan to release our initial climate action plan to lay out specific details of how we plan to achieve our stated goal of reducing our greenhouse gas emissions by 26% on an absolute basis by 2030. We have great momentum building within our ESG efforts and remain on the forefront in building a more sustainable future. So Garrett, I'm going to turn it back to you, and we can get into Q&A.

Fantastic. Thank you, Lance and Kenny. If anyone participating on the webcast has a question, please submit it through the portal, and I will relate it to management. So appreciate the commentary on quarter-to-date trends. Lance, maybe to start, how would you characterize the underlying demand you're seeing from your customer shipper base? Understanding we're still dealing with some disruptions in the key premium categories, but how should investors be thinking about the underlying demand in that momentum as we think about next year?

Yes. I'll start, maybe Kenny has some [indiscernible]. The underlying economy is feeling pretty darn good right now. The industrial economy is showing through our industrial business and bulk business. And consumers are still pretty flush, and they're still interested in buying things. The issue inside the premium line is about chip shortages in the vehicle manufacturing world, and it's about a disruption in the international intermodal supply chain that really has nothing to do with the underlying demand. It's whether or not that demand gets transloaded in the L.A. Basin away from us or whether it continues to come inland to IPI and then international.

Yes. And the only thing that I'd add is I love the fact that we've got new products in place like Inland Empire, and we have a clear focus to grow that product base. So as the ocean carriers try to figure out if they want to go inland or stay local, we'll be able to handle that business and have a solution regardless.

Yes. Bottom line, we feel really good, Garrett, about going into next year. The economy feels good.

And you've clearly been very aggressive in trying to solve and work through some of these supply chain bottlenecks. I was interested in your thoughts on how the container refund program you've instituted for Saturday and Sunday delivery is working. And do you think the container fees levered by the ports will help ease congestion in Southern California?

Yes, two thoughts on that. The first is it's early. It's a pilot program. And it's the right thing to do. I mean if for no other reason, Garrett, then optically, it says we're pulling out anything we can think of to try to encourage movement 24/7. I'd have to say early returns show it's not utilized. We're not getting a lot more -- we're actually getting very few boxes in the period beyond normal with this $60 per box incentive. And when it comes to what the ports are doing with their $100 penalty per day for boxes that sit on the port longer than 6 days if they're rail oriented and longer than 9 days if they're truck oriented. A, we think it's ridiculous that those 2 dates aren't the same, right? There should be no reason to give truck more time than rail. They're all occupying precious dock space. B, it's still, in my mind, a little too early to tell if that's making any difference.

Garrett, our commercial team just left the Port of L.A. and Port of Long Beach last week, and we sat down with them to discuss everything that Lance just reiterated. One of the things that we also discussed is the solutions that we've got out there. So we've got a storage solution on Salt Lake City. We've got a storage solution on the G3. We've been talking to the international ocean carriers. So again, across the board, we're coming to the table with solutions, whether it's the $60 incentive or 24/7 operating model that Eric instituted. We're just walking towards them and walking towards all the solutions for our customers.

Garrett, one last thing to note. Inside of that, we are essentially normal in our international supply chain on Union Pacific, from ports to intermodal ramp inland. So we'd love to see more come IPI because we're ready for it. The dwell on dock right now is 3 or 4 days, very much in the normal range, and we're getting back to normal in dwell inland ramp as well.

No, that's very helpful. Also wanted your thoughts on the vaccine mandate. Obviously, you've been preparing, but what's your understanding, interpretation of the vaccine mandate set to go into effect next year, absent some legal injunction? How are you preparing for compliance? And does this represent potentially another supply chain shock for the industry in labor availability?

Yes. It's not fun and it's not something that we're [indiscernible] kind of happily. For Union Pacific, the vaccine mandate that applies to us is the executive order that Biden put out, I think it was in late September, regarding federal contractors. And that order essentially said if you're a federal contractor, then your employees have to be vaccinated. At first, it was by December 8, fully vaccinated. Now that date's booted out a little bit to January 4. It's an ethics issue from our perspective, right? We looked at that order. Our outside constitutional legal scholars told us it is a lawful order. The president has that authority. And we know we are a federal contractor. We ship, amongst other things, armored vehicles for the United States from base to base or base to train, and we're going to continue to do that. So our obligation was to comply with the federal contractor mandate. We announced in the first half of October that we were going to do that, and we've been at it ever since. At this moment in time, we've got about half our employees fully vaccinated in the database. I think that's underrepresentation of all the employees that are vaccinated. And then there's about another, I don't know, 10%, 15% that are in the database either looking for an accommodation, religious or medical, or with only 1 shot or their paperwork's not right -- quite right or whatever. My sincere hope is that we get everybody compliant before we're compelled to start reacting with consequences. And the consequence for us is if you're not in agreement, you can't work for us anymore. And if you're part of the craft profession, you're going to go on a medical -- unable to perform. So that's where we're at. I would tell you, right now, COVID is still having an impact on our crew availability. If I looked at crew availability issues, and that's probably the single biggest thing that's keeping us performing at a high level operationally, it starts with employees that are quarantined because of exposure. Then employees that are getting vaccinated, right. We are compelled to give them time-off based on being able to get vaccinated and also maybe secondary impacts. And then our own kind of lack of fluid operations is creating things like recrews and unproductive crew starts. But that's probably the order. I know that's the order of crew availability issues, and that's got me frustrated right now.

No, that's very helpful. And maybe just to wrap this section up. Do you think supply chain congestion has peaked? There's a lot of fatigue setting in certainly for the operators and shippers across the economy, but is it too early to think we're past the worst of this? And do you see some credible path to normalization ahead?

Yes. Kenny and I are both going to share a little perspective on that. I'll start by saying I don't think we're past peak supply chain disruption. Now I think we might have seen the worst of it when it comes to chip shortages for finished vehicles. And that looks like -- slowly but surely, that will start healing. Again, I want to emphasize the word slow. I think it's -- I don't think it's going to snap back quickly. But in the international intermodal supply chain, I think it's going to take a while. And it feels to me like we're going to see fits and starts where ocean carriers flood towards transload in the L.A. Basin, which limits -- reduces the amount of volume we see on the railroad. And then I think they're going to come back to us because we're very fluid. And if our partners on the end can't take the containers off ramp and get them through a warehouse, that will get congested and then maybe it will flow back again. So we really have to see more people getting into the trucking industry and getting into the warehouse industry so that, that capacity spools up to handle the demand.

Yes. I think Lance hit it spot on, on both of those points. And the one thing that we've been working with our customers on is -- as it stands today, we do, Garrett, believe that those inland ports that we serve are ready for more business. And we think that it is a more -- a faster, more efficient supply chain right now than them going to these local warehouses. So we're working with them on that. Even when they make these shifts, I do believe they may flip back and forth until they feel and have good confidence that things are [ working out ].

Well, that's great. And just also interested in your thoughts on how this challenging operating environment has impacted your 3-year guidance to grow volume faster than industrial production. And Kenny, if you can review those drivers again for us on how you expect to grow faster than industrial production.

Yes. You heard it in my remarks, we remain unchanged, that 3% outlook that we have. And you've seen the drivers that we've laid out. We're still committed to those. A lot of it will be on the intermodal space. You know the tangible investments that we made in there. I talked about the G4 containerized grain piece that will make us more competitive on the international side, the investments up in the Twin Cities terminal. The Inland Empire, a lot of investments. We feel good about being on the forefront with renewable diesel and all of the products that we have there. Really proud of our commercial team. We've been able to have some really key wins on the petrochem side of our industrial chem and plastics business. And then just across the board, we feel good about the domestic business that we have with Knight-Swift coming off. So very bullish right now. I'm really excited about where we are, and people have to really make sure they calm me down.

You should never be calmed down.

Not. I feel good about things that are out here.

Garrett, I want to be crystal clear, our 3-year guidance from Investor Day is unchanged. [indiscernible] is unchanged. So we've got some short-term issues that we're dealing with from a crew availability issue. I think that's COVID related. I know it is. And I see slow progress, but it's frustrating to me. That's why I'm talking about it. In terms of the supply chain disruptions, whether it's chip shortage or what's going on in international intermodal, that is not going to last for a long, long time. It's not -- I don't think we're going to snap back quickly. But through next year, I think that continues to get better. And in the second half of next year, I think we're in a pretty damn good place. We do need workers to get into the trucking industry and get into the warehousing industry so that we've got capacity that handles the [ in dock ], bottom line.

That's great. And conversely, despite some of these congestion issues, the pricing environment has firmed up across transportation. Interested if you could talk about what you're seeing in the fourth quarter as you work through that small sleeve over pricing and then the repricing opportunity as you think about next year.

Yes. I want to reiterate that's a smaller portion, of what we see. And I want to just talk about what we're seeing on the domestic intermodal market, so I want to limit it to that. So much of my feedback is on those things. It's a better pricing environment today than it was earlier in the year, and so we'll see what happens. We're going through the [indiscernible] today. You heard my comments that it's a better pricing environment, and our approach will reflect that. And we'll see what happens, but it's a very tight environment right now.

That's helpful. And then just switching to PSR and some OR topics. Could you remind us of the opportunity you have to grind out efficiency gains? Obviously, it is a challenging environment, but I know you're working hard to extend train length and weight and improve plan compliance. So talk about some of the traction you're seeing. You're off the lows from August, but what's the opportunity to normalizing some of those service metrics?

Yes, 100%. The opportunities are exactly the kind of numbers that we put up at the tail end of last year and early part of this year: car velocity in the 220-plus range. Our trip plan compliance numbers should be in the high 80s for intermodal, low 90s; in the kind of mid- to low 70s for our automotive and manifest product. We've got plenty of opportunity when it comes to train length. This year alone, we're installing another, call it, 20 plus/minus siding length extensions. We've got another set of projects adding in a couple of new corridors for us into next year. That helps with both crew utilization in terms of, if I can run fewer trains on the route, I'm using fewer crews per day. And it also helps just in the overall pure productivity of more cars on a train, which is great for our locomotive productivity as well. Plus, we're seeing some really good numbers when it comes to our sea rate, we showed that in the third quarter of this year. And usually, when our locomotive productivity suffers, sea rate suffers with it. And we've actually been able to push through that and still get fuel consumption productivity, which is really encouraging to me. That's starting to show traction that's been long coming. And just the T Plan itself, we continue to manage through how best to navigate the current car flows, the current trade flows and reflect it in our transportation plan. So we're only touching cars where we need to, and we're moving them all the way to the end where they want to be -- where customers want them to be. So I feel really, really good about our productivity capability. I'm frustrated right now, but that's -- I think it's going to be short term.

That's helpful. And we're running up on time, so maybe the last question here. Lance, interested in your thoughts on some of the differentiating factors of the Union Pacific franchise. And coupled with the operational strength that you see getting back online here shortly, how are these drivers positioning the company for better relative growth in the years ahead?

Yes. What's great about us is our franchise. You think about we've got a wonderful I-5 corridor starting on the West Coast. We've got good routes to and from consumption areas out of the L.A. Basin and out of the Pacific Northwest, whether that's Chicago, could be Salt Lake, opened ramp now in Minneapolis, St. Paul, down into Dallas, down into Memphis and also Houston, New Orleans and points in the Southeast. Our service product from the L.A. Basin into the Southeast U.S. is better than anybody else's by a day. And it's reflected in our opportunity to grow there. Then you come along the Southern corridor and going to Texas, and that Gulf Coast petrochemical franchise is the envy of every other railroad. It's wonderful. We've got a lot of track infrastructure there. It's very hard work, right? That's all manifest, all blocking and tackling. A large percentage of our business in the Gulf Coast stays there. It's to and from ourselves. So it's double work, if you will, and we love it because it's profitable and it's grown. Plastics industry is growing. Industrial chemicals are growing. Refined products into Mexico is a growth market for us. And then you come on up into the middle of the country. Whether it's the breadbasket, whether it's construction material, whether it's the consumption markets of Chicago, the industrial markets of St. Louis and Chicago. Those are great origin and destination points for us. And our network's in excellent shape. It's really never been better. We got about less than 1% of our railroad slow order right now, which is fantastic. So it's physically in very good shape. You got to push through this COVID-related impact on our ability to have crews when we want. We're hiring right now, and hiring is not easy, but it's not impossible. We're finding the people we need. We got to get them through the training pipeline. But yes, I feel very, very good about our future. It's -- as you point out, our franchise, coupled with how we're operating the railroad, we're the most efficient in the industry right now as measured by operating ratio. That's got a ton of promise as far as we can see into the future.

That's great. With that, we're out of time for the webcast session. Special thanks to Lance, Kenny and Brad and everyone on the line for joining us, and we hope you have a great rest of the day. Thank you.

Thanks, guys. See you.