Union Pacific Corporation (UNP) Earnings Call Transcript & Summary

Welcome back. This is the first, I think, probably, well, at least that I'm doing, company presentation. Welcome to everybody that is watching, and the numbers are filling quickly. So very exciting, have the -- as not a mystery to anybody that's on this, the leading railroad company in the world. And so thrilled and thank you. Let me just start by saying, thank you, Jennifer. I know I'm a little new to this whole railroad thing, and it is a real shot in the arm for me that you agree to do this. So I really do appreciate it. But I don't want to take any more time than that because I know that you've got some things to say, and then we'll get to the Q&A. If anybody does have any questions, there is a way to submit those. I will do my very best to lob them in, time permitting. But the longer I talk, the less time is permitting. So Jennifer, I'll turn it to you, and then we'll get to Q&A a bit.

Sounds good. Thank you, Ben, very much for that introduction. Good morning, everyone. So the slides that are accompanying my prepared remarks this morning, while shown on this video chat, can also be found on our investor website next to the webcast for the event. Before we start, I would like to remind everyone that 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 starting off on Slide 3, let me quickly recap 2021, which was a record financial year for Union Pacific. In the face of major weather events, global supply chain disruptions and continued pandemic impacts, we stay focused on the fundamentals to deliver strong shareholder value. Over the past 2 somewhat difficult years, we improved our operating ratio of 340 basis points and grew earnings per share 19%. But more importantly, these achievements established a strong foundation that supports our focus on growth. Before I talk about 2022, let me do one final look back. Slide 4 demonstrates the truly remarkable value we have created for our owners over the past 5 years with a 90% increase in annual dividend per share and our strong share repurchase program which reduced our average share balance by 22%. We returned $41.3 billion to our shareholders. This performance demonstrates the financial strength of our company and our commitment to rewarding shareholders for their ownership in Union Pacific. Now let's turn to look at 2022 on Slide 5, starting with a look at the current volume picture. Volume started the year slowly as the normal holiday dip was a little deeper and the recovery a little slower than normal. Thankfully, outside the impact of weather this past week, the volumes have recovered to pre-holiday levels and are showing some signs of momentum in its building. Looking at the business teams in a little more detail, bulk is leading the way, up 9% versus last year driven by strong pull volumes, which are up 27%. Grain and grain products is down 1% with a tough comparison against last year. Biofuels and sweeteners continued to be strong driven by our business development efforts. Industrial is up 4% versus last year with strong growth in metals and minerals, up 19%. We've also seen strong volumes in forest products and industrial chemicals and plastics as well. The only reported industrial business line that is actually down versus last year is energy and specialized markets driven by lower control in shipments. The gains in bulk and industrial are being offset, though, by continued challenges in our premium business. Intermodal is down 10% to start the year as international volumes continue to be very soft, down over 25%. This is offsetting some of the growth in domestic, which is driven by our new [ exited ] business. Automotive volumes are down 5% year-over-year, and although we are seeing and continue to be encouraged by sequential improvement and our automotive parts are actually up 7%, led by improved semiconductor availability in addition to business development efforts. While a slow start, we're encouraged by the overall volume trend in the past few weeks. And I know if Kenny were here, he and his team would tell you they are still very bullish on the prospects for the year. Turning to Slide 6. At our earnings release a couple of weeks ago, we discussed the operational challenges based on 2021 and the recovery path we were on to return our network to a fluid state. As you can see, we're making steady progress as we have seen crew availability continue to improve. More importantly, we're encouraged by how the network has responded to the increasing volumes over the last few weeks. For January, freight car velocity was 208 daily miles per car as we made steady gains. This overall improvement led to the significant improvement we've seen in the manifest and auto trip plan compliance, which was 68% in January, while intermodal trip plan compliance has held steady in the high 70s. While there's certainly still work to do, especially as some recent winter storms did impact our network, we've made great strides to put our oar in a stronger position to handle the increasing volumes we expect through 2022. Turning then to Slide 7, where we laid out our expectations for the upcoming year. At our Investor Day last May, we provided 3-year targets for the 2022 to 2024 time period. Those targets remain intact and are the building blocks of our view for this year. Through our business development efforts, we expect to outpace industrial production, which is currently forecasted to be at 4.8%. We expect first half volumes to be led by bulk and industrial, while the second half should be led by our premium business as supply chain and chip shortages are expected to improve. The combination of growing volumes, pricing above inflation and strong incremental margins should lead to the achievement of a full year operating ratio of around 55.5%, which is the achievement that of a long-term goal established by Union Pacific to hit a 55% operating ratio that we set back in 2016. Through our strong cash generation, we will invest for growth and continue to maintain a healthy network while also rewarding our owners with an industry-leading dividend payout ratio and strong share repurchases. All in all, 2022 is really setting up to be another record financial year for Union Pacific. I'd like to wrap up now on Slide 8 with an update on our ESG work. In December, we took a significant step forward in our journey with our release of the time and action plan. Within that document, we laid out our plans to achieve our long-term greenhouse gas reduction targets by 2030 as well as committed to achieving net zero by 2050. For our 2030 targets, we believe we can achieve them through operational efficiency and increased use of renewable diesel and biodiesel blends. But to achieve net zero, more is needed, including alternate propulsion technology for our locomotive fleet. A couple of weeks ago, we announced the first step in that process with our plans to purchase 20 battery electric locomotives, 10 each from Wabtec and Progress Rail for testing in our yard operations. These locomotives do not use fuel and emit zero emissions. We anticipate the first of these units will arrive on site in late 2023 with complete delivery by 2024. We plan to use the locomotives in rail yards in California and Nebraska where we can test performance against different weather elements. Altogether, between the locomotives and the yard infrastructure, we expect to invest over $100 million towards this initiative, demonstrating our commitment toward a greener future. UP has a rich history of innovation that shaped our nation's history, and we're excited to be a leader on our nation's path to a sustainable future. Finally, before turning it over to you, Ben, I do want to highlight that we're taking another significant step on our ESG journey later this week with the release of our first human capital report. This report will outline our efforts to support employees throughout their career journey and how we are intent on building a more diverse and inclusive culture here at Union Pacific. So be on the lookout for that announcement very soon. With that, Ben, I'll turn it over to you for your questions.

Well, that was great, and thanks for outlining all that. Let me start with a question that I get very often, and I think you are probably the perfect person at Union Pacific to answer. The -- if we look at the shares, they've done well, and the multiple is a little bit higher than where they normally are. I guess my question to you is, can you make a pitch for why that is sustainable or there should be even greater multiple expansion relative to what it maybe used to be like? Is the company today different than the company that people were used to looking at 5 years ago?

Well, absolutely. And I could probably talk to the remainder of our time about all these things, Ben, but let me try to keep it short here. So 2 things. Certainly, in the rearview mirror, what has driven a large part of our ability to grow -- to have growing free cash flow, to be able to support strong returns to our shareholders while continuing to invest in our network has been the fact that we have substantially improved our efficiency. And that has been supercharged, I'll say, over the last few years, when in late 2018, we adopted precision scheduled railroading. And of course, through that time, we also were very diligent in terms of the pricing of our business and making sure that we are pricing our business in a way that can give us sustainable returns to support that investment. But as we sit here today, we have a network that is extremely well maintained, that has capacity, and we're positioned for growth. And you heard us talk about that a lot at our Investor Day and you've heard us talk about that, I think, pretty consistently since then. And it really lines up with the targets that we've set for 2022 in terms of looking for us to be able to grow our business [ fundings ] in excess of industrial production, which, again, currently, that's about 4.8% for 2022. So that growth dynamic is something that is new for us. Not that we have intentionally tried to shrink our business the last many years. But when you look at the way the coal has fallen off, when you look at some of the ups and downs that we've had economically, some of the ups and downs that frankly we had in terms of our service and our ability to handle growth, I feel like those challenges are marginally in our rearview mirror. We are setting ourselves up for growth. We have the resources to grow. And you've heard several examples from Kenny and his team about how they're going out and winning new business. And that really is the catalyst for us to be able to drive that growth. And with that growth, across a very efficient cost structure, provides all sorts of opportunities for us, and importantly, the chance to grow op income or operating cash and have a lot of optionality in terms of how we can reward our shareholders with that.

To that end, is PSR and growth, are they mutually exclusive? Can you do both? And can you do both well, do you think?

I absolutely believe that we can. When we started it up, PSR, late 2018, the market was starting to go into a bit of -- I don't want to say a recession, but industrial production was certainly dipping down at that time. We were continuing to see coal volumes fall off really substantially over that period. And we were implementing PSR. And of course, then in 2020, the pandemic hit. And one of the things that less volume on your network does is it takes away some of your optionality in terms of how you set up your flows and your traffic, how you construct your trains because you still have to meet your customer commitments. And if I have less volume, that means I'm not going to be able to grow my train length as much. And so to be able to do some of the things that we did with our initial PSR adoption over that time period in a time of decline in volumes, I think, actually masks some of the productivity and the efficiency gains that we're making and that the network is really set up for today. So I absolutely don't think those 2 things are mutually exclusive.

Okay. Good. So I think we got that out of the way. I think that's sort of the high-level stuff. Now I was going to dive down a little bit into some of the nuances of the business, if we can. Let's start with intermodal. I assume that today and tomorrow at our conference, whether you're talking trucking or rail or shipping, supply chain is just going to be the primary focus of the conversation. From your perspective, as a railroad, is there a silver bullet that you can say, "Okay, hey, we've not been where we wanted to be, but a year from now, we are going to be and here's why?"

Yes. Unfortunately, there is a silver bullet, Ben. If there is one, it's probably labor. And I don't see that as being something that certainly is cured overnight. I think we're seeing some more stability in the labor markets. Certainly, when we look at our hiring that we're doing, coming out of the holidays, we did see an uptick in the number of people that were applying for our postings. We're seeing our classes that we're putting together being full or closer to being full. And so that's encouraging for us from that standpoint. But we know we need -- in terms of going back to intermodal, we know we need dray drivers. We know we need people to support them. We know we need warehouse workers. And so those are going to be things that, until that labor supply firms up a little bit, could have some bumps. Now the encouraging thing is you are seeing the COVID cases post the big surge of Omicron, that has fallen off pretty dramatically, I think, in most places. Certainly, we're seeing that here where we live in Omaha, Nebraska and we're seeing that across our certain territories. When we look at our crew base and our crew availability, that's starting to look much better. So I'm hopeful that, that might be not that would make the last big search that we have there, and that by putting some of that behind us, that will certainly contribute to some better labor availability for the supply chain.

So -- but in your view, labor, is there anything besides labor that is if you could fix it immediately would help?

I think labor is #1, 2 and 3, probably. I think once you get past that -- we have ordered chassis. I think we talked about that last year. We've got a chassis order that's coming in. We do still have boxes that are stacked because we don't have available chassis. So there's maybe a little bit on the equipment side, maybe some on the warehousing side as well. But all of those things, once you have that labor, you can get the chassis turns that will speed up. You can hopefully get the churns better through the warehouse. So I really feel like labor is the [indiscernible] to this.

Okay. So again, we'll jump around a little bit here. And again, if anyone does want to submit questions, I will do my very best to feed those in here for you. But just things that, as I was sitting in advance of this, I was like, okay, what are things I wish I knew a little bit more about or that maybe you could expound on. What about Mexico? You guys are a big player in Mexico. There is a lot going on there competitively, dynamically from the market with near-shoring and other things, possibly auto issues. I mean there's -- Mexico is a big deal. And I think from my perspective, especially as it relates to you guys, it's often overlooked because it's not maybe as big of a deal as intermodal for instance, right? But can you maybe talk a little bit about how you're seeing the competitive dynamics and landscape developing as it relates to Mexico and where you see that fitting in within the framework of Union Pacific?

So let me start by sizing it. And so if you look at Mexico, it accounts for about 10% or 11% of our business volumes, so a decent chunk, not as big as intermodal, and that's the mix of everything in terms of that 10% or 11%. We do really believe it's a franchise strength of Union Pacific, though. We're the only railroad with access at 6 major border crossings into and out of Mexico. I think you're familiar with the fact that we have a 26% ownership in one of the other railroads there, the FXE. It's been a great long-term partnership with the FXE. We've had that ownership position since the late '90s, and it's been a great working relationship. And there's tremendous opportunities for growth in Mexico. Up until these last couple of years, Mexican GDP has been growing faster than the U.S. GDP and economy. And so that's always been a bit of an uplift to our volume ability. That's actually -- that dynamic has changed these last couple of years. I think that's the same in terms of estimates into 2022. But long term, that's still an economy that has a lot of growth potential in it and that I think is going to continue to be, obviously, a very important trade partner of the United States. And to the extent that you see potentially some near-shoring, if it goes into Mexico, we see that as a long-term positive for Union Pacific because if that business is going to be ultimately consumed in the United States, and we've got a really good shot at handling it, whether it's as a bridge carrier going to the East or if it's goods that are going to be consumed in our territory.

And what about -- how do you view the dynamic of the Canadian Pacific and Kansas City Southern? Obviously, Kansas City is big Mexico franchise. Does it have any impact on you guys at all? Or you pretty much operate autonomously?

So I mean it is a competitive dynamic that we're obviously paying attention to. We're participating in the STB process. And really our key points, our key concern, the thing that we're working towards there is we want to make sure that our customers continue to have the same competitive options tomorrow than they have today. I mentioned the 10%, 11% of business that we move in and out of Mexico. That split kind of roughly 50-50 between business that we interchange with the FXE and business that we interchange with KCSM. And that business today could instead of interchanging with us, could stay on the KCSM at the border and go to the Canadian Pacific and move forever. It chooses not to because we have the better route structure. Now certainly, it will become more of a single-line service that's available to them after the merger. And that's why we want to make sure that those competitive options are maintained for our customers and then they're treated fairly, both north and south of the border because we do believe we have the ability to serve those customers very well going forward.

All right. Perfect. So again, we're hopping off of Mexico and moving to another topic. Energy prices are really high right now. And I think there are a multitude of potential impacts on you guys. And I don't want to put words in your mouth, but I mean, certainly, relative to competing with trucks, that's important. Relative to the goods that you're moving, it's important. If we were to stay in an environment where oil prices are $80 to $100 a barrel for a while, what does that do to Union Pacific?

Higher prices, as you mentioned, from a fuel perspective, widens that gap between rail and truck when you consider how fuel efficient we are. Certainly, one of the main arguments that we make there is the ESG benefit. I mean we're more fuel-efficient. We're putting out less emissions, and we're actively obviously working to reduce that emission profile. And so for companies that are paying attention to that, on how to reduce their greenhouse gas emissions, we absolutely think they should be considering using more rail versus truck. We also, as you know, have fuel surcharge programs. So as fuel prices move up and down, those fuel surcharges are going to fluctuate. There's a couple [ at play ]. We're going to have to compete based on our service offerings and other things. Fuel is just one of those cost elements. The only other thing I would mention is we were talking about this directly with energy prices, but the high natural gas prices have driven a pretty favorable dynamic in our coal business over the last call it, 8 to 9 months or so. And that is something that if you look at the forward curve, that looks like it's going to stay elevated at least into the middle part of this year. So that's something that's supportive of the coal business when you think about that trade-off between coal and natural gas.

Yes. And that's one of the things that I've been something of a proponent of given sort of my energy background is we're not -- king coal is not quite dead yet. So -- and I think this is probably going to be a pretty good year. So another, again, sort of different question but one that I had was as we think through the earnings growth that you guys had, on a per share basis, certainly, an element of that has been performance and margins and, to some extent, even growth. But also an element of that has been a falling share count. I think you guys have been very aggressive on buying back shares. Can you maybe -- and furthermore, the debt balance has been going higher. And so effectively, you've sort of been borrowing to buy back shares. Can you maybe frame in where you're comfortable letting that go? Like how much can you borrow in order to buy back shares? Does that change at all if interest rates are rising? And does that change the earnings per share growth trajectory at all in your opinion?

Yes. So I mean I think we've been -- hopefully, we've been very fair in terms of what our guiding line is relative to our debt capital structure, and that is that we want to maintain a solid investment grade, a strong investment-grade credit rating. And we're in that position today. We're generating very strong cash flow that supports the increased debt. And as we continue to grow the earnings of the company, EBITDA, that does support higher debt levels. And so that's very much the conversation that we have with our rating agencies. They know that we have that bright light -- our investors' equity and debt now that we have that bright light that we're following. And so that has, to your point, it's been very strong. The last 5 years, we reduced our outstanding share 22%. So that has been a significant driver. But that is -- I don't want to say it's a footnote to our performance. It's an important part, but we need to drive the earnings growth, the operating income growth that underlines that, that supports that. That's first and foremost what we have to do. And then with that, using that capacity in the best way that we have to support shareholder value.

You're a CFO. It's more than a footnote. That's an important part of the business. But maybe just to drill down a little bit. What does it mean to have strong investment-grade credit? Like what -- can you maybe frame in what that leverage looks like?

Yes, I mean we haven't set -- well, let me back up. So back in 2018, when we announced that we were changing our capital structure and we said that we were going to go up to 2.7x debt to EBITDA, that was a fundamental shift. And so we put what I'll call a bright line in terms of that 2.7x debt-to-EBITDA target out there. We've moved up to that, and we're now -- we're continuing to see our earnings grow and continuing to see very strong fundamentals in terms of our cash flow, op income growth. And so we think that, that bright line is less important versus saying strong investment-grade credit rating. And so that's where we're in dialogue with our rating agencies, so they understand what our plans are, what we believe our earning potential is, what we plan to do against that. And so that's where they have to be comfortable relative to the earnings performance of the company, and that's why we're not using what I'll call it bright line anymore. It really is about the power of the operations, the power of the operating income and cash generation performance, and then, with that, the commitment to a strong investment-grade credit rating.

All right. Perfect. So I'll shift back to the operating side a bit. Given all of the chaos that's been going on, on West Coast ports, specifically L.A. Long Beach, there's been people trying to find other alternatives, maybe going to the -- through the Panama Canal, to the Gulf Coast or the East Coast or to Canada or Mexico. From your perspective, is there any long-term risk that maybe the U.S. West Coast is going to be slightly marginalized if they can't get their act together? And, obviously, it has implications on your own volume.

No, absolutely. So we have seen since -- I'll go back to, I think, it was 2005, when we had one of the first major ILWU strikes. Really ever since that time, different shippers have been looking at ways of diversifying where their goods are going to come into, whether it's Canada, Mexico, East Coast. So you saw that in 2005. I think you saw it again, I think, it was in 2015 when there were some disruptions. And then the pandemic and everything that's happened there in terms of supply chain disruption just kind of further reiterates and emphasizes that point that the diversification is necessary. And so as a result, you've seen -- while the West Coast ports are still growing, it's at a slower rate than some of these other ports or other entry points have grown. So while that has taken maybe some of the top off, it hasn't taken away their growth. The infrastructure is still there. It is still a very major port of call, and that's not anything that can be replicated easily. In other parts, other areas, certainly are doing things to grow, but you still have that as a major not only ports that can handle that but also a major consumption point. And so I don't see that marginalizing those, but certainly, the growth rate has slowed. And at some point, it comes to a point of competitiveness and it comes to jobs. Those are all things. And I think that actually the ILWU contract comes up for negotiation again here, I think, sometime in 2022. So I'm sure that will all be part of the mix in dialogue, and that's where they're going to need to look -- think about it themselves in terms of what can they do to stay competitive because, as we all know, if you're growing your volumes, that could be growth to your employee base and get some job security.

Yes, you're absolutely right. And it's July, I think. While I'm running out of time, but there's a perfect follow-on right here. To that end, have you seen any developments or much in the way of an expedited level of traction on things like autonomous railroading? Because I mean we're talking about maybe autonomous stevedoring or adding autonomous effects into the import side. Has any of this disruption enabled you guys to say, "Okay, hey, this is going to happen sooner rather than later? Or is it still a slow path?"

Well, I think it's still somewhat of a slow path. As you know, we are going through labor negotiations right now. And really the focus of those negotiations is how to have some flexibility with crew size potentially going from 2 persons to 1 person crews. That's obviously not autonomous, but that's some flexibility for us. So we think that's supported by the current technology structure that we have, the positive train control platform that we've all installed as an industry over these last many years. The technology -- kind of stepping back from autonomy, technology in and of itself is a great tool for us to get better to be able to serve our customers more efficiently and more reliably and to just overall improve the rail service that we have. And I think it's going to be a substantial driver for us as an industry going forward in terms of being able to be more efficient, being able to be more productive and more reliable.

Perfect. So last super fast question. What's -- from your point of view, what's the biggest headwind for your company? What's the biggest tailwind?

Well, the tailwind, I think, is what I mentioned at the very beginning is the fact that we've got this extremely efficient network with improving service reliability and capacity to grow. So first and foremost, that's our tailwind and a kind of momentum behind that growth when I look at the contract wins that we've had. Biggest headwind, quite frankly, could be Washington and regulation. There's a continued desire, it seems like, by the STB to be more active. And certainly, I think the current regulatory environment is one that has allowed the railroads to grow and thrive and support their customers, and I would really hate to see that negatively impacted by regulation.

Yes, as would I. Well, we are out of time. But I do want to tell you, once again, you're incredibly kind to do this and that I am very appreciative. So thank you very much. And this was a great conversation, and hopefully, everyone felt the same. So thank you very much, Jennifer.

All right. Thanks, Ben, very much for your time.

Sure.