Union Pacific Corporation (UNP) Earnings Call Transcript & Summary

Good morning, everyone. Welcome to Barclays 41st Annual Industrial Select Conference here in Southeast. I really appreciate everyone attending. I'm Brandon Oglenski, an airlines and airfreight analyst. Firstly, we're really honored to host Union Pacific here. And joining us, Jim Vena, CEO; and Jennifer Hamann, Chief Financial Officer. And throughout the day, there's going to be -- when you sit through these sessions, we do have an audience response system. So you look at this like old-school Blackberry looking thing in front of you. Just pick that up because we're going to run through a couple of audience polls here. So for those of you in the room, just pick up the thing here and let's go to question #1 real quick before we get in with Jim and Jennifer. This should be, do you currently own Union Pacific? Yes, overweight; two, market weight; three, underweight; and four, no. And if we can pull that, please?

Do I get one of those? No? You're not going to give me one, Brandon.

I think Brad...

Brandon will vote for you.

Brandon, will you vote for me?

Question #2. Got some more in the room. Question #2, please. What is your general bias towards Union Pacific right now? One, positive; two, negative; or three, neutral. Go ahead and poll, please. Okay. In the back, are we polling? Maybe it's not working. Okay. All right. And then question #3. In your opinion, through cycle EPS for Union Pacific will be one, above peers; two, in line with peers; or three, below peers. Well, we get the results here. Thank you for coming down. I really appreciate you guys coming to Barclays. I know you have a sheet here that you've handed every investor in the room, so maybe you want to walk through some of those comments first.

Listen, Brandon, thank you very much. And if you don't mind, maybe I ask some of you questions, especially those ones that you were not positive on us. I'd love to answer some of your questions, but we'll leave that to later on. Okay. Well, I'll judge you at the end of the questions when we come through. So Brandon, listen, thank you very much. I really appreciate everybody taking the time this morning. And I always have to do the boilerplate first. So let me remind everyone that we will be making some forward-looking statements this morning. 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. Why don't I start with making a few comments. And when we handed out the sheet, I think what's really important to take a look at is, when you operate a railroad and you want to provide good service to customers, we have a clear vision and clear goal of what we want to be. And what we want to be is, we want to be excellent at safety. We want to be the best in safety. And as an industry, the railroad industry in the United States and Canada and in Mexico have done a good job of improving safety across the board on the employee interaction and the derailments. But at the end of the day, I don't think it's good enough. I think we have more work to do. And we at Union Pacific will continue to invest in our employees, how we onboard them, how we train them, how we keep them fresh, how we make sure that all the tools that they need to operate are the best that we can provide and that they work together as teams to make sure that they go home safe and we cover for each other what people are doing. The business that we're in, and I've been in railroad for 47 years, probably more than most of you have been alive. So in those 47 years, I've seen a lot of change. We had 4 or 5 people on every train and we're down to 2 and switch people is 2 with remote control. And we have technology out there that inspects our track and our equipment. And for us, that's really important. And we'll continue to invest that way because, as an industry, we need to get better. So even good is good, but guess what? If you want to be great, you need to improve from where you are. The second key point that we always look at and our strategy is built around service. And what service? At Union Pacific, we're simple people. We just want to deliver what we sold to the customer. That's what it comes to down to. It's not anything fancier than that. We should have clear measures with every customer on what the expectation is, what we've agreed to do for them for the price they pay. And we have a broad range of customers. We have customers that expect world-class service, on-time performance in our parcel division and the group that we handle, make sure that we have to deliver at a very high level, in the high 90s, 98%, 99%, so that they can make their store and deliver the packages that they have on the street. And there's others that have a different level of service that they want. It's much more of a consistent discussion versus a discussion of speed. Speed is always important. So car velocity is a metric that I look at very closely, and I break it down into the different segments. So if we can move equipment quicker, what happens is the customer has a better experience. They can see how much their input costs are and what they're moving on us. We make it less expensive for them. We decongest the network. We keep it fluid and that helps us. But that's what service is for us, is how fast we move. And we're real proud that we were the winner from UPS in Christmas rush and the buildup of their peak be the railroad that won best-in-class in performance. So that shows what Union Pacific can do. When it gets to [ time fluid ] and everybody is working together for the same goal. And the last piece is operational excellence. And there's always a lot of discussion about what you do for operating excellence. Do you forget that you need to still operate the railroad. Railroading is never consistent, never flat. If you graph it, there's peaks and valleys as you go through the year both on demand and on the effect of working outside. So January was a pretty tough month for a lot of railroads in the U.S. and in Canada. But I'll tell you, what I'm really happy about is how fast we were able to recover and get the network fluid. That's real important. You know you're going to get impacted especially if you get lots of snow. So for us, operational excellence is pretty simple. We think we have the capability to be the best operating ratio, best margin railroad in North America, and that's what we're driving towards. And we're not there right now. Now do I think it's going to be easy? No. I know the other railroads, when I say that, I'm sure my friends at CM that I know real well go, [ let's fight, ] Vena, we're going to be trying to stay ahead of you. When Ghislain comes up later on this morning, you might want to tell him that he's probably going to be able to see me in the rearview mirror real quick, and then we'll see what happens after that. So at the end of it, that's really important is how we move ahead. And if you take a look at the -- what we handed out, these graphs show the resiliency in the network, the quick bump up after we had the slowdown in January. You can see the productivity. Now we've given you 2 productivity metrics in there. Workforce productivity, real important for us, and locomotive productivity. But below that, there is a number of ways that we look at it underneath. But it's a good guide that if you're using your assets faster and you're getting more mileage a day, then it's better for the system and better for our customers and better for ourselves and how we operate. And workforce productivity, we have some challenges. We have challenges in some of the agreements that we signed last year. And whether it's the 11 and 4, the scheduling, but it's going to have an impact on the number of people that we need to operate the railroad. We're working hard to make sure that we are able to be efficient in that and not transfer all the costs of the additional people to the expense side of the company. And we did a great job of it in the fourth quarter and we'll continue through this year. And I think we have a good plan to be able to mitigate most of that. So that's what it's all about for us. Last piece if I can talk about is, how do I look at operating ratio. For me, it's sequential growth, sequential improvement, as we move ahead. Now more revenue really helps you. So we're driving hard looking for business and we're doing that by providing and investing. There's a new Phoenix intermodal terminal that we think that we can penetrate a market there that has not been penetrated very well, and we can remove trucks off of a highway coming from the West Coast. And we can use that as the leverage point in that area to be able to win with our customers. We also have a new service on coming from the border because we think with near-shoring and everything that's happening in Mexico, we have a great opportunity that traffic is going to both North and South traffic. And we put on a training that is unparalleled. There's no one that could move as fast as Union Pacific on that corridor from the border, and we have great access into Mexico. We have 6 different access points into the Mexican market. So it gives us great penetration. And we own 26% of the FXE and we need to -- and we started down the road and we will continue to build that so that we -- customers look at us as 1 railroad and not as 2 railroads. And if we can be more seamless on how we hand off traffic and how we move and we penetrate the market, I think it's a win, Brandon. So that's it, that's my prepared. And I know my compatriot from Union Pacific said, I knew he was not going to read what I gave him.

I appreciate that, Jim. And I want to ask much more about the long-term outlook here, but not sure if I can. Volumes for Union Pacific and other carriers were pretty challenged in January. I think cold weather across the continent was the leading cause. But what can you tell us about trends so far in the first quarter, if you don't mind? .

Yes. I mean, I think you hit that exactly right, Brandon. If you look at our January volumes, they were down about 6%. Since then, as the chart shows, our velocity has improved tremendously and our carloads have come back. And now quarter-to-date, I think we're down about [Technical Difficulty]. That tells you that February, we're seeing recovery. And you saw that from us in the fourth quarter as well. As our volume ran faster, we improved network fluidity, we were meeting our customer demands and I think that's very much where we're at today. We knew there were going to be some challenged markets, kind of the challenged market which is why you're still seeing this a little bit lower year-over-year. Biggest year-over-year challenge is in coal. Everyone knows what's going on with gas prices and just the stockpiles have been built up over the course of 2023. So that's just a much more challenged market for us. We also talked on the quarter about an intermodal contract loss, so that's a little bit of a headwind. But when we look at the rest of our markets, we see some great growth opportunities. And it really does go back to what Jim talked to is, service, and meeting those customer needs, showing them the recoverability of the railroad. And so I think we're well positioned as we continue through February and into March to move the demand that our customers have.

Appreciate that. And Jim, when you came onboard at Union Pacific, I think, you said look at freight car velocity, right, to track improvement or if we are or aren't. Is that still the metric that you want investors to focus on?

Well, listen, you need to look at a whole bunch of things, and I wouldn't expect everybody to look at everything I get first thing in the morning. So when I woke up this morning, I get a number of reports that makes it easy for me. I'd only have to go look at them. So there's a number of them. But if you take a look at that for us, and every railroad can look at it their own way, I find that some of the other metrics are not truly representative of the fluidity in the railroad and what they're delivering. So people talking about train speed, if you look at how train speed is figured, it's a pretty easy fix. If I change train numbers a couple of times or I stop them in a terminal and do that, you remove time out of that schedule on paper. The customer doesn't see any value in that, so you can have faster train speeds. So if I was being compensated for train speed, I can get it to 30, but that's not a real metric. And the reason I like using car velocity -- and you know what, you have to make sure that what you measure is a clear description of the result. When my kids came home from school, and I got it, I'm a tough marker, no ifs, ands, or buts. But if they came home and said to me, they got 85% on an exam. You know what the next question was Brandon? Where are you in the class average? Are you in the top group or are you in the bottom group? Or is this now the teachers are just giving marks away? Sometimes I think they are. But that's okay, okay? So at the end of it, so car velocity is the metric. Car velocity is real important. And that gives you a good feel of what and how the railroad is operating. And for me, that's a key metric that I would ask people that want to look at us and see how we're doing, that's a good one to tell.

And I think it most closely correlates with the experience that our customers have in terms of how fast those cars are moving.

Yes, because car velocity is where a customer releases the car to the time you place the car at the customer. And that's the crux of it. There's a few other nuances, like if they don't accept them or a cargo is bad order or something, you deal with that. But overall, it's a measure of how well customers see that. And the feedback is, you get to the level where we are right now. Customers are -- the feedback we're getting, I spent a lot of time with customers earlier this week. And the feedback is you're delivering what you sold us. And hopefully, we can grow the business together.

Well, when you came onboard mid last year, I think it was pretty rapid improvement we saw in some of these service metrics including car velocity. What changes did you make in the organization? I think you've spoken about pushing decision making forward in the organization. Is that right?

Look, Brandon, I give the team a lot of credit. I do have a very strong team. If you look at the people that a lot of you will not meet in the next short while, but hopefully we get a chance to bring them out at our Investor Day and we can meet some of the other people, is as -- you just have to be focused on exactly what's important. Don't lose sight of trying to do the things that you think are important, but you concentrate on them. And we concentrated on our intermodal. We have a 70-mile hour railroad and we've built the speed that we can operate freight trains to 70 miles an hour on the majority of our railroad except for -- through the mountains and some of the curves, but we can go 70 miles an hour. Ourselves and our competitors in the west are the only 2 railroads that's built to that standard. It's a safer railroad because the tolerances are way less. And if you concentrate on what's possible and you have the team aligned on what's necessary. It's amazing what you can do. And they have to be focused. Now don't kid yourself, it doesn't -- it sounds easy. When you're handling hundreds of thousands of railcars, thousands of locomotives, thousands of customers that have a different view of when they release cars, when they move, but if you make the right decision, Brandon, you can do that, and that's what it's all about. And hopefully, I did learn something after railroading for 40-plus years that I've had a little skill. I'm not good at a lot of things. I'm not trying to tell you I'm real good at everything. But railroading, I'm not bad. I give myself a B+ mark because I'm a tough marker.

Jennifer, I think, I heard sequential improvement in the operating ratio. I mean, is that something that is possible here in the first quarter with January headwinds and..

Yes, I mean, when since that sequential improvement, I wouldn't take that as an absolute. I mean, he's looking at -- and this is the way we look at it and you all should judge us is, how do we perform last quarter? What are the metrics that we're putting up? You obviously have different seasonality in our business, but that takes away what I'll call pure sequential improvement. But are we showing productivity? Are we holding the metrics? Are we continuing to whittle away at the cost structure? We know we have the inflation. We've talked about that pretty broadly. What are the opportunities to chip away at that and be more productive and use less assets to move.

Okay. And on the volume outlook this year, I think, you guys were maybe a little bit more muted given, I think, you mentioned, in intermodal contracts in grains and coal. Can you speak through some of the headwinds and then some of the tailwinds as well?

You hit the headwind. We could have come out with a different message, and I think we want to be prudent in the message that we give. If you operate the railroad in a very efficient manner, you give our marketing salespeople a new chance to win in the marketplace, and that's really important. That's what we've done. I think we have a product now in the entire network that we have in the different commodities. Now we're not sure and we were not sure when we spoke in mid-January after the fourth quarter, but what the economy is going to look like. If I was -- if it was a dream, I would hope that interest rates drop down to 2, GDP growth is 3 or 4. We get industrial production up. But that's not the fact, and I can't see it and we can't see it. So we decided to be the way we should be. And I've always been like this. I don't -- you know what, judge me on what we do, judge us on what we do, and judge us that if we have the capability to move ahead. Anybody that says that they know what's going to happen in the latter part of the year is really guessing as far as what I see. And maybe they're smarter than me and they can see it better than me and we're ready for it, if it happens. But we have to be cognizant of what the economy will give us and we're well set up with the capacity that we have and the way the railroad is set up for us to improve. But that's why and we're being very careful. I've always been like that. You'll never hear me tell you where we think we can deliver an operating ratio of X. Let's go deliver it and then people can judge it. I've come out and said that we're going to be the best. I'm pretty confident about that number. I'm pretty confident that we will get there. But the rest, Brandon, I don't guess. I think it's not prudent for us and for our investors to tell them a story that is not factual than what we see. Now if the economy turns on us, if we have an improvement, some of those things happen. We have an improvement in the general economy and interest rates, that can help us with bonus products and a number of products that we move in the housing business. If the consumer keeps on spending in services, but also moves the products that they buy for their homes and building, I think we're well set up with the capacity that we have in the railroad to bump up.

And Kenny and team have done a good job in terms of business development. You heard us talk about that in the fourth quarter call. When we look across the portfolio, we know we've got some business wins in the automotive side. So we feel very bullish about automotive volumes both parts and finished vehicles this year. Biofuels is going to continue to be a strong growth area for us as more plants come online in our served territory. And we also have had some business wins in the petrochem market, plastics. Some of that is supporting the auto industry, but that's another part of our business that we feel really good and saw that continued growth and strength in that market.

And if the audience has questions, by the way, this can be interactive, so just raise your hand, we'll get you a mic. But I guess, Jennifer, how long does it take for this new service equation to then translate to customer base? Is it new customers or is it just winning more business with your existing base?

Go ahead. Why don't you start?

It's both, right? I mean, certainly, our easiest opportunity, and I'll put it in air quotes because Kenny would say it's never easy, is with existing customers. Because we know most of our existing customers aren't shipping all of their business with us. So that's where us demonstrating day after day, week after week that we're a resilient customer service product. That gives us an opportunity to grow with them. But then it's also the truck conversion. We know that's the holy grail for the railroads, is converting more of that business moving on the highway today. And again, that comes down to consistency. And I think we need to show that over a period of time. It's not weeks. It's showing it through different cycles, it showing it through different weather events, what we just went through, showing that resiliency.

So Brandon, no customer -- when you sit down to talk to a customer and you tell them and they've seen it. For 3 months, you've had great service. You're providing the service that you sold us. Three months is not long enough to actually make the transition where people say, we trust the Union Pacific enough that we are going to shift some of that business. The business is there for us that to convert. And the nice part about the network that we have, if I take you for a quick tour around the network, everybody wants to start with the intermodal business that's anchored in L.A., Long Beach and Seattle, and that's really important to us. But -- and that's important for us to make sure that we're in the right place. And if we are efficient, if our margin, if our operating ratio is the best in the industry, it gives us way more to play in that truck competitive business. We think we have a product. Greenhouse gas emissions, 70% less impact both to the environment than by truck. So we need to sell that. And I expect Kenny to sell that and make sure, and that's why we opened up Phoenix to make sure we do that. But if I keep on going around, it's not just there. Industrial complex that we have that we serve, and we're the biggest server from -- all the way from New Orleans down to Brownsville, Texas, is a great franchise for us to have. And that product actually is doing real well, okay? That is up year-over-year, and we see continued investment by U.S. companies in that area, by companies in that area, and we see that as an improvement. I can keep on going. I could spend the rest of the time whether it's the grain franchise. That's just the way I look at it. If you operate the railroad well, you operate it for enough time that the customers are comfortable that you have a product that they can rely on and you're cost-effective. And I'm not talking about halving the prices. That's not the game I'm in at all especially with the inflationary pressures that we felt. Then there's no reason for Kenny and the team to go sell that. And I'm going to judge him, and he knows it, on how well he sells. I'm a patient man for about 3 weeks, okay? So guess what, you better get out there and start selling the business that we have and bring it on the railroad.

Three weeks. Got it.

He just added a week. I thought it was 2.

Jennifer, you did provide guidance though, on the cost side this year for inflation expectations of 5%, I think, both on compensation benefits and overall inflation. Can you talk about potential offsets for that? Does that include productivity expectations or...

No, that does not include productivity. That's just the inflationary pressure that we see in those categories. So to your point, that's their opportunity is through the productivity and the efficiency that we look to gain on the railroad. And we have opportunities in every category. There's no cost category out there that we think that we have maximized our productivity or that we're doing the best job possible. So with labor, we know that we can do better with our labor. We're learning as we're implementing some of these new agreements. We're also implementing remote control technology that helps us. We're looking at how we can reduce recrews as the velocity of the railroad spools up, that gives us better predictability, helps us improve and reduce that, reduce the need for borrowings across the company. And that's a cost savings for us. Fuel efficiency, that's a big one. Locomotive productivity helps that, but also just looking at how we're running the locomotives across the network and being more diligent about shutdown, start-up procedures to save fuel, some very simple things that we can do. Purchase services, some of that driven by purchase transportation if you think about our loop subsidiary and the demand for autos. Within is locomotive maintenance, it's car maintenance. So as we reduce those fleets, as we use fewer assets, that's helping to save money. And just our procurement services being out there, being good in how we're contracting services that are providing.

So we have -- at Union Pacific, we have this inflationary pressure. You tackle it two ways: One is through price. And I think we're going to do a good job of being able to make sure we cover that and we can price so that we cover that expense. But on top of that, we think that there's productivity on assets, how we use the railroad, efficiency of the people, everything else. Listen, the people that we have operating the railroad every day that pays, they're pretty good jobs. They pay well and we're comfortable. The deal's the deal. We -- I don't like that some of the things that we provided without getting some productivity dealings within the agreement, but I can't look back. But looking forward, we've identified ways for us to mitigate that on an efficiency basis and also how we price and make sure that we get ahead of that. Now it's not a 6-month. We don't have all our contracts coming up short term, so it might take us a little bit longer. But I'm very comfortable. I see a point down the future where we will cover all the expenses that we have for inflation and we're able to operate more efficiently. And I think you saw that in the productivity numbers for the fourth quarter.

We're almost out of time here, but maybe we can queue up question #4. But audience, question #4 here, please, in the back?

Ghislain, you cannot ask the question. I'll see you back there, [ Derek. ] Welcome, gentlemen.

Folks in the back, question 4. There we go. In your opinion, what should Union Pacific do with excess cash? First 2 here are M&A; third is share repurchase; fourth, dividends; five, debt paydown; or six, internal investment. While we wait to get the response from Jim, I do want to ask, what's your view of capacity on Union Pacific? Because if you look back volumes from an RTM or GTM perspective probably peaked a good bit ago and probably 20% lower today than where they were a few weeks.

Well, a lot of that is the coal business that's come down, and so where the coal -- with the coal franchises, we have capacity, 20% or whatever the number is. You always want to have some capacity in the railroad because it's not a byline, capacity help you recover, helps you recover quicker. So I'm very comfortable that the railroad infrastructure is set up for us to handle any growth in business that we foresee in the next few years. No issues there. Are we going to have to invest in certain pockets? We will, and we'll continue to do that to make the place more efficient. On the locomotive side, I joked around last night and said that we have more locomotives parts than one of my Class 1 friends, and it's the truth. So I don't think we're short of locomotives. We're in good shape there in the number of locomotives we have. And the railcars and everything else, I'm very comfortable. Can you flex up the people? We have had no problem hiring at this point. We go out and look for people to come out in the railroad, we've been able to bring them on after the pandemic. It was a little bit harder right after. But right now, when we're looking for people who join the railroad, they want to join them. They're good jobs and they come to us, no problem. If you put the 3 things that you need, railroad capacity, asset capacity, and people, I'm very comfortable that we have the room to grow.

Okay. Question #5, please. In your opinion on what multiple of 2024 earnings could Union Pacific trade? You have ranges there 1 through 6. We're almost out of time. Can you guys talk about capital priorities though outside the investment? Is it share repurchase, dividend? Where is the priorities?

Let me start and then I want Jennifer to jump in because we want to talk about -- let's talk about generally the way I look at it is operating income is really important, and I think Union Pacific does a great job on operating income. We -- with that, we will continue to invest in the railroad. And this year, we have a plan for $3.4 billion, and that means millions of dollars every day spend on the railroad. Half of that goes to refresh, renew the plant to make sure we operate a safe railroad. And the rest of that is in assets and investments for growth. And that's the way we look at it. Now we can flex that number if we have to. If something comes up, we're not so locked that it has to be $ 3.4 billion. It could be $3.3 billion by the time we're done or $3.5 billion. But at the end of it, it has to be we're clear with what we do. So we spend the money to reinvest. People want to look at a lot of things. I don't know, I'm an investor in other companies. I look at how much money we make, net income, free cash flow, very important to me. And if we can have free cash, we want to buy back shares, we want to increase our dividend, and we want to make sure that the shareholders, the owners of our company, are taken care of when they invest in Union Pacific. That's what I look at. You can ask Jennifer, I always look at what's the free cash flow, how much money would we have left over after we paid all our bills and what do we do? That's very important to me.

I think that [indiscernible] but maybe we can get the last question, question 6. What do you see as the most significant share price headwind for Union Pacific: Core growth, margin performance, capital deployment or execution and strategy? Jennifer, last word on capital, and I really appreciate you guys coming.

Yes. No. I mean, I think Jim summed it up very well. And we said that we aren't going to be back in the share repurchase market here in the first quarter. We've got about $1.3 billion of debt coming due and so we're going to use operating cash to pay that debt. But we absolutely know that share repurchase is something that's important to our shareholders. And as we improve our earnings profile and grow that cash, we're going to get back in the mode of distribution through share repurchase.

Great. Thank you both. We have so much more we could add, but we're out of time.

Well, Brandon, listen, thank you very much. Thanks, everyone. Appreciate it.

Thank you.