Union Pacific Corporation (UNP) Earnings Call Transcript & Summary

I'm really happy to have from the UP team Jim Vena, the CEO; Jennifer Hamann, CFO; and Kenny Rocker, EVP of Marketing and Sales. I'm going to pass it off to Jim. He's got some comments he's going to make, and then we'll get right into it.

Well, listen, thanks, Scott. And next year, we'll come with a panel, okay? I'll think I'll get Phil Yager to come with me, and I'll get C.H. Robinson and Schneider and some of the other -- Knight-Swift. I'll bring them all up here, all customers ours, important customers. And so -- if you want that instead. And in fact, at the end of the day, if we bring all that high-price help, I don't even need to be here. So I probably -- I'll just send Kenny. Listen, all joking aside, thank you very much. Really appreciate it. Love your coverage. Love how you keep us on our toes and ask us the tough questions, Scott. So keep that up. That's what's it all about. We know what it is to win at Union Pacific. So pretty straightforward. So listen, I've got a couple of slides, and Jennifer loves to make sure that I don't miss any of the points. So she says, would you read this? It's always the worst thing for me. I hate following a script. But I'm going to follow the script. You guys can tell me later on whether it's any good. It helps or not. And maybe next time, I'll just be myself and pound through it in my own way. But -- so let's get going. So first of all, I'd like to remind everyone that we will be making some forward-looking statements. These statements are subject to risks and uncertainties. So please refer to UP website and SEC filings for additional information about our risk factors. I'm going to start by making a few brief comments. For those not in the room, the presentation I will be referencing can be found on our investor web page. So going to the next slide. Starting with the first quarter recap on this slide. As many of you are aware, we had a great start to the year. I'm pleased that we were able to report earnings growth in a tough freight environment. This built out the strong results we demonstrated in the fourth quarter as we exited last year. Highlighting a few key items in the quarter, removing the impact of fuel surcharge, freight revenues were up 4% on a 1% volume decline. This demonstrates our commitment to pricing for the value we create in the market. Expenses in the quarter were down 3%, driven by lower fuel prices and productivity gains. The team is working hard every day to make our network more efficient. All in, this resulted in an operating -- industry-leading operating first quarter ratio of 60.7% and excluding fuel, it was 60.1%. While there's work to be done, there is another proof statement of what's possible as we execute our multiyear strategy to lead the industry in safety, service and operational excellence, which ultimately will lead us to more growth. Turning to the next slide. Paramount to our strategy is success in safety. To start the year, we're showing year-over-year improvement in both reportable personal injuries and derailment rates. There's a long way to go, but momentum is moving in the right direction, and we see where the endgame needs to deliver us. Delivering the service we sold to our customers is the next key component of our strategy. And we're doing that, as Slide 4 demonstrates our April year-to-date numbers show good progress versus last year. I know that many of you track our freight car velocity and other operating metrics closely. You've seen a little noise recently as the team dealt with significant flooding in Texas around our key Houston terminals. Once again, the team recovered the network quickly to minimize the impact on our customers. Very important to have resiliency when you're playing an outdoor game that you can recover quick. And those overall service levels are being reflected in our new service performance index, specifically the intermodal, our service levels this year rival the best levels we've provided in our history. This level of performance is key to building trust with our customers as they look to increase their business with us. We want our customers to win. If they win, we win. Finally, we must provide the service efficiently as possible. I think our first quarter results showed we're making great progress in this area as well. Wrapping up on Slide 5. Ultimately, this is all about growth. Let's not lose sight of that. We must leverage our fantastic franchise to introduce new service products and expand our network reach in high-growth markets. We've added many new products over the past several months, whether that's our Falcon & Eagle premium service that continue to be the fastest route between Chicago and Mexico. I guess Keith was supposed to be in just before me. I put that line in purposely for him. We're connecting growing industrial markets in Mexico with areas of high demand in the Southeastern U.S. Very recently, we announced a new domestic intermodal service between L.A. and the western side of Chicago, leveraging our 70-mile an hour railroad. We're able to shave 2 days off our transit time, delivering a truck-competitive rail service to the marketplace. In addition to these new products, we continue to expand our network reach in high-growth markets. To that point, we have increased our trends, load capacity and now have around 25 sites across the U.S. This leverages the strength and efficiency of rail, coupled with the flexibility of final-mile trucking. Safe, reliable, efficient service driving growth to our customers, this is how we win, and we have a Union Pacific team that is energized behind that strategy. So you see, Scott, I was nice. I just said the team was great.

And by the way, Jennifer, I was thinking, you only went off script once there.

I know he did a pretty good job.

That was pretty good. By the way, it's great to see a full room. I see some people standing in the back and the sides. I do see some seats in the front row. So if you want, we have seats for you.

So again, I'll start with questions. You have some, raise your hand, we'll get you involved. I always like to just start with all the companies just from a macro standpoint. Volume, starting the quarter, down about 1%. RTM is down about 4%, 5%. What's -- help us explain that -- the mix between RTMs and carloads? And just in general, are volumes better than what you were planning for, worse than what you were planning for? What end markets you feel to invest or worse versus plan?

Well, let me start, and Kenny and Jennifer, jump in. But -- so you always have to be -- you have to understand what fits into the different metrics, and that's real important. Otherwise, you can get lost because there is so many public touch points with how the railroad's operating. RTMs, of course, the revenue number is pretty easy, x the tons makes a big difference. So if you have a downturn in a high-volume, high tonnage product like coal, you're going to affect your RTM. So you have to be careful that you use the number of coal cars and volume that we have to fix that. At the end of the day, I think we're where we expect to be in this quarter. And I think what you'll see is we'll be fairly close on a volume basis of where we expect that the quarter was going to end up. Is there a challenge in the marketplace? Absolutely. Now what I also like is, and we don't give revenue guidance and we don't put out the revenue number. Otherwise, we might as well not even have quarterly calls. Everybody would have everything upfront. So there's a reason for us to have these quarterly calls and get out. But the revenue side, I think we've done a good job, and we'll continue to build on what we were able to do in the first quarter. So even though our volumes were stunted overall, but we were able to grow our revenues. And I would expect us this quarter to be able to do something similar. Now the challenges are we have a lot of inflationary pressure that was built into the railroads that we have to deal with. So you have to tackle that two way, and that's what we're doing. We're doing it by pricing, and pricing to the level that we need to and for the product that we're providing. And our product is pretty good. So if you can provide a good product, you have some pricing power that has to happen. And also, on the other side, on the below the line, we are looking at every opportunity to be more efficient in how we can be more productive and that's the way I look at that whole RTM, GTM, carload. What's a win -- and then I'll let Kenny talk about the specific sort of markets that we are because they're not all down. Coal is down big time, but Kenny will take us through that. What's a win? It's about revenue. And if we can grow the revenue, and -- which I think we did a good job in the first quarter when we were 4% higher, and we can continue to do that, and then we can continue to grow volume in the right places with what it gives us, and we can be more efficient, I like that. That's the picture. That's what we want to deliver. And we'll continue to have some pressures on inflation, but I don't see anything that bothers me that we can't figure out with some time where we get to the right place. And it is time. You don't want to impact your markets by being irresponsible in how you price and irresponsible of how you look at the railroad and how you spend money. So I'm very comfortable, Scott, where we are. Kenny or Jennifer?

You start and I'll...

Well, before Kenny gives you some of the market detail. Going back to your first part of your question, Scott, about what we expected coming in. I think Jim's right, on an aggregate basis, volume numbers are probably not that far off. I will say the mix is a little bit different though. We continue to see strength in that international intermodal segment which we like that, but that is a little bit of a headwind to us on a mix standpoint, particularly when you see our industrial segment down 1% so far in the quarter. So that mix difference, I think, is important, but also Jim's comments about our revenue, and it's really revenue ex-fuel is how we're thinking about it. We want that to grow in excess of our volumes because that really relates to Kenny and the pricing his team's doing.

Yes, you come into the year, and we're not naive enough to try to forecast growth for coal. So coal will do whatever it's going to do. We'll see what happens there. What Eric and I try to make sure we do, which we're doing as a management team is just capturing all of the demand that's out there. That's the first thing. And then you walk through some of these other markets like the industrial markets. Our petrochem business has been holding up. It's been strong. We'll continue to see paper and forest products, what happens there with our SAAR. And then on our premium side, and Jennifer mentioned this, domestic intermodal has just been stubbornly stagnant over a year now, which is something that has to change at some point. But it has been a pleasant surprise. We've been able to capture all demand on the international intermodal side. We've been very excited and positive on what we've done with wins and the market growth on finished vehicles. And then the last piece that you saw with the slide, when you have an economy like this, you can't moan and groan. You've got to go out there and create new products to improve your light in life, and that's what we're doing.

Great. So just a couple of follow-ups. I think, to me, one of the positive surprises from Q1 were some of the yield trends. When I look at yield ex-fuel, Jennifer, up 3.5% in Q1, right? And I'm guessing there was some positive mix within that.

There was.

Your point about mix in Q2, should we assume some sort of deceleration relative to that 3.5%? Is that what you're trying to suggest?

I'm trying to suggest or just say, our mix is going to be negative in the second quarter. I don't think hugely negative, but we're going to go from a positive mix to a negative mix, and that obviously flows through the yields.

And -- okay, that's helpful. I want to think about underlying price for a little bit because I think it's -- for so many years, we've talked about rails' duopoly businesses with pricing power, and it was sort of a given, inflation plus pricing power. And we -- and all the rails continue to say it, right? Jennifer and Jim, I'd love to get all your perspective on this, right? You now -- Jennifer, you now talk about inflation, pricing dollars, exceeding inflation dollars. But you've also said price/cost maybe is not a tailwind to margin this year. I think that is one of the big keys for the rails broadly. When do we get back to price/cost as a tailwind to margin? And it's been this, we've had this unprecedented price/cost headwind. Is there -- do we have visibility to a catch up? Could it be a multiyear catch-up on price/cost? I'm -- I'd love to get all your perspective on this.

Do you want to start, or you want me to?

Go ahead.

Two things...

Scott told me I have to be nice to you. I don't know. I'm always nice to these two but I'm okay. Go ahead. I'll tell you if there's something wrong.

So a couple of things, Scott. It does take us multi-years to price through our contract. We do have, call it, 50% of our book of business is in multiyear deals. And so there is going to be some catch-up as we work through those deals to be able to actively price them. There are escalators on those, but then there are limits to some of those escalators that are prohibiting us from fully keeping up with the inflation we saw over the last couple of years. So that's part of it. The other part of it is what happens with inflation. It's starting to come down, but we have another 4.5% wage increase that goes into effect July 1. So if you look historically, we would say inflation was probably in the 1.5%, 2% kind of range. The last couple of years, we've been 5% plus. So there is a bit of a headwind there that's going to take us a bit. I'm not going to give you a prediction of when we're going to turn that tide. We're going to turn it as soon as possible. But part of it is what we can control in terms of our ability to go out and price in the market. And then part of it is that inflationary environment and what happens there, again, coming back a bit, but not still back to what I'll call more historical level.

Where we are and have an opportunity to renew contracts, we're being very aggressive. We are taking risk. We are unapologetic as we talk to our customers about the inflationary pressures that they see. They have it going on in their markets too. I was with our construction products customer here recently, and they are having the same inflationary pressures. They are taking prices in the marketplace too. So with our stronger service product that we have now today, there's no reason why our commercial team isn't going out and articulating those challenges and being as aggressive as possible.

So if I -- Scott, if I could summarize it, one is every contract doesn't come up every year. So we have some contracts that give some flexibility so that the people we partner with can react to market conditions. So those things as they come up, we'll have to deal with that. But we are pricing, and we price to the value of what we deliver, and what we deliver is a valuable product that really on a cost per unit basis for the people that ship with us, makes sense for them to be on the railroad. There's no other way that can give them that cost benefit. And if we can have the service level high. So when I -- the first time I was at UP in 2019, and I looked at the railroad and if 2024 was 2019, I'd set up here and say, "Don't worry about it. We can outstrip costs faster than any inflationary pressure." So that would take care of the issue directly. But we don't have 1,500 locomotives we can park anymore. We parked some more. But -- so now it's taking it to the next level. It's a lot of hard work, but we see that possibility using technology, using our infrastructure, training and teaching people and making sure we have the right processes. And if you look underneath the numbers that you don't see every day, we get way more cars -- double-digit more car switched per employee. We get a lot of things that are way better already. So that will help us. We do those two things. This might not be -- listen, last time I was -- I took a sabbatical, that's the way I call it, when I left UP for a while. It was sabbatical for a couple of years, and I went and found myself in Nepal and other places. But at the end of the day, I'm back to work. And I'm building on that, we have a great network. I think we have pricing power because of the level of service and the value we give our customers. If we were trying to price purely just because of inflation, I think that's -- you're going to lose that game. Eventually, people will go somewhere else. But the value we give our customers is high and it's worth what they pay us. And we are going to price against that. And I don't see anything slowing us down. So that's where we are right now. Very good place the way I see it.

And so it sounds like some of this is still -- even though it's been a few years, it's still -- there's still some degree of a timing issue here. Are we, right -- convinced that at some point, we start talking about price/cost as a margin tailwind? I know we're not saying when that inflection is. But like when -- Jim, when you talk about getting to the operating ratios you want to get to, is there an assumption that yes, we do get the price/cost tailwind rather than just price/cost dollars or whatever the language is these days.

Scott, I hate to answer with one word, yes, you're correct. That's exactly the way I see it is, is -- let me, again, just expand on that a little bit. We have some pressure here over the short term. And when I joined UP, I was very clear that this was not going to be a short fix. You can't fix the inflationary headwinds that were put into the entire railroad system from wages and from the products that we buy. So we need to deal with that, and you can't deal with that over 6 months or a year. So if it takes you a couple of years, at the same time, you work hard to be able to open markets with using our access into Mexico, having that high-speed train coming out, that we've already put in, out of Mexico, and nobody can beat us. In all seriousness, I was joking about the other railroad, CPKC, but in actual fact, we have the best network, and there's nobody that can beat us. So if speed and consistency is important, which it is for some people, we think that's a win. So we see that being able to grow and we see the results of that. And then we think that we can win using -- leveraging our system coming into Chicago. And we're under 3 days coming into Chicago. So that's a long ways to go in well under 72 hours. And we think that's competitive to be able to move domestic containers and trailers and products. We don't have to just go intermodal in that lane. I have no problem putting somebody who wants to put some box cars in there that want to get into that market. So when you add all that up, that's how we win. It might take us a couple of years to get that. If we can, every quarter, be able to improve ourselves sequentially in our operating ratio, and I don't have a problem, saying operating ratio instead of margin, okay? I have no idea why anybody would have a freaking problem and want to swap at the margin. I don't know. I'm a math guy. Isn't it margin -- don't you just do the inverse 1 over x or something -- like whatever, okay. But bottom line is, I'm an operating ratio guy because I'm a simple guy. So we're going to improve our operating ratio by doing the things underneath that people don't see every day. And as we're able to price, and as we're able to bring the business in, that's a win-win, Scott. And I said, and I'll repeat it, I don't give a number. I know some people don't like it. They'd love me to be able to give them a number so they can put it in. Look at my record, okay? We're going to have the best. We'll have some other quarters when we're not the best, operating ratio, but we're going to be the best. So I hope that somebody delivers [ 59.5% ] this quarter because then we can figure out how to beat them next quarter. So at the end of the day, we're going to be the best, and that's all there is to it, Scott. I love a challenge.

A couple of just quick follow-ups there. On the -- just back to the -- one more on this price/cost discussion. Kenny, how important is truck pricing in this equation? Is that a limiting factor right now for Western rail long length of haul or not so much?

So I mentioned that the truck prices have just been stagnant-to-low for a year now. Early in the year, it was down. Contracted rates, call it, low double digits, and now it's improved to high digits, maybe mid-single digits. And so that's improving. Yes, it's important. Better truck rates or higher truck rates help us compete not just in intermodal, but also some of our box car business. So yes, we would like that. But again, a stronger service product helps us compete in the marketplace. Earlier this week, we were going through some wins where, because we have a lower cost structure, we're able to go in and win some business against truck on our carload side that we probably wouldn't have been able to done had we not made the changes that we've made. So if you can't get it in the market, you get in some of the products that we mentioned, and Jim has talked about that we've expanded our footprint in Southern California. We've improved our service product out of Southern California. We've got products out of Mexico. So where the market isn't giving you help, like I mentioned, you create new products there.

Yes. And Scott, as I know you know, we do have a couple of mechanisms, both on the intermodal side and the coal side that are impacting our overall pricing right now because of those market dynamics.

Okay. And then another follow-up. Jim, you said, "Hey, judge us on what we do. We want to improve margins just sequentially or operating ratio sequentially every quarter." I don't know, if Jim or Jennifer, you want to take this. Any thoughts or color on how we should think about sequential OR improvement from Q1 to Q2 versus whatever normal is? Is it -- are we -- should we be modeling normal seasonality on OR? Any of the puts and takes.

Well, Jennifer always gets excited when I say sequential. She'd rather have me talk about year-over-year. So there is some -- there always is some pressure because of mix that could affect you quarter-to-quarter. I like to look at it truly year-to-year, and I'd love also to be sequentially better first quarter to second quarter. So I don't know what June is going to be like. I don't know what the weather is going to be like. I don't know what impact we're going to get on the cost side. But that's the way I look at it is how can you improve it? And the best way to think about it, Scott, is as we price better, as we -- we do have some markets that are tough, some of them because of where the competition level is like on the domestic trucking, but we also have some markets where we like them. We see in our originations that they're winning. Would I like interest rates to come down? Absolutely. That would have more people buying and selling homes and that every home that's sold, it gets painted first by the people selling it because they want to try to sell it at a higher price. And then I don't know about the rest of you, and I've had like 23 different homes in my life already, moving is when you walk in, somebody in the house doesn't like the paint that somebody else put up there, so you paint it again. So I like that kind of thing, and that impacts us on the products that we move across the board that consumers use. So I'm very comfortable. Scott, I know it's difficult if I had your job. You'd love it if I came up here and said our operating ratio is going to be this, and our revenue is going to be this and you can put it in the model. Listen, I'm a prudent guy, okay? Who will take it one step at a time, but I like the direction and what we're doing to move ahead. We've got the right focus on this.