CSX Corporation (NASDAQ:CSX) Q4 2023 Earnings Call Transcript

CSX Corporation (NASDAQ:CSX) Q4 2023 Earnings Call Transcript January 24, 2024

CSX Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good afternoon. My name is Krista, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the CSX Corporation Fourth Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I will now turn the conference over to your host, Matt Korn, Head of Investor Relations. Matt, you may begin.

Matt Korn : Thank you, Krista. Hello, everyone. Good afternoon and welcome to our fourth quarter earnings call. Joining me this afternoon are Joe Hinrichs, President and Chief Executive Officer; Mike Cory, Executive Vice President and Chief Operating Officer; Kevin Boone, Executive Vice President and Chief Commercial Officer and Sean Pelkey, Executive Vice President and Chief Financial Officer. Now in the presentation accompanying this call, you will find our forward-looking disclosure on Slide 2, followed by our non-GAAP disclosures on Slide 3. And with that, it is now my pleasure to introduce Mr. Joe Hinrichs.

Joe Hinrichs : Alright, thank you, Matthew, and hello everyone. Thank you for joining our conference call today. As you will hear from our leadership team today, we are very happy with the momentum we carried in the start of the New Year. Of course, Mother Nature gave us a few challenges over the last couple of weeks, but we are proud of the work our ONE CSX team has done to set us up for success this year. Our railroad is performing well and Mike Cory and the operations team are already bringing new ideas that are helping us run even better, safer and more efficiently. Our customers are happy with the consistent service that our dedicated employees are delivering and Kevin Boone will discuss how this is translating into profitable business opportunities.

Sean Pelkey will go over our financial position, which remains very strong as we continue to deliver healthy volumes, favorable pricing, strong operating margins, and high levels of free cash flow. Before we talk about the details of the past quarter and our expectations for 2024, it is important to take a step back to appreciate all that our ONE CSX team accomplished in 2023. Everyone on this call knows it’s been a very active period for our entire industry. Recall that it was just over a year ago that Congress took action to prevent a major rail strike. Soon afterwards, highly visible events last winter led to important public debates about railroad safety. And through the year, Class I railroads have completed major mergers and made significant leadership changes.

Meanwhile, our customers have had to manage through higher interest rates and inflation on the one hand, and wars and supply chain disruptions on the other. Through all of this, the aim of our ONE CSX team has been to keep moving forward on our key goal of delivering sustainable, profitable growth that benefits to all our key stakeholders, our customers, our employees, our shareholders and the communities we live in and serve. For example, CSX was the first Class I railroad to reach basically agreements with our union partners, and we were the first railroad to significantly change our attendance policies based on employee feedback. We were also the first U.S. Class I railroad to be released and additional service metric reporting by the STB back in May, based on our improvements and service to our customers.

Now here on slide five, we have listed several key achievements from this past year, and helped us take important steps forward. First and foremost, our focus on safety has driven strong results over the year, especially in the fourth quarter, enabling us to report much improved accident and injury rates compared to 2020. Our service metrics that have consistently led the industry. And today CSX remains ahead of our peers. Importantly, this is improving our customers’ experience, which puts us in a great position to gain their trust and gain share. You’ve heard me reiterate this all year long, our team delivered positive volume growth in merchandise that beat U.S. industrial production, improved efficiency helped us grow coal volumes, and our intermodal business gained traction led by our service and market initiatives.

Our commercial and operating teams are more closely aligned than ever. Our customers know that when we offer them a solution, we have the commitment and the expertise to deliver it. Finally, we have seen our efforts to renew the culture here the railroad start to really take shape. Through our site visits family days, and our regular surveys and town halls, we see the increased pride and energy that our employees are feeling through ONE CSX. And this is great progress. And we are proud of what we’ve accomplished this past year. None of these efforts are done or complete as this is a journey. There’s so much more that we can accomplish as we work together as ONE CSX team. On Slide 6, we highlight some of the key results from our fourth quarter.

Total volume grew by 1%, reaching 1.56 million units in the quarter. Much of this growth was driven by our strong merchandise franchise, which gained 3% year-over-year. Our total revenue decreased by roughly 1%, 3.68 billion as the effects of higher volumes and favorable pricing were offset by a decrease in other revenue and lower fuel surcharge due to lower diesel prices, as compared to last year. We earned $0.45 per share, compared to 49% — $0.49 per share a year ago. With that. I’ll now turn the call over to Mike Cory to go over the details of our operations.

Mike Cory : Yeah, thank you, Joe. And good afternoon, everyone. Let’s go to Slide 8 and let’s just go to the Q4 recap. As I’ve said many times before, safety is foundational to every success we have. We saw a reduction in engineering and mechanical related accidents and a reduction in transportation injuries during the quarter. And I really want to thank every CSX employee for their continued efforts on creating a safe working environment for themselves and each other and that is extremely important. But we know we still have worked to do well. Though the full year numbers showed overall improvement, we were flat on transportation related accidents, and saw an increase in engineering related accidents. These are all areas of opportunities we aim to improve in 2024 and beyond.

Safety at its core isn’t solely about incidents, it’s about how employees feel working within the organization. We have an environment where employees feel included, respected, valued and listened to, we can continue to identify areas of improvement as a team and change them. In 2023 we listened to our employees and we made positive changes to the work environment in response, converting these conversations in sound successful practices. Our results are beginning to demonstrate that this is already making a difference but we have a ways to go. We’ll continue to keep this dialogue open and learn from each other. When done right, the entire ones CSX team will meet its great potential when it comes to operating safely and efficiently and service to our customers.

Over the next slide, and on this slide is pretty self-explanatory to me. It shows we’ve stabilized our network and we’ve performed pretty well over the quarter. While one of our key focus areas is on maintaining and bettering our customer facing metrics. Our fluidity has started to allow us to look deeper at our operating plan, again to better align the hard assets needed to move the volume. The team’s been focused on maximizing car connections and maximizing the train load, while at the same time reducing locomotive dwell and active horsepower on trains. As a result, we’ve seen both the reduction in active locomotive use and daily train start. Tighten connections standards in our yards are starting to drive changes to our operating plan that result in quicker connections.

Driving a strong focus on using our locomotive technology to reduce fuel usage on line of road has contributed to a savings overall fuel cost. Altogether, we’re finding tangible opportunities to open up more capacity on this network. I expect these metrics to continue to improve as we go forward. Moving over to Slide 10. And I really believe we’ve made good headway in Q4 and especially over 2023. Our key metrics continue to improve in our network fluid. Our headcount is at the point that we’re now able to manage through efficiency and attrition. We’re paying close attention to resource requirements for any new business coming online when needed. Our focus on car connections and train tonnage closely matched horsepower along with network fluidity allowed us to reduce 2.5% of our daily starts in the quarter and start to store active locomotives.

Among other things, this coming quarter, we’ll be performing full territory reviews with our team that will further improve our customer service and continue to identify opportunities to better align asset use. And of course, we’ll be working right along with Kevin and his sales and marketing team to deliver this great service and grow with our customers. During closing, during my four months on the property, I continue to learn more about this network and especially the women and men that make up this tremendous ONE CSX team. I’m extremely excited about our potential to deliver our customers better service with greater safety, efficiency and teamwork. I’m excited to do this together as one group of great railroaders. So thanks for the time.

Over to you, Kevin.

Kevin Boone : Thank you, Mike. It really has been great to see how well our teams have been working together and the positive momentum we are building with our customers, as they recognize CSX’s focused on service. The teamwork is allowing us to build on new opportunities and drive attractive and profitable growth across all of our end markets. Business conditions in 2023 were challenging for many of our customers, with some of our key markets experiencing volatility driven by a number of factors, including inventory destocking. On the positive side, we saw many of these markets show improvement in the fourth quarter, which combined with our industry-leading service provides optimism that the team can deliver strong revenue growth.

Turning to Slide 12, look at our merchandise performance. As you can see, our revenues were up 5% on both a quarterly and annual basis. Even with the effects of reduced fuel surcharge. Volume increased by a solid 3% for the quarter, and 2% for the full year — excuse me, outpacing domestic industrial production that’s been effectively flat. And we’ve delivered pricing results that reflect the higher inflationary backdrop that we’ve all experienced. Looking at the details of the quarter, automotive performed well, even with a temporary disruption caused by the UAW strike, as total volumes held up and we continue to see leverage, and we continue to leverage service to gain new business. Chemicals was challenged over most of the year, but delivered positive growth in the fourth quarter driven by shipments in plastics, sand and waste.

For fertilizers, strong domestic demand and higher CSX shipments of potash exports supported volumes. Short haul phosphate shipments remains constrained by supply issues, which weighs on volumes but provides a tailwind for yields. Metals has continued to be an area where our service provided growth opportunities. And in minerals, infrastructure related demand continue to be very healthy over the quarter, with new cement production supporting volumes. For forest products volumes was modestly lower year over year, but increased sequentially, as cardboard demand has started to show signs of recovery. While the ramp up in ag and food over the fourth quarter was challenged, with southeastern feed buyers remaining well supplied from local crops, combined with slower ramp up in exports.

Now, as we head into 2024 we are encouraged with the momentum we built across the business and we see many opportunities across the end markets we serve. Our Service continues to differentiate CSX in the marketplace, and we are excited about the opportunities this offers us to work with customers to collectively grow our businesses together. Turning to Slide 13. Coal revenue decreased 1% for the fourth quarter as we lapped very strong export pricing from a year ago. Volumes remained positive, growing by 3% for the quarter, and 8% for the year. Our coal business continues to be strong, with service levels accelerating in the fourth quarter, and global export prices supporting U.S. production. At the end of the last quarter, we indicated that export demand remained strong that lower natural gas prices and reduced restocking demand would likely weigh on domestic shipments.

And that’s exactly what happened in the fourth quarter, with export tonnage up a full 27% while domestic tonnage declined by 13%. Coal RPU of just over 3,200 per ton was up 5% sequentially in line with our expectations. For the New Year, we are optimistic, supported by continued strength and export demand, as global benchmarks for both met and thermal we currently remain at half healthy levels. We also see incremental production growth on our network in West Virginia, which will primarily be focused on the export market. Domestic demand in 2023 was supported by months of aggressive restocking at utilities and a very hot summer. With stockpiles at more normal levels demand upside will largely be dependent on weather conditions in 2024. That said, total electricity demand growth remains substantial, especially in the Southeast, driven by new industrial capacity to data centers, achieving EV charging stations.

Turning to Slide 14. Fourth quarter intermodal revenue decreased 4% on flat volumes. For the full year, revenue decreased 11% on volumes that were down 7%. Lower fuel surcharge drove the largest impact to yields. Our domestic intermodal business continued to perform well, with volume increasing sequentially and growing in the mid-single digits on a year-over-year basis. We saw growth with our key partners that continue to experience industry-leading service performance, which was recently highlighted in JOCs customer satisfaction results. Our ability to deliver domestic growth was an extraordinary team effort, especially given the significant challenges facing the trucking market. In International, volumes were lower compared to last year, but we were encouraged to see improvement each month with December actually showing modest year-over-year growth as the positive effects of more normalized retailer inventories gain traction.

Our team has continued to work hard to maximize our opportunities, which showed up in the growth as we work to build new partnerships, create new service offerings and leverage higher activity at the inland ports that we serve. Positive market trends are taking shape as we head into 2024, and we expect the combination of a more supportive market, new conversion opportunities and service offerings to drive year-over-year growth in both the domestic and the international business. We continue to monitor the evolving situations at both the Panama Canal and the Red Sea. To date, we have not been significantly affected by any changes in our customer behavior but we stand at the ready with the capacity and capabilities to adapt as needed. Finally, as we turn the page to 2024, I’m excited about the opportunities ahead.

The team is accelerating our efforts in many areas of our business to work hand-in-hand with our customers to identify areas for growth. From industrial development to identifying market-specific operating metrics that enhance the customer experience. Team has been working closely with our rail partners to unlock growth. These are just a few of the focus areas for the team. Now I’ll hand it over to Sean to review the financial review.

Sean Pelkey : Thanks, Kevin, and good afternoon. Fourth quarter revenue fell by 1%, while operating income was down 10% or $139 million. Now these results include $180 million of discrete year-over-year impacts from declines in other revenue, real estate gains and export coal benchmark prices. However, the underlying results also reflect the benefit of our sustained service levels throughout 2023 and growing momentum in the business. Across merchandise, coal and intermodal, revenue excluding fuel increased by 5%, benefiting from strong core pricing across the merchandise portfolio and 3% volume growth in both merchandise and coal. Counter to normal seasonal trends, the team delivered sequential volume gains, helping operating income increased by $25 million relative to the third quarter.

Interest and other expense was $16 million higher compared to the prior year. Income tax expense decreased $23 million, the effective tax rate of 22.9% included $19 million of favorable adjustments primarily for state tax matters relative to $33 million of favorable adjustments in the prior year. Our expected tax rate going forward remains 24.5%. Earnings per share fell by $0.04, including $0.07 of impact from the previously mentioned discrete items. For the full year, operating income fell by 8% or $462 million, while earnings per share was 5% lower. These results were impacted by the prior year Virginia real estate transaction declining intermodal storage revenue and lower export coal benchmarks totaling nearly $700 million on a combined basis.

The hard work of our ONE CSX team provided our customers reliable and consistent service throughout 2023, and laid a strong foundation for long-term profitable growth. With profitable growth in mind, we will also be making a change in how we report results going forward. Starting in the first quarter of 2024 and we will transition to a more conventional approach of reporting operating margins rather than operating ratio. Our goal is to target margin improvement, aligning the business around a balanced approach that includes profitable volume gains and pricing to the value of our service, all while controlling costs and optimizing asset utilization. Let’s now turn to the next slide and take a closer look at fourth quarter expenses. Total fourth quarter expense increased by $89 million as the impacts of lower real estate gains, inflation, increased depreciation and higher head count were partly offset by lower fuel prices and efficiency savings in PS&O and rents.

Turning to the individual line items. Labor and Fringe was up $82 million, impacted by inflation and additional headcount. The quarter also included costs that related to the timing of union employee vacation and sick benefits. We expect this to adjust down resulting in a lower sequential cost per employee in the first quarter. Purchased services and other expense increased $4 million versus last year, as inflation was mostly offset by savings from our intermodal and engineering teams. We expect a modest sequential increase in the first quarter, similar to what we have seen in recent years. As a reminder, we’ll cycle a prior year insurance recovery of nearly $50 million in the first quarter. And while we expect increased technology carry costs and a need for more locomotive overhauls to impact expense in 2024, we are actively implementing cost savings and efficiency initiatives that will help offset these headwinds.

Depreciation was up $24 million, including an $11 million adjustment related to prior periods. We are projecting roughly $40 million to $50 million higher full year depreciation expense in 2024. Fuel cost was down $59 million driven by a lower gallon price. While fuel efficiency was stable year-over-year, we saw strong sequential improvement. These results are especially encouraging as we typically face seasonal efficiency headwinds in the fourth quarter. Mike and the team expect to continue the momentum in this critical measure into 2024 and drive meaningful year-over-year savings. Equipment and rents was $9 million favorable, driven by faster car cycle times across all markets. Finally, property gains were $47 million unfavorable in the quarter.

At this time, we do not expect any individually significant transactions during 2024. Now turning to cash flow and distributions on Slide 18. Full year free cash flow remains strong at $3.3 billion. Our first priority use of cash remains investing for the safety, reliability and growth of our business. As such, this figure includes $2.3 billion of capital spend across a wide range of projects to ensure the integrity of our network infrastructure as well as the high return strategic investment opportunities. Looking to 2024, note that free cash flow will be impacted by about $380 million of Federal Cash Tax Payments that were deferred from 2023. Cash flow generation also supported close to $4.4 billion in shareholder returns for the year, including $3.5 billion in share repurchases and nearly $900 million of dividends.

While economic profit finished lower for the year, largely due to lower intermodal storage revenue and export coal pricing, our goal is to increase economic profit over time which has been shown to strongly correlate with outsized shareholder returns. With that, let me turn it back to Joe for his closing remarks.

Joe Hinrichs : All right. Thank you, Sean. Now we will conclude with our initial thoughts on our expectations for the full year 2024. As of today, and based on our visibility with our customers and our expectations for the CSX specific initiatives that we are putting in place, we anticipate growth in total volume and total revenue in the low to mid-single digit range. We see encouraging momentum across our merchandise business, but we are benefiting from service-led gains in market share and wallet share and new industrial development activity. We expect growth in our intermodal business as a prolonged destocking cycle finally winds down and our strategic initiatives continue to drive volume, and Export coal demand continues to be very strong with CSX gaining from the ramp-up of a new mine on our network.

By growing volumes and utilizing our existing capacity, we expect our profitability to benefit from a favorable combination of solid pricing better operational efficiency and a moderate easing in cost inflation. Kevin’s team continues to do a great job making sure that we are getting paid for the service we provide. And as Mike discussed, we see all kinds of new opportunities run this network better, safer, faster and more efficiently. We expect an increase in our capital spending to approximately $2.5 billion this year as we invest in safety infrastructure, locomotive rebuilds, upgrades to our portion of the New Alabama Interchange with CBKC and other specific high-return investments, including technology investments. Finally, as before, there is no change to our balanced opportunistic approach to capital returns, using our excess cash to fund share repurchases and dividends to benefit our shareholders.

In closing, I am very proud of what our entire team accomplished this past year. To our ONE CSX team, I want to thank all of you across all of our facilities in every state and province that we’re operating in, through your hard work and for demonstrating that our ONE CSX culture can be something real and impactful. We’re in a great position we had in 2024 and with your help, we can make it even better year than the strong one we just had. For everyone on this call, thank you for all your interest in and support of CSX. Matthew, we’re now ready to take questions.

Matt Korn : Thank you, Joe. We will now move to our question-and-answer session. In the interest of time and to make sure that everyone on this call has an opportunity to take part, we ask you to please limit yourselves to one and only one question. Krista, we’re ready to start the process.

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Q&A Session

Operator: Thank you. [Operator Instructions] Your first question comes from the line of John Chappell from Evercore ISI. Please go ahead. Your line is open.

John Chappell: Thank you and good afternoon. Sean, I wanted to dig a little deeper on this part of the guide and maybe some of the delayed productivity improvements that you spoke about. If the volume commentary is low to mid-single digit, you have some of the productivity levers that you were hoping to pull even though you have some of these, I guess, other fixed cost increases in the form of D&A, et cetera. How do you think about margin expansion in 2024 based on your base case of volume and revenue?

Sean Pelkey : Thanks, Jonathan. That’s a bit of a loaded question, a lot in there. Well, I’ll do my best. I think when I step back our target is to always expand margins, and we can do that by growing the business profitably, operating safely and running an efficient railroad. When I think about 2024 and sort of how that year progresses, we built some momentum coming from Q3 into Q4. We grew volumes. We grew operating income. That’s not always the case. Our hope is to continue that momentum going into the first quarter, whether or not withstanding here. And then build that momentum into the second quarter as well. We’ve got some headwinds year-over-year that we can talk about in the first quarter. They began to ease in the second quarter. And then by the time we get to the second half of the year, the comps are a little bit easier, and that’s where I think you’ll really see some very strong incremental margins.

John Chappell: Thanks, Sean.

Operator: Your next question comes from the line of Bascome Majors from Susquehanna. Please go ahead. Your line is open.

Bascome Majors : Joe, you opened the call talking about a lot of the progress you had made in your first year leading the business. Can you talk about how your focus or at least investors will see your focus involved over the next 12 to 18 months following the success you’ve had improving a lot of stakeholder relationships in your first 16?

Joe Hinrichs : Yeah. Thanks, Bas. And I think you heard a little bit of that in, on the commentary from the team here. We now see our business has stabilized. We’ve reached a threshold on customer service that has been recognized in the industry, and now you’re seeing the opportunity for us to take advantage of that stability to get more efficient. We’re now at the manpower levels that we were targeting. There’s always going to be some needs here or there. But generally speaking, we’re the manpower levels we were targeting. So we head into 2024 with an opportunity to be in a much more stable setting the momentum we’re building on culture and how people are working together. Mike coming in and his perspective and working closely with Kevin and his team, I feel really good about the opportunity going forward now is for us to leverage the strength we have in our operating model and the people we have to get more efficient.

Obviously, we want to see more safety improvement this year as we saw in the fourth quarter of last year and building momentum there, and then take advantage of the opportunity to grow with our customers. We now have over a year of providing stable, persistent, reliable service that our customers are recognizing us for. And we have the opportunity now to talk to each one of them about, okay, what can we do together to grow and how can we work together? The journey on efficiency, safety, culture never ends, and we’re going to keep working together. But I will tell you, we come into 2024, our network was in good shape, very good shape. Our manpower levels are in good shape. The team is working better together than I’ve seen it in the time I’ve been here.

And so that gives us confidence that we can build on the momentum we’ve established over the last year.

Operator: Your next question comes from the line of Brian Oseenbeck from JPMorgan. Please go ahead. Your line is open.

Brian Ossenbeck : Hey, good afternoon. Thanks for taking the question. Maybe just a quick follow-up for Sean first. Can you just give us the commentary about the comp per employee stepping down into the first quarter after the increase in 4Q? And then maybe for Mike, can you just give us a sense in terms of what you’re seeing? I know it’s still little bit early, but a little bit further down the path over the last call, it sounds like fuel efficiency is an area for some big improvement that you’re targeting. Maybe some more network in taking out some of the locomotives as the fluidity continues to improve. So what are you seeing there and maybe some rough order of magnitude would be helpful? Thank you.