Union Pacific Corporation (NYSE:UNP) Q1 2023 Earnings Call Transcript April 20, 2023
Operator Greetings, and welcome to the Union Pacific First Quarter 2023 Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, and the slides for today’s presentation are available on Union Pacific’s website. It is now my pleasure to introduce your host, Mr. Lance Fritz, Chairman, President and CEO for Union Pacific. Thank you, Mr. Fritz. You may begin.Lance Fritz Thank you, Rob, and good morning, everyone, and welcome to Union Pacific’s first quarter earnings conference call. With me today in Omaha are Kenny Rocker, Executive Vice President of Marketing and Sales; Eric Gehringer, Executive Vice President of Operations; and Jennifer Hamann, our Chief Financial Officer. The story of the past quarter for Union Pacific is one of resiliency, battling heavy snow, Arctic temperatures, flooding and tornadoes, the team maintained service levels and exited the quarter on a positive trajectory.
Persevering through those harsh conditions, our employees delivered for our customers, which demonstrates again that our people are the foundation for the great things that lie ahead.Turning to the first quarter results. This morning, Union Pacific is reporting 2023 first quarter net income of $1.6 billion or $2.67 per share. This compares to first quarter 2022 results of $1.6 billion or $2.57 per share. Our first quarter operating ratio of 62.1% deteriorated 270 basis points versus 2022 driven by excess costs, inflation and lower volumes.A series of weather events throughout the quarter had a real impact on our ability to capture demand, especially within our coal business as well as added cost to the network. Through those events, our service products showed greater and greater resiliency, quickly rebounding each time as we were better positioned with crew resources to support our customers.
And with April month-to-date, freight car velocity is about 200 miles per day. We are operating a network that is positioned for consistent and reliable service. While a more difficult start to the year than expected, it doesn’t reduce our expectations for 2023. As you’ll hear from the team, all of our goals are still in front of us.Let me turn it over to Kenny for an update on the business environment.Kenny Rocker Thank you, Lance, and good morning. Freight revenue for the first quarter increased 4% driven by higher fuel surcharges and solid pricing gains, partially offset by a 1% decline in volume. Bulk volumes were muted in the quarter as weather and service-related challenges impacted shipments. Additionally, weaker market conditions for premium also drove lower volume for the first quarter.
However, our strong focus on business development and new business wins partially offset by some of that decline.Let’s take a closer look at each of these business groups. Starting with bulk. Revenue for the quarter was up 4% compared to last year, driven by a 7% increase in average revenue per car reflecting higher fuel surcharges and solid core pricing gains. Volume was down 3% year-over-year. Grain and grain products volume was down 1%, driven by weaker export grain shipments as world demand for U.S. grain has softened, coupled with drought impacts affecting supply in UP’s served region.Fertilizer carloads were flat in the quarter. Strong export potash was offset by a decline in phosphate volume from weather conditions delaying shipments.
Food and refrigerated volume was down 6% due to reduced beer imports and weather conditions negatively impacting both fresh and can shipments. And lastly, coal and renewable volumes was down 4% compared to last year driven by weather interruptions and associated service challenges that impacted our locomotive and crew resources.Moving on to industrial. Industrial revenue was up 5% for the quarter driven by a 5% improvement in average revenue per car due to higher fuel surcharges and core pricing gains. Volume for the quarter was flat. Industrial chemicals and plastics volume was down 2% year-over-year driven by lower industrial chemical shipments due to challenged industrial production and reduced housing demand.Metals and minerals volumes continued to deliver year-over-year growth.
Volume was up 3% compared to last year primarily driven by growth in construction materials and increased frac sand shipments, along with new business development wins.Forest products volume declined 19% year-over-year driven by soft housing starts and lower corrugated box demand for nondurable goods shipments. However, energy and specialized shipments were up 6% versus last year driven by strength in demand for LPG and petroleum products. These gains were partially offset by fewer soda ash shipments due to weather and service-related challenges.Turning to Premium. Revenue for the quarter was up 3% on a 1% decrease in volume compared to last year. Average revenue per car increased by 5%, reflecting higher fuel surcharge revenue and core pricing gains.
Automotive volumes were positively driven by strengthening OEM production and dealer inventory replenishment for finished vehicles.Domestic intermodal business wins were offset by a weak freight and parcel market, driven by high inventory, increased truck capacity and inflationary pressures. On the international side, despite weakened imports, more container shipped inland versus the first quarter of last year, resulted in year-over-year growth.So now moving on to Slide 7. Here is our outlook for the rest of 2023 as we see it today. Starting with our bulk commodities, we expect grain to be challenged near term as export demand softens and supply tightens throughout this crop year. However, as we look ahead towards the next crop season in late fall, we’re encouraged by the initial forecast.For coal, low natural gas prices and a milder winter allow utilities to build more inventory.
We are experiencing normal softness through the shoulder months. Looking further out in the year, demand will largely be dependent on natural gas prices and summer weather.Lastly, we expect biofuel shipments of renewable diesel and their associated feedstocks to grow due to solid market demand, new production coming online and business development wins.Moving on to industrial. The forecast for industrial production is to shrink in 2023, and the demand is getting weaker in forest products. However, we expect to see continued strength in construction and metal with new business wins.And finally, for Premium, we expect near-term challenges in the intermodal market from high inventory levels, inflationary pressures and weak consumer spending as people shift back to spend more towards services than goods.
We will be closely watching for a potential market uptick in the latter part of the year. In addition, we expect automotive growth to continue, driven by strong OEM production and dealer inventory replenishment.So to wrap up, we are facing economic uncertainty and a tough price environment in a few of our markets, but we expect to see strength in some other commodity areas. Our diverse portfolio allows us to maintain our pricing guidance. To capture more demand, we are working closely with Eric and his team to be agile and have resources available in locations where we need them. I am confident that the team’s relentless focus on business development will drive volumes to exceed industrial production this year.With that, I’ll turn it over to Eric to review our operational performance.Eric Gehringer Thank you, Kenny, and good morning.
Starting on Slide 9. We continue to make great strides on safety, as evidenced by our 10% improvement in derailment performance for the first quarter. While encouraging progress on safety, our goal remains a future with zero incidents and zero injuries. We’ve made progress on derailments by implementing state-of-the-art technology, like Precision Train Builder and our geometry inspection fleet. This is on top of our network of more than 7,000 wayside detection devices and our 24/7 operating practices command center.Further supporting our efforts, in March, the industry announced a set of key safety actions. These include the installation of additional wayside detectors and enhanced standards for how we proactively use and share critical data.
In addition, the industry is expanding efforts in first responder training and deploying technology to provide real-time railcar condition monitoring. The railroad industry remains one of the safest transportation modes in the nation. And through our capital renewal program, Union Pacific invests almost $2 billion annually back into its network to further improve safety.Now moving to Slide 10 for a look at our current operational performance. As Lance mentioned, Mother Nature made her presence felt across the Union Pacific network this season, bringing extreme weather in many forms. UP crews in California battled flash flooding, persistent mudslides and heavy snow. The Central Sierras, for example, recorded over 700 inches of snow this season.
That’s 222% above historical averages. Employees across our central corridor in upper Midwest portions of our system also worked through prolonged blizzards, ice and Arctic temperatures. These events challenged our ability to maintain a fluid operating state on specific portions of the system. However, thanks to the dedication and proactive efforts of our employees, the network quickly recovered after each event.And as the chart on Slide 10 demonstrates, we’re exiting the quarter on a positive trajectory versus the congested state we were entering this time last year. Our April month-to-date metrics show a network in a healthier state with freight car velocity at 200 miles per day, intermodal TPC in the high 70s and manifest TPC on the rise as well.
That result also reflects our hiring efforts as we focus on backfilling attrition and targeting locations where crew challenges persist. We currently have around 1,000 employees in training, which is an increase of approximately 500 versus last year.In addition, we have utilized borrowed out employees to address hard-to-hire locations and get crews where needed.Now let’s review our key performance metrics for the quarter, starting on Slide 11. Sequentially, we held our ground through the obstacles of the quarter. Both freight car velocity and manifest and auto trip plan compliance made slight improvements from last quarter’s results. Intermodal trip plan compliance remained effectively flat as we battled resource imbalances driven by weather interruptions.With our current traffic mix, freight car velocity consistently running around 200 to 205 miles per day will strengthen our entire service product, including bulk, manifest and intermodal performance.Turning to Slide 12 to review our network efficiency metrics.
Locomotive productivity dropped 5% versus first quarter 2022. However, it remained flat sequentially from last quarter’s results as we continue to operate a larger locomotive fleet in an effort to support the recovery of the network. In the second quarter, the team is focused on moving more freight and rightsizing the fleet. To that point, we are in the process of storing over 100 units to at the ready status. First quarter workforce productivity declined 6% to 991 daily miles per FTE driven by an increased number of trainees and lower volumes. Our strong training pipeline supports our ability to capture available demand and future growth while managing and reducing borrowed out employees. As employees graduate from training, we expect productivity to improve.
Train length is effectively flat compared to last quarter’s results. Lower intermodal traffic, coupled with extreme cold temperatures across the Northern tier of our network presented a headwind to our train length initiatives for the quarter. The team remains committed to strengthening the network while we’re covering loss productivity.Wrapping up on Slide 13. The success drivers for 2023 remain unchanged. And the entire team is dedicated to building on the momentum gained as we exited the quarter. We remain committed to addressing employees’ quality of life feedback and are pleased with the recent agreements regarding paid sick leave. We will continue to work diligently in finding win-win solutions that enable a strong service product and provide our employees with more consistent work schedules.In addition, as you heard from Kenny, we continue to aggressively look for opportunities to strengthen volumes.
With the service product demonstrating resiliency, we have added back train sets and targeted freight cars to the network to capture available demand. I am confident that the foundation we’re laying will provide a safer, more consistent and reliable service product to meet the growth needs of our customers.With that, I will turn it over to Jennifer to review our financial performance.Jennifer Hamann Thanks, Eric, and good morning. We’ll start on Slide 15 with a look at our first quarter income statement. Operating revenue totaled $6.1 billion, up 3% versus 2022 despite a 1% year-over-year volume decline. Other revenue decreased 5%, driven by $30 million of increased subsidiary revenue, which was more than offset by a $50 million reduction in accessorials.
Lower intermodal volume and greater supply chain fluidity drove the accessorial decline. Operating expense increased 8% to $3.8 billion, resulting in first quarter operating income of $2.3 billion, down 3% versus last year. Below the line, other income increased $137 million year-over-year, largely driven by a $107 million onetime real estate transaction that contributed $0.14 to earnings per share. Interest expense increased 9%, reflecting higher debt levels.Net income of $1.6 billion was flat versus 2022. But when combined with share repurchases, resulted in a 4% increase in earnings per share to $2.67. Our first quarter operating ratio increased 2.7 points to 62.1%, following fuel prices during the quarter and the lag on our fuel surcharge programs positively impacted our operating ratio by 190 basis points.
Core results offset the fuel benefit and were a 460 basis point drag to operating ratio. Included in that is the impact of weather, which is difficult to quantify. But between both lost revenue and additional expense, we estimate to be in excess of $50 million.Now looking more closely at first quarter revenue. Slide 16 provides a breakdown of our freight revenue, which totaled $5.7 billion, up 4% versus last year. Lower year-over-year volume reduced revenue 150 basis points. Total fuel surcharge revenue of $883 million added 475 basis points to freight revenue, reflecting the lag in our programs. The combination of price and mix increased freight revenue 75 basis points as ongoing pricing actions were mostly offset by our business mix. Fewer lumber shipments and more short-haul rock shipments were the primary drivers of the negative mix.Turning now to Slide 17 and a summary of our first quarter operating expenses, which totaled $3.8 billion.
Compensation and benefits expense increased 7% versus 2022. First quarter workforce levels increased 4% with transportation employees up 5%, the result of our dedicated hiring efforts over the last 12 to 15 months. Cost per employee only increased 3% in the quarter as wage inflation was partially offset by a larger training pipeline.During the first quarter, we signed agreements with the majority of our labor unions to provide paid sick leave to our employees. These agreements became effective April 1 and represent just under half of our craft professionals. Assuming we are able to reach agreements across the board, we would expect cost per employee to be up mid-single digits for the year, consistent with what we discussed in January.Fuel expense grew 7% on a 9% increase in fuel prices as we moved less freight.
Our fuel consumption rate deteriorated 1% as the impact of our fuel conservation efforts was more than offset by reduced network fluidity. Purchased services and materials expense increased 16% driven by maintenance of a 3% larger active locomotive fleet and inflation. Equipment and other rents was up 9% as a result of increased car hire expense related to elevated cycle times, and the other expense line grew 6% related primarily to higher environmental remediation costs.Turning to Slide 18 and our cash flows. Cash from operations in the first quarter decreased to $1.8 billion from $2.2 billion in 2022. The primary driver was Presidential Emergency Board back pay settlements paid in January which totaled $383 million. That payment also impacted our quarterly cash flow conversion rate and free cash flow, with both roughly in line with last year’s performance when you exclude that payment.In the quarter, we returned $1.4 billion to shareholders through dividends and share repurchases.
And we finished the first quarter with an adjusted debt-to-EBITDA ratio of 2.9x as we continue to be A-rated by our three credit agencies.Wrapping up on Slide 19, we are maintaining our 2023 full year guidance to achieve volumes above industrial production, price gains in excess of inflation and operating ratio improvement. Our plans for capital allocation also are unchanged.As with every year, there are puts and takes to how the year plays out. While 2023 started a bit slower than expected, I need to remind everyone, it is only April 20. We have 8.5 months in front of us and many opportunities with volume, service and productivity.Before I turn it back to Lance, I’d like to express my thanks to the UP team. We are skilled in running the outdoor factory that is our railroad.
But Mother Nature seemed very focused on testing those skills this year given the extremes we faced, and yet the team forged ahead, keeping the network fluid and our customers served. Fantastic work by everyone.With that, I’ll turn it back to Lance.Lance Fritz And thank you, Jennifer. As Eric discussed, we continue to make great strides on safety. Derailments have been in the spotlight recently. The entire industry understands the critical role we play in support of the communities we serve. In fact, since 2000, Union Pacific’s mainline derailments are down almost 30%, helping make this past decade the safest for the rail industry. Working collaboratively and proactively, the industry can further improve on that safety record.Looking forward, as you heard from Kenny, consumer-facing markets are in rough shape right now.
Importantly, though, there remain opportunities to capture additional demand in a number of markets. The entire team is executing a plan to capture those additional carloads supported by an improved service product.Finally, with Earth Day approaching, I’d like to highlight the actions Union Pacific is taking to protect our planet. At the end of 2022, we released our second annual Climate Action Plan, highlighting updates to achieve our greenhouse gas emission reduction targets. This includes our goal of net zero emissions by 2050. Over the past year, we’ve turbocharged our locomotive modernization program. We’ve committed to both battery and hybrid electric locomotive, and we’ve increased our biodiesel blend to over 5%. And we’re being recognized for that work.This past year, Union Pacific was selected as a member of the Dow Jones Sustainability Index for the first time.
And we were the highest ranked railroad in the transportation category on Fortune’s most admired companies. Union Pacific is committed to being a sustainability leader, driving long-term value for all of our stakeholders.Before turning to Q&A, as it relates to the CEO search process, the Board is fully engaged in executing its duty to identify the next leader. And I can say from personal experience what a wonderful job it is to be at the helm of a company like Union Pacific. I’ll continue to lead the team until the new CEO is identified, and I’m energized by what we can accomplish in the coming months, as well as the great potential this company has for years into the future.With that, let’s open up the line for your questions.
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Question-and-Answer Session Operator [Operator Instructions]
And our first question today comes from the line of Scott Group with Wolfe Research.Scott Group Lance, any timing on CEO search?
And any thoughts on what you and the Board are looking for? And then Jennifer, margins down 270 basis points. Obviously, we need some nice improvement the rest of the year to get to full year improvement. Can you help us bridge us to that full year improvement? And any thoughts on second quarter? It’s an easier comp. Do you think margins inflect positive in Q2? Just any thoughts?Lance Fritz Yes. Thank you, Scott. So I’ll just circle back to the press release that the Board sent when they announced earlier in the year that we were in the process of identifying a new CEO. They were clear on what they were looking for then, right, a track record and experience in safety, customer service, business development, clear vision on culture and a good operating experience.
So they are crystal clear on what they’re searching for. And the only update I have for you is we’re using an excellent party, external consultant, and they’re being very thorough in their search, which is underway.Jennifer Hamann So then, Scott, to your question, I mean, you’re exactly right. We need to make sequential improvement through the year, and then that needs to become year-over-year improvement at some point for us to be able to meet that guidance. The factors that are going to help drive that, certainly, fuel is something that is looking different to us this year than it did last year. Particularly right now, you saw the 1.9 points that it benefited our OR in the first quarter. That will — comparison will get a little tougher in the back half.
So it may look different than ’22 did. But certainly, fuel, I think, is something.But then it’s the main levers that you know that we have available to us. It’s volume, price and productivity. And of course, volume, it depends a little bit what that is, but we also have pure cost control. So if volumes are something that are not our friend, and we’re not able to get that leverage, we also have the ability to control costs through being very careful and diligent in our management.Lance Fritz And Jennifer, one last thing. What gives us a ton of confidence as we look into the year is how the network is operating right now. It’s in a place where we can get the volume and we can squeeze out the excess cost.Jennifer Hamann Absolutely.Operator Our next question comes from the line of Tom Wadewitz with UBS.Tom Wadewitz I wanted to ask you about the head count level.
I think you know the training pipeline for T&E looks like it’s larger but I think that the level of people that you’ve had that are trained on the system seems like it’s been static for a while. And so I’m just wondering what do you think about in terms of where you need to get for TE&Y that are trained in on the system? And I guess, in terms of attrition, has attrition been an ongoing problem has that stabilized? Just thinking about that headcount dynamic and then I guess, how that fits into how you would expect network performance to go from where we are.Lance Fritz Yes. So Tom, we entered the year saying total headcount hires addition to the TE&Y would look kind of like what it did in 2022 predicated on our plan for volume. Volume is looking a little cloudy right now to us, certainly in the first quarter in the back half.
And so of course, that hiring plan is being looked at and adjusted.Net-net, in the second quarter, you’re going to see us add to the active TE&Y headcount coming out of the training pipeline. The question really is what the training pipeline look like for the rest of the year? Having over 1,000 in the pipeline is a very strong pipeline for us.In terms of attrition, we tend to have about a 10% turnover in our TE&Y workforce. That really hasn’t changed over the course of the last five years. We don’t necessarily see it changing right now. So one of the adjustment factors is if we find ourselves getting out over our skis a little too far, attrition can help us suggest quickly.Tom Wadewitz So it sounds like the, I guess, trained level goes up, but overall headcount kind of static as the training pipeline comes down is maybe the best way to look at it.Jennifer Hamann I think it really does depend on the volumes to a degree, Scott.
And so certainly, as Lance said, the second quarter, I think you certainly see our total head count is going up. It’s going to be probably different than last year. First half, we’ve got the training pipeline loaded in the first half. And I think the question is going to be what does the second half look like.Operator Our next question is from the line of Ken Hoexter with Bank of America. Ken Hoexter So just — it looked like the operating service levels were flat — you mentioned that a couple of times, I guess, Eric did, but velocity was — really came down the past few weeks, I guess, during the quarter, and then more recently showed a pretty solid rebound, I guess, maybe the last week or two. Is there anything changing with the operating plan?
Was this — I don’t know if Eric or Lance, you want to throw in some thoughts? Or was this just kind of the end of some of the weather stretches that you were talking about? Maybe just talk about how operations are doing now and what’s changing.Eric Gehringer Yes, Ken. Thanks for the question. Your summary is exactly accurate. And it was towards the tail end of winter is really where we were about 3 weeks ago, having come out of that. And with all the work that we’ve done on the hiring side is amongst other actions, you’re seeing the output of having 2 to 3 weeks without weather being that headwind. With [weather] largely, if not entirely, behind us winter, you should expect us, as our customers expect to maintain where we are. We’ve reinforced that 200 to 205 miles per day.
It’s what drives our TPC metrics to the level our customers expect.Operator Next question is from the line of Chris Wetherbee with Citigroup.Chris Wetherbee Maybe one quick follow-up on the head count point. I guess I’m just curious, given what you guys have been able to do with some degree of service recovery, would you think about pausing sort of the hiring as you sort of reassess volumes depending on sort of how that plays out in the second half of the year? Curious about that.And then maybe on that point for Kenny. Just in terms of like what you’re seeing in the month of April, it seems like we’ve seen March and April be a little bit softer across the board of transport, not necessarily Union Pacific specifically, a little bit softness there.
Curious what you’re hearing from the customers. Has there been a bit of a spring lull here or maybe that picks up in the near term? Just kind of some thoughts there would be helpful.Lance Fritz Chris, this is Lance. I’ll start and then turn it over to Kenny on your second question. So let’s unpack the headcount question a little bit. We are in much better shape this time, this year versus same time last year. The hiring pipeline is full, but more importantly, we’ve been filling our classes everywhere we’ve been looking for people across the railroad for about the last 3 or 4 months. That is very different than our experience last year where we found it very difficult in about crew hubs all in the Northern region to be able to find, candidly, the workforce to be able to hire.
So we’ve been much more aggressive in the back half of last year, ramping up things like hiring bonuses, finding creative, unique ways to create a workforce, a pool to hire from. And that’s paying dividends right now. So you’re exactly right in terms of as we look into the year, right now, we’re starting to evaluate our original plan for hiring versus what volumes are doing and what the back half of the year balance is going to look like. Our longer-term guidance remains in place, and that is we fully expect to be volume variable and have ultimately our head count grow at less than our volume numbers are growing.But clearly, coming out of last year, we had to fix the ship and get our crew boards healthy, add a little excess — not excess, add a little factor of safety to the crew board so that we could take events and recover quickly so that our service product was consistent.
And we’re in that place right now. We’re essentially there. We’re solving some of the problem with borrow-outs. So hiring is going to have to replace them because they’re expensive, and it’s a burden on our employees to be borrowed. Out, but we are in much better shape looking into the rest of the year. Kenny?Kenny Rocker Yes. Chris, so let’s just start off. You look at our coal, we’re expecting it to have a seasonal lull this time, the shoulder months that I mentioned. If you look at it last year, natural gas prices were much higher. So this is more of a normal look for domestic intermodal. We’ll keep an eye on it. It’s a very loose market right now. There’s quite a bit of truck capacity that’s out there. So we’ll be watching that.And then also, last year, if you look at it, our grain business was still pretty strong at the time of year.
