Union Pacific Corporation (NYSE:UNP) Q3 2023 Earnings Call Transcript

Union Pacific Corporation (NYSE:UNP) Q3 2023 Earnings Call Transcript October 19, 2023

Union Pacific Corporation beats earnings expectations. Reported EPS is $2.51, expectations were $2.45.

Operator: Greetings. Welcome to Union Pacific’s Third Quarter Earnings Call. At this time all participants will be in listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded, and the slides for today’s presentation will be available on Union Pacific’s website. It is now my pleasure to introduce your host, Mr. Jim Vena, Chief Executive Officer for Union Pacific. Thank you, Mr. Vena, you may now begin.

Jim Vena: Rob, thank you very much, and good morning, and good morning to everyone that’s joined us, and thank you for joining us today to discuss Union Pacific’s Third Quarter Results. I’m joined in Omaha by our Chief Financial Officer, Jennifer Hamann; our Executive Vice President of Marketing and Sales; Kenny Rocker and our Executive Vice President of Operations; Eric Gehringer. It’s been a busy couple of months since we joined in Union Pacific. I’m very excited to be back to come back to work with over 40 years of railroading experience, including two years here at UP. I know this railroad, I understand the opportunity. To win, you need a strong management team, the right culture, and a great franchise, and that’s the goal, win and be the best in the industry.

A large fleet of freight trucks travelling down an interstate highway. Editorial photo for a financial news article. 8k. –ar 16:9

Since I started, I’ve spoken with employees, customers, regulators, community officials and investors. And my message has been consistent. It starts with safety. Our goal is to be the safest railroad in North America. That’s the standard we should set for ourselves. We also expect to be the best in service and operational excellence. Service is delivering what we sold to our customers. Operational excellence is using our resources and assets as efficiently as possible. It’s being mindful of our cost and developing our people. A key early initiative of mine is to drive decision-making lower in the organization. This means reducing layers and simplifying how we work. We need to deliver value with speed. This is a cultural change to empower our people.

We recognize that our business volumes fluctuate and weather presents its challenges. So we will always keep a buffer of resources to manage those situations. This commitment to safety, service and operational excellence will lead to growth. And for you, our owners, that generates industry-leading returns. There’s work to be done, but the entire team understands our strategy for success. Now let’s discuss third quarter results, starting on slide three. This morning, Union Pacific reported 2023 third quarter net income of $1.5 billion or $2.51 per share. This compares to 2022 third quarter net income of $1.9 billion or $3.05 per share. Our third quarter operating revenue declined 10%, reflecting lower fuel surcharge revenue, reduced volumes and decreased other revenue.

Expenses also were lower year-over-year driven by fuel expense and last year’s onetime charge for labor agreement. But there’s an ongoing mismatch in our cost structure, resulting in an operating ratio of 63.4% as we continue to be challenged by inflation, including pressure from new labor agreements and higher casualty costs. Additionally, the lag on our fuel surcharge program negatively impacted results as fuel prices rose during the quarter. No doubt about it. It was a tough quarter, but I’m pleased with the positive productivity we’re quickly gaining. Our service performance also is strengthening as we’re positioning ourselves to meet customer demand while at the same time, storing assets. I’ll let Eric and Kenny discuss both in more detail.

Ultimately, we’re taking the right actions to build from here. So with that, let me hand it to Jennifer to provide more details on the third quarter financials.

Jennifer Hamann: Thanks, Jim, and good morning. I’m going to discuss our third quarter results by walking through the income statement on slide five. Starting with operating revenue of $5.9 billion, down 10% versus last year on a 3% year-over-year volume decline. Breaking it down further, as illustrated in the appendix slides, freight revenue totaled $5.5 billion, down 9% versus 2022. Total fuel surcharge revenue of $637 million declined $515 million from last year. The impact of lower year-over-year fuel prices as well as the lag in our surcharge programs reduced freight revenue 8%. The combination of price and mix increased freight revenue, 150 basis points as solid core pricing gains were partially offset by an unfavorable business mix.

Increased short-haul rock moves and fewer lumber carloads outweighed the impact of moving fewer low average revenue per car intermodal shipments. In addition, our pricing gains continue to include the impact of certain coal and intermodal contracts that are more reflective of current market conditions. Wrapping up the top line, other revenue decreased 13% versus last year, driven by a $70 million year-over-year reduction in accessorials. Switching to expenses, where again, more detailed information can be found in the appendix. Operating expense of $3.8 billion declined 4%, driven by lower fuel prices, last year’s onetime charge for labor agreements and volume-related costs. Digging deeper into a few of the expense lines, compensation and benefits expense decreased $77 million versus 2022, which does include last year’s $114 million onetime labor charge.

Third quarter workforce levels increased 3% and our active TE&Y workforce is up 2% as we graduated new train crew personnel during the quarter. At this point, with our train crews more appropriately staffed, our training pipeline is shrinking. Today, we have just over 500 employees in training, down more than 50% from last quarter’s pipeline of roughly 1,200. Excluding the impact of last year’s labor charge, cost per employee was essentially flat in the third quarter as we are starting to generate better overall productivity. As a result, we now expect full year cost per employee to be up closer to 3%. Both third quarter and full year cost per employee reflect elevated workforce levels and better crew efficiency, partially offset by wage inflation, which includes $20 million in the third quarter from paid sick leave.

Fuel expense in the quarter decreased 25% on a 21% decrease in fuel prices from $3.96 a gallon to $3.12. Our fuel consumption rate was flat, but showed positive momentum through the quarter as we stored locomotives and improved freight car velocity. Finally, other expense grew 18%, primarily related to continued pressure in casualty costs. It also reflects the impact of onetime write-offs as highlighted in the financial walk down slide on 22 in the appendix. The resulting outcome is third quarter operating income of $2.2 billion, down 17% versus last year. Below the line, other income decreased $18 million driven by last year’s $35 million gain from a real estate transaction. Interest expense increased 6%, reflecting higher average debt levels.

Income taxes are lower in the quarter on reduced income and lower tax rates that resulted in a $41 million deferred tax expense reduction. Similar to last year’s $40 million tax reduction, we again had three states cut corporate income tax rates in the third quarter. Net income of $1.5 billion declined 19% versus 2022, which when combined with a lower average share count resulted in an 18% decrease in earnings per share to $2.51. Third quarter operating ratio increased 3.5 points to 63.4%. Core results, which include the impact of inflation, lower volumes and cost inefficiencies accounted for the majority of the year-over-year change. Turning now to slide six and cash flows. Year-to-date, cash from operations totaled $6 billion, a decrease of roughly $1 billion from 2022.

The combination of lower net income and nearly $450 million of labor payments were the main drivers. Free cash flow and our cash flow conversion rate also were impacted. Year-to-date, we’ve returned a little more than half of the cash generated or $3.1 billion to shareholders through dividends and share repurchases, and we finished the third quarter with an adjusted debt-to-EBITDA ratio up slightly from 2022 levels at three times as we continue to be A rated by our three credit agencies. Wrapping up now on slide seven. The overall financial story and outlook for the remainder of 2023 is largely unchanged. We’re facing a demand environment where we don’t expect full year volumes to exceed industrial production. We do, however, still expect to generate pricing dollars in excess of inflation dollars.

Although as we’ve discussed through the year, not to the level that offsets the negative impact of elevated costs on our operating ratio. Fuel also remains a headwind on earnings per share, although moderating from the $0.34 negative EPS impact in the third quarter to approximately $0.10 of negative year-over-year impact in the fourth quarter. And that assumes fuel prices in the fourth quarter are around $3.30 a gallon. And significant inflation headwinds remain primarily in the form of the new labor agreements. We expect similar levels for fourth quarter paid sick leave expense to third quarter and the impact of the BLET work rest agreements will primarily be seen through elevated force levels. Finally, our capital plan is coming in a little bit higher at $3.7 billion.

All that said, the important takeaway from today’s results and our view of tomorrow is that we’re making gains from maximizing growth opportunities and repricing our business to improving service and generating productivity, we’re striving to build on the current momentum as we end 2023 and enter 2024 on a path to further financial improvement. With that, I’ll turn it over to Kenny to give us a view of the business environment.

Kenny Rocker: Thank you, Jennifer, and good morning. You just heard from Jennifer that freight revenue declined 9% with a 3% decrease in volume for the third quarter. Let’s jump right into the business team to recap the market drivers on the revenue side. Starting with Bulk. Revenue for the quarter was down 10% compared to last year, driven by a 6% decrease in average revenue per car due to lower fuel surcharges and a 4% decline in volume. Grain exports were softer than last year due to tight supply. Coal volume was down 5% for the quarter by continued decline for the use of coal and electricity generation combined with competitive pressures from lower natural gas prices. Lastly, we saw a reduction in import beer carloads due to the increased utilization of larger railcars, which creates value for both the customer and Union Pacific.

Industrial revenue was down for the quarter driven by a 6% decrease in average revenue per car. Core pricing gains in the quarter were offset by lower fuel surcharges and a negative mix in volumes. Softer decline for lumber and corrugated boxes continue to be a challenge, but our relentless focus on business development is driving excellent growth in our Rock network that supports construction of new emerging LNG facilities along the Texas Gulf and growth in the petroleum products for both domestic and Mexico energy reform. Premium revenue for the quarter was down 12% on a 4% decrease in volume and a 9% decrease in average revenue per car from fuel surcharges in a challenging truck market. Automotive volumes were positive with continued strength in OEM production and dealer inventory replenishment for finished vehicles and auto parts.

In addition, a robust business development pipeline like winning both wagon shipments from the Texas Gulf enabled us to outperform the market in the quarter. Intermodal volumes were down in the quarter, primarily driven by softness in parcel segment and weak imports on the West Coast. However, domestic truckload volume was slightly up driven by business development wins and strengthen our Mexico shipments. Turning to slide 10. Here is our outlook for the fourth quarter as we see it today. Starting with bulk, we anticipate continued challenges in coal as natural gas futures remain volatile. We are watching grain closely as we enter the export season. Crops have been harvested right now and increased supplies will be available to move. US soybean export sales have started out floor than forecasted.

However, we have an improved service product this year to capture more available demand. Lastly, our forecast for renewable biofuel feedstock continues to remain strong. We see solid demand in this market and continue to capture new business. We recently landed opportunities with projects coming online soon in Iowa, Louisiana and Nevada. Moving onto Industrial. The economic forecast for industrial production looks to stay depressed in the fourth quarter. However, we expect petroleum and construction markets to remain favorable due to our focus on business development. And finally, for premium, we are staying close with our intermodal customers in this challenging demand environment. We’ve seen a seasonal uptick at the beginning of the quarter and we believe our improved service product positions us well to handle market demand.

In addition, we expect automotive growth to continue, driven by strong OEM production and elevated shippable ground count. However, we are watching closely the ongoing UAW negotiations and the negative impact they are having on fourth quarter volumes as the strikes persist. In summary, we are fortunate to have a diverse portfolio that allows us to see positive momentum in some of our commodities. The team remains focused on what we can control. and I’m proud of the progress we’ve made in such a challenging market. We have a strong pipeline of opportunities that we’re actively pursuing by leveraging our great franchise and extending our reach with transload, interline and short line partners. We are winning new business and I am confident that with our improved service product, we can open up more doors to new profitable growth opportunities.

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 12. As Jim mentioned, safety is the foundation of everything we do, and our goal is to lead the industry. Union Pacific can be the best because we’ve been there before. We have exceptional people and the entire team is focused on returning every employee home safely every day. While our progress has been encouraging, we must continue to improve technology and strive to provide best practices to the industry and the communities that we serve. Safety impacts every facet of our business, our employees, customers, communities and shareholders and we are committed to world-class safety performance. Closely aligned with our goal of industry-leading safety, we are confident in our ability to lead the industry in both service and operational excellence.

In late August, the southwestern portion of our network was challenged by a series of intense weather events that caused widespread flash flooding and washouts. However, through the bold and relentless efforts of our team, we were able to quickly respond and rapidly restore operations. Despite the weather headwinds, our performance metrics improved year-over-year. We look to maintain that positive momentum as the vast majority of our metrics in the month of September represented our best performance year-to-date. Freight car velocity improved 5% this quarter versus last year. Throughout the last several weeks, we have maintained a freight car velocity of around 210 miles per day. The impact of increased freight car velocity can be felt by our customers through the benefit of improved trip plan compliance, both intermodal and manifest and auto TPC saw a sizable 13 and 6 point year-over-year improvement, respectively.

We will continue our work to deliver the service we sold to our customers. Now let’s review our key efficiency metrics for the quarter on slide 13. The team is continuing to take actions to right-size resources to align with current volumes and run an even more efficient network. This incorporates Jim’s strategy of empowering our people closest to the work and removing layers to increase the speed of decision-making. Locomotive productivity improved 4% versus last year, as we continue to identify opportunities to utilize the fleet more efficiently. The third quarter marked both our lowest active high horsepower fleet size and the highest quarterly locomotive productivity number since the first quarter of 2022. Workforce productivity, which includes all employees, was down 6% versus last year, reflecting the impact of volume declines, coupled with increased workforce levels.

Leveraging a larger workforce, we have reduced borrow outs to the lowest total of the year and slowed hiring. We remain firmly focused on effectively managing our workforce levels and recognize the importance of balancing our resources as we plan for the future. Train length improved 1% compared to third quarter 2022, despite lower volumes in our intermodal business. By putting more product on fewer trains, we have increased train length across our system by over 500 feet or 6% since January of this year. Our focus on train length is paying dividends, and we are continuing our work to further improve this measure. While our service product demonstrated noticeable improvement, there are more opportunities to improve the efficiency of our locomotive fleet, increased workforce productivity and maximize train length.

We must sustain momentum across all of our operating metrics as we exit the year. So with that I’ll turn it back to Jim.

Jim Vena: Thank you, Eric. Turning to slide 15. Before we get to your questions, I’d like to quickly summarize what we’ve — you’ve heard from our team. Jennifer walked you through the inflationary pressure we continue to face broadly throughout our cost structure, but more specifically from new labor agreements. These are real hurdles that will require price generation and productivity to overcome. Kenny outlined a challenging volume environment, one with price spots like construction and biofuels, but ultimately is being overwhelmed by soft consumer markets. Despite this environment, the team is leveraging our business development pipeline to bring new business to the railroad. And finally, from Eric, you heard that we’re improving safety, service and efficiency.

We exited the quarter with great momentum. September was a very strong month across all of our operating metrics and the momentum continues today, but we’re still nowhere near what I believe we can deliver. There’s still plenty of room to improve. I came back to win and I could see the opportunity at Union Pacific. In a short period, we’ve increased the urgency across all facets of our strategy. The ultimate outcome is better service for our customers, which drives growth for the railroad by aligning the team with a strategy of safety, service and operational excellence, we will win. We’re now ready to take your questions. Rob?

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Q&A Session

Operator: Thank you. We’ll now be conducting a question-and-answer session. [Operator Instructions] And our first question will be from the line of Ken Hoexter with Bank of America. Please proceed with your question.

Ken Hoexter: Hey, good morning, and congrats on the new role, Jim. Jim, maybe just starting there on operations and Eric, is this — what is changing here or what needs to change? Is it the plan? Is it — you have too much equipment — maybe talk a little bit about what metrics you focus on as you get started or productivity. You threw out there, there were too many locomotives, maybe provide some numbers and targets and thoughts on how you get there? Thanks.

Jim Vena: And nice to be back and nice to hear your voice again, and I’ll let Eric jump in, in a minute, but because he’s the operating person. He’s responsible. He is the person I’m going to keep accountable for to make sure we drive it. But what metrics do I look at? I haven’t changed. A successful railroad is always fluid, make sure that you operate in a manner where you don’t impact the network because of decisions you made with the kind of service that you’ve sold and the way you use your assets and people and whether you have the capacity on the railroad. So when I look at Union Pacific, what do I look at, at a high level, I look at do we have the physical plant to be able to handle the traffic and be able to handle the ups and downs that every railroad or knows happens with weather who thought we were ever going to get a hurricane in the West Coast, okay?

That’s always an Eastern seaboard issue more and a Gulf issue, but not Western, but I think we did as a team, we did a great job of recovering. So you need a strong network, and we have the capacity there. We’ll continue to invest to make sure. So that’s important to me. And we have to make sure that we have a buffer of people and assets so that we’re ready for the ups and downs the business that happens because I wish it was flat line Ken and you know it as well as I do. You’ve been following the railroads for a long time. So let me go on because this is an important question is what do I look at? I look at — in the morning, first thing when I get up, I’d probably get about 100 different touch points on the railroad, all in one spreadsheet.

But what I actually look at is I look at revenue first. Where are we financially? What was our volume like? And what kind of — where the revenue is? And if it’s not good, the next call is to Kenny. Okay? Then the next thing I look at is car velocity. It’s an end-to-end measure tells me how well the railroad is doing. 210 is a good number, but nowhere near what’s possible. So Eric’s got has done a great job so far, but we need to push more. Then it’s — then you continue to look at the fluidity numbers. How well we are at crew changes, how the intermodal terminals, how fast we’re getting to pad, how fast we’re allowing the truckers to go through. So there’s a lot of metrics that we look at that most people probably haven’t heard me talk about, but I thought I’d give you a little broader view of what I look at.

And then after you do that, there’s the asset issue. How many cars per carload, the locomotives. So we’ve got over 500 locomotives parked. And those 500 are ready to go locomotives. So we could turn them on in a short period of time. We’ve got some place in strategic locations if we need them on the network to keep the service level that we sold. On top of that, we have more locomotives that are stored for longer term. So we’re in good shape on assets. We spool up this railroad to operate at the level that is possible with the type of business that we have. And I think it’s a win-win for us Ken and that’s what I look at every morning. Eric, do you want to add anything?

Eric Gehringer: When we think about recap in the quarter, Ken, you start thinking about we did make great progress in the quarter from a fluidity perspective to Jim’s point. And when you think about what did we do with that, we were able to store approximately 300 locomotives during the quarter. We’re able to reduce our recrew rate. We took down our borrow out to the lowest level we’ve had all year. Now we continue to face the headwind from a workforce productivity of some of our agreements. So clearly, the challenge that we’ve given ourselves and we continue to challenge ourselves with is how do you work to overcome that productivity headwind. So when you think about things like some of the agreements that we’ve signed that actually allow us to remove certain people off of certain jobs across the system.

We work to continue to reduce the fleet even more as we grow train length. I’m super proud of the team for the train length they’ve grown since January. There’s still more opportunity there. When I think about remote control locomotives have been able to reduce some of our gain productivity and some of that, that’s an opportunity for us. And the list goes on and now, we probably could talk about it for an hour. So I’m very excited about it. I think this is just the beginning.

Jim Vena: Thanks for the question. Appreciate it.

Ken Hoexter: Great. Thanks for the time.

Operator: The next question is from the line of Fadi Chamoun with BMO Capital Markets. Please proceed with your question.

Fadi Chamoun: Yeah, good morning, and welcome back, Jim. I mean a quick question. I think we’ve heard this in the past many times and maybe from you Jim, it’s first, you have to fix kind of the engine and ultimately energize the commercial momentum. And I think the success story around the industry really are in that vein where a collaboration between operation and commercial have been a big catalyst for that. So my question is in terms of fixing the engine and you talked about car velocity, where do you think kind of you are for the network that you have in that process? And what is ultimately the right kind of goal from a car velocity perspective from an asset velocity perspective for UP, where are you in that process? And as we go into 2024, can you kind of make progress can you improve operating ratio even if volume or flat or the economy is muted and there is no momentum on that front?

Jim Vena: So Fadi, I like the question because it frames exactly what — when I came back to work the challenges that I could see the first challenge we had was inflation, both input costs plus labor costs and some of the collective agreements we signed. Every CEO that comes in always wants to blame people beforehand. That’s not the way I look at it. That’s the challenge. I knew what I would get myself into. So we do — how do we fix that piece is as we drive and look for efficiency, and there’s efficiency there. Usually, I don’t give a — and you know that, Fadi, I don’t forecast numbers. But I’ll tell you, I’ll be disappointed if that car velocity doesn’t return to where it was before that we had in 2020. There’s no reason for us to not be low 220s.

So that’s about as far as I’m going to get on that number. If I look at the other piece that we have to do and Kenny is all over it and his team is, we know that we can’t through efficiency and productivity recover everything in the long-term. But what we can do is we can price properly for what the service that we’re providing to our customers, and Kenny’s all over that. And that’s going to take a little bit of time, and I’ll let Kenny later on talk about this. But — so the way I look at it is those two things, if we do them right, and let’s leverage this railroad that we have, okay? We’re a 70-mile an hour railroad. There’s only one other railroad in North America that runs their freight trains at 70 miles an hour, okay? So let’s leverage that.

And you could see that when we changed the service out of Mexico because we want to leverage Mexico to grow our business in and out. And by doing that and providing customers a service that from the border, nobody can beat us to Chicago. We have the fastest service of anybody, especially with the new train service that we have on. So we should leverage that. Now not everybody wants speed, so we have to make sure that we’re consistent. We also have to leverage our network. I love the places we serve and where we can take our customers to. I love the way our origination customers are and the number we have in the variety crossing all market segments. And if we do that, Fadi, we become the most efficient railroad. Operationally, we — I’ve always said this, and I will continue to say it.

We will have the best margin railroad in North America, best operating ratio, best margin, whichever way you want to look at it, I’m comfortable with that. And we give a chance for the customers that are with us to win and we look to move customers that are using other modes, including trucks that look at the railroad as their way that they want to win. So I’m happy. I didn’t come back to work to lose. I came back to win. I was more than comfortable. Most people in my age are thinking about doing other things. In fact, I had a trip to K2 plant. And when the opportunity came up and we agreed with the Board on what the strategy was and what we wanted to do moving forward, I said, listen, I’m all in. Let’s go. So I’ve been working hard with the team and I’m pushing them hard.