Union Pacific Corporation (NYSE:UNP) Q4 2023 Earnings Call Transcript

Union Pacific Corporation (NYSE:UNP) Q4 2023 Earnings Call Transcript January 25, 2024

Union Pacific Corporation beats earnings expectations. Reported EPS is $2.71, expectations were $2.56. Union Pacific 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: Greetings. Welcome to the Union Pacific Fourth Quarter Earnings Call. At this time, all participants are 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 are available on Union Pacific’s website. It is now my pleasure to introduce your host, Mr. Jim Vena, Chief Executive Officer for Union Pacific. Mr. Vena, you may now begin.

Jim Vena: Thanks, Rob. Good morning, and thank you for joining us today to discuss Union Pacific’s fourth quarter and full year 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. The Union Pacific team is executing our multiyear strategy to lead the industry in safety, service and operational excellence. Our fourth quarter shows a lot of what’s possible and demonstrate that we’re on the right path to achieving those goals. We exited 2023 with strong momentum, which gives me great confidence that we have a winning strategy. There’s work to do, but we’re building the foundation for future success.

Now let’s turn to Slide 3. This morning, Union Pacific reported 2023 fourth quarter net income of $1.7 billion or $2.71 per share. This compares to 2022 fourth quarter net income of $1.6 billion or $2.67 per share. Fourth quarter operating revenue was flat as increased volumes and core pricing gains were offset by lower fuel surcharge revenue and business mix. Expenses year-over-year were also flat as lower fuel expenses and productivity gains were offset by inflation, volume-related costs and higher casualty expenses. Our fourth quarter operating ratio of 60.9% improved 10 basis points versus last year. And more importantly, we demonstrated strong sequential OR improvement of 250 basis points from the third quarter. We are taking the right actions to increase the efficiency of our railroad while also improving service for our customers.

Key to our strategy is excelling in what we control. We made great progress in those areas this quarter. That provides further proof that we’re on the right path for future success. So with that, let me hand it over to Jennifer to provide more details on the fourth quarter and full year financials.

Jennifer Hamann: Thanks, Jim, and good morning. Let’s begin by walking through our fourth quarter income statement on Slide 5. Starting with the top line. Operating revenue of $6.2 billion was flat versus 2022 on a 3% volume increase. Breaking it down further, freight revenue totaled $5.8 billion, up 1%. The biggest driver of freight revenue in the quarter was fuel. Lower year-over-year fuel prices reduced fuel surcharge revenue and impacted freight revenue 375 basis points as fuel surcharges declined $180 million versus 2022 to $795 million. Volume growth in the quarter contributed positively, adding 350 basis points to freight revenue, and the combination of price and mix also was positive, increasing freight revenue, 75 basis points as solid core pricing gains were mostly offset by an unfavorable business mix.

Intermodal shipments up 5% contributed heavily to the mix dynamic. Wrapping up the top line, other revenue decreased 13%, driven by lower accessorial and subsidiary revenue. Switching to expenses, we provided expense details for both fourth quarter and full year in our appendix slides. But let me hit some of the highlights. Against our 3% volume growth, operating expense of $3.8 million was flat. Digging deeper into a few of the expense lines, compensation and benefits expense was flat compared to 2022. Fourth quarter workforce levels decreased 2%, while our active TE&Y workforce was flat against the 3% volume growth. This solid level of workforce productivity mostly offset wage inflation as cost per employee only increased 1% in the fourth quarter.

Fuel expense in the quarter decreased 11% on a 15% decrease in fuel prices from $3.70 per gallon to $3.16. Our fuel consumption rate deteriorated 3% as we moved a less fuel-efficient business mix with increased intermodal shipments and fewer coal moves. Finally, other expense grew 20% as a result of higher casualty costs and the comparison to 2022, which included insurance recoveries. Coming out of COVID, we had a sizable case backlog that we largely worked through the last couple of years. Importantly, we do not see these elevated expenses as a reflection of a long-term trend, particularly with our intense focus on improving safety. Fourth quarter operating income was flat at $2.4 billion. Below the line, other income increased $16 million due to higher real estate gains.

Fourth quarter net income of $1.7 billion and earnings per share of $2.71, both improved 1% versus 2022. Our operating ratio of 60.9% improved 10 basis points year-over-year and 250 basis points sequentially. Moving to Slide 6 with a quick recap of full year 2023 results. Revenue of $24.1 billion declined 3% driven by reduced fuel surcharges, business mix and lower volumes, partially offset by core pricing gains. Operating income totaled $9.1 billion and our full year operating ratio of 62.3% deteriorated 220 basis points. Earnings per share of $10.45 decreased 7% versus 2022 and then reflecting the impact of our overall financial results, return on invested capital declined 180 basis points to 15.5%. Turning to shareholder returns and the balance sheet on Slide 7.

Full year 2023 cash from operations totaled $8.4 billion, down roughly $1 billion from 2022. The combination of lower net income and nearly $450 million of labor agreement payments were the main drivers. Free cash flow and our cash flow conversion rate also reflected those impacts. We returned $3.9 billion to shareholders in 2023 through dividends and share repurchases. Our adjusted debt-to-EBITDA ratio finished the year at three times as we continue to prioritize a strong balance sheet and be A rated by our 3 credit agencies. While 2023 was a difficult year, I’m pleased with the progress we’ve made over the last several months to improve our service and productivity. We believe this performance marks an inflection point as efforts to improve the efficiency of our railroad through safety, service and operational excellence is starting to be reflected in our financials.

With that, I’m going to turn it over to Kenny to provide some comments on 2023 and kick off our commentary on 2024.

Kenny Rocker: Thank you, Jennifer, and good morning. You just heard from Jennifer that freight revenue was up 1% in the quarter as our volume gains of 3% were partially offset by lower fuel surcharges. So let’s jump right into the business teams to recap the market drivers on the revenue slide. Starting with bulk, revenue for the quarter was flat compared to 2022, driven by a 3% increase in volume, offset by a 2% decrease in average revenue per car. Core pricing gains were more than offset by lower fuel surcharges and the unfavorable impact of low natural gas prices on our index-based coal contracts. Fertilizer shipments grew compared to 2022 as demand for fuel application was strong due to lower nitrogen prices. Grain product shipments were up for the quarter as our team secured new feedstock opportunities for renewable diesel production in Louisiana and California.

Additionally, ethanol shipments increased with our improved service. Lastly, coal continued to be challenged in the fourth quarter due to mild weather and decreased coal competitiveness from low natural gas prices. Industrial revenue was up 4% in the quarter, driven by a 3% increase in volume. Core pricing gains in the quarter were mostly offset by lower fuel surcharges and a negative mix in volume. Business development in our petroleum and LPG commodity segments contributed to the growth. Demand improved for our plastics business in both export and domestic markets. However, sand volumes were negatively impacted by softer natural gas prices that reduced drilling in the Eagle Ford Basin and increased utilization of in-basin sand in the DJ Basin.

Premium revenue for the quarter was down 3% on a 4% increase in volume and a 7% decrease in average revenue per car from lower fuel surcharges and truck market pressures. Automotive volumes were negatively impacted by the UAW strike, but those decreases were mostly offset by dealer inventory replenishment and business development wins that I mentioned on the last quarter’s call. Intermodal volumes were positive in the quarter, driven by stronger West Coast imports, domestic business development wins and strengthen our Mexico volumes. Now let’s start talking about 2024. Here are some key economic indicators that we’re watching this year on Slide 10. These are S&P’s forecast from their January report, and you’ll notice that it shows a mixed picture for 2024.

Industrial production looks to be flat. Housing starts are expected to remain challenged, but demand for auto continues to be strong. Turning to Slide 11. Here is our 2024 outlook as we see it today for the key markets we serve. Starting with bulk, we anticipate continued challenges in coal as natural gas futures remain volatile and inventories are high. Domestic grain is relatively stable, but we are keeping a watchful eye on export demand. On a brighter note, we expect fertilizer to be strong as repair that Canpotex Portland facility are now complete and commodity prices remain competitive moving into the spring season. And growth within biofuels continues to be driven by strong demand outlook, combined with a heavy focus on capturing new business, including incremental volume secured from Minnesota and Iowa origins.

Moving on to Industrial. The construction market will be challenged to exceed last year’s record volumes as we’re seeing softness in parts of the market. However, we foresee the petroleum and petrochem market remaining favorable due to our focus on business development. And finally, for premium on the international intermodal side, we expect the market to improve year-over-year, but a contract we lost earlier in 2023 will negatively impact our 2024 volumes. On the domestic side, we are staying close with our customers who have indicated that they’ll see a soft start to the year. Nonetheless, our strong service product sets us up to handle market demand. And for automotive, we will see strength in this market with improved OEM production and business development wins.

In summary, the economic environment continues to look muted in 2024, particularly in the first half. We’re off a slower start in January based on severe winter storms and market challenges we’re seeing in coal and intermodal. But I am encouraged that we expect to see growth in some markets with our strong focus on business development. For the second half, we are well prepared to handle the demand if the market and economy improves. We continue to make significant capital investments on both the carload and intermodal front to capture more freight over the road. Those investments, along with our unmatched service offerings and improved service products from Eric’s team create a winning environment for our customers. I’m excited for the opportunities in front of us, and our commercial team is ready to help our customers win in the marketplace.

And with that, I’ll turn it over to Eric to review our operational performance.

Eric Gehringer: Thank you, Kenny, and good morning. Moving to Slide 13. To start, I want to express my appreciation to the team for their relentless focus on improving our service product and driving network efficiency. It’s thanks to their efforts that our network showed tremendous fluidity and reliability during the fourth quarter. Freight car velocity improved 14% to 217 miles per day compared to fourth quarter 2022. Increased train velocity and a reduction in terminal dwell drove that performance. Service was strong during the quarter as we saw a significant 12-point improvement in both intermodal and manifest and auto trip plan compliance. In addition to trip plan compliance, we have hundreds of customer-specific performance metrics that also showed great improvement throughout the quarter.

Most importantly, we are delivering the service we sold to our customers, which is critical to our long-term growth strategy. While winter is here and has certainly brought its challenges, the railroad overall is very healthy, and I’m confident the team will continue its positive momentum. Safety continues to be the foundation of everything we do. During the quarter, we delivered improved derailment performance through our investments in technology and process. We remain focused on the critical actions that drive real change. So everyone goes home safely each day. Now let’s review our key efficiency metrics for the quarter on Slide 14. During the fourth quarter, we saw year-over-year improvement across all of our efficiency metrics. Locomotive productivity improved 14% versus fourth quarter 2022 and 9% sequentially as we continue to identify and execute on opportunities to utilize the fleet more efficiently.

Throughout the second half of 2023, we stored nearly 500 units from our operable fleet. Workforce productivity improved 4% compared to fourth quarter 2022. With a strong crew base, we are focused on effectively managing workforce levels to the demands of the business. However, challenges do remain from scheduled work agreements that in the near term, require additional employees. Train length improved 2% compared to fourth quarter 2022 as we continue to remove car touch points from the system. In total, throughout 2023, we were successful in extending train length as improvements in the second half more than offset the declines in intermodal shipments. We remain persistent in our focus on train length to drive productivity while providing a better service product to our customers.

As we move into 2024, we will continue to transform our railroad through a variety of technology initiatives and targeted capital investments designed to further improve safety, improve our service product, enhance resource utilization and ultimately lower our cost structure. So to wrap up, let’s review our capital outlook for 2024 on Slide 15. We are targeting capital spending of $3.4 billion in 2024. Similar to 2023, we will support safe and productive operations by investing in our infrastructure and renewing our older assets. This includes modernizing locomotives and acquiring freight cars to support replacement and growth opportunities. We are also investing in technology and terminal and mainline capacity projects to improve productivity.

Specific to our technology investments, we recently cut over NetControl, replacing our 50-year-old transportation management system. This cutover positions us to use real-time analytics to open new capabilities for Union Pacific and our customers. Great work led by our technology team. On the growth front, we will continue to invest in projects that expand our intermodal footprint and support business development in targeted high-growth areas such as Inland Empire, Kansas City and Phoenix to name a few. So with that, I’ll turn it back to Jennifer to lay out our initial financial thoughts for 2024.

Jennifer Hamann: Thanks, Eric. Turning to Slide 17. Let me start by pointing out that we added a new appendix slide that contains several of the 2024 modeling assumptions that should be helpful to everyone in framing our current expectations. As you heard from Kenny, it’s a difficult market to forecast, as economic indicators show a muted and uncertain economy. Throwing a couple of other variables such as what the Fed might or might not do with interest rates and a presidential election, and we’ve got an interesting year ahead. On top of the macro pressures, lower coal demand and some lost international intermodal business are expected to negatively impact our volume. And as you’ve seen in the weekly carload data, January is off to a slow start as cold temperatures across our system impacted operations and volume with first quarter volume down 9% year-to-date.

I am confident, however, that our strong and improving service product will allow us to capture available demand. We clearly demonstrated that in the fourth quarter as we took advantage of the unexpected but short-term surge in intermodal. More certain than the economy is our expectation to generate pricing dollars in excess of inflation dollars even with ongoing headwinds from certain intermodal contracts. With those pressures, we do not expect price to be accretive to margins in this year. Key for UP in 2024 is our ability to control the controllables by driving a strong safety culture, making ongoing service gains and improving network efficiency. We’re confident that regardless of the demand environment, we will take the necessary actions to run a more efficient network.

Finally, with capital allocation, there is no change to our long-term strategy. We are investing $3.4 billion back into the railroad as Eric detailed. Next, we prioritize our industry-leading dividend payout and then excess cash will be returned to shareholders through share repurchases. However, given first quarter debt maturities of $1.3 billion, we will not be repurchasing shares in the first quarter. It’s always difficult in late January to make predictions for the year ahead, and this year is no different. There are clearly ongoing challenges from a macro and inflationary perspective. What is very encouraging though, as we start out 2024 is our momentum, which you’ve heard us mention several times today. We demonstrated with our fourth quarter performance, what’s possible, and we look forward to further improvement in the year ahead.

With that, let me turn it back to Jim.

Jim Vena: Thank you, Jennifer. Let’s turn to Slide 19. Before we get to your questions, I’d like to quickly summarize what you’ve heard from our team. Kenny outlined our view on the upcoming year. Our volume outlook today reflects headwinds from lost business, coal demand and relatively soft economic forecast. Much of that is out of our control. We are mitigating these impacts through business development and value creation by providing great service to our customers. Eric described the progress we’ve made to return our service levels to industry best, while there’s work to do, the team made consistent improvement through the quarter to exit in a very fluid state. Obviously, winter is here, but that’s part of railroading. I judge our success by how we minimize the impact on our customers and how quickly we recover the network.

So far, we’ve grown – we’ve shown great resiliency. Finally, as Jennifer laid out, our productivity and pricing gains will be key to overcoming ongoing inflationary pressures in 2024 as well as the soft economy. While many unknowns remain, I’m confident we’ll succeed in the areas we control. We’ve got plenty of opportunities this year to improve safety, service and operational excellence. As you heard me say in October, I came back to Union Pacific to win. My vision and the opportunity I see for this company has not changed. We have the right team and strategy in place to grow this railroad long term, and I’m very confident we’ll see a better Union Pacific in the future. We’re now ready to take your questions. Rob?

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Q&A Session

Operator: Thank you, Mr. Vena. We’ll now be conducting a question-and-answer session. [Operator Instructions] And our first question today is from the line of Chris Wetherbee with Citigroup. Please proceed with your question.

Chris Wetherbee: Thanks. Good morning. Maybe if I could ask just sort of the outlook for 2024. As you sit here, it sounds like a muted macro environment is keeping you cautious. But I guess when you think about the opportunities that you have, can volume be up this year? I know some of the macro indicators that you highlighted are muted, but they are still positive. So curious about volume growth. And I guess, in that context, with pricing maybe not necessarily being accretive to margin. Is there enough in that volume and some of the cost efficiencies that you guys are working on to get margin expansion?

Jennifer Hamann: So Chris, maybe let me start and then Kenny can give you some more color. I mean we’re just not going to give you a number in terms of what we think can happen with volumes because of what you yourself said. There’s just a lot of uncertainty, and we just don’t think it’s prudent sitting here at the end of January to give you some sort of a forecast based on hopes for a second half recovery. Do we hope that, that will happen? And are we going to work diligently to move every piece of business that’s there? Absolutely. And I think you really saw what the network can do with our fourth quarter performance, but we just need to see a little more certainty. And hopefully, that plays out through the year, and we can provide that. But sitting here today, we just don’t see that. But Kenny, maybe talk about your margin…

Kenny Rocker: I talked about it in my opening comments, there’s a mixed bag of opportunities that are in front of us. We feel really good about the biofuels market. That market is growing. Demand is growing. We’re capturing business in those markets. On the industrial side, we’ve had some record year on the construction side, still be a strong year. But as we are coming out of the gate with weather, that’s going to be a little bit challenged for us. We feel really good about our petrochem business and wins that we’ve had from a business development perspective. On the petroleum and LPG side, those are all positive for us. On our premium business, again, those are really economic driven. And so we’ll be looking to see what happens with demand overall.

I talked about the international intermodal side and the loss there. We feel really encouraged by our ability to win on the auto side. And you heard us talk about Volkswagen [ph] win in last quarter. And so as there’s a lot of demand there and the forecast for growth there, we really feel good about that market.

Chris Wetherbee: Anything on the margins?

Jennifer Hamann: I’m sorry?

Jim Vena: Margins?

Chris Wetherbee: Anything on the margins?

Jennifer Hamann: On margins. Again, I’m not – this might become a broken record, I hope not. But I mean, we are not going to give specific guidance. I mean we’re going to do everything we can as much as we can. And again, you saw what we did in the fourth quarter. But every kind of other guidance I would give is going to be predicated on what I think is going to happen with volumes, and we just don’t have that clarity. And I don’t think it’s prudent to do that sitting here today.

Chris Wetherbee: Got it. Thanks for the time. I appreciate it.

Jim Vena: Chris, let me just maybe just try to put this all into a box of the way we’re thinking. It’s very difficult for us to look forward and say this is exactly the way the year is going to go. More important to me and the team is, what have we done operationally? And what are we doing to provide Kenny and the entire team, the capability to go out there and maximize what’s available for us and what we can bring on to this railroad. And for me, that’s the single most important thing. I think what we’ve shown is the capability to flex up. We have the assets to be able to flex up. We have the capacity to be able to flex up. And if we continue to drive the efficiency of the railroad, which I expect we will, then what we do is we win in the marketplace.

And whatever is out there, we’re going to compete against everybody else, trucks and other railroads, and we think we have a winning model, so that’s the challenge we have. And it would be truly there would be a mistake for us to come out and say, because I can’t tell what’s going to happen, like Jennifer pointed out with the inputs and the effects from interest rates and everything else that’s happening in the economy. But I’m very comfortable that we are going to maximize what’s available for Union Pacific and win.

Chris Wetherbee: Okay, that’s helpful. Thanks. Appreciate it.

Operator: Our next question is from the line of Walter Spracklin with RBC Capital Markets. Please proceed with your question.

Walter Spracklin: Yes. Thanks very much, operator. Good morning, everyone. On the intermodal side, I know there was a business loss there. And – but looking at some of the statistics in LA Long Beach, there seems to be a really good uptick in volumes into those regions or that region. Red Sea impact, perhaps East Coast is down. Kenny, are you seeing that there is new business coming that way? And could that be a nice offset to any business loss? Or could it create an opportunity for a business – more business wins as more volume shifts to LA Long Beach and perhaps the fluidity of LA Long Beach is that keeping pace with the new volume mix coming its way?

Kenny Rocker: Yes. So thank you, Walter. We spent a lot of time looking at the global supply chains in the canals and so forth. I’ll tell you right now in the near term, we haven’t seen any significant shifts. We’ve been talking to our – the vessel carrier owners. We know they put in tariffs, our customers have put in tariffs to go over the Panama Canal, for example. And so we’ve been working with them to move as much as we can with the network that we have, with the match-back opportunities that we have, with the reload opportunities that we have, with the new products that we have on the – with the Houston lanes that Eric has given us to give our customers every reason to go to the West Coast. So what we have seen is we are seeing more going IPI, and we have a very efficient service network to accomplish that.

We’re happy about the customers that we have that have been able to grow in that market. And then finally, we have a great network where the service, we’re able to capture that and get all of that business that’s out there.

Jim Vena: That’ true, Kenny as we think about that because to your point, you can’t predict the future with entire clarity. It’s another reminder, Walter of the fact that when we talk about having a buffer and you look at what we did in the fourth quarter, we generated the ability to make sure we have that buffer. That buffer in locomotives, that buffer in railcars positioned in LA. So in the event the volume is there, we’ve supported Kenny’s team to be able to actually capture it.

Walter Spracklin: And the fluidity in the terminals right now? Is it – how would you assess that?

Kenny Rocker: Very fluid. As you saw in the fourth quarter, 14% improvement in car velocity doesn’t come unless you’ve got very fluid operations. Now to Jim’s point, are there opportunities? Of course, there are. In fact, I’ll talk about those as we go through this. But overall, right now, yes, very fluid.