Union Pacific Corporation (NYSE:UNP) Baird 52nd Annual Global Industrial Conference 2022 November 7, 2022 9:30 AM ET
Company Participants
Jennifer Hamann – Executive Vice President & Chief Financial Officer
Eric Gehringer – Executive Vice President, Operations
Conference Call Participants
Garrett Holland – Baird
Garrett Holland
We appreciate you being with us this morning. We’re very pleased to have Union Pacific participating at the Industrials Conference this year. Joining us from the company are Jennifer Hamann, Executive Vice President and Chief Financial Officer; Eric Gehringer, Executive Vice President of Operations. So, management’s going to review a few opening comments and then we’ll return for Q&A.
So with that we’ll turn it over to the team.
Jennifer Hamann
All right. Well thanks Garrett and good morning to everyone. For those who aren’t in person today, the slides that accompany these remarks can be found on our Investor website next to the event webcast and I do want to remind everyone that we will be making some forward-looking statements. Those statements are subject to risks and uncertainties. So, please refer to the UP website and our SEC filings for additional information about those risk factors.
So, looking at our third quarter results quickly just to give a recap. Our reported results were impacted by a prior period charge for a change in estimate related to labor accruals. Excluding that charge, our earnings per share grew 24% to $3.19 on an adjusted net income of $2 billion. Our adjusted operating ratio of 58.2%, which was a degradation compared to 2021 as we remain impacted by both inflationary pressures as well as inefficiencies in our network, which are most directly reflected in some higher compensation and benefits expense as well as purchased services.
Eric will provide more color in his remarks in just a moment, but the team has activities directed in both of those areas to increase efficiency and reduce costs as we further improve our service product.
I think it’s important to note that sequentially our operating ratio improved from the second quarter reflecting both our attention to that increased network fluidity and taking costs out of the network. And although we achieved quarterly records for operating revenue, operating income, net income, and earnings per share in the third quarter, our focus is to build on that momentum in the fourth quarter and into 2023 to drive further gains both operationally and financially.
If you look now to the fourth quarter, let’s look to slide four and this is a look at our current volume picture. Carloads to start the quarter are up 6% in total. If you look at each of the business teams in a little more depth, bulk is up 3% for the quarter. That’s led by growth in our coal business, which is up 11%.
Offsetting some of that growth are declines in some of the other bulk commodities, notably grain and grain products, which are down 2% as a result of elongated cycle times as well as a tough comparison to 2021.
Our industrial business is up 5% versus last year, driven by continued strength in business development in our industrial markets. Metals and minerals remained strong up 15%. We’re also seeing growth in energy and specialized markets and that’s being led by soda ash. Offsetting a portion of the growth though is a decline in forest products, down 16% versus last year as both paperboard and lumber demand has softened.
Finally, with premium it’s up 8% and that’s driven by automotive volumes up 13% as shipments of finished vehicles continue to recover. Intermodal is up 7%, now that’s led by our international intermodal shipments, which are up over 25% against last year’s very steep drop that was related to supply chain congestion issues. Domestic intermodal volumes are soft to start the fourth quarter down about 8% and that continues to be pressured by weakness on the parcel side of our business.
Now, let me turn it over to Eric to provide an update on our service.
Eric Gehringer
Thanks Jennifer and good morning everyone. I’m going to begin on slide five. Our operating metrics continue to demonstrate improvement to begin our fourth quarter. Freight car velocity is trending upward as we’ve posted weekly results in excess of 195 miles per day since the start of October. Likewise, we’ve seen an improvement in trip plan compliance measures which is critical.
We continue to partner with a subset of our customers to reduce excess inventory in select geographic areas. Crew availability has improved as we’ve added graduates to our crew base, most of which have recently finished training. Those new graduates are also helping to reduce the overall level of borrow-outs and thus reducing the excess compensation expense.
Although we’ve exceeded our hiring goal for TE&Y employees for the year, we continue our push to hire in the most challenged locations to meet the bulk business demands.
As stated in the third quarter earnings we are focused on driving excess cost from the network. In particular, we’re working to improve the overall efficiency of our locomotive fleet as we store excess locomotives, which reduces our maintenance costs.
Additionally, a more efficient locomotive fleet coupled with productivity enhancements like our fuel management systems are driving lower fuel consumption rates which is helping to mitigate the impact of higher year-over-year fuel costs.
Now let’s turn to slide six an update on the investments in our locomotive fleet. Locomotives are one of our most essential assets. We continue to make investments into our fleet to improve its reliability, while also investing in future propulsion technologies to lessen our carbon footprint.
We are very excited about the announced acquisition of our battery-electric locomotives to use in our yard operations. Although still in development we are in the process of upgrading our yard infrastructure to be ready for the battery-electric locomotives in the near future.
And as we’ve previously mentioned we continue to invest in modernizing our locomotive fleet as evidenced by our recently announced deal with Wabtec. We plan to modernize an additional 600 locomotives through 2025. Each completed unit will be 80% more reliable, up to 18% more fuel efficient, have a lower emission profile, and a greater haulage ability.
Lastly, I wanted to highlight a new partnership with ZTR Control Systems to develop a hybrid electric mother-slug locomotive sets for use in our yard operations. These hybrid locomotives will work much like a hybrid car, capable of operating in multiple modes and in several ways to charge the batteries including onboard charging capabilities.
We expect the first prototype to be delivered in late 2023 with five additional units arriving in 2024. Each of these investments plays an essential part to improve the liability and the fuel efficiency of our fleet while advancing towards the achievement of our emission reduction goals.
Wrapping up, the service improvements we’ve made and continued momentum provide confidence in the actions we’ve taken to safely restore network fluidity. The task at hand remains to operate in a more than volume variable manner.
With that I’ll turn it back over to Jennifer.
Jennifer Hamann
Thanks Eric. So, looking on slide seven, we just want to give a quick look ahead to 2023. And while the economic forecast for next year are becoming increasingly pessimistic, we believe Union Pacific is very well-positioned to withstand and excel in a challenging environment. Our confidence comes from a strong and diverse business franchise and our broad geographic footprint that provides us access to a variety of markets.
In addition, our lower cost structure allows us to compete for and win business that was previously out of reach. We have a strong portfolio of business development wins highlighted by Knight-Swift and Schneider in the domestic intermodal space and supplemented by wins in metals and biofuels.
In addition, we expect demand for less economically sensitive commodities such as coal to remain high as natural gas prices stay elevated. We also see strong rock demand driven by the infrastructure bill spending and continued autos restocking.
The expected strength in these business segments combined with our business wins gives us confidence in our ability to outpace the growth of our industry peers in 2023. That growth model, our adherence to PSR principles, strong pricing discipline, and focus on providing a safe and reliable service product, provides the foundation for continued success as we close out 2022, and turn our sights ahead to the year 2023.
So with that, Garrett, we’re ready for your questions.
Question-and-Answer Session
Q – Garrett Holland
That’s, great. And everyone, we’re going to head into Q&A. Now, if you’ve got a question for the team, please feel free to submit it through the portal and I’ll be sure to relay it. Great update on Q4. I think that’s very much in line with the outlook that you revised in the third quarter. I guess, what do you see is tracking better or worse relative to plan? And especially, in this environment where demand appears to be cracking even more, talk about your visibility heading into 2023 and what you’re hearing from shippers.
Jennifer Hamann
Yes. So I’ll start with that last part, and we were talking a little bit before we came on stage here. I mean, there are a lot of moving pieces and parts and it does seem like some of the outlooks are getting, a bit more pessimistic. Inflation obviously, is staying high. The Fed’s continuing to take actions. And I think we probably — there’s a lag effect there, right? And they’re purposely trying to increase interest rates to tamp down some of that economic activity. That’s how the process works, unfortunately. So I think it is likely that you’re going to continue to see some slowdown. I think that’s where we feel very confident, and feel good about what we have ahead for us next year, as I just laid out in terms of, some of the business wins, the bulk commodities, just some continued good demand there that I think is going to let us outperform the economy.
One of our long-term goals is to have volume growth in excess of industrial production. I think the latest numbers I saw there, is industrial production forecast to be down like 1.5 points two points next year. So, we do feel good about being able to outperform that. In terms of this quarter, up 6% quarter-to-date, that feels pretty good. We are — putting more assets into service to move some of that bulk demand. Eric talked about that at the earnings release, and so you’re seeing that certainly reflected in the coal business. You’ve seen that in our rock business as well. So, I think net-net, we feel pretty good about where things are sitting here, I’ll call it almost midway through the quarter.
Garrett Holland
That’s, great. And it’s good to see network performance starting to recover. Eric, maybe a question for you. Are we starting to see those benefits translate into better growth, or is that still ahead of us?
Eric Gehringer
We’re definitely seeing the benefits. I mean when we look at the two biggest opportunities we have, we’ve been I think very consistent certainly, in the last nine months. The progress we’ve made on the hiring, we said 1,400 TE&Y. We’ve got about two-thirds, of them on the railroad actually operating trains. We’ve got the other one-third in trains. We’re going to make our goal.
Now, what we still see is an opportunity to gain velocity on the service product, but we still have those pockets where we are constrained. And remember, those are in our Northern region and they’re in our rural communities. Now, we’ve taken a whole bunch of different actions. Not only are we in different venues to try to get our message out that we’re hiring. We’ve also adjusted incentive bonuses, based on the difficulty of that market. So I’m looking forward to those last 500 — approximately 500 people.
As you move beyond that, and I mentioned it a little bit in my prepared comments, and we continue to partner with a subset of our customers. What we’re most focused on is, we know the supply chain congestion even outside of intermodal is having a broad impact. Working with our customers, we need to continue to make sure that we keep that inventory level where you’ve heard us talk about cars per carload at that optimum. And it’s not just for the service product alone. I mean velocity drives our service product. So, what you’ve seen us do really since April, is be able to drive that down from say a high of like 202,000 204,000 cars to 190,000. But you also saw in my chart it’s kind of become level, right? So this is a push and the continued momentum to get that back down and that drives velocity.
Garrett Holland
We had a question from the room. Obviously, the rails have been tripped up by a series of supply chain shocks. Are we approaching a state of resiliency would you say, to where you can weather maybe a hiccup or two on the network? Just a question on resiliency for the network after, some fragile strays performance across the industry really this year.
Eric Gehringer
Yes. That’s an excellent question. I think about it first from the perspective of, us being the middle mile, right? And you want to answer that question with the first and the last mile as well. I think for us, we’ve remained very agile. We saw what last year entailed with the congestion here in Chicago, actually. We haven’t had that this year. For anybody who’s been watching you’ve seen really over the last five months, both us and our counterpart drive the inventory off the ports down. We now are back to the range that’s a historical range and a good range.
You’re seeing no ships off berth, as of the last couple of weeks, which is really encouraging. What we don’t see yet, is we don’t see that last mile improving. And we can do the first mile, we can do the second mile, but we’ve got to see that last mile. So chassis street time being elevated. That needs to come down. Box dwell needs to come down. You’d have more capacity on the dray side. More ability for shippers to receive that product, that’s still an opportunity for us. And I think it will be an opportunity through the beginning of next year.
Jennifer Hamann
Yes. And I think with that it would be — there’s certainly some resiliency building in the network as we’re getting healthier from a crew standpoint. I think we also learned some lessons, through some of these supply chain challenges. And when Eric referenced the West Coast ports, you might recall that last year, we surged resources to try to clear some of the West Coast ports. And all that did was move the problem from the West Coast ports under our ramps, on the eastern terminus of our network. We were very diligent about not repeating that here in 2022. And it’s maybe meant, a little bit slower, build down or drop of that backlog, but we did it in a measured way that kept things moving more fluidly and was ultimately I think provided, a better service product to our customers.
Eric Gehringer
There’s, no doubt about that.
Garrett Holland
That’s, great perspective. And since we’re here in Chicago, major hub of operations for you just wondering, if you could virtually take us through the terminal. How much more efficient is it performing today? Not that if Chicago goes the network, but what do operations look like today relative to three or six months ago?
Eric Gehringer
Yes, that’s a great question. And you’re, right. Chicago, is a very important node in our network. So you really want to talk about that both in the manifest and intermodal side. Let’s do the intermodal side, first. If we had rewound time five years, we would have had one more terminal than we do now, which we don’t have any longer. We would have had G4 and G2, which is our largest domestic and intermodal terminals. They would have been about maybe 70% the size they are now.
What that means is, we’ve made investments on our storage tracks. We’ve made investments in our working tracks. We’re putting in the wide span gantry cranes that’s designed not only for the efficiency of our current customers but also for that growth. You would have seen and this probably would have been the biggest one, you would have seen is Proviso Yard, which is the largest manifest yard we have here. I mean, we’ve effectively — through PSR, we’ve stopped using the hump and we’ve removed half of the yard and turn it into a bigger intermodal facility. That’s been, incredibly important for us.
One, it’s allowed us to capture growth. Two, when you think about like actual metrics, we’ve increased train length out of Chicago, by 200 feet year-over-year. If you look at the operation from a cost per car perspective in Chicago, they’re at their record best. So every decision that we’ve made although certainly, we had to think through many of those very carefully, we’ve been rushing towards how do we capture that growth, how do we make the proper investments and how do we make those investments at a measured pace? I think we’ve done an excellent job with that.
Jennifer Hamann
Yes. And just using the Proviso example, so that’s been, a yard — was a large hump operation for us for years. And unfortunately, I worked for the company long enough I remember all the discussions about, how we were going to redo that manifest yard. And there was talks of putting call it $0.5 billion to redo that. And instead with our PSR implementation, we completely re-envisioned that yard. As Eric talked about, we’re not using the hump anymore. We’re converting that into more intermodal space and using that much more efficiently, with a much smaller cost profile. So that to me, is a huge success story for us.
Garrett Holland
That’s great. And just a couple of longer-term questions on the growth profile. It’s a common point of debate among investors. Can the rails actually grow? We’ll see. But what are some of the differentiating aspects you covered a few of these in the prepared remarks that really should deliver that outcome? And then — a longer-term tailwind from nearshoring. How does Union Pacific participate in that trend? And how big of a benefit would you say that could be?
Jennifer Hamann
Yes. I mean, we know that historically we have not shown the ability to grow. So we get that it’s a bit of a show-me for investors. We need to not only talk to you all about it, but demonstrate it. And I think you’re seeing that from us here this year, maybe at a little bit slower pace than we originally thought but we’re still targeting 3% or so growth here in 2022. Some of that is coming through business wins. And so that’s attributable both to our service product as well as our cost structure. That’s opening up markets that previously weren’t available to us and letting us go in and compete and win and so I think we’re being very successful there.
I think it’s reimagining ourselves a bit in terms of in the past where we maybe would have thought we had to add a whole new train pair to service a customer because we’re doing more work events we’re willing to stop the train on line of road pick up and set out cars. And that’s directly in that PSR mindset. That’s allowing us to work with smaller customers that in the past we had walked away from quite frankly. So I think that’s another area of differentiation for us.
And then the piece that we haven’t really talked about at all and it’s still one of those things that I say is on the come is the ESG benefits of rail versus truck. That’s a hugely untapped market for us and some of that is because we’ve had to work on our service product. We need to continue to become more reliable and show that day in day out to our customers.
But we know our existing customers have a large amount of freight that they’re not moving on us today so that’s an immediate opportunity as well as those other shippers that aren’t using rail today either because they don’t think they can rely on us or they think we’re inaccessible. And that’s where Kenny and his team, and Rahul on the technology side are really working to make ourselves more accessible to, kind of, demystify rail for shippers and make it an easier switch for them.
Garrett Holland
That’s great. On the pricing front clearly inflation is sticking around. How are you building — what’s embedded from an inflationary standpoint as you think about Q4 and then potentially next year? How do you stay on top of that from a price/cost perspective?
Jennifer Hamann
Yes. Well we’re playing a bit of catch-up certainly because the inflation has come on stronger this year than we expected it to be. We came into the year, we were thinking around 3%. Now we’re thinking it’s going to be closer to 5%. Some of that certainly is attributable to the recent PEB and what we talked about earlier in terms of the charge associated with labor.
But we’re seeing inflation across the board and labor is a big part of that. When I think about like our intermodal contractors, our automotive contractors some of the folks that do work on our railroad they’re seeing those labor inflation pressures and we’re seeing some of that passed on to us. So that’s an uphill battle for us. But Kenny and team understand that and as they’re getting access to different parts of the portfolio to reprice it that’s absolutely part of the discussion.
We’re extremely committed to offsetting inflation making our dollars of price yielding those in excess of our inflation dollars. We’re still putting together the 2023 plan. So we’ll talk about our inflation view for next year. But we know just out of the gate in the first half of the year I have a 7% wage increase for our agreement employees. And in the back half of the year, I’ve got another 4%. So we know those pressures are going to be there next year.
Garrett Holland
And then just any thoughts on OR implications both for Q4? Still feel directionally that sequentially we’re moving higher from an operating ratio perspective. And then what levers can you pull from a productivity or efficiency standpoint to maybe offset some of those inflationary headwinds?
Jennifer Hamann
Yes. So we didn’t give a fourth quarter number, but we said for the full year around 60%. We’re still comfortable with that. In terms of the levers on the productivity side that’s probably…
Eric Gehringer
I will cover those.
Jennifer Hamann
I’ll give to Eric that one to jump into.
Eric Gehringer
Yes. So if you think about the very first to lever you’re really talking about what we did this year, right? There’s opportunities clearly that Jennifer and I both talked about. It’s not repeating then next year, right? Easy to say. It doesn’t make it easy to do. But when you see the momentum that we’ve built in the last half of this year it brings me confidence that we can do that.
Second after that, yes, we talk about train length but we talk about train length a lot and it’s really important. We’re going to continue to leverage that. I want to keep driving the conversation too to also some of the technology initiatives that we’ve taken on. As we think about yard operations, it’s one of our biggest users of crews.
I was in Kansas City two weeks ago or last week and I was actually watching an operation. It’s a pilot program, but we were down there with effectively one person doing what three person normally do because we’re leveraging technology to be able to do that. It’s going to be that portfolio of initiatives that’s going to continue to allow us through multiple years to be able to push that productivity in really truly meaningful ways. You can put even a single person crew or re-crew — crew redeployment in that same bucket.
Jennifer Hamann
And technology, obviously, enables a lot of it.
Garrett Holland
It does. Absolutely. And we’re — thinking about how to manage through downturns what are the levers that you consider pulling if the demand outlook were to further deteriorate? How is that a little bit different in this labor environment? You just restored your service product. I want to make sure that continues obviously into the next year to transfer more volume to the network. What are the levers that you see as first pull this if demand continues to deteriorate in 2023?
Eric Gehringer
Yes. So the playbook that we use really hasn’t changed. I think this last year maybe even the last two years certainly to Jennifer’s point earlier there’s a few lessons to be learned. But the playbook is still — you’re starting off with what’s the demand that I actually have out there.
Jennifer mentioned train pairs, for example. Train pairs are driven by demand. If the demand dries up we start reducing train pairs. If we also start seeing demand we take our locomotives to continue to balance that.
Where you’re going to see, I think, the most questions get asked is how do you contend with the people that you just hired? We want to be really clear. Our attrition rate on the TE&Y side is about 1,000 people roughly. So when we talk about hiring 1,400 people 1,000 of them are just there.
For that entire population, we have the ability first to do borrow outs if there were places in the system where it made sense to do that. Two, we have the ability to reinforce and really reinstitute our AWTS program, which we have about half the system where we can do that. And remember for those that don’t know it’s — AWTS is just kind of a temporary part-time position. We work them a certain number of hours per month to keep them qualified so they’re available to us when the demand changes and we need them.
And then if it would come down to it we still have the option of furloughs. Nothing about the PEB and nothing about the last year changes that as a tool. Now that’s not a tool that we employ without thinking very carefully through that because what we want to be most prepared for is when the demand shifts we want to be able to capture that without missing a beat.
Garrett Holland
We just had a question from the group about the employee churn. Post COVID is it higher? And help us understand the path towards ratification of the agreement. And clearly you want to maintain good performance. Any thoughts on those attrition and ratification?
Eric Gehringer
Yes. I can start with the attrition. When you look both at individual crafts for our collective agreement professional group as well as even our non-agreements, our attrition rate is not significantly different than years in the past when you look over the last five years. That doesn’t mean though that we’re not paying extremely close attention to that, should we see a shift in that and adjust. On the labor union side…
Jennifer Hamann
Yes. We’ve had — seven of 12 now have ratified. That’s about call it, 25% or so of our agreement workforce. Certainly, the biggest piece of that, that is still yet to go through the ratification process is our TE&Y crews. And so you’ve got two unions there. You have SMART-TD and you have BLET. They’re just really in the process of getting into that ratification. Their union leadership is going out and talking to the membership about it. We know through conversations with them they’re going out and they’re supportive of the agreement to their membership, which I think is very important.
And so, they’ll be starting in probably here real time in terms of some of the actual ratification votes. We’ll know that sometime end of next week I believe, is the timing on that. So that’s really the next big trigger point is with them. We’re very hopeful. We’re certainly — I know, Eric and his team, are spending time out in the field talking to employees as well, engaging them, helping them understand the puts and takes of the contract.
We think it’s a great deal and it marks a step forward for us, and then we can start talking about some of the quality of life issues that have come up through this round of negotiations. Eric alluded to it when he talked about crew redeployment single-person crew but we also have a pilot that I think is worth mentioning that we’re doing in Kansas that’s really aimed at that need that has arisen through this negotiation about scheduled work within kind of an unscheduled craft.
Eric Gehringer
That’s exactly right. So figure about 60% of our TE&Y force are unscheduled. The other 40% they work in yards. They work on locals. They kind of — same schedules. This pilot is down in Kansas. And what it really is, it’s a relatively small group of people, because we want to learn and what we’re putting them on is 11 and four schedule.
And so, what they’ll do every — what we call half every 15 days, is they actually will know which days within that 15-day period are they going to have off. It’s something we have to do through the collective bargaining agreement. We can’t just instantly put that across the system. But I am — I’m very excited to see over the next we have about 60 days left in it, to see the results of that and then see how we can be thoughtful about expanding that.
Garrett Holland
As we pull up and think of longer term, the number of cross wins this year, I guess help us think through some of the factors where you may be over-earning or under-earning relative to plan as we try to model out 2023, 2024.
Jennifer Hamann
Well, probably the swing factor is fuel to a degree and fuel surcharge. So, while fuel has definitely been a headwind to our operating ratio performance here in 2022, it’s been a tailwind from an operating income and EPS standpoint. And so, going into 2023, we’ll see where that plays out. It’s hard to think that it’s going to have that same magnitude on either of those metrics in terms help or hurt, but we’ll see.
If you go into a period of time where the economy really slows down, you could probably see fuel prices fall off. That’s historically what’s happened. So that’s probably one of the swing factors that’s outside of our — I shouldn’t say, probably it is outside our control, but that’s a swing factor that can make earnings look a little bit different in 2022 to 2023. We’ll see what happens there. We’re most focused on the things that we do control.
And those are the three levers you’ve heard us talk to historically. It’s the volume piece and I think we’ve talked about that. I think we feel pretty good about our ability to bring more volume onto our railroad next year. What that looks like in the context of the economy is still to be determined, but I think we will outperform. So I feel great on the volume side.
Price side is, obviously, the other piece, heightened level of importance maybe this year with the strong inflationary environment. So, Kenny and team are having those conversations. We know that it’s an absolute. And then, it’s the productivity and cost side and the efficiency piece and being able to leverage more volume across a very efficient operation, we know can generate really great earnings, very strong cash flow and that gives us a great opportunity to return that to our shareholders. So that’s very much the model that we have in mind and look forward to executing.
Garrett Holland
Very helpful. And we’re running up on time but I just wanted to — we covered the growth dynamics and the algorithm, but interested in your thoughts on some of the other targets you laid out at your Investor Day: 55% percent OR, if still achievable, still comfortable with those goals. Any thoughts there?
Jennifer Hamann
Yes. No. And we mentioned this on our third quarter earnings call. We still think that 55% is achievable. It’s not going to be the goal for next year. It’s going to take a bit because of some of the cost pressures inflation to get back to that. But we see no reason. We were there a couple of quarters. We see no reason fundamentally why we can’t get back to that level. We think it’s an important level from a competitive standpoint and we think we should be able to lead the league in terms of our operating ratio.
Garrett Holland
That’s great to hear. Well, with that, we’ve run out of time, so I want to thank Union Pacific. Jennifer Eric, really appreciate you being with us today. Thanks for everyone in the audience and hope you have a great rest of the conference.
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