Norfolk Southern [NSC] Conference call transcript for 2022 q1
2022-04-27 12:02:08
Fiscal: 2022 q1
Operator: Greetings, and welcome to Norfolk Southern Corporation’s First Quarter 2022 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. It is now my pleasure to introduce Meghan Achimasi, Senior Director of Investor Relations. Thank you. You may begin.
Meghan Achimasi: Thank you, and good morning, everyone. Please note that during today’s call we will make certain forward-looking statements, which are subject to risks and uncertainties and may differ materially from actual results. Please refer to our annual and quarterly reports filed with the SEC for a full discussion of those risks and uncertainties we view as most important. Our presentation slides are available at nscorp.com in the Investors section along with our reconciliation of non-GAAP measures used today to the comparable GAAP measures. Our full transcripts and download will be posted after the call. It is now my pleasure to introduce Norfolk Southern’s President, Alan Shaw.
Alan Shaw: Good morning, everyone, and welcome to Norfolk Southern's first quarter 2022 earnings call. I am joined today by Cindy Sanborn, Chief Operating Officer; Ed Elkins, Chief Marketing Officer; and Mark George, Chief Financial Officer. I would like to start by recognizing the contributions of Norfolk Southern's employees who have worked safely and tirelessly to serve our customers and a challenging supply chain environment. I sincerely appreciate the commitment of our employees to Norfolk Southern and our customers. Norfolk Southern delivered solid financial performance in the first quarter with record first quarter revenue, earnings per share and net income. While our operating and marketing teams worked around the clock with our customers to address current network challenges and a dynamic supply chain. We know we need to improve service and are committed to increasing network fluidity and restoring service to levels our customers deserve. Cindy will share updates on our accelerated hiring and progress of our new operating plan, TOP SPG. Viewing the results for the quarter, you'll note that revenue increased 10% as a 16% increase in revenue per unit more than offset a 5% volume decline. Expenses grew over $200 million or 13% year-over-year, due primarily to a sharp increase in fuel price. Higher fuel costs, along with slower network velocity and reduced volume contributed to an increase in our operating ratio, which was up 130 basis points versus last year's first quarter record. We remain confident in our ability to improve service while simultaneously delivering productivity and growth. Our outlook is bright. I'll now turn the discussion to Cindy for an update on operations. Cindy?
Cindy Sanborn: Thanks, Alan, and good morning, everyone. I'm going to talk to you all today about the outlook for our operations. During the past quarter, resource levels have challenged the fluidity of our operation, yet we have continued our momentum on increasing train size. We are in the very early days of seeing the fruits of our hiring initiatives and are working every avenue to improve service levels as quickly as possible. I'll provide an update on our Thoroughbred operating plan initiative as well as what we're doing with technology to make the railroad safer and more productive. First, turning to slide 6 as a recap of our operational activity metrics in the quarter, GTMs were down slightly, outperforming the unit volume decline as mix shifted modestly towards our heavier merchandise and coal segments. Our crew starts were down 5% in the quarter, which is a good news, bad news story. Resource levels prohibited us from operating some starts that we would have preferred to operate and our recovery mechanism was challenged as a result. However, on the positive side of the ledger, we continue to drive very beneficial road train consolidations across our segments, most pronounced in our boat franchise as we move similar coal tonnage with 6% fewer train starts and saw train weight up across the board for intermodal, merchandise and bulk. In an effort to improve resiliency, we kept a portion of the surge locomotive fleet active, yet we still achieved another quarter of fuel efficiency improvement. Turning to network performance on slide 7, train speed and terminal dwell closely resembled the levels they were at in the fourth quarter. Qualified T&E levels continued to decline throughout the quarter, culminating in what we expect to be the trough in March. As we start to see relief in certain areas, we are prioritizing crew starts that can have the most impact on customer service levels, and we are redeploying our go teams when possible. I want to reiterate that improving service levels is our top priority. And turning to slide 8, I will provide more detail on where we are with our hiring efforts. As we progress through 2021, we quickly identified the need to increase hiring within our transportation workforce. We were met with a very challenging labor market that made our ramp-up time longer than expected but we responded with a robust plan to streamline our pre-employment process, deploy a variety of financial incentives and mobilize additional onboarding resources. These efforts have paid off in a big way in 2022, and we now have over 800 conductor trainees on the property. As a result, we now expect our qualified T&E headcount to begin growing sequentially throughout the remainder of the year. We are laser focused on utilizing these additional employees to improve service levels and provide a solid platform from which to launch top SPG, which I will discuss on slide 9. As we did last quarter, I want to reiterate the approach of focusing on service, productivity and growth as equal pillars in our latest evolution of the top plan, which we envision launching in late second quarter. Let's talk about service quality and resiliency first. Several key elements of PSR are having a simple and executable operation as well as having a balance. You heard us talk about some of these PSR fundamentals when TOP21 was rolled out, and we now need to revisit a few of them with a renewed focus while ensuring they are embedded in all of our segments, including intermodal. One of the greatest strengths of our network is the quality and positioning of our intermodal franchise. And as we've performed the zero-based review of how we link together our major markets, we found opportunities to simplify how we connect those terminals while providing more capacity than what we have today. This will include ensuring we have assets flowing across our network in a balanced fashion so that less intervention is required for resources to be in the right place at the right time. Let me be clear, TOP SPG is another lever we're pulling to improve our service and represents an evolution of our current operating plan. This pathway towards enhanced service will allow us to better plan forward and execute longer trains. Additionally, going back to the idea of encompassing all business segments, while we've made great progress on enhancing book train sizes within coal, there is more runway ahead. Other facets of the bulk network such as grain, will see benefits as we develop the capability to run longer trains through those parts of the network, such as the mid west. This productivity dividend is very complementary to the service pillar as it will give us more flexibility to handle commodity volatility. These improvements in train productivity have obvious benefits of reducing labor intensity but will also propel further fuel efficiency improvements. Finally, these efforts will ensure that we grow capacity within our terminals and along our main lines, including the initiatives I've discussed with you before, to bolster our infrastructure with targeted siding extensions that are actively coming online. We are going to provide the capacity our customers want to grow with us organically while still creating the flexibility to respond quickly and effectively to new opportunities. Moving to our safety update on slide 10. We have seen improvement in both FRA train accidents per ton miles moved as well as the FRA injury index year-over-year. However, we will not be satisfied as long as there is a single injury or accident, which is why we continue our efforts to get better in this area every day. First, on the engagement front. In 2021, we conducted our first annual safety survey, which was across the entire workforce. This has provided us with insight on what and where we need to focus our engagement efforts. We've expanded our field training program to leverage outlets such as online training, classroom training and our signature safety train events so that we empower our workforce to actively engage in our goal of continuous improvement when it comes to safety. Lastly, we're making great progress building momentum with technology investments that are focused on safe and efficient operations, and I'll give a great example on slide 11 with an update where we are with one of our key technology pillars; automation. More specifically, we are using machine vision technology to detect component failures before they occur. We're in the process of deploying fully automated inspection corridors, which will cover more than 90% of the cars moving across our network using a variety of systems to detect signs and symptoms of pending failures before they occur. Equally as important as deploying the hardware is developing the next-generation AI algorithms that detect these failures with edge computing and procedures for intervening quickly. This is where we've made really exciting progress and we are already actively preventing incidents. We are finding that the technology is enabling us to achieve better outcomes than the human eyes alone can achieve. One reason for this is the power of seeing how these components are behaving on a train in motion versus well stationary during a manual inspection. We're generating high success rates with very few false positives and detecting components that need to be replaced, but had no outward indication to the human eye. The close and effective working relationship between our data scientists and field team is creating a feedback loop that is accelerating our progress. This is one of the most revolutionary technologies we are working on, and I'm extremely excited for what we are achieving with our relentless pursuit of safety first and productivity. I will now turn the call over to Ed.
Ed Elkins: Thank you, Cindy, and good morning, everyone. If you would, let's turn to slide 13. Our results for the first quarter lagged challenges that we experienced on the volume side with supply chain constraints and network fluidity. These were offset by record success in revenue per unit. Overall, our volume decreased 5% year-over-year in the first quarter, driven by declines in our intermodal, automotive and steel franchises. But despite these volume declines, total revenue improved 10% year-over-year to $2.9 billion due to higher revenue from fuel surcharges and strong price gains. Within merchandise, volume declines were led by automotive and steel for chip supply and equipment cycle time challenges significantly inhibited our ability to drive growth. Partially offsetting these decreases were gains in agri fuels, feed and aggregates due to increased gasoline consumption, higher demand for agriculture products and rising levels of construction spending. Higher fuel revenue and price improvement more than offset the headwinds from volume and mix that generate 4% revenue growth year-over-year, along with record level revenue per unit. Revenue per unit less fuel was also a record for the quarter. Total intermodal shipments declined 6% in the first quarter, driven almost entirely by the international market where tight drayage capacity, high street dwell for chassis and warehouse throughput drove customers to seek alternatives to Inland Point Intermodal, or IPI. Domestic shipments grew modestly year-over-year on sustained consumer demand that outpaced supply. However, as network velocity improves, and as top SPG is implemented, we're confident that we will provide the capacity our customers need to grow. Higher revenue from fuel surcharges was the leading driver of intermodal revenue growth this quarter, followed by storage revenue, price improvement and positive mix, all leading the record quarterly revenue metrics for the franchise. Intermodal revenue per unit less fuel grew for the 21st consecutive quarter. Now moving to coal. Total volume was down slightly year-over-year in the first quarter as gains in utility shipments were offset by declines in export coal. Utility growth was driven by higher levels of demand for electric power and the need to replenish depleted inventories. Our export franchise experienced a number of acute service disruptions that limited shipments for a period of time, resulting in a year-over-year decline. But despite these volume headwinds, coal revenue grew 25%, primarily due to price gains, underscoring the near-term market demand opportunities we effectively secured. Revenue per unit and revenue per unit less fuel reached record levels this quarter. Now let's turn to slide 14 for our market outlook for the remainder of 2022. In general, we anticipate continued, consumer driven strength in demand and improvements in our service product. Both of these will enable us to deliver year-over-year volume and revenue growth in 2022. However, we are closely monitoring a base of uncertainty in the macro economy, including inflation at levels we haven't seen in over 40 years, rising interest rates and evolving post-pandemic labor market and ongoing global geopolitical conflict. Merchandise volume growth will be led by agriculture, forest and consumer products where we're seeing elevated demand for products such as soybeans and corn as global food supply chains face ongoing uncertainty. The USDA recently increased their expectations for export soybeans from the US amid declining foreign availability and highlighted rising demand for corn, both of which create opportunities for rail transportation. Also contributing to volume gains will be automotive for US light vehicle production is expected to improve 19% year-over-year in the month of April through December on improving chip supply. Total construction spending in the US has been steadily increasing since mid-2020 and currently sits at the highest level on record, signaling opportunities for our construction related markets. Within intermodal, our expectation is for a healthy and resilient consumer in 2022 based on a strong balance sheet, suggest an increased spending power from excess savings despite record high inflationary pressures. Growth in the consumer led economy will drive demand for our domestic intermodal service, which we expect will benefit from service improvements in the second half of the year and drive growth to offset the volume declines that we experienced at the start of the year. Sustained tightness in the truck market and rising diesel fuel prices are both contributing to an economic environment that encourages highway to rail conversion and provides a superior value proposition for our customers because of our fuel efficiency advantage, especially when compared to the highway. For our international franchise, we're working diligently to create the capacity our channel partners need to take advantage of the opportunities on Norfolk Southern. Our efforts are expected to boost volume recovery and drive year-over-year growth in intermodal this year. And lastly, turning to coal. Record high seaborne prices continue in an already strong market that is amplified by geopolitical tensions. This will provide opportunities in the near-term. Pricing is expected to remain a tailwind in the export markets. Utility shrink continues with higher natural gas prices though it will continue to be counteracted by higher coal prices. Inventories are still lower than target heading into the summer season. In our domestic met market, consumer demand remains high for domestic receivers. Coal supply availability and production remain tight in every market, which will be the determining factor and upside potential. Overall, we're confident in the growth potential for Norfolk Southern for the remainder of the year. And we expect to deliver revenue and volume growth over last year. I would like to thank our customers for their partnership and reiterate that we remain intently focused on improving service and driving value for our customers and shareholders. I will now turn it over to Mark for an update on our financial results. Thank you.
Mark George: Thank you, Ed. I'm on slide 16. We delivered double-digit revenue and EPS growth in the first quarter. Both were record levels for NS. Starting with revenues, the 10% growth was despite the 5% volume decline, thanks to the strong RPU growth that Ed just detailed. Operating expenses were up 13%, driven in large part by a sharp increase in fuel prices, but also higher costs related to our network challenges. Despite revenue dollar growth exceeding OpEx dollar growth, we experienced a 130 basis point increase in our operating ratio. Recall that at the first quarter conferences, we previewed pressure on our OR, compared to our original expectation of flattish sequentially due to lighter volumes that we were experiencing to start the year and also the rapid rise in fuel expense. The way it landed, fuel prices alone represented 100 basis points of OR headwind relative to our expectations as well as year-over-year. We also booked an accrual adjustment within claims expense that created another 40 basis points of headwind. The volume shortfall also adversely impacted OR as we previewed, along with incremental service related costs. These were only partially offset by the strong RPU improvements. OR side, the operating income and earnings per share were both Q1 records growing 7% and 10%, respectively. Drilling into the breakdown of operating expenses in the quarter on slide 17, you'll see that 60% of the $206 million increase in the quarter was from higher fuel prices on a year-over-year basis. Purchased services was up $31 million or 10%, driven in large part from inflation and service related costs that more than offset benefits that would typically come from lower volumes. Equipment rents increased $13 million or 17%, driven by slower network velocity and less equity earnings from TTX. The $20 million increase in materials and others is driven by a $13 million accrual adjustment in claims related to the 2017 through 2020 years based on an actuarial study. Comp and benefits were up 1%, with compensation inflation offsetting savings from lower employee levels in several categories. Qualified T&E employees were down mostly offset by conductor trainees. The unwanted attrition of qualified T&E employees drove higher overtime cost to move the freight. Shifting to slide 18. In a discussion of the P&L below operating income, other income was a $5 million expense in the quarter, driven largely by losses on the company owned life insurance investments. Pre-tax income was up 5%, while net income was up 4%. Our effective tax rate in the quarter was 23%, in line with the 23% to 24% range that we guide. EPS was up 10% on the 4% net income growth, thanks to nearly 2.2 million shares repurchased in the quarter. We're moving nearly 1% of the outstanding shares. Closing with cash flow and shareholder distributions on slide 19, free cash flow was $605 million, down 19% from last year due to property additions in Q1 this year that are $124 million higher. Recall Q1 2021 property additions were quite low to start the year, due in part to weather. Free cash flow conversion in the first quarter was a healthy 86%. Despite a lower free cash flow year-over-year, shareholder distributions were nearly 7% higher with a 19% higher dividend payment and modestly higher share repurchases. We'll now turn it back to Alan for a wrap up.
Alan Shaw: Thank you, Mark. Turning to slide 20. We show multiple approaches on how we're building upon our record of sustainability leadership. With the launch of our next-generation carbon calculator in mid-March, we've made it easier for customers to do business with us, incorporating carbon into their freight decision framework with quantifiable benefits of utilizing the most efficient and least carbon intensive mode of ground transportation. Also in March, we announced the continuation of our locomotive modernization program in partnership with Witek, which will improve our operational performance and reliability and help us achieve our science based target emission reductions, up 42% by 2034. The pace of our sustainability initiatives has increased and is recognized in the industry as evidenced by several prestigious awards received in the quarter, including named as supplier engagement leader by Carbon Disclosure Project for 2021 recognized with the 2022 Green Bond of the Year award from Environmental Finance and earning the Responsible Care Energy Efficiency Award for locomotive fuel efficiency, from the American Chemistry Council. We are incredibly proud of our progress in this area, and we will continue to build upon our sustainability initiatives, which are good for business and the right thing to do for all of our stakeholders. Let me close by confirming our commitment to deliver our targets this year. Our confidence at this stage is based on our assessment of economic indicators, which at this time remain supportive of manufacturing and consumer activity as well as our service recovery efforts associated with accelerated hiring and the successful implementation of TOP SPG. These factors will support healthy volume growth in the back half of the year. In fact, potential upside exists to our revenue outlook and energy prices remain elevated throughout the year. As you've heard from our entire team, we are disappointed with our current service levels. We are laser focused on restoring the quality of our product to a level that allows our customers to succeed and grow. We are confident that our decisive actions to restore service, including hiring and the launch of TOP SPG will create long-term sustained value for our customers and shareholders, leveraging our unique franchise strengths. Before we open the call to questions, I want to take the opportunity to thank our retiring CEO, Jim Squires for his tremendous leadership to our company over the past 30 years. During Jim's tenure as CEO, NS improved our operating ratio by more than 1,200 basis points, more than doubled our market cap and returned over $17 billion to our shareholders. He led our company through the challenges of our freight recession and global pandemic. Jim launched an industry leading digital transformation strategy, elevated sustainability to a strategic business priority and personally championed diversity and inclusion. And Jim united our team and the new headquarters in Midtown Atlanta last year. On behalf of all NS employees, retirees and stakeholders. Thank you, Jim, and we wish you and your family all the best in your well-earned retirement. We will now open the call to questions. Operator?
Operator: Thank you. We’ll now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Chris Wetherbee with Citi. Please proceed with your question.
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Operator: Thank you. Ladies and gentlemen, that concludes our question-and-answer session. I'll turn the floor back to Mr. Shaw for any final comments.
Alan Shaw: Thank you for your time and your questions, and I appreciate you joining our call this morning.
Operator: Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.
