Union Pacific Corporation (NYSE:UNP) Cowen 2022 Global Transportation & Sustainable Mobility Conference September 7, 2022 8:40 AM ET
Company Participants
Lance Fritz – CEO, Union Pacific
Conference Call Participants
Jason Seidl – Cowen and Company
Jason Seidl
Good morning, everybody, and welcome to Cowen’s 15th Annual Global Transportation & Sustainable Mobility Conference. I’m your host, Jason Seidl. With me today, we have Lance Fritz, CEO of Union Pacific.
And I just want to say, what an honor it is to have Lance join us. 15 years ago when I started this conference, never could I have envisioned it getting so big is to have so many great companies presenting.
I’m going to turn it over to Lance. He’s going to run through about half a dozen slides and then we’re going to go back to a fireside chat Q&A.
So without further ado, Lance, please take it away, sir.
Lance Fritz
Yes. Thank you, Jason, and good morning to all of you who are joining us this morning. Just before I get started, some cautionary information, the slides that accompany my prepared comments can also be found on our investor website next to this webcast event.
And also before I start, I’m going to be making some forward-looking statements and they’re subject to the risks and uncertainties that we outlined both on our website and our SEC filings. So please refer those for additional information.
So I’m going to start out talking a little bit about service and which service? I feel like there is real positive momentum in the revenue side is — you can see it in our overall statistics. We’ve seen gains in our operating metrics, current freight car velocity is around [Audio Gap]. I expect the Labor Day holiday to get in the way a little bit, but only briefly with much less impact than we saw for 4th of July or for Father’s Day or Memorial Day for that matter.
Our cars per carload remain in the low 8s, 8.2, 8.3 something like that. But one of the most important things that we’ve done is we’re using our crews much more efficiently. Recall that the big causal factor for us in terms of the kind of congestion we saw in April coming from March into April was both crew availability and crew utilization.
I’m really pleased to announce that our recrew rate, which had been 11-plus percent in April is down to about 7%, 7.5%, which generates crews all by itself. And we’ve been graduating — hiring and graduating new conductors. So far this year, we’ve got somewhere north of 650 graduated. We’ve got another somewhere 450 to 500 in the pipeline, and our expectation by the end of the year is to higher and ultimately graduate 1,400 new crew.
We do use some borrow outs. We’re using them exclusively in the North that’s where we are short on crews still, but we are remedying that as we graduate and as we get away from the holiday season, we’re in pretty smooth sailing for the rest of the fall, and I expect continuous improvement in terms of increasing car velocity, improved utilization of crews and improved car per carload metrics.
Turning to the PEB and labor negotiations. You all know we had a Presidential Emergency Board. We are about 2.5 weeks following its findings. We’ve got 5 of our 12 unions have signed a temporary agreement and they are taking them out to ratification. That leaves seven, which means there’s still plenty of hard work.
And we’ve got till September — the end of September 15, beginning of September 16 for the end of the cooling off period. And our job is to try to get as many unions as possible, preferably all of our unions signed up for an agreement based on PEB recommendations and then getting into ratification.
Let’s go to Slide 4. The third quarter volume to date is looking pretty good now. Volumes across all three business teams have been impacted in the second quarter and early third quarter by actions we took to regain fluidity in the network. But those impacts are less and less every day, and we can see that in volume growth. We’re seeing good strong demand in most of our commodities.
When you look at volumes year-over-year were up 4%, bulk is up 4%. And that’s driven by grain and grain products that are up 7%, continued strong coal demand that’s up about 5%. And our cycle times on our shuttles and in our coal sets are all improving, which is supporting increased loadings.
If you look at Industrial, we’re up 4% as well, and that’s very broad based. There’s growth in those markets supplemented by our business development efforts, and that’s led by metals and minerals up 6%, and Industrial Chemicals up 5%. And then in premium, we’re up 3%. Automotive is leading the pack there. Finished vehicles up 28%, auto parts up 7%, Intermodal volumes are up 1%, with international up 3%, parcel down 12% and truckload up 1%.
And in terms of the customer experience, we go to the next slide, A key component of our strategy, which is serve, grow, win and doing that together, our 2022 success factors is expanding our book of business and advancing the customer experience. We are integrating ourselves more closely with our customers to understand their needs.
And that’s focusing in on, first and foremost, consistent and reliable service. That’s why we spend so much time talking about regaining fluidity in the network making sure we have exceptional exception management when something goes wrong, over communicating and making sure we have solutions for our customers, seamless interactions and tools to interact with us easily.
And developing APIs. We have over 50 APIs right now that allow customers to connect into us seamlessly gather the data they want to use in their systems and that that suite of products allows us to be much more truck competitive. And then the last thing to mention is creating stickier strategic partnerships with our customers, which allows us to see more of their book to grow and makes us a more important supply chain partner for.
If we go to the next slide, let’s talk a little bit about our environmental stewardship. You all know we’ve set SBTI targets to reduce greenhouse gas emissions by 26% by 2030 and to be net zero by 2050. So far, what we’re doing. The first thing is achieving that 2030 target requires us to consume a great deal more bio and renewable diesel. So our consumption rate of biofuels is above 4% right now, we’re targeting 10% by 2025 and 20% of the blend by 2030.
If we do better than that, we have an opportunity to do better than a 26% reduction in our greenhouse gases by 2030. We’re also modernizing our locomotive fleet, modernized locomotives that are more fuel efficient, and we can reduce emissions from the units by over 50% for each unit that we modernize, plus we get a substantial boost in reliability, which helps our consistent and reliable service product.
We’ve got an agreement that you all saw, I believe, which we signed with Wabtec to modernize 600 locomotives between 2023 and 2025, the price tag a bit over $1 billion. And we purchased or are in the process of purchasing 20 battery electric locomotives for use in our yards. We’re going to test out getting to a zero emission with battery electric locomotives in our yards. And if it works, we’ll spread that through the entire network.
We’re not yet seeing the technology available converting units over line of road to battery electric. But we’re experimenting there also with an eye towards fundamentally changing fuels like to hydrogen. And then the last slide, we continue to deliver increased shareholder value. Growth is becoming a bigger part of being able to deliver that. The recovery plan is demonstrating progress.
That’s a foundation for being able to grow. Our transformation through implementation of PSR has created a really strong foundation even through the pandemic. And the fundamentals for long-term success remain in place. We’ve got good strong business development wins.
I show a few here on the slide. We’ve got a very strong balance sheet and strong investment credit rating, and we are very efficient and good developed creators and deployers of capital. And we’ve got an industry-leading dividend with very strong track record of dividend increases in the last year or 1.5 years.
So with that, Jason, why don’t I turn it back over to you so we can get into Q&A.
Question-and-Answer Session
Q – Jason Seidl
Fantastic. Thank you, Lance. And let me remind everybody that’s listening in, you could ask a question, you could type it in and your webcast chat there. I will see it. Or an alternative method as you could e-mail me at jason.seidl@cowen.com. So let’s kick it off a little bit and talk about some of the volumes that you spoke of. Things seem to be going well, which is a great sign.
Can you really narrow it down a little bit more, talk about what’s maybe a little bit more positive or potentially a little bit more negative than the last time you spoke to investors during your 2Q results?
Lance Fritz
Yes. So Jason, let’s start on the negative side and then I’ll end on the positive. The negative side is clearly consumers are under pressure. We can see that in consumer sentiment surveys where they’re hitting lows for recent history. You can see it in kind of the political atmosphere there’s just so many markers that say, U.S. consumers and global consumers are very concerned and anxious.
Now having said that, they’re still sitting on a lot of powder. They’re still in a healthy condition on average as regards to their personal balance sheets. And then on the more positive side, we’ve really got some relatively easy comps year-over-year, and we’ve done a hell of a good job on business development to secure and win new business, really across the spectrum of markets, whether it’s us adding nice swift at the beginning of this year, Schneider at the end of this year or SDI as a new steel manufacturer, west of the Mississippi near Corpus Christi or any other number of new industrial and bulk customers.
We’re gaining market share across most commodities, and that makes us feel pretty confident in the growth that we see. The last thing I would say is, as I mentioned in my prepared comments, we’ve taken some actions since, call it, March, certainly mid-April to recover the network. Those actions limited the amount of volume that we were enjoying from our customers and supporting our customers with. That’s been — those actions have been having a less and less impact on volume as the network has increased its fluidity. And we’re in a place now where we’re seeing growth because our network is more fluid.
Bulk sets are cycling faster and we’re getting more grain loads. We’re getting more co-loads out of every set that we have in service. So as we look into the back half of the year, we think markets don’t have to get better for us to grow. We’ve got growth opportunity in coal, in grain, food and refrigerated we’ve got growth opportunity in vehicles. We’ve got growth opportunity in domestic and international, even though both areas are slowing down.
I think there’s still an opportunity for us year-over-year to show growth. So, we’re pretty eager really to keep moving into the second quarter, keep showing improvement.
Jason Seidl
It’s good to hear that, and it’s nice to hear that the consumer, at least might still hang in there with the dry powder. Could you talk a little bit more on the international and moral side? So it’s good to see that it’s growing. We have heard some signs of people moving some freight from the West Coast to the East Coast. You see that in some of the numbers we use coast ports.
Is this a real issue longer term for the West Coast ports when you add in maybe some of the Eastern U.S., maybe some of the CNS plans up in Canada and maybe even some of the touch runs we’ve seen from CPA and KSU from Lazaro or Chicago?
Lance Fritz
Yes. So, we definitely have an eye on market share and market share, but the potential for market share loss out of the West Coast ports. And it is a real issue. It’s been a real issue for two decades plus. The big catalyst tends to be labor disruption.
When we have a labor disruption in the West Coast ports, that tends to be a real driver of share loss, whether it’s on the East Coast or Canada or potentially to the Gulf Coast. The good news is, so far, the ILWU negotiations smoothly, that contract expires, I believe, or expired, I believe, on July 31.
But so far, both sides seem to be negotiating in good faith and in earnest. And I feel pretty good about the ability for the West Coast ports to reach an agreement without a labor disruption. That’s very important. The other thing to note on International Intermodal is the international shippers themselves have largely moved back coming off the West Coast to normal behavior.
If you recall, in the back half of last year and early part of this year, our international carrier customers were trying to get their boxes back to Asia loaded and back on the water and an effort to do that as quickly as possible. They were transloading more in the Inland Empire in the L.A. Basin. And that meant less international boxes were coming to our railroad.
As of the middle of this year, call it, July, we were shipping 2x — over 2x the amount of international boxes inland than we were in January of this year. Our volume doubled coming off quarter.
Now it’s remained at about that level. It softened a little bit, and I anticipate the box volumes into the ports are going to continue to soften. We see box volumes coming out of Asia right now at about 10% or 15% less than they were, call it, a month or two ago. I think that’s indicative of plenty of inventory in the pipeline and retailers having to chew through that inventory.
But as I said earlier, year-over-year, because of that behavioral change by the international shippers last year, we’ve still got opportunity to show growth. And there’s still boxes on port that if at the inland distribution warehouses, customers start flowing their product a little more fluidly, we’ve still got some box volume, we’ll be able to take off port and continue.
Jason Seidl
Well, I was going to say this question for later, but it sort of fits better into here. So given what you just said about sort of the international intermodal, what are your views on peak season given everything you just stated?
Lance Fritz
Yes. We haven’t had a normal peak season in years. And I’m going to guess this year probably looks like a repeat. Who knows maybe, maybe peak has shifted fundamentally and really doesn’t exist like it used to. I think this year, for sure, what I’m hearing from our customer base is muted peaks, in some cases, might have already occurred.
In other cases, maybe it’s just attenuated on into the approach to the holiday season. We’re not counting on that for growth. It would be very helpful. If we saw consumers really amp up their spending, but I don’t anticipate that’s going to happen, not with as anxious as consumers are right now.
Jason Seidl
Okay. Let’s talk a little bit about service and headcount. You went over that. That’s great. Where are you versus plan in terms of headcount? Because if I talk to any CEO out there, and I think everybody said trouble hiring regardless of the industry that they’re in, this sort of has been a first a with the rails having this much difficulty. Where are you versus plan? And where is this going to track in terms of your operational performance as we move towards the end of the year?
Lance Fritz
Yes. So that’s a great question [Audio Gap] for hiring and graduating about 1,400 new team, new conductors. We came into the year about 300 people behind that hiring plan. We had started hiring about May, June of last year. As of right now, we’ve cut that deficit by about half, maybe a little better. And any deficit that is left tends to be in isolated areas where it’s very difficult to find workforce.
So for instance, places like Boone, Iowa or North Platte, Nebraska or places out in Wyoming, Green River, for instance. So what we’ve been doing is borrowing out into those locations. So we’ve largely got our workforce at around planned levels at most areas of the network, but it’s being done in the north in some spots through borrow outs as opposed to graduated hires on the ground. We’re in good shape generally in the South.
I had mentioned that we were crew deficit and our utilization of available crews was inefficient in the April time frame. Right now, our recrew rate is in historically very good condition. We could make another step, a percentage point or so move, but we’re comfortable where we are right now, if this is where it stays. And as we continue to hire and graduate, we’re continuing to get healthy. What I ultimately want to do is get those borrow outs back to their home terminals and replace them with hires.
We have done a couple of things in the hiring that have helped. Second chance hiring has created a whole new labor pool. That’s where we’re finding people who have a record and have served their debt to society. And then we partner up with somebody to look through the 20-plus million adult working-age U.S. citizens who have a felony record and look for the ones that are employable that want to work. They just made a bad life decision and they’d be wonderful employees. And we’ve had great success with that so far.
So we’re going to keep that up because that opens up a whole pool of employees, potential employees. And we’ve had great success with a recommendation with the referral program. We launched the referral program at the beginning of the year, and we’ve had around 10,000 referrals, maybe a bit over that have generated something like 1,500 offers and something over 800 near 900 hires. That’s just in the first, call it, eight months of 2022. It’s us. So there’s a lot we’re doing to find the people we need. We are finding the people we need. There’s a few spots that are very difficult.
Jason Seidl
Well, that sounds promising. I’m going to shift the discussion a little bit here. We haven’t talked about pricing. When I look back over the better part of more than a decade, the rails have been able to price above the rail cost inflation. However, what’s sort of changed this year is we’ve never seen inflation like this, at least in my analytical career. So is the rise in inflation, sort of the pace that’s been increasing, going to endanger the rails not being able to do that for maybe a quarter or so just because of how things are going to fall?
Lance Fritz
Yes. Let me first state unequivocally, we can get more dollars in price yielded than we experienced inflation dollars. That’s been our mantra for a long, long time, and this is a very difficult environment to make that true and we still see that it’s going to be true. So having said that, yes, you’re exactly right, Jason.
It’s a difficult environment. I mean we’ve got suppliers of our own strategic suppliers showing up virtually every day within contract telling a story of a need for a price increase unscheduled and essentially really pleading for us to consider it. Now in circumstances for very rare occasions, sometimes that makes sense. But it’s a very difficult environment. Inflation is quite real right now.
And in turn, we’re going to our customers. And even in an environment where our service product isn’t where it needs to be. We still have to ask our customers because of the inflationary impact on our cost as well as the lack of available capacity to handle their volume. We are asking for price increases to overcome and account for those pressures. So yes, it’s quite real, Jason, and it’s quite difficult, but we remain confident that we’re going to be able to get the pricing dollars ahead of inflation dollars.
Jason Seidl
And I imagine as your service levels improve, those conversations with your customers become a little bit easier?
Lance Fritz
Service is the salve for virtually everything, whether it’s the STB or our customer attitudes, and it’s fully understandable. Our customers have bought a service product for us. They rely on us in their supply chain and we’re doing everything in our power to recover back to that point. We’ve made really good progress to this point, but we are not still have a lot of hard work left to do.
Jason Seidl
Okay. So you mentioned the STB, let’s talk about it a little bit. I’ve covered the industry 24 years. This feels like the most for lack of a better word, rail hostile STB. So what do you expect out of them? And what can they do given their limitations as an organization?
Lance Fritz
Yes. So clearly, the STB is postured to be a more active STB than we — it’s not unprecedented, but they’re clearly quite active. And they’ve got a lot on their plate to make decisions about. What we do is we engage with both the Board members and their professional staff with frequently.
There’s somebody from the UP in discussion with somebody at the STB weekly, whether it’s about current service product ideas to resolve those service products or what they’re working on actively in terms of regulation like whether it makes sense to take exemptions away from fully truck competitive product like intermodal or scrap steel or whether it makes sense to open up every Class 1 railroad property to competition, in order to satisfy an individual customer’s desire essentially for better price in the guise of better service.
Because we all know that opening up to forced open access won’t create better service. It will create interchange where there’s not investment to handle it and a disincentive for the serving railroad to invest in the property because they don’t know if they’re going to be able to benefit from the line haul from that customer.
So going back to your original statement, our primary objective is to get service back as quickly as possible and remain there with consistent and reliable service so that customers want to grow with us, customers don’t feel a need to go to the STB and complain. And if they do, there’s really not a ground for those complaints when it comes to the service product. It becomes a little bit more apparent that that maybe they’re transparent as on price.
Jason Seidl
Okay. Great. Let’s talk a little bit about CapEx. I think for ’22, you’re probably largely set. I know you haven’t said anything about 23%, but directionally, can you talk about it a little bit? And also in terms of use of cash ’23, there have been some law changes that might impact people’s buyback patterns. Do you foresee that changing how you are sort of giving back the money to investors?
Lance Fritz
Yes. Great question, Jason. So let’s start with your last question then we’ll end. So you know that we are a great generator of cash. We focus on it. And right now, in today’s world, let’s call 2021 a $9 billion, $9.5 billion kind of generator of cash in deploying that cash, job one is pay our employees, job two pay all of the vendors and the support teams that help us run the railroad.
And then job three is paying back to shareholders. But before that, in support of the railroad, there’s capital which I’ll get to at the tail end. When it comes to paying it back to shareholders, we do two things. We have an industry-leading dividend. We say we’re going to pay back something like 40% to 45% and we try to stay within that knowing that we want to keep dividends relatively smooth so that our shareholders can rely on them.
And we also pay back through share repurchases. And because we have ever increasing cash generation capability, we can use the balance sheet to do that, too. We do have new law that says there could be a tax on shareholder buybacks. And that will impact to a certain degree, the amount of cash we have available to do that might have an impact in the first year of implementation in terms of reported metrics like EBS, but that’s still a very tax-efficient way to report our shareholders, and we still plan to use it.
Let’s talk about capital now. CapEx for this year is 3-ish and we’re right on track for that. And that’s going to a lot of different places. There’s a lot of capacity additions that are occurring so that we can continue enhancing the service product and the efficiency of the service product, something north of 20 siting and siting extensions around the railroad. That’s a very big number for us. But it’s becoming the kind of number we’ve done in the last two years or so.
We’re doing a lot of capacity additions on intermodal ramps to support new business. We’re doing a fair amount of equipment purchasing where needed. And when I look into 2023, I think the best marker to use is we’re going to consistently be below 15% of revenue as we’re building the capital plan, I don’t see a reason to go above that. And I think the capital plan is going to reflect both some of what we’ve announced. We’ve announced locomotive modernizations that are going to consume some capital but also consistent and reliable service enhancement, making sure we’re ready for the growth of Schneider and other domestic intermodal business and then continually enhancing the technology that we’re using on the railroad.
So, I expect a little bit of all of the above showing up in next year’s cap.
Jason Seidl
That’s great color. I’m going to jump to questions here because we’re running out of time. We got a bunch. I apologize we’re not going to get to all of them. A question from a client.
Could we clarify when Lance says consumers are under pressure. Does that fully explain the parcel decline? UPS had mentioned taking volumes from rail to truck?
Lance Fritz
Yes, I think it does. Candidly, I’m not seeing a lot of volume from rail to truck with any of our primary customers. But I am seeing parcel volume decline because consumers are buying less good. They’ve converted some of their purchasing to experience, and that was expected. Remember, there was a massive shift in the early part of COVID to goods purchasing and I think the heat’s come off of that a little bit.
Jason Seidl
Okay. I’ll just slip one more in here with a minute to go. For the service metrics, have you considered measuring actual trends at time against trip plans or initial ETA?
Lance Fritz
That’s exactly what we do. Trip plan client is exactly that. We are in the middle of reconfiguring some of our customer service metrics. Those aren’t ready for prime time yet, but there’s a lot of homework there. And that homework is all built around what customers want us to measure that more closely matches their need.
So stay tuned for that. We’re months away from doing anything about that. But we’ve been working at it for quite some time. And to your point, yes, trip plan compliance is about measuring against trip plan, whether — whatever kind of product you are. So you’re on top of that.
Jason Seidl
Right, fantastic, but we run out of time and on behalf of myself, my team, and the entire talent organization, Lance, thank you very much. It’s been an honor to have you and everyone be safe out there at UNP.
Lance Fritz
Thank you, Jason. We really appreciate.
Jason Seidl
Take care.
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