CSX Corp (CSX) — Q3 2022 Earnings Call Transcript

Thank you, operator. Good afternoon, everyone, and welcome to our third quarter call. Joining me on today's call are Joe Hinrichs, President and Chief Executive Officer; Jim Foote, our outgoing President and Chief Executive Officer; Kevin Boone, Executive Vice President of Sales and Marketing; Jamie Boychuk, Executive Vice President of Operations; and Sean Pelkey, Executive Vice President and Chief Financial Officer. In our earnings presentation, you will find our forward-looking disclosure on Slide 2, followed by our non-GAAP disclosure on Slide 3. And with that, it's my pleasure to introduce our President and Chief Executive Officer, Joe Hinrichs.

All right. Thank you, Matthew, and hello, everyone, and thank you for joining our conference call. I'm excited to be here with you today on my first earnings call as President and CEO of CSX. The entire CSX leadership team is here with me this afternoon, and we appreciate the opportunity to discuss our strong third quarter results with you. Our whole team is very motivated to build on our current momentum, strengthen our key relationships, provide better service to our customers and deliver profitable growth for years to come. We will achieve this through our One CSX culture, which at its core means one team working together to serve all our key stakeholders. As Matthew mentioned, also joining us on tonight's call is Jim Foote, who as you all know, led this company through its remarkable transformation over these last five years. Jim cares deeply about this railroad and its employees, and he has already been a great resource during my first several weeks in this role. I'll be happy to have his invaluable advice in the months ahead, and I want to thank him for all the help you have given me personally as I get the privilege to follow him. Jim, on behalf of everyone here at CSX, thank you.

Thanks, Joe. As I have said on every earnings call since I took over as CEO five years ago, I am incredibly proud of every CSX employee who has been by my side as we transformed this organization into the best railroad in North America, a company that's safer, more efficient, more profitable and far more successful than when we started. I have the utmost confidence that Joe and this team will take this organization to even higher levels of success. This transition process has been underway for a long time. It was critically important that the Board and I ensure that a succession plan was in place when the right time came. Having seen CSX through the initial phases of our transformation, pass some unusual challenges. And now with our operating performance starting to get back to normal, it's the right time for me to step away. Joe is a great guy. He is very talented, and he brings a tremendous amount of operations experience in running a large, complicated industrial company. His years working with a diverse unionized workforce will clearly serve him very well. It's truly been an honor to serve as President and CEO of CSX, and I wish all of you and everyone connected to this railroad the best. And now back to Joe.

Thanks, Jim. I promise you this team won't let you down. I am honored to be here on behalf of the entire CSX team. I've spent the last month traveling all across the network, visiting our facilities and meeting with our customers, our employees, union leaders, regulatory partners and government officials. At this point, I can tell you two things for certain. First, this is a fantastic railroad. Our people and our infrastructure are second to none and the principles of scheduled railroading that drive our successful resilient operating model are deeply embedded throughout the company. I knew that CSX was a very impressive place when I started, but I did not appreciate how impressive it really is until I saw for myself how this team of skilled, dedicated men and women work together to move thousands of box cars and containers for our customers each and every day. Second, for as much as this company has achieved over its transformation during the last several years, there is still so much more that CSX can do. Rail is a low-cost freight solution. Rail is a freight solution with low emissions. Manufacturing investment in the United States is accelerating. We have great advantages in this market, and our customers should have every reason to ship more by CSX rail, but we have to focus our efforts to make this happen. We have to make it easier for our customers to use our service. We have to provide better service to our customers. We have to engage with all of our employees, especially those out in the field serving our customers every day to ensure that we deliver the reliability that we promised. And we have to challenge ourselves to nurture the kind of culture that fosters a nimble creative and market-leading company, while staying true to the operational discipline that makes this all possible. The concept of one CSX as one team working together to accomplish great things can be very powerful. We have to bring one CSX to life. We'll talk more about that in a few minutes. But now let's turn to our presentation to review the financial highlights for the third quarter of 2022. CSX moved nearly 1.6 million carloads in the third quarter and generated approximately $3.9 billion in revenue. Operating income increased 10% year-over-year to $1.6 billion, which includes the effect of additional labor and fringe expense related to the tentative agreements reached with our unions last month. Results this quarter also reflected lower real estate gains compared to last year. Earnings per share increased 21% to $0.52 a share. Our operating ratio for the quarter was 59.5%. Now let me turn it over to Kevin, Jamie and Sean for the details.

Thank you, Joe. Turning to Slide 5. Third quarter revenue increased 18% year-over-year with revenue growth across all markets. Overall volumes were up 2% as modest volume growth in merchandise and intermodal more than offset a minor decline in coal. Merchandise revenue increased 14% on 1% higher volumes, driven by pricing that reflects rising cost inflation and higher fuel surcharge revenue. We saw strength in the automotive market, where revenues rose 31% on 13% higher volume. Semiconductor challenges continue to ease and we see significant finished vehicle inventory that needs to move. Ag and food was also a bright spot as improving cycle times, as well as stronger demand for grain, wheat and ethanol resulted in revenue growth of 25% on 10% higher volume in the quarter. Fertilizers and metals and equipment both saw modest revenue growth despite volume declines in the quarter. Fertilizer shipments continue to be impacted by reduced phosphate shipments and production facility turnarounds. Lower metals and equipment shipments reflect volatile commodity pricing and mill maintenance outages. Intermodal revenue increased 19% on 2% higher volume, as yields remained strong and supported by high fuel prices. International shipments were partially offset by lower domestic volumes, which reflected tight equipment availability and softer truck market. Intermodal demand remained strong in the quarter, with the team continuing to collaborate with customers and identify new opportunities, including a new international service line that contributed to growth. Customers continue to recognize our industry-leading service product in a challenging market, as they seek lower cost and lower emission alternatives to truck. Coal revenue increased 36% on 2% lower volume as pricing continues to benefit from strong export benchmarks. Volumes remain limited in the quarter due to production issues at the mine, infrastructure constraints at the export terminals and general manpower shortages, though our crew availability did show improvement into the end of the quarter. We were also able to reopen portions of our Curtis Bay Terminal in September, which provides additional volume opportunities as operations normalize. Demand remains strong and we see opportunities to move more volume as some of these constraints ease. Trucking revenue increased 26%, mainly due to strong core pricing and higher fuel recovery. Other revenue increased largely due to higher intermodal storage and equipment usage fees. The strong sequential increase was driven by continued limited warehouse capacity at customer sites. Looking forward, there is obvious macroeconomic uncertainty as the Fed remains committed to raising rates and addressing high inflation. Given this backdrop, the team is highly focused on its efforts to drive strategic growth opportunities that target truck and expand CSX's addressable market. As you've seen, our select site program continues to facilitate new customer partnerships. Last month, a key emerging domestic lithium supplier for the EV and battery markets announced the construction of a $600 million refining and manufacturing facility on a CSX serve site in Tennessee. We also have several other potential projects in various stages of development. We continue to see customers investing in new projects across our network. We're also moving forward with efforts to facilitate ESG solutions for our customers. Before year end, we will be releasing an updated version of our carbon calculator that is integrated within our ShipCSX interface. This new calculator will enable customers to drive into much deeper detail and understand in real time, the environmental benefits that CSX Rail can provide. Finally, we are also encouraged that service performance is on an upward trend and we expect to turn this positive momentum into additional opportunities with customers.

Thanks, Kevin. Safety remains our top priority at CSX and operating safely is the foundation of our service restoration efforts. In the third quarter, our personal injury rate and train accident rate decreased sequentially. Though we are not satisfied with our performance, I'm encouraged by our success, especially given the number of new employees across the network. As we mentioned last quarter, it is critically important to instill a culture of safety in our new T&E employees from day one. That emphasis on safety does not end when new employees graduate from training. It requires continuous attention throughout every railroader's career. To reinforce this, we are actively engaging with new hires and all of our employees in the field to discuss recent injuries and accidents, to ensure that we take each opportunity to learn from one another. In the fourth quarter, our efforts will continue to focus on making sure our employees are protected from incidents that commonly occur as weather changes. Increased education and awareness of seasonal safety risks will help our team become safer. Turning to slide 7, we are encouraged by the recent improvement in our operational performance. These strong results are a testament to the one CSX team and their unrelenting devotion to serving our customers. If we only look at the third quarter averages, train velocity, the well and carload trip plan performance all showed deterioration versus the prior year, though intermodal trip plan compliance continued to improve 240 basis points. However, on the right side of each chart of this slide, shows the substantial improvements we have made throughout the quarter and continue into recent weeks. As shown here, in the most recent four week performance, all of these four key operational measures are above the averages for the third quarter 2022. But they're also ahead of third quarter 2021 performance. We are confident that these metrics show that our efforts to hire, train and retain new employees are starting to take hold and make a difference for our customers. Though we are encouraged by the operational momentum, we will not let up. We will continue to push forward and take actions necessary until service is fully restored to a level that our customers expect. We are promoting new conductors, allocating the appropriate number of assets and improving the overall reliability and operational resilience of our network.

Thank you, Jamie, and good afternoon. The favorable operating momentum, Jamie discussed was accompanied by strong revenue growth of 18% or $600 million, including gains across all markets. Operating income was up 10% to $1.6 billion as top line gains outpaced expense headwinds from higher fuel costs, inflation, and tentative union agreement impacts that I will discuss in more detail on the next slide. The operating ratio was 59.5%, which, as a reminder, includes roughly a 250 basis point ongoing impact from quality carriers. Interest and other expense was roughly flat, as was income tax expense. The effective tax rate in the quarter was 21.9%, lower than our statutory rate as a result of a favorable state legislative change. As such, net earnings of $1.1 billion, was up 15%, with EPS up 21%. Now, let's take a closer look at expense on the next slide. Total third quarter expense increased $460 million versus the prior year. Fuel was up nearly $200 million, primarily due to higher prices. Inflation remains above historical levels with $82 million of inflation across labor, PS&L, and rents. Labor inflation alone was around $50 million, which reflects the proposed wage rate increase from the tentative union agreements. In addition, we recorded $42 million of out-of-period expenses related to adjusting union labor accruals for the tentative agreements. The most significant piece of this is the impact of the proposed union bonuses. When you think about labor expense going forward, the $42 million is a net catch-up and will not recur. The base labor per employee, excluding this impact is expected to be the new run rate for Q4 and into the first half of next year. Of course, comp per employee will also be impacted by seasonality mix and other factors, but the full impact of the tentative union agreement is now in our base labor costs. We do expect some of the congestion related expenses to continue into the fourth quarter, but view these costs as the first efficiency opportunities to be realized as we achieve sustained improvements in network performance.

All right. Thank you, Sean. Now let's conclude with a review of our outlook as shown on slide 12. There is no change to our expectation for double-digit revenue and operating growth for the full year, excluding the effects of the Virginia real estate transaction. While there is uncertainty in the global economy, we feel confident in our ability to deliver on this guidance as we look over the remainder of this year. As we mentioned in our earlier remarks, we are pleased with the positive momentum in our service metrics. And we continue our hiring and training efforts to ensure that we have the resources needed to build on these trends and drive improved network fluidity. We remain committed to returning excess capital to shareholders, as you saw over this past quarter. And finally, we reiterate our priority to building a unified cohesive culture of ONE CSX that will strengthen the relationships we have with our employees, customers and all other stakeholders. This is a great company. And working together, there is so much more that we can accomplish. And that's why I'm so excited to be here. Thank you all. I'll now turn it back to Matthew for Q&A.

Thank you, Joe. Now in the interest of time, I’d ask that everyone, please limit yourselves to only one question. And with that, operator, please open up the line.

Can you discuss your learning curve, why you are suitable for this role, and what you hope to achieve? Additionally, could you elaborate on the trucking aspect? You mentioned the rate ramp. Does loose capacity affect it, or is the chemical business fundamentally different from trucking? I'll let you start with that, Joe.

Okay. Thanks, Ken. Well, I think Jim highlighted a couple of things, but certainly, the labor side of the business experience in the automotive industry is applicable to our situation that we're in now, when you look at working through with our labor union partners, tenant agreements and ratification and working through those issues. But more importantly, I had the opportunity to be a customer for 20 years of the rail industry and have shared a lot of those experiences with our team and have challenged us to continue to look at things from a customer perspective to make sure that we are holding ourselves to a higher standard of service and accountability for our side of this relationship. I can tell you that when you deliver a better service and more reliable, predictable service, we want to do more business with you. So, we'll have to chase growth by trying to do unnatural things. We need to continue to do the things we're doing, leverage our operating model to continue to deliver better service. And with that increase the headcount and with that, comes the opportunity to serve our customers better.

Yes. I mean you have to remember when we were looking at this business, it's high touch customers who really care about product quality. Pricing has been very, very good and continues to remain that way. And so that's what we continue to see. It's a very, very different market. People have to be highly trained, highly skilled to do that business, and they have a great workforce doing it.

Hi, Thanks, afternoon, guys. Sean, maybe just any near-term color guidance on the other revenue, the labor comp per employee, anything on operating ratio in Q4. And then, Joe, just it sounds like more of a focus on service culture, so maybe, I guess, more of a growth focus. I guess how are you thinking about the ability to grow and improve operating ratio over time, or is it more just about growth, or is it both? Just your big picture strategy going forward.

In terms of other revenue, we have previously indicated that we expect it to normalize as supply chains return to normal. However, that did not occur in the third quarter, as evidenced by the increase in our other revenue line. Our expectation remains that we should see a decrease in the fourth quarter and again into next year. Regarding the labor cost per employee, it’s helpful to consider the $42 million we mentioned, which pertains to out-of-period expenses related to the tentative union agreement. If we exclude that from our labor costs, that gives you the employee run rate to consider for Q4 and the first half of next year before the next increase takes place in July 2023.

The way I like to describe it really is just to step back for a second. I had the opportunity throughout the summer to educate myself on railroading and get educated on CSX. The way I like to describe is how we're looking at things is around improved safety, improved customer service, control costs, improve your asset utilization and engage and then ultimately, value and evolve your employees. So if you take a look at all five of those things, they're all very important. And so operating ratio is a big part of looking at controlling costs and your asset utilization.

Thanks. I appreciate the time guys. I wanted to get back to the coal side of it a little bit. Those outages have kind of continued both at the mines and the ports. Given the demand that you're seeing from your customers, is it possible to give any color as to how much incremental volume is achievable, let's say, in the next six months? Is that sort of if you're just categorizing areas of the business, that's probably the one area that we're looking into next year, there's the best growth potential? How do you think of it that way?

Yes. I think probably the gating factor as we get into next year, and we obviously are confident in resolving our labor issues as to what can the producers actually produce. Coal mines have been undercapitalized, quite frankly, and now have a lot of money looking for equipment, reinvesting. I anticipate it will get better. We also do have a mine coming online middle of next year that will help us and we have a number of them that are still ramping up. There’s clearly a need when you look at the utilities we serve; they have a lot of inventories they need to replenish, and we anticipate a lot more consistent deliveries over the next year.

Thanks, operator. Hi, everyone. Joe, hearty congratulations to you. I wish you the best, and Jim will miss you. Regarding the cost structure excluding fuel in the fourth quarter, I'm really interested in your thoughts for 2023, especially since we are still facing a high inflation environment. And related to that, Kevin, once Sean addresses this, could you share your confidence in your ability to grow the franchise sufficiently to achieve earnings and EBIT growth next year compared to 2022?

So I mean, think about the fact that the labor cost has now been reset. So we know what our base is kind of going into next year. Inflation doesn't show any signs of abating here more broadly outside of labor and recognize that some of our costs are based on lagging indicators, meaning they'll get set based on where the inflationary rates are in 2022 for next year. But that being said, we've been carrying extra costs here throughout the year as the network has not operated the way we would have wanted it to based on not having enough resources in the right places. That problem is rapidly getting fixed here. You can see it in the numbers over the last couple of weeks. And so some of those costs are probably going to be a bit sticky going into the fourth quarter.

I'm confident in what the team is doing and what we're going to be able to control going into next year. We have a tremendous amount of initiatives that are really taking hold, and we're really going to capitalize on the service product that we expect to deliver next year. We started the process very, very early in terms of looking at those. And so that's where my confidence lies. We were just with our short-line partners, and I think there's a lot of confidence that they have opportunities to go out into the market and take share from truck.

Thank you. Good afternoon. Jamie, I think last quarter, I asked you about capacity as you're still trying to ramp up the labor force. What would you estimate the spare capacity is today on the network to take on new business, meet this demand that you've been leaving on the table for much of the last 12 months? And, I guess, the other way to phrase it, too, is if we do go into a pretty deep downturn, is that capacity that you'd be willing to kind of flex off the network for a short period of time, or it's something you want to keep to make sure you're never short again?

When we take a look at the capacity that we currently have out there right now, it's all about people, people, people. And we've been saying this quarter after quarter. And you're right, we are getting closer to our targets, but we're still a few hundred people off. So we have pinch points out there that aren't as fluid as we want. Over the next couple of quarters, you're going to start to see that momentum continue to pick up. And as Sean mentioned, yes, we still have too many locomotives out there. If we get to that point, we know that we've really grown this company beyond where we think we can.

Wanted to see if you could offer maybe a quick thought on operating ratio in fourth quarter versus third quarter. Another railroad reported earlier today, Union Pacific and I think, surprised people a bit with talking about worse to normal seasonal OR in 4Q versus 3Q. So I wanted to see if you could offer a quick thought on that. And then for Kevin, I think in a higher inflation environment, you'd like to get more price, but the counterpoint to that is that the truck market is weaker.

I think typical seasonality, it's not always this way, but usually, it's a little bit worse from Q3 to Q4, and that's primarily because we start to wrap up some of our capital projects, and we've got some winter-related expenses that hit. Beyond that, hopefully, we're able to pick up some volume as the network starts spinning, take some costs out. And then I think it's a matter of what do we see on the intermodal storage side because that can be a bit of a swing factor for us as we sit right now.

What you have to remember is we don't really operate in the spot market when the truckers are getting 30%, 40% rate increases. That wasn't the reality of our business model. And so we're still leaning into that, and there's a lot of appetite that we continue to hear of companies wanting to do that and for the environmental reasons as well.

Wanted to come back to you, Jamie, on the headcount. The guidance is we're going to continue to increase transportation head count or store service. Can you frame what your expectations are for how large you need to get the headcount to get the service levels where you want it to be?

I would say, our target, as we said, at the end of this year, 7,000 active T&E. We're pushing up to 7,200 as we move forward to make sure we can handle the demand. If we get softening market and we come out of this, we are going to be prepared to handle all the traffic that comes back at us.

Thank you, operator, and thank you, everyone, for your interest in CSX. We look forward to speaking with you again on our next quarter.