Union Pacific Corp (UNP) — Q1 2022 Earnings Call Transcript

Thank you, Rob and good morning and welcome to Union Pacific’s first quarter earnings conference call. With me today in Omaha are Kenny Rocker, Executive Vice President of Marketing and Sales; Eric Gehringer, Executive Vice President of Operations; and Jennifer Hamann, our Chief Financial Officer. Before we discuss our first quarter results, I want to reflect on Russia’s invasion of Ukraine. The people of Ukraine have had their lives turned upside down and the UP family is holding them close in our thoughts and in our hearts. We have leveraged our resources to help, with a $500,000 donation from our foundation and by matching 2:1, our employees’ gifts to select charities that provide direct aid. I also want to recognize the Union Pacific team for more than their generosity. They are a team dedicated to serving our customers. But recently, our service product has not met our customers’ expectations. You will hear from Eric; we have an action plan in place to recover and it is starting to yield benefits. I am confident in our long-term ability to grow while providing our customers a reliable service product. As they have proven time and again, no matter the challenge, our employees rise to the occasion. Turning to our first quarter results, this morning, Union Pacific is reporting 2022 first quarter net income of $1.6 billion or $2.57 per share. This compares to first quarter 2021 results of $1.3 billion or $2 per share. Our first quarter operating ratio of 59.4% improved 70 basis points versus 2021. Business development and a robust demand environment drove 4% volume growth in the quarter, coupled with strong pricing gains and the positive business mix. However, our service challenges are contributing to higher costs in the quarter. That performance is also having a real impact on our customers and their ability to serve their markets. We must improve to realize the volume growth we expect this year and into the future. So, let me turn it over to Kenny first for an update on the business environment.

Thank you, Lance and good morning. First quarter volume was up 4% compared to a year ago. Solid gains in both our bulk and industrial segments were more than offset by a decline in our premium business group from continued global supply chain disruptions. Freight revenue was up 17%, driven by higher fuel surcharges, strong pricing gains, and a positive mix. Let’s take a closer look at each of these business groups. Starting with bulk, revenue for the quarter was up 21% compared to last year, driven by a 12% increase in volume and an 8% increase in average revenue per car, reflecting higher fuel surcharges and solid core pricing gains. Coal and renewable carloads grew 29% year-over-year driven by continued favorable natural gas prices and two new contract wins that started on January 1. Grain and grain products were up 1% in volume due to the increased biofuels production partially offset by fewer grain shipments from longer shuttle cycle times. Fertilizer carloads were up 2% year-over-year due to strong agricultural demand. And lastly, increased shipments of import beer and can goods were the main driver of the 4% increase in food and refrigerated. Moving on to industrial, industrial revenue was up 16% for the quarter, driven by an 11% increase in volume. Average revenue per car also improved 5%, primarily driven by higher fuel surcharges and core pricing gains. Energy and specialized shipments were down 6% compared to 2021 driven by fewer petroleum shipments. Volume for Forest Products grew 7% year-over-year primarily driven by strength in both lumber shipments and paper. Despite rises in interest rates, housing starts continue to be strong, coupled with demand of corrugated boxes and scrap paper. Industrial chemicals and plastic shipments were up 14% year-over-year due to the increased demand and a favorable comp from last year’s Gulf swarm that impacted production. Metals and minerals volumes continued to deliver robust year-over-year growth. Volume was up 25% compared to last year, primarily driven by growth in the construction materials, strong steel demand, and an increase in frac sand shipments. In addition, we had a favorable comp in our construction market from last year’s storm that I mentioned earlier. Turning to premium, revenue for the quarter was up 14% on a 3% decrease in volume versus last year. Average revenue per car increased by 17% due to higher fuel surcharge revenue, core pricing gains, and a positive mix in traffic. Automotive volume was up 6%, driven by an increase in auto parts as demand recovers. Shipments for finished vehicles were down 3% as a result of ongoing semiconductor shortages. Intermodal volume was down 5%, driven by continued international supply chain disruptions. However, domestic volume was up in the quarter, aided by business development wins, tight truck capacity, and continued strength in parcel shipments. Now, moving on to our outlook for the rest of 2022, at a micro level, we will be closely watching our markets to see how rising inflation and the global events in both China and Ukraine will impact our overall volume. But as it stands now, here is how we view the outlook across our business lines. Starting with our bulk commodities, we expect fertilizer to grow due to solid market demand, especially on the export side. For coal, we anticipate continued favorable natural gas prices to extend through the year. But when it comes to how much of that demand we can capture, that will depend on how quickly we recover our service levels. We are optimistic on growth with grain products from biofuel demand and business development wins. For grain, we have a tough comp to last year as exports were strong. And like coal, although we expect cycle times to improve, it is dependent on our service recovery. Moving on to industrial markets, we continue to be encouraged by the strength of the forecast for industrial production. This will positively impact many of our markets, like metals. Customer expansions and business development wins will drive growth in our industrial chemicals and plastics commodity groups. We do not expect to see petroleum shipments return to 2021 levels. And lastly, for premium, we expect domestic intermodal to continue its benefit from inventory restocking, retail sales strength, tight truck supply, and our business development wins. International intermodal is more uncertain with possible effects from ongoing supply chain challenges and pandemic shutdown in China. For automotive, while we do expect the supply of semiconductor chips to improve throughout 2022, recent events in China and Ukraine may disrupt the supply chain for certain key components. We are keeping an eye on whether this will have an impact on production and stand in close contact with our customers.

Thanks, Kenny, and good morning. As I will discuss in greater detail in a few minutes, our service is not to a level that meets expectations and we acknowledge the impact that deteriorated service levels are having on our customers. We are implementing plans to restore network fluidity and build a safer, more reliable and resilient network. Safety results have been mixed to start the year as we implement enhancements to our safety programs through partnerships and guidance from our external safety consultant. We remain focused on achieving world-class safety performance. We value the health and the safety of our employees above all and want all employees to return home safely each day. Now, let’s review our key performance metrics for the quarter, starting on Slide 9. Freight car velocity and related trip plan compliance measures were lower relative to 2021. Coming into the year, the network was in a more fluid state, seeing improvements in operating metrics and crew availability from reduced COVID infections. In late February, however, while the network was still fragile, episodic events challenged the team and our service product. This led to both decreased velocity and an increase in freight car inventory, particularly private cars, as resources were added to counteract sluggish service and meet growing customer demands.

Turning now to Slide 10, although the overall network performance muted most of our efficiency metrics, we continue to operate a more efficient rail network compared to pre-PSR levels. Locomotive productivity declined 6% compared to the first quarter 2021 due to locomotive utilization during the quarter. To assist and recover in the network, we also brought additional units online, further impacting our productivity results. First quarter workforce productivity improved 5% to a record 1,056 daily miles per FTE. We continue to hire for growth and normal attrition throughout the network. In 2021, we graduated over 250 new transportation employees with almost 400 employees graduated to date in 2022. We have a strong training pipeline of roughly 500 employees as we work closer toward our goal of onboarding around 1,400 employees this year. We have, however, been challenged across the Northern region at several locations to meet our hiring targets. And we continue to work with our workforce resources partners to increase our hiring pools in those locations.

Thanks, Eric and good morning. Let me start with a look at the first quarter operating ratio and earnings per share on Slide 13. As you heard from Lance, Union Pacific is reporting first quarter earnings per share of $2.57 and a quarterly operating ratio of 59.4%, a 70 basis point improvement. Comparing year-over-year first quarter results, you will recall that Winter Storm Yuri significantly impacted 2021. So in 2022, we have the positive effect on our operating ratio of 160 basis points and $0.16 to earnings per share. Rising fuel prices throughout the quarter, the lag on our fuel surcharge programs, and widening spreads between WTI and highway diesel fuel prices negatively impacted our quarterly ratio by 80 basis points, while adding $0.12 per share. Core results were a 10 basis point drag on the operating ratio but contributed $0.29 to EPS. These core results are indicative of both operational inefficiencies in the quarter as well as the strong top line growth we delivered. Looking now at our first quarter income statement on Slide 14, operating revenue totaled $5.9 billion, up 17% versus 2021 on 4% year-over-year volume growth. Operating expenses increased 16% to $3.5 billion. Excluding the impact of higher fuel prices, expenses were up 7% in the quarter. First quarter operating income was a record at $2.4 billion, a 19% increase versus last year. Adjusted for fuel price, first quarter incremental margins totaled 56%. Expectations for full year incrementals are unchanged in the mid-60s, which is the lower end of our Investor Day guidance.

Turning to my remarks on Slide 15, I want to focus on how we are innovating the freight rail industry in new and unique ways to serve our customers' growing needs. We have looked at the future and are exploring new technology solutions that will enhance our service offerings. Our customers are leveraging our services to help them overcome disruptions and understand real-time conditions in the market that they operate in. We see this as an opportunity to continue leading in the industry and we are actively working on initiatives that place us in a position to capture more of the intermodal market. With that, let’s move on to our questions.

Thank you, Rob, and thank you all for engaging with us this morning and for your questions. We are looking forward to talking with you again in July to discuss our second quarter results. Until then, take care.