CSX Corporation (NASDAQ:CSX) Q3 2023 Earnings Call Transcript

CSX Corporation (NASDAQ:CSX) Q3 2023 Earnings Call Transcript October 19, 2023

CSX Corporation misses on earnings expectations. Reported EPS is $0.42 EPS, expectations were $0.43.

Operator: Good afternoon. My name is Krista, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Third Quarter 2023 CSX Corporation Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Mr. Matt Korn, Head of Investor Relations, you may begin your conference.

Matt Korn: Thank you, Krista. Hello, everyone, and welcome to our third quarter earnings call. Joining me this afternoon are Joe Hinrichs, President and Chief Executive Officer; Mike Cory, Executive Vice President and Chief Operating Officer; Kevin Boone, Executive Vice President and Chief Commercial Officer; and Sean Pelkey, Executive Vice President and Chief Financial Officer. In the presentation accompanying this call, you will find our forward-looking disclosure on Slide 2, followed by our non-GAAP disclosure on Slide 3. And with that, it is now my pleasure to introduce Mr. Joe Hinrichs.

Joe Hinrichs: All right. Thank you, Matthew, and hello, everyone. Thank you for joining our conference call today. Over this last year, CSX mission and message have remained clear and consistent. We have seen great progress with our ONE CSX initiatives, which are helping to build a focused, collaborative culture that enables all of our employees to feel engaged, energized and focused on working better together. At the same time, our service levels continue to lead the industry. These successes go hand in hand. And as our customers see that CSX is truly dedicated to providing consistent, reliable service over the long term, they’re responding positively. As we look forward to all the opportunities ahead, we are confident that these efforts we are making will drive clear, sustainable, profitable growth.

And we took another step forward on this path this quarter. Thanks to the hard work put in by our ONE CSX team, our railroad is running well. Our merchandise business remained steady, and our coal shipments were very strong. Our domestic intermodal volumes are growing well compared to last year. Our international intermodal business, though down year-over-year, has stabilized. Overall, our network continues to perform, and I am pleased with how the team has succeeded in managing the things that we can control. I continue to be very excited about all the potential ahead for CSX. Now, let’s turn to Slide 5 to review the highlights for the third quarter. First, we moved over 1.5 million carloads this quarter, which was down just slightly from a year ago, with flat year-over-year performance in merchandise and 9% growth in coal.

Our operating ratio ticked up into the low 60% as we faced challenges that we have been talking about all year, with lower fuel recovery, reduced intermodal storage revenue, lower export coal prices, and higher costs of inflation, most notably with our labor contract. As in previous quarters, our margin does include the impact of the Quality Carriers trucking business. Second, we generated $3.6 billion in revenue, which was 8% lower than the previous year. The last year we benefited from high diesel prices and record export coal benchmarks that were both much lower this quarter. Third, even with the year-over-year changes we faced, charges — changes we faced, operating income still came in at $1.3 billion for the quarter compared to a little under $1.6 billion last year.

And our earnings per share were $0.42, down from $0.52. I am proud of what we accomplished this quarter given all the challenges. None of us here are satisfied with these results. We’re not sitting back and simply waiting for markets to turn. We’re looking throughout the entire network to see where we can operate more efficiently. We continue to work closely with our customers to build our business pipeline and drive more volume onto the railroad. And we’re emphasizing the importance of cost discipline to every team in every one of our locations. One of the reasons I am so confident about what is ahead for CSX is the great leadership team that we have in place. As you all saw last month, we are very pleased to announce that Mike Cory has joined our railroad as Chief Operating Officer.

Mike brings great experience and a thorough understanding of schedule railroading, and he also shares our deep dedication and appreciation for customer service and the employees who provide that service day in and day out. Mike arrived in Jacksonville a few weeks ago and is now here joining us on this call. And so, I will now turn it over to Mike to say a few words and cover our operational performance over the quarter.

Mike Cory: Well, thank you very much, Joe. And I truly appreciate the words. And I’m extremely thankful for the opportunity to work with such a committed team of people with so much potential to lead this industry with great customer service. Safety, service, efficiency, and along with engagement with each other, customers and stakeholders, is how we’re going to leverage this great franchise to be best in class. And I’ve been here a short time, pretty much less than a month, but I’ve been really busy. I’ve visited major yards, coal export facilities, and I’ve spent time in headquarters meeting with an array of people from different functions of the railroad. Well, in person, I’ve listened to and I’ve spoken with employees from all across the company; from people on the ground executing the plan, from people developing the plan, to sales and marketing, finance, field and network ops, IT facilities, and the list goes on.

But what really resonates with me is their collective desire to be the best they can be for our ONE CSX team and our customers. And we’ve got great talent in all our functions, and our job is to connect the talent and maximize the value of their efforts. We’re doing this in order for our team to be the best at providing what our customers need in the safest and most efficient way. We’re doing this because decision-making, acting on what they see and know, must be quick and done as close to where the opportunity is taking place. That said, I see opportunities, one of which, and to me, the most important at this stage, is to create and share a robust and visible flow of information that will derive improvement through the continuation of the lean principles that define schedule railroad.

We all need to see the effects of our collective decisions as fast as possible, be more nimble and responsive to our customers’ needs. As well, collectively we’ll learn and share best practices throughout the organization from this and other available data as it gives us a platform to learn as it happens. This will create the speed and the trust that we need to move together as one team. So, let’s go over to the slides and we’ll start looking at our safety metrics. Our third quarter injury and accident rates increased as we saw track-caused and human factor incidents trend upward. These aren’t acceptable outcomes for us. And we’re taking action to continuously improve the environment our employees operate in, as well as the overall safety culture.

Human factor incidents, especially with newly hired employees, is one of the trends this year that have driven the increase. In Q3, the team added additional time for initial training for our new conductors at our REDI Center in Atlanta. We also looked at the length of training when new hires graduate from Atlanta and report back to their home terminals and increase the length of that training as well. Increased training gives us more time to develop skills with our new hires, but we also determined we needed to place resources to spend that time with them. So, we train unionized mentors and now we have them across the property with the new hires. These mentors are available to teach and answer questions, reinforcing the ONE CSX culture by being part of developing and coaching their newly hired peers.

Lastly, on safety, we’re not taking our focus off life-changing events. We’ve partnered with DEKRA, a speciality risk management group, to rollout training to help employees self-identify risk in an ever-changing environment. Now traditionally, railroads train on operating rules, but we can’t write a rule for everything or test our way to a positive safety culture. Both identification of risk and eliminating that risk when possible is one of our major goals moving into Q4 and beyond. So, let’s go over to the next slide on our operating highlights. Our end-to-end train velocity averaged 17.6 miles an hour in the third quarter, slightly lower than last quarter, but still up substantially from the same period in 2022. Dwell averaged 9.6 hours, an improvement of nearly 20% compared to the same period last year.

Intermodal trip plan performance was 94% and increased by 4 percentage points year-over-year, while carload trip plan performance was 82% and improved by 25 percentage points. Our service performance remains fluid. And though we did see a slight seasonal dip during the middle of the quarter during peak vacation and holiday season, our metrics are rebounding into the fourth quarter. We all know and we will — we all know we will and we’re all working together to improve these results. Our ability to leverage this great franchise by connecting the people and the vast talent they bring will allow us to improve all key aspects of our business, with a strong focus on those lean management principles that drive reliable, consistent service. I’m really confident that connecting all of these dots together is going to result in a strong team now, and, more importantly, bench strength for the future.

This is really our ONE CSX goal. And so, with that, over to you, Kevin.

Kevin Boone: Thank you. Mike and I have been spending a lot of time together and it is really great to have you on the team. To start, I’m pleased to say that our improving service levels are a key differentiator in the marketplace. I can’t thank the entire team enough for all the hard work. These improvements are being recognized by our customers and are leading to new initiatives and discussions around how CSX can partner with our customers for growth. Our ability to grow profitably requires us to be proactive, quickly adapt to changing markets, and think differently. I’m proud of how well we have been able to coordinate with operations to drive both growth and efficiencies. With Mike in his role, we have only seen these efforts accelerate.

It’s no surprise that overall economic conditions remain uncertain, but it has been encouraging to see gradually improving sequential trends across several of our end markets over this past quarter. We see many, many reasons to be optimistic as we continue to build our business pipeline with an eye toward 2024 and beyond. Turning to Slide 10 to look at our merchandise performance for the quarter. Our revenues were down modestly compared to last year on flat volumes, as solid core pricing gains were offset by lower fuel surcharge and negative mix effects in certain markets. Our automotive business continued to show strength with higher production and business wins driving a 19% increase in volume year-over-year. Minerals continues to perform very well, sustained by infrastructure activity that is supporting new cement facilities and healthy demand for aggregates.

Metals performance has also benefited from our service levels, leading to competitive wins and solid demand. Our chemical franchise, while challenged, has begun to stabilize and even showed some promising improvement in domestic plastics over the quarter. Fertilizer revenue growth was strong in the quarter, despite volumes that were impacted by weaker short-haul movements with production challenges in Florida. As we expected, the strong Southeastern corn crop meant less rail volume for grain, and forest products remains one of the most challenged areas with many mills still taking meaningful downtime. As we start the fourth quarter, we are encouraged by the early October volume trends with most markets showing sequential momentum. We anticipate a strong rebound for ag and food as a strong Midwest harvest kicks in.

And across other markets, we expect our service improvements to drive opportunities to win in the marketplace as we focus on modal conversion. Turning to Slide 11. Third quarter coal revenue declined 5%, even though volumes were very strong, growing 9% compared to last year. Export demand continued to be a major volume driver, growing 26%, with the hot summer also supporting solid domestic demand. Strong coal volumes minimize the effects of lower international benchmark prices, which were setting all-time records this time last year. The key difference was met coal pricing where global benchmarks were much lower than in the same period last year. Sequentially, our coal RPU declined 11% compared to our guidance of mid-teens decline, with stronger-than-expected shipments to longer length of haul Southern utility customers driving the moderate outperformance.

Looking ahead to the last quarter of the year, we expect export markets to remain strong and are pleased with the increases in international benchmarks that we’ve seen over the last several weeks. On the domestic side, we have seen stockpiles normalize and demand in the 2024 will be driven by winter weather and related demand needs. The increase in global benchmark prices should benefit our cold yields next quarter. So, I would remind you that we have a diverse portfolio of met customers and we have seen U.S.-based met coal benchmarks and those in other regions lag spot prices in Australia. Turning to intermodal on Slide 12. As a whole, the business remained challenged with revenue declining by 14% and total volume decreasing by 7%. Overall, RPU declined by 8% year-over-year with the impact of lower fuel surcharge accounting for the decline, partially offset by positive price.

That said, we are seeing encouraging trends from our domestic business. Our volume turned positive on a year-over-year basis early in the summer, and that’s continued to improve since then. We offer a diverse mix of transportation solutions within domestic intermodal, and we’ve seen great results from our strong channel partnerships and our direct relationships with major retailers. Our team has been successful in converting traffic off the highway in a market facing plentiful truck capacity, which is a testament to the team in the market-leading service product. Meanwhile, international intermodal activity has stabilized but remains weak. We haven’t seen any clear signs of a positive inflection yet. Retailers remain concerned about the health of the consumer.

And though de-stocking may have slowed, we haven’t seen this turn into sustained increases in order rates or imports. For the rest of the year, we expect trends to largely continue as they were over the third quarter, with domestic gradually strengthening, supported by our team strong sales efforts. While we prepare for the turning point for international, recall that we saw meaningful drop offs in our intermodal volume in the back half of the fourth quarter in 2022, as markets slowed substantially, which will benefit our reported growth rate for the current quarter. Slide 13 provides a clear illustration of the encouraging signs we’re seeing within our intermodal business. On a year-over-year basis, domestic intermodal has shown a favorable trend since the beginning of 2023, turning positive around mid-year and steadily improving since.

While international volumes remain lower compared to 2022, we’ve seen stability in the past few months. Altogether, across all of our businesses, our team continues to push forward across multiple initiatives, aimed at winning wallet share, converting truck traffic and bringing new customers to the railroad. We remain confident that our leading service performance will continue to provide opportunities to win business. And we know that we have the resources and capacity in place to deliver growth when the market environment inflects. I’m proud of what the collective CSX team has accomplished this quarter. I’m excited about all the potential ahead. Now, I’ll turn it over to Sean to discuss financials.

Sean Pelkey: Thank you, Kevin, and good afternoon. The third quarter operating income of $1.3 billion was lower by 18% or $284 million. These results include nearly $350 million of year-over-year impacts from lower intermodal storage revenue, export coal benchmark prices, and fuel recovery, partly offset by $42 million of favorability related to last year’s labor agreement adjustment. Suffice it to say this quarter should represent the peak year-over-year impact from these discrete items. Revenue fell by 8% or $323 million despite strong pricing across many merchandise portfolio along with positive volume trends across many merchandise markets, as well as domestic intermodal. The operating team also worked tirelessly to meet customer needs and deliver a 9% increase in coal volume.

Across merchandise, coal and intermodal, revenue excluding fuel recovery increased 2% in the quarter and was up mid-single digits, excluding the impacts of coal RPU headwinds. Expenses were lower by 2%, and I will discuss the line items in more detail on the next slide. Interest and other expense was $13 million higher compared to the prior year. Income tax expense decreased $32 million as the impact of lower pre-tax earnings more than offset a prior year favorable state tax item. And this quarter’s effective tax rate came in at 24.9%. As a result, earnings per share fell by $0.10, including nearly $0.12 of impact from the previously mentioned discrete items. Let’s now turn to the next slide and take a closer look at expenses. Total third quarter expense decreased by $39 million.

Lower fuel prices and cycling the prior year labor true-up were mostly offset by the impacts of inflation and higher depreciation. Turning to the individual line items. Labor and fringe expense decreased $7 million as the prior year union labor adjustment was largely offset by inflation and increased headcount. Heightened attention to overtime benefited cost per employee, particularly in our mechanical workforce where overtime ratios are now running at multi-year lows. Purchased services and other expense increased $25 million versus last year, including $16 million associated with higher casualty expense. Turning to sequential performance versus Q2 on the right-hand side of the page, network performance and numerous cost control initiatives in the quarter drove a nearly $20 million reduction in PS&O across our operating departments.

We expect these savings to remain in the fourth quarter aside from normal seasonality. Depreciation was up $21 million as a result of last year’s equipment study, as well as a larger asset base. Fuel cost was down $89 million, mostly driven by a lower gallon price. This was partially offset by higher consumption, including approximately 2.5 million gallons recognized from prior periods. Adjusting for this, fuel efficiency was still unfavorable versus the prior year. And Mike has brought an increased focus on this critical measure. While seasonality will impact fuel efficiency in Q4, we fully expect to get back on trend. Equipment and rents was $10 million favorable, driven by faster freight car cycle times across all markets. These benefits were partly offset by costs related to higher automotive volumes.

Finally, property gains were $21 million unfavorable in the quarter. As a reminder, we are cycling over $50 million of prior year gains in Q4 and expect sales this year to be minimal. Now turning to cashflow and distributions on Slide 17. Reflecting the discrete factors I discussed earlier, free cashflow is down from the prior year, but remains strong, supporting investments in the safety and reliability of our network, as well as an increased level of high return strategic investments. Robust cashflow has also supported over $3.5 billion in shareholder returns so far this year, including $2.9 billion in share repurchases and over $650 million of dividends. Economic profit, as measured by CSX cash earnings, is about $160 million lower year-to-date, impacted again by intermodal storage revenue and export coal pricing.

Nevertheless, the focus on economic profit is helping to incent a pipeline of high return initiatives that will deliver growth and ongoing efficiency gains. Now with that, let me turn it back to Joe for his closing remarks.

Joe Hinrichs: All right. Thank you, Sean. Now as shown on Slide 19, we will finish with some updated comments on our outlook as we approach the final quarter of 2023. We continue to expect low single-digit growth in revenue ton-miles for the full year, supported by our consistent performance in merchandise and export coal. Automotive and minerals remain important growth areas. So, obviously, we’re watching developments with the [Detroit Three] (ph) automakers and the UAW very closely. As Kevin mentioned, we also look for a substantial rebound in our ag and food business over the fourth quarter. Export coal volumes remain strong as global demand stays high for U.S. met and thermal coal. For domestic coal, we anticipate some slowdown from the third quarter, which benefited from hot summer weather, though so far this quarter we continue to be pleased with our shipment levels.

For intermodal, as we mentioned, we expect domestic activity to keep gaining modest momentum through the fourth quarter. While for now, our international business looks largely stable. Overall, our volume growth rate in intermodal will reflect favorable year-over-year comparisons. As we’ve said all year, the pricing environment remains supportive, and we have been encouraged by the agreements that you’ve already reached for 2024. Note that with the slowdown in intermodal storage revenue that we have seen over the course of this year, we are now expecting supplemental revenue, excluding trucking, to decline by $325 million for the full year. Our commitment to efficiency and cost control remains in place as we keep our eye on service performance, not just in the near term, but also as we look ahead to improve market conditions and greater demand for rail capacity.

Finally, our estimate of $2.3 billion in capital expenditures remains unchanged, along with our strong focus on innovation and growth. I will close by saying that I’m very proud of what we’ve accomplished as ONE CSX team as I finished my first year with CSX. When I spoke to all of you last fall, we talked about our belief that CSX could accomplish great things and create so much value by working better together as one team to serve our customers. We have made very good progress. And all of us know that there remains so much more we can do. I’m even more enthusiastic about our opportunities than I was last year. We all appreciate your support and interest in our company and we keep — as we keep moving forward. All right, thank you. And Matthew, we’re now ready for questions.

Matt Korn: Thank you, Joe. We will now move to our question-and-answer session. Now, in the interest of time and to make sure that everyone on this call has an opportunity, we ask you to please limit yourselves to one question. Krista, we’re ready to start the process.

Operator: [Operator Instructions] Your first question comes from the line of Chris Wetherbee from Citigroup. Please go ahead.

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Q&A Session

Chris Wetherbee: Hey, thanks. Good afternoon, guys. Maybe Joe or Mike, kind of wanted to start with your sense of where you are in terms of resources and services relative to the volume environment. So, headcount moved up again. Maybe give us — if you can give us a sense of where you think you need to take that or if you’re at reasonable staffing levels? And maybe how we think about, like I said, that resource base relative to the volume environment? Do you have the ability to do more at these current levels, or are we still in a little bit of the recovery phase?

Mike Cory: Hey, Chris, it’s Mike. Look, and again, I’m going to preface every — probably most of my answers with, I’ve been here less than a month, but we still have the training pipeline. We still have people that we need to get into position that I spoke of earlier. But overall, I’m comfortable that we have enough to improve the size of train, the amount of trains, the velocity with the people we have. But however, there are areas where we’re probably getting affected somewhat on the flow of the goods. And so, it’s constant. We’re working — not just Kevin and I, but our teams together. So they really get the ground floor view of what we can do. And not having been here for that long, I haven’t really stretched the opportunities out there yet.

So, I’d say, to answer your question, we’re where we need to be. We have people that are being trained that are going to be positioned. And remember, we have attrition, whether its retirement or whatever the case. So, we’re filling that. And with the people we have. We’re in good shape. We have to get in better shape, and a lot of that’s going to come from self-help and how we utilize the assets.

Joe Hinrichs: Yeah. Chris, just the last thing I’ll add is, as Mike mentioned, we’re still hiring in a few key locations. That’s down to a little more than a handful. And largely, we’re in pretty good shape in most other spots. And with the natural attrition we have, we’re still hiring to replace some of that because we are still — our merchandise volume is up this year. So, we’re still seeing some growth in volume. But we feel pretty good about our ability to manage that. And Mike has really challenged the team to come with a new set of — fresh new set of eyes to look at how we can do some self-help to free up some of our crews to help us even be more efficient. Thanks.

Operator: Your next question comes from the line of Brian Ossenbeck from JPMorgan. Please go ahead.

Brian Ossenbeck: Hey, thanks for taking the question. And Mike, welcome back to the industry. Congrats. Just wanted to ask more about the — excuse me, on the service side, maybe for Kevin. You’re seeing some conversion that you mentioned of areas that have excess truck capacity. So, is the stuff that you thought you lost before and was going to come back, or has the service been so good for so long that people actually going to convert and stay there? Just trying to get a sense of the stickiness of that. And then, Sean, if you can just give us some comments on the cost per employee for the fourth quarter? It looks like overtime is coming down quite a bit. There’s always mix and trainees involved. So, any color on that would be helpful. Thank you.

Kevin Boone: Yeah. I would say on the truck conversion side, we’re really, really early into this thing. The good news is customers are willing to start to have those conversations that quite frankly we just couldn’t have a year ago, given where we were. And so, we’re building momentum. I expect this to build on itself into next year. The great thing is, I think as an industry, we’re starting to become aligned in terms of going after growth, going after some of the opportunities that exist out there collectively as an industry, and I think that’s very encouraging as well. But it’s a mixture. It’s a mixture of going after new customers. Clearly, you pointed out, the trucking market is not very supportive right now. But even in this market, we’re finding customers that, with ESG and with other things, are wanting to have that discussion.

There’s still value that we can drive. But I only expect as that trucking market firms up in the next year and the years ahead that this will accelerate on itself and see a lot of momentum coming.

Sean Pelkey: Brian, on your follow-up question around cost per employee, we did — made a lot of progress on the overtime front in the third quarter. That’s an area that Mike has been focused on right from the very beginning, trying to figure out ways we can restructure the work and eliminate waste in certain locations. So that’s going to help. I will say though sequentially Q3 to Q4, you probably will see still an uptick in cost per employee like we normally do. That’s driven by some capital work labor that will go over to OE in the fourth quarter. We also have some seasonal vacation and some accruals that will hit in the fourth quarter. So I would say, sequentially Q3 to Q4, you’ll probably see comp per employee up a few percent.

Operator: Your next question comes from the line of Brandon Oglenski from Barclays. Please go ahead.

Brandon Oglenski: Hey, good evening, and thanks for taking my question. And Mike, welcome back as well. And I guess, Mike, can I just ask you, the U.S. roads historically just haven’t had a great track record of organic growth and we know it seems like coal have been a long-term headwind. But what have you seen in your first month or so that you like to see at the CSX plan or changes you want to make that will help with this idea that CSX can outgrow the market looking ahead?

Mike Cory: Hey, Brandon. Thank you. Wow. I mentioned in my remarks, the visibility of information and it just — it creates this connection where people see — we have people that manage terminals, that manage the dispatch on the road, we have people that manage people from a crew management perspective, we manage — look, we do all these things individually and to see that altogether and then again back to being understanding of what it is you can do, whether it’s from a capacity or service perspective, but then cutting in with Kevin’s team, we can get sticky because we can really understand all the work we’re doing is really to get that business is to keep that business. And I see that here — the opportunity here is — look, the railway I came from, you got the business, you went 1,200, 1,500 miles and then there was more business here, it’s everywhere.

And it’s not — it’s competitive, but there’s lots of that. And Kevin — we’re not talking so much about the truck. Obviously, we’re going to grow with the market and what it gives us, but I just — I think the opportunity here when we connect our people, we are everywhere. We service, what is it, two-thirds of the U.S. market. And that’s just opportunity in itself is. So, I don’t know if I’m answering your question. Again, I’ve been here a month. But I see that, that’s really what our goal is. We want to grow properly. We wanted to be ratable. We want to make sure that we’re in position for it. And we’re going to make sure that we rid ourselves of waste. So, we’re not getting rid of the assets that we need when it does come.

Operator: Your next question comes from the line of Jonathan Chappell from Evercore ISI. Please go ahead.

Jonathan Chappell: Thank you. Good afternoon. Mike, I kind of want to build on that and you kind of brought up your former role as well. You transitioned there from a PSR railroad to a growth railroad, and maybe that didn’t go as smoothly as you would have hoped. So, you’re not joining a fixer-upper here. CSX’s service metrics have improved vastly over the last year or two, and now you’re pivoting the growth. So, what are some of the lessons that you’ve learned from that transition at the last role on some of the dangers to avoid? And how you manage capacity as you’re trying to fill the network without clogging up the network and causing service issues?