Norfolk Southern Corporation (NYSE:NSC) Q1 2024 Earnings Call Transcript April 24, 2024
Norfolk Southern Corporation misses on earnings expectations. Reported EPS is $ EPS, expectations were $2.6. NSC isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Greetings, and welcome to Norfolk Southern Corporation’s First Quarter 2024 Earnings Call. At this time, all participants are in listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It’s now my pleasure to introduce Luke Nichols, Senior Director of Investor Relations. Thank you, Mr. Nichols. You may now begin.
Luke Nichols: Thank you, and good morning, everyone. Please note that during today’s call, we will make certain forward-looking statements within the meaning of the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. These statements relate to future events or future performance of Norfolk Southern Corporation, which are subject to risks and uncertainties and may differ materially from actual results. Please refer to our annual and quarterly reports filed with the SEC for a full discussion of those risks and uncertainties we view as most important. Our presentation slides are available at norfolksouthern.com in the Investors section, along with a reconciliation of any non-GAAP measures used today to the comparable GAAP measures, including adjusted or non-GAAP operating ratio.
Please note that all references to our prospective operating ratio during today’s call are being provided on an adjusted basis as referenced in our earnings release. Turning to Slide 3, it’s now my pleasure to introduce Norfolk Southern’s President and Chief Executive Officer, Alan Shaw.
Alan H. Shaw: Good morning, everyone, and thank you for joining Norfolk Southern’s first quarter 2024 earnings call. Here with me today are Mark George, our Chief Financial Officer; Ed Elkins, our Chief Marketing Officer; and our new Chief Operating Officer, John Orr. I am excited to have John on the Norfolk Southern team. John is a 40 year railroad industry veteran and a proven PSR expert, who has worked with Hunter Harrison, Claude Mongeau, and Keith Creel to implement PSR railroads across three countries. I promised you that we would focus on productivity in 2024 and we’re taking action to do just that. Bringing in someone of John’s caliber was another step to accelerate our operational improvement. John is going to share the progress in our operating metrics that he and his team are already driving and his plans for furthering productivity in our merchandise network to deliver immediate margin enhancement.
Our strategy is about balancing service productivity and growth, with safety at its core. This strategy is anchored on a PSR driven operating plan and designed to deliver top tier earnings and revenue growth, with industry competitive margins. When we say industry competitive margins, it has to be within 100 basis points to 200 basis points of the industry average. Let’s recall where we’ve been and discuss our path forward. Last year in response to East Palestine, we prioritized investments in safety and service to protect our franchise and our shareholders, and we delivered on both fronts. We are operating one of the safest networks in North America and are producing service levels better than anything we’ve seen since 2019. Despite that progress, more work remains to be done to get us back to industry competitive margins.
We were not delivering the productivity and we were not running fast enough or efficiently enough. I needed to make changes to accelerate our progress and to introduce greater operational discipline into our culture. To that end, we started making organizational and process changes last fall, culminating with the recent hiring of John Orr. Now, we have safely built the foundation to drive substantial gains in productivity, and we’ve committed to a [400 basis points to 400 basis point] (ph) OR improvement in the second half of this year. We will close that margin gap with peers. We will deliver a sub-60% operating ratio in the next three to four years, and we will do it at a safe, sustainable manner that recognizes our current operating environment and brings key constituents, including our shareholders, customers, employees, and regulators, along with us on our mission.
We will urgently deliver productivity through disciplined operational excellence that continues to safely serve our customers, positions us to grow by meeting markets as they evolve, and allows us to generate outsized returns for our shareholders. I’ll now turn it over to Mark, to review our first quarter financial results.
Mark R. George: Thanks, Alan. As seen on Slide 5, our GAAP results in Q1 were impacted by four items that we’ve called out for you. Earlier in the month, we announced the $600 million agreement in principle to resolve a consolidated class action lawsuit relating to the East Palestine derailment. That addresses the most significant remaining legal exposures for our shareholders. Including other cleanup costs and insurance recoveries in the quarter, our operating income was adversely impacted by $592 million. You’ll note at the bottom another $108 million of insurance recoveries in the quarter. That brings our recoveries to-date in excess of $200 million toward our $1.1 billion insurance coverage tower. Moving to the right, we told you last quarter about our initiative to drive a 7% reduction in non-agreement headcount, for which savings will begin to materialize in Q2.
That initiative along with our operations leadership change resulted in a $99 million charge. Next, our advisory costs associated with our now very public shareholder matter recorded in non-operating. Finally, we also called out here a favorable deferred tax adjustment affecting our income tax expense. For the remaining slides, I’ll speak to our adjusted results excluding these items as shown here on the far right. Moving to Slide 6, let’s focus on the adjusted variances compared to Q1 of 2023 in the year-over-year columns. Those results were impacted by 4% lower revenues driven by meaningfully lower fuel surcharge as well as headwinds in intermodal that Ed will detail later. Operating expenses were up 3% from inflation and the increased workforce.
You’ll see an OpEx year-over-year waterfall in the appendix that provides more detail. Not on this page is non-operating income, which was down $17 million from lower gains on our company-owned life insurance. That decline coupled with the lower operating income drove the net income and EPS reductions you see here on a year-over-year basis. Let’s talk on the right side about the sequential variance from Q4 2023, where we guided to a 100 basis points to 200 basis point deterioration in our OR, which is in-line with normal seasonality. That’s exactly where we landed right at the lower-end of that range. On the next couple of charts, we will detail the sequential revenue and OpEx walks from Q4. So, revenue here on Slide 7 moved down sequentially driven by fuel surcharge headwinds and overall lower volumes driven by coal and intermodal.
Coal pricing was weaker and intermodal faced difficult conditions with volumes down 3% and continued adverse mix from softness in our higher yield premium business. Slide 8, turning to our operating expenses, they were down 1% as compared to Q4. We faced typical sequential headwinds associated with the reset of payroll taxes and we had meaningful headwinds from returning to normal incentive compensation accrual levels as well as no property sales in the first quarter. We offset those headwinds by lower spend in purchase services, efficiency gains in comp embedded, as well as favorable fuel prices. While fuel expense was down 6% sequentially, recall that surcharge revenue was down 17% sequentially and that drives a 40 basis point OR headwind on a sequential basis.
As we turn to the balance of the year, we will see our margins improve materially from here. We are finally starting to see excess service costs unwind and they will accelerate downward in Q2. That trajectory along with the reduction in non-agreement headcount as well as other productivity initiatives leave us confident in a strong productivity story for Q2. We anticipate a modest seasonal volume lift sequentially, although there is some pressure to our coal business from the Baltimore Bridge disruption. Despite the port closure, we still believe we will be within the first half 67% to 68% OR guidance range assuming that the channel reopens at the beginning of June. The revenue impact from the channel closure is in the $25 million to $35 million per month range.
More productivity momentum builds in the back half as well as stronger volumes and that provides us with confidence in the 400 basis points to 450 basis points of OR improvement. John will talk more about the productivity runway in front of us, but first, I’ll hand over to Ed, to discuss revenues.
Ed Elkins: Thank you, Mark, and good morning to everyone on the call. Starting on Slide 11, I’ll go over our commercial results for the quarter. Overall, volume grew by 4% versus last year driven by intermodal. Revenue for the first quarter came in just above $3 billion down 4% year-over-year as total RPU fell 8%. Starting with merchandise, volume was flat versus last year while revenue ticked down a percent driven by lower fuel surcharge revenue. RPU less fuel increased by 3% year-over-year, setting an all-time quarterly record which also led to a new all-time quarterly record for revenue less fuel. This marks the 35th out of the prior 36 quarters that merchandise RPU grew year-over-year and once again reaffirms our commitment to price and the increasing value of our service.
Turning to intermodal. Volume grew 8% year-over-year, primarily on strength and international. However, revenue decreased 8% as RPU excluding fuel and storage and fees declined by 6% overall. Revenue was also impacted by the lane rationalization across intermodal that simplified our network. This decision demonstrates how marketing, operations, and finance are aligned to increase productivity and drive smart and sustainable growth. Digging into coal, volumes for the quarter declined by 4% as weakness in the utility market was only partially offset by export strength driven by historically strong export quarter as our cross functional efforts to boost throughput at our Lambert’s Point terminal yielded positive results. These results are a great example of all of NS pulling together to deliver strong value for our shareholders and for our customers.
Let’s move to Slide 12, where I’m introducing a new view of our results that helps frame the main first quarter drivers of revenue and revenue per unit. Overall, fuel surcharge revenue was the single largest headwind in the quarter declining by $115 million. The first quarter was also the last one where intermodal storage and fees are a substantial year-over-year headwind with revenues declining by $35 million. In coal, we experienced positive mix from higher export volumes and higher utility shipments in the south. This positive mix was more than offset by lower realized price and export shipments as seaborne coal prices weakened significantly throughout the quarter. Merchandise revenue excluding fuel was driven higher by pricing gains across the entire book.
Overall pricing and volume increases in our metals franchise were boosted by improved network fluidity from increased car velocity. That same velocity and fluidity helped volumes in automotive remain flat despite manufacturing headwinds at several of the plants that we serve. Intermodal revenue excluding fuel and storage and fees increased as higher volumes more than offset adverse mix and continued slight capacity in the domestic truck market created headwinds to RPU. Higher international shipments and lower domestic premium shipments were the main drivers of adverse mix. Additionally, RPU was impacted from higher international empty shipments as these grew 57% year-over-year in the quarter. We believe elongated ocean transit times are a driving factor pushing ocean carriers to deploy their capacity back on the water as soon as possible, which increases the need to reposition empty containers back to the ports.
Turning to Slide 13, let’s go over our market outlook for the remainder of ‘24. The macro landscape presents a mixed bag with uncertainty regarding inflation and future Fed rate actions overshadowing the recent recovery in manufacturing. However, our improving service product places us in an excellent position to capitalize on growth opportunities. Starting with our view on the widely varying merchandise markets, we generally see support for volume from the normalization of auto production and the continued strength in infrastructure projects across our network. A positive price environment will continue, which is supported by the increase in network fluidity. Improved cycle times, equipment availability, and network velocity will be a broad positive tailwind across our portfolio and merchandise.
And, we also expect to drive incremental volumes through project development such as our recently announced Great Lakes Reload acquisition, the merger of TDIS into Triple Crown Services and continued industrial development wins. Intermodal volumes are expected to increase as international trade remains robust. We expect continued mix impacts from higher international empty shipments as geopolitical tensions remain elevated, but a weak truck market continues to drive stubbornly low truck rates, which will dampen domestic non-premium intermodal pricing. Additionally, we expect volumes in our domestic premium business to fall as challenging LTL market forces reduce freight demand for parcel shipments. Finally, coal volumes will be challenged as high stockpiles and low natural gas prices reduce utility shipments.
In addition, export shipments will be affected by the Baltimore port shutdown. We are diligently working with our customers to provide alternate supply chain solutions, and the increased network fluidity is providing the capacity necessary to execute on those solutions. Finally, seaborne coal prices have weakened as supply has outstripped global demand, and this headwind is expected to continue throughout the remainder of the year. Before I turn it over to John, I’d like to close by thanking our customers for trusting Norfolk Southern to move their freight.
John F. Orr: Thank you, Ed. I arrived at NS in late March and immediately got to work immersing myself in the operations and connecting with our people. I’ve had boots on the ground assessing terminals and engaging craft colleagues and frontline supervisors. I’ve also met with our stakeholders from labor, regulatory and community leadership. What I’ve seen confirms that NS is a robust franchise with a talented team and the resources to deliver impressive results when properly executed. Our safety performance, as shown on Slide 15, has trended favorably. I have observed a strong safety commitment and we are building on that. My first action as COO was a system safety blitz to provide clarity around the value of safety. Turning to Slide 16, it is imperative that we close the profitability gap with our peers.
We are now delivering encouraging trends in productivity. Our strategy is balanced, where operating efficiency and service excellence are achieved in tandem. Our approach is a flywheel of value creation, where people, processes and accountability intersect to drive performance, anchoring our service and profitability proposition. Accountability is key. We’re providing our team with the metrics they need to track their performance. In my first 30 days, we have removed approximately 200 locomotives from the available fleet. Most of these have gone into storage status or driven offline for HPH ballast. Our availability count is now below 2,500 units. As shown on the slide, we will be able to increase locomotive drawdown over the next six months.
Terminal Dwell has improved by 8%. We are driving out more waste by fine tuning workload in our terminals through disciplined planned execution. Near-term, we are targeting 20% improvement. Car miles have improved by 8%, and this is another productivity measure we target for double-digit improvement. Recrews are trending down 22% as network and terminal improvements are combining to improve fluidity across the mainline. And lastly, we are reviewing the entire train service plan. This will drive co-rationalization in the range of 4%. Resulting from these initiatives, we are driving out excess cost as we close the gap to our peers. Referring to Slide 17, network update. To accelerate improvements and address network underperformance, I have established a network optimization team that identifies areas for immediate improvement.
I have deployed two task force to drive field productivity and throughput at two major terminals. The outcomes from these efforts will rapidly go to scale throughout the network. We are training our operations leaders to think differently, to make faster decisions, and to eliminate waste more vigorously. My commitment is to develop PSR railroaders, to instill the discipline for continuous improvement, and to streamline execution by relentlessly managing assets in context to our commercial obligations. The initial results across the entire network have been promising. Our people are driving PSR results. To create accountability and to track progress, we’re introducing a comprehensive set of metrics. I’ve laid out challenging and urgent near-term targets, and I’m taking an aggressive disciplined approach to achieve our long-term financial glide path.
And, I can tell you now we have a significant runway on cost reduction. As our fleet becomes more efficient, we benefit in rents and materials by shedding assets and from improving the fleet composition and getting out more costly cars. Our locomotive fleet now has significant capacity. I believe we will be able to scale down discretionary capital spending on the fleet, and we have a robust terminal footprint covering a rich array of industrial activity. And, as we optimize our terminals, we are challenging their historic use to create value through consolidation and efficiencies. I am proud and excited to have the opportunity to lead the operations team at NS. I look forward to your questions and I will turn the call back to, Alan.
Alan H. Shaw: Our strategy is designed to mirror the great success stories of the Canadian railroads, who have recognized that PSR is about more than tearing a railroad down to its studs and slashing costs regardless of the fallout. As our Board member, Claude Mongeau, demonstrated when he was CEO of Canadian National, a PSR operating model, when part of a customer-focused balanced strategy, can deliver top-tier revenue growth and a sub-60% operating ratio. John Orr was an integral part of Claude’s leadership team at CN and thus a perfect fit from Norfolk Southern as we turbocharge productivity in pursuit of industry competitive margins and top-tier earnings growth. Core to this are the men and women of Norfolk Southern. I’m incredibly proud of all they’ve done to progress the execution of our differentiated strategy.
To my colleagues, thank you for everything you do for Norfolk Southern, our shareholders, our customers, and your fellow team members. Together, we are on a transformational journey to a safer, more profitable railroad, poised for growth with strong execution from an experienced leadership team. We will now open the call to questions. Operator?
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