Based on the earnings that the company released, but more importantly, based on where the company sees itself on the timeline for implementing precision railroading (PSR), Vena is coming to a company that appears to be on its way toward meetings its PSR-driven goals.
In releasing its fourth quarter earnings, as it has been for all railroads implementing PSR, the first glance is always at the company’s operating ratio (OR). For the quarter, UNP posted an OR of 61.6 percent, a minor basis point improvement sequentially from the third quarter but a significant drop from the 64.6 percent posted in the first quarter and a 110 basis point improvement over the fourth quarter of 2017.
On the call, Rob Knight, a UNP executive vice president and CFO, said the company’s target is a sub-60 percent OR by the end of this year, and sub-60 percent by 2020. That is up by about 100 basis points from earlier forecasts.
When Vena was hired earlier this month, Bank of America Merrill Lynch transportation analyst Ken Hoexter said in a note to investors that Vena was the “biggest free agent in the rail group” with experience alongside the founder of precision railroading, the late Hunter Harrison. Vena had been executive vice president and COO at Canadian National most recently, but had a career there that stretched back to 1977 when he joined as a brakeman on the railroad, according to Hoexter’s note. “It will be interesting to see (and remains to be proven) if Mr. Vena can adopt a network into a PSR format versus growing in a system already executing PSR.”
Vena was given an opportunity to discuss some of his philosophy on the earnings call with UNP analysts. “The end result is that if you want to have great service, there’s going to be noise on the way there,” Vena said in response to a question about customer dissatisfaction with the changes that accompany PSR. But the goal is efficiency, he said, and it’s the type of efficiency that results in turning locomotives faster, which means “you need less of them and less to service them,” Vena said.
But it isn’t just a cost-cutting exercise, Vena noted. “You run a real efficient railroad so you can attract new business,” he said. And when those efficiencies are in place, it puts the railroad in place to attract new business not just from other railroads – all of whom except BNSF have announced plans to adopt PSR “principles” – but also from trucks. “The quicker we can get to that drives the bottom line,” he said.
Some of the operating statistics reported by UNP showed gains in the benchmarks that are generally accepted as the standards for the effective implementation of PSR. For example, freight car velocity measured as daily miles per car was 189 for the seven-day average through January 22; it was 174, with a target to increase that by approximately 10 percent by the end of the year. Cars per carload – measured as operating inventory per daily carloads – were 7.3 through January 22, and eight in September. Other benchmarks, such as locomotive productivity (using fewer locomotives is a key principle of PSR), car trip plan compliance and workforce productivity, measured as daily car miles per full time employee, were all higher between September and the most recent seven-day period.
These changes are impacting customers, and UNP officials on the call said they have been brought into the discussion. We’ve been very proactive with our customers and we have been very granular on the changes we want to make,” Kenny Rocker, UNP’s executive vice president for sales and marketing, said. “We tell them exactly what will happen and talk to them about when it will happen, and then we talk about what they can expect will be done at every turn.” UNP CEO Lance Fritz followed that up by saying that customers are not necessarily “accepting that right away, and we’ve had some tough discussions.” But he added that customers are “understanding what they need to do to receive better service, net-net, overall.”
The specific changes are granular enough that Tom Lischer, executive vice president for operations, said that since October in the mid-American corridor alone, UNP has made 160 changes to its existing operations. But he also said the upside to that is that car inventories are down 16,000 cars and dwell time is down four hours. On the West Coast’s Sunset Route, there are more than 200 changes planned in the network and half are done already, Lischer said.
That leaves the employees. Vena said on the call that the “last piece” in adopting PSR, based on his past experiences, is the “culture change… how people think and how they do.” But it can also take capital expenditures; Vena cited the installation of longer sidings as an example.
Among other key financial and operating metrics, Union Pacific had a solid quarter:
—Freight revenue was up 6 percent from the prior quarter and several UNP executives on the call said they had not seen any signs of a slowdown in the first quarter of this year.
-–Although terminal dwell was better – a key benchmark for PSR – average train speed was 24.4 mph, down 3 percent from a year earlier.
—Operating income of $2.2 billion was slightly less than in the corresponding quarter of 2017, with expenses having risen more than $300 million mostly because of higher fuel prices and equipment expenditures. Net income comparisons to the prior year are affected by enormous income tax benefits taken in the fourth quarter of 2017 by UNP. Net income was $1.55 billion. Earnings per share of $2.12 per share beat consensus forecast by 4 cents, and total revenue of $5.76 billion beat forecasts by $20 million.
—Equity markets like what they heard. At approximately 1:45 p.m., Union Pacific was up $4.02, or 2.61 percent, to $158.35. It had been above $160 earlier in the day. That increase might have been higher, but as CFRA analyst Jim Corridore said of the stock price, “While UNP is likely to continue to benefit from an improving U.S. economy, we think much of this is discounted into the current share price and think weak agriculture volumes might persist for a couple of quarters, although we do expect a rebound in energy and for general merchandise strength to remain.” He kept his Hold recommendation on the stock.