Union Pacific Corporation (NYSE:UNP) Stephens 2020 Annual Investment Conference November 17, 2020 9:00 AM ET

Company Participants

Jennifer Hamann – EVP & CFO

Eric Gehringer – SVP, Transportation

Conference Call Participants

Justin Long – Stephens

Justin Long

Hi, everyone, and welcome to our next fireside chat with Union Pacific. Representing the company today, we have Jennifer Hamann, CFO; and Eric Gehringer, who’s SVP of Transportation now in his role is going to be changing here. Shortly, as many of you have heard.

Jennifer and Eric, thanks for being here. Really appreciate your time. Wish we could do this in Nashville, but looking forward to having this discussion.

Jennifer, I’m going to open it up to you to make some prepared remarks. And then after that, we’ll go to Q&A. [Operator Instructions]

So with that, Jennifer, I’ll turn it to you.

Jennifer Hamann

All right. Thanks, Justin, and good morning, everyone. We’ll start off with our customary slide that shows that we have some forward-looking statements that we might be making today, and so those statements are subject to risks and uncertainties. So please refer to the UP website and SEC filings for additional information about our risk factors. And these slides that accompany our presentation can be found on the investor website next to the webcast link for the event.

I’m excited to have Eric with me here today. In a couple of minutes, I’ll have him introduce himself to you all and provide an update on our operational performance so far in the fourth quarter. First, let me start with a quick recap of our third quarter performance.

Beginning on Slide 3, this gives you a summary of the highlights from our third quarter where we delivered strong financial results despite volume declines of 4% and a revenue decline of 11%. In this environment, we did an excellent job controlling costs as volumes rebounded from the lows of the second quarter.

To put some numbers around it, sequentially, as third quarter volumes increased 19% from the second quarter, fuel adjusted operating expenses increased only 11% to produce an all-time quarterly operating ratio of 58.7%, which was our first sub 59 quarters as a company. Strong productivity gains of $205 million in the third quarter were key to driving that operating ratio improvement. In fact, year-to-date productivity totaled $610 million as the operating continues to progress train length initiatives against an improved service product.

You turn now to Slide 4 and our fourth quarter volumes are staying pretty steady in the 160,000 7-day carloading range. And that’s been in that range growth for the past several months.

For the quarter, volumes are currently up 3% year-over-year as we continue to see growth in our premium sector and improving sequential volumes in both bulk and industrial. Looking a little deeper in each business line, premium is currently up 11% versus fourth quarter 2019 as we continue to see growth in our intermodal business, which is up 14%. Intermodal volumes continue to be led by e-commerce business and inventory restocking as we enter the holiday shopping season. Business wins across auto parts and both international and domestic intermodal also are contributing to strengthen this area.

Our bulk business is down 1%, as coal continues to be a headwind, down around 19% quarter to date. However, that it is mostly being offset by strength in export grain, as grain and grain products are up 17%. Business wins and commodities like specialty grain, sweeteners and tomato paste are elevating volumes for us as well.

Finally, our industrial business is down 7%, demonstrating some sequential improvement that added more muted pace. While energy markets continue to be challenged, with crude and sand down 20 — excuse me, 40% and 25%, respectively, a strong housing market is driving our product line up 11%, while industrial chemicals and plastics have made sequential gains. Again, we won business in commodities like recycled glass, steel and industrial sand.

In the face of macroeconomic headwinds, our marketing sales team is using a more reliable and consistent service product, combined with a reduced cost structure to go out and win in the marketplace.

Our optimism for the long-term potential of our franchise has never been greater.

So with that, let me turn it over to Eric for his remarks.

Eric Gehringer

Thank you, Jennifer. I’m excited for the opportunity to introduce myself and provide some thoughts on my vision for Union Pacific’s operating department going forward.

I’ve been with Union Pacific for 15 years, starting my career in our engineering group, holding various positions until I was named Chief Engineering Officer in early 2018. At the beginning of 2020, the mechanical department was added to my responsibilities, which was dear in my heart given my aerospace engineering background. Then I move to my current position of Senior Vice President of Transportation.

I’ve been fortunate to work with Jim Vena since he came to the Union Pacific almost 3 years ago. And I’m appreciative of the opportunity to continue to receive his guidance and mentorship through the end of June.

While more recently, I’ve been experiencing PSR through the lens of train operations, over the past 2 years, we’ve also been transforming the engineering and mechanical departments. From being more efficient with our track time to maintain our infrastructure to how we service locomotives to turn the asset faster, we are applying PSR principles in every facet of the departments.

Under Lance and Jim’s mentorship, the entire leadership team has been immersed in this way of operating since we began our journey in early 2018.

Shifting gears to current operations on Slide 5, we’re providing an update to our key metrics for October. As you can see, we once again made improvements across nearly all of our metrics. You’ll know that locomotive and workforce productivity made sequential improvements from the third quarter as we continue to use those resources more efficiently. Those improvements were spurred by continued improvement in train length as we made a 100-foot sequential improvement in October to almost 9,100 feet. This improvement was made with sequential volumes essentially flat as we [Technical Difficulty] we continue to update to our vision,

[Technical Difficulty] our customers with an enhanced service product [Technical Difficulty]

and remains so in October. During the earnings call, we discussed the challenges in Intermodal with the rebound in traffic we saw on the West Coast. As we noted then, our service product has recovered strongly, as evidenced by the 83% on-time performance we achieved in October.

As I look to the future, we have a full pipeline of productivity projects across the operating department that’s [Technical Difficulty] I see as critical to our success. Safety. Everything we do, let’s be done with an eye on doing our work safer. Train length. We will continue to push train length to be more productive and provide a better service product to our customers.

Terminal rationalization, our terminals must be as efficient as possible to improve the reliability of that service product. Asset management, we must be judicious with our resources and turn them quickly.

And finally, technology. We will leverage technology whether using the PTC platform or new technology to drive productivity and efficiency.

I’m proud our entire operating team and their achievements during the challenging year. In fact, we’re acknowledging the outstanding work that our agreement professionals have done throughout 2020 to ensure the safe, efficient and timely delivery of freight to our customers with a bonus. We could not have achieved what we did in 2020 without their support and commitment.

As we look ahead to a strong finish to the year, we’re excited about our opportunities in 2021 to provide our customers with a safer, more reliable and more efficient service product.

With that, I’ll turn it back over to Jennifer.

Jennifer Hamann

Thanks, Eric. So finishing up on Slide 6. Our thoughts on the fourth quarter and full year 2020 are unchanged from what we discussed at our October earnings call. We expect fourth quarter volumes will be up low single digits, which will be our first quarter with positive year-over-year growth in 2 years.

Given this outlook, we expect full year volumes to be down 7% or so. Our full year expectation for productivity is to exceed $700 million, and our long-standing pricing guidance is unchanged.

We expect the total dollars generated from our pricing actions to exceed rail inflation costs. These expectations for volume, price and productivity should produce a record 2020 operating ratio. In fact, we expect the full year operating ratio to improve by roughly a point and start with the [Indiscernible].

In terms of cash generation and capital allocation, full year capital expenditures are projected to come in around $2.9 billion, and we will continue providing strong cash returns to our owners through our dividend and share repurchases.

Longer term, capital expenditures below 15% of revenue, a dividend payout ratio of 40% to 45% of earnings and ultimately achieving that 55% operating ratio remain a vision and objectives for our company.

Finally, I also want to highlight the agreement that Eric just mentioned. As we announced last week, we’re providing monetary recognition to our agreement professionals in the form of a $1,000 bonus paid in December. Our agreement employees have been on the front line of the pandemic, providing an essential service to our company and our country. Quite literally, these employees kept our country moving when we needed it most. They went above and beyond to take great care of our railways and our customers.

For that commitment, we’ll be paying approximately 31,000 employees, a onetime $1,000 bonus. Including taxes, that will add around $37 million to our compensation and benefits line in the fourth quarter of 2020.

The value of women and men of Union Pacific provided in 2020 far surpassed our expectations. So this recognition is incredibly well reserved. So with that Justin, I’ll turn it back to you for the Q&A.

Question-and-Answer Session

Q – Justin Long

Well, thanks. I appreciate all the color that you provided. And Jennifer, maybe to follow-up first with a question for you.

All the guidance sounds like it’s being reiterated. So this quarter, has there been any major surprises, either positive or negative as you look across the business? Or would it be a fair characterization to say that trends have been fairly in line with your expectations?

Jennifer Hamann

Thanks, Justin, for that question. Yes, I would say, overall, the things are trending basically in line with how we expected. We had expectations with the intermodal business, the e-commerce parcel was going to continue strong in the quarter, and that certainly continues to be the case. We also expected grain to play a bigger role in the fourth quarter. We’ve seen it strengthen through the third quarter, and that’s absolutely continuing here in the fourth quarter.

But we are seeing some sequential gains on that industrial side, which is encouraging. Still very muted what’s prior to pandemic, but we are starting to see how we start just looking a little bit better. So the lumber products. The industrial side of the business still is pretty muted.

Obviously, coal continues to be a significant headwind along petroleum and frac sand. But I would say that was very much expected coming into the quarter.

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Justin Long

Okay. And Eric, I’d love to ask you a question as well, and it’s great to meet you even if it’s virtually. And I know there are a lot of investors that are eager to hear from you and meet you as well.

So I wanted to ask about PSR implementation at UP. Obviously, it was — it’s off to a very successful start. Jim’s leadership has been an important piece of that.

So the main question, I think investors have, just to be direct, is that sustainability of this success as this transition plays out. So from your perspective, what’s the message to investors to give them confidence that the foundation of PSR has been built, the blueprint has been laid and we’ll see continued success and a smooth transition into next year.

Eric Gehringer

So thank you for the question, Justin. It’s a great one. I want to be just crystal clear that everything — the strategies we have, the actions we’ve taken, they will continue. When you think about what Jim has shared in the past, he an absolute driving force to evolve the way that we look at our business, obviously, with a clear sight on asset and productivity.

When I think about moving forward, though, you’ve also heard Jim say that although he was that driving force, his mission was to empower our team to evolve in their mentality to embrace the PSR types, and that’s what we’ve done. You see it across the entire board within every department we’ve been operating that we are focused on those 5 types of PSR. And I don’t expect that to change a single bit with his departure in June next year.

Justin Long

And from a high level, as you think about the productivity opportunities in 2021, what are the kind of key areas that you would highlight, Eric?

Eric Gehringer

So the 3 most important ones to me after safety are going to be train length, balancing, and then we look at our assets, specifically around locomotives.

So all 3 of them individually, collectively, they all drive the same result, which is less crews, less locomotives, less products. That doesn’t mean that we’re going to put less priority on our service product, that needs to maintain its very strong position, but we’ll continue to push those 3 areas because they directly drive bottom line productivity.

Jennifer Hamann

Yes. Justin, I know you’re familiar with. So we completed — I know we did this summer exactly around close to 20 or so of the siding projects that are enabling those train length initiatives so far in 2020, we’ve got more than we’ll complete before year-end.

And then we’ve got more that we’re going to be starting and working on in 2021 and completing in 2021.

So when you hear Eric and others talk about continuing that train length story, part of that is driven by the capital investments that we’re making, but then they’re also obviously doing a lot of good work around the transportation plan and just looking at ways to be more creative and combining more trains to further drive that train length.

Eric Gehringer

Yes. And I’ll just add to that, Justin, when we think about train length, and Jennifer just mentioned at the end, when I think balancing, that’s what I really mean is, yes, we can make infrastructure investments and we are. But even beyond just the capital investment, we also have opportunities to just take our existing trains, given their current length and look for every opportunity that complements.

So a very common ones when we have trains leave a coal mine, we have the ability once they reach our railroad to combine 2 of them in their transit all the way to Chicago. It’s those types of process improvements and that continued the evolving of the mindset that says we can run longer trains, that then you would see me continue to reinforce on a daily basis.

Justin Long

And I know the opportunity to run longer trains is going to vary based on the commodity and where you are in the network.

But just generally speaking, how much room do you have to go on that front? I mean, is there another a 15%, 20%? Just if you look at the average across the network, how much more can train lengths improve?

Eric Gehringer

So we have this conversation frequently with people because it usually comes in the form of what physical limitations are there. Now there are physical limitations in our infrastructure. We do have to make investments in that.

But I wouldn’t even put a number on it at this point, Justin, because we’re pushing ourselves to not even feel in any way constrained that there is an upward bound. Instead we’re just going to continue to [indiscernible] but consistently push that envelope. And I hope that it’s much longer than it is today.

Justin Long

So I think the conclusion is that this is a multiyear trend, not just a 2020 and 2021 trend as volumes bounce back. Is that fair?

Eric Gehringer

It’s 100% fair, and you know that it’s going to go beyond that because part of our ability to grow train length, it depends on mix. And so as we see changes to our business, we’re going to continually ask ourselves, okay, is there the ability to grow train length as a result of that change in mix.

Jennifer Hamann

Yes. And I would just go back and say one of the great crude statements that it’s not just about infrastructure or volume given it is the way that we grew train length in the second quarter when our volumes were down almost 20%.

So that’s where really kind of the process that Eric touches on and the transportation plan plans to roll. And so you’ve got — just kind of think of a Rubik’s cube that we’re continually twisting and reshaping and finding ways to grow that trend.

Justin Long

And Eric, you mentioned your background in engineering. I wanted to ask about that. And as you think about stepping into this new role, how do you feel like that could help you in the continuation of implementing PSR. And just from a technology standpoint as well, what do you see as the opportunity there? Will we see UP invest more in technology under your leadership the next couple of years?

Eric Gehringer

Yes. It’s a great question. So I really want to be crystal clear in this that since the very implementation of PSR, I’ve been involved in it. Yes, I was in the engineering environment, but we were applying the PSR tenants of engineering just as we do in transportation.

When we think about — and I’ll just stick with some of the examples we mentioned, the signing construction projects, if we think about how we’re doing that in the last 2 years versus historically, we’re delivering those projects twice as fast and about half as much cost. That’s straight under the PSR [Indiscernible] that says how do you take an asset base and deliver it faster with less cost or said differently, do more with less.

Now when I had the opportunity to take mechanical the same thing applied there. We applied PSR tenants so an example there is, if I think about our locomotive inventory, part of the cycle on a daily basis of a locomotive on a getting serviced, right? It comes into a terminal. It has to be serviced with fuel and cleaned and brought back out.

When we think about that operation, we focus a considerable amount of time to driving that down and make double-digit percentage improvements in that area, that directly correlates to a smaller fleet. So there again, applying PSR growth in the time of the last 2 years.

And then in the last 7 months, with transportation, I’ve had the opportunity to just pivot from that and apply that same mentality to our transportation product, and you’ll see me continue to do that.

Now regarding technology, it will continue to be a driver of productivity and try to become even a greater driver of productivity in the long term. When I think about some examples, we’ve talked about our ITR, which is our Intermodal Terminal Reservation System, that’s a technology that allows our customers to get improved visibility, and it also allows us to plan more appropriately our asset base for the oncoming demand, whatever that may look like.

And then in our TSR strategy, we have to be very good in our assets. You also will see technology in some of our autonomy or semi-autonomous equipment. There’s — continues to be more and more advancements in that area. So when we think about how we maintain the railroad, how we renew the railroad, there’s massive opportunities to drive that to more of a machine-based operation versus a more human-based operation.

Jennifer Hamann

And I was just going to add, Justin, so under Eric’s leadership and Engineering group, one of his, I’ll call Eric [indiscernible] really that productivity side and applying technology to it, and working with suppliers to develop a number of new maintenance machines or strings of machines, that could both be more safe because we really got less people, could be quicker, less track timing consumed and just improve the overall productivity. And so that’s work that he started and continues to be underway.

Justin Long

That’s helpful. And just thinking about the OR, you have this longer-term goal of getting to a 55%. I know you haven’t put a time line around that. It sounds like that’s maybe something you would address next year if we can all get together for an Investor Day.

But as you think about progressing towards that 55% OR, do you feel like you need to see revenue growth in order to hit that target? Or do you think the productivity opportunity and continued pricing above inflation is enough to get you there?

Jennifer Hamann

Well, Justin, I think you probably are very familiar. When we first put out the target of the G 55, the G was for growth, and that was put out several years ago. And fortunately, our volumes have not grown since then. Although, we have made substantial progress towards that goal, and it really has basically been on the backs of price and productivity.

So I think in my mind, it’s all about trajectory. I think if you can get all 3 legs of the stool moving together at the same time, in terms of volume, price and productivity, there’s a greater trajectory forward in terms of making progress towards that goal.

If you’re going to have 1 of the 3 or 2 of the 3, that’s going to impact the trajectory, but if — none of that does change our commitment to be able to reach that. In an ideal world, we’d be calling on all 3 levers and getting there in short order.

Justin Long

Makes sense. I wanted to ask about peak season. Obviously, the freight market has been very strong. I think expectations across the board were for a strong peak. Curious what you’re seeing out there today.

And then just from a service perspective, I know there were some disruptions in the third quarter related to congestion. Any risk of that in 4Q and into year-end as peak season kicks in?

Jennifer Hamann

Yes. I mean, I’ll start, and then Eric will probably want to add on a little bit. As I mentioned earlier, our volumes have really stayed pretty steady over the last several months, I’ll call it, since kind of the August time frame in that 160,000 7-day carloading level. The mix has changed a little bit as grain has started to play a bigger role, but intermodal continues to be up.

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So we still think there’s going to be some peak season volumes relative to intermodal, but we’re already operating that at a pretty high level historically for us. And if you talk to the parcel folks, they have seen because of the e-commerce shift, obviously, very strong loadings over the last many months, since we kind of came out of that initial pandemic shutdown.

So I think if you think about our volume guidance as being up low single digits in the fourth quarter, that’s all fairly consistent with what we’re seeing today in terms of our overall carloadings. But Eric, do you want to maybe touch on the service side?

Eric Gehringer

And Justin, we closed the quarter to 77% on our Trip Plan Compliance so that we reported at the end of October that then got to 83%, which was an evidence of our rebound coming out of the surge.

Since that time, we’ve maintained that level. So I don’t expect anything to change going down. And it will continue to be a major emphasis to your point as we come into what we’ve historically called peak season because we would have to be exceptionally consistent during that period.

Justin Long

And one question we’re getting a lot is just on the inventory restocking that needs to occur going forward. Do you have a view on how long that will last? Is that into the first quarter of next year? Could it be beyond that? What’s the feedback that you’ve heard from your customers?

Jennifer Hamann

Justin. So certainly, we do believe the inventory restocking is still alive and well. In fact, anecdotally, I can tell you, we’ve got a big furniture store here in town. And one of the anecdotes we’ve heard recently is that they normally have, call it, 4,000 refrigerators in stock at any one point in time. And more recently, they’ve got like 400.

So I think in terms of how long you’re going to have the tail on that restocking really depends on the consumer. We’re obviously going into the holiday shopping season. Is the consumer going to stay engaged? I know retail sales just came out today. I think they were a little bit lower than what was expected, but still up year-over-year.

So that’s, in my mind, is how long that tail lasts is how the consumer stays engaged. Consumer balance sheets, I think, are in much better shape than they were coming into the pandemic.

But certainly, the jobs, there’s still a lot of people that are not at work. I think there’s questions around, are we going to get a third stimulus package, all of those things are going to play into mosaic in terms of how long we see that tail. But I do think that there’s substantial opportunity still ahead of us in the near term.

Justin Long

And how do you think about the industrial sector headed into next year as well? I mean, obviously, retail and the consumer has driven this recovery, so far, industrial has been weaker. Do you think we’re on the cusp of that changing? And next year, maybe industrial fares better than retail and the mix implications of that could be positive. So I would love to get your thoughts around that, too.

Jennifer Hamann

Well, to the last part that you mentioned there, Justin, certainly the mix implications of that could be very positive for us. How that [Indiscernible] can actually play out is obviously too soon to call.

As I look back at some of the industrial production numbers, we were kind of entering into a slowdown relative to industrial production through the back half of 2019. I think that was reflected in our carloadings. And then when I look ahead at some of the projections for 2021, if you take out the second quarter, which is obviously the pandemic comparison, it’s pretty muted overall.

And I think even still in negative territory in the first quarter. So that is where our lines have been more muted. I think customers are a little bit less conviction right now in terms of where they’re going to put those capital dollars. So I think that kind of remains to be seen.

Certainly, we can get some stability relative to the virus and the vaccine and see some better trajectory there and maybe some recruitments going forward in that regard. That will help, but it could be muted, at least certainly to start 2021.

Justin Long

And then on mix, just sequentially going into the fourth quarter, you mentioned overall carloads have been pretty stable here recently, but the mix has changed a little bit with grain picking up. I know grains higher RPU, I think it tends to be a higher-margin percentage versus consolidated levels. So do you expect mix to improve in the fourth quarter relative to the third?

Jennifer Hamann

I think sequentially, for the reason that you just stated, Justin, that we should see a little bit of improvement on the mix side. Certainly, we still have the headwinds of less petroleum and frac sand, but the grain does help a little bit from a mix perspective.

Justin Long

Okay. And wanted to shift to truckload conversions and what you’re seeing here in the fourth quarter. I know earlier in the year, you had some nice wins that you’ve highlighted, and those have kicked in more meaningfully. But have you seen an acceleration in truckload conversions recently? And any thoughts about that opportunity going into next year?

Jennifer Hamann

I don’t know that I could say that we’ve seen an acceleration in the truckload wins. We’re just going into kind of that [Indiscernible] season right now. And so the fact that truck capacity has stayed tight and looks to be tight going into the first part of 2020, I think can be a favorable dynamic for us.

We certainly know that by working with our customers to convert their truckload business into rail business, that, that can be a very positive ESG [Indiscernible] for them. Very carbon friendly [Indiscernible] for them. So we’re having those conversations with our customers.

And as Eric pointed out, our service product has really never been better. So we see all the stars lining up that way. And the marketing sales team is definitely going out and having those conversations. And I think there’s great opportunities. And we’re making small wins, I would say, not every day, but very frequently that Kenny is reaching out and reporting back to the team of another business win.

So the team is out there winning in the marketplace, and that’s part of what gives us a lot of options we put out in 2020.

Justin Long

And thinking about the last couple of years, there have been very significant productivity gains. As we look ahead to 2021, is it another year of significant productivity? Or is your view that there could be a pivot towards growth and more of a focus on leveraging the changes that you’ve made with PSR driving conversions, as we just discussed and growing volume on the network.

Jennifer Hamann

Yes, Justin, of the things that I would say has been a number for us maybe since the start of our PSR adoption is that we were trying to constrain growth while we implemented PSR. That has never been our intention. We have been historically very margin focused in terms of making sure that the right business is moving on the railroad. So we didn’t come into this with a large effort to shed business.

Unfortunately, volumes have declined while we have implemented TSR. And I think you’ve heard us talk about that, that actually creates more challenges as the volumes are returning, that gives Eric and his team more optionality in terms of how they’re going to handle those volumes. It builds longer trains, bypasses more terminals.

So we very much are looking forward to growth. We want to grow. And we see things lining up a little bit better for us here in 2021 in terms of, knock on wood, hopefully, no lockdown to the economy and another kind of second wave of pandemic-impacted volumes, and the team, like I said, has been winning to the marketplace.

So that very much is something that we look forward to, and that can actually drive more productivity. I mean, Eric and team can leverage more in terms if you think about building that train length, if I’ve got more volume to do it with, I think that makes it a little easier. Do you want to talk at all about other productivity volume here?

Eric Gehringer

I mean, Jennifer, you really covered most of them. I mean, to your point, we’ve built a service product, we built a network and we built a transportation plan that all align to bringing on business — incremental increases in the business, but handle them within their existing access base. Anytime we do that, that’s a direct driver of productivity.

Justin Long

Helpful. And Jennifer, I know you’re not giving guidance on 2021, but you made the comment on the call that you expect volumes to be positive. As you look across the business, what are the areas that you expect to drive the most significant growth next year?

Jennifer Hamann

Well, I mean, again, there’s a lot of things that are going to have play out over the course of 2021. So I’m not going to make any big predictions.

But certainly, if trends continue from where we’re at during the fourth quarter, at least into the first half, we have opportunities for intermodal to continue to stay strong. And certainly, that’s going to be parcel, that is going to be domestic.

The first quarter of 2021, international Intermodal was pretty substantially impacted because the pandemic was already over in the Asian countries and that was — they were in lockdown at that point. And so international intermodal was pretty substantially impacted in the first quarter. Certainly, at the automobile manufacturers and the shutdown that they experienced in the second quarter and kind of a slow start there. So I think there’s opportunities there.

But really, we’re looking across the board. All recent coal and petroleum products aside. But beyond that, with some sequential improvement in the economy, I think there’s opportunities across our whole book of business.

Justin Long

And as we think about headcount with volumes coming back, any updated thoughts around the sequential trend in headcount in the fourth quarter? And then looking into next year, if we see a volume environment that’s growing, let’s call it, mid-single digits, is that an environment where you can still hold the line on headcount and keep it flat, maybe even down? Or do you think you’re going to have to bring people back in that type of volume growth environment?

Jennifer Hamann

Yes. Justin, I’m not going to make any predictions relative to headcount or actual volumes, but you have seen it, I think, be very judicious in terms of how we brought headcount back onto the railroad. As the volumes have come back, you just saw Eric talk about over-course productivity number in the month of October that improved even over our third quarter levels. So we very much are focused on being very productive from a workforce standpoint.

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We know that, that is — if you look at our common benefits line, that is the biggest driver of our operating expenses. And so we’re going to manage that very closely and look for every way that we can to be more productive with our workforce.

Justin Long

And from a comp per employee basis, any major changes in the fourth quarter outside of the severance costs going away? I know that’s something you highlighted on the last call, but any way to help us think about the trend there sequentially?

Jennifer Hamann

Yes. Well, I mean, I did just mention that we are going to have $37 million in that line that you perhaps weren’t modeling in relative to the bonus that we’re paying to our agreement workforce here in the fourth quarter. So I think that’s definitely something to add to the model, so to speak.

But beyond that, the severance, sequentially, will not be there. That was a third quarter item. There was a little bit of payroll tax that was involved in the third quarter.

But otherwise, we are — because we are being very judicious in terms of how we’re bringing employees back on to the payroll, you are seeing us have a little bit higher cost per crew because we — it’s better for us at this point in time to run a little extra over time, get a little bit more in terms of arbitraries versus actually adding that headcount back, especially as we’re going into the holiday season, when we know our volumes will fluctuate, and we know we’ll have some periods over volumes or less.

So we don’t want to be in a position where we’re bringing some people in off furlough and then have to turn around a furlough them again as we get into a seasonally lighter period of volume because once we bring that person off of furlough, we’re now going to be paying benefits for them for 4 months.

And that’s not fair to them from a lifestyle perspective, either, quite frankly. So we’re being very careful there.

Justin Long

That makes sense. And maybe we can talk about locomotives as well. Eric, could you provide an update on how many locomotives you have in storage today? And as you think about that number, longer term, where do you think that number normalizes?

Eric Gehringer

So I would say, in current stage, we still have approximately 3,000 locomotives that are in storage. For much of the reasons Jennifer mentioned, I can’t guide to what that future state would look like, I understand very clearly, though, that it continues to be a huge focus for us to ensure that those assets, all of which are $3 million or more become as efficient as they possibly can. You’ve seen us reach an ultimate high here in the last month. That’s something you should continue to expect on us, Justin, and continue to grow that.

Justin Long

Could you talk about your locomotive rebuild plan as well, just sticking with that theme, how many units you’re rebuilding annually right now? And is that something that we could see accelerate?

Eric Gehringer

Yes. So this year is a bit of a different year since we temporarily closed our facility that does the rebuilds. Now we’ve reopened that facility from a headcount perspective, it’s less than we had before. We’re being very diligent in making sure that the demand for the business, which is, in this case, the form of volume is driving additional locomotives there before we put more people into that shaft overhaul. The rebuild program itself is very important to us. When you think about the 3,000 locomotives that we have stored, that doesn’t mean every one of them is a candidate for rebuild. But obviously, we’re prioritizing the rebuilding of our existing assets before going out and purchasing new assets. So that will continue to be a priority in 2021.

Justin Long

And how are you seeing the performance of those rebuilt units relative to Tier 4s.

Eric Gehringer

Our performance on the rebuild program is very subtle. There’s no doubt about it. We see — we measure that in a couple of different ways. Obviously, we’ve measure that in uptime, but we also measure it in variability events. And if you look at the rebuild units versus all others, it’s strong performance.

Justin Long

Maybe we can shift to price for a moment, just given the improvement in the freight market and what we’ve seen in the truckload sector, the stage seems to be set for an acceleration in pricing going forward. Would you agree with that view, number one? And number two, how should we think about the pace of repricing in your business and just the cadence of that over the next year?

Jennifer Hamann

Justin, so I would say, certainly, a strong truck pricing environment, a stronger economy overall and a good service product are all dynamics that play favorably to that price question. And so if those trends all stay in that direction, I think that is a positive statement of for us to be a positive momentum for us.

And I think you probably know, in any given year, it’s only about half of our book of business that we’re able to actively touch. We have about half of the book that’s under multiyear contracts that do have escalators. But then it’s the other half that we’re touching either in 1-year contracts or [Indiscernible] type pricing. So that’s how that breaks up work for us.

Justin Long

I want to go back to a comment that you made briefly on ESG. That’s something that’s coming up in a lot more conversations. And I’ve gotten a couple of questions on it. How meaningful is that theme in discussions that you’re having with your customers today as they look at rail versus truck and the fuel efficiencies of rails. Is that something that’s meaningful? And how do you expect that theme to evolve going forward?

Jennifer Hamann

So Justin, I think it’s meaningful at various levels of our customer organizations. I don’t know that from a transportation manager, the person who is often the person on the ground is maybe making some of those buy decisions that hasn’t become a clear focus for them yet. And so we’re looking forward to that top-down message that I think you’re hearing from all companies around the world, quite frankly, talking about ESG, and that needs to get pushed out further into the organization that becomes a priority and a driver relative to those transportation managers.

So I think that’s something that still has a little bit to play out. It certainly is something that we’re putting on the forefront when we’re talking to our customers, we’re giving them data. We’ve actually long had a carbon calculator on our website that employs — or, excuse me, the customers could use to calculate a conversion of the [Indiscernible] from truck to rail. Here’s what I’m saving.

So I think that’s very much something that’s ahead of us in terms of what it will help deliver to us from a volume standpoint.

Justin Long

We probably have time for a couple more questions, but what I wanted to throw out there was on capital allocation, specifically related to buybacks. The macro environment seems like it’s changing every day. But now that the election is out of the way, I guess, depending on who you’re talking to. And we’ve got some positive data points on vaccines going into next year. Would it be reasonable to assume that you could be a little bit more aggressive on the buyback here in the near term? Or how do you think about that?

Jennifer Hamann

So I think you’re well aware, when we look at capital allocation, the first dollars that we commit is going to go back into our railroad, into our infrastructure and into growth opportunities within the railroad. But then beyond that, we’re — we want to make sure that we pay a dividend, have an industry making dividend on a payout ratio basis to that 40% to 45%, and then excess cash, so to speak, to our shareholders in the form of repurchases.

And part of that we’re using our balance sheet for, as we have been taking on additional debt and using that for share repurchase.

So I think that’s been a winning combination for us, as it’s something that at this point, I anticipate us continuing as we go forward. We’re always looking to see what’s the best mix of that. We think that we feel good about our balance sheet position. We feel very good about the cash that we’ve generated even through the course of the pandemic.

And obviously, we restarted our share repurchase here again in the fourth quarter, and I think that signals further the confidence that we have in our company.

Justin Long

Well, Jennifer and Eric, as we kind of wrap up, I wanted to give you both the opportunity to just provide some concluding comments or remarks, anything that you think is important to emphasize into year-end and 2021, especially for you, Eric. Just as you step into this new role. I know we discussed that earlier, but would love to just get kind of final thoughts.

Eric Gehringer

Yes. So I would just — it’s kind of where we started, Justin, that the position that I’m getting on January 1 and continue to work in, we are not going to change our strategy. We are going to continue to focus on the PSR tenants, continue to focus on safety and productivity.

Not only do we have all the success that we’ve had in the past to build upon, but we have a very strong pipeline of additional productivity initiatives, mostly around our asset base that we’ll continue to deliver on next year as well.

Jennifer Hamann

Yes, Justin. And I would just say that from a momentum standpoint, I feel very good about how we’re closing out 2020. I think everybody is anxious to close out the year, to be able to put 2021 down. I don’t know how much the world is actually going to change on January 1, but we’re certainly looking forward 2020 in the books and coming out of it with great momentum, both from a volume standpoint, a service standpoint and productivity standpoint.

I really feel great about the team and everything that we have behind us in terms of momentum into next year, the pipeline of initiatives that’s there, the pipeline of business development, that Kenny and team have, I think it can be a great year going into next year. We obviously need a macro environment to support some of that, but we’re also not going to let that hold us back as I think we’ve demonstrated here in 2020.

Justin Long

Well, Jennifer, Eric, thank you so much for your time. It’s great to see, Eric, congrats on the new role. And looking forward to 2021, myself, and hopefully, we’ll be doing this in Nashville.

Jennifer Hamann

I hope so, too, Justin.

Eric Gehringer

Thank you, Justin.

Justin Long

Thanks, everyone.

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