Analysts compared Union Pacific’s second-quarter results with those of CSX and during the railroad’s earnings call on Thursday asked executives why UP doesn’t measure up.
Deutsche Bank analyst Amit Mehrotra noted that UP is now less profitable than CSX despite UP’s advantages of operating in the West, where its route structure favors longer hauls and higher revenue per carload.
Does watching the rapid improvement at CSX, Mehrotra asked, bring a greater sense of urgency to UP?
“Notwithstanding what any other railroad is doing, you can see our elevated sense of urgency and focus and determination when our headline quote for a quarter where we just generated record earnings per share and record income is ‘And it could have been better,’” CEO Lance Fritz replied. “Because it could have been better, to your point. We called out $65 million in cost in the network that really shielded us from generating much more attractive productivity. We’ve demonstrated we know how to do that … it’s frustrating that we weren’t able to drop more of the top line to the bottom line.”
UP’s operating ratio increased 1.1 points, to 63 percent for the quarter, as costs increased due to network congestion amid crew shortages and a tunnel collapse that closed a main route for three weeks. Until the May 29 tunnel collapse, UP’s operating metrics had been showing slow, but steady, improvement.
Fritz said UP is “laser-focused on getting the network right.”
And once the system is running normally, the costs of using extra locomotives, freight cars, and crews will go away, he says.
“We’ve got plenty of productivity opportunity. And we know how to get at it. We’ve just got to get rid of these excess costs in the network as we bring service back up,” Fritz says.
Wolfe Research analyst Scott Group noted that UP has added train crews while CSX has reduced its train and engine crew ranks by 11 percent.
“Why aren’t we talking about a real sort of change in strategy here to more fully embrace this Precision Scheduled Railroading concept that seems to be working,” Group asked, referring to the operating model the late CEO E. Hunter Harrison developed at Illinois Central and brought to Canadian National, Canadian Pacific, and CSX.
UP has taken steps to become a more productive and efficient railroad and has learned from CSX, CP, and CN, Fritz says. These include reducing its low-horsepower locomotive fleet by a quarter over the past three years and beginning to shift some unit train traffic into the manifest network.
The Blend and Balance program at UP, which began last year with a pilot program in the Pacific Northwest, is reminiscent of the Harrison philosophy of running general purpose trains and balancing the network by running equal numbers of trains in each direction every day. The idea is to keep crews and power in balance with the added efficiency of increasing train length.
UP has shifted 70 percent of finished vehicle traffic out of unit trains and into the merchandise network, executives said in May. UP has declined to provide additional details but says it’s in the early stages of reviewing its operating plan on a corridor-by-corridor basis.
Fritz also emphasized that the number of active crews at UP held steady as volume grew 4 percent in the quarter. The higher overall crew numbers reflect the presence of more than 700 conductors in the training pipeline.
Morgan Stanley analyst Ravi Shanker came to the rescue by noting that there’s a hyperfocus on operating ratio, which comes at the expense of attention to sustainable growth. UP was gaining volume at a good pace, Shanker added. UP’s quarterly growth was twice that of CSX.
“You’re exactly right, Ravi,” Fritz replied. “We care about a number of measures that demonstrate whether or not we are running the business well over the long-term.”
Generating operating income and cash is at the top of the list.
“We actually had a pretty damn good first half in that context,” Fritz says.
Return on invested capital measures whether the railroad is being wise with capital expenses. And operating ratio measures whether management is dropping top line revenue to the bottom line.
“At this point it’s appropriate to focus on O.R. and say we’re disappointed with our ability to efficiently drop top line to the bottom line,” Fritz says. “That doesn’t mean we can’t do it. It means we didn’t demonstrate doing that in the second quarter. We have all the confidence in the world that we’re able to do that both over the long run and rectifying that in the short term.”
UP is run with an eye on the long-term and meeting the needs of shareholders, customers, employees, and communities, Fritz says.
“We think about all of that when we are running the business,” he says.
At 55 percent, UP has the industry’s most aggressive long-term operating ratio goal. It also aims to hit a 60 percent operating ratio by 2020, something executives say they are confident will happen.
