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On Feb. 11 and after an almost 5-year absence, Norfolk Southern hosted an investor conference in its soon-to-be headquarters city of Atlanta, and NS management gave us what the audience and I were seeking:
• a bold, three-year transformation plan (Thoroughbred Operating Plan, or TOP 21), rich with detail;
• a bold, strong goal (60 operating ratio in 2021), with lots of detail;
• key leadership/”change agent” introductions;
• and a demonstrated level of drive and commitment from the management team, and President and Chief Executive Officer Jim Squires in particular, that had been heretofore hidden from view by what I hope is now the old investor relations (“say little and stick to the script”) methodology.
This was a big meeting and it could have gone badly; instead, it was a great success. The market liked what it heard right away (NS shares were up over 3 percent on the day). Upon reflection, I would like to see more (of course) — more numbers, more info, more education of the shareholder base (on OR/capex/ROIC, etc.). But make no mistake: This opening salvo of the “Reimagined Norfolk Southern” hit its mark and then some. I was looking forward to this for months — no, years — and, like a perfect Christmas when one is a child, it was worth the wait.
Most of it, for me and the investor/analyst audience.
Demonstrated commitment. This was clear throughout the meeting, from the CEO and the known C suite to the new players — particularly the new prized change agent, SVP-Transportation Mike Farrell, whose reputation precedes him. While much was expected of him by the financial community, the vague language describing the initial precision scheduled railroad decision (“informed by PSR” etc.) meant that the audience entered the David R. Goode Building skeptical and left (almost) entirely convinced.
Bold targets. To hit an OR in three years means a reduction of close to 700bps — NS uses 65.4 OR for the past (2018) year, while the Street sees that as more like 67 due to a big “lump” of real estate sales in Q4. That makes the goal that much more bold. Yes, we've seen huge OR reductions in the first years of PSR implementation before (CSX and CP), but from higher start points. A key point here is that the OR target — and even the 5 percent CAGR level for revenue growth in the plan, period — were above Street expectations.
New plan detail. I want to taste the sausage (improved financial results), sure, but in this case I want to see how it is made. NS provided a lot of detail on the transition from initial terminal focused “clean sheeting,” led by Farrell (and with a great deal of customer involvement, it seems) to “Top 21,” the latest, PSR-infused version of the “Thoroughbred Operating Plan.” The focus went on “hump yard reduction,” the simple, even simplistic analyst proxy for PSR. Although that may have contributed to questions regarding the possible differences between Top 21 and other railway PSR conversions, I heard a lot of similarities, starting with the word “accountability” often:
• Simplification — of service offerings (“single network optimization”), of organization (the Networks Ops Center/dispatching centralization, for example, with all four regions dispatched under one roof); of Top 21 management — a new cross-disciplinary Network Planning & Optimization (NPO) group under John Friedmann will be in charge of the plan, rather than four independent networks on the system.
• The reduction/elimination of (what Union Pacific calls) “Boutique Services,” or trying to be all things to all shippers.
• Possible de-marketing, using its “Yield Up” focus; and changing customer behavior (from five- to seven-day service, etc.) via carrot and stick (“This won't be ideal for every customer”). Note that while NS is using assessorial charges and demurrage to “change customer behavior,” it isn’t a major line item. They're also offering credits for when the delay is on their side of the ledger.
• Large reductions of excess assets — rail cars, locomotives (-500 by ’21) and headcount (-3,000, back-end loaded, by ’21). Rail-car fleet size reduction, for NS and its shipper/customers, is a direct target of TOP 21 (and PSR, in general) through better asset utilization. The locomotive fleet will be renewed at the same time by a stepped up AC-conversion plan, mostly rebuilds supplemented by some new unit acquisitions.
Yield Up — taking advantage of “one of the best pricing environments in years,” as well as changing the volume mix and putting rail assets to best (ROI) use.
Still-healthy capex. As in the ongoing range of 16 percent to 18 percent of revenues). Rewarding investment in the network is still challenged by large sectors of the financial community, as the Q&A demonstrated.
Improving sequential service levels. Velocity is up 13 percent and dwell down 20 percent, year to date, for example. Service improvement is a usual (although sometimes eventual) PSR outcome, leading to a hoped-for return to the virtuous circle, aka “the Grand Bargain” — unspoken but understood between shippers and rails: price for service and capacity ... and investment. NS has redefined (though not to us, fully) its Service Delivery Index and targets a 40 percent increase by ’21. The “capacity dividend” coming form TOP 21 will be used to serve, in part, as “surge capacity,” which should be reassuring for shippers and regulators alike.
Short lines remain important — 250 of them touch NS. There have been rumors and discussion of how PSR changes would raise costs for the railroad's short-line partners. That was left unexamined, but their importance to NS was underscored several times — and by the fact that top marketing/strategy leadership left Atlanta after the conference for a major short-line meeting at Brosnan Forest. However, Squires said that unlike what happened with CSX, NS officials expect no major “package” of short-line segments ... just the usual small amount from time to time.
Technology understanding. We heard from VP of Customer Service Karol Lawrence on customer-facing technologies — a new portal, no mobility access, improved terminal operations, etc.
One issue is that unlike “traditional PSR implementation (big operational and financial gains early in the process), the NS Top 21 Plan is, in the three-year timeframe, back-end loaded — with 100bps coming out of the OR this year (and about one-sixth of the headcount reduction), there is a bit of trust required to believe that years two and three will deliver.
Some of my suggestions are to simply build on what they shared — for example, to make a pledge to come back every couple or few years (a la CN) to update us and provide detail, even if we have to wait on the 2021 completion of this plan and the official opening of the Atlanta HQ. Others deal with marketing in what was clearly, and rightfully so, an operations-driven meeting.
Details, details. Volume estimates weren’t provided. I understand the macro-economic elements involved (auto production, consumer spending, etc.), but I like to look at railroads through units (and not only, RTMs, eh?), as well as revenues.
• The 5 percent CAGR revenue growth outlook to 2021 looked high to some in the crowd; it seems low to me, given the described pricing environment — the breakdown being intermodal, 10 percent (low!); merchandise, 5 percent; and coal, 2 percent.
• Does the 5 percent revenue CAGR, assuming, say, 3 percent price, mean net of “de-marketing”?
• Can they define their “lane rationalization” (a la — sorry — CSX)?
• The macro data used wasn’t always directly relevant. For example, FTR’s intermodal expectations of 2019 [domestic unit — unit! — growth of 4.9 percent (E) and international of 2.4 percent (E)] are interesting, in a vacuum (although we tend to follow Larry Gross) — but the NS domestic intermodal machine should continue to grow much more than the industry!
• The three segment VPs didn’t answer Q&A (nor mingle much), and head of Strategy Mike McClellan didn’t get a presentation slot, which is a shame and hopefully the last vestige of the “old IR regime.” I had a lot of questions for Intermodal VP Jeff Heller, and hopefully wont have to wait till IANA in the fall for answers. One question was: What does J.B. Hunt think of slide 5 of the Network Planning presentation — coal cars running on a double-stack train?!
Still no ROIC! NS didn’t reveal its ROIC — neither 2018A nor the 2021 target. ROIC is the ultimate justification for “high” or “elevated” levels of capex, an evergreen issue for some in the analyst community, especially given the Union Pacific “line in the sand.”
ROIC also is a great counter to the “Cult of the OR,” especially when achieving a 60 percent OR target will only serve to shrink, but not eliminate, NS's so-called “OR gap” to its peers, especially CSX. And given the premium intermodal franchise, and the contribution to said OR gap of intermodal, ROIC serves to help publicly justify the intermodal franchise.
More could have come on tech. This will be the big rail/investor issue, post-PSR. Given the NS leadership role on the rail-tech regulatory side — led by EVP of Law and Administration and Chief Legal Officer John Schieb. You might recall his RailTrends 2017 speech on moving PTC from the “unfunded mandate” to the “backbone of the future digital railroad.” NS is working on several fascinating projects like the visibility into inbound empties, a huge market share issue, with short-lines and a big paper company.
Tony Hatch is an independent transportation analyst and consultant, and a program consultant for Progressive Railroading’s RailTrends® conference. Email him at firstname.lastname@example.org.