Q3 2020 Norfolk Southern Corp Earnings Call
Greetings and welcome to Norfolk, Southern Corporation third quarter 2020 earnings call.
At this time, all participants are in listen only mode a.
A brief question and answer session will follow the formal presentation.
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As a reminder, this conference is being recorded.
It's now my pleasure to introduce Pete trouble director of Investor Relations. Thank you Mr. trouble you may now begin.
Thank you and good morning, everyone.
Please note that during today's call, we will make certain forward looking statements, 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 FCC for a full discussion of those risks and uncertainties, we view as most important.
Oh presentation slides are available at Norfolk, Southern Dot com in the Investor section along with a reconciliation of non-GAAP measures used today to the comparable GAAP measures.
Additionally, transcripts and downloads will be posted after the call is.
It is now my pleasure to introduce Norfolk, Southern's, Chairman, President and CEO, Jim Squires.
Good morning, and welcome to Norfolk, Southern's third quarter 2020 earnings call.
On the call with me today are Cindy Sanborn, Chief operating Officer, Alan Shah, Chief Marketing Officer, and Mark George Chief Financial Officer.
Before diving into our third quarter results I'll highlight a previously disclosed noncash impairment charge of $99 million related to an equity method investment.
Slide four provides an adjusted view of our financials. Excluding this charge, which is the view I will speak to in my comments. This morning.
During the third quarter, our volumes decreased 7% year over year, while adjusted operating expenses were down 15% more than double the volume decline.
On an adjusted basis, we reported our best operating ratio to date, but this is just the beginning.
As we continue rolling out P.S. or our team sees additional opportunities for efficiency and growth that will close the organic with the rest of the industry driving shareholder value creation.
As our third quarter results demonstrate we are implementing sustainable cost structure improvements across our company.
Employment levels are down 25% since the start of 2019, well active locomotives have decreased by 26%.
We have advanced these resource improvements every quarter since launching top 21 last year, including most recently by decreasing head count by 2% sequentially in the third quarter, even as volumes surged 22%.
We converted a fifth hump yard in the quarter and you'll hear from Cindy regarding further network enhancements that are underway.
In the coming quarters, we will identify and execute on additional productivity initiatives to yield further efficiency gains.
Turning to network performance.
Even as we implement a deep and lasting cost structural moves in the third quarter, we ran a fast and fluid network. We train speed terminal dwell train performance and shipment consistency all better than before top 21.
We've now push screen size to record levels.
Finally, we were excited to have Cindy Sanborn join us as Chief operating officer.
Cindy came to and ask to drive operational change and improvement, bringing decades of experience and a deep commitment to precision scheduled railroading.
Cindy has made it clear she sees many opportunities to increase efficiency and bottom line results at N.S. and I know she looks forward to sharing her thoughts Cindy.
Thank you Jim I am very excited to lead operations and look forward to participating in the analyst calls as Chief operating officer for.
For those of you I've not yet met I've been railroading for 33 years and had experience working for several class one railroads.
My experience has included driving change and achieving what PSR is all about.
Being efficient consistent and improving the operating ratio.
What drew me to Norfolk, southern or the significant opportunities ahead. Each railroad is different in terms of markets and customer mix, but I believe we can and will operate at the very best levels of the industry.
Across the organization I am finding a team that is committed to driving efficiency, while delivering the highest quality service to our customers I know that we have great potential and are just getting started making this company more productive.
Moving to slide six.
We have a strong foundation in place, but we still have a lot more work to do and we need to move faster.
Our top priority is building on the momentum underway by taking steps to further unlock our PSR capabilities.
We are taking a bottoms up approach to reviewing each part of the operation and I'm confident we will find opportunities to apply principles that have been successful during prior experiences.
And my 58 days here I've already found opportunities that will help us improve and achieve higher levels of productivity.
We are transitioning to put additional focus on rail car velocity. This scrutiny at the most granular level represents a big opportunity to convert structural change into games and fuel efficiency train size equipment utilization and service levels.
Turning to the quarter on slide seven our mission was to absorb returning volumes with minimal additional cost.
We successfully achieved this goal and in so doing made significant network changes that we expect to yield ongoing efficiencies.
Here, we see continued year over year improvements in our service and productivity metrics.
By leveraging we increased volumes versus the second quarter, we drove improved productivity, while maintaining stable service metrics.
Returning volumes combined with disciplined execution and successful control of additional train starts enabled us to drive train weight and fuel efficiency to record levels.
I bet a train links to the metric shown here because we actively manage train lengths and this represents another opportunity for improvement.
I've included a snapshot of our train length history in the appendix because it is important that we have a baseline for measurement.
Across these efficiency indicators, we have significant opportunities for improvement.
The graph on the next slide is an updated illustration of our train productivity since the onset of the pandemic as.
As volume continue to ramp up throughout the quarter. We kept crew starts virtually flat in August and September.
Instead of reverting to previous train plans, we blended traffic into our new train plan to leverage the existing available capacity.
The more important take away is that most of our train plans still has capacity to absorb traffic and our initiatives on car velocity and train size are designed to produce even more productivity.
Moving to slide nine to discuss where we are structurally with network configuration.
As you already know the beginning of the transformation included the idling of the home at two yards last year.
Then in the second quarter of this year two more idle for a total of four.
But as you've heard of the team say many times, we are focused on creating additional opportunities for improvement.
In September we stop using the hump. It had no luck, Pennsylvania, the fifth home to go down since last year.
The change it a no avoids an upcoming capital investment and <unk> will result in a more reliable and faster operation.
Next week, we are kicking off a much larger set of changes in the south when we stopped pump operations at our yard in Macon, Georgia.
Concurrently we will also close several local yards in the Atlanta area. These.
These changes enable us to re work many of our south Eastern intermodal flows for improved service lower cost and additional growth capacity.
After the Macon conversion, we will have curtailed operations at six homes in just the past 18 months.
Leaving us with four high volume hump yards.
Before I conclude I want to emphasize the team is moving with a sense of urgency.
And they can change is just one example of how we have accelerated our plans to create efficiencies.
That project originally planned for early 2021 is being executed more quickly.
I said it earlier, but let me reiterate this is just the beginning our opportunities are significant and I am excited about keeping you up to speed on the progress we are going to make.
Now I will turn it over to Alan who will cover the market outlook.
Thank you Sandy and good morning, everyone.
In the third quarter volume improved sequentially as business levels continued to recover from April and May lows.
Consumer driven markets are driving the gain is reflected in our intermodal and automotive franchises, which delivered year over year volume growth in the third quarter.
Norfolk, Southern and our customers are responding to market needs amid an extremely tight truck market.
Playing to the strengths of our service focused product and our robust consumer oriented franchise.
We continue to enhance our pipeline for growth with sustained investment by customers along our lives.
We checked the pulse of economic trends and market shifts innovating supply chain solutions for existing and potential customers.
These solutions evolve as the environment changes as exemplified by the Covidien do supply chain shifts and the need for increased inventory levels and faster distribution.
Our strong customer relationships and market knowledge have allowed us to respond to these market shifts and quickly secure new business.
Moving to slide 11 revenue for the quarter declined 12% year over year, driven by 39% decline in our energy related markets.
While our remaining markets declined 4%.
Overall volume was down 7% as growth in intermodal and automotive, partially offset NRG declines.
Price gains have now produced higher revenue per unit less fuel for 15 consecutive quarters and both our merchandise and intermodal business units.
Overall ARPU was impacted by the negative mix associated with increased intermodal volume and lower fuel surcharges.
The continued effects of the pandemic and lower energy prices led to a 10% decline in merchandise revenue for the quarter.
Recovery in the automotive sector, partially offset these declines with revenue, 9% higher than prior year levels as manufacturers increased vehicle production to meet consumer demand.
Merchandise RPU ex fuel increased 3% year over year as we continued to deliver solid service.
Our intermodal volumes surpassed 2019 levels with growth in our domestic franchise.
Ecommerce activity and record tight truck capacity strengthen demand.
That was further enhanced by new intermodal services and our superior franchise.
International volume growth improved throughout the quarter with September daily volumes, 13% above July.
Intermodal revenue and ARPU were impacted but impacted by lower fuel surcharge revenue with RPU less fuel up 3% due to positive price and mix.
Coal revenue declined 38% year over year due to sustained low natural gas prices and high inventories.
Utility volumes fell, 30%, but improved on a sequential basis warmer than normal weather.
Year over year export continued to face demand challenges and low seaborne pricing.
Moving to our outlook on slide 12, we expect continued strength in our consumer oriented markets.
The energy market will remain a headwind, but its impact has decreased as coal revenue represented 10% of our topline in the third quarter.
External economic forecasts remain optimistic and expect continued improvement as the economy adjusts.
The impacts of lower interest rates and improved personal income will continue to drive spending and the consumer markets, but housing starts and durable goods spending experiencing V shape recovery.
Manufacturing has been slower to recover it has not kept pace with sales evidenced by the decline in inventory sales ratio a positive indicator for future transportation demand.
Truck capacity is that the tightest level on record also generating a greater need and opportunity for Norfolk Southern's product.
Within merchandise the negative impacts of lower energy prices will continue to be a drag on energy volume in the fourth quarter.
Strengthen the soybean export market will mitigate some of that headwind, while the automotive recovery will benefit adjacent markets like steel and plastics.
Norfolk Southern's automotive volume is expected to decrease sequentially due to plant downtime associated with model changeovers.
Offsetting increased production from other plants.
We are collaborating with our customers to deliver supply chain solutions to help them compete in an evolving market.
Intermodals continued strength will be supported by economic factors, including E commerce, low inventories and a tight truck market.
Well, it's in S. initiatives, promoting new products and highway conversions.
Deep supply chain disruptions from Cove. It had led many of our customers to reevaluate how they move goods to reduce risk.
We are working with our best in class channel partners on new opportunities deliver in a truck like product and providing capacity to move their business safely and efficiently.
We continue to leverage our capacity diverted from efficiency improvements to expand our business Bill.
Built upon the foundation of our robust and flexible intermodal franchise.
Within coal, we expect the utility market to face pressure associated with high stockpiles and low natural gas prices.
Export volumes are likely to improve sequentially, although seaborne prices will remain below prior year levels.
At Norfolk, Southern we remain poised to continue to seize immediate opportunities for growth at the same time that we strategize to the long game.
Focused on delivering profitable growth to our shareholders, while serving our customers and growing our franchise.
We are executing this strategy with investments already made in consumer driven markets that provide access to over half of the U.S. population.
Positioned to succeed in the fastest growing segments of the U.S. economy.
We will continue to realize the value of our service product maintaining our focus on profitable growth through both revenue and volume.
We built and maintained strong relationships with our strategic partners and provide them with an excellent service product meeting their needs and allowing our customers and Norfolk southern to grow profitably and sustainably, which I will discuss further on slide 13.
Through our powerful intermodal franchise and best in class network of industrial development sites short line partnerships and Transload facilities, which served to expand the reach of our rail products were delivering more options than ever to a marketplace that is increasingly valuing low carbon transportation solutions.
Our unique pioneering role in sustainability as evidenced by our decade long participation enforce carbon offset programs in South Carolina, and along the Mississippi River.
As well as our wetland restoration projects.
In addition, we continued to reduce our impact by enhancing fuel efficiency.
Which you heard from Sandy as we modernize our locomotive fleet and deploy energy management solutions.
Our partner with customers as part of a pledge called operation clean sweep to prevent plastic pollution, while it is in transit.
These are just a few of the reasons Norfolk Southern was recently named one of the 100, most sustainably manage companies in the world by the Wall Street Journal.
Rail is three to four times more fuel efficient than truck and our leadership and sustainability resonates with our customers and the markets we serve.
And will be an important aspect of the continuing growth story across our truck competitive segments as we leverage our commitment to sustainability.
I will now turn it over to Mark who will cover our financial results.
Thank you Alan good morning, everyone.
On Slide 15, you see the key financial measures I'll talk on this slide and in the remainder of the presentation to the adjusted numbers, excluding the impact of the $99 million impairment charge.
Revenue was down 12% on volume that was down 7%.
As Alan shared RPU ex fuel for our merchandise and intermodal segments was positive, but declining fuel surcharge revenue along with adverse business mix, including within coal created revenue headwinds.
We drove down operating expenses, 15% in the quarter with comp and Ben purchased services fuel and materials, all declining by double digit percentages solidly in excess of the volume decline.
This resulted in operating income being down 6% and an operating ratio of 62.5% that was 240 basis points better than Q3 of 2019.
Despite the 57 million dollar decline in operating income free cash flow of 1.7 billion for the nine months was more durable up by $211 million or 14% a record for and us.
On slide 16.
You will see the walk of our adjusted earnings from Q3 2019 referenced at the bottom as a 240 basis point improvement in a car and a two cents increase in EPS.
You will recall that in Q3 2019, we had a receivable write off that adversely impacted operating income, creating a favorability in the compares this quarter by 110 basis points in the O R and nine cents on EPS.
That leaves core or improvement in Q3 2020.
As 130 basis points, while EPS declined by seven cents.
Youre improvement was driven by strong operating expense reductions versus last year as you'll see on slide 17.
Operating expenses were down $278 million or 15%.
Comp and benefits are down 15% led mainly by employment cost with the workforce down by 4400 or 18%.
Fuel was down 100 million with lower pump prices contributing to $61 million of that reduction in consumption was down 36 million led by fewer gtlds as well as a strong 6% improvement in fuel efficiency in the quarter.
Material spend was down 13 million due to lower spend associated with smaller and more efficient locomotive and railcar fleets.
Purchase services was down $35 million or 10% as we continue evaluating the structural and semi structural costs within this category.
I'll point out that the depreciation increase of $7 million was due to a nonrecurring leasehold improvement write off due to a terminated lease.
Given the amount of structural change that we're driving into the business each and every month I'd like to touch on how we have recovered.
From the volume trough in the second quarter on slide 18.
As background Rick.
Recall in Q2, we did a tremendous amount of work to manage the short term by more than matching the volume decline with crews start leverage while also forging ahead with structural change by idling, two hump operations and driving head count down 20%.
As a result, we positioned ourselves very well for Q3 and beyond to leverage these sustainable cost structure improvements.
From Q2 levels revenue increased 20% or $421 million, while we constrained costs to just 6% growth to deliver nearly 80% incremental margins.
We drove headcount down another 2% versus Q2.
Materials purchased services and equipment rents combined for an increase of only 6% on the 20% sequential revenue gain.
And fuel efficiency improved three points sequentially.
As increases to train weight and length continued to record levels as Cindy highlighted.
We are confident that our advancing implementation of PSR is producing benefits and we have great momentum to build on our cost structure improvements moving forward.
On slide 19, we look at the full panel.
With a Q3 to Q3 look and here you will see that other income net of $39 million is 17 million better than prior year.
We had another strong quarter of gains on our company owned life insurance investments.
These coli returns, including proceeds are not subject to income tax as they contributed to our lower effective tax rate in the quarter of 22%.
As did the tax benefits associated with stock based compensation.
This is why net income contraction was only 2% compared to the 6% contraction in operating income.
Adjusted EPS, you'll note was actually up 1% supported by nearly $300 million of share repurchase activity in the quarter.
Shifting to cash flow on slide 20.
Through nine months ended September 2020, our free cash flow was a record 1.7 billion aided in large part by fewer capital additions as well as timing of income tax payments.
Spend on property additions was 1.05 billion nearly 450 million below 2019 levels and on a run rate to be at our target of roughly 1.5 billion for the year, which will be a 25% reduction from 2019 spend levels.
With our strong cash generation and liquidity profile, we were able to continue to distribute cash to shareholders through our dividend, while ramping back up share repurchase activity.
In the quarter, we repurchased 1.4 million shares for roughly $300 million.
As of now we have approximately 1.4 billion of cash on hand, with less than 100 million of debt maturities in the next year provide.
Providing us confidence that we have appropriate liquidity in this uncertain market.
With that I'll hand back over to Jim.
Thank you Mark.
Before we conclude I will.
Want to recognize all of our employees for their dedication to operating this railroad as efficiently and safely as possible, while continuing to deliver for our customers. During these unprecedented times.
As you've heard this morning, our leadership team is unified in a commitment to improving Norfolk, Southern and will leave no stone unturned in the quest for shareholder value.
We are confident our momentum will enable us to achieve our goal of a 60% operating ratio and once we get there we won't stop as we drive additional improvements across our network.
In closing we have built an organization that is moving faster than ever to deliver returns for shareholders.
Thank you for your attention and we'll now open the line for culinary.
Operator.
Thank you well now be conducting a question and answer session. If you like to ask a question. Please press star one on your telephone keypad and the confirmation tone indicate your line is in the question queue.
You mean press star two if you relate to remove your questions from the queue.
For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys.
Due to the number of analysts joining us on the call today. So we let me everyone to one primary question and one follow up question to accommodate as many participants as possible.
Thank you and our first question comes from the line of Jon Chapelle with Evercore ISI.
Thank you good morning, everybody.
Alan I want to start with you you mentioned briefly that some of your auto customers are shutting down in the fourth quarter issues do you expect a sequential decline, but if we look across autos and intermodal incredibly strong third quarter, maybe the start to the fourth quarter a little bit less.
Less robust is there anything happening within the network, whether its some of the initiatives that Cindy is putting into place or is this really a focus on yield as you try to manage your capacity in a tight market.
Yes, John we do have some specific plant outages and retooling and the and the fourth quarter within our automotive franchises that are going to.
Great. Some pressure you know I'll circle back to the results in the third quarter revenue was up 9% year over year and.
Our audit team is working everyday to make a better franchise for our customers and so you know that's a phenomenon that you're seeing right. Now is a short term phenomenon. We've got a lot of confidence in the strength in our automotive franchise or saying with the intermodal franchise. You know, we're we're delivering record volumes within domestic and internet.
National volumes are starting to tick into the positive territory for US right now so we're very confident and the and the strength of that franchise and basically all of our consumer oriented markets moving forward.
Now I'll tell you Cindy is Cindy is focused on improving productivity. She is also focused on giving our customers a very good service product.
That's a good lead into my quick follow up to Cindy just curious as you have you been there now for two months is your kind of initiative to come in from the top down with maybe a new team and invoke some some pretty significant changes or are you just taking what Dennis has already been doing over the last year, and a half and and kind of tweaking here and there.
Well John Thanks for the question I would say that.
Theres a very strong foundation, that's been built here and then operating here very very focused on the basics of running the railroad.
And I'm looking at it from the bottoms up and from the top down and it's really more than tweaking.
Significantly more than tweaking.
Introduced.
Some information around train length, we're going to be working on that that's helps us tremendously with our locomotive productivity as well as fuel.
We will also be working very strongly on car velocity a lot of these home conversions that you've seen that were referenced in my early remarks. The team is engaged in at a discrete level actually improves car speed.
And at a system level, what we want to do is if would touches all together if at all possible and if we can speed the cars up that's good for us in terms of asset intensity and it's also good for our customers it buys them anymore.
A more timely service product, so there's quite a bit of work going on.
And I'm I'm really excited about the team here and excited about exactly what we're going to be working so thanks.
Thanks for the question.
The next question comes from the line of Justin Long with Stephens. Please proceed with your question.
Thanks, and good morning, and congrats on the quarter.
So maybe just start I wanted to ask about headcount is there any color you can provide on your expectations for head count sequentially going into the fourth quarter and then maybe same question on the Oh are even if it's just Directionally you would love to get your thoughts about Fourq, you and and what we could see based on.
In hand today. Thanks.
Hi, Justin Good morning, well, let me, let me tackle the for the the second question first and then I'll ask Mark to address the the head count trend.
We're not going to give quarterly guidance you see the volume trend, we're working away on the expenses I think it would be reasonable to expect an operating ratio in the fourth quarter below last year, but beyond that we're not going to give guidance mark the employment.
Yes, so as you saw the employment.
Employment trends are quite strong we took out 4400.
Or 18% since Q3, 2019 actually 2900, so far in the nine months.
Of 2020 and sequentially, we did come down.
I do believe that volume growth and attrition our both our friends from this point forward.
Not going to give a specific target for Q4, but the hope is that we certainly won't add.
Here in the fourth quarter, and hopefully with attrition being our friend we might see.
Continued continued decline.
Okay, Great. That's helpful and then Cindy maybe one for you when you look at that 500 to 600 basis point margin gap versus your eastern competitor today.
I wanted to ask about how that gap looks and general merchandise versus intermodal is one of those segments.
Eric does one of those segments need to play catch more catch up and the other from a margin perspective as you look to close that gap.
Just when I think about every railroad kind of has a difference in terms of markets and customer mix, but you know our network is as good as any.
And I don't see any barriers to us continuing to reduce the gap between us and our competitor here in the east in both markets that you described both merchandise and intermodal we're.
We're going to drive very hard in that direction.
The next question comes from the line of Jason Seidl with Cowen. Please proceed with your question.
Thank you operator, and good morning, everybody I wanted to stay with Cindy there for well Cindy.
You mentioned your great amount of railroad experience you've been at two class ones that have implemented PSR can you talk a little bit about what you learned there were TSR and how you think you can apply that at Norfolk, Southern and also what might be different.
Well I would say Jason that.
You know PSR is at its core is just very basic railroading and focusing on making every move count.
And accelerating asset intensity improving asset intensity.
Is the core of it and no matter, which railroad I've worked for.
That has really been the effort as we implemented PSR.
I don't see things different at Norfolk Southern.
I see a a workforce.
Im that I've inherited that is very focused and very energized about what we are working on they understand just how much work, it's going to be and I think we're going to be we're going to be able to close the gap with any railroad in the country.
And Cindy as a quick follow up on <unk> as Norfolk starts gaining more and more ground with PSR, how should we think about maybe the gains on capital investments because it seems like closings.
Closing some lumpy ours is already eliminated some capital investments are there more to come should we expect to pay us.
Smaller capital investment profile going forward as you guys make progress.
Jason I actually haven't gotten that far into the details on capital I would say that you will see us make some investments and locomotives that you might not see otherwise as we convert from the DC fleet to an AC fleet.
So and so forth, but at this point I I really I really can't answer that question terribly fully but mark I'm sure has a has a view and then I'll turn it down.
It's a very good question and observation and actually the.
The knoller closure.
Hum closure is an example, where we will be avoiding some.
Capital.
So so you do see some relief there and the same thing even the locomotive impairment that we took back in the first quarter, where we idled 703.
Locomotives.
Kinda reveals that we do feel with all this PSR momentum we have that we've got enough in the locomotive fleet and.
Hopefully, we won't be buying locomotives anytime soon.
So I do think some of the transformations that we're making.
Will relieve us of Capex demands, but that said cindy's coming in and really taking a look at traffic patterns.
And looking at our train plan and there may be areas, where we need to do some siding extensions as an example to to help accelerate the network. So.
Overall, we are still working on that Cindy and I've been spending a lot of time, along with Alan trying to understand some of the ideas and observations that she's had coming in and we will know better I think as we enter the first quarter, what the overall impact will be on on capital.
Certainly in the next year or two.
Thank you. The next question is coming from the line of Allison Landry with Credit Suisse. Please proceed with your questions.
Thanks, Good morning so.
So given that the step function improvements that you've made and train lengths and wait I.
I guess first how much further room do you have here.
And then are there are there any parts of the network that might need additional siding too.
I'll keep the train length moving higher and then if you could speak to how you're thinking about operating leverage on incremental margins in 2021, given these productivity improvements as well that the recent volume than I am.
Also let me let me, let me start out and then I'll I'll turn it over to Cindy to fill in the details, but as you noted we we did achieve significant asset and the other resource productivity is in the third quarter. For example, we had record performance on fuel efficiency train weight train length see any productivity on locomotive productivity.
Typically so virtually across the board.
Record record levels of productivity, but that's just the beginning as Cindy has has just gone through she sees and we see lots of additional opportunities for improvement.
And those are those the improvement opportunities will take the form of of asset velocity, a focus on railcar velocity, which is something she has brought to us is a signature initiative or focus within PSR.
We will continue to look at the network footprint, we will continue to look at labor and all other aspects of our operation and indeed, our company in search of productivity is that will propel us.
Towards the goal of the.
Pure operating ratios. So city. So you have to add to that Allison I think if we look at September I was looking at some some numbers here.
Like literally last couple of days and our merchandise network, we operated with tonnage up to the match up.
Up to what our locomotives pool so.
Maxine out that locomotive capability about 9% of the time.
And when you look at our intermodal opportunity in terms of links where were going over 10000 feet. We.
We were we had about 10% of our trains over 10000 seats for the entire district. So we have a lot of opportunity here.
It may as Mark alluded to it's on the radar to think about where there might be barriers to that from a sighting linked perspective don't really have that completely flushed out, but we do have significant opportunity to improve our trailing.
Alan you mentioned incremental margin going forward Mark why don't you.
Take a stab at that yes, as you know Allison we had very strong sequential growth in the top line here from Q2 to Q3 that allowed us to really leverage it and deliver 70% incremental margin and frankly, that's a recipe we're hoping for going forward that we can get good volume growth here.
And our goal would be to to leverage it and deliver.
Very strong incremental margins now I don't know that we can do 78% to 80%.
Every single quarter I think it will depend on how much volume, we get it where that volume comes from.
But certainly I would expect that we would have accretive incremental margins in each quarter, where we do have growth.
I'd also add that we won't these numbers that I provided you know, it's not something we're going to be able to 100% of the time theres going to be situations, where you're not going to reach perfection, but that's what we have to work toward and we're going to be that's all part of closing the gap that we've got here on cost.
And that's just some of the ingredients in the in the concepts and areas that we're looking at to find those opportunities.
Okay Thats that was really helpful.
So as my follow up is there a way to think about or quantify the cost savings or the benefit from in the network changes that you made hum closures et cetera, and then more broadly do you see opportunities for further rationalization that's yards or facilities or other assets I'm curious, maybe what's left to do.
And theres anything you're considering as far as changes to the coal network. Thank you.
Let me, let me add one component in terms of the terminal footprint. So we've we've read the team has redesigned traffic what flows through the terminals and.
Continuing to do that with the making change that we're talking about but once we once we sort of goes with the first time, we don't we don't stop looking.
Go back to areas that we've looked at we've that we've converted and we continue to try to continue to optimize the up the operation to those areas. So we most recently made some I try and consolidations that are a result of the changes we made at Bellevue that we just have put in place as we have seen traffic balance out and.
Traffic continue to change and allow us to continue to.
Optimize I guess is the best word how we think about trying to close so the areas that we've already been through so.
A lot of.
It's not like you go through this one time and it's done it's continuous improvement continuous focus.
And and driving our cost gap reduction.
Our next question comes from the line of Chris Wetherbee with Citi. Please proceed with your questions.
Hey, Thanks, Good morning, I wanted to touch on the 60 or target curious if you guys are comfortable reinstating or putting a time around that it's something that's achievable next year and then maybe if you don't want to comment on the timing can we talk a little bit sort of structurally do you think you have the pieces in place I'm thinking about the hump yard slide structurally the network.
Where it needs to be as volume comes back that's a clear line of sight to the six years or more work to be done.
Well, let me summarize Chris as Weve as Weve noted several times already our goal is to close the O R gap with our peers and along the way we will naturally get to a 60% operating ratio. We believe we have line of sight to 60% during 2021 through a combination of cost reductions and revenue growth.
But we're not going to stop there and we'll continue to drive harness and get that or into into the the pure range and as low as we possibly can which ought to generate a great deal of shareholder value.
The progress will come from a combination of productivity and efficiency initiatives as we've been discussing already this morning and revenue growth insight during 2021.
Okay. Okay. That's very helpful. I appreciate that.
Follow up for Alan can you talk a little bit about the intermodal competitive environment and specifically the yield up strategy I think it was there another record intermodal yield ex fuel. This year could you talk a little bit about sort of the opportunity as you turn the page into 2021 in terms of taking share you have to cycle kind of turning in your favor from a truckload perspective, you have a pretty decent competitor.
During the Easter is also wanting to grow that business can you just put a little bit context on how you think about how intermodal looks as we move forward over the next several quarters.
Hey, Chris.
Through strategic foresight market approach, we've got the most robust intermodal franchise in the east and we are aligned with the best choice.
Channel partners in the business, who are also committed to growth I think we're in a very unique truck environment. What you've seen is that truck capacity is any last stick with demand and spot rates are.
Our at two three year highs capacity is about as tight as it's been and we're in the midst of a prolonged inventory replenishment cycle.
As I noted were getting record volumes and domestic right now and in our international business is ticking up to into positive territory. So I'm very confident about where we're going.
The remainder of this year and next year and it's just a continuation of what we've delivered remember in 2017, our revenue was up 11%, we followed that with 18% improvement in 2018.
Declined very slightly last year in the midst of a truck recession and right now it's back to growth.
Thank you our next.
Questions coming from the line of Ari Rosa with Bank of America. Please proceed with your questions.
Hey, good morning, guys.
So first question I wanted to touch on how you're thinking about available capacity, because obviously you've done a great job here of cutting resources, but you know as we see volume growth into 2021, how do you think you can get that without without further adding to headcount or take on additional resources.
Yes, yes plenty of capacity.
Particularly in light of our goal and our intent to increase trend like that right. There will absorb additional volume into the into the train plan as far as infrastructure is concerned with the possible exception of some some spot places where we need to increase citing links we have.
More than adequate infrastructure capacity right now.
Hi, Ed that the way the markets are are shaping up the incremental volume will largely fold into existing train network.
We redesigned our network. So that we've got capacity you saw that in the incremental margins in the third quarter and.
At least consumer end markets, whether it's in the merchandise network or the intermodal.
Additional growth is going to be all about creating additional revenue density on our trends and and as we increase our train length that reduces the number of trains actually on the network, which frees up capacity on line. So there's a number of levers here from a capacity perspective that we have in our favor.
Understood that's very helpful.
And then just looking at the evolution of PSR across some other railroads in North America, Obviously, it's opened up a lot of real estate opportunities for them and.
I know you guys have taken some actions in that regard, but maybe you could talk about where you think you are in terms of the real estate footprint, what we could see in terms of opportunities for either real estate sales or maybe leveraging some available real estate to.
To grow incremental volumes, which are clearly doing it very high margins and so maybe just a couple of thoughts on where you are with your real estate strategy.
Yeah, I'm going to let out this is mark I'll, let Alan talk a little bit more about.
The tactics, there, but I would say that we typically right now liberate about $30 million to $40 million of.
Land per year, we generate gains from that and that is.
We've got plenty of properties out there that.
Contribute to that and I think Alan why don't you talk a little bit more about what the strategy is our yes.
Yeah within real estate, we are focused on delivering cash flow via two means.
One is through land sales the other is through ongoing leases and our real estate team is linked very closely with our best in class industrial development team to work the site additional business on our.
Airlines and you just saw a.
One announced and.
Hey.
Hey, adults with product that was recently announced our network. It's one of the reasons that we serve more north American vehicle production than any other railroad and then in addition to that.
Our real estate strategy is also about sustainability and were using some wetland credits on our real estate to bridal to provide offsets for infrastructure improvements on our lines to increase our capacity and also to help with local economic development, which will drive more.
Yes, the Norfolk, Southern so lets say they multifaceted approach all designed to improve ongoing profits from Norfolk, southern and our shareholders.
Our next question comes from the line of Cheryl and Rad, one with TD Securities. Please proceed with your question.
Thanks, very much and good morning.
And that was my question on real estate, so maybe ill ask one on technology and just ask whether you could give us a bit more color on the joint venture that you announced last week and speak a bit more broadly about technology and whether you're looking at some of the automated inspection technologies that your peers are adopting.
Okay.
Let me let me take the question about technology. It is a core part of our strategy. One of our strategy pillars is is digital strategy and development of technology to promote both efficiency and growth in our operations particular areas of focus.
In the digital realm in recent years have been customer engagement and.
Making sure that we have best in class customer tools tracking tools and and shipment intelligence tools. We've we've devoted quite a bit of technology time and effort in that area. We're also very focused on improving asset productivity through technology and that does include automated inspections. Yes. We are focused on that we see we see a.
The second opportunity there.
And in other areas as well replenishment of legacy information systems and.
Artificial intelligence initiatives machine vision initiatives, there's a raft of initiatives coming at us and and.
And we're very excited about the prospects for promoting shareholder value through the through those investments. So specific to your question about the recently announced rail Paul. So that's just another example of Norfolk Southern innovating within the supply chain ecosystem provide a value added truck competitive product now that's our partnership with GW.
And wacko, and Gtx and Trinity rail on combined with US that's about 20% of the North American railcar fleet and we're focused on doing is providing focused on improving safety and transparency.
Within the overall ecosystem, so that we can provide it truck competitive.
Got it.
Thank you for the time.
The next question comes from the line of David Ross with Stifel. Please proceed with your question.
Yes, good morning, everyone.
I wanted to talk a little bit about intermodal again, because it's been a very hot area and maybe it's due to the yield up strategy, but volumes were only up about two or 3% on the Norfolk Southern last week.
So we don't know because why you think.
You're not seeing the same volume growth that purposeful because of the yield choice or is there something else going on in the network with the customers.
Yeah, we're starting to see improvements within our international business and now we're looking for some gains as the quarter progress is from from the West Coast and so we're very confident about where our intermodal franchises.
Do you think it will be high single digit growth in the fourth quarter.
Not.
I'm not going to provide guidance on it but intermodal was a growth driver for us in the third quarter and along with automotive and we expect it to be a growth driver for us in the fourth quarter as well, we've got an unrivaled intermodal franchise in the east and we're in a very tight truck market or provide a really good service product.
And then just last question because we've got the election coming up next week Jim.
Is there anything you know.
One way or the other that has a bigger impact on the rails is there something that maybe you are most concerned about are most excited about if it goes one way or the other.
Well we'll.
You know what we'll work through the implications of the election outcome either way and of course, we have close relationships on both sides of the aisle we maintain.
Constant communication with with all those who support the the rail industry and Norfolk Southern in particular, so I'm confident that.
We will navigate through whatever political choice.
Changes may may come.
We've been at this for a long time and are active in the political realm, and so I have a lot of confidence that we can we can manage through whatever changes may be on the horizon.
Thank you.
The next question is from the line of Jordan Alisher with Goldman Sachs. Please proceed with your question.
Hi, Good morning question I understand the.
On the mix side revenue per carload.
The impact of intermodal on the total.
ARPU of the business I'm, just sort of curious like within a specific commodity.
Chemicals were up 6% agriculture is down one there's a couple of others that were negative year over year is that mostly a function of the fuel surcharges their length of haul issues again, I understand sort of the total I'm just sort of wondering within a commodity cattle category, what's the big Bend the biggest driver of.
The ARPU and when do you think you could start to see some of that total ARPU now.
Negative mix start to look a little more normalized thanks.
Yes, most of our ARPU pressure right now is coming from fuel surcharge and from.
Seaborne coking coal pricing.
Which we've provided.
Some color on in the past.
Unwind, our ARPU, a little bit and you're going to see 15 consecutive quarters.
Of RPU less fuel growth in both merchandise and intermodal and even within intermodal, we just posted a record.
Or RPU less fuel so.
We are we're fully committed to to revenue growth and we understand that Thats got two components one of that price, Florida, that's volume and we're providing most stable service product than we ever have over a long time period and we've got.
We are positioned for where markets are headed.
Yes.
Strength in the consumer is aware ines is positioned and where we excel.
Okay. So I mean, presumably then as the fuel stuff starts to normalize the revenue per carload as we move I'm assuming into next year.
We're making good progress.
I think.
You know I identified the two headwinds looking at revenue per revenue ton mile up 3% Okay.
Okay.
All right well, thanks very much.
Thank you. The next question is from the line of Scott Group with Wolfe Research. Please proceed with your questions.
Hey, Thanks morning, guys. So wanted to just ask on some of the cost pieces Mark any any way to think about comp per employee going forward and then purchase services were down.
I think down year over year for the first time.
[music].
Is that a sustainable sort of an inflection in purchased services and then maybe if we just tie it all together.
Your your your when you talked about line of sight to 60 or next year.
What.
Level of revenue growth if any do you think you need to get there.
Yes, Scott Thanks, the comp comp or employee sequentially looking forward into Q4, I'd say is likely to be in the flattish flattish range.
You know this quarter. Obviously, we were we were up very very modestly at 1.3% I would expect us to be flat going into Q4.
I'm sorry, the second question.
Just purchased services purchased services Yep.
Yes, So look purchased services, we I thought we did a very good job. We've got you know some of the structural changes that we have been implementing kind of flowing through that line as well.
So you know.
Pretty good momentum going into the fourth quarter I do think as volume steps up especially in intermodal.
We'll start to see purchased services elevate a bit.
In conjunction with volume and that volume variability equation.
And Scott Your your question about line of sight to 60% during 2021.
A combination of cost reductions and revenue growth would be our expectation and we do expect to see a rebound in revenue next year and growth year over year during 2021.
So you know it will be it will come from the do but we have a lot of a lot of productivity initiatives in the Hopper and I think we've shown that during times of volume softness. This year that we are fully committed to the PSR way.
And to driving course referral improvements throughout the organization. So that that will be something we continue to rely on as we as we push for.
That that pure.
But just directionally if you have thoughts I mean do you think you need can you get there next year with mid single digit kind of revenue growth you need closer to high single with easy comps to get there just any directional thoughts as you sort of.
Give us time to from a firm up our Robin give us time to firm up our revenue outlook and we'll we'll talk a little bit more about what we expect for the for the year come come January we're still working on our forecast right now things things appear to be headed in the right direction, we would expect growth year over year, but we'll get back to you a little more detailed outlook in January.
Thank you. Our next question is from the line of Brian Ossenbeck with Jpmorgan. Please proceed with your question.
Hey, good morning, Thanks for taking the question.
Maybe one for Alan we've seen a few coal plant retirements announced last month or so looks like it's more of a western rail issue, but how do you see that risk for Norfolk based on the plans and mines that you serve and given where natural gas is about three bucks and export prices, maybe stabilizing a little bit do you think you're past the peak of the.
Headwinds when it comes to the call from ARPU perspective.
Yes, Brian I think though.
Hi closures are a result of the economic factors that are driving it.
Our prices in the PJM right now or below $20.
A megawatt hour coal coal is going to have a really hard dispatching in to that environment and while natural gas has rebounded nicely does three bucks now the spot market is still.
Below two boxes closer to about a buck 70, which is kind of where.
What KOL uses the dispatches as that spot market. So that's going to create continued pressure for us in the fourth quarter and in addition to the fact that stockpiles are about 45% higher than they were this time last year.
We are seeing improvements in export demand as I noted all though with the.
The Chinese Australia and trade tensions.
The.
The premium low vol price out on the seaborne market actually declined yeah. They had climbed up to about $128 a metric ton now it's.
There are about 115, so we'll see some some more export volume.
And Matt and in thermal as as China, and India have opened up but they're still going to be pressure on on pricing there.
Okay got it and just one follow up on the comp per employee comment maybe.
Maybe mark if you can give us a sense of how you think of overtime as potentially productivity, whether you probably have to incur maybe improve a bit more as you manage headcount with the volume environment, So a little bit uncertain, but as things sort of normalize and you start to draw that line of sight to the 60 or do you think this is an area of investment for you or not.
Opportunity or are there maybe factors that would prevent you from being able to take some significant savings on the OTI line item.
Yes, good good question Brian.
We've done we've done a pretty good job already bringing overtime down.
Quite a bit and it is another area that we are looking at.
Going into the future.
There is a lot of things, obviously that impact the comp per employee.
Just increasing volumes.
As an impact on the t. any activity levels in their in their pay rates as well so.
So those are all there it's not just overtime, but.
It's also the activity levels in general.
But.
I'd say, we're looking at all the levers the re crews is another area, where we've done a good job tackling.
Trying to keep a lid on it I think if you look at our overall comp and Ben trends over time, you've seen we've done a pretty good job keeping a lid on things, but we do see more opportunity going forward and those are exactly some of the areas that Cindy and her team are talking about since she's come on board.
Thank you.
Nearing the end of our allotted time for a question and answer session. Today have time for one additional question next question is coming from the line of Tom Moderates with you. Yes. Please proceed with your question.
Hey, this is Mike Shanahan on for Tom.
So just wanted to ask about industry related volumes. The energy complex is obviously weak but are you optimistic that we see continued improvement in some of the other segments like metals or housing or do you see any headwinds as we enter into 2021.
Yeah, we do see a lot we have a lot of confidence in our consumer oriented product whether that's in industrial.
Industrial products or within intermodal ad.
I think we're going to see some improvements and.
In AG, we're going to see improvements in metals.
And intermodal is going to be a growth for us as well and not only are we focused on growth. We are focused on productivity as sandy talked a lot about some of the initiatives that she's employee and then within our intermodal network, we're applying technology and process improvement to improve the efficiency of the terminals and increased revenue density.
We have the trains as well so yes, the consumer market is where Ns his position, it's a position of strength for us and that's where we excel.
Okay on the how much exposure or leveraged due housing do you have in the overall booking you do you think that can be a meaningful driver, especially on the car loading side as we as we go forward here.
Exposure housing.
To housing is that what you asked.
The housing yes.
No lumber River yeah.
It's.
It certainly helps with housing housing products as Mark noted lumber.
Some steel and then you've got the stuff that goes into it. It also really helps drive the intermodal product as well.
Well first the house or.
Some of the some of our larger Bcf those are involved in the housing market. So there is.
Theres opportunities there and as I noted you know, we're seeing a V shape recovery in both durable goods and in the housing market. So we've got a lot of confidence in these consumer oriented markets as we head into 21.
Thank you.
At this time I will turn the floor back over to Mr., Jim Squires for his closing comments.
Thanks, everyone for your questions. This morning, and special Thanks to all the Norfolk Southern employees, who helped US deliver solid result in the third quarter. Thank you.
Thank you ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect. Your lines at this time and have a wonderful day.