Union Pacific Corporation (NYSE:UNP) Bernstein’s 39th Annual Strategic Decisions Conference June 1, 2023 8:00 AM ET
Company Participants
Lance Fritz – Chairman, President and Chief Executive Officer
Brad Stock – Assistant Vice President, Investor Relations
Conference Call Participants
David Vernon – Bernstein
David Vernon
Thank you for joining us here on the second day of Bernstein’s 39th Annual Strategic Decisions Conference. We very much appreciate your support and your interest, and we also like to thank and welcome Lance Fritz and Brad Stock from IR at Union Pacific Corporation for joining us here today. We are going to do mostly fireside chat. Lance is going to kick us off with a couple of slides. You guys should know the drill by now as far as Pigeonhole, if you put it into the system, and it’s a question we can work into the Q&A, we’ll be happy to do that.
And with no further ado, I’m going to hand it over to you to go through a couple of introductory remarks and then we’ll get into the Q&A.
Lance Fritz
Perfect. Thank you very much, David. And thank you all for being here this morning. For those of you who are not in person today, you can find the slides that accompany these comments on our webpage on the Investor webpage. It’s next the event webcast. I also want to remind everybody, I’m going to be making some forward looking statements today. So you can find our SEC — in our SEC filings or on our UP website, any of the risk factor information that would be applicable to those forward looking statements.
Let’s get into the discussion. We’re going to start with safety. We always want to start with safety. It’s a paramount value for Union Pacific. The most important thing for us is to ensure the safety of our employees, the communities that we serve and the customers that we’re providing service to. Freight rail is the safest large bulk form of transportation mode in the United States. We are 50 times less likely to have an accident than truck and when it comes to hazardous material, which is a requirement for us to ship. Trucks have 16 times more the fatalities when it comes to an incident with hazmat and three times more property damage than rail incidents, transporting hazmat.
As a common carrier again, we’re obliged to carry hazardous material, it makes it to destination 99.9% safely. In 2019, as a proof statement of our own commitment to safety from 2019 to today, our reportable derailments on mainline and sightings are down 26%. So one quarter fewer derailments while train size is up about 20%. And you can read in the paper periodically that there’s a connection some will make between train size, train length, and safety and a new UP, it’s a negative correlation. There is zero correlation between safety incidents and train size.
And we don’t stop there. You’ve also heard learned a little bit about since East Palestine wayside detection. Wayside detection is a voluntary technology that railroads have put in place to take the next step and safety on Union Pacific we have over 7,000 devices along are 32,000 miles of railroad, and they’re all wired together in basically a safety net. And we use AI and machine learning to trend off the data they get, so that we can find equipment that’s in the process of failing before it fails.
If you look over to service, essentially the railroad is operating as designed right now. We measure freight car velocity it’s all miles by all cars every day. That’s kind of a king measure for us when it comes to customer service. That 202 today is something like 205 or 206 but the last two months, we’ve been between 202 and 206. And we’re facing about an 8 to 10 mile an hour headwind. We’re essentially on plan for freight car velocity at this point.
Our customers are essentially experiencing normal good service from us. And you can see that also on the right hand side, our trip planning compliance whether it’s intermodal or the manifest and auto network that’s been at goal per our filings with the STB for about a month or two. Once we got out of winter, as we said, we would get snapped the service product back and it’s occurred.
And now the focus is pretty much on getting excess cost out of the network. We got a couple of notes here. One is about 200 locomotives have been taken out of the network since the start of the second quarter. That’ll take a little while for that to translate into cost, but it will translate into cost. And at the same time, our recrew rates are dropping year-over-year by about 3%, 3.5% points.
We’re in a very good run rate right now of how many crews it takes to get your original transportation plan accomplished. A recrew is waste, it’s a crew you didn’t plan on, and we’re at about 6.5% right now, which is good run rate for our railroad. Something else for us to talk about is the franchise that Union Pacific represents. It is a value creator. We are the premier franchise in North American railroading. We serve the six rail gateways, two in from Mexico.
We enjoy about two thirds of all freight transport by rail between the United States and Mexico. We serve the Gulf Coast industrial franchise. It’s a crown jewel for us. We serve the breadbasket of the United States. We serve many, if not most, or all of the largest, fast growing West populations in the United States. And we’ve got good connectivity to every other railroad about 40% of our business connects to another railroad either for origin or destination.
And then on the upper right, from the standpoint of how’s the quarter coming along. We’re up about 1% in bulk and industrial and bulk. That’s really being driven by rock as a strong commodity right now. We’ve got bio renewable diesel, some other things that are strong commodities and industrial steel. We’ve got some weaknesses, lumbers are little weak, coals actually doing pretty well year-over-year, but it’s secular, long-term down.
And then in premium, it’s really about a loose truck market. The premium market has been loose for most of this year. It looked like it isn’t getting any worse from the standpoint of excess capacity, but it certainly hasn’t necessarily recovered. Part of that is also being driven by consumers buying experience, going out, traveling, using their dollars that way, as opposed to being in the goods economy to the same extent they were call it a year or two ago.
I want to finish my comments on our work towards building a sustainable future. We bucket these in five different buckets. The two on the left, what I’ll talk about there is we are the first railroad that signed up for a science based target with the SBTi initiative. That target was by 2030 for us to reduce in absolute terms 26% of our greenhouse gas emissions.
We’re in the process this year of revalidating that with the SBTI for instead of below 2 degrees centigrade, being below 1.5 degrees centigrade as a target. So I anticipate our 2030 targets will probably move up to 26% absolute to something higher and we’re committed to being carbon zero by 2050.
For us, it’s all about the locomotive. 83% of our emissions are either Scope 1 or Scope 3 coming out of the locomotive. So it’s what we burn and its alternative fuels. In the middle there, I mentioned in sustainability that we’re very proud of some of the work that we’ve done. We’ve got a target to be 11% female employees by 2030. That sounds like an exceptionally low number, but we’re starting from about 5%.
And that’s because in our craft population, the men and women who are actually conducting the work of the railroad on the railroad, that number is probably closer to 3%. So, we’ve got to make our jobs more attractive and we’ve got to attract more. We’re generally being successful in inching that up.
We’re moving towards 40% minority representation on our workforce by 2030. We started at about 26%. We’re at about 33.5% right now, we’re on track to make that goal or exceed, and that’ll reflect the population for the communities that we serve. Then if we go to the right, safety, culture is critical to us. We’re constantly working on the environment on training on making sure we’ve got a healthy peer to peer program. We can talk about any of that, that’s on your mind.
And with that, let’s get into Q&A.
Question-and-Answer Session
Q – David Vernon
Excellent. So thank you very much for the prepared remarks. I want to start with a governance issues. You announced earlier this year that you were going to be retiring as CEO of Union Pacific Corporation. The Board has had a search underway. Could you give us an update on the status of the search as it is right now? When do you expect to make a decision that kind of thing?
Lance Fritz
Yes. So a reminder, for those of you that aren’t aware in the audience, about February, we announced that this is my retirement year. As David said, we’ve been working on that for as a Board probably two years at this point. We do have an external search consultant. We’re looking at external candidates as well as internal. That work has been underway since the about that timeframe of our announcement a bit earlier, probably had that consultant in place by November of last year.
And the Board has been crystal clear on what they’re searching for, right. They want operational and safety experience and expertise, they want somebody who’s demonstrated growth, somebody who understands what it means to serve all your stakeholders at the same time, and they want to make sure that there’s somebody that cares deeply about culture, and engaging our workforce and helping our workforce feel fulfilled and empowered at work.
All of that’s underway. We’ve got a slate of excellent candidates that we’re reviewing through different pieces of the pipeline. And there is — the Board is working on that daily, essentially. So, I don’t have a tighter timeframe than what they said, which is 2023, but the work has been progressing very well to this point.
David Vernon
And as you think about the challenges facing the Company that your successor is going to be inheriting, right? Obviously, when we look at the objective data around, sort of employee satisfaction, the railroad industry is pretty low. When we look at what we’ve heard about customer satisfaction in the hearings in DC, customer satisfaction is pretty low. The regulator doesn’t seem to particularly like Union Pacific in some of its comments. How do you think about the priorities in terms of what needs to be fixed for that or what the next CEO needs to be working on, as they come in as an employee engagement? Is it — I know it’s all of these things, but help me understand like, what is the internal perspective on the priority of employee engagement regulator, customer financials? What’s the prioritization of that?
Lance Fritz
Yes. I think the next CEO is going to be working on the same things that we’re working on right now and have been. Starts with service, our strategy has served grow win together. And so, consistent, reliable, safe service is the starting point for us. Clearly, that’s got to be the foundation that gets built.
Second, is making sure that our employees feel like they’re valued like they’re heard. They have a place and that their voice matters, and that they can see reaction to their voice. So, that culture and that engagement of our employees is the second critical factor. We believe those two turn into growth, the second part of the strategy serve growing together.
And then beyond growth, we think harnessing technology is an enabler that needs to permeate all aspects of the business. It permeates asset utilization, safety, the service product, customer experience. All of those have work against it right now. I’d love to talk about that, but that’s what the next CEO is also going to be focused on.
David Vernon
And last one on this on this point. Is there a predisposition toward someone with hands on rail experience or maybe somebody from the outside with a fresh perspective? How does that factor into the Board’s discussion? I mean, the industry has been pretty insular, I think, over its history. How are you thinking about weighing that advantage of bringing fresh eyes versus relying on somebody who has more hands on experience within the industry?
Lance Fritz
Yes, in the Board’s current funnel of potential candidates, there’s all of the above, and they’re going to look for the individual that best balances and meets all the criteria they’re looking for.
David Vernon
Okay. So thank you for that. We got that out of the way. Maybe talk a little bit about what you’re hearing about, from customers about the state of the economy? You mentioned the truck market still very loose. Volume trends are some areas good, some areas bad kind of mixed overall. What are you hearing from your customers about the potential for a second half volume inflection at 2024 outlook? Are you hearing anything about that right now? Or what are you guys sort of planning?
Lance Fritz
Yes, David, our customers have really morphed over time over the course of the last six months that, as we were exiting last year, most of our customers would tell me they expect the week first half, and the recovery in the second half, maybe even to a strong second half. And as the years progressed, that dialogue has muted in the second half, but some of our industries have also raised the fact that maybe the first half isn’t going to be as bad as they had originally thought.
You know, if you look at different industries, there’s some real dichotomies going on. Grain looks like in the back half. Crop is getting in the ground early. There’s more planted soybean and corn acres. And so grain looks like it’s going to have some promise in the fourth quarter when new crop comes in. Right now, we’re pretty much out of crop, right. So, we’re shipping what we can as we can that network because absolutely spooled up, and shuttles are very efficient right now. And we’re looking for business to ship.
If you look at coal, also staying in bulk, coals — our customers in that world are very much focused on what’s happening with the weather and what’s happening with natural gas prices. And natural gas prices were not really forecast to go as low as they did, in the first half of this year. They dropped all the way to 2 bucks and a little bit plus or minus. They’re starting to climb back, and for us, if that number gets above about 3 bucks or in the high 2s or towards 3, 3.50. That’s not a bad place for us.
We can live there for a little while and have demand and we also need good normal weather warm in the summertime. Automotive is going to be a real interesting story. There, the auto OEMs are telling us, their supply chains are largely corrected and they’re producing. And while customer demand is falling, they were so short of product on their lots that they think we’re going to see growth even as customer demand falls because their production levels are going to go up and so far that’s playing true.
In the first half automotive and auto parts has been a position of strength. We’ve got some business winds that are kind of fighting against what’s happening in the economy. Steel, metals or min, but we’ve got some new producers that have landed on us, particularly one large one in Corpus Christi. It’s the first steel mill that melts and rolls west of the Mississippi 100 years. And we’re enjoying new business there.
Housing is soft and we can see that in lumber and our lumber customers are telling us, it’s probably going to remain soft through the year. And we’ll have to look into next year to see what happens with housing and starts. Constructions gangbusters really good, rock in Texas is as strong as I’ve ever seen it. And that’s without any real impact from the infrastructure bill. We don’t think infrastructure spending has really rolled yet. What we’re seeing is Texas and state spending, and that’s very strong. So, it’s a mixed bag. It’s a real mixed bag right now.
David Vernon
And as you think about sort of the class 1 industries tenuous relationship with growth, right. What is it about the railroad industry and its ability to kind of generate sort of consistent RTM growth? Historically, and what do you think needs to change to get a better growth algorithm in the class 1 road industry? I mean, it’s always a constant topic of conversation. We know the truck market is big. We know the big opportunity to take share, but what is — what needs, what hasn’t happened in the past and what needs to happen in the future for that share opportunity to really crystallize?
Lance Fritz
Yes. So, one thing that’s happened secular and you know, this, David, with coal really being cut by two-thirds in the Western United States. That’s a significant headwind for a company like UP. You’re talking a percent, a percent and a half a year of volume decline driven by coal, all by itself.
If you think about what it takes to grow, we have to have a relatively low cost basis so that we can compete effectively for the opportunity that’s out there. And we’ve got to demonstrate to our customers that we can be consistent and reliable. That’s the first thing they want, so the last thing they want. And to have, almost every customer I meet with their story is Lance, I’m exposing my company to a portion of my supply chain to your service.
Because I’m confident you’re going to perform well enough to where you fit within that. But there’s a whole segment of my supply chain where knowing your cost, knowing your service product, if it runs consistently and reliably, like I’ve seen you and you’re capable of running, there’s a whole segment of my business that you’re not exposed to yet that you can be. So, it’s all about consistent and reliable and making sure our cost structure allows us to compete.
Now in that context, even with Union Pacific not being consistent, reliable the last two years, we were the only railroad that grew last year. And this year, we’re the U.S. class 1 that’s outpacing every other class 1. So, there’s opportunity out there, as we get consistent and reliable and stabilize the service product, I think it’s substantial.
David Vernon
And do you think that the industry needs to change the way it approaches interchange relationships to unlock some of that growth potential? We’ve the watershed problem that exists because of the interchange and the just the agency issue, right? CSX doesn’t want to do 20% of the work for only 20% of the move or whichever railroad you’re interchanging with. How does the industry grapple with that problem? So, I’ve always thought that’s a real bottleneck towards a very easy share take opportunity.
Lance Fritz
Yes, it can be for sure, right. And what David’s describing is where two railroads meet, if one railroad in a joint line move has short miles, sometimes the juice isn’t worth the squeeze why put my labor force, why put my assets against that, if I can instead put them against the move that’s going to get me longer miles, more revenue, more margin dollars.
And one thing that helps that is virtually every railroad now certainly our partner railroads are all following similar models of how to operate their business, these PSR models or Precision Scheduled Railroading models. And so, we all are looking differently at our railroads and that joint moves than we had say 5, 10 or 15 years ago. And we can see that we’ve just created a strong joint move with the CN and the FXC in the Falcon Premium service.
And that came together quickly. And it’s a great example of how railroads can look at each other, look at our networks and design up a product that can act like a single service provider even though it’s got three railroads in it. So yes, there’s some of that. I think, more importantly, David, the big unlock is about customer experience, making it not terribly hard to do business with a railroad, and with the customers that are currently doing business with us unlocking that part of the supply chain, that could be available to us by demonstrating month after month after month, that we’re going to be there for them at a certain service level.
David Vernon
It wasn’t around this topic, as you think about that issue of how easy it is to do business in the railroad. I remember 20 years ago looking at processes where spreadsheets would be sent in for car requisition and someone be clicking and clacking and doing all that kind of stuff. How do you see the opportunities for Union Pacific to use technology to remove some of those friction points? And where are you in the process of actually implementing those open APIs that would allow a customer to more easily interact and do business with UK?
Lance Fritz
Yes, love that you asked that question. So, we’re the market leader when it comes to using technology to help make it easier for customers to do business with us. We’re clearly the market leader on APIs. We’ve got somewhere in the neighborhood of 75 or 80 APIs out there actively working right now, millions of hits a day and transferring data with our customers. And we’re absolutely open for business. Our system, net control is architected as micro services. So, it’s natural to have API interactions with our customer base. So that’s been a real boon. And it’s made the existing customer stickier, and it’s been part of our business development weaponry to find new customers.
The other things that we’re doing is we’re working with transportation management system providers to embed modules or plug-ons that make it easier for customers to choose to do rail. Right now, a lot of TMS systems are oriented designed around truck as the primary mode. And so, we’re making it easier for TMS users, which is every shipper in the world to identify and use rail by providing plug-ons that they can use with their TMS system to easily more naturally not have to type in all that information. And instead, it pre-populates because it knows what it’s doing.
David Vernon
And if you think about the percentage of customers that are using those APIs today, is it all of them, is it half of them? Like what do we think about that adoption rate? And what I’m trying to get at is, is there additional sort of tail winds from this or are we already there?
Lance Fritz
No, it’s a huge upside. I bet on a revenue side. I haven’t seen the number in a little while, but I’m going to bet on the revenue side. It’s 15% to 20%, the most sophisticated large scale customers, but from penetration, it’s super early earnings.
David Vernon
Interesting. Okay. Sticking on growth a little bit, I do want to spend some time on the service issues because that’s very top of mind for investors. Two issues on growth, West Coast ports, is that diversion going to be forever? How do you feel about your position with respect to LA Long Beach versus some of these coastal water moves either Panama Canal or Suez? And how do you think about that shear shift over time?
Lance Fritz
Yes, so the shear shift from the West to East and Gulf Coast and also Canada has been real over the last 20 years. And it almost always has been prompted by labor issues. So when the West Coast has experienced either the fear of a labor strike or a slowdown or strike, they’ve lost a handful of percentage points, maybe even up to five percentage points and they get back about half of that. And so, if you looked at the start of 2019, share split out something like 46% on the West Coast, 46% on the East Coast and call it 8% on the Gulf Coast.
At the end of last year, that was something like 42 to 46, 47 and 10 or 12. So, it’s real and the way that’ll stop is for labor to be more stable in the LA Long Beach area through their cycles. This cycle looks like that’s happening, which is good, and also for the entire supply chain to be more transparent and easier to deal with as one entity with our customer base. So we’re working very hard with both LA and Long Beach, on shared KPIs and visibility, and those are available to our customers and we’re starting to get traction with that.
The other thing that we’ve done is recognizing there is some shear shift. We’ve launched a new product down off the Gulf Coast. To serve, I want to say five or six different destinations out of barbers cut, which is a purpose built part of port of Houston for kind of on dock container shipments. And in the in the West Coast, we have the best franchise for serving those West Coast ports with ICTF, that’s our international intermodal terminal being literally about 4 miles away from the port facilities. It’s a wonderful mechanism to take blocks off dock, turn them into trains and get them inland.
David Vernon
Okay, and then the other big sort of growth area I wanted to touch on was Mexico. The potential from nearshoring, how’s nearshoring going to change? Are you seeing any evidence in nearshoring in your customer base? How is that going to change demand for transportation and demand for rail? Kind of going forward to be the first question and then we can talk a little bit about some of the potential risks around CPKC.
Lance Fritz
Yes. So, let’s talk nearshoring is a conversation I have with our multinational customers. And to varying degrees, every single one of them is thinking about redoing their supply chains to enhance sustainability, but really reliability, right, to take the risk out of concentration in Asia, and distribute that risk around the globe a little bit more. They’re also very much focused on local for local to the extent they can drive local production for local consumption, they want to do more of that, not less than that.
We’ve seen some early innings change in behavior and investment, not just in Mexico, but also in the United States, but it’s very early. I would not call that wholesale yet. I’d call it indications that customers are following through on their strategic planning, but I’ve yet to see full scale onshoring occur.
David Vernon
And then as you think about the regulator’s approval of the CPKC transaction and the potential diversion risk to the Union Pacific Corporation being the biggest railroad on the north side of the transporter. What kind of risks or what kind of impact should investors expect that transaction to have on your north south trade business? Are you going to see volume pressure rate pressure? How do you think about the competitive implications of the CPKC merger?
Lance Fritz
Yes. So, we’ve done a an extensive amount of homework and strategy around how to not just protect the current book of business, but also continue the growth rate between the United States and Mexico on the UP. Mexico represents call it something like 11%, give or take of our business. And of that, it’s about 50-50 split between the FXE and the KCSM. And of the KCSM traffic, there’s really only a portion that is you’d kind of term it at near or medium-term at risk.
So our focus is on making sure that our customers are deeply satisfied, making sure that they have contractual arrangements with us that go pretty deep into the future, and making sure that we’ve got competitive product to win new business. It’s one of the reasons we launched the Falcon Premium service with the FXE and the CN. That is the best service to not only take advantage of our franchise, which is the best franchise connecting Mexican business to the U.S. communities and U.S. business to Mexico, but also partnering with CN, which has the best intermodal ramp franchise up in Canada.
So, it’s action like that. Clearly, in their merger application, the CPE talked about the need to find a bunch of synergy. And at first, they talked about all of that coming from truck conversion off the highway, which is fabulous. But more recently, there’s a recognition that probably some of its going to come from converted business from the UP and the BN. And my team’s job is to make sure that it comes from the BN not the UP.
David Vernon
Okay. And as you think about, specifically in that portion of the KCS originated traffic is at risk. How much of that is intermodal versus automotive versus different types of business? And you know, more specifically UPs done a tremendous business and parts trains out of Mexico, up into the Michigan footprint. Is there any risk to that specific piece of business going forward?
Lance Fritz
Well, that’s a crown jewel piece of business. Our auto parts franchise is second to none in the United States. And to your point, David, the business that runs between the United States or Canada and Mexico that is autos related is robust. It’s an important part of our book. We’ve got the best service product by far. It’ll stay that way. We’ll continue to invest in it.
And now, we’ve got to just be eyes wide open on how to make sure that our customers feel like we’re the partner to make sure that they want to do business with long-term. And that’s the host of everything, right? It’s the service product, or how responsive we are to their needs. It will include pricing, perhaps at some point, we’ll see.
David Vernon
Okay. And UP did make the decision to appeal the Surface Transportation Board and approval of the merger application. Can you talk about what you’re hoping to gain from that? Or maybe what’s the motivation for the appeal? And kind of what the case is for that you’re trying to make here?
Lance Fritz
Yes, so let me lay the groundwork real quickly for all of us. The Surface Transportation Board is the regulator, the commercial regulator of freight railroads in the United States. And when freight railroads merge, it is the entity that has authority for approval or denial of the merger. The FTC and the Justice Department don’t play a role. They can chime in and make suggestions, but it’s the STBs decision. It’s a long process. The KCS has been trying to acquire the C or the CP has been trying to acquire the KCS for probably two plus years and got approval for it in a month, month and a half ago.
And in that process, the Union Pacific highlighted three big concerns we had. One big concern was the KCS CP would have an opportunity using KCS market power in Mexico to fundamentally block out customers on the Union Pacific that are enjoying access to and from Mexico today. And we said our natural obvious remedy would be proper rates, proportional mileage base rates in Mexico for whatever CPKC quotes to Kansas or wherever they’re quoting to. I’ll compete all day long on a fair basis, if I get a fair basis in Mexico.
That was big issue number one, big issue number two was in their application, the CP said, we have strong growth expectations, and train count is going to increase in and around Houston through Houston. Houston is not a fragile part of our network. But it is a constrained part of our network. It does a lot of business.
There is a ton of manifest industrial traffic there. And we stay in front of it with capital investment. But in the application, I talked about adding up to 10 trains a day. Well, that would require significant capital in order to maintain a good service product in that area.
So, we asked that the STB if that’s true, that there’s a mechanism put in place for the CP to invest ahead of time, so we don’t crater the railroad and then solve it a year and a half later. Going back to consistent reliable is what our customers want. And then the third thing was just making sure we got free and fair access to the railroad bridge at Laredo, which we have as part of a merger remedy from years ago.
And the reason why we sued the STB is that, while they recognized the validity of our concerns, in their response to the merger application. They did not have what we considered a robust enough remedy. In essence, on the commercial concern of market power in Mexico, the remedy was, as it occurs, bring those instances to us and we’ll figure it out.
And in Houston, the remedy was railroads. You should get together and figure this out before the traffic shows up. And of course, we’ve been trying to do that in both cases with the CP for quite some time, and we’re having a hard time coming to an agreement. So, we sued them and what we’re looking for is for the quote to ask the STB to take a little bit harder look at what the remedy might be on those concerns.
David Vernon
So, I do spend some time on service. When talking to investors about this and the perception of the marketplace, I think has been that UP service has lagged from a recovery standpoint relative to peers. Norfolk then sort of had the issue ways Palestine, which is really had an impact on their service, but if you think about the rate of service recovery UP relative to CSX, I think it has been a little bit slower. Why is that?
Lance Fritz
Well, CSX went into the ditch earlier than us, right. They had a pretty lousy 2021 and talked about being behind headcount most of that year. And they got remedied on their labor force issues earlier in 2022, clearly than we did. We started having service issues about the middle late February of 2022. And it was really all about not having the critical resource of labor, where we needed it when we needed it and the quantity we needed it.
And that dock does and our customers all through 2022. We got that pretty well remedied coming out of the year and we are in fine shape right now. If you look at this year, we’ve graduated 650 plus conductors alone. We have 1,100 conductors in the training pipeline. We said our target for the year to graduate conductors was about 1,600 based on our volume assumptions, and we’re going to have that potential in place by July or August. That was deliberate.
I wanted to forward load the hiring for this year to take service off the table as quickly as we could and we’ve essentially done that. The service product is rock solid over the course of about the last two months, and I think we’re resource to keep that up.
David Vernon
And as you think about that, that rate of resource addition relative to ’19 and it does look like in the STB data on headcount. CSX is well ahead on T&E, you guys are maybe a little ahead on 2019 levels of T&E. Do you expect to continue to expand that T&E workforce into a similar sort of high single digit growth of T&E headcount? Or how much extra resource do we need to maintain the service level, since it really the question?
Lance Fritz
Yes, that’s a great question. So clearly, with our current pipeline sequentially and year-over-year, we will grow again in the second quarter and into the third quarter as we graduate. I would anticipate that. We’re looking in the back half of the year now because volumes not showing up the way we had planned. And so, we’re going to have to tweak our hiring plan again because we front loaded the hiring plan.
We had a more of a steady state hiring plan through the year, I front end loaded that to take labor off the table sooner. And the fact that volumes a little weaker, says we’re really going to have to tweak and adjust the outward hiring. Having said that, we’re going to be in the hiring mode all year, but changing how we do it looks like hiring bonuses are being taken down or eliminated. We don’t need to do that cross the railroad.
We used to have about six or seven hubs that were real hotspots for us. That’s dropped to about five. We’re going to be in the market in those hubs, hiring people all year. But that’s a relatively small number. And I also want to keep the hiring mechanism in place from the standpoint of making sure we don’t go to zero, and then fire the mechanism back up because it’s hard to do that. We want to be in the market with looking for individuals, looking for the best talent and when we find it, bringing it in.
If you look at 2019, our current volumes, call it 160,007 a day, that’s probably about where we were back then maybe a little plus minus. And overtime, I would expect productivity to mean we need less labor per unit that we ship, but on the service side, that labors got to be where we need it to be. And that gets us to David, I want to mention, we just signed an agreement with our BLET. So, that’s the engineers in the cab of the locomotive to change their unscheduled work to look a lot more scheduled on an 11 and 4 basis.
Look, the way our industry works is, if you work in the transportation mode, that’s the individuals that are taking the freight trains over the railroad. There’s a conductor and an engineer. They are on call, they’re on a Board. And they rise up the Board as people get called for a train. And if they’re next out, they get called. And that’s the train they take. That means they could be called at 1 in the morning or 8 in the morning or 4 in the afternoon. That work is considered unscheduled.
That doesn’t mean you’re working all the time. On average, they work about 35 hours a week. But it means they’re on call all the time. And that feels like the man’s got his thumb on you. And so, we just cut a deal where in a half a month, 11 days, they’re going to have to protect the phone 4 days, they don’t, they don’t even have to worry about it. That’s a life changer for those individuals.
David Vernon
And as we think about some of those changes that you’re making around scheduling and paid time off, adding resources into down volume. Obviously, it would make sense that as volume comes back, there’s going to be a productivity catch up, but how should we think about that relationship going forward of resource additions and volumes, because it does seem like going back historically, we’ve always had this sort of two steps forward, one step back with zeros. We’re waiting for growth, we get the growth then we then the service and you got to down. Then we don’t get the growth and then we furlough and then we got to catch back up. Like how do we think about that breaking that cycle of push pull? And what does breaking that cycle push pull me in from a margin perspective going forward?
Lance Fritz
Yes. Fundamentally that cycle of push pull is about getting the, what you’d call the SIOP process the sales, inventory and operations planning tighter. The reason why that exists is of the five critical resources, cruise locomotives, line of road, terminal capacity and freight cars. The shortest to add is cruise and it takes about five months from the time. I think I want somebody to the time I’ve got to graduate ready to work, that’s as fast as we can get it, at least at this point.
So by not having perfect insight into what’s going to happen a half a year from now, there’s this really difficult push pull that happens where we either overshoot or undershoot the forecast, that’s always going to happen. What we’ve tried to do is shrink that five months, that used to be seven months. So, we’ve knocked out about two months of that timeframe to get that critical resource.
And the other thing that we can do is have a resource that’s a bit more flexible. A big step is taking unscheduled work and making it scheduled, so availability goes up. And then the next big step is reinstituting our alternative work and training boards so that when work runs dry, we’ve got an alternative place to put excess labor without exiting from the Company.
All of that comes with a bit of cost, but our calculus says that bit of cost is going to be a lot better than the cycle that you just recognized. Because we can be more stable and we can be more consistent. There’s a whole book of business out there from existing customers that want to do business with us and know what we’re about, but just don’t see enough stability to pull that trigger.
David Vernon
Does that mean then that margins are maybe a little bit more cyclical? Or do some of that work that you’re going to reassign somebody to become capitalized and you kind of keep it out of the OR line?
Lance Fritz
Yes, I don’t think margins become more cyclical. I think they probably a little less cyclicality in margins and margin pressure, because what you just described over resource, taking it out under resource, putting it in over resource that has real implications on cost, and inefficiencies. And if instead, those resources can be a little bit more balanced and swayed a little bit less. I think when you had growth, there’s margin opportunity, not margin pressure.
David Vernon
Okay, so when you think about that margin opportunity long-term UP has said in the past, we can get to a 55 operating ratio, which is a 45% margin for those not playing off the railroad playbook. Is that still on the table? Is it not on the table? There’s always this constant conversation around how far can be OR go? And I’d love to get your perspective on that. I’ve always thought that, the OR is just going to be a function of your mix. And if you want to get to 55, just go fire the intermodal franchise.
Lance Fritz
There’s some truth to what you just said. But we do still believe that our margin could and should at some point be in the mid-50s. Inflation was real. And in our world, it’s hard to catch up with inflation because of some of the fixed nature of our cost and also our contract nature. So, it’s going to take us a little while to make sure we get all that inflation kind of matched and back out of the network.
But having said that, what we firmly believe and expect we’re going to be in the mid-50s at some point in the future. What we’re most focused about is cash dollars, margin dollars, and that’s all about growth. If and as we do that, the operating margin is going to take care of itself, right? We know how to be efficient. We need to demonstrate. We know how to grow and grow consistently.
David Vernon
So, you’ve been in the railroad a long time. And I want to ask this question, because it just occurred to me, as you mentioned this, this focus on cash dollars and margin dollars? Is that focus different now that you’re at a low 60s or a 60 or than it would have been if you were to 70 or 75?
Lance Fritz
No, it’s always been the focus. The way we generated cash dollars and margin dollars was to go from 87% operating ratio or 13% margin to 75% to 65% to where we’re camped out right now call it 60% or 60% and a kicker. We think going from 60% to 55%, there’s margin there. For sure margin dollars and cash, there’s much more if we grow.
David Vernon
If it is from a pricing level, or is it from volume growth? I always thought if you’re running a relative like an 80%, or an 85%, or 75%, or whatever, your returns are a little bit closer your cost of capital, you really want to kind of push price, maybe you can’t be as aggressive on growth with a higher OR but as at a lower OR you maybe can be a little bit more aggressive?
Lance Fritz
David, in my experience, it’s just more blood and guts and practical than that. With a 60% operating ratio or 40% operating margin, our cost basis is fundamentally different than at 75% or 85%. And that cost basis is real. It opens up markets to us that used to look on attractive. If you’re at a — it just fundamentally changes the equation on what looks attractive to you.
David Vernon
Okay, all right. So, switching gears a second to talk a little bit about the regulatory environment. Obviously, in my I guess close to 30 years now of looking at the railroad industry closely, I haven’t seen that environment as tense as it is right now with the regulator. And then I know the answer is going to be to solve the service issue, but like, what else do you need to do to kind of, to get the regulator off your back to a degree?
Lance Fritz
Yes, well, part of the strategy is constant engagement. I personally am engaged at the STB probably every three weeks. And that’s responding to feedback that we’ve heard from our STB Board members, which is, don’t surprise us. Let us know what’s going on. Good news and bad news just keep us informed and make sure that we’re kind of treated as part of the team. Absolutely doing that, there’s an executive that UP that’s engaged at the STB several times a week, without a doubt.
David Vernon
And is that different than maybe 5, 10 years ago?
Lance Fritz
Probably, yes, I would say 5 or 10 years ago, we would have treated that regulator as somebody who when they ask, we would respond. And in today’s world, we’ll volunteer. And if they ask some more then we’ll get deeper into the conversation and keep going. To your point, the fundamental remedy is, don’t have customers complain to the STB. They’re naturally set up to receive all of the complaints that customers feel aren’t being listened to by their provider. And so naturally, they’re going to be starting from a point of something’s wrong, how do we — what do we need to do to remedy it? And we’re just trying to take that off the table to the extent we can.
David Vernon
And do you see any sort of changes to the hazardous materials sort of regulatory environment that is going to have a big impact on the industry, shorter trains, different handling practices for different types of commodity codes, that kind of stuff?
Lance Fritz
You know, there will be some changes that clearly something’s going to come out of Congress, I believe. I think the committee kind of missed an opportunity there. There are a number of things that the railroads have talked to Congress about regulating that we would welcome. I mentioned our Wayside detection system is completely voluntary. That makes sense to have regulatory regime around where they’re located, how you deal with them, what’s the algorithms, you’re looking for that kind of thing.
We also talked to them about regulating tank car standards. There are tank car standard regulations in place, but the last conversion happens in 2032, that probably can be pulled forward. So, there’s a number of things that we talked to them about. Unfortunately, the bill in its current form got loaded up with a bunch of stuff that doesn’t do anything to make railroads safer. And senators and congressmen are looking at that and thinking that doesn’t make sense to us. And so, it’s got less of a chance to pass.
David Vernon
And then the regulator has sort of made the proclamation that having done the CPKC transaction, they’re now going to look at open access, which in its worst form is kind of scary. What do you think is going to come out of that document hearing around access reform?
Lance Fritz
What I hope happens is the conversation around open access, historically really was about rates. I think that conversation has changed, and I think it’s becoming more about service. And that’s probably a healthier place for that conversation to occur, i.e., if a railroad is serving a customer, and their soul served, and that railroads on its knees and cannot satisfy the needs of that business, there might be an opportunity to use access or some kind of quid pro quo to open that customer up for satisfying that need.
That’s targeted, it’s short lived and it makes sense. The problem with open access broadly, is it puts interchange where interchange isn’t meant to be. If it was meant to be there, it would be occurring there. Railroads have been around for 150 years, we’ve invested heavily where we have natural interchange opportunity with our partners. And so, when you start putting interchange where it’s not planned to be, it’s inefficient.
And every single time you interchange, it adds about a day to the length of the car cycle. So the service product gets worse costs go up and you start congesting parts of the network where you don’t have capital. And open access takes the incentive to invest off the table. So, you’ve created a problem and there’s no solution to it market force. It needs to be a very targeted, very narrowly defined mechanism, and then it might work.
David Vernon
Well, we are at the end of our allotted time here. I just want to give you a last moment to close us out. Tell us why investors would be well served in terms of putting capital work into Union Pacific? It’s kind of the open mic moment for you.
Lance Fritz
100%.
David Vernon
So handed over to you.
Lance Fritz
So, we are an awesome cash generator and return generator. Last year, we had the best return on invested capital in the industry. We had the best dividend payout ratio in the industry. We were second by a 10th of a percentage point on margin. We’ve historically been able to be the best we will again, and we’re great stewards of your capital. So, please invest as us and for those of you that are invested with us. Thank you for being on the journey. We appreciate it.
David Vernon
Thank you everyone for joining us, and thanks for coming out.
Lance Fritz
Thank you, David.
David Vernon
I appreciate it.
Lance Fritz
I appreciate it.
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