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Well, good morning, everybody. I'm Jason Seidl. I'm Cowen's Trucking, Rail and Logistics Analyst and welcome to Cowen's 12th Annual Global Transportation Conference. There's, obviously, lots of questions I think investors have in the transportation space and the overall global macro right now and I can't think of a better company to kick off than Union Pacific. We're honored to have them back once again. And representing Union Pacific to give the presentation today is Rob Knight, their Chief Financial Officer. So, without further ado, I'll turn it over to Rob.
Thanks, Jason, and good morning. With me here today are a couple of folks: Kenny Rocker sitting up here on stage is our Executive Vice President, Marketing and Sales; and then Mike Miller is our Head of IR. Kenny will be joining me after my prepared remarks for Q&A.
And before we start, I would like to remind everyone that I will be making some forward-looking statements and these statements are subject to risks and uncertainties. So please refer to the UP website and SEC filings for additional information about our risk factors. Union Pacific has a very unique franchise. It is a foundation of our business. Our network includes 32,000 route miles, stretching across 23 states in the Western 2/3 of the country, supporting a balanced mix of four business groups and over 10,000 customers. We view this franchise diversity as a key differentiator in the marketplace. We have a broad geographic footprint that allows us to participate in a wide variety of markets and puts us in a great position to compete in the markets of tomorrow.
Our terminals are located strategically across our network to provide convenient access for our customers and to support business growth. In addition, we have unparalleled access to the Gulf Coast and the industry's best access to Mexico, with border crossings at all six major gateways. Over the long term, our franchise diversity coupled with a reliable, consistent and efficient service product, will continue to provide us with a wide range of opportunities to grow profitably with existing customers and penetrate new markets.
Now turning to the business, third quarter volume is currently down 7% year-over-year, driven by excess truck capacity and weaker coal demand related to lower natural gas pricing as well as global trade uncertainty. Energy carloads are down 14% in the quarter as strength in petroleum products is more than offset by a 17% decrease in coal volumes and 42% fewer sand carloads. Premium shipments are down 10% quarter-to-date, driven by double-digit decreases in our international and domestic intermodal shipments.
Agricultural product carloads are down 2% compared to last year, driven primarily by a 6% decrease in food and beverage shipments and 5% less fertilizer carloadings, partially offset by a 1% increase in grain products volumes. On a more positive note, industrial shipments are up 2% quarter-to-date. The drivers in this category are 17% increase in construction volumes and a 5% increase in plastics shipments, partially offset by lower forest products and metals carloadings.
Next, I'd like to update you on our Unified Plan 2020 key performance indicators. As we discussed on the July earnings call, our network was challenged by significant flooding during the second quarter. But even with the weather, most of our second quarter metrics improved year-over-year. This was a direct result of our relentless focus on improving network efficiency and service reliability. Now in the third quarter, with the significant weather issues behind us, our KPIs are continuing to improve. Our focus on asset utilization and minimizing car classifications has led to a 19% improvement in freight car terminal dwell and 8% improvement in freight car velocity compared to July of 2018.
July train speed decreased 4% year-over-year but is trending in the right direction as the network disruptions from the second quarter are behind us. And, although, our August metrics aren't yet finalized, we are experiencing further improvement from the July levels.
Turning now to slide 6, locomotive productivity improved 18% versus July 2018 as our network performance continues to improve. As of July -- as of August 31, we had about 2,300 locomotives stored, an increase of 150 since just June. Workforce productivity, measured as daily car miles per FTE, is up 5% year-over-year in July and continuing the positive momentum from where we finished the second quarter. In addition to improving productivity, delivering a great service product is of equal importance to the team. Car trip plan compliance was 7 points better than July 2018, reflecting a more fluid network as we move beyond the first half weather issues.
Slide 7 highlights some of the network challenges that we have made to improve -- network changes that we have made to improve service and increase efficiency as part of our Unified Plan 2020. From a terminal rationalization standpoint, we have stopped humping cars at Hinkle, Oregon; Pine Bluff, Arkansas; and Proviso Yard in Chicago. We've also curtailed yard operations at locations in Denver, San Antonio and Wisconsin to name just a few. And in Kansas City, we've reduced complexity by consolidating traffic out of our Armourdale facility, while cars previously handled in Des Moines, Iowa are now switched in Kansas City.
Our plan to simplify intermodal operations in Chicago also was well underway as we have idled our Global III facility and the Canal Street Container Depot. Going forward we will continue to look for ways to reduce car touches on our network, which will undoubtedly lead to additional terminal rationalization opportunities. And we're making excellent progress with our train length initiatives, as illustrated on the graph on the right. By putting more product on fewer trains, we increased train length 11% since January of this year and we expect to see continued improvement as the year progresses. While a number of bold steps have been taken and the results are evident, there are a lot of opportunities ahead of us to further improve service reliability, asset utilization and network efficiency.
Turning to slide 8, we continue to generate strong cash flow, as cash from operations in the first half of 2019 totaled $3.9 billion. Free cash flow before dividends totaled $2.3 billion, resulting in free cash flow conversion rate equal to 77% of net income for the first half of this year.
Taking a look at adjusted debt levels, we finished the second quarter with an all-in adjusted debt balance of $27.7 billion and adjusted debt-to-EBITDA ratio of 2.5 times. As we have previously mentioned, our target for debt-to-EBITDA is up to 2.7 times, while maintaining a credit rating no lower than a BBB+ and BAA1. In line with this guidance, we just completed a $1 billion debt offering in July.
Dividend payments for the first half of 2019 totaled more than $1.2 billion and consistent with our target payout range of 40% to 45% of earnings, we announced a 10% dividend increase for the third quarter of 2019. This marks a total of five dividend increases in the past eight quarters. We also repurchased a total of 21.9 million shares during the first half of 2019. And these share repurchases are part of our previously announced three-year plan to repurchase approximately $20 billion of shares by 2020.
At the end of the second quarter, the plan was little more than 60% complete with the share repurchases totaling $12.4 billion. Between dividend payments and share repurchases, we returned $5.4 billion to our shareholders in the first half of this year.
Looking ahead, third quarter volumes have been softer than anticipated. As a result, our current thinking is that volume for the second half will now be down mid-single digits versus 2018. However, our pricing strategy remains unchanged as we continue to price our service product to the value it represents in the marketplace, while ensuring it generates an appropriate return.
We remain confident that the dollars we yield from our pricing initiatives will again well exceed our rail inflation costs in 2019. And the positive momentum from our productivity initiatives, gives us confidence, that we will still deliver at least $500 million of net productivity this year. Importantly, with improving margins in the second half of the year, our guidance of a sub-61% operating ratio in 2019 on a full year basis remains intact.
Furthermore, an early look at next year's productivity line up, gives us confidence in our ability to achieve an operating ratio below 60% for 2020. We have to play the hand that we're dealt when it comes to volumes, where we're committed to achieving our financial targets and that is unwavering.
So with that Jason, I will turn it back to you for any questions.
Fantastic. So I'll wait for you to come on down here. So, going through PSR, obviously you are not the first railroad to do so, but there is three railroads jumping together in a short period of time. What has surprised you during the implementation, both positive and if there's any negatives out there as well?
Yes. Let me start and then Kenny who runs marketing sales obviously has direct interface daily with our customer base will have some good perspective on that as well. It's been a pleasant surprise to me now. I would tell you that, we got off to a very positive start with our operating team and then I think everyone knows we then brought on Jim Vena previously with Canadian National and now is our Chief Operating Officer in Union Pacific. And I would tell you that, Jim I think is an outstanding operating leader. He is obviously a proven PSR general and has absolutely taken the bull by the horns and all the initiatives that you see are from Jim and his leadership of the entire organization.
And I think what I have been and again I'm not surprised because I knew Jim was good. But what I have been pleasantly impressed with is the pace and the confidence and the buy-in that Jim and the team have within the operating team and also I think within the marketing team to work closely and make this a success. And as I said in my comments, while we have had early inning success with the PSR implementation and working closely as Kenny will talk about with our customer base to do that, we think there's a lot more opportunity still in front of us as Jim and the team continue to roll it out.
Yes. I'll make my comments brief. I'll tell you that the thing that surprised me is the pace and the way we work with our customers. I think most people thought the approach would be to break a lot of glass and then build the backup. And what we've done is, we worked proactively with our customers and it's really helped us out. They know what's going to change. We communicate to them exactly what's changed.
And if you look at the metrics now, our car trip plan compliance is the best it's been in a few to several years now. Those metrics were for most of our manifest business, but the same is true, if you look at our bulk and our intermodal business. So, that reliability will pay a lot of dividends in terms of growth and how we approach the marketplace.
And that's really what shippers look at, right? I mean, it's the compliance, it's not like the train speeds or terminal dwells and everything else did. They just care, are you getting the cars here when you say you are?
You know, when we sit down with our customers, we speak less about train velocity and those and train size. We talk specifically about car trip plan compliance and not just at a global level, but for their business, we personalize it for their business.
Now, Rob, you talked a little bit about the OR guidance for 2019 is intact and that's despite, obviously, the volume guidance having to come down because you so aptly put it you're playing the hand it's dealt. So, clearly things are going probably better than expected with some on the cost side, I would imagine from PSR. Talk a little bit about what's better than expected on the cost side?
Yes. That's a great question and I would tell you we'd rather have the volume. And so…
I understand.
…we'd rather have the volume and there is more optionality, if you will, from not only obviously operating income, but there's more optionality for the operating team to implement PSR. And the one question I frequently get is, is PSR harder or easier in a shrinking or a softer volume environment? And frankly, Jim and the team and Kenny and I would say we -- it would be easier with more volume, rather than some people thinking that it's easier to be successful with PSR implementation in a softer volume environment. We think just the opposite. So the fact that we have been successful with the implementation as we have with this year soft volume, again, I think speaks to the credit of the operating team and their implementation and marketing working with them. But yes, just what I would say to your specific question on the OR guidance, I think, what that shows is our confidence in continuing to drive the productivity initiatives. And yes, maybe the productivity dollars might have been even greater, had the volume been stronger than it is now, but we're still holding it at $500 million-plus productivity. That along with improved service, continued pricing initiatives and pricing, as I commented, dollars well above our expectation for inflation dollars, the combination of that, even with a softer volume environment is what gives us continued confidence to break sub-61% OR this year. So it's kind of all-in. It's not -- no single home run or base hit here or there. It's really just a collection of successful implementation of the PSR that gives us that productivity confidence.
And longer term, how should we think about the headcount for UNP as PSR progresses?
You know, this year, Jason, as our guidance was and continues to be that we expect to end this year at 10%-ish, better headcount year-over-year by the time we finish the year. So that implies, because by midyear that number was 6% for the first half of the year. So 10% on a full year basis implies which is the case that we expect to continue to make even greater progress in the second half on that measure than we did in first half and that is our belief. And again, the second half should be weather easier than the first half was with all the floodings. So that's part of it, but also it's the momentum of the PSR implementation. As you look longer term, there was some step function headcount reductions that we were able to capitalize on this year. That I don't think will repeat as we go into 2020 or beyond, but I would say that without putting a specific number on it, I believe that there'll be continued opportunities in our headcount and we'd like to see volume grow and those areas where we’re volume variable. We're okay with headcount moving back up, but not one for one, because there's even with volume growth, we'll continue to squeeze out productivity as those volumes come back on our line. So we will grow some of those volume variable headcounts like the folks the TE&Y folks who were driving the trains that likely will increase, but again, not one for one because of the efficiency of PSR or Unified Plan 2020.
Interesting. I'll turn the question Kenny back to you. Talk a little bit about the competition with trucks and how much business that you think you lost there especially on the intermodal side probably a little bit of merchandise too?
Yes. So everyone is aware of the spot truck rates and what has happened there. And some of it is lost business, Jason, some of it is just you don't have as many opportunities that don't have as many add-backs to go on and compete because the spot rates are so low. At the same time, we have been able to have some wins with contracted business. So if we weren't able to have such a great service product, we probably wouldn't be able to be in a position -- probably would be in a worse position. So I’ll tell you coming out of this depending on what happens with the marketplace I'd much rather have a service product that we have now than we did in the past when that's what you're selling. So we’ll see what happens with the truck rates, but as those markets change, I feel very confident and we're pretty upbeat about the fact that we have a really strong product to sell.
And should I read in the fact that Rob said to analysts, we're still very confident we're going to price above our rail cost inflation number. That means you're holding your price. Obviously that's an across-the-board comment, but you're probably holding your pricing more as opposed to just slashing it and trying to get some of that so, as it comes back you're probably in a better position to get rates beyond that?
Yes Jason. I'd say the expectation for the team -- for the commercial team is that we're going to price consistent with the value proposition that we have here. It would not be prudent for us to have some of best service we’ve had in a few to several years and then we make adjustments. So we're going to stay the course in terms of how we look at the market.
Makes sense. And Rob's opening comment, you mentioned, obviously trade and that's been on everybody's mind, I mean, I don't think a day goes by where we don't wake up to some new news item or some new tweet that comes out that ravels the market or puts everyone in question. So a couple of questions. Like one, where are you seeing the biggest impacts at UNP in terms of volume wise that you can point to and say, that's trade issues?
Two, what are your customers telling you? Like if this gets settled, when will this come back and plus you how that's impacting them as well?
Yeah. So, the big -- one of the bigger -- larger area is on the ag side, on the grain side, where the soybeans that get exported. I think the U.S. provides about a third of all the soybeans that go to China, and so clearly we've been hit there. And that started late last year, we'll see what happens. We're heading into a harvest for the soybean, so we'll keep an eye on that. If they were a positive tweet today, I'm not sure that -- I'm not certain that the supply chains will be able to pull back up in time. And so we'll keep an eye on that.
The other area is our Premium business, specifically on our international intermodal business. So, we saw the pull ahead also start late last year. And it seems like there are still some inventories in place. We're expecting a very compressed peak season, but we're still expecting one. So, we'll see how that plays out too.
Actually now that on the soybean and the crop, do you think that they're going to find other buyers? Obviously, China was by far and always the number one buyer, right? But multiples of the number two. Should we expect just to sort of a different route as more is going to go out of the Gulf on the PNW?
Yeah. They do have different buyers right now. They have Brazil as a buyer -- as a purchase -- a person that they are purchasing from. I've talked to several of the buyers from China. It doesn't seem that there's permanent infrastructure there to get a lot of the grain out, so we feel good about the fact that there does not seem to be any permanent supply chains that have been built up around that. But again, the longer we have this trade issue then the longer that becomes a concern.
Right. We'll switch to a more positive trade issue. Obviously, Mexico, how -- and you guys have such great access there, how's the business from Mexico been looking?
It's been solid. We'll see what happens with USMCA. We're seeing -- we're very positive about that. There is a chance that could get done yet this year. We'll continue to look at our business going into Mexico, but it continues to be a pretty strong growth engine for us.
I see. Let me turn back over to you and ask you a little bit. Obviously, you found early success with PSR. What's been the interaction and the feedback from the Surface Transportation Board?
Yeah. I mean, we pay close attention, they pay close attention. And as we've discussed here today, we consciously, you heard me say this before conscious, Jason, we consciously invested primarily, I'd say in Kenny's organization to communicate. I mean, we're knowingly saying, let's not be guilty of under-communicating with the customer. Let's over-communicate.
So, we put a lot of time and energy under Kenny's leadership to do that. And I think that helps. So, we typically will have Kenny and his representatives and somebody from the operating organization sit down with the customer. So, they're not -- the point of that being, so they're not waking up with a service change to looking on a note that comes across the wire that service changes tomorrow. There has been communications. They know what's going to happen. We get their -- hopefully their buy-in and that's not -- it's not get all or celebrating, or standing, and applauding in every case, but at least they know what's coming and understand what -- why we're doing it and what we're doing. So that has helped. And I think the Surface Transportation Board has heard that. So I think that has played well.
Now, we're also being very cognizant to make sure that we communicate with the STB, and they understand what's going on. Kenny personally has been involved in those communications. So we feel very good about that. We're mindful though that we are making some changes that impact customers and that customers -- there'll be some issues there.
But when you've got a scale or size of what's happened in our organization versus maybe what's happened in some other notorious examples of implementation, we feel like we have done a good job, and we plan on still continuing down that mode of being as open and honest and forthright as we possibly can at the same time driving the efficiency cycle turns asset utilization improvements that are not only good for us, but we think are good for our customer base at the same time. So, we'll continue to be aggressive in doing that, but will also be over-killing the communication with the customer base.
I have one more, before I turn over to the audience here. Talk about CapEx longer-term, and what sort of impacts PSR might have on the CapEx outlook?
Yeah. Yeah. I'm proud over the last several years that we have been, I would say, leading the league in terms of efficiency in our capital spending, where we've walked it down to the current guidance of our capital spending. We expect to be less than 15% of our revenue.
And as we say that's not how we build our capital plan. I mean, we don't look at revenue, and then back sold for capital. But it's just kind of a guiding light if you will that we've given the investment community.
I would tell you that what we have seen already from -- in our Brazos spending backing off is an example of this, and that is that the buyers that I have and that we have with our capital spending as we look further down the road, as we build on the success of Unified Plan 2020 is continued downward spending on our capital. I say that with confidence, because we've got a network that we've handled several years ago, we handled 196,000 seven-day carloadings for the entire year on average. And right now, we're running, call it 170,000-ish. So we have excess capacity in parts of our network. There are parts where we don't. That's one factor.
Number two is the efficiencies that we in fact are seeing with Unified Plan 2020 free up if you will, free up capacity. We've got 2,300 locomotives stored as I've said. I doubt in my -- the rest of my lifetime we'll be buying any more locomotives. We've got still some spending with positive train control, but it's far less than what it was a few years ago. So you add all that up, I think the bias is downward on the spending, but our guidance right now over the planning horizon is less than 15% of revenue.
Do you think some of the spending is going to shift out into the future and is there going to be more spend for automation if you will?
Well I think there will be a shift. In fact, we announced shift this year, when we backed off on Brazos, we shifted some spending to other parts of our network that were more PSR-friendly if you will. I mean they kind of help us drive the returns and the deficiency that we're going to need with our Unified Plan 2020. So our total capital spending this year stayed around $3.2 billion, but we did some shifting there. I think you will see more spending and you're seeing more spending in technology. There's no doubt that I think if you kind of curve this out you'll see more dollars in our company and probably our entire industry go more towards technology than maybe had been the case in the past. But I don't think it's going to change the metric of the less than 15% revenue for us. It's relatively small compared to buying a fleet of locomotives as an example.
Correct. Exactly. Why don't we turn the question opportunity back to the audience. We'll have somebody walk around here with a mic and you can ask questions in UNP. Well I think you've done such a great job there is no questions. Oh, no we have one right here.
You talk a lot about not buying new locomotives, but I think your guys are overhauling or modernizing a lot of locomotives and so is part of your confidence about not buying more just because you have seen success with this modernization initiative? And can you give any quantification about what percent of your fleet you are modernizing? What percent is kind of eligible to kind of demodernized and the benefits you're seeing from that over recent years?
Yes. I mean we've always had a modernization program at Union Pacific and locomotives I mean it's just a smart investment to rather than not keep it current and overhaul. I don't have specific numbers to your question, but I would just tell you that yes that is part of the confidence. It's not new. We have always been attentive to maintaining and overhauling if necessary locomotives. So we will continue to do that. So what gives me confidence that I can say maybe not the rest of my life, but the rest of my career that we won't buy any more locomotives is the combination of our -- we kind of know what we're doing, when it comes to overhaul metrics. And we got a very good mechanical team that really does do that well and again that's not new they have always done that.
But the fact that we have got with the success of Unified Plan 2020 gives us even more confidence, but we got over 2,000 locomotives available. So hopefully, as volumes turn back up in a positive way, we'll be able to -- we will in fact be able to leverage the success of the efficiencies from Unified Plan 2020. And if necessary, we're more than happy to bring some of those over 2,000 locomotives back online to handle that volume. But that 2,300 locomotives is a big number.
Rob, do you think you'll ever need to hold them back or do you think there's a...
We will see. I mean -- the question is will we need them all back ever? We'll see. I mean the...
You'd love that.
Yes. We'd love that. Yes. So we will see.
Okay. So any other questions from the audience for UNP? Over here in the corner please.
Is there any structural reason why your car trip compliance couldn't reach those of your leading competitors?
Any structural reason why our car trip compliance numbers couldn't, no I mean maybe Kenny can elaborate on it. But I'd say that there's -- no there's no structural issue. I mean we -- oil railers are a little bit different length of haul mix or the most obvious issues that different -- make a difference between one railroad or another, but besides that there's no structural issues that I can think of Kenny?
Yes. And let me kind of back and I don't want to confuse anybody. We're not celebrating the numbers up there. We're celebrating the improvement. Clearly, the expectation would be to be much better than where we are. So I don't want to confuse anybody in thinking we're celebrating that this is the endgame where we are today.
Yes, good point.
So there's a lot of room to improve?
No. There is the expectation that it will improve.
Yes. It will.
Perfect. Is there any other questions from the audience? No. Well everyone please join me in thanking Rob and Kenny.
Thank you.