Earnings Call Transcript
NORFOLK SOUTHERN CORP (NSC)
Earnings Call Transcript - NSC Q4 2020
Operator, Operator
Greetings. And welcome to Norfolk Southern Corporation Fourth Quarter 2020 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce Pete Sharbel, Senior Director of Investor Relations. Thank you, Mr. Sharbel. You may now begin.
Pete Sharbel, Senior Director of Investor Relations
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 SEC for a full discussion of those risks and uncertainties we view as most important. Our presentation slides are available at norfolksouthern.com in the Investors section, along with our reconciliation of non-GAAP measures used today to the comparable GAAP measures. Additionally, a transcript and downloads will be posted after the call. It is now my pleasure to introduce Norfolk Southern’s Chairman, President, and CEO, Jim Squires.
Jim Squires, Chairman, President and CEO
Good morning. And welcome to Norfolk Southern’s fourth quarter 2020 earnings call. Joining me today are Cindy Sanborn, Chief Operating Officer; Alan Shaw, Chief Marketing Officer; and Mark George, Chief Financial Officer. I’d like to begin today by recognizing the hard work and dedication of all of our employees who persevered and adapted throughout 2020 to serve our customers and communities, and enhance shareholder value. As the past year unfolded, change was one of the few constants driven by the COVID-19 pandemic, as well as a global shift in energy markets that significantly impacted our business. Our people day in and day out ensured that our railroad was positioned to succeed by delivering for our customers’ changing needs, while seizing efficiency opportunities that produced record productivity levels and advanced our PSR-based operating plan. Moving to our results on slide four, for the quarter EPS was $2.64 and the operating ratio was an all-time record at 61.8%. Prior to summarizing the full year results, I’ll highlight two previously disclosed non-cash charges. First, recall in the first quarter, we launched a rationalization of our locomotive fleet by 703 units, which resulted in a non-cash charge of $385 million. This was possible due to the deep and lasting efficiency that we’ve driven into our train network through precision scheduled railroading. Next, in the third quarter, we disclosed a $99 million non-cash impairment charge related to an equity method investment. I will speak to full year results excluding both of these charges. For the full year, revenues declined 13% as we experienced significant disruption in business levels from the dual impacts of the global pandemic and energy market changes. In response, we pressed forward with PSR initiatives and quickly adapted to control costs. And as a result, we more than offset the revenue decline with a 14% reduction in adjusted operating expenses. The adjusted operating ratio improved to 64.4%, which marks the fifth consecutive year of improvement. As we managed significant volume fluctuations throughout the pandemic, we idled four additional hump operations, streamlined our resources, and completed a redesign of our Southern operations around Atlanta ahead of peak season. Since our launch of TOP21, we’ve completed a total of six hump rationalizations and we’ve substantially reduced our asset requirements. Our ongoing efforts to improve fuel efficiency and resource productivity produced our best results to date. These actions contributed to another year of operating ratio improvement on an adjusted basis and are especially crucial to drive profitability and efficiency even further in 2021. We see ample opportunity to affect more positive change and remain focused on closing the operating ratio gap with the industry. Moving into 2021, we are committed to providing superior value to shareholders and best-in-class service to customers through an efficient, profitable operation. Building further upon record productivity and efficiency gains to foster a platform of growth. Increasing resilience in our service offering and creating latent capacity to grow with our customers is in lockstep with our goals to grow profitably and efficiently. This alignment is paramount as we continue to leverage our superior positioning to consumer and industrial markets that have been proven growth drivers for Norfolk Southern. We will leave no stone unturned as we drive efficiency and create value for our shareholders. I’ll now turn the call over to Cindy.
Cindy Sanborn, Chief Operating Officer
Good morning. When I spoke to you last quarter, I had been at Norfolk Southern for less than two months, but I had already found a strong foundation and opportunities for us to maximize the value of our franchise. The most recent quarter has reinforced my belief in the magnitude of opportunity in front of us and that we are positioned to capture that opportunity. During the fourth quarter, we saw volumes continue their climb from pandemic-induced lows earlier in the year, so the mission of the operating team was handling more business while reducing resources and improving productivity. Our push for efficiency led to record train weight and record train lengths in the quarter. These larger trains combined with our strategy of better matching train size and locomotive horsepower drove us to record fuel efficiency and enabled us to get the job done with a smaller workforce and a record low count of locomotives. I also have to thank the people that make up our operations team and all crafts. We achieved these records due to their hard work, and most importantly, we did so safely. Turning to slide seven, our network performance throughout most of 2020 was strong, with many metrics at or above record performance levels even with unprecedented volume volatility. We accelerated network changes in the fourth quarter ahead of holiday peak season and as volume reached the highest point of the year. As you can see on the slide, our network fluidity metrics came under pressure as the quarter progressed. It is important to note that implementing these network changes as soon as possible, while challenging, is key to future success with our ongoing efficiency and growth initiatives, which I’ll cover in more detail shortly. I can confidently say that we are meeting these challenges head-on and have already improved fluidity in the first quarter as the black line on the graph indicates. We are focused on executing and improving the plan, and when necessary and justified deploying temporary resources to quickly address congested areas. For example, while we put locomotives into storage this quarter, we will use those locomotives temporarily if needed before returning them to inactive status. I have been very pleased with the way the team has risen to the challenge, especially during the holiday peak season when they upped their game to meet service expectations, even with additional premium intermodal traffic. Moving to slide eight, traffic coming back is both our challenge and an opportunity. We can and will add resources to meet customer needs, but first we must explore every option to fully utilize our existing crews and locomotives. We eliminated a lot of structural costs, including indirect and supporting costs during the pandemic. So we’re being very careful to keep those costs from creeping back. Before we add a new service, the team goes through an extensive vetting process to explore the alternatives, including rebalancing traffic between existing trains and tactical extra trains. The focus is on using additional volume to help us increase the value we bring out of each locomotive and each crew start. Railcar velocity is our touchstone throughout as we push to quickly move volumes through the network. We have also made our organizational structure within operations more efficient during the quarter by reducing from nine to six geographic divisions and delayering our management structure to speed decision making and ensure that communication is clear and quick. As Alan will explain, we are preparing for significant volume growth in 2021. On slide nine, our six techniques that will help us get maximum leverage from additional traffic. Full pin is a technique used to optimally match train size with the pulling power of locomotives. While volume fluctuations can make this challenging, full pin drives fuel efficiency, controls crew starts and improves asset turns. Increasing the blending of different kinds of traffic on the same train supports full pin and minimizes additional train starts. We improve car velocity by blocking cars for the most distant possible destination, reducing yard costs by minimizing handlings. While we have reshaped the network through our four recent hump yard conversions, we are successfully minimizing hiring and training costs by helping furloughed employees in one craft transfer to another. This helps both the employee and Norfolk Southern. Those craft transfers are one way we are being more agile, flexing our resources up and down in sync with traffic volumes. We adapted the plan quickly through the pandemic and we continue to exercise that muscle memory. Finally, we are dynamically managing our operation to handle traffic fluctuations, keeping cars moving even when volume spikes. I am confident that we can meet customer expectations with our fast efficient network. With that, I will turn it over to Alan.
Alan Shaw, Chief Marketing Officer
Thank you, Cindy, and good morning, everyone. Headwinds related to COVID-19 and energy markets challenged volume in 2020, with revenue improving sequentially through the second half of the year. Throughout the recovery, we continued our focus on project-driven growth and margin improvement supported by our market approach and service product. As you can see on slide 11, the dual shock of the pandemic and declining energy markets pressured volumes in 2020. However, volume in both our intermodal and industrial markets excluding energy returned to growth during the fourth quarter as the economy continued its recovery from the pandemic. Turning to slide 12, full year 2020 revenue decreased 13% and total volume declined 12%. While our business capitalized on a V-shaped recovery and consumer-driven markets, year-over-year declines persisted in energy, which accounted for more than 70% of the 2020 revenue decline. Our continued commitment to margin improvement partially mitigated these impacts, resulting in revenue per unit (RPU) less fuel increases in all three business groups during each of the last four years. The mixed impact of increasing share of intermodal volume relative to decrease in energy volume resulted in the total RPU decline. Merchandise revenue fell 11%, with almost all markets experiencing pandemic-related losses. Notably, energy-related commodities faced supply and demand shocks, prompting high inventory levels and record low commodity prices. Most prominent in the second quarter, dramatic declines in manufacturing and vehicle production placed downward pressure on steel prices and production for much of the year. Intermodal revenue recovered significantly in the second half of the year. However, first half losses resulted in a 6% revenue reduction and a 2% decline in revenue excluding fuel for the full year. E-commerce and consumer-driven business supported the intermodal recovery, particularly in our premium segment. Secular declines in the coal industry accelerated during the pandemic, as coal revenue and volume dropped 37% in 2020 in the face of declining low demand, with product substitutes gaining market share. Utility volume fell sharply year-over-year due to sustained low natural gas prices, reduced industrial power demand, and high stockpiles. Lower seaborne coal prices were a headwind entering 2020, which coupled with the onset of COVID-19 and import restrictions, led to challenged volumes, especially in the second and third quarters. While pandemic conditions negatively impacted revenue and volume in 2020, we maintained our focus on delivering a service product that enables our customers and Norfolk Southern to grow, as the dynamic transportation environment continues to strengthen. This approach supports our strategy of providing a truck competitive, consistent, and reliable service product to our customers, allowing our customers to compete, while creating operating leverage for Norfolk Southern and adding value for our shareholders. Moving to slide 13, our fourth quarter revenue results improve sequentially and outperform normal seasonality, as the economic recovery gained momentum. Total revenue for the quarter was down 4% year-over-year, as energy declines outweighed the year-over-year growth in both intermodal and merchandise excluding its energy components. RPU declined reflecting lower fuel surcharge revenue and the negative mix effect of higher intermodal and lower coal volume. Within merchandise, both volume and revenue were down 5% year-over-year, driven by declines in crude oil and natural gas liquids. Crude oil shipments were heavily impacted by reduced global consumption due to COVID-19 leading to lower refinery run rates, significant storage worldwide, and unfavorable price spreads. Shipments of natural gas liquids were also down significantly due to additional pipeline capacity, coupled with lower consumption. Partially offsetting these declines were gains in soybeans from increased opportunities for export, reflecting our long-standing focus on margin improvement. Merchandise quarterly revenue per unit less fuel increased year-over-year for the 23rd consecutive quarter. Intermodal business levels grew meaningfully year-over-year as we leveraged our powerful franchise to secure new opportunities from the surge in e-commerce activity, record tightness in the trucking sector, and recovering global demand. Excluding fuel, fourth quarter revenue increased 11% year-over-year. Domestic shipments were up 7% year-over-year, propelled by more than a 30% increase in premium shipments. Revenue per unit less fuel reached a record level in the fourth quarter, marking the 16th consecutive quarter of year-over-year growth. Our coal franchise experienced continued declines amid low energy prices in the fourth quarter. Thermal export volume increased, which was more than offset by a 40% decline in utility tons. Our utility franchise faced continued pressure from low natural gas prices, renewable generation, and reduced manufacturing output. In total, coal volume fell 25% from the same period in 2019. Record level revenue per unit less fuel was driven by positive mix within our utility markets and volume shortfalls. Moving to our outlook on slide 14, we are closely monitoring economic developments and the attendant impacts on our franchise. Markets have not recovered equally. The consumer driven market recovered first and has exceeded pre-pandemic levels, while manufacturing markets have been slow to recover with existing social distancing protocols and labor force participation. Although, economic uncertainty persists, current trends support optimism for our business in the coming year, with an improving manufacturing sector and expected strength in consumer spending. With respect to the merchandise markets, we expect the steady recovery in manufacturing activity to support our customers’ efforts to rebuild inventories and meet increasing demand. Total manufacturing activity is accelerating, driving opportunities across our merchandise segments. Supply chain disruptions and supplier shortages have further impacted inventory levels downward, creating an additional need for increased activity in the coming months. Prices for steel are up more than 80% year-over-year, which will lift production and trade activity. U.S. light vehicle production is expected to exceed 2019 levels by 3% in 2021, which will support automotive volume and adjacent markets like steel and plastics. Housing remains a growth story resulting in increases in construction activity. Growth in our agriculture and forest products segment will be led by agrofuels and food service related markets, as consumer gasoline demand returns and the service sector recovers. Although most energy-related markets are expected to remain challenged, projected strengthening consumer spending, low inventory levels, record tightness in the trucking industry, and our best-in-class channel partners will continue to spur growth in our robust intermodal franchise. Good spending is forecasted to rise 7% in 2021, due to continued pandemic-induced spending patterns and high levels of personal savings, triggering increased demand for our intermodal product. Our outlook for coal remains pressured by high stockpiles that will lower utility volumes. Partially offsetting these declines will be export thermal and domestic met volumes projected to increase as the global recovery from COVID-19 continues into 2021. In summary, we expect 2021 revenue growth as overall economic conditions improve throughout the year. We’re constantly adapting to the evolving needs of our customers, providing valued transportation solutions to the marketplace. We recognize that sustainable low carbon transportation is essential to our customers and our growth strategy. We remain committed to our efforts to improve fuel efficiency, modernize our fleet with energy management solutions, and partner with our customers to prevent pollution. Our leadership in sustainability is resonating with our customers and the markets we serve, validating these efforts. We’re confident in our ability to leverage our value in the marketplace to secure new opportunities to support our customers’ growth and grow our margins. I will now turn it over to Mark who will cover our financial results.
Mark George, Chief Financial Officer
Thank you, Alan, and good morning, everyone. On slide 16, you’ll note Q4 2020 was free of any non-core items, meaning the OR improvement of 240 basis points was clean. We did in Q4 2019 report a non-operating asset impairment of $21 million that adversely impacted EPS by $0.06 and a $19 million retroactive income tax credit that aided EPS by $0.07. So with the absence of those two items, core EPS improvement this quarter was $0.10. Moving to the fourth quarter highlights on slide 17. Revenue was down 4% on volume that was down 1% as mix and fuel surcharge headwinds continued. Against that 1% decline in volume, we drove down operating expenses by 8% in the quarter as benefits from workforce and asset productivity continued to grow. As a result, operating income actually grew in the quarter by $22 million or 2% and the operating ratio improved to 61.8, a 240-basis-point improvement over Q4 of 2019. This is a record low OR for Norfolk Southern and we are well-positioned to continue driving this down in 2021 and beyond. The margin improvement achieved in the fourth quarter capped off a year in which free cash flow improved by 14% to $2.1 billion, another record for NS. Moving to a review of operating expenses on slide 18. Total operating expenses were down $139 million or 8%, fuel costs were down $87 million with lower pump prices contributing to $62 million of that reduction and consumption was down $21 million led by fewer GTMs, as well as a 3% improvement in fuel efficiency in the quarter. Compensation and benefits are down 7%, led mainly by employment costs with the workforce down by 3,300 or 15%. $10 million in one-time separation costs for certain craft employees partially offset these savings. Purchase services were down $41 million or 11%, as we’re making progress on the structural and semi-structural costs within this category, as well as due to the absence of detouring costs associated with flooding in the prior year. Depreciation increased modestly by less than 1%, as we’ve been able to successfully reduce asset intensity, including within the locomotive fleet, which continues to have ample surge capacity to absorb growth. Materials were down 7% due to lower spend associated with a smaller and more productive locomotive fleet. Lastly, gains on the sales of operating property were $11 million in the quarter, a decline of $32 million versus the prior year. So another quarter of expense reductions far in excess of the volume decline, leaving us well primed to deliver strong operating leverage as 2021 unfolds. Now turning to slide 19, for the remainder of the fourth quarter P&L. Below the operating income, you’ll see that other income net of $43 million is $25 million better than the prior year, due to the absence of the $21 million impairment of natural resource assets in Q4 2019. We also had another quarter of healthy gains on our company-owned life insurance investments. Our effective tax rate in the quarter was just under 23%, helped by the coal gains that are exempt from income taxes. Net income increased by 1% and EPS rose by 4%, as we ramped up share repurchases to nearly $500 million in the quarter. Now for a look at the full year on slide 20 and to preface I’ll speak to the adjusted numbers on this slide, excluding the impacts of the two non-cash charges during the year, the $385 million locomotive rationalization and the $99 million investment impairment. Despite the unprecedented volatility in business volumes that resulted in a 13% decline in revenues, we maintained focus on our long-term operational transformation, while adapting to the market changes that were induced by the global pandemic and the contracting energy markets. In the midst of this, we produced record workforce productivity, locomotive productivity, and fuel efficiency, which allowed us to more than match the revenue decline with a 14% reduction in adjusted operating expenses, while ensuring we are ready to serve improving freight demand as the economy recovers. The adjusted operating ratio posted improvement to 64.4%, the fifth consecutive year of improvement. But there’s more under the covers when we look at the 30-basis-point improvement for the year. Moving now to slide 21, you can see during the second quarter of 2020, the 29% hit to revenue on a year-over-year basis took a toll on the operating ratio, but every other quarter of the year improved in the 230-basis-point to 240-basis-point range. Throughout the year and especially during the depths of the pandemic-induced volume trough, the team really pressed forward to adapt our operating plan to the changing business environment. In fact, two of the four hump idling during the year occurred within Q2 and when the nationwide automotive network shut down, we completely redesigned our auto plan to absorb it into existing trains. In addition, we continued to press lower on resources and ensure that we were able to serve a surge in demand as economic activity increased, which is exactly what happened. We maintained a heightened sense of urgency to transform the business, while ensuring we are positioned for long-term success and further margin improvement. Moving on to cash flow on slide 22, although 2020 cash from operations came in under the 2019 levels, spend on property additions for the year was right in line with the reduced target we set earlier in the year of $1.5 billion, which was a 26% reduction from 2019 levels. We pivoted early in the year to this reduced CapEx target at the outset of the pandemic and executed the plan, while keeping priority on the health of the physical network. Thanks to these tight controls on both capital and operating expenses, free cash flow improved to a record $2.1 billion, while shareholder distributions totaled $2.4 billion. Average share count declined by 3%, with over $1.4 billion of buybacks as we maintain focus on returning capital to shareholders while maintaining strong liquidity. To close, we have excellent momentum on improving both our cost and asset structures while we deliver on the growth in 2021. We expect this formula to yield even greater margins and cash flow and we remain committed to delivering significant returns for our shareholders. With that, I’ll hand back over to Jim.
Jim Squires, Chairman, President and CEO
Thank you, Mark. Turning to slide 24, I will wrap up with our 2021 expectations. As you heard from Alan, we expect segments related to manufacturing and consumer activity to drive growth, while energy-related commodities are likely to remain challenged. We are modeling total revenues up approximately 9%, with intermodal leading the way, merchandise growing solidly, and coal declining. The power of our intermodal and merchandise segments to propel us to growth despite the secular decline in coal highlights the continuity of our strategy over time. As we move ahead, we will leverage many avenues to drive long-term volume and revenue growth, including a fast and reliable service product, the advancement of technology initiatives such as Access NS and Rail Pulse, just to name a couple, and our steadfast commitment to being a sustainable and socially responsible corporate citizen. With this positive momentum, we expect to achieve greater than 300 basis points of operating ratio improvement in 2021 versus our adjusted 2020 results and to end 2021 with a full year run rate of 60%. As we have said before, when we achieve our targets, we won’t stop there. In addition, we expect capital expenditures to approximate $1.6 billion, with a dividend payout ratio of 35% to 40%, an increase versus our prior target payout ratio of one-third. As we demonstrated in 2020, we are committed to protecting liquidity while using remaining cash flow and financial leverage to repurchase shares. We are optimistic about growth in the year ahead and we will advance productivity initiatives to bring freight onto the railroad more profitably than ever. We know there is more improvement to be made across the organization and we’ll continue executing on our commitments to drive efficiencies and create long-term sustained value for our shareholders. Thank you for your attention. We’ll now open the line for Q&A.
Operator, Operator
Thank you. Our first question comes from Brian Ossenbeck with JPMorgan. Please proceed with your question.
Brian Ossenbeck, Analyst
Hey. Good morning. Thanks for taking the question. Maybe just one for Cindy, on just the service levels. You mentioned you had some challenges when you’re doing the redesign in the fourth quarter, but you expect them to improve. Maybe you can give us some level of confidence as to how you’re applying some of the resources tactically across the network? What sort of issues you’ve had to face and just how you feel about hiring in the pipeline as you start to get ready for this type of growth in 2021?
Cindy Sanborn, Chief Operating Officer
Thank you for your question, Brian. As we entered the fourth quarter, we implemented some operational changes, including those related to our Southeast plan and some organizational adjustments. We reduced our locomotive fleet by approximately 100 units during this period. As we addressed several challenges, we noticed a decrease in our operational pace and temporarily added some resources for support. Additionally, while navigating these challenges, we experienced some COVID-related impacts with employees affected by health protocols as well as individual illnesses. This is how I would assess our performance in the fourth quarter. As we move beyond that period and into the holiday season, we have seen significant improvements. Although we are not back to 2020 levels, our situation has greatly improved. We continue to optimize our operations by consolidating trains, which presents further opportunities for adjustments within our network. We will also add resources as needed to ensure a swift recovery from any challenges. Regarding the volume we are encountering, some of it is related to unit trains, which will require a different approach to resource allocation compared to our scheduled network. In our scheduled network, we still have considerable potential to consolidate trains, increasing their length and weight, building on the progress we made in the fourth quarter. For example, in our intermodal fleet, approximately 10% of our trains are operating over 10,000 feet, indicating we can further enhance operations in this area, which should assist us in managing our workforce effectively in the coming year to remain flat or decrease from levels at the end of December 2020. I am confident we will continue to see advancements in both our operations and locomotive fleet.
Brian Ossenbeck, Analyst
Great. Thanks Cindy for all the details there. Maybe one for Mark, looking at the gains, I think you said about $11 million in the quarter? Looking at the cash flow, I think it implies something a little bit higher than that, just looking at the gain on disposal. So maybe you can clear that up for me? And then just give us a sense as to what you’re expecting for gains in 2021 when you look at that 300 basis points of operating ratio improvement.
Mark George, Chief Financial Officer
The property gains in the fourth quarter were $11 million. We finished the year with approximately $26 million in gains, which is slightly below our expectations. For 2021, we are projecting gains to be in the range of $30 million to $40 million. However, these property gains can fluctuate, and we will keep you informed. If we experience larger gains in any given quarter, we will highlight those for you.
Brian Ossenbeck, Analyst
Got it. Thank you, Mark.
Operator, Operator
Next question comes from the line of Scott Group with Wolfe Research. Please proceed with your questions?
Scott Group, Analyst
Hey. Thanks. Good morning, guys. So, Alan, I want to start with you, on the 9% revenue growth. Can you give us directionally how much is volume versus RPU? And then in the fourth quarter coal RPU was really strong, was there any liquidated damages or is that just a mix? I’m just trying to understand if that’s sustainable or not?
Alan Shaw, Chief Marketing Officer
Scott, as we look into ‘21, we are projecting very strong growth in both our intermodal and automotive markets, as well as our merchandise excluding energy. We expect energy revenues to remain about flat. They accounted for about 75% of our revenue decline in 2020. So we’re not going to have that headwind, which is going to uncover the growth in the other markets. And we’re targeting 9% revenue growth, upper single-digit volume growth. So modest RPU growth, just because of the mix impact of intermodal leading the way. With respect to coal, I mean, you are right. We did have about $12 million of incremental year-over-year in volume shortfall, which aided the RPU. We also had positive mix within our utility franchise in which our utility North volume, which as you know was shorter haul was down about 50% and our utility South volume was down about 30%. And then we also got some good pricing too in some of our markets as well. So all that rolls up into the overall RPU improvement that you saw within coal.
Scott Group, Analyst
Okay. Helpful. And then, Mark, for you on the cost side, so it sounds like full year headcount is going to be down a couple percent, but maybe help us think about some of the other pieces on the cost side. I know comp per employee, purchase services, depreciation, any other big items you can help us with? Thank you.
Mark George, Chief Financial Officer
Scott, are you referring to 2021?
Scott Group, Analyst
Yes.
Mark George, Chief Financial Officer
Right. So for cost per employee, you can expect the traditional year-over-year inflationary rate increases of a few percent, but you’re going to also have some incentive headwinds as well. Clearly, we didn’t pay out on incentive compensation at target this year. We fully expect to be at or above target next year. So you’ll have pressures there. In addition, you’re going to have some pressures on certain variable costs, like purchase services, and as Alan says, those go with volume. And we are, though, however, pushing on efficiency and productivity to help mitigate some of those things.
Jim Squires, Chairman, President and CEO
Depreciation.
Scott Group, Analyst
Is there any way to just say what the headwind would be from incentive comp, just going from a partial payout to a full payout?
Mark George, Chief Financial Officer
I’m not going to put a finer point on that just yet, Scott. But you can probably compute that. This year incentive comp was down and we expect that that is going to bounce back and hopefully bounce back significantly. But we’ll provide a little bit more guidance on that as we get into the year and we start to see how the trends are going.
Scott Group, Analyst
Okay. Thank you, guys.
Operator, Operator
Our next question is from the line of Bascome Majors with Susquehanna. Please proceed with your questions.
Bascome Majors, Analyst
Yeah. Thanks for taking my question. I wanted to go back to some of the merchandise markets where the outlook is pretty constructive outside of energy. We get steel prices through the roof. You mentioned auto. But could you talk with what you’re hearing from your customers? I mean, are there discrete items where you have plants reopening, utilization rising? Like how much visibility do you have into this turning into a real sequential volume acceleration versus just seeing some of the indicators in a very different backdrop from what we saw in the first six months of last year? Thank you.
Jim Squires, Chairman, President and CEO
I think we have good visibility into this for at least the next couple of quarters. Our merchandise, excluding energy, has shown year-over-year growth in the fourth quarter, and we're maintaining that momentum. Steel prices are at 12-year highs, and our customers are discussing adding back capacity. The markets for corn, wheat, and soybeans are at six-year highs, and the housing market is among the strongest it has been in 14 years. Additionally, wholesale inventory levels are near two-year lows, indicating significant demand for our products. Even in the paper market, producers of corrugated cardboard are sold out due to the growth of e-commerce. Overall, we're observing strength across our merchandise network, which gives us confidence as we move into 2021.
Bascome Majors, Analyst
And as that grows, should we expect the traditional relationship, where you’re able to add cars to existing trains or have some of the train length gains that you’ve made may be limited that normal kind of cyclical calculus that we’re used to?
Jim Squires, Chairman, President and CEO
No, you're exactly right. We've got capacity for growth, as Cindy highlighted. Most of our growth will focus on consumer and manufacturer sectors, which typically involve carloads and small block shipments. This aligns well with our current intermodal and merchandise trains. To provide a data point, we have been enhancing productivity within our intermodal franchise, and train weight has improved year-over-year by about 900 basis points more than train length. This indicates the potential for vertical stacking, which increases revenue density and enhances the productivity of crews, fuel, and locomotives.
Bascome Majors, Analyst
Thank you.
Operator, Operator
Thank you. Our next question is from the line of Amit Mehrotra with Deutsche Bank. Please proceed with your questions.
Amit Mehrotra, Analyst
Thank you, Operator. Good morning, everyone. Congratulations on the results. Alan, I have a question for you. Looking back at 2020, when we compare your volume performance to that of your closest competitor, there was a notable decline in volume. This isn't a critical question; I'm just trying to understand what factors contributed to that, particularly concerning merchandise. I apologize, I believe I lost connection.
Alan Shaw, Chief Marketing Officer
Yeah. Amit. I’m sorry. I missed the last part of your question.
Amit Mehrotra, Analyst
I'm trying to understand that CSX currently has a lower cost structure. Regarding the volume underperformance compared to CSX in 2020, specifically in merchandise, is that simply a market share shift, or is there something else that might provide a clearer explanation? Additionally, could you discuss your expectations for how this relative performance will trend in 2021?
Alan Shaw, Chief Marketing Officer
Yeah. Amit, we talked about this a lot last year. We are fierce competitors. We’re going to go out there and we’re going to compete for every pound of business that’s available to us, both with our eastern rail competitor and within that $800 billion trucking logistics market. We’ve got a lot of confidence in our franchise. We have a lot of confidence in our customers. And you can take a look at revenue per revenue ton mile comps and you can see our focus really is on helping our customers grow and margin improvement. Specific to merchandise, as I let’s say that the year-over-year gap between us and our eastern rail competitor was about 550 basis points in the fourth quarter, 400 basis points of that was just energy, 400 basis points. So that’s over 80% of it. I talked about, as we lead into the fourth quarter that we were about to run up against the most difficult comp of the year with respect to crude oil and that certainly played out. And so, those energy headwinds that we saw last year, which defined about close to three quarters of our overall revenue decline, are not something that we expect to see this year. We’re not calling for growth there. And if that does happen, we’re well-positioned to handle it and to profit from it. And we are seeing some signs there that commodity prices are strengthening and thermal coal is in pretty high demand in the worldwide market. But we’re not expecting that level of headwind this year, which is why we really believe we’re going to rotate into pretty strong growth led by our intermodal and our merchandise ex energy franchise.
Amit Mehrotra, Analyst
Great. Okay. That’s really helpful and encouraging. My second follow-up, I guess, for Cindy or Mark, is regarding the guidance, which suggests mid-to-high 70% incremental margins, a very attractive figure. If we break it down in terms of dollar cadence, you’re essentially forecasting a $900 million increase in revenue alongside a $200 million rise in expenses, which reflects excellent performance. It would be beneficial for either Cindy or Mark to discuss your confidence level in achieving that. How much of this is dependent on pricing and how much relies on effective management and maintaining control of the cost structure? What is your overall confidence in reaching that goal?
Mark George, Chief Financial Officer
Sure, I'll start. Cindy can provide more details. We are facing traditional inflation in wages, but we aim to keep our headcount steady or even slightly reduce it from the end of this year. This will largely depend on where the additional volume comes from, as it will determine how effectively we can manage headcount-related costs. We feel confident in our plan to handle this and mitigate wage inflation. We also have fuel inflation affecting our costs, along with the usual increase in depreciation. However, we are implementing efficiencies and productivity improvements at various levels in our profit and loss statements. As Cindy mentioned, we have the capacity to make our trains longer. While we will need to add crews and costs for unit train traffic, that's the only significant change. Cindy, do you have anything to add?
Cindy Sanborn, Chief Operating Officer
No, I believe that captures everything very well. While we are encouraged by the growth and aim to provide excellent service to our customers, if the expected results do not materialize, we will take necessary actions. There is significant potential to absorb existing growth and continue optimizing our train operations and cars. We will concentrate on our car velocity initiative and be ready to adapt if needed. The team is gaining a lot of momentum, as reflected in the results from the fourth quarter and the first quarter; we will continue to drive forward.
Amit Mehrotra, Analyst
Great. Okay. Thanks very much, everybody. Good luck. Appreciate it.
Jim Squires, Chairman, President and CEO
Thanks, Amit.
Operator, Operator
The next question is from the line of Walter Spracklin with RBC Capital Markets. Please proceed with your questions.
Walter Spracklin, Analyst
Thanks for taking my question. Good morning, everyone. So I just thought...
Jim Squires, Chairman, President and CEO
Good morning.
Walter Spracklin, Analyst
Could you provide some guidance on the variability in the other income line that you mentioned? It has fluctuated quite a bit from quarter to quarter and has influenced the results in the last few quarters as well. What can we expect on a general base level on a quarterly basis moving forward?
Mark George, Chief Financial Officer
Thank you, Walter, for the question. The primary factor affecting volatility in that line is the returns on our company-owned life insurance investments, which are allocated to both equities and fixed income. Consequently, it fluctuates significantly based on market performance, which explains the observed volatility. Historically, we have indicated that other income would fall within the $80 million to $100 million range. However, it will vary from quarter to quarter, and if the markets decline, it could pose a potential challenge for us. Nonetheless, we have experienced strong gains over the past couple of years.
Walter Spracklin, Analyst
Yeah. Absolutely. And you were guiding historically for 23% to 24% tax. You’ve had a good run with lower taxes this year. What would be your expectation on the tax rate for ‘21?
Mark George, Chief Financial Officer
Yeah. So you’re right, we guide to 23%, 24%. We’re not going to change that guidance right now. We know that there’s tax law being debated and whether the federal statutory rate moves up to 28%, which is what the current administration is aiming for. We don’t know the timing. We don’t know if there’ll be some compromise at a lower rate. But our better performance than the guide, it’s really driven by in large part the company-owned life insurances, those gains are non-tax. So that definitely provides us tailwind, which is why we’ve been better past couple of years than the guided rate. We’re not going to bake that in and anticipate more tailwind from that here in 2021. So we’re going to stick with our guide of 23% to 24%. Thanks, Walter.
Operator, Operator
Our next question comes from the line of Cherilyn Radbourne with TD Securities. Please proceed with your questions.
Cherilyn Radbourne, Analyst
Thanks very much and good morning. I’ll just stick to one here. There’s certainly been a lot of talk across the industry about congestion in LA, Long Beach and in Chicago as a result of the import surge that we’ve seen. Is there having a collateral impact on Norfolk Southern and if so how are you working with shippers and your rail partners to alleviate that congestion?
Jim Squires, Chairman, President and CEO
Thanks, Cherilyn. Good morning. The congestion at the West Coast ports has limited the volume we can handle. It has also caused some of our channel partners to allocate more resources there, reducing opportunities for growth in the East. Regarding Chicago, most of the congestion we're experiencing is outside our intermodal gates, primarily involving the drayage community and warehouses that are struggling with pandemic protocols and workforce issues due to COVID concerns. This slows down the turnover of assets, such as chassis and containers, which can further limit volume growth. We are maintaining close communication with our channel partners, aligning with the best in the industry who excel at their roles. Together, we are working on solutions to mitigate these challenges. As a result, our intermodal revenue, excluding fuel, increased by 11% year-over-year in the fourth quarter.
Operator, Operator
Our next question is from the line of Allison Landry with Credit Suisse. Please proceed with your question.
Allison Landry, Analyst
Hi. Thanks. Good morning. So, just clarified on the 60 run rate by the end of the year, I mean, is this how we should think about Q4 or would you expect that to be more of a second half run rate? And then if you could comment on your expectations for the Q1 OR with some of the other relative been a bit cautious on both year-over-year improvement and are also pointing few sequential degeneration that’s a bit worse than normal. So is that a fair way to think about Q1 and then just if you could clarify on the run rate for the 60?
Mark George, Chief Financial Officer
Allison, this is Mark. Thanks for the question. We’re not going to discuss quarterly guidance for Q1. Volume will be an important factor, and it has started off strong. However, Q1 is typically our highest operating ratio quarter. There are seasonal cost factors to consider. I expect to see year-over-year improvement each quarter, but I won't provide sequential insights until we have a clearer picture of where volumes will land. The timing will also depend on the volume trends throughout the year. I anticipate a steady progression towards that target of 60, but it's too early to determine in which quarter we will reach it.
Allison Landry, Analyst
Okay. That helps. And then maybe, Mark, I guess, another one for you. Maybe if you could just give us your thoughts on leverage and what you’re targeting for 2021?
Mark George, Chief Financial Officer
Sure, Allison. So we’re basically staying fully committed to our BBB+, Baa1 credit rating with Moody’s. So we’re going to manage leverage in the course of the year accordingly to make sure that we work towards staying in balance and stay committed again to our current rating. So I’m not going to put an exact number of what that means in terms of incremental debt or necessarily deleveraging, but just know that we’re committed to be within the balance.
Allison Landry, Analyst
Okay. Great. Thank you, guys.
Operator, Operator
The next question comes from the line of David Ross with Stifel. Please proceed with your questions.
David Ross, Analyst
Yes. Good morning, everyone. Having a conversation with somebody in the industry the other day, who said that intermodal and PSR in his mind were incompatible, because intermodal is about accommodating and balancing surges, and PSR’s goal is really to eliminate them. How do you think about intermodal and then your PSR goals, and is there friction there?
Jim Squires, Chairman, President and CEO
Strongly disagree with that characterization of PSR is applied to an intermodal franchise. We believe that and we have applied PSR principles to our intermodal network and we’ll continue to do so, while maintaining intermodal as a growth engine. Cindy?
Cindy Sanborn, Chief Operating Officer
Yeah. I would say that PSR is really about simplifying things and having very good asset terms. That can be done in any class of business you want to think about. And absorbing volume growth into existing schedule trains, mixing trains so that we in case some cases, while you will see some intermodal in the train, you’ll also see manifest and other commodities. So all of those are levers that you naturally pull with PSR and are completely compatible with any kind of business that we might be able to bring onto the rail.
Mark George, Chief Financial Officer
David, our intermodal franchise is unmatched in the East. This provides strength for us, our shareholders, and our channel partners. PSR focuses on minimizing complexity and ensuring timely train operations, which is essential for an intermodal network. We already have a mostly direct intermodal network with minimal intermediate switching. Our emphasis on productivity initiatives within intermodal aims to bring more business into the existing train structure. Additionally, our train weight is increasing significantly more than our train length. This means we are incorporating more business into the current trains and enhancing our capability to double stack.
David Ross, Analyst
Yeah. And just as a quick follow up on that related to double stacking, are there any corridors left in the network, where that’s a problem and you can’t take advantage of the double stack capabilities?
Mark George, Chief Financial Officer
We are double stack capable and well over 95% of our launch segments.
David Ross, Analyst
Excellent. Thank you.
Operator, Operator
The next question is from the line of Chris Wetherbee with Citi. Please proceed with your questions.
Chris Wetherbee, Analyst
Hey. Thanks. Good morning. Alan, sticking with the intermodal outlook for a moment, you have improved the yields in that business excluding fuel over the past few years, particularly in the last three. Looking at 2021, how do you balance the approach, especially since truckloads are expected to perform well from a pricing perspective? This likely has some implications for intermodal as well. Will you focus more on volume or continue to strike a balance by aiming for higher prices within the franchise?
Alan Shaw, Chief Marketing Officer
Chris, we will maintain our balanced approach. We have long-term agreements with our channel partners and have adopted a long-term perspective on the markets. We aim to avoid the fluctuations tied to the spot market influencing our intermodal rate structure. While a small portion of our business is transactional and we are adjusting our rate strategy accordingly, we mainly implement measured rate increases. You saw the benefits of these increases in 2019 and during the first half of 2020, despite being in a challenging recession. Over time, this means our rates are rising at a pace that exceeds changes in the spot market and slightly outpaces developments in the contract market. Therefore, you should not anticipate any significant rate hikes in 2021, as overall contract rates in the truck market saw a slight decline in 2020. This will support rate improvements in 2022.
Chris Wetherbee, Analyst
Okay. That's helpful, and I appreciate it. I have a follow-up on capital expenditures. You're guiding down to around 15% of revenue, but I recall that during the Investor Day launch of PSR, the guidance was possibly a bit higher for the long term. I'm trying to understand what has changed since then and whether this reduction indicates a more sustainable run rate as a percentage of revenue. Any thoughts on capital expenditures would be appreciated, as this decrease is likely to enhance free cash flow.
Mark George, Chief Financial Officer
Yeah. Thanks. We’ve took our CapEx down at a significant readjusted baseline level of $1.5 billion this past year. And we’ve talked throughout the year about the fact that we want to grow it modestly from here and really like to see revenue growth outpace the growth in CapEx. That means growing into a smaller percentage then so be it and certainly that’s where the math equates to this year is that we will grow into a smaller percentage. We want to do CapEx and budget CapEx based on logic and need not just based on revenue based affordability for example. But that said, we put this budget together and if Alex come, I am sorry, if Alan comes in and says we’ve got these certain projects we need to help drive growth. We will examine it. If Cindy comes and says we got some work to do on siding expansions or to augment the network a little bit more from a maintenance away perspective, we’ll examine it. So we’re not going to be dogmatic and I would like to kind of bury the 16% to 18% range from here.
Chris Wetherbee, Analyst
Okay. That’s helpful color. I appreciate the time. Thanks.
Operator, Operator
Our next question comes from the line of Brandon Oglenski with Barclays. Please proceed with your question.
Brandon Oglenski, Analyst
Hey. Good morning, everyone. Thanks for taking my question. Cindy, I guess, I wanted to come back to the beginning of the call here. Did you explicitly say that headcount could actually be down in 2021? And I guess it just wanted to balance that against the comments that you’ve had with bringing back some unit train service and need for crews. Can you just maybe hash that out a little bit more?
Cindy Sanborn, Chief Operating Officer
The guidance indicates we expect it to be flat or slightly down from where we finished in 2020. To maintain that flat outlook, one reason is the unit trains. This means we are still in the process of consolidating and finding ways to make our scheduling more efficient, accommodate growth, and deliver a strong service for our customers. That is our focus moving forward. We are currently engaged in this work and have made good progress, and I believe we will see positive outcomes as we continue.
Brandon Oglenski, Analyst
Okay. And I don’t mean to be pesky here and I know it’s been a long call. But on the first quarter you did say something about bringing back temporary resources. Is that going to have any impact on those metrics in the near-term that we need to be aware of?
Cindy Sanborn, Chief Operating Officer
Yeah. When I spoke about that, it was really about recovering from some of the challenges that we faced in the fourth quarter, including some COVID-impacted crew districts, where we had to move some temporary in from a headcount perspective. Those were back out now. And then, secondly, we had reduced locomotives in the quarter and some of the challenges that we had at the very end, we injected those for a very temporary period of time and have since pulled those out. So, what I was talking about earlier in my commentary was really around the fourth quarter.
Brandon Oglenski, Analyst
Got it. All right. Thank you.
Operator, Operator
Our next question comes from the line of Jon Chapell with Evercore. Please proceed with your questions.
Jon Chapell, Analyst
Thank you. I have a couple of questions for Alan. First, regarding coal, you mentioned in your outlook that you expect a decline this year, which is a widely accepted view. However, the comparisons are quite favorable from the middle of this year due to the significant decreases you experienced, particularly in the second quarter. You've seen increases in volume as the year has progressed and we move past the pandemic. The revenue per unit has gone up since the end of 2020 and even during the first few weeks of 2021; the carload comparisons look reasonable. I understand that coal is in a long-term decline, but is there a possibility of seeing a temporary increase in 2021 considering these factors?
Alan Shaw, Chief Marketing Officer
Hey, John. I hope you’re right. My main concern is the status of stockpiles at utility plants, which are across our system. The publicly available numbers indicate they are close to about 130 days. This is really going to limit our volumes and is about 40% higher than this time last year, which is a setback. Additionally, if they require manufacturing engineers, commercial businesses need to reopen to start generating that load for the utilities, and natural gas prices seem to be stuck in the mid-twos per million BTUs, presenting another challenge. All of these are headwinds. However, if conditions improve, we are prepared, and we have a strong coal franchise. I believe there is potential in thermal export coal, but we are not counting on it in our outlook. That represents additional upside.
Jon Chapell, Analyst
Okay. Understood. And then shifting to auto, you guys have had a really strong start to the year, really real strong last several months. We’re hearing some issues with chip shortages, potential near-term production issues. Obviously, you have a bit of a unique franchise there. Are you hearing any concerns from your customers about potential near-term shutdowns because of some of these equipment shortages?
Alan Shaw, Chief Marketing Officer
Yeah. We’ve got a great auto team and they’ve done a very good job of building that franchise for us. Yeah, there are supply disruptions and basically many of the markets, if not all of the markets that we serve, semiconductors that you referenced is something that we’ve heard of as well. Although, generally the automakers are allocating the scarce resources to the SUVs and trucks and vans, which is predominantly what we handle in our bi-level product. But the auto volume will be upside for us this year.
Operator, Operator
The next question is from the line of David Vernon with Bernstein. Please proceed with your question.
David Vernon, Analyst
Good morning, everyone. One point that often comes up when discussing the intermodal market and railroads is their efforts to enhance service levels. Many channel partners have expressed frustration over the handoffs at terminals. Considering your outlook for volume growth, are you concerned that the channel and terminal network can manage mid-to-high single-digit volume growth in the intermodal segment? How are you prepared to address this? It appears that during the last peak season, we experienced significant congestion throughout the intermodal network.
Alan Shaw, Chief Marketing Officer
David, good question. We talked about that briefly before where the drayage community slowed down in the processing of the warehousing has impacted street dwell and turns of equipment chassis and containers, and that is limiting the upside. However, even with that, we still delivered 11% year-over-year revenue growth in the fourth quarter ex-fuel surcharge. And you can see that our volumes within our intermodal franchise to start the year are up double-digit. So we’ve got a great franchise, we’ve got great channel partners. Again, they’re very good at what they do and managing complex supply chains. So we’re going to work with them on this. We’re delivering that level of growth with our intermodal franchise now.
David Vernon, Analyst
Is there anything you can do to improve the efficiency of the handoff operation? Do you need to reconsider how you interact with channels to unlock additional growth potential, or will it be more about continuing with the current approach? I'm trying to understand how you can unlock the potential in the intermodal business.
Alan Shaw, Chief Marketing Officer
Yeah. It really is about improving the transparency and the visibility of what we’re seeing and the assets that we share. And then it’s about channel partners working with their BCS and the warehousing not getting in the chassis back into the gate.
Operator, Operator
Our next question comes from the line of Jason Seidl with Cowen. Please proceed with your questions.
Jason Seidl, Analyst
Thanks, Operator. Good morning, everyone. Cindy, you talked a lot about taking some structural costs out of the network in 2020. As you look at 2021 and beyond, are there any structural costs left in your opinion and if there are, when do you think you guys can address them?
Cindy Sanborn, Chief Operating Officer
We have discussed the terminal consolidations and hump conversions that have taken place over the past few years. Prior to my arrival, significant efforts were made in this area. Currently, we have four hump yards still in operation. We will continue to examine our yards to enhance car movement. The main goal related to terminal capabilities and footprints is to keep cars in motion rather than having them sit in terminals. There is still considerable potential for improvement. We have shifted our focus more towards optimizing train lengths and locomotive utilization. However, we will always revisit ways to maximize our network efficiency, and improving the speed of cars at terminals is one strategy we employ. While I don’t have a specific number to share, please know that we are constantly looking for opportunities to reduce structural costs whenever possible.
Mark George, Chief Financial Officer
Well, thanks. That’s helpful. Follow-up here, Alan, you talked a little bit about intermodal RPU. I just want to make sure I understand what you said. You said that really don’t look for too much this year in terms of gains, but it’s going to be more of 2022. Is that how we should think about it?
Alan Shaw, Chief Marketing Officer
I mentioned to you, Jason, that we have long-term agreements with our channel partners.
Operator, Operator
Thank you. This concludes the question-and-answer session. I will now turn the call back over to Mr. Jim Squires for closing comments.
Jim Squires, Chairman, President and CEO
Thank you for your questions today. We look forward to talking with you again next quarter.
Operator, Operator
Ladies and gentlemen, thank you for your participating. This does conclude today’s teleconference. You may disconnect your lines at this time. Have a wonderful day.