National Grain and Feed Association
Presentation by Jim Young, Chairman and CEO
March 30, 2009
I want to start off by saying that I’m very excited to be here today to talk about Union Pacific’s grain business. Although I’ve been at the railroad for 30 years, I’ve been around agriculture even longer. I’ve spent my entire life in heart of the Midwest – Omaha, Nebraska, surrounded by fields of corn and soybeans. As a matter of fact, my childhood home is just a couple of miles from the famous Omaha Stockyards, which was the largest livestock center in the world in the 1960s.
I feel fortunate to have been exposed to the type of industries that made America great through the centuries. When you think about hard work and tenacity, it’s tough to come up with better examples than America’s farmers and railroaders. They work in the brutal heat, the bitter cold and through natural disasters to provide America its way of life.
So let’s get started . . .
Our goal in serving grain and feed customers is multi-faceted. First off, we always start with safety. We have a mindset that we can’t serve our customers successfully unless we run a safe railroad. It is a core value we all have in common.
Not only is rail the safest mode of freight transportation, it is one of the safest industries. At Union Pacific we have a diligent focus on three key areas – employee, public and customer safety.
We have reduced employee reportable injuries by 45 percent over the last seven years. Although we are proud of this improvement, we will not be satisfied until we are at zero accidents.
Safety - "Zero Tolerance"
In the area of public safety, we’ve experienced a 29 percent reduction in crossing accidents. We also care about safety beyond our track, which is why we are members of the Progressive Agriculture Foundation.
Finally, to achieve the 23 percent reduction in reportable derailments,UP employs state-of-the art technology. This has had a huge impact on making sure your product is delivered undamaged and on-time.
Our next goal is to reliably move our customers’ goods to their core markets, while providing access quickly to new markets when trends shift.
Strength of a Unique Franchise
Here is a quick snapshot of our system. You can see on the map that we serve the top producing grain states. In total, our 48,000 employees and 8,400 locomotives transport goods over 32,000 miles in 23 states.
We link every major West Coast and Gulf Coast port. This was critical the last couple of years with the increases in grain exports due to the declining U.S. dollar and changing diets in Asia.
We connect with Canada’s rail systems, and are the only railroad serving all six major gateways to Mexico. And we interchange traffic with Eastern railroads through our gateways at Chicago, St. Louis, Memphis and New Orleans.
We serve seven of the eight fastest growing states. As a matter of fact, your grain is one of the top commodities we ship to four of those states: Idaho, Utah, Arizona and Texas.
Our mix of business helps us extend our reach to those states and beyond. It has been through economies of scale that we’ve been able to expand our capacity. And the diversity of these commodities reduces volatility in our business, allowing us to invest even when certain markets struggle.
Keeping an Economy Moving
Although in today’s time, it appears no industry is safe from the recession. Four of our six units have seen significant volume declines. Not surprisingly, the biggest is autos, down more than 50 percent.
Chemicals, Industrial Products – which includes items like lumber, steel and concrete – as well as Intermodal – are all down significantly. Decreased consumer spending, fewer housing starts and inventory shrinkage have all contributed to the decline.
Although a bit down year-to-date, the volume weakness in Ag Products and Energy is less severe. And, much of that relates to the comparisons we have against strong demand in 2008. For example, export wheat and feed grains were up a combined 40-plus percent in the first quarter last year, and we set coal tonnage records out of Wyoming’s coal fields
We promised to serve those markets at higher levels of customer service, and we’re delivering on that promise.
Creating Value Drives Customer Satisfaction
 Key Drivers: Increased velocity – turning assets/inventory quicker; Greater reliability – on-time delivery of your grain; Capacity expansion – investing in your growth |
Union Pacific has been sending out surveys with 35 questions to approximately 200 customers each month for more than two decades. We feel this process has given us a consistent measure of how customers feel about our service over a significant period of time.
As you can see, Ag Products improved 12 points over the last 2 years and hit an all-time record of 81 in 2008. The scores are coming in even higher so far in 2009. The improved rating reflects faster service, greater reliability and investments that are aligned with your growth.
Driving Efficiency Through the Supply Chain
 UP Shuttle Trains - Turns Per Month |
These improvements are a concerted effort in understanding and driving customer value. When you look at this chart tracking shuttle train cycles, we see two things:
- One, we are very consistent. In 2007 and 2008, we averaged around 3.5 turns per month. This predictability allows you to spend your day managing and planning your business strategy, rather than putting out fires like swapping trains.
- Secondly, we see a steady increase in turns. In 2006, our average turns were less than three a month. In 2009, we’re turning four a month, creating a smaller, lower-cost supply chain as well as improving equipment utilization.
Lessening the Impact of Mother Nature
A key component of cycle time improvement is to reduce the impact of weather-related incidents that not only drive up our cost but delay your product to market. I’m sure you’ve heard us say, we’re a 32,000 mile factory without a roof. That statement really hit home last year with the Oregon mudslide, Gulf hurricanes and June floods.
The mudslide in the mountains wiped out 3,000 feet of track. For 105 days, the engineering team worked through nights and snowstorms until all service was restored. It took 700,000 tons to stabilize that mountain. And it was done without a single injury.
Our resilient network, additional resources and improved processes are creating a totally different experience for customers. Remember the 2006 Nebraska snow storms and how long it took us to get back on line that winter? Some of you ran short on grain. We’ve focused on recoverability and changed the game.
Last year’s Iowa flooding where our east/west main line crosses the Cedar River was a great example. The water exceeded the previous peak recorded more than a century ago in 1851. We were flooded out on the Central Corridor from June 8 through the 16th. We rerouted grain trains via Kansas City, and when the waters subsided, our team set to work repairing the track structure. Operations were back to pre-flood levels in about a week, and with additional resources available, our grain trains were only delayed a few days.
The bottom line is, we can’t control Mother Nature, but we’re in a better position to respond, lessening the impact to customers.
Increasing Productivity Through Technology
 Distributed Power |
Driving efficiency equates to the ability to carry more of your product, while providing competitive pricing.
We use technology to drive efficiency. Distributed Power is a great news story for our grain customers. Distributed Power trains are longer but have improved brake control and reduced slack action as a result of having multiple locomotives placed at various points in the train consist. In February of last year, we ran virtually no DPU grain trains. If we fast forward a year, 53 percent of grain trains were utilized Distributed Power.
DPU trains lower cost by about five percent because of improved fuel efficiency and increased train size. There are some challenges, such as train size limitations at facilities that we need to work through. It’s a critical initiative, because it means more grain can ship at more reliable levels of service.
 Unit Train Customer Interface |
I’m also very excited about our new Unit Train Customer Interface. It’s a system we’re developing to support our agriculture business. When we ask you what is the most important information we can provide, most of you say: accurate time of arrival.
This tool is aimed at that issue and will help provide more timely and accurate information, which leads to better planning and more efficiency. It will also improve the quality of life for your employees. The automatic train release feature will simplify the process you go through to release trains. And it will improve our response time by getting our crews out there sooner.
Railroads Help Keep Agriculture Competitive
 Changes in Prices Paid by Farmers for Various Farm Inputs Used for Production (1990 - 2007) |
At the end of the day, we need to grow the value we provide our customers. That means keeping our prices competitive, so you can compete in the marketplace. Most businesses expect input costs to rise due to inflation. The farming industry is a perfect example of that. From 1990 to 2007, fuel costs were up 164 percent and machinery costs were up 99 percent. However, rail rates were up only 29 percent – a small amount compared with the other inputs.
This is a great example of how the cost-effectiveness of rail has helped customers manage the prices of their goods.
Inflation-Adjusted Rail Rates Declined
 (Selected Commodities 1990 - 2007) |
While we must stay focused on productivity, it’s important to note that we build and maintain our own steel highways. This requires us to set prices that provide a reasonable return on past and future investments.
Railroads have begun to get a better price for our services in the marketplace as transportation demand has increased. However, when prices are adjusted for inflation, you can see that we’ve passed a lot of our productivity savings on to our customers, including agriculture which still was down 14 percent in 2007 .
Railroads Have Higher Capital Requirements Than Other Industries
 Capital Expenditures as a % of Revenue: Avg. 1997-2006 |
That brings me to our investments.
Railroads are the only transportation mode that pays for its own infrastructure. The inability to earn our cost of capital or achieve a reasonable return on investment is intensified by the high cost requirements to maintain a railroad. Railroads must reinvest a higher percentage of revenue than almost any other industry.
The average U.S. manufacturer spent 3 percent of revenue on capital spending, compared to freight railroad’s 17 percent – more than five times higher. To ensure that railroads are a viable transportation option in the future, they must be able to earn adequate revenue to cover these costs.
The Cost of Railroading: 1990 vs. 2008
Increased costs are making the hurdles even higher. You can see several examples on this slide:
- The cost of one mile of new track has doubled.
- The cost of a new locomotive has jumped 62 percent and the price of a new covered hoppers has increased 43 percent.
- And the fuel to move the grain to market increased by 344 percent.
 71% or $2.2 Billion Went Toward Replacement |
We maintain 100 million railroad ties, 300 tunnels, 20,000 bridges and 8,400 locomotives. Each year, the vast majority of our capital spending goes toward replacing assets that are worn out. This held true in 2008 when our replacement cost was 71 percent or $2.2 billion of our capital investment, which left $900 million for growth.
Over a five-year period, we’ve invested approximately $2 billion on our agriculture business. This includes new locomotives, freight cars and capacity, including $87 million to support the growth of ethanol in the Midwest.
Our investments have been in lock step with our returns. As you can see on the chart, when our returns improve, our investments and service increase. Our desire is to keep that strategy in place. I must be honest; however, if the government mandates rates below market value, we will be unable to continue at these levels of investment.
It’s very simple. If our returns exceed our cost of capital:
- Capital spending expands
- Stronger physical plant; more and better equipment
- Provide faster, more reliable service
- Sustainable business model
If our returns are below our cost of capital:
- Lower capital spending
- Weaker physical plant, equipment
- Slower, less reliable service
- Disinvestment throughout the industry
It is the decision every logical businessperson would make.
Economic Challenges – Prepared for Turnaround
Lastly, we need to be forward thinking and prepared for what’s around the corner.
While I don’t have a crystal ball, we’re hoping we have seen the bottom of the recession. We are resourced to handle a network of roughly 200,000 carloads each week, but demand levels in March were closer to 150,000. For us, this means we have $5 billion worth of assets not producing revenue.
Ready and Waiting for Service
We learned a hard lesson in 2004 when we cut back too far. Retaining excess assets (locomotives and cars) and ensuring a readily available pool of trained employees – while expensive – is a deliberate strategy. The key is balance – to be ready for the rebound while managing efficiently.
It’s a strategy focused on creating customer value. We have the people, we have the power and we have the cars – including 8,500 grain hoppers in storage. No matter how quick the economy turns around, we are ready.
Washington Issues
In addition to the economy, we also have concerns in Washington. The regulation that came from the 1980 Staggers Act has seen great success. It’s balanced approach resulted in improved safety and productivity, while providing customers more affordable, reliable rail service. As we move forward, we must be sure not to lose the critical components that benefited both railroads and their customers over the last 30 years.
Our ability to invest in our grain network is directly related to the financial returns we make. If the returns are capped or pricing dynamics change through unfair regulation, we won't be able to keep investing.
Another issue is an antitrust bill. Let me start by saying railroads are subject to almost all antitrust laws, including those that prohibit agreements to set rates, allocate markets or unreasonably restrain trade. The few exemptions to antitrust laws prevent dual, and potentially conflicting oversight by the courts and the STB. These are the same type of exemptions that apply to agricultural marketing cooperatives.
Commuter rail is also a concern, as many in Washington believe using freight rail’s rights of way is the answer to relieving highway congestion.
Lastly, we have endorsed a proposal to congress that provides a 25 percent investment tax credit for rail expansion. This would help meet the projected future demands for rail transportation. According to the Department of Commerce, for every $1 of rail investment from the incentive, $3 in total economic output would be generated.
Benefits of Freight Railroads
- Safest mode of transportation
- Four times more fuel efficient than trucks
- Reduces dependency on foreign oil
- Cuts emissions by two thirds
- One train takes 300 trucks off congested highways
- Avoids taxpayer investment in roads
- Saves customers logistics costs
Though times are tough, we remain focused on our long-term strategy:
- Improved safety
- Excellent customer service
- Continued efficiency
- Strategic investments
- To provide the communities we serve the safest, most fuel-efficient, cleanest form of freight transportation.
Financial Returns Drive Growth Investment
At the end of the day, we have a great success story, but we need to be cautious going forward. I showed you this slide earlier, but it’s important to understand that our returns are mandated by our shareholders. If those returns are capped below market value, many unintended consequences will arise.
Limited capacity is a very real outcome. Once that happens, the government will come in and dictate who gets first choice. The chemical customers believe it will be them – because of the need to purify drinking water. The coal customers believe it will be them – because of the need to heat homes.
It’s not the way you nor I want to see the rail industry run. We must stay focused on earning adequate returns that provide the ability to grow customer value.
Thank you. I’d be happy to take any questions.