New labor agreements expected to cost Union Pacific millions

July 26, 2023

How much new sick leave and scheduling agreements might cost Union Pacific was one of the main themes of UP’s earnings call Wednesday to discuss second-quarter 2023 results.

UP has ratified sick leave agreements with all 13 of its labor unions, according to Eric Gehringer, executive vice president of operations, who said providing sick leave will result in an additional labor expense but it should also improve job attractiveness.

Providing sick leave could add roughly $50 million in labor expenses in the second half of 2023, according to UP CFO Jennifer Hamann, who said these costs are being viewed as added inflationary pressures that will be reflected in UP’s pricing.

There are other potential labor costs on the horizon as well. UP has a crew consist agreement with the International Association of Sheet Metal, Air, Rail and Transportation Workers — Transportation Division (SMART-TD) that Gehringer described in prepared remarks as providing greater scheduling flexibility while also enabling the redeployment of brake or switch persons to work either in or outside the yard. It should also provide an expedited path for brake persons to become conductors and ultimately engineers if they choose to do so.

“For the company, it allows us to now reduce brake persons where the work does not require the third person, allowing us to partially offset short-term hiring demand,” Gehringer said. “It also sets the stage to establish ground-based enhanced utility positions with fixed days off and greater certainty about their weekly assignments through scheduled shift work.”

UP also has a ratified agreement with its locomotive engineers that provides a work schedule of 11 days on and four days off. It is continuing to negotiate a work-rest agreement with its train conductors.

These agreements should eventually add an additional 400 to 600 employees to UP’s roster, according to Gehringer.

“For the company, this enables the railroad to better manage staffing levels as we receive a more predictable, available workforce. That reduces labor and failure costs, which combined support more consistent and reliable service, enabling long-term growth. We also believe it will improve our retention rate, reducing hiring expenses and lost productivity,” Gehringer said.

The SMART-TD brake person agreement resulted in a one-time ratification payment of $67 million that increased UP’s operating ratio by 110 basis points and reduced its earnings per share by 9 cents, according to Hamann, while the implementation of the work-rest agreement with the locomotive engineers could cost around $20 million.

UP is uncertain what labor costs could be should a work-rest agreement be reached and ratified for train conductors.

“The challenge in putting a finer point on that estimate is both timing and forecasting employee behavior. We don’t yet have an agreement with SMART-TD, and we are still working through some technology and logistics before we start the rollout,” Hamann said. “And while we certainly expect better availability, better service and more flexibility with our crew boards, providing more access to time off likely adds employees and expense. The exact math depends on how employees utilize this greater flexibility as well as how we translate better predictability into increased levels of productivity and service that ultimately drive profitable growth on our railroad.”

But despite the increased labor costs, “we get a tailwind from implementing the brake person agreement,” UP President and CEO Lance Fritz said. “And as we implement the work-rest schedule, I am confident that it generates both productivity and service product improvement. The issue is timing and magnitude.”

UP’s outlook for the remainder of 2023

Serving as a backdrop to the discussion on labor costs was UP’s other announcement Wednesday morning that it has named former COO Jim Vena as its new CEO and promoted Beth Whited, its current sustainability and strategy EVP, to serve as the Class I railway’s president. The changes will become effective Aug. 14. Vena will replace outgoing Fritz.

As for the second half of 2023, higher natural gas prices and extreme heat in the near term are supporting UP’s outlook for coal volumes, and the railroad is also “optimistic” about opportunities to move grain carloads in the fourth quarter because of new crop supply forecasts and UP’s improved rail operations, said Kenny Rocker, executive vice president for marketing and sales.

Shipments of renewable diesel and their feedstocks are also expected “to remain strong,” he said, while UP’s industrial segment is mixed. The forecast for industrial production is down in the back half of 2023 and forest products demand is below 2022 levels, but there is some continued strength in construction.

Meanwhile, inflationary pressures and the shift in consumer spending from goods to services are likely to put pressure on UP’s international intermodal volumes, he said.

“It’s hard to say when the economy will begin to recover in certain sectors, but our diverse portfolio allows us to see positive momentum in many of our commodities,” Rocker said in prepared remarks. “The team remains focused on winning new business and has a strong pipeline of opportunities with a great track record for closing deals.”

Yet despite the potential headwinds in the second half of 2023, UP is preparing its offerings for when demand returns for segments such as domestic intermodal, according to Rocker. These offerings include a new service product at Port Houston and intermodal capacity expansions near Twin Cities, Minnesota, and the Inland Empire in Southern California.

UP is also upbeat about its Falcon Premium service with Canadian railway CN (NYSE: CNI) and Ferromex, which Rocker says has a shorter route structure.

“We feel good about domestic intermodal. At some point, you need demand to be there. What you’re hearing me say is that we’re prepared as that demand comes on. And we’re adding new products, we’re adding new services, we’re adding new customers. We’re excited,” Rocker said.

UP’s net income for the second quarter of 2023 was $1.6 billion, or $2.57 per diluted share, down from net income of $1.8 billion, or $2.93 per diluted share, for the second quarter of 2022. Financial results for the second quarter of 2023 include the previously disclosed $67 million labor expense and a $73 million income tax benefit, UP (NYSE: UNP) said.

Operating revenue fell 5% year over year to $6 billion on reduced fuel surcharge revenue, lower volumes and an unfavorable business mix, partially offset by core pricing gains, UP said. Volumes were also down by 2%.

Operating income slipped 12% to $2.2 billion, while operating ratio was 63%, compared with OR of 60.2% for the second quarter of 2022. Investors sometimes use OR to gauge the financial health of a company, with a lower OR implying improved health.

“The results this quarter were impacted by softening consumer markets, inflation, a one-time labor expense, and increased workforce levels,” Fritz said in the Wednesday news release. “The entire team remains focused on maintaining a solid service product while taking steps to recapture lost productivity and lay a strong foundation for sustainable future success. We took actions throughout the second quarter to drive greater network fluidity and provide our customers with better service. We finished the quarter with resource levels more aligned with demand, as we stored excess locomotives, improved recrew rates, and reduced borrowed-out employees.”

On UP’s earnings call, Gehringer confirmed that the railway has been taking action to “rightsize resources to align with current volumes,” through steps such as removing locomotives from the active fleet and storing 200 units in the second quarter.

“There are many more opportunities ahead for improved efficiency of our railroad. From redeploying brake persons to improving fuel efficiency, growing train length and rightsizing our locomotive fleet, there is productivity to be captured,” Gehringer said in the prepared remarks.

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