Ask The Experts: September 11, 2019

Tony Hatch
Independent Transportation Analyst and Consultant

Q: How has the general performance of the rail sector compared with Canadian Pacific Railway (CP) growth?
A:
Canadian traffic was up for the last quarter, US volumes down, and Canadian Pacific’s (CP) PSR journeys are several life cycles ahead. But, in the scheme of things, given expectations of overall market (S&P 500) earnings being flat to down and against tough YOY comparisons, the consensus expectations of +6% EPS, aided by buybacks to be sure, seems pretty good (and will, as with CP, prove low by some 50%). Transportation analysts have been crying poor and cutting numbers all spring and summer, so far (FDX didn’t help) – but the rails, the only good performing transport sector, continue to outperform the broader markets (YTD S&P500 +19%, rails +~30-35% ex-GWR).

Q: What are the real reasons for short line sales by Class I’s, and what are the benefits of Class I’s going private?
A:
CSX has sold two line segments with more to come; the success of that project might help persuade other major rails to look to do similar things....but short line sales by Class Ones aren’t – or shouldn’t be – about the dollars (which are trivial, in the grand scheme of things) but about value creation for the main, core rail network (feeding the beast).

As for the “trend” of going private, well, BNSF is already quasi-private (Berkshire Hathaway) and often alludes to the benefits of that status, only sometimes tongue-in-cheek (note Union Pacific’s (UNP) push back of late in a most interesting war of words developing). The rest of the railroads simply are too valuable – UNP’s market cap is $118B ($8B being the “Vena bonus”); and frankly, as we have seen up North, the public markets can still work for capital intensive transportation businesses.

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Alison Babcock
Ask The Experts: September 4, 2019

Tony Hatch
Independent Transportation Analyst and Consultant

Q: Rail volumes overall are continuing to decrease. What do you believe are the reasons for this?
A:
Volumes have been shockingly weak – we know there are six basic reasons. Here is the Wall Street Journal (WSJ) on “Railroads Carrying a Lighter Load as economy Slows”: https://www.wsj.com/articles/lighter-loads-weigh-on-railroads-11563235311?mod=searchresults&page=1&pos=1. The breakdown by rail is interesting – the Canadians are up (more so CP – up 6% to 1%); the Big 4 US all down ~4% (despite BNSF not “doing” PSR and CSX being the only one to publicly shed business). KSU was down “only” 1%. So, to determine what is going on, we need to determine how much weight we should put into each bucket:

1. The economy, still throwing off mixed signals - weakness in manufacturing (note autos, steel, housing) but “good jobs numbers”. Overall, consensus sees a slowdown, but not as bad as the usually correlating rail loadings would suggest.

2. Trade – yes, the recent threat to add tariffs to Mexican trade (in violation of NAFTA) was removed, for now, and there is a truce with China (note – that simply removed the (immediate) threat of further tariffs). But China has yet to resume purchasing US Ag (soybean) products. If nothing else, trade-by-tweet has severely disrupted the market. The dollar, meanwhile, was up 6% in Q2/19, which used to be good for international intermodal but….

a. China’s GDP growth for Q2 of 6.2% is both suspect and the lowest level in decades; US imports from the PRC are down 12% YTD-May. There is a lot of speculation about re-engineered supply chains away form China but the key issue is….to where? The answer seems to be – elsewhere in Asia, and to Mexico! But not re-shored – (The Economist) “There is little evidence of US manufacturing bringing production from China (back) to the US.”

b. Mexico – AMLO is going “off the reservation, as the whole imbroglio surrounding the resignation of his Finance Minister showed (see also BloombergBusinessWeek on his $8B (self-estimated) vanity project, the Mayan Train. Meanwhile, the economy may be tilting toward a recession (although the biggest YTD gain in exports to the US was Mexico +$10B while China was -$25B).

c. Trade overall continues to be worrisome for rails (recall that well over half of the rail business is trade dependent or related). The OECD estimated global trade growth of 2.1% for this year; in 2017 it was almost 6%. McKinsey notes that 16 of its 17 “major industries” worldwide have contracted their supply chain….protectionism is on the rise of course, but the economy is slowing, threats (often IT-related) are increasing, ocean shipping getting more complicated (IMO2020) and erratic (slow steaming)….

3. Weather – It is the wettest year ever in the US and the Midwest is still drying out (estimated economic losses - $12.5B, worst of all-time) and the flooding disruptions still impacted Q2/19. In addition, the water-logged fields are leading to poor crop outlooks (the USDA reduced the corn production numbers by 8% from May). CP noted in its call the unprecedentedly long duration of the flood problems….

4. PSR – the operating changes have two impacts on volumes, plus two stages:

a. The first impact is the hard-to-quantify volume share loss as (some) shippers try to avoid playing in the revolutionary stages of the PSR story; this may be less pronounced than recent history since essentially everybody is doing it (as Matt Rose warned), but CSX is ahead of NSC and BNSF isn’t playing (I can hear the chorus – “yet!!”). This share historically returns, in spades, as the metrics improve….

b. The second impact is planned volume loss (AKA de-marketing) – we haven’t heard much about this, partially given the heightened STB focus on the process (after CSX) – but we do know that CSX planned a second ~7% volume reduction this year in Intermodal (roughly its current run rate, BTW – are they therefore running flat without the planned lane eliminations, etc?)

c. The first stage of PSR is creative destruction – lane closures, using assessorial charges to “change customer behavior,” cuts in personnel, etc

d. The second stage of PSR – We the North! – is (to quote CP) the “pivot to growth”!

5. Trucking competitiveness – after a year (2018) of extreme capacity shortage, the world has turned upside down – with one immediate effect of shrinking the historic gap between truck and rail/intermodal pricing. This will not last forever….

6. Tough comparisons – mid-single digit growth in Q2-3/18, fueled of course and in part by….the tax cut.

Q: Why do you think CP volumes are increasing while general rail industry volumes are dropping?
A:
While the industry and its investors is in general worried about volumes, CP grew volumes (both RTMs and, my preference, units) by 6% and revenues by 13%, beat the Street(s) by 15 cents and Q2/18 (adjusted) by fully 36%. By holding operating expenses (FXA) to a slight (1%) increase, they dropped their OR by 580bps – to 58.2%. and – kudos! – they announced their LTM ROIC was 16.8%. That – the result and the announcement of it – was huge. Other highlights:

  • All 6 operating/safety metrics improved, the latter, after a tough, cold Q1, by 25-30%.

  • They raised the DPS by 28% and stated they could raise their FCF Conversion rate from ~55% to ~75% in the next few years.

  • CEO Creel (et al) faced off on 3 basic questions, asked a few different ways:

    • Comparisons get tough in H2 (just as the economy may be cooling) – can you handle it? A: Yes – both in terms of lowering variable costs (and always reducing fixed costs) and due to planned growth in areas like autos, where business development led to 5% unit growth (+12% revenues) in Q2/19 – significantly better than auto traffic industry-wide.

    • So, aren’t they being too conservative in their OR projections (-100bps/year to the “mid-fifties”)? A: Perhaps….

    • CBR – how big and when? A: CP wont gamble capital on a short term business but expects a solid H2 (enough, along with autos, forest products, export coal and potash, and intermodal to make up for any overall slowdown this fall) and beyond – for 3-5 more years….

  • CP gained $35mm in incremental revenue from short lines YTD – a good yield from their renewed focus.

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Alison Babcock
Ask The Experts: August 28, 2019

Tony Hatch
Independent Transportation Analyst and Consultant

Q: How did CSX perform in Q2/19?
A:
CSX actually had a strong quarter despite the headwinds, outperforming the industry on the merchandise side (the PSR sweet spot), with most of the volume issues either strategic (de-marketing some intermodal) or simply cyclical/political (and thus not secular). So let’s quickly look at the CSX Q2/19 results:

  • Volume declined 4% units (-3% RTMs) – and revenue declined 1% despite the mix hit coming from the 7% YOY drop in export coal.

    • The Philadelphia refinery that exploded accounts for 1% of CSX usual annual volumes.

    • However, within merchandise 5/7 commodities were up, and overall merchandise/car-load volumes were up 1% for the quarter – that’s actually a singular achievement in this environment.

    • Intermodal was down worse that I expected (volumes down 10%, revenues down 11%) but, remember, they planned to shed 7-8% of the business this year after shedding 7% last year – beginning in the fall, so lapping the de-marketing period at the end of this quarter will provide an optical boost; Foote said IM still enjoyed a 15-20% price gap to truck (which, along with JBHT earnings, should have been a healthy rejoinder to those that question intermodal’s future value proposition); in fact, CMO Mark Wallace said the secular growth rate for domestic intermodal might no longer be double-digit but was still GDP +2-300 bps; more time on the future of intermodal at CSX, the competitive challenges from truck and from rail (NSC), etc could have – and should have been spent. We’re getting to the point where another investor conference might be (is) warranted….

  • Yet earnings were up 7% YOY (consensus called for +10% but likely didn’t take into effect the export coal decline, inevitable, but early); CSX. CEO Foote noted it could still improve the OR by a point a year even with down volumes – and revenues….It is true that real estate gains were significant (1—bps in OR) but in this stage of CSX PSR transformation, it would be unfair to call that “unusual”….

  • Capitulate, not reiterate - And there it was….my thoughts when Foote took down FY19 guidance from a revenue growth rate of 1-2% to a decline of a similar amount, without (above) any change in their OR guidance. Foote essentially said he almost felt compelled; he was bound by the SEC to do this – but remember its all volume-related – and that the biggest issue is the confusion stemming from “puzzling” mixed signals. Yes, it really wasn’t the direction (up or down), it was the uncertainty. Once it is clear that a recession has been reached (or not), CSX can quickly bring down variable costs accordingly (or not). This is, in fact, a historic railroad strong point; the key is how much of a lag is need to ascertain the actual economic trend. And for now, neither CSX nor their customers are forecasting a recession….

But the bottom line here was that despite the headwinds the OR improved by 120bps to an amazing 57.4% - crew starts were down 5%, more then the traffic decline, equipment rents were lower, etc.

  • Operating metrics improved YOY, if not sequentially – velocity by 14% and dwell by 6%.

  • O/T originations (88% and arrivals (still only 53%) followed a similar pattern.

  • Safety showed remarkable improvement (P/I by 22% and train accidents by fully 54%).

Q: What were the reasons behind Canadian Pacific’s (CP) high numbers in Q2?
A:
Canadian traffic was up for the quarter, US volumes down, for one thing, and their PSR journeys are several life cycles ahead, for another. But, in the scheme of things, given expectations of overall market (S&P 500) earnings being flat to down and against tough YOY comparisons, the consensus expectations of +6% EPS, aided by buybacks to be sure, seems pretty good (and will, as with CP, prove low by some 50%). Transportation analysts have been crying poor and cutting numbers all spring and summer, so far (FDX didn’t help) – but the rails, the only good performing transport sector, continue to outperform the broader markets (YTD S&P500 +19%, rails +~30-35% ex-GWR). That is not to say the volume trends (~--3% for the quarter but -5% in June) aren’t troubling – they are….

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Alison Babcock
Ask The Experts: August 21, 2019

Tony Hatch
Independent Transportation Analyst and Consultant

Q: What are your takeaways from the Canadian National Railway (CNI) Q2/19 report?
A:
Good quarter shows that they are back on track and that the future is Precision Scheduled Railroading (PSR) 2.0 - CP may have won the Gold Medal for Q2/19, but Canadian National ran a hard last lap to close the gap significantly – an all-Canadian top 2, and solid (if likely repeatedly ignored) evidence that the future of North American freight railroading is PSR 2.0 (sometimes called PHR, by me, anyway). CNI’s EPS was up 15% YOY (and 4% above consensus); volume grew 2% - half the CP rate but the only other Class One to show growth at all; revenues were up 9% (price was, and will continue to be, “solid”). CNI reiterated its short term guidance – including “mid-single digit” growth in 2019 RTMs, so with H1/19 slightly below 3%, assumes….an acceleration in H2/19 (!). More importantly (but also, of course) they reaffirmed their longer term targets from Investor Day, only 7 weeks ago, notably stabilizing in a “high 50s OR), yet investing to grow even while normalizing capex (that means 18-20% of revenues, folks) and producing a 15—17% ROI. On that note I do wish that they had joined CP in revealing their LTM ROI (CP’s was just under 17%!) to make a louder argument. The OR came in 70bps lower to 57.5% which “adjusting for real estate sales will prove to be the lowest in the industry – CNI’s traditional role.

Q: What did we see for industry revenues in Q2?
A:
The usual strength in Forest Products was reversed (quarterly revenues down 1% on an 8% carload drop)due to “recent BC plant closures and production curtailments”; powerhouse Intermodal grew only 1% in units (15% in revenues) – and that as including TransX’ revenues (~$100mm of the $129mm YOY increase). On the other hand, coal was up 5% (units) on Canadian met exports and “higher volumes of domestic thermal coal to US utilities” and Grain was up 3% (revenues +7%) on higher Canadian wheat “and US corn and soybeans” exports. Go figure….of course the star was Petroleum & Chemicals (volumes up 12%, revenues 23%) led by CBR, which by June was back up to about 2/3 capacity on the CN, awaiting expected Alberta government contracts and the removal of production curtailments.

Q: How does the forecast look for potential new business pipelines?
A:
Good (“constructive” forecasts include that CBR – and propane, autos, international and eventually domestic IM) ….there has been no degradation of the new business potential pipeline (an additional $1.25B-$2.32B – in new-win revenues by 2022!) as outlined on Investor Day. July appears to support the acceleration thesis – traffic (RTMs this time) is running up ~6%....

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Alison Babcock
Ask The Experts: August 14, 2019

Tony Hatch
Independent Transportation Analyst and Consultant

Q: What are your thoughts on the Q2/19 performance of Kansas City Southern (KCS)?
A:
Kansas City Southern – beats expectations on an adjusted basis, and reassures the markets but (slightly) disappointed me. In addition, they fell victim once again to the “It’s Always Somethin’” Syndrome (in this case the OR dilutive but income neutral Mexican fuel excise tax elimination) and had a complex quarter. Cutting through all that, their EPS grew (adjusted/diluted) by 6% and their OR fell by 30bps to 63.7% . They too followed the Q2/19 rail pattern of reiterating near term revenue growth and intermediate term OR targets while capitulating to the inevitable on volumes, with more than 6 months traffic booked (now “flat to slightly down” for 2019). Pricing obviously is strong. Q2/19 carloads were flat, but 4/6 commodity categories were down, one flat – and chemicals/petroleum up 18% - led by refined product shipments to Mexico (“Mexican Energy Reform” volumes grew 125%, revenues 136%). Their outlook is split 60% positive, however, 20% neutral, and 20% negative. That latter category includes energy (coal, CBR and sand) which makes sense, - and Intermodal, both in Mexico (hurt by the unequal fuel tax) and US domestic (truck overcapacity). I do not like the sound of that….nor the phrase from CEO Pat Ottensmeyer (RailTrends 2019 Railroad Innovator of the Year) that “with the exception of intermodal, things look good….” And, in fact, in Q2/19 cross-border intermodal volumes grew 10% and even Lazaro Cardenas volumes grew (by 2%). So what happened to “Service Begets Growth”, their (excellent) mantra from April? Yes, Pat said it in the Q&A, but this felt like a more standard USA PSR story unfolding, rather than the exceptional one I saw in April. Time will tell….

  • Operations were sort of mixed – operating expense increased 4% on that flat growth level; headcount was flat. But, early stage PSR is working for them too – dwell improved 11%, velocity 12.55, cars on line down by 17%. Their active loco fleet is down 12% form YE18, and system car fleet by 7%. There’s more to come (and another related charge) in H2/19. In fact, they have more than doubled their own targeted 2019 PSR benefit level, (to $40mm from $16mm; on an annualized basis from $25mm to $55mm). making up for some of the volume headwinds.

  • KSU cut planned 2019 Capex to “below $600mm” from their earlier range of $640-660mm; reiterated that the YOY increase was due to the now completed $140mm loco plan. Capex will still be at ~18% of revenues for 2020-21, but this still feels like a sop to the short term. Yes, volumes are weaker or at least more uncertain – now. Yes, PSR has reduced the asset base (rolling stock etc) and what’s left is newer. But what is the outlook five years from now? What are you implying? We know that rails are awful at precisely matching supply with demand – so why try? Come one guys – be best!

  • AMLO keeps trying to reduce Mexican dependence on US refined products, KCS’ shining star, but the markets aren’t buying the Pemex reform plans – at all….

Q: Genesee & Wyoming Railroad (GWR) is to be acquired by Brookfield Infrastructure Partners (BIP). What were the reasons behind this deal, and what does it mean for GWR’s future?
A:
Thanks in part to an unprecedented amount of deal info leaking (kudos to Bloomberg), this was no real surprise. In addition, as far back as their last Investor Conference in November 2017, GWR had itself said that North American deal making was getting harder as asset inflation accelerated (due in part to the differing return requirements between public, strategic, private equity and infrastructure investors) – but the upside was that they realized their own portfolio was under-valued. Interestingly, the short line community thought this was a done-deal for some time; the investment community was a tad more cautious, an interesting role reversal. Meanwhile, as an aside, the timing of Canada Day for a Canadian-led deal (and BIP is widely followed up North) wasn’t too bad, given recent major rail calls on Yom Kippur, etc. But what does it mean – to GWR, to the rail industry, for other deals?

Why did GWR do this? Well, the deal represented a 40% premium to the share price before the leaks began (for the 4% short – oops!), and at 13.3X 2019E EBITDA and 26X ‘19E EPS, that’s a healthy haul! The sellers market bonanza, as described above and noted by GWR repeatedly for the last 18+ months, for one reason. In addition, GWR can be viewed in part as a victim of their own success – by creating a 114-railway behemoth in North America, they made it harder on themselves to continue to make deals “that move the needle”. A $10mm revenue deal that would be coveted by some SLHCs would require the same effort in due diligence and “go teams” and yet be barely noticeable to their investors. It could be inferred (even though denied) that this problem could cause GWR management to take bigger risks and do deals in other regions (the UK, perhaps, if not Australia). A combined deal/operating company might not be best suited for quarterly results.... 

What does this mean for GWR? They can recommit to the small, fill-in deals, for one – and at the same time have a parent with deep, deep pockets for larger ones, should they arise. But the deal leads to some questions. Will the current management stay? They say they will. Did BIP see this as a pure infrastructure investment (stable, say mid-single digit returns/hands off style), or will they view this more as a private equity investment (investing with an aim to provide something – capital/expertise/directional change- to improve results and achieve double-digit returns)? The deal press release states that BIP et all “fully supports the G&W business plan”, but some sources say that isn’t entirely accurate, citing some issues of operational efficiency, and growth potential....In addition, a Canadian source close to BIP said that the ownership & fund structure was complicated – with some seeing themselves as lifetime investors and others with a 10-year (still “long term”, to be sure) horizon. The source suggests perhaps 1/3 of the ownership confederation would be in that more opportunistic (PE) category....That could be interesting – an internal “activist” in the mix? 

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Alison Babcock
Ask The Experts: August 7, 2019

Tony Hatch
Independent Transportation Analyst and Consultant

Q: How will modern technology be integrated into the rail industry in the future? Will we ever see real time traffic reports, live data tracking like we can see in google maps/waze for automobile traffic?
A:
Rails fully get that they are at a growing technological disadvantage, having for years (ever) thought of themselves as rather cutting edge (and at times that was so – think of all of the public data they produce weekly). They also know that winter is (or may be) coming in the form of driver-less trucks, platooning, etc – that may be further off than originally projected but there are lots of smart folks in Silicon Valley and elsewhere working on ways to chip away to the first two rail advantages versus trucks – manpower and fuel efficiencies (the third is their network infrastructure, the final and likely unstormable castle). And with the coming completion of PTC, the rails have inadvertently but now recognizably built the backbone of the coming digital rail, not just safety but visibility! They are working on tech all over – and their shareholders are demanding that they do so. I think CN and BNSF may be the leaders but all of them are now at least talking the talk….

Q: What are your thoughts on Union Pacific (UP) performance?
A:
“UNP’s earnings lift railroad stocks/eases railroad fears/help put rail stocks back on track/etc” – so ran the many headlines (and the analyst congratulations) after UP reported essentially the same trend as CSX – weaker volume outlook, reaffirmed OR targets - but in a more palatable manner (evidently)….Union Pacific reported a 12% increase in (YOY) EPS – consensus was +9% - despite a 4% decrease in volumes and the OR declined 340bps to a record low 59.6%. revenues “only: dropped 2% because pricing was up almost 3%. The new-ish four commodity categories read thusly, in terms of volume and revenues YOY” Ag (flat, +4%); Energy (-9%/-13% - yikes; not only was coal down 7% but sand was down fully 50% - I wonder if the rails contributed to killing this once golden goose?); Industrial (again, the primary target for PSR - +2%/+4%, with plastics traffic up 6%); and Premium, or IM & auto, -5%/-2%. The largest subcategory here, Domestic Intermodal, showed a worrying 11% decline, and that’s supposedly without de-marketing – CMO Kenny Rocker said lane closures have had a “very minimal impact”. Looking slightly ahead, UP sees 6 of 12 categories as positive, 4 negative and 2 (grain and trade-related) as “?”. UNP expects sequential but not YOY volume gains in H2/19

Operating efficiency clearly saved the day for UP – expenses declined 7% on the 4% volume drop. Headcount (and comp&benefits) dropped 8%. 4 of the 6 listed KPIs improved. Productivity gains were $195mm gross, $170mm net (after weather-related “operational challenges headwind”), but UNP reiterated targets for FY productivity ($500mm) and OR (below 61% this year and sub-60 for next. Safety was interesting – it was listed at the top of the Unified Plan 2020 continued focus list, and as an inflator of “Other Expenses” due to higher casualty costs – but safety stats, a normal operating metric (P/I, accident rate) were nowhere to be found. In fact, we need a deeper dive into the related U/P2020 KPIs since those listed in Omaha last year (pre-management shakeup, pre-PSR) are obviously useless….

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Alison Babcock
Ask The Experts: July 31, 2019

Tony Hatch
Independent Transportation Analyst and Consultant

Q: How has Norfolk Southern (NS) been performing?
A:
NS service appears to be improving most rapidly – and this is before they install their new Op/Plan (“Top 21”), on top of the completed “Clean-Sheeting” bottoms-up process. I wonder if in many ways that this is a sort of re-tightening of their once-renowned operating discipline (remembering their late COO Steve Tobias). I think I do need to hear more about their marketing plans and Intermodal’s role given their longtime growth leadership in that segment. There has been a lot of discussion about NS’ “Yield Up” policy – it was noted that in terms of yield (revenue/unit – which is really not price) NSC has like a 20-30% gap to CSX – 23% in 2018, although grew carloads 14% more. Will we see a reversal of the “growth at all costs” outlook – or is that, as I suspect, a false premise?

Q: What can we expect to see from Genesee & Wyoming (GWR)?
A:
Despite the national increase in share repurchases, GWR showed a slowdown in buybacks – another wisp of smoke in the ongoing search for going-private fire? Nothing much came out of what seemed to be a rather perfunctory, if not desultory, AGM. However, there has been interesting investor discussions of 20-30% premiums to the current price (NAV). Further, Bloomberg suggested that the process included some of the biggest PE names (AKA “the usual suspects”) were already into the second round, and that GWR was looking for something at or above the upper end of the afore-mentioned range. Is this for real (as the short line community believes) or a valuation process?

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Alison Babcock
Ask The Experts: July 24, 2019

Tony Hatch
Independent Transportation Analyst and Consultant

Q: How does Precision Scheduled Railroading (PSR) impact Short Lines?
A:
Canton Railroad has previously noted that the one thing that comes with overall PSR adoption is “more work for the Short Lines that the Class Ones used to do” – citing rate-making, (local) marketing, and hand-holding”. To which I would add, of course, pre-blocking and other first/last mile operations. This new, “over the transom” workload will be met with some small carrier push-back.

Q: What are your thoughts on the reefer boxcar market?
A:
The high cost reefer boxcar market could be revived if the cycle times improve from ~7X/year (!!) to once a month – something that could well happen with PSR, unlocking a new market opportunity in a low current share environment.

Q: How well are Short Lines and Class I Railroads working together in efforts to use Information Technology (IT)?
A:
Efforts to use IT links in a combined Short Line/Class One service & visibility (particularly to empties) are apparently progressing very slowly, and efforts to convince Class I’s that this type of information isn’t proprietary continue to run into roadblocks….

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Alison Babcock
Ask The Experts: July 17, 2019

Tony Hatch
Independent Transportation Analyst and Consultant

Q: How do things look for rail carload volumes for the rest of 2019?
A:
Better….the trade/political disruptions haven’t gone away, but the weather has, and the improved operations at the major carriers have allowed for rather quick recovery. In fact, the “average” Class One was behind plan for the first quarter, but reiterated solid guidance for the full year, indicating an improved outlook for the last eight months.

Q: What do you see happening in rail five years from now?
A:
Five years from now is always hard to predict but something the rails have to look to given the nature of their capex requirements and the long life of their investments (30-year locos, etc). And although technology is both an opportunity and a threat (again, a subject for another day), I see healthy rail spending on IT. In addition, the PSR disruptions will be behind them (they better be!) and a newly energized short line industry will be even larger partners in adding carload business….

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Alison Babcock
Ask The Experts: July 10, 2019

Tony Hatch
Independent Transportation Analyst and Consultant

Q: In your opinion, which recent Class I hiring decisions have been notable?
A:
There were two major hiring announcements from Class Ones, both of whom started their rail careers at the ATSF (thanks to the only SP-foamer in the industry for pointing that out), the SF of the BNSF, and both of which produce interesting mysteries as well as deep implications and interesting ramifications:

  1. I didn’t see that coming! Canadian National announced the retirement of COO Mike Cory as of July 1 – and his replacement….by an American (Rob Reilly)….whose entire career has been at the only Class One railway (that very same BNSF) not espousing PSR!! Let that sink in for a moment – just as every US-based PSR railroad (CSX, UNP, NSC, KSU) has gone “big-game hunting” for a Canadian railroader (or at least one with CN or CP experience), the PSR Mother-ship, CN, goes and finds someone without direct PSR experience nor a predilection for Tim Hortons. I hear only good things so far about Reilly. This is clearly a sign of a culture change in the PHR world. We will all miss Mike Cory, as well, who will be around to transition Rob for a while.

  2. Double Down! CSX announced that Farrukh Bezar will be their new EVP & Chief Strategy Officer. I have known Farrukh for a while, and I hope I am not prejudicing anyone by revealing that he is a New Yorker and a die-hard Mets fan. After railroading he was a consultant for some time; this announcement comes as a surprise to me in part because only March 6, CSX— as part of a restructuring of the marketing department— announced that Kevin Boone was moving from IR to VP Marketing & Strategy….This also seems similar to when NS, having the estimable Mike McClellan as Strategist, also in March announced the election of John Scheib as EVP and Chief Strategy Officer. Apparently the situation is working well at NSC.

Q: What are your thoughts on Rob Reilley moving from BNSF to CN?
A:
Of the CN move to grab Rob Reilley from the BNSF, a former CTO there, the estimable Dave Dealy, had this to say:

“Rob spent most of his BNSF career in either intermodal operations LA or Chicago or as Regional VP of the Santa Fe Transcon (Chicago to California.  He is a very intelligent, critical thinking leader, well respected by those who work for him.  The transcon operation demanded precise execution of the service sensitive intermodal trains (UPS, FEDEX, JBH Premium and LTL) as well as the high volume steamship double-stack network. Over the past two years in my conversations with Mike Corey and JJ, they have had difficulty in handling the intermodal growth out of Prince Rupert.  Rob is a “sweat the assets” guy, and learned well from yours truly.  He will NOT do anything to degrade the PSR mentality at CN.  I believe that he is the right guy at the right time.  Big question is why did BNSF let him go?  Matt Rose had strict instructions to his PEERS, keep your hands off my people….Carl does not have that same relationship with his peers.  BNSF will miss Rob.”

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Alison Babcock
Ask The Experts: July 3, 2019

Tony Hatch
Independent Transportation Analyst and Consultant

Q: What are the main takeaways from the International Energy Agency’s report on “The Future of Rail”?
A:
The International Energy Agency (IEA) issued a major report on “The Future of Rail.” It will save you a lot of time to understand that the key point is that more rail use, while expensive, has a great return on investment (ROI) when climate, safety, efficiency and other issues are taken into account….

Q: What type of growth can we expect to see from Canadian National (CN)?
A:
CN made a case for $1.3B-$2.4B (C) in organic – or “secular” – i.e.; above “market”/economic and pricing - growth opportunities without over-emphasizing CBR nor counting on Inorganic Growth (i.e., M&A) contribution beyond the two deals already completed (more below). The big range there comes from energy, of course (helped perhaps even further by more delays on the Enbridge pipeline) – but intermodal should provide $750mm-$1.1B of growth, supported by BC port expansions and service reliability. One area that surprised me is the opportunity in the east (of Toronto/Montreal) region, now about 23% of the GTMs, with sole-served Halifax (big ships/big trains/minimal expansion capital needed) being teed up to be a Prince Rupert clone (despite the loss on their JV bid on the terminal – they can work well with PSA). The Eastern Region is run by a marketing specialist, esteemed veteran Doug Macdonald, rather than a traditional ops person. (Meanwhile, not to be fully outdone on CN’s birthday, CP issues a press release touting their new Vancouver auto facility, part of their own franchise-extension strategy).

Q: What do you expect Canadian National (CN) will do to raise its numbers?
A
: Capex will provide the fuel as CN transitions from “catch-up” (running ~25% of revenues 2018-19) to “keep up” (~20% of revenues to fuel the growth opportunities – worth it at that return on investment level and strongly countering the ongoing, mindless statement that Precision Scheduled Railroading (PSR—-or just “SR” in CN’s parlance as the originator)  - CN’s priority order for cash remains…. 1) the railway, yielding that 15-17% 2) Dividends (growing dividends per share faster than earnings per share, raising the payout to 35% from 33%); 3) M&A to “feed the beast”, or the network; 4) last – buybacks (still healthy!).  Speaking of catch-up, it was made clear that service metrics were close to or at 2017 (pre-surge) levels despite the higher volumes (in the case of the critical western region fully 15% more GTMs over the 2 years.

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Alison Babcock
Ask The Experts: June 26, 2019

Tony Hatch
Independent Transportation Analyst and Consultant

Q: What are your thoughts about the recent rail traffic reports?
A:
Bad news. Volumes aren’t recovering so the encouraging “reaffirmations” of 2019 volume/earnings outlook, so prevalent in the Q1/19 calls, will likely not be the theme for Q2/19 next month! Now, I don’t care about that, per se, but as we slowly pass the winter wet weather impacts, and try to decipher the tweet effects, it does lead us to ask: What’s going on? Yes, comparisons are tough but, still….

  • The May RTI (AAR) noted that the 3% decline in US/Canadian total traffic represented the 4th straight month of decline; only 6/20 commodities increased (CBR, chemicals) in the US (8/20 in Canada). In fact, Canada was the saving grace – US carloads dropped 2% and intermodal almost 6%; whereas Canadian carloads were up 2.5% and intermodal eked out a slight (+0.4%) gain. Canadian coal was actually up 5% (vs US -0.4%) and motor vehicles +8% (-3%). Must be the clean living….we the north!

  • More recent traffic is even more worrisome: the AAR reports that for the week ended 6/8/19 North American volume (Mexico gets to play in the AAR weekly but not monthly numbers) was down more than the YTD levels – carloads and intermodal both down 6%; once again only Canada showed positive results (+2%/1%).

Q: How has the weather been influencing rail traffic?
A:
You always take the weather with you, or there is something happening here: the news has been full of weather issues with relevance to rail. Here are five:

  1. The USDA reduced the grain outlook due to the wet (and “expected bigger rainfall conditions”) fields.

  2. Barge shipping has been jammed up by the Illinois, Arkansas, and portions of the Mississippi River closures, due to too much water.

  3. On the other hand, the Panama Canal is still suffering form too little, which looks to be chronic.

  4. On the Bright side, the Northern Sea Route, which cuts distances by up to a fifth, now looks more, er, promising, and COSCO has now entered a JV with the Russian line.

  5. The coming IMO 2020 rules, meant as a response to climate change to reduce emissions in ocean-going shipping (by forcing a scrubbing of bunker-fueled engines, or a fuel switch) will be very disruptive; from a NA rail point of view it will increase “slow steaming” and therefore sharply reduce schedule consistency putting pressure on landside operations (docks, dray, warehouse, and rails).

Q: Is rail becoming a more popular shipping option for the big retail companies?
A
: There has been lots of discussion on the idea that the retail/E-tail giants AMZN and WMRT were now negotiating directly with the rails – in the case of the former, I believe that was always the case. WMRT has also created a 53’ box fleet – a very encouraging event….

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Alison Babcock
Ask The Experts: June 19, 2019

Tony Hatch
Independent Transportation Analyst and Consultant

Q: What do you think the future holds for Canadian National (CN), and are they still a leader in Precision Scheduled Railroading (PSR)?
A:
CN increased their anticipated earnings growth rate for the three year period 2020-22 to “low double digits” from the (accomplished) ~10% earnings growth of the prior 3-year period; more importantly they reiterated their ROIC range of 15-17% - the appropriate way to measure success in a an emerging PHR (Post-Hunter Railway) or SR/PSR 2.0 railway industry.  CNI remains not only the “Mothership” but also the trend-setter and leader, with competition coming from Calgary to be sure (and perhaps the remaining rails?) in the intermediate future….CNI is also the best refutation of the still de facto misunderstanding of PSR as a cost-cutting, volume-shrinking, short-term orientated policy (see the current Trains magazine:  “it is neither precision nor scheduled” and is anti-growth).  CNI is all about growth and is willing – eager – to spend to achieve it given, as it always comes back to, the returns on investment.

Q: What decision did the Federal Railroad Administration (FRA) make regarding 2-man crew legislation?
A:
Good news out of DC?  Actually, yes – the rails scored a victory freeing them up to negotiate crew size reduction (to 1 from 2) by utilizing the safety benefits of the huge PTC investment.  The FRA seemingly has put the ki-bosh on legislated 2-man crews in time for the fall section six notices that are the kickoff of (US) national rail labor negotiations – and on the very same day SMART Transportation Union (the former UTU, covering brakemen) national Legislative Director John Risch was telling the audience at the Wolfe Transportation Conference of his union’s to-date successful efforts to get state legislatures to produce laws mandating two man crews; the FRA’s notice of proposed rule-making (essentially withdrawing the proposal for national 2-man requirements from the last administration) preempts any state efforts.

Q: What was new in technology at the Canadian National Investor Conference?
A
: Technology was the underlying trend, much as it was in 2017.  In fact, some of the tech day (+) was a follow-up from that earlier conference , an update on two major projects we saw on the drawing board in Montreal in ’17 and in the fiend in Toronto this week – the Automatic Inspection Portal (AIP -a shed with cameras that can photo-inspect cars at running speed (up to 60mph) rather than over several hours in a yard – and after all 80 or so algorithms are included, at a much higher rate of accuracy.  There are two deployed now, 6 more coming this year (including two in the US) with 8 coming in 2020 and another 8 in 2021.The other is the Automatic Track Inspection Program (ATIP), essentially a specialized boxcar that can do full track inspections also at speed in a revenue train, instead of in a hi-rail at ~10mph (Canadian).  CN expects to get regulatory approval by 2021. The AIP sheds also capture real time information by car – which I believe could have commercial/visibility potential, as well.  We saw new hand-held products (“Lynx”) replacing reams and reams of spec documents for car repairs, an intermodal “MobilePass” system built with GE, and perhaps most interestingly, the beginnings of a rail-centric Transportation Management System (TMS) with car-tracking visibility (including empties!) that can potentially be a real “game-changer”.  In response to my question about the myriad of TMS products out there (a big part of the IT world since the first internet wave), CN responded that all of those were 3PL oriented – and a quick check of the “TMS Guide” in the latest “Inbound Logistics”, listing ~80 products,  proved that to be the case.  I look forward to re-visiting the TMS project in 2021….along with an update on their “Smart Network”, a “fully integrated network simulator” due to be functional by late ’21.  CN is also on the verge of hiring its first Chief Digital Officer (stay tuned).

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Alison Babcock
Ask The Experts: June 12, 2019

Tony Hatch
Independent Transportation Analyst and Consultant

Q: What are your thoughts about recent personnel changes at CSX? Do you think this is hinting towards a merger?
A:
Just when we thought the freight rail personnel surprises were past us and the news from Canadian National (picking a new COO from….BNSF) and CSX (hiring a Strategist) – see note attached, just in case - the latter strikes again by announcing the “departure” of CFO Frank Lonegro, the last of the CSX “Old Guard” and a man well-respected by the Street.  Signs of haste include the fact that Kevin Boone, only recently elevated from IR to Marketing Strategy, now slots in to replace Frank – on an interim basis.  That move may at least clear up the issue of having two recently appointed strategists after last week’s surprise hiring of Farrukh Bezar.  However, it still leads one to wonder what’s going on behind the highly-charged dynamic outward posture at CSX (as chaos in personnel late last year did the same for UNP); CSX has remained tight-lipped, of course.  Many had tabbed Lonegro as a possible successor to CEO Jim Foote….Several have posited that this is a step toward a merger but….well, no.  just….no.

Q: What is the latest in rail traffic reporting, and how has the weather been an issue?
A:
Bad news in traffic – well, there is still weather, but maybe more behind the latest week (#21) results – an almost 7% (-6.7%) decline in volumes (carloads -5%, intermodal down fully 8%); Canada was up and Mexico down, although less.  In light of recent rail volumes and truck pricing reports, I find the ATA’s +8% YOY April tonnage growth number to be….as suspicious as the reported Q1/19 GDP growth.  In fact, DAT’s volumes (units and just dry van) were up ~2%, and the Cass April Freight Index numbers showed a 3% decline.  So what’s right?  Even the ATA suggested that the April tonnage numbers might be “misleading”….Some have said that the rail service improvements owe more to the lower volume rather than the vaunted PSR changes, but the resiliency shown in the face of weather issues is a pretty good refutation of that premise, in my humble opinion.

Q: What were some of your takeaways from the Wolf Transportation Conference last month?
A
: The Wolfe Transportation Conference offered a terrific late spring/mid quarter update – few revelations, no Canadians and many reiterations….however the latter (of FY19 guidance, itself reiterated after the weather impacted Q1/19 results) is actually saying something given the still below expectations volumes; one thing it implies is better-than-projected service (and related, productivity) levels in the rail group.  A coal and energy panel was interesting with Vistra calling for applause for the way the rails handled and recovered from the extreme weather,  That’s not something one hears every day.  Vistra and Southern Companies highlighted their continuing, irresistible move away from coal (and the rapid growth of renewables within their portfolios).  Old friend Joe Adams of Fortress’ Transportation & Infrastructure Fund highlighted their CBR/refined products ventures in Texas centered on exports into Mexico with CBR and blending on ongoing (even with pipeline development) part of their strategy (good news for Canadian rail, Watco and KSU in a tough week for the latter).  He also allowed that, yes, their Maine short line operation is for sale.

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Alison Babcock
Ask The Experts: June 5, 2019

Tony Hatch
Independent Transportation Analyst and Consultant

Q: Recently there were two major hiring announcements from two Class I Railroads, Canadian National (CN) and CSX. What do think will be the resulting implications/ramifications?
A:
Canadian National announced the retirement of COO Mike Cory as of July 1 – and his replacement….by an American (Rob Reilly)….whose entire career has been at the only Class One railway (that very same BNSF) not espousing PSR!! Let that sink in for a moment – just as every US-based PSR railroad (CSX, UNP, NSC, KSU) has gone “big-game hunting” for a Canadian railroader (or at least one with CN or CP experience), the PSR Mothership, CN, goes and finds someone without direct PSR experience nor a predilection for Tim Hortons. I hear only good things so far about Reilly – we will all learn more early next month. This is clearly a sign of a culture change in the PHR world. We will all miss Mike Cory, as well, who will be around to transition Rob for a while. The Investor Conference is now particularly well-timed, and while I retain faith in CN, there has indeed been a lot of ops turnover/retirement of late …

Double Down! CSX announced that Farrukh Bezar will be their new EVP & Chief Strategy Officer. I have known Farrukh for a while, and I hope I am not prejudicing anyone by revealing that he is a New Yorker and a die-hard Mets fan. After railroading he was a consultant for some time; this announcement comes as a surprise to me in part because only March 6 CSX, as part of a restructuring of the marketing department, announced that Kevin Boone was moving from IR to VP Marketing & Strategy….This also seems similar to when NS, having the estimable Mike McClellan as Strategist, also in March announced the election of John Scheib as EVP and Chief Strategy Officer. Apparently the situation is working well at NSC …

Q: How do you think government intervention in the rail industry can be avoided?
A:
One way to forestall government intervention is to provide good rail service – and it is inarguably getting better. Why? The reduced volumes YTD? I don’t think so (years of elevated – and necessary – capex, new operating plans) but it is a topic that has been raised. My Aussie friend Rick Patterson noted that as he sees it, over the last five years, good service quarters occurred 22% of the time; “bad service” quarters, however, registered at 35%. Some of that, he saw, was self-inflicted – crew or power shortages or capacity pinch-points (a matter of investment). To which I would add poor demand forecasting and the related, OR-driven and absolutely futile “chase of equilibrium”. Hence CN talking about the need for “surge (excess) capacity”, for market share and political reasons. Having a ~16% ROIC seems to me to justify that risk-modifying stance.

Q: BNSF CEO Carl Ice was a speaker at NARS last month. What were your takeaways?
A
: CEO Carl Ice was the key-noter – and really wanted to stress that although they did not fall under the PSR umbrella, efficiency is still the driving focus of rail operations (and said they are doing similar things to what they see in PSR). In response to my question about Berkshire’s Buffett’s quotes concerning UNP (and their lower OR), Carl said the implications drawn by the rail community (that BNSF would soon join the PSR party) didn’t reflect their internal views. They must be doing something right at BNSF Operations if the Mothership comes calling …

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Alison Babcock
Ask The Experts: May 29, 2019

Tony Hatch
Independent Transportation Analyst and Consultant

Q: What are your thoughts on the current US Agriculture markets?
A:
Soybean prices have fallen below $8/bushel (an Iowa State University study pegs break-even at about $9); storage is at record levels; the African Swine Fever outbreak in China has reduced their appetite (even as LatAm competition – and harvests – grow rapidly.  Not a pretty picture.  The White House’s offer to renew a farmer bailout program (~$12-15B) is aimed at 2020, of course; their discussion on using crops for humanitarian aid doesn’t really apply to soybeans (not consumed by humans, largely).  One bean farmer quoted in the Journal had to leave last year’s crop in the field because he lacked storage space (exacerbated by the metals tariffs!) – and thus didn’t qualify for the bailout money (only for harvested crops!).  Catch 22….

Q: What do you think about the latest reactions to Precision Scheduled Railroading (PSR)?
A:
I continue to marvel at the misconceptions and willing or naive pontifications on the subject.  It is linked to what I have been calling the “Cult of the OR”, to be sure – and to the pure cost-cutting side of that equation.  And, it has  attracted investors on the shorter time horizon part of the spectrum (pressuring capex).  But it can and should (will?) mature into a “pivot to growth” (viz CP) – as I have also stated, look north to the freight rail future (potential). 

  • That hasn’t stopped the critics – in DC (below) of the “Old Guard” rail/transport press.  The Journal of Commerce (JoC) called it unproven (while correctly noting the poor communication effort at CSX, whose experience will inform that of the reaction to the other US rails undergoing the transformation).  The JoC quoted the usually reliable Full Tariff Rate (FTR) in stating that railcar capacity utilization had only improved slightly (they put it at 78%, up from 75% in 2017 – though how they get that proprietary information is anyone’s….guess). 

  • Change is hard - More egregious was “Trains” magazine’s rip (calling PSR “the latest operating fad”) – saying it is “designed to reduce employment” (no, ideally all assets get reduced due to increased consistency/reliability; also see KSU’s recent proclamations on the subject – “Service begets Growth”).  They (Solomon) goes on to say it’s “driven by Wall Street” which makes me wonder of Hunter was aware of Wall Street while initiating this on the Frisco – and why the – focus here – owners of a company are expected to have no say?  To be sure, rails get punished by “short term-ism” – see my push to focus on ROIC and Capex – but rail investors have actually been pretty patient ones this century.  Further: PSR seems to be “formulaic simplifications to please investors (here we are again, Kamerade) while glossing over shippers needs”.  Is that happening above the 48th parallel?!?  One thing they did get right is the reaction – which they are inflaming – to PSR is bringing back re-regulatory threats again.

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Alison Babcock
Ask The Experts: May 22, 2019

Tony Hatch
Independent Transportation Analyst and Consultant

Q: What impact is the US-China trade war currently having on the rail industry?
A:
Trade – the big issue since….2017.  Wrote the FT’s Global Insight columnist Edward Luce:  “(President) Trump has staked his reputation on eliminating the trade deficit (as opposed to changing the intellectual property rules etc) with China.  Most economists think that goal to be unattainable – and undesirable”.  Remember that the much-publicized AAR figure of “42% of US rail volume is trade-related “greatly understates the total impact on the Class One industry.  The recent heating up of the US-China trade war, only a few days ago thought to be resolved, is obviously not great news for rails – impacting ag, autos, consumer goods, plastics, etc.  The chemicals sector is “particularly hard-hit” (the FT, again).  The latest salvos have been estimated to include fully 50% of the trade between the USA and China – and The Economist notes that “China vows to fight to the end” on this issue.  Q1 US exports to China were down 30%; imports from, down 9%.  Overall global trade declined 1.1% for the first two months of this year. 

Q:  What are your thoughts on the current NAFTA 2.0 situation?
A:  Border disruptions related to immigration and our declining relationship with Mexico have been estimated to cost ~$800mm/day (although that should lead to market share opportunity for rail!).  AMLO, meanwhile is both underwhelming in his attempt at broad changes (for example on the use of the army – “meet the new boss, same as the old boss”) and going back even further in time to offer broad support to Pemex, which just received an $8B credit approval, which would constrain US refined products imports, a big growth prospect for KSU.  Meanwhile, NAFTA 2.0 is getting push-back – from the US Democratic congress, and from Canada and Mexico who argue, rather convincingly, for the rollback of the metals tariffs (and clearly will not accept quotas as a “substitute”).  Meanwhile, the US International Trade Commission, an independent government agency, pegs the impact of 2.0 (AKA “USMCA”) as minimal (increasing GDP by 0.35%) – which makes sense in that, despite all of the rhetoric, it really is an only slightly modified 1.0; they see the biggest, unquantifiable, benefit being the investment/regulatory stability that USMCA (NAFTA resolution) would bring – but “stability” seems like a distant goal from here….The US added tariffs to Mexican tomatoes – so clearly, following the price gyrations in Avocados, this sector of the trade war isn’t auto-focused, but rather, concerns salsa….

Q:  Do you think regulation is a current threat to the rail industry?
A:  (Re) Regulation.  Its seems to be a rising threat – one prominent lawyer, one of my few conservative/communist friends, says that rail assessorial “abuse is rampant” – and the STB will soon be holding a hearing on the issue.  But its not just the USA – Mexico has stepped up what we might consider anti-trust oversight and the CTA up north has taken the CN to task for since-corrected congestion in Vancouver.  But it’s the USA that is really heating up, as we have discussed since STB Chairman Ann Begeman’s incendiary (but enthralling) speech at last year’s RailTrends.  Their recent “Rail Reform Task Force” report was scary – but remember it’s Washington.  Things move slooooowly.  The AAR’s Jeffries stated it “lacked balance.”

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Alison Babcock
Ask The Experts: May 15, 2019

Tony Hatch
Independent Transportation Analyst and Consultant

Q: What are your thoughts on Canadian National’s (CN) Q1/19 Report?
A:
Canadian National’s Q1/19 (slight) earnings shortfall made it the second railway – and the second, of two, Canadian Railway, to report below-consensus results – but, as with CP, they harsh winter added to the other distortions (trade, Albertan market interference, etc) to make this quarter’s results hard to decipher and less important than CN becoming the second Canadian to reiterate full-year expectations despite the slow start.

A field day for the (cold):  CN’s CEO JJ Ruest informed us that CN faced ~7 weeks of Tier 3 and even Tier 4 cold – in light of that a 17% increase in adjusted/diluted EPS and an 11% revenue increase that matched the cold-brewed 11% expense increase was actually pretty darned good  (1% of the expense was a PTC charge).  The (adjusted) OR actually improved 60bps to 67.2% - but remember last year was the congestion-winter of CN’s discontent.  Volume was up 1% - you can track the weather impact on their slides, plus the “nosedive” in CBR due to the provincial government’s heavy-handed market interference.  Operating metrics declined in many categories (train velocity down 1%) but showed improvement in dwell (-12% versus last year’s congested performance) and car velocity (up 8%).  The injury and accident rates ticked up, too.  CN didn’t delineate the winter hit to earnings, which on the one hand would have made all of our lives easier, but on the other is a cool way of saying this is just….the rail business.

There’s something happening here:  Resiliency and recovery – along with “railway” one of the Three Rs of CN.  The railroad is now fully fluid, the outlook looks bright – high single digits for the FY19 means quite a strong last 8 months of the year – but CN believes that will happen even if CBT doesn’t ramp back up to December (pre-Albertan interference) levels.

Q:  How is the Surface Transportation Board (STB) working to increase transparency in the industry?
A:  At both NEARS and ASLRRA there was discussion of coming Surface Transportation Board (STB) activism.  In fact, the STB will hold a hearing in DC on the increase in assessorial/demurrage charges (some of which is the actual imposition of existing contractual requirements) on May 22 in DC.  New Vice Chairman Patrick Fuchs spoke, to positive reviews, about these concerns, as well as more use of “Rule 11” pricing (think unbundled/transparent interline 7 switching bills), which add to transparency but bring not insignificant new information complexities….My fears are that, although the recent PSR transformation efforts have compared well with CSX rapid revolution, the well has been poisoned by the latter’s experience - even if it did what it set out to accomplish – better service metrics….and that the STB’s seemingly forgotten caseload includes the reciprocal switching/access decision in a world that seems judicial but is actually highly political…

Q:  What is Canadian National’s (CN) philosophy on OR?
A:  CN’s CEO JJ Ruest explained that lower OR can be achieved, for sure (and CN has the most annual gold records in this category in modern times) – but it “depends on how much risk you want to take on”, defined here as risk of demand as well as “harsh conditions” (to which I would add political).   Describing OR as a “one trick pony” (and the new PSR-led focus on it a “limbo contest”), Ruest continued: “what you’re seeing from CN is a more balanced scorecard – EPS growth and especially ROIC - than strictly pure PSR”.  OR isn’t unimportant or useless, it’s just not the be all and end-all.

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Alison Babcock
Ask The Experts: May 8, 2019

Tony Hatch
Independent Transportation Analyst and Consultant

Q: How do you interpret Canadian Pacific Railway’s (CP) Q1/19 results?
A:
The rail winning streak is broken.  I (we) didn’t see this coming, although perhaps we should’ve – CP’s Q1/19 results came in some 5-7% below Streets (Wall & Bay) consensus and their OR increased by 180bps as severe February weather knocked even this cold-weather warrior for a loop (and, tragically, led the three fatalities).  But like UNP before them they have fully reiterated their FY Guidance issues in January - said CFO Velani:  “We can absorb this difficult first quarter and still over-achieve (for the full year)”.  But this breaks this quarter’s rail hit streak at 3 (it sure appears that NSC posted a big W, bringing the scoreboard to 4-1 so far in the quarter.)

Q:  Keith Creel thinks there will be consolidation because “the industry will run out of capacity.” What are your thoughts on this?
A:  I know that Keith Creel is an actor in the drama (and I am merely an observer), but I don’t buy it.  Given that the rails are (mostly) all converting to PSR, and just beginning to look at the benefits of PTC (especially on capacity), and with the increased free cash flow generation (and the PHR view of Capex, as CNI will discuss next week), I don’t see that capacity shortage coming in our lifetime, if ever.  And, of course, the “pro-competitive” risks to offset any such gains in capacity are huge.  This is why Matt Rose has gone from being such a leading advocate of KC’s position to his current one….

Q:  What do you think about Norfolk Southern’s (NSC) Q1/19 results?
A:  By now this is well-known:  NSC blew away Street estimates with what one wag at “SeekingAlpha” called “a perfect quarter”.  True – they set records in railway operating income, net, EPS ($2.51, up 30%YOY) and Q1 OR 66% (-330bps).  And that EPS record was also fully 15% higher than consensus estimates, a bit reflecting skeptic concerning NSC’s level of commitment to PSR.  For me, that went away following their excellent, long-awaited Investor Conference mid-quarter (3/1).  All of those targets (including achieving a 60% OR by 2021) were reiterated ‘with confidence”.  Clearly they are seeing operating improvements following their “clean-sheeting” process – velocity up 14%, dwell down 23% - and no mention at all of weather issues (till the Q&A) in the webcast..  Management stated that changes were “ahead of schedule”, allowing for a confident roll-out of “Top-21”, the PSR, single-system plan which is to be fully implemented by July 31 (when, it was hinted, we can expect some decisions on yards and terminals, a sop to those who see “Hump Yard Closure” being the sign universal PSR progress).  Much of the Merchandise system was “sped up” to the intermodal speeds of 60mpg (from 50) to better co-mingle business and break down unnecessary unit train businesses.  Volumes (flat) reflected the slower economy, tough comparisons (especially in intermodal and export coal) and rolling events (trade, etc).  Price wasn’t delineated of course – but seems to be strong and, as CMO Alan Shaw stated, NSC is “fully committed to testing the upper limits of market-based pricing”.  All good – great, even.  But….some darker thoughts creep in after 24+ hours….

  • Junk in with the jewels – of the $131mm in increases “Income from Railway Operations”, $16mm came from fuel (normal waxing & waning of oil prices); higher than “normal” gain on real estate sales (the sale/leaseback of the Atlanta HQ) added $11mm; increased capitalized labor added $8mm; and increased assessorial charges another $23mm.  Factor in the lower-than-normal tax rate of 21.4% and the 17% YOY decline in shares outstanding (due to their buyback program, of course) and you see that, while still goo, maybe great, perfect might be a stretch.

  • We can only know what we see – NSC produced ~10 slides in their presentation as they appear to be succumbing to the PSR-philosophy of “Greatest Hits Only – No B sides”.  And in the 5 operating KPIs, which we were set up to focus on from the Investor Conference, there was….no new data, just the 3/1 slide repeated, with some color (much of it “we’re on track”).  Expenses were  - matching volumes – helped by fuel and hurt by a 6% increase in purchased services despite intermodal volumes only being up 2%.  There was no safety – a historic NSC strength – data.  I thought this was all over after the First of March; hopefully this is an aberration.

  • Intermodal Angst – Mine, not their.  NSC has the best IM franchise in the east, as they duly noted (without mentioning the “Corridors” at all).  The Q1/19 International volume growth of 10%, tariff-affected, is obviously not sustainable (secular growth should be, as stated. “GDP+” – or better).  The domestic Q1 decline of 2% is slightly worrisome – although of course comparisons are very tough.  The mention of “lane rationalizations” was also a concern – a big (and necessary part of CSX’s strategy, but for Norfolk?  It is apparently been focused not just on pricing but complexity (also key to ROI).  But then Shaw noted that it was small in scale, and that it had been done every year since 2013!  So far, so good.  But then the CMO said, in discussing merchandise (always a PSR focus) and IM, that NSC’s “primary focus was on their “Yield Up” process – not on volume.  And this after considering all of the service improvements to flow from Top-21 (not to mention the lower cost base to come from PSR).  Compare this to KSU’s “Service Begets Growth”/PSR manta.  Maybe just words, but “semantics begets Tsuris”….

This was a fine way for Norfolk Southern to leave the post-Investor Conference starting gate – it just wasn’t….perfect.  Lets see how the Top-21 implementation goes as we look to the summer.

Click Here to learn more about Tony Hatch and ABH Consulting.

Alison Babcock
Ask The Experts: May 1, 2019

Tony Hatch
Independent Transportation Analyst and Consultant

Q: How is Kansas City Southern (KCS) interpreting Precision Scheduled Railroading (PSR)?
A:
KCS reveals its PSR Mantra – “Service Begets Growth”!  The subset to the code was four-part: Customer Focused; Facilitate Growth; Improve Asset utilization and (4th!) Improve Cost Profile”.  And yet, despite that unusual (refreshing) PSR ordering, KSU shook off any doubts that I might have had by going full bore on the concept (4 full slides, as compared to just one in the January webcast) and having their Chief PSR Officer as a major component of the broadcast/Q&A.  KCS was also impacted by the weather events sweeping through its largest interline partners as well as those specific to its unique location – trade distortions and tariff fears, teacher strikes, etc (there was little to no discussion of politics on the webcast).  But with the exception of, after the 1% decline in units in Q1/19, reducing FYG for volume by a point (to +2-3%; 70% of the book still is classified as “favorable”), the remaining targets were unchanged.  But my biggest takeaway was a bold view of PSR as a growth-driver (something that EHH always espoused); of looking at change not to please the lowest common denominator (“our approach is not to – just - close yards”) but to achieve their credo – Service begets Growth!

  • Mr. Fahmy noted their were “a lot of fruits still hanging”; presumably including some that are low-hanging.  I must say my only reservation was not his discussions, for I have a long-lived respect for Sameh; it was a lingering sense that a lot of the clear progress being made was coming from he and COO Jeff Songer (& team) and less from a systemic change – there was great stock taken in “exception reporting” (as there should be, I assume) but I think the market, having seen KCS rise, slump and rise again (like the House of Stark – which would make UNP Lannister?) would like to see changes that clearly could survive the loss of great PSR warriors.

  • Q1/19 Operating Metrics improved sequentially and YOY – dwell by 5%/16%; gross velocity by 11%/13% (KCS changed their reporting of this from net); and car-miles/day by 5% (YOY) – and with it the looked for net reduction of the locos (by ~100) and rail-cars (“1000 identified”).  PSR initiatives so far have accounted for ~$19mm in 2019 savings (which will grow to $25mm in annualized savings) – at a cost of a Q1/19 charge of $67.5mm.

  • KCS had the usual non-value accounting issues – in this case Mexican tax reform creating a GAAP change; they also effectively downplayed the Mexican government study on market dominance (covered before).  CEO Ottensmeyer strongly stated in the face of numerous questions that fact that there is one KCS – not a US and a Mexican system joined in Texas.

  • The KCS growth opportunities continue to show promise despite all of the political haranguing, etc – cross-border volumes were up 13% (revenues +18%) while “energy reform” related volumes grew 188% and revenues 164%.  Cross border IM volumes grew a less robust 5% (revenues dropped 6%) but recent border disruptions and the long truck lines they engendered are seen as, in effect, a marketing opportunity for CBI.  Lazaro was still dismal (-26%).

Q:  It appears that Union Pacific (UP) has not been recently concerned with growth. Do you find that to be true?
A:  It’s not that Union Pacific isn’t concerned with growth – they in fact had to defend that accusation and did so with conviction – its just that their presentation was more traditional PSR, if revolutions can have a tradition, cost and productivity and operations focused.  The fact that they reiterated their 2019 FY Guidance in the face of the 15 cents/share hit to earnings  from the flood is remarkable in of itself.  However, the faced their baying hounds on issues of OR – and capex (asking if PSR would allow UNP to spend – well - below 15% of revenues) with a different attitude, just as assured of course, but focused on productivity.  I have always said there are multiple ways to skin a raven.  It is curious. However, that the financial community seems to be unsullied, as it were, by the PHR rail experience in Canada (growth pivot backed by spending, high ROIC), even as Vena was a big part of it….

For UP, Specifically:

  • The fact that UNP reiterated its FYG on volume (low single digit, after Q1/19 started out as down 2%), pricing (Q1/19 “core price” gains of +2.75 were a step forward for UNP – though probably would rank in the bottom of the league tables); and OR (“sub-61% for 2019 & below 60% for ’20”) – after the weather ravaged first quarter was, and was attributed to, a sign of PSR working and resiliency being built into the network.  UNPO is almost entirely behind the operational and financial impacts of the storm and flooding….”We are moving traffic as presented”, noted the COO.

  • Most specifically, the reiteration of the FY19 UP goal of $500mm+ in net productivity gains (savings) was truly noteworthy – given that Q1/19 produced “only” $60mm in such savings (fleet size, train length, car hire, etc) and was matched by $60mm in “operational challenges.”

  • Despite those challenges, 4/6 of the KPIs listed by COO Vena showed improvement (best – dwell down 19%), though safety, not highlighted, suffered (P/I up 22%).  It seems that they are making quick progress, without straying form their “measured approach” politically….

  • Hump removals!  Give the people what they want – UP reversed its strategy (after one quarter of a new COO) and closed/repositioned two humps, will add a third (it sure seems like a Chicagoland IM yard) and – after saying they were committed – stopping construction on the Brazos (NM) yard.  As CEO Lance Fritz correctly noted, PSR (or UP2020/G55-0) is “evergreen” – as it should be.

  • More bread for the masses – with locomotive  productivity up 6% in this difficult quarter, the stored-power roster reached 1900.

  • The volume story was mixed – and I sensed an increased concern about the economy even if CMO Rocker was questioned about being perhaps over-optimistic; only CBR, industrial products  and international intermodal (“Tariff pull-ahead”, which may distort numbers till towards the end of Q2) looked good – but as stated in my “Preview” (and inherently obvious), this quarter’s volumes, especially for UNP (and BNSF) are hard to extrapolate from!

  • Capex conundrum – while being asked if they were able to reduce their spend (on a %/revenue basis), UNP will take the “savings” from Brazos (etc) and reallocate the funds to sidings on the Sunset etc to accommodate longer trains (clearly coming – train length was up 7% for Q1/19).  But I remain questioning – if not fully skeptical, given the known unknowns - about the long term, comparing UP’s PSR revolution to the ”Golden Companies”, the PSR 2.0 (or PHR) railroads up in the North, despite Vena’s claims of building a railway to last (“two, three, four and even five years out”; emphasis of course being my own). 

Click Here to learn more about Tony Hatch and ABH Consulting.

Alison Babcock