Ask The Experts: February 19, 2019

Tony Hatch
Independent Transportation Analyst and Consultant

Q:  Overall what are your thoughts on Norfolk Southern's Investor Day in Atlanta?
A:  This was a big meeting and it could have gone very badly – instead it was a great success.  The market liked what they heard right away (the shares were up over 3% on the day); upon reflection I would like to see more (of course) – more numbers, more info, more education of the shareholder base (on OR/Capex/ROIC, etc); that’s always the case.  But make no mistake - this opening salvo of the “Reimagined Norfolk Southern” hit the mark and then some.  I was looking forward to this for months – no, years – and like a perfect Christmas when one is a child, it was worth the wait.  Let’s just not wait as long next time.

Q:  What do you think it will take for the Norfolk Southern Top-21 Plan to be able to deliver results in years two and three?
A:  With 100bps coming out of the OR this year (and about 1/6 of the headcount reduction), there is a bit of trust required to believe that years 2 & 3 will deliver. Some of my suggestions are to simply build on what they shared – for example, to make a pledge to come back every couple or few years (a la Canadian National Railway) to update us and provide detail – even if we have to wait on the 2021 completion of this Plan and the official opening of the Atlanta HQ.

Q:  What are your thoughts regarding Norfolk Southern's target numbers?
A:  To hit the 60% Operating Ratio in three years means a reduction of close to 700bps – NSC uses 65.4% OR for the past (2018) year, while the Street sees that as more like 67% due to a big “lump” of RE sales in Q4.  In point of fact, that makes the goal that much more bold.  Yes, we saw huge OR reductions in the first years of PSR implementation before (CSX and CP), but from higher start points.  A key point here is that the OR target – and even the 5% CAGR level for revenue growth in the Plan period – were above Street expectations.

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Alison Babcock
Ask The Experts: February 5, 2019

Tony Hatch
Independent Transportation Analyst and Consultant

Q:  How is Union Pacific (UNP) and its new “$8B COO” faring in its Precision Scheduled Railroading (PSR) conversion?
A:  So far, good progress. But one discordant note – recently promoted from CIO to CIO/Strategy Lyndon Tennison is now…. ”retiring” days after being lauded on the earnings call.  This follows the “WTH?” pattern of long-awaited Investor Conference in May, change the C-suite out 6 weeks later, announce the switch toward PSR not long after….this, uh, process, involves hard change but the behind-the-scenes aspect seems a bit muddled. Union Pacific’s big earnings outperformance made it 4-for-4 for the rails (later 5-for-5 – and with travel and general weakness, CN has made it, just, 6 for 6), but more importantly, as the most focused on PSR convert, they showed “good pro-gress” (as 10-day-on-property new COO Jim Vena repeatedly said).  UNP showed 39% YOY EPS growth (about a nickel above optimistic consensus, and lowered their OR 110bps to 61.6%.  Volume growth was 3%, which will shake out below the industry average – have they already been doing some PSR adjusting?  As CEO Lance Fritz stated, they are ahead of schedule on their new (gulp) G55/Unified Plan (UP)2020 plan launched before Vena’s onboarding, last October (and, to be fair, launched some 4 months after their Investor Conference).  They are accelerating into the PSR rollout, as EVP-Operations Tom Lischer stated, and expect to complete full geographic implementation by mid-year.

Q:  It seems like Canadian Pacific (CP) has been reaching all of their goals. What are your thoughts?
A:
  Canadian Pacific beat consensus in Q4/18 by some 6-7%, and last year by 41% (adj); their OR (adj) was 340bps lower to a (still hard to adjust to) 56.5%.  And still, there was talk about low guidance (“mid-single digit RTM growth, double-digit EPS growth”) and taking their OR even lower, on a full year basis.  Revenue growth was impressive (+18%) in Q4/18, but unit growth (the way I look at things) was more mundane - +5% (which will be more in line with the industry).  In that regard, the 8% increase in Opex and 10% in Comp/Benefits (headcount up 6% in 5% more cars handled) was….pretty good.  Pricing was obviously good (close to +4%; renewals more like +4.5%).  Operations/Metrics were stellar, actually – Dwell and Velocity improved by 6% and 3%, respectively, and safety was terrific (injuries down 14% and accidents down 31%).  Call it PSR, call it Canadian know-how – CP is running a pretty tight ship.  Their near term outlook has some revenue timing issues, no big real estate sales, improving more in H2 and into 2020 – but there are no dark clouds in their horizon.

Q:  What is the latest on the trade situation?
A:  
Ottensmeyer is a hero for his defense of NAFTA (1.0) and free trade, and it is true that NAFTA 2.0 was signed by all three nations.  But it hasn’t been ratified!  My best DC insider/expert things there will be a lot (a lot) of sturm & drang but that it will pass Congress.  But, still, it hasn’t yet.

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Alison Babcock
Ask The Experts: January 29, 2019

Tony Hatch
Independent Transportation Analyst and Consultant

Q:  Bloomberg/BusinessWeek, in its 2019 Preview issue, listed “50 Companies to Watch” for the year – and not one of them was a railroad. What do you think about that?
A:
   With PSR transformations of varying degrees underway at, one could argue, at 5 of the 8 major railways (GWR inclusive), a reinvigorated regulatory approach in the US & Canada, not to mention the great impact that trade (or further trade disruption) could have on their volumes - BusinessWeek doesn’t think this year will an interesting one for railways? WTH?!? 

Q:   What are your thoughts on the Canadian Transporation Agency's investigation into rail service in British Columbia?
A:
  Sure, Canada is upset with being labeled a “security risk” (in steel and aluminum – and it was close for automobiles) by their heretofore biggest ally.  And yes, it is an election year.  But, for the CTA to launch an investigation into rail service in BC – not this time last year but now – seems silly.  At best.  Sort of like closing the barn door after the horse had run off, returned, washed itself, and put away the saddle.

Q:  How did the two big Canadian rails react to the investigation?
A:  
With justifiable umbrage.  CP’s Keith Creel said he and CP “take great exception”  Both carriers demonstrated that they have grown significantly over the winter time period in question in Vancouver (CN, for example, is up 10-11% in the last two months).  Oh, Canada, WTH?!?!

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Alison Babcock
Ask The Experts: January 22, 2019

Tony Hatch
Independent Transportation Analyst and Consultant

Q:  Is rail going to see a new regulatory threat from Congress?
A:
  Joining a more aggressive STB and RTA, Hill sources here tell me that the presumptive Railroad Subcommittee leadership in the New Congress plan to hold hearings on Amtrak/NEC; Chinese railcar manufacturing – and on PSR (from a shippers point of view; the scripts were written years ago but will be dusted off along with the fake tears).  In H2/19 we may see hearings on PTC, depending on the rate of progress.  In any event, a new front, if less dangerous, might be opening on the re-regulatory battlefield.

Q:   What are your thoughts about CSX and their start to the new year?
A:
  CSX – naturally – beat expectations for Q4/18, growing by 58% YOY, 3 points above the Street.  The OR improved by 480bps to 60.3% for the quarter; confusing (for me) that was also the FY OR.  CSX sees that FY60.3% as more realistically being ~61% given the lumpiness of RE & Line sales, etc.  therefore, CSX guided towards a sub-60% OR next year (thereby achieving the 2020 goal a year early).  That appears to suggest the end of the wild, multi-hundred OR point reduction period (2017-18), but the new long term OR goal isn’t clear, in order to balance with growth (and that’s a good thing, despite some plaintive analyst bleats on the call).  Free cash flow jumped 88% FY18 and/but cash distribution jumped even higher (102%; the hard numbers were $3.2B and $5.4B); CSX announced another $5B buyback program to replace the just-completed one.  CEO Jim Foote stated several times that their 2019 Guidance of low single-digit revenues came from reading the same headlines we all do and that repeated talks with customers suggested underlying economic strength and ’19 will see much lower fuel surcharges in the revenue mix). 

Q:  Overall, how did rail do in 2018?
A:  
Operationally it was obviously a solid year. Notably expenses shrunk by 2% despite the unit growth, safety improved (FRA reportables by 36%, for instance) and velocity gained 17%, dwell shed 13%.  However, on-time originations improved, but by a point to 78% - and O-T arrivals declined sequentially to a still-not-great 58% (YOY better by 2 points, to be fair). All this with a 6% reduction in headcount (which is likely to stay around that rate of natural attrition in the next few years).

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Alison Babcock
Ask The Experts: January 15, 2019

Tony Hatch
Independent Transportation Analyst and Consultant

Q:   Is Jim Vena, ex-COO at CN and newly appointed to the same critical role at UNP in their operating transition to PSR, worth $8B?
A:
  Jim Vena joined the UP and the market loved it.  In fact, the day after his announcement, UNP raised their Q4/18 OR target to improvement from slight increase – not on the property for a day and already they have to raise expectations (literally in this case). 

  • He is a proven PSR railroader, and thus eliminates any nagging doubts about the UP’s commitment to the process change.  But it does also raise some questions?  At RailTrends only 6 weeks ago, UP CEO Lance Fritz made an excellent case for the UP’s commitment and progress (accelerating the 2nd region to undergo the change, etc).  Does this move indicate stalled progress?  Or had negotiations and possibly legal efforts simply taken time?  And what is the endgame for Messrs. Vena (60 years old) and Fritz (a dynamic 55)?  Is one man (and one man not named “Hunter”) worth all of the new “Buy” recommendations?  I can honestly say that since RT18 I liked the story before, and this move only clarifies it and adds momentum. 

  • The earnings call on January 24 will be too soon for Vena to know much, though that didn’t stop EHH on his first calls on new property, at CP or CSX; in any event, we will be able to discern more about the new working relationship between the two Alpha-male leaders in Omaha.  In addition, the announcement added to the overt pressure on Norfolk Southern, the other rail undergoing an operating change (“informed by tenets of PSR”) – and BNSF, the only railroad not bringing in PSR (see Matt Rose, below, as well as more, of course, of course, on PSR).

Q:   What are your thoughts regarding commissioner changes at the Surface Transporation Board?
A:
  At the turn of the year, Deb Miller left the Surface Transportation Board but Patrick Fuchs and Martin Olberman were confirmed, joining with Chairman Ann Begeman to form a three-person Surface Transportation Board.  Of course, the full complement is 5….but the Board may feel it has enough heft to begin to tackle some of the issues before it as well as to, er, “monitor” the PSR efforts at the UP and the NS.   Recalling the Chairman’s speech at RailTrends18, that is something the railroads must be very careful about….see, for example, the recent WSJ article on “New Railroad Fees Attracting Scrutiny” on assessorial/demurrage fees as Ms. Begeman highlighted in letters to UP and NS and in her speech.

Q:   The Surface Transportation Board recently released its ROIC (Return on Investment Capital) numbers for 2017. What are your thoughts?
A:
  The STB – finally – released “revenue adequacy” (ROIC vs. WACC) statistics for the rails – but for 2017.  That’s unusually late even by government standards, and cannot be blamed on the lack of Commissioners (can it?)….the rails’ performance in this regard – and this is US-only so eliminates the excellent results from Up North – was “barely adequate”, or, technically, actually inadequate: Return on Invested Capital of 9.9% coming in below the Weighted Average Cost of (that) Capital of 10.04%, with four carriers above the line (UP 14.1%, CP’s Soo Line at 10.7%, BNSF and NS at 10.1%) and three below – mid-revolution CSX at 8.8%, CN’s Grand Trunk at 7.7% and KCS (US) at 7.1%.  Remember, this is already quite old news….And I am not sure it will mean reduced STB presence (the theory being that the rails are “inadequate” so not over-charging) given the dated info and the PSR efforts.

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Alison Babcock
Ask The Experts: January 8, 2019

Tony Hatch
Independent Transportation Analyst and Consultant

Q:  How are the railroads handling the implementation of technology?
A:
  The mindset has totally changed in just a few short years.  These include the visibility projects going on at the short lines, CN’s boxcar based track inspection (thus used in revenue service rather than capacity-sucking special cars – 8 on order for 2019), and automated train inspection portals (at speed – up to 60mph - and without the manpower and time of an optical inspection).

Q:  What do you think the future holds for Short Lines?
A:  
Short Lines may be entering a New Golden Age, in terms of organic growth fueled by technology, better Class I cooperation and merchandise focus – and through the creation of new shortlines (a la CSX).

Q:  What is your opinion on AAR's current rail traffic results?
A: 
 The results suggest a slowing economy (although, as mentioned above, the comparisons are more difficult). Overall, US+Canada, Intermodal + Carload, was up 2% in November, the slowest rate of growth in 2018. Only 9/20 US and 12/20 commodities in Canada showed increases. The US carloads were flattish (actually down 0.2%; ex-coal & grain up 0.4%); intermodal up as reported by 2.5%. Canada showed us a different story – carloads up 7.5%, IM +1.7%. Leading the charge was Chemicals + (especially) Petroleum, up 8% in the US (petroleum up fully 29%). Weakness came from US Ag, motor vehicles, coal, sand….Crude by rail impact was profound – up 29% US and fully 39% up North.

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Alison Babcock
Ask The Experts: January 3, 2019

Tony Hatch
Independent Transportation Analyst and Consultant

Q:  How it's been going since Almo was inaugurated on Dec 1, 2018?
A: 
Almo was inaugurated in Mexico City on December 1st, and it’s been a rough start for those who saw “moderate” in him and for those who saw better cooperation with the US (the FT reported that POTUS calls him “Juan Trump”).  In his inaugural address, the new President vowed to “end free-market policies” and decried liberalism. The FT has been particularly focused on him, as the headline “Investors in no mood for the Mexican leftist president” attests. Currently, Amlo is in a battle with the bondholders of the canceled MC airport project.

Q:  What is the most current information regarding the US Grain market?
A: 
The unintended consequences of distortions in the soybean supply chain are a historical fact (the ‘90s trade war vs Japan helped jump-start the Brazilian soybean industry). Now, the US exports to China are down 44% through 9 months. Worse, the “normal” rail move of beans, a mostly for-export crop, from the upper Midwest to the PNW – perhaps the most lucrative rail market there is, or was - is a much lower return move to the Gulf to backfill Argentina (which sends their beans to China). Meanwhile climate change’s frontlines, if not in coral reefs, are in Ag, pushing corn northward, for example (Canadian corn crops?) In addition, the still stoutly GOP farm belt (helped by the US Government bribes, er… ”assistance”) is now all of a sudden finding storage prices going through the roof, in part because the tariff-inflated price of steel! Farm equipment growth will be down some 4/5 this year. And, the US trade surplus in Ag will be the lowest in a dozen or so years….

Q:  Has rail traffic been increasing in North America?
A: 
  North American Rail traffic is hanging in there – in fact, in week 50 (12/15) it was up 4% (carloads a bit less than +2%, intermodal up over 6%).

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

Alison Babcock