Ask The Experts: May 8, 2019
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.
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