Earnings Review/Including BNSF

February 27, 2019


“Too many equity investors are tourists….”
/Caisse de Depot CEO (and old friend/CNI CFO) Michael Sabia

Greetings from Houston, where SWARS (South West Association of Railroad shippers) starts tonight, and I will get a chance to hear from - and mingle with - the new CMOs of UNP and KSU, and the new CEOs of Watco and CIT Rail, along with what is expected to be a huge crowd of shippers in the chemicals/petrochemicals and plastics space, among other commodities: https://www.swrailshippers.com/wp-content/uploads/sites/5/2019/02/SWARS-2019-The-Woodlands-Agenda-v10-2.13.2019.pdf .  I expect to be the only analyst here, as per usual.  From here, after a quick weekend stop in Glendale, AZ to check on Clayton Kershaw’s shoulder, I head further into the western desert to La Quinta CA and the REF (Railroad Equipment Finance) rail-car conference, hearing from shippers, leasing companies, OEMs, and BNSF’s Matt Rose (for the 4th time this year!) – here is that agenda: http://www.railequipmentfinance.com/agendas

Note:  for Clients & Companies – this is likely the last note sent from IFS; they will no longer be my research selling partners.  Nothing else will change….

Speaking of BNSF, with Mr. Buffett finally gracing rail observers with his earnings, Q4/18 is finally complete.  Berkshire lamented the lack of mega-deals, and so will continue its new trend of buying back shares.  As for railways, I am not sure how you can sum up the rails without looking at the largest player in the group – not that Berkshire Hathaway makes it easy on us!  It will also be very, very interesting to follow BNSF this year; it’s long time leader, the afore-mentioned Executive Chairman Matt Rose, will retire this spring and so far his railroad is the lone holdout from PSR, potentially setting up the true test of growth potential and strategy, looking at the three rail models out there:  PSR, PHR (Post-Hunter, or PSR 2.0 – think Canada!) and non-PSR.  BNSF does have three discreet unbalanced (what some might call “boutique”, though more like “big store”) businesses - Intermodal (AKA “Consumer Products”; Ag & Coal - and the bluest of blue chip customers in those units.

BNSF’s net earnings grew 30%, more than 3X its operating earnings (thank you, tax cut – 24% rate versus 37%) on a 10% increase in revenues; volumes grew 3%.  Their OR increased a bit, 30bps, to an industry-high 65.6% (see below).  This compares to UNP’s 4% volume growth, but “only” 6% revenue lift, and OR 380bps lower.  Some of that can be attributed to the size of BNSF’s intermodal business, but I wish we had more detail to fully compare (such as ROIC!).  Speaking of IM, BNSF’s Consumer Products segment increased revenues 9% on flat volume (due to a “sizable” customer loss, but leaving their 11% “Purchased Services” increase somewhat mystifying).  Industrial Products, helped greatly by energy, and even, at long last, plastics, grew volumes 7% and revenues 13%; Ag was a healthy, corn-fed +5% (both) and even Coal grew volumes 5% and revenues 12%.  The good volume/revenue side was partially compensated for by expense increases, even beyond fuel – Compensation up 6% (on that 3% volume growth) and “Materials” up 51% pushed by Personal Injury and Derailment increases.  Capex will increase by 5% (a trend – see below).  Lets see what Mr. Rose says on Monday….


CP wins the Q4/18 “Blue Ribbon”, leading in four categories….So what else does the above table tell us (aside from the one-time benefits of the tax cut)?  A pretty good financial result given GDP growth of ~2.6%  Only three companies list ROIC – so how else are we going to get away from the “Cult of the OR” if we don’t include alternatives?  I surely hope this changes in the future.  Note that the best margin rails (and yes, that is what CN is now calling it!) also have terrific ROIs (and are spending for growth.  Note that capex is trending back up, with 5/7 showing increases and with UP flat, only CSX down YOY (CSX doesn’t have ROIC targets in its compensation plan and is focused on OR improvement – perhaps overly so.  That should change after 2020, if they follow the PHR/Canadian pattern.  And I hope that they do!

The Q4 and FY18 volumes speak of “missed opportunity”, given the 6.6% increase in truck tonnage for the year, and the well-known trucking driver issues – the ATA says there is still a 50K driver shortage, but FTR pegs that at 300K!  JB Hunt, Knight/Swift, Schneider and Hub all reported good numbers.  The financial numbers were rock-solid, but the metrics and the intermodal growth, related, was disappointing.  Service levels must improve, and with the increased capex and “measured approach” to PSR, I anticipate that they will.

And, once again, they were cautiously optimistic about this year’s environment (WSJ: “Railroads upbeat about the economy”).  They will have some things going for them in terms of service, as expected – the so-called “comeback” of CNI, the continuation of CSX entering what I think anyway, the next phase of their PSR experience (a la CP and their “Pivot to Growth”; CSX doesn’t view their pathway in quite the same way).  And some commodities have some real tailwind – CBR (if not sand), plastics (JoC: “the long-awaited boom may finally be here”).  They face a series of headwinds, however, at least to reported earnings:

  • The “Polar Vortex”, and the impact on network fluidity in the first quarter and possibly beyond

  • The slowing global and US economy (WSJ, again:  “January industrial numbers “strikingly weak”).  The expectations for S&P500 earnings have turned negative for Q1/19; FY at +5% (half of what it was only 3 months ago). Auto production will be lower, again….

  • Trucking moving back to “normal” and maybe even overcapacity

  • Trade issues – NAFTA 2.0 ratification and China (noting that the March 1 deadline was extended indefinitely via presidential tweet).  This is clearly impacting FDI and investment in  general….and led to warnings from CAT, B&D, Cargill, ADM, VW, Toyota, etc

  • Government interference:

o   AMLO in Mexico

o   Alberta oil markets intervention

o   Increased US scrutiny by the STB and Congress on PSR, etc

  • The tax cut being lapped (and with 84% of US companies not changing their investment strategy with the new tax rate according to the National Association of Business Economics, no lasting impact expected….)

  • The ongoing secular decline of coal, BNSF’s results notwithstanding, although it does illustrate the move of coal from baseload to spot, and the inherent increase in volatility along the decrease in volume.  The US EIA says that coal production will fall even faster than it had expected as recently as 2015, despite the so-called “end of the ‘war on coal’”.  The EIA expects another 20% drop in production  over the next 20 years, versus an earlier expectation of 18%.  Coal shares have been abysmal, reflecting expectations that coal will decline from 29% of energy share to 21% by 20135….

Also of note:

  • Shareholder information related to the rail group:

o   Even as Warren turns to share buybacks in lieu of big-gorilla deals, Democratic leadership is turning (further) against them, led by Schumer and Sanders.  Likely just ‘hot air’ as we near the election cycle, but….

o   NASDAQ and 319 companies have signed a letter asking the SEC to police proxy advisors, whose importance has greatly increased with the rise of “passive investing” and

o   Activist campaigns have grown in number, up 17% in 2018, to 247 (Lazard)

o   Schroders estimates that if environmental risk was properly accounted for  in 11K analyzed companies globally NAV would decrease by 2-3%

o   Private Equity outperformed the S&P500 by 2-3% a year 1986-2017 – but that gap is narrowing considerably….

  • CSX operations succession plans seem to be getting clearer as SVP of Network Operations Jamie Boychuk has been also given responsibilities for Engineering & Mechanical and Intermodal Ops (the latter being the segment until recently run by Amy Rice, 2018 “Progressive Railroading Rising Star”)

  • CSX also appears to have re-railed its line sales program, now having completed its (FLA) Panhandle line sale to Rail USA (and Gary Marino!)

  • Although Mexico has NAFTA 2.0 and AMLO issues unresolved, the Mexican Association of Intermodal Transport (AMTI) says that intermodal growth was 4-5% last year, led by cross-border up 11%.  What’s interesting about that is KSU, despite some late-year congestion challenges, grew 2X the cross-border market overall….

Anthony B. Hatch 
abh consulting