GWR seeks Gold in High Valuations & Rail Meetings in the Southwest (SWARS & REF)/Takeaways

March 12, 2019

Greetings;

After a last gasp of travel, before SEARS next week (hearing from BNSF/Industrial Products, XPO, major paper shippers, and Clarence!) ; some relevant quotes over the past week plus on the road:

  • Self driving – “the technology might be here but the promises are on life support….”

                       /Ashley Nunes, Researcher, MIT & Harvard (as quoted in the Palm Beach “Desert Sun”)

  • “Rail must build from the huge advantage of vertical integration while massively leveraging technology”

                      /Rod (“Dr. Doom””) Case, Oliver Wyman (who also noted at REF – below – that rail has so much to gain with technology application above and apart from “driverless” – “Why pick this fight now?”)

  • “Operating Ratio” is a naïve fixation”

                      /BNSF Executive Chairman (for 20 years, until April 2)  Matt Rose (who also quoted his predecessor Rob Krebs:  “Grow or Die!”)

Before the parties, the news:  I have attached my slides from today’s William Blair luncheon/call on rails and technology (with a focus on WAB/GE, followed closely by my host, my old colleague and friend, Blair’s Nick Heymann); as you know I cover the rails, not the suppliers.  I have also attached (separated from the main body) two talking points slides on GE+WAB; the combined company will be a (the?) key player in helping rails regain their technology mojo; whether that is enough to overcome locomotive production uncertainty is for other folks to decide….

Over the last week I have attended two of the best conferences on the rail calendar, SWARS and REF (shippers & rolling stock).  Takeaways below….Whilst traveling, time refused to stand still, so first the Top Five of the Current “While I was Away”:

 

  1. GWR Goes for Gold?  GWR CEO Jack Hellman, beginning at their late 2017 Investor conference, and many times since, noted that their current scale and the massive valuation inflation had made doing deals difficult – but that, on the other hand, that same asset craze (infrastructure and PE firm driven) made a re-evaluation of their own company most interesting.  To that end, Bloomberg published an article late today stating that sources say (hmmmm) that GWR is “exploring strategic options, including a minority stake” and that they are “working with a financial advisor and have  begun early-stage talks with potential suitors including Brookfield A.M. and other infrastructure-investment firms”.  The emphasis was mine, as I note that GWR already has a deal with Macquarie in its 51% owned JV in Australia.  At REF (below) Greenbriar Capital’s Mike Weiss noted that before 2015 the average LBO purchase multiple had never hit 10X; with 2018’s record 10.6X it has now done so that last four years in a row. 

  2. There is a lot going on in the short line space (CSX selling, Fortress selling its last one Down East, Gary Marino returning, lines for sale in the east, etc etc) and this just adds to the drama….It seems like a feeding frenzy,, but it is timed to the asset sale stage of many of the early segment buyers (and the potential need to reinvest in the network) – as well as to a PSR-fired renewed emphasis on short lines as partners (“pre-blocking”, etc) and as sales targets.  CSX just has their short line meetings (more details in the next note, as well as an attempted explication of their various personnel moves/succession plans, etc).

  3. Hatchet job?  CBS “60 Minutes” – historically one of my favorite shows - on 3/3 took on rail safety via an “investigation” of three recent Amtrak crashes; here’s my initial reaction as written to my aunt, who was scared off of Amtrak (they should sue) by a particularly vicious and under-researched account: “What a crock. Rails aren’t unsafe – their safety record is one of continuous improvement.  PTC isn’t being somehow, someway purposely delayed (why?).  The rails have spent $15B on it so far (CBS implication that foot-dragging is behind the reason of why isn't it out in the field again, why?  The answer is because PTC is hard). The key is interoperability - linking Amtrak to CSX trains for example - hasn't been done anywhere before. And if/when the two systems do NOT link  - everything stops. “60 Minutes” also showed a segment of track in SC and said there is a derailment there almost every year (no proof or even evidence); thereby implying that this segment, and even freight rail in general, is under-maintained. In fact, we all know what 21s century rail capex has been.  The American Society of Civil Engineers gives an "infrastructure rating" every 2 years. US overall - D-! Rail got the only passing grade (B) and that was held down by under-investing in passenger/transit....

  4. Wal-Mart to join Amazon as transportation disrupter?  WMRT’s decision to use more of its own transport brought bad news to dedicated truck fleets at more than a few locations around the country – but, as with AMZN, may hold out a silver-lining for rail – using its own driver pool (8K) and a “new proprietary container design” (Transport Topics) is expanding further into intermodal!

  5. More retirements?!? Say it ain’t so!  Apparently it is (cue the dirge), so we wish not only Matt Rose (exiting stage right in early April) the best, but good friends Allan Roach (WATCO) and Jack Dail (SWARS)  thanks – and Vaya con  Dios!  And, sadly, Joe Boardman, who served as he FRA Administrator and the CEO of Amtrak: RIP.

Southwest Association of Railroad Shippers Key Takeaways:

  1. SWARS was extremely well-attended (a record 700+) and featured impressive presentations by 3 critical new (since the last conference “cycle”, say) Playuhs, er, Players:  Watco’s new CEO (and ex-Expo!) Dan Smith, and new CMOs at UP (Kenny Rocker) and KSU (Mike Naatz); for that matter, adding in CIT’s Jeff Lytle (even though he spoke at MARS in  January) meant that SWARS was truly a “New Breed” rather than “Old Guard” event.

  2. UP rocked SWARS (I am sure this isn’t the first time he/they have heard or read this).  The idea of the Union Pacific PSR process being more collaborative and less confrontational (than the shippers’ collective memory of CSX in 2017-18) was endorsed by many (of the many) shippers, as well as Watco (Smith:  this is an opportunity to do what we do  best for our partners”), in attendance.  CMO Rocker, no relation to the Braves reliever that inspired “Eastbound & Down”, really stressed the need for UNP to simplify its plan and that UP2020 (not “PSR”) in order to become a more reliable service partner (UP’s service began to deteriorate, slightly but consistently. In the beginning of 2017, well before Hurricane Harvey).  His answer to the challenge that PSR/2020 was a Wall Street-inspired, OR-focused cost-cutting formula, strongly rebutted that the impetus was service consistency – UP will grow their way to (better) profitability, not shrink”.  A better answer might not have been possible; so UP’s marketing is talking the talk; operations has accelerated the new plan – let’s see how soon they walk the walk.

  3. KSU continues to navigate a stormy macro-sea, but recent talks with AMLO & Friends (see below) have been encouraging.  Interestingly., KSU only brought up PSR on their last slide – although this was a shipper, not an investor, audience.  PSR will “have a role in restoring KCS to the title of ‘fastest growing railroad’ – and service (is what) begets growth”.

  4. Many stakeholders remain skeptical about PSR, often misunderstanding it as only investor-driven – coming as well from a mis-characterization of the Street as being only short-term investment driven.  This was evidenced at both (all?) conferences; references to BNSF’s intermodal success because they don’t have shareholders to listen to (as if Buffett didn’t care); references to PSR as being only cost-cutting and in fact anti-growth – and in fact “pure marketing hype”! (ulp! PLG); hope (by railcar lessors; below) that PSR didn’t really “sweat the assets”; etc; the short term view (irony!) that “if it’s so great what about current velocity trends (hello, Polar Vortex?).  To which I say – “Increasing shareholder value” does NOT have to be oppositional to growth (see CN!).

Railroad Equipment Finance 2019 Conference Takeaways: The railcar market appears to be still overbuilt.  Some fast facts and thoughts:  As CIT CEO Jeff Lytle noted at SWARS, car supply/demand equilibrium is historically achieved with about 10% of the fleet parked – but that number is currently about 18%.  With ~1.6mm railcars, normal replacement-only additions would be about 40K/year; expectations for 2019 are in the high 50s.  Lessors won about 54% of the fleet (and growing) excluding TTX at 6% (the rails and shippers own about 18% each).  Critical to the leasing industry is rail velocity – will it decline then improve as is the normal PSR pattern?  Will PSR lead to shedding more cars so the total parked goes possibly well above 18%?  (Yes.)  One issue concerning equilibrium is the wide variety of car types and related markets (which is what helps make REF so interesting, from a bottom’s up point of view).  This combined with the leasing companies’ historic inability to resist over-building into a boom (think: ethanol, CBR, sand, plastic pellets, etc) combined with the growing trend of builder/leasing company hybrids makes equilibrium difficult to achieve; and yet, current pricing doesn’t seem to justify the new builds.  Some other takeaway thoughts:

  •  Watco CCO Stefan S.P. Loeb advocated for a boxcar pool, in one of the most interesting panels in the desert.  Wither the box car has been a long-time theme at REF – with an ancient fleet dropping even faster than sluggish markets, railroad desire to homogenize the fleet (to two types; mirrors the PSR desire the avoid over-“boutiquing” their plans).  What’s new is that the markets have revived, especially paper (packaging) and offer cyclical, secular and modal share growth opportunity.

  • Even the head of supply chain (Manager, Coal & Rail William McNally) for Oklahoma Gas & Electric readily admitted: coal is in a continuous decline phase….

  • IM guru Ron Sucik reported talk that TTX was on the verge of announcing an order of ~$1B of intermodal equipment

  • UP’s “General Director of Equipment Distribution” Adam Simeon discussed his railroad’s move from train to car focus (and revealed that UP is relying on HIS’s macro-economic forecast calling for a sharp drop in US GDP next year to +1.6%)

  • There was much consternation – at BOTH conferences - at what’s seen as Alberta’s ham-fisted entry into the markets, both in terms of production (-9%) curtailment (PLG: the province is “acting like OPEC”) and entering the car markets (the famous $C 3.7B investment said to produce an almost $2B windfall; an opportunity that somehow escaped the capital markets).  PLG also took Mexico to talk for their efforts to repair Pemex (noting the weakness of the country’s refining capability).

  • Chicago Freight Car’s Todd (Henrik) Kahn covered the hopper side, seeing massive over-capacity in sand/cement cars (much of the back-log is not expected to actually be built), anticipated over-building in plastic pellet cars (stands to reason given historical trends though PLG saw that fleet as being “in balance”) and the loss of rail share in Ag weighing on grain cars.   Some of that is the trade war impact on soy beans especially 9the golden rail crop) as well as short haul trucking taking more corn (and dropping rates).

The last big speech by Matt?  After years of basking under the Berkshire Hathaway “Cone of Silence”, BNSF Executive Chairman Matt Rose has been on the road with plenty to say, as you all know.  REF provided me with the fourth such opportunity this year to visit with and hear from the “Future RR Hall-of-Famer”.  He continues to be a rare holdout unwilling to sip from the buckets of PSR Kool-Aid being passed around the industry, and decries (what I might say is a short termist bastardization of PSR) focus on a cost-cutting driven rail operating model (“not in the best interests of our industry”).  However, this time he did in fact allow that CN’s post-PSR (“PHR”) model was “a great one”.  Specific to PSR and the BNSF, his stand on “Boutique” versus “Balanced” networks is clearly in favor of the former; for BNSF, given the power of their Intermodal (whose relative underperformance in 2018 had to do with the Japanese steamship consolidation), Ag and Coal franchises, unbalanced all, lends great credence to that stand.  We noted Matt’s quotes on OR and (Krebs) growth, above. 

  • Matt took some issue with my (immediately prior) presentation slide on “Railroad Renaissance 2” (service driven share gains in intermodal and industrials) noting still-enormous coal decline headwind (Matt:  coal has not yet “stabilized”, as I had said).

  • BNSF’s ROIC is around the level of UP’s (~15%), despite the OR difference, driven in part by the differing intermodal franchises; given what Matt believes is the “real” cost of capital of “about 7%” (compared to the STB’s official number for 2017 of ~10%), that is a business worth investing in (taking to task those who are cutting capex as a % of revenue – he’s looking at you, CSX & UP).

  • BNSF was a pioneer in what is now called PTC; Matt remains a believer in its benefits.  However, “with 36K grade crossings” he sees a (near-term?) future of attended not full automation (in other words, one man crews).

  • My friend Bill Vantuono of railway Age wrote this about Matt’s talk (note my continuing differences with the characterization of the PSR model as one that (overly, apparently) favors decreasing expenses – wait, that’s a bad thing? – at the expense of growth – again, folks – look to Canada!): https://www.railwayage.com/financeleasing/matt-rose-at-ref-2019-its-about-growth-not-cutting/?RAchannel=home

Also of note (speaking of BNSF, of regulations, etc):

  • BNSF won a case in the Supreme Court this week (BNSF vs. Loos) upholding their interpretation of injury settlement, specifically that payments for “lost wages” are taxable….

  • Bloomberg hosted a webinar on rail regulations with AAR and NITL on Thursday (3/7) - Here is the registration/replay link: https://bloomberg.cwebcast.com/ses/UbbGAXtAPpuFouhFiIL92A~~?ref=analyst

  • As trade wars appear to be cooling off with China (along with the Chinese economy, forecast to grow ~6% in ’19), are they heating up with the EU?  The trade “deficit”, much watched despite its irrelevance, has widened 16% since January 2017….

  • Three news organizations/two interpretations: while the WSJ reported positively on the announced 2.6% US Q4/18 GDP growth, which indeed beat Street expectations (+2.2%), but the NYTimes stated that “The economy loses steam after surge at midyear” and the (neutral) FT stated that “US growth begins to weaken in fourth quarter”….and the AP (from the Arizona Republic) noted in its headline that “Economists looking for a slowdown ahead”.  And that may prove true – US manufacturing slowed in February (ISM at 54.2 versus 56.6 in January).

  • Adding to Prime Minister Trudeau’s mounting woes, Canadian GDP grew only 0.4% in Q4/18; and the under-the-radar “comeback” of gulf heavy crude is a direct response to Canadian crude transport issues….

  • And finally Mexican prez AMLO (verbally) attached rating agencies (S&P and Fitch) for their Pemex and national debt rating downgrades (and vowed to bring “new-liberal” leaders of the past possibly to trial for “failed policies” – yikes!).  It’s clear that the national debt downgrades are directly related to the government spending to try to prevent the Pemex downgrades….as the FT reported, despite high approval ratings, “Economic reality catches up with Lopez Obrador” – noting a 1.5% decline in FDI in 2018, and a Q4 reduction in industrial output of 1.7%.  In a speech commemorating his first 100 days, AMLO  said the economy is fine:  “There is no hint of recession….as analysts forecast with bad faith”.  The rhetoric has a ring of familiarity about it….

Anthony B. Hatch 
abh consulting
http://www.abhatchconsulting.com