HNY/Rails - The NRC, STB & the New $8B Man! (ETC)

January 10, 2019

Greetings and Happy New Year!  (I can still write that, can’t I?)

So some big things happened to start the year – starting with the top three:  1) Jim Vena adds $8B to UNP market cap 2) the STB loses one commissioner – but adds two; 3) the STB also releases ROIC numbers – for 2017 – and the NRC Conference, always important, rises to essential this year with amazing long star-filled panels on PTC and PSR….

1. 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?  And if that’s the case, what is Mike Cory (CN’s COO – more on the estimable Mr. Cory below) worth?  And what about the Man Himself, Mr. Keith Creel of the CP?  The men who might also prove invaluable are the lawyers on both sides of all of their contracts….In any event, JV joins 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).

2. And now there are three (at the STB).  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 RT18, 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.

3. Revenue (sort of) adequate?  Speaking of the STB, they – 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.

NRC was an embarrassment of riches!  National Railroad Construction & Maintenance Association (NRC) Conference was an amazingly detailed entry to the New Year for freight rail.  NRC is always worthwhile – and this year also provided the annual insight into the state of rail capex from the contractor’s viewpoint (quite positive if not ebullient) as well as from the railway engineering departments (even a tad more positive, if continually frustrated by the permitting process).  But in 2019 it outdid itself – providing a new (NRC + RSSI) panel on Signaling & Communications (read: PTC), a Fireside Chat with BNSF Executive Chairman Matt Rose (beating but – I promise – not excelling my own version of this next week at MARS); and a Panel on PSR featuring 2 former CN ops execs, Howard Green, author of the by now seminal book on EHH, “Railroader”, and CN’s (current!) COO, our old pal Mike Cory.  Kudos to NRC CEO Chuck Baker, Chairman Mike Choate (Wabtec/RCL), Jim Hansen (Herzog) and old-RT friend Steve Bolte (Danella).  As we have learned about RT18 – the bar’s been set pretty high – now what are you gonna do?  I have attached the slide deck I would have given….So, in order (with switchbacks because PSR was of course a constant theme everywhere):

1. C&S/PTC – “PTC will be the biggest change for/in rails since dieselization” – Matt Rose.  The panel featured every major rail except NSC, and showed a range of readiness – BNSF ahead of schedule, with 2mm trips already undertaken, to CSX at 94% implemented (their extension was received on December 18th, in the nick of time due to a still over-extended FRA) to GWR (in a separate presentation) being about halfway complete with their loco-only implementation but already being interoperable with the two big western rails.   But this “fraternity of signals engineers”, who have worked together across carrier lines for a decade or so, are now excited to see light at the end of the tunnel, and to road test their new PTC data machines.  None more so than CSX – fully committed to PSR, having a real “sense of urgency”, and where data is king (EHH: “without data you only have opinion”).  While UP noted, interestingly, that “there really wasn’t anything wrong with the old system”, CN noted on its US PTC-lines a reduction of signal-based delays by some 55%.  It should be noted here, however, that in the later PSR panel CN’s COO Cory thought that PTC would be disruptive to precision scheduling, at first, before bringing the benefits of added capacity and data, data, data….

2. Matt Rose, as always, tells it like it is – Starting by detailing some highlights of his 19 years (!) at the top, and his moving his company from the public to the private (or Berkshire-owned) markets – saying that he had reached a point after 39 quarterly earnings calls (and at that point I could have sworn he winked at me) and dealing with new hedge-fund whiz kids, where he thought private capital made better sense (“I wish all railroads were out of the public markets”), he then went on to preach on three broad topics: DC Risks, PSR, and Consolidation:

a. DC – the BNSF is at the forefront of the public frustration with permitting (to spend their own money, and lots of it, mostly with major public benefits involved); he also expressed concern with other ways of government interference such as the possibility of mandating two-man crews (especially galling as the DOT, etc, roll out the red carpet for AV trucking) and once again supporting the highway mode over others if they were to institute a major infrastructure spend without user-pay provisions.  PSR also raises the risk of STB intervention – see below….

b. PSR.  He is not a fan.  While some of his engineers in other panels stated things like “we don’t subscribe to PSR although we use precision scheduling for portions of our business”, Matt went so far as to quote Hunter himself:  “This is all bull (crap)”.  Why?  Well, I would posit that the huge unit train franchises of intermodal and grain (and even still coal) are not PSR-accepting.  But Matt also noted that PSR didn’t show reliability improvement to him (interline service with PSR carriers hasn’t improved).  It might, given the importance of the OR (the “cult”) put downward pressure on capex in an industry whose ROI requires spending on capacity.  Worse, it raises regulatory risk by “re-defining markets” – by de-marketing lanes despite the common carrier obligation (especially if both carriers – say CSX and NSC, de-market the same customers or locations).  That last bit was a revelation, to me anyway.  But maybe the best line came earlier, at the C&S panel, by one of his engineering lieutenants: “We don’t want to fit customers into our network – we want to work them and become more customer-centric”.  Compare that to the “eliminate boutiques” mantra at the UP (et al)….So, can a quasi-private BNSF remain the lone hold-out after their current leader rides off into the sunset?

c. Consolidation – not gonna happen. “The public litmus test (enhanced competition) isn’t supportive”, and the valuations are so high that M&A or MBO/LBO (going private) would be prohibitively expensive.

3. PSR Panel – CN’s take. What is PSR, exactly? Well, it is clearly operations focused (80% of CN’s management meetings under EHH were about ops).  It is clearly a fast-moving change .  it is about simplification and clarification.  About responsibility and leadership creation.  The panel thought that Vena would indeed bring that change-agent focus to UNP (remember, UNP and NSC are the first two railroads to try PSR without Hunter or even, heretofore, one of his top acolytes; they are also the first to try a new PSR-infused Operating Plan while being led by the same team running the old Plan).  It is indeed about “sweating the assets”.  It is a “war on bureaucracy” (just gitter done) and often (too often?) leads to other fights (with other stakeholders.  It is not (necessarily) about humps (CN, being a big merchandise railroad, needed its humps and retained most of them; CP, being at heart a big bulk railway, did not).  It is about cutting costs but not, after the initial re-sizing of the asset base after taking out all of the “buffer stock” on people, track and equipment, not necessarily about cutting capex (see CN’s upcoming second mega year in a row when they announce their plan later this month).  PSR has always been hard to define, because in many ways it is a combination of older ideas with that “sense of urgency” and accountability – as the great railroader Tug McGraw said in 1973 – “Ya gotta believe!”

4. The only down notes – some grumbling about the usual “over-focus” on the OR (again, see “OR, the cult of”) but maybe with some validity….one supplier talked about a major railway taking a major haircut in rail ties, claiming theirs now “lasted longer” (some predictive intelligence etc may help in that regard but the supplier thought the concept preposterous); in other cases their were non-ops layoffs (such as in state lobbying efforts going into what appears to be a bigger re-reg threat year – TSW etc .  If PSR sheds assets (and employees are teammates but also “assets”) as precision scheduling rolls through the railway (and eliminates the need for “buffer stock”), this sounds like pure cost-cutting unrelated to any of that.  It smacks, without all of the facts, of a Big League ball-club cutting out, say, 10 scouts ton save money, whose combined salary is equivalent to the Major League minimum, and whose value is a multiple of that….

In addition – Random Railway Thoughts:

  • Why hasn’t the short line (ASLRRA) names a new CEO after 7 months?  It took the mighty AAR less than half that time – and like with the AAR, the best candidate is right there….

  • Canapux!  “Railway Age” pointes out (December) that the various court decisions blocking/delaying pipelines only serves as a further boost to my favorite new technology, CN’s Canapux, delivering heavy crude in plastic pucks….

  • Real trux:  Q3 Driver Turnover dropped fully 11 points in Q3/18 – to 87%.  Another sig of a missed intermodal opportunity?  On the other hand Class 8 orders fell 43% YOY in December (and 24% from November)

  • Introducing Virgin Trains USA!  Richard Branson et al bought a minority stake in the exciting Brightline (Fortress) venture in South Florida, which has been renamed for the second time….

  • CN joins its brother PSR carrier, CSX, in changing its reported service metrics as of 1/1/19 (with past restatements) - https://www.cn.ca/en/investors/key-weekly-metrics

  • Speaking of new railroads – Happy Birthday to the Florida Gulf & Atlantic, the ex-CSX “Panhandle” line now owned by Rail USA (Gary Marino!) and the Ithaca Central, Watco’s first foray into my Empire state; meanwhile RJ Corman won the contract to serve all 4 Toyota loading sites – that’s a big win….

  • Shale drillers – woof.  A new study says that drillers missed output projections in the past few years….by 10%!

  • Refining capacity – AMLO plans to begin a new $8B refinery in his home state of Tabasco this year – which could be an issue for the importing of refined products, a hot rail market opportunity.

  • Stating the Obvious – The Jacksonville Journal notes that CSX’ focus will be on Operating Ratio improvement in 2019….

  • Stating the Obvious Part 2:  “Outgoing House Speaker Ryan fails to mention transportation in his farewell speech” (Transport Topics)

  • Stating the Obvious Part 3:  (Coal) Mining Firms to Cut Output (in 2019)” – WSJ

  • Stating Treason – or “Is ‘Trains’ Magazine a major part of the RR 4th Estate or the 5th Column?” – In a column on “Future Freight Railroads”, Brian Solomon argues for automated operations (see KSU’s promise of full automation in 6-10 years) but also for “Open Access Arrangements” – get this – “comparable to those in place in (that freight train paradise known as) Europe”!!  The argument is that it (open access) would lead – I swear to God – to “greater incentives to improve infrastructure”!  Someone needs a course in “The History of the Soviet Union”!

  • Speaking of the FSU, I do like Sanford Bernstein research quote on the big phase in funds:  “Passive Investment is worse than Marxism”!

  • Q4/18 Preview next week, along with the mighty, might MARS Conference….

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