Mother of Dragons! Two Western Rails Interpreting PSR Differently - UNP & KSU Q1/19 Earnings Takeaways

April 23, 2019

Greetings;

“Chaos isn’t a pit; chaos is a ladder”.  Of the seven rail thrones, 3 have reported and have eclipsed Wall Street expectations; later today we’ll look to the North, as Winterfell, I mean CP, reports its results.  They will be followed by to me the two most interesting Houses in this song-cycle, Norfolk Southern and the Mother of Dragons, Canadian National (next week).

Two differing strategies to get to the Iron (Road) Throne:  Two western (well, west of the Mississippi) rails reported above-consensus earnings last week:  KSU growing YOY by 18% (adjusted; versus Street estimates of ~10%) and UNP, in its weather-dominated quarter, by 15% YOY (vs. ~12%); the former lowered its OR by 160 bps to (adjusted) 64.2% and the latter by a point – having absorbed a 160bps weather impact - to 63.6%.  it was also noted that “at Union Pacific we do not include real estate sales in our OR”.  Zing!  But more than the results it was the differing tone and tenor of the webcasts that struck me; both carriers unveiled for the first full time their PSR gurus (the high-profile big game Canadian prizes of Sameh Fahmy, Chief PSR Officer at KCS and Jim “$8B Man” Vena, COO at UP).  But listen to KSU CEO Pat Ottensmeyer in response to the baying of the analyst members of the Cult of the OR (“Shame!  Shame!”):  “Our focus here (is on) operating ratio improvement as a result of changing the way we operate and manage the network….(we are) primarily focused on service and growth”.  That quote could have come from the book of the Mad King, Hunter Harrison himself…. 

Union Pacific:  Summer is coming!  It’s not that Union Pacific isn’t concerned with growth – they in fact had to defend that accusation and did so with conviction – its just that their presentation was more traditional PSR, if revolutions can have a tradition, , cost and productivity and operations focused.  The fact that they reiterated their 2019 FY Guidance in the face of the 15 cents/share hit to earnings  from the flood is remarkable in of itself.  However, the faced their baying hounds on issues of OR – and capex (asking if PSR would allow UNP to spend – well - below 15% of revenues) with a different attitude, just as assured of course, but focused on productivity.  I have always said there are multiple ways to skin a raven.  It is curious. However, that the financial community seems to be unsullied, as it were, by the PHR rail experience in Canada (growth pivot backed by spending, high ROIC), even as Vena was a big part of it….

For UP, Specifically:

  • The fact that UNP reiterated its FYG on volume (low single digit, after Q1/19 started out as down 2%), pricing (Q1/19 “core price” gains of +2.75 were a step forward for UNP – though probably would rank in the bottom of the league tables); and OR (“sub-61% for 2019 & below 60% for ’20”) – after the weather ravaged first quarter was, and was attributed to, a sign of PSR working and resiliency being built into the network.  UNPO is almost entirely behind the operational and financial impacts of the storm and flooding….”We are moving traffic as presented”, noted the COO.

  • Most specifically, the reiteration of the FY19 UP goal of $500mm+ in net productivity gains (savings) was truly noteworthy – given that Q1/19 produced “only” $60mm in such savings (fleet size, train length, car hire, etc) and was matched by $60mm in “operational challenges”

  • Despite those challenges, 4/6 of the KPIs listed by COO Vena showed improvement (best – dwell down 19%), though safety, not highlighted, suffered (P/I up 22%).  It seems that they are making quick progress, without straying form their “measured approach” politically….

  • Hump removals!  Give the people what they want – UP reversed its strategy (after one quarter of a new COO) and closed/repositioned two humps, will add a third (it sure seems like a Chicagoland IM yard) and – after saying they were committed – stopping construction on the Brazos (NM) yard.  As CEO Lance Fritz correctly noted, PSR (or UP2020/G55-0) is “evergreen” – as it should be.

  • More bread for the masses – with locomotive  productivity up 6% in this difficult quarter, the stored-power roster reached 1900

  • The volume story was mixed – and I sensed an increased concern about the economy even if CMO Rocker was questioned about being perhaps over-optimistic; only CBR, industrial products  and international intermodal (“Tariff pull-ahead”, which may distort numbers till towards the end of Q2) looked good – but as stated in my “Preview” (and inherently obvious), this quarter’s volumes, especially for UNP (and BNSF) are hard to extrapolate from!

  • Capex conundrum – while being asked if they were able to reduce their spend (on a %/revenue basis), UNP will take the “savings” from Brazos (etc) and reallocate the funds to sidings on the Sunset etc to accommodate longer trains (clearly coming – train length was up 7% for Q1/19).  But I remain questioning – if not fully skeptical, given the known unknowns - about the long term, comparing UP’s PSR revolution to the ”Golden Companies”, the PSR 2.0 (or PHR) railroads up in the North, despite Vena’s claims of building a railway to last (“two, three, four and even five years out”; emphasis of course being my own). 

Mother of Dragons!!  KCS reveals its PSR Mantra – “Service Begets Growth”!  The subset to the code was four-part: Customer Focused; Facilitate Growth; Improve Asset utilization and (4th!) Improve Cost Profile”.  And yet, despite that unusual (refreshing) PSR ordering, KSU shook off any doubts that I might have had by going full bore on the concept (4 full slides, as compared to just one in the January webcast) and having their Chief PSR Officer as a major component of the broadcast/Q&A.  KCS was also impacted by the weather events sweeping through its largest interline partners as well as those specific to its unique location – trade distortions and tariff fears, teacher strikes, etc (there was little to no discussion of politics on the webcast).  But with the exception of, after the 1% decline in units in Q1/19, reducing FYG for volume by a point (to +2-3%; 70% of the book still is classified as “favorable”), the remaining targets were unchanged.  But my biggest takeaway was a bold view of PSR as a growth-driver (something that EHH always espoused); of looking at change not to please the lowest common denominator (“our approach is not to – just - close yards”) but to achieve their credo – Service begets Growth!

  • Mr. Fahmy noted their were “a lot of fruits still hanging”; presumably including some that are low-hanging.  I must say my only reservation was not his discussions, for I have a long-lived respect for Sameh; it was a lingering sense that a lot of the clear progress being made was coming from he and COO Jeff Songer (& team) and less from a systemic change – there was great stock taken in “exception reporting” (as there should be, I assume) but I think the market, having seen KCS rise, slump and rise again (like the House of Stark – which would make UNP Lannister?) would like to see changes that clearly could survive the loss of great PSR warriors.

  • Q1/19 Operating Metrics improved sequentially and YOY – dwell by 5%/16%; gross velocity by 11%/13% (KCS changed their reporting of this from net); and car-miles/day by 5% (YOY) – and with it the looked for net reduction of the locos (by ~100) and rail-cars (“1000 identified”).  PSR initiatives so far have accounted for ~$19mm in 2019 savings (which will grow to $25mm in annualized savings) – at a cost of a Q1/19 charge of $67.5mm.

  • KCS had the usual non-value accounting issues – in this case Mexican tax reform creating a GAAP change; they also effectively downplayed the Mexican government study on market dominance (covered before).  CEO Ottensmeyer strongly stated in the face of numerous questions that fact that there is one KCS – not a US and a Mexican system joined in Texas.

  • The KCS growth opportunities continue to show promise despite all of the political haranguing, etc – cross-border volumes were up 13% (revenues +18%) while “energy reform” related volumes grew 188% and revenues 164%.  Cross border IM volumes grew a less robust 5% (revenues dropped 6%) but recent border disruptions and the long truck lines they engendered are seen as, in effect, a marketing opportunity for CBI.  Lazaro was still dismal (-26%).

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