Rails - KSU & CP Produce 2 More Wins? Quick Takeaways - And the market for Canadian railroaders just got more expensive

January 23, 2019

Greetings from Denver University and the always-excellent DU Transportation Institute annual rail/transport Seminar (schedule attached);

Two more calls, two more wins (rail earnings beating expectations; narrowly at KSU and more expansively at CP).  The talk is still all-PSR all the time – even when there are some other important topics (trade?).  An old (Canadian, of course) friend shows up at KSU in the person of Sameh Fahmy, the CN tornado – and another with the (finally!) selection of the NRC’s Chuck Baker to take the top posting at the American Short Line & Regional Railroad Association (ASLRRA).  CP, meanwhile, just keeps setting up targets and knocking them down.

Canadian Pacific beat consensus in Q4/18 by some 6-7%, and last year by 41% (adj); their OR (adj) was 340bps lower to a (still hard to adjust to) 56.5%.  And still there was talk about low guidance (“mid-single digit RTM growth, double digit EPS growth”) and taking their OR even lower, on a full year basis.  Revenue growth was impressive (+18%) in Q4/18, but unit growth (the way I look  at things) was more mundane - +5% (which will be more in line with the industry).  In that regard, the 8% increase in Opex and 10% in Comp/Benefits (headcount up 6% in 5% more cars handled) was….pretty good.  Pricing was obviously good (close to +4%; renewals more like +4.5%).  Operations/Metrics were stellar, actually – Dwell and Velocity improved by 6% and 3%, respectively, and safety was terrific (injuries down 14% and accidents down 31%).  Call it PSR, call it Canadian know-how – CP is running a pretty tight ship.  Their near term outlook has some revenue timing issues, no big real estate sales, improving more in H2 and into 2020 – but there is no dark clouds in their horizon.  but is Some thoughts:

  • There was expressed concern about the evolving Alberta oil situation – with the narrowing spreads to US oil prices after the government of Alberta intervened in the market place to reduce production by some 9-10%.   CBR remains the biggest wildcard for 2019 (although the narrow spreads has seen an uptick in interest, anyway, in the Bakken!)

  •  Intermodal saw revenues up 11%, RTMs up 7% - but units up 2%.  They won a big domestic deal (“Dollarama”) and extended their largest international (and, I believe, overall IM) customer Hapag Lloyd.

  • Free cash was up 41% in 2018; it is expected to show “moderate improvement” this year (no planned RE sales).  Capex is flat to up ($1.6B versus $1.56B spent in ’18); CP thinks it has available capacity (“even if RTM growth doubles our Guidance – as long as it isn’t concentrated in one sector”).  CFO Nadeem Velani stated that their capex plans go through a rigorous process, and thus investors should expect “no negative surprises” (which to the audience meant no sudden increases; less so to this observer).

  • Most impressive all was not the OR, of course – but the ROIC of 16.2% - a 10% YOY improvement and quite an achievement - and yielding the first question on re-regulation threat, given PSR, new Congress, and snazzy returns – as we have mentioned “all year” so far.  CP also reiterated their displeasure at being “investigated” for service issues in Vancouver, but seemed not worried given the metrics. 

  • One Canadian not on the market: CEO Keith Creel is locked up till  Q1/22, by which time the current PSR programs should be on the “pivot to growth” trajectory; in addition he (and the team) just got a raise and he said he was “having a great time” at CP.  As in baseball, taking KC off the market raises the value of a lot of other players.

Kansas City Southern beat estimates, also though not as much nor as celebrated (late last week), by 1 cent (WSJ) and 3 cents (SeekingAlpha), and showed adjusted YOY growth of 13%.  The reaction from the investors was a bit different than with CP – but then again KSU is just, sort of, entering PSR rather than “pivoting”.  It should be stated at first that the stock is up some 8% since last Friday in a rising market.  But that is short term – on the longer term analysts kept boring on what I would say is KSU’s level of commitment (and Guidance) to (and in) the PSR process – questions on the amount and timing of “cost takeout” (rather than operational improvements that yield lower costs), or on “accountability”, etc.    But as CEO Pat Ottensmeyer noted repeatedly – they are not starting from a position of relative disorder (CP); in fact they produced a mid-table FY18 OR of 64.3%, flat despite some congestion issues and massive political distractions on both sides of the border.  Still, seeing “incremental” improvement from the magic PSR revolution seems small to those who, perhaps superficially, see only the great OR successes at CP and CSX.  Three things stand out to me aside from the expected hyper PSR focus: 

1.       The introduction of Mr. Fahmy, on board (as a consultant) since last month– a procurement tyro who worked closely, as was pointed out, Jim ($8B Man) Vena – but also with EHH himself as well as Creel, Ed (CSX) Harris, and CN’s own Mike Cory.

2.       KSU’s seeming full embrace of PSR (to somewhat skeptical listeners).  To quote Pat – some have “written that maybe PSR doesn’t apply to us because of our size and because of the magnitude of our interchange.  We don’t believe that.”  COO Jeff Songer added “I look across (our railway) and don’t see any of those (PSR fleet right-sizing) elements that aren’t really applicable to our network”.  But at RailTrends only some 6 weeks ago, Chief Innovation Officer (former CMO) Brian Hancock laid out a solid case for taking some parts of PSR and not others (note – Brian was in the room but unfortunately not on the call).  In fact, the original (Q3/18 call) discussion of PSR at KSU was because of the size of their interchange, with the PSR-changing UP.  Incidentally, COO Songer stated that “we are not really seeing any difference yet in service” – neither interchange blowback nor improvement - at UNP – food for thought as we listen to their webcast tomorrow.

3.       Before PSR, KSU seems to have righted the ship in Texas and Monterrey and is planning a sizable (~27%) increase in capex for 2019 – though as I was getting excited about the renewed commitment to growth capacity  - not that KSU hasn’t funded this segment significantly - I remembered that’s mostly the already-announced loco purchase.  Capex will still stay around the 20% range through the year after next (then – ugh – maybe slightly decline on a “%/revenue” basis).

Also of interest from this quarterly call of many moving parts:

  • KSU sensibly thinks that the recent tragic events in Mexico around pipeline gasoline theft only highlight how rail can help mitigate this growing economic and political problem; refined products still looks to be a big plus for the company for some time.

  • Cross-Border – the heart of the KSU “story” grew sharply in Q4/18 (revenues by 14% and volumes by 16%) – and within that category Cross-Border Intermodal Volumes grew 22% (given that, the revenue growth was a tad disappointing at +8%).   So – when will that be enough to move the needle?  Recently, Slower than expected growth has emerged as one of the top investor concerns – and the Guidance to +3-4% level for 2019 even if true isn’t constructive in this area (note there are some ramp-up, Sasol delays, CBR uncertainty (see above), and other headwinds, but we want to see a distancing from the traditional “manana” disparagement.

  • Trade etc – no one asked about this; Ottensmeyer is a hero for his defense of NAFTA (1.0) and free trade, and it is true that NAFTA 2.0 was signed by all three nations.  But it hasn’t been ratified!  My best DC insider/expert things there will be a lot (a lot) of sturm & drang but that it will pass Congress.  But, still, it hasn’t yet,  and that is assuming the shut-down ends, eventually.

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

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