Rails - Mid-Winter Bits 'n' Bobs & Thoughts on GWR, NSC, ETC
February 22, 2019
“(Hump Yards) may not represent the frontiers of technology, but it is a distinct advantage over ‘flat switching’, the traditional technology”/Noted railroader (OK, “New Yorker” writer) John McPhee, “Coal Train” from “Uncommon Carriers”, 2006. McPhee also noted that with the PRB coal growth in that period, the increased “viscosity” seen on the Union Pacific, the railway he traveled on….Meanwhile, the list of Class One hump yards in North America starts with UP at 12, NSC at 10, BNSF 8, CSX 5, CN 4 and CP 1.
Pitchers & Catch-Up: So, over the past 6 weeks we have seen a flurry of rail-related news, earnings (“Q4/18 Review” coming after BNSF/Berkshire reports – now slated for tomorrow, February 23 – although the WSJ still lists 3/1 as the report date), major analyst meeting, and 5 conferences – which meant that some important events or decisions occurred without comment, so this is a catch-up on mid-winter news….before the next round of conferences next week (SWARS – chemical & plastics shippers – and REF – railcar OEMs/shippers/leasing companies and bottoms-up rail volume plans by car type). Some Top Ten thoughts/occurrences: There was, interestingly little discussion of PSR, almost a welcome relief, but curious in light of GWR (and the entire shortline industry) needing to come to grips with it (pre-blocking, and so on) and the renewed focus, at least publicly, in short line relations from the almost full PSR adopted Class One sector. They did say that CSX disruptions weren’t that costly in their transformation (~$1mm), and that UP and NS were truthful in their claims of being collaborative (see NS and short-lines, below).
GWR – Making North America Great Again (for short lines) – riding strong (+6.5%), above Class One trend volume growth, Genesee & Wyoming beat earnings expectations by over 10% in Q4/18 (making it 6 for 6 got the Group). However, they see volume decelerating (F:+2%), but they still expect a healthy (+12-17%) growth in earnings and a 100bps reduction in consolidated OR to ~80-81%. In a shift from historic norms, they are presenting themselves as a “North American short-line rail holding company”, at 2/3 assets/sales and 80% of the bottom line. Nonetheless, the Street continues to focus on the “chronic under-performance” (from the webcast Q&A) in the UK. Management would like us to view the Aussie operations, 51% owned, as, in effect, a dividend, with contractually-structured reduced variability (weather, etc) and run “almost independently”. Their upside from the coal alliance with Glencore looks good over the next few years (more trainsets likely ordered this year, back-stopped by future contracts) – but the intermediate-to-longer term is something to think about in light of Glencore’s astounding announcement that they were capping coal production at 2019 levels. Both will be overseen in part by their former group COO (see below). GWR won’t divulge ROIC (seen as competitive advantage in M&A – not much discussed, either).
More thoughts on NSC – & PSR - after a rash of Street ratings upgrades (with a price target – always silly, given the wide range of investment types and durations – range of something on the order of ~$133-$200!). One recurring thought is, perhaps leaving Virginia isn’t so bad after all, given recent events. Many have questioned whether NSC’s targeted 5% revenue growth CAGR is too low (me – given pricing of 3%+) or too high (given the recent CAGR track record – coal-effected, of course, and the perhaps over-optimistic auto estimates; Bain has production dropping to below 12mm by 2025).
a. Another thought regards short lines and NSC - and immediately after the Investment Day, most of the management team flew to the Forest, their SC “retreat”, for a meeting for the top players of their 250 short line connections. Reviews of that meeting were (also) positive, with the NS team showing signs of confidence but also some measure of….well, I heard that there was a lot of discussion of “you’re on – or you’re off the team”, a la Hunter Camps and EHH’s “I can see it in their eyes” mantra.
i. Short Lines are expected to be the second biggest growth contributor, after
ii. But you know it don’t come easy: Car type reductions (simplification) will
come with some pain, as will, of course, increased “pre-blocking”
iii. It was reiterated with even more emphasis that short line sales are unlikely with
the new Watco “Ithaca Line” likely the last for some time….
iv. There was some expressed concern that the coming headcount reductions will
reduce institutional knowledge, break longstanding relationships and leave too
few sales people (it was noted that there is only one salesman in the NE – but
since its NEARS-superman Chad Grinnell, that may be all that is required….
b. “A Railroad Legend’s vision Loves On” – from Bloomberg/BusinessWeek January 28, noting the industry is “re-making itself in Hunter Harrison’s vision”
c. The rail observer “old guard” remains restive concerning PSR – my friend Fred Frailey of “Trains” wants to see a Class One RR CEO “running scared” (for fear of obsolescence) – I say, look up, pal! In Railway Age (RA) we read about “captive shippers exploited by the rails and a do-nothing STB (wait for it); the former a myth exploded by the very same STB’s hearing on CSX’ PSR transformation (you remember EHH’s post meeting assessment – “so shippers had to turn to the highway and pay more for trucks than rail service; well kiss my deleted”). Finally, also in RA (“The Ghost of Rail Xmas future”, is the claim that “the PSR trend – contraction & reduction – seems incongruent with what the industry needs now”. So, I say – see CN & CP! Look for the PHR (Post-Hunter Railroad0 – a story of investment – and growth. Where to look for this? Why, look at your very own cover story!
d. Which is JJ Ruest, CN’s CEO and the RA Railroader of the Year! JJ reiterates the case he makes he makes for investment – in the first mile/last mile portion of the supply chain (drayage and ports) and railway capex, given their 15-16% ROIC. This was the only argument/educational topic neglected in the NSC Analyst Day….
3. Personnel changes all over the industry! Time seems to be moving faster….
Amy Rice, head of CSX Intermodal Ops, (formerly head of the CSX lines sales program) and the star newcomer at the CSX Investor Day last year, has resigned; after all of the praise heaped on her by her superiors, this is a shock. There will likely be some more clarification on succession issues in CSX Ops soon.
John Orr, SVP and Chief Transportation Officer at CN, retired (announced today) after 30 years….one assumes he has the standard CN non-compete or he would already be a rich(er) man
GWR announced – after the webcast - that Dave Brown was longer serving as their COO (although he is still running important projects in Australia and the UK); there may be other ops leadership changes there, too….
Matt Bell was named head of the National Rail Construction (NRC) trade association; well-deserved, succeeding his old boss Chuck Baker, who is running the ASLRRA (short lines group)
KSU upgraded Sameh Fahmy from “PSR Consultant” to EVP-PSR!
Omnitrax, the short line holding company (part of the Broe Group) named two big rail players to its Board – our friend Dave Garin, retired Group VP/Industrial Products, BNSF, and Cameron Scott, the former UP EVP & COO; that’s pretty big firepower for an SLHC.
4. Alberta, formerly the “Texas of Canada”, has morphed into the epitome of the planned, interventionist economy (the Sweden of North America?). The government announced the planned 3-5 year lease program for 4400 tank cars (originally a planned purchase of 7K), and plans to contract capacity on CN & CP. The question of where they will find the cars will be a big point of discussion at REF (Railroad Equipment Finance) at the beginning of March; by the time the fleet is assembled, might pipelines be ready?
This is the second interventionist step after Alberta imposed 9% production reduction quotas on the oil sands – with the unintended effect of narrowing the price gap to the US so much that is sharply reduced CBR, if perhaps temporarily. Imperial Oil halted shipping CBR from Edmonton to the US gulf and blamed the Alberta government; refiner/destination Phillips 66 said the Canada-US CBR “economics are now closed”.
On a related note, Canada’s election is this October, and suddenly it seems Trudeau might be in trouble; his leading opponent, the Conservative candidate, is described by BusinessWeek as a “skeptic of globalization” (uh, oh – for Canada?!?!) and as “pro-Brexit” (really?!?)
5. Trade….as ever. Always in the headlines, never any resolution. So is March 1 a read tariff deadline (from 10 to 25%), or not? So, our government somehow doesn’t understand a fundamental principal of long term investment – certainty (January “Inbound Logistics”: “Uncertainty is the bane of supply chains”). We’ve already entered an era of what The Economist labeled “Slowbalization”, with trade running at GDP levels rather that 2X; in a late-2018 global survey The Economist reported that 49% of company respondents expected a closer/simpler supply chain over the next 5 years (but that number is only 45% in the US); 18% expect it to remain the same – and 33% expect their supply chains to be longer and more complex.
i. January inbound container imports were up 4.1%
ii. China re-entered the US soybean market, on a demonstration basis. Cargill and ADM
expressed hope for a successful trade deal; ADM offset 70% of its China grain with
sales elsewhere. The USDA’s Forum
(slides: https://www.usda.gov/oce/forum/2019/speeches/Johansson_Slides.pdf )
says that it will take several years to work off the US bean glut (assuming these
negotiations are successful).
iii. American steel seems to have become addicted to tariffs (“lobbying extensively for
them” – WSJ) - but like a lot of addictions, this one too might not be good for them
(encouraging capacity additions of some 20% over 2017) which caused coiled steel
prices to reverse course in H2/18 (-21% after jumping 41% in H1); steel shares
iv. VW (auto tariffs) and Maersk (global trade/protectionist trends) both cited this issue as
the major factor behind sharply reduced 2019 outlooks – tariffs could take a 10-15%
bite out of the former’s earnings, and led to a 20% cut to the latter’s outlook.
6. Mexico – “So far from God, so close to the United States” (Porfirio Diaz) – AMLO is the topic, of course, for 2019 – pumping up Pemex capex through “tax relief” (note – the annual pipeline “shrinkage” is estimated at $1.6B!) after a “disastrous” (multiple sources) investor roadshow in the US; dealing with an upsurge in “industrial actions”, making anti-business comments (The Economist: “On a daily basis AMLO shows an antipathy to economic modernization like no other Mexican leader in 30 years”) but less so in actions (and actually Mexico raised $2B in debt, 4X oversubscribed, to pay off the Mexico City air[port bondholders, a notable victory).
7. Traffic – January was, for rails, a month of two directions, as noted by the AAR’s RTI. There was strength in the first three weeks, weakness in the last two (Polar Vortex, government shutdown, trade uncertainty). Note that two of the three are self-inflicted; for why the third had an impact see CN video, below). For example, weeks 1-3 saw US carload growth of 8%, and IM of 6%; weeks 4-5 saw declines in both of 7%. Overall, 11/20 commodities were up (US); total (US + Canadian traffic (CL+IM) was up 1.9%, IM alone up 0.8%. But the contrasts with truck was sharp: the ATA reported that after a December lull, January truck tonnage grew 2.9% (or 5.5% seasonally-adjusted); truck capacity grew even more (Class 8 sales up 40% for the month, YOY).
8. The Federal railroad administration in the news:
a. Their February PTC Update noted that all of the rails either met their 12/31/18 deadline or successfully extended for two years; 83% of the freight miles in the US are now covered,
b. Nice guy/great railroader Ron Batory, the FRA Administrator, finds himself caught in the battle between the White House and California over, among other things, the Wall – he issued an order canceling $929mm in HSR (high speed rail) funding
9. Conference Nuggets over the last month (from MARS/DU/GET/ SW RR):
a. The big issue of Truck Size & weight appears to be “DOA” according to trucking lobbyists and the ATA, at the DU Forum – noting that the trucking industry cannot agree on the issue, making it hard to lead to action on the Hill; meanwhile the ATA is all for a user-pay system to break the infrastructure funding deadlock and sees AV as driver-assist, not driver-less
b. PTC benefits on the cheap? At the Southwest Rail Conference, Ron Lindsay (ex-CRR &CSX, now running Strategic Railroading) talked about what he called “virtual PTC”, a low cost, low maintenance way to get to the promised land of “moving blocks” and increased visibility (etc) – perhaps a solution to extend PTC to non-mandated areas to reap the capacity/IT benefits?
c. CIT Rail, at MARS, sees about a fifth of railcars in storage – and this before the full effect of PSR at roughly half of the industry; interestingly they are considering investing in domestic intermodal equipment….
d. Matt unbound” BNSF’s retiring Executive Chairman Matt Rose has been unleashed and is out talking about the need for equitable, user-pay infrastructure development; PSR and the potential of increasing regulatory oversight; the need for increased tech spend and savviness; future rail consolidation (unlikely, as we have covered before), and the non-OR benefits of the $3B spend on its fabled Transcon intermodal route (helping to generate an ROIC of ~15%....
10. Winter is ending/Winter is still coming: Amazon’s growing role in the logistics side is cited as a major factor behind the Chapter 11 filing for New England Motor Freight, and a $600mm (!) reduction in 2019F revenues at XPO….I still view AMZN as an opportunity for rails, but then again, so did NEMF and XPO….
Other important facts & factoids:
AV investment has exploded – from $282mm in 2015, not that long ago (!), to $4.5B last year! Investment banks put Waymo, the acknowledged industry leader, as having a value of between $175B (Morgan Stanley) and $250B (Jeffries)
Maersk has admitted that is weakening credit rating will prevent the newly streamlined carrier from doing any major deals for a while, in an industry ever-ripe for consolidation, in addition to the
The EU killed the Siemens-Alstom rail (OEM) merger, despite the rising China threat
The announcement from TVA that they would close two coal-fired plants despite government pressure (to….keep them open) has an immaterial effect on CSX and is really more of a sign of the secular pressure on US utility coal from a cost – and political – perspective.
That USDA Ag Outlook Forum also predicted that while US corn and soybean trade should grow (again, IF….), US global market share will decline by 7 points over the next decade (to 36% and 31%, respectively); separately, Bunge, under activist investor pressure, is said to be strongly considering asset sales….
Thoughts and Media Reviews!
Barrons like Wabtec: a week ago Sunday Barrons stated that “WAB bearishness seems overdone”, quoting (my former NatWest colleague) Blair analyst Nick Heymann. Note that on March 11 I will join Nick for a rail/WAB luncheon at Blair’s NYC offices – one topic will surely be the PSR-fired loco fleet reductions coming at UP and NS; my visit with WAB/GET in January convinced me, however, that locos are in many ways the “hardware” and that GE technology – the “software” – will be the key to the their (and the rails’) future….
What might have been, now that the deal is off - Virgin Rail USA (formerly Brightline, formerly All Aboard Florida), the Fortress-created passenger line on the FEC rightaway, IPO Presentation: https://www.retailroadshow.com – though Fortress then nixed the public deal in favor of a potential private one….
Former STB Chairman Dan Elliott’s DC rail conference agenda: https://d38k609s96gn1e.cloudfront.net/_jobs/247892/docs/2019PassengerandFreightRailroadsUniteDraftAgenda013019.pdf
Blockchain pushback? https://www.nytimes.com/2019/02/15/books/review/blockchain.html?rref=collection%2Fsectioncollection%2Farts&action=click&contentCollection=arts®ion=stream&module=stream_unit&version=latest&contentPlacement=12&pgtype=sectionfront
Why winter makes railroading tough – a great 2015 CN video: https://vimeo.com/user10659353/review/141187132/56b39106b0 and see photo of CP and friends in a BC winter wonderland, 2014 (attached)
For the foamers out there: https://www.bostonglobe.com/arts/art/2019/02/17/making-diorama-century-north-shore-railroad-has-consumed-this-man-life/GgThppl2ahGfWM2FXgDtFP/story.html?et_rid=720312685&s_campaign=todaysheadlines:newsletter
Anthony B. Hatch