Sanity Restored? Takeaways from the Western Rails - UNP & KSU

Greetings;

Hot!

I am in Norfolk at the AARS (Railway Superintendents) conference in the lame-duck HQ of NSC, featuring not only hometown/NSC CEO Jim Squires and top shelf operations personnel (https://supt.org/event-3097339 ) including CSX CMO Ed Harris, in a daring raid onto enemy territory, but also many top execs coming to support their “Rising Stars”, including at least two (other) Class One CEOs….so it will power-packed and I plan to never go outdoors (the heatwave in NYC wasn’t enough, I have to go chase it southwards….). Meanwhile, late last week UNP and KSU reported earnings that seemed to stabilize the markets….and both carriers have resisted one common result in PSR carriers – the reduction of information shared (for example in the number of actual, non-picture slides in the quarterly presentations, where both webcasts were chockablock).

“UNP’s earnings lift railroad stocks/eases railroad fears/help put rail stocks back on track/etc” – so ran the many headlines (and the analyst congratulations – one semi-tough question came with an almost tearful apology!) after UP reported essentially the same trend as CSX – weaker volume outlook, reaffirmed OR targets - but in a more palatable manner (evidently)….Union Pacific reported a 12% increase in (YOY) EPS – consensus was +9% - despite a 4% decrease in volumes and the OR declined 340bps to a record low 59.6%. revenues “only: dropped 2% because pricing was up almost 3%. The new-ish four commodity categories read thusly, in terms of volume and revenues YOY” Ag (flat, +4%); Energy (-9%/-13% - yikes; not only was coal down 7% but sand was down fully 50% - I wonder if the rails contributed to killing this once golden goose?); Industrial (again, the primary target for PSR - +2%/+4%, with plastics traffic up 6%); and Premium, or IM & auto, -5%/-2%. The largest subcategory here, Domestic Intermodal, showed a worrying 11% decline, and that’s supposedly without de-marketing – CMO Kenny Rocker said lane closures have had a “very minimal impact”. Looking slightly ahead, UP sees 6 of 12 categories as positive, 4 negative and 2 (grain and trade-related) as “?”. UNP expects sequential but not YOY volume gains in H2/19

Operating efficiency clearly saved the day for UP – expenses declined 7% on the 4% volume drop. Headcount (and comp&benefits) dropped 8%. 4 of the 6 listed KPIs improved. Productivity gains were $195mm gross, $170mm net (after weather-related “operational challenges headwind”), but UNP reiterated targets for FY productivity ($500mm) and OR (below 61% this year and sub-60 for next. Safety was interesting – it was listed at the top of the Unified Plan 2020 continued focus list, and as an inflator of “Other Expenses” due to higher casualty costs – but safety stats, a normal operating metric (P/I, accident rate) were nowhere to be found. In fact, we need a deeper dive into the related U/P2020 KPIs since those listed in Omaha last year (pre-management shakeup, pre-PSR) are obviously useless….

An observation:

  • This was clearly COO Jim Vena’s call – in the Q&A he fielded questions ranging from operating efficiency opportunities, further headcount reductions (accelerating in H2 fleet size and yard/terminal closures (not definable answers) to OR targets – too conservative? (hints of affirmation) but also on intermodal, and customer-facing metrics such as performance vs. trip plan, etc - most often the purview of the CMO….Following up on CSX’ call without their CMO and COO on the scripted portion, makes me wonder whether on-air time is a new KPI (maximizing the utilization per speaker) for PSR?

Kansas City Southern – beats expectations on an adjusted basis, and reassures the markets but (slightly) disappointed me. In addition, they fell victim once again to the “It’s Always Somethin’” Syndrome (in this case the OR dilutive but income neutral Mexican fuel excise tax elimination) and had a complex quarter. Cutting through all that, their EPS grew (adjusted/diluted) by 6% and their OR fell by 30bps to 63.7% . They too followed the Q2/19 rail pattern of reiterating near term revenue growth and intermediate term OR targets while capitulating to the inevitable on volumes, with more than 6 months traffic booked (now “flat to slightly down” for 2019). Pricing obviously is strong. Q2/19 carloads were flat, but 4/6 commodity categories were down, one flat – and chemicals/petroleum up 18% - led by refined product shipments to Mexico (“Mexican Energy Reform” volumes grew 125%, revenues 136%). Their outlook is split 60% positive, however, 20% neutral, and 20% negative. That latter category includes energy (coal, CBR and sand) which makes sense, - and Intermodal, both in Mexico (hurt by the unequal fuel tax) and US domestic (truck overcapacity). I do not like the sound of that….nor the phrase from CEO Pat Ottensmeyer (RailTrends 2019 Railroad Innovator of the Year) that “with the exception of intermodal, things look good….” And, in fact, in Q2/19 cross-border intermodal volumes grew 10% and even Lazaro Cardenas volumes grew (by 2%). So what happened to “Service Begets Growth”, their (excellent) mantra from April? Yes, Pat said it in the Q&A, but this felt like a more standard USA PSR story unfolding, rather than the exceptional one I saw in April. Time will tell….

  • Operations were sort of mixed – operating expense increased 4% on that flat growth level; headcount was flat. But, early stage PSR is working for them too – dwell improved 11%, velocity 12.55, cars on line down by 17%. Their active loco fleet is down 12% form YE18, and system car fleet by 7%. There’s more to come (and another related charge) in H2/19. In fact, they have more than doubled their own targeted 2019 PSR benefit level, (to $40mm from $16mm; on an annualized basis from $25mm to $55mm). making up for some of the volume headwinds.

  • KSU cut planned 2019 Capex to “below $600mm” from their earlier range of $640-660mm; reiterated that the YOY increase was due to the now completed $140mm loco plan. Capex will still be at ~18% of revenues for 2020-21, but this still feels like a sop to the short term. Yes, volumes are weaker or at least more uncertain – now. Yes, PSR has reduced the asset base (rolling stock etc) and what’s left is newer. But what is the outlook five years from now? What are you implying? We know that rails are awful at precisely matching supply with demand – so why try? Come one guys – be best!

  • AMLO keeps trying to reduce Mexican dependence on US refined products, KCS’ shining star, but the markets aren’t buying the Pemex reform plans – at all….

On to CNI (looks great on the surface) and NSC, perhaps the most interesting and important webcasts of the group for Q2/19….

Anthony B. Hatch
abh consulting
http://www.abhatchconsulting.com
abh18@mindspring.com