Back to School Special

September 7, 2018

They don’t get it – that’s why they’re analysts
-My friend Hunter Harrison to AP reporters, as quoted on “Railroader – The Unfiltered Genius and Controversy of Four-Time CEO Hunter Harrison” by Howard Green

Greetings

I realize that publishing at the end of summer isn’t always the smartest move, so for those of you that care, I have attached my August 31st piece (“MAFTA”): READ HERE.  Before a month of acronym rail travel (SEARS/IANA/AREMA/NEARS/MSU/CP – more detail on the conferences in the next note), I thought I would present a “Back to School” Special, with words of wisdom from my Group of Railways Wise Men, notes from the Precision Scheduled Railroad (PSR) master himself, Hunter Harrison (a review/extraction from the soon-to-be published authorized biography), and some updates on recent events.  The next note will cover the always well-timed (if overly CFO-reliant) Boston Railroad Equity Conference, the upcoming shipper-rich schedule, rail car leasing, etc….

 

Canada still in the game?  First, clearly the USA backed off from its hardline last Friday (8/31) deadline for Canada to join the Mexico-US agreement on “NAFTA 2.0” (ie; “MAFTA”) despite mean-spirited swipes form Washington about them (as well as Congress and Labor on this issue).  The sopa opera continues….

  • The bad reviews keep coming in:  NYT editorial position (“A bogus deal”), and BusinessWeek’s excellent behind-the-scenes, gossipy “This is your brain on NAFTA”

  • FYI, the USA has a surplus with Canada on….dairy.

  • Ford, which may or may not have moved its entry-level car production from Mexico last year, to China, now will, given tariff issues there, simply not make the model at all.

  • Overall, the auto industry seems somewhat relieved that the talks aren’t getting even worse for them (although getting Canada on board was of course essential to the industry) – one supplier was quoted as saying that “MAFTA” as presented, without all of the details, of course, was a “solution in search of the problem”; the Center for Auto Research (CAR!) stated that despite the rhetoric one shouldn’t expect a big influx of auto jobs in the US

  • Meanwhile auto sales were flat in August (above consensus save for GM) with expectations of an H2 stall

  • Interesting timing for “Trains” magazine’s otherwise excellent cover story on Kansas City Southern, covering much of what I saw personally (and wrote about) form my May trip to Monterrey – upside from cross-border, intermodal, plastics, grain, and refined products (IF).   The article quantified the Laredo bridge opportunity (border crossing simplification) – from 22-28 trains/day to 36-45.  Excellent points made on the importance of capex to future growth even if initially unpopular (former CEO and “NAFTA-Railway creator Mike Haverty: KCS spent “much to the chagrin of many financial analysts who followed KCS”.  Not me!).  Haverty also says: “I am amazed – amazed that somebody hasn’t come after KCS!”.  Hmmmmm………

Wise Men take us to school – so I reached out to 22 rail leaders, all operators or asset owners (and, sadly, all actually men, so far).  My “W/M” list (as opposed to the “League of Extraordinary Gentlemen” tasked with the Chicago capacity/fluidity report) is ~3/4 retired and includes 11 C-suite types, 6 of them former CEOs, as well as 5 group heads and 3 Ops/Strategists.  Half responded (I had a late August short deadline; the results as it were temporarily preempted by MAFTA) to the basic questions – What do you think of the railroads today?  And where do you see the industry in ~ 5-years’ time?  I received 8 detailed, thoughtful responses, a 36% hit rate – not bad for the summer doldrums.  Of the 8, 3 were unambiguously positive (all, notably, from former CEOs, including some notable pioneers); 2 would be described as “negative” or at least “concerned”, and 3 were….in the middle.  Sounds about right….We’ll do this again….Highlights (only slightly edited, not of course for content):

The Good:

  • “The North American rail Industry is in excellent shape today as reflected in the reported results”….

  • “The NAFR system is as strong as it ever has been in history.  The railroads have invested billions and billions of dollars over the past decade….and the lines are in great physical shape….I only see the NAFR industry getting stronger over the next five years for one main reason (highway congestion)….”

  • “The current state of the NAFR industry from a market standpoint is the strongest I have seen in years, (due to, in part) the shortage of truck capacity (although the rails too have difficulty hiring crews)….technology will help rails become more efficient; I am optimistic as long as the rails make those necessary investments to capture growth opportunities” which is tied to his belief that while “OR will continue to be a key measurement tool….revenue growth, yields, EPS etc will become equally important to the Street”

The Bad:

  • “I see the future of rails to be challenging…the economy is ripping along and the rails are on cruise control….have you noticed the decline in overall capital spending (A: YES) – reflecting a negative economic outlook or ‘gilding the lily’ for their buy-side (investor) overseers?  (I have) a generally low opinion of the overall quality of the rail leadership (due in part to the )incestuous development and promote from within culture, with few exceptions, at the rails (NOTE – I have heard this expressed a fair amount of late)”

  • “We are looking at a huge missed opportunity (NOTE – readers won’t be surprised at that comment!), (even here, with a focus on carload) - this is a classic case of playing the short game when the long game is called for (due in part to the) OR focus (NOTE: not say “Cult”) and price inflexibility.  When truck capacity normalizes (and it will) it will present a huge issue for the rails who by that point will have been used to a price/service combination that is based on shippers’ limited alternatives.  The solution to all of this is to stop the focus at the railroads on OR and unit prices increases….”

The Unsure:

  • “Railroads are financially string with a mature carload business and IM opportunities.  Cost containment/elimination has become the name of the game (the mighty OR chase). It seems like the RRs are content to see small traffic gains (tied to a growing economy)and add traffic (only) selectively….the frustration is the railroads’ inability, or lack of interest in developing a good consistent service product”….(Over the 5 years) “the slow growth/OR chase pattern will continue.  The future of intermodal is the real wildcard – will RRs improve service?  The new logistics world is not going to wait for the rails, it will lap them….”

  • “The state of the rail industry is great if you’re an investor, pretty good of you’re a customer, and not-so-good if you are a prospective customer….(NOTE: interestingly: ) rails are running well and the big problems of CSX and CN seem to have evaporated (the CSX metrics are pretty impressive); rail pricing has gotten reasonable, too”  - BUT rails seem to have a baked in no-growth future (regarding those prospective customers – what are the Class Ones doing to keep or increase their share??  (Finally) I think we will see a lot of short line spinoffs….if CSX completely follows through it will be a very different company….maybe creating a new sales channel”.

  • “The PSR/Hunter/OR game has left us whip-sawed – the drive for (unhealthy) efficiency has left the RRs with no ability to have anything other than the “perfect amount of resources, and since we live in an industry (NOTE: and an economy) of constant change, (NOTE: and given the terrible state of demand planning) that goal of perfect balance never occurs – as a C-1 exec told (the writer) ‘we are trashing years of future success in search of riches in the next quarter’ (NOTE: oof!)”.  But, “that trajectory will not last long (see post-Hunter success in Canada).  We need a ‘maverick CEO’ to buck the trends and show the power of some of the franchises (hello, Omaha?).  I see opportunity for young leaders to pick up the industry from the ashes of PSR….so, question to you (me) – how do we get investors to start looking at this industry in a sustainable way again to usher in my bright-future scenario? (NOTE: How indeed?)

The Master – Hunter Harrison’s authorized biography “Railroader” gives a great back-story and highlights the values in PSR (if not always the ,most diplomatic way to get there).  “Railroader, available soon (I received an advanced copy) isn’t a how-to manual like “Switchpoints” was (the 2009 consultant-speak – ironically given EHH’s “fire the consultants!” mantra – look at the behavioral science behind the changes at CN, filled with things like the “consequences pyramid” and the “ABC toolkit”, which interestingly heaped praise on Keith Creel – beginning on page 113 – and current CN COO Mike Cory on page 131). 

A good read - Both boil down SR/PSR as being about (all) asset turn, with quick results (note that CN’s velocity increased 16% in EHH’s first year).  Yes, I am cited (as is Hunter’s receiving the RailTrends/Progressive Railroading Magazine’s Railroad Innovator of the Year award in  2009).  By the time he got to CSX he was sicker than I had thought, and had it further boiled down to a playbook, with perhaps too much emphasis on the investor stakeholders; I am talking about perhaps a slightly unbalanced wheel,  obviously higher velocity improves the fortune of all of the stakeholders involved, eventually, but the book quotes EHH at CSX as knowing y then exactly what he had to do to improve results – “I know how the Street thinks; that’s the most important thing to me”….other interesting revelations (or confirmations, as it may be):

  • EHH changed the CN hump yards to flat-switching (“outlived their usefulness” ay CN, in part because of the development of unit-train business; by his time at CSX he seemed to disparage both!

  • There’s a great scene at the IC that EHH describes himself – tearing down all of the “Customer is Always Right” signs at HQ!  By which he meant, as we now know, that catering to each individual customer ruins efficiency – the rail should move more like an assembly line, removing as much variability as possible….

  • Former CN CEO Paul Tellier: EHH was “awful” at government relations….Former CN Chairman David McLean – EHH “was an effective change agent, but once PSR was implemented running the railroad day-to-day was not his strong suit”.  “Effective” change-agent?  Ya think?

  • “Switchpoints” does have interesting blurbs (“Railroader”’s aren’t out yet) including by Pat Foran, the esteemed editor of said “Progressive Railroading” magazine, and by former UP CEO Dick Davidson; the latter is interesting on SO many levels….

Also of note:

  • ISM through the roof at 61.3 – the last time we saw that was at the very beginning of the “Railroad Renaissance”, 2004.  Meanwhile, the ATA reports truck tonnage up almost 9% in July, 8% for the first seven months.

  • Infrastructure completion - Did you go to the parade?  I-95 was completed this summer….

  • Coal is holding on, globally – EIA puts coal share at 38%, same as 20 years ago (due to EM growth)

  • Has frac sand gone from shortage to glut already (WSJ)?

  • Maersk – back to the future?  Trying not only the Northwest Passage but now actual sails?

  • Anyone hearing any activists out there??

  • “Atlas Obscura” loves trains:  READ HERE

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

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