GWR Q2/18 Reflections: Back in the Game?

August 2, 2018

Greetings:

GWR joined the list of rails reporting Q2/18 earnings that beat consensus estimates and cruised far past last year’s results  - now only BNSF remains between you lot and my Q2/18 RR Earnings Review.  Earnings came in at 4% and 4 cents above last year’s and Q2/18 Guidance, and about 2 cents above consensus.  That they were helped – a lot – by the tax cut doesn’t detract from their obvious optimism on their webcast about the demand side and their ability, in future, to bring in 50%+ incremental margins, on the one hand.  And on the other it adds dry powder to their choice between more share buybacks and/or more M&A – and in regard to the latter, their recent (“favorable” ) ruling on the CSX “proceeding”, final decision due soon, may bring them back into the game with the current Class One short line sales leader.  And that would be big news indeed….

The popular takeaway was the demand story and the quarterly performance was good, with hopes for incremental improvement.  But GWR did have some trouble bringing the demand down to the bottom line, due in part to the fuel surcharge lag – but also to the costs of derailments, a bit of a shock from a carrier whose very first slide again showed their injury rate roughly 2/3 that of the Class One average (comparing GWR’s 6mos to the C1’s Q1 results, which slightly flatters the former).  Full year carload growth expectations were raised slightly to a very healthy +5%.  The NA results were buoyed by the fully 8% increase in same-railroad car-loads (GWR had a great slide in the appendix highlighting their H1/18 volume outperformance to the C1, ex-IM).  Metals showed that GWR was so far avoiding any tariff hot (and lumber, resourced to the PNW, showed that in Q2, anyway, they might actually have benefitted from the trade war.   Core price was up ~3% (leading to what I like to call the “Peggy Lee Pushback”:  “Is that all there is?”).  Service from their C1 partners was still sub-standard but, unlike Q1/18, didn’t warrant a line item….

International operations were contributory – “Everything feels really great in Australia”, said CEO Hellman, and Australia came in on plan.  Meanwhile, the UK/Europe was actually ahead – enough so that GWR is considering not parking some power as had been planned (but not enough that they didn’t get the usual “what would you differently now” question.  Bulk was surprisingly strong in the UK, and their competitive position improved.  For Oz, the prospects are also improving – new trainsets on order, some of the new spot business is being converted to contract.  The huge expected jump in Q3 volume versus a more tepid revenue growth expectation reflects that in 2018 the customer is taking, not just paying.  No commentary on the big questions being raised on the very (intrusive) nature of regulations on freight rail prospects Down Under….

The biggest “story” for GWR, upon reflection, concerns their capital structure, M&A and share buybacks.  They bought in 2.7mm shares ($192mm) in Q2/18, about 2/3 of their program completed.  The extended and added to their credit facility (+500mm plus “unlimited capacity” below 3.25X leverage.  They can maintain a “balanced plan”.  They can easily find partners, of course.  And they are in the process of “active evaluation of acquisitions and investments in multiple geographies”, which we interpret to mean short line sales in North America and train sets Down Under (and one expects, not much in the UK/Europe).  And with the CSX legal (near) resolution, hopefully they have a seat again at the biggest table in the US?  But note – there’s a rising issue of rail asset inflation, with all of the big money (Carlyle’s new fund, for example) now chasing rail deals and all of the notoriety around the CSX packages have helped to flame a valuation issue for some of the professional, strategic players – as GWR’s Hellman noted “you could say there has been a slight change in emphasis (on buybacks vs. M&A) simply because we have seen more value in ourselves than what we’ve seen in the market”.  Does that include the 8 or so Chessie lines, which presumably heretofore they haven’t had the chance to fully evaluate?

Anthony B. Hatch
ABH Consulting
http://www.abhatchconsulting.com/

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