Rail Earnings (Cont): Takeaways from KSU & CNI

April 25, 2018

Greetings:

GDP (Grounded into a Double Play):  Canadian National and KSU reported – slightly but still - below expectations but declared their confidence in their upcoming, especially H2, “plate appearances”, with some justification.  Meanwhile, NSC is reporting now, and UNP tomorrow, and judging by the EPS surprise at Norfolk Southern, one might wonder what all the fuss about service and operational fluidity is all about….More on that tomorrow.  CNI provides an object lesson on what congestion and capacity shortages can do to the bottom line – and what can be done to restore their reputation for excellence.  KC Southern shows us what sticking to one’s business plan and ignoring the swirling, tweet-filled hype can bring.  Both carriers fell just short of expectations, guaranteeing that the rail group, even with the NSC “surprise”, will fall below the overall market (80% beating consensus quarterly estimates) averages for the first time in a while.

KSU’s results looked worse on the surface – a mild “miss” versus Street expectations in an 11% YOY (FX-adjusted) increase in Q1/18 EPS; volume up only 1%, OR up 40bps (to 65.8%).  But a quick peak beneath the hood reveals the always volatile FX impact, a “rail network congestion impact” (essentially interchanges with BNSF and, I suspect, really UNP in Texas – more on that tomorrow), and the well-known Texas utility coal decline effect.  Taking a longer term viewpoint, there was actually much to admire, starting with a pretty fair operational performance, and with fully 80% of KSU’s volume listed under the “Favorable” category for FY18 (April +4% volumes - has been ahead of plan even if Q1 slightly below), pricing running ~+3% (and gaining impetus), the coming lapping of Hurricane Harvey….and also:

  • The NAFTA renegotiations appear at last to be on an intensive fast track (2 weeks?) and look positive for the first time in a long while; coming elections, Mexico’s success in other trade treaty “updates” (with the EU), etc, and the trade focus switch (for now) to China may all have played a part.

  • Discussions with the leftist (and leading) Mexican presidential candidate, Lopez Obrador,  appear to have been fruitful in terms of their concession and on the continuation of energy reform (and willingness to abide by any successfully renegotiated NAFFTA treaty by the current ruling party); in addition the whole rereg (“COFECE”) threat was removed a few weeks back

  • Key long term growth opportunities showed good progress – X-Border volumes were up 12% (revenues +9%), X-Border Intermodal +17% (11%); automotive grew 6% in units (and 17% in revenues!); “Energy Reform revenues and units almost tripled with significant (JV) capacity expansion underway or planned; and the plastics/petrochem opportunity (SASOL in Louisiana, etc) is just beginning to emerge in time to pump up H2 (and beyond).  In addition, KCS appears to have available capacity to partner with CP in moving Alberta CBR into the Gulf.  In the meantime, more cyclical merchandise traffic such as paper and steel are also gaining momentum.

  • KCS appears to be gaining share within Mexico even as Mexican freight growth outpaces the NA averages.  I will be in the heart of industrial Mexico next month with hopes of learning more about the KCS opportunities and to sample non-Pemex gas stations….

CNI’s Q1/18 EPS – down 13% YOY and below expectations – were worse, and not just on the surface, as the capacity issues that surfaced last fall all came home to roost.  CN’s GAAP-adjusted OR worsened by 600bps to 67.8% - and it was repeatedly pointed out that result would place them in the back of the rail pack, far from their traditional leadership role.  But CN has “manned up”, admitted mistakes (mostly of demand planning – the impossible dream), and mustered resources and spend – including another $200mm (Canadian, but still +6%) bump in capex to $3.4B - to counter it, with some results already beginning to appear late in the quarter.   Demand isn’t the problem, obviously (carloads grew 3% in the quarter, a “little lower than expected” but not bad, and price by 2.7%, with renewals at +4.8%). Despite the clamor, I don’t believe that there will be much permanent damage to their customer relations (they are always testy in the farm provinces, anyway).   Intermodal grew 10%.  CN will re-enter the CBR markets this spring, in an orderly fashion.  Merchandise, CN’s traditional string suit,  is where the service issues showed the most (even if Canadian grain was the squeakiest wheel).  Opex was the chicken coop – a  12% increase, 4X the workload (volume) growth – training, overtime, rents, purchased services, etc.

  • Operations may have inflected – all 6 reported categories showed YOY deterioration in Q1/18, some it dramatic (the big two – train velocity down 15% and terminal dwell up 37% - especially).  But all six categories reported improvements from March to April (velocity was up 5% and dwell down 16%).  It is early yet (and some of the capital improvements are behind schedule; we also assume the industry-wide shortage of locomotive parts isn’t helping).

  • CN and COO Mike Cory did a good  detailed job explaining how the mix and regional shift (westward) affected their operations, and how their spend is addressing the capacity issues, in time for an H2 overall inflection – and what is shaping up to be a very strong 2019.  Canadian National pas hors de la forêt encore, mais bien tôt

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

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