April 23, 2018
Rails on an early roll? Earlier than I anticipated, anyway, as the winter service issues seemed to indicate (to us) that the pitchers (costs of less than perfect service) were ahead of the batters (rail earnings potential), not atypical for the first quarter, but certainly an issue now. However, while I was off in Newport at NEARS (write-up tomorrow), actual early rail earnings started off Q1/18faster than I had expected. In fact, the first two batters reached base: CSX with a sharp hit after a knockdown, and CP with an infield hit, or perhaps a promising walk. And, as of this writing Kansas City Southern’s at-bat is looks pretty good, too (Our full review of the KSU box-score will be coming in a few hours)….
Get on the board early: Heading into this, second big – bigger - reporting week (CNI today, NSC tomorrow, UNP), the rails seemed poised to score, while we await Official Review of the Teamster’s strike call on the CP (not likely a long term investable event). Rails offense is historically good – to shed the baseball analogies for a moment, the rails have typically beaten expectations more than the market averages, and I thought that trend would certainly return, but later in the spring. I am not sure what the implications are if this turns out to be the case; certainly we’ll have to consider the costs of service (and long term benefits) versus the operational focus (and short term results) again….
PSR evolves into Moneyball – data, smart investing, patience….Similarities in the first two results – and the management discussions – highlight the post-Hunter railway model. Both CEOs, from a common pedigree, see a bright volume/share/opportunity future – and both urged a rational, measured approach to achieving that. CP’s reaction to the emerging CBR-2 opportunity in Alberta (see Desjardin’s excellent work on the oil opportunity) is like a team that sticks to its plan and develops rookies rather than over-spend of free agents in a (usually) futile attempt to “win now”. Think (and boy it pains me to write this) the Astros versus the Giants or the 1980s Yankees. When I heard the opening and closing statements of CP’s Creel and CSX’ Foote, both ex-CN, ex-Hunter - but one an ops and the other a marketing leader, I nonetheless heard the same winning approach.
CSX ripped the first pitch of 2018 into the gap….Investors had barely taken their seats and some old baseball men (well, me) thought that they might take a quarter or two to warm up this chilly spring. But no – they beat Street expectations by 20%, and last year (pre-Hunter!) by 53%. Their OR improved by fully 570bps (to 63.7%) despite the weather (no mention), general service/operational issues (Jim Foote: “The Apology Tour is OVER!”), and lower (4%) volumes and flat revenues….As management themselves pointed out, this was just the first quarter, not only of 2018 but of the 12 in their Three Year Plan….to which they made no changes and only reaffirmation.
But let’s be honest – there was no way CSX could fail in the first full earnings report of Jim Foote’s new tenure as CEO, and the first report since the big Investor Conference on March first. It was to be all hands on deck – Ed Harris as COO and Frank Lonegro as CFO, first responders. And there were three (at least) helper engines contributing:
1. A 96% increase in “Other Revenues” – Demurrage & Damages, the former described not as an income source per se, but in the full PSR-revolutionary way, as a behavior modification device and a catch-up on earlier slack oversight while “liquidated damages increased $19mm. I am sure that the demurrage bills went down easily at Shipper HQ….even if this is a page out of the old PSR play-book.
2. A $30mm increase in RE gains ($32mm vs $2mm) – admittedly a lumpy segment and previewed as such back on 3/1
3. Equity Earnings of Affiliates (a category I don’t recall concerning myself with, though it counts the results of activities from the Indiana Rail Road and their shares of Conrail, TTX and the Belt railway of Chicago - etc) almost doubled to $25mm YOY and (as well as) including a tax “true-up” of $10-15mm
Operations and cost control shined in a great “comparison” (new management) quarter – a great tribute to their recovery, to the impacts of the Scheduled (what happened to the “P”?) Railroading revolution. We all know the big facts – 8 fewer hump yards, 23% fewer locos, 11% less cars on line. OpEx dropped 13% for the quarter YOY led by a 12% labor savings – we could see that coming, right? But, velocity increased 7% sequentially, and 14% YOY while terminal dwell decreased 2% sequentially and 10% YOY, and bottlenecks in Chicago and Memphis have been ameliorated. Safety moved in the wrong direction, but it appears to be more accounting, less systemic. Overall, operational performance is not where it needs to be, yet, but we begin to see why CSX has “nothing to apologize for” at present….
The key to the “Post-Hunter” railway is growth – in volumes, share and returns. CSX spent H2/17 de-marketing (ethanol, the 7% of the intermodal base, etc) so the flat revenues – and flat intermodal volumes in that context - wasn’t too bad a result. Although I remain somewhat concerned about the capex cut (yes, “doing more with less” does indeed mean an asset rightsizing, but see the capex patterns of CP and especially CN and wonder if a reckoning is coming) but I was encouraged by Jim Foote’s “steady as she goes” banter in the Q&A, reassuring on the long term, deflecting the inane short (to-immediate term) questions, aware of the need to manage the considerable upside.
1. Pricing was not fully (or adequately) described – though efforts to protect some utility coal business through rates was, without any real sense of the outcome (at all: domestic coal tonnage was down 15% on one fewer day for Q1/18). Export coal remains strong – tonnage up 22% in the quarter.
2. The focus remains on merchandise opportunities – not intermodal (making this week’s NSC call all the more interesting….).
3. Nothing yet on segment sales but the interest remains red-hot
CP’s results were pretty fair (“Way to battle, Gordie!”) if not exactly a thing of beauty. However, the management of the call was better than that, even if some market boo-birds may have disagreed. Sure, they registered an almost two point increase in the OR (to the newly adjusted level of, gulp, 67.5%), but their 8% (adjusted) EPS gain beat Street expectations (if not the seeming whisper number nor my overly optimistic view that they might pull some of CN’s service issues to their bottom line). Still, they did show revenue increases in 8 of 10 sub-categories (splitting Ag into Canadian – Good and US – Bad). Intermodal grew 14% in revenues on an 8% unit growth – a sign of CP’s recovery in the marketplace and competitive issues across competitive modes. Revenues grew 4%, in line with units (RTMs were +6% - but units – car-loads plus IM – count more, to me). That they did this in a quarter when operational performance wasn’t up to par (and CP gets the “Earl Weaver Excuse Award” for being the first rail to mention weather) - dwell was 11% higher and velocity 8% worse (and reportable accidents increased rather sharply, though injuries were down 6%) - was a pretty good omen for the future.
CP can’t wait for its next AB – the future was very much on CEO Keith Creel’s mind, with more to de discussed at the June 5 Investor Conference in Calgary. While CP reiterated its 2018 Guidance despite the blustery start, he really positioned CP as a post-restructuring story - the “big cuts (in OpEx) are over – now it’s about sustained, controlled growth”. Creel and CMO John Brooks see “no shortage of demand”, least of all in the CBR segment where pipeline delays and inter-provincial battles make longer term deals more palatable to the oil companies and this a better ROI available to the railways in Alberta; we expect news on contract s before the Investor Conference. I really appreciated CP’s reluctance to chase the high hard one in this high-growth, low sustainability/stability segment – and management’s general and constant reiteration of their long term focus in terms of maintaining overall service, and continuing their operational cost-focus (where the labor issue, with a 3-4% headcount increase planned - and CP’s desire not to sacrifice long term gain for short term peace slots in).
Lots going on, back to you shortly!
Anthony B. Hatch