Rails Q3/18 - CP & KSU Takeaways (Another One Bites the Dust?)

October 22, 2018

Greetings;

A quick look at the end of last week before this really big week (all three of the big PSR/or not related stories:  CNI, NSC, UNP) in rail earnings and, of course, more importantly, webcasts.  I will be at the 100th annual Railway Tie Association meetings in sunny Florida, hopefully getting my annual jump on 2019 capex outlook form the Class One Chief Engineering officers in attendance….meanwhile, from above I hear the beat (Thump! Thump! Thump!):

Are you ready, hey, are you ready for this? 
Are you hanging on the edge of your seat? 
Out of the doorway the bullets rip
To the sound of the beat

Another one bites the dust
Another one bites the dust
And another one gone, and another one gone
Another one bites the dust
Hey, I'm gonna get you, too
Another one bites the DUST!

/Queen

Rails- No News (Good)/Some News (Good?) - At the end of last week the second and third North American Freight Railway reported their Q3/18 results; CP and KSU – one fine, the other a tad less so (but with interesting developments).  Neither really mattered, per se – one pre-reported and gave us hours of background only two weeks before; the other gave out tantalizing hints about the future as well as tangible comments on how 2019 will be better than Q3/18….Tp be nitpicky, however, one gave results in like 4 slides (admittedly after hours spent together in Calgary); the other continues to go old school with 20-30 pages of useful data….

CP & KSU:  Canadian Pacific had already –pre-reported improvements in the quarter at their Analyst Conference – drawing out their migration under PSR from efficiency to growth -  only two weeks before so, in this case no new news was, of course, good news (and in contrast to some other post-Investor Conference quarterly results).  One funny result of this timing was to count the number of analyst questions regarding the changes since October 4th and the impact on near-term results.  Meanwhile, Kansas City Southern had received good news regarding NAFTA 2.0 but found it was their turn to be in the service execution (or “operating congestion/is PSR the solution?”) cross-hairs….The amount of questions on congestion/and fluidity suggested that the KSU management was under pressure (I am saving those lyrics for later this week) and, indeed, two intriguing things came from CEO Pat Ottensmeyer’s statements during the Q&A:

  • The have looked at “elements of Precision Scheduled Railroading methodology that makes sense” – trip plan compliance, asset utilization, discipline, etc….

  • (And this should have been obvious to me!) they are “paying a lot of attention to what’s going on with their (chief, especially cross-border) interchange partner, Union Pacific” which is undergoing their version of PSR conversion; the “magnitude and degree (high!) of their interchange with UP is really going to dictate that we cooperate and in some cases probably follow their lead on some changes in (to) their operating philosophy”.   In the spirit of the upcoming new movie, “Bohemian Rhapsody” – has another one bitten the dust?

Quick looks at the actual quarterly results….

CP pre-released and still beat results by a nickel!  Not bad, though it smacks of “UP in the ‘90s” kind of financial engineering.  Nah, that’s too harsh….Anyway, CP reported that demand remains strong; they appeared to be prepared for it (having learned the lessons – ramping up hiring, etc) and they continue to be smart about what and where they add business to the network.  Volumes were up 5% (units) and 13% (RTMs, the difference in part attributable to their book of business rationalization, including exiting that short-haul “Expressway” business).  “ECP” (Energy, Chemicals & Plastics) business grew 58% - but still +23% without CBR).  Potash and Canadian grain look strong, intermodal especially so.  They advanced their shareholder buyback application (since approved) from December.  The OR improved 270bps to 58.3% - all positive.  See the report after their Investor Conference….but there were two discordant notes:

  • There wasn’t much said about NAFTA 2.0 (unfortunately, for me anyway) but CEO Keith Creel seemed to take personally questions about China trade and its impact on CP – Canada is a trading nation so it seems logical to me, and I believe that the rails (overall) have been under-selling the trade threat impacts….Efforts to find out what they was all about unrewarded, so far….

  • Service wasn’t….exemplary.  This wasn’t covered at the Investor Conference; I applauded CP’s marketing (“PHH”) emphasis, but strangely for a railway that still says it is “operations first”, I should have paid more attention to the lack of focus on the metrics at the conference.  For Q3/18, velocity was down 6% and dwell was up 5%.  Safety did improve (injuries and accident rate both by 1%) and productivity improved (train length and weight) by 1-2%, respectively.  No crisis here….

 

Is this for real?  Or is it just fantasy?  KSU’s Q3/18 was down a tad YOY (officially “in line” with consensus) though still up 16% YOY, adjusted.  There were, as always, lots of real adjustments – taxes, FX, fuel – and Hurricane Harvey in 2017.  They got good news in the quarter from the political arena (USMCA, a calmer AMLO as he prepares to take office in December, already backing off some of his wilder campaign promises – “We will only spend what we have”, etc).   This was originally expected to be a fine, coming-out quarter for KCS – coming to the end of the coal “hangover” (12/31) but already lapping the impact of Hurricane Harvey last year.  Instead, some of the North American service chickens came home to roost on the Texas/Mexican border, as specific growth and interline issues combined with some difficult issues around Monterrey caused (that dread word) “congestion” and fluidity issues that rippled through the cost structure and delayed some revenues….so looking at the bad news first, which led to a tough Q&A session and (mistakenly) delayed confidence in KSU’s ability to pull off this “Mexican miracle”:

  • KSU lowered their FY18 (so what?) volume forecast from “mid” to “low single digit growth – which was impacted by service (especially “Industrial & Consumer”, which also likely saw some tariff impact in metals – still unresolved)

  • Dwell was up 12% YOY; velocity down 6%

  • Lazaro Cardenas port volumes still a trouble-spot for KCS

  • Capex will be in the low end of their guided range this year (~$530mm) and low capex was a theme (see PHH carriers)

On the other hand, it really wasn’t that bad.  First, the obvious positives:

  • Earnings were up 16%, revenues 6%, “core price” up 3.7%

  • The adjusted operating ratio improved by 100bps to 63.4%

  • X-Border volumes were up fully 20% (aided by Harvey comps, hurt by congestion, still solid)

  • Solid demand in the key commodities: autos, intermodal, chemicals, plastics and refined products heading south, as reported in my May trip to Monterrey

  • Plans in place to address fluidity; improvements already showing up.  Among the plans, 50 locomotives ($140mm, meaning increased 2019 capex); working with customers, adding unit train destination capability and more refined-product storage tank capacity in Mexico (some of which I saw in May as well); working with the UP to make better use of their other gateway (Brownsville); and, of course, maybe working with the UP on operating philosophy….

Under pressure?  So – is it possible to initiate PSR as an interline carrier?  In a partial way following the lead of a carrier doing it in a measured way?  Can KSU discuss ROIC and capex and reassure investors that adding capacity makes sense?  Or will events impose themselves on KSU?  Have we come a long way where a quarterly financial performance like this (KSU Q3/18) warrants questions like those?

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

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