Sweet 'n' Sour: Rails - Q2/18 Earnings Preview

July 17, 2018

Greetings:

Quote of the week:  “A trade was is not a good thing”; CSX CFO Frank Lonegro, as a recent investor conference….

And:

“All told, during my 37-year career, I got to participate in (NOTE – I would have said “play a leadership role in”) the renaissance of America’s freight rail industry, and the (creation of the) BNSF….it had been a great ride on the rails”

/retired BNSF CEO Rob Krebs in his autobiography, “Riding the Rails” (emphasis my own; see below)

Sweet & Sour?  Que? Rails will produce a solid quarter, financially, with earnings up about a quarter, versus the overall (S&P500) market anticipated earnings gain of about a fifth.  For the market, this will be an interesting quarter, with interpretations all over the place (WSJ in the same week:  “Earnings Peak?  Growth not as good as first quarter” and “Strong earnings to rejuvenate stocks”!!); estimated earnings growth of 20%, down from the Q1A of 27% raises some questions, along with future impacts from the trade war and past/present gains from the tax cut (without which H1/18 overall market earnings would have “only” been up some 12-15%.  So, in this confusing time rails look pretty good versus the broader markets (driven also by an estimated – and even better when you look at the big US carriers, three of the so-called “Big Four”, UNP/NSC/CSX, all of whom will report earnings up over a third (BNSF as part of Berkshire Hathaway will do so as well within the conglomerate’s earnings due out in early August).  Sounds pretty sweet, doesn’t it?

A few factors to consider for the quarter:

  • Oil prices were up 13%, so there will be some headwind/lag effect on rails’ OR

  • The dollar was up 5% (though political events are “trumping” financial ones, - even as they are intertwined – in volume impacts so far

  • Buybacks, driven by tax cuts, have regained momentum  and are on a record pace

  • Commodity volumes have been dynamic, to say the least – hard actions (cancelled orders, etc) versus what’s been called “doomsday prepping”

Demand remains firm:  The calls ought to be encouraging on the demand and pricing side – volumes accelerated throughout the quarter.  Pricing is clearly accelerating (which might increase the political friction – see below).  For rails, the idea that we have achieved maximum velocity (or a “peak”) is clearly not true.  In June, 14 of the 20 AAR/RTI tracked commodities showed YOY increases, admittedly down 1, but 16 of 20 Canadian commodities increases (up one). Total US/Canadian traffic (car-loads plus IM) was up 4.4%....For the last month of Q2:

  • Grain was up almost 4% - see tariffs, depression in the farm states & provinces – so this was a surprise.  My Go-To-Grain-Guy wonders whether there might not be a pretty good H2 for exports – among other things, has the PRC acquired enough soybeans to prevent pork price inflation, a political no-no?

  • Coal was down 2.5% (-2.7% in the utility-dominated US), a return to the long term trend line….

  • Chemicals were up 4% (good but not….”booming”) while CBR, etc. was up a whopping 23% (28% in Canada)

  • But stone/sand/gravel was up “only” 6%; bears watching, of course

  • Forest products were up2%, driven by lumber up 4% as housing and construction picks up steam (and offers competition for transportation jobs!)

  • Autos eked a small gain (+0.5%), but that contrasts with the 5% sales gain the industry enjoyed

  • Intermodal, US and Canada (AAR), was up 5.7% (containers up 4.7%, TOFC up fully 19%); this was just short of the YTD levels, if i am to be honest.  IANA put the monthly number at +5.4% (1.3 points below the YTD level).  By their reckoning, trailers were up 12% and domestic containers 5%, as were ISO (international) containers.  5% growth in domestic isn’t too bad, but in context, in this market, it means lost opportunity.  Hunt’s overall solid results showed a 2% decline in transcon business within an overall load performance of +4%, below the benchmark, though pricing was of course strong….

Which leads us to the real issue – how long can rails show above-market performance financially and below-standard service (velocity, etc) performance?  What will the rails have to say as some of the recent statements of summer recovery now appear to be, at best, optimistic?  We are excepting CSX (what a difference a year makes!) and see CN as living up to its turnaround plan.  But for some of the others, we hope to hear an honest dialogue.  Are their hiring issues?  Parts shortages?  Too early for capex plans to show an impact?  Capex plans too small (if so, hopefully “at first”)?

Also of note:

  • The first meeting between senior Washington officials and the incoming Mexican equivalents produced subdued rhetoric and “reasonable optimism”

  • Rick Webb of Watco is moving upstairs to Executive Chairman – this was my biggest shock of the week, which included losing to Croatia and Ian Snell not making the ASG- those of you (all) who know Rick cannot see that man slowing down….

  • Speaking of short lines, Omnitrax took control of two small CSX properties – two NOT in the announced “packages; congrats to both sides as the “New Golden Age” of short line deal-making continues….

  • The recent Spring/Summer Issue of TRB News (Transportation Research Board) is all about “40 Years of Transportation Deregulation” with interesting historical perspective from old friends Frank Mulvey on the STB and Bob Gallamore, following up on his noted book, on rails….

  • One down, one to go – I breezed through “Riding the Rails”, Rob Krebs’ excellent autobiography; it’s an honest (often brutally so) look at his role in creating the modern, customer responsive, intermodal-driven rail industry – and the need to spend to create the capacity, service and efficiency to generate growth and a good return (“build it and they will come”).  At the turn of the century, Rob took it on the chin form the investment community over the spending but the 21st century performance of the BNSF, led by intermodal, shoes who was right and who was too conservative – lessons for today?  And while I wasn’t personally quoted, I will take the oblique reference in the last lines (quoted above) as my reward…

  • Next up – the Hunter bio!

  • But first – earnings start later today, of course, with CSX….Expect big numbers and real confidence as the buck the overall lousy-service trend

 

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

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