Calm Before the Storm? The Last 2 RRs Beat Expectations (& Raise Questions)

U.S. Weekly Rail 1

Greetings;

 

NSC and CNI were the rail leaders of the last decade – can they be again?  Does Q1/20 count, even? Yes, both hard-luck PSR Mothership CNI and former TOP-horse NSC beat Street expectations last week….in the calm before the C19 storm (although of course, the pandemic began its awful influence before the quarter ended).  There were some similarities – both produced good financial results despite a (pre-C19) tough environment; both had improved ORs (although both were in the mid-60s and trailed the group); (yet) both produced very solid operational metrics; both cut their CAPEX (CNI by only a little, NS by….a whole bunch – more below).  Both, of course, cut their Guidance.  But they appeared to differ in the length of their vision focus, as we shall see.  While Q1/20 may well be remembered only as the “calm before the storm”, there are enough interesting takeaways, upon reflection, to consider.  So, pitter, patter, let's get at ‘er!

 

CNI’s good Q1 beat back bad luck – does it matter?  Canadian National, the PSR Mothership and the winner of best freight railroad on the planet, all-in and century-to-date – is facing increased competition, of course, from her children spreading the religion across North American.  The best ORs (in Q1/20) came from CSX, UNP (!) and CP, all helmed or operated by CN alumni – but it is important in judging CN over the quarter and the past year is the run of bad luck they have suffered – most notably and recently the illegal blockades that dominated the winter headlines.  So in that regard, their operating metric improvement in car/train velocity (+10%) and dwell (-7%) is remarkable. CN noted that by March, post-blockade, their OR was in the “high 50s”.  April, etc will not be so kind (though with volumes down ~15%, there’s was a relative bright spot – but they’re looking to May to be the low point….hopefully); now their recent run of bad luck has been shared by all of us.  But their ability to handle the blockade (etc) impacts was an important piece of “new news” – since a lot was pre-covered, if you will, in their notable late-Q webcasts.  It has been a long while since CNI has had an easy or clean quarter, mostly no fault of their own; it will still be a while, thoroughly no fault of their own.  Still:

  • CNI attributed their agility – as seen in their rapid cost takedown where the expense decline (6%) matched that of volume – as a result of “PSR being in their DNA”
    • Headcount was down 12% (now running over 14%) YOY.
    • Train productivity was 5% better YOY.
    • They remain industry leaders in fuel (and therefore emissions) efficiency which improved 6% YOY – they think there is plenty of opportunity remaining, as well.
    • Safety improved – injury rate by 3%  but the accident rate (compared to 2019’s so-called “polar vortex”) by fully 36%.
  • CNI noted their strong FCF (guiding to a “minimum of $2.5B in 2020”), balance sheet, debt ratings, etc.
  • CNI reduced its Capex plan – stop the presses – but by a “mere” $100mm to $2.9B (noting that given the volumes down some 25% now, they can stretch their Capex dollar a lot further).
  • CNI stressed the long term nature of their business and their L/T opportunity – notably in their IT investment (and they noted that their track geometry car was getting an FRA test – very good news); they did suspend not only their Guidance but also, noting that even the Bank of Canada suspended guidance, their 3-year Guidance that dated to their last (2019) analyst/investor conference but they stressed.
    • Their excellent appendix included their pipeline of growth (and stressed that channel partners such as ports are going forward with their expansion plans - and their experience in previous economic shocks.
    • They are preparing for changed post-pandemic freight flows, though they think some of the talk of near-shoring etc is “emotional” and “overblown” (hear, hear!).

 

Norfolk Southern posted results that thrilled the Street but the webcast still leads to questions. This is a bit of the same old song, with the same ol’ meaning even when the volume’s gone.  And the volume was long gone even before C19 – units down 11% (to be fairrr, the pandemic hurt international IM, an NS strong point, in February, and everything else by the mid-end of March – and NS presented some  excellent charts– page 8 – on the impacts on commodities from C19 and the energy catastrophe, and the outlook on the cost structure impact).  But – talk of difficult comparisons (“pretty elevated volumes” said the….COO) isn’t a great answer (Q1/19 volumes were flat, and intermodal was up just 2%.  And -  QTD NSC’s volume drop of ~30% trails the pack.  It’s too soon to extrapolate from the Q1/20 numbers what’s going on…. But still, like a honeybee stings, some interesting eastern railroad comparisons (thank you Bill Stephens):

  • Intermodal – CSX flat (albeit after two years of de-marketing leading to easy comparisons); NS -11%.  And of that, the domestic IM drop of 9% is, well, troubling is too strong, but concerning might not be (relative to JBHunt, to CSX, to the industry – and mostly to the NSC history and potential in this critical market.  How does the terminal focus (below) and the consolidation of commodities (“blending traffic into even the premium network”) fit with the vaunted Corridor system that brought them to the premier IM position in the east?  Increasingly the future is premium.  BTW – that comment came not from the CMO but from the COO!).
  • Coal – CSX -15%, NSC – 31% (not sure that is a market/market share issue).
  • Merchandise – CSX +2%, NSC -5%.
  • RPU – CSX -4%; NSC +4%.

 

What can explain this? Certainly not the webcast, where various attempts were batted aside like an expert cricketer and a spin-bowl.  Questions on the impact of lower oil prices and competitive rails and modes were dismissed (by the COO, notably).  Yes, NSC has touted its “Yield Up” strategy, which is a positive thing, although leads to a small but vocal minority of observers (short lines, shippers, etc) claiming that its part of a “shrink-to-grow” strategy.  I am and have always been a big believer in railroad pricing to their value – they are not a utility nor are they a charity.  I am sure there are good answers here – but we do not know, and we won't for a while.  And - Yes, CSX has gotten better from a service perspective (after initially getting worse during its PSR implementation), but so has NSCX, and it is the historic service leader (the melody keeps haunting me) and clear IM brand-holder.  On the other side of the ball, how did NSC do in Ops/productivity in Q1/20?  Pretty well as their version of PSR (and) TOP-21 is kicking in (with Phase 3 due for completion this quarter).  Crew starts were down 19% in Q1/20, close to double the volume drop; impressive.  They have “pulled down” much of the auto network, fully consolidated trains to a greater degree than ever, and given a “hard look” at terminals and yards (note – in fact the very day after the webcast, they “idled” Linwood yard in North Carolina).  Here the voluble Mike Wheeler, COO, had lots to brag about:

  • Train speed up 10% (car velocity N/A); dwell down 16%.
  • 6/6 in major KPIs – but without hard numbers  (the Service delivery Index was 27% better YOY – that’s fantastic – but what is the actual number?  Fuel efficiency improved by 5% - but what is it?  How does it compare to leaders like CN, CP, and CSX?
  • Expenses down the same amount as the volume decline (11%); headcount was down 19% YOY (and 6% sequentially); as with KSU, NSC thinks some 60% of their cost structure is variable/semi-variable.
  • Of course, there’s the big locomotive fleet reduction (and resulting charge), targeting a 22% reduction form 2019 levels (there are some 405 locos still on the block – after disposing of 298 in Q1, somehow – kudos), so if anyone is interested?  One good answer by the CFO as to why the big charge – to get the associated costs out, and “to get the organization focused on removing assets”.  You could feel the swoon through the internet – super PSR from a non-railroader!

 

So, what’s the answer?  Unfortunately, we won't know for a while, either, as the pandemic sweeps such thoughts aside for several quarters.  But also of note:

  • Coal – oof – down 30% in Q1/20, down ~60% Q2TD; 125 days of utility inventory, March was a low burn (ever); CMO Shaw repeated their awareness of the commodity’s secular decline.  One NSC response that had to have a lot of Roanoke retirees on edge was the sale of the venerable Pocahontas Land Corporation.
  • Who’d-a-thunk it would be NSC to blink or blink the most? 
    • Capex plans – CSX unchanged; NSC -25%.  Yeah, you read that  correctly.  It’s as if they switched scripts on the actors in a play.  Of course, this was perceived as a very good thing by many if not most on the webcast – but not all.  New CFO Mark George is the clear hot-new-star of railroading earnings Q1/20, and he looked at taking out assets (mentioning structures as anther possibility) as a way to take out D&A.  and as I have argued since about 2012, the coal decline means a lighter railroad, and that should mean lower MoW Capex over time.  But I found this statement worrisome – “the reduction in CAPEX is really a little bit across the board, not so much on the locomotives but in other areas, whether it’s IT (and) a little bit of our maintenance” (emphasis mine).  I do not believe, for instance, that they are cutting R&D on AV and EV in Silicon Valley.  COO Wheeler, again, noted that they have “some great technology in their company (relative to the engineering cost takeout), and I believe it – but it needs to be nourished like an exotic plant.
    • Shares were down 3% YOY – and the repo plan was slowed but not put on hold.      
  • Notably NSC did not pull its 2021 OR Guidance (6-0), but there was, IMHO, too much focus on the OR versus the future….

 

Anthony B. Hatch 
abh consulting
http://www.abhatchconsulting.com 
1230 Park Avenue suite 4A NYC, NY 10128 
abh18@mindspring.com