Rail Earnings Start (Does it Matter?) with KSU - Plus DC Matters

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Greetings;

Before anything, another “mea culpa’ correction – a typo – Fiona Murray, of course, works for and represents at Chair of the RAC  Canadian National!  Now, on ...

 

KSU replaces CSX as the leadoff hitter in the Q2/20 rail earnings period – this is a fine time for a promotion! - with earnings expected to be down about a third (and, strangely, consensus estimates cut by a quarter since the beginning of the quarter).  But, note, earnings!  I am not sure I have ever entered an earnings period where the actual financial results meant so little (in terms of understanding the carrier’s strategy and future prospects).  The volumes have been bad – in descending order, they are CP -12% YOY; CN -16%; BNSF (remember them?) -18%; UNP and CSX ~-20%, KSU -21%....and trailing the pack NSC -25%.  Given all of that, the industry suspended guidance in the Q1/20 webcasts; after (expressing that they were) hitting bottom mid Q2, with the wave of state opening rollbacks (throughout major rail regions), and in the case of KSU, Mexican steroidal pandemic numbers (and uncounted numbers), the near term visibility has, if anything, gotten worse.  The rails will beat expectations – again.  But unlike the past, this time it won't mean much (and I sure hope that they don’t do too much short term cutting to make a meaningless quarterly number!).  the WSJ HOS “earnings forecasts (overall) are too dire” (S&P 500 calls for -44%!  And Industrials by 90%!)  Of course, while what they report may have the shortest shelf life ever, we very much want to hear what the managements have to say!  For KSU – and, starting next week, the rest – that includes:

  • The nature of the auto industry comeback, in fits and starts (hampered by labor issues/C19 second wave) – demand for cars has been encouraging
  • The nature of trade (see China, below) and cross-border traffic, which was devastated in April and, following the cars, started to come back….beyond USMCA, some understanding of trade flows post C19 (and nearshoring – is there any evidence?).  Also specific to KSU, how goes the negotiations on extending exclusivity?
  • Capex – ahh yes – are further reductions necessary or desirable given the real opportunity afforded by larger track windows, cheaper materials, etc?
  • Will the rails, as they exit 1.0, use this strange time as a means to exit the “Cult of the OR”?
  • Looking to the future in a long term business versus short term “pushing the panic button” (or PSR 2.0 vs. 1.0, or….) – note CN’s address on the post C19 world – we need more of that!  When does the future begin?  2021 as the S&P earnings forecast suggests?  2022?
  • Can we see anything in the crystal ball on energy?  The destruction of shales businesses (Chesapeake, et al) didn’t stop S&P Energy from being a top 10 performer in the quarter.  Housing?
  • Technology/visibility must be discussed very webcast!  Can they regain momentum versus the highway?
  • Can they turn the Washington story around?  (see below)

 

Washington – the Pendulum swings back against the rails:  Last week I commented on the poor timing to even discuss M&A given the ongoing saga of the obstacles to selling a low density (Massena) line, as well as some of the issues in Mexico.  Meanwhile, and related to the atmosphere of seeming anti-freight rail biases, here comes the House-passed “Moving Forward Act” as a possible successor to the FAST Act, which expires on September 30.  The rail trade groups (AAR, ASLRRA, RSI, NRC)  have been diplomatic, but it doesn’t take a Detective Bosch to understand what’s really going on.  The partisan bill as it relates to rails is a broad gift to the railway unions, a form of old-style Democratic leadership that dates back to the ‘50s & 60s; it would entail:

  • Mandated 2-man crews (after the successful implementation of the “unfunded mandate” of PTC!); coming during the national rail labor negotiations (for a good read on the hard feelings around the negotiations, if not the actual discussions themselves, see Frank Wilner’s column in the May issue of RA).  Meanwhile, if anyone cares, the FRA announced that PTC implementation was at 98%.
  • Directed a study on PSR strategy, as noted before (barn door/horses in the glue factory – but still – invasive)
  • Ditto on demurrage (barn door, horses mostly gone as shipper behavior conformed to new practices)
  • It appears to be also invasive of private business practices in terms of train length and, importantly, the ability of rails to outsource MoW and other work (which would hurt as well as also have the government interfere in rail/labor bargaining)
  • But too soon to panic – it doesn’t appear that the Senate will support this, but in 2021?
  • The STB’s full plate is coming into the dining room of visibility (sorry) – with longer-term stomach aches being possible in terms of market dominance, revenue adequacy….remember, rail regulation is big business versus big business (the AAR in one corner, the ACC in the other, so that, anyway doesn’t have a partisan edge and won't be impacted much by November.  The two (of 3) votes on the Massena line were one Dem, one GOP.
  • Meanwhile, in Ottawa, it’s quieter (naturally) but the RAC (chaired by Fiona Murray of the Canadian NATIONAL) is working with the government on a form of ETC, having ranked the corridors in play and developing the technical documents….

 

China & Trade – while new flashpoints erupt (the EU), the US-China relationship is cooling considerably, as well are aware – statements about perhaps/likely no Phase Two, Trade Czar Navarro moving from blowing up the markets to bizarrely attacking Dr. Fauci (it’s your job to inject nonsense into the trade debate; stay in your lane!) – to worries that China won’t live up to its Phase One buying commitments (much of the ordering of late is actually for the coming crop year, and can, therefore, be canceled in a show of force or whatever).  Meanwhile, China’s return to growth (GDP up 3.2% for Q2 was directionally positive if somewhat inflated by timing and their own government expenditures. China faces the issue of manufacturing recovery without a global/NA demand recovery.  The China cold war is spreading, to the UK and, of interest in trade flows that might affect NA rails, Australia.  It is important to remember, also, that even the Phase One peace treaty left the original tariffs in place….
 

Seven (+) Myth Busters on Trade from “Trade is Not a Four Letter Word” by Fred Hochberg, former head of the US Ex-Im Bank (2020 Avid Reader Press)

  1. China is always the villain in trade (ask soybean farmers prior to 2017)
  2. Bilateral trade deficits matter – this is huge (should be #1) – they do NOT.  Larry Summers (former President of Harvard who also had other jobs) wrote “the trade deficit is a terrible metric to judge economic policy” – see for example our switch to a services economy – we run a services surplus with China
  3. Tariffs are paid by foreigners.  We all now know who pays….the consumer!  (via the producer!)
  4. Trade agreements are all about jobs – actually, the word “jobs” showed up only 6 times in the 5000 pages of the TPP, for example
  5. Trade wars work/are winnable.  Seriously?  Instability is the enemy of investment.
  6. The less we import the better off we are.  Sure, if we want $10 bananas and $100 t-shirts….
  7. Trade is always win/win – competition always has winners and losers

OK – there is also #8 – “Everything that Donald Trump says about trade is wrong” – no, China does steal technology; Airbus is protected/supported, etc.  So I will give you that one….

 

Ag- who would have thought of Ag as the “stabilizer” as it has been so far this year? -  is the biggest debate point for Phase One purchases of course; with ethanol hit by crushed demand exports take on a big portion of the hope.  It has been a fine growing season so far; the reduction in corn plantings  (still USDA says it will be up 3% YOY) was seen as helpful to the markets (not necessarily the rail transportation).  Both CN and CP set monthly, quarterly, and H1 grain records.  Soybean plantings look to be up 10% this CY – which, if China does continue, will be very good for rails. For 202 it has been very good that the farmer and the railway can be friends….

 

 

Anthony B. Hatch 
abh consulting
http://www.abhatchconsulting.com
abh18@mindspring.com
Twitter @ABHatch18