Rails- Earnings Call Reflections Part 1 - and a Rant

Tony Hatch

Greetings;


Snowy enough for you?


Rail earnings concluded last week – well, except for the largest railroad by some measures, the BNSF (via
Berkshire Hathaway will report….later this month?). So we’ll offer our reflections in stages,
starting with the first two to report, UNP and CSX, neither of which seemed to thrill the intraday markets
much. UP beat expectations, of the four that did so, while CSX joined KSU to fall slightly below
consensus. Both offered a rather limited return to visibility, though UNP promised to hold what will be a
must-zoom Investor Day in May.
Before this initial review, some news:

  • Zoom/review? Southwestern rail conference: 2021 Southwestern Rail Conference – Texas Rail
    Advocates last week – and Texas Rail Advocates, the sponsor, has given me ten (10) free spots –
    “Each person you choose will need to register in advance at
    https://filemaker.taylormadeservices.com/fmi/webd/TRAdatabase. “ If anyone is
    interested….you have seen me before, of course.
  • Overall the analyst questions are migrating to growth plans, to technology., to ESG, etc (all part
    of a rail transition to PSR 2.0) but the very first question of 2021 asked about OR in the current
    quarter!
  • With the change in administration parties, Martin Oberman succeeds to the Chairmanship of the
    STB – congrats! – but I see no directional change in this most bipartisan of all government
    bodies….

    • I want to take a pause here….I am sure folks get frustrated with things I have written or
      said and I know I have expressed frustration at naïve or inexperienced or very short
      term focused questions, for example (see the Bullet Point immediately above) but rarely
      do I hear a statement, as aside from an assumption, that is factually incorrect. Towards
      the end of the CSX Q&A, an experienced analyst, who happens to be Canadian, said –
      not asked: “With regards to Washington (DC)….a swing in power in favor of the
      Democrats have not been a good thing from a railroad regulatory standpoint”. Assuming
      he means “from a railroad’s perspective” (and not a shipper’s) – that is completely
      untrue. One must question what other palpably false assumptions are in that research.

      • The Staggers Act, while with bipartisan support, came under the Carter
        administration.
      • The recent round of rail consolidation was approved under the Clinton
        administration.
      • The scariest time for rail re-reg efforts heretofore was during the younger Bush
        administration.
      • The most interventionist Board in years was that of the Trump administration.

    • Most importantly, while the generic term “regulation” might seem to have a Dem/GOP
      split (on environmental regulations, for instance – though the EPA came to be under the
      Nixon administration), rail regulation essentially comprises disputes or issues between
      very (often very, very) large businesses – think UNP and Dow Chemical - and is NOT a
      partisan issue. Period. Full stop.

  • CP announced a 5:1 split (more later) – not sure why
  • UPS announced it was selling its (LTL) Freight unit to Canada’s TFI for $800mm
  • I have been unable to find how much rail freight plays in GameStop, or in silver for that matter.
  • There has been no discussion of this crucial round of labor negotiations!
  • This quarter’s phrase-we-MUST-lose: “unpacking”. Please.
  • Finally, my partners in RailTrends, Progressive Railroading, have launched a new premium
    service, RailPrime – check it out: RailPrime | ProgressiveRailRoading - Subscribe Today

I’m just a rail whose intentions are good – Oh Lord please don’t let UP be misunderstood! Union Pacific
beat Q4/19’s results by 17%, beat expectations by 5% or so, lowered the OR by 410bps (to 55.6% - ! –
and full-pandemic-year by 210bps) – and was met by a yawn. What’s a major railway to do? Well, they
had technical difficulties in their webcast (been there) to start, and recall, they also pre-announced a fair
amount of their good news earlier in the month in an 8-K (concerning the Brazos impairment charge).
They also provided the big-webcast debut of Eric Gehringer as COO, who did fine (but to some investors
is not Jim Vena – give him time! They proceeded to leave a lot of visibility/strategy questions
unanswered (though they did promise to hold a May Investor Day, which is more than just kicking the
can down the road in my opinion). And they committed the cardinal sin (for the more short term
oriented of those within their ownership mix) of conservatism in what guidance they did provide. Let’s
see what they did do before considering what they didn’t promise.

Operations showed improvements in 6/7 of their listed KPIs (train velocity was flat – not bad given the
California congestion issues we hear so much about in the beginning of the 4th quarter). Safety was
listed as a top priority (in slide 7) but safety numbers not given in the documentation or slides (in the
comments, UP stated that FY Personal Injury rate was flat but the FRA Accident rate was 17% worse),
the first of the slightly head-scratching disclosure issues. Train length was up 12% YOY (and 30% since
the “switch” to the PSR “philosophy”. Fuel efficiency – so important to the tactical side of ESG – was 4%
better. Headcount was down 14% - on the volume increase of 3%. Trip plan compliance improved by 1
point and 3 points, respectively, for Intermodal and Manifest (but I must add that the improved
numbers, 83% & 74%, might not impress analysts and investors who follow AMZN). And there were
questions, historically justifiable, about maintaining service levels in a growth environment.

Sir Mix – not? Revenues declined 1% on (despite) the volume turnaround – but the fuel surcharge
impact on revenues was -3.5 points, and mix (higher IM lower coal, CBR) hurt by another 0.25; more
likely though ostensibly offset by “above-inflation” price gains. On the Bulk side, coal volume decline of
16% was almost exactly compensated by grain’s 20% increase (the mix impact can be guessed as flattish
or better given the export component of the grain increase). Industrial (revenues down 7% on volumes
down 6%) was hammered by CBR and (related minerals) as well as industrial chemicals, somewhat offset
by plastics and forest products (housing and brown paper). Premium had a 5% revenue increase on a
fully 9% volume jump. So here’s the question – we understand the concept of mix within the rail
portfolio, but within the commodity? Mix within mix? Yes – auto business was down, but just 3%
(actually a rather amazing recovery from the spring depths). So what happened with Intermodal’s 12%
increase? Weren’t both domestic and international up? Was this where the LA/LB congestion issues
added to costs?

Finance, as it does, tied it all together, but added some questions. A 3% decline on -14% headcount?
Productivity gains of another $170mm helped their eye-popping margin (OR) improvement. Their ROIC
declined only a bit to 14.3% (adj) versus 15% (given the FY revenue drop of 10% and OPI decline of 5%).
Capex is slated to be flat-to-up (and trail BNSF again). Solid dividends, restored share buyback….

Expectations – too modest? But here’s where UNP’s day got worse: pricing gains in excess of (rail)
inflation dollars? Vague, but: check. Mitigated by calling what appears to be a quite favorable IM
pricing environment as “somewhat favorable”). Mix headwinds to continue? Che-ee-eeck, although I
might have said IM gains to continue (CMO Kenny Rocker did say that earlier, though by focusing on
domestic IM, the lead dog to be sure, it raised questions about the international side that weren’t
answered to everyone’s satisfaction). $500mm in 2021 productivity/PSR gains (“not over”) – actually
solidly positive. Pro-shareholder capital allocation plans? Yep (I won't bother to reiterate my CAPEX
issues – and I will acknowledge the “capacity dividend” from PSR). Full-year volume growth
expectations of 4-6%....wait…what? Versus 2020? That doesn’t even make it past 2019 levels (and as I
continue to remind everyone, not that it is needed: 2019 was a pretty bad year for the industry!). Now,
Mr. Rocker noted that those numbers would be +5-7% without coal (interestingly the EIA anticipates
decreased coal cats bouncing a bit in ’21; for a detailed historical look at the 66% decline in UP’s daily
train count out of the PRB see the current issue of “Trains” magazine). But there was immediate
pushback in the Q&A

Looking forward to the (Virtual) Investor Day - There wasn’t a lot of discussion of technology, specifically
– and none on the Tu-Simple investment. Their new CIO seems to be a great hire – came in mid Q4.
But there was a sense – from Lance Fritz and team, and from the unlikeliest of sources within the
financial community, of UP’s own “pivot” to growth and to PSR 2.0 (note – they don’t call it that!). Once
those floodgates were opened, the discussion turned almost entirely to growth (and the Q1/21 OR
question was put in our rear-view mirror). Details were scarce. IM is a focus (“becoming more
profitable”?). If so, the TPC must get to the “low 90s”….Hints came of non-traditional, seemingly 3PLlike opportunities (from the COO, note). May can't come soon enough!

CSX and (just don’t call it that) the Pivot to Growth: While as reported, CSX appeared to report earnings
slightly (1-2%) below expectations, “core” earnings were about the same amount above consensus, and
the OR improved by 300bps to 57%. But it was the tenor of the webcast, a focus on growth and (what I
call PSR 2.0, or perhaps best for CSX, PHR) that stood out to me and was noted on the webcast (even by
some of the unlikeliest of sources); one could argue that “tone” had to be important as opposed to
“facts” or “outlook/guidance”. Both UNP and CSX are yet to offer the kind of growth pipeline visibility
that, say, their Canadian cousins (and spiritual fathers) routinely do. UNP has a May Investor conference
and CSX has hinted as such….CMO Mark Wallace wasn’t on the call, so perhaps that had something to
do with it – but CEO Jim Foote’s enthusiasm really drove the sense of tone-shift.

Operations were solid, of course, we are getting used to that, but 2021 was a challenge. Financially, CSX
handled 4% more loads with 8% fewer folks, partially due to trains running almost a fifth longer. But at
a cost? The so-called metrics weren’t super pretty (as was noticed in the Q&A) as both velocity (train,
down 11%) and dwell (car, up 21%) were worse YOY – but that’s the shark’s tooth for you (as they
portray clearly in their presentation slide #11). Safety was mixed – personal injury improved by 10%
FYOY, and fully 34% in the Q4, but the train accident rate jumped (+65%) in Q4 and therefore FY20 (but
still markedly better than 2018). But this is a worrisome – industry – trend. It should be noted that all
railroads were hit by C19 (as were all shippers and all of us), but CSX, it seems, particularly so. fuel
efficiency improved by 16% since ~2018 and ~5% in Q4 - is solid and good for tactical ESG efforts.
Carload trip plan compliance (TPC) at 75% for the Q4, was down YOY (83) but up sequentially (73) and
reportedly better each month and into 2021. Intermodal TPC was less positive – at 84% it was down
both YOY (95%) and sequentially (87%). Total railway on-time originations and arrivals were 10% and
19% worse, respectively. Maybe Mark W was just teed off? Capex will be up (~+5-10%) after two years
of flattishness – this is two-point-oh. Productivity isn’t over as a theme – there were questions about
CSX achieving a 55% OR, the long-term goal of the UP*, it just has partners, and also “the OR will be
what it is”, classic 2.0.

And the key is growth – of share, of the wallet, versus the highway, versus “the other guy”. Questions
on specific growth opportunities were dodges, for now. The total volume growth of 4% (4/10
commodity groups showed gains) translated, after FS and mix, to revenues down 2% (yet 5/10 were up).
They are putting their money where their expectations are – beginning a somewhat accelerated
hiring/training program and continuing locomotive rebuilds, etc (per CFO Kevin Boone: “Our goal here is
to be prepared for the growth”). Foote summed up his part by saying that they anticipated that
volumes to “outpace” GDP growth, looked at as Coal doing slightly better YOY (supported by EIA
expectations for US power generation), Merchandise exceeding Industrial Production and….”Intermodal
volumes (to) grow faster than merchandise”. Well –

  • I would sure hope so!!
  • What happened to fall 2020 (for instance at RailTrends) declarations of at least 2X
    GDP?
  • OK, comparisons will be somewhat tougher in H2/21 (volumes jumped 11% in Q4,
    thereby throttling NS) – so what’s the anticipated IM trend line?

*But we need to note in terms of the CEO’s response that calling a 55 OR a “double-nickel” is really an
insult to March 29, 1995 (before the CN IPO, BTW): Top Moments: Double-nickel game proves Michael
Jordan is officially back | NBA.com


Also:

  • NYT on concepts for adding back passenger service in “rural” Montana: In Rural Montana, a
    Hope That Biden Will Reopen the Rails - The New York Times (nytimes.com)
  • Speaking of Berkshire - Buffett & Sumitomo: Warren Buffett’s Investments in Japan Struggle to
    Keep Up With the Market - WSJ
  • The current issue of “Trains” magazine, aside from having the great review of the PRB, also has a
    short article on Proviso Yard under (UNP antecedent) the CNW – if you look closely in the 1966
    photo you can just make out a young Jim Foote peering over the crowd….

 

 

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