Greetings from Lockdown (cont.)….
Most importantly Nadeem Velani was named Canada’s CFO of the Year (I won’t say what my fingers originally produced and auto-correct, usually such a pain in the rear, this time chose not to catch). ….So, to move on to KSU, Texas and western rails, but first, a first….
We have entered the Quiet Period for company reporting with Q1/20 rail earnings beginning – with KSU – at the end of next week. That is normal; these times are certainly not. So, Kudos to CN, CP, and KSU for their updates in this stressful and unsure age; CN followed up with another (as did KSU yesterday in a special podcast with RA). NSC wins the weeks “Captain Obvious” Award by revealing – in an 8-K, that COVID-19 “could have a material effect” on their earnings. So, in contrast, I salute the three that came forward….I tweeted about the CN call, as a follow-up. Yes, you read that correctly – along with my friends at Commtrex I have started a rail-tweet, what? Service? @ABHatch18 is my handle. This is the direct URL link: https://twitter.com/ABHatch18 The first, CN, was a little rough – I misunderstood the amount (words? No – characters!)
So, unbroken into 8 separate tweets, is what I wrote about CN’s most recent update/webcast:
- Welcome to the first official abh/Commtrex Freight Rail tweet! CNI held another live presentation; kudos (I have to come up with a new word) to them (and CP & KSU) for realizing that even if Q1/20 calls are coming up in a few weeks, these are very challenging times -information helps! CNI acknowledged that C19 was hitting their RR, even since last week (see my Report on CP&CNI); in fact, things will get worse in April and May and that it will take an analysis of the next weeks or so to gauge the demand-destruction portion even as Chinese manufacturing (& exports) return. Bulk and domestic intermodal are growing, however; and they have shock absorbers in the lower fuel price and FX. CNI has a proven record at reducing expenses in a volume decline and Is undertaking actions now in reducing headcount, rolling stock and even some terminals. But to their credit, they continue to look to the long term and, from a position of financial strength (highest investment grade in the industry), only are reducing Capex a little (and some of that will be through efficiency). They see, though admittedly a cloudy crystal ball, a U-shaped recovery - very tough Q2, a flattish Q3 and hope for recovery by Q4 (with some commodities such as autos delayed beyond that). But keep in mind, long term planning works – as their CFO pointed out, from 2010 through 2019. CNI dropped their OR somewhat, losing their best-in-class title, but grew the top line by 80% - whilst producing a great ROIC. I will make that trade every time….(NOTE subsequent to the Tweet: Has CN’s luck continued? The National Geographic reports an outbreak of “huge feral hogs” in Canada. I will give up if we see a “plague of frogs”; I will just….give….up. Of course, knowing CN as we do, they just might turn this into a new “feed-the-beast” business unit….
I also wrote:
Meanwhile, I have an idea for all of the C1s – for safety/social distancing, and with PTC almost complete, how about experimenting with one-man crews?
Sign up for more, if you want….
KSU Updates from a Position of Strength – There volumes were outpacing the industry (up 5% QTD; albeit down 2% in March MTD 3/23) - which should make for an upbeat leadoff-hitter in what might be the strangest “earnings period” of the modern era. In their webcast, CEO Ottensmeyer and CFO Upchurch reiterated their strong start to the year and even more importantly, the major and reassuring themes that apply to them, and for the most part their peers as well:
- Proactive response to C19
- Strong financial position (BBB etc); strong free cash flow and “ample liquidity”
- 4 of 6 Business Units still look strong (Chem/pete exports, IM (up 10% despite Lazaro Cardenas)Industrials & Consumer (metals and pulp/paper; the latter AMZN et al) and A (see below); only Autos has seen plant shutdowns
- PSR and their clear success with it, which has an impact on their current efficiency & fluidity - and still more to come – still on track for the targeted $61mm in PSR savings in 2020
- Flexible cost structure (50% direct variable, 10% “semi-variable”
Some things not discussed are a bit more of a mixed bag:
- The Mexican Government!
- Experts on the Coronavirus (such an unfortunate name in this regard) believe that Mexico’s government trails only Brazils in its’ poor response to the pandemic which could lead to bigger problems down the road – even the President of El Salvador joined the chorus urging AMLO to wake up
- Some see Mexican GDP contracting as much as 7%! And Pemex is becoming even more of a mess and a drag at these global oil prices….
- Mexico/AMLO refused water permitting for a new mega-beer plant ($1.4B) to be built in Mexicali after a referendum that received ~5% of the eligible responders “voting”. That is a direct hit for Grupo Mexico, but after the Mexico City airport fiasco, another blow to large scale capital project development
- I have long thought that the afore-mentioned Grupo Mexico (Ferromex & Ferrosur) was only really around to play the role of the Washington Generals to KCS’ Globetrotters, has I have learned that it has actually become a leader in some forms of rail-tech, notably in working with Wi-Tronix to in “excess loco idle” and other fuel productivities with savings in the many millions per locomotive per year….
- The WSJ and others have noted that Mexico “has yet to capitalize on new US trade” future – with China, with C19, etc with no pickup in FDI…. How will trade flows change after C19 and (hopefully) after tariffs?
On the other hand, three positives:
- The first of two new rail lines into the port of Veracruz opens in Q2, giving KCS access there for the first time, with some opportunities in international intermodal and more in refined products
- Next year the South-West International Gateway Park (SWIG-P!) will open in Texas and solely on the KCS which should be a boost for northbound manufacturing/boxes and southbound plastics/boxes
- The Mexican government actually sent in the National Guard to break up blockades on the railways – that is a very positive step (eh?)
So – Can we sum it up? Of course not….yet…but….Those two and the state of KCS operations are strong points, but the states of Mexico and Texas may prove to be overwhelming, in the short term. In the longer term, of course, those are some of the very best fields in which to play….KSU reports a week form, er, FROM Friday.
Texas/Tejas – El Doble “whammy”….The Plight of Texas and….UNP, BNSF, KSU, et al….
But then there is the state of the state – of the Oil Industry and of Texas….Texas is also being impacted by C19, of course, but in addition to “Contagion,” we have to deal with “Contango” (even “Super-Contango”). Speaking of Captain Obvious I will quote every business publication of late (specifically in this case The Economist): “Cheap oil used to a boon to America’s economy. This is no longer the case.” For Texas, economic diversification has been a success, but energy is still a whopping 9% of state GDP. I am no oil analyst but to restate what has happened YTD:
- The “oil war” between our friends in Russia and our friends in Saudi Arabia
- The complete drying up of US/global demand under lockdown (which has combined to lead to what the WSJ calls “The biggest crisis in oil in 100 years”). Whoa….Of course, the price-plummet impacts the entire continent (and globe) especially Alberta, Oklahoma, Pennsylvania but let’s focus on the rail-centric state of the “Texas Miracle”
- The financing problems in the shale sector – Capex will be down some 40-50% this year as the Street refuses to continue to finance the sector (FT: “Is the Shale Boom Over?” and “Hopes Dashed for US Energy Independence” – ouch). The Street seems to think the Permian needs $47/bl oil to break even….
- One strange potential upside is rail car storage (Storage in Transit or SIT) for crude - in fact, on Monday I (sorry) tweeted:
- The Texas “Double-Whammy” as per WSJ (oil prices & C19) is obviously not great for it’s biggest railroad, UP; but when a door closes just perhaps a window opens? UP has been considering re-purposing its uncompleted Brazos (NM) yard for SIT – now perhaps Permian oil storage?
- How big is Texas – for rails? UNP operates 6335 miles of track and BNSF another ~5K – it’s a quarter of UP’s volume and a higher percentage for sure of their profits (and returns); they spent almost a fifth of their Capex their last year.
So what about the mighty Union Pacific and their rival in the battle to be “Numero Uno”, the BNSF?
The former is the subject of the cover story in the latest issue of Progressive Railroading with the spectacularly ill-timed title of “So Far, So Good”. Nonetheless, Jeff Stagl got to the heart of the issue that investors were concerned about as mentioned in the sub-title (“Better service now needs to translate into better financial results”) and the carrier’s desire to take its new PSR machine and translate that into top-line growth – to become what I call the PHR Railroad, as we see to the north of them (and also to the south). In the short term, the timing, as stated, is poor, but the article still makes for good reading – if one can tear themselves away from another cover highlight “What’s new in vegetation control?” I kid because I love, as Jonathon Winters used to say.
UNP reports on the morning of April 23, and Berkshire Hathaway/BNSF not until May 2nd. BNSF has been outperforming UP on the volume front (as pointed out by Roy Blanchard’s WIR). It has been mostly a relative outperformance of late, of course, as both carriers have faced tough sledding. In Q4/19 BNSF units were down 6% and UP’s down fully 11%. UP “won” in the broad category of “Industrial Products (flat versus -10% in carloads) and, unusually, in Ag (-2% to -3%), likely because BNSF’s mighty export grain engine was so constrained by the trade war. BNSF won in their core “Consumer Products” area (IM & Autos); they were down 5% and their rivals down 15% - this may be price on the international front as UP has long claimed but very likely more so due to BNSF’s having clearly over the course of this century (and dating back to Krebs & Haverty and JB Hunt) creating a true brand – and maybe, just maybe, from more aggressive Capex and an earlier focus on technology? I wish we could prove this thesis out (or not….). As for coal? Now that is a story. In Q4/19, BNSF’s coal volumes dropped 7%, no surprise (and with natural gas prices, no turnaround likely). But UP’s dropped 20%, and their revenues dropped 25% (BNSF’s quarterly revenues were down “just” 11%). The pattern has been a long one – as “Trains” rail ace Bill Stephens points out, since the coal peak of 2008, BNSF volumes are down about a quarter and UP’s by almost 60%. UP puts it down to pricing. It is true to BNSF, mostly free from quarterly pressures, had had more price freedoms. Will that change (also?) under new leadership in Omaha? Also, BNSF owns a lot of the PRB trackage, while UP pays a user fee, in effect, which impacts the pricing philosophy, perhaps.
ON the Ag front, several rails have noted that the grain trains are still moving in times of uncertainty. But, for how long? It is, as always, interesting times in the farm states (and provinces). The winter of 2018-19 was, as we all recall, the wettest on record, with all of the spring flooding of last year. This past winter was better – but still the 19th wettest on record (of 125 years). So weather remains a worry….The USDA’s big plantings report for the coming crop year caused consternation. Corn acreage was estimated up 8% CYOY and soybeans +10% (wheat down 1%). Some of that is acreage lost last spring coming back into production, but those were considered surprisingly big numbers. And stocks were down 8%/17%/11% (C/SB/W). is it believable? Well, as with everything these days, there is uncertainty and competing whirlwinds, head and tail, to wit:
- Ethanol is having its own “double-whammy” – uncertain federal support and the complete highway shutdown. Some points on ethanol – it usually takes up about 40% of the corn crop, but it is also a truck-market (the finished product comes out in a rail tank car, but I have long argued that net/net, the rails would rather haul corn long haul in hoppers. Thoughts anyone?
- China is buying corn and beans or has. Will they make their promised but not really believed purchase levels?
- The US (and world) restaurant industry may be the number one economic victim of the pandemic, with huge impacts on NA grain, feed-grain – and potatoes
Three BNSF parties to attend by Zoom? I would be remiss not to point out three big BNSF anniversaries to be celebrated this year – 50 years of B+N (the CB&Q and the NP); 25 years of the BNSF, and 10 years of BNSF as part of the Buffett family. I hope the next 10 go as well as the past decade….
Finally, for now, earnings are coming up and there have been a bunch of analyst reports on Rails, or Transports (or Insert Industry Here) and COVID-19. All well and good, but often, as is often the case, too short term oriented. We know that the volume impacts are just starting. We know that that, as well, as other things such as the Canadian blockades, make this quarter another one without much meat on the bones as far as understanding what the quarterly reports are really for – a snap-shot in time to check on management’s strategy and applications in operations and marketing. So, of course, we all will listen to the calls starting at the end of next week (especially from those who did not receive our Kudos – you know who you are). We also know that we do NOT know how long this will last. But we do know that this too shall pass, so I hope to focus not on “Rails IN C19” but, rather, the “Rails AFTER C19”. Stay tuned, and I will leave you with a blurb I wrote for Commtrex on why the rails are essential and ready to look post-crisis:
Rails are as – really much more - resilient as any industry. Yes, they are mostly a derived-demand business (if there is nothing produced, nothing will move) with some share capture abilities. But rails actually have a lot going for them:
- They have a critical, well-maintained (privately-maintained, without politics) infrastructure; with lasting value for North America
- The rails are operating well now, with a very fluid network, thanks in part to 2018-initiated PSR at US rails, as well as earlier efforts (PHR)
- The rails still carry essential commodities such as grain, as well as rebuilding commodities
- Rail operations are essential, and often well-situated for work in C19 conditions (outdoors, etc)
- Rails have a proven ability to reduce expenses in a recession (about 50% of their expenses are variable)
- The rails are in excellent financial condition, with plenty of liquidity (this may be the most important point of all)
- They have management teams looking to the long term in this crisis, which will pass
Anthony B. Hatch