Rails - More than Earnings Season

Close up of side of train

Greetings and have a great weekend (Note: this was meant originally to be sent on Friday but ran into the periodic technical gremlins)….

First up, and this pains me to report, but RailTrends is or is close to, sold out.  Please recall that I serve as the “front of the house” - as MC and in creating & setting the agenda of the conference I co-founded with “Progressive Railroading” magazine (TradePress); I have nothing to do with the operations, site selection, pricing, P&L, etc (i.e.; the “back of the house”).  So if you were hoping to attend, please get in touch with Amy Brown (cc me if you would like) of TradePress ASAP.

Second, while we say this note is about “more than earnings”, we will nonetheless start with them….

GWR, heading down to the final countdown of its public life, reported Q3/19 at last, via its 10-Q – and the results were…OK, many ways similar to their Class One partners.  Overall: revenues down 3%, operating income down 12%, flat EPS (on 4% fewer shares with a 190bps increase to 80.7%.  that, on the surface, is pretty mediocre.  But in some areas, GWR in their core segment,  North America, outperformed the C1 group (see table below) with revenues down 1% (inline) – but for continuing operations (excluding the two Canadian lines that came off lease) revenues were up 1% despite the 5% drop in (adj) volumes, meaning a strong (+4%) showing in adjusted (for mix and fuel – i.e.; the closest thing to price) yield.  Nonetheless, the OR increased 170bps to 72.9%  Interestingly, their top volume performers (ag +15%, autos +21%) were very different than the overall freight rail trend.  “Freight-related” revenues (switching and the like), a real short line opportunity, rose (adj) 6%- it’s almost a fifth of the NA total….

  • Oi!  Good news from Down Under before they turn over the pink sheets….Oz, soon itself to be a discontinued operation, showed a flat (FX-adjusted) revenue on a 3% volume drop (Ag -32% due to the drought and ores -16% outweighed the 9% increase in core coal shipments.  Australian OR improved slightly (20bps) to 72.8%

  • I am sure management is happy not to talk about UK/Europe to the investment community; FXA revenues were down 2% as was volume but the OR was 420bps worse to….101.5%

  • Conversations with GWR management at a few of the fall meetings has convinced me that management is staying on (“we’re having fun” – CEO Jack Hellmann) and that their soon-to-be new owner BIP’s offers to help (which sounded ominous to me coming from, despite their claims, non-railroaders) can indeed be meaningful in the areas of warehouse synergy (and other real estate) and technology….

Rail earnings Q3/19 showed resilience in the freight recession.  The overall theme was solid financials, poor environment and “matching resources to demand” – and wait for the January earnings calls for real details into our intermediate-term thinking.  Now all-in, the simple table below shows the group overcoming the volume drop with price, cost-cutting and operational restructuring.  As stated last week, earnings beat the market (handily, in fact: +9% versus -3%), although the 66% win rate trailed the 75% success of the companies in the  S&P 500 to beat Street expectations…. Margins (the OR, sigh) improved on average 190bps, which does represent real PSR progress for the newcomers (and consistent success by the old-hands up North).  The earnings were helped by a generous dollop of share buybacks, which continue to buck the trend (-15% 2019E and -5% 2020E consensus) of the overall market.  But it’s not a thrilling picture, and at this late date it’s hard to see Q4/19 showing any change; indeed the short term pessimism in the earnings calls suggests (hopes for?) a midyear 2020 inflection.

 

11.18.19 image 1.png

Why so glum? Because volumes are scary – and decelerating (the 4% quarterly drop in total has been doubled in October!). A slide from my RailTrends presentation:

 

11.18.19 image 2.png

Let’s look at some recent headlines in the volume/economic arena:

  • The US GDP grew 1.9%, supposedly, in Q3/19

  • Cliché of the fall:  the “muted peak” season; i.e. no help from a Xmas rush…. LA/LB port numbers were down 14% in October (although the National Retail Federation expects an 85 increase in imported TEUs this month (only)

  • Global trade fell 1.2% in August; US imported consumer goods down over 4% in September as US consumer spending growth shrank from almost 5% in Q2/19 to just under 3% in Q3….BUT – US resins (plastics) exports grew by 35% in H1/19 with Houston’s up 57% (48% of the total) but likely to hit capacity soon (good for rails).  And Maersk actually increased its 2019 guidance….and other steamship lines have ordered more capacity in the form of new (23K TEU) mega-ships:  MSC (5), Evergreen (6) and CMA/CGM (9)

  •  FDI was down 20% in H1/19; into the US it was down 25%!  So much for re-shoring, at least so far….

  • The manufacturing PMI has been in negative territory since August….

  • The secular decline of Canadian (BC) lumber due in part to beetles and various tariffs has led to a reduction of 2B board-feet (5% of total NA capacity) – Canada has seen a 25% reduction in capacity in the last 10 years as production continues to shift to the SE of the US

  • The auto slowdown may be as much as a quarter of the global GDP reduction YTD, and fully one-third of the trade reduction according to the IMF; the GM strike cost it some $3B this year.

  • US CAPEX is now expected to increase just 1.5% this year – which would be one-third of the level achieved just two years ago

  • Yet the ATA reports September truck tonnage up 3.5% (for the quarter, up 1.2% - still a sharp contrast to rails).  Given the overcapacity in that mode (Class 8 truck sales up 20% again in September), how can that be?  Has the American Trucking Company become like China’s economic statistics bureau?  The Cass numbers have been down all year(September down 3.4%)…and TL rates are beginning to inch back up, at least sequentially.  I expect to hear some lively discussion on this at RailTrends from Donald Broughton and Larry Gross.  Meanwhile, a very esteemed senior trucking analyst/statistician is calling for a 2020 recession (I point out that he has called for 5 of the last 2 recessions but still….).

  • But there is good news on trade coming….right?  See below.

So are we getting a trade deal or not?  It’s funny that it now seems that we might actually get a US approval of USMCA (“NAFTA 2.0”) before we get Phase One (“Mini-Deal”) completion with China.  On the latter, China appears reluctant to be committed to absolute dollar level of Ag purchases (the “$50B a year” number – over 2X the pre-war levels, always seemed like….hyperbole….to me).  All of this can turn on a dime, or a tweet though DC, anyway, has a lot going on (of course – the Redskins just lost to the Jets!).  Mexico, meanwhile, has been seeing continuous bad news on the economic growth front - a recession may be avoided, but just.

Other DC Distractions – a rise of (re) regulatory sentiment?  We ‘ll know a lot more by the end of the week as we will hear from Ian Jeffries, CEO of the AAR and Commissioner Patrick Fuchs of the STB at RT19 (as well as the ASLRRA, the RAC, the RSI and old friend Administrator Ron Batory of the Federal Railroad Administration.  Over the last few weeks the STB has held hearings and issued proposed rules on an expedited rate case process called Final Offer Rate Review (FORR) – immediately opposed as illegal by the AAR – and other findings from the Rate Reform Task Force (hmmm) that will include a “Market Dominant Streamlined Approach”, endorsed by the ACCC (always known for fair and balanced endorsements) and a soon to be defined Revenue Adequacy.  This has been building and in the case of the Chairman of the STB a vestige of what’s known as “CSX hangover’ (referring to the rapid adoption of PSR in 2017-18, as well as an aversion to the late Hunter Harrison).  However, to me, the STB hearing on CSX and EHH in late 2017 actually proved the negative as shippers lined up to discuss CSX’ service failures leading to the use of more (subsidized) trucking and higher logistics costs.  Yes, supply chain costs went up but the chains remained intact – so what shipper “captivity” is that?  Hunter’s response, as recorded in the book “Railroader”, serves of me, too….

  • Speaking of the FRA, the Class Ones look to hit their 2020 PTC deadlines – and next year will be the big test of interoperability (then 2021 will be the year to “turn on the data spigots”).  The fact that UP & BNSF, as well as CSX & NC, have completed their tests and are “interoperable’, suggests that this can work, given effort and expense.

  • Meanwhile, as we begin national labor negotiations, it’s worth noting that the Rio Tinto] driverless train experiment in Australia (“AutoTrain”) is working, increasing overall velocity – and capacity – by 6%.

  • Speaking of labor, with an 8% YOY reduction in headcount (per BLS)….the unions (AFL/CIO( have begun a PR campaign against the ancient practice of furloughing….

More Sentimental journeys – in Chicago last week at the annual MSU Rail Certificate program led to a series of interesting conversations, with two themes worth mentioning:

  1. I met with universal derision (hey – it happens) in my presentation to the class on the virtues of PSR 2.0 – you know, the “We the North” bit.  The class consists of mid-career short-liners, switching railroaders and suppliers – all of whom completely buy into the thesis that the rails are only obsessed with maintaining the Temples of the Cult of the OR….So there’s that, and it’s not helpful.

  2. Talking with a veteran PSR operations guy opened my eyes to future research needs – he says that initially the cost-cutting and schedule-changing of the restructuring process lead to reduced track time for engineering projects, leading to inflation and often reduced work (and all that implies).  Watch rail & tie installation (and forecasts versus actuals) as well as slow-orders and derailments.  I will be reaching out to my friends at the Railway Tie Association (RTA) for help.  This falls under the heading of a concern but likely not a panic because by PSR 2.0 (AKA PHR) those that have reached that stage have caught up and re-balanced. 

  • The RTA Conference reported that despite the increase in SE lumber capacity overall, supply for ties is a problem; that and what they say are “PSR” issues will lead to flat-to-down years this year (-3%E) and next in installations.  And, I must admit, while at RTA I often overheard the dreaded term “deferred maintenance”!  However, Class Ines vehemently denied it, overall MoW numbers have been flattish despite the overall CAPEX reductions from 2015-19, and several big project completions (BNSF, CN) account for some of the reductions and planned reductions….

  • According to the newly released AAR publication “Railroad Facts”, over the past 5 years (US only) ties laid are down 11% from 5 years ago, and rail down 15%.  Capex overall is down 18% (the starting point being a year behind the unusual 2015 peak, but still on a relative basis very strong.  Roadway & Structures spend was down 7%.  This year 5/7 (overall 5/1/1) Class One major railroads planned to increase their MoW budgets.

  • In that same period (2014-2018) Freight Loss & Damage is flat but train accidents are up 8% but injuries are down 11%.  Overall that seems the very definition of “mixed”….

KSU, as promised, announced their new capital allocation strategy to great acclaim – though it might be a bit worrisome to this self-proclaimed defender of Capex – 40-50% of the cash flow dedicated to “Capex” leaving 50-6-% to direct shareholder payouts (dividends – which were raised – and share repurchases – which were re-installed to the tune of $2B with $550mm “accelerated”).  Is this a response to their success at PSR so far (ahead of the Class of 2019) or to Mexican slowdowns and trade issues?  Probably the former.  No change to management compensation plans but I really want to see their ROIC targets.  I am reassured by the whole “service begets growth” argument and hope to be further reassured by CEO Pat Ottensmeyer’s address at RailTrends as the “Railroad Innovator of the Year 2019.”

Other news to consider:

  • Amazon’s shipping costs increased 46% (!) in Q3/19; UPS earnings were in-line and Hub Group’s better than that.  And Wal-Mart even better (a “monumental comeback” says the FT’s “LEX”).

  • Regional Rail, the short line and rail-related holding company helmed by Al Sauer and owned by infrastructure fund company 3i (which received a great recommendation by the very-same FT’s Lex), bought three Florida lines from the Pingry Group as the Short Line Boom Continues….

  • "Rail Talk"

  • 53’ containers were exempted by the US from China tariffs

  • Convoy, the “digital truck broker”, raised $400mm in its next round of funding, valuing the company at $2.75B

  • The US Ag community, corn division, is up in arms over the emerging new rules on ethanol, according to the “US Farm Report” (weekly on the RFD network)

  • $1.5B new-build freight rail in the Utah Niobrara shale deigned to carry petroleum unsuited for a pipeline project that – somehow – escaped my attention.

  • However the rest of the US shale-world is looking more [problematic – production is still up despite talk of scaling back in the face of lower prices and weakening financial outlook (The WSJ reports that the junk bond market is signaling real trouble in 2020.  The top 6 publicly-traded sand firs reached a market cap of !18B at their peak a few years back; it’s now $800mm; the sand price/ton was $100 and is now ~$15….

Just for fun:

  • If you care, below the name are a few pictures of the famed Union Pacific steam locomotive “Big Boy” I took when it happened to hit Tucson when I did (I am no foamer; but then again you can see I am no photographer, either).

  • Hasta la vista, baby and good luck on your retirement from “Trains” Mr. Fred Frailey.  May all your future centrals be NYC!

  • Also retiring, at least from his current CEO position, is Michael Sabia, credited justly for the big turnaround at the Caisse in Montreal after being such an integral part of the team at the CN’s IPO and beyond.

  • PBS’ “NOVA” had an interesting episode on self-driving cars (“Look Who’s Driving” 10/21 on On-Demand)

  • Walgreens going private?  Maybe just a way to save their “Curly W” from brand erosion due to Kurt Sazuki?

  • Speaking of bad brands, Murray Energy filed for Chapter 11 (despite the changed EPA regs and support from on-high

  • See many of you at RailTrends in NYC next week!

 

Anthony B. Hatch
abh consulting
www.abhatchconsulting.com
abh18@mindspring.com