Reflections #2: NSC & KSU - Can I See All Obstacles In My Way?

Tracks Late Daytime

Greetings;

This week we’ll get some mid-quarter updates from some of the boondoggles, er, “conferences” being held between rounds of golf in Florida.  While still waiting for BNSF and the 4th quarter Railroad Review, I have had some time to ponder some of the earnings.  The second set of earnings – those of the other US converts to PSR, KSU And NSC – appeared at first to be easy to categorize.  By song, after “Kind of a Drag” (UNP & CSX, more on the outlook than the performance) I proclaimed these two to follow the old Johnny Nash hit, “I Can See Clearly Now (the rain has gone)”….and I feel that first thought still applies to the KCS.  As for Norfolk Southern, whose stock rose over 6% in the ~24 hours after their earnings announcement, I think I needed to put another dime in the jukebox, baby:

 

“Got a feeling inside (can't explain)/It's a certain kind (can't explain)
I feel hot and cold (can't explain)/Yeah, down in my soul, yeah (can't explain)
I said (can't explain)/I'm feeling good now, yeah, but (can't explain)

 

OK, Norfolk just has me a bit confused.  EPS beat expectations (by a fair bit) but were still down YOY and the OR was 140bps higher to an industry-trailing 64.2% (full-year OR of 64.7% was down 70bps, and a record for the company).  Revenues were down 7% on -9% volume (that’s a big number without any planned de-marketing); the “Yield Up” plan appears to be working (too?) well, with RPU (Less Fuel) up 4%.  They expect flat revenue for 2020, and as with their peers, that means a much better H2 than H1.  NS proclaimed that as they go through PSR (Top 21 Sate 3 underway now) they, uniquely, saw service improvements.  To quote another song, “It ain’t necessarily so”, as we’ll see with KSU below (etc); but NSC did, indeed show service improvement.  But they revealed a bit of their philosophical bent when CEO Jim Squires stated: “Let me say first, this is a cost-structure, cost reduction based plan, particularly in 2020 when we forecast flat revenue; (and) it remains fundamentally an efficiency-oriented financial plan even as we move into 2021 (where they aren’t “factoring in a lot” of growth, either).  All of the emphasis is mine.  Wall Street cheered (margin improvement without requiring volume improvement!) but - Compare that with “service begets growth”?

There was a lot to like in NSC’s Q4/19, to be sure:

  • Network Performance improvement – As stated by COO Wheeler (not Farrell), train (not car, as per their peers) speed was up 17%, dwell down 30% (FY; for Q4/19 it was +19/-24); the five KPIs all showed improvement, including a 50% jump in their Service Delivery Index (SDI).  With a lot of noise, to be expected in any final quarter, their “core OR improvement” was 240bps, and they reduced operating expenses by 5% (headcount was down 16%).  Their newfound resiliency showed in their recovery from a mainline derailment, expected to cost $25mm (Q3/19 call) came in at $13mm. 
  • The earnings call served as the coming-out party for rail debutant Mark George, their new CFO, who, as Mainers would say, is “from away” (UTX), rare for the railroads and especially for the Thoroughbred.  He did a fine job. And was refreshing (in 2020 “we fell a little bit short”).  His plan to study Capex (“I want to understand the rationale for the spends that we have; the justification financially and the prioritization….”) is as to be expected and while likely thrilling for those on the call, in this day and age, made be a tad….nervous.  NS will spend about 5% less this year than last but as of now is sticking with the 16-18% of revenues Capex guidance (with a few questions on that as compared to the two peers, UNP and, especially, CSX).  There is clearly latent capacity.
  • With their flattish revenue guidance, which as noted was slightly more “optimistic” than the guidance issued by CSX, that includes a recovery in volume in Intermodal.  This is the NSC growth generator and this year’s performance will be very interesting and instructive.  There was some confusion on IM’s incremental (as opposed to overall margins, but clearly the domestic opportunity is (and has to be ) priority #1….
  • They expect “greater than 235bps” OR improvement in 2020 and reiterated their 60% OR Target for 2021.

 

Dizzy in the head and I'm feeling blue/The things you've said, well, maybe they're true
I'm gettin' funny dreams again and again/I know what it means, but…. I Can't Explain”

 

I’m Feeling Good Now, yeah….But there were also some questions, and as much as have followed, often with delight, Norfolk’s historic leadership role in the “Railroad Renaissance”, there are some things revealed in the Quarter that….I can’t explain….some are perhaps just my level of concentration (for example, NS having 45-G – the short line ITC – tax credits?); others may be of philosophy. Such as:

  • KPIs and metric goals – why in the world., having brought that SDI up so much, and already to the 2021 Goal level, would they
    • Maintain their 2021 goal (for rails chasing service improvement is like dogs chasing cars – it is always just ahead of them and in this brave new Amazon-inspired world, always will be); and
    • Why in the world would they defend that decision?  At the very (very) least give some kind of double-talk rail speak….Is it too expensive and a poor ROI to take that SDI to 2.0?
    • The 2021 goal in cars on line was also already achieved but that may be more of an operating plan (after all they have to provide capacity) than anything else – at least I hope so….
  • Transparency
    • The all-time unbroken winner of the Harriman (safety) Award didn’t disclose it’s safety numbers (which I thought was a cardinal sin for railroads)….It is important not only in terms of costs, stakeholder relationships, service consistency, etc, but also in this PSR process
    • One way to discuss margins, especially when one has the highest OR and there are questions, valid or not, on incremental margins, and especially if one is the intermodal “ax” in the east, is to discuss returns (ROIC).  NSC did not….
  • Questions abounded on why purchased services weren’t responding to PSR/Top 21 – can it truly not be wither volume or consistency variable?
  • Although NS’ plan to bring on PSR/T21 in a “collaborative” manner (a response to the “CSX Hangover” and the STB reaction, etc) makes great long term sense, it is nonetheless notable that they seem to bring less of their dramatic operating improvement to the bottom line….

I have faith that by a year from now intermodal will lead NS higher and higher, as Jackie Wilson said, where they will look straight ahead and there’s nothing but blue skies….But I would like some numbers, perhaps by mid-year, that will bolster that conviction….

 

Now, back to Johnny Nash….

 

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