Reflections on RailTrends 2021 - Talking the Talk....

Greetings and….

 

Wowza!  RailTrends21 was indeed Live from New York City!  RT was eclectic and hectic but the themes that emerged centered on RRs “talking the talk” on service and growth focus, and the big pivot to the themes that were juuuust beginning to emerge pre-pandemic – Growth, ESG, Technology.  There were outside consultants and observers urging them to “walk the walk” (or is it “walk the talk”?) notably a rather unconvinced major carload shipper and an equally skeptical Chairman of the STB – but there was also a clarion call from Oliver Wyman’s Rail Partner Adriene Baily (see slides attached, below, and Bill Stephens’ take: The future of the rail industry is up for grabs, consultant says - Trains), who labeled these days the (opportunity) for the “Great Pivot” from efficiency (and the “Cult of the OR”) towards growth.  This echoes the CSCMP Logistics 2030 report that called for s shift from cost-control to “ensuring supply”….so the RT21 Top 5 Takeaways were:

  1. Rail Growth focus – echoed by the Class Ones in attendance, notably UP’s Kenny Rocker, the CPKC, the short lines, and, in what may prove to be a valedictory address, CN’s JJ Ruest.  This current/future effort will be driven by technological advances, both defensive (operational) and offensive (customer-centric) and we heard not only from the rails themselves but from two suppliers, Wabtec and Rail Pulse (below)….
  2. The existential battle for the soul of railroading – TCI vs. CNI – was mentioned only in passing….but the commentary by CN on the future of railroading was an eloquent defense of the growth strategy, one we had been looking for.  And, on the other hand, the attack on margin focus, headcount reduction, service deterioration (related?) by Martin Oberman, Chairman of the STB, used the TCI (and initial CN response) as a (the) example of the evils of shareholder-driven railroads
  3. Green shoots?  The beginnings of a service/supply chain inflection, with no hopes for immediate success but barring any further Acts of a Vengeful God (hello, BC mudslides?) the worst may indeed have passed? This appears to be true at the rails and, more critically, at the ports (note that container pricing has dropped by about ¼ from its peak, even though it’s up ~3X YOY).   The ports have, like the rails, instituted a carrot/stick approach to price and assessorials (and tried 24/7, to no great shakes, and “sweeper ships”, pop-up yards, etc).  By the way, for a great explanation for what’s going on at LA/LB, see Bloomberg’s “pictograph” – and note how many (few) times “railroads” re mentioned: California’s Busiest Port is Straining the Global Supply Chain, Causing Delays (bloomberg.com).  There’s been a massive amount of “Supply Chain Crisis” discussion, but as Galileo said about intermodal:
    • And yet it moves: Truck tonnage was up just under 2% YOY in October and IANA reports IM up almost 7% for the same month (Domestic up 3% and International up 10%) – the AAR noted that Chicago volumes were up 11% YOY
    • The FT and others see little to no evidence that the “crisis” is pushing de-globalization (which would be a relief for rails) – note the widening trade gaps in general and to China in particular.  Just-in-Case may also be a pipedream, but that would be a pleasant one for rails….
  1. A labor inflection?  Labor is obviously greatly connected to the overall service/supply chain issue, and of course, it’s complex.  In fact, the short line panel noted that labor issues had spread to their segment, but the Class Ones, notably CSX, was more sanguine about their pipeline….
    • What didn’t get discussed is the National Labor discussions – such a major deal, given the timing, the administration, the national shortages but also the coming technological opportunities
    • Also on the horizon, and just what the twin-port of LA/LB needed is the 2022 ILWU negotiations
    • Labor's renewed power has many positive economic implications, but one manifestation is the FRA's waiver revocation of automated track inspection- a poor outcome for efficiency - and safety, as noted by the AAR’s CEO Ian Jefferies
  1. The CPKC merger – what shocked me about the application was the huge percentage of synergy volume that was rail-based and that didn’t go unnoticed at RT21  - subsequently, the formerly hidden Class One opinion spilled into the open (from the Tweets):
    • Shoes Dropping as hinted at RT21, UNP (and CNI) urged the STB to reject the CPKC merger application (NOT, per se, the merger itself) claiming the lack of detail, especially surrounding Mexican gateways; this, despite the applications total of 4342 pages. CP responded that CPKC’s “impact on competition will be positive; the impact on competitors may not be”. Game on!  The STB didn’t take long to reply….
    • Nyet,” says STB to CN and UP (and, in supporting roles, CSX and BNSF in accepting the CPKC application, stressing the “old rules” format.  Merger comments are due 2/26/22 (and I certainly expect much backroom “discussion”) as well as, or more than, public commentary).  Then, any (hah) rebuttals will be due roughly a month later – final briefs due 7/1. And while the STB has denied applications and required re-submissions before (see CSX/Pan Am) the fact that they didn’t hear does not dissuade me from my opinion that the actual review will be lengthy.  Indeed, it will be a busy winter/spring for the STB – and rails - in general!
    • In many ways, the argument over rail share in the North-South lanes is:
      1. A fight to restore Mike Haverty’s original legacy, a “go-it-alone” strategy (for example, from Lazaro Cardenas into the US heartland on the KCS, now perhaps further on the CPKC)
      2. A battle over the value of single-line service advantages over a shorter but multi-rail (for example, the UP to KCSM) service offering – which is ironic since the fight to put together CPKC itself likely put the kibosh on any future (“Big Four) transaction consolidation

 

 

Other takeaways from the presentations:

  • Regulation – This could have been a major takeaway listed above but a) much of this debate, while critical, has been known since the summer and b) five is a nice number.  The STB will hold a series of hearings in early 2022 (quoth Ian Jefferies of the AAR – the STB “has a brand new hearing room and is dying to use it).  The AAR is frustrated with what it (and I) see as a pro-labor stance that serves as a deterrent to technology (see above) and on an interventionist STB pushing reciprocal switching/forced access in a time of supply chain crisis.  When the Chairman spoke, it did surprise because he actually praised the railways for stepping up in the S/C “Crisis” (noting that “rails were not the cause!”).  But after the sugar came the spice – rail service has deteriorated in the years he has served on the Board, yet rails have cut headcount, pushed longer trains, de-marketed, and spent their cash on their shareholders (that “drain” coming at the expense of service and employees).  There is truth in all of those statements, just no linked causality.
    • And then there’s the TCI example, on which we agree.  As I raised the issue in the Q&A, rails haven’t become “too shareholder-centric” except in extreme times, though that risk exists and the battle of long and short-term shareholder interests is eternal.  But, IMHO, in the rail case, the L/T usually wins – note the CAPEX spent this century!  But this is where the railways' walk is so critical because DC isn’t listening to the talk!  Some key dates for winter/spring hearings – after all, outside of M&A and rate cases, STB solutions take time and the Board serves mostly, as MO noted, as a “bully pulpit”):
    • January 13 on CSX and the Pan Am Railway
    • February 15 on Amtrak (and CSX & NSC) in the Gulf
    • And the granddaddy of the bowl games, Reciprocal Switching (“Forced Access”) on March 15-16
    • No info on hearings on CPKC but I am guessing the Board will like the sound of their new room and hold some; also no mention of hearings or discussion on the WC lines or Massena
    • Sanimax case allowed to proceed – This could be BIG, and it wasn’t well-noticed but the Chairman made special mention of it - a Minnesota shipper case argues that the UP’s poor service amounts to a violation of their common carrier obligation….as Matt Rose warned way, way back in 2019, the CCO is the potential Achilles heel of the PSR crowd and price/de-marketing – another reason the rails better walk tall and quickly
    • The Chairman noted that the next few years could and should see a boom in PPPs in such things as inland ports and other supply chain enablers
    • The Railway Association of Canada’s Marc Brazeau said that the Canadian railways were cooperating with the Canadian government (Transport Canada) to bring about a new and improved (and cheaper) form of PTC to Canada, ETC – and that we may see progress within 18 months!

The Great Pivot (OW – see slides and one in particular, below).  The annual RT/Oliver Wyman presentation highlighted the choice for RRs – essentially Grow or  Shrink (the latter being what the STB fears/expects).  Which way will they go?  Bailey noted that rails gains in efficiency and in technology were both impressive and necessary (what I call “PSR 1.0”, the baseline) but “at some point cost-cutting alone becomes a value destroyer”.  Railroads are holding share (Larry Gross will dispute that, below).  We are at that great pivot point (“the future is up for grabs!”) and, to OW, the railroads need to:

  1. Serve the New Supply Chain (note that on the daily service requirements of the rail traffic mix go up, even as JIC and technology give rails a chance to better compete)
  2. Improve the Transit Experience (it’s the service – stupid!)
  3. Embrace Customer Centricity
    • See the slide at the very bottom that shows the addressable market if the Pivot is made (and note that this presentation was the most requested by C1 leaders….)
    • To that end Rail Pulse, the visibility game-changer, was represented by 2/5 of its founding members (NSC & TRN). The platform for railcars (location/condition & safety monitoring etc) has its launch date accelerated (YE'22) and expects new member announcements very soonish…..
    • Wabtec’s CMO Gina Trombley echoed the G/P clarion call, leading a charge in sustainability (where she quoted CN’s head of Sustainability Janet Drysdale, as saying that, for rails, it wasn’t a silver bullet but rather a silver bucket!).  The rails and WAB (and others) have to continue to push the envelope because their current huge emissions advantage is, as I have been calling it, temporary and tactical (CN’s Ruest noted that the current state of the advantage “will eventually come to an end”).  GT discussed WAB’s efforts in new loco power (“a process”, albeit one with huge incremental upside)and to full automation, from “re-imagined rail yards and terminals” to single-person crews (see Labor, above)….
    • The Larry Gross intermodal presentation was a challenge to the emerging “Talk”/thesis – noting that volume peaked in March and that the demand blame for the S/C “crisis” was, perhaps overstated, he assumed the 2021 “Doctor Doom” title (Rod Case being on the IR list with an oblique injury) by stating that rail “intermodal took a major hit in 2021; the damage is reparable but” rails have lost share and given up most of the gains made over the past decade!  This echoes what I termed the “red zone fumble” of the rails failure to capture sticky container business in truck-challenged 2018 into 2019 period….

CPKC!  CP(KC)'s rock-star CEO Keith Creel didn't disappoint nor back down from the revelation of how much of the expected synergies, especially by and after Year Three, were coming from rail….KC noted that they weren’t planning to go to war but….we didn’t list any questions for Keith in my RT Preview because, well, it simply wasn’t necessary!  CP will need to spend (~$300mm in the US Midwest so I am assuming those are greenbacks, not Loonies) to compete, and they just raised money ($2.2B) on the debt market.  He seemed thrilled by the adventure he and his team are in and to come (“this is the biggest thing in our lives”).  In other news (other?) he noted three things about CP’s sustainability efforts:

  1. Their hydrogen-powered loco project
  2. The solar farm at their Calgary HQ
  3. Their recognition at COP26!
    • KCS (KSU) was there in abundance – notably in a great ceremony for departing PSRV exec Sameh Fahmy.  John Orr, COO,  presented his work following on Sameh’s in creating a true (and positive) PSR culture at KCS (just in time for Mr. Creel) – creating what Orr called a “speak-up culture” and promoting “creative tension” – phrases I have heard in Calgary.  John also showed some notable metrics improvement, especially in Mexico.
    • Union Pacific’s CMO Kenny Rocker didn’t take the bait on the merger competition, sad to say (from a drama perspective only).  Although the heart of their IM franchise is the N/S (Pacer) lanes seemingly targeted by the CPKC, KR noted only that they “are not afraid to compete”.  In truth, they do have a brand and mileage advantage.  Rocker focused on the big picture, and seemed to eerily but positively echo OW – “It’s all about the Growth”.   I was pleased that he discussed “leveraging PSR” into that growth – it must be made clear to DC that the disruptive part of PSR implementation is over but the benefits remain and can be part of that “pivot” (quoting both OW and CP).  He also discussed UP’s plan to (in effect, unattributed) follow the pattern established by the PSR motherships in Canada (cost-to-growth then) by expanding their network reach (IM, “AccessUP”, Loup logistics (M&A? CEO Lance Fritz has hinted recently)….
      • One thought occurred to me – the CPKC maps showed two critical pinch points in Texas where KCS moves over UP trackage rights – I see a Travis-like line in the sand maybe….
    • The shortlines showed why they are the beating heart of entrepreneurial railroading.  At RT21 we were lucky not to suffer from the one-time-only simultaneous ASLRRA/RT timing, with a great panel featuring an owner (Anacostia), a President (GWR), and two top marketing execs (Watco and RJ Corman).  We noted (and correct my public mistake) that two of them, Watco and GWR, are also charter members of Rail Pulse.
      • Their consensus was that PE-sales of SL Holding companies would be the deal driver “over the next 3-5 years” (even “seeing a lot of (such) activity in the next 18 months”)
      • Secondarily would be more switching deals (a la Watco-Dow), and another ancillary/complementary deals
      • The Class One re-focusing on growth (again, the major theme of the conference) is a big positive
      • There are major items of unfinished business at the STB (Massena/PAR/WC)
  • CSX saw some daylight  - feeling “so much better today than three months ago” in filling the (40/week) crew/training pipeline despite challenges  - on the labor front and the “best growth opportunities in years and years” – what’s not to like about that?  CMO Kevin Boone noted the tailwinds for his carrier and his peers – the E in ESG, inflation pressures being good for low-cost transportation, the driver shortage, on-shoring (though neither UP nor myself have seen the evidence), and –improvements in service quality….and the Quality Carriers acquisition, in the very early innings, along with PAR, show the pattern of PSR under Jim Foote that we saw at CN (and, under KC, at CP).  CSX has also seemingly handed the target-on-its-back to Norfolk Southern, subject of a rather stern reprimand today (11/23) from the STB on its service issues….
  • Canadian National’s CEO JJ Ruest won the RT21 “Railroad Innovator of the Year” Award for the body of his work “Redefining the Future of the Railroading” through a growth lens (noting his development of new business opportunities at Prince Rupert n(and NOLA/Mobile), new technologies, and the “Feed the Beast” mindset).  JJ, with the team in two, discussed some recurring themes that are/will be put to the test in then TCI (and Elliott?) fight – the DSR, the stakeholder-served railroad, the growth strategy focused on earnings/cash flow and ROIC financial results not (just) the OR….CN noted that their big cut in CAPEX (17% - as a % of revenues, still used and still useless) comes after years of capacity additions(up to 25%+ of revenues and is also due to the huge hit in the anticipated Canadian grain crop.   CN continues to support built-in resiliency and supply-chain thinking (and, separately, JJ allowed that CN was still on the hunt for ancillary FTB acquisitions!).  If this defense had been unveiled in September things would be very different indeed….

 

Meanwhile:

  • Finding a “world-class leader” for CN, in Quebec, has its own set of complications – just ask Air Canada: Parlez-Vous Français? Air Canada Boss Says ‘Non’ and Gets an Earful - WSJ
  • Ecommerce comedown?  It was 11% of retail sales in 2019, jumped to 16% in the dark days of Covid (2020), and is expected to end this year at ~13%, according to McKinsey.  Amazon somehow managed to disappoint its investors with its Q3/21 results and holiday outlook….
  • The FT reports that the Bakken Shale is in secular decline….
  • Not much to report on the US/Canada/Mexico “Three Amigos” summit; the latter two supposedly made their case against “Buy American” (especially in terms of EV auto production) and the US countered with concerns about Mexican interference in energy transport, but everyone made nice publicly….
  • Air cargo is ~36% of airlines' 2021 revenues, according to IATA, up from 12% in 2019!  And there are new entrants from the steamship world, Maersk, and CMA CGM (even Watco is looking skyward – but working to bring a rail/IM concept, not buy planes).  Why are shipping lines looking to the air?  Normally air costs are usually 12.5X ocean’s but at present, they are only 3X, which helps explain….
  • Container shipping profits were $1B H1/20; they were $23B H1/21.  So, is it gouging now or death-spiraling last year?
  • Rivian – an EV (pickup) truck OEM, went public with a $100B – BILLION - market cap earlier in the month – making it worth more than all but the two large western railways.  As of the IPO it had created all of 12 vehicles.
  • Proxy-fighting to get easier? The SEC approved “universal proxy” ballots, rather than rival sets of paper (the FT: “one possible consequence is that fringe forces will find it easier to barge their way into the boardroom”)
  • The government really, really doesn’t like share buybacks.  Not only is the White House considering proposing a 1% surcharge, but it cites share buybacks versus pump prices for gasoline majors as a reason to investigate (“mounting evidence of anti-consumer behavior” from two majors who are “planning billions of dollars of buybacks despite rising pump prices” – despite or because?).  And - we already know what the STB thinks about the matter.  I am no fan, as anyone with history with me knows, of buybacks over CAPEX(as opposed to a “balanced” use of free cash flow), but this is simplistic “logic” at play here

 

Anthony B. Hatch 
abh consulting
http://www.abhatchconsulting.com 
[email protected]
Twitter @ABHatch18

11.24.21
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