RRs - NSC, CSX & UNP All EPS "Wins" BUT is an Emerging Tone-Deafness an Issue?

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Greetings!

 

NSC joins CSX and UNP in the winners' circle; CP later today (slight beat, but hear the trumpet’s call) and then BNSF….?

From the Tweets:

NS, after UNP & CSX makes it  3-for-3 in earnings “wins” (i.e.; beating Street expectations) -  but signs of Tone-Deafness emerge, from (over) emphasis on the OR (the big focus of NS’ incentive although an over-1000bps improvement is, to be sure, worth crowing about), to headcount reductions and also assessorials, (1/2 of the YOY RPU growth), etc; the former is out of date (rail investment themes have moved to – forgive me – PSR 2.0 and Growth/technology/ESG) & latter may be necessary - but read the room, guys!

  

Norfolk Southern beat expectations by a lot, even excluding the 17cent/200bps gain from a property sale and a +9 cent tax change  In fact, NSC’s “core” OR improved 1040bps to 58.3%, perhaps the railway record for a single quarter YOY performance; the comps, of course, lack real meaning, but the OR improved sequentially by 100bps.  NSC raised their Guidance for revenues (FYG to +12%, implying rather flattish H2 comparisons).  From a financial perspective, NSC, NSC’s results were stunning – volumes up by a quarter but OpEx only up by 11% as headcount was down 8%.  This was a Very Good Quarter – free cash flow (FCF) was up 44%.  NSC talked about service and capacity improvements, then faced a barrage of questions essentially on the same….CMO Alan Shaw well summarized the rail perspective on the supply chain – “it’s not an issue of capacity but of throughput”.  some thoughts:

  • Oblivious to the climate?  No, I am not talking about the real climate (in fact CEO Squires did address ESG and their issuance of $500mm in “Green Bonds”; fuel efficiency improved by 4%), but the political climate:
    • The emphasis on OR is important for NSC, the recent industry laggard, and also given where it is in its PSR evolution, but….it is time to move compensation towards ROIC and growth.  That said, two of the first three questions (and 4/15) were on the OR guidance (H2 flattish with Q2 ex-RE) for the near term….so in this case both the chicken and the eggs need to change their clucking.  And maybe this wasn’t the quarter for a 58 OR!
    • GRRRR - This argument was NOT helped by a ridiculous almost dangerous, even analyst question, also asked by the same offender of CSX and UNP, about the OR impact of growing intermodal.   That sounds benign, but the gist was that intermodal was bad because OR improvement was everything so that efforts to grow IM must, somehow, be compensated for.  Being an analyst should carry the responsibility to understand the industry.  And NSC missed the opportunity that others, notably CN, take to shift the emphasis to ROIC and growth.  After all, JBHunt’s blowout Q2 performance came at 89.2% OR!!
    • Operational efficiency improved a fair bit – train lengths by 14%, weight by 16%, the headcount/volume growth – but terminal dwell increased by fully 24%, and (train) velocity decreased by 18%.  And the velocity hit comes as the slowest commodity, coal, continues its secular decline!  Yes, it appears to be recovering in the early Q3, but….Of course, as I have been emphasizing, it is not all NSC’s nor the rail network’s “fault” (see chassis failures, and the whole supply chain issues, etc), but, still…..
    • So the fact that half of the 17% RPU gain in intermodal came from storage may be correct and rational but sounds a jarring note, I am sure, in DC….
    • NSC is hiring (H/C was up 8% remember) and is finding only spot shortages of labor and has plenty of power
    • COO Cindy Sanborn’s presentation on their emphasis on yard & local service shows that they are focused on the right place, and her demonstration of the PSR success on locomotives (not simply asset reductions, but the DC-to-AC conversions, the improved visibility into the issue, the accountability all mean a 175% increase in reliability since PSR began 2+ years back.  And that is an example where what I call “defensive” technological efforts (think football; technology installed by the COO for productivity) can be turned into “offensive” technology (to gain/retain shippers).  Think of improved reliability as a “Pick-6”!
    • Interesting to note that NSC, the perennial winner of the Harriman Award, the now-retired annual rail safety award, didn’t list its PI or incident numbers….
    • The curmudgeon in me also finds it hard to be happy about “distributing 8K smartphones to the NSC workforce – even this troglodyte has had a smart-phone since soon after the turn of the century….
  • Volume numbers were solid - remember the comparisons make these at best hard to put into context.  They attempted to compare to 2019, for which they deserve kudos (remember 2019 was a pretty bad year for railroad volumes).  Revenues were still down 4% Q221 v Q219, as “Energy” was at 2/3 of the levels of only two years ago – but “non-energy” was up 4% over the span.
    • Rails face inflation too including raised trainee expense, OT, signing bonuses, etc – but rate increases of size (in addition to demurrage, etc) provide excellent soundbites to the already encouraged “opposition”….

 

CSX was the first rail to post a positive result versus Street expectations, and shocking, well, me, anyway, by reporting a 43.4% OR (again, shhhhh) – though of course after excluding the big Virginia property/passenger deal, it was a lousy 55.1%  Volumes were up 27%, revenues up a third.   Even coal got into the act, up 44%/47% (vols/revs).  CSX is the railroad with the most before the STB (Massena sale, PAR purchase, ACC letter), if not the biggest stakes, and the one that since Hunter, that the STB has been the most angry with….All the operating metrics reported went the wrong way (velocity down 16%, dwell up 18%, On-Time Arrivals -20%, Originations -11%, etc) save flat fuel efficiency.  Trip Plan performance was 15% worse in carloads (69% - it was in the mid-80s in ‘19) and 5% worse in IM (89%).  Poor timing (the STB might argue this has caused the timing).  CSX is emphasizing, correctly, its efforts to turn around the situation, via technology (D/P, ATI, other buzzwords), strong Capex (a turnaround, to be sure), loco rebuilds

 

Some thoughts:

  • CSX posted its safety numbers.  Hurrah? To paraphrase an old Richard Pryor joke, that’s what they’re supposed to do!  That said, their Personal (PI) Injury Rate improved 13%  (YOY – it ticked up a tiny bit sequentially) and Train Accident rate fully 34%
  • CSX is of course hiring, or trying to (CEO Jim Foote – this is “the biggest challenge in his 50-year career”.  OK, 30).  They wanted 500, are looking to settle at a more expensive 200.  Foote allowed that if he did have the 500, most of CSX’s metrics would improve a lot….which has implications for the argument that shippers are slow to get boxes (etc).  Meanwhile, the big jump in “Other Revenues” was attributed to IM storage fees…..
  • CSX maintained FY Revenue Guidance (FY “double-digit”)
  • Quality Carriers (NOT an alternative to IM – see grrrrrr above) will add 6% to revenues in ’21, will be neutral to EPS, and likely runs at a good-TL OR level (say, 88-90%), thereby adding, say, a point to the reported OR but contributing – by itself and as a driver of ail chemical traffic – to the ROIC
  • There was no discussion of the Massena line issue, the PAR (newly re-filed), nor the soon-to-be-opened Carolina Connector IM Hub….
  • Jim’s response to the hoopla over the EO and the STB’s response (and the STB in general) and the ACC and….is very astute, I think:
    • it's really my personal opinion, it's really unfortunate, when the supply chain, all of these essential workers who have been doing an amazing job now in during a pandemic, are kind of singled out as, our railroad is made up of all these employees that are out there working, and all of these regulatory ideas, which are really pushed forward by industry lobbyists, who want to change the rules and regulations, decided at this point in time when everybody's working so hard, that we should suddenly upend and take advantage of a difficult time to try and push forward a regulatory agenda.  As Winston Churchill said: "Never let a good crisis go to waste"….

  

Union Pacific showed the way for US carriers – beating the Street by 5-7%,  2020 (“skewed comps”) by 63%, and 2019 by 23%; their OR of 59.6% was 590bps lower than last year and still 450bps lower than 2019.  Do remember, however, that 2019 was a lousy year, so it will take a while for true comparisons to emerge for UNP and for the rails as a whole.  And Q1 was impacted by the Texas winter, recall.  In operations, productivity (loco, “workforce”, train length improved while service metrics (car velocity, Trip Plan Compliance for manifest, and IM) declined.  An apt metaphor for the rails in Q2/21?  They were hurt by LA/LB, by wildfires, and re-routing due to the Dry Canyon bridge 9with that name, perhaps someone should have seen it coming, like Lou Gehrig and ALS).  Still, they see the network constraints (such as the Chicago embargo, etc, as “transitory”.

  • Volumes were up 22% and revenues 29% - with that 7% gap due to Fuel Surcharges and price….In bulk, grain remained the big winner (revenues up 22%) – but was flat sequentially and faces “ongoing pressure” from tougher comps and an uncertain (though hardly problematic) harvest.  Industrials saw across the board strength in “Energy”, Forest Products, Industrial Chems & Plastics, and Minerals.  Premium saw a big jump in the yet still troubled autos and a 21% gain in IM revenues (+10% sequentially) – but we knew that.  The overall outlook for H2 (FY21) is for more of the same with “?” only in coal and autos, the latter until the chips are sorted.  Their “Pop-Up” IM terminals in the Twin Cities and the Inland Empire (CA) are a cool success story….
  • UP raised Guidance a bit – FY volumes to +7%, 200bps in OR improvement
  • No safety stats!  There was reference made to “equipment incidents”, and, per CFO Jennifer Hamann, “a little bit higher expense in….some of our environmental and personal injury accruals” that may have cost “a nickel” in EPS
  • From the DC Soundbite Dept: headcount was flat (although for UP, who had invested in labor staying close at hand, sees no hiring problem unlike, say, CSX).  And:
    • UNP pulled in $235MM in H1/21 productivity results, and plans for $500mm for FY21, with “workforce” so far providing $44mm.  Now this is, for example, with Manifest TPC (Trip Plan Compliance) down 9 points to 67%....that’s a soundbite,  even if CEO Lance Fritz is 100% correct when he said the supply chain issues – which will last throughout the year – are (mostly) due to issues outside of UP”.
    • UNP is accelerating its share repurchase program, increased its dividend by 10% (in H1 it returned $5.4B to shareholders), kept its Capex plan at >15% revenues – and in the Q&A UP’s CFO stated “we are using our balance sheet and our EBITDA growth to fund” share repos, and that the May accelerated $2B share buyback was “funded through debt issuance” – and that may be fine, but it is also an STB “hot-button”
    • Their salesforce compensation plan appears to be a hybrid of volume and price – though, thankfully CMO Kenny Rocker has stated on the record that “volume growth is imperative for us” but as was pointed out, their pricing so far has been “incredibly robust”, and they are “improving on that price acceleration” into H2/21.
  • Labor in the future – Lance mentioned the national negotiations and stated “we think taking somebody out of a capital locomotive and putting them on the ground actually makes the job more attractive”

 

Note – in their prepared remarks for their Q2/21 earnings webcast (on NOW) CP did not mention KSU at all, and stated later in their Q&A that they have enormous “self-help” opportunities and that in the absence of M&A will still outperform the industry….more to follow.

 

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