Rails - Dealer's Choice? Plus, send in the USMCA, LNGR, and Traffic

20161212 Tonyhatch (Cropped)

Greetings;

A belated Happy Canada & Independence Days, as well as the official start of USMCA/NAFTA2 - and surely, Happy (or happier) Summer since we are only 15 days till MLB baseball….right?  As we track the re-openings, re-closings, etc, my friends and RailTrends (till on!) partners Oliver Wyman have this great Covid-19 tracking tool. Note that the C19 resurgences are coming in some rail-heavy states, notably Texas and Florida….

 

The usual “Schedule” section for Rail and related conferences continues to shrink:  Both AREMA and RTA have opted for “virtual”, joining ASLRRA (and NITL, FTR, while the RSI canceled) So, far, along with RT20, favored by its late November (11/19-20) dates, NEARS is still on for the fall and here is the link (www.railconference.org )to their virtual Spring Conference, “filmed” a few weeks back (you can see the immaturity, in a literal sense, of my Zoom skills as I actually fall off my chair whilst adjust the screen; pandemic humor is the best! Also, it should be noted that the leaders of two of those organizations have retired – the RTA’s Jim Gauntt and RSI’s Mike O’Malley – best of luck, guys.

 

So the big issues these days, aside from the biggest are the following:

  1. Big Rail M&A?  (again?) – my answer is no, or better, not now!
  2. Rail Deal Mania continues.
  3. “From the Halls of Montezuma to the shores of Lake Erie-eeeee….” – USMCA.
  4. The LNG news is good – but it’s complicated (and not huge).
  5. Traffic is less bad in June.

 

The Same Old Song: Mergers & consolidation rumors return, centered (again) on Kansas City Southern.  Some nostalgia is fun, but this isn’t like listening to Golden Oldies or “Sgt Pepper” - it is more like reviving Nickelback.  Now, I don’t want to go on a crazy rant (see Railway Age: “KCS isn’t for sale.  Quit Salivating!” – whoa Bill; a great lesson on not writing after “quarantini time”!) – but actually I agree. My position on rail consolidations should be well-known by now – too much risk for the gain, especially as technology can (should) continue to improve interline operations, etc.  Over the past year or so, two of the leading proponents of mergers, BNSF’s now-retired Matt Rose (very poor risk/reward; will only happen when customers want it to/when rails run out of capacity) and CP’s Keith Creel (PSR extends his window from  “within 5 years” to 10 years) have changed their minds.  So - why now?

  • Surprisingly some very smart observers see the post C19 world as requiring some form of rail/IMC connection and a real need for rail/intermodal to “up their game” – and fast (there is still the elusive rail “Pilot Project” on visibility out there to allow me to hope that big risks aren’t necessary)
  • KSU CEO Pat Ottensmeyer, our reigning RT Innovator of the Year, is perhaps a more practical man on thoughts of M&A than Mike Haverty
  • USMCA makes the future rosy, right?  (see below)
  • Succession issues started the last round (BN+SF) – and looking at the Big 7 rail carriers, we see unnamed transitions at….5 to 7 of them in the next few years
  • There’s a lot of money in the PE/Infra world – and many of those players have often teamed together in the past (for example, in rails in Australia)
  • Berkshire Hathaway is in transition – Maybe they would start it?

    • The very issue of its “conglomeracy” is being questioned – are they too big?  Are they the wrong portfolio for a post C19 world?
    • Some longtime shareholders of BH have sole (notably Bill Ackman)
    • Are they losing their touch?  The financial press has opined that they were “hoodwinked” on a recent German industrial deal.
    • But their big bet on pipelines – the $4B purchase of Dominion’s assets (plus $6B in assumed debt) is an interesting gamble given the recent rejections/delays in 3 other pipeline deals or expansions (Dominion’s own JV Atlantic Coast, the Dakota Access and the star-crossed Keystone XL).  The sudden political/judicial/environmental; swing against pipelines may make existing pipe capacity more valuable, and may help CBR, particularly in the Bakken  (and even LNGR – see below)

On the other hand:

  • The rails are hardly in need of capacity now! One-third of the railcars are parked….
  • While their service has been terrific, the question of how much credit goes to the carriers (PSR, tech, Capex) and how much to C19 (volumes) remains
  • Congress is not supportive of the rails at present, to wit:

    • The proposed GAO study of PSR and Railroading in the bill in the T&I Committee– the government investigation into a private industry’s operating methodology is….crazy not to mention the fact that it is like counting the horses that left the barn two years ago….….Combined with a possible mandate of 2-man crews (AFTER the installation of Fed-mandated PTC) shows that the House leadership seems committed to fighting the battles of the last war - It is both an over-reach and irrelevant, a full double-play (from my tweets last week)
  • The STB is much more interventionist, even as Republicans – many thought the Brookfield-GWR deal was held up for too long, and the STB, by a 2-1 vote, has also put in “pro-competitive” measures into the sale of the Massena line by CSX to the CN (which I view as offering truck-competitive business from US east coast ports northward) that may well scuttle the deal….there are petitions to the Board both for and against the condition
  • It is that very “enhanced competition” measurement that IMHO offers substantial risk as the (some) shippers, with great heft, will use the opportunity to extract what might be not their pound but rather their ton of flesh, helped by activists in legislature and regulatory bodies – just say NO!
  • So – as I have always said, if I am wrong I will be very, very wrong, and quickly.  But I don’t think I am wrong – this time….

 

But don’t think there are no deals to be had in railroading! The short line boom is proving impervious to the pandemic, as existing industry players (short line holding companies), sometimes backed by PE (private equity) or Infrastructure funds, though as often those funds are on their own and buying companies intact with managements (Brookfield-GWR) remain excited about North American rail assets.  And don’t believe the negative hype about “zombie rails’ 9show me one!) and possible rail; defaults after high multiples – all that talk is from folks who do not understand the nature of private equity (PE) and especially Infrastructure investors.  As of now there are at least 5 deals/proposed deals out there – and I am sure that I am undercounting:

  • Dow has sold its internal plant switching operations to the SLHC Watco, already a major terminal/switching operator, for $310mm.  I don’t have the data to evaluate the deal – I trust Watco’s leadership and I do know that this is in their wheelhouse (just as I know that every related SLHC and PE/Infra player will tell me that they grossly overpaid).
  • As reported in the FT, Arcelor Mittal is selling a stake in the transportation infrastructure, including the 260 mile “Cartier Railway” in (far) northern Quebec, a rail deal that resembles Australian/Pilbara railroading, more like a conveyor belt than a “traditional;” short line.
  • US Steel, in some financial difficulty, is said to be selling the remaining 7 lines of its TranStar segment (3 were sold to CN earlier).
  • One of the Iowa Pacific/Ellis lines, the Mass Coastal, was sold (for $2mm) to “Coastal Rail LLC”; another line in Utah (the Salt Lake, Garfield & Western) is said to be on the market – it is tied to the SLC-area refining business.
  • The other big-rail rumor, after the usual (KCS) suspect, was rumors that Brookfield (alternative hamstrung by the C19 hit to commercial real estate or the biggest beneficiary of the crisis in office blocks) and its SLHC, the mighty G&W, formerly GWR, held talks with Grupo Mexico, the owner of Ferromex and the FEC.  No one ever comments on rumors, of course, and the G&W has gone deep state on us analysts (and Grupo, nominally a public company, has never acted like one).
  • England; the poorly kept secret was made public of late that a book (BMO) was out; note – they have gone down this road only to U-Turn before.  I know the PAR decently, without financials (of course), and like its management team.  It is 1700 miles and connects to the G&W, CSX (its largest interchange partner), CP, and the NS.  The latter has protected themselves, as they did with KCS (Meridian Speedway) with a JV on the 437-mile “Pan Am Southern” (part of NS’ “Patriot Corridor”).  It is not clear exactly what poison pills NS wrote into the deal, but it was a McClellan special, and all that implies.  The PAR also can connect to the CN, but not well; word is that they have already declined interest.  The PAS deal may diminish any Class One interest, and CSX already has rights (as well as other ex-CRR access to the region).  Although real estate has been mentioned as a sweetener, it isn’t clear exactly what that’s about either (folks have sworn it was excellent acreage on the Boston waterfront – another said Portland.  PAR is also a regional railway, not a classic shortline – among other things it has significant intermodal and auto exposure, which I view as a good thing but isn’t classic infra-investing stable.  One question will be network condition and the status of the collapsed/rebuilding Hoosac Tunnel.  Another is why they, as the Guilford 9and former Boston & Maine)  ever took up the “Pan Am” moniker – especially when “Republic” and “Braniff” were available.
  • When I say “Portland” I mean Maine; the other one is in Oregon.

 

July 1 was USMCA Day – for all the sturm und drang, there was so little mention of it!  Of course, not much really changed from NAFTA (The Economist called it “slightly altered”) despite protestations to the contrary and even cover stories in partner’s trade press that USMCA represented “certainty” and trading in a relic”.  For the former, it has restored some certainty, especially compared to 2017-18, but less than pre-2016.  By a long shot.  Will it be enough for a near-shoring bonanza given Sino-US relations?  I raised my doubts a week back (attached); KSU CEO/Innovator of the Year Pat Ottensmeyer countered that with an Op/Ed in the Dallas Morning News (also attached).  Yesterday, of course, two of the three leaders met to celebrate (the deal, and the strangest political friendship since the Molotov-Ribbentrop pact), although there remain unresolved issues, including non-rail issues but chief being Mexican legal challenges to their labor reform law that was required; another being US trade leadership (I resisted) already issuing grumbling hawkish comments like “The US will act early and often” if problems arise (Lighthizer) and “I couldn’t wait to get USMCA into effect so I could start to enforce it” (ditto); in addition, further threats of tariffs (for example on Canadian aluminum) all make for the excellent start to a partnership!  I have also attached the presentation by Alejandro Reyes (who will be a speaker at RT20 we are pleased to announce), the head of the Mexican SCT (their STB) on the Mexican Federal Commission of Economic Competition study on railways (key line” “the concession scheme works”) – note, this isn’t a big threat to KCS but the slope is always possibly slippery.

 

The True North Strong & Free! USMCA is actually a three-way deal, not that you would know that on TV (especially since Trudeau stayed away and Deputy Prime Minister Freeland welcomed the July 1 “entry into force” of “the new NAFTA” – you GO, girl!).  Canada seems to be often overlooked (most recently by the UN which chose nations such as Niger, Estonia, and St Vincent over it) but not here.   segue allows me to belatedly praise the CN for being the first to take on looking at the rail world post C19.  Now what they had to say in the presentation by CEO Ruest and CFO Houle wasn’t exactly new as much as repackaged, but still, they allowed for 4 responses to the changing world:

  1. View on supply chain/trade changes – CN being a tricoastal railroad has revived its Gulf Coast (Mobile and NOLA) talk while highlighting its Canada/Rupert East efforts as a hedge against China losing supply chain share to, among other places, the Suez.
  2. Cost-cutting efforts that include permanency – their headcount was down 21% YTD June; train length up 12% in June, weight +6%; more remote work
  3. Technology – CN has been a leader both in technology and in talking about technology; this was a playing of their “Greatest Hits” album but they are good songs (“American Woman”/These Eyes”/No Sugar Tonight” etc)
  4. ESG (see below) – fuel efficiency leadership, safety, diversity (speaking of which CP’s VP of Public & Government Affairs was just named Chairman of the Railway Association of Canadas, the first woman to be so named.


We expect to hear more from them and CP (and the Americans) in Q2 webcasts soon – remember guys, Q2 was bad but so what?

 

LNG by rail (LNGR?) is coming, but not necessarily to the rescue – the government’s decision (PHMSA) to allow rail transport of LNG is certainly good news, but how good, how soon, etc have yet to be worked out.  The key issue is the specialized (DOT 113C120W9, if I have that right) cryogenic double-tanked equipment.  There are….~65 cars today.  In North America.  And they cost, estimates Dick (“railcar guy”) Kloster., some $200K.  Each.  To Build.  Plus the infrastructure for unit train loading and unloading, etc.  But, folks think, there is a market, at least seasonally, in the Northeast, and maybe one for export, including to Mexico (and with pipelines seeming to fall by the wayside, maybe more, though US exports in 2020 are expected by HIS to fall by some 50%).  The OEMs see a new good margin market (1000 cars?); the  leasing companies, who would be the equipment owners, are said to be “looking closely at this” but have the fool me twice experience of ethanol and CBR to consider; the shippers see rail as ~1/3 cheaper – and a lot safer – than trucks….the most obvious market is the N/E (benefitting Pan Am, one supposes) which is a short-to-medium length of haul market from the Marcellus to New England (when the pipes are full in peak weather seasons).  A Kloster back-of-the-envelope look showed unit trains at 20 turns/year (that’s with PSR, folks) X ~500mi X$1500-2000 car (hazmat) equaling some $30-40mm in revenues.  I suspect that’s (also0 undercounting, but that also assumed unit train efficiencies, etc.

 

Traffic in June is less bad and that’s also, if not great, then good – according to the always excellent AAR RTI, North American volumes were down “only” 14% (carloads -21%, intermodal -8%).   In the US, the total was down 22%, with autos down 30%.  And that is a victory, coming from complete shutdown 9a friend who knows tells me that NS recovery in autos is at ~75% of pre-C19 numbers, and CSX ~68%.  US intermodal actually led the Gang of Three at -7%.  Canadian carloads were down 17%, IM down 8%; Mexico was -13/-21.  For the quarter we see the bottom/full impact of the pandemic – total carloads down 25%.

 

From the Commtrex “Ask the (forgive me please) Experts” Questions: What technology initiatives would provide the greatest impact for your business?

A: These questions don’t really apply to me, directly – my business is analyzing railroads and freight, not moving freight, so I will answer #1 with an eye to the companies I follow, specifically the railway industry in North America.  I would wish for a bigger (or more obvious) push on customer-facing technology.  The rails have actually done a good job of late on expense-related tech and improving inspections, MoW, etc (think of CN’s car inspection portals); they are also, one supposes, making headway on crew-reductions with the onset of PTC (as part of the ongoing labor negotiations).  All of this helps the rails’ marketing departments, too – more reliable service is better service; lower costing service is a more competitive service, etc.  But they need to jump-start “ease of doing business” tech, with one aspect being visibility.  We often hear, say from buy-side investors who follow all transports, “why can't the rails be more like UPS/FDX/XPO” in terms of package-tracing (given that their packages are the size of rai)?  Well, of course, those are closed-loop offerings, and rails are a continent-wide network,  But it is still a good question, whose answer is complex but, it seems, achievable.  A solution is as much political – or diplomatic – as they are technical (requiring agreements between carriers big and small to solve interline issues).  I know smart folks are working on this….but the clock is ticking….

 

Meanwhile!

  • On technology – from the UP.
  • Also UNP and BLM.
  • A short film by Bloomberg on Fracking – and Permania!
  • Trains as residence.
  • RIP Jim Sherwood, founder of Sea Containers and reviver of the “Orient Express” brand (now that was an analyst trip!)
  • FDX beat expectations handily despite cutting its ties to Amazon.
  • Finally, the government makes its modal bias clear – the USG paid out $700mm to YRC in return for a 29.6% stake, citing DOD business (while ignoring a lawsuit over said business – the FT calls it a “sweetheart deal”).
  • ESG is becoming more and more important, it is generally agreed.  “Inbound Logistics” magazine listed its top 75 “Green Supply Chain Partners” which included just about everyone we follow – Class Ones, IMCs, the parcel guys, even a company with the unfortunate name of “Yale”.  In fact, it is more notable who was left off – CP and KSU – no idea why….
  • NS is flattening its reasonably new Bellevue Yard (thanks Roy).
  • BP decided to sell out of the petrochemicals business – now that’s against trend.
  • Omnitrax named former UP COO Cameron Scott as Chairman
  • The new Trains Magazine special “CSX at 40” is out and it looks great – much more business than foam, and a great update on PSR (although I might say that some up north might object to CSX being called “the ultimate scheduled railroad”).
  • Finally, want to get away?  To take that train, down at the station, Lord till it runs out of track?  But you’re in lockdown?  Try this: 6 Virtual Train Rides From Around The World You Can Take Right Now.

 

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