“What is our most valuable asset? The network!” /JJ Ruest, CN’s CEO, at RailTrends 2019
“There is a very good time coming up ahead” /ibid
At last! Holidays, a side trip to Chicago to give my annual “Sand House Gang/Northwestern University Holiday Luncheon” address, as well as writers’ block and trying to make sense of what is as ever, and purposely, a most eclectic conference has all combined to delay this year’s “RT Reflections”, but it's finally finished. The overall summary theme, if there was one, was no near term inflection (the current state of the economy and of rail volumes was barely addressed) but preparation for that coming inflection, whenever it is, and future market share battles, is underway; PSR is not anti but rather critical for future growth. The November issue of RailTrends partner Progressive Railroading magazine featured excellent profiles of two RT speakers, our “Innovator of the Year” Patrick Ottensmeyer, CEO of the KCS, and Barbara Wilson transitioned from rail car leader to short line (RailUSA) CEO. First, there has been some news that cannot wait until the regular write-up coming this week.
USMCA (“NAFTA 2.0”) has – finally - been signed and agreed to by the US (and the changes in the late negotiations approved by Canada & Mexico after a last-minute kerfuffle over the notion of labor “inspectors” versus “panelists”). The Congressional vote will be soon. This is good news, for KSU, UNP – and all of the railroads. Remember, this is s “solution” to our self-Imposed problem and, for transports, a restoration of the “status quo antebellum”. It does provide some restoration of macro stability, the three nations and manufacturers had before 20117 (the NYT editorialized that “The new NAFTA was better than no NAFTA” but the FT/Global Insight stated that the “USMCA will never guarantee full stability for North American trade”). Perhaps the best summary came from Oxford Economics – “the benefits come not so much from what it brings as to what this prevents”. Canada issued a nice video. (could they make any other kind?) The WSJ lists autos, ag, manufacturing and energy sectors as gainers (all rail-served).
Sour notes #1: The IMF in an earlier analysis noted that USMCA, as opposed to NAFTA in today’s economy, could add 28K auto jobs – but also lead to 140K fewer cars sold (due to higher prices)
Sour note #2: USMACA is 6/16 – that is it has a sunset clause at 16 and can be renegotiated after only six 96!) years….
Sour note #3 – Mexico pointedly did not join Canada and the US in signing a side-letter promising an integrated and open NA energy market, which bears watching as this is a big rail growth market….
On a related issue, Celadon’s Chapter 11 filing should help Mexican cross border intermodal (KSU, then UNP and BNSF) although by the time of the filing I am told that less than a fifth of the trucker’s capacity was dedicated to what had once and forever been their primary market. The filing should – at least symbolically and psychologically – help the overall truck-rail competitive balance.
The new front on what is truly a global trade war, again self-initiated, is Latin America (so far threats only) – oh, and France (ditto). The WSJ (of all publications) wasn’t amused – see their editorial “Mount Tariff Erupts Again”. Latam impacts on NA rail aren’t huge, only ~4% of metals imports (although Brazilian slab steel into the US – 50% of slab imports - southeast could be an issue). Meanwhile, thanks to other battles, Brazil is about to pass the US as the world’s largest soybean farmer.
Meanwhile, the international business press and others have taken note of the US starvation of the WTO, rendering it useless at present and perhaps extinct soon?
Phase One of the China trade fight looks to be resolved in a detail-scarce mini-deal- more “status quo antebellum”? In what is described by the White House as a win but seen by many as a victory for the nationalist part of the PRC, the USA postponed new tariffs and reduced some (~1/3 of affect ted goods) existing tariffs in return for….well, as far as rails are concerned, more ag purchases (~$40B/year, though some doubt that). Even the American Farm Bureau says that the gains might not be worth the losses; the US consumer paid the tariffs and the US taxpayer paid for farm “relief” while China went form the largest US ag market to number 5. 25% of tariffs still apply to two large IM customer groups – electronics and furniture.
Positive note #1 – it is not getting worse.
Positive note #2 – large purchases of corn (by Mexico) and soybeans (by China) have been recorded in the last few days, according to the American Farm Report.
The CN strike, so ill-timed for RailTrends, was of course resolved after 8 days, at a near term cost of 15 cents (C) to this year’s earnings. It was the first at CN in about a decade; they managed to keep ~10% of their operations running. For those reading into the US labor negotiations, don’t – the strictness of the Railway Labor Act make even a multi-day strike, highly, highly unlikely.
CP provided a flurry of news – the CMQ deal (below) and what appears to be a small share loss of Teck coal to CN – optimistically labeled an “increased capacity opportunity (love it!). in addition, on the CBR front:
CP won what looks to be a possibly significant 50K/bl opportunity at sole-served Hardisty of a new bitumen, non-hazardous product (“specifically designed for rail service”) – note their interchange partner and fellow “winner” is the KCS
CP also suffered a derailment, fire and 1.5mm “litre” (~9500/bl) spill. There were no injuries nor long term damage; the car types include the older 111s and 117Rs (we don’t know which breached, etc). as a non-oil analyst, I was surprised that Albertan oil caught fire…
The STB Hearing on “Revenue Adequacy” is a sign of a more aggressive agenda in DC – see below….It has drawn significant attention from all sides, and even some warnings – see Ashley Wieland’s blast email from the NRC at the very bottom.
In the interests of space, we combine 5, 7 & 8 - so a Top 7 (plus 2 advertisements for 2020) below:
1) DC matters (again). Of course, it always did and does, but as AAR CEO Ian Jefferies pointed out, the STB is becoming “very, very active” once again, starting with the hearings on assessorial charges, etc (no resolution, but pressure) and continuing to the recent hearings. STB Vice Chairman Patrick Fuchs was almost scarily eloquent in his speech - although perhaps less open than Chairman Begeman last year due to open cases before the board this year - where he noted in his overall theme of “7 Important Numbers” the number 0 – representing the number of rates cases filed over the last 3 years at the STB. While I argued that maybe because of the amount of business under contract and thus exempt from the STB’s rather dwindling volume coverage, the STB thinks it is due to the complexity and cost of filing and under-represents what they think might be railroad “market dominance” (I always at this point think back to Hunter’s great quote on use of truckers in his- CSX - STB hearing in 2017). He did give the rails good marks (the number: -77% cars on line 2017-present) on PSR progress in 2019. Ian’s overall response was string, and best summarized by the man himself from his Op/Ed piece from The Hill.
- Chuck Baker of the ASLRRA (American Short Line & Regional Railroad Association) noted that despite 45-G “fatigue”, the short line investment tax credit process was alive and well, although (in addition) he is looking into other finding efforts such as “RRIF Express”, etc.
- Mike O’Malley of the RSI (the Railway Supply Institute – railcars – OEMs, leasing companies, etc) noted the efforts to prevent Chinese devouring of the market, first by CCRC in the passenger market but with freight car implications (it appears Congress will act in this) and the harsh “Debarment Law” for suppliers in (mostly passenger work) in NY State (and in fact, since RT, the law is being legally challenged).
- Ashley Wieland of the NRC (railway construction and contractors) is represented below – she discussed her conference next month at which I will speak, along with (overshadowed by?) CP’s CEO Keith Creel and Commissioner Fuchs again, along with his colleague Commissioner Marty Oberman, who also serves as a Chicago city Alderman, and whom I just met at the SandHouse Luncheon yesterday.
- The Federal Railroad Administrator and old friend Ron Batory discussed rail safety improvements and noted that the freight rail industry was at or ahead of targets in PTC implementation, with some worries on the passenger side (“no losers just laggards”).
- Ottawa counts too – after the strike, the heat will be felt more by railroads in the US than in the North, but the politics in Canada are getting almost as fractured as here. Railway Association of Canada CEO Marc Brazzeau noted the three-way national split – the west/”Wexit”, the east and Quebec, again). Canada appears to be in some form of a self-doubting funk. Brazzeau noted the official reductions in expected GDP; PM Trudeau is calling for tax cuts as a stimulus and the CEO of Royal Bank of Canada noted that “the next couple of years will be challenging” (emphasis mine). On a positive note, the RAC is working with Ottawa for support for a Canadian version of PTC (see below).
2) Tech fear was ever-present – in the Q&A and of course in the presentation of my good friend, the evil (kidding) Doctor Doom, Rod Case, head of the Global Rail Practice at Oliver Wyman. As noted by the estimable Roy Blanchard in his Weekly Review (WIR), Case did offer some good news: PSR will help the NA rails by lowering their cost (and increasing their competitiveness, adding (cheap) capacity, reducing dwell and increasing reliability. But then Rod was Rod – and we need Rod to be Rod. He noted that rails still needed to fully embrace a culture of continuous change (not just continuous cost-cutting). And, scarily, he posited that the coming changes in energy impact through technology (the reduction in costs for truckers, etc) will be even more impactful than the labor advantage counter-attack from the highway (AKA AV, or “driverless”). Under his current scenario, without changes in rail, a flattish overall carload outlook to 2045 – despite economic and population growth – would mean an overall share drop from 32% to 27%. His two examples were incredibly interesting – finished vehicles and grain! The former is really the first sector of rail share capture in the early days of the “Railroad Renaissance” and the latter is, well, the heartbeat of rail. Scary indeed….and my fear is that much of the technology shown to the investment community over the past year is operations-focused. That’s not a bad thing (see Rod-lowering costs, above) but moves like the CN moving the CIO position to report to the COO scare me that the customer-facing technology might get short shrift. Also on the negative side of the ledger, that “pilot project” between short lines, a major paper shipper and a Class One that I was so excited about ~18 months ago is still….stalled.
3) Addressing the Tech Fear – On the other hand, CN assures me that my fear is misplaced, and every Class One (and the short lines) talked tech – UNP discussed API, NS it’s “Trackmobile” project (and speaker EVP John Scheib noted that PTC was moving from “unfunded mandate” to the coming “backbone of the virtual railroad” in RT17), etc. The night before RT, a dinner with KSU Chief Innovation Officer Brian Hancock and Janet Drysdale of the CN – both in the audience at RT19 (see below) - was most reassuring. Both carriers are at the very top of the rail tech game, and both are looking at a new, more modern PTC (called “ETC” in Canada) for the two NAFTA countries not covered by the US law to install their own system-wide digital backbones. We also heard about an imminent carrier-led industry initiative to get all rail equipment tagged and visible, perhaps within half a decade from approval! Finally, Wabtec CEO Rafael Santana was incredibly impressive in describing the efforts to counter the Bad Doctor’s warnings about energy/fuel competitiveness for rails starting with a battery conversion of the existing fleet (being tested on the BNSF next year) as well as discussing their ongoing efforts to make themselves more productive.
4) The Year of the Short Line – deals, deals, deals (at RT it was announced that the CP had bought the CMQ, the Fortress-rescued line in the Canadian/US east that the CP itself spun off years back– for, it was said, some 10 times what Fortress paid for it). Our traveling circus panel first started at the ASLRRA Convention in 2017, has grown – in addition to the CCO/CMO of GWR, Watco, Pan Am, Anacostia & Pacific, RJ Corman we welcomed newcomer RailUSA. I think I can make a case, as I have done since we put this band together, that these could well be the smartest folks in the room, even if one of them is my college classmate….The noted that the valuation boom was an issue, not even a double-edged sword for them (excepting, perhaps, GWR, about to “make it rain”). Eric Jakubowski of Anacostia (Harvard ’82) thinks that there will be more supply from the Class Ones to come, beyond and including CSX – as lower density segment sales “is the next natural step” after PSR. Among the panel highlights:
- All of the panel short lines are growing, bucking the overall big-rail trend
- Pan Am is very excited about the CP-CMQ deal.
- The SLHC (holding companies) also think that my (and others’) fear of a coming short line “Capex flood” is overblown (the theory holding that short lines created 15-30 years ago are coming to the end of the former C-1 parent’s spending and capital “honeymoon”, with a big true-up, especially in bridges, coming). RJC noted how efficient with Capex; GWR noted how their expensive bridgework “de-risked the business”. Most of their capital work is done by contractors (so the NRC conference the second week of January will be quite interesting, as always).
- Despite all of the C1, at RT19 and everywhere, have been singing the praises of their SL partners, those partners still elements of what one SL called the “traditional C1 ‘mind-set’”, with a focus on optimizing their own systems rather than the network as a whole, with eventual even larger benefits. The continuing disappointment of my beloved “paper industry pilot program” is actually not an example of this, but brings up one aspect – the idea of data being either company-specific (bad) or non-proprietary (good).
- The short lines also think that the C1 remains too OR-obsessed, and have perhaps cut too deep. The old Hunter maxim, that through PSR we create a “service that sells itself” doesn’t actually work in the skeptical, once (?) burned real world….
- It seems silly to end this short line takeaway on a sour note – the panel was on the whole very, very optimistic (see “A”, above).
5) The Class Ones wisely looked beyond the current slump to the future – and they see PSR not (just) as a cost-cutting tool but primarily as a growth driver. Now, this viewpoint might have been colored by the fact that we had two CEOs who were CMOs, 3 current CMOs, and a Head of Strategy as the C1 representatives – but that is also why they were chosen! In chronological order:
- Union Pacific (Kenny Rocker, CMO) – sees PSR as helping to provide “customer solutions”, and the cost-cutting in the consolidation of their Chicago intermodal footprint as a way of simplifying their offerings and product. He noted that Car Trip Plan Compliance was up 10% YTD to the low 70s.
- Norfolk Southern (John Scheib, EVP Strategy) represents a company most squeezed by the competing (in appearances, anyway) demands for shareholders and regulators, but noted their enormous operational improvement, without any noticeable regulatory complaint – and without any spike in safety incidents.
- CSX (Mark Wallace CMO) sees more growth potential at this US network than in his two stops in Canada, including the “mothership”. That’s saying something (and remains to be seen). But giving Mark confidence is their own operational improvements under PSR – notably their Car Trip Plan Compliance, after seeming to plateau, has stair-stepped up to the 85% level. The current project is the rebuild of the (“broken”) intermodal franchise.
- Canadian National (JJ Ruest, CEO). CN and JJ were heroes for coming during the middle of their strike. Some of the bigger takeaways were their growing belief on the eastern part of their network as a growth driver – the Massena deal with CSX, the development of Quebec City as a big ship/big train hub. JJ interestingly took a slightly different tack on PSR – he noted that it didn’t address the rails’ “growth deficiency”, which at CN they are doing through new market development, funding capacity growth and off-rail partnerships (short lines) and M&A.
- Canadian Pacific (John Brooks, CMO) – John is the author of one of my favorite phrases describing the PSR life-cycle, the post-revolution “pivot to growth”, and he furthered that thesis with his descriptions of what he called the normal Canadian “intermodal re-balancing”, and the flurry of deals CP has been announcing, and the capture of a three-peat of the rail “Triple Crown” (2017-19 industry-leading volume growth, safety record and lowest OR). John continued to emphasize the monetization of their real estate assets (often created by PSR) to “provide room to grow”.
6) Will rails gain their intermodal mojo in 2020? (the following paragraph is from my contribution to the upcoming “Journal of Commerce” Annual Yearly Preview for 2020)
Well, they had better; intermodal remains the best opportunity for rail to show secular as well as cyclical growth, and to participate in the new economy. Certainly, after the tough year of 2019, it will certainly look (somewhat) better, not just due to comparisons but reduced “de-marketing” under the new PSR operating plans. The big macro questions, the ones the rails cannot control, remain – the state of the economy and, particularly, the status of trade wars; in addition trucking overcapacity may be coming down but isn’t over. So what’s a railroad to do? It is certainly easy to see what they should have done – provide more reliability and capacity last year (2018) – which will go down as one of the biggest “missed opportunities” of all time. By the time they began to get their service act back together (with the help – yes – of PSR), it won’t be too late; they are still in the game. But the lost year combined with a general policy of holding the line on price meant that a stair step or two of share was lost. The added volumes last year (’18) came in the form of trailers – not un-coincidentally the worst-performing subset this year; had the rails been able to offer more domestic container capacity and reliability in 2018 they would have been ahead of the game. Some think the rail management decision-making comes from short-termism and too much focus on the Operating Ratio (OR) – I am sure that played a role. Looking ahead, balancing out the aberrations (trade & tariffs, ELDs, etc) as PSR plays out across the industry, we can start to think of a restoration of the upward trend line in service – and therefore, market share. But I will always wonder what if….
The Analyst Panel with Donald Broughton, Larry Gross and myself really focused on intermodal. Don and I debated whether or not trucking statistics have all of the believability of China’s official economic statistics – his views on truck pricing surely carry weight but the ATA’s tonnage seems to often be divorced from economic reality. Larry noted a few points that bear reflection:
- Within the decline in overall NA IM volumes (-3-4%), international is flat. It is of course very trade-distorted – but that number also trails the +2% international TEU import growth – so share is being lost here, too (mostly by port diversion re-accelerating towards the east, a sign of the Chinese portion of the trade war). Eastern ports have much lower rail share, remember….
- The great “look northward” Canadian argument/example (mine, among others) post-PSR growth pivoting must also take into consideration port diversion – BC ports over US pacific ports (although I would argue that Canadian rail service played a part in that). Larry stated that international big ship movements fit the big train bias of PSR (although, recall that Hunter himself was no fan of the intermodal IM business since the ocean voyage itself was so unpredictable and thus hard to manage on the rail asset side, a trend that will only increase).
- Resin (plastic pellet) growth in the Gulf also distorts the figures, with many containers staying in the ports without the commensurate gains in transloaded 53’ boxes as happens in SoCal.
- Both Don and Larry expected “very modest” IM upside in 2020….
7) Kansas City Southern CEO Pat Ottensmeyer wins the coveted Progressive Railroading 2019 Innovator of the Year Award and practically the whole team came to celebrate. Pat went over the transitions at KCS under his leadership, with three big wins: 1) Massively improved relations with all of the Class One rails (started by his predecessor and mentor Dave Starling) 2) Build out a great team. 3) Create a culture of innovation (Pat’s baby, with his CIO Hancock) to which really should be added. 4) Become politically engaged as he was a strong leader throughout the USMCA process. The KCS PSR process has seemingly been the smoothest of all south of the 49th parallel (Pat noted there have been no complaints to the STB) and has been driven by my other favorite phrase of the PSR process, “Service begets growth”. Pat brought out his baseball roots by saying that the transformation of KCS was “in the 8th inning (gulp!)….of a 17 inning game!”
8) The RailTrends Audience….This may seem to serve only as an advertisement for RT20 (November 19-20; Client informal dinner 11/18), but what we like most about or RailTrends baby is the quality of the audience and the fact that most speakers (90% of those mentioned above) graced us with their words but also their presence for the entire event. In the audience were key suppliers and shippers as well as owners (shareholders and private equity) and, in addition to the KCS team I so poorly photographed, top management leaders from NSC and CSX attended, 10 other short lines, one labor leader, the sole Commissioner of the ARTF (the Mexican equivalent of the STB, likely to be solely responsible for the antitrust case on 31 O/D pairs near Veracruz – note only 7 are KCSM). In addition, three Class One CEOs not on the panel came by after the AAR Board meeting ended. So there was lots of opportunity to chat….
9) Dick Kloster and Integrity Rail Partners – I didn’t mention any stats from Dick’s annual session-ending rail car presentation – ask Dick or me of you would like to see this year’s version of his detailed report. Dick did use RailTrends as an opportunity to announce his brand new, independent venture (see slide below) – Integrity Rail Partners, a research & advisory virtual firm to which I am honored to serve as an advisor. Stay tuned….
Wither Maersk? Meant both ways? First, they lost their COO, then their CFO went to GE, of all places….
Oscar Munoz will step down (or up) at United
Home Depot issues a warning….
Investor groups, notably old friend TCI, are getting more, er, “active” on the issue of corporate reporting of emissions risk (this is seen also as a shot across the bow at passive investors).
There are legal and legislative issues in California that bear watching – the ILWU lost a lawsuit that threatens to bankrupt them, and the AB-5 law could decimate drayage out those major ports (by calling the drivers “employees”)
The WSJ annual Top 250 (US) Companies listed but one railroad….can you guess who it was?
Anthony B. Hatch