Greetings;
KSU started Q2/21 Earnings “season” with the sort-of thud, and CNI slightly beat expectations(cue elephant-in-the-room trumpeting). This quarter will – hopefully – be the last of less-than-useful comparisons, which will naturally be tougher in H2 - although what management says will be important, of course. Recent traffic has been sluggish, but then so have been overall supply chains (the demand is there). CSX meanwhile just produced a 43.4% OR in the quarter (OK, OK – but an adjusted 55.1% is pretty great) and UNP seems to have done even better, bring the RR “score” back to even at 2 & 2. I was shocked and pleased that 5 of the first 6 questions to the leadoff hitter, KSU, were about actual fundamentals despite the, you know, Big Deal in the background (I was even more shocked that CN received a TOTAL of 5 questions!!). So, to honor that re-focus on “what a railroad does and why” versus “what a railroad buys, and for how much, I will actually start my note with a few thoughts on the Big Deal proposal, CNI+KSU, before then getting to the fundamentals….Intermodal happenings covered in the next piece out shortly. Oh, and US citizens (assuming, of course, if fully vaxxed) can travel to Canada beginning on August 9, a big opening move on a border closed since March 2020 and important to railway folks and analysts….
Note - One recurring theme is inflation – not rail-caused (as in-service challenges) but rail-faced. Pricing seems to be in hand but this will be messy, I am sure – but only in the near term….also remember the Fuel Surcharge lag factor….
Note 2 – I hadn’t realized at first how American-centric the EO is. Of course, the executive is POTUS, emphasis “US”, but saying that 4 railroads (once 30+) now “dominate” ignores not only modal competition but, you know, the other two NAFTA nations where big shippers and manufacturers go, and the reason for all of this KSU kerfuffle (below)….
NOTE 3 - Does “non-compete clause” = “paper barrier” to Joe Biden? Of importance to Short Lines and their investors, sellers, etc….
NOTE 4 – Some please tell folks that “Follow Up Question” does not mean an entirely new, unrelated question – rather it is “a continuation or repetition of something that has already been started or done”
Waiting on the man….or women and men of the STB - KSU revealed little on the deal (“refer to the proxy statement” etc) though expressed genuine support and:
- Expressed the (correct IMHO) opinion that the Biden Executive Order was not targeting the proposal and in fact expressed only existing STB opinion (see “Take a Breath!”, attached – and CEO Pat Ottensmeyer “I don’t necessarily see them as tied together”)….Again, Pat: “Again, I don’t see the EO as necessarily changing (anything)”….
- So don’t believe the “hype” (this is a family report) - Biden’s Antitrust Initiative Threatens Kansas City Southern Railroad Deal - Bloomberg (a lesson may be that a Big Media company owned by someone of the left – middle I would say but whatever – and one owned by someone – clearly – on the right side of the political perspective can make similar mistakes in hype; note that the Financial Times coverage, “Biden takes on the role of (TR)”, didn’t mention “railways”….once.
- Analysts seem to be lowering their odds, or finally cottoning on to “this time is (or maybe) different” – many are putting the odds of a VT approval at 50/50 and one even said 10-20%. I don’t blame the analyst community regarding the new rules (“different”0, etc – when I once said “TTID” at a morning meeting on the Street the Head of Sale dumped his coffee on me (true story).
- KSU reiterated that their special stockholders' meeting would proceed on August 19 whether or not the STB ruled on the Voting Trust, and even if they ruled and ruled negatively (they correctly stated that they couldn’t answer what they would do in the event of the latter based on the multiple constituencies and the need to see the language in the decision from the very-wordy STB)
- CN said even less (same slides on the merits) but seemed to express more direct confidence in the successful VT vote in the next, but reiterated their stance on open gateways (backed by binding arbitration and pricing visibility)
- Remember, post (either) merger the STB has no jurisdiction in Canada or Mexico!
- Remember that, as CN CEO JJ Ruest noted, rails were one of 72 industries in the EO
- Speaking of which, the week prior STB Chairman Martin Oberman addressed the (private event, ahem) summer getaway MARS (Midwest Association of Railroad Shippers). I wasn’t there (I go to the work-event January MARS, a must-do annual event) but a friend who wrote: “(Oberman expressed) Concern over RR ability to ‘resource up’ as economy recovers. Workforce reduction is more than just COVID-driven and (he feels that) RRs may have gone too far; ‘Backup Quarterbacks’ may be needed – i.e.; people. (Notably) Current competition laws don’t fully work for rail (ie; for rail shippers). (Expect) to have more public hearings with him as chair... has new hearing room even (and wants to test drive it). (He) continues to hear shipper complaints but those shippers want anonymity (to avoid) ‘retaliation’... he won’t stand for that” (NOTE – methinks Cargill or Dow or Ford can stand up for themselves, but that is an old story/fear – is there any basis in it still?)
KSU disappointed in its earnings results- really more it’s disappointing H1/21 and a reduced (well, increased) H2/21 OR forecast, a reminder that rail-growth markets like Mexico (maybe only like Mexico) are always 2 (or 3 or 4) steps forward and a step back. In this case, one backward step was regulations on refined products manifest trains that increased congestion (two thoughts: 1) that’s never good in any time - much less a clogged supply chain & 2) is this some AMLO effort to help Pemex?). Overall “Mexico Energy Reform” volumes were still up 107% YOY and cross-border overall up 42%. Another was of course the ongoing chip shortage in auto production (but that will just mean pent-up demand). Yet another is a contract issue (undefined) that costs KSU $7mm. The Q2/21 numbers were a bit – shocking – confusing (among other things, on a reported basis the CP $700mm termination fee was included but the CN reimbursement won't be recognized until that shareholder's vote). All wasn’t lost – the OR improved 380bps (adj) to 61.4% and volumes jumped 31%. But the cost of congestion/recovery and of handling the jagged upward slide of the shark’s tooth means an increase of some 300bps in target 2021 OR to ~60%. But FY EPS Guidance was left barely changed (from “$9+” to “~$9”) and 2022 ($10.50-11ps) unchanged at all. One analyst friend thought that the robust volume expectations for H2, required to make FYG, were a bit Wizard of Oz* like (the deal will be done so “pay no attention to the man behind the curtain”).
Operations were challenging, to say the least (just as an example velocity and dwell both moved 29% YOY – in the wrong direction. Newly installed (~10 weeks in) COO John Orr seemed to have a handle on the necessary recovery strategies (one thing – headcount was 8% higher and the training pipeline filling up). Also remember, volumes jumped 31% YOY (and +5% sequentially) - and in autos from the dead to life (+139%!). The Q&A reveals bigger picture things too – bringing us back home to the issue of “WHAT IS PSR?” From an investor’s dream scenario under EHH to the ugliest of phrases to the STB – it’s often misunderstood as just a cost-cutting system. Orr relayed the keywords:
- Multifunctional (not just Ops)
- Visibility – use data to see what & where the problems are
- Accountability – most of all….
CNI met or exceeded expectations in Q2/21 through below the line controls, although given the hiring (+9%) and other inflators; as was noted, the OR deteriorated but by 120bps (to 61.6%). But they “are not running the company for OR” (hear, hear!). FYG was reaffirmed and the intermediate-term volume outlook looks strong – potash, the CBR chain, propane, lumber – and of course intermodal. Their operating metrics were solid car (though not train) velocity up and dwell down. Train length was down a bit (2%) – what was that relationship to fluidity? They expressed great confidence in their ability to handle (staff, power, capacity) the ongoing volume strength. There was a big improvement in the safety numbers. Some thoughts:
- There was no (real) Q&A on three big issues for CN, two of which involve….the STB (their sale of WC lines, their possible purchase of the Massena line from CSX – and the closing of the Quebec City Port Project!). My attempts on the latter haven’t gotten anywhere, either.
- CN booked a gain on its Tu Simple investment!
- Grain had gone from great/stabilizing to tougher comparisons and weather-affected (it feels like grain is going back to the head of the “unpredictable” club, where it belongs) – but CN promised a strong Q4, no matter what…
- There were two questions on Amtrak (sigh) and the last one was, finally, on technology opportunities – the answer – bringing inspection portals to the KCS – could have been more expansive. But they are preoccupied….
Ohhh Mexico – it sounds so simple I just had to go…. At the hundredth meridian/Where the great plains begin - NAFTA NOTES:
- AMLO took to the woodshed by Business Week over the Pandemic response in Mexico, starting with little testing but really due to no stimulus package, whose impact may yet to be fully felt….Just another reminder that
- On the other hand, cross-border trucking capacity is getting even tighter – the JoC stated “that shippers needed….to consider new ways to move goods” in a three-page article that did not even MENTION intermodal….and KSU noted that it thought that, despite consistently impressive XB growth, only about 5-6% share…
- On the northern side of the 3-way NAFTA border (are you listening, Joe?) BHP will decide go/no-go on their huge ($6B) Jansen potash project in Saskatchewan….
- And the BC fires are serious; the TSB (safety board) is investigating “possible train activity fire” as the cause. CP, rather rightly it seems, took umbrage on the mention without any evidence (then noted, ahem, that it was a CN-controlled train that last rolled through the region). The investigation may take two years….There are speed restrictions that are subject of govt-railway(s) negotiations….
Anthony B. Hatch
abh consulting
http://www.abhatchconsulting.com
abh18@mindspring.com
Twitter @ABHatch18