Greetings from St Louis, site of the 2021 Railway Tie Association conference (See below - an excellent chance to get a “sneak-peak” at 2021 rail CAPEX (especially growth CAPEX), more relevant than ever this year….why? The answer is, of course:
Supply chain! What else is there? For (just one of many, many) examples: Click Here.
But first – Canada….
1) CPKC filed its formal merger application with the STB. No surprise, all expected – as was the fact that the filing, keeping in pattern, was announced on Friday at 11 pm eastern. Seriously? What is the time difference between Calgary and NYC? Then the 4332-page (!) application document was dropped onto the STB website overnight on Monday. Trains/Bill Stephen's usual excellent reaction is here: CP and KCS project dramatic rise in daily train counts - Trains. My parsed highlights:
- It’s coming in fast (not the approval – I think the STB will take its time – but the benefits: within three years CPKC sees $716mm in revenue synergies (presumably the remaining $104mm comes in Year Four?) and $173mm in economies/productivity (ditto)
- The benefits are coming from other rails! 80K carloads, 137K containers from other railroads – “only” 64K from “trucks off the highway”
- They will compete with the UP from Chicago-Laredo, in auto parts (recall my Intermodal EXPO anecdote)
- They will compete with BNSF – albeit not as well – from Chicago to Dallas
- They will compete with everyone and attempt to fulfill the Mike Haverty dream of linking Lazaro Cardenas port to the US/Canadian east & Midwest in single-line service (which would then serve as a competitor, at long last, with LA/LB)
- They will spend the capital I warned would be required (for example to allow the slow Davenport sub to go from 7 to 22 trains/day) - $276mm for rolling stock, CTC communications in (Iowa) dark territory, terminal development (Chicagoland/Twin Cities) and track capacity. And they plan to add 1000 jobs.
- They will make operational changes that will reduce congestion, if implemented, in Chicago (by bypassing BC/Western Canadian goods heading south) and by adding to already planned Mexican expansion reduce switching at congested Laredo and Sanchez yards
- They seemed not to have mentioned CN! (But we do - below). Also below is UNP’s “concerns” about CPKC – now we (and they) have some meat on the bones. Will CPKC keep the BNSF and UNP (and NSC and…) gateways fully open and fluid?
2) CNI vs. TCI – Round 4! I wasn’t sure if CN had their heart in the fight after their Q3 bombshell (see attached) announcement that CEO JJ Ruest, the 2021 RailTrends Innovator of the Year, would retire ~end of January 2022, ahead of the planned March 22, 2022, Special Shareholders Meeting. But (from the tweet):
CN v TCI – With CN’s “Letter to Shareholders” today is the answer to my “Fight or Flight” Question….So, first, CN named a new board member, not one of the TCI Gang of Four: (Jo Ann dePass Olsovsky, with an impressive – and rail-related (not that it matters!) CV. Then today came the letter (also attached). And with it, the answer to my question - it’s Round 4, and CN chooses combat. The letter defends growth over OR, and highlights the nature (lower margin/higher growth/good return) and also the need for Intermodal. CN also focused on the long-term value of investment – be still my heart! Indeed, this was the response I expected before when CNI outlined its 2022 (as opposed to long-term, or 5-year) Plan. Of course, they are still in the arena with a team captain who is retiring – not ideal given the stakes. But they remain IN the arena, and that existential fight over the future of railroading, the competition between margin/OR and growth, of a COO-led or CMO-led vision, can play out. ….So, let the battle begin! Some thoughts:
- Of course, who’s to say that Jim Vena, operator extraordinaire, cannot also be the next-gen, tech-ready markets-driven leader? Keith Creel combined the skill sets, but Hunter didn’t. I recall Jim answering a fair number of marketing questions in the 2019-20 UNP webcasts – maybe he is also a renaissance man?
- TCI’s board picks in their CSX fight over a decade ago included some of such quality (see O’Toole, Tim) that they stayed on the CSX Board even after the crash/Great Recession forced TCI to sell and leave the board directly; Gil Lamphere was also on that Board
- Who is Korn Ferry presenting to the Board as potential “world-class” candidates? Some of suggested Vena himself, cutting out TCI (and Elliot? Where do they fit in?), perhaps with a shorter limit to his proposed tenure; Toronto papers, maybe without credible sources, have suggested that Sameh Fahmy, soon to be completing his KSU assignment, might be in the running, and/or former CN COO Mike Cory. Supposing it must politically be a Canadian; I would have been promoting Matt Rose.
- CN alumni have been privately expressing concerns about the cutting (headcount/CAPEX) done as part of the almost schizophrenic (defend growth/capitulate to the OR Cult) response to (caused by) TCI; worries that after a big round of layoffs in 2019 this round is a bridge too far (beyond fat to muscle, now bone) – said one “They act like they are some kind of stewards for safety, employees, customers, and shareholders, but the reality is their actions don't align”! And the CAPEX catchup after earlier big cuts (see leadership, 2015-16) – is it too soon? Capex cuts, headcount cuts, (entire network) service issues, unhappy customers (impacting the WC line sale process where some shippers are willing to hack off their own noses to spite CN’s face – may be best described as “Historic CN”, or EHH), OR reductions, increased buybacks – it’s the STB’s dream scenario as a “call to arms”.
- Heard the one about the Rather Prominent Analyst who in late summer recommended CNI shares on the theory that they go up if they win KCS and go up if they don’t because they will restructure, and “focus on margins overgrowth”, perhaps with the “assist” of (or maybe to) an activist. Then, just recently, the very same RPA recommended CP on the thesis that there were market share opportunities because CN was focusing on margins overgrowth. This Janus-like all things to all people echo TCI’s major ownership of both CN & CP but without the self-awareness.
- Good ESG News: Canadian National Railway and Caterpillar are partnering with Renewable Energy Group (NASDAQ: REGI) to test high-level renewable fuel blends including biodiesel and renewable diesel in support of the companies' sustainability goals
Cue another shameless promotion for RailTrends 2021 November 18-19, NYC (www.railtrends.com ) – see attached. Remember, “Progressive Railroading” magazine and their owner TradePress handles the P&L, so I am shamelessly promoting this because the agenda is good, not for my own financial gain but rather our collective information exchange!
Union Pacific had a terrific Q3/21, financially. Earnings beat 2020, 2019, and expectations, and the OR improved 240bps to 56.3%. And this in the face of supply chain issues/congestion and the western fires, weakness in grain and the auto ecosphere and their own labor shortages, etc. Bulk revenues were still up 14% (coal up 9%) and Industrial +22% (steel, lumber, Mexican Energy reform – no mention of inspection issues, by the way). Premium, ie; Intermodal & Automotive, was challenged – overall revenues down a percent on -9% volumes (auto -18% and IM -6%). Price/mix was +6.5%, which got some folks excited but to me, there must be more to come – that was a good mix quarter (coal, chemicals). On the come however is the best Premium pricing market since 2018, they say (let’s hope that they can pull off a sticker win; to use a football expression, overused on their call during MLB playoffs, the industry fumbled on the goal line in 2018, gaining yards but not pints by not having enough box capacity/service to retain much of the 2018 gains into 2019). With Q4 2/3 complete, UNP (etc) reiterated their 2021 outlook, whose pattern followed Q (overall FYG volumes adjusted down 2 points to +5%). Incremental margins were 94% as headcount only increased 3% (overall volume was flat).
- Operations metrics took an almost across-the-board hit, for the obvious reasons and the less obvious ones (re-routing around the wildfire and bridge outage/damage, which cost the company 50bps in OR). Trip Plan compliance for both IM and Manifest was down into the 60s, down 11 and 12 points, respectively. Less obvious unless the facile answers are true is UP’s and an industry-wide phenomenon – a worsening of the safety record (in UP’s case Personal Injury numbers 11% worse, derailments 5% - the usual train accident rate….was not disclosed. Both the COO and CFO used the webcast as a major, and generally well-considered, defense of PSR, which on the face of it, could be annoying to the STB but were couched as providing “a platform for growth”
- Question # one was….you guessed it, Q4 OR!
- UP was – deep apologies from me here – cautiously optimistic about steady if slow improvements in the LA/LB supply chain since mid-summer (still held back in part by chassis – street time” is up 20%), and actually quite optimistic about 2022+ opportunities in steel, forest products….with pent up demand in Premium, in addition to new ramps in the Twin Cities and Inland Empire, and the Knight-Swift business. They continue to view the current, well-publicized situation as temporary (CEO Lance Fritz: “the way the supply chain is disrupted right now doesn’t last”)
- Lance also, in the same context, stated that there were rail-adjacent M&A opportunities. This follows a pattern we have seen at CSX (Pan Am, Quality), CP (CMQ, the Detroit Tunnel, and that north/south deal) – and at CN (Trans X, etc). Or at least the CN pre-TCI.
- Speaking of “that N/S deal”, Lance reiterated that there were “a number of concerns we have in maintaining and enhancing (note – “enhancing” is NEW rules) competition with this proposed merger (CPKC)” – in fact, “there are bonafide risks to our business to and from Mexico” that requires “some kind of remedy”. To my mind, this is the most expansive that Lance and UP have been publicly on the deal. . Never underestimate UNP’s political abilities, which we may never publicly see in this regard.
- Lance seemed to also hint broadly about the need to improve IT/partnership for customers in the areas of “transparency and visibility” – sounds a lot like Rail Pulse to me, which CMO Kenny Rocker stated at NARS was under discussion (Kenny may expand on this at RailTrends).
Norfolk Southern continued the positive earnings surprise trend. EPS up 22%, well above Street, OR down 230bps to 60.2% (it’s an outcome). Units were flat, headcount down 7% (careful….) but that is, they admit, lower than they would want and are attempting to match their raised attrition rates more closely), but train size up. They have 9 siding extension projects (one completed). COO Cindy Sanborn also discussed process improvements, fired by technology (such as mobile track authority & train reporting, as discussed on the webcast), as future capacity enhancers.
- The revenue performance was impressive (+14% on flat units), powered by the “Yield Up” program (RPU less fuel up 11%). That’s music to the Street’s ears, rightly so, but sounds a rather discordant triumphalist note in DC (one question concerned NS’ “long term yield for volume” and how that played with “Yield Up”). NSC, the biggest auto carrier, overcame the issues there, with overall merchandise volume up 5% and RPU/lf +2% - not bad given the mix0within-mix issue. Speaking of mix on the positive side, coal volume bounced (meow!) +9% and revenues plus….32%! And, mix-within-mix, while domestic utility volumes continued their secular decline (-17% was even sharper than I would have thought), exports, the ne plus ultra of mix-enhancers, grew 58% (and domestic met coal grew 29%). NS allowed that it would be “irresponsible” of them to expect that for 2022.
- Intermodal volume wasn’t as good, following the rail group pattern (volumes down 4% with domestic down 6% and international not bad at -1%) – but not CSX’s pattern, which was positive in units. Admittedly, CSX is coming off a two-year plus shrink/restructure (the old CN model CEO Jim Foote has used successfully before). NS did state that IT had “the most powerful intermodal franchise in the east”. Revenues, helped by “storage solutions”, were up 16% as RPU/lf was up fully 14% – as CMO Alan Shaw pointed out spot trucking rates increased 21% in Q3/21. Labor – rail but also (more so) drayage/warehouse/shipper) hurt, of course; NS’ chassis repair program has righted the ship there, and help in terms of chassis capacity appears on the way. But the supply chain “issue” showed up in overtime, purchased services, chassis repair, etc, and in the Operating Metrics (velocity down 8% and dwell up 15%. There was talk about further east coast port gains – but I remain convinced that is at best a mixed blessing for eastern railroads….
- Capex is below guidance and free cash flow is up 33%...NSC still got questions on 4th Q OR, and future “leverage on the labor line” (read the room!) although also one on the STB (albeit misguidingly wondering about their – direct – price regulation). That’s a tough balancing act….
- Safety numbers were not disclosed….Nor was, in response to a direct question, the optimal headcount addition nor the volume lost (and this is true of the rail network) to intermodal supply chain inefficiency.
- NSC bucked the trend of acting or considering non-rail M&A
We still have BNSF/Berkshire Hathaway earnings (this week/end?) before we “close the books” on rails in Q3/21….
Also:
- From the RTA, mid-conference: I am disappointed in the planned tie purchase growth estimate of +2.2% for 2022 (admittedly the numbers were crunched in September) – that doesn’t jibe with the full impact of 45-G ITC in short lines and even more so, with the public statements (Q3 webcasts) of all of the Class Ones about increased siding development, etc. also:
o A new worry – while we have, as said, heard nothing on the national rail/labor negotiations front, the ASLRRA’s Chuck Baker told the RTA that the DOT’s new Unified Agenda calls for Crew Size Mandates, so permanent (and unnecessary) two-man crews, having been beaten legislatively, may be coming from DOT/DRA regulations….Expect hearings, etc in 2022. This could be Very Bad News as AV trucking continues on its merry, subsidized way….
o Another is the worry on Vax Mandates – NSC faced a question about the risk, not of Covid….but of mandates (sheesh!) – their answer – it’s the law, they must comply - wasn’t great IMHO
- New rail SPAC – I wasn’t sure I would see this day, what with, in general, too much money chasing limited opportunities, especially in the short line & regional space, but introducing the Integrated Rail and Resources Acquisition Corp: S-1/A (sec.gov) https://www.sec.gov/Archives/edgar/data/1854795/000119312521308096/d91862ds1a.htm#toc91862_10 – there is some gravitas in the advisors (see Bredenberg, Rollie); some observers think it’s tied to the Uinita Basin project proposal (which is much, much bigger than the stated total for the SPAC, but I am reminded that number isn’t always relevant); others see rail-ancillary opportunities. All in know for certain is that SPAC can be remembered as Speculative Acquisition of Capital….
- Speaking of short line holding companies, the Anacostia & Pacific lines created a pretty powerful 4-person board, all rail vets and many I have or still do work closely with – Rod Case of Oliver Wyman fame, the FRA, and CRR’s Ron Batory, ex-BNSF (etc) Dean Wise, and Andrew Fox, former CEO of Anacostia’s own South Shore and PHL lines. Co-founder/CFO Bruce Lieberman can explain how they plan to utilize all that horsepower when he speaks at RailTrends….
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Anthony B. Hatch
abh consulting
http://www.abhatchconsulting.com
abh18@mindspring.com
Twitter @ABHatch18