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Rails- Top Ten Things We Hope to hear (but may not) on the Earnings Calls

Tony Hatch - ABH Consulting
Track

Greetings;

 

An old vaudeville joke goes:  “Doc, will I be able to play the piano after the operation?” “Certainly,” the doctor replies. “That’s great! I wasn’t able to play the piano before,” the patient admits.

Day 9 – the CDC says that I can fly a plane now….though I never could before (and I wouldn’t get on any flight with me as Captain, to paraphrase another vaudevillian, Groucho).  Anyway,  it seems that rail earnings start tomorrow (Thursday, January 20, also a Big Day Here) with Union Pacific slipping into the leadoff role bumping traditional opener CSX to the two-hole.  With that, we thought we’d drop a Top 10 List – of things we hope to see or hear on the rail earnings call over the next 8+ days (the “+” meaning the wait for Berkshire Hathaway/BNSF and our assumption that KSU will report under CP next week).

 

  1. Earnings themselves – let’s not read too much into the reported numbers (again).  Yes, rails will once again satisfy the Street and perplex – not to say annoy or even anger - the District (of Columbia) by showing good financial results despite poor service metrics and poorer traffic (Class Ones, down 3.3% in Q4/21, as reported by the AAR and discussed in the last report).  Rails will report earnings ~25% up, YOY in Q4/21.  But to what end?  How is that to be analyzed?  The fourth quarter of 2020 was a pretty good one, for rails, recall, as they earned a collective good grade for their response to the unbelievably rapid comeback of volume (what I called the “shark’s tooth” pattern) in the second half.  But it wasn’t “normal”, to be sure.  Full-year numbers will be all over the place, reflecting those events, charges related to M&A, and wounds, some of course, self-inflicted.  After trade wars, truck capacity and over-capacity issues, wild-fire, super-freezes, mud-slides, and blockades on both sides of the US border – that’s a lot.  And of course, all of that doesn’t even approach the impact of the Pandemic, which continues to be seen and felt in tangled ports (etc), Omicron impacts on headcounts (and on analysts), China’s hard-core reactions shutting ports, etc.    Hopefully 2023 over this year….

  2. Talking the talk–rails positioning themselves and their stakeholders for a growth focus.  Yes, skeptics are correct to say that’s old hat, but you can’t walk before talking, and re-focusing shareholder attention on growth prospects, such as UNP’s plan to outgrow Industrial Production, is an important step and rails will be held accountable.

    1. The TCI-CN issue, with a key date of March 22, is of course a potential spanner in the works.  TCI has not stated that their slate of directors nor their choice of CEO were anti-growth – far from it, in their rather anodyne public statements.  But they have, in effect, allowed analysts to represent their position as a shift in focus from growth (CN’s “feed the beast” plan) to margin….this is, as I have stressed, Very Important
    2. How will rails grow?  Yes, “trucks off the highway” – everyone loves that.  And in fact, it is – or must be the future.  But I do hear drums from the jungle, and a growing dread of cannibalism – pointing to both the CPKC merger application (I am 1000 pages down, just ~3400 to go; refer also to their excellent presentation at MARS last week, see write-up), and also today’s announcement that UP won the Schneider intermodal business beginning January 2023 from the BNSF, the market – and brand – leader.  Details weren’t disclosed, naturally; this is a ~top-10 BNSF customer, and the arch-rival of their #1, JB Hunt (which just reported a fine quarter by the way, and almost doubled growth Capex plans).  BNSF is the premium player in intermodal in the west (in the continent, in the world), and as part of its overall industry-leading volume growth last year outgrew UP in IM by 8.3% to 3.1%.  These things happen; I am sure Schneider is better off out from under JBHT (and UPS)’s shadow, and JBHT is likely happy too.  But I hear the drum beats and I fear the sound….
    3. Short lines – they remain a hot asset class, and there is definitely some smoke and maybe fire to the Class-One-repurchase theory, so far mostly coming from the mothership (CN, which admittedly has sold the WC lines) and its PSR spawn, CP and CSX.  But now also BNSF and MRL (yet another reason I wish BNSF would talk to us!).  CP has extolled its short line relations in their plans for CPKC, so I hope this emerging trend of C1s taking (back) short lines remains case-specific.  Short lines are mos def part of the walk-the-walk solution….
    4. That said, although coal is set to (eventually) revert to the secular decline trend – it was the best-performing asset class last year, BTW, and there is trouble in Canadian (and maybe, US) grain, there are near-to-intermediate term opportunities in potash, steel/scrap/met coal, moto vehicles, paper, chemicals – and of course intermodal.  Ag, meanwhile, may in the USA have some positive opportunities in H2 given weather issues in Latam – also dependent on US-China relations, of course; China fell $16B short of its two-year Phase One Ag purchase commitments (which actually isn’t bad, considering).
    5. Understanding the real volume opportunities requires legwork – look for me on the road (eventually) at SEARS, NEARS, NARS, IANA/EXPO, ASLRRA, and of course RailTrends 2022.

  3. Supply chain and service reliability – we’ll hear a lot about the latter, some about the former, and few details.  Here’s hoping I am wrong.  The NY Federal Reserve Bank stated that supply chain pressures peaked in October (coincidentally the last good YOY month for rail intermodal).  On the other hand, the FT’s “Big Read” stated that “there was no end in sight” only a week ago.  There are still ~110+ ships parked from the LALB docks back to China….and the Baltic Container Index rose 180% in 2021 (the Dry also rose, 75%).  So, from the rails, I expect we’ll hear improving news in hirings (as we did from CSX and NSC at MARS), fairly robust Capex plans (as always a focus here), and hopefully some on specific capacity pinch points (chassis, domestic containers).  At the New Year, USA Today listed “Supply Chain” as #10 on its own Top 10 list of phrases to be canceled (number 1 was “Wait, what?”).  They said it was “simply a buzzword”.  Wait - what?  If we have learned anything in the pandemic (and that itself is subject to question) it is that supply chains are critical.  Here’s to moving off the front page but staying prominent in the business section.  One interesting factoid – grocery stores usually average 5-10% out of stock and are now running at ~15%

  4. The economy – with consensus estimates now for GDP growth of 3%, down a point from just October (lower for both Canada and still the laggard, Mexico).  The biggest concern is, of course, inflation, and “Supply Chain Crisis “is often listed as #1 (the UN stated that it added 1.5%, globally) – but let’s all not forget: weather (freeze/fire/flood), labor & the Great Resignation, the direct costs of the pandemic changes – and the ongoing impact of ~$370B+ of tariffs on Chinese goods which didn’t slow down imports one bit – see China’s record trade surplus….oil hit $85+ (highest in 7 years, since the boom days in the Bakken).  Rails will retain pricing power (if they don’t go all cannibal) but rail-inflation-plus will be a major discussion point…Do not fall for naïve assumptions on yield coming from the Street.

  5. Labor – we won’t hear jack, jack, on what is in my mind one of the biggest issues of the year – the ongoing (2019) US Rail (all) -Labor (most) negotiations.  We know labor hasn’t had a raise since the negotiations began, and we know the pandemic has slowed the already historically sloooow process (apparently no one in DC heard of zoom till last year).  We know labor has more “hand” (see Costanza, George – and see Kellogg/Deere/Amazon, and the Biden administration, and the FRA, and soon the ILWU and….).  If the rails can beat these headwinds and stick to their case for technological reform (autonomy, inspections, crew consist) in a soundbite world, then they -and the AAR – deserve medals.

  6. STB – we have covered the rising activism of the DTB (and FRA and House T&I) early – and ad nauseum, as have the Class One leaders.  We don’t expect much in these calls – there will be questions to be sure but answers will wait till at least the reciprocal switching/forced access hearings in March.  Expect hearings, not actions, in 2022.

  7. CPKC – I fear the rails won't say as much as we want to hear, having heard for example UP’s CEO Lance Fritz on the topic many times over the past few months.  The intent (fight for access, defend their position and use the deal as an opportunity) is clear, the tactics undisclosed and likely to stay that way.  Perhaps NS will discuss their specific maneuvers regarding the application; certainly CN will to some degree.  We know the CPKC position (though each iteration of their promotion has yielded insights).  It is of course a pity we can't hear from BNSF (Mexico?!?)
    1. Speaking of Mexico, it’s been newsworthy – the Q4/21 Pemex purchase of a Texas refinery reveals more of what the NY Times (etc) has called Mexico? AMLO’s “self-reliant energy plan”.  We saw in Q3/21 how Mexican regulators interfered in manifest train refined products business, as well as foreign refiners formerly invited into Mexico.  Now this plan, which encompasses bringing Mexican heavy crude to Texas and re-shipping refined products south, may  - may - allow for rail business to continue (US refiners could lose ½ million barrels/day), but overall most critics see some negative end results, beyond just AMLO interfering in the marketplace:
      1. Mexican energy would be more expensive and less reliable.
      2. Mexico will be significantly less green, just as ESG and “Scope 3’ move to not just the mainstream but the forefront.
      3. This can – and had – affected FDI – note GM stating that they would curtail Mexican investment
  1. Capex versus Buybacks – we are in a record period – again – for share repurchases; we know where the STB stands on this, and you know where I do (balance!).  Early indications from NRC at the beginning of the month (again, see report) suggest that capex will be up a decent amount (of revenue/% levels flattish, save for CN).  To support the growth Talk, they need some capex walk.  Yes, there are ongoing PSR capacity dividends (see CP) as well as add-on acquisitions (see CP).  There also needs to be more spent on straight capacity (see CPKC) and on

    1. Technology (see CP – and really all of them).  I neglected to mention coming out of MARS that Greenbrier, the railcar OEM/leasing dynamo, had joined the Rail Pulse ownership group.  That is a big step – now we await another Class One (UP? CSX?) and then the momentum will be irreversible.
    2. The intermodal supply chain (boxes, chassis, terminals).

  2. ESG – you can’t say enough about ESG, and the rails will…..Blackrock’s letter this week was instructive – ESG isn’t woke (per se) it’s good business.

  3. Succession Plans – we expect to hear soon from or about Canadian National, and over the course of the year, CSX.  I had always had UP on this list, but Lance gets younger every time I see him….all joking aside this is critical.

 

So that’s my Q4/21-FY22 Top 10.  If I would add something it would be the need for more visibility, clearer communications, more investor days as the pandemic (hopefully) wanes.  We need to see more (of) management in 2022….so we can see how they are getting along in their new PSR2.0, post-PSR, DSR, or whatever, growth walks….

 

Railcars 2022 from colleague and (usual) RT presenter Dick Kloster!  As many of you saw in Dick’s article in our partner publication, Progressive Railroading, Dick sees 2022 as a year of industry recovery, an inflection point (my phrase – with OEM deliveries and backlogs seen increasing, and lease rates up at long last.  Of course, this sector is always very car/market-specific, with grain and pellet hoppers hot, and boxcars the eternal “?”.  More specifically, Dick states:

  • Equipment markets will continue to improve in 2022 with Leasing companies seeing improvements in most metrics, including lease rates
  • New car deliveries are forecast to total 43,656 cars in 2022, up 40% over 2021, with tank cars and covered hoppers set to account for 67%
  • Retirements in 2022 are projected to total 51,798 cars in 2022, down 5.5% from 2021 due to lower scrap steel prices and higher fleet utilization/railcar usage, but still 18% higher than new builds
  • A new industry-wide build cycle is kicking off that will be 95% reliant on the replacement market
  • This cycle will look very different from past cycles that were dominated by one or more commodity/car type growth segments that peaked fast and burned out abruptly, i.e., CBR, frac sand, etc. This cycle will be more prolonged and measured.

 

Also:

 

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

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