Post on 08-Jul-2020
2017! ABH PresentationIt’s always something
The Rail Renaissance& the Brave New World
SWARS!abh consulting January 2017
NYC
Deregulation & Vertical Integration Works!
0255075
100125150175200225250275300
'64 '67 '70 '73 '76 '79 '82 '85 '88 '91 '94 '97 '00 '03 '06 '09 '12 '15
Staggers Act passed Oct. 1980
"Rates" is inflation-adjusted revenue per ton-mile. "Volume" is ton-miles. "Productivity" is revenue ton-miles per constant dollar operating expense. The decline in productivity in recent years is largely due to the effect of higher fuel prices in the productivity calculation. Source: AAR
Productivity
Rates
Volume
Revenue
U.S. Freight Railroad Performance Since Staggers(1981 = 100)
21st Century: the Railroad (equity)Renaissance: From Triumph to Challenged• Rails have well beaten the stock market 2001-2014 – 7 Big Reasons
– Globalization/trade (IM)– Capex&Productivity&Service– Pricing & ROI – Through economic turmoil (manufacturing/energy/markets)
• Of Late – “Not So Much” (now regaining “par”)• Energy Impact: real (coal) and hype (CBR)• Visibility & Sentiment change – financial & government/public • Earnings Power (always) misunderstood: Rails beat Street estimates – in
the Boom, in the great Recession, and the tepid recovery, in this period• 2015: Record margins & results (and Capex and Buybacks/DPS and….)
despite the coal - and drought and lukewarm economy, etc….• Rails are still re-gaining market share from the highway despite oil prices
(2017?)• Brave New World
50,000
60,000
70,000
80,000
90,000
100,000
110,000
120,000
130,000
140,000(average weekly originations)
ASSOCIATION OF AMERICAN RAILROADSSLIDE 4
U.S. Rail Carloads of Coal
Data are average weekly originations for each month, are not seasonally adjusted, do not include intermodal, and do not include the U.S. operations of CN and CP. Source: AAR Weekly Railroad Traffic
2010 2011 2012 2013 2014 2015 2016
Q4/16 Earnings to-date: Meh!
• 3 beat expectations, 3 not so much (BNSF TBD)
• Q4 volumes end with momentum (barely carried 2017 YTD)
• Call Guidance more muted than expected (though pricing/domestic IM, metals look solid) – recent increased optimism
• Initial Capex down 6/7 RRs, roughly 10%
• Big stories – NAFTA/Trade,economy, EHH-CSX
Hunter’s Back (We Think)
• Mantle/EHH proposal after EHH leaves CP
• Not about consolidation!
• As such, only 1 Stakeholder group – CSX shareholders – need to approve! (2/10)
• Precision Railroading will improve OR but\
– CSX isn’t like CP (damaged goods)
– CSX isn’t like CP (density/complexity)
– Customer Service is more important than ever!
New Administration “Promises”
1. The end of the “War on Coal”
2. Drill, Baby, Drill (and pipelines, eh!)
3. Infrastructure (Privately Financed)
4. Bye-bye Trade (NAFTA)
5. Get out and stay out! End of the 150-year relationship of GOP & “Big Business” (ask Ford)
6. War on Regulation (maybe) on Red tape (likely)
7. Lower taxes
8. Labor – Who’s driverless, now?
ASSOCIATION OF AMERICAN RAILROADS SLIDE 8
2
3
4
5
6
7
8
'07 '08 '09 '10 '11 '12 '13 '14 '15 '16
(millions)
U.S. Rail Carloads of Coal: Not Pretty!
Data are originations and do not include the U.S. operations of CN and CP. Source: AAR Weekly Railroad Traffic
ASSOCIATION OF AMERICAN RAILROADS SLIDE 9
U.S. Electricity Generation
by Type of Fuel
Source: Energy Information Administration
2000 2005 2010 2015Coal 52% 50% 45% 33%Natural Gas 16% 19% 24% 33%Nuclear 20% 19% 20% 20%Hydro 7% 7% 6% 6%Renewables 2% 2% 4% 7%Other 3% 4% 1% 1%
40,000
60,000
80,000
100,000
120,000
140,000
160,000
60
80
100
120
140
160
180
Generation from coal
Coal carloads
(average weekly originations)
ASSOCIATION OF AMERICAN RAILROADSSLIDE 10
U.S. Rail Carloads of Coal vs. Electricity From Coal
2010 2011 2012 2013 2014 2015 2016*Electricity generation is 3-month moving average, million megawatthours, through Oct. 2016. **Coal carloads are 3-month moving averages based on weekly average carloads. Source: EIA, AAR
Overview of North American Rail Environment & Key Issues
• Rail Renaissance (and heavy Capex!)is the theme (1980-) 2001-2013;
• OVER?? Major Challenges Emerge – Energy Decline (Coal/Oil)
• End of the “Commodity Super Cycle” (?); Trade Slowdown; $/FX
• Service & Safety Issues; Rereg threats re-emerge
• Service & Productivity & Safety (all related to Capex) are a) getting
resolved & b) Even More Important Than Ever….
• Intermodal performance more critical than ever (recently confusing)
• Rails, however, are still re-gaining market share from the highway
• Managements, New & Challenged: Visibility, Guidance; Capex & Cash
• Asked & Answered: Is M&A the Solution? (What’s the problem?)
• What now?
11
Close Correlation Between RR ROI and Reinvestments
7%
8%
9%
10%
11%
12%
13%
14%
'05 '06 '07 '08 '09 '10 '11 '12 '13 '14
$16
$18
$20
$22
$24
$26
$28
$30
Reinvestments* (right scale, $ bil)
*Capital spending + maintenance expense. **Net railway operating income / average net investment in transportation property. Data are for Class I railroads. Source: AAR
RR ROI** (left scale)
16
13
$0
$2
$4
$6
$8
$10
$12
$14
$16
$18
'80 '83 '85 '87 '89 '91 '93 '95 '97 '99 '01 '03 '05 '07 '09 '11 '13 '15
Class I Freight Railroad Capital Spending ($ billions)
Source: AAR
Returns Finally Justify the Massive Expenditures – But Do Future Prospects??
14
Railroads Help Keep Coal-Based Electricity
SLIDE 15 ASSOCIATION OF AMERICAN RAILROADS
Coal: -1,031,178 (-20.1%)
Petrol. & petr. prod.: -154,422 (-21.4%)Metallic ores: -39,706 (-12.7%)
Crushed stone, gravel, sand: -38,779 (-3.3%)Primary metal products: -30,588 (-6.5%)
Pulp & paper products: -20,099 (-6.4%)Grain mill products: -16,465 (-3.3%)
Primary forest products: -11,763 (-15.5%)Stone, clay & glass prod.: -8,780 (-2.2%)Lumber & wood products: -8,173 (-4.6%)
Nonmetallic minerals: -5,913 (-2.5%)Iron & steel scrap: -3,516 (-2.0%)
Farm products excl. grain: -1,188 (-2.5%)Food products: 879 (0.3%)
Coke: 17,904 (9.0%)Motor veh. & parts: 18,743 (2.1%)
Chemicals: 24,094 (1.5%)Waste & nonferr. scrap: 28,431 (16.8%)
All other carloads: 30,887 (11.1%)Grain: 80,480 (7.3%)
Source: AAR Weekly RailroadTraffic database
Change in Originated U.S. Rail Carloads:
2016 vs. 2015
Note: intermodal is not included in this chart. Intermodal was down
220,171 (1.6%) in 2016 vs. 2015.
Total 2016: 13,096,860Total 2015: 14,266,012( 1,169,152 or 8.2%)
Railroads Help Keep Coal-Based Electricity
SLIDE 16 ASSOCIATION OF AMERICAN RAILROADS
Coal: -1,728,543
(-29.7%)
Petrol. & petr. prod.: -230,768 (-28.9%)Primary metal products: -115,949 (-20.8%)
Metallic ores: -86,802 (-24.1%)Crushed stone, gravel, sand: -45,710 (-3.9%)
Iron & steel scrap: -43,494 (-19.8%)Stone, clay & glass prod.: -32,552 (-7.7%)
Nonmetallic minerals: -29,205 (-11.2%)Pulp & paper products: -26,665 (-8.4%)
Primary forest products: -17,356 (-21.3%)Lumber & wood products: -15,080 (-8.2%)
Grain mill products: -14,757 (-3.0%)Farm products excl. grain: -2,119 (-4.4%)
Food products: -2,068 (-0.6%)Coke: 18,110 (9.1%)
Waste & nonferr. scrap: 27,469 (16.1%)Chemicals: 29,897 (1.9%)
Motor veh. & parts: 48,433 (5.5%)All other carloads: 65,323 (26.8%)
Grain: 120,669 (11.4%)
Source: AAR Weekly RailroadTraffic database
Change in Originated U.S. Rail Carloads:
2016 vs. 2014
Note: intermodal is not included in this chart. Intermodal was down 6,723 (0.05%) in 2016
vs. 2014.
Total 2016: 13,096,860Total 2014: 15,178,027( 2,081,167 or 13.7%)
Railroads Help Keep Coal-Based Electricity
SLIDE 17 ASSOCIATION OF AMERICAN RAILROADS
Coal: -1,076,279
(-19.4%)
Petrol.products:
-216,738 (-19.4%)Crushed stone, gravel, sand: -70,897 (-5.2%)
Metallic ores: -66,686 (-8.3%)Primary metal products: -49,549 (-8.5%)
Pulp & paper products: -26,996 (-5.8%)Grain mill products: -16,023 (-2.8%)
Primary forest products: -12,090 (-7.7%)Nonmetallic minerals: -10,971 (-3.6%)
Stone, clay & glass prod.: -7,150 (-1.6%)Iron & steel scrap: -2,968 (-1.4%)
Lumber & wood products: 6,080 (1.8%)Food products: 10,000 (2.3%)
Farm products excl. grain: 10,027 (4.4%)Chemicals: 15,426 (0.7%)
All other carloads: 23,433 (6.9%)Coke: 23,435 (10.3%)
Waste & nonferrous scrap: 25,886 (14.0%)Motor veh. & parts: 28,128 (2.4%)
Grain: 62,146 (4.0%)
Source: AAR Weekly RailroadTraffic database
Change in Originated U.S. + Canadian Rail Carloads:
2016 vs. 2015
Note: intermodal is not included in this chart. Intermodal was down
258,402 (1.5%) in 2016 vs. 2015.
Total 2016: 16,861,914Total 2015: 18,213,700( 1,351,786 or 7.4%)
Railroads Help Keep Coal-Based Electricity
SLIDE 18 ASSOCIATION OF AMERICAN RAILROADS
Coal: -1,832,494
(-29.1%)Petr. prod.: -287,961 (-24.3%)
Metallic ores: -243,580 (-24.8%)Primary metal products: -142,926 (-21.2%)Crushed stone, gravel, sand: -107,038 (-7.7%)
Iron & steel scrap: -49,907 (-18.7%)Stone, clay & glass prod.: -39,164 (-8.0%)
Pulp & paper products: -38,254 (-8.0%)Nonmetallic minerals: -32,245 (-9.9%)Primary forest products: -12,530 (-8.0%)
Grain mill products: -12,498 (-2.2%)Food products: 9,955 (2.3%)
Farm products excl. grain: 11,656 (5.2%)Lumber & wood products: 13,234 (4.0%)
Waste & nonferrous scrap: 18,358 (9.5%)Coke: 25,094 (11.1%)
Chemicals: 26,393 (1.2%)Grain: 41,598 (2.6%)
All other carloads: 62,350 (20.8%)Motor veh. & parts: 73,469 (6.5%)
Source: AAR Weekly RailroadTraffic database
Change in Originated U.S. + Canadian Rail Carloads:
2016 vs. 2014
Note: intermodal is not included in this chart.
Intermodal was up 104,065 (0.6%) in 2016 vs. 2014.
Total 2016: 16,861,914Total 2014: 19,378,404( 2,516,490 or 13.0%)
2018 RR EPS/Expectations
• RR earnings so far struggling to match improved sentiment & increased expectations
• Volume inflection (coal stabilizes/IM grows)
• Productivity (and price) retention
• Capex down…but not out
• Guidance & Visibility still missing
• Winter is coming (and going)
• Big Labor Year
• He’s Baaaaaack!
EHH & CSX - First thoughts & Assumptions
(while struggling to make sense of it all):
• Rail consolidation is not the goal here - This is not a covert M&A attempt, a way to go back after the denied CP+CSX (merely discussed) or CP+NSC (more public) proposed deals.
• This plays to the fans, the investment community - For those proposed or suspected deals, many stakeholder groups (unions/shippers/other RRs/etc) at least initially opposed those (any?) combinations -but the investment community, having made $$$ with EHH at IC and CNI, clearly did not. And now they
have the “EHH-fixes-CP” story to brag about as well. A common refrain was “if only EHH had come to an eastern railroad alone rather than with a merger plan & CP….” – well, this might be that wish granted.
• Early returns favorable: After dropping after earnings, CSX was up some 10%+ on this “news”….early days…..
• This was the first we heard of this alliance and plan – but not likely the first move: One can assume (guess) that some or a lot of the Mantle money has been put to work at CSX already, perhaps (as is often the case) with friends and allies.
• Like Melville’s great captain, this time EHH would be very much alone – unlike the last time, with EHH in his 70s, when one reassurance was having Keith Creel (et al) behind him as a partner and successor. KC is just starting his own story in Calgary. But CSX has a dynamic new C-level team, and like the old MBOs of old, there is talent at the target.
• Like Melville’s great white whale, CSX is not a weak fish: It should be pointed out that, partially as a response to the CP threat from a few years ago, CSX – really, both eastern carriers - improved operations dramatically etc since 2014And if the long held 65% OR target seems always out of reach for CSX, one really can nor should not dismiss the fact of the $2B+ of lost (high margin) coal revenue over the past 5 years; .
• That said, I haven’t found a rail leader who would deny that EHH and Precision Railroading would cut costs at a (any) US carrier…..
EHH & CSX - First thoughts & Assumptions (while struggling to make sense of it all):
• Great skills/right fit? So, EHH’s arrival in a leadership role at CSX could be terrific financially and would certainly be exciting - but is not without some risk, based on historic performance.
• The New Model Railroad faces threats (the permanent, secular loss of coal business, perhaps AV trucking down the pike) and cost cutting, the EHH specialty, cannot be the only answer. The opportunities to grow are highly service oriented, and require capital, finesse, IT as well as productivity improvements - intermodal, particularly domestic, and merchandise.
• Kinder/gentler: This is the skill set of the CN – which took the legacy of EHH’s spectacular job there and layered in customer responsiveness, supply-chain extension, etc.. On the other hand, EHH is 72, and perhaps (as we mentioned in our MBO comparison) after stage one of the revolution, there is already at CSX someone ready or soon ready to perform at the next-level in the manner of Claude Mongeau at CNI….
• Minimal outside influence would be brought to bear: This could be a coming showdown (or alliance) between the Mantle Team and CSX (and their management, their board and their shareholders). In other words: Other stakeholders don’t have the influence on this emerging story (there is no regulatory oversight etc) but remain interested observers.
• This time….it’s personal: EHH has always said he doesn’t care a whit about “legacy” but one can’t help feeling that the chance to utilize “Precision Railroading” on a US carrier, with all of their densities and complexities, would dispel the lingering skeptics (and there are some – not many, to be sure) that P/R works well….in Canada.
• See Rule #1 – Ahab didn’t land Moby Dick but unlike that crusty, peg-legged old sea captain, in this fishing expedition one must remember – Never Underestimate E. Hunter Harrison!
Our Troubled Industry?
• Q4 OR averaged 63%
• Rails in best-ever condition: network, finances, IT, managements
• Coal has stabilized
• Volumes have inflected
• Intermodal is growing again
• What’s next?
ASSOCIATION OF AMERICAN RAILROADS SLIDE 24
0
20,000
40,000
60,000
80,000
100,000
120,000
140,000
2010 2011 2012 2013 2014 2015 2016
Originated Rail Carloads of Crude Oil by Quarter
Data are for Class I railroads. Source: AAR (Freight Commodity Statistics)
2010 29,6052011 65,7512012 233,6982013 407,7612014 493,1462015 410,249
Annual Totals
ASSOCIATION OF AMERICAN RAILROADS SLIDE 25
0.0% 0.0% 0.1%0.2%
0.8%
1.4%
1.6%
1.4%
0.8%
2008 2009 2010 2011 2012 2013 2014 2015 2016*
Source: Association of American Railroads (Freight Commodity Statistics)
Crude Oil as a % of Total Originated Class I Carloads
ASSOCIATION OF AMERICAN RAILROADS SLIDE 26
0
20,000
40,000
60,000
80,000
100,000
120,000
140,000
160,000
Crude industrial sand (STCC 14413)
Crude oil (STCC 131)
2010 2011 2012 2013 2014 2015 2016
Originated Rail Carloads of Crude Industrial Sand & Crude Oil by Quarter
Data are for Class I railroads. Source: AAR (Freight Commodity Statistics)
Shale-Related Rail Traffic Relative to Coal Loadings
0
200,000
400,000
600,000
800,000
1,000,000
1,200,000
1,400,000
1,600,000
1,800,000U.S. Quarterly Carloads Originated
STCC 14413- Industrialsand andgravel(includes fracsand)
STCC 131 -CrudePetroleumand NaturalGas
STCC 1121 -Bituminouscoal
4 Qtr. Avg. 1,754,908
4 Qtr. Avg. 77,644
3 Qtr. Avg. 1,389,835
-365,073
4 Qtr. Avg. 204,778
+127,134
Source: Surface Transportation Board, PLG Analysis March 2016
Railroad Respond to the Challenges
• “Traditional Response” – cost cutting
• Strategic response to secular changes – coal
• Capex response – TBD (stakeholder division?)
• Radical change (ex. M&A)?
• (Continue to) Focus on growth areas
• Retain concentration on Service & Productivity
• Innovate! (“regain tech ‘mojo’’)
Silver Linings?
• Service (& Safety) Recovery Trend (Capex Pays Off)
• Productivity (& volume?) Inflection
• Restoration of the “Grand Bargain”
• Reduced (N/T) Political Pressure
• Coal “stabilization” (Part Two)??
• IM (etc.) latent demand….Bi-Modal results; Ag
• Gas-fired Industrial Buildout; Southbound migration of industry
• Revised MoW Capex (GTMs/Mix) frees CF/2017+
The “Grand Bargain”
• In return for higher prices (& ROI), rails spend, increase capacity & improve service (2005-2012) –The unstated “Grand Bargain”
• Rails gain pricing power (~2003) & F/S
• Rails (re) Gain Market Share
• Rails Spend Cash “Disproportionately” on Capex (~18-20% of revenues)
• Promotes “Virtuous Circle” – all stakeholders benefit
• Under challenge, perceived and real
Future Growth Potential (Revised)
Secular stories and specific targeted sectors (in order)….1. Intermodal – international and now domestic2. Chemicals/re-industrialization? Near-sourcing/Mexico (??)3. Cyclical recovery – housing, steel, autos (still….)4. Grain & Food – Exports up 10% this CY? NA still the world’s
breadbasket, but obviously (un)predictable?
5. Car-load merchandise – capacity available!6. Shale/oil/sand – demonstrated “flexibility”7. Other rail opportunities exist but in smaller scale: for ex: The
manifest/carload “problem”- Unitization
- Industrial Products/MSW
- Perishables
Issues for RR/Intermodal to 2020• Return to Growth?
• Fight over Capital – MoW vs Buybacks?
• M&A Fight fallout effect on Capex?
• RR Pricing Power Still?
• Factors: Oil Prices, Consumer Spend/GDP, Truck Capacity
• Infrastructure Advantage (vs subsidized highway)
• Trade and the Panama Canal impacts? NAFTA?
• Rail Service (& Safety) Improvements
• Coal stabilization
• Driverless beats One Man Crews to the market?
33
ASSOCIATION OF AMERICAN RAILROADS SLIDE 34
Close Correlation Between RR ROI and Spending
6%
7%
8%
9%
10%
11%
12%
13%
14%
'06 '07 '08 '09 '10 '11 '12 '13 '14 '15
$16
$18
$20
$22
$24
$26
$28
$30
$32
Rail spending* (right scale, $ bil)
*Capital spending + maintenance expense. **Net railway operating income / average net investment in transportation property. Data are for Class I railroads. Source: AAR
RR ROI** (left scale)
ASSOCIATION OF AMERICAN RAILROADS SLIDE 35
Higher Rail Profitability = Higher Rail Spending
'06 '07 '08 '09 '10 '11 '12 '13 '14 '15
$0
$4
$8
$12
$16
$20
$24
$28
$32
RR spending*
*Capital spending plus maintenance expenses. Data are current dollars and are for Class I railroads. Source: AAR
RR net income
($ billions)
ASSOCIATION OF AMERICAN RAILROADS SLIDE 36
Railroads Have Only Recently Earned Their Cost of Capital
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
'81 '83 '85 '87 '89 '91 '93 '95 '97 '99 '01 '03 '05 '07 '09 '11 '13 '15
RR Cost of Capital
RR Return on Investment
Class I RR Cost of Capital vs. Return on Investment
Note: In 2006, the Surface Transportation Board significantly changed the method by which it calculates the rail industry cost of capital. Source: STB
Railroad Philosophy
• Critical to the “RR Renaissance” has been Capex
• Private vs public capital (failing US infrastructure)
• Capex sparked by growth and ROI prospects –examples: IM, CBR
• “Open Access” antithetical to this….right?
• Is a RR its Network (Class One belief) OR is it its Operators (Hunter)??
• Cult of the OR vs ROIC; short-termism
Future RR Capex
• 2016 Capex down across the board (annopunced average -16%!) –except CN and further midyear cuts bring 2016E to -20%?
• Changing Mix of volumes - Most Important Decision Period in Years
• 2017 -Further cuts – Still able to avoid muscle?
• Coal: “Stranded Assets”? NS selling segments….CSX of Tomorrow
• Coal/Mix: Reduced Gross Ton Miles=Reduced Maintenance of Way?
• Yet remember: Service & Safety are even more critical to future RR success
• Changing mix of capex?
• Changing %revenues (16%)?
• PTC Extension resolution – more to develop? ECP?
39
ASSOCIATION OF AMERICAN RAILROADS SLIDE 40
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
RRs Paper Plastics &Rubber
Chemicals All Mfrg. Petr. & CoalProd.
Sources: Census Bureau, AAR
Class I RRs
Motor
VehiclesFood
Railroads: Far More Capital Intensive Than Other Industries
Capital Expenditures as a % of Revenue: 2014
Computers Wood
Prod.
Nonmetallic
Minerals
Railroads Help Keep Coal-Based Electricity
SLIDE 41 ASSOCIATION OF AMERICAN RAILROADS
Railroads Are
Far More
Capital
Intensive
Than Most
Other
Industries
Capital Spending as % of Revenue*
Average all manufacturing 3%
Food 2%Petroleum & coal products 2%Machinery 3%Chemicals 3%Wood producs 3%Primary metal products 3%Fabricated metal products 3%Motor vehicles & parts 3%Plastics & rubber products 3%Paper 4%Nonmetallic minerals 5%Computer & electr. products 5%
Class I Railroads 18%
*Avg. 2005-2014 Source: Census Bureau, AAR
Maintenance Spending RemainsDurable
0.0
2.0
1.0
3.0
2015 2016B
Select Class I Capex Budgets$ in Billions
$5.0
4.0
2015
$2.8
2016B
$2.9
2015
$2.5
2016B
$2.4
$4.3
$2.4
$3.7
(18%)
(1%)
$1.9
$1.9 $1.8
$1.4+4%
+7%
$1.4
$1.4 $1.5
$1.3
(10%)
+2%
$1.2
$1.2 $1.2
Infrastructure
Other Capex
Note: CN in CAD. SOURCE: Greenbriar!
Take-Aways From RailTrends16
• Good: IM & (especially) Merchandise Opportunities and near-term inflection; plastics, Ag,
• Maybe Good: reduced taxes and regulation? Infrastructure?
• Bad: Railcar production, coal (war is over)
• Ugly: Visibility, Trade
• Really, really ugly? AV trucking
• Have Faith & Innovate: Canadian National
Railway Night Sweats
• Politics (& Regulation)
• Trade – Globalization over?
• (Specifically) NAFTA – which impacts S….&N!
• Driverless – AV beer runs! (ahh the irony)
• Amazon – who isn’t scared?
• 3-D Printing – good enough for combat?
• Short-Termism/Over-reactions
• Capex and FCF planning
Competitive Advantage: RR Capex vs Aged National Infrastructure
ABH Consulting/www.abhatchconsulting.com
Anthony B. Hatch
1230 Park AvenueNew York, NY 10128(917) 520-7101ABH18@mindspring.com
www.railtrends.com