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November 2011



Rail News: Rail Industry Trends

RailTrends 2011: The Growth Story Retold



By Tony Hatch

RailTrends® 2011, which was held Nov. 1-2, matched its new opulent surroundings at the W New York Hotel with our most impressive content to date. We focused on a combination of the tried and true (and extensive look at the interaction between Washington and the freight rail industry) with the selected focus on growth and innovation. Speaking of innovation: An event highlight was the presentation of Progressive Railroading's Railroad Innovator Award to Kansas City Southern's Mike Haverty. Despite the uncertain business climate, it was clear from sentiments expressed during the conference that there will be no double dip in the near term, and that there are real growth prospects in the intermediate to longer term.

At RailTrends, we focused on intermodal, of course, particularly domestic, but also on grain and Mexican cross-border opportunities (part of Haverty’s innovative legacy). And although it wasn’t a direct focal point, the ramifications of the shale explosion surfaced in several contexts, whether presenters talked about rail-car building, new services or other positive ramifications (such as on the chemical industry). Meanwhile, shale was the subject of a glowing Nov. 2 Wall Street Journal article on the Bakken in North Dakota.
 
Views From Washington
Our "Washington" panel — featuring the presidents of four associations representing key stakeholders — highlighted the continued need for vigilance on the regulatory front. The net impact of the capital scene is more positive than usual; the attitude of “rail-as-solution” truly has taken hold, even as funding to help effect change is not available. There is little direct threat out there compared with, say, what we saw a few years ago, but we may well see the next steps of a regulatory claw back on rails via the Surface Transportation Board (STB). There also was the matter of a key (and as yet unresolved) national labor contract.

American Short Line and Regional Railroad Association President Richard Timmons' presentation was thoroughly detailed and a must for students (i.e., investors) in that sector. One jarring note was the revelation that bigger trucks (the truck-size-and-weight issue), although unlikely to materialize at the national level, could be a very painful one on a regional, state-by-state basis. About one-fifth of short-line revenue could be at risk. As for the Section 45G infrastructure tax credit? Once again, it will be a last-minute thing.

Railway Supply Institute President Tom Simpson noted it was “a good time to be a rail supplier,” given railroads' capex budgets and growth prospects. Simpson's sentiments were supported later in the day by Rail Theory Forecasts L.L.C. President Toby Kolstad’s data-filled overview; growth in tank cars and covered hoppers led by shale and in 53-foot domestic intermodal platforms and eventually grain cars are all expected and no longer a surprise, Kolstad said.

National Industrial Transportation League President Bruce Carlton, representing a large body of rail shippers, came into the lion's den, as it were, and presented his case for STB action on his organization’s petition on reciprocal switching, etc. (opening access/bringing in rail competition, etc.). (Note: On Nov. 3, the STB issued a decision stating it would defer action on NITL's petition. A decision will be delayed until board members finish reviewing a lengthy record developed in a separate and broader rail competition proceeding, the STB said.)

Association of American Railroads' President and CEO Ed Hamberger vigorously defended the rail position on the NITL petition and other matters — notably, the Presidential Emergency Board's (PEB) position on the rail labor stand-off (the PEB's recommendations were issued on Nov. 5), with Hamberger supporting the usual history of following the set “pattern” — in this case, the largest union, the UTU, in September ratified a contract calling for a 17 percent wage increase over 60 months and a 78-month cap on health insurance contributions.

It should be noted that the audience at RailTrends was, as usual, filled with industry luminaries in addition to the speakers, and several important union officials there told me they expected a differing result, that the UTU would not set a pattern. Bottom line: It may be semantics, and lead only to whether we see a strike or a lock-out (as opposed to peace) on Dec. 5. Either way, I don’t expect any long-term, major disruption — save for the parcel industry (see below).

More D.C. Moments
In a separate presentation, STB Chairman Dan Elliott spoke about the board’s expanding role, and did reveal one thing that might have gone unnoticed. He had said at the North American Rail Shippers' annual meeting in May that one case before him (Norfolk Southern Railway and the issue of “revenue adequacy”) had the potential for being as disruptive as the hearings last spring that led to the aforementioned NITL petition. That case was quietly settled, and with that goes the challenge.

Meanwhile, Federal Railroad Administrator Joe Szabo gave an enthusiastic speech concerning his agency’s expanding role, and how it has benefited rails that are getting a larger hearing (and more funding) from D.C., notably in the form of TIGER grants, 40 percent of which were rail related (TIGER III is pending).

In his typically engaging fashion, Chairman of the House Transportation & Infrastructure Committee John Mica (R-Fla.) discussed the need to remove the transportation (formerly “highway”) bill from politics and make it a six-year bill before it's due for yet another “extension” on March 31, 2012; he still held out hope that a bill could be passed before year's end. Mica’s bill would certainly help rails and ports more than previous ones. But politics were never far from the surface. Mica criticized the previous (Democratic) Congress for getting nothing done despite controlling all three governing bodies.

Meanwhile, a few individuals representing rail-union interests handed out leaflets ("Mica - Unfair to Amtrak!"), protesting his presence in New York City; immediately following his address to the RailTrends crowd, Mica and U.S. Rep. Carolyn Maloney (D-N.Y.), also present at the conference, went to tour the 2nd Avenue Subway project.

And Then There's Growth ...
On the growth side, the uptake was more universally positive, of course, albeit not without challenges — for example, as intermodal attention is being focused on shorter-haul domestic traffic, the need for “operational excellence” has never been greater. It seemed to resonate when I said that "service will be the determinant factor in the next cycle."

Canadian Pacific was a topic of conversation, with RailTrends coming just days after the announcement of Pershing Square’s 12.2 percent stake. Analyst Rick Paterson of UBS laid out a convincing argument that this will lead to a tightening of pressure to reduce CP's operating ratio (OR) gap to the Class I average and to Canadian peer CN. Paterson also demonstrated that while the Street pays lip service agreement to CSX’s 65 percent OR target by 2015, not too far in the future, the consensus estimates suggest that CSX will miss its target by some 300 basis points (bp). Extrapolating this out, it helps explain why the Street is generally bullish on the rails yet is constantly surprised by their performance, and why the “rail renaissance” still has room to run in the stock as well as transportation markets.

CP's Stephen Whitney, vice president of marketing and sales, agribusiness and market development — told a bullish story about the Class I's grain prospects. Ag is often the forgotten growth segment by the Street, and at CP, the spotlight is often on Teck coal or other commodities. But ag represents 35 percent of CP's revenues when you take into account the “inputs” (fertilizers, etc) and has terrific prospects itself, with a 25 percent increase expected by 2015 in Pacific Northwest exports, the opportunities to grow with the sunset of the Canadian Wheat Board, and excellent franchises in Canada in the prairies and in the United States in the former Soo/DM&E territories.

On Day 1, KCS had a doubleheader to play, with back-to-back presentations by Executive Vice President Sales and Marketing Pat Ottensmeyer and Executive Chairman Mike Haverty. Ottensmeyer demonstrated conclusively that Mexico, as a business opportunity, is far removed from the headlines, and with the cost of doing business rising in China (and on a relative basis), Mexico is the place to be for near sourcing. Big growth is expected in autos, grain, chemicals and intermodal, with cross border — only recently dismissed by rail observers — as the leading component of growth. Haverty gave a great talk, making one wonder why he is often reluctant to speak at such events. He talked about perseverance (he's exhibited it in spades) and seeing opportunities others did not (often, much to his chagrin). Witness intermodal (the 1989 J.B. Hunt-Santa Fe deal) and in Mexico, where KCS is still finding new opportunities as they work to exploit the known ones.

On Day 2, we offered two great presentations from best-in-breed carriers. From a Class I perspective, CN Executive VP and COO Keith Creel pointed out that CN's sub-60 percent OR in Q3 (sub-64 percent year to date) is “not perfect” and that the railroad has plans to drive even more efficiency, starting with fuel productivity and “supply chain collaboration” — the latter an interesting discussion, considering it was coming from an
operations leader, showing the tight collaboration needed to run a railway as well as CN does.

Genesee & Wyoming Inc.
President and CEO Jack Hellman offered an update that was fortuitously a day after GWI reported terrific earnings. What really struck me about his presentation was the company's opportunistic and evolving global strategy, with expansions in Canada and Europe and Australia. In fact, GWI has added, it would seem, a third plank to its strategic platform: (1) make their existing rails more efficient (they took 400 bp from its OR in Q3); (2) make short-line acquisitions (early this month, GWI announced it had leased the Hilton & Albany Railroad in Georgia from NS, which sounds like old times); and (3) grow alongside global mining operations, which explains their expansions in Canada and, especially, Australia.

Spotlight On Intermodal
Intermodal was the dominant theme of the conference, with a panel and presentations by two chief marketing officers whose companies are largely intermodal plays (and the Innovator, or course). In terms of growth, while it isn’t alone (as it's been in the past) intermodal remains the once and future rail king. Aside from the aforementioned KCS story, what follows are a few nuggets gleaned from the intermodal presentations.
 
We heard an excellent (and rare) presentation from BNSF Railway Co. Chief Marketing Officer John Lanigan. BNSF is expecting “modest growth” in 2012, with a seven-year gap between peak and recovery. But longer term, the railway sees great opportunities. BNSF is the chief beneficiary from the Bakken, but I was pleased, given the intermodal theme at RailTrends, that the world’s largest intermodal player sees growth not only in its international segment (with  minimal future impact form the Panama Canal’s widening in 2014) but in “pure” domestic truck conversion — which most observers think is purely an eastern prospect. Lanigan reiterated that Warren Buffett's ownership hasn’t changed the day-to-day or even strategic direction of the company ... although BNSF is spending a whopping $3.8 billion on capex this year. Some of that is due to the flood hit BNSF took, second only to CP.

The intermodal panel was one of the highlights (if not the highlight), in my view, with Intermodal Association of North America's Tom Malloy pointing out that we are moving that segment close to 50/50 (percent) international/domestic due to the growth of transload (converting three 40-foot international containers into two 53-foot boxes at or near ports) and, especially, the growth of domestic truck conversion. Domestic 53-foot boxes have grown year over year for eight quarters in a row, or right through the Great Recession.

Also growing is the expedited parcel business, highlighted by FedEx joining the intermodal party at last in 2011; UPS has been a or the top railroad customer for years.  This comes at an interesting time, given the labor date deadline of Dec. 5, which usually would be after the peak season; this year, it coincides with an e-commerce (“gift card phenomenon”) holiday rush on parcel carriers and their intermodal partners.

Back to the intermodal panel: Union Pacific Railroad VP of Intermodal Marketing and Sales Brian McDonald gave a thorough demonstration of UP's commitment to intermodal by providing capacity — well over half of the intermodal boxes in circulation run on UP. That UP has taken such a different tack from western rival BNSF on the issue of equipment is one of the interesting points on an always-fascinating business, and it will be the subject of future analyses. UP also has implemented a Mutual Commitment Program (volume for capacity guarantees) to take some volatility out of the process, and it has worked well from an operating perspective.

Our Best Ever
NS is riding the current hot hand in the segment, growing both components well above industry averages, and VP Intermodal and Automotive Marketing Mike McClellan showed (1) that it is hard work and demands a higher level of commitment in the eastern lanes (“operational excellence”) and (2) that with 1.1 million available loads out there (and bi-modal partners clamoring to give it to them), it is worth it. And NS’s growth so far is coming without its “Corridor” program really kicking in yet (notably the Crescent).

Also joining the panel was Adam Bridges, VP of business development for Fortress Investment Group’s TRAC Intermodal. TRAC is working to solve the problem of intermodal chassis now that the steamship lines are finally exiting the business — TRAC believes as I do that “capacity has value.”

Jim Hertwig wasn't on the intermodal panel; he delivered a presentation of his own. The ex-CSX Intermodal head now serves as president and CEO of the Florida East Coast Railway, another Fortress property. FEC is now 81 percent intermodal, with a unique value proposition to take containers (post-widening of the Panama Canal) north from Miami and/or Port Everglades, helping to balance the age-old problem of southern Florida being a major head haul example (with a historic 4:1 ratio of loads in:out). FEC also has an interesting passenger angle, as well; the system is so much better suited for Tri-Rail than CSXT.

Capping off Day 2 in the difficult final slot of the summit was Oliver Wyman's Manny Hontoria. In a brief session titled "Dynamic Risk Management," he reminded us that "risk is good — the flip side of risk is reward." Particularly in a growth in environment.

All in all, RailTrends 2011 was our best ever, setting up a real challenge for 2012. We thank all of our participants and sponsors, especially platinum sponsor Miller Tabak + Co. L.L.C.  We all left the summit with an increased confidence in a steady near term and a glowing intermediate term outlook for the rails, which still are not appreciated in the markets. See you next year!

Tony Hatch is an independent transportation analyst and consultant, and a program consultant for Progressive Railroading's RailTrends® conference. Email him at abh18@mindspring.com.


 


Keywords

Browse articles on RailTrends John Mica Mike Haverty Michael Haverty John Lanigan intermodal shale Bakken Shale Norfolk Southern Union Pacific BNSF Genesee & Wyoming CN Keith Creel Florida East Coast Tony Hatch Anthony Hatch Railroad Innovator Award short line Canadian Pacific Pershing Square

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