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The rail industry, like every other, is experiencing a demand drop of unprecedented proportions as this economic crisis unfolds. And like other companies, railroads are reacting to the sharp volume drop by reducing costs, both fixed and variable, as fast as they can. Cutting expenses quicker than Wall Street expectations is where they’ve traditionally shined during the last few recessions.
In Q1, the rails demonstrated that anywhere from 30 percent to 50 percent of their cost base is variable and can be pulled down (fewer train starts being the most obvious but not only example). As of this writing, they once again were beating consensus earnings estimates, helped no doubt by lower oil prices.
Rails also continue to work on the 50 percent to 70 percent of their cost base that is fixed, breaking it into long and intermediate terms (about half each) and accelerating their ongoing (since Staggers) efforts to get more efficient. Facilitating this effort are the increasingly powerful information systems and real-time database usage, as well as the continuous fine-tuning and outright revamping of their operating plans (e.g., CSX Corp. with what I call its “OnePlan 2.0”). In short: Cost-cutting is a direct response to the economic crisis, which may be showing some signs of bottoming, as well as an ongoing, investor-demanded way of life in the rail industry.
A new tradition. Another carrier tradition is the husbanding of cash as they reduce capital expenditures in response to demand declines — a tough balancing act between the short term (the economic outlook) and the long (the life of assets employed). The rails often went beyond cutting growth capital to cutting back on maintenance — a tactic employed often in the pre-Staggers Dark Ages that standing derailments came to symbolize the condition of the once-proud rail network.
No longer. With the concept of the “rail renaissance™” now firmly ensconced in the minds of rail managers and boards (and, increasingly, shippers and investors, if not yet fully in the minds of legislators and regulators), rails are increasingly thinking longer term, or strategically rather than tactically ... or shorter term.
Yes, management highlighted cost cutting in Q1 teleconferences last month as they flexed their tactical muscles. Even with Norfolk Southern Corp.’s just-announced capex cut (bringing them in line with the industry), Class Is will resist investor pressure to further reduce 2009 capex from the announced 5 percent to 10 percent year-over-year cuts, which came after a flattish 2008.
Remember, transportation demand (volume) has been recessionary going as far back as the end of 2006, so for rails to set records in ’06 and ’07 and ’08 is in itself amazing; for the cuts to come in at below or just barely double-digit in the face of this never-before-seen economic disaster is, well, astounding. It’s also a sign that railroads have learned the lessons of 2004, when several were caught short of capacity after cutting back too sharply in the ’99-’02 period. When the economy and volume come back, a capacity crunch is likely and it could be severe. It also could provide opportunities for marketshare gain potential.
Spreading the wealth. Who benefits from the Class Is’ strategic thinking? Well, the rails themselves in this brave new world — I foresee a major shortage of truck-load capacity as the trends that ignited the renaissance reassert themselves (globalization, etc.), aided and abetted by emerging trends like the growth and development of a true domestic intermodal revolution. Short lines will be winners, as well. So will rails’ bimodal partners.
Also benefiting will be rail suppliers tied to track, right-of-way, signals and systems — and they’ll get the turbocharged boost of the continuing passenger-rail resurgence. So far, only those on the rail-car side (builders, lessors) are really taking it on the chin. They held up for quite a while through the transportation slowdown, but they could not withstand the economic — and, for the leasing companies, financial — meltdowns.
Of course, share buybacks are on hold, which clearly shows rail management’s long-term thinking.
Washington — friend or foe? The only threat to continued investment in rail — from the Street and thus from the rails into their own networks — is “re-regulation” or any legislation that caps returns. Passage of a re-regulatory bill would reduce capex immediately, and send the “renaissance” in the other direction.
Recently, though, I have detected a warming trend in D.C. Let’s hope it isn’t a false spring but a real thaw as the Obama Administration realizes the benefits to our nation from a stronger, not a curtailed, private rail industry.
Tony Hatch is an independent transportation industry analyst and consultant