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December 2018



Rail News: Rail Industry Trends

That's a Wrap: RailTrends 2018 recap by Tony Hatch



Tony Hatch is an independent transportation analyst and consultant, and a program consultant for Progressive Railroading’s RailTrends® conference.

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RailTrends® 2018 was jam-packed, exciting and filled with talk about railroad's near- and longer-term plans — from precision scheduled railroading (PSR) implementation to an evolving regulatory climate to technology adoption to new marketing frontiers. But sometimes it's wise  for those of us living in these exciting times to pause to consider the often cyclical nature of change. What’s new can be, and often is, old. Or reconstructed. 

Consider this 1960 (!) article from the Harvard Business Review:

“The railroads did not stop growing because the need for passenger and freight transportation declined. That grew. The railroads are in trouble today not because that need was filled by others (cars, trucks, airplanes, and even telephones) but because it was not filled by the railroads themselves. They let others take customers away from them because they assumed themselves to be in the railroad business rather than in the transportation business. The reason they defined their industry incorrectly was that they were railroad oriented instead of transportation oriented; they were product oriented instead of customer oriented...” — Theodore Levitt

But also consider these sentiments that we heard repeatedly at RailTrends 2018, which was held Nov. 29-30 at the New York Marriott Marquis:

“I have never been so excited to be in the railroad industry and to be at [my] railroad.” — a paraphrase of three rail leaders who spoke at the conference

“PSR is foundational.” — Eric Jakubowski, vice president and chief commercial officer of Anacostia Rail Holdings, which owns six U.S. short lines, and ex-PSR strategy vet at CN, echoing many related comments

There were many, many comments I wish I could share and discuss here. What follows are my five top takeaways from RT18. 

1. I believe in the commitment of the newcomers to PSR — particularly Union Pacific Railroad, whose CEO Lance Fritz gave a detailed speech and stated UP was accelerating its change process.

2. PHR (post-PSR) — CN, CP and CSX, so far — is the future, and the future looks bright. (That's PHR as in the Post Hunter Railroad.) 

3. Kansas City Southern may have jumped to the top of the leader board in terms of technology and innovation, and officials promised that their railway will be fully automated in six to 10 years!

4. Short Lines may be entering a New Golden Age in terms of organic growth fueled by technology, better Class I cooperation and merchandise focus — and through the creation of new short lines (see CSX).

5. Risks and challenges surely do remain — huge investments in technology by (and into) competing modes, tighter service requirements, the need for greater network cooperation, etc. But the means and, increasingly, the mindset to change exist, as well.

RailTrends rolls and flows with the times; it reflects not just what's happening in the present, but what's coming in the industry. As such, these two themes — PSR and technology, dominated the discussion. Every Class I was represented by top leadership, save one (BNSF, sorely missed), as were the vast majority of short-line holding companies. The audience also was high-powered as per (and even more than) usual — railroads, shippers, investors, suppliers, consultants, labor, foreign entities, etc. The discussion was active– of execution, of competition, of failure to innovate — were also in evidence, as were the related challenges of imposing change on such an “ancient” industry. The key themes:

• risks/challenges: Execution/technological/regulatory;

• technological response;

• PSR 2.0 (existing practitioners);

• PSR Next-Gen (newcomers, and the level of PSR adoption — and commitment); and

• how a rail world increasingly PSR-impacted will look, and the implications for shippers, short lines, consolidation, etc.).

Risks & challenges

The rails are having another terrific year from a financial perspective, but as we have covered almost ad nauseam. Service was still subpar, leading to missed opportunities and a suboptimal situation with shippers and their representatives. Will rails right the ship in time to handle the still strong demand and capture (or recapture) market share? Can they fend off the rising tide of investment into technologies that will narrow the gap in two of their three competitive advantages versus the highway (labor and fuel efficiency)? Will they continue to develop their network to take advantage of their third, and most enduring competitive advantage, their control over their own network? 

I'll examine four presentations that touched on the "challenge" theme — Oliver Wyman's Rod Case on technology ("New Competitive Realities: Growth at Lower Costs"), our short-line panel ("Short Lines' Competitive Advantage"), and representing the government impact, our annual "State of the Industry" (i.e., the D.C. & Ottawa) Panel” and a presentation from Surface Transportation Board Chair Ann Begeman.

• Ever since Rod Case began his fact-filled crusade to get railroads to regain their tech mojo, the head of the rail practice at industry thought leader and RT18 sponsor Oliver Wyman has noticed a real change in leadership attitude, a new level of acceptance AND a renewed view of carload manifest business as an opportunity. But Case ("Dr. Doom") still called on railroads to improve efficiency (not just cost, not just OR takeout) and resiliency. Part of that is a changed leadership thought process — Case noted that most railroads value train delay hours at ~$200 (thinking locally and operationally), with one putting a $1,500 price tag on that delay (capacity/ missed revenue opportunity). Case encouraged the industry to try new services or technologies, even if many flame out or fail. And he did live up to his nickname: He said that if railroads don't change, with the changes coming someday in trucking (if not fully AV soon, certainly platooning), they still can grow — but they will lose between 16 percent and 22 percent market share to the faster-growing trucks by 2045. Ouch. So, Case —  and we — might say, time is of the essence. 

• Representatives on our Day 2 short-line panel (and Anacostia Rail Holdings President and CEO Peter Gilbertson, who represented the American Short Line and Regional Railroad Association on our Day 1 kick-off D.C. panel) noted the gaps, narrowing but still extant, between rail rhetoric and real cooperation in what is a network business. Two issues stand out to me:

(1) The belief that data capture, looking even brighter post-PTC installation, is seen by too many as proprietary.  Data must be shared to grow overall market share and customer appreciation.

(2) While PSR is concerned with the first mile and pre-blocking (and thereby pushing work and costs onto shippers or short-line/switching partners, it is the last mile that remains, as one RT18 speaker noted, “the black hole of PSR." And, in a warning of sorts to the Street, speakers on the short-line panel — as bright a bunch as we have put under our bright lights, decried the OR-driven, but futile, attempt to precisely match capacity with demand while therefore sacrificing resiliency ... with all that implies for shipper share, regulator interest, etc.). In addition to the aforementioned Mr. Jakubowski, the short-line panel comprised: Justin Broyles, vice president of commercial development at R. J. Corman; Michael Bostwick EVP and chief commercial officer at PanAm Railways; Stefan Loeb, EVP & CCO at Watco Companies LLC; and Michael Miller CCO for North America at Genesee & Wyoming Inc.

• STB Chair Begeman's presentation was particularly interesting. Historically at RT, and elsewhere, government officials often are circumspect with their words, knowing their various constituencies (and the trade and business press) are there to interpret their speeches. She did not follow the historic pattern, providing a true breath of fresh air to the event —  and also a warning or two to the rails and their investors. Although Begeman was a GOP appointee and a vocal supporter of a deregulated rail industry, a more active STB looks to be in the offing. Noting that we cannot see a repeat of the CSX experience of 2017, she's already demanded regular info and data from NS and UP (the two railroads implementing some form of PSR at present). She's also chided them, in effect, for using demurrage, etc., to change customer behavior, which is a regular PSR tool. Unlike some in the financial community, Begeman applauded UP’s “measured approach,” and discounted my question of whether a fast and painful, but more quickly concluded (the so-called “rip off the band-aid”) approach to PSR yielded gains for the shipper (“CSX gains in the metrics were against ... 2017!”). 

Two other statements she made caught investors' attention. She talked about her concern over reduced railway capex 2016-2018 (I share that concern, as I've noted in the past with my “Grand Bargain” comments, but I do worry when the government does). She also said she thought the new Congress (not the STB) was interested in preventing future CEO/activist “raids” like Hunter at CSX. That statement made several investors take notice — as if the shareholders (aka owners) are not entitled to choose their managements!). Chair Begeman is one of two (soon to be only one?) STB commissioners, well short of the full complement of five, so we have seen delays in big rulings, but an increase in weekly pro-activeness.

To the extent that the major strategic advantage for rails lies in their self-funded network, any cooperation in the next Congress with Trump on his top 2017 priority — infrastructure, as noted by the D.C. panel, is one of the few areas of possible agreement across party lines, but on which action I think is improbable. It would involve a lot of rail moves of steel and cement, which would only serve to help mitigate the deterioration of the highway system.

Speaking of politics: On Day 2 of RT 18, the three North American countries signed NAFTA 2.0. There is obviously a lot of work to be done to try to get back to a fully investable environment and to promote free trade  — to that end, I applaud the rail industry (especially Kansas City Southern and UP) for their public efforts in this regard.

In other (potentially) regulatory-related topics: Consolidation dreams are always a risk, but UP’s Fritz adamant argument for the "NO" position — that the need for “enhanced competition” — means that the risks of the approval process trumps any benefits that might accrue. Given the mighty UP’s position, that ought to put the kibosh on this idea for a while.

This isn’t the best spot for this, but: Countering those in government (we’ll exempt Chair Begeman for the time being) and others from interfering in private enterprise has been the Association of American Railroads. And the valedictory speech by outgoing AAR CEO — and the 2018 Progressive Railroading and RailTrends Railroad Innovator Award winner — Ed ("the railroad guy in D.C.”) Hamberger gave a terrific valedictory address. The presence of his successor Ian Jefferies (as well as new railway Association of Canada CEO Marc Brazeau) was reassuring. There's continuity of passion and purpose for those who “walk on that wall” for the railroad industry.  

Responses and a roadmap

Oliver Wyman's Case set the stage and KCS Chief Innovation Officer and ex-CMO Brian Hancock offered a roadmap to a brighter future — for his railroad and for the industry. 

Hancock talked about the railroads being a “knowing” culture — the downside of a strong, 150-year-old culture is the notion that folks already “know” what to do. The industry must move to becoming a “learning” culture, Hancock said, joining the short-line panel contingent in declaring that “data must be democratized.” KCS will focus on using innovation and IT on infrastructure; on the use of technology itself (KCS is a rail pioneer with respect to blockchain, which has been adapted to international transactions and will look to bring some form of next-gen PTC to Mexico to help serve as the backbone of the digital railroad. KCS also will focus on using technology to boost process and operational excellence, as well as to drive cost savings and efficiencies (not unrelated, IMHO). Three of Hancock's pronouncements stood out:

1. In “six to 10 years,” all KCS rail operations will be autonomous. (Whoa!)

2. KCS will reinstate earnings guidance.

3. KCS officials think that about 65 percent of PSR principles apply to its railway — noting that KCS's high interline percentage both makes PSR inevitable but also impacts its full application. Furthermore, KCS de Mexico impacts this, as well.  They will (and in fact have already started) applying PSR, in effect, to try to eliminate variability (and thus waste). They'll use blended service, optimized train length (given their network constraints), trip plan compliance, rationalized fleet and total cost rationalization “techniques.”

It’s everywhere! Every railroad presenter at RT18 mentioned technology, in some form — as Case noted, the mindset has changed in just a few short years. The mentions ranged from shipment "visibility" projects short lines are undertaking to CN's boxcar-based track inspection (used in revenue service rather than capacity-sucking special cars — there are eight on order for 2019) and automated train inspection portals (at speed — up to 60 mph — and without the manpower and time of an optical inspection) to CP's "bots" and predictive analysis work.

PSR 2.0: The Old Guard looks to the future

At RT18, we heard from the CFOs at both the first and second PSR railroads — CN and CP, respectively. CN CEO JJ Ruest was scheduled to speak, but illness prevented him from joining us. Fortunately, CFO Ghislain Houle filled in most admirably, the best pinch hitter from Montreal since Rusty “Le Grande Orange” Staub. 

Interestingly, these three presenters (CSX CEO Jim Foote, Houle and CP CFO Nadeem Velani), as well as short-line presenter Jakubowski, are all graduates of the PSR revolution under Harrison at CN. This level of industry leadership from one source, the CN mothership, explains at least somewhat the burning desire of the investment community to have the others hire someone with similar experience. CN & CP share a nationality of origin, of course, as well as being the most tenured in the PSR/PHR space. They also differ from the newest member of the club in relating a PSR-to-PHR timeline, from an inward focus on operations and culture change to a “pivot to growth” as articulated by both CFOs. The quote is from Velani; CN refers to “feeding the beast."

When I asked Foote about where his railroad was on the PSR timeline, he adamantly stated the question didn’t apply to his railroad and said CSX is looking to grow. I suspect this is semantics — CSX had an accelerated PSR revolution and, so, reached the PHR stage very quickly compared with CN's experience. This echoes conversations between officials from CSX and CP a year ago at RT17. Given CSX's parallel track restructuring — the railroad isn't yet done with intermodal and did, in fact, start growing business again in the second half of last year. So, in retrospect, I suspect CSX's Michael Rutherford was correct at RT17. But CP’s timeline chart is easy to follow. For what its worth, I place them on PSR/PHR timeline — and in any event, the railroads now are all on the same path.

So, reverting to chronological order, both of presentation and of PSR experience:

• CN expects to become boring next year. After a year of demand overwhelming growth (a lesson apparently learned, again about resiliency and the folly of precision, in demand planning, anyway), CN hopes to go back to being “boring and predictable” in 2019, Houle said. Their efforts and expense to restore operational order appear to be paying off (though Mr. Houle wanted to be clear — this isn’t a “turnaround: because a turnaround wasn’t necessary). The railroad's long-term goals are a mid-50s OR (essentially its run rate) with growth (export coal and grain, intermodal, etc.) driving a 10 percent-plus EPS CAGR. This level of service isn’t cheap — CN is spending about 25 percent of revenues on capex in 2018-19 — and will return to its “historical range of 18 to 20 percent” (bless!). But it comes with a great payout (15 percent to 16 percent ROIC). This is the epitome of PHR.

• CP “rebuilt their engine” (PSR) before the inflection/growth pivot. CFO Velani reiterated themes we heard at the railroad's October Investor Conference in Calgary — growth would be “thoughtful, disciplined and sustainable” (perhaps, just perhaps, in response to CN’s rocky year, but important nonetheless). Another differentiator for CP with respect to its PSR and Canadian “big brother” is the amount of banked land (under the category “room to grow”) versus CN’s capacity struggles in 2018 and in Toronto specifically — that and the Canadian grain jump-ball business now that both are investing into new rolling stock, etc. It'll be fascinating to watch this play out.  On ag, the first round might be going to CP, as the regulators are allowing an almost 6 percent increase in grain rates this crop year — more than double allowed (yes, allowed) to CN. Back to CP: PSR was not about slashing costs (the “biggest myth”), but about culture, Velani said. Now that the revolution is over (the engine rebuilt), a culture of “constructive (but respectful) tension” should persist. The revenue planners now report to Velani to maintain disciplined growth, although there are some who criticize the rail industry (if not CP directly) of being too beholden to the CFO. And to investors.

• CSX’s Foote gave us a barn burning victory speech. CSX is growing again, and doing so with less: with 9 fewer yards, some 22,000 fewer rail cars and 1,100 locomotives. Velocity and dwell are both approaching 20 percent improvement levels, although that's against the revolutionary year of 2017, as STB Chair Begeman pointed out. But still. And CSX reached the industry leadership position in safety as measured by personal injury ratio. No apologies necessary.

New (and not new) to the PSR game

While CP’s Velani declared himself “no fan of a “measured approach” to PSR, KCS's Hancock gave the first and best argument for taking elements (but not necessarily all) of PSR, as it's been applied to date. STB's Begeman provided ample warning on why total disruption would have political consequences. And UP's Fritz gave the closer’s argument: They are in it to win it (i.e., UP isn't taking a “PSR lite” approach). NS Chief Marketing Officer Alan Shaw shared a similar strategic policy defense.

The short lines are ready. As noted, we heard a bit about the industry's retail future during the short-line panel discussion. In many ways, short lines already practice PSR; in other ways, they still have work to do to adapt to their much-bigger partners' operating plans. Short lines serve as the first-mile, “pre-blockers” for much of the merchandise business — and as the “shock absorbers” for the overall network (Genesee & Wyoming). The last mile is still the “last frontier” (Anacostia Rail), but small railroads can help reinstate the boutique, customized businesses (Watco) that are being compressed into the mainstream by the Class Is (see UP below). They do see the changes in Class I focus: Short lines have defined the rules better (Watco) and they move faster (Pan Am executed a new service deal from “soup to nuts” with CSX in only 30 days). They see opportunities in new line segments (Watco’s Decatur Line, formerly CSX's, is proving to be a big winner from the gate) and in switching opportunities (R. J. Corman). They do admit to some angst in watching these transformations, and they worry about the Class I OR focus, which manifests itself in trying to balance expensive, long-lasting capacity with greatly imperfect demand planning (it leaves out resiliency and surge capacity. There is no perfect equilibrium; balance is hard to achieve and impossible to maintain. I worry about that, too.

Union Pacific is committed. Lance Fritz was more than convincing about that. Sure, there was the chaotic, off-screen start after the May 1 Analyst Day (which never incorporated “PSR” in what then were the railroad's long-term plans). “Old UP” (that is, spring 2018) had a plan that got unwieldy, running, as Fritz said, a lot of train-based “boutique” businesses and lanes (coal, rock, intermodal) designed to maximize efforts for those commodities and shippers — but often at the expense of the network by adding complexity and unshared capacity. So: It was back to the drawing board, and the focus on car trip-plan compliance focus (something UP had introduced years before, in fact). The railroad will review those plans as often as two to three times a year. And UP is enlisting PSR vets to help guard against unintended consequences (the killer of the boutique business). Is UP committed? Sure, the railroad still has hump yards — UP is building one still (Brazos, 2020) — but even Hunter didn’t hate hump yards if they had the volume to justify their existence. UP does, although I would suspect that some smaller yards or terminals might go at some point. UP's first PSR segment, the Mid-American Corridor (MAC), is no small step. It's bigger than all of CSX, or CP plus CN. Is it working? It sure seems so — metrics are already improving, the STB says “so far so good.” Shippers at RT18 were supportive, if wary. Meanwhile, UP has taken 750 (older) locomotives out over the last three months. And most important, the success so far at the MAC has encouraged the railroad to accelerate the second region to be transformed (L.A .to Chicago) — work began last month, two months ahead of schedule.

NS's Shaw also knows that, in some ways, what’s old is new again, though now powered by a new sense of urgency and technology. In his presentation, Shaw talked about the need for “customer focus” — in 1988! The point: The core principles at NS were important then and just as important now. But you "need to anticipate where the markets are going," Shaw said. NS continues to see great demand, and it continues to benefit from earlier development of its intermodal “corridor” system (including a new one for me, the ex-CRR “Premier Corridor, Chicago-to-New Jersey). The railroad's strategic plan was delivering, financially —but not on service reliability and consistency, which was costing NS on the merchandise side. Strategists at the railroad needed to “re-imagine the NS network,” Shaw said, noting NS had begun a process of “clean sheeting” (re-thinking old problems in new ways) at the beginning of the year. Unlike UP’s regional approach, NS is starting with yards and local services (“Working backwards from the customers, Shaw said). Can that work? Is one way better?  Are all “tenets” of PSR applicable to NS? Can the creators of the old Flexible & Balanced Plan be the re-imagineers? We'll find out.

Game time! For railroads, it's Game On — from an operating plan foundation to a technology development/rollout to a creating a true customer centric North American network. Or, as the good Dr. Doom implied, it’s Game Over. Place your bets! I know where I'm placing my chips.

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.

 



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