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10/8/2008



Rail News: Rail Industry Trends

RailTrends 2008 Recap: In these most uncertain times, the 'Rail Renaissance' endures


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By Tony Hatch, abh consulting

A good crowd of hardy souls involved across the spectrum of rail operations and finance gathered in New York City Sept. 30-Oct. 1 for RailTrends 2008 and heard some rather scary things from bankers and government (no surprise). But they also heard encouraging words from participants representing a variety of rail and infrastructure development positions — from large rails to small, from ports to power plants, from rail equipment owners to users. All in all, RT08 provided more confirmation that, even in tough times, the rail secular story stands out.

Finance "Apocalypse Now"? RT08 kicked off with officials from Platinum Sponsor and abh consulting partner Miller Tabak + Co. L.L.C., who analyzed the explosion of derivative investment in the rail group, above and beyond the swaps that gained notoriety in the CSX-TCI case. They (Miller Tabak Co-CEO Jeffrey Tabak and Strategic Stock Surveillance EVP Erin O'Reilly) also noted that mutual funds represented three quarters of rail equity ownership in 2003, with hedge funds at about 10 percent — now, hedge fund ownership is at 28 percent and traditional funds down to 59 percent!

The annual analyst presentation brought more diversity of opinion than usual, with UBS' Rick Paterson doubting the longevity of the pricing story that both Tom Wadewitz of J.P Morgan Chase and I espoused ... and (yet) Rick believes the Union Pacific "turnaround" story has more "legs" than Tom does. The "Impact of the Credit Crisis on the Rail Industry" panel was scary — essentially, the credit markets are frozen, even for investment grade companies, although rail credits have outperformed the market and other industrials as much as their equity has (had).

The Rail Equipment Finance panel was a bit more reassuring — after all, the asset values of rolling stock and locomotives provide excellent collateral. It is worth noting that fully a quarter of the rail private-car fleet is or was just recently for sale, (however, as I've started in the past, it's been more often than not due to the parent companies' financial conditions brought on by non-rail lending). In addition, current lease rates are out of historic kilter with asset values, and rail velocity improvements will begin to have real impact on fleet sizes, which is actually good news.

Also, we heard from a few speakers on rail cars — notably the Railway Supply Institute's Tom Simpson, leasing company execs and RT standby Toby Kolstad — that next year looks bleak for the rail car OEMs. For '09, Toby projects 42,000 deliveries (compared with about 50,000 this year and down from the recent peak in '06 of 75,000), and it's already looking 10 percent to 20 percent too optimistic.

Trading Places — Funding (debt, infrastructure improvements, etc.) was the recurring theme. Would the private sector recover? Would the government(s) have any money to spend? We heard two excellent presentations on public-private partnerships (PPPs) as a funding source, from the successful to date (Norfolk Southern's Heartland and Crescent corridors, with NS EVP Jim Hixon offering details) to the not-yet (CREATE, an update for which was provided by CSX Transportation AVP Mark Hinsdale). But will the government come up with funding even for PPPs that are incredibly cost-efficient?

Government — "Who's in charge here?"
We also heard from two members of Congress, both from Florida — U.S. Rep. John Mica (the minority leader on the House T&I Committee) and U.S. Rep. Corinne Brown (the head of the T&I Rail Subcommittee). The Floridians split their votes along party lines on the first "bailout" plan and disagreed on similar lines about Amtrak, but they both agree quite passionately that freight rail is a present and future solution to infrastructure needs. Mica extolled the need for an Eisenhower-type plan, with high-speed rail and potentially a $1.5 trillion transportation budget, perhaps $500 billion to come from the reauthorization of SAFTEA-LU next year. As Mica predicted, Congress on Oct. 1 passed the Safety Bill, which would add to hours-of-service (and thus some costs), though in a much less Draconian way than the original House version, and mandate positive train control (PTC) by 2015 (funded by a mere $250 million, or far less than 10 percent of the cost). The PTC provision, on the heels of the California tragedy, includes passenger and most freight mainline, but the details will be key (interoperability and cost allocation being the major ones).

Associations plan for calm after the wind. Both Cliff Mackey of the Railway Association of Canada (RAC) and Ed Hamberger of the Association of American Railroads (AAR) gave solid and forceful presentations on the continued need for vigilance on "re-reg," especially as "deregulation" becomes a bad word in D.C. The RAC (backed by CN) is trying to actually bring deregulation to the last holdout in Canada, the export grain transportation business (which as presented ought to be a great cautionary tales for Rep. Oberstar about getting what you wish for). The AAR is looking for the Surface Transportation Board to announce on Oct. 25 whether it'll open a proceeding on replacement costs, looking at toxic inhalation (TIH) risk-capping, and also getting all the unions back as allies in the 2009 "re-reg," investment tax credit and SAFETEA-LU battles.

Railways — organizing for the future. BNSF Railway Group VP Kevin Kaufman and CN SVP Marketing J.J. Ruest gave great presentations on ag, which will remain a bright spot even as cyclical traffic looks even less certain. The export grain story continues to appear solid into the immediate and intermediate future despite the "noise" presented by the financial crisis and the Baltic Freight Index (really driven by coal and coke). We heard about the other major bulk from the American Coal Council's Jason Hayes, who stated that despite the enormous overhang of regulatory/legislative uncertainty, coal ought to continue to grow at about a 1 percent (compound annual growth rate) domestically supplemented by exports. John Giles, president and CEO of Fortress' RailAmerica highlighted their progress, bringing the group operating ratio to 80 percent by fixing, not selling. Interestingly, Giles stated that RailAmerica would remain on the sidelines on the acquisition front (unlike Genesee & Wyoming) — for now.

Intermodal will lead the rails out of the darkness. I have oft-stated my belief that international exports will recover whenever the economy does, and that true domestic will be the growth leader in the next economic cycle. RT08 featured three presentations that support my thesis. Rodolfo Sabonge, VP of Market Research and Analysis for the Panama Canal, gave a great overview of the big ($5.25 billion) expansion plan under way, which will allow for container ships of up to 12.6 thousands TEUs (triple today's 4,000) to traverse the canal by 2014. Although a positive for the intermodal industry, it only adds to the Great Debate between the anticipated growth of West Coast and All-Water import movements.

Will U.S. ports be ready for the bigger ships given the government funding issues? UP VP of Intermodal John Kaiser, who delivered one of RT08's Day One keynotes, clearly believes in the future of the West Coast. UP expects to benefit form massive capital projects that enable the Class I to take advantage of what it believes are route structures either superior to (the Sunset) or equal to (L.A.-Chicago, Seattle-Chicago) western rival BNSF's. But has BNSF created a "brand" in those markets? Kaiser didn't comment on Pacer and the big contract expiration, of course ... but he did highlight the growth and opportunity of UP's new Streamline product, which is clearly a response (or shot off the bow) to 2011. He also noted that for UP, intermodal represents a big portion of legacy contract opportunity, and that UP (and BNSF) also had only 30 percent of western intermodal — meaning that they, too, could participate in the coming domestic opportunity.

Finally, Kansas City Southern SVP Intermodal & Automotive Brian Bowers discussed the Mexican market and KCS' value proposition in cross-border intermodal, where Laredo issues and difficult-but-manageable operating problems (drayage, ease of doing business, lack of commitment), coupled with terrific opportunities (low current share, 10 percent to 25 percent potential shipper savings, big truckload and parcel trucker partner potentials) make KCS' effort look very promising.

Shippers raise the red lantern. Rail shippers in the audience and on stage noted that not all was well, and not just on Wall Street. Certainly, the liquidity impact on the consumer is the biggest overall fear. But service challenges remain. Leslie Moll of ArcelorMittall USA (the largest steelmaker in the country) gave a most enlightening presentation, noting that the steelmaker would love to use more rail but complexities and their own lack of institutional knowledge made rail share gains difficult, if not currently impossible. In fact, Moll noted that ArcelorMittall planned an enormous plant expansion in Indiana, but due to what they perceived as NS' intransigence on pricing (etc.), the company did not even include a rail spur! But with 2,500 truckloads a day and the desire to save costs, this, to me, is both a sign of rails' past and the symbol of opportunity in the future. We also heard from and met Bruce Carlton, the new leader of the National Industrial Transportation League, who comes off as an intelligent observer seeking to get up to speed on rail issues.

RT08 sought to provide discussion on a diverse mix of rail-related issues, and in the end, delivered. We didn't know how "lucky" (?) we would be in the timing of some of our financial discussion, but we remain convinced that this, too, shall pass. Meanwhile, bruised and battered but very much alive, the "Railroad Renaissance" endures.

 

RailTrends Program Consultant Tony Hatch of abh consulting is an independent transportation industry analyst/consultant.



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