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By Jeff Stagl, Managing Editor
Through May, Class Is' traffic had rebounded to the point that carloads were reaching 2008 levels. Slightly increased consumer spending, some inventory restocking by retailers and a tad more industrial production were the primary drivers.
Yet, despite encouraging traffic demand during the year's first half, a few legislative developments continued to be discouraging to Class Is in a business-growth context — namely, the evolution of the Surface Transportation Board Reauthorization Act (S. 2889), which proposes to increase rail competition and strengthen federal oversight of railroads, and the lack of federal funding options to help cover the $10 billion-plus cost of implementing positive train control (PTC).
Class Is also were confronting other steep operating costs, such as fuel and manpower, as June approached.
While high operating expenses, legislative uncertainty and traffic fluctuations drew plenty of Class I CEOs' attention in the first half, the topics figure to remain hot ones for top execs in the second.
To gauge their opinions on where things stand and where things are headed on all three counts, Progressive Railroading posed several questions to all seven CEOs: BNSF Railway Co.'s Matt Rose; Canadian Pacific's Fred Green; CN's Claude Mongeau; CSX Corp.'s Michael Ward; Kansas City Southern's Mike Haverty; Norfolk Southern Corp.'s Wick Moorman; and Union Pacific Railroad's Jim Young. Their emailed responses (in alphabetical order by last name) follow.
Green: The sustainability of our current volumes is uncertain, and 2010 is proving to be a little more volatile than some of the pundits had predicted. We are seeing greater bulk volumes and a return to a more normal split in volumes between our bulk, intermodal and merchandise business. We will continue to respond with agility to the fluctuations in our customers' demands.
Neither we nor our customers have a lot of visibility into the second half of the year. With our continuing focus on financial flexibility, productivity improvements, structural cost, reliable service, and the creation and preservation of growth options, CP is well positioned to manage in this ongoing uncertain economic climate.
Haverty: KCS has not given updated volume and revenue guidance for the full year. We are projecting second-quarter volumes to be up 15 percent or somewhat higher from last year and revenues to be up approximately 30 percent. While we think that we'll continue to see gains in automotive, intermodal, chemicals, agriculture and minerals, as well as healthy revenue gains in coal, we have not put out new guidance for the second half. We are still cautious and surveying the economy and consumer behavior.
Right now, KCS believes that business should continue to strengthen into 2011 unless international economic difficulties exert downward pressure on the North American economy. We are cautiously optimistic, however, that KCS business will continue to grow at a good rate.
Mongeau: CN recently updated its full-year 2010 financial outlook. In percentage terms, CN is aiming for solid double-digit growth in 2010 adjusted diluted earnings per share (EPS) over adjusted diluted EPS of C$3.24 in 2009. This outlook is based on a number of assumptions, including low double-digit growth in carloadings driven by a gradual improvement in the economy. The recovery is still fragile, and any unexpected changes in economic conditions could impact our volumes.
The strength year-to-date in 2010 is in part due to inventory restocking.
We're staying close to our customers to understand the pace of gradual economic recovery. If the economy continues on its recovery trend, increased traffic levels and solid execution should help CN produce strong financial results for its shareholders in 2010 and beyond.
Moorman: We expect our volumes and revenues to grow, driven by manufacturing recovery, specific project growth — such as expansion of our ethanol network as new terminals are added in our territory — tighter capacity and higher fuel and labor costs in the trucking industry, and increased auto and appliance production, which will drive demand for more steel and metallurgical coal. We expect automotive volumes to remain essentially flat, while demand for forest products will depend largely on the recovery of the housing market. We look for an improving pricing environment as demand increases and capacity tightens up.
We remain focused on long-term investments that will have us well positioned to more efficiently serve our customers when the economy turns around. We plan to invest about $1.4 billion, slightly higher than our 2009 capital spending, in our rail network in 2010, including leveraging technology to improve operational efficiency and service, and support the business growth we expect in future years.
Rose: We are beginning to see some recovery from the recession, which has been reflected in a modest increase in volumes. We expect slow and steady improvement. However, we think it will be a couple of years before we are back to the peak levels.
Ward: We expect the economy to recover slowly and gradually over the balance of the year. We've seen improvement across most of our markets, and continue to work closely with our customers to develop new business opportunities. We remain confident that CSX stands out as a compelling value for customers in this recovery, especially as they seek transportation that is both value-priced and environmentally sound.
Young: The first quarter was the first time in two years that we experienced carload growth. Equally important, we leveraged volume growth by running a safe, service-focused and efficient operation. We are utilizing our capital investments, technology and productivity enhancements to move increased carloadings with fewer resources. Strong service levels continue to deliver value to our customers.
While volume increased in the first quarter, we are still a long way from our peak. The good news is we are seeing some staying power with demand. A decline in the economy could stall growth and while I am cautious about the future, our recent carloading numbers have been steady and we feel better about volume growth in a more stable economy.
I think it's a little too early to project the 2011 business climate. When our customers start hiring workers again and when we put more people back to work who are furloughed, that would be an indicator to me that a more sustained economic recovery is under way.
Green: We have entered a period of increased regulatory uncertainty with consequential impacts to our long-term planning and operations. I am encouraged that there are a number of thoughtful policymakers in the Administration and in Congress who understand the importance of the rail industry and are receptive to its concerns.
As an industry, we have been working in good faith with the Senate Commerce Committee and the House Transportation and Infrastructure Committee since January 2009 as they try to develop the most significant piece of railroad economic regulatory legislation since the Staggers Rail Act of 1980. I believe it is essential, not only for the rail industry but also for the economy and the environment, that the legislation be balanced. While it is essential that rail receive the revenues necessary to maintain existing infrastructure and service, it is equally essential that it be able to address the capacity needs of a growing North American economy.
We also share the concern that implementation of PTC be reasonable. The regulations require that PTC be implemented not only on passenger-rail routes but also on those carrying Poisonous Inhalation Hazards/Toxic Inhalation Hazards (PIH/TIH) where the money might be better spent on more effective — and cost-effective — alternatives. In any event, PIH/TIH routings will be changing between now and the implementation date of Dec, 31, 2015. PTC installation on PIH/TIH routes should be based upon traffic at that time.
Haverty: With the rest of the U.S. rail industry, KCS continues to monitor legislative developments, including the STB Reauthorization Act passed out of committee in the Senate. A dialogue on that legislation with Congressional staff continues. We believe this will be productive; however, right now, there is nothing new to report.
Mongeau: CN has been an active participant with our rail industry colleagues and other stakeholders who have been working with the Senate Commerce Committee staff on the committee's legislation covering economic regulation of the railroads and we are continuing to work to improve provisions of the bill. It is important that Congress keep in mind that the railroad industry is highly capital intensive and that the regulatory system must provide the opportunity for railroads to generate sufficient revenues to make needed capital investments to maintain and improve their networks.
The market-based reforms of the Staggers Act of 1980 have enabled the railroad industry to strengthen its financial position and become a more viable competitor. Policymakers may believe that some adjustments are needed to the regulatory system to provide additional safeguards for rail customers, but it is important that such changes do not undermine the market-based system.
Moorman: We are still engaged in defending against the long-running initiative by a small, but well-funded, group of rail shippers who are attempting to alter the economic regulatory regime that governs us so as to lower their rates, and at the same time seriously damage our ability to invest in the future. The industry has been working with the Senate Commerce Committee for well over a year now to try to find common ground. The Commerce Committee has produced a bill that causes grave concern, but they want our support and we are continuing the dialogue with them. At the end of the day, I still believe that a bill that's fundamentally bad for our industry cannot be passed.
Washington has mandated the installation of PTC by the end of 2015. What concerns us about PTC is that the mandate is unfunded, the technology is unproven for heavy mainline operations, the estimated NPV cost of installation of the system is estimated to be $10 billion, and the government itself estimates that every $22 of cost will yield $1 of benefits. It is a legislated mandate, so all we can do is argue for changes in the legislation.
It's not all bad news, however. In Washington, in state capitols, and in broader public opinion as well, is the growing belief that rail transportation, for both freight and passengers, must play a much stronger role in helping to solve our nation's growing transportation problems. This is the reason that U.S. Transportation Secretary Ray LaHood is calling for a complete rethinking of transportation policies and advocating shifting freight traffic off of highways and onto rails. Not only is the Administration advocating this, with broad Congressional support, they are putting money up to get the process started.
Rose: We have an Administration, a Congress and a public that has never had more interest in freight rail, but there are things on the legislative front that are contrary to this. The first concern is regulatory bills around STB reauthorization and antitrust issues. These vary in their impact and we will continue to work with interested parties to shape balanced policy. It is imperative, however, that any regulatory bill that ultimately passes answer the fundamental question of whether freight railroads will earn enough to sustain future service and growth. This is necessary to realize the great efficiency, environmental and congestion-relieving advantages of rail.
We also have a significant concern with the PTC requirement. The PTC cost-benefit analysis amply illustrates that the costs do not have a corresponding safety or operational benefit. The FRA estimates that the cost-to-safety benefit ratio is 22:1. The broader implications of this mandate are that it will either affect service or the cost of service. If the railroads must fully bear the cost of this mandate, it will certainly come at the expense of capacity expansion and, potentially, other maintenance or safety technology investments.
Carbon legislation is another concern. We have been a strong supporter of efforts to ensure that climate change legislation will not harm existing coal-fired plants or the future viability of coal as an energy source. We are already experiencing the impacts of this uncertainty in the lack of new coal plants being sited in the U.S. Maintaining coal-fired generation is an economic imperative for the country.
We strongly support development and funding of carbon capture technologies, and believe any legislation needs reasonable emission-reduction benchmarks and timelines that allow for technology development, commercialization and implementation. This is absolutely necessary if we are to reduce emissions while not harming the overall U.S. economy.
Ward: The industry is in continuing discussions with Senate Commerce staff as they seek to craft legislation that would reshape the railroads' regulatory landscape. Our goal in these discussions is to ensure that the legislation will enable railroads to continue to make the investments needed to sustain and enhance a healthy national rail network. In the last five years, the major U.S. railroads have invested a remarkable $40 billion-plus. Sustaining that level of investment and the associated job creation will not be possible without future earnings growth to support it.
I find it encouraging that economic recovery and job creation are viewed as bipartisan matters. At a time when the U.S. competitive advantage for manufacturers is critically needed, freight rail provides a unique and compelling benefit for U.S. businesses in the global marketplace. As a critical piece of the national supply chain, we are proud of the CSX story. It's an American success story about job creation, environmental innovation and leadership, safety and homeland security, balanced regulation, infrastructure investment and energy independence. That is why it is so important to get this legislation right.
Young: We continue to be engaged regarding the health of our industry and the value we create to the economy. From my meetings and conversations, I can tell you that every member values rail and what it brings in terms of jobs and energy efficiency. The rail industry is among the most capital intensive and most critical to America's infrastructure. Everybody wants to get potential legislation right because getting it wrong could mean less private investment by the railroads.
Green: CP's ability to adapt to fluctuating market demands and our drive to seek out or create new opportunities caused me to see the recent downturn as a time of opportunity. Adjusting our variable expenses to match our revenue declines was critical and I set a series of ambitious targets around cost control, helping the company become a more efficient railroad. We are emerging from the downturn as a stronger, leaner and more effective organization. To continue the positive trend line, CP continues to scale resources to demand with a solid strategy based on five key objectives: managing our balance sheet to ensure financial flexibility; driving productivity improvements to reduce variable costs; reducing structural costs; sustaining price increases through consistent, reliable service; and creating and preserving growth options.
We have driven a series of initiatives on variable and structural costs. We have successfully returned assets back into production at a ratio lower than one-to-one, ultimately resulting in the creation of a culture of sustainable cost management integrated into day-to-day business practice. As the economy improves and the structural cost initiatives take hold, our next step is to move to an increased focus on improved customer service and improved asset utilization.
CP continues to embrace technological change, investing in technology and processes that reduce our structural and variable costs. We are an industry leader in the use of distributed power, we have deployed fuel optimization software and top-of-rail lubrication to great effect, and our recent rollout of train marshalling software has allowed us to operate longer and overlength trains on our transcontinental operations. I expect every CP employee to pursue continuous improvement, to take personal responsibility for seeking out every incremental improvement that will result in a lower cost structure for CP.
Haverty: KCS believes that it can continue the operational improvements it has set into place in both the U.S. and Mexico. We've made significant improvements integrating the operations of KCSR and KCSM. Now, about 25 percent of our total revenues come from cross-border traffic. Having the two systems working well together allows us to enhance revenue on this longer-haul traffic.
Our improved operations are also allowing us to handle traffic at near 2008 levels with considerably fewer locomotives, about 17 percent less rolling stock and approximately 5 percent fewer employees. This is helping our margins and those margins are being further enhanced by the continued revenue growth we're experiencing. We see that combination continuing throughout 2010 and beyond.
Mongeau: CN continues to keep a tight rein on expenses and will preserve and build on the significant productivity gains the company generated during the recession, in terms of operating efficiencies and increased asset utilization.
CN has also made a number of significant investments in recent years — Harrison Yard reconfiguration in Memphis, extended sidings, increased use of distributed power and ongoing investments in information technology — and we expect to reap the productivity benefits of these expenditures in the years ahead. With these initiatives, CN expects to maintain its industry-leading operating ratio.
Moorman: We are aggressively looking at all of the places that we can do things with technology, including remote control. We are focused on crew size across the railroad, and we are in the middle of rolling out our LEADER technology across the Northern Region. And as the year goes on, we expect to see further fuel savings as a result.
Rose: We have been able to trim costs during this difficult time and continue to see opportunities for additional productivity enhancements moving forward.
With volumes picking up, we are pleased that we have been able to bring back the majority of the people who have been furloughed. A high percentage of those who have been called have been able to return to BNSF.
Ward: We will drive increased productivity, control costs and manage resource levels closely as volumes grow. In addition, we will continue to build on our momentum in safety, and maintain our leadership position as one of America's safest industries. Our employees are committed to safety and delivering a strong service product.
Young: We are committed to continuing to run a safe and efficient railroad. Strong volume leverage, continued operating efficiency and core pricing gains contributed to our record operating ratio in the first quarter and we will continue our focus on those areas.