Announcements

Freight Rail Update


Greetings from back in the good ol’ USA (but congrats to the Raptors – We the North!)
We have bunches of good news, some less so, and some neither good nor bad, like the attached cartoon on rail foamers and the CN, in light of my noting that the fact that they took us to immense “Mac” Yard – but not up in to the tower to see the majesty of it all (and thereby, I wrote, missing the chance to create a new generation of railfans). The cartoon is from “Model Railroader” magazine (hey – I need to know how to speak their language!). at the bottom is a graphic/interview piece on current truck drivers attitudes from the Times.

Good News: Kansas City Southern CEO Pat Ottensmeyer will the 2019 “Railroad Innovator of the Year”, given at RailTrends (www.railtrends.com ) – and no one deserves it more. What a series of challenges Pat and KCS have had to negotiate – and they are not done yet (see below).
Bad news: Matt Bell and the NRC (Rail Construction & outsourcing) have parted ways – that’s a loss for the industry.

More bad news - Volumes aren’t recovering so the encouraging “reaffirmations” of 2019 volume/earnings outlook, so prevalent in the Q1/19 calls, will likely not be the theme for Q2/19 next month! Now, I don’t care about that, per se, but as we slowly pass the winter wet weather impacts, and try to decipher the tweet effects, it does lead us to ask: What’s going on? Yes, comparisons are tough but, still….
• The May RTI (AAR) noted that the 3% decline in US/Canadian total traffic represented the 4th straight month of decline; only 6/20 commodities increased (CBR, chemicals) in the US (8/20 in Canada). In fact, Canada was the saving grace – US carloads dropped 2% and intermodal almost 6%; whereas Canadian carloads were up 2.5% and intermodal eked out a slight (+0.4%) gain. Canadian coal was actually up 5% (vs US -0.4%) and motor vehicles +8% (-3%). Must be the clean living….we the north!
• More recent traffic is even more worrisome: the AAR reports that for the week ended 6/8/19 North American volume (Mexico gets to play in the AAR weekly but not monthly numbers) was down more than the YTD levels – carloads and intermodal both down 6%; once again only Canada showed positive results (+2%/1%).

Future bad news – “Weaponized Trade, trade wars and lasting impacts; or, the never dull growth opportunity for KCS (etc): Wow, that whole Mexico trade war over immigration was a whirlwind! Two thoughts on the POTUS decision and reversal, leaving out the “secret deal in the envelope” – the reprieve is only for 45 days or so (to demonstrate progress in an intractable problem), and what does this cyclone of uncertainty do to capital investment (by rail customers, etc)? And is that the very idea? How long can AMLO (FT: “Mexico’s Magical Thinker”) be patient in the face not only of threats but of (seemingly) arbitrary threats? Mexican public approval of the US has plummeted from 2/3 favorable only 2 short years ago 30 32% currently. What will this mean for the passage of the (ugh) USMCA as we enter the election cycle here? Laredo is the key – for rail & truck (truck shipments were up 6% at that border crossing last year). Some more thoughts:
• The tariffs would have (may be?) very harmful to the auto industry; the response to the US Ag industry. Ugh. And consensus was a reduction in US GDP by ~0.7 points…. The proposed tariff would have violated NAFTA (both 1.0 and 2.0!) – what are the implications of that?
• Mexico had thought to be a winner in the other trade war, the one with China (ignoring the emerging front in India for now). But a recent US Chamber study of US business in China found that, while 40% are considering (some form of) relocation, only 10.6% are considering Mexico (although its almost 2X the USA, supposed intent of all of this; 25% are looking to other Asian locations)
• Mexican sovereign (and Pemex) debt has been downgraded by Fitch and Moody’s….
• But US imports from Mexico were still up 5% (Q1/19)….
• Meanwhile US imports from China are down 5% over the first five months, and that may be the tip of the iceberg; “Sea-Intelligence” is anticipating a 10-15% reduction in total US imported TEUs in the coming “peak season” due to reductions from China (that seems aggressive but, still….).

You always take the weather with you, or theirs is something happening here: the news has been full of weather issue with relevance to rail. Here are five:
1. The USDA reduced the grain outlook due to the wet (and “expected bigger rainfall conditions”) fields
2. Barge shipping has been jammed up by the Illinois, Arkansas and portions of the Mississippi River closures, due to too much water
3. On the other hand, the Panama Canal is still suffering form too little, which looks to be chronic
4. On the Bright side, the Northern Sea Route, which cuts distances by up to a fifth, now

THOUGHTS FROM THE NEARS CONFERENCE


THE COWEN INSIGHT

While shippers remain concerned about PSR implementation, early results for "The Next Three" (recent PSR implementers NSC, UNP, KSU) are far better than the recency bias created by CSX's early PSR struggles. Shippers remain in a "show me" mode while rails look for increased business after service improves.

NSC Chief Marketing Officer Alan Shaw

Alan Shaw, EVP and Chief Marketing Officer of Norfolk Southern, was the keynote speaker for day two and highlighted how his railroad is focused on changing the culture and the way the railroad operates. They are taking a more measured and balanced approach to PSR with a long-term focus on growth and productivity (with equal importance given to both goals). NSC is re-engineering its interface with its customers in a collaborative way. The railroad is clean-sheeting their terminals first and once they are done with terminals they will turn their focus to road operations. Additionally, NSC is converting its DC locomotives to AC locomotives, which should increase the power of the fleet and allow the railroad to operate with fewer locomotives. Early results appear favorable.


The Shippers' Perspective On PSR


Two shippers (Kevin Acker of The Chemours Company and Ross Corthell of the Packaging Corp. of America) spoke about their current experience with PSR implementation. While investors may look back to the last implementation by CSX and the bad taste it left in many shippers' mouths, these two shippers noted that this is not the case thus far with The Next Three. One of the shippers stated that UNP's results were mixed but believes that some of the early issues could have been weather related. Another commented that NSC had done a good job thus far and that their service (as measured by specific origin/destination pairs) had improved 15%. If this is sustainable, the shipper added that they would need far fewer rail cars.


Gil Lamphere On The History Of PSR


Long time rail executive Gil Lamphere brought the audience down the PSR memory lane as he recalled the first conversations with the operating system's creator Ed Moyers (Hunter Harrison perfected PSR but did not invent it). Mr. Lamphere had pretty high praise for the operating model but noted that operating ratio improvement was just a byproduct and not a goal of the original PSR. He stressed that people and assets that are not in motion are considered redundant in the PSR model. He reflected on the very rapid pace at which Hunter was able to implement PSR at CSX and noted he broke alot of eggs. He spoke highly of the current efforts of KSU, NSC and UNP and applauded their measured approach.


Cowen NEARS Survey


Once again, Cowen sponsored a survey among NEARS conference attendees. When asked whether they are more confident in the direction of the economy today than they were three months ago, 37% of shipper attendees answered that they are more confident, while 63% answered that they aren't. We contrast this with our 1Q19 Rail Shipper Survey, which showed that 48% of shippers are more confident than they were three months ago, but note that the NEARS survey consists of a smaller, geographic-specific (North East) subset of shippers, compared with a broader shipper base for our 1Q19 Rail Shipper Survey.
Second, we inquired about shippers' experiences with "The Next Three" Class I's, the three recent adopters of PSR, NSC, UNP, and KSU, as each rail undergoes a transformation. 45% of survey participants said that they were contacted by the Next Three about their PSR plans and implementation process; 43% said that they have had negative service impacts from the early PSR implementation; and 57% expect negative service impacts in the future.
Lastly, we surveyed NEARS attendees on the railcar market. 28% answered that their need for railcars has increased over the last three months, 6% answered that it decreased, and 67% answered that it remained the same. Asked whether they are concerned about the availability of railcars, 15% are "Very Concerned", 47% are "Somewhat Concerned", and 38% are "Not Concerned".

Jason H. Seidl
646 562 1404
jason.seidl@cowen.com

Matt Elkott
646 562 1409
matthew.elkott@cowen.com

Adam Kramer
646 562 1375
adam.kramer@cowen.com

Former Harrison colleague: 'Hunter's the daddy of precision railroading


TRAINS

By Bill Stephens | April 9, 2019

Some of E. Hunter Harrison’s former colleagues are expressing surprise that a railroad financier credits former Illinois Central CEO Ed Moyers with developing the concepts behind Precision Scheduled Railroading.

Last week Gil Lamphere, a former board member at IC, Canadian National, and CSX Transportation, told a shipper conference that credit for creating Precision Scheduled Railroading should go to Moyers.

Lamphere financed the founding of MidSouth, the regional created in 1986 from former IC lines, and three years later led the acquisition of the IC itself. Moyers found success with his operating plan at MidSouth, then brought it to the IC before Harrison was hired to lead operations, Lamphere says.

But several of Harrison’s former colleagues disagree.

While Harrison and Moyers shared similar views, they say Harrison was the driving force behind the scheduled railroading principles that turned a struggling IC into a highly profitable Class I railroad.

Gordon Trafton, who worked with Harrison at Burlington Northern, Illinois Central, and Canadian National, was part of the service design team that Harrison put to work in 1988 to create the first scheduled railroad plan. The plan was based on an effort Harrison led to develop the first car trip plans at BN in the early 1980s.

“Our job was to figure out how to trip-plan all merchandise cars on the railroad, coordinating the train schedules to do so that included block swapping and the elimination of switching in yards throughout the system,” Trafton recalls.

The objectives were to provide consistent and reliable service while controlling costs and maximizing asset utilization.

The trip plans were an outgrowth of the scheduled railroading concepts Harrison initially developed while at the Frisco and refined in his early days at BN, when he was an assistant vice president of transportation after BN's acquisition of the Frisco in 1980.

“No one was more passionate than Hunter about service, cost control, and asset utilization,” Trafton says.

But BN management at the time was not interested in Harrison’s idea of a scheduled railroad, Trafton says, which prompted Harrison to depart for the IC.

“The reality is Hunter is the only one who has been successful at a number of Class I’s in taking the scheduled railroading concepts, implementing them, and refining them over the years,” Trafton says.

Tom Utroska, who retired from Canadian National in 2001 as vice president of transportation, was an assistant division superintendent when Moyers and Harrison arrived at Illinois Central in 1989.

With the IC in dire financial straits, Moyers was by necessity intensely focused on cost-control, Utroska says. Moyers came to the railroad from MidSouth with a plan to single-track the IC main line and install centralized traffic control, Utroska recalls.

Moyers also was interested in proper use of a railroad’s assets. Utroska remembers taking a hi-rail trip with Moyers, who asked why a large pile of tie plates was sitting near a depot. Utroska told him they’d been there for more than a year, awaiting a rail relay project.

“A railroad that operates like that, with assets laying around, doesn’t deserve to be in business,” Utroska recalls Moyers saying.

But it was Harrison who put greater emphasis on improved utilization of assets like locomotives, freight cars, and train crews, Utroska says. Even more important: Harrison’s car scheduling system that covered the movement of cars from origin to destination.

“The key metric was trip-plan compliance. It was all Hunter’s push,” Utroska says. “He made us so aware of asset utilization and cost control.”

What Moyers did, Utroska says, was give people responsibility and then hold them accountable. And that created an environment where Harrison could prove the scheduled railroading concepts he had developed while at BN, he says.

“When Hunter came to the ICRR, he inherited a rag-tag group of operating officers, many of whom had been brow-beat for having fresh ideas,” Utroska says. “In one of his first meetings with the operating officers, he said, ‘If you stick with me, I’ll make you successful.’ He took that group … and led them to success. In short order, the ICRR went from the worst-run railroad to the most efficient. He was a leader and damn few of them exist.”

“Hunter’s the daddy of precision railroading,” Utroska says.

That’s a title Harrison never sought, according to Harrison biographer Howard Green, whose book, “Railroader,” was published last year.

“Hunter did not claim to be the sole inventor of Precision Scheduled Railroading and he said so,” Green says. “He began thinking about the concept in the early 1980s when he was at Burlington Northern, with the help of a few others including a computer programmer named Sue Rathe who provided him wi

BNSF & GWR Earnings - It's More About the Conversation - Tony Hatch


Greetings – Last two and next the Review….But what was most interesting wasn’t the actual results reported by BNSF (obviously via Berkshire Hathaway) and Genesee & Wyoming – both weather-impacted, the latter slightly below consensus but with reiterated FY Guidance – but was said by their respective top leaders, Messer’s Buffett and Hellman, at official Q&As. Both leaders are, of course, esteemed men – the former the “Oracle of Omaha” and the latter a former winner of the “Progressive Railroading Magazine/RailTrends Innovator of the Year”. Thus we have to take what they say seriously – Buffett on PSR and Union Pacific (“we pay a lot of attention to what is going on at the UP” in terms of margins/OR) and Hellman on M&A in the short line regional space and the role of PE & Infrastructure Funds (and whether they see themselves as a buyer or a seller). First, the results:

BNSF reported a slight increase in revenues (2%) on a 5%+ volume drop – of course heavily impacted by the floods that hurt UP, too….expenses declined 1% (helped by some one-time items – including a “retirement plan curtailment gain”), and while the reported OR increased slightly (20bps) to 68.1%, the adjusted OR dropped 200bps to 66.5%. PTI was up 10%, net income up 9% (without the boost the other rails gained from their share repo programs). The performance of their “Consumer” Business Unit (IM, plus autos) was initially worrisome – revenues up 8% but volumes down 6% (due to lower international numbers and “increased truck competition”; uh-oh). The rest flowed like this: Industrial Products (revenues +8%, units up 1%+); Ag (-3%/-7%); Coal (-8% 15%/-10%). They didn’t break out the weather impact, of course, but it was bad for them as for their chief rival. Capex will be up ~8% ($3.6B vs. $3.3B).

Speaking of UP, as a reminder, they reported a 15% increase in EPS on a 1% increase in OPI ($3.5B of share repurchases - $18.1mm shares - in the quarter); units were down 2% and the OR improved 100bps to 63.6%. That’s pretty comparable although the OR is 300bps lower for UP. Comparing business units, UP reported a worse revenue performance in “Energy” (coal) and Industrial Products and flat in Ag. But UP’s “Premium” outperformed BNSF’s “Consumer” – in units (+2% compared to -6%) but not in revenues (+3% compared to +8%).

So what’s “Uncle Warren” all worked up about? In a first, the team of Jain & Abel, the latter overseeing BNSF within the BH portfolio, joined WB and Charlie Munger for the in the 6-hour marathon Q&A session at Buffett-Fest in Omaha over the weekend. To be sure, the business press didn’t cover rail questions – but Bill Stephens of Trains did. The Oracle fielded “several questions” on the PR difference between BNSF and UNP – and revealed that he was very aware of the PSR story in the industry dating back to EHH & the IC. He stated: “It’s not like we’re losing business to anybody but they have been operating more efficiently, in effect, than we have during the last few years and, like I say, we take notice of it; We’ll see what that does in terms of shipper satisfaction….but we are measuring ourselves very carefully against what they do and if changes are needed we’ll do them.” And: We are not above copying anything that is successful”….is this why Matt Rose left? Where is the business mix/growth potential/ROI argument, Mr. Buffett?

GWR results came in 3 cents below consensus, but the weather impact on them (and on their interchange partners) cost them 9 cents – and they too reiterated FYG despite the under-water start to the year. North America was where the weather was, of course but Australian JV results were slightly below original guidance due mostly to more severe FX and drought effects (in fact they exited a grain branch business in WA). Oz is still seen by GWR (and their 49% partner, Macquarie) as a growth opportunity with contractual, stable characteristics (“and its free cash flow attributes are extremely strong”). And, in a role-reversal, UK/Europe, the UK came in ahead of plan, posting a positive OR (97.9% versus 101.6%) – yet still adding another charge (of $5.5mm) to Q1 results. But the focus was on NA; some takeaways:
• Safety was great in of itself, but GWR slipped from #1 to number 4 – and remember, everyone had winter
• GWR eliminated a “Region” going from 3 to 2; they also consolidated some dispatching
• They added (leased) two new short lines back home in Indiana, thereby enabling them to fill in the holes and create a 400-mile contiguous railway – back-to-the-future for their “cluster” strategy; they also had some nice Industrial Development wins
• Their volume of -1.2% still outperformed the Class One carload level for Q1/19 by 220bps

So, the renewed Short Line Value Proposition, enhanced by Class One PSR conversion and its merchandise focus,