Congress Acts
Inside This Issue
· Congress Acts: Labor Clash Done, Trains Will Still Run
· Sick Leave Loss: Lawmakers Reject Proposal for Extra Time Off
· Forrest Thump: UP and Others Seeing Big Declines in Lumber, Pulp, Paper
· The Three-Legged Stool: CP Bullish on Bulk, New Business, KCS
· Hiring Harris: CN Turns to Veteran Exec to Manage Operations
· Hard or Soft Landing? Economy Cleary Weakening, But How Much?
· Creel of Fortune: Venerated CEO Explains the Secrets of CP’s Success
Track Talk
“At this critical moment for our economy, in the holiday season, we cannot let our strongly held conviction for better outcomes for workers deny workers the benefits of the bargain they reached, and hurl this nation into a devastating rail freight shutdown.”
-U.S. President Joe Biden
Reminder: Railroad Weekly publishes 48 issues a year, with two-week pauses in August and December. The last issue of 2022 will be on Dec. 19th. The first issue of 2023 will be on Jan. 9th.
The Strike Threat Ends
· At last, the drama ends. As expected, the U.S. Congress, at the urging of President Biden, passed legislation preventing a national railroad strike. The succinct two-page bill makes all tentative agreements based on the recent Presidential Emergency Board recommendations binding, never mind that four of the industry’s 12 unions voted their disapproval. You can read the exact language of the bill here: https://www.congress.gov/117/bills/hjres100/BILLS-117hjres100enr.pdf
· For the record, the measure passed by 290 to 137 votes in the House. It was then approved by the Senate in an 80 to 15 vote. The 15 no votes included some strange bedfellows, including New England Senators Bernie Sanders and Elizabeth Warren on the left, and sunbelt Senators Ted Cruz and Marco Rubio on the right.
· Several Senators including Bernie Sanders attempted to pair the contract imposition measure with an amendment—one that would have granted seven days of paid sick leave to all railroad workers. The amendment, however, failed to win the 60 votes needed to pass. Naturally, union leaders were disappointed. Tony Cardwell of the BMWED said of the failed Senate amendment: “This leaves me baffled, exasperated, and deeply saddened.” Other disappointed workers said railroads would have an even harder time retaining and attracting workers now. Sick leave benefits proved the biggest sticking point in trying to reach consensual agreements.
· Workers will, however, get a 24% pay increase covering the five years from 2020 through 2024. Senator Sanders of Vermont, for one, wasn’t impressed. “It sounds like a lot of money. That is for a five-year period. They have not received a pay increase in the last three years. And if you average it out, that pay increase is less than inflation to date. It is not a great wage increase. It is not terrible, but it is not a great wage increase.” Senator Rubio of Florida felt “Congress should have sent everyone back to the negotiating table, but instead it told rail workers to suck it up and be grateful.” He also mentioned how the “industry cut nearly one-third of its employees over the past six years, even as demand surged.” Senator Cruz of Texas, along with Rubio, supported an attempt by Alaska Senator Dan Sullivan to resume negotiations. “As a matter of principle, I do not support government intervention to decide terms of employment. We should extend the cooling-off period, as Congress has done before, and send both parties back to the table.”
· President Biden, for his part, counts organized labor as an important supporter yet deemed a rail strike too damaging to the economy. The 1927 Railway Labor Act, which still governs railroad labor disputes today, attempts to balance the rights of workers to bargain collectively with the fact that their jobs are mission critical to the functioning of the country. Airlines, by the way, are also covered by the same law.
· How are the railroads reacting to the imposed settlement? Their labor negotiating body, the National Carriers’ Conference Committee (NCCC), said this: “We have heard and recognize the deeply felt concerns regarding paid leave benefits and will work with rail union leaders in future bargaining rounds to assess the structure of these provisions.”
· Importantly, the bill that ended the strike passed on Dec. 1, well before the Dec. 9th strike deadline. Had the dispute lingered for a few days longer, railroads and shippers would have had to act in advance to manage the potential disruption, curtailing commerce. Amtrak, meanwhile, would have had to pre-cancel passenger trains. This type of anticipatory disruption, remember, occurred as railroads and their unions failed—until the very last moment—to reach a tentative contract agreement. That was back in September.
Update on the U.S. Economy
· As Congress and the White House were busy ending the railroad labor dispute, Federal Reserve chairman Jay Powell raised the possibility of easing up on interest rate hikes. He was careful to reaffirm his commitment to smothering inflation but hinted that the next rate hike (on Dec. 15th) could be just half a point, not three-quarters of a point. Since March, the Fed has lifted overnight interest rates from zero to 3.75%, sending 30-year mortgage rates from below 3% to above 7%. They’ve fallen back some in recent weeks as inflation shows signs of cooling—the price index for personal consumption expenditures (PCE) is now up only 6% y/y, down from 7% in June. The Fed’s goal is 2%.
· The latest Fed Beige Book, a collection of commentary from businesses across the country, made it clear that the economy is cooling. Five of the Fed’s 12 regional districts reported slight or modest gains in economic activity. The rest experienced either no change or slight-to-modest declines. “Interest rates and inflation continued to weigh on activity, and many contacts expressed greater uncertainty or increased pessimism concerning the outlook.” So clearly, the economy is slowing. But will there be a major recession in 2023? Or will there be a “soft landing,” in which the job market stays healthy, inflation recedes, and overall output stays positive or at least flat?
· The jobs market so far continues to hum. The Labor Department’s November update showed another 263,000 new jobs, about a third of them in leisure and hospitality. Railroad workers, for the record, numbered 147,800, up from 147,600 in October. The number was 145,800 last November. It was 195,800 in November 2019. It was 235,600 in November 2015.
A few other economic updates and data points from last week:
o The Census said construction spending declined slightly from September to October but rose 9% versus October 2021 (single-family homes and manufacturing plants are two areas of weakness).
o The Institute for Supply Management, which surveys purchasing managers, said “order backlogs, prices, and now lead times are declining rapidly” among manufacturers, whose output contracted in November after expanding for 29 straight months. Respondents in the service sector too, suggest “growth rates and business levels have cooled.”
o S&P’s purchasing manager survey for manufacturers similarly noted declines in output and new orders, slowing employment, contracting order backlogs, and a rise in unsold stock—but also that price pressures are now abating rapidly.” Companies are thus “cutting production at a rate not seen since the global financial crisis, if the initial pandemic lockdowns are excluded.”
o Retail inventories, the Census shows, shrank a bit from September to October but remain way up y/y.
o According to the National Association of Realtors, existing home sales plummeted 28% y/y in October (median prices are up though).
o There are still 10.3m unfilled jobs in the economy, the Labor Department says. One issue is that there’s simply not as many Americans in the workforce as there were pre-pandemic. A sharp decrease in immigration is another factor. A lot of open jobs, furthermore, require skills that too few workers possess (i.e., nursing)
o The Conference Board, measuring sentiment, says “consumers’ expectations regarding the short-term outlook remained gloomy.”
o The latest data from the Bureau of Economic Analysis show that U.S. GDP grew a rather robust 2.9% in Q3 (annualized), following a 0.6% contraction in Q2.
Update on the Canadian and Mexican Economies
· Canada’s economy is slowing too. S&P Global’s Canada Manufacturing PMI (purchasing managers index) indicated a contraction in output and a slowdown in new orders. November, the report said, marked the fifth successive month that new orders have fallen. Prices are still up, but “input costs rose at their slowest pace for two years.” Also noted: “Sourcing transportation for deliveries remains a problem for both manufacturers and suppliers.”
· Canada’s Bank of Nova Scotia, which reported earnings last week, said economic growth is moderating, “but economic levels of activity remained robust.” The labor market continues to be strong, it added. Ditto for corporate balance sheets. In the meantime, prices for Canada’s many export commodities remain elevated. National Bank of Canada, for its part, said a soft landing for the economy remains possible with many indicators “moving in the right direction.” These include moderating inflation, “which could allow the Bank of Canada to slow the pace of interest rate hikes and reach a peak in the policy rate over the next few quarters.” Thanks in part to “very strong employment conditions and high level of savings coming out of the pandemic,” the Canadian economy should grow in 2023, though at a more “moderate” pace. Uncertainty, the bank makes clear, “remains high as the economy continues to face compound risks, including the impact of inflation and rising interest rates, geopolitical tensions, and ongoing supply chain disruptions.” Interestingly, it pointed to Quebec’s unique economic strengths, including sector diversification, more affordable housing, lower consumer leverage, a high proportion of dual-income households, more stable energy prices, and a relatively strong fiscal position.
· For Mexico, the S&P Global Mexico Manufacturing PMI highlighted the challenge of weak export demand as the global economy struggles. Many Mexican factories are incurring higher costs but electing not to raise their own prices, hoping to protect and grow sales. The report mentioned a drop in orders from the U.S. (which could affect rail volumes for companies like Union Pacific and Kansas City Southern). Separately, a Bloomberg News article examined the trend of Chinese manufacturers setting up factories in Mexico to access U.S. markets tariff-free. It mentioned one construction company with plans to build an industrial park near the port of Lazaro Cardenas. That’s music to the ears of Canadian Pacific.
Other Rail Developments
· CSX made a modest move it hopes will simplify operations and save a bit of money. It’s integrating the Toledo Ore Railroad Company, or TORCO, into its operation. CSX currently operates the Class III railroad jointly with Norfolk Southern. Customers won’t see any changes though. TORCO owns and operates about 2,100-feet of railroad in Ohio.
· Railroads insist their service is getting better thanks to aggressive re-hiring efforts. But make no mistake, customers are still complaining. Here’s an example from just last week: REX American Resources, which produces ethanol fuel from corn, spoke in its earnings call of “challenging logistic problems caused by issues with the railroad.” It mentioned the large number of railroad layoffs between 2019 and 2021, which meant “there is not enough manpower… We see sometimes that power is already there, or power made it to the plants to pull, but there’s no driver.”
Management Changes
· Norfolk Southern has a new CEO this year. CSX has a new CEO. Same for Canadian National. That’s half of North America’s Big Six railroads with new leaders. Naturally, new CEOs like to hand pick their key lieutenants, hence the departure, for example, of Cindy Sanborn at NS. Now, CN’s Tracy Robinson has selected a new chief operating officer to replace Rob Reilly, who was hired by Robinson’s predecessor J.J. Ruest in 2019. The new COO is Ed Harris, who’s been working as a consultant for CN since April. He previously worked at the Illinois Central and CN itself before running operations at CSX and later Canadian Pacific. This video is from 2020, when Harris spoke with the Indian Railway Traffic Service:
· Let’s see if Joe Hinrichs, who just took over at CSX in September, decides to install any of his own picks at key positions. BNSF’s Katie Farmer, remember, assumed her role just last year. Union Pacific’s Lance Fritz has been CEO since 2015. Keith Creel, surely the industry’s most celebrated executive, became CEO of Canadian Pacific in 2017.
Highlights from the Credit Suisse Global Industrials Conference
Union Pacific
· CFO Jennifer Hamann, fielding questions from Credit Suisse transportation analyst Ari Rosa, was naturally asked about the industry labor dispute. For context, she was speaking on Nov. 30th, as the U.S. House of Representatives was passing legislation to forestall a work stoppage. UP has been in “active dialogue” with unions, with the White House, and with Congress, she said. “Because we absolutely believe it’s critical that we avoid any kind of a work slowdown, work stoppage, or a rail strike.” At the time, UP was hoping for Congressional legislation that would impose the terms of the Presidential Emergency Board, plus “a little bit of unpaid sick time that was agreed to back in September.” Hamann noted that the portion of the workforce that rejected their tentative agreements did so by a “very close” margin. “I think there's a strong desire by the workforce to get this behind us and move forward. We want to be able to pay the wages that our workforce deserves. And certainly, as part of the package, 24% wage increases over 5 years, we think, is a very strong deal for our employees.”
· As for UP’s business, things have regrettably taken a turn for the worse operationally. Not dramatically so, but enough to move average freight car velocity down to just 186 miles per day. When UP presented at the Stephens conference two weeks earlier, the figure was 192 miles. At the start of this year (January), it was 208. Hamman said UP was “working with select customers in certain geographic areas where we still have some of that crew tightness.” To address the issue, it’s controversially imposed “congestion embargoes,” so much so that STB regulators want an explanation (they’ve scheduled a hearing on the matter next week). Hamman’s response: “It’s a tool of last resort. It’s not what we want to do. But in terms of trying to regain fluidity on the network and to be able to provide service to all of our customers, in some select locations in areas we have done that.”
· What’s the latest on demand? Carload/container volumes so far this quarter (through Nov. 25th) are up 3% y/y, boosted by a 22% increase in auto shipments, specifically finished vehicles. As a reminder, auto production was greatly constrained by a semiconductor shortage this time last year. And production is now recovering, albeit not fully free of its semicon issues. Also lifting total volumes this quarter is a 27% surge in the crushed stone, gravel, and sand category, boosted by ongoing strength in nonresidential construction. Coal movements are still running ahead of last year’s levels. So are intermodal shipments but more due to easy comparisons with last year. Supply chain bottlenecks have eased, allowing for more containers to move (international volumes are up a colossal 25%). But intermodal demand, to be clear, has softened. And that softness is showing most prominently in the domestic intermodal business, which is down 9%. The key driver of that decline is a 20% fall in parcel shipments. It’s also important to note that UP’s overall volumes have improved with help from more fluid operations, recent setbacks notwithstanding. Also helping with growth are new business wins, in industries ranging from steel to autos to biofuels.
· Which categories, besides domestic intermodal, are weaker this fourth quarter versus last? Start with forestry products, led by lumber’s 17% collapse. That’s not surprising given the sharp slowdown in housing construction. Pulp and paper products are down too (less of a need for cardboard boxes as ecommerce cools off). Forestry aside, the two most important areas of weakness for UP are chemicals/plastics (volumes down 2%) and grain (down 5%). Hamman also said food and beverage was down about 8%, and fertilizer down about 10%.
· Despite losing some momentum on volume growth, Hamann reaffirmed her confidence in hitting the company’s annual goal for operating ratio: around 60%. UP, furthermore, still expects to be able to price above inflation. That said, it also expects to have more flexibility to “be more competitive in the market” as precision scheduled railroading (PSR) lowers its cost structure. Or put another way, the lower its cost base, the more aggressively it can discount to win new business.
· Speaking of new business, a big development in 2023 will be the onboarding of Schneider as a major intermodal customer. UP hopes to win more business by touting its environmental credentials versus trucking. As it improves its service delivery, meanwhile, “we see that opening more and more doors for us.” Hamman did say that operational issues are currently impacting the bulk business most: “When I look at our bulk network, that’s probably an area where you could probably most clearly point to and say those volumes could be stronger if we were operating more fluidly.” Examples include coal and rock—“We know we’re not meeting all of the coal demand that’s there… You could probably say the same thing in rock where, although the rock volumes are up strongly, there’s still more demand there for us to be meeting.”
· Sometime in the next few months, the STB is going to make its call on Canadian Pacific’s Kansas City Southern takeover. Will it approve the deal? UP isn’t terribly worried about the possibility of a newly enlarged competitor. After all, it will remain the only railroad in North America that has connections to all six major gateways between the U.S. and Mexico. “Even with the CP-KCS merger, we’ll still have the better route structure north-south of the border.” Hamann also pointed to having more destination points for “where that freight ultimately wants to [originate or terminate] north of the border.” UP does, however, want STB assurances that its customers “aren’t de facto being forced to ship on CP-KCS by the way that they’re pricing their business south of the border.” It wants, in other words, to retain business currently moving on joint UP-KCS journeys. UP separately wants equal access to a new bridge KCS is building in the border town of Laredo, Texas. And it demands that CP invest in improved infrastructure around Houston, where the merged railroad will be using UP trackage rights. That’s “a very busy part of our rail network.”
Canadian Pacific
· John Brooks, Chief Marketing Officer of Canada’s second largest railroad, likes to talk about two halves and three-legged stools. The two halves refer to this year’s freight volumes, which were subdued early on but growing more vigorously since the summer. Indeed, carloads this quarter (through Nov. 26th) are up a hearty 12% y/y. During the first and second quarters of the year, they were down 10% and 1% respectively. Why the second half surge? For three reasons: grain (this year’s big harvest), intermodal (easing supply chain bottlenecks and new business wins), and auto (recovering production). Coal volumes, on the other hand, are down a lot this quarter, in part because one of its key customers (Teck Resources) has been forced to suspend production at its Elkview steelmaking coal mine in British Colombia. As a result, Brooks said, CP has “missed out on about 100 trains of coal quarter-to-date.”
· Now what’s that three-legged stool he’s referring to? It’s the foundation for what’s expected to be strong growth in 2023 and beyond. First, there’s CP’s vital bulk franchise, which generates 40% of the company’s revenues. That’s principally grain, potash, and coal, all expected to do well next year. In coal’s case, Teck’s Elkview mine should “come back at some point in December.” The second leg of the stool? What Brooks calls CP’s self-help initiatives, including its efforts to boost intermodal traffic through the port of St. John and new business it’s winning from companies like Ford. The third leg? CP’s takeover of Kansas City Southern, which the STB will approve or disapprove probably sometime in January. If approved (that seems to be likely), CP could take full management control as early as February. Brooks feels as bullish as ever about the potential synergies, chiefly the chance to seize business from trucks, and from other railroads. The merger will create new north-south shipping lanes, says Brooks, and open new single-line opportunities like moving Canadian potash to the U.S. Gulf Coast, where it can be exported to markets like South America. As an example of what the two railroads can do by working together, he pointed to the unique crude by rail product (DRUbit from USD Partners and Gibson Energy) that CP and KCS currently move—using a typical interchange agreement for now—from northern Alberta to Port Arthur. Texas. “I’m super excited about the synergies, I think the opportunity is as big or bigger than we initially thought it would be.”
· Brooks reminded investors that more than 80% of KCS’s volumes today interchanges with another carrier. A lot of that traffic can be converted to single-line longhaul journeys after the merger, which would provide convenience to shippers. CP has noted that its own network is very strong with respect to originating freight but weaker in terms of destinations with strong demand (think lots of Canadian commodity exports but not so many places on its own network to ship them). KCS is the opposite, with lots of strong destination markets like Mexico but fewer strong origin markets. The two networks, in other words, complement each other well.
· KCS aside, CP is winning business along its existing network, including new deals with ocean liners like Hapag-Lloyd and CMA. It’s winning more energy business in western Canada too. Brooks mentioned a new plastics facility in northern Alberta. New business with Ford begins on Jan. 1st.
· But CP doesn’t just take any new business. It’s interested only in high-margin business. Management claims to be “wildly successful” in pricing above inflation. That translates to higher profits and lower operating ratios. But it also weeds out lower-margin freight that would congest its capacity-tight network. The goal is to “create capacity to allow us to bring on more profitable business.” CP has a whole team—sitting between sales and operations—dedicated to deciding which new business it can accept without slowing down the network.
· But what about getting kicked out of the EMP interline container pool run by Union Pacific and Norfolk Southern? “I’ll tell you a couple of things about that,” said Brooks. For one, CP has its own large order of domestic containers “that will backfill a lot of that capacity.” In addition, it was able to drive “some pretty significant rate increases on our cross-border intermodal business” after repricing some of that business.
· Brooks did mention that supply chains remain “pretty choppy” in some areas. And weakness is increasingly evident in the intermodal import-export business. In addition, CP’s energy, chemicals, and plastics business is down in terms of volume. That’s all meaningful, for sure. Yet the bulk business reigns supreme at CP, and the outlook for grain, potash, and coal is looking rosy for 2023. Same for autos. Add those other two legs of the stool—new business wins and the KCS merger—and it starts to become clear why CP’s stock has performed so much better than its peers (see chart above). That’s good news for investors like Bill Ackman’s Pershing Square, once again a major CP shareholder.
· Separate from the Credit Suisse event, CP’s CEO Keith Creel gave a lengthy interview as a guest on the Knowledge Project podcast. He spoke in detail about the benefits and even shortcomings of moving freight by rail. Creel acknowledged the potential threat of driverless trucks, which would give them a sizeable labor cost advantage. Railroads, therefore, need to innovate as well. Naturally, as a disciple of Hunter Harrison, he shared his thoughts on Precision Scheduled Railroading (PSR), highlighting its emphasis on fewer, longer, and heavier trains. Traditionally, he explained, railroads would construct 6,000-to-7,000-foot sidings (so trains could pass each other) every ten miles or so. With PSR, the ideal is more like 10,000-to-12,000-foot sidings every 15 miles, roughly speaking. This allows for efficient spacing to sequence trains, run long trains, and execute train meets. PSR, he said, is the railroad equivalent of lean manufacturing. There’s a whole lot more to the interview, from stories about working with Harrison (not to mention Bill Ackman) to a detailed account of how CP came to buy Kansas City Southern. Be sure to watch it: