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Railroad Weekly August 14, 2023
Photography by Frederick Manfred Simon © www.steelwheels.photography
Inside This Issue
· Freight Expectations: When Will the Downturn End?
· Relief on the Rails: Railroads Suffering Less from Freight Slump than Others
· Box Street Boys: Maersk Execs, Larry Gross, Share Views on Intermodal’s Future
· Wall Street Treat: Union Pacific Stock Rising as Reign of King Vena Begins
· Wall Street Meet: Railroads to Present at Deutsche Bank Event This Week
· Inflation Fears Fading: But Others Emerging
· Your Bad Service Hurt Us: Coal Miner Ramaco Blasts NS and CSX
Read American Places, a book with deep insights into the most important trends and developments throughout the U.S. economy -Jay Shabat, Publisher, Railroad Weekly
“We have made great progress in transforming our operations to this point. Our focus is unwavering as we will continue to improve safety, service, asset utilization, and network efficiency in order to provide customers with a service product that is competitive and provides value.”
-Newly-appointed Union Pacific CEO Jim Vena in October 2020, during his final company earnings call as UP’s chief operating officer; he assumes his new position this week
The Freight Recession
· As the autumn fast approaches, railroads and other supply chain players are all asking the same question: When will the freight recession end? Railroads are luckier than others, to be sure, in that several of their prime freight markets are bucking the trend and performing quite well—autos, coal, construction material, etc. Railroads also retain more pricing power than most supply chain companies, owing to the consolidated state of their industry, not to mention the market power they hold over say, a coal mine dependent on a single rail line. Nevertheless, transporting consumer goods is a major part of their business. And make no mistake: Consumer goods transport is in deep recession. That’s reflected in shrinking intermodal markets, with container and trailer units hauled by rail down 10% y/y across North America this year. The chart below shows U.S. intermodal traffic year-to-date through early August for the past several years. You can see how depressed this year’s volumes have been, and not just versus the peak years of 2018 and 2021.
· Will fortunes soon turn? The hope is that they will, as companies that over-ordered in 2021 eventually sell down all that excess inventory, prompting a return to more normal ordering activity. But not too many signs of that yet. And there’s risk that a re-stocking renaissance might never take hold if consumer spending starts to falter (thankfully not too many signs of that either so far). Consumers have shifted more of their spending on services rather than physical goods (which need to be shipped). But goods spending is still pretty healthy historically speaking, based on the latest retail sales data. Goods retailers like Walmart are doing just fine. For the sake of railroads, they just need to order more inventory.
· The European shipping giant Maersk has a good view of trends. In its earnings call last week, it said point blank: “We do not see any sign of an expected volume rebound in the second part of the year… [with] inventory destocking continuing to be the primary driver for lower volumes.” Keep in mind that Maersk is serving ports worldwide, not just in North America. But the giant transpacific market, in which North American companies order inventories from Asian factories, via ports like Los Angeles, is central to Maersk’s business. Executives did say volumes and rates were “stabilizing at a lower level.” The intermodal recession, remember, started around this time last year, so y/y comparisons are starting to reflect that. Expressing some hopefulness, Maersk highlighted a “disconnect between how container volumes are moving and how GDP is moving… You could say the boom of 2022 was not underpinned by GDP because people were ordering more than they were consuming. And now… the correction—the minus 26% in the first quarter and 17% in the Pacific in the second quarter—is not underpinned by GDP either.” Consumption, it added, is currently higher than “what is essentially being imported,” implying that imports should be poised to normalize. But with economic growth subdued, “the volume recovery is not going to be a double-digit rebound once the destocking has taken place, it will be modest and it will be more in line with GDP growth.” Maersk's comments, to be clear, are most relevant to the international intermodal market.
· Intermodal expert Larry Gross writes in the Journal of Commerce that the international intermodal market depends on many factors beyond a railroad’s control, like the level of imports and exports, which ports shippers are using, and the extent to which steamship lines like Maersk are interested in extending their services inland. For domestic intermodal, however, Gross insists, “it’s all about the industry’s competitive posture vs. truck. It’s about service levels, capacity, and above all, economics.” He cites figures showing how intermodal has lost market share to longhaul trucking, and would have moved 15% more boxes than it did last quarter, if only had it retained the share it held in 2019. Between 2015 and 2018, furthermore (Gross calls these the “good old days”), intermodal held a 6.7% share of longhaul trucking, versus about 5.6% today. “Had that 6.7% share been achieved in the second quarter [of this year], domestic volume would have been 19.5% higher, translating into another 408,000 domestic revenue moves, or about 1.6m more annual loads on the rail.” He reminds that the 2015-to-2018 period was largely before the widespread adoption of Precision Scheduled Railroading, which restructured intermodal networks. It was also before the “de-marketing/conversion” of the trailer-on-flatcar (TOFC) market. Gross adds, “Run the math on 1.6m loads and that means the industry would have generated an additional $4b dollars in annualized revenue had it achieved a 6.7% domestic intermodal market share in the second quarter.” How does Gross propose the railroads and their intermodal partners recapture all this lost share? “History tells us that intermodal success during truly normal times is a proposition that is simple to describe, although difficult to execute. It involves reliable service with a door-to-door on-time percentage in the low ’90s or high ’80s, schedules that get the freight to destination within one to three days longer than truck (depending on length of haul) and door-to-door savings per package, pallet or carton of at least 10% to 15%.”
The longer-term view:
· The Economist ran an article entitled: “America’s Logistics Boom Has Turned to Bust,” with the subtitle, “A pandemic-era frenzy of hiring and investment has gone into reverse.” In 2020, the article states, American consumers began splurging on goods, supported by stimulus checks and public health measures affecting service sectors like travel and dining out. “Appliances, cars and furniture clogged up ports, warehouses and truck depots… [and] revenues in the logistics industry soared, increasing by roughly a third between the start of 2020 and mid-2022, according to America’s Census Bureau. Firms in the industry hired 1m workers and built 1.8b square feet (nearly three Manhattans) of new storage space on hopes that the frothiness would continue.” Alas, it didn’t. “Goods spending, adjusted for inflation, has stagnated, leaving retailers with excess inventories. Consumers are also returning to physical stores, reducing the number of miles their goodies need to travel to reach them. Revenues in the logistics industry have now clocked up three consecutive quarter-on-quarter declines.” What’s more, the Cass Freight Index, a measure of rail and truck activity, is down by 5% over the past year. According to ACT Research, some 20,000 truck operators, nearly 3% of the national total, have ceased activity since mid-2022.” The latest is Yellow, an industry giant with 30k employees. Parcel-delivery firms have cut 38,700 workers since their staffing peaked in October. Warehouse operators have cut 60,800. And that’s despite the phenomenon of labor hoarding, whereby firms are reluctant to reduce staff after suffering severe worker shortages during the boom. In the meantime, “the number of warehouses under construction in America has fallen by 40% from a year ago,” says Prologis. What lies ahead? “Optimists hope the sector will start moving again in the second half of the year, once retailers finish clearing their excess inventories and start restocking their shelves,” The Economist writes. “That may well come to pass, provided the American economy continues to be surprisingly strong.”
Retailer Inventories Since 2019 (note: figures are not inflation-adjusted so the upward slope is somewhat exaggerated. But the trend is clear)
Around the Industry
· This week, Union Pacific’s new chief Jim Vena assumes the throne, replacing Lance Fritz who’s retiring. Vena is accompanied by new president Beth Whited. On Tuesday, several rairlaods will present at a Deutsche Bank investor event in New York. And speaking of investors, they seem to like UP’s choice of Jim Vena—the railroad’s stock price has jumped so far this month, while other Class I railroad stock has slumped. Separately, BNSF debuted two-way traffic across Lake Pend Oreille in Idaho, thanks to its newly-constructed Sandpoint Junction Connector rail bridge. Two shortline railroads owned by Genesee & Wyoming—Georgia Central and Heart of Georgia—plan to test zero-emission rail-freight technology from the intriguing startup firm Parallel Systems. The Alliance for Innovation and Infrastructure, an independent research group, published a study on train length, drawing the following conclusion: “The available data up to this point does not provide strong evidence that increasing train lengths correlate with safety concerns as measured by train accidents. There may even be weak evidence to the contrary, as accidents continue to decline as train length increases. The alternative to long trains is more trains, which may increase the probability of certain train incidents. Capping train length may also shift marginal freight loads to other transportation methods, namely trucks. The added freight on public roadways would cause a net increase in safety risks, and perhaps ironically may lead to highway-rail crossing incidents.”
· Be sure to catch John Orr’s podcast discussion with Railway Age Editor-in-Chief William Vantuono. Orr is CPKC’s Chief Transformation Officer, charged with ensuring a smooth post-merger integration. He speaks about some of the new railroad’s early priorities, including its new MMX cross-border service, its efforts to develop the Mexican port of Lazaro Cardenas, and its plans to move more perishable freight like fresh fruits from Mexico north (and proteins in the opposite direction). Moving more auto parts is another big opportunity. But operating in three different countries comes with unique challenges, like the need to navigate three different sets of laws and regulations. Climate variations across the three counties, meanwhile, can be extreme. Orr said during the interview that CPKC staff in Monterrey, Mexico, were working in 44-degree Celsius heat (111-degrees Fahrenheit). It’s not uncommon for winters in Canada, he said, to see temperatures below 40-degrees Celsius.
· On the topic of labor relations, the AAR said railroads have now reached more than 40 agreements that extend individual paid sick days to employees who previously did not have them. “As of August 3, 2023, the majority of the unions at the NCCC carriers, representing 78% of all craft employees, now have individual paid sick leave days, in addition to pre-existing short- and long-term paid sickness benefits already in effect across the industry.” (NCCC stands for the National Carriers’ Conference Committee, which negotiates with unions on behalf of BNSF, CSX, Norfolk Southern, Union Pacific, and Canadian National’s U.S. properties).
The Economy: All Good or Trouble Coming?
· Inflation took center stage last week as the Bureau of Labor Statistics (BLS) published its latest consumer price index for July. It showed the price level again up only 3% y/y, albeit with a modest move upward from June to July. Inflation is no longer the intense worry that it was a year ago, though certain trends like rising wages in the healthcare sector remain a concern. Also causing some discomfort in the past few weeks has been rising oil prices, and even more inflationary diesel fuel prices. As diesel prices rise, so does the cost of transport (all else equal), and thus so does the cost of everything transported, including basics like food. A worrisome new trend? Or perhaps just a momentary spike, linked to the intense summer heat that disrupted some refinery production? Producer prices by the way (that’s another index compiled by the BLS) rose less than 1% y/y in July. For U.S. companies, energy remains much cheaper than it was last year. Same for transporting and warehousing goods. Construction, on the other hand, is one area where price increases remain elevated. The cost of rail freight, for the record, dropped 2% y/y in July. The cost of trucking goods plummeted 12%.
· In the first six months of 2023, the U.S. exported $1.5 trillion worth of goods and services. Imports, meanwhile, amounted to $1.9 trillion. What exactly does America export? Some $88b in autos and auto parts, for one, during the first half. It exported $84b in food, $56b worth of crude oil, $54b in aircraft and aircraft parts, $51b in pharmaceuticals, and $28b in semiconductors. Oh yeah, and $2b in railway transportation equipment. On the import side, leading categories include $223b in autos/auto parts, $100b in food, $98b in pharmaceuticals, $79b in crude oil, and $61b in cell phones. Compared to last year, the first half of 2023 saw exports rise 2.5% and imports decline 4%, hence a narrower trade deficit.
· Overall, the latest prevailing narrative about the U.S. economy is that conditions are much healthier than many expected, with the job market, the stock market, household finances, financial sector stability, corporate earnings, consumer spending, and so on, all in pretty good shape, offsetting the goods and freight recession, slumping non-transport manufacturing sales, a stalled housing market, and other areas of weakness. Indeed, the Atlanta Fed has a very bullish 4.1% forecast for Q3 GDP growth. Narratives can change fast though, and new concerns are emerging about China’s deteriorating economy, as well as Uncle Sam’s deteriorating finances. The latter has bond markets increasingly nervous, with Treasury yields up again last week (see chart below). Markets, remember, are always about supply and demand, and the Federal Reserve itself has become a Treasury bond seller (or more technically a non-re-buyer as its holdings expire) rather than a buyer. Also remember that a government shutdown could happen this fall, as might an auto strike.
· Not to end this section on a pessimistic note but for a bleak longterm view, consider former Bank of International Settlement economist William White, referenced in the Financial Times last week. He says, according to the FT (their words not his): “The world is moving from an age of plenty to an age of scarcity. Numerous trends since the end of the Cold War—the expansion of global supply chains, growth in the global workforce, trade growth outstripping increases in gross domestic product, less spending on guns and butter—are now going into reverse. At the same time, energy supply is constrained by concerns about climate change and security, while record levels of both private and public debt restrict policy options as well as being a drag on growth. This paves the way for a more inflationary world, in which inflation and interest rates are likely to be more volatile.” Again, this is just one view. But hardly an implausible one.
Update from Rail Customers
· It’s pretty common to hear railroad customers talk about improved rail service this year, some even praising the reliability of CSX, most notably. That’s not what you’ll hear from Kentucky-based Ramaco Resources, however. The metallurgical coal producer said in its earnings call that in Q2, “We were again plagued by non-performance by our rail partners. In the month of June, both Norfolk Southern and CSX failed to deliver over 80,000 tons of contracted shipments, which was over 10% of tons sold during the quarter.” These were 85,000 tons that were contracted to ship during the last weeks of the quarter but pushed into July. That’s hardly Ramaco’s only headache though. It said benchmark prices for a key type of coal it mines averaged 25% lower in Q2 versus Q1. Speaking on Aug 9th, it said, “Today, prices are down another 10% from the second quarter.” As a reminder, metallurgical coal is used to make steel, demand for which is expected to grow significantly in tandem with infrastructure development, the shift to electric vehicles, and the green energy transition. Ramaco’s top competitors include Warrior, Arch, and Peabody, all themselves major railroad customers.
source: Ramaco Resources citing Bloomberg; met coal prices in $/metric tonne FOB port for U.S. High Vol A (monthly average). Steel prices in $/short ton (monthly average)
· Canada’s Ballard Power spoke about how its rail business “has been really a pleasant surprise over the last number of years with the progress we’re making there.” Ballard is providing fuel cell technology to help CPKC develop hydrogen locomotives. The initiative is advancing with CSX’s cooperation, and with a new pilot program to deploy the locomotives to move steelmaking coal for one of CPKC’s most important customers, Teck Resources.
Freight Car America
· During its Q2 earnings call, Chicago-based Freight Car America (FCA) echoed what rival manufacturers (i.e., Trinity and Greenbrier) have said about the current strength of the railcar market. “During the quarter, our level of inquiries, order activity, and demand for our products remained solid, with industry demand largely tied to the replacement of aging railcar fleets.”
· But what about the freight recession causing North American railcar volumes to decline this year? “Although weakness in freight car loadings and the overall macroeconomic environment conditions pose market uncertainties, we affirm industry forecasts of railcar deliveries of 45,000 railcars in 2023.” Customer inquiries, it said, point to railcar demand “across a diversified range of car types… We continue to see tight car supply in some segments due in part to high utilization of our lessor customers’ fleet, combined with railcar retirements.”
· During Q2, FCA closed order deals for 381 railcars, bringing its half-year total to 2,341. This half-year total is up 23% versus the first half of 2022. Last year, Union Pacific, Vulcan Materials, and Infinity Transportation accounted for 55% of FCA’s total revenues. The year before, its top three customers were TTX (the railroad-owned railcar pool), CIT Rail (a lessor), and Union Pacific. In general, railcar manufacturers sell to three categories of customers: shippers, financial institutions/lessors, and railroads themselves.
· FCA no longer partakes in railcar leasing itself, having decided to exit that business. “Our continued exit from leasing supports our unique position as a pure-play manufacturer with all of our focus on achieving manufacturing excellence and deepening our customer relationships.” In its earnings call last week, it stressed the advantage of not competing head-to-head with some of its best customers, i.e., leasing companies. According to Trinity, in a recent investor presentation, North America’s top five railcar lessors, other than itself, are CIT, Wells Fargo, Union Tank Car, GATX, and the Japanese bank SMBC.
· FCA, which is now building all its railcars in Mexico, ended Q2 with an order backlog of 3,288 railcars, which it values at close to $400m.
Freight Car America’s Railcar Products (source: company annual report)
· Earlier this summer, CSX chief Joe Hinrichs spoke with Michelle Livingstone of the Supply Chain Institute at the University of Denver. Next month, Hinrichs will complete his first year on the job, having arrived as an industry outsider from the auto sector. He’s since spent lots of his time in the field talking and listening to employees, often showing up at yards unannounced (just last week, for example, he was visiting staff at CSX’s Osborne Yard in Louisville).
· One reason for the heavy focus on labor relations, he explained, was the mere fact that CSX (and the railroad sector at large) is losing workers and having difficulties attracting new ones. There are various theories trying to explain why, touching on possible causes like America’s shrinking working-age population to new attitudes about work among younger people. Railroading, for sure, is hard work, much of it conducted outside in all forms of weather. Train crews spend lots of time away from home. It does pay well, however, relative to many other sectors.
· Key to addressing this longterm labor challenge, Hinrichs says, is recruiting more females to the industry. Railroading is currently a male-dominated profession, he explains, and past efforts to attract females have proved challenging.
· Turning to CSX’s much-praised service recovery, Hinrichs stressed that the company has simultaneously improved both its punctuality (trip plan compliance) and its operating ratio. There’s no conflict between the two, in other words. On the contrary, running a reliable railroad will open many doors and help CSX grow. But he cautioned that one railroad can’t ensure good service by itself. Some 40% of goods that CSX handles will touch another railroad at some point along their journey.
· Other topics discussed in the interview included CSX’s new cooperation with CPKC, with whom it’s jointly developing hydrogen locomotives and jointly creating a new interchange in Alabama. You can watch the interview here.