Photography by Frederick Manfred Simon © www.steelwheels.photography
Inside This Issue
· Mart Attack: STB Chair Oberman Still Unhappy with the Railroads He Regulates
· It’s Great. It’s Sedate: The Emerging Dichotomy in Railroad Demand
· Don’t be Nervous About Service: New Crop of Rail Chiefs Emphasizing Reliability
· 99 Problems but Getting Rich Ain’t One: Making Money is the Easy Part
· At Least Someone Likes Us: Can Class Is Please More Than Just Their Owners?
· Work Perk: UP and its Engineers Agree to More Worker-Friendly Schedules
· The Box Pox: Still Not Much Evidence of an Intermodal Revival
· Recession in Freight but Outlook Still Great: CN Expects Strong 2nd Half
· Wicked Switch: STB Switching Regs Likely; Parallel Threat in Canada
· I’ll Take That: Mexican President Seizes Railroad Assets from Ferrosur
Track Talk
“When you’re not running well, you’re not providing a good service product and that has consequences. It has consequences on the top line and it has consequences in the expenses.”
-NS CEO Alan Shaw, at the Wolfe Global Transport Industrials Conference
The Latest
· Nobody can argue that U.S. railroad service today is worse than it was a year ago. It’s demonstrably better. And that’s a reality Marty Oberman readily acknowledges and commends. But that didn’t stop the STB chair from swinging his axe at a shippers conference last week, berating the Big Four U.S. Class Is for all manner of transgressions (see below). He even wondered aloud whether industry deregulation has gone too far, perhaps meriting a partial rollback of the Staggers Act. That’s beyond his scope of work. But the STB seems keen on advancing at least one new regulatory defeat for railroads, pertaining to reciprocal switching. A decision on that appears imminent. Make no mistake: Earning 60% operating ratios makes Wall Street euphoric. And this immense profitability leaves railroads with plentiful funds to pay good wages, maintain their infrastructure, and invest in growth (none of that was true pre-1980). But under pressure from the Oberman-led STB, as well as from labor unions, politicians, and their own customers, railroads are starting to adopt a new approach, exemplified by a new crop of chief executives keen on de-emphasizing operating ratios. They’ve concluded that an extra few points of operating margin isn’t worth the risk—the risk of being re-regulated, the risk of labor relations growing even more toxic, the risk of not being able to find enough new workers, the risk of having their safety record distorted, the risk of customers revolting and shipping by truck instead… To be sure, maintaining a low operating ratio remains a top priority. But it’s no longer the top priority. No less important going forward are things like reliable service and improved labor relations, even if that means, for example, stomaching a period of overstaffing during a downturn.
· Did somebody say downturn? That’s not quite the situation for railroads currently. As executives again described to investors and shippers last week, demand for rail freight is simultaneously weak and strong—weak for certain things like moving consumer goods via containers but strong for other things like materials for industrial construction. The latest S&P Global gauge of purchasing managers nicely captures the larger macroeconomic picture (relevant to Canada too): “The U.S. economic expansion gathered further momentum in May, but an increasing dichotomy is evident. While service sector companies are enjoying a surge in post-pandemic demand, especially for travel and leisure, manufacturers are struggling with over-filled warehouses and a dearth of new orders as spending is diverted from goods to services.” S&P’s report likewise described the inflation trend now underway: “The inflation picture is also changing. Whereas manufacturing prices spiked higher during the pandemic due to strong demand and deteriorating supply, it is now the service sector’s turn to be hiking prices amid resurgent demand and an inability to cope with order inflows due to a lack of capacity.”
· Overall, annual consumer price inflation now stands at 4.4%, according to the index based on personal consumption expenditures (PCE) for April. That was up from 4.2% in March, perhaps weighing in favor of yet another Fed interest rate hike when policymakers decide next on June 14th. Besides its PCE update, the Bureau of Economic Analysis also published revised GDP figures for Q1; it now says output rose an annualized 1.3%, following 2.6% growth in Q4. The Census, meanwhile, showed more data that underscores the declining trend in orders for manufacturing companies, at least excluding aircraft (Boeing is having no problems selling planes, though it is having problems building them). Other new census data captured the trend of Americans buying fewer goods from overseas: imports of consumer goods fell 13% y/y in April. Perhaps most importantly, Congress and the White House have a deal, albeit subject to approval, on the debt ceiling.
· Just one final note about the economy: One sector that’s performing well currently—it’s a sector important to railroads—is agriculture. John Deere, in its latest earnings call, remarked: “We are coming off a really great year last year. Income is going to moderate, but we are still looking at farmers’ margins that are going to be above the 10-year average.” Input costs, helpfully, “have come down quite a bit.” That’s certainly true of fuel. Farmland real estate prices have held up well too. As an aside, it will be interesting to see how artificial intelligence might help boost crop yields in the future.
· On the labor front: A week after striking a deal on sick pay with Norfolk Southern, the BLET union (representing locomotive engineers) secured an agreement with Union Pacific on improved work schedules. The new arrangement, subject to member ratification, provides engineers with a schedule of 11 days on, four days off. The company pledged to make “meaningful progress implementing the new work/rest schedules within a year of ratification.” The union stated, “The 11-4 work/rest schedule will be life-altering for employees who are used to working on-call 24/7, 365 days a year.” Railroads seem convinced that labor markets have forever changed, and that work schedules must change as well, lest not enough people opt for railroading careers. Separately, Canadian National secured ratification of a new contract with its roughly 6,000 engineers, represented by the Teamsters Canada Rail Conference union.
· A head’s up: Railroad executives will be on the investor conference circuit again this week. On Thursday, Bernstein hosts its 39th Annual Strategic Decisions Conference.
note below how much oil prices are down y/y
also note how railroad stocks had a rough week
Highlights from Last Week’s NARS Conference in Chicago
· STB Chair Marty Oberman, speaking at an event hosted by the North American Rail Shippers Association, began by applauding the recent improvement in rail service. He also expressed some hopefulness about the industry’s new CEOs and their stated commitments to growth and better labor relations. Alas, the compliments and pleasantries stopped there. Oberman proceeded to castigate railroads for a litany of sins, including unjustified freight embargos, “entirely self-inflicted” service problems, irresponsible layoffs, and on two occasions nearly forcing Foster Farms to mass slaughter its chickens. Oberman insists the industry hasn’t gone nearly far enough in hiring back workers, stating that pre-pandemic employment at U.S. Class I railroads topped 140k, while now it’s less than 110k. It’s gone up by about 6k since the STB held a series of hearings on rail service last spring. The figure is much lower still when counting just train and engine workers. Union Pacific—offender number one on Oberman’s naughty list—piqued his ire when suggesting in a recent investor call that it might scale back hiring plans. Railroads say attracting new workers is difficult right now. Oberman says that’s “nonsense,” pointing to the airline industry’s aggressive re-hiring. “If the price were right, railroads could find more workers.” He said more generally that railroads must fulfill their obligations to the economy as Congress defines it. But they’re still falling far short, as he and his STB colleagues encountered most recently on a trip to the Green River soda ash mines of Wyoming. There, UP has been providing “unreliable and inadequate service” for many months, damaging the businesses of glass manufacturers, lithium battery makers, and so on. Oberman said mines would like to expand and add some 65k railcars worth of additional shipments annually yet haven’t received any commitments from UP regarding its ability to handle the extra volume. Not to entirely pick on UP, he also claimed BNSF was underinvesting in capacity to move finished vehicles, forcing automakers to cut production. There are currently about 70k finished vehicles stranded across the U.S, he said, unable to move to dealers. Might Congress need to re-regulate the industry? This is not 1980 anymore, he suggested with ominous overtones, referring to the year in which the Staggers Act deregulated freight railroads, sending them on a path to mass consolidation, extraordinary profitability, and—some say—lousy service. As for matters that do fall under the STB’s purview, expect a ruling on reciprocal switching very soon—it’s the board’s “highest priority.”
· Speaking at the NARS conference one day earlier, UP’s lame duck chief Lance Fritz defended his railroad’s record, saying it was the only U.S. Class I that grew traffic last year. It also had the second-best operating ratio of all Class Is, and now has average car velocity running above 200 miles a day. “The network is operating as it should.” Fritz also highlighted the new work schedules it just arranged with its engineers. Regarding demand, rough weather has impacted bulk volumes this year. Intermodal volumes are getting help from not only new contract wins (Schneider and Knight-Swift) but also an increase in imported containers moving inland from the west coast (shippers are no longer sending boxes back to Asia upon arriving at ports like L.A., instead sending them inland to look for additional U.S.-originating loads). Along with this bump in IPI intermodal business is “super” strength in rock demand (especially in Texas). Also performing well is the metals business. Auto demand has structurally fallen, but production is growing y/y as supply chain issues get resolved (there should be more auto volume to move regardless of what happens with consumer behavior). Biofuels and renewable diesel are other growing businesses. There’s even a new steel plant coming onto its network in Corpus Christi, Texas (most U.S. steel production happens east of the Mississippi). But still, paper and housing-related shipments are weak, and industrial production more generally remains a big question mark. Fritz separately expressed his views on safety and his confidence that intermodal markets will improve as inventories drop. He discussed UP’s decision to sue the STB over its CPKC approval, its support for the RailPulse initiative, and efforts by the board to find his successor. UP, he assured, will have a new CEO by the end of this year. (One quick fact from UP external affairs director Wes Lujan, addressing an IANA forum last week: UP alone, he said, carries 46% of all Class I hazmat shipments).
· Katie Farmer of BNSF emphasized the industry’s strong safety record, achieved with lots of investment, training, and technology. She spoke of “challenges” with the rail safety bills currently working their way through Congress—any reforms must by data-driven, science-based, measurable, and have a demonstrable impact on safety. BNSF did not offer good service in 2022, she admits. But that’s changing this year, with “more work to be done.” Farmer mentioned some of the investment projects BNSF has underway, most importantly its “BIG” project in southern California, which she insists will remain the fastest and most economical gateway to reach inland ports like Chicago. West coast ports will likely regain some market share after a port worker labor deal, she says. And yes, intermodal markets remain BNSF’s leading avenue of growth opportunity, as it works jointly with J.B. Hunt and others to prepare for future demand.
· CSX chief Joe Hinrichs is becoming a more visible face at investor and shipper conferences, having solidified his views on what his railroad needs to succeed. Most importantly, it needs to provide better service and have better relations with its workers. Everyone except investors “hated us,” he said, and all that resentment is now coming home to roost as Congress, labor unions, regulators, and the general public take aim at railroads for their perceived transgressions. Better relations with these stakeholders, Hinrichs insists, is a prerequisite to profitable growth. By all accounts, CSX is performing exceptionally well operationally, so well as to prompt the STB to remove some of its reporting requirements. A smooth operation, of course, is also great for keeping costs low, even more important Hinrichs says, than any extra benefits he might offer his workers. He boasted of reading all 3,600 comments that came to him from an employee survey, coming away convinced that he needed to make adjustments to attendance policies and sick pay benefits. Such changes are necessary to attracting the “workforce of tomorrow.” Pivoting to an update on business conditions, he said merchandise business is up about 4% this year but intermodal is down about 10%. Coal, auto, grain, aggregates, and metals are all strong. Domestic intermodal has improved a bit in recent weeks. But chemicals, paper, and housing-related shipments remain soft. Labor attrition rates are better but still elevated. Summer staffing levels are a little short of goal. Lots of new business beckons as new industrial sites appear along its network. He called it “humiliating” to not be able to tell customers where exactly their railcars are located, underscoring the need for a solution on visibility (note that CSX has not joined the RailPulse coalition). On a final note, Hinrichs said that 40% of CSX’s traffic interchanges with western railroads, highlighting the dependency North American railroads have upon each other.
· Norfolk Southern’s Alan Shaw gave a detailed account of the East Palestine affair, from the moment he received a phone call in Atlanta on a Friday night in early February, to the situation on the ground today. Among the leadership lessons he’s learned from the experience? Be visible, be personable, and be connected. He thinks the narrative has now turned, with hostility among residents of East Palestine greatly reduced. Shaw says he’s getting more “thank yous” when he visits now, from residents appreciative of the railroad’s remediation efforts. And as he’s always quick to remind everyone, accident investigators said NS employees did nothing wrong, and there was nothing wrong with the railroad’s tracks or wayside detectors. At fault was a wheel bearing in the first car to derail, a car (not owned by NS) that had been handled by three other railroads before entering the NS operation. Last week, NS joined with its 12 unions in jointly committing to rail safety improvements. In the meantime, Shaw has engaged consultants with backgrounds in the U.S. military, including the nuclear Navy, to help improve the railroad’s safety culture. “We’re going to be the gold standard of safety.” Shifting gears, Shaw is no less committed to becoming the gold standard of railroad reliability. “We make one product: Service. We sell one product: Service.” NS also wants to grow, and it won’t stop hiring despite the current “murkiness” in the economic outlook. Chasing lower operating ratios while neglecting service and labor relations is what gave Precision Scheduled Railroading a bad name. But the point is, rail service offers shippers the capacity, the efficiency, and the environmental advantages they will increasingly need. NS in fact just hired Stefan Loeb for the newly created role of vice president to oversee first- and final-mile markets, recruiting him from the Watco shortline empire. Naturally asked about intermodal markets (to which NS has outsized exposure), Shaw says he’s starting to see evidence of inventory de-stocking, and even “a little bit of sequential improvement” in demand. But there’s still a lot of uncertainty surrounding consumer confidence, household debt, housing weakness, and so on. It would be irresponsible he suggested, to say with confidence that intermodal is on the cusp of an imminent recovery. He’s hoping that demand has at least hit its bottom. He said creation of CPKC could be potentially helpful to NS, calling it “stabilizing for the industry.” There’s plenty in the Senate “Vance-Brown” rail safety bill “that makes a whole lot of sense to me.” One of Shaw’s leadership mottos: “Change moves at the speed of trust,” which includes trust among employees and customers. Gone are the days when NS undertook mass layoffs at the first sign of demand distress. “We’re not going to let our service fall apart every three years.”
· Also at the NARS event, Trinity’s chief Jean Savage talked about the merits of RailPulse, the growing trend of lessors owning railcars, and the new and improved railcar models Trinity now builds (i.e., autoracks that can carry larger commercial vehicles). She said the supply chain has improved but is still “nowhere near” as fluid as it was pre-pandemic. Looking ahead, lots of aging railcars will need to be replaced, though not one-for-one because newer railcars can handle more weight and volume. Railcars are becoming lighter too, which saves on fuel consumption—composites are one promising technology to achieve further improvements.
Annual Railcar Orders, 2018-2022
source: Railway Supply Institute
· Another speaker was Adam Nordstrom of Viking Navigation, who lobbies Congress on behalf of shortline railroads. He said the Railway Safety Act of 2023 (the pending Senate bill) is “a long way from becoming law” and describing its focus on Class I carriers rather than shortlines (Congress tends to treat shortlines better). The Senate bill features mandates on defect detectors. It would redefine what constitutes a high-hazard car. It could potentially lead to new rules on train length, though there’s a high probability of that anyway, since the DOT already has authority in this area. The Senate bill would phase out older tank cars earlier. And most controversially, it would mandate two-person train crews. The current version of a House bill meanwhile, includes an increase to the permissible weight of commercial motor vehicles to 91k from 80k. This, Nordstrom says, is an “existential threat for small railroads.” On a brighter note, smaller railroads are benefitting from a “golden age of rail project funding.” (as an aside, the FRA discussed the topic of funding in a webinar last week; you can watch it here.)
· Economist Roger Tutterow of Kennesaw State University gave an engaging overview of current economic conditions, expressing concern about consumer sentiment, notwithstanding a boost from falling gasoline prices. He said retail sales and industrial production have been largely flat this year, adjusting for inflation. Office construction is poised to drop. Bank lending standards have tightened. The strong dollar is a headwind for U.S. firms selling abroad. The Fed’s unwinding of its massive bond-buying effort (to lift activity during the pandemic) threatens to drain the economy of liquidity. Importantly, the pandemic proved an unprecedented shock to labor markets, which is still causing an under-supply of many goods, including autos and household appliances. His pessimism is reinforced by the Conference Board’s leading economic indicators, which have a good track record of signaling a downturn, and which currently, well… signal a downturn. Tutterow is not totally pessimistic though. The drop in energy prices is a big deal, because (places like Texas, Oklahoma, North Dakota, and Alaska aside), cheaper energy is very much pro-growth for the United States. (Note from the market chart above just how much oil prices have declined in the past year).
· Veteran analyst (and renowned baseball super-fan!) Tony Hatch of ABH Consulting repeated his description of the “Great Experiment” now underway, in which railroads are holding onto their employees despite declining traffic. Railroads, he said, are under pressure from service meltdowns, East Palestine, and labor criticism. He’s concerned that growing anti-rail sentiment might lead to new regulations that stunt the adoption of important new technologies like automated rail inspections. He reminded everyone that railroads are not allowed to carry hazmat—they are compelled to. Union Pacific’s new CEO, he said, should be a marketing-oriented person, not an operations-centric person, and thus not Jim Vena, whom activist shareholder Soroban is pushing for. The top job at UP, Hatch adds, is the industry’s version of managing the Yankees, a high-profile position with lots of great advantages to exploit—which have been underexploited in the past. (Hatch says Lance Fritz has presided over multiple “gaffes,” including antagonizing the STB, harping on about its 55% goal for operating ratio, and under-committing on capital expenditure). Hatch is unmistakably bullish on CPKC. He wonders if better service really will beget more business. And he anticipates more FRA rulings that railroads won’t like.
Highlights from last week’s Wolfe Global Transport Industrials Conference
CSX
· Hinrichs, the former auto executive now about eight months into his railroad career, gave investors in New York an updated look at current demand conditions
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