Inside this Issue:
· Beware of the Chair: STB Chairman Says Railroads Still Not Doing Enough
· Freight Still Great: No Signs Yet of Weakening Demand
· The Chassis Challenge: Why the Shortage?
· Summer Coal Crunch? Railroads Warn of Short Supplies
· Short Line Profile: Pennsylvania’s Reading & Northern
Track Talk
“For the most part, the responses have been woefully inadequate and to some degree insulting.”
-STB chair Marty Oberman, asked (at an NITL Summit) about railroad service recovery plans
The Latest
· Just in case you weren’t sure, now there’s no doubt. STB chairman Marty Oberman is not happy (that’s putting it mildly). He’s not happy with America’s Class I railroads, specifically BNSF, Union Pacific, CSX, Norfolk Southern, and their inability to meet shipper needs. Responding to a question from Railroad Weekly at last week’s NITL Summit, Oberman said flatly that he’s seen no meaningful improvement in service since the STB held hearings on the matter last month. The railroads themselves, conversely, are telling investors that things have in fact improved at least some. Oberman, furthermore, sounded wholly unimpressed by what he’d seen of the recovery plans each railroad submitted on May 20th. He called them “woefully inadequate” and “to some degree insulting.”
· The feeling is that railroads aren’t taking the STB’s admonishments seriously enough, risking the regulator’s ire. After all, in an industry structurally predisposed to foster extremely high profit margins, the single biggest risk is arguably new regulations that alter that structure. Executives, for their part, insist that current service issues are not for lack of trying, nor lack of caring, nor lack of effort. Simply put, railroads faced a once-in-a-century pandemic that initially looked like it might cause a major economic crisis. So they downsized their workforce accordingly. Little could they know that demand would instead come roaring back, and that restaffing would be challenged by an ultra-tight labor market and subsequent waves of the Covid virus. They’re now re-hiring as fast as they can, the executives say, pledging to operate more reliably once hiring plans are complete.
· What else are railroads saying? They presented to investors again last week, following up on the prior week’s Bank of America event with another hosted by Wolfe Research and its transportation analyst Scott Group. Again, the Class Is in both the U.S. and Canada spoke bullishly about the remainder of 2022, with demand across most categories of rail freight still booming. That implies ongoing pricing strength, helping to offset higher labor and material costs. We’ll hear again from railroads this week, at an investor event hosted by Bernstein.
· The U.S. economy is indeed holding up well, with retailers, banks, Census data and service sector companies like airlines all pointing to resilient consumer spending. That’s putting wind in the sails of the consumer-oriented intermodal market (not to mention the consumer packaging market). Commodities and other raw materials, meanwhile, are in high demand and short supply, buttressing the market to move everything from chemicals to fertilizer to farm output. The auto market remains hobbled by a semicon shortage but getting better. The housing market is clearly slowing but certainly not crashing 2008-style. The latest S&P Global update from purchasing managers in the manufacturing sector described “strong and steep expansions in output and new orders respectively, alongside a faster upturn in employment.” It said, furthermore, that supply “bottlenecks showed further encouraging signs of easing.”
· At the same time, the economy faces many “storm clouds,” a term used by JPMorgan Chase, the largest U.S. bank. Inflation is first and foremost among them, making everything from labor costs to consumer products to home mortgages more and more expensive. Will it be enough to tip the U.S. economy into recession? That’s the trillion-dollar question.
Highlights from the National Industrial Transportation League (NITL) Annual Summit (held virtually)
· The NITL, an advocacy group, calls itself the “shipper’s voice.” No surprise then, that its members are seething at railroads and their unreliable service this spring. The shippers clearly have sympathy from STB chairman Marty Oberman, who addressed the summit. He immediately made clear that he views the current rail service issues as a “crisis,” and one that’s affecting the entire economy—he even thinks it bears some responsibility for the current inflation crunch. On Friday, May 20th, BNSF, Union Pacific, CSX and Norfolk Southern sent the STB their plans for service recovery, detailing efforts to add workers and remove railcar inventory, for example. Oberman didn’t seem impressed, calling the plans “woefully inadequate and to some degree insulting.” He recounted how the four U.S. railroads reduced their headcount by some 45,000 since the start of the PSR era a few years ago. When the pandemic hit in March 2020, they cut another 11,000 jobs, leaving them without any slack to handle a recovery (which started to become evident around June of that year). In the two years prior to the pandemic, he added, railroads saved $4b in payroll costs thanks to their job reductions. But they spent $37b over that same period on stock buybacks and dividends. It’s not just the STB that’s upset. So is the White House and many members of Congress, he warned, highlighting a recent letter signed by a bipartisan group of prominent Senators. The railroads and their bad service, Oberman joked, have managed to unite the country politically. “I don’t think the Class Is have gotten the message about how serious this is?”
· Does Oberman blame Precision Scheduled Railroading? Not per se. PSR as a means to boost efficiency has some merit, he acknowledged, recalling his days in 1970s Chicago when unions insisted that sanitation trucks be manned by no fewer than four people. Employee downsizing, in other words, can sometimes make good economic sense. But not when used as a “mask” to cover for gains funneled to Wall Street. He wonders whether the Big Four U.S. railroads even want much of the local business they pick up—maybe the STB needs to start taking business away from the Class Is, he suggested. He also raised the possibility of new fines and other penalties to compel the big railroads to improve. His suspicions even extend to data integrity, wondering aloud if companies might be manipulating information that’s shared with customers and regulators. Labor relations too, are a sore spot for Oberman, who mentioned BNSF’s “superficial” modification of its controversial new attendance policy, one he thinks might be driving workers to leave the industry. The STB, however, moves slowly, he admits, not least because of all else that’s on its agenda at the moment—the CP-KCS merger, the Amtrak Gulf service application and so on. In summary, Oberman is unmistakably upset about the current state of freight rail service and unimpressed with efforts thus far to improve.
· In a separate discussion at the NITL event, FTR’s Todd Tranausky, speaking with Ross Corthell of the Packaging Corporation of America, gave an update on industry trends. He started with—what else—the current service issues, noting that reported dwell times can be a misleading indicator of progress, because they only pertain to dwell times for cars at railroad facilities. Nobody, Tranausky says, wants to go back to the 1960s and ‘70s—not shippers, not regulators, not the railroads themselves. Those were the dark days of mass bankruptcies. Stakeholders thus need to find a “middle road.” Everyone also seems to want many of the same things: A rail network that’s growing, that’s efficient, that’s environmentally friendly and that’s mostly self-financed. But there’s simultaneously an age-old natural economic tension between railroads and shippers that’s never going to disappear, requiring the STB to sometimes get involved. The language of the documents that govern what the STB can do, he adds, is rather permissive, with widespread use of the word “may.” Railroads in other words need to be wary of its power.
· Turning to business conditions, Tranausky said carload shippers are currently seeing price increases in the 6% to 7% range, though FTR expects that to drop a few points as the year progresses. Intermodal rates have already started easing but from very high levels—not long ago, intermodal rates were increasing at a 10% to 15% clip. He ends with a few warnings: One is that past railroad mergers have almost always resulted in some degree of service disruptions, so shippers need to keep an eye on developments with Canadian Pacific and Kansas City Southern. In addition, railroads have long been reluctant to share data with shippers but need to recognize that data transparency has become a key feature of the modern economy. He invoked the proverbial pizza order and being able to track even that in real time.
· A panel on managing rail fleets featured executives from CIT, Exxon Mobil and Trinity (a lessor, a shipper and a manufacturer, respectively). CIT’s Jeff Lytle said railcar velocity in the system currently stands at about 22.5 miles per hour, compared to 27-plus before the pandemic. Supply of most car types are tight, especially those carrying coal, for example. Box cars are in high demand, as are large covered hopper cars for things like grain and fertilizer. Upcoming environmental regulations will further tighten supply. Another factor is the high price of scrap metal, encouraging owners to dispose of their cars. On the other hand, if lease rates continue to increase, the keep-vs.-scrap incentives could reverse. Lytle expects the number of newly built cars to exceed the number of scrapped cars this year. He also thinks orders might pick up for covered hoppers, refrigerated boxcars, cars handling renewable diesel fuel and perhaps tankers as regulations kick in. Environmental concerns will more generally add momentum to new railcar ordering. So would higher diesel fuel prices which tilt the competitive advantage to rail over truck. But panel moderator Dick Kloster of Integrity Rail remarked that railcars are still “dumb assets” that need to be upgraded to convey more data. Carole Bradley of ExxonMobil stressed that even a small one-to-two mile per hour reduction in train speeds can equate to many fewer railcars needed to move the same volumes. There’s a critical link, in other words, between a railroad’s service and the demand for railcars. Eric Marchetto of Trinity, echoing some of the same points, cited three main drivers of the current railcar supply tightness: 1) more than 50,000 a year are getting scrapped, 2) carload volumes are up and 3) train speeds are slowing and the response has been to “throw more equipment at it.” He cautions furthermore that those upcoming regulations (pertaining to ethanol requirements, for example) will boost demand for railcar maintenance and modifications, at a time when steel prices are high and labor scarce.
· The title of this year’s NITL summit, by the way, was “Navigating the Supply Chain Chaos.” One aspect of that chaos is the shortage of chassis, the topic of another panel. Jon Eisen from the American Trucking Associations unpacked the reasons for the shortage, detailing America’s unique ownership arrangement in which Intermodal Equipment Providers rather than trucking companies own most of the chassis (which just to be clear, are the wheeled frames used to move containers). A major cause of today’s shortage is the 200% tariff the U.S. imposed on Chinese-built chassis before the pandemic, which left a vacuum that U.S. producers have been unable to fill.
Highlights from the Wolfe Research Transportation Conference in New York City
Union Pacific
· Like other North American railroads right now, UP stressed that it’s seeing “more demand in the marketplace than we’re shipping.” That’s especially true in the company’s bulk network, which includes coal and grain. What’s more, UP says the outlook continues to look strong, with consumer buying behavior resilient despite mounting economic headwinds (higher prices, rising interest rates, ongoing supply shortages, etc.). One by one, CEO Lance Fritz and ops chief Eric Gehringer spoke optimistically about each area of UP’s business, including intermodal and autos, both still challenged by supply-side bottlenecks. Demand for shipments related to the housing market continues to hold up despite suddenly declining home sales. Ditto for demand to move metals, rock, gravel and cement, even before infrastructure spending takes off in earnest with Washington’s trillion-dollar spending bill. Industrial chemical shipments are another bright spot.
· To be clear, UP is still moving less freight this year than it was last year, again the consequence of supply-side issues, not lower levels of demand. Carload volumes through May 19th were down 3% y/y, even as bulk volumes were flat and industrial volumes up 4%. The drag was in the premium market, where intermodal and auto freight dropped 7%.
· UP is sticking to the financial guidance it shared with Wall Street during its Q1 earnings call. But admittedly, hitting its operating ratio target is becoming more difficult as diesel fuel prices skyrocket. Yes, railroads can recover higher fuel costs through fuel surcharges. But not immediately.
· During the first quarter of 2022, UP was the only Class I railroad in North America to post an operating ratio below 60% (it was 59.4%). It was one of only three (along with CSX and Canadian Pacific) to achieve the same feat for all of 2021. And even then, its 57.2% figure was best in the industry. At last week’s Wolfe event, Lance Fritz specifically mentioned UP’s margin superiority over western rival BNSF, which he attributed to a significant cost advantage.
· Industry-high margins and industry-best operating margins are not—this is an important theme right now—the only thing railroads care about. If they did, margins could easily be fattened in the short run by reducing less lucrative activities like intermodal transport. But the point is, railroads intend to grow not shrink, pressured by demands from stakeholders other than Wall Street, specifically regulators, legislators, customers and their workers. As it happens right now, the decline in international intermodal activity due to port congestion in southern California means UP’s mix of business is becoming more heavily weighted with higher-margin activities, like grain and industrial product transport. That should reverse later in the year, however, as intermodal movements increase, which implies a coming headwind for OR.
· What’s the latest on UP’s service recovery? Car inventories are dropping following difficult conversations with customers—they’re now down about 7% from their April peak. Freight car velocity is up to 191 miles per day, from about 177 in early April but still down from above 200 in January and February. Critically, staffing continues to increase, citing “great progress” in the last 45 days.
· As for the industry’s contract talks with unions, Fritz downplayed hopes of a near-term agreement, though involvement of federal mediators should help accelerate talks. His best guess is that the matter will end up with a Presidential Emergency Board (PEB) sometime in the third or fourth quarter of this year. Before that happens, the National Mediation Board would have to determine that “further mediation will not help the parties reach agreement,” and that either party or both decline the option of binding arbitration. That would trigger a 30-day cooling off period, after which unions could strike if they wished. Unless that is, President Biden establishes an emergency board to review the matter, which is perhaps likely given the disastrous impact a nationwide rail strike would have on the U.S. economy. Asked about the controversial topic of removing conductors from trains, Fritz replied: “I still believe there is a chance for single-person crews.”
· Back in the commercial realm, UP’s pricing remains strong, supported by the high rates trucks are increasingly forced to charge as diesel fuel prices soar. That’s keeping prices up when domestic intermodal contracts come up for renewal. And speaking of the domestic intermodal business, UP sees lots of growth ahead with trucking partners new and old, including Schneider, XPO and Hub. J.B. Hunt, remember, has since aligned itself with UP’s rival BNSF.
· In the meantime, UP is watching developments at the L.A.-Long Beach port complex, where turn times for boxes and chassis remain slow. UP itself has a few thousand boxes at the ports that need to be cleared. Management is working to ensure against a repeat of when its inland intermodal terminals and warehouses were overwhelmed last year. And it’s of course keeping a close eye on labor talks involving the ILWU union.
· On regulatory matters, Fritz said railroads can take the heat off with better service. But until then, he worries about new regulations he considers counterproductive, including forced reciprocal switching. That will add complexity without solving anything, he said.
CSX
· Former CFO and current marketing chief Kevin Boone said what all the railroads are saying: That there’s “more demand out there than we’re meeting.” CSX is hiring aggressively and now stands just a few hundred workers shy of its goal of 7,000 active crewmembers. He’s confident that service problems have “bottomed,” implying ongoing improvements going forward. He did warn, though, that summers can be challenging from a staffing perspective, with higher rates of absenteeism and more people taking vacations. The service issues, he made clear, are indeed about staffing levels, not locomotive availability—if anything CSX has more locomotives than it needs.
· Coal is a big topic for CSX, responsible for 14% of its total revenues—that represents the highest coal exposure of any Class I railroad. The story right now will sound familiar—surging demand but limited supplies. Boone warned of potential power shortages across the U.S. this summer, with utilities in some cases down to single-day stockpiles of coal. One issue is that coal producers are incentivized to export abroad, lured by extremely high prices as markets like Europe and India clamor for energy. At the same time, coal mines have had trouble increasing production, due to labor and other disruptions. Of course, few investors were putting any money into coal production these past few years, anticipating the carbon-heavy sector’s looming extinction. Little did they anticipate the events of 2022, including Russia’s invasion of Ukraine, which whipped commodity markets into a frenzy. In any case, CSX makes clear that it doesn’t own any coal itself, so it can’t decide where to move supplies. But it will prioritize trains moving domestic coal to help avoid those summer blackouts. Its fire-damaged coal export facility in Baltimore, by the way (Curtis Bay), should be fully back online in September.
· One trend CSX is watching is whether America’s Asia-focused commodity exports increasingly shift east, assuming more U.S. products like energy, steel and food move to Europe instead. Put another way, U.S. overseas trade will perhaps become more Atlantic oriented and less Pacific oriented. For that to happen though, CSX and its customers would need to invest in infrastructure upgrades. Today, for example, CSX doesn’t have a wheat export franchise. So it would have to develop one.
· Boone definitely doesn’t see signs of a recession, with merchandise orders “very strong” and domestic intermodal growth held in check only by shortages of trucks, chassis and containers (investments in these areas are helping though). He sees international intermodal remaining strong at least through the summer, with more shippers using east coast rather than west coast ports. Auto volumes should continue to recover as low dealer inventories need to be replenished. Railroads should win more business thanks to inflation, which makes customers more price-sensitive and thus more amendable to shipping by rail versus truck. A desire to cut carbon emissions also helps railroads win business. Same for the onshoring/nearshoring phenomenon CSX anticipates, referring to U.S. manufacturers moving more of their production to sites within North America to enhance supply chain resiliency.
· Interestingly, Boone noted the recent comments by Walmart and Amazon that they were overstaffed last quarter. This, he said, could be a sign of loosening labor markets that might help railroads recruit more workers. He also reminded investors that it’s not just the railroads experiencing labor shortages—their customers are short-staffed as well.
· CSX, like others, unequivocally wants to grow its domestic intermodal business, recognizing that Norfolk Southern has a larger slice of this market in the east. One potential growth area is the busy Interstate 95 corridor running from the northeast to Florida. The company is separately working with BNSF and UP to interchange more intermodal traffic moving east from the western half of the U.S.
· A few other points: Boone says railroads and the STB are aligned on most matters, including their desire to move more freight, hire more people and shift more cargo from trucks. CSX is not seeing the softness in spot market pricing that trucks are starting to see. The acquisition of Pan Am in New England won’t have a big impact on CSX’s bottom line in the near term but sees that business growing faster than the rest of the network. The company is not actively pursuing any additional takeovers right now.
Norfolk Southern
· CEO Alan Shaw, alongside CFO Mark George, mostly echoed what UP and CSX said about demand, service, staffing and pricing. Shaw said service at NS has stabilized but still “absolutely not where it needs to be.” The good news with respect to labor is that engineer and conductor headcount is no longer in decline as the addition of newly-inducted employees outpaces attrition.
· Shaw called the near-term outlook for coal “tremendous,” with volumes down y/y but only because of last year’s abnormally high figure, and because of this year’s production shortcomings. Chemicals, and especially energy-related chemicals, are an area of strength. But so is pretty much everything else—other commodities, manufactured goods, agricultural goods, consumer goods, etc. Intermodal demand, meanwhile, is “white-hot.” Forecasters see light vehicle auto production in the U.S. rising 19% y/y for the remainder of 2022 as chip availability improves. NS, remember, has the railroad sector’s largest auto exposure thanks to all the vehicle plants throughout its southern and midwestern turf. It’s a hot area for business development at the moment, with U.S. and foreign manufacturers alike spending billions to establish new electric vehicle and battery plants. Korea’s Hyundai just announced a new $5.5b plant near Savannah, Georgia, scheduled to open in 2025. (NS will get some of that auto business via the Georgia Central Railroad, part of the Genesee & Wyoming family of short lines).
· NS is in the midst of reviewing its operations, seeking productivity improvements at each of its major geographic locations. It began with a close look at its intermodal franchise, where it hopes to free up more capacity for more train frequencies and by extension, more overall revenue growth.
· Sounding bullish on the future, Shaw said “we’re gonna see a lot of margin improvement, particularly in the second half of this year.” That assumes service improves, which has the double benefit of boosting revenues and lowering costs. Operating ratio should be in the 60s, though fuel is definitely a short-term OR headwind.
· Shaw is hopeful NS won’t have to buy any more current-generation locomotives, extending the life of its existing fleet with A/C power conversions, and getting more usage out of its current fleet by increasing velocity. The next locos NS will buy, ideally, will be powered by a clean energy source, be it electric batteries, hydrogen or some other technology.
Canadian National
· Executives Ghislain Houle and Doug MacDonald boasted of CN’s three-coast network, while underscoring efforts to boost profit margins under new CEO Tracy Robinson. Among those efforts is a review of its four large hump yards (in Memphis, Chicago, Winnipeg and Toronto) to optimize for on-time departures, block integrity and connection performance. It’s doing the same type of review now at its flat-switching yards (Vancouver, Prince George, Montréal and Fond du Lac). Already, they say, signs of improvement are visible as velocity improves.
· Demand is “very, very strong,” with no apparent weaknesses anywhere. Auto shipments are running well ahead of last year’s volumes, with new EV plants coming online. Coal is going “gangbusters,” both out of the U.S. and out of western Canada (where two mines recently reopened). The domestic intermodal business is “super strong” and effectively sold out (aided by the difficulties truckers are facing with the diesel fuel shock). As for the overseas intermodal business, that’s still “bumpy” due to supply bottlenecks but nevertheless strong. Another wave of boxes from Asia is anticipated as China’s port capacity frees following Covid lockdowns around Shanghai. Even the grain business, while hit hard by Canada’s rough harvest last fall, has been “great” in the U.S. There’s a backlog of forestry products like pulp and paper that has to move, so things should remain busy there even if demand slows. CN can’t get enough cars meanwhile, to handle all the demand for moving metals and minerals. Add petroleum and chemicals to the list of strong areas as well. It’s hard to sound any more bullish than that.
· At the Bank of America investor event a week earlier, Robinson made clear her intent to “curate” CN’s book of business, reviewing which customer contracts it wants to renew, and which business it would rather forego. The point is, it has less capacity than there is overall demand, and it wants to make sure it’s not displacing high-margin shipments with lower-margin ones. Sure enough, CN is not taking as much intermodal business as it could, leaving room on the network for more profitable shipments.
· CN has more unused capacity in the eastern part of its network—the west is where operations are more strained. With this in mind, it’s hoping to lure more Asian intermodal business through its Halifax port. It would like to see more come through its Mobile port as well, located in Alabama along the Gulf Coast.
Canadian Pacific
· Keith Creel is nothing if not excited about taking control of Kansas City Southern. The CP chief waxed dreamfully about the many opportunities he sees, enough to likely “blow by the $1b in synergies” it promised investors. One of several examples he gave was a CP grain train from Manitoba carrying wheat to Mexico City. That’s a lengthy 3,000-mile haul taking 9.5 days each way. Currently, it’s done with 110 cars, about 25 shy of “the sweet spot,” in other words, what’s economically optimal. Creel speaks of running a 135-car train along the combined CP-KCS network, which wouldn’t require any more locomotive power or any additional crew. “That’s how you create margin.”
· Another opportunity is KCS’s Meridian Speedway joint venture with Norfolk Southern. That line extends to Dallas, around which KCS has abundant land to develop new infrastructure—a transload facility, perhaps, to move Canadian lumber to the giant and fast-growing north Texas housing market. Separately, Creel called Mexico “the fruit basket of North America,” highlighting all the produce currently moving north by truck, complementing all the U.S. and Canadian protein moving south. He’s hoping to develop more potash exports alongside partners like Canpotex, the number one producer in the world (visit its website and the first thing you’ll see are images of CP railcars carrying its output).
· Not all these opportunities will be realized in 2023, even assuming the STB approves the takeover early next year. It will take time to invest in the necessary launching and landing infrastructure. Early on though, CP and KCS will establish what it’s calling a Chicago-Laredo speedway down to Mexico. It’s already offering intermodal steamship service from Asia to Chicago via Mexico’s Lazaro Cardenas port. Port Saint John, meanwhile, the largest on Canada’s east coast by volume, is expanding, heralding more eastern intermodal expansion for CP (which reestablished its Atlantic presence with the 2019
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