Photography by Frederick Manfred Simon © www.steelwheels.photography
Inside This Issue
· Omaha Stakes: Union Pacific Restructures
· CN Buys a Stake: Makes a Shortline Investment in Nova Scotia
· Building Helps Buffett: BNSF Boosted by Infrastructure Construction
· Boxing Injuries: NS, BN Find Carrying Too Many Boxes Hazardous to their Wealth
· Cold Comfort: Warehouse Firm Americold Trumpets New CPKC Relationship
· The U.S. Economy: As Job Growth Cools, is Rate Hiking Finished?
· Into the Schneider-Verse: Intermodal Giant Sees 2024 as “Transition Year”
· Tanks a Lot: Bulge of Tankers Coming Due for 10-Year Inspections
Track Talk
“Becoming a winning team requires leaders to make courageous and unpopular decisions.”
-Union Pacific CEO Jim Vena
Management Re-Org at Union Pacific
· He wasn’t kidding. Union Pacific’s new CEO Jim Vena said changes were coming—changes to improve the railroad’s service, its operations, its safety culture, and yes, its profitability. Well, last week, he and his colleagues introduced a reorganized management structure, designed in part to “better empower employees to make decisions.”
· Naturally, when an incoming chief announces a re-org, employees quickly fear “layoffs.” Sure enough, UP’s new plan will shrink the company’s management team, with about 5% of current staff affected. Some in this 5%—100 people specifically—will be reassigned to one of 23 “strategic projects.” But the projects will only last for several months, after which these workers will have to reapply for new jobs. Others were offered new jobs in different areas of the company. Still others can only stay if they retrain as craft employees, i.e., engineers, conductors, etc.
· To be clear, front-line craft employees are unaffected by last week’s announcement. Like other railroads, UP is still reluctant to undertake mass front-line furloughs despite the freight downturn, fearing that it won’t be properly staffed for the next upturn. It has done some craft furloughs since Vena’s arrival though, and the new chief speaks with less conviction than some of his peers about avoiding front-line furloughs. As he told Bill Stephens of Trains magazine last month, “Furloughing somebody is always the last thing you want to do. [But] if you truly get to a point, and you’re excess, and it’s for a long time, and you still have a buffer left, and you have that expense, you have to furlough.”
· He’s certainly mindful of the staffing readiness issue though. In a letter to employees last week, Vena wrote, “As leaders identified ways to work more effectively, I also asked them to factor in anticipated attrition and ensure we have a buffer of resources to handle the expected ebbs and flows and cyclical nature of our business.”
· In a separate message to customers a few days before the big re-org announcement, UP’s marketing chief Kenny Rocker perhaps foreshadowed the cuts to come, saying he’d be “remiss if I didn’t talk about the challenges we’re facing on our cost side. We are all seeing inflationary pressures at both home and work. And the new labor agreements… have significant impacts to our costs as well.” Rocker also pointed to demand challenges in “certain pockets of our business.” On a brighter note, he spoke of improvement in some markets. In addition, UP’s service metrics continue to improve, with average train velocity for example reaching 211 miles per day towards the end of October. He also highlighted UP’s nearly $4b in planned investments this year, which will include a focus on expanding the railroad’s market reach by adding more transload infrastructure. More intermodal facilities are likewise part of its investment plans.
· On a lighter note, UP delighted railfans with plans to again showcase its “Big Boy No. 4014” locomotive next year, touring it around its system. It’s the world’s largest steam locomotive and a throwback to UP’s illustrious past.
The Latest
· It was an eventful week for railroads, not just because of UP’s re-org announcement but also BNSF’s earnings (see below), plus a partial shortline takeover by Canadian National. CN will buy a stake in the Cape Breton & Central Nova Scotia Railway from Genesee & Wyoming (which itself acquired it in 2012, and which will continue to operate it going forward). The CBNS runs trains along 145 miles of track connecting the towns of Truro and Point Tupper, both in Nova Scotia. Running south from Truro is CN’s line into the port of Halifax, a major strategic market for the Montreal-based railroad. On the other end, beyond Point Tupper, is an inactive rail line running to the town of Sydney. There’s some talk of building a new container terminal near Point Tupper, which CN might have its eyes on. But that aside, it’s more generally hoping to develop new business in far eastern Canada, especially in the renewable energy space. Forestry has long been big business in the area; one of CBNS’s major customers, according to Saltwire.com, is Port Hawkesbury Paper. Another customer is the Point Tupper Generating Station, which moves coal. Saltwire notes that hydrogen and ammonia plants are coming to the area, which might help explain CN’s interest.
source: G&W
· Several key railroad suppliers and customers reported their Q3 earnings last week, in some cases highlighting rail-relevant developments. Koppers, which sells pressure-treated railroad crossties, continues to make not-so-subtle threats to exit the business. CEO Leroy Ball said, “costs in just about every way you can imagine have gone up significantly.” Some railroad customers have been willing to pay more. But discussions with others “have been more painful, to be quite honest.” Koppers says its rail business “has been in a downward slide since 2017,” partly owing to changes related to the implementation of Precision Scheduled Railroading (PSR). “If we can’t turn it around soon, we will be forced to make some major changes.”
· Americold, which operates temperature-controlled warehouses for food companies, supermarkets, and others, spoke to Wall Street about its new relationship with CPKC, which it considers one of its “key areas of development focus.” An agreement earlier this year enables Americold to build and operate cold storage facilities on “strategic nodes” along the CPKC rail network. Separately, Canada’s AltaGas, which last month renewed and expanded its relationship with Canadian National, said the new five-year arrangement provides “long-term certainty over rates.” He said the rates will be lower than what it was previously paying but do include inflation-indexed escalators. “We feel that we’ve got a very strong contract that gives us certainty.”
· At the STB in Washington, board members set the schedule for reviewing a plan by CPKC and CSX to establish an interchange in Alabama—the plan involves the acquisition of track from the Meridian & Bigbee (MNBR). Interested parties can comment until December 8th. Replies to comments will be accepted until January 8th. The STB, however, hasn’t yet set a date for closing the procedure. Note that the STB considers this to be a “minor” transaction, which entails a much lower bar to approval than say, the giant merger between CP and KCS. In fact, the STB has already said the proposed transactions “would create a new, direct Class I to Class I connection that could provide potential improvements in the efficient movement of existing and future intermodal, automotive, and other interline traffic between the Southeastern United States and the Southwestern United States and Mexico.” In addition, “it could also reduce the amount of traffic that CPKC currently interchanges with intermediate carriers—including with the MNBR at Meridian—and allow certain movements to avoid areas such as New Orleans that are difficult to traverse and susceptible to seasonal weather disruptions… Moreover, adding a new gateway would provide redundancy in the national network and could reduce the economic impact of future outages in other areas (e.g., if rail infrastructure in the New Orleans area becomes unusable for a prolonged period due to flooding). The shorter transit times could also benefit shippers by lowering equipment costs and inventory carrying costs.”
· Expect a lot of additional railroad discussion in the weeks ahead. On Wednesday, CSX CEO Joe Hinrichs will address an investor event in Chicago hosted by Baird. The following week, Stephens and Scotiabank will hold investor forums featuring various railroad executives.
The Economy
· The Labor Department’s Bureau of Labor Statistics published its October employment report on Friday, showing 150k newly created jobs. It’s not as many as September’s 297k (that’s a revised number). But it still reflects a healthy job market, and perhaps one that’s no longer quite as inflationary. On average American workers in the private sector earned $34 an hour last month, or $29.19 excluding workers with supervisory roles (i.e., managers and executives). A year ago, those figures were $32.66 and $27.96, respectively. Rail sector employment was flat from September to October. But two sectors closely linked to rail transport—manufacturing and warehousing—saw major job losses. Manufacturing’s losses, to be clear, were mostly caused by the UAW strike. On the other hand, the care economy (health care, social work, etc.) once again led the economy in job gains. More helpfully for railroads, construction continues to add many new jobs. Government and leisure were other areas of growth.
· Higher interest rates are supposed to be poison for the housing market. Sure enough, the market has in fact stalled, with transaction volumes down sharply. But unlike the housing shock of 2008/09, housing prices in 2023 counterintuitively continue to climb. According to the Federal Housing Finance Agency (FHFA) and its seasonally adjusted monthly House Price Index, U.S. homes were 6% more expensive this August than last August. The explanation lies in extremely limited supply, the consequence of underbuilding for many years. In addition, Americans with cheap long-term mortgages—locked in before rates started rising—are now highly disincentivized to sell. Who wants to trade a 3% mortgage for an 8% mortgage?
· The latest sentiment from purchasing managers, according to the Institute for Supply Management, shows manufacturing again in contraction territory but services still expanding. The stock market, meanwhile, saw big gains last week, helped in part by a drop in oil prices. Railroads very much participated in the stock rally. Investors also sense that the Fed, which held rates steady last week, might be done for good with its hikes. Some think it might even lower rates at some point next year.
· A final note from the American Chemistry Council: Chemical manufacturing shipments, it said, rose 0.5% in September, led by gains in agricultural chemicals and coatings/adhesives. Separately, the ACC said that of all the manufacturing sector construction happening across the U.S. right now, 18% is from the chemical industry. One more fun fact: The largest chemical manufacturing site in the U.S. is Dow’s Freeport complex south of Houston, which primarily produces ethylene used to make plastics. Dow used to run its own rail operation out of Freeport but sold the unit to Watco in 2020. Union Pacific, meanwhile, is a big player in the area.
BNSF’s Q3 Earnings
· Berkshire Hathaway’s BNSF showed a 68% operating ratio for the third quarter, which was again below average for North America’s Class Is. Troubled Norfolk Southern, in fact, fared only slightly worse with a 69% O.R. On the other hand, BNSF’s y/y margin deterioration was relatively mild given the combination of falling revenues and rising non-fuel costs that the industry faced. Last year, its Q3 O.R. was less than a point lower (NS’s O.R. was more than seven points lower—see chart above). One thing BNSF and NS have in common: above-average exposure to the lower-margin intermodal market. Hopefully for them, this exposure will give them an edge when trying to grow in the years ahead. But there’s no mistaking the fact that moving containers and trailers is less lucrative than say, moving chemicals or coal.
· BNSF’s Q3 revenues dropped 12% y/y, more than any other Class I. But its operating costs dropped nearly 12%, also more than any other Class I. The big damage came from its consumer products business, for which revenues plummeted 18% y/y on 7% less volume. This business includes auto shipments, which fared well this summer. But as mentioned, BNSF has heavy exposure to the intermodal business, which was hit by declining west coast imports, the loss of Schneider as a customer (to UP), and “competition from lower spot rates in the trucking market.” The latter affected its domestic intermodal market. Overall, intermodal freight accounts for more than half of all the volume BNSF currently moves.
· The company’s coal revenue declined 15% (on 6% less volume). The problem here was lower natural gas prices, which led power plants to use less coal. BNSF is a major player in the largest coal-producing area of the country, namely the Powder River Basin of Wyoming and Montana. According to the Wyoming Tribune Eagle, the PRB is on pace to yield about 231m tons of coal this year. That would be down from last year’s figure of 238m but slightly up from 2021’s level of 230m. Big coal rail shippers in the PRB include Arch Resources and Peabody Energy. Another is the Navajo Transitional Energy Company, which—you may recall—convinced the STB to force BNSF to provide it with more service.
· BNSF’s Agricultural revenue last quarter fell 9% (on 3% less volume). Domestic grain shipments were in fact up. Ditto for renewable diesel. But grain exports were down, with overseas buyers importing more from Brazil and elsewhere.
· Revenues from moving industrial products, however, declined less than 1%. And volume for industrial products actually increased by about 1%. The all-star sub-market here was construction, boosted by infrastructure spending. On the other hand, BNSF’s industrial products division saw lower demand for plastics, chemicals, sand, and lumber.
· As other railroads made clear, a lot of these revenue declines across different markets stem from lower fuel surcharges, which react to fuel prices (though not immediately). BNSF’s intermodal business surely collected less revenue from storage fees as well. On a positive note, it reported favorable changes in its business mix, meaning a larger portion of what it carried was higher-margin freight (i.e., more autos and fewer intermodal containers).
· Looking at the earnings scoreboard chart above, you’ll see that BNSF’s Q3 labor costs declined 6% y/y. That seems counterintuitive given the new labor contract
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