Market Overview

Railroads Discuss Hedging Against Market Uncertainty

Railroads Discuss Hedging Against Market Uncertainty

Uncertainty about why U.S. rail volumes are down, competition with the truck market and potential mergers and acquisitions were among the themes explored at two investor conferences this week. Here are just a few highlights:

Kansas City Southern

Kansas City Southern (NYSE: KSC) is seeing more volumes move from Mexico ahead of the U.S. deadline to impose import tariffs on Mexican goods, said Jeff Songer, chief operating officer.

"We're seeing a push of volumes ahead of June 10," with more finished autos moving north from Mexico to the U.S., Songer said at the Deutsche Bank Global Industrials and Materials Summit on June 5.

Forty-one percent of the railroad's volumes are cross-border, and about 16 percent of KSC's total carload volumes could be affected should the U.S. start to implement the tariff that U.S. President Donald Trump proposed on May 30 as a way to force Mexico to respond more forcefully against illegal immigration.

If the U.S. puts a 5 percent tariff on Mexican imports, Songer calculated that about 5 percent can be absorbed by the supply chain. But if the tariff increases as it is scheduled to do in the upcoming summer months, "we'll have some diligence to do," Songer said.

Looking at performance indicators, Songer said KSC started running 6,000-foot trains in May, which was one of the company's operational goals for 2019. The railroad is also nearing its terminal dwell goal of 21 hours for 2019. Year-to-date terminal dwell is 21.6 hours, down from 23.1 hours for the same period in 2018.


The trend of big companies like WalMart Inc (NYSE: WMT) and, Inc. (NASDAQ: AMZN) seeking more control of their supply chain is likely to continue, CSX (NYSE: CSX) chief executive officer Jim Foote said at the Deutsche Bank investor summit.

"Is there discussion in the marketplace that some companies are moving to a direct interface with the rails? I think that's just a natural evolution," Foote said. "When someone gets big enough, they don't need the middleman or they want a different kind of relationship.

"I think this is just a natural evolution and we'll see how it plays out," he added.

As to why U.S. rail volumes have been down so far this year compared with 2018, Foote pointed to stronger volumes in 2018, which is resulting in weaker year-over-year comparisons. But he also said market uncertainty is a factor, despite business being as usual with CSX's customers. Customers haven't pulled back on capital projects, for example.

"Trade, the weather, and all kinds of external factors are an issue, but more so an issue in terms of visibility. There is and has been a whole lot of noise for the first five months of the year, in trying to get a sense of why we are slightly below [where we] expected them to be," Foote said at the UBS Global Industrials and Transportation conference on June 6. Meanwhile, devastating weather in the Midwest has compounded that uncertainty, he said.

"It's just a confusing time for all of us in transportation and anybody in manufacturing or business in general to have a really good sense of why we're seeing this kind of softness," Foote said.

U.S. tariffs on imports of certain goods from China have actually benefited CSX's traffic volumes because the tariffs have spurred increased production of domestic coal, steel and iron ore, Foote said.

Meanwhile, CSX has been demarketing lanes tied to a short-haul regional intermodal strategy that it deployed pre-PSR, constituting a 15 percent loss in intermodal volumes since late 2017, Foote said. As a result, CSX's intermodal volumes have been trending lower overall, he said.

Norfolk Southern

Norfolk Southern (NYSE: NSC) has begun initial roll out of the next phase of its precision scheduled railroading program, but it will fully turn on the "TOP21" program on July 1, chief executive officer Jim Squires said at the UBS conference on June 5. The railroad is seeking to improve network fluidity and velocity, reduce circuity and have fewer train starts and crew starts as a result of TOP21. It began developing the TOP21 program last year using computer modeling and simulation tools to analyze data and train flows, the company has said.

Norfolk Southern will have "one big network cutover" to switch to this next phase, Squires said. This phase will focus on the railroad's general merchandise market.

Norfolk Southern has turned on a few locations, such as Harrisburg, Pennsylvania, to test out the system. Once TOP 21 is fully in place, nodes like Harrisburg will see heavier volumes passing through.

When asked about the competing truck market, Squires said Norfolk Southern has contract business with channel partners, and so it is less exposed to the spot market for trucks. Channel partners though are more exposed to the spot truck market, which has been loose, and so NSC's partners are hoping for the spot market to tighten in the second half, he said.

Canadian Pacific

Canadian Pacific (NYSE: CP) chief financial officer Nadeem Velani said consolidation between the North American railroads could still happen, particularly as almost all the railroads have implemented some form of precision scheduled railroading.

"We've been vocal advocates for consolidation," Velani said at the Deutsche Bank investor summit. "Running two networks as one could result in greater capacity and better service for customers."

As demographics change and the highways become more congested, two railroads could consolidate as a way to become an even more attractive shipping option, Velani said. Consolidation would allow railroads to increase capacity with limited investment, he said.

"One day, it will be the right thing to do from a North American transportation system point of view," although whether it will occur two years or five years or 10 years from now remains to be seen, Velani said.

Consolidation also comes from weakness or from when a railroad might be struggling, and "right now, it's not that point in time," Velani said.

Canadian National

Canadian National (NYSE: CNI) expects operational cost savings of C$200 million to $400 million over the next three years in large part because of how it will be deploying technology. Technological tools, such as those to help with track inspection, can result in lower maintenance costs over time and enable CNI to be more predictive than reactive in addressing safety and maintenance issues, said Keith Reardon, senior vice president of the consumer product supply chain.

The railroad also expects to reduce operational costs through efforts to bring more new, fuel-efficient locomotives online and return leased locomotives, which are less fuel efficient, Reardon said at the Deutsche Bank conference.

Investing in technology is one of three elements in its capital strategy. Another is investing in infrastructure, such as enabling containers to move faster through ports, and the third is a "feed-the-beast" play consisting of potential mergers and acquisitions of short line railroads or intermodal or trucking assets, according to Paul Harridine, vice president of procurement and supply management.

When asked whether large shippers work with CNI directly instead of with intermodal marketing companies, Reardon said CNI has two supply channels, one for retail and the other for wholesale to beneficial cargo owner.

This division "is not new to us. It's been very successful for us and we'll continue down that path," Reardon said. "As there are ebbs and flows in capacity, we can smooth our risks on the upside and downside with those two channels."

Union Pacific

Bad weather has dampened Union Pacific's (NYSE: UNP) second quarter volumes, which are down 3 percent so far compared with the same period in 2018.

Flooding is impacting routes in Kansas, Oklahoma and Arkansas, and the railroad has put some embargoes in place, with some of that affecting intermodal business, according to Jennifer Hamann, senior vice president of finance.

The railroad is expecting volumes to improve in the second half of 2019, in part because of favorable comparisons between 2018 and 2019. Hamann said at the Deutsche Bank conference.

Union Pacific is in the middle stages of implementing Unified Plan 2020, its version of precision scheduled railroading, and as a result, it is looking at additional terminal rationalizations and opportunities to consolidate assets such as intermodal facilities, locomotive shops and railcar facilities.

"There's really nothing that's off limits," Hamann said.

Image sourced from Pixabay

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