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Railroads Face Major Challenges To Jump-Start Their Intermodal Business

Railroads Face Major Challenges To Jump-Start Their Intermodal Business

Not all that long ago, say 2015 to 2017, it was the best of times for the railroads' intermodal business. These times are not like those times.

The railroads have been mired in intermodal red ink all year long. Traffic is down 3.3% year-to-date, according to the Intermodal Association of North America (IANA). As of the week ending October 12, the volume of containers and trailers was down 6.6%, according to the Association of American Railroads (AAR). 

Intermodal has hit some dubious benchmarks so far this year. Through mid-October, domestic container traffic – the bulwark of the segment – was off 5% to 6%. Domestic container volumes didn't decline even during the 2008-09 financial crisis, said Larry Gross, who runs an intermodal consultancy. Intermodal's share of long-haul dry van traffic declined relative to truckload for four consecutive quarters through the second quarter, which Gross called an "unprecedented" development. The declines are especially striking since long-haul coverage is the railroads' wheelhouse. (Gross noted that recent long-haul trends indicate that railroads' share has stabilized.)

A deeper look under the intermodal hood exposes some of the difficulty that the railroads have faced. Domestic container traffic controlled by so-called private firms such as C.H. Robinson Worldwide Inc. (NASDAQ: CHRW) and J.B. Hunt Transport Services, Inc. (NASDAQ: JBHT) is down year-to-date by under 2% compared to the same period in 2018. Railroad-owned and controlled container volumes, by contrast, are down 12.7%, Gross said.

The blanket explanation for the weakness is that problems exist in the railroads' price-service balance relative to truckload carriers, whose rates are comparable to intermodal for what is considered a superior service. Rail intermodal is typically late to the price party, with the railroads raising intermodal prices after the market is well into a rate correction, said Rick LaGore, CEO of InTek Freight and Logistics, an intermodal marketing company (IMC) that works with the carriers. They are also late on the back end, dropping rates as a turn is imminent, LaGore said.

Precision scheduled railroading (PSR), which in theory is aimed at providing rail customers with a consistent and reliable service, has at the same time allowed the railroads to streamline their networks and eliminate lanes. This may be beneficial to the railroads, but it may foreclose service options for shippers. The railroads are focusing on PSR to optimize their operations, yet those benefits have yet to be extended to shippers, Gross told the Journal of Commerce Inland Distribution 2019 conference October 22 in Chicago.

Rail executives could also be stubborn, prideful creatures. They are convinced of the value they create and the efficiencies they foster, and are loathe to cut rates in the face of challenging market conditions. At the start of 2019 when intermodal requests for proposal hit the street, customers were met with quotes that, in many cases, were higher than what they could get in what was a weak truckload non-contract, or spot, market. 

Ron MacDonald, senior vice president of marketing for multi-modal company Cornerstone Systems, said the railroads were convinced that the macro weakness felt at the start of the year – especially after so many businesses had moved inventory into the U.S. ahead of threatened January 1 tariffs on Chinese imports – would reverse by April or May, leaving the railroads with pricing power. That didn't happen, and railroads found themselves on the short end of the rate stick, he told the JOC conference.

Another challenge for the railroads and the IMCs is J.B. Hunt, which offers what LaGore said is a compelling value proposition for big shippers, particularly in a market with relatively loose capacity. Hunt pitches what is tantamount to a dedicated service in which it will take care of all of a customer's intermodal requirements. Hunt also backs up its pledge with unmatched directional flexibility in its intermodal network, LaGore explained. In return, customers can't cherry-pick lanes, meaning they must be all in with Hunt, according to LaGore. "Hunt is the 1,600-pound gorilla in the room," said LaGore. "They are very good at what they do."

The domestic macro outlook doesn't appear favorable to intermodal. Paul Bingham, director of transportation consulting, economics and country risk for consultancy IHS Markit, forecasted at the conference that U.S. GDP will continue to drift lower through 2022, bouncing around the 2% level during that time. Bingham cautioned that economic activity could decline further than that, which would carry negative implications for freight.

Gross said there will be "no meaningful recovery" for intermodal in 2019, and he remains very cautious on the 2020 outlook. No one at the conference said there has been anything resembling an autumn seasonal peak.

The trucking ecosystem won't stand still either. New and incumbent players are leveraging technology to improve asset utilization. There's much low-hanging fruit; Shelley Simpson, Hunt's executive vice president, chief commercial officer and president of highway services, said that about one-third of all capacity is currently underutilized. A more efficient trucking industry means better service at competitive rates, neither of which bode well for the railroads.

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