North American Railroads Chart The Course For 2020

Recent weakness in carloads and expectations for the fourth quarter of 2019 and beyond were key topics as several management teams from North America's largest Class I railroads gathered at the Credit Suisse 7th Annual Industrials Conference in Palm Beach, Florida, on Dec. 4.

Current Market/Volumes

Jim Foote, President and CEO at CSX Corp. CSX agreed with the term "less worse" when describing current demand. He said he hasn't seen anything to change his outlook for 2019, which was lowered from a modest revenue increase to a modest 1-2% decline during the summer.

Heading into the fourth quarter of 2019, Foote thought coal would see declines of more than 10%, but those declines have accelerated recently. Through the week ended Nov. 30, CSX's coal carloads are 17.2% lower quarter-to-date but still well off the heavier declines earlier in the year (-38.3% year-to-date). Lower energy and natural gas prices are impacting utility coal while metallurgical coal is being negatively impacted by declines in the global economy, resulting in lower steel production.

Coal Carloads (Class I US Railroads) – SONAR: RTOCO.CLASSI

Total Carloads (Class I US Railroads) – SONAR: RTOTC.CLASSI

Canadian National CNI President and CEO JJ Ruest was a bit more upbeat on volumes even though his company has seen carloads drop significantly due to the recent eight-day strike by roughly 3,200 of its conductors, trainspersons and yard workers. In the latest reported week, CN's carloads declined 20% year-over-year and revenue ton-miles were 35.8% lower. So far in the fourth quarter, CN's reported carloads are 8.9% lower, with revenue ton-miles declining 16.7%. This prompted management to lower its full-year 2019 adjusted earnings guidance earlier this week.

Management now expects 2019 earnings per share (EPS) to increase in the low-to-mid single digit range for 2019, lower than the company's prior guidance calling for high single-digit growth. CN estimates that the strike will result in a C$0.15-per-share negative impact to earnings as available network capacity declined by 90% during the walkout.

A Canadian dollar equals US$0.75.

Ruest said he doesn't anticipate a "full peak" season this year as the containers that arrived at the key intermodal ports of Prince Rupert and Vancouver were not as robust as hoped.

Total Carloads (Canada) – SONAR: RTOTC.CAN

Canadian Pacific CP President and CEO Keith Creel said October was a "little disappointing," but he believes that revenue ton-miles bottomed in November when they were down 11% year-over-year. Through the end of November, revenue ton-miles are down only 6.4% for the fourth quarter, and Creel said he believes the company can recoup this in the weeks to come. All in all, he expects flattish results and feels comfortable with the company's guidance.

Rob Knight, chief financial officer at Union Pacific UNP and his Jan. 1, 2020, successor, Jennifer Hamann, current senior vice president of finance, noted that carloads were down 11% quarter-to-date compared to their prior expectations of a 10% decline.

Quarter-to-date carloads of coal (-23%), sand (crushed stone, gravel and sand down 16%) and intermodal (-13%) were noted as the culprits. Management said coal remains in secular decline, excess truck capacity continues to be a headwind to the intermodal franchise, and demand didn't increase like it normally does in peak season.

Kansas City Southern KSU Chief Operating Officer Jeffrey Songer and precision scheduled railroading (PSR) head Sameh Fahmy presented on behalf of KCS. Songer said KCS continues to benefit from growth in chemical and petroleum carloads given Mexico's progress on energy reform and that improving rail service has been a tailwind for industrial and consumer carloads. Songer noted that auto movements related to the GM strike were a headwind in the quarter and that intermodal traffic hasn't been as strong as they expected heading into the quarter.

2020 Outlook

No one will provide official earnings guidance for 2020 until January, but a few management teams provided some framework around expectations for the upcoming year.

UNP's Hamann said 2020 is expected to be positive, but likely back-half loaded. Current volume weakness will continue into January given tough year-over-year comparisons. She said intermodal comps will be difficult early on because 2018 benefitted from a backlog at the ports as container shipments increased ahead of expected tariffs. She believes that the severity of last year's inclement weather is unlikely to repeat and will provide a volume tailwind in March and April. Further, Hamann said the outlook for grain could be positive and that demand for plastics will be a tailwind as new production facilities are coming online. Lastly, she said the construction business has been strong all year and that the trend appears to be carrying into next year.

Ruest sees several tailwinds for CN in 2020. He believes that crude by rail, still facing a tough comparison in December from 2018's record shipments, will see some traction as production curtailments are relaxed. Also, the Western Canada Select-West Texas Intermediate spread remains favorable and within the margin needed to promote production.

He noted that downtime at several of the industrial facilities the railroad serves could be modestly prolonged at the beginning of the year, but that domestic intermodal remains a favorable means of improving density in its eastern network. A new container port in Quebec City as well as capacity additions at the container terminal in Prince Rupert and at the Port of Halifax are likely the primary catalysts for the growth.

CP's Creel said potash (-38% quarter-to-date) demand has normalized and that crude by rail activity has increased. He said they didn't pursue crude by rail all that much a year ago because they didn't have the locomotives and headcount to capture incremental shipments without negatively impacting network fluidity. Grain is likely to be a tailwind too.

The railroad recently announced that it moved an all-time company record of grain and grain products in November, hauling 2.74 million metric tonnes (mmt) and besting the prior month's new record of 2.66 mmt. The company's grain franchise is benefiting from recent investment in 8,500-foot trains with hopper cars that can haul 10% more grain by weight.

All in all, Creel believes that the company's prior expectation of double-digit EPS growth in 2020 with mid-single-digit increases in revenue ton-miles remains intact.

Foote noted that CSX has some easy intermodal comps moving forward as the company intentionally exited some less favorable pieces of business. The company has taken out approximately 15% of intermodal volume from the network over the past two years. CSX's total intermodal traffic is down 17.3% year-to-date compared to the same point in 2018 and 6.8% lower year-over-year in the fourth quarter, providing it with an easy comparison moving forward. Foote expects intermodal growth next year and the year after.

Pricing

Those who commented on future pricing said rail inflation plus is the expectation for rate increases on future contracts. CP's Creel said there was some pricing weakness recently, but that they still expect to capture 3-4% price increases on a same store sales basis in 2020.

Ruest said rail inflation plus "has to be the mandate." He believes that competition from truck will impact intermodal pricing modestly, but that the company has to capture rail inflation plus to recoup their capital investments.

Foote said he believes that intermodal service has improved significantly enough at CSX that there isn't a need to cut rates to compete with truck anymore.

UNP's guidance for the fourth quarter of 2019 calls for "pricing well in excess of inflation dollars."

Image by Pit Karges from Pixabay