Rail Renaissance: Returns, Capital & Capacity AB HATCH [email protected] 155 W68th St Suite 1117 NYC 10023 www.abhatchconsulting.com July 13, 2010 2010 Midwest Regional & Short Line Railroad Summer Conference
Mar 31, 2015
Rail Renaissance: Returns, Capital & Capacity
AB HATCH [email protected]
155 W68th St Suite 1117 NYC 10023
www.abhatchconsulting.com
July 13, 2010
2010 Midwest Regional & Short Line Railroad Summer Conference
Economic malaise Rising capital
requirements Regulation Maritime trade flows
Rail Assessment
Opportunities Threats
Strengths
Pricing Volume Growth Service levels /
productivity Modal shift Consolidation?
Strong secular growth Favorable market
structure Supply constraints Solid barriers to entry Limited alternatives
Challenges Capital intensity Capacity bottlenecks Port congestion Reliability vs. trucks
Railroad PerformanceClass I Railroads
0
50
100
150
200
250
300
64 68 72 76 80 84 88 92 96 00 04 08
Index 1981 = 100
Source: Railroad Facts, AAR (Based on a design by R. Gallamore)
Productivity
Volume
Revenue
Price
Street influence on RRs – and Why that affects ALL stakeholders
Battle for cash
Management’s reactions to pressures
Investors, competitors, regulators, politicians, labor – oh,
yes, and customers
Rare Industry: Short term decisions (current economic
outlook)/long term consequences (40+ year life of a
locomotive)
Remember 2004! (?) – rails unprepared for volume;
embargoes
Which “bucket” (Capex, share repo, DPS) will they place
their chips?
Simple Math
RatesReturnsCapital ExpendituresCapacityService
ARE ALL CONNECTED!
Virtuous Circle (’03-07) or Disinvestment?
Rail Freight Volume
Major studies done in 2005-07 (ie; at the cyclical peak): DOT, Global Insight, Cambridge Systematics/AAR
New Studies being undertaken – due late 2010 Visibility coming off of all-time lows (“no solid feel for
H2/10”) Government role both supportive (PPPs, etc) and a
threat (re-reg, coal) Major intermediate-to-longer term variables for coal,
autos, paper, housing, retail, and trade sourcing Emissions a two-edged sword (coal flattens,
intermodal growth accelerates) GDP has the highest correlation – by far
Future Growth Potential
Oil, Carbon, Infrastructure & EfficiencyIntermodal – International and DomesticGrain – the world’s breadbasketCoal? ExportsThe Manifest/Carload “Problem”MSW (garbage), perishables, othersPoint-to-point vs. Hub & Spoke (or
Southwest vs. United)
Grain TrafficMajor U.S. and Canadian railroads
22,000
24,000
26,000
28,000
30,000
32,000
34,000
36,000
38,000
40,000
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Combined U.S. + CanadianAverage Weekly Rail Carloads of Grain
2006
2009
2008
Data are weekly average originations for each month, are not seasonally adjusted, and reflect revisions from original reporting. Source: AAR Weekly Railroad Traffic
2007
Jan. 2010
Source: AAR Railroad Time Indicators, February edition, page 12
Intermodal Growth DriversDomestic and International
Globalization
Trade
Railroad Cost
Advantages
Share Recovery
From Highway
Truckload Issues
U.S. Railroad Intermodal Traffic(millions)
0
2
4
6
8
10
12
14
81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09e
U.S. Railroad TOFC/COFC Units
Source: Association of American Railroads’ Weekly Railroad Traffic Year 09e week 52 is estimated
Long-run Railroad Intermodal Revenue Growth Has Outpaced Coal (Short-run has not)
1990 1995 2000 2005.
$0
$2
$4
$6
$8
$10
$12
$14
Bil
lion
s
Source: Carload Waybill Statistics (includes non-Class I railroads)
Coal Intermodal
17%18%
19%20%
21%22%
23%24%
25%26%
98 99 00 01 02 03 04 05 06 07 08
Coal Intermodal
*Data for BNSF, CSX, KCS, NS, and UP Source: Railroad financial reports
Intermodal and Coal as a % of Revenue*
Coal and Intermodal are the Top Sources of U.S. Freight Rail Revenue
U.S. Railroad Intermodal TrafficTrailers vs. Containers (millions)
0
1
2
3
4
5
6
7
8
9
10
88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09e
U.S. Railroad TOFC Units U.S. Railroad COFC Units
Source: Association of American Railroads’ Railroad Facts Year 09e week 52 is estimated
Domestic Intermodal
The real growth opportunity is the age-old goal of taking trucks off of the highway
Driving down the LOH (requires very tight service standards)
Corridor development (see NS’ “Crescent”); truck partnerships (see JBHunt)
Fuel price, carbon footprint, infrastructre shortages and congestion, driver shortages (CSA 2010)
Trailer (TOFC/”Piggyback”) the gateway drug” for containerization
Opportunities in unitized carload as well
0 10 20 30 40
2035p
2002
DOT: Future Demand for Freight Transportation Will Continue to Grow
p – U.S. DOT projection
Billions of Tons of Freight Transported in the U.S.
CS: Future Corridor Volumes Compared to Current Corridor Capacity (Cambridge/AAR)
2035 without improvements
Below capacity
Near capacity
At capacity
Above capacity
Carbon Footprint– from cocktail chatter to decision point
2003 – 221/F500 report on carbon; 409/F500 in ’09
Green supply chains enforcement by Wal-Mart (from $2B transport spend to $4B+ by ’11); GE, P&G, etc….
Anticipating future EPA regs and emissions law
S0 -What is the growth rate?
Great studies done – in 2007 Is there a “Great Re-set”? (paper, autos, retail, coal) Or do we look past 2035 and simply add a few “lost”
years? (the emerging consensus save for the coal question)
AAR new assumptions suggest coal is flat from DOT projections while the rest reaches 2025 targets despite Great Recession impact (ie; future intermodal/carload growth is higher than recent studies…)
Will the government policy help to increase modal share by 10%?
UNCERTAIN Domestic Coal
Rail Intermediate term volume prospects
ABOVE GDP
BELOW GDP Paper Auto Parts (?)
ABOVE GDP Intermodal – Domestic (+
+) Intermodal - International Agricultural products Export Coal Ethanol
GDP-GROWTH Autos Lumber Chemicals (+?) Aggregates Metals
Growth is Expensive
Huge Capex - $40B in the last 5 years in the US – through the Great Recession!
AND: Comeback of the share repo/DPS?EPS beat the Street consistently, yet:
Uneven returns in the Modern AgeRecent improving trend lineThreats to ROIC threaten capacity
Regulatory Review/Discussion
Staggers (1980) and predecessor ActsFreedom to set ratesFreedom to sell/abandon low density
track (growth of short line industry)Freedom to exit passenger businessImpetus to cut costs, divest massive
non-rail holdings & become “pure” rail plays
Source: AAR
0306090
120150180210240270300
'64 '67 '70 '73 '76 '79 '82 '85 '88 '91 '94 '97 '00 '03 '06 '09
Revenue
Volume
Productivity
Price
Staggers Act Passed Oct. 1980
The Staggers Act: An American Success Story
(Index 1981 = 100)Productivity decline due
mainly to fuel price volatility.
0%5%
10%15%20%
25%30%35%
40%45%
'80 '83 '86 '89 '92 '95 '98 '01 '04 '07
Pipeline excludes natural gas. Source: U.S. DOT
Railroads: The Leader in Freight Transportation
Railroads
Trucks
Water
Pipeline
(% of Ton-Miles)
$0
$1
$2
$3
$4
$5
$6
$7
$8
$9
'99 '00 '01 '02 '03 '04 '05 '06 '07 '08
$ b
illio
ns
Finally, Railroads Making Decent Money...
Net Income
Source: AAR
Railroad Return on EquityClass I Railroads
0%
2%
4%
6%
8%
10%
12%
14%
91 93 95 97 99 01 03 05 07
Source: Railroad Facts, AAR
n.m.n.m. = not meaningful (negative value)
RR CoC vs. ROIC – RR Stocks have done well but… they still trade at a discount to all stocks
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
Cost of Capital Return on Investment
Source: Surface Transportation Board Note: Cost of equity estimation method changed by Board effective 2006 and 2008.
Rail Regulatory Risk?
STILLSTILL Biggest Uncertainty in 2010 Safety Bill done/UTU influence S2889 (“STB Reauthorization Act”, formerly the
“Competition” Bill AKA“M-A-D”) + Anti-Trust And yet, STB makes it 3-straight shipper “wins” Cost of Capital Revision shock (no replacement costs
mandate – a “study”) Mandated STB, CTA “Reviews” AAR/RAC/ASLRRA have great “D” but hard to score
on defense Compromise or fight? Quid pro quo in the future?
Rocky & The Dark Star – new horror movie?
Other DC Issues
S2889 not fatal, would be a long time before changes manifest themselves; compromise could lead to future monies, for example:
($500B)Transportation Bill (SAFTEA-LU 2) already behind schedule, under extension – could have increased monies for intermodal - and yet potential truck size (TSW) threats
Rail is not a particularly partisan issue (more regional)
Administration – supports a 10% modal shift toward rail
Rail Capacity and Capex
Rail Capacity is extremely fungible Heavier/faster track, double track., sidings; Larger cars (avg size: ’80 79tons; ‘90 88.2 ’08 110.5) Unitization, shuttle trains Denser systems (2001 8.9mm RTMs/mi; ’08 11.6) IT – planning, signaling, communications (PTC?) Unitization Equipment in storage (down to the dregs) T&E employees System Velocity
12
13
14
15
16
17
18
19
20
'99 '00 '01 '02 '03 '04 '05 '06 '07 '08
Mill
ion
s...And Tighter Capacity
Up 31%
Source: AAR
(Ton-Miles Per Mile of Railroad)
35,000
40,000
45,000
50,000
55,000
60,000
65,000
70,000
75,000
1987 1990 1993 1996 1999 2002 2005 2008
High Density* Rail Miles Have Increased
*Track with freight density of at least 20 million gross ton-miles. Excludes way and yard switching tracks. Source: AAR
(Miles)30
% o
f C
lass
I N
etw
ork 72%
13,00013,50014,00014,50015,00015,50016,00016,50017,00017,500
1987 1990 1993 1996 1999 2002 2005 2008
Second, Third, and Fourth Main-Line Miles Have Increased
Data are for Class I railroads. Source: AAR
(Miles)
1987 - 2008 Density of Heavy Duty Main Lines for US Class I Railroads
0.00
10.00
20.00
30.00
40.00
50.00
60.00
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
Year
Den
sit
y (
million
s o
f Ton
-Miles p
er
Mile)
Avg Density - Class A MainLinesAvg Density - Class B MainLinesAvg Density - Combined AB Main Lines &
Reflects two years following SP/UP merger. UP wasconforming SP reporting to its own standards. During this time, miles were reported but densitycould not be determined for the entire system and so remained unreported.
Average density of Class A mainlines has continued to grow even astotal mileage has increased
Class A main lines have > 20,000,000 gross tons annually; Class B main lines have >5,000,000 gross tons annually but < 20,000,000.
$0$1$2$3$4$5$6$7$8$9
$10$11
1980 1984 1988 1992 1996 2000 2004 2008
Roadway and Structures
Equipment
Railroad Capital Spending($ billions, constant 2008 dollars)
Data are for Class I railroads. Source: AAR
-$2
$0
$2
$4
$6
$8
$10
$12
'80 '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08
Source: Association of American Railroads
Net Income
Capital Spending
Class I Railroad Capital Spending vs. Net Income
(Current Dollars)
Rail Service Cycles
Is the recent improvement in the metrics
sustainable? Systemic?
Is it a product of huge capex injection
and IT?
Or, is it merely a product of lower
volumes/less stress on the network…
Capacity Constraints
The revival of passenger railroading (the vast majority of which is on freight network)
HSR (and HrSR)TIH/NIH issues TSA and secuirityNIMBY – see the CN and its tortured
purchase of the EJ&E; efforts on MSW
02468
101214161820
1980 1984 1988 1992 1996 2000 2004 2008
New Passenger Service Must Compete With Freight Growth
Data are for Class I railroads. Source: AAR
Millions of Revenue Ton-Miles Per Mile of Road Owned
0
50
100
150
200
250
300
350
400
1980 1984 1988 1992 1996 2000 2004 2008
RR Fuel Consumption
RR Volume
Avg. RR Price of Fuel
Double the Freight on Same Amount of Fuel!
Volume = revenue ton-miles. Source: AAR
(Index 1980=100)
$0$1$2$3$4$5$6$7$8$9
'99 '00 '01 '02 '03 '04 '05 '06 '07 '08
$ bi
llion
s
Net Income
$100,000
$125,000
$150,000
$175,000
$200,000
$225,000
$250,000
'99 '00 '01 '02 '03 '04 '05 '06 '07 '08
RRs Still Making Record Re-Investments
RR Spending Per Mile
Source: AAR
Current Issues
Rails in the RecoveryAfter the Rereg Fight what? Partnership with government?The Green mantleNew “Golden Age”?PE &Infrastructure funds – back for
good?Service
Key Class1 Issues in Recession ‘10
Re-regulation Bigger Threat than EverRates (versus Volumes)The Recovery (Pace & Durability)Service – The Key to the Future!Green Ramifications – positive/negativeStimulus, TIGER 1&2, MAP21, ATRK,
“HSR” & HrSR - (ONERail)PTC-”unfunded”- and unknown -mandate
Service will be the Key to the Next Cycle
Service at all time highs$40B spend in last 5 years (service
ought to be better!)Putting increased traffic back on at
current velocity means: Higher asset utilization, more market share gains, greater operating leverage (perfect circle affects all stakeholders)
Implications for equipment fleets
Threats to the Renaissance
Cyclical vs. secular argument New Congress –impacting labor & shippers Mandated Reviews – STB, Canada Rereg – the MAD answer Emissions impact shakeout (coal down, intermodal up,
ethanol?) Execution: service Execution: merger (unlikely) Activist hedge funds? (unlikely) Liquidity? (proven not to be a direct issue in Q408)
Warren’s $44B “all-in” bet
Advantages of going private? (capex cycle)
Influence in DC“Robber Baron” vs. “Sage”Bets not (just) on economy – rereg, coal,
western intermodalBought on the cheap!
RR/Investor Issues Summary-3Rs3Cs
Recovery?The Re-SetRe-RegulationCapital NeedsCapital CooperationCash Flow
Developing website
www.abhatchconsulting.comTopShipper SurveyRailTrends 2010 September 28-29
ABH ConsultingAnthony B. Hatch155 W. 68th StreetNew York, NY 10023(212) [email protected]