2017! ABH Presentation It s always something. The Rail Renaissance & the Brave New World SWARS! abh consulting January 2017 NYC

Transcription

1 2017! ABH Presentation It s always something The Rail Renaissance & the Brave New World SWARS! abh consulting January 2017 NYC

2 Deregulation & Vertical Integration Works! U.S. Freight Railroad Performance Since Staggers (1981 = 100) Staggers Act passed Oct Productivity Rates Volume Revenue '64 '67 '70 '73 '76 '79 '82 '85 '88 '91 '94 '97 '00 '03 '06 '09 '12 '15 "Rates" is inflation-adjusted revenue per ton-mile. "Volume" is ton-miles. "Productivity" is revenue ton-miles per constant dollar operating expense. The decline in productivity in recent years is largely due to the effect of higher fuel prices in the productivity calculation. Source: AAR

3 21 st Century: the Railroad (equity) Renaissance: From Triumph to Challenged Rails have well beaten the stock market Big Reasons Globalization/trade (IM) Capex&Productivity&Service Pricing & ROI Through economic turmoil (manufacturing/energy/markets) Of Late Not So Much (now regaining par ) Energy Impact: real (coal) and hype (CBR) Visibility & Sentiment change financial & government/public Earnings Power (always) misunderstood: Rails beat Street estimates in the Boom, in the great Recession, and the tepid recovery, in this period 2015: Record margins & results (and Capex and Buybacks/DPS and.) despite the coal - and drought and lukewarm economy, etc. Rails are still re-gaining market share from the highway despite oil prices (2017?) Brave New World

4 U.S. Rail Carloads of Coal 140, , , , ,000 90,000 80,000 70,000 60,000 50,000 (average weekly originations) Data are average weekly originations for each month, are not seasonally adjusted, do not include intermodal, and do not include the U.S. operations of CN and CP. Source: AAR Weekly Railroad Traffic SLIDE 4 ASSOCIATION OF AMERICAN RAILROADS

5 Q4/16 Earnings to-date: Meh! 3 beat expectations, 3 not so much (BNSF TBD) Q4 volumes end with momentum (barely carried 2017 YTD) Call Guidance more muted than expected (though pricing/domestic IM, metals look solid) recent increased optimism Initial Capex down 6/7 RRs, roughly 10% Big stories NAFTA/Trade,economy, EHH-CSX

6 Hunter s Back (We Think) Mantle/EHH proposal after EHH leaves CP Not about consolidation! As such, only 1 Stakeholder group CSX shareholders need to approve! (2/10) Precision Railroading will improve OR but\ CSX isn t like CP (damaged goods) CSX isn t like CP (density/complexity) Customer Service is more important than ever!

7 New Administration Promises 1. The end of the War on Coal 2. Drill, Baby, Drill (and pipelines, eh!) 3. Infrastructure (Privately Financed) 4. Bye-bye Trade (NAFTA) 5. Get out and stay out! End of the 150-year relationship of GOP & Big Business (ask Ford) 6. War on Regulation (maybe) on Red tape (likely) 7. Lower taxes 8. Labor Who s driverless, now?

8 U.S. Rail Carloads of Coal: Not Pretty! 8 (millions) '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 Data are originations and do not include the U.S. operations of CN and CP. Source: AAR Weekly Railroad Traffic ASSOCIATION OF AMERICAN RAILROADS SLIDE 8

9 U.S. Electricity Generation by Type of Fuel Coal 52% 50% 45% 33% Natural Gas 16% 19% 24% 33% Nuclear 20% 19% 20% 20% Hydro 7% 7% 6% 6% Renewables 2% 2% 4% 7% Other 3% 4% 1% 1% Source: Energy Information Administration ASSOCIATION OF AMERICAN RAILROADS SLIDE 9

10 U.S. Rail Carloads of Coal vs. Electricity From Coal (average weekly originations) Generation from coal Coal carloads , , , ,000 80,000 60,000 40,000 *Electricity generation is 3-month moving average, million megawatthours, through Oct **Coal carloads are 3-month moving averages based on weekly average carloads. Source: EIA, AAR SLIDE 10 ASSOCIATION OF AMERICAN RAILROADS

11 Overview of North American Rail Environment & Key Issues Rail Renaissance (and heavy Capex!)is the theme (1980-) ; OVER?? Major Challenges Emerge Energy Decline (Coal/Oil) End of the Commodity Super Cycle (?); Trade Slowdown; $/FX Service & Safety Issues; Rereg threats re-emerge Service & Productivity & Safety (all related to Capex) are a) getting resolved & b) Even More Important Than Ever. Intermodal performance more critical than ever (recently confusing) Rails, however, are still re-gaining market share from the highway Managements, New & Challenged: Visibility, Guidance; Capex & Cash Asked & Answered: Is M&A the Solution? (What s the problem?) 11 What now?

12 Close Correlation Between RR ROI and Reinvestments 14% 13% 12% 11% 10% RR ROI** (left scale) $30 $28 $26 $24 $22 9% 8% 7% Reinvestments* (right scale, $ bil) '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 $20 $18 $16 *Capital spending + maintenance expense. **Net railway operating income / average net investment in transportation property. Data are for Class I railroads. Source: AAR 16

13 $18 Class I Freight Railroad Capital Spending ($ billions) $16 $14 $12 $10 $8 $6 $4 $2 $0 13 '80 '83 '85 '87 '89 '91 '93 '95 '97 '99 '01 '03 '05 '07 '09 '11 '13 '15 Source: AAR

14 14 Returns Finally Justify the Massive Expenditures But Do Future Prospects??

15 Change in Originated U.S. Rail Carloads: 2016 vs Total 2016: 13,096,860 Total 2015: 14,266,012 ( 1,169,152 or 8.2%) Note: intermodal is not included in this chart. Intermodal was down 220,171 (1.6%) in 2016 vs Source: AAR Weekly Railroad Traffic database Railroads Help Keep Coal- Grain: 80,480 (7.3%) Based All other carloads: Electricity 30,887 (11.1%) Waste & nonferr. scrap: 28,431 (16.8%) Chemicals: 24,094 (1.5%) Motor veh. & parts: 18,743 (2.1%) Coke: 17,904 (9.0%) Food products: 879 (0.3%) Farm products excl. grain: -1,188 (-2.5%) Iron & steel scrap: -3,516 (-2.0%) Nonmetallic minerals: -5,913 (-2.5%) Lumber & wood products: -8,173 (-4.6%) Stone, clay & glass prod.: -8,780 (-2.2%) Primary forest products: -11,763 (-15.5%) Grain mill products: -16,465 (-3.3%) Pulp & paper products: -20,099 (-6.4%) Primary metal products: -30,588 (-6.5%) Crushed stone, gravel, sand: -38,779 (-3.3%) Metallic ores: -39,706 (-12.7%) Petrol. & petr. prod.: -154,422 (-21.4%) Coal: -1,031,178 (-20.1%) SLIDE 15 ASSOCIATION OF AMERICAN RAILROADS

16 Change in Originated U.S. Rail Carloads: 2016 vs Total 2016: 13,096,860 Total 2014: 15,178,027 ( 2,081,167 or 13.7%) Note: intermodal is not included in this chart. Intermodal was down 6,723 (0.05%) in 2016 vs Source: AAR Weekly Railroad Traffic database Railroads Help Keep Coal- Grain: 120,669 (11.4%) Based All other carloads: Electricity 65,323 (26.8%) Motor veh. & parts: 48,433 (5.5%) Chemicals: 29,897 (1.9%) Waste & nonferr. scrap: 27,469 (16.1%) Coke: 18,110 (9.1%) Food products: -2,068 (-0.6%) Farm products excl. grain: -2,119 (-4.4%) Grain mill products: -14,757 (-3.0%) Lumber & wood products: -15,080 (-8.2%) Primary forest products: -17,356 (-21.3%) Pulp & paper products: -26,665 (-8.4%) Nonmetallic minerals: -29,205 (-11.2%) Stone, clay & glass prod.: -32,552 (-7.7%) Iron & steel scrap: -43,494 (-19.8%) Crushed stone, gravel, sand: -45,710 (-3.9%) Metallic ores: -86,802 (-24.1%) Primary metal products: -115,949 (-20.8%) Petrol. & petr. prod.: -230,768 (-28.9%) Coal: -1,728,543 (-29.7%) SLIDE 16 ASSOCIATION OF AMERICAN RAILROADS

17 Railroads Help Keep Coal- Grain: 62,146 (4.0%) Based Motor Electricity veh. & parts: 28,128 (2.4%) Change in Originated U.S. + Canadian Rail Carloads: 2016 vs Total 2016: 16,861,914 Total 2015: 18,213,700 ( 1,351,786 or 7.4%) Note: intermodal is not included in this chart. Intermodal was down 258,402 (1.5%) in 2016 vs Source: AAR Weekly Railroad Traffic database Waste & nonferrous scrap: 25,886 (14.0%) Coke: 23,435 (10.3%) All other carloads: 23,433 (6.9%) Chemicals: 15,426 (0.7%) Farm products excl. grain: 10,027 (4.4%) Food products: 10,000 (2.3%) Lumber & wood products: 6,080 (1.8%) Iron & steel scrap: -2,968 (-1.4%) Stone, clay & glass prod.: -7,150 (-1.6%) Nonmetallic minerals: -10,971 (-3.6%) Primary forest products: -12,090 (-7.7%) Grain mill products: -16,023 (-2.8%) Pulp & paper products: -26,996 (-5.8%) Primary metal products: -49,549 (-8.5%) Petrol. Metallic ores: -66,686 (-8.3%) products: Crushed stone, gravel, sand: -70,897 (-5.2%) -216,738 (-19.4%) Coal: -1,076,279 (-19.4%) SLIDE 17 ASSOCIATION OF AMERICAN RAILROADS

18 Coal: -1,832,494 (-29.1%) Railroads Help Keep Coal- Motor veh. & parts: 73,469 (6.5%) Based All Electricity other carloads: 62,350 (20.8%) Change in Originated U.S. + Canadian Rail Carloads: 2016 vs Total 2016: 16,861,914 Total 2014: 19,378,404 ( 2,516,490 or 13.0%) Note: intermodal is not included in this chart. Intermodal was up 104,065 (0.6%) in 2016 vs Source: AAR Weekly Railroad Traffic database Coke: 25,094 (11.1%) Waste & nonferrous scrap: 18,358 (9.5%) Lumber & wood products: 13,234 (4.0%) Farm products excl. grain: 11,656 (5.2%) Food products: 9,955 (2.3%) Grain mill products: -12,498 (-2.2%) Primary forest products: -12,530 (-8.0%) Nonmetallic minerals: -32,245 (-9.9%) Pulp & paper products: -38,254 (-8.0%) Stone, clay & glass prod.: -39,164 (-8.0%) Iron & steel scrap: -49,907 (-18.7%) Crushed stone, gravel, sand: -107,038 (-7.7%) Primary metal products: -142,926 (-21.2%) Metallic ores: -243,580 (-24.8%) Petr. prod.: -287,961 (-24.3%) Grain: 41,598 (2.6%) Chemicals: 26,393 (1.2%) SLIDE 18 ASSOCIATION OF AMERICAN RAILROADS

19 2018 RR EPS/Expectations RR earnings so far struggling to match improved sentiment & increased expectations Volume inflection (coal stabilizes/im grows) Productivity (and price) retention Capex down but not out Guidance & Visibility still missing Winter is coming (and going) Big Labor Year He s Baaaaaack!

20 EHH & CSX - First thoughts & Assumptions (while struggling to make sense of it all): Rail consolidation is not the goal here - This is not a covert M&A attempt, a way to go back after the denied CP+CSX (merely discussed) or CP+NSC (more public) proposed deals. This plays to the fans, the investment community - For those proposed or suspected deals, many stakeholder groups (unions/shippers/other RRs/etc) at least initially opposed those (any?) combinations - but the investment community, having made $$$ with EHH at IC and CNI, clearly did not. And now they have the EHH-fixes-CP story to brag about as well. A common refrain was if only EHH had come to an eastern railroad alone rather than with a merger plan & CP. well, this might be that wish granted. Early returns favorable: After dropping after earnings, CSX was up some 10%+ on this news.early days.. This was the first we heard of this alliance and plan but not likely the first move: One can assume (guess) that some or a lot of the Mantle money has been put to work at CSX already, perhaps (as is often the case) with friends and allies. Like Melville s great captain, this time EHH would be very much alone unlike the last time, with EHH in his 70s, when one reassurance was having Keith Creel (et al) behind him as a partner and successor. KC is just starting his own story in Calgary. But CSX has a dynamic new C-level team, and like the old MBOs of old, there is talent at the target. Like Melville s great white whale, CSX is not a weak fish: It should be pointed out that, partially as a response to the CP threat from a few years ago, CSX really, both eastern carriers - improved operations dramatically etc since 2014And if the long held 65% OR target seems always out of reach for CSX, one really can nor should not dismiss the fact of the $2B+ of lost (high margin) coal revenue over the past 5 years;. That said, I haven t found a rail leader who would deny that EHH and Precision Railroading would cut costs at a (any) US carrier..

21 EHH & CSX - First thoughts & Assumptions (while struggling to make sense of it all): Great skills/right fit? So, EHH s arrival in a leadership role at CSX could be terrific financially and would certainly be exciting - but is not without some risk, based on historic performance. The New Model Railroad faces threats (the permanent, secular loss of coal business, perhaps AV trucking down the pike) and cost cutting, the EHH specialty, cannot be the only answer. The opportunities to grow are highly service oriented, and require capital, finesse, IT as well as productivity improvements - intermodal, particularly domestic, and merchandise. Kinder/gentler: This is the skill set of the CN which took the legacy of EHH s spectacular job there and layered in customer responsiveness, supply-chain extension, etc.. On the other hand, EHH is 72, and perhaps (as we mentioned in our MBO comparison) after stage one of the revolution, there is already at CSX someone ready or soon ready to perform at the next-level in the manner of Claude Mongeau at CNI. Minimal outside influence would be brought to bear: This could be a coming showdown (or alliance) between the Mantle Team and CSX (and their management, their board and their shareholders). In other words: Other stakeholders don t have the influence on this emerging story (there is no regulatory oversight etc) but remain interested observers. This time.it s personal: EHH has always said he doesn t care a whit about legacy but one can t help feeling that the chance to utilize Precision Railroading on a US carrier, with all of their densities and complexities, would dispel the lingering skeptics (and there are some not many, to be sure) that P/R works well.in Canada. See Rule #1 Ahab didn t land Moby Dick but unlike that crusty, peg-legged old sea captain, in this fishing expedition one must remember Never Underestimate E. Hunter Harrison!

22 Our Troubled Industry? Q4 OR averaged 63% Rails in best-ever condition: network, finances, IT, managements Coal has stabilized Volumes have inflected Intermodal is growing again What s next?

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24 Originated Rail Carloads of Crude Oil by Quarter 140, , ,000 80,000 60,000 Annual Totals , , , , , ,249 40,000 20,000 0 ASSOCIATION OF AMERICAN RAILROADS Data are for Class I railroads. Source: AAR (Freight Commodity Statistics) SLIDE 24

25 Crude Oil as a % of Total Originated Class I Carloads 1.4% 1.6% 1.4% 0.8% 0.8% 0.0% 0.0% 0.1% 0.2% * Source: Association of American Railroads (Freight Commodity Statistics) ASSOCIATION OF AMERICAN RAILROADS SLIDE 25

26 Originated Rail Carloads of Crude Industrial Sand & Crude Oil by Quarter 160, , , ,000 80,000 60,000 40,000 20,000 0 ASSOCIATION OF AMERICAN RAILROADS Crude industrial sand (STCC 14413) Crude oil (STCC 131) Data are for Class I railroads. Source: AAR (Freight Commodity Statistics) SLIDE 26

27 Shale-Related Rail Traffic Relative to Coal Loadings 1,800,000 U.S. Quarterly Carloads Originated 1,600,000 1,400,000 1,200,000 4 Qtr. Avg. 1,754, ,073 STCC Industrial sand and gravel (includes frac sand) 1,000, ,000 3 Qtr. Avg. 1,389,835 STCC Crude Petroleum and Natural Gas 600, , ,134 4 Qtr. Avg. 204,778 STCC Bituminous coal 4 Qtr. Avg. 77, ,000 0 Source: Surface Transportation Board, PLG Analysis March 2016

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29 Railroad Respond to the Challenges Traditional Response cost cutting Strategic response to secular changes coal Capex response TBD (stakeholder division?) Radical change (ex. M&A)? (Continue to) Focus on growth areas Retain concentration on Service & Productivity Innovate! ( regain tech mojo )

30 Silver Linings? Service (& Safety) Recovery Trend (Capex Pays Off) Productivity (& volume?) Inflection Restoration of the Grand Bargain Reduced (N/T) Political Pressure Coal stabilization (Part Two)?? IM (etc.) latent demand.bi-modal results; Ag Gas-fired Industrial Buildout; Southbound migration of industry Revised MoW Capex (GTMs/Mix) frees CF/2017+

31 The Grand Bargain In return for higher prices (& ROI), rails spend, increase capacity & improve service ( ) The unstated Grand Bargain Rails gain pricing power (~2003) & F/S Rails (re) Gain Market Share Rails Spend Cash Disproportionately on Capex (~18-20% of revenues) Promotes Virtuous Circle all stakeholders benefit Under challenge, perceived and real

32 Future Growth Potential (Revised) Secular stories and specific targeted sectors (in order). 1. Intermodal international and now domestic 2. Chemicals/re-industrialization? Near-sourcing/Mexico (??) 3. Cyclical recovery housing, steel, autos (still.) 4. Grain & Food Exports up 10% this CY? NA still the world s breadbasket, but obviously (un)predictable? 5. Car-load merchandise capacity available! 6. Shale/oil/sand demonstrated flexibility 7. Other rail opportunities exist but in smaller scale: for ex: The manifest/carload problem - Unitization - Industrial Products/MSW - Perishables

33 Issues for RR/Intermodal to 2020 Return to Growth? Fight over Capital MoW vs Buybacks? M&A Fight fallout effect on Capex? RR Pricing Power Still? Factors: Oil Prices, Consumer Spend/GDP, Truck Capacity Infrastructure Advantage (vs subsidized highway) Trade and the Panama Canal impacts? NAFTA? Rail Service (& Safety) Improvements Coal stabilization Driverless beats One Man Crews to the market? 33

34 Close Correlation Between RR ROI and Spending 14% 13% 12% 11% 10% 9% RR ROI** (left scale) $32 $30 $28 $26 $24 $22 8% 7% Rail spending* (right scale, $ bil) $20 $18 6% '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 *Capital spending + maintenance expense. **Net railway operating income / average net investment in transportation property. Data are for Class I railroads. Source: AAR ASSOCIATION OF AMERICAN RAILROADS $16 SLIDE 34

35 Higher Rail Profitability = Higher Rail Spending $32 $28 $24 $20 $16 $12 $8 $4 $0 ($ billions) '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 ASSOCIATION OF AMERICAN RAILROADS RR spending* RR net income *Capital spending plus maintenance expenses. Data are current dollars and are for Class I railroads. Source: AAR SLIDE 35

36 Railroads Have Only Recently Earned Their Cost of Capital 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% Class I RR Cost of Capital vs. Return on Investment RR Cost of Capital RR Return on Investment '81 '83 '85 '87 '89 '91 '93 '95 '97 '99 '01 '03 '05 '07 '09 '11 '13 '15 Note: In 2006, the Surface Transportation Board significantly changed the method by which it calculates the rail industry cost of capital. Source: STB ASSOCIATION OF AMERICAN RAILROADS SLIDE 36

37 Railroad Philosophy Critical to the RR Renaissance has been Capex Private vs public capital (failing US infrastructure) Capex sparked by growth and ROI prospects examples: IM, CBR Open Access antithetical to this.right? Is a RR its Network (Class One belief) OR is it its Operators (Hunter)?? Cult of the OR vs ROIC; short-termism

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39 Future RR Capex 2016 Capex down across the board (annopunced average -16%!) except CN and further midyear cuts bring 2016E to -20%? Changing Mix of volumes - Most Important Decision Period in Years Further cuts Still able to avoid muscle? Coal: Stranded Assets? NS selling segments.csx of Tomorrow Coal/Mix: Reduced Gross Ton Miles=Reduced Maintenance of Way? Yet remember: Service & Safety are even more critical to future RR success Changing mix of capex? Changing %revenues (16%)? PTC Extension resolution more to develop? ECP? 39

40 Railroads: Far More Capital Intensive Than Other Industries 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% Capital Expenditures as a % of Revenue: 2014 Computers Class I RRs Nonmetallic Minerals RRs Paper Plastics & Rubber Wood Prod. Motor Vehicles Food Chemicals All Mfrg. Petr. & Coal Prod. Sources: Census Bureau, AAR ASSOCIATION OF AMERICAN RAILROADS SLIDE 40

41 Railroads Help Keep Coal- Based Electricity Average all manufacturing 3% Railroads Are Far More Capital Intensive Than Most Other Industries Capital Spending as % of Revenue* Food 2% Petroleum & coal products 2% Machinery 3% Chemicals 3% Wood producs 3% Primary metal products 3% Fabricated metal products 3% Motor vehicles & parts 3% Plastics & rubber products 3% Paper 4% Nonmetallic minerals 5% Computer & electr. products 5% Class I Railroads 18% *Avg Source: Census Bureau, AAR SLIDE 41 ASSOCIATION OF AMERICAN RAILROADS

42 Maintenance Spending Remains Durable $ in Billions $5.0 $4.3 Select Class I Capex Budgets 4.0 $ $2.4 (18%) $1.9 $2.8 $1.4 +4% $2.9 $1.4 $2.5 $1.3 (10%) $2.4 $ (1%) $1.9 $1.8 +7% $1.4 $1.5 +2% $1.2 $ B B B Infrastructure Other Capex Note: CN in CAD. SOURCE: Greenbriar!

43 Take-Aways From RailTrends16 Good: IM & (especially) Merchandise Opportunities and near-term inflection; plastics, Ag, Maybe Good: reduced taxes and regulation? Infrastructure? Bad: Railcar production, coal (war is over) Ugly: Visibility, Trade Really, really ugly? AV trucking Have Faith & Innovate: Canadian National

44 Railway Night Sweats Politics (& Regulation) Trade Globalization over? (Specifically) NAFTA which impacts S.&N! Driverless AV beer runs! (ahh the irony) Amazon who isn t scared? 3-D Printing good enough for combat? Short-Termism/Over-reactions Capex and FCF planning

45 Competitive Advantage: RR Capex vs Aged National Infrastructure

46 ABH Consulting/ Anthony B. Hatch 1230 Park Avenue New York, NY (917)