Thursday, November 16, 2017

Cowen study: What a NAFTA exit will mean

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There have been four rounds of NAFTA (North American Free Trade Agreement) re-negotiations, with the fifth round set for Mexico City beginning Nov. 17. According to Workingman’s Dead: NAFTA Withdrawal Risk Sector Impact, a just-released study from Cowen and Co.’s 11-member Washington Research Group, a U.S. pullout from the landmark agreement forged more than 20 years ago will likely have a significant negative impact on the freight railroad industry.

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The full report discusses 30 companies Cowen covers, 8 of which are a Class I railroad or a major supplier conducting cross-border business. Cowen Managing Director and Railway Age Wall Street Contributing Editor Jason Seidl and analyst Matt Elkott cover 16 of them.

The full report can be downloaded at the link below; following are highlights:

• There are three big-picture takeaways: We view NAFTA withdrawal as unlikely, but this is something President Trump can do unilaterally (no Congressional role) and protectionist trade theory has been his policy North Star for decades. This is a zero-sum, visceral issue for Trump. This is likely a Q1 2018 issue, though the Mexican Presidential election in July and potential left-wing win could make NAFTA’s demise a self-fulfilling prophecy. The three sectors most impacted will be autos, apparel, and freight carriers.

• The deadline of February/March is due to Mexico’s Presidential election on July 1. Leading candidate Andrés Manuel López Obrador, also known as AMLO, is a fiery left-wing populist who has said he too will re-negotiate NAFTA. NAFTA’s demise could become a self-fulfilling prophecy in a Trump-AMLO negotiation with shades of Newton’s third law: For every action, there is an equal and opposite reaction.

• Since Trump first dipped his toes in the deep waters of the Presidency 30 years ago, trade has been the one policy constant. We have flagged Trump’s near unilateral powers on trade as one of the greatest short-term policy risks since his election in November. The U.S. has not had a protectionist/defensive trade President since The Great Depression. Trump’s margin for victory in the Electoral College largely came from the Rust Belt, where trade is a pariah and a four-letter word. This is one of the few issues … where the Trump and (Sen. Bernie) Sanders wings are in broad agreement. And let’s be honest: The [Republican Party] is no longer anchored on free trade, internationalist foreign policy, and entitlement reform. Trump’s fair-trade evangelism on the campaign trail has converted huge swaths of the GOP to a party of born-again mercantilists that sings from the same hymnals as their brethren in organized labor.

• Trump’s zero-sum view on trade has been consistent through his public years. The six “core industries” for the “America First” trade agenda, as described by the White House: 1) steel; 2) aluminum; 3) vehicles; 4) aircraft; 5) shipbuilding; and 6) semiconductors.

• The U.S. has not withdrawn from a trade agreement since 1866, but that is not because of its difficulty. There is an escape hatch built into [NAFTA], which makes it very easy to void: Article 2205. This basically states that six months after Trump sends the Canadian Prime Minister and Mexican President written notice, the treaty is dissolved. No Congressional approval is required. Because this hasn’t happened since 1866 (which is a bit of a ridiculous practical precedence given the changes in economies, etc.), we do not know what would actually happen if this happened: tariffs reset to 1994? U.S. investment to Mexico blocked/unwound? It would be a zero-gravity environment. What is clear is that President Trump can go down this road with a single stroke of a pen and a six-month lag.

• A termination of NAFTA would likely have a net negative impact on the U.S. and Canadian freight carriers in our coverage universe. Freight is, first and foremost, a function of the economy and trade activity. If protectionist policies are implemented and prove detrimental to trade, the carriers would be bound to see the impact in their volumes. Additionally, potential changes to border crossing procedures could disrupt the fluidity of carriers’ networks and potentially increase dwell time and empty miles. Perhaps the most at risk in our universe is Kansas City Southern..

• Among the publicly traded railcar builders, Greenbrier faces the highest risk from the potential of protectionist trade policies toward Mexico, followed by Trinity. American Railcar Industries (ARI) and FreightCar America, on the other hand, could benefit, as substantially all their manufacturing infrastructures are in the U.S. We estimate at least 80% of Greenbrier’s current railcar production for the North American market comes from Mexico, where the company has three facilities.

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