Wednesday, November 30, 2011

2011 Outlook: Investing for growth

Written by  William C. Vantuono, Editor

Strong earnings spur railroads to build capacity and productivity. If one word could define the thrust of railroad capital spending on improvements, it would be "growth"—growth in capacity, growth in productivity, growth in service levels, and, not least, growth in customer satisfaction.

Capital spending was at a high level in 2010. Indications are that it will again be at a high level in 2011. For example, Union Pacific told an analyst's conference on Dec. 1 that it would spend $3.2 billion in 2011, compared with $2.6 billion in 2010 and $3.1 billion in pre-recession 2008. UP's five-year outlook calls for purchase of 100-200 locomotives annually, starting with 100 in 2011 (see chart, p. 24).

Railroads enter 2011 in a somewhat better position politically, following last November's mid-term elections. Reregulation is effectively dead, though the Surface Transportation Board has the authority to reinstitute regulation for certain commodities, if it chooses to do so. Of immediate concern is truck size and weight. Observes long-time Railway Age contributor and Washington policy analyst Frank N. Wilner, "The railroads want to tap into the Highway Trust Fund in the next transportation bill, and some truckers want increased weights—and perhaps nationwide approval to run triples. UPS, for example, doesn't need higher weights but might desire triples as its relatively lighter loads tend to cube out before weighting out. Clearly, the truckers' position will be that if there is any siphoning of funds to rail from the new transportation bill, the quid pro quo will be relaxation of truck size and weight limits. This fight has been going on since the 1970s. ).

"I don't think any legislative strategy will emerge until the new T&I Committee is in place and the railroads can determine where Chairman John Mica and Ranking Democrat Nick Rahall want to go with this issue, but it should heat up very quickly by March or April. Until then, expect the lame duck congress to pass an extension of the transportation bill through March—and then probably another extension because it's doubtful a bill can be finalized even before summer." ).

Besides the truck size and weight issue, how fuel is taxed is going to be examined. "Instead of a cents-per-gallon tax on gasoline and diesel fuel, there is growing support to scrap that method and replace it with a percentage sales tax on the price of fuel, allowing the tax to grow as fuel prices increase," notes Wilner. "If it is finalized, it is going to meet a hailstorm of interference on the House and Senate floor as part of more-broad tax and spend considerations." ).

(For Wall Street's view, and additional analysis on issues facing the railroads, see the commentary by Jason Seidl, Larry Kaufman, and Tom Simpson.)

A recovery from the Great Recession is well under way. At what rate do the railroad chief executives see it progressing next year, and in what areas? How will capital spending in 2011 compare with projected spending in 2010 and actual spending in 2009? How do they view the emerging political landscape? Here's what they told Railway Age: ).

Jim Young, Union Pacific: Based on what we are seeing in our carloadings and what we are hearing from customers, we expect to see slow but positive economic growth in 2011. The infrastructure investments we have made the past several years allow us to operate more productively and with greater reliability. The unemployment rate remains a concern. It clearly is dampening consumer confidence that in turn lowers primary demand for the goods we haul. We will continue to monitor housing starts and heavy construction business for signs they are returning to more normal, pre-recession levels. The areas directly impact our lumber and aggregates businesses.

Union Pacific plans capital investment of around $3 billion in 2011, plus another $250 million for Positive Train Control development (our capital investment budget was $2.6 billion in 2010 and $2.5 billion in 2009). Included in the $3 billion is the planned purchase of 100 new locomotives. Historically, capital spending has totaled around 17-18% of revenue. Over the next five years, our volume, pricing, and investment opportunities suggest that we will need to maintain that relationship to accommodate growth as well as cover the unfunded PTC mandate that we expect to cost an estimated $1.4 billion. ).

We will continue to pay attention and stay engaged on the important railroad-related issues on Capitol Hill. When thinking of the most important problems facing our country, I have a hard time seeing where issues involving railroad regulation would be near the top of any list. ).

Wick Moorman, Norfolk Southern: We expect that the economy will continue to expand, although at the fairly slow rates we have seen over the past few quarters. We anticipate continued growth in our core businesses, which will be supplemented by new business development and our ongoing corridor strategy. Our outlook for the agricultural and ethanol market remains bright, and we expect the grain export season to be positive. We anticipate our chemical business to expand as well, and we see a slow upward trend for the automotive market. Our steel business, which includes export and domestic metallurgical coal along with finished iron and steel, should continue to benefit from the gradual recovery in global steel production.

Current dynamics in the trucking industry, along with improving economic conditions and our developing corridor strategy, bode well for continued intermodal conversion from road to rail. We expect to see growth in all of our coal market segments over the year. Projected increases in electricity demand along with lower stockpiles should positively impact utility coal's performance. ).

Our current estimate for 2010 capital spending is about $1.5 billion. While our 2011 capital plans have not been finalized, we do anticipate that our spending will be driven by PTC, new locomotives, the conclusion of our implementation of SAP, and reinvestment in our coal car fleet. We own in excess of 20,000 cars and the majority of that fleet will be reaching the end of its useful life over the next six to eight years. We already have renewed more than 3,000 of those cars and are starting a program this year to improve between 1,000 and 3,000 cars annually. In addition, we're looking at our ongoing equipment strategy as to the advantages of ownership rather than our current policy of leasing some of our core assets. ).

Common sense is trying to prevail in Washington, and people realize that doing something that would seriously damage the railroad industry is not in the best interest of the country. But that drum beat always will be there, so we continue to make our case and explain why it is not a bad thing for railroads to earn their cost of capital and be able to reinvest. NS and the entire industry continue to work with the FRA to refine regulations related to PTC. As passed by Congress, however, it is an unfunded mandate with only a $1 of benefit for every $22 the rail industry will spend installing the system.

We are concerned about potential regulatory or legislative changes that place new restrictions on the power utilities and companies that burn or mine coal. The Environmental Protection Agency is considering rules to significantly curb carbon dioxide emissions from electric utilities, while Congress and statehouses nationwide are debating bills that could result in higher costs to produce electricity from coal and discourage its use for power. In addition, potential restrictions on coal mining companies would affect metallurgical coal, which could have a detrimental impact on the global competitiveness of the U.S. steel industry and manufacturing in general. ).

A bipartisan bill to advance research on clean-coal technologies, the Carbon Capture and Storage Deployment Act of 2010 (S. 3591), would put in place a comprehensive approach by the federal government to support the development and early use of carbon capture and storage technologies by electric utilities. If passed, the bill could accelerate availability of clean-coal technology in the marketplace, create jobs, and help keep the price of electricity affordable. We're working with members of both the Senate and the House to explain the benefits of the bill.

Michael Ward, CSX: We continue to see a slow, gradual recovery, which is reflected in increasing rail volumes across virtually all markets. We have adapted to higher traffic levels by returning stored locomotives and railcars to service and recalling most of our furloughed employees.

The underlying fundamentals of our business remain positive. We will be discussing our 2011 capital investment program early next year. In the meantime, we have increased 2010 capital spending from $1.7 billion to approximately $1.8 billion. This new capital is focused on strategic investments in support of our strong growth in our intermodal business and investments in rolling stock. In addition, we are making significant investments in our network such as the National Gateway, a six-state public-private initiative to clear a rail corridor for doublestack intermodal traffic between Mid-Atlantic ports and Midwest markets.

While no one can say for sure how any changes in Congress will affect the regulatory debate, we are confident that policy makers will exercise care to ensure that any new laws or regulations do not disrupt the pace of economic recovery.

As to current federal laws governing truck size and weight, the public has consistently expressed opposition to increases on the grounds of highway safety. Heavier trucks would increase publicly funded highway maintenance needs. Fuel and other taxes that heavy trucks pay cover only a fraction of current maintenance needs.

Matt Rose, BNSF: We believe the worst of the recession is behind us and we will see some growth, but nothing near the levels we saw in 2006. We remain cautiously optimistic as we head into 2011. While we have seen some recent growth, the rate of that growth is slowing. GDP growth is now estimated to be in the 2% range, instead of over 3% like we saw in the first quarter of 2010.

International intermodal grew double digits in 2010, but the growth may not continue at that pace. It remains unclear if this growth was due to replenishing of inventories or if retailers are anticipating a strong increase in consumer spending this holiday season. But forecasts are still projecting international growth to be higher than GDP growth.

BNSF is in the planning stages for its 2011 capital program. We have continued to make investments in our railroad despite the decreased volumes over the past three years. We will continue to progress major multi-year projects, such as the double-tracking of Abo Canyon, scheduled to be completed in 2011. With this, our 2,200-mile Transcon Corridor will only have about 30 miles of single track.

Regarding truck size and weights, if the public agrees that longer trucks and heavier trucks are needed, then the burden of the increased wear and tear on the highways should not be placed on the taxpayers. As well, climate change legislation should incentivize more freight by rail and capitalize on the environmental efficiencies of rail. The wrong carbon policy could expose significant railroad revenues and reinvestment related to coal haulage. We need to ensure that clean coal technologies and continuation of rail investment are key priorities.

David L. Starling, Kansas City Southern: The U.S. and Mexican economies look generally positive in 2011. Both are growing, with growth in the Mexican gross domestic product (GDP) expected to somewhat outpace that of the U.S. in 2011 just as it did in 2010. Besides looking at GDP, we also follow the PMI (Purchasing Managers' Index) and tie it to our carloadings, and we monitor industrial production trends both in the U.S. and Mexico. Both are trending positive. Finally, we closely track our most economically sensitive commodity areas such as chemicals, autos, steel, and consumer products. We are not seeing any underlying softness in any of these areas.

Our outlook for 2011 calls for us to spend 17-18% of revenue on capital, which would be consistent with our projected 2010 spend. On an absolute dollar basis, 2011 capital will be higher than both 2010 and 2009.

Claude Mongeau, CN: The economic recovery in 2010 exceeded our initial expectations. Inventory re-stocking and government stimulus played significant roles in driving economic performance, particularly in the first half of the year. Our year-to-date 2010 volumes are essentially back to pre-recession 2008 levels. As we look ahead to 2011, we are expecting the pace of economic recovery to moderate as inventory re-stocking is largely complete and government stimulus winds down.

CN will provide guidance for its 2011 capital spending plans when it announces fourth-quarter and year-end 2010 financial results in late January 2011. In 2009, capital spending was approximately C$1.5 billion. In 2010, CN expects to invest approximately C$1.6 billion, of which approximately C$950 million is targeted toward track infrastructure CN's equipment spending, targeted to reach approximately C$350 million in 2010, is intended to improve the quality of the fleet, and includes acquisition of new high-horsepower locomotives. CN also expects to spend approximately C$300 million on facilities to grow the business, including transloads and distribution centers; on information technology to improve service and operating efficiency; and on other projects to increase productivity.

Fred Green, Canadian Pacific: In 2011 we will face a recovery punctuated with volatility. Energy-related demand will be positive and CP is well positioned to capture that growth on both sides of the border. We are excited about the growth we have seen in the Bakken oil and gas formation in North Dakota, the Marcellus region in Pennsylvania, and the industrial heartland northeast of Edmonton. Coupled with improvements in the ethanol market and significant potash expansion for export volumes, CP is well positioned in each of these markets. Areas tied to the North American economy—consumer products, forest products, autos—will continue to mirror the broader jobs recovery, with weaker growth vs. the export market.

Typically, 13-14% of CP's revenues are reinvested in maintenance capital. In addition, we will make discretionary capital investments to improve operations. I expect our capital spend to rise to the upper end of the industry-normal range for the next few years. We are going to increase our focus on longer, more efficient train strategy. We have the capability of running 12,000-foot transcontinental trains and even 14,000-foot trains.

We also expect to see continued investment in our physical plant, including siding extensions enabling us to run additional long trains. We also plan to take ourselves to another standard in the information technology world. We'll invest in electronic train and track inspection surveillance technology that allows us to address fleet and track maintenance proactively, and Automated Inventory Reporting tablets that allow us to capture inventory changes in real time, ensuring efficient management of customer shipments.

In Canada, CP has been actively engaged with the Rail Service Review Panel. We support the Panel's conclusion that commercial solutions are preferred over regulatory changes.