Sunday, February 28, 2010

Norfolk Southern investing in growth

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Doublestack clearance projects are central to the Heartland Corridor and Crescent Corridor projects. Domestic intermodal, says Wick Moorman, “is going to be a driver of the industry's growth.”

When times are tough, don’t let up—standard practice for railroads. Norfolk Southern, like all Class I’s dealing with a major revenue downturn, is not skimping on capital investment. Its 2010 program will be consistent with 2009’s, around $1.4 billion. The Thoroughbred’s largest expansion initiative, the $2.5 billion Crescent Corridor—a public/private partnership involving state and federal dollars—is on target. It’s “a huge planning exercise for whole company,” says chief executive Wick Moorman, “the biggest since the Conrail acquisition to put all the pieces together—real estate, terminals, trackwork, etc. Completion depends upon how the PPP portion works out. We can put capacity in quickly, compared to a highway.” (See www.thefutureneedsus.com.) Indeed, a big selling point of the Crescent Corridor is that it will eventually be able to take many thousands of truckloads off overworked I-81.

Business this year should improve, Moorman says. “If the economy continues to grow, even at a slow rate, we expect a better 2010,” he says. “The economy is clearly showing signs of improvement for some segments of our business. Agricultural products should be better this year, along with motor vehicles and metallurgical (export) coal. Domestic coal [for utilities] is a wildcard. The recent cold weather will have a positive impact, but stockpiles have gotten higher, and we have to see what happens with natural gas. Domestic intermodal should continue to grow. Our recently announced agreement for a long-term partnership with J.B. Hunt, and our partnerships with Hub Group and others, will be good for business. We believe that, long term, domestic intermodal, particularly in our service area, is going to be a driver of the industry’s growth. That’s what the Crescent Corridor is all about. International intermodal, in the other hand, is still a wildcard.”

NS’s 2010 capital program “is an indication of our belief in the value of the franchise, and our continued opportunity,” says Moorman. “We believe, in spite of the profound revenue decrease and economic uncertainty, that this company and this industry have a very bright future, one in which we want to invest.” Most of this year’s capex program is focused on the basics of keeping a well-oiled machine well-oiled. “About 75% of our capital budget is for state of good repair, the remainder an investment in growth,” Moorman says. “This year we have a couple of wrinkles. We have a higher Positive Train Control number, and a significant investment in SAP software for our back office systems. There’s no capital for locomotives or cars this year, but we are planning for some long-term car fleet replacements.”

Moorman describes car replacement as one of “two looming capital issues.” “A significant portion of our coal car fleet is reaching the end of its life expectancy, and we’re going to be making significant capex decisions about buying coal cars over the next year or two or three,” he says. “We’ve been able to offset some of our requirements through increased productivity (for example, with hybrid aluminum/stainless steel cars acquired about two years ago), and hopefully we’ll be able to do some more of that. We’ll also be looking at replacing some locomotives.”

Over the next 10 years, according to Vice President Mechanical Tim Heilig, up to 33,000 of NS’s fleet of roughly 102,000 cars will need to be replaced. The actual replacement number, due to capacity and productivity improvements that new cars offer, should be closer to 25,000 units. As for locomotives, this year NS will be squeezing extra life out of some of its older units (GE Dash 8s and 9s, SD40-2s, and some SD70s), through overhauls, midlife tuneups, emissions kit installations (165 units), and reliability programs that replace components such as power assemblies. The other looming issue is PTC, which is “of great concern,” says Moorman, who like other CEOs believes that federal funding to support a federal mandate is essential. “At the end of the day, while railroads spend an enormous amount of capital, it’s a finite amount. This mandate could ultimately mean that we will not be able to invest in other areas, some of which conceivably have as much or more of an impact on safety of operations as PTC. It’s great technology, but this unfunded mandate is just bad for the industry, there’s no question about it.” For example, the Federal Railroad Administration mandate of two PTC screens in the locomotive cab “is very unfortunate, very unnecessary—just an additional burden that has no bearing on safety of operations.”

Vice President Operations and Planning Support Gerhard Thelen says FRA’s dual-display requirement “creates a lot of additional design work.” NS’s PTC system, OTC (Optimized Train Control), is a vital (safety-critical) technology that is “largely software-driven,” he says. “Any design changes will require recertification.”

NS’s PTC expenditure is projected at about $1.1 billion—close to one year’s worth of capex—for total installation, “including cleaning up all the peripheral issues around our signal system that will need to be addressed,” Moorman says. “That’s an enormous amount of money, not only when we’re looking at significant capital requirements for maintaining the property, but investing in new assets to replace life-expired assets, and projects for future growth. It’s just a very unfortunate mandate. We’re trying to make the argument that we need some kind of assistance, whether it be through an investment tax credit, or some other kind of grant, or having the passenger operator pay for it. It’s all well and good to talk about additional capex for passenger rail, but the real issue is going to be funding the ongoing operating costs. To some extent, when new passenger service is added, Amtrak looks to the states, but the states don’t have much money. How does that work? It’s just like it’s always been. There’s a lot of uncertainty.”

The Crescent Corridor, says Moorman, “is the opposite of PTC, which has a 15:1 cost/benefit ratio. We’re anticipating a 25:1 benefit/cost ratio with the Crescent Corridor. The Heartland Corridor will be finished mid-year, on time. We’ve established a good working relationship with FHWA. If you look at the Projects of Regional and National Significance in SAFETEA-LU, only three are under way. When we talk about the Crescent Corridor with public officials, they know we have a proven track record of executing well, once the funding is in place.

“When public policy leaders talk about changing transportation policy in this country, the Crescent Corridor is an example they point to, as do we. It’s gotten enormous support. We have a five-state coalition requesting federal TIGER Grant funds, and everything is looking positive. Over the long term, Pennsylvania and Virginia have committed funds, and we have already completed projects in Virginia. Tennessee, Mississippi, and Alabama are on board.”

For state-of-good repair, Vice President Engineering Tim Drake says that lower traffic volume enabled his department to shift about two months’ worth of track work scheduled for 2010 to 2009. That translated to 160,000 extra ties and 58 extra track-miles of rail installed. “We gained 45 days worth of work time, finishing our 2009 program by mid-October instead of late November,” he says. “But we kept working. It makes good business sense to take advantage of the extra windows to better the property. We want to be ready as traffic begins to come back.” This year’s m/w program calls for 2.6 million ties, 270 track-miles of rail, and 2,500 track-miles of out-of-face surfacing.

Other than providing an opportunity to stay ahead of the m/w curve, has the Great Recession enabled the industry to showcase its value? Moorman used the analogy of two characters from Mark Twain’s “Huckleberry Finn” who were trying to portray themselves as a Duke and an Earl. “They were eventually tarred and feathered, and run out of town on a rail,” he points out. “While this was happening, one remarks that if it weren’t for the honor, he’d just as soon not go through it. That’s kind of how I look at 2009. The industry responded extremely well. We’ve shown that we have a resiliency that we did not used to have in terms of being able to respond to a set of economic circumstances that none of us could have foreseen and were far worse than we could have planned for. That’s been a real positive for the industry, an illustration of the fact that we, collectively, had gotten very close to sizing our companies for the level of business we were handling, and were able to adjust a little better than when we had surplus assets and people. We had to do some unpleasant things, by far the worst of which was furloughing people. But overall, the industry responded very positively. It’s an indication that it is far healthier than it has been in the past and able to withstand an economic blow like this, and not take a huge hit in terms of earnings to the point where it was unable to make money. We all managed to make money. In terms of investing in the property, we moderated a little bit, but you did not see big slashes in capital or maintenance. That’s an indication that we all have the same core beliefs about the future of our industry.”

Moorman takes a tough stance on STB reauthorization—the so-called “reregulation bill.” While the initial response from Wall Street and other industry observers was mild, Moorman says the battle against reregulation (or for balanced regulation, as the AAR now puts it) is far from over: “It is no less threatening, and for 2010 the most significant issue we are facing. The way it’s drafted now, the bill out of the Senate Commerce Committee is one we can’t support. We’ve been working with the Commerce Committee staff close to a year, and we will continue to work with them to explain why the various provisions could be very detrimental to this industry.”

Moorman points to the subtleties of the draft legislation: “This is one of those deals where every word will matter, and we need to make sure that those words are right. If you really delve into it, you start to see all of the different pieces that could be very negative for the industry. There are some very troubling things—the whole access issue, the nuances of the way the bottleneck issue is addressed, and the whole issue of the STB becoming accuser, judge, and jury on any number of issues. It gives them a whole new role in getting them into the day-to-day service obligations of a railroad. The short line paper barrier issue is very problematic for the short line industry. Even without the very disturbing retroactivity, I think it spells the death of the creation of new short lines, the way it’s written. The list goes on and on, but we’ll continue to negotiate.”

There’s an irony on Capitol Hill, Moorman says: “Juxtapose this legislation, which in no way, shape, or form is good for the industry—in fact there’s nothing positive for us—with what we know about what the FRA is trying to do in terms of developing a long-range national rail plan—a very positive picture of what the rail industry should be, and all its benefits. The Administration `is putting together a plan that’s extraordinarily positive in terms of what we should be doing. On the other hand, there’s a bill in Congress that’s going counter to it. How does that work? What’s going on? The two don’t jibe at all.”