Friday, January 13, 2017

Cowen and Company: "Notable earnings improvement in '17"

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Optimism was the main thread that ran across the presentations we saw at the Midwest Association of Rail Shippers (MARS) meeting in Chicago Jan. 11-12. Most people felt better about the economy and, while many were positive about the new administration’s view on corp taxes, there was reservation about trade policies. We continue to believe that the rails will show notable earnings improvement in '17.

Most industry conferences have one or two top tier speakers but the MARS conference had three big industry names to convey their wisdom on attendees. The first up was Carl Ice, President and CEO of the BNSF Railway. The BNSF ended a difficult 2016 with 2,500 employees furloughed (down from a high of ~ 5,000) and plenty of locomotives in storage. They currently have capacity in all areas but noted that they are starting to see signs of improvement in their business. He pointed to plastics and building related products as areas that represent growth opportunities for the western rail giant. Mr. Ice believes his railroad can utilize technology and big data to improve their operations and communication with their customers. While positive train control (PTC) was an unfunded mandate for the industry it could present railroads with potential benefits. Indeed if railroads are able to drop to one man crews or develop autonomous operations, PTC will likely have helped pave the way. He did acknowledge potential long term threats including autonomous trucking (AT) and political issues with trade policies.

Next up was David Yeager, CEO of the Hub Group who highlighted an intermodal market that had lots of opportunities but was not without its risks. The intermodal industry is coming off its worst year since 2009 but some of the headwinds faced are starting to become tailwinds. Mr. Yeager noted an accelerated trucking market over the past few months which has driven spot rates higher. The outlook is favorable in his view as trucking load availability was tracking above its 5 year average while trucking capacity was below its five year average. Combine this with a year over year increase in diesel prices and we should start to see a rebound in the intermodal market. While many people may believe the growth in e-commerce could limit the importance of intermodal Mr. Yeager saw an opportunity. He believes as the cost of the last mile delivery weighs on online retailers' margins intermodal can help offset these costs by reducing line haul expenses. That said, AT could present some serious competition for the intermodal industry. Trucking is mainly competitive in lanes up to 600-700 miles in today's market but Mr. Yeager believes AT could push this up to 1,400 miles. In addition to his intermodal business, technology is presenting some issues for his brokerage business. He pointed to Uber Freight (which started operations this past fall) and its desire to compete with just a 5% gross margin target which is far below the mid-teens level we see from the public brokerage firms. While they are just a start-up their growth could impede industry margins going forward.

The proverbial big gun for day two was Clarence Gooden, President of CSX, who decided to give his presentation without slides and noted what he said were his thoughts and not necessarily that of his company. He started out his talk with a focus on the economy, which he believes is on solid footing. In fact he predicted that GDP for 4Q (when finally adjusted) would be 3% or slightly greater. He is a believer that automotive growth will continue due to the high average age of light vehicles. Export coal has also bolstered his near term outlook. He pointed out that export coal was stronger than they thought it would be in 4Q and they expect that strength to continue into 1Q and potentially the entire 1st half of 2017. He remains hopeful of a new infrastructure bill and its potential to spark more projects much quicker than the prior one. He thinks many projects are waiting for money to become available. Looking into the future, Mr. Gooden said they were focused on the “CSX of Tomorrow.” This will focus the eastern based carrier on its network, service excellence, automation and a “team of tomorrow” (a younger workforce).

Eric Starks, Chairman & CEO of FTR Transportation Intelligence, presented his views on the economy. He did a quick survey of the audience (over 700 transportation devotees in attendance) and asked everyone about their business. The results were somewhat encouraging as very few noted a decline, about half saw their business levels about “flat to blah” and nearly half noted healthy growth. Current economic indicators also support this as ISM data has improved while industrial production is about flat. Inflation is under control and he does not believe a recession is likely in the next 13 months. The job market is nearing full employment and the housing market has very low inventory. While all of that seems very positive there was an area where Mr. Starks was somewhat skeptical. He remained concerned about the infrastructure bill in terms of it potentially adding too much debt.

Deb Miller, Vice Chairman of the Surface Transportation Board (STB), updated attendees on the state of the regulator. 2016 was an important year as they began the implementation of the STB Reauthorization Bill. The STB will now expand to 5 members from 3 and they will no longer be attached to the DOT. Two big issues loom in front of the board; standalone cost calculations and reciprocal switching. While these could impact the rail industry it appears the board will likely wait until President-Elect Trump appoints two new members to the board (a move that is not expected before the summer).