Wednesday, September 09, 2009

Dahlman Rose & Co. 2009 Global Transportation Conference Report

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The railroads are well-positioned for the recovery—a point emphasized by the railroad industry speakers at the September 9-10 Dahlman Rose & Co. 2009 Global Transportation Conference in New York City, moderated by Director-Rail & Trucking and Railway Age Contributing Editor Jason H. Seidl. From top: BNSF Executive Vice President and CFO Thomas Hund, hund-bnsf.jpgUnion Pacific EVP and CFO Rob Knight, Canadian Pacific President and CEO Fred Green, with Norfolk Southern EVP and Chief Marketing Officer Donald W. Seale, CN Executive Vice President Claude Mongeau, CSX Vice President Strategic Planning Lester M. Passa, Genessee & Wyoming President and CEO John C. Hellmann, and Kansas City Southern EVP and CFO Michael W. Upchurch all detailed their railroads’ focus on maintaining a strong, safe network and controlling costs during a recession that has seen traffic volumes drop by record levels. Speaking to an audience consisting mostly of investors, these executives also talked about the benefits and advantages of rail, and the absolute necessity of continued investment in physical plant and an adequate return on that investment.

“Railroad executives voiced optimism about the market but cautioned that the recovery is likely to be a slow and gradual one,” Seidl summarized. “Solid rail pricing continues to underscore the fundamental strength of the major railroads.  Capital expenditures should to be largely maintenance related and cost cutting measures are likely to continue. One silver lining that can be seen through the thick clouds of the current recession is that the railroads are likely to emerge leaner and meaner as they have trimmed unnecessary costs and learned what expenditures they can forego without incurring material detrimental effects to their business. The near term outlook for the rail industry is positive, as volumes should begin to show growth in September.  While this is partly due to easy year over year comps, it is also a result of improving traffic in the automotive, chemicals, agricultural products, and steel sectors. As business picks up the railroads are likely to enjoy high incremental margins on the first 10% of growth as they should only have to add railcars, and not trains, in response to volume increases.”

“We have to maintain a strong network,” said Hund. “We’ve reduced capital spending, but maintenance spending has not been reduced. We’ve placed an emphasis on cost control, with a deliberate variable cost structure focused on productivity. We’ve maintained financial flexibility by temporarily stopping our share repurchase program. So, we’re well-positioned for an economic recovery.”

“We can’t control what happens in the economy, but we can control how we manage our business,” said Knight. “UP has achieved consistent improvements in safety and customer service. In August we set a record for customer satisfaction. This was not just based on service quality, but on customers’ perception of value—whether knight-up.jpgthey feel they are getting their money’s worth.”

Hund pointed out that railroads have a much smaller carbon footprint than trucking. With the Obama Administration’s focus on the environment, “there’s a risk to some parts of our business like coal, but an increase in traffic in other segments will help offset that, he said. He pointed out that the Administration is talking about 10% shift in transportation market share from truck to rail. “Key is earning our cost of capital,” Hund said.

There is some concern over utilities switching from coal to natural gas, due to the latter’s current low cost, but the impact should be modest at current prices. “Natural gas is competing with coal, but longer term, we don’t expect that to continue,” said NS’s Seale. Natural gas futures indicate the price per million BTUs is rising. (Natural gas prices are inherently volatile, due to wide variations in supply and demand, plus limited storage, compounded by speculative trading mechanisms). More important, coal stockpiles, which are 20% above normalized levels, are impacting domestic rail volume. “Coal volume is under tremendous pressure as stockpiles are drawn down,” said UP’s Knight.

However, said Seale, “Our coal export bookings are encouraging.” One example is China, which has become a major importer of metallurgical (met) coal, and is investing over $500 billion in transportation infrastructure over the next few years. “The U.S. has high quality met and coking coal that’s getting a close look,” he said. As well, blast furnace restarts for met coal are occurring, and green-and-seale.jpgsteel production is resuming.

On the motor vehicle side, “we do see a few signs of hope,” said Knight. “We see an opportunity to increase volumes this year. The true test for automotive will be what happens to sales without government incentives.” The Cash for Clunkers program increased sales by 14 million vehicles, he noted. As well, new North American assembly plants opened by manufacturers like BMW and Volkswagen will add to existing business from Detroit’s Big 3 (GM, Ford, and Chrysler).

One growth area is domestic intermodal. NS, said Seale, has launched 14 new intermodal services within the past year and is continuing to build new terminals. Among these are the Meridian Speedway, and a new refrigerated container service from Chicago to the Titusville, Fla., in cooperation with the Florida East Coast. He pointed to NS’s “six corridor intermodal mongeau-cn.jpgstrategy, with a significant opportunity east of the Mississippi.” It includes overnight service on the Heartland Corridor from the Atlantic Seaboard to Chicago/Detroit, and the Mid-America, Titusville, Meridian Speedway, Crescent, and Pan Am Southern corridors. New terminals are being built through public/private partnerships, “and the public portion of the money is flowing,” he said.

CSX, said Les Passa, is concentrating on “network investments that build on our strategic advantage.” Among these are such public/private partnerships as the National Gateway, which will link major east coast ports to producers and consumers.

UP’s Knight pointed to his railroad’s ability to go after non-traditional and niche markets. “We have an aggressive effort to identify these markets, especially those that have not of late been considered suitable for rail by shippers,” he said. One example is the used car market, for moving cars across the country, whether for wholesalers or individuals. “That market is 100% truck, and it’s based on service quality.”

Other opportunities? “We see continued growth in biofuels, as a result of increasing demand for export grain and new ethanol terminals.” Said NS’s Seale. Another potential bright spot is passa-csx.jpgdomestic industrial development—“Yes, manufacturing in this country,” he said. He noted that 74% of the U.S. population is in NS’s service area. One study suggests that there is a potential for capturing 30 million truck movements. Plant relocations or upgrades on the NS network have produced $1.4 billion in new revenues over the past 10 years. Year-to-date, NS has added 62 new industries and expansions that have generated 100,000-plus carloads. Looking further ahead, the rail market will continue to increase in complexity, through emergence of multiple markets and shifting global trade patterns. As well, motor carrier costs will continue to rise, driving highway-to-rail conversions.

CP’s Fred Green listed as among his railroad’s long-term growth opportunities the Edmonton, Regina, and Les Cedres intermodal terminals, the Canadian industrial heartland, the Dakota, Minnesota & Eastern acquisition, and a new Toyota plant outside of Toronto. Among short term growth opportunities are condensate from the oil sands region in the Calgary area, grain elevator expansions, canola seed crush facilities, ethanol plants in South Dakota, and the Kansas City Gateway, which connects with all major railroads. CP is expecting a good U.S. grain crop, and the Canadian grain crop is looking like it might be better than expected. “We want to extend our haul as far south of Chicago as possible,” Green said. “The DM&E integration proceeding as planned,” he added. On the down side, “We have no indication of a traditional fall peak,” he said. “Retail consumption will be modest. We won’t see the extreme peaks of the past.” As well, forest products are showing no immediate signs of recovery. Automotive is hard to read—is it a blip as a result of government incentives?” As for CP’s capex program, “Our capital budget will be tight for next year, but we will not scale back maintenance,” Green said.

hellmann-gw.jpgKansas City Southern, said Upchurch, despite scaling back its capex program significantly, completed an important expansion project: rebuilding of the Victoria to Rosenberg, Tex., line that it acquired from Union Pacific. This line will provide KCS with much faster traffic flows on its north-south alignment that carries traffic across the Mexican border at Laredo, Tex., eliminating a trackage-rights haul across UP lines. “We’re beginning to see a rebound in our traffic,” said Upchurch. “We’re poised for incremental margin improvements and free cash flow improvements.” Chemicals, automotive (again, attributable to the Cash for Clunkers program), and appliances have seen relatively solid improvements. Chrysler has said that, following its merger with Italy’s Fiat, its plant in Toluca, Mexico will become an important manufacturing facility, producing Fiat vehicles for the export market.

Like the Class I’s, short line operator G&W has been “patient” with new acquisitions, and has focused on adjusting its capex program and other cost-control measures, John Hellmann reported. G&W carloads bottomed out in May at roughly 61,000 and have been climbing slowly but steadily since then. Among the holding company’s priorities for the remainder of the recession are improving safety and continuing training and development programs.

Rail legislation—reregulation—is being considered on Capitol Hill, but will not see action until next year. “It will be a 2010 issue,” said BNSF’s Hund. “There will be some type of re-reg bill, but we’re starting to see a movement toward a middle ground.” Hund pointed to intense discussions involving key Congressional committee staff and rail industry constituents (railroads, shippers, and labor). “We will see sensible regulation,” said Hund. “The devil will be in the details. Once everything is settled and we know where we stand, upchurch-kcs.jpgwe’ll be able to take a more offensive position, and go after things like an investment tax credit.” Added NS’s Seale, “The railroads can do what government expects, with regard to the environment and fuel conservation.” CSX’s Passa stressed that the rail industry is building momentum, educating Capitol Hill on “the significant public benefits of rail.”

“We are going through one of the longest and deepest recessions since the 1930s,” said CN’s Mongeau, who will succeed Hunter Harrison as CEO in January 2010. “We have seen the floor and expect traffic to gradually recover.” CN’s record performance in all service metrics are only partly attributable to lower volumes and fewer trains on the network, he said, pointing to “a full pipeline of top-line initiatives,” among them the Prince Rupert intermodal terminal, new canola seed crush plants, potash mine expansions, new iron ore nugget plants, and truck retail share gains.

As all his colleagues reported, “We’ve achieved solid results in a challenging environment, in a high-fixed-cost business,” said Mongeau.

—William C. Vantuono, Editor, Railway Age