Monday, September 13, 2010

Dahlman Rose conference consensus: No double dip

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Based upon the presentations at last week’s 3rd Annual Dahlman Rose Global Transportation Conference in New York City, there is a consensus among major freight transportation companies that “a double-dip recession is unlikely to occur,” according to Director-Equity Research and Railway Age Contributing Editor Jason Seidl.

“Rail executives from leading Class I and short line railroads provided a much needed breath of fresh air by voicing optimism regarding the current state and prospects of the NorthAmerican railroad industry and overall global economy. While they expressed some caution, they described a steady and sustainable, albeit slow, recovery, evident in their unique insight into multiple components of the economy and their recent interactions with their customers,” said Seidl.

Railroad executives presenting at the conference “noted continued strength in automotive carloadings fueled by a recovering autoindustry, robust intermodal traffic aided by burgeoning domestic moves, rebounding coal shipments, growing metals and minerals volumes, and favorable prospects for agricultural products, chemicals, and potash,” says Seidl. “Overall North American rail traffic has been posting solid growth both sequentially and year over year. While the year-over-year growth rate continues to decelerate, this is largely attributable to toughening comparisons rather than a real dampening in market demand. We believe that in the remainder of 2010, the volume strength will co-exist with the aforementioned decline in the growth rates created by the optical illusion of tougher year-over-year comparisons. The strength in rail traffic does not come at the expense of pricing or margins. In fact, the railroads described a healthy pricing environment with increases in excess of rail inflation. Additionally, the continued presence of operating leverage means that volume gains translate into disproportionately large increases in operating margins, which should continue to lead to impressive bottom line performances.”

“CSX delivered a clear message of optimism, noting that the strength seen in first-half 2010 should continue into the second half and beyond,” notes Seidl. “Volumes, which are up 15.3% year-to-date, have much upside left as they are still 17% off the peak seen in the first half of 2006. On a macro level, the company noted that despite some uncertainty in outlook, some indicators are encouraging. While the Purchasing Manager Index (PMI) has dipped a little, the Consumer Inventories Index (CII) remains favorable. Key rail drivers indicate further expansion as seen in the Coal Mining Production index, which is up 0.5% in 2010; consumer spending is up 1.6% in 2010; automotive volumes are driving metals and chemicals; durable consumption is increasing; imports are still growing; and intermodal demand remains strong, which should lead to a strong peak season.

“Genesee & Wyoming said that traffic continues to grow at solid rates even though comps get tougher as we move through the rest of the year, with coal haulage and chemicals and plastics leading the growth. G&W indicated that the Freightlink acquisition allows it to expand its footprint in Australia, which should create freight rail business over 1,400 miles from Tarcoola to Darwin to export bulk minerals such as iron ore, manganese, and copper to Asia. GWI also discussed its newly formed subsidiary, Western Labrador Rail Services, which serves the ConsolidatedThompson Iron Ore Mines. This subsidiary was formed to allow the company to take advantage of an emerging mine business, which is coming in a big way in 2012 and beyond. The company indicated that it has a lot of capacity along itsnetwork, with only about 7-8% of locomotives still in storage, and is having an easy time pulling them out to meet demand.

“RailAmerica highlighted its focus on organic growth through improving traffic, pricing, and non-freight revenue, as well as external growththrough opportunistic acquisitions. The company is in a strong position to pursue acquisitions as it had cash of $141.9 million at the end of June. While the recent Atlas acquisition is providing synergies and expanding the serviceoffering and geographic coverage of both companies, RailAmerica’s primaryacquisition targets continue to be other short line and regional railroads. Thecompany also provided an update on Project Horizon, which is improving thebasic operations of all RA-owned the railroads by reducing paperwork andintroducing handheld technologies. On the legislative front, RailAmerica stillexpects the 45G tax credit to be passed this year and to be retro-active for2010.

“Norfolk Southern noted that, while the recovery may be choppy and uneven, the company does not see a double dip. In fact, NSelaborated that a double dip is not seen in carloadings or in conversationswith customers. The company expects good volume growth in the second half ofthe year in all commodities, except forest products, which is negativelyimpacted by a slow housing market and the shift to digital devices from paperproducts. Domestic intermodal has been very strong (up 20% compared to 2009 andessentially flat with 2008), and the company expects more truckloadconversions. Steel production is strong and is driving both met coal and the company’ssteel franchise, which is the biggest in the industry. Utility coal has shown aclear improvement in the second half, which is expected to continue through2010.

“Canadian Pacific, which tends to be generally more cautiousin its commentary than its Class I counterparts, indicated that the demandenvironment remains volatile and the visibility of the market going forward isfairly limited. Even though the market for CP seems volatile, there are partsof the business that are showing strength. The automotive business has a strongproduction forecast, the U.S. outlook looks strong, intermodal has recovered toan 11% growth rate, the outlook for potash is favorable, and commodity pricesare driving volumes, which are up 5% quarter-to-date. CP's goal is to reach anoperating ratio in the low 70s and achieve price increases in the 3-4% range.

“Canadian National indicated that its volumes are up 19% quarter-to-date.We note that this is higher than the overall North American rail traffic, whichis up 13% QTD. CN noted strength in metals, grain, automotive, and intermodal. Onthe other hand, forest products remain significantly down from 2008 levels asthe housing market remains weak and paper products are being replaced bydigital media and electronic devices. On a macro level, CNl noted a slow butsteady recovery while saying that if the pace of such recovery picks up, thecompany has plentiful capacity ready to be put on line. On the operationsfront, the company highlighted its continued focus on distributed power, whichallows for longer trains and increased productivity.

“Kansas City Southern revealed some of the biggest news atthe conference when it announced for the first time that it has established anoperating ratio goal in the 60s. While the company did not discuss a time framefor achieving such goal, it said that the combination of volume growth, strongpricing, and expense reduction were behind its new ambitious number. We believeKCS may provide a little more clarity regarding the time frame during its third-quarterearnings call in October. Another new revelation was that KCS saw 700 intermodalunits from multiple customers go from Lazaro Cardenas into the Texas market,signaling the beginning of growth coming out that port, whose current capacityof around 750,000 TEUs is expected to more than double over the next year. KCSalso announced that it signed a big appliance company that opened amanufacturing facility in Mexico. We believe the company is Whirlpool Corp. Onthe hurricane front, the company indicated that Alex caused 80 washouts andsignificant damage, causing volumes to fall 18% in July from June. However, theits insurance policy should cover the majority of lost profits. The network nowappears to be back to normal and KCS expects second-half 2010 revenue growth of20%.”