The Target Is Actually the Hunter

Written by David Nahass, Financial Editor
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FINANCIAL EDGE, RAILWAY AGE MAY 2021 ISSUE: The scuffle between CP and CN to acquire Kansas City Southern requires comment. In the 2021 Railroad Financial Desk Book, it was noted that KCS’s franchise value was above the $208 per share offered by Blackstone, and that the July 2020 rejection of the Blackstone offer by the KCS management team was financially astute and in the interest of shareholders. After CN’s most recent offer, KCS’s stock is now valued at $325 per share. (In March 2020, the stock traded at $108 a share.)

Keith Creel, President and CEO, Canadian Pacific

CN or CP will be able to wade through the regulatory swamp and close this transaction. (STB has already blessed CP’s strategy.) There will be concessions to the other Class I’s to approve the acquisition (CN more than CP), but the deal will get done. The deal has enough worthwhile benefits: moving traffic north to south while bypassing Chicago, the opportunity to exploit near-shoring with south to north traffic, and the possible creation of a crude by rail pipeline for Canadian crude. 

Unfortunately for CP’s Keith Creel, unless he matches or improves upon CN’s offer, he will have made the same mistake as Blackstone (but with more serious consequences). In a frothy market, never risk embarrassment resulting from pride or cleverness. When making a play for a stock going from $108 to $275 in 13 months, commit to being the winner.

Pat Ottensmeyer, President and CEO, Kansas City Southern

Speaking of winners, kudos again to Pat Ottensmeyer and team KCS for its “West Coast Cool” approach in letting the market come to them. Results? A 56% increase over the Blackstone bid (200% increase since March 2020).

Rail Equipment Finance 2021 Update

The Rail Equipment Finance (REF) 2021 Conference (virtually on demand) provided an update on the current state of rail equipment, rail freight and a look forward to the coming year. REF 2021 started with a live presentation from Dr. Sergio Rebelo, MUFG (Mitsubishi UFJ Financial Group) Bank Distinguished Professor of International Finance at Northwestern University’s Kellogg School of Management. Dr. Rebelo’s presentation was covered by Railway Age Contributing Editor Jim Blaze:

“Railroads operate in a broad economic environment, and the U.S. economy appears to be in pretty good shape, fundamentally. Consumer spending, Dr. Rebelo told attendees, may lead the U.S. recovery in 2021. Data shows that household savings has increased as the government has provided stimulus payments to citizens. 

“Corporate debt remains inexpensive. Lower debt costs and a corporate focus on resiliency over efficiency has the potential to encourage growth in near-shore manufacturing. Near-shoring is supported by a mix of factors made more important by the pandemic: lower energy costs, security of the supply chain, and the potential for automation.” 

Here is a rundown of the key takeaways from the other REF sessions: 

• Dr. David Humphrey, Railinc, provided an update on the North American railcar and locomotive fleets. Key takeaways: While the railcar fleet is shrinking slightly (mostly coal), tank railcars continue to be the largest build segment. By capacity, the covered hopper and tank markets are increasing, while boxcars and coal are declining. On the locomotive fleet, the national fleet is declining slightly, as production over the past few years has been tepid. 

• Eric Starks, FTR Transportation Intelligence, talked about the role of North American rail in a post-Covid environment. The consumer-led recovery is slightly masking a slower recovery in general freight. Pressure to move goods is at an all-time high, elevating manufacturing output to pre-Covid levels. Rail loads are not expected to match 2018’s peak until after 2022. New car deliveries are not expected to approach higher levels until the end of 2021 and 2022. Increased scrapping will help.

• Graham Brisben, PLG Consulting, discussed the entire energy spectrum. Quick summary: Coal’s decline continues with another downward inflection in 2025. Sand continues to be oversupplied; Canadian CBR will experience growth and then get into pipelines. NGLs to Mexico have remained strong. New plastics production is plateauing and will surge forward when the next demand cycle returns. Future trends to watch: renewable diesel, waste plastic conversion, and e-commerce warehouse expansion that can influence rail loadings growth.

• Matt Elkott and Jason Seidl, Cowen and Company, gave the analyst update on the rail industry. The big topic: Railcar freight volumes have been increasing but without some of the tenacious gains in some trucking markets. Intermodal freight has been strong with a consumer-led recovery. Both project continued strength for freight demand through 2021 and into 2022. As the industry enters the later stages of PSR, recovery in railcars orders and lease rates in 2021 and 2022 is projected.

• The railcar and locomotive appraisal panels highlighted surprisingly stable railcar and stable-to-lower locomotive values across almost all car and locomotive types (except sand and coal). On railcars, the panelists expect more scrapping of older cars with higher scrap rates as having a positive impact on values. They  expressed some optimism but also lamented that, in some cases, leases rates do not support today’s valuations. On the locomotive side, survey results were split, with some smaller switcher units (such as the MP15) continuing to hold value, while some six-axle power values languish while Class I’s continue to store excess power.

The REF virtual portal will open to the general public around June 1 for 30 days. Dr. Rebelo’s presentation will not be available. Email the address below if you wonder about REF and want to receive any emails announcing the viewing period.

Got questions? Set them free at [email protected]

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