Rail Renaissance, RIP

Posted by Fred Frailey
on Tuesday, August 27, 2019

Railroad analyst Anthony Hatch coined the term “Railroad Renaissance” to commemorate the industry’s rebirth. How right he was! By 2004 railroads had become red hot, gobbling up market share and expanding capital budgets to increase capacity. Today it’s obvious we’ve come to a turning point. Fully half the Big Six railroads (CSX, Norfolk Southern and Union Pacific) appear to have thrown in the towel and no longer pursue business growth. Oh yes, they all talk the talk, but won’t walk the walk. North of the border, the railroad business is booming, but that could just reflect the nature of Canada’s energy-driven economy. This leaves BNSF Railway, which appears to be torn. I sense that CEO Carl Ice wants to keep investing in a bigger railroad, but last year BNSF returned twice as much money to owner Berkshire Hathaway ($5.5 billion) as it had in 2016, and had to borrow to fund capital spending. Today Hatch concedes to me: “The Renaissance is troubled for sure. . . I would say the patient is weak but stable.” But as I see it, the Railroad Renaissance is on its deathbed.

The problem is that growing your business is expensive for railroads. A decade ago some railroads were spending one-fifth to one-fourth of their revenue on capital projects. After all, unless you expand capacity, taking on more carloads will only gum up the works and drive those new customers away. Granted, railroads are generating record amounts of cash. But there is conflict over what to do with that money. Reinvest it in the property? The owners—investors, Wall Street—are saying no, that they would rather have the money returned to them in the form of higher dividends and expanded share buybacks. It’s not just a railroad phenomenon, either. For as long as I remember, pundits have deplored Wall Street’s short-term vision.

CSX illustrates the problem well. Merchandise loads on CSX in 2018 (everything except coal, autos and intermodal) were off 25% from their high mark in 2004. Against that backdrop, Ed Harris, its executive VP of operations, talks the talk. He told a railroad superintendents convention that CSX has streamlined operations, improved train performance and become a low-cost railroad. Railway Age reports his saying that “the lowest-cost carrier has the most leverage to compete against highway trucks and other rail carriers. That gives CSX a sustainable pricing advantage in the markets.”

Harris is correct, but CSX won’t walk the walk, so far refusing to be flexible on pricing to entice shippers to use its trains. In fact, as of mid-August 2019 intermodal revenue ton miles at CSX were down 9.4% for the year, coal RTMs were off 5.9% and everything else rose a mere 0.5%—this in a robust economy. Chief marketing officer Mark Wallace told analysts in July that upward momentum in pricing continues unabated. “Every contract that we have still needs to come across my desk for approval,” he said. “I’m extremely pleased with the discipline that our team is bringing.” Wallace talks about new marketing initiatives, but it’s hard to add customers when you price your product to the sky.

The intermodal arm of railroading was supposed to make up for the stagnating carload business. But now it too is in trouble. Through July of this year, intermodal loadings fell 3.7% versus a year ago. Again, aggressive pricing by railroads may be to blame. The Journal of Commerce’s Ari Ashe reports that on average, shippers are saving only 5% choosing rail intermodal over all-highway, versus a traditional saving of roughly 20%. Larry Gross of Gross Transportation Consulting put it very well: “Railroads have been reluctant to follow the softening prices in the longhaul market. Pricing discipline is a good thing, but when you represent less than 7% of the [transportation] market your ability to affect overall pricing is very limited.”

And this brings us to why it matters. During the 1970s railroads were dying. Once deregulated in 1980, it took two decades for the industry to get things in order and achieve some pricing power, prompting analyst Hatch to declare his Railroad Renaissance. But this has turned into a renaissance only for the owners, who suck the cash out of railroad treasuries instead of reinvesting it. The trucking companies are growing with the economy while railroads, once again, are not. Instead, they become less and less relevant to the economy and to the American people. Who will be the railroad executive who reverses this decline?—Fred W. Frailey

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