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Rails Beyond Coal – The Dawning of the Domestic Intermodal Age AB HATCH [email protected] 155 W68th St Suite 1117 NYC 10023 www.abhatchconsulting.co / MillerTabak Green vs Black? The RR Renaissance & “the end of the coal age” Wisconsin RR Day/Eau Claire October, 2012 Rail Assessment Strengths Strong secular growth Favorable market structure Supply constraints Solid barriers to entry Limited alternatives Opportunities Pricing Volume Growth Service levels / productivity Modal shift Consolidation? Challenges Capital intensity Capacity bottlenecks Port congestion Service/productivity Reliability vs. trucks Threats Economic malaise Rising capital requirements Regulation Maritime trade flows Utility Coal Future Growth Potential 5 Secular stories (in order)…. • 1-Intermodal – International and now Domestic • 2 –Shale/Oil – Problem and solution? • 3-Chemicals/Re-Industrialization • 4 - Grain – the world’s breadbasket • 5 - Coal? Exports – “legs”? • Other Rail Opportunities exist but in smaller scale: The Manifest/Carload “Problem” (hub&spoke) vs. point-topoint “Unitization”/Industrial products/MSW (garbage) /perishables/others Rail Intermediate term volume prospects ABOVE GDP ABOVE GDP Intermodal – Domestic (++) Intermodal – International Shale/oil Agricultural products Export Coal Chemicals! BELOW GDP Auto Parts (?) Domestic Coal (-?) GDP-GROWTH Autos (+?) Lumber (+?) Aggregates Metals (+?) UNCERTAIN Paper Ethanol Railway Innovation focused on growth Intermodal is Emphasized • CP – larger trains • CN – alliances, routing protocols – the scheduled railroad! • BNSF – Logistics Parks, JBHT&Domestic Intermodal, grain “Shuttles”; • NS – PPPs, JVs and “Corridors” • KCS – little engine that can – Mexico, Lazaro, Houston… • CSX – MSW, RailEx, Trop Train, Near Term • Q1 – EPS +30% despite: coal, grain, economy- beats Street expectations • Q2 – up ~20/20 RRs again beat expectations, reiterate Goals/Targets • H2 outlook perhaps a bit more muted • End of coal decline? But not grain? Where are we in recovery? Pricing? • Cash flow – still “balanced” use? Capex will still be supportive of growth segments Current Issues • Rails in the Recovery – or in another slowdown? Is 2012 “just another” 2011? • What’s true? RR (cyclical) traffic or business headlines? • End of the Coal Age? • Capex – Strategic or Tactical plans prevail? $13B! • PTC • After the Rereg Fight what? STB? TSW? • Govt role –partner? Or preoccupied &broke? • The Green mantle – two-edged sword…. • PE &Infrastructure – and activist? – funds: back for good? CP…. • New “Golden Age”? Service Underlying Themes or “Givens’ • Green is here to stay • Oil Prices will remain high (price points at $65, $45, $25/bl) • Governments spending will be problematic • Infrastructure will be challenged • Trade will be dynamic but remain strong • Near-sourcing and in-sourcing remain themes • Trucking Productivity has peaked • Driver shortages are a secular/demographic issue exacerbated by govt regs (CSA/HoS) Carbon Footprint– from cocktail chatter to decision point • 2003 – 221/F500 report on carbon; 409/F500 in ’09 • Green supply chains enforcement by Wal-Mart (from $2B transport spend to $4B+ by ’11); GE, P&G, etc….advantage intermodal • Anticipating future EPA regs (12/23/11) and emissions law – advantage cheap & plentiful Natural Gas • Rails – Double-edged Sword – green developments hurt coal, help intermodal & shale • One major result is: Coal in Trouble • Domestic in secular decline due to regs/legislation, accelerated by weather, economy and, especially NG price • Exports tied to global economy (ie; China); competition – and infrastructure access • What was once “stable” and base business is the most uncertain • Solution: invest elsewhere…. Every picture distorts a story? Exports to the rescue? Shale • Frac Sand, brine & water, pipe and aggregates inbound • In cases of Oil, “Rolling Pipelines” out…. • Hess – 286 cars, 9 trainsets now, 27 in a few years (followed by Phillips 66, others) • Pipeline companies developing rail terminals in ND • Tar Sands and pipelines • Chemical Industry – secondary impact • Industrial Development – tertiary impact Estimated Delta In RR Revenues/Prologistics Group Approx Annual Carloads 2008 Approx Rev/Car Change In Rev 2011 Coal 8,320,000 7,120,000 $1,700 ($2,040,000,000) Oil 6,000 92,000 $3,700 $318,200,000 Sand 160,000 360,000 $3,500 $700,000,000 Total 8,486,000 7,572,000 ($1,021,800,000) Shale Plays 15 Why move crude by rail? • Moving a barrel by rail can cost $7 to $14, compared with $2 to $5 by pipe, depending on destination. But that price difference pales in comparison to a $15 to $30 premium for reaching the right markets • Producers are working shale everywhere and rail transload terminals are a costeffective, very quick way to start moving crude to market • Flexibility to serve all markets using existing N.A. rail infrastructure. Existing rail routes have capacity to reach East and West Coast markets in the U.S. that may not have sufficient pipeline capacity. • Isolation of commodity to provide a “pure barrel” to the destination • Speed to market – 12 months to build a unit train rail terminal • Comparatively low entry level capital requirements • Source: Watco What, me worry? • • • • • • • Coal – its price not community Quick then suddenly – 10% hit? Activists – what's next? Compensation: shale (+++)? Compensation: chemicals? Compensation: export coal? Compensation: domestic intermodal? Revenue Share Percent of Total Revenue for Major US Railroads * 2012 estimated based on first half of year Source: AAR analysis of 10-K reports for BNSF, CSX, KCS, NS & UP Intermodal Growth Drivers Domestic and International • Globalization • Trade • Railroad Cost Advantages • Fuel prices • Carbon footprint • Share Recovery From Highway • Infrastructure deficit & taxes • Truckload Issues; regulatory issues, driver issues US Railroad Intermodal Traffic TOFC-COFC Units Millions Recessions * 2012 estimated based on first 35 weeks of year Source: AAR analysis of 10-K reports for BNSF, CSX, KCS, NS & UP Modal Shift Projection % of Market Share Current Rail Intermodal Market Projected Market Shift Current Truck Market TRANSLOADING REACHING NEW HIGHS Source TTX, IANS, Piers Ron Sucik RSE Consulting International Intermodal • Still game in the old vet • Even with near-sourcing • Even with changing flows (which may disadvantage rail) • Retail still tied to Asia • MLB still tied to rail service • Growth of 1-2.5X GDP Intermodal Issues 2012+ • International: trade flows, retail sales, exports & balance – UNP’s vision vs NRF, TTX • Panama Canal? On time? How much? Etc…. • Emerging Developments – Rupert, Lazaro, Miami • Domestic – development of “Corridors” & “Gateways”, etc • Domestic – bimodal partners, shipper developments • Domestic – service & pricing? • Q1/12 – up 5.9% (domestic +9%, int’l +3%, IMC+11%)! • “There’s somethin’ happening here….” Re-industrialization? • • • • • • Near-Sourcing: Mexico, CA Gas effect round two: CHEMICAL INDUSTRY Fertilizers Steel/Autos/White Goods etc Northeast, etc back “in play” Growth is Expensive • Huge Capex - $50B in the last 5 years in the US – through the Great Recession! • AND: Comeback of the share repo/DPS? • EPS beat the Street consistently, yet: – – – – – – Uneven returns in the Modern Age Recent improving trend line Misunderstanding Intermodal profitability 2004-8 Threats to ROIC threaten capacity Street begins to call for capex reduction? Suppliers 2012 looks solid – can they hold on till true recovery? Rail Capex in 2011/12/13? • Record $12B last year • Record $13B this year – many rails pegging at 17-18% of revenues (rising by double digits) • Corridor developments, NG, terminals, locos, cars, shale buildouts, etc • PPPs – in decline? • Still emerging as DPS plays, buying in shares Railroad Capital Expenditures Class I Railroads Billions $12 $10 $8 $6 $4 $2 $0 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 Source: Railroad Facts & Analysis of Class I Railroads, AAR RR CoC vs. ROIC – RR Stocks have done well but… they still trade at a discount to all stocks 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 81 82 83 84 85 86 87 88 89 90 91 92 93 94 Cost of Capital 95 96 97 98 99 00 01 02 03 04 Return on Investment Source: Surface Transportation Board Note: Cost of equity estimation method changed by Board effective 2006 and 2008. 05 06 07 08 09 10 ROI is everything • Rails must retain price (@”rail-inflation plus” levels, or +3-5% YOY) • Productivity – through capex, IT, scheduling, service • Must remain de-regulated (even if not directly an intermodal issue) Simple Math • Rates • Returns • Capital Expenditures • Capacity • Service ARE ALL CONNECTED! Virtuous Circle (’03-07) or Disinvestment? Election 2012 • • • • • • Republicans pro-coal Dems pro-gas Labor not a near term issue Tea-Party and Infrastructure PPPs? $- no matter who wins, who can pay? www.abhatchconsulting.com ABH Consulting/www.abhatchconsulting.com Anthony B. Hatch 155 W. 68th Street New York, NY 10023 (212) 595-0457 [email protected] www.railtrends.com CP • OY. 2nd (3rd) Proxy Fight since 1954 • Not a takeover • HH track record vs recent CP (OR, weather, M&A, growth) • HH goal 65% OR by 2015 • CP goal 70-72% in three years (YE’11 83.1%; C1 avg 71%) • (as example) CSX goal 65% OR 2015 • CP’s new management team yet to be revealed…. Positive Train Control (PTC) • “Unfunded Mandate” – part of 2008 safety bill • Overseer is FRA – who puts cost/benefit ratio at 22:1 • Rails have put cost of installation and maintenance at $10B – and rising (UP, CSX have increased 2011 capex based in PTC) • Possible benefits in capacity, velocity, fuel consumption as well as safety; many of those captured by other technological advances • Covers all rail interaction with passengers and TIH as of 2008; short lines exempted • Technology proven only in limited scope (BN/Wabtec: ”ETMS”) • Initiated after Chatsworth accident – obvious public benefits • Contrarian viewpoints exist – the new “Digital Railway” • Efforts to reduce footprint, extend deadline…. New Transport Bill • Rumor! Tue – too little/too late (or “calamity averted barely and not for long”) • Tiger 3 20% RR decline ($104mm) • PTC deadline to be extended from 2015 to 2020? Not yet…. • No TSW change • No Freight Plan • Govt’s declining role (in infrastructure!) Warren’s $44B “all-in” bet • Advantages of going private? (capex cycle) – will we see now? • Influence in DC - “Robber Baron” vs. “Sage” • Bets not (just) on economy – rereg, coal, western intermodal • Bought on the cheap! – How does the investment look today, folks?