Is the Railroads’ “Renaissance simply a thing of the past?€¦ · · 2017-06-01Is the Railroads’ “Renaissance” simply a thing of the past? SWARS! Alamo City abhconsulting

Is the Railroads’ “Renaissance” simply a thing of the past?

SWARS!Alamo City

abh consultingFebruary, 2016

21st Century: the Railroad Renaissance

• Rails have well beaten the market 2001-2014• LTM – “Not So Much” (CP doing relatively well)• Earnings Power misunderstood: Rails beat

Street estimates – in the Boom, in the great Recession, and the tepid recovery

• Record margins & results despite the coal hit (and drought and lukewarm economy, etc….)

• Rails are still re-gaining market share from the highway

Emerging Challenges to the Railroad Renaissance

• Earnings & Ratings Reductions/Sentiment• Coal’s Decline (#1US Utility #2 NA Export)• CBR Volatility (XL; CRR, etc….)• Rail Service, Safety & Capacity Issues• Rereg Threats• Cyclical Traffic Weakness (metals, etc)• Management Changes• Management Reactions: Guidance, Capex

Railroads Help Keep Coal-Based Electricity

SLIDE 4 ASSOCIATION OF AMERICAN RAILROADS

Coal: -755,916 (-12.0%)

Metallic ores: -182,607 (-18.5%)

Primary metal products: -93,070 (-13.8%)

Iron & steel scrap: -47,095 (-17.7%)Crushed stone, gravel, sand: -39,766 (-2.9%)

Stone, clay & glass prod.: -32,131 (-6.6%)Grain: -25,526 (-1.6%)

Nonmetallic minerals: -20,710 (-6.3%)Pulp & paper products: -10,883 (-2.3%)

Waste & nonferrous scrap: -7,870 (-4.1%)Primary forest products: -682 (-0.4%)

Food products: 480 (0.1%)Coke: 1,027 (0.5%)

Farm products excl. grain: 1,360 (0.6%)Grain mill products: 4,436 (0.8%)

Lumber & wood products: 7,095 (2.1%)Chemicals: 10,704 (0.5%)

All other carloads: 28,133 (9.4%)Motor vehicles & parts: 40,656 (3.6%)

Source: AAR Weekly Railroad

Change in U.S. + Canadian Rail Carloads: 2015 vs. 2014

Note: intermodal is not included in this chart. Intermodal was up 364,192 units (2.2%) in 2015 over 2014.

Petrol. & petr. products: -73,056 (-6.1%)

Silver Linings?• Service Recovery Trend (Capex Pays Off)• Restoration of the “Grand Bargain” • Reduced (N/T) Political Pressure• Productivity (& volume?)Inflection• Coal “stabilization” (Part Two)??• 6/7 Report “wins” Q3/15;Pricing Power Remains• IM (etc) latent demand….Bi-Modal results• Industrial Buildout (SHIELD); Mexico,South• Revised MoW Capex (GTMs/Mix) frees CF/2016

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MARS Winter 2016 Audience Polling - Tony Hatch• Tuesday, January 12, 2016

Q2: Has RR service noticeably improved over the past year?

Q3: Do you expect RR service in 2016 to?

Q4: Based on the "value proposition" for rail vs other

modes, for 2016 do you expect to:

Q4/2015 – Inflection Point?• Low expectations for rail (transport) quarterly

earnings – CSX starts us off with a “win”• Coal stabilizing? Sigh….• Productivity/service turnaround?• Management confidence/guidance?• Waiting on “Big Decisions” on Capex, “stranded

assets”• The “Renaissance” thesis faces first real

challenges this century

RR Q4/15- How Full is the Glass?

RR VOL% REV% EPS% W/L/T OR% BPS PRICE ‘16CapExYOY

CSX -6 -13 -2 W 71.60% -20 4.1 -4NSC -6 -12 -27 L 72.50% 350 NA! -13UNP -9 -16 -19 L 63.20% 180 3.5 -13BNSF TBD -25CNI -8 -1 15 W 57.20% -350 3 +7%!CP -6 -4 1 L 59.80% = 3 -26KSU -2 -7 -3 W 63.40% -330 4 -15GWRR TBD

AVG* -6 -9NMF 3/3/0* 65.10% -25NA (~3+) -13

Renaissance Discussion Points!• Can Rails Survive (or even thrive) the N/N?

• Or, can rails replace coal (ROI if not OR) with (domestic) intermodal (etc)?

• What is the future of industrial/merchandise railroading? (A: “Plastics”….)

• Rails will exit transitional period (faith)• CBR to continue longer term – as volatile as Ag?• Service Recovery – Politics, Productivity & Price• What is the new standard for Capex?• Is M&A the answer?

Top 10 Thoughts on Possible CP-NS merger

1. Risk/Reward Ratio Unfavorable2. Diplomacy (“Politesse”) Required3. Shipper Support Required4. NS Approval Important (and….);

Valentine’s Day Filing?5. STB/CTA (etc) Pro-cess Will Be

Long & Drawn-Oot

Top Ten NS/CP Continued

6. NS’ “Problems” Mostly Not of its Own Making (COAL!) – yet value is in “fixing” NS!7. NS is Advanced in Preparing for “Post-Coal” World8.New RR World to be Very-High-Service Focus9. CP-NS Could Stand alone -but would it? NO….10. YET: Never Underestimate EHH

Q6: Are you in favor of RR consolidation (merger)?

(17)

Future Growth Potential (Revised)

Specific

targeted sectors

Secular stories (in order)….

1. Intermodal – international and now domestic

2. Chemicals/re-industrialization? Near-sourcing/Mexico

3. Cyclical recovery – housing, autos

4. Grain & Food – the world’s breadbasket, (un)predictable?

5. Shale/oil/sand – problem and solution?

6. Other rail opportunities exist but in smaller scale: for ex: The manifest/carload “problem”

- Unitization

- Industrial Products/MSW

- Perishables

What Looks Good for 2016?

• Not much….at least in H1(H2 Comps better)

• What are the “givens” for oil, the $, crops?• Chemical growth building (see SHIELD

data)• Autos coming off of a record• Wither Intermodal?• Low Expectations heading into “earnings”

The “Grand Bargain”• In return for higher prices (& ROI), rails spend,

increase capacity & improve service (2005-2012) – The unstated “Grand Bargain”

• Rails gain pricing power (~2003) & F/S• Rails (re) Gain Market Share• Rails Spend Cash “Disproportionately” on Capex

(~18-20% of revenues)• Promotes “Virtuous Circle” – all stakeholders

benefit• Under challenge, perceived and real

2,0004,0006,0008,000

10,00012,00014,00016,00018,000

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2009

20152016

2014

ASSOCIATION OF AMERICAN RAILROADSSLIDE 21

(average weekly originations)

U.S. Rail Carloadsof Petroleum and Products

Data are average weekly originations for each month, are not seasonally adjusted, and do not include intermodal. Source: AAR

6,0008,000

10,00012,00014,00016,00018,00020,00022,00024,00026,000

(average weekly originations)


U.S. + Canadian Rail Carloadsof Petroleum and Products

2009 2010 2011 2012 2013 2014 2015 2016Data are average weekly originations for each month, are not seasonally adjusted, and do not include intermodal. Source: AAR

-20%-10%

0%10%20%30%40%50%60%

(% change from same month previous year)


2010 2011 2012 2013 2014 2015 2016

U.S. + Canadian Rail Carloadsof Petroleum and Products

Data are average weekly originations for each month, are not seasonally adjusted, and do not include intermodal. Source: AAR

24Experience / Expertise / Excellence www.plgconsulting.com

New Energy Rail Growth Story -Crude and Frac Sand

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

U.S. QUARTERLY CARLOADS ORIGINATED

STCC 14413 - Industrial sand and gravel (includes frac sand) STCC 131 - Crude Petroleum and Natural Gas


However Coal Volume LossStill Not Offset by Shale Products

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

1,600,000

1,800,000

U.S. QUARTERLY CARLOADS ORIGINATED

STCC 14413 - Industrial sand and gravel (includes frac sand)

STCC 131 - Crude Petroleum and Natural Gas

STCC 1121 - Bituminous coal

4 Qtr. Avg. 1,754,908

-288,724

+167,368

4 Qtr. Avg. 77,644

4 Qtr. Avg. 1,466,184

4 Qtr. Avg. 245,012

Despite dynamic shale-related growth, ~500k carloads/year net loss for

energy-related rail traffic

Intermodal Growth DriversDomestic and International

• Globalization• Trade• Railroad Cost Advantages• Fuel prices• Carbon footprint• Share Recovery from Highway• Infrastructure deficit & taxes

(public vs privately financed network!)

• Truckload Issues; regulatory issues, driver issues

Modal Shift Projection %

of M

arke

t Sha

re

Current Truck Market

Current Rail Intermodal Market

Projected Market Shift

Intermodal 2016+

• Return to Growth?• Rail Service Improvements• Pricing?• Factors: Oil Prices, Consumer Spend,

Truck Capacity• Infrastructure Advantage• Panama Canal impacts?• Driver Shortages Re-emerge?• “Cult of the OR”

Re-industrialization?

• Near-Sourcing: Mexico, C/A• Natural Gas effect round two:

– CHEMICAL INDUSTRY (see PLG)– Fertilizers

• Steel/Aluminum/Autos/White Goods etc.• Northeast, etc. back “in play”?• Subject of future research


SHALE SUPPLY CHAINAND DOWNSTREAM IMPACTS

Feedstock (Ethane)

Byproduct (Condensate)

Home Heating (Propane)

Other Fuels

Other Fuels

Gasoline

Gas

NGLs

Crude

Proppants

OCTG

Chemicals

Water

Cement

Generation

Process Feedstocks

All Manufacturing

Steel

Fertilizer (Ammonia)

Methanol

Chemicals and Polymers

Petroleum Products

Petrochemicals

Inputs Wellhead Direct Output Thermal Fuels Raw Materials

THE NEXT WAVEManufacturing renaissance in the US based on

abundant, low cost energy and feedstocks

IMPACTS TO-DATE INCLUDEDramatic reduction in crude imports, lower electricity costs, lower gasoline prices, increased refined products exports

Downstream Products

Significant rail impacts noted in red


US gas demand will grow due to: Coal-fired generation plant converting to gas More industrial use – steel, fertilizer, methanol Mexican export via pipeline and LNG export

overseas LNG exports will start to grow from 2015 Increasing use as transportation fuel

US gas cost competitiveness is sustainable 30 year supply at ~$4/MMBtu according to IHS Cost of production decreasing with drilling efficiency Supply will overwhelm demand as prices

approach $5/MMBtu

Low-cost gas and NGLs will drive US industrial “renaissance”

Source: EIA, September 2015

Source: EIA for historical and CME Group Oct 2, 2015 settlements for futures

60

65

70

75

80

85

2013 2014 2015 2016

U.S. Natural Gas Production (Bcf/day)

Historical Projections

0

2

4

6

8

10

12

14

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Natural Gas Price at Henry Hub ($/MMBTU)

Historical Futures

US SHALE GASBACKGROUND AND FUTURE


2008 2010 2012 2014 2016 2018 2020 Phase III – “Manufacturing”: Raw material cost driven

Phase I – Industries using natural gas as primary feedstock have global cost competitiveness; mothballed facilities reopened, new US factories being built

Phase II – Downstream products require significant processing facilities investment and lead time

Phase III – US material cost advantage will enable traditional manufacturing to return to the North America as about 65% of the cost of manufactured product is material cost

Phase II - Downstream Products: Petrochemicals, Resins

Phase I - Gas & Power-intensive Industries: Fertilizer, Methanol, DRI pellets

Shale Gas Phased Impact To U.S. Industrial Expansion

PLG Analysis

Ratio is approaching 15 which may delay additional future gas-related projects

Crude to Natural Gas Ratio is one of the key indicators of gas competitiveness


Shale Gas Impact to Industrial Expansion, Rail and Other Logistics

Key data points from PLG’s shale gas-related industrial project database includes: Over 230 projects totaling $280B of announced

investment

Over 50% of the announced investment is in the Gulf Coast

PLG predicts that 73% of the increased petrochemical production volume will remain domestic

PLG predicts that 200,000 rail car movements will be added by 2020 with 85,000 additional potential by 2023

PLG predicts that over 30,000 rail cars will be needed by 2020 with 13,000 additional potential by 2023

PLG predicts that there will be over 1 MM additional truck movements added by the expansion

Product Categories include: Acrylics, Ammonia, Other Chemicals, Chlor-alkali, Ethylene, Gas Processing& Fractionation, LNG, Methanol, Polymers, Propylene

Railroad Capital ExpendituresClass I Railroads

$0

$5

$10

$15

$20

80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14

Billions

Source: RRFacts & Analysis of Class I RRs, AAR; abh estimates

ASSOCIATION OF AMERICAN RAILROADS

SLIDE 36

Close Correlation Between RR ROI and Reinvestments

4%5%6%7%8%9%

10%11%12%13%14%15%

'04 '05 '06 '07 '08 '09 '10 '11 '12 '13$15$16$17$18$19$20$21$22$23$24$25$26

Reinvestments* (right scale, $ bil)

*Capital spending + maintenance expense. **Net railway operating income / average net investment in transportation property. Data are for Class I railroads. Source: AAR

RR ROI** (left scale)

Returns Finally Justify the Massive Expenditures

2016 Capex

• Most Important Decision Period in

Years

• Coal: “Stranded Assets”?• Coal/Mix:Reduced GTMs, Reduced MoW?• Service & Safety are even more critical to

future RR success• Changing mix of capex?• Changing %revenues (16%)?• PTC Extension resolution, wind-down….

2016 Capex (Continued)

• Guidance Suggests -13% YOY; ranging from -25%+ (BNSF, CP) to + 7% (CN)!

• Balance:• Shareholders’ demands – Buybacks &

DPS vs. ROIC• Regulatory Demands (and false claims)• Safety Demands (CBR, etc)• Shipper Demands (service, service,

service!)

Rails Have Room to Improve in ROI

Deregulation - & Vertical Integration – Works!


ExperienceAbout PLG

Partial Client ListPLG Team Real-world, industry veterans Delivering value to over 200 clients since 2001 Over 30 logistics, supply chain and engineering experts

with operational leadership experience

Core Expertise Bulk commodities Rail transportation and logistics Energy and chemical markets Private equity and corporate development

Services Include: Diagnostic assessments and optimization Supply chain design and operational improvement Logistics infrastructure design Site selection Investment strategy, target identification, due diligence,

post-transactional support Independent logistics technology assessment and

implementation Hazmat training, auditing and risk assessment


PLG Has Built SHIELD To Analyze the Future Impact of Shale Gas To the Industrial Economy

SHIELD is the data and market intelligence source focused on defining the complex industrial expansion driven by shale gas.

SHIELD features include: Interactive, searchable database with satellite mapping Over 250 projects with $280B of announced investment Detailed project information including logistics flows, modal

volumes and equipment requirements 30 fields of data for each project that can download to Excel Expert commentary throughout SHIELD with access to PLG

subject matter experts

Sample SHIELD Screenshot

Unique logistics data on over 250 SHIELD projects includes: Product volumes Inbound logistics mode intelligence Outbound logistics volumes by mode Annual railcar shipments Annual truckloads Annual marine volume Rail fleet requirements Serving railroad

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http://www.shieldbyplg.com/

www.abhatchconsulting.comABH Consulting/www.abhatchconsulting.com

Anthony B. Hatch155 W. 68th StreetNew York, NY 10023(212) [email protected]

www.railtrends.com

mailto:[email protected]

Q1: How would you rate the RR's performance vs other modes on each of the following criteria, with

1 as the BEST and 5 as the WORST

Q1: How would you rate the RR's performance vs other modes on each of the following criteria,

with 1 as the BEST and 5 as the WORST

Q5: Which of the items below would offer the greatest value for increasing the use of

rail? (Select all that apply)

Deregulation - & Vertical Integration – Works!

Documents

Is the Railroads’ “Renaissance simply a thing of the past?€¦ · · 2017-06-01Is the Railroads’ “Renaissance” simply a thing of the past? SWARS! Alamo City abhconsulting