Is the Railroads’ “Renaissance simply a thing of the past?€¦ · · 2017-04-27Is the Railroads’ “Renaissance” simply a thing of the past? NRC! Chicagoland . abh consulting

Is the Railroads’ “Renaissance”

simply a thing of the past?

NRC! Chicagoland

abh consulting January 13, 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

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

Renaissance Discussion Points!

• Can Rails Survive – or even thrive – in the NOW?

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

• What is the future of industrial/merchandise railroading?

• What is the new standard for Capex? • Is M&A the answer?

Top 10 Thoughts on Possible CP-NS merger

1. Risk/Reward Ratio Unfavorable 2. Diplomacy (“Politesse”) Required 3. Shipper Support Required 4. NS Approval Important 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” World 8.New RR World to be Very High Service Focus 9. CP-NS Could Stand alone (but would it?) 10. YET: Never Underestimate EHH (& Friends)

9 Experience / Expertise / Excellence www.plgconsulting.com

SHALE-RELATED RAIL TRAFFIC GROWTH HAS NOT MADE UP FOR COAL LOADINGS LOSS

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- Industrialsand andgravel(includes fracsand)

STCC 131 -CrudePetroleumand NaturalGas

STCC 1121 -Bituminouscoal

4 Qtr. Avg. 1,754,908

4 Qtr. Avg. 1,466,184

4 Qtr. Avg. 77,644

4 Qtr. Avg. 245,012

-288,724

+167,368

Source: Surface Transportation Board

NET LOSS OF ~120K CARLOADS PER QUARTER

Rail Renaissance Phase Two • Rails will exit transitional period (faith) • CBR to continue longer term – as volatile as Ag? • Domestic Intermodal will achieve investable returns – the

big bet will pay off • Service Recovery – Politics, Productivity & Price • Market confusion – OR vs ROIC=opportunity (BNSF

example) • Industrial revival – the real energy advantage

(PLG&”SHIELD”); TPP (& NAFTA) • Risks: Service; Execution; Safety; Regulation • Risk: M&A??

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

(12)

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

Chicago • Once again, as in the “Roaring 20s” or ‘68, the

nation looks at Chicago as dangerous • What is new about these traffic flows? • Should (could) this have been foreseen? • How can one match 30-50 year assets and

incomplete demand forecasts? • What is being done about it? • CREATE? CTC)? The League of Extraordinary

Gentlemen!! • M&A????

Four Kinds of Growth/Location

• Cyclical (ex autos) • Secular (ex intermodal) • Episodic (Grain – 50 year drought then

record 7 record); coal? • New – brand new – CBR • Where? Low-density “Northern Tier” +

winter • Direction – some through Chicago • Remarkable adjustment to handle a brand new industry

and play a major role in America’s “energy revolution”

2010-2020: New Energy world Shakes Up Freight Railroading

• Coal drops 30% 2010-2015, more to come?

• CBR from 4K cars (‘09) to 500K+ (2014) – Now What?

• Gi-normous RR Capital Spend (over?) • Targeted Spend – Chemicals (SHIELD),

fertilizers, steel, autos, Mexico • Can rails handle it?? And - Was it

worth the angst?


SHALE ENERGY IMPACT ON RAIL TRAFFIC TO DATE

-

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

180,000

0

500

1,000

1,500

2,000

2,500

3,000U.S. Class I Carloads Originated for Ind. Sand, Crude, and LPGs with U.S. Land Rigs

U.S. Land Rigs

U.S. Quarterly Carloads Originated for Industrial Sand (STCC 14413)

U.S. Quarterly Carloads Originated for Liquified Petroleum Gases (STCC 2912)

U.S. Quarterly Carloads Originated for Petroleum (STCC 131)

Car

load

s O

rigin

ated

U.S. Land Rigs

Source: Surface Transportation Board, Baker Hughes, September 2015

SHALE GAS & CHEMICALS: THE TRANSPORTATION IMPACT


SHALE-RELATED RAIL TRAFFIC GROWTH HAS NOT MADE UP FOR COAL LOADINGS LOSS

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- Industrialsand andgravel(includes fracsand)

STCC 131 -CrudePetroleumand NaturalGas

STCC 1121 -Bituminouscoal

4 Qtr. Avg. 1,754,908

4 Qtr. Avg. 1,466,184

4 Qtr. Avg. 77,644

4 Qtr. Avg. 245,012

-288,724

+167,368


NET LOSS OF ~120K CARLOADS PER QUARTER

Intermodal Growth Drivers Domestic 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? • Pricing? • Factors: Oil Prices, Consumer Spend,

Truck Capacity • Infrastructure Advantage • Panama Canal impacts? • Rail Service Improvements • Driver Shortages Re-emerge?

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 CHAIN AND 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 WAVE Manufacturing renaissance in the US based on

abundant, low cost energy and feedstocks

IMPACTS TO-DATE INCLUDE Dramatic 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 GAS BACKGROUND 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 (including LNG export terminals)

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


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: User-friendly, interactive database with satellite mapping

based on drop down selections Detailed project info including logistics flows and volume for

over 230 projects with $280B of announced investment Download 30 data fields to Excel for each project PLG expert commentary throughout database Access to PLG subject matter experts

Sample SHIELD Screenshot

Unique logistics data on over 230 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

shieldbyplg.com

http://www.shieldbyplg.com/

ASSOCIATION OF AMERICAN RAILROADS

SLIDE 31

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)

Railroad Capital Expenditures Class 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

Railroad Cost of Capital vs. Regulatory Return on Investment


Note: Cost of equity estimation method changed by Board effective 2006 and 2008.

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?

2016 Capex (Continued)

• Guidance from Railway Interchange, RTA, RailTrends, NRC – then Q4 (January)

• 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!

Powered by

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

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

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:

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

rail? (Select all that apply)

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

Deregulation - & Vertical Integration – Works!

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

mailto:[email protected]

Documents

Is the Railroads’ “Renaissance simply a thing of the past?€¦ · · 2017-04-27Is the Railroads’ “Renaissance” simply a thing of the past? NRC! Chicagoland . abh consulting