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Rail Renaissance: Returns, Capital & Capacity
AB HATCH [email protected]
The Transportation Conference
Toronto September 2008 ::
Railroads at historic tipping point
The Railroad Renaissance is here – will it last? Capacity issues across all modes Volume increasing – right? Share, rates, service levels (yes) – and returns increasing But pushback (shipper/regulator/union) also increasing! A secular, not a cyclical story – right? Capacity and infrastructure – and competitor - issues remain Fully reflected in the market? Or is this just another cyclical
slowdown? NET/NET- The industry is poised to go up – or down –
based on decisions made here & now
Railroad PerformanceClass I Railroads
0
50
100
150
200
250
300
64 68 72 76 80 84 88 92 96 00 04
Index 1981 = 100
Source: Railroad Facts, AAR (Based on a design by R. Gallamore)
Productivity
Volume
Revenue
Price
Street influence on RRs – and Why that affects ALL stakeholders
Battle for cash
Management’s reactions to pressures
Investors, competitors, regulators,
politicians, labor – oh, yes, and customers
Short term decisions/long term
consequences
Which “bucket” will they place their chips?
Show Me the Money
Share Price is the Indicator – over time!
Cash (Flow) is King
High ROIC = High Stock Price
And Vice Versa
Key is the phrase “through a cycle”
Old Model: Disinvestment
New Model: TBD (But CP gives us a clue)
Simple Math
RatesReturnsCapital ExpendituresCapacityService
ARE ALL CONNECTED!
Virtuous Circle (’03-07) or Disinvestment?
Sources of capital
FCF – booming at most carriers (capex vs. ROIC)
Governments – states, PAs, Feds, PPPs Governments – Canada as contrast Traditional Street sources & Banks Institutional investors Hedge funds Private Equity/Infrastructure Funds (still?)
New Sources of Capital – Threat or Opportunity?
Fortress-RailAmerica/FEC (etc)
Infrastructure Funds (Toll Roads)
Hedge Funds & “Activists” (TCI)
PPPs – Heartland, Nat’l Gateway, CREATE
Share repos
C-1 Buyouts (DM&E)
JVs – Meridian, Patriot corridors
Threats to the Renaissance
Cyclical vs. secular argument New Congress –impacting labor & shippers Mandated Reviews – STB, Canada Rereg – the MAD answer Execution: service Execution: merger Hedge funds? Liquidity?
Railroad Daily Stock PricesJanuary 2, 2008 through September 16, 2008
50
75
100
125
150
175
1/2 1/16 1/30 2/13 2/27 3/12 3/26 4/9 4/23 5/7 5/21 6/4 6/18 7/2 7/16 7/30 8/13 8/27 9/10
S&P500 Simple Average of BNI, CSX, NSC & UNP
Index Jan 2, 2008 = 100
Sources: Yahoo Finance (adjusted for dividends and splits)
Railroad Daily Stock PricesSeptember 2, 2008 through September 16, 2008
80
85
90
95
100
105
110
9/2 9/3 9/4 9/5 9/6 9/7 9/8 9/9 9/10 9/11 9/12 9/13 9/14 9/15 9/16
S&P500 Simple Average of BNI, CSX, NSC & UNP
Index Sept. 2, 2008 = 100
Source: Yahoo Finance (adjusted for dividends and splits)
S&P 500 and RailroadsMonthly Data January 1980 – April 2007
Index Jan. 1980 = 100
Sources: MSN and CSI, Inc.
0
200
400
600
800
1000
1200
1400
Jan-80 Jan-85 Jan-90 Jan-95 Jan-00 Jan-05
S&P500 Railroads
Railroad Return on EquityClass I Railroads
0%
2%
4%
6%
8%
10%
12%
14%
91 93 95 97 99 01 03 05 07
Source: Railroad Facts, AAR
n.m.n.m. = not meaningful (negative value)
RR CoC vs. ROIC – RR Stocks have done well but… they still trade at a discount to all stocks
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07p
Cost of Capital Return on Investment
Source: Surface Transportation Board, 2007p based on AAR filing and Railroad Schedule 250s Note: Cost of equity estimation method changed by Board effective 2006.
Railroad Intermodal Revenue Growth Over 5% - Long Live the New King!-
19901995
20002005
.
$0
$2
$4
$6
$8
$10
$12
$14
Billion
s
Source: Carload Waybill Statistics (includes non-Class I railroads)
Coal Intermodal
17%18%
19%20%21%
22%23%24%
25%26%
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Coal Intermodal
*Data for BNSF, CSX, KCS, NS, and UP Source: Railroad financial reports
Intermodal and Coal as a % of Revenue*
Intermodal is the Top Source of U.S. Freight Rail Revenue
U.S. Railroad Intermodal Traffic(millions)
0
2
4
6
8
10
12
14
81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07
U.S. Railroad TOFC/COFC Units
Source: Association of American Railroads’ Weekly Railroad Traffic
U.S. Railroad Intermodal TrafficTrailers vs. Containers (millions)
0
1
2
3
4
5
6
7
8
9
10
88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07
U.S. Railroad TOFC Units U.S. Railroad COFC Units
Source: Association of American Railroads’ Railroad Facts
Intermodal Growth DriversDomestic and International
Globalization
Trade
Railroad Cost
Advantages
Share Recovery
From Highway
Truckload Issues
0 10 20 30 40
2035p
2002
Future Demand for Freight Transportation Will Continue to Grow
p – U.S. DOT projection
Billions of Tons of Freight Transported in the U.S.
Intermodal’s Enduring Questions
Lots of moving parts
The improved ROIC of RR Intermodal ’03-’06 is the
essence of the Railroad Renaissance
Long term volume growth rate of 5-7%
Long term pricing growth rate 3-4%
True International drives the train
Will “True” Domestic join the party?
Truckload Issues
TL surplus – “perfect (ugh) storm” in the short term
Driver shortages – permanent?
Tight capacity – a secular issue
Q4/Q1 capacity and rates a temporary/cyclical issue (isn’t it??)
Transload increase to absorb some capacity?
Stubbornly high fuel prices – growing price gap to intermodal
Insurance costs
Traffic congestion
Net: better switch than fight?
Coal and Ag – Bulk Comeback
New growth mode? Emissions and environmental issues Oil prices and coal Politics and coal; and grain/rereg Ethanol Exports Feed
New operating plans
Cooperative alliances
Working with customers
Technology
Massive equipment and infrastructure investment
Additional employees
What Are Railroads Doing to Increase Capacity?
150,000
152,000
154,000
156,000
158,000
160,000
162,000
164,000
166,000
168,000
170,000
2001 2002 2003 2004 2005 2006 2007 2008
Total Class I Employment: Jan. 2001-Mar. 2008
Rail Employment is Up for the First Time in Decades
Source: Surface Transportation Board
Railroad Capital ExpendituresClass I Railroads – and so far 2008 looks to be a paradigm shift!
$0
$2
$4
$6
$8
$10
80 82 84 86 88 90 92 94 96 98 00 02 04 06
Billions
Source: Railroad Facts, AAR
RRs and Investment
Is growth affordable? Capex up 10% in ’07? One rail cuts, 2 increase capex during ’07 What will 2008 look like? (long term growth v
short term weakness) Is additional capacity necessary? Desirable? Can the intermodal model extend to carload? Wall Street’s constrictive role (“fighting the last
war”) – is it changing? Is this disconnect between the Renaissance and
the Street the opportunity of a lifetime?
% Growth in Trains Per Day From 2005 to 2035 by Primary Rail Corridor
Future Corridor Volumes Compared to Current Corridor Capacity
2035 without improvements
Below capacity
Near capacity
At capacity
Above capacity
Future Train Volumes Compared to Future Train Capacity
2035 with improvements
Below capacity
Near capacity
At capacity
Above capacity
-$1$0$1$2$3$4$5$6$7$8$9
'80 '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06
Source: Association of American Railroads
Net Income
Capital Spending
Class I Railroad Capital Spending vs. Net Income
(Current Dollars)
25% tax credit for projects that expand rail capacity
Expense other infrastructure capital expenditures
Leverage private investment
Tax Incentives to Leverage Capacity Expansion
Railroad Rates- the old story Class I Railroads, Revenue Per Ton-Mile – another (related) New Paradigm
01234567
'81 '83 '85 '87 '89 '91 '93 '95 '97 '99 '01 '03 '05 '07
Cents
Source: Railroad Facts, AAR
Current $: Down 1% since 1980
Constant $: Down 54% since 1980
Railroad Employee ProductivityClass I Railroads, Ton-Miles Per Freight Service Employee
0
2
4
6
8
10
12
80 82 84 86 88 90 92 94 96 98 00 02 04 06
Source: Railroad Facts, AAR
Millions
Rail Service Cycles
Is the recent improvement in the metrics
sustainable? Systemic?
Is it a product of huge capex injection
and IT?
Or, is it merely a product of lower
volumes/less stress on the network…
Rail Regulatory Risk
Biggest Uncertainty Entering ’08Safety Bill“Competition” Bill (“M-A-D”)Cost of Capital RevisionMandated STB, CTA “Reviews”AAR/RAC/ASLRRA have great “D” but
hard to score on defense
ABH ConsultingAnthony B. Hatch155 W. 68th StreetNew York, NY 10023(212) [email protected]
