How full is the glass? Railroad Q4 2015 earnings: Tony Hatch's top 10 takeaways

By Tony Hatch

For a full year now, the rails have suffered in the face of — as BNSF Railway Co.’s Matt Rose noted — an energy depression, manufacturing recession and slow growth from the consumer. Rail investor sentiment has suffered to an even greater degree; after all, rail revenue declines (averaging 9 percent in fourth-quarter 2015) were as much as fuel surcharge as anything else (volumes dropped 6 percent, half of that ex-coal). Despite the pessimism, pricing remained strong and operating ratios (ORs) averaged 65 percent! That’s a troubled industry?!?

As of Feb. 7, we had yet to hear reports from Genesee & Wyoming Inc. (GWI reported on Feb. 9 - ed.) and BNSF via Berkshire Hathaway, and, given their extraordinary service (and thus productivity) recovery, are likely to tilt major rail earnings into the “win” category. So far on the Q4/15 earnings front, three railroads beat expectations and three fell short. Regarding Q4: Here are my top 10 takeaways:

1. Railroads’ performances were mixed. Earnings were all down, of course — except for CN’s exceptional (again) report. But several railroads beat (lowered) expectations, the sky never fell and OR was lower, on average, year over year (YOY).

2. Rail sentiment remains weak, as quantified by the stock pricing performance and qualified by the Q&A in the rail earnings calls to date. It doesn’t help, of course, that the overall economic picture is cloudy. So: What can railroads control?

3. Visibility is poor, which also doesn’t help investor sentiment. Guidance was limited and in some cases (CSX, Kansas City Southern) eliminated.

4. Rail service returned to and in some cases exceeded earlier record levels. This is helped by lower volumes (and the mix shift from slow to fast!), but especially by the massive, targeted expenditures in the network, crews and power.

5. Productivity was the driver in the record margin performance that occurred despite the volume/revenue shortfalls. Productivity is the flip side of the service coin, and as Hunter Harrison has showed, they go hand in glove.

6. Pricing remained firm. It's up 3 percent to 4 percent, well above “rail inflation” and it's happening despite deep-seated fears from the financial community linking volumes (rather than service) to price.

7. Volumes were down 6 percent for the quarter — accelerating downward as the year and quarter went on. For the full year, total volume was down 2.3 percent YOY, but volumes were down less than 1 percent as recently as August 2015. Coal was down 12 percent for the year. But comparisons get easier starting this month.

8. Some better days are ahead. Not just with comparisons and coal “stabilization” but autos still look promising. And intermodal will recover with the service levels, the end of oil price declines, and trucking and driver issues (turnover reclaimed triple digits in November at big TL firms!). Meanwhile, the chemical expansion will be a big deal, getting more visible by year end into 2017-19; it will add some 20 percent to chemical/plastics carload volumes (and provide intermodal opportunities) — see the SHIELD work by PLG Consulting as described here.

9. Capex is coming down by some 13 percent — not, as popularly described, because of the near-term volumes, but because big projects, capacity expansion and debottlenecking projects are reaching end-stage levels. I still applaud CN’s stance on the matter, even if foreign exchange affected.

10. So, cash flow can be directed toward a rebalancing ... with higher share buybacks and DPS.

Oh, and:

11. The M&A story remains unresolved, as Hunter Harrison plays Hamlet (to proxy, or not to proxy?), and Valentine’s Day is supposedly the due date for Norfolk Southern Corp. proxy moves. Hunter will address the railroad nation from Florida a few times in the next two weeks, the first time on Feb.10.
 
Tony Hatch is an independent transportation analyst and consultant, and a program consultant for Progressive Railroading's RailTrends® conference. Email him at abh18@mindspring.com.