CSX and NS: It takes two to make a duel

By Tony Hatch

Everybody’s talking about CSX and Hunter Harrison. And why not? Hunter's track record at the Illinois Central, CN and CP speak (volumes) for itself, which is why shareholders have flocked to CSX.

While we await full news on the so-called “Hunterization Plan” for CSX, we’ll get only hints from the quarterly results and the annual meeting — look for a full-scale meeting on targets and forecasts in late summer or early fall. But we should remember that in the battle for freight rail pre-eminence in the southern and eastern United States, as well as in the duel for the winning philosophy for railway management (and long-term ROI) — indeed, for the whole soul of the “Railroad Renaissance” — there are two participants. And in post-Staggers history, Norfolk Southern isn’t used to being the “other guy.” So, with honor challenged must come a response.
 
NS CEO Squires draws down on the latest threat. It has been a (pleasant) surprise to see NS CEO Jim Squires out in public in early spring making the case for his railroad at Southwest Association of Rail Shippers (SWARS), where he gave perhaps the best speech of his career (to date). As he did in the quarterly earnings call, Squires noted that NS had gotten beyond its mostly self-imposed service challenges of 2014, and in the face of the changing traffic mix (the secular devastation of coal, as well as the impact of the 2015-16 “freight recession”), still had produced its best operating ratio (OR) ever (68.9, down 360bps). The railroad is well on its way to realigning resources and selling off non-core coal (and other) lines. And NS is continuing to reinvent itself from a rail/customer service perspective, with five points of focus:

1. Improving service quality, the most important part of the railroad's efforts, moving to get above its 2013 peak.
2. Re-invigorate its vaunted (historically “best in class”) industrial development effort.
3. Improve the customer service “experience” through digitization/infromation technology.
4. Accelerate pricing responsiveness — which does not mean reducing price!
5. Improve the interline experience — taking a leadership role and extending NS's influence on the supply chain (hence, the appearance at SWARS).

I'd add two more points:

6. Use PTC, now that it will be implemented on schedule, as a platform for service and productivity, and customer responsiveness improvements.
7. Focus on carload (merchandise/manifest/industrial products) business, under Mike McClellan as he outlined at RailTrends 2016.
 
An Affair of Honor. But upon reflection, what we are really hearing from NS, if we listen hard enough, is a challenge accepted: It is clear to everyone in the North American freight-rail that E. Hunter (“Shane”) Harrison coming to CSX means, among other things, that the already quick pace of change would increase as EHH is — as I have always said, by dint of reputation and record as well as by the force of his mighty intellect and will — a de-facto change agent.

Just as important, it also means that the investment community expects great things from CSX, starting with rapid OR improvement. CSX will be compared with themselves to measure the pace of change — but also, as ever, with NS, which means pressure (I suspect a high percentage of calls into Norfolk from the financial and media communities are about events to come in Jacksonville). After all, CSX shares are up about four or five times that of the market year to date, and four times that of the average freight railroad — including their “comp” and rival NS. 
 
So, one thing we agree on is that change is coming (and has already started). Would this come at the expense of the customer experience? Would the 1,000 headcount reduction in Jacksonville include muscle as well as “fat”? Will NS be perceived as “falling behind” if CSX should improve productivity at a pace similar to what happened at CP? 
 
Fire back! How should NS respond to the challenges, real and perceived? By trying to “out-Hunter” Harrison? Or, should NS present another model, a growth model based on, say, ROIC improvement as much as it is on OR improvement? We are beginning to get a hint: Should they go to CSX’s erstwhile customers and say there is an option? CN did so in Canada, for example. How does one handle the financial community?
 
A duel of two philosophies. In many ways, this can be boiled down to a duel of two philosophies — an operational excellence model (“precision railroading”) versus a strategic network (more blended) model. One is OR-obsessed; the other more growth (and with it op/capex) focused.

Is one way better than the other? Or can this cat be skinned two ways?

Jim Squires and his team have offered up, in their own reflective if not fiery way, a challenge to the investment community — and to rail shippers. Let’s see now what CSX says and does when Hunter steps off that noon train with his handlers, rapier at the ready.

The coming four years (EHH’s contractual term) will be fascinating — a test of precision railroading below the northern border, and also of operating, marketing and financial philosophies in the East. Who in the end will emerge victorious? Or, like D'Artagnan joining the Musketeers, will each influence the other to combine values — and shippers and shareholders of both win?

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.