Tony Hatch: Volume and earnings improvements coming for the rails?

By Tony Hatch

It's early March as I write this and we are — hopefully — exiting winter. We've already entered the spring conference season. And a good thing, too, because now that Warren Buffett Inc. has reported, we have a full set of rail earnings to make comparisons and see what, if any, key questions have been answered. Of course, we know that Warren et al. have been busy, given the Kraft Heinz Co.-Unilever Plc merger attempt. For rail intermodal, Unilever is an enlightened example of a great customer, so maybe gains at Warren's rail subsidiary BNSF Railway Co. will ease the Oracle’s pain.

Railroads' 2017 previews still have validity, of course, but recent Class I management teams' comments at a few investor conferences were more positive than the cautious ones we heard in late January. Perhaps it’s the early thaw. But the rails experienced a solid end to 2016. Will we see volume and earnings improvements this year?

Class I earnings in fourth-quarter 2016 essentially were in line with Street expectations. The final score was 4 wins, 3 (slight) losses, plus BNSF owner Berkshire Hathaway. That the railroads performed better than their truckload partners/competitors (they were down 30 percent) and worse than their intermodal marketing company partners is of some consequence when considering the future.

The improvement in volumes over the course of Q4 continued into January: up 4.3 percent, according to Intermodal Association of North America data.

During the earnings conferences, the top four critical issues I highlighted in my Q4 preview all were addressed, to varying degrees:

• Strategic planning, in light of the secular mix changes and coming technological challenges, was not fully addressed ... although one could argue that the news out of CSX Corp. and related to CSX — the headcount reductions/changed leadership/probable future changes in top leadership — constitute an ongoing strategic discussion and one that, in due course, will bring accelerated change discussions to Norfolk Southern Corp.

• Pricing appears to have troughed in the fall and will pretty clearly be above the rail inflation bar again in 2017 (+2 percent to +2.5 percent). And it'll accelerate over the course of the year to about a +3 percent run rate by Q4. Union Pacific Railroad did keep its promise and gave a fuller explanation of its pricing in terms of results, strategy and competitive response, while BNSF’s results didn’t show significant recent share changes in the West.

• Capex will be down in 2017, and a tad more than I expected. All Class I carriers except Canadian Pacific (!) and (in the core) CSX will show varying degrees of reduction and will be in the 16 percent to 17 percent of revenues range — save for UP, which is slightly and inexplicably targeting around 15 percent. Interestingly, share buybacks have passed their peak usage, it seems. After bucking the capex trend for the entire 21st century, could railroads succumb to short-termism and re-direct cash to shareholders just as the rest of the corporate world moves in the opposite direction? I don’t think so, but it does bear watching.

• Visibility and sentiment (given the coal stabilization): After an initial consensus guidance of “cautious optimism” that was more cautious than optimistic, the outlook over the course of the winter has clearly improved along with freight volumes — notably, the return to growth of intermodal. But direction and targets remain unaggressive.

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.