Tony Hatch: Railroads' second-quarter earnings mostly were on plus-side despite floods, coal market transitions

— by Tony Hatch

Railways performed fairly well in the second quarter in the face of still-trying circumstances, including floods (Canadian Pacific), coal transitions (all, especially CSX Corp. and Norfolk Southern Corp.), no corn supply (all) and, yet again, a disappointing economy.

They posted a "winning record" with financial performance, both year over year, where they were up 20 percent, and versus the S&P non-financials likely to come in between minus-1 percent and plus-1 percent.

Even excluding the two big gainers, CP and Genesee & Wyoming, the group was still up 6.7 percent with only one of nine — NS — posting an earnings decline versus expectations of five wins, a loss and two draws.

Included in the winners is the once again superior performance of Berkshire Hathaway Inc.'s BNSF Railway Co., which increased operating income by 10 percent (Berkshire itself posted a 46 percent gain).

Q2 Takeways

Overall, several trends emerged during the quarter and the earnings calls:

• The second-half expectations were conservative or just dull; traffic weakness registered in June, now somewhat turned back, weighed heavily on management.
• CP's excellent quarter was masked by the sky-high expectations and whisper numbers (the figures the Street believed the company would hit). Only with Chief Executive Officer E. Hunter Harrison and the opportunity he brings to CP could a 59 percent year-over-year improvement in earnings per share and a 750 basis-point reduction in the OR be called anything less than terrific.
• Intermodal numbers (plus 2.5 percent) were to me a bit disappointing, with international slumping along with weaker retail sales (up only 0.4 percent in June). Domestic wasn't growing share at the pace of Q1 (especially notable within NS' "sole" intermodal bright spot were the single-digit gains in its critical Crescent Corridor). I do not expect this to be a beginning of any reversal of the single-most important trend in the "railroad renaissance," but it bears watching.
• Price was more confusing than most quarters. It seems that rails held to their "rail-inflation-plus" guidance (or plus-3 to plus-4 percent), but the impact of coal, especially export coal declines, and changing investor relation attitudes on disclosure allowed for more questions than answers — never a good thing. Bears watching.
• Rail operating metrics performance in the second quarter can be summed up as "flat to down," with several carriers reporting increases in accident rates and velocity declining a bit. I do not — at all — believe that this is systemic. But in light of the increased service requirements of today's rail industry, and the three well-publicized global rail tragedies (the two European passenger accidents and Quebec derailment), this is an area of extreme public focus and — you guessed it — bears watching.

Summer Doldrums To Soon End

Late August is seemingly the time to get away, and in fact I will be doing so, heading Down Under for a two-week visit to look into Aussie railroads (and how they relate to the Chinese economic outlook, U.S. grain and coal exports, U.S. rail investment, etc.). While many folks head to the beach or the ballpark (has anyone watched my Dodgers lately?), the rails have been chugging along, seemingly picking up some volume momentum weekly, with what appear to be improving operating metrics.

And the summer to date has hardly been all quiet — from the awful news out of Lac-Mégantic, Quebec (the accident's final repercussions, on tank cars, have yet to be announced), to the pretty decent earnings reports, to the solid court win de-certifying the class-action fuel surcharge antitrust case against four Class Is, to the Pemex news (the Mexican government made do on a campaign promise to change its constitution to allow foreign investment and partnerships in its energy business — the most radical change since nationalization in 1938).

But the last weeks, aside from the traffic/metrics reports, should revert to the old "Dog Days" of summer. The fall will heat up, however, even more than it usually does.

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.