Railroads will set another capex record in 2014. But will what they spend be enough?

By Tony Hatch

For the Class Is, capital expenditures will increase again in 2014 — on average by about 9 percent overall and 5 percent-plus per railroad, according to initial reports. Railroads once again will top 18 percent of annual revenues on capex, compared with 3 percent for the "average industrial” company. And I don't expect that to be the extent of it. In 2013, several railroads announced increases during the year, and given the emerging perceptions of safety and service issues — as well as new revenue and share capture opportunities — I wouldn't be surprised to see more and bigger numbers down the road.

As of mid-March, Class Is planned to spend the following this year:
• BNSF Railway Co.: $5 billion, up 16.3 percent compared with 2013's total
• Union Pacific Railroad: $3.9 billion, up 8.3 percent
• CSX Corp.: $2.3 billion, up 4.5 percent
• Norfolk Southern Corp.: $2.2 billion, up 12 percent
• CN: $2.2 billion, up 5 percent
• Canadian Pacific: $1.3 billion, flat
• Kansas City Southern: $0.6 billion, down 7 percent
 
Of course, there are a number of capex issues to consider in the weeks and months ahead. Here are a few of them:

• For the first time in years, service and safety have become issues, of perception and (therefore) of reality. Railroads' velocity declines, with BNSF running down 2X (8 percent to 16 percent), have become well known.  BNSF et. al experienced simultaneous growth in all four categories: cyclical (forest products, etc.), secular (domestic intermodal), episodic (ag is roaring to life after the lingering drought effects) and brand new (crude by rail, or CBR). Service issues are being raised by shippers and "re-reg" lobbyists just as the service requirements for some of the newer business types — again, domestic intermodal — are ever more exact.

• Congestion absorbs assets. And now it appears there’s a locomotive shortage emerging even as Tier IV emission requirements appear to be onerous; so far, only one of the two locomotive manufacturers is ready to accept compliance orders.

• The weather. It hasn't helped, and it still isn't helping.

• Although safety incidents continued their downward trajectory last year, the risks per incidents have gone up with the carriage of the now-we-know-it’s-explosive Bakken light crude. The national eye is on railroads to prove their safety record is for real — it is — but the pressure is real, as well. That said: The correlation between capex and controllable safety is clear.

• The new CBR business comes with new freight flows. And it often comes on former light-density track or through hubs that were just under their saturation point. (Think: Chicago) As they did with ethanol, railroads are allowing their shippers to participate in most of the capital requirements (terminals, cars) but not on the network, which is sacrosanct.

• The emerging competitor for free cash flow dollars is … more capex! Heretofore, it’s been calls for direct shareholder spend, such as the share repurchase agreements and DPS, that have been a critical driver of the CP story and the subject of so many questions at the conference calls. But that was under the assumption that service at least would plateau at a high level. Never before in rail history has consistent service been such a critical requirement — a driver of productivity (see Hunter Harrison!) as well of marketshare in an ever more complex (short-haul domestic) world.

• Are railroads turning back the clock on rail cars? Within BNSF’s massive $5 billion capex budget is a plan to buy 5,000 tank cars. Remember, all of the intensity around the tank-car issue is not — directly — a railroad issue as they don’t own the cars. The debate, therefore, is between the interests of the product company, the leasing companies and the OEMs. In general, rail-car ownership has been dropping for decades as railroads realized that it is the network that defines them (hence their spend!). Not surprisingly, BNSF’s tank-car purchase announcement in late February shook everyone up a bit. Is it a sign of the future, which therefore would be a more expensive one, or is it a statement of commitment to the CBR market, and/or to the U.S. Department of Transportation to get its new regs out NOW, to be followed by a later quiet announcement of a fleet sale/leaseback?

• The national infrastructure is in terrible shape, which is a modal advantage for rail — and the public finance option list is small in a no-tax world. Those who lived by public funding and subsidies will go down for the lack of them as the highways buckle; meanwhile, the rail industry is hard at work (and at spend) to resolve the perceived safety and service issues that likely will measurably turn the corner by the time the weather warms.

For those who worry about the increase in capex, I say follow the return on investment, which continues to improve because investments in service and safety are really good business decisions.

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.