Canadian Pacific has given Norfolk Southern stockholders a reading assignment in advance of the NS annual meeting on May 12.
In a white paper, CP seeks to make the case for how its “precision railroad philosophy” would improve NS operations by transforming it from an “industry laggard to leader.”
“Politicians, shippers and others are calling for a strong, healthy and high-performing rail system yet no one has the stomach to challenge the status quo,” said CP CEO E. Hunter Harrison in the paper. “Clearly, moving goods reliably and efficiently is top of mind for everyone in the industry; we believe precision railroading and a CP-NS combination address those challenges.”
The white paper, which was part of a series that CP has issued over the past few months to make the case for its proposed takeover of NS, said that precision railroading has enabled CP to reduce its operating ratio, improve service, reinvest record amounts of dollars in its network and create “significant shareholder value.”
A PDF version of CP’s latest white paper can be downloaded at http://www.cpconsolidation.com.
CP described precision railroading as a tried and tested approach that has already transformed two of the worst-performing Class I railroads into top performers.
The latter was a reference to CP and Canadian National, where Harrison was CEO for several year. Harrison also applied his precision railroading approach at the Illinois Central when he headed that railroad before moving to CN.
“Over the last 20-plus years, Mr. Harrison’s execution of precision railroading has transformed three Class I railroads into the best-run railroads in the world,” CP’s white paper said. “The likelihood is high that, under his leadership and guidance, NS can achieve similar success and perform far better than its management currently believes possible.”
The white paper noted that the previous management of CP had claimed during a 2012 proxy fight with Harrison and financier Bill Ackman of Pershing Square Capital Management that precision railroading would not work at CP.
“But precision railroading is a set of non-discriminating principles that can be effectively applied to any railroad in the world,” the white paper asserts. “Geographic, network, and business mix differences are irrelevant in the application of the underlying principles that guide day-to-day decisions.”
Harrison has stated that his operating philosophy has five foundations of improving customer service, controlling costs, optimizing asset utilization, operating safely, and valuing and developing employees. “These five foundations can be applied to any railroad with the same result,” the paper said.
The white paper said that after implementing precision railroading practices, CP was able to slash transit times, increase system velocity and reduce terminal dwell times.
By increasing efficiency, CP cut its locomotive fleet size by 40 percent and saw its operating ratio fall from 81 percent to 61 percent.
“The prevailing view in the rail industry is that more locomotives, more cars and more crews allow for the movement of more volume,” CP said. “Precision railroading challenges this view.
“Because track and yard capacity is finite, adding more equipment creates congestion and slows down the system. While it may sound counterintuitive, reducing fleet size actually enables a railroad to move more volume. By running fewer and heavier trains, faster and on schedule, assets can be utilized far more productively and can yield significant savings.”
As an example of how precision railroading has worked, CP said it has increased domestic intermodal traffic by 19 percent between 2012 and 2015.
CP claims it could achieve $1.2 billion annual savings at NS by shifting it to the precision railroading model.
Among other things, Harrison has suggested that NS would be able to mothball up to a third of its locomotive fleet.
NS CEO James Squires, though, has described precision railroading as a “short-term focused operating model” that would result in service deterioration, diversion of traffic to trucks, and a loss of service-sensitive customers.
Squires said that the CP approach would mean unacceptably deep reductions in capital spending and employment levels.
NS has begun to implement its own five-year strategic plan to gain $650 million in annual savings by 2020 by reducing expenditures, seeking new traffic and increasing profitability.
CP interests are sponsoring a resolution to be voted on by NS shareholders that would direct NS management to discuss a merger with CP.
The resolution is non-binding and the NS board of directions is opposing it. The NS board also has rejected three offers from CP to buy NS stock.
Trains magazine interviewed a former CP executive who said that Harrison deserved some, but not all of the credit for improvements since he took over after the 2012 proxy fight.
The executive, who Trains did not name, said that under CEO Fred Green, CP had begun making progress by cutting $80 million from equipment rental payments, saving $150 million for the pension plan, closed intermodal terminals, reduced fuel consumption and begun operating longer trains with the use of distributed motive power.
“We were a lot further along the curve than people realize,” the former executive said.
The executive, though, did give Harrison and his team credit for being more aggressive through such moves as shutting down humps in several yards.
“Hunter’s a good railroader. He gets it,” the former executive said. “He drives the assets.”
The former CP executive operational efficiency and cost-cutting were not the sole drivers of CP’s rebound.
“Fundamentally the franchise needed top-line growth,” the former executive said. “CP needed to flex its muscles in terms of pricing. It’s done that well.”
Even before Harrison had arrived, CP management has discussed whether it was being aggressive enough with above-inflation pricing.
After Harrison arrived, CP’s total revenue increased by 18 percent between 2012 and 2015 although its total carloadings fell by 1.5 percent.
During that same period, CN saw its total revenue rise by 27 percent and its traffic grow by 8 percent. Last year CN led North American Class 1 railroads with the lowest operating ratio at 58.2 percent.
Whether the success of CN and CP in using precision railroading would translate well at a U.S.-based Class 1 remains an open question.
Trains magazine quoted railroad analyst Anthony Hatch as saying that it is not possible to draw conclusions about the growth rates of CP and CN due to their different traffic mixes, particularly their bulk and carload business.
“But you can say that CN has done a terrific job leveraging the precision railroading legacy of EHH into the New Model Railroad — one that combines efficiency, productivity, and marketing to grow faster than the rails as a whole, transports as a whole, and the continental economy,” Hatch said.
A former NS executive, though, is not enthusiastic about precision railroading as it might apply to NS.
In an interview with Trains, former NS CEO Charles “Wick” Moorman called precision railroading a recipe for disaster.
“If Hunter puts out an order to park 700 locomotives, I don’t even give it a week,” Moorman said. “The service would collapse. It’s just that easy.”