Posts Tagged ‘Wall Street’

STB Head Wants More Rail Competition

July 14, 2021

Class 1 Railroads got an ear full on Tuesday from U.S. Surface Transportation Board Chairman Martin J. Oberman who suggested the carriers are shirking their obligations as common carriers due to pressure from Wall Street investors.

Speaking to the Midwest Association of Rail Shippers, Oberman called for more competition in the industry and is in agreement with an executive order issued last week by President Joseph Biden directing federal agencies to limit the dominance of large corporations.

 “There are just many, many parts of the country . . . where there’s just not real effective competition among rail carriers,” Oberman said.

In regards to railroads, the STB head said he sees a less robust freight rail system due to job cuts related to the implementation of Precision Scheduled Railroading.

Oberman also said that some commodities moved by rail have suffered due to Wall Street pressure for ever-lower operating ratios.

“While everybody applauds efficiency — and I do — I am concerned that we may well have stripped our resources down too far to keep our national rail network as healthy as it needs to be to rebuild the economy,” Oberman said.

He acknowledged that railroad did well in moving traffic as the economy rebounded from a recession last spring triggered by the COVID-19 pandemic.

Oberman and other STB members will be weighing these and other concerns in upcoming merger cases involving Canadian National acquiring Kansas City Southern, CSX buying Pan Am Railways, and a bid by Watco to buy CN’s former Wisconsin Central branch lines in Wisconsin and Michigan.

Amtrak’s relationships with its host railroads also are on the docket in a pair of cases, including involving Federal Railroad Administration mandated on-time performance standards.

Oberman Fears Wall Street Pressure Harming Class 1 Railroads

May 28, 2021

A top federal regulator express concern this week during a webcast that Wall Street investors are pressuring railroads, which has thus led to a deterioration of freight service.

U.S. Surface Transportation Board Chairman Martin Oberman also raised questions about the need for major railroad mergers.

“Our mandate as an agency . . . is to ensure and protect a strong national rail network. That’s why we exist. And everything we do should be aimed at that outcome,” Oberman told investors.

He said the pressure from Wall Street includes pushing for ever-lower operating ratios and aggressive share buyback programs.

“There’s been a huge decrease in the level of the workforce over the last few years, I think something like 25 percent,” he said.

“I am concerned it has left the Class I’s with too little cushion to respond to a major crisis like the pandemic or the [polar] vortex, which is more likely to keep coming around. So we are keeping a close watch on the situation.”

In the past decade, the North American Class 1 railroads have adopted the precision scheduled operating model.

Typically, aggressive cost cutting, including reducing the size of the labor force and the number of trains being operated, has followed in the wake of PSR adoption.

The railroad have sought to reduce their operating ratios in a bid to boost profitability.

From February 2017, the month before CSX adopted PSR, through December 2020, U.S. Class I rail employment fell 21 percent overall.

“We’re seeing, I believe, some impact from that on the service side,” Oberman said citing missed switches and crew shortages.

“A lot of this stems from furloughs and quarantines from COVID, but I think it’s also related to the fact that the whole workforce has been greatly reduced over the last few years, I think largely in response to pressures from Wall Street. And I am beginning to get concerned that this could start impacting capital expenditures as well.”

As for stock buybacks, Oberman said in some cases those have been funded with borrowed money.

Stock buybacks are efforts by railroads to boost earnings per share and stock prices.

“Those forces are of concern to me in terms of what they mean for the long-term health of the freight industry and whether we’re going to have an industry staffed enough to fully serve and with enough incentive . . . to keep spending money on greatly needed capital improvements,” Oberman said.

“It’s not our job to come in and micromanage and tell them how to run their companies, but it is our job to keep an eye on the ball so things don’t get too far out of whack,” he said.

Independent rail analyst Anthony B. Hatch told Trains magazine that for all of the talk about railroads cutting capital expenditures, the industry spends far more of their revenue on capital expenditures than most other industries.

He said financial strength is what enables railroads to keep their physical plants in good condition.

The STB chairman also questioned the rationale for railroad mergers as well as the substantial premiums Canadian Pacific and Canadian National were willing to pay to acquire Kansas City Southern.

As for railroad mergers, Oberman expressed skepticism that consolidation will lead to railroads being able to siphon more freight business away from trucking companies.

“I am all for promoting much more competition in the freight world, particularly among railroads and particularly with railroads getting more freight off the highways and onto the rails,” Oberman said, adding that what is needed is more rail competition, not less.

“The thing that’s impressed me most since I’ve come to the board is the lack of competition for most shippers in most parts of the country,” Oberman said.

Many of these shippers are captive simply because they are located on a single rail line with no opportunity for service from a distant second railroad.

Wall Street May be Backing Away From OR Obsession

March 20, 2021

A Wall Street analyst said this week that some institutional investors have begun to move away from their obsession with ever lower railroad operating ratios.

Most North American Class 1 railroads have in recent years striven to drive their quarterly operating ratios into the 50s.

The operating ratio is a measure of what percentage of operating revenue is spent on operating expenses and is widely viewed as a measure of efficiency and profitability.

The quest for a lower operating ratio has driven management into taking aggressive cost-cutting measures, including selling real estate, closing and consolidating facilities, and operating longer trains manned with fewer crew members as a way of reducing labor costs.

An analysis published on the website of Trains magazine said the shift in thinking would represent a major change for how Wall Street investors view publicly-traded railroads.

One implication of what some have termed “the cult of the operating ratio” is that railroads have sacrificed traffic gains in order to focus on the most profitable commodities that they haul.

Allison Landry of Credit Suisse said the new outlook on Wall Street is a desire for railroads to focus more on attracting higher traffic volume.

The Trains analysis noted that analysts in the recent years have seen unconcerned that railroad freight volume peaked in 2006.

Instead, their objective was to see earnings growth driven by rate increases, cost-cutting, and share buybacks.

The popularity of precision scheduled railroading, which had aggressive cost cutting as a byproduct in how it has been implemented at most railroads, played into that line of thinking.

Now, the Trains analysis said, investors seem to be concluding that PSR was a one-trick pony.

“While there is still plenty of room (particularly for the U.S. rails) for margin expansion, at some point, expense cuts will . . . bottom out; whereby the O.R. will approach a number for which it will not go below,” Landry wrote in an outlook note to clients earlier this year.

“The bottom line is that long term rail valuation will be dictated by growth; the margins at which the growth comes; and how much it costs to maintain the asset base.”

The Canadian Class 1 systems, Canadian National and Canadian Pacific, have already moved in the past couple of years toward giving a higher priority to traffic growth.

CSX, Norfolk Southern and Union Pacific may not be far behind as railroads seek to reverse a steady loss of market share to trucking companies that has been ongoing for decades.

In January CSX CEO James Foote hinted at a change in thinking when he said, “If we wanted a 50 operating ratio, we’d have a 50 operating ratio. We would do it . . . quickly. I’m not sure what would be left of the company in the process.”

Railroad management is not going to give up its laser focus on keeping down costs because otherwise it might lose some competitive edge. Railroads are, by nature, a high fixed costs business.

Nor are railroads going to stop turning away low margin business.

However, the fixation on ever lower operating ratios has meant sacrificing some profitable volume growth.

The average operating ratio last year for North American Class 1 railroads was 60.4 percent, an improvement of 10.4 percentage points since 2012.

Todd Tranausky, vice president of rail and intermodal at FTR Transportation Intelligence, a freight forecasting firm, told Trains that even if operating ratios were to skyrocket into the 70s there would still be plenty of profitable business for railroads to seek to capture.

Some railroad executives, among them Union Pacific CEO Lance Fritz, have argued that the cost cutting of recent years has created a situation in which business that once didn’t look attractive now looks good because UP has a lower cost structure.

Analyst Says Cost Cutting Leaves Railroads Vulnerable

May 26, 2019

Class 1 railroads in North America are captive to the desires of Wall Street and that has left them vulnerable to unexpected although predictable calamities.

Rick Patterson, who works for Loop Capital Markets and was one employed as a railroader in Australia, said that as a result railroads get caught with shortages of crews and locomotives and can’t recover quickly from such things as hurricanes or polar vortexes.

Speaking at a meeting of the North American Rail Shippers Association, Patterson said that in the past five years rail service has been poor more often than it’s been good. He said the industry is trying to please Wall Street stock analysts who are laser focused on operating ratios, which are the percentage of revenue earned by a railroad that goes to pay operating expenses.

That has led to widespread cost-cutting moves, including idling locomotives and reducing the workforce, most often in the name of implementing the precision scheduled railroading model.

Patterson said as a result railroads try to perfectly match crew and motive power resources with their current traffic levels, a process that leaves then with no margin for error.

He said rail service can either be bad, good or truck-like.

Bad service occurs when operating metrics fall 10 percent or more below average and take six to 15 months to recover.

Good service occurs when freight generally arrives on the right day but is neither time-definite nor dependable.

Truck-like service occurs when service has day- and time-definite reliability and predictability.

By his calculations, Patterson said over the past five years service was good only in the past 22 percent of the quarters. It was bad in 35 percent of the quarters and showed no clear trend in the remaining quarters.

Patterson called CSX the best operating railroad in North America at present with its service composite is 41 percent higher than its historic average.

However, it had service problems during a polar vortex in 2013-2014 and during the early months of its transformation to PSR under the late E. Hunger Harrison.

“Hunter Harrison cuts the merchandise network over to PSR without apparently telling anybody, including his own operating people,” Paterson says. “But as usual, he was right and everything worked out and all was forgiven.”

Although PSR encourages cost cutting, Patterson said the operating model is a good one, noting that CSX recovered quickly after a pair of hurricanes last year that hindered service.

However, Norfolk Southern, which was hindered by the same storms, saw its velocity sink to the lowest levels since the Conrail split of 1999.

Patterson said railroads should plan for adverse weather, saying that climate change is likely to produce more extreme flooding, cold snaps, and wildfires.

The carriers could keep a buffer supply of crews and motive power relatively at low cost, which Paterson said would help maintain service levels during trying conditions.

He predicted that the pursuit of lower operating ratios will someday halt as carriers are unable to justify above-inflation freight rate increases and will be forced to seek more robust volume growth, which will require more power and crews.

Patterson called on shippers to encourage railroads to provide more consistent service by doing a better job of communicating expected freight volumes to the railroads.

He also said railroads could reduce locomotive risk by supporting multiple manufacturers and reduce crew risk by moving toward partial autonomous operations.