Class I railroads outline 2021 projections, February weather impacts

Rising fuel prices could eventually help with truck conversions

By Joanna Marsh for freightwaves.com

All of the publicly traded Class I railroads presented at investment bank JP Morgan’s industrial conference last week. Here are some themes expressed through the multiday event:

Weather dents February’s rail volumes and could impact first-quarter results

When the Class I railroads reported their fourth-quarter earnings results in January, they anticipated favorable volume expectations for 2021.

That outlook hasn’t changed for most, given rail volumes in January and March, but the severe weather conditions in large swaths of the U.S. affected both the railroads and shippers. 

“January was starting off on track. February slammed us in the head,” said CSX (NASDAQ: CSX) CEO Jim Foote.

Unplanned operating expenses resulting from the bad weather, such as train length restrictions and congestion around Chicago, are potential one-time expenses for the first quarter.

“February was not a good month from a revenue and cost standpoint, and so that’s going to have an impact on the quarter,” Foote said. 

Almost all of the Class I railroads presented at JP Morgan’s industrial conference last week. (Photo: Jim Allen/FreightWaves)

Norfolk Southern (NYSE: NSC) Chief Marketing Officer Alan Shaw said rail volumes were running higher year-over-year in January, but then the February storms impacted not only Norfolk Southern (NS) but also interline partners, customers and the drayage community.

But volumes have since rebounded amid underlying improving macroeconomic conditions, Shaw said. Although the automotive industry encountered the semiconductor shortage in the first quarter, pent-up demand and inventory replenishment will push volumes higher in the second and third quarters. Also, NS is seeing more demand to move merchandise carloads and there is more strength in commodity pricing, such as higher prices for export thermal coal for the first half of this year, Shaw said. 

“Generally speaking, we don’t feel February’s events will adversely affect us,” said NS CFO Mark George.

Union Pacific (NYSE: UNP) CEO Lance Fritz said quarter-to-date volumes were mixed, with premium volumes up 3%, bulk volumes down 4% and industrial volumes down 14%. UP’s intermodal service is in its premium segment. 

Intermodal container volume outbound from LA is up 28% y/y during the past week. Total Los Angeles outbound international container volume for 2021 and 2020 are shown in blue and orange, respectively. (FreightWaves SONAR) To learn more about FreightWaves SONAR, click here

The chip shortage affected auto volumes, but the strong housing market is providing a lift to forest products volumes. Meanwhile, grain and grain products are up 14% but coal’s decline of 17% is offsetting that growth, Fritz said.

Meanwhile, in Canada, CN (NYSE: CNI) tackled the “full brunt of winter” in February, operating shorter trains because of the frigid temperatures, according to CN Chief Operating Officer Rob Reilly. 

 

But despite the weather, exports of Canadian grain and a record grain harvest have boosted quarter-to-date volumes for CN, Reilly said. The railroad is on pace to exceed last March’s record grain volumes, he said. 

Fuel surcharges expected to affect first-quarter results

Higher fuel costs could affect the railroads’ expenses and operating ratio in the first quarter. However, the railroads expect to benefit eventually because higher fuel prices means that it could raise prices in the trucking market.

Roughly 85% of our revenue is tied to highway diesel, Shaw said. As fuel prices go up, it will increase demand for our service product, he said. 

“Rising fuel prices make railroads more competitive to trucking.” said Kansas City Southern (NYSE: KSU) CFO Mike Upchurch. 

The chart above shows the average percent difference between intermodal contract rates and truckload contract rates for loads moved in the same three-digit ZIP code origin-destination pairs. (FreightWaves SONAR) To learn more about FreightWaves SONAR, click here

 

WIll the second half of 2021 be better for the Class Is?

The consumer economy is finding support from e-commerce and expectations that U.S. retail sales will continue to be strong in the second half of the year. That in turn could benefit intermodal volumes. 

 

E-commerce has been growing for the last 12 months, and even the Chinese New Year didn’t impact container volumes, said CN’s Reilly.

“We’re seeing this as an opportunity to move more freight and increase our yield. … We could see intermodal strong for the next couple of months,” Reilly said.

But the outlook for a recovery in the industrial economy is less clear. Container availability remains a concern in the first half of the year. However, forecasts for gross domestic product growth are favorable for the rails, as are strong housing starts figures. Meanwhile, some Class I executives that the automotive industry will get the chips they need so that they can ramp up production in the second and third quarters. 

Three automotive production plants had shut down, but now we expect them all to reopen later this spring, Upchurch said. The automakers are hinting of demand, we could see production pick up in the second to fourth quarters, he said.

Upchurch also said some Gulf Coast refineries and facilities were still ramping up production in early March after being online in February because of the winter storms. 

What are the Class Is’ plans for real estate development?

The Class I railroads are exploring ways to monetize their real estate assets as a way to generate sales or recurring revenue.

 

NS has some unique real estate assets, and the company is looking to whether new industries or transloading opportunities can occur there, Shaw said. 

Foote said one way CSX is looking at its real estate is through the e-commerce lens and whether a property is suitable for transloading. 

“The past has been, let’s take a look at this nonessential rail property, free it up and monetize it. … There was talk of selling off a lot of lines and creating industrial development on the line, and I thought, why can’t we do that or partner to do that,” Foote said.

CSX brings on employees to manage anticipated rail volume growth

Foote said CSX has been “aggressive” about bringing on employees to ensure that there is enough workforce to handle an anticipated increase in rail volumes in 2021.

As CSX hires more crews, Foote acknowledged that the industry needed to improve how it manages its crews in such a way that provides better planning and visibility. The rail industry has tended to be reactive when it comes to hiring practices but if rail wants to be viewed as a service, “we have to be better at that,” Foote said.

CSX has seen record volumes for intermodal, and it is seeking to grow its merchandise volumes, according to Foote.

 

However, the company is benefiting from the expansion projects of the port authorities on the East Coast, such as focusing on-dock rail and inland port development at the Port of Savannah. There are still opportunities to expand infrastructure capacity supporting the ports, such as the efforts to enable double stacking at the CSX tunnel through Baltimore, Foote said.

“It’s a really exciting time to be in the international intermodal arena on the East Coast right now,” Foote said.

To win customers, CSX needs to focus more marketing efforts on transloading to show greater connectivity across the whole supply chain, from point A to point B, according to Foote. That means looking at transloading opportunities related to warehousing and connectivity with distribution centers, he said. 

“We need to focus on running a rail system as a transportation system,” Foote said. 

NS seeks to increase train lengths and weights

NS plans to continue its strategy of increasing train size in 2021, which will in turn improve labor productivity, Shaw said.

The company is seeking to increase the train weight for its intermodal trains by 20% and growing their length by 14%. This enables NS to handle volume growth for intermodal without adding more trains or creating network congestion, Shaw and George said.

But like its competitor CSX, NS is also seeking to improve its merchandise franchise and “make it cycle agnostic,” said Shaw. To do this, NS needs to provide consistent and reliable service that also offers “a great level of visibility and transparency.”

“Our focus right now is offering the efficiency of truck with the simplicity of rail,” Shaw said.  

NS has more network capacity in its northern region than in its southern region, where there are more restrictions in certain areas. As time goes on, it will seek to add capital in key geographic areas to improve capacity, Shaw and George said. 

Union Pacific talks tech, West Coast port congestion

To cope with the congestion at the West Coast ports, UP has been working with the ports to improve transparency and visibility, Fritz said. That includes ensuring UP and its supply chain partners are referring to the same key performance indicators during moments such as getting intermodal boxes off the dock and into a well and getting them moved inland, he said.

UP had applied surcharges in the quarter to ensure that committed customers have boxes available. The purpose of the increased surcharge rates was to force boxes to be returned so that they can go to committed customers. As of last week, most of the surcharges have been removed, according to Fritz. UP has also made changes to its accessorial charges program as a way to turn assets more efficiently, he said. 

In the past month, the Class I railroads increased rates on eastbound lanes from Los Angeles to protect capacity for contracted shippers. (Source: SONAR; the intermodal spot rates for the movement of 53-foot domestic containers in the 20 densest domestic intermodal lanes and their month-over-month percent changes are shown above. (FreightWaves SONAR) To learn more about FreightWaves SONAR, click here

UP is also seeing a good bid season with the beneficial cargo owners, Fritz said.

The company is seeking to refine its technology offerings and get customers more comfortable with using them. One example is its reservation system for intermodal trains, which is meant to maximize existing capacity with current demand. That should also help assets turn around better, Fritz said. 

UP is working on making sure our technology is seamless with the customer base, Fritz said, whether that is through using APIs or improving customers participating in UP’s reservation systems.

Indeed, UP last fall hired former Walmart executive Rahul Jalali, who Fritz says brings not only a deep knowledge base of technology but also the perspective of building technological platforms in an agile environment. 

Winter weather dents Kansas City Southern’s volumes

Last’s week’s conference occurred before Kansas City Southern (KCS) and Canadian Pacific (NYSE: CP) publicly announced their proposed merger on Sunday.

As the companies await the progress of their proposed merger, it’s business as usual for KCS and CP.

Despite February’s weather-induced volume downturn, KCS expects to keep its operating ratio target of 57.5% for the year. Operating ratio is a tool investors use to gauge the financial health of a company, with a lower ratio of expenses as a percentage of revenue as an indicator of improved financial health. 

There will be easier year-over-year volume comparisons going forward, Upchurch said. “We’re about to enter territory where we see volumes expand,” he said. 

CN describes next stage PSR

Although port congestion in Southern California has gotten a lot of media attention lately, Reilly said CN has seen market share shift over time to the Canadian ports of Vancouver and Prince Rupert.

Prince Rupert provides advantages such as a shorter route across the Pacific Ocean as well as access to the upper Midwest, Reilly said. 

CN expects to move less energy products and more intermodal volumes this year, which is “still a good business” but comes with a different margin, Reilly said. The company is adjusting pricing levels according to demand levels, with CN seeking higher yields in western Canada. 

The railway is also prepared to handle adjustments to its operations amid a potential strike at the Port of Montreal

With precision scheduled railroading (PSR) well underway at CN, the next step is the “digital scheduled railroad (DSR),” which will build on PSR principles and utilize machine learning and artificial intelligence to bring about automation, Reilly said. 

DSR is also a way to improve the customer experience so that the technology not only benefits them but helps them grow their business with CN, Reilly said. 

Meanwhile, CN has been operating positive train control on the U.S. portions of its network for about a year. The safety technology has helped train dispatchers by eliminating the need for radio communication, making dispatching operations more efficient, Reilly said. 

Canadian Pacific outlines growth plans with partners

CP CFO Nadeem Velani expects CP to have a “flattish” operating ratio in the first quarter, with record revenue ton mile in January and an “extremely positive” March offsetting a weather-induced volume downturn in February.

Among the projects that are expected to come online this year are its Vancouver transloading facility with vessel operator Maersk, which is expected to be ready in the third quarter, and the start of the diluent recovery unit in Hardisty, Alberta, in the back half of 2021. The unit will enable freight trains to transport a type of heavy crude oil from Alberta to the U.S. Gulf Coast.

A benefit of having the partnership with Maersk is that Maersk and CP have an aligned strategy toward environmental, social and corporate guidance objectives, Velani said. Both are building a transload and distribution facility that would service Maersk by shuttling the containers of Maersk’s customers to and from the ocean terminals at the Port of Vancouver. The new multicommodity transload facility would be an expansion of CP’s existing intermodal facility in Vancouver.

“They can move their boxes effectively and efficiently with a view on the environment, and we can do the same thing,” Velani said. 

As the Vancouver transload facility begins operations, CP will be looking at ways to scale up the facility to increase output capacity and take on business in an area and lane that has growth opportunity, Velani said. 

 

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