We attended the NEARS (Northeast Association of Rail Shippers) City Series event in New York City and hosted a call with a Farrukh Bezar, Chair of STG Logistics. Following are our takeaways.
NEARS CITY SERIES
NEARS panelists spoke to challenging freight trends through Summer, exceptionally tight warehousing space that is leading to significant price hikes and improving rail service. CSX remains optimistic about project pipeline and tax bill could be a major boost for industrial development.
A transport economist noted possibility of freight market bullwhip resulting from recovery out of tariff air pocket. We have also highlighted this as a potential bull case though we believe it is too early to call. The presenter sees TL spots seeing strength in the Fall if this scenario plays out. This economist’s analysis of regulatory impacts on the trucking driver pool suggest ~2% could be ultimately put out of service due to new English language rules, which is not large enough to tighten capacity in our view. Another panelist at our event also cited enforcement challenges for the rule. In the long run, the economist believes autonomous trucks will alleviate any real/perceived driver shortage problems.
A business development representative from CSX spoke to the company’s deep project pipeline that continues to grow (~600 current projects). Expansion requests can turn into real carloadings within as little as six months, and brand-new sites can begin moving cars in ~1-2 years. The panelist noted the potential tax bill is very positive for CSX and the rail group due primarily to the new bonus depreciation methodology that would allow 1) 100% bonus depreciation for qualified properties in the first year, which could result in a “huge inflow” of funds for new projects, and 2) as noted in our CSX investor dinner, accelerated depreciation could result in $200 million a year in cash for CSX.
Warehousing is very tight, according to a large roofing shipper, and it is having to explore sites in secondary and tertiary locations to hold inventories. 3PLs it partners with are being hit with steep rent hikes, which is making this shipper vigilant in due diligence while enlisting 3PL providers.
The multi-modal panel acknowledged better rail service but sees room for advancement. Responsiveness and communication with customers and short lines has improved. However, shippers see the Class I’s still often focusing on metrics that benefit the network as opposed to the customers’ operations. Ease of doing business with Class I’s also came up as a pain point, with one shipper pointing out that moving volume with the short lines was a much easier process than with the Class I’s.
INTERMODAL/RAIL SUPPLY CHAIN UPDATE
We hosted a call with a Farrukh Bezar, Chair of STG Logistics. The freight “air pocket” should be followed by sequential growth, though still below last year’s levels. The intermodal pricing environment remains sluggish and hinges on the TL market while rail service remains solid. Class I’s look for long-term growth drivers amid steady loss of share to highway. We remain cautious on the intermodal market, including JBHT and HUBG.
Current demand has stabilized, though air pockets in the transloading business have yielded material declines. RPU has been the biggest challenge for IMCs and is likely a 2026 story. STG expects a sequential step-up in volumes (off the air pocket) though y/y is still expected to be lower. Despite industry reports of full warehouses, STG doesn’t expect to see significant levels of assessorials (nothing close to COVID levels), and surcharges are to be determined.
STG does not see a rail merger likely, though it believes it is in the realm of possibilities, especially given 1) lack of organic growth drivers and 2) ambiguity on the next generation of rail leadership. We believe the only possibility would be a Western carrier acquiring an Eastern carrier, and the current rules in place would likely need to change. We do not believe a merger is likely and note a Class I CEO’s recent commentary: “Not a hill of regulatory risk to climb. There are mountains of regulatory risk … I think it’s nice to talk about. I don’t think it’s very probable. I don’t think it’s possible. I don’t think it’s going to happen. And I don’t think it’s necessary.”* We note, however, that he is the first Class I executive to publicly come out and say “no” to future consolidation.
STG sees a considerable long-term volume and earnings growth opportunity for the rail industry but emphasized a mindset shift is needed to seize it. We concur and believe railroads will need to rekindle growth to defend valuations. Bezar offered two preconditions for this to occur: 1) the Class I’s (especially the truck-competitive Eastern rails) need to demonstrate sustained service improvements and 2) a notable shift in commercial focus is needed from peer competition to truck conversion.
The growth runway is considerable as 87% of U.S. transport spend moves over the road (OTR), and even modest share gain represents a significant volume opportunity for the rail network (we note, however, that a good portion of that 87% fits more naturally with OTR moves). This requires a focus on EBIT growth and moderation in pure OR optimizing, though Bezar remarked this was not inconsistent with PSR (despite popular belief), which he believes would have had a chance to coexist with growth if the pandemic had not interrupted operations drastically.
The intermodal pricing environment remains subdued. Shippers had gradually started to pull forward bids to lock in low rates at the start of the year, but a recent slowdown has led them to expect sluggish pricing to persist. The fate of rates continues to hinge on TL pricing, and Bezar sees a recovery that is unlikely to bring us back to 2021-2022 high watermarks, with 2019 being a better yardstick. This would offer a potential 15%-25% improvement in pricing from current levels (which show little in the way of pricing gains for IMCs). We continue to see intermodal pricing as more of a 2026 story, which we believe is the consensus view at this stage. However, if we get to the latter half of this year with no improvement, notable gains in 2026 could prove elusive.
*Editor’s Note: It was CPKC President and CEO Keith Creel, at the Wolfe Research 18th Annual Global Transportation & Industrials Conference. – William C. Vantuono
