Question: Where’s the belief in growth? Our State of the Rails chart (bottom) is starting to look good, and we show a truncated version. We now have half the industry, including the two biggest players, turning assets materially faster than their post-recession historical averages, with Norfolk Southern and CN not far behind.
Only CPKC is in negative territory, but we all know why, and it also has the highest bar to clear because it has typically been the best operator. Point being that the industry is in pretty good shape, at least relative to its own operating history. The last time continent-wide Class I operations were this good was in mid-2020, benefiting from pandemic shutdowns that temporarily suppressed volume pressure.
As we recently alluded to, now would be the perfect time to get serious about service from a position of operational and financial strength. Instead, the industry is breaking the glass and reaching for the big red button labeled Transcontinental Merger Hail Mary. It’s the mother of all distractions, and we’re surprised by how quickly the players are falling in line. Union Pacific is, of course, the chief protagonist, but the two eastern railroads appear eager to fold. The fact that the talks with Norfolk Southern are in an “advanced” state confirms NS is fully engaged and open to a deal, in stark contrast to 2016 when NS was digging in its heels and citing insurmountable regulatory hurdles when a Hunter Harrison-led Canadian Pacific was trying to engage with it. Clearly, the key players are now different.
Down in Jacksonville, comments from CSX’s CEO on its recent earnings call essentially flips its shingle from “Open for Business” to “For Sale.” BNSF at least has the luxury of being able to remain silent, protected under the Berkshire umbrella. Now, to be clear, these management teams are doing what they’re paid to do: get the stock price higher. Union Pacific is a giant with market power and pricing power, and if it can get 50% bigger and enhance pricing power even further, why wouldn’t it do that? The two eastern rails clearly see a one-time ~30% acquisition premium as a satisfactory way to check out. Our unease around this whole situation is that if these companies truly believed they have a bright future in their current states, including an ability to grow volumes, why are they being so quick to go down the transcontinental rabbit hole, which may turn out to be an expensive and distracting dead end?
Answer: There Isn’t Any
Even if the U.S. railroads are successful in consolidating from four players to two, here’s how it would play out in terms of service, and we’ll assume the combinations are UP-NS (remove the dash and say that fast a few times) and BNSF-CSX:
• Fifteen months of drama before the STB talking about enhanced competition tests, downstream effects, voting trusts and trackage rights, during which time the sales and customer service teams, and everyone at HQ in Atlanta and Jacksonville will be demoralized because they know their chances of surviving a merger is less than 50%. Even UP and BNSF would be on hold commercially, regarding strategic investments until the STB makes its final decision.
• Once approved, the railroads will do what they always do and fire too many people with key customer and institutional knowledge at the acquired entities, which will require the reconstitution and repair of some customer relationships in the East.
• Then we have the IT integrations. You know where this is going. We’ve been painfully tracking CPKC’s struggles with an IT cutover that essentially encompasses only a handful of U.S. states, four U.S. yards that matter, and three tracks. If Keith Creel’s team can’t get this right, what are the odds UP and BNSF can do a better job cutting over every state east of the Mississippi? How does zero sound?
What we basically end up with is a lost half decade in service. That’s how long it will take to secure STB approval (again assuming it’s granted), rationalize sales and operating teams, do the IT cutovers, and fine tune the networks into a normal state. At that point the benefits start showing up in terms of more direct routing, fewer disruptive interchanges, a less congested Chicago, and faster rate quotes to customers. So yes, there are tangible benefits, but there are hurdles to be overcome before they materialize.
CPKC Repairing Terminal Dwell
Merger news chased CPKC off the cover last week as it struggles with the fallout from the botched IT cutover attempt from the old KCS Management Control System to CP’s “TYES” system back on May 3.
The first chart below shows the big picture on dwell, including Canada and Mexico, and we’re now seeing consistent sequential improvements in full system terminal dwell. We’re almost back to a more normal 10 hours. It’s important to remember that we’re dealing with a network, and you almost never have a situation where all locations function well at the same time. There are always moles to whack, and it’s OK if outperformers offset underperformers.
In terms of the key yards we’ve been tracking, you can see in the second chart below that Sanchez in northern Mexico remains a big problem, but there’s good news elsewhere, with recent significant drops in dwell times at Monterrey, San Luis Potosi, and most critically Shreveport in Louisiana, following a two-year high set in the first week of June.
If we drill into Shreveport and look at dwell times including and excluding run-through trains that only stop briefly to refuel or change crews without switching cars, the former metric is now back to where it was prior to the cutover, at 20 hours. If we exclude run-through, which is the better measure in our view, it’s still sitting at a poor 50 hours, which is double U.S. competitor Union Pacific’s yards, for example, but at least we’ve finally seen a material step down to a post-cutover attempt low.
