CN - For All Rail Freight Amtrak's Fight With The Union Pacific Signals More Change

2023-05-02 00:35:42 ET

Summary

• Amtrak's lawsuit against the Union Pacific Railroad seems to be a test case, which if won, could spread to all the major freight railroads.
• We sense that Amtrak will win, further pushing haulers toward a more tenable long-term financial model.
• Short-term results for the majors might be volatile with the likely coming changes.
• Without firm plans in place, we would avoid buying for long-term investing, Union Pacific or CSX.
• When the dust settles from the East Palestine derailment, investors might consider buying Norfolk Southern with its well-thought-out change in vision.

With many headline freight train derailments and clashes between Amtrak and host railroads including the Union Pacific ( UNP ) particularly along the former Southern Pacific Sunset route, freight railroad business models may once again be push into significant modification or drastic operational changes. Amtrak filed a lawsuit against Pacific in December with the Surface Transportation Board ((STB)) under Section 213 claiming the freight railroad unduly obstructed Amtrak Sunset Limited's schedule with poor dispatching. Amtrak placed the blame squarely on Union Pacific's version of Precision Scheduled Railroading ((PSR)). Amtrak's claim included,

"Union Pacific routinely runs freight trains as long as 12,000 feet, Amtrak says, among the longest of any Class I railroad. But even as UP has made its trains longer and longer, it hasn’t invested in building longer sidings to handle them, choosing instead to spend billions each year on stock buybacks. Amtrak claims that freight trains longer than 10,000 feet can’t take a single siding for more than 450 miles along the Sunset Limited’s route."

Note: UP claims 25% of its traffic travels between Colton, CA and El Paso, TX, a portion of the old Sunset Route. Much of that route is double track, but not all.

On average, Amtrak claims that the freight carrier delayed its train approximately 2 hours a trip. The passenger rail corporation asked that the STB act speedily skipping the customary arbitration step.

Defining PSR

From the Union Pacific's website , "Precision Scheduled Railroading ((PSR)) looks a little different from railroad to railroad, but at its core it’s intended to benefit customers by providing consistent, reliable, predictable service." The basic concept views business on a carload rather than the whole train set mentality. Attributed to the late Hunter Harrison, PSR concepts came to the 48 states through Harrison's CEO influence while CEO at Canadian National (CNI). All major freight railroads adapted this approach accepting the privately owned Burlington Northern Santa Fe (BNSF).

The Freight Railroads Debacle

Others outside of corporate management have coined less than flattering terms, "“slash-and-burn” removal of expenses and headcount. Or, PSR is “Positive Shareholder Reaction,”" A seeming area of agreement between most parities is that what really happened is railroads eliminated headcount by 25%, classification yards (for the UP, this meant shutting down Pocatello, ID and Hinkle, OR among others), consolidating of dispatch centers and the diminishing of capital budgets. In effect, the question becomes, can this approach last long-term? These changes now bring into play Amtrak's power granted to receive priority dispatching from Congress with the consent of the cash bleeding American railroads in the '60s.

From the '60s to today, much has changed with freight railroads most generally generating significant levels of cash being more than $7 billion in profits alone during 2022. In this fifty-year period, traffic has more than double while infrastructure meaning, multiple tracks, yards, and sometimes, rolling stock, has been abandoned or mothballed. Seemingly what was once profitable now unprofitable trackage in the view of management have been sold off to short lines or completely abandoned. One glaring example is the complete abandonment decades ago of the former B&O's Parkersburg to Clarksburg main line. The relational of this action still finds itself being in the middle of arguments. In particular, during the 1980s, large sections of track found itself under new owners or darkened. Alternative route possibilities significantly diminished.

Amtrak, with its Union Pacific lawsuit, offers its own assessment, customer service isn't prioritized. This issue stretches across all major freight railroads. The passenger carrier issued this slide:

On the far right, freight interference trumps all other causes. Amtrak isn't squeaky clean either. It has more than worn out its welcome. Using but a few words, if the relationship between Amtrak were contractual, the legal marriage would have been terminated justifiably so, long ago. But the issue now before the STB against Pacific might be considered a test case for Amtrak with its required consistent, on-time performance eluding the carrier. What, in essence, Amtrak argues, is that a flexible free flow of differing traffic no longer exists or never really existed.

What The Precision Financial Model Produced

The General Accounting Office ((GAO)) began an investigation interviewing a broad set of groups into the real effects of the model. Although nobody has the same definition, the investigation thus far yielded this commonality, it caused significant reductions in staff, brought on fewer but significantly longer trains, and reductions in assets such as locomotives. In many cases, the right- of-ways remained unmodified. Freight customers interviewed "identified concerns such as reduced frequency and reliability of service, and increased fees." Customers also identified that unreliable service caused: shutdowns, higher costs and frustration. This report adds fuel to the importance and direction that the STB might take in resolving the Amtrak and customer complaints.

It doesn't end with service, rather continues into the topic of safety. A safety board identified several incidents where the train makeup, ordering of cars, was likely a factor in those derailments.

State legislatures are beginning to act in response to the above issues. Nevada now limits train length to 7500', while Ohio mandates at least two crew members be aboard each train.

What PSR produced was closer to congestion and in many cases, poor service. This nightmare for passenger service results in Amtrak beginning what we again believe is a series of lawsuits demanding improved and more flexible networks coupled with priority dispatching. What Amtrak can promise is beyond our expertise.

Three Majors Change CEOs

Within the last year, three of the major freight railroads changed CEOs. The next table shows the preceding and succeeding CEOs.

In the case of the Union Pacific, key stockholders forced the change. With the other two, the preceding CEO retired. Union Pacific's plan, with the company leaderless, remains in limbo. Investors wanted a change, and one is coming. The Amtrak suit might or will likely impact at least a part of its operation along the Sunset Route with a likely remedy limiting train length to the requisite trackage configuration. Future suits, from Amtrak, might affect other freight lines in similar fashion. This could become financially disruptive in the short run.

Continuing with CSX's transformation, the Wall Street Journal interviewed the new CEO, writing this article, How a Railroad Outsider Aims to Improve Service. In it, CSX's new CEO, Joe Hinrichs, outlined his perception of the situation.

"Precision scheduling “was heavily indexed toward controlling costs and improved asset utilization and, in many ways, didn’t prioritize improving the employee experience and improving customer service ,” Mr. Hinrichs said."

Continuing, Hinrichs added,

[O]ur website claims five properties: improved safety, control costs, improve asset utilization, improve employee experience and lastly improve customer service. "Now, it was implemented in a way that didn’t really take the employee experience into account and frankly, didn’t prioritize better customer service. " Hinrichs also remarked that precision railroad is neither good nor bad, it is always about balance between customer needs and costs."

BNSF with its private ownership, seems to be avoiding most of these issues, but perhaps not all. Amtrak still experiences significant delays on its Southwest Chief, that train dispatched by the Santa Fe portion of the road.

Signaling (Singling) Out Norfolk Southern

In our view with change forced upon the majors, we include some details from Norfolk Southern's recently presented, "new vision." At its last investors conference, the four hours' worth of salesmanship is worth listening to at some level. The CEO, Alan Shaw, begins by confirming its commitment to PSR followed by explaining it is highballing away in a drastically different direction, one driven by balance. Did you notice Hinrichs' observation concerning balance hinting where CSX might be headed.

Before continuing, let's step back noting a few comments made at the Barclays conference . Mark R. George, CFO, and Claude E. "Ed" Elkins, Chief Marketing Officer, attended representing the railroad. In about the middle of the discussion, George admitted that business shrank during the last 6-7 years with its response, cut to match, an untenable direction. In describing the change, the representee focused on Southern's target toward a trillion-dollar flexible freight business now dominated by trucking. Further explaining the coming changes simply meant matching predictable truck delivery times while adding scale, a focus which also matches Amtrak's critical needs.

Stepping back to the investor's day presentations, our interest focusses heavily on management's attention and buy-in toward key business fundamentals. In our view, l ong-term thinking managers direct by balancing a few simple fundamentals applicable to its product(s). We found the presentation rich and rewarding with its constant attention to the simple, but critical factors. The CEO passionately described its vision, service with productivity aimed at smart growth . A summary, in our view of critical factors, follows:

• Customer centric service and service and service, etc., etc., etc.
• Balances between:
  • ROIC
  • Revenue
  • Earnings
• Balances between:
  • Reliable & Resilient Service
  • Smart Sustainable Growth
  • Maintaining headcount even during the bust part of the shipping cycle.
• Balances between:
  • Simplicity
  • Excellent execution (predictable plus timely)
  • Compromise with customers
• Balances between:
  • Cost
  • Sustainable capacity

The word balance garnishes its planning frequently replacing where financial metrics once roamed. This provides clear meaning for investors, understanding that a business almost completely driven by a singular financial metric now morphs its operations being bounded, not managed by, practical monetary constraints.

Targeted growth within Norfolk involves again that principle, balance, against approaching sector systemic tailwinds including:

• Transition from just-in-time to just-in-case inventory management.
• Continued energy inflation.
• Growth in online shopping vs. buying at a big box store.
• Difficult hiring markets forcing major changes in past hiring and furlong practices to respond to the natural 3–4-year business cycles.

This seemingly monumental change forces wise investments into infrastructure including closely located intermodal yards, rolling stock (both power and car) and trackage capacity. Providing on-time and timely service thus competing with single point-to-point truck hauling draws rail freight closer to that the elusive flexible system which Amtrak so much seeks.

We, also, understand that Norfolk faces ugly scars, both financial and brand, from its East Palestine derailment.

Summing Up Risks

Each of the major freight railroads seem headed to major changes that will negatively impact short-term results. Infrastructure builds always lead revenue, even by years. In the case of Southern, its management is developing relationships that equate to five-year planning. We suspect that CSX and eventually Union Pacific will be forced into following suit.

We believe that Amtrak is just now getting started in using its power legally extended. It appears that this passenger rail pressure will prevail adding to the existing systemic forces forcing major changes within the right-of-ways operated and owned by private freight railroads. In the longer view, this direction will provide improved and sustainable financial performance, the original target behind PSR. In the short run, performances will be riddled with volatility creating that much hated investment word, buying opp.

In our view, we would be a buyer of Norfolk once the dust, from the Palestine debacle, settles. It seems tragic that the one line finds itself dealing with this catastrophe shortly after management put together a well thought-out transformation. Our investment thoughts concerning CSX or Union Pacific are on hold. But investors can expect a level of volatility, meaning unwelcome financial news from time to time.

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