Domestic economies are beginning to reopen as evidenced by the number of TSA airport security screening checks.  They totaled 87,534 April 14th and by May 25th had tripled to 257,451.  “We’re past the trough in terms of peak damage”.  Much of the pickup reflects the states’ decisions to open parts of their economies.  While global supply chains remain fragile the mechanics of transportation decision making remain unchanged.  What is the payoff from the trip? Is it high value/time-sensitive? Where is traffic currently being allowed, and what mode is most cost-efficient?  

Globalization fostered the ever-increasing specialization of labor across countries.  The Covid-19 crisis has demonstrated the weakness of over-reliance on extended supply chains, whether for manufacturing automobiles, aircraft, or pharmaceuticals. ‘Just in time’ easily can become ‘just too late’. An example: the U.S. relies heavily on Mexico for parts and vehicle production.  Thirty-nine percent of auto parts ($60.8 billion) were imported from Mexico in 2019. Without Mexico, the Detroit auto industry will be unable to effectively restart production. Going forward the private sector must re-examine supply links, border restrictions, risks, and define solutions.  

Increased taxes financed the spending that helped the U.S. get out of the Great Depression in the 1930s.  From 1929 to 1939 the corporate tax rate rose from 11% to 19%, capital gains tax rates went up from 12.5% to 22.5%, and personal income tax rates jumped from 24% to 62% (the top marginal rate was 91% in 1960).  With the current level of deficit spending and lost tax revenues due to lockdowns, it’s not hard to imagine higher taxes. But borrowing now amounts to a transfer of economic activity from the future to the present.  

With air travel demand picking up, how full will planes be? Single-aisle airframes generally have 3+3 seating. Leaving all middle seats vacant implies a maximum load factor of 67%.  On a fleet-wide basis, the International Air Transport Association has said “social distancing would mean a maximum load factor of 62%.”  That would require a different business model than the airlines have been using.  Break-even loads vary with changing cost and airfare fluctuations (in 2019, the systemwide beak even load factor was 73.8% while the actual load factor was 84.6%).  

Class One Railroad operations remain strong with freight car velocity, terminal dwell, and car trip compliance improving. The Roads are running fewer and longer trains on tight schedules (Precision Scheduled Railroading). As traffic has declined, crews, locomotives, and freight car resources are being ‘balanced’ to meet the lower current volumes and improve operating ratios. New equipment deliveries are down and an equipment surplus hangs over the industry.     

The Global economy: the European Union’s borders remain closed to non-nationals until mid-June, and China has suspended entry of foreign nationals. U.S. tensions with China are escalating over trade, technology theft, the coronavirus, and Hong Kong’s independence. Managing a transportation portfolio in this turbulent ‘New Normal’ requires an ability to identify and seize opportunities the markets are currently offering. As demand recovers, focus on improving your odds of success. Call RESIDCO.

Air cargo represents less than one percent of global trade by tonnage but amounts to $6 trillion worth of goods moved every year – more than 36 percent of global trade by value.  Globally, half of that airfreight cargo has been carried on passenger jets rather than dedicated freighters. The rapid shutdown of passenger flights has eliminated passenger jet freight capacity, and air freight rates have responded, increasing significantly. 

With the cascading passenger flight cancellations (and flight restrictions), air carriers are moving idle passenger planes to freight in high-demand routes, taking advantage of the very high air cargo market rates at a time when fuel prices have plummeted (American Airlines Group Inc. is flying its first scheduled cargo service since 1984 between Dallas and Frankfurt).  As Asian manufacturing capacity comes back online, moving goods to the U.S. will further increase demand for airfreight. Equipment maker, John Deere & Co., is budgeting an extra $40 million in expedited freight cost for the second quarter to help ensure parts from Chinese suppliers can reach its facilities in Moline, Illinois.

Markets are telegraphing their uncertainty over how long the coronavirus will impact the domestic consumer activity which has driven our recent eleven-year bull market run.  The sell-off that’s occurring is being amplified by a constant media blitz of event cancellations, corporate travel bans, ‘shelter in place,’ school closings, and election-year ‘coronavirus politics’.  To stop the pandemic, we are forcing a recession.  Near-term, the impact will reduce second-quarter economic growth.  However, the politics of the fall election (and a $2 Trillion Stimulus package) will lead to a rebound in the second half.   

While commercial passenger air travel has been turned on its head, U.S. rail freight continues to move the essential goods we need to survive.  The slowing of the global and U.S. economies will delay domestic rail traffic improvement.  

But, as the summer appears, and the virus abates, domestic manufacturers and retailers will need to play inventory catch-up.  Companies will face such a need to restock there will be the potential for a significant freight traffic recovery in the second half of this year.  Longer-term, rail equipment demand uncertainty has been created due to the industry’s adoption of precision scheduled railroading (“PSR”). PSR (and trade) are driving the market dynamics, impacting rail equipment values and lease rates.  

Rail traffic (excluding coal and grain) is down year over year (still up from January lows).  First-quarter container volumes through the Port of Los Angeles, the largest U.S. gateway for inbound seaborne container shipments from China, are expected to be down 15% year-over-year.  Spring flooding will impact traffic along the Mississippi.  Oil’s slide will negatively impact the demand for crude oil tank cars and the frac sand cars that serve the shale oil industry.  

Air and Rail equipment values and lease rates are stressed.  But consider what the markets allow. Volatility creates opportunities. Now is the time to look for those gaps, weaknesses, and areas of growth; ask “Where are the most productive assets available?

We have some answers.  Call RESIDCO.

Market Competition

When a National Bank invests in personal property, the Code of Federal Regulations, Title 12 Part 23, and the Office of the Comptroller of the Currency provides regulatory investment guidelines.  Prior to the early 1990s, banks entered into personal property leases only when they were the functional equivalent of a loan (meaning leases had to be “net, full-payout leases”). 

As bank regulations relaxed, banks began to enter the operating lease markets by creating operating subsidiaries that met regulatory investment requirements. With their low cost of capital, banks quickly became significant market competitors. Wells Fargo1, CIT, PNC, and Citigroup are examples. They own a significant portion of the national fleet of 1.6 Million units.  But with 400,000 railcars in storage and 2019 lease rates down 10 to 20% from the prior year, it has become a challenge to remarket or sell off-lease “nonearning assets” given current market pricing.    

Other than intermodal and autos, railcars carry grain, coal, crushed stone, sand, gravel, primary metal products, chemicals, iron and steel scrap, petroleum products, lumber, wood and paper products, and other high-volume, low-value commodities. Shippers want to manage their supply chains and inventory investment by controlling transport capacity and linking deliveries directly to production lines, customer factories, distribution centers, and ports of entry/export.  

With several modes of transportation available (truck, rail, air, and river), shippers and railroads are aware of the value of consistent delivery, pricing, and volume; this is what is driving the Class One focus on ‘Precision Scheduled Railroading.’ But by reducing service in insufficiently profitable secondary lanes, the Class 1 railroads are deciding to grow margins and cede market share to alternative modes. The result is the Class One Railroads are using fewer railcars and locomotives.

Rail Traffic as of January 2020

Exacerbating the oversupply of equipment U.S. rail volumes fell (again) in January (their 12th straight decline).  Excluding coal (which was down 13.8%) and grain (down 11.6%), U.S. carloads were down .6% in January. Carload gains included chemicals, grain mill products, and metallic ores (carloads of iron and steel scrap were up 5.2%).  U.S. intermodal originations fell 5.4% and have now fallen for 12 consecutive months.  

Job gains, the Institute for Supply Management’s (“ISM”), Manufacturing Purchasing Managers Index (“PMI”), the Non-Manufacturing Index (“NMI”), housing starts, and consumer spending were bright spots, all higher in January.  

Positive trade developments (the new U.S.-Mexico-Canada Agreement – “USMCA,” and the China “Phase One” deal) are being offset by the unknown economic impact of the Chinese coronavirus outbreak.  In January, coal carloads averaged 69,706 per week, the lowest January average since before 1988. In the first 10 months of 2019, coal accounted for less than 24% of U.S. electricity generation, down from 27% in 2018, and 50% in 20052.  Moreover, weekly average grain carloads in January (19,635) were the lowest for January since 2013.  

Investment Solutions

Railcar leasing can provide stable and predictable cash flows as freight volumes return, and the Class Ones show tangible benefits for shippers, such as consistent delivery and pricing that is market competitive.  As markets adjust, how can investment results best be managed? For restructuring solutions, seek the advice of independent, unbiased, and experienced counsel.  Call RESIDCO.

1Wells Fargo maintains they are the largest railcar lessor in North America, with more than 175,000 railcars.

2Ibid.

Labor and Equipment Demand

Eliminating hump yards and running fewer, longer, ‘scheduled’ trains, the Class One’s are continuing to implement Precision Scheduled Railroading (“PSR”). It’s transforming rail networks, reducing the need for labor and equipment. 

The Union Pacific is planning to reduce its workforce by eliminating 3,000 workers this year (after reducing its staff by 11% in 2019).  As train speeds increase, the need for rail equipment decreases.  It’s estimated that for every one-mile increase in average freight train speed and additional 50,000, additional railcars will be moved to storage. Of a fleet of 1.6 Million railcars, 25% were in storage this January.  And train speeds are increasing due to PSR, lingering trade tensions, and to lower freight volumes caused by our slowing manufacturing economy*.  Going forward with larger capacity and new cars being delivered, fewer cars will be needed.  Added to this, the Rails are losing market share as shippers move product to truck to meet just-in-time inventory requirements. 

The Election Effect

Over the years, car ownership has changed dramatically.  In 1962 the railroads owned 90% of the freight car fleet.  Today, 75% is privately owned. The oversupply of railcars and locomotive power caused by PSR and lower freight volume is acting to reduce market values of existing equipment and lease rates at renewal.  The current low-interest-rate environment is depressing lease rate factors available for new equipment.  Uncertainty over the fall election and direction of international events (both in the Middle East and Asia) are working to hold the business investment flat.  As a result, new railcar deliveries for 2020 are expected to trend down. 

Given the election year, Trump signed a “phase one” trade deal with China this January 15th.  It provides a measure of relief for rail shippers.  China agreed to make purchases of $200 billion worth of U.S. goods over a two-year period, doubling its agricultural purchases to $40 billion.  Whether China will honor this agreement (which includes ending its practice of forcing foreign companies to transfer technology to Chinese companies as a condition for access to the Chinese market) is an open question.  

The agreement won’t fix everything.  There will be a continuing lack of cooperation over technology, national security, military, and political ideologies.  These are significant and continuing issues.  As the U.S. and China pursue their own national and economic interests, the conflict will continue.  A degree of economic decoupling is likely and the future of freight traffic between the two countries remains unanswered.  At stake are a stronger economy and global influence.  

Globalism, which fostered complex supply chains spanning multiple borders, is retreating.  The U.S. has become unilateralist and is rewriting trade rules to prioritize its interests while shunning trade blocs.  Bilateral deals have been completed with Canada, Mexico, now China, and soon with Britain, as it has left the E.U. The economic impact of the coronavirus in China is unknown, but airlines are suspending flights and businesses are shutting down operations there.  

Investment Risk Planning

As fiscal stimulus fades and global growth slows, U.S. GDP growth is expected to remain at 2%.  Even though we’re in the longest bull market in history, overall uncertainty has not been reduced.   Tariffs have led to a decline in business investment. While change is certain, how we react to events, preplan for them, and manage through them is within our control.  

Struggling to price investment risk and looking for answers?  Call RESIDCO

*The U.S. manufacturing sector contracted for five straight months through December, the Institute for Supply Management.

The Foundation of Investment Decisions

Strategic decisions are never simple.  Despite the significant resources investment managers devote to the decision process, they often make judgments that go wrong because of human shortcomings.  Behavioral economics teaches that human biases, such as over-optimism about the likelihood of success, often affect the decision process, and employee incentives may be misaligned with long-term investment results.  

Most investment managers know about these pitfalls.  Yet cognitive bias distorts the way managers collect and process information, and judgment often is colored by self-interest.  Overoptimism and loss aversion (the human tendency to experience loss more acutely than gain) are the causes. All investment decisions have two essential components: the likelihood of the expected outcome, and the value placed on it.  When investment probabilities are based on repeated events optimism may be less of a factor. 

The Impact of Loss Aversion

But loss aversion also influences investment decisions.  Consider Boeing’s design and marketing decisions for the 737MAX.  Did Boeing sacrifice safety and airframe design principles to meet competitive pressures from the Airbus A320neo?  Boeing and Airbus operate a ‘duopoly’ in the market for single-aisle jets (valued at over $3.5 trillion over the next 20 years).  Neither can afford to fall behind.  Boeing had considered the single-aisle market large enough to launch a new aircraft design (New Midsize Airplane, “NMA”).  But in 2011, when American Airlines announced a record order for 460 single-aisle planes from Airbus (260 A320, 130 of which were the A320neo) and 200 737s from Boeing, Airbus had managed to break the longstanding monopoly Boeing had with American.  

The Airbus order, “loss aversion’ and market forces forced Boeing to commit to revamp its best-selling 737 with new engines rather than develop an all-new NMA.  Analysts had said that developing an all-new replacement for the 737 would have cost Boeing as much as $12 Billion. But with the 737MAX grounded world-wide since March 2019, Boeing has now booked $9.2 billion in charges.  In the rush to meet market competition Boeing opted not to develop the new jet.  Now, Boeing may still be required by regulators to re-approve the plane as a separate aircraft type from the 737 family.

Mitigating Risk

As investment decisions are evaluated, a misalignment of time horizons frequently leads to the wrong decisions.  Short term paybacks are favored over the impact decisions may have on longer investment horizons. Precision scheduled railroading (“PSR”) promises to improve operating ratios, train speeds, and yard through-put.  But the Rail Industry is not addressing how to provide delivery precision to the final railway freight shippers’ docks.  Boeing’s re-engined 737 and the Class One’s PSR implementation are examples of optimizing short-term performance at the expense of customer relationships and longer-term corporate health.  Boeing feared the loss of market share and Class One’s fear of being left behind. This ‘loss aversion’ phenomenon can lead decision-makers astray. 

Be reluctant to ‘bet the farm’ on these larger decisions.  Minor decisions can be managed as part of a long-term diversified risk-mitigating strategy.  The way to become better is by using tools and techniques that create a culture of constructive debate.  Initial assessments should be supplemented with independent second opinions.  

The economics of transportation equipment investment are complex.  Take a fresh look and ensure the right questions are being asked and answered.  When does it make sense to take risks? Call RESIDCO.  

Value Forecasting

Residual value forecasting for transportation equipment often begins with an expected value curve that traces ‘value decay’ over an asset’s assumed useful life. Once the basic value curve is in place, value volatility must be considered and incorporated (value decay curves do not provide an accurate forecast since the value of transportation assets doesn’t always go down).  

Overlaying volatility allows an estimate of the range of expected value at any point, given the impact of expected changes in market factors and customer needs on specific equipment types in the portfolio. The economics of an investment requires lessors initially measure their residual as the present value of the amount that they expect to derive from the underlying asset following the end of the lease term; This is a value that is not guaranteed by the lessee or any other third party unrelated to the lessor, discounted using the rate implicit in the lease. An investor’s individual risk tolerance affects residual values that eventually are incorporated in the economics of lease return calculations. At the same time, accounting recognizes book income during the life of a lease based on the assumption that residual values will be realized, unless ‘impaired.’  

Aircraft values were impacted by the events of 9/11 and by the 2008 global financial crisis.  Passenger and freight traffic tumbled, and airlines parked their jets by the hundreds and returned leased planes as lease contracts expired.  Yet over the decade following 2008, the global airline industry logged ten consecutive years of profitability. 

Effects of Equipment in Storage

Today, as CSX, Norfolk Southern, and the Union Pacific implemented Precision Scheduled Railroading, they are storing or returning locomotives and freight cars, idling yards, and laying off employees.  On December 1, 396,200 railcars were in storage, almost 25% of the 1.7 Million car fleet (storage levels last peaked in 2016 at 425,000 cars). The future economics of these car types are complex. Of the railcars in storage, 35% are Covered Hoppers, 28% Tanks, and 12% Coal Gondolas.  

Equipment in storage, whether a locomotive, railcar, or a 737MAX that is not flying, is worth less than if in service.  Planes are built to fly. Once recertified, it will take 100 to 150 hours of additional work for each 737MAX to return to flight. Maintenance must spool the engines and boot up a flight computer and auxiliary power units every week.  Exterior surfaces and cabin interiors must be protected. The longer in storage, the more maintenance needs to be done.  

Are These Assets Impaired?

“Impairments” are recognized only if there is a “permanent” reduction in value (the amount of an impairment loss being the difference between an asset’s carrying amount and its current fair value).  With a 30% decline in value, an investor who is leveraged 2:1 would experience a 60% decline in net worth if they were to take a write-down. Bank lessors, who are typically leveraged 10 to 1, will elect to store their equipment rather than sell into a down market.  Next year’s equipment values will be impacted by the existing fleet, new equipment demand, the business cycle, and the always unpredictable ‘unexpected’ events.  Strategic thinkers leverage experience, judgment, and proprietary data to manage residual risk and achieve investment goals.  Call RESIDCO


“Economic Nationalism”

The President’s September 24th address to the United Nations promoted ‘sovereignty’ above international relations.  “The future belongs to sovereign and independent nations, who protect their citizens, respect their neighbors and honor the differences that make each country special and unique.” 

His favorite themes?  Unfair trade, imbalanced defense spending, illegal immigration, creeping socialism, and China’s “embracing an economic model dependent on massive market barriers, heavy state subsidies, currency manipulation, product dumping, forced technology transfers, and the theft of intellectual property and trade secrets on a grand scale”. 

Many call this ‘economic nationalism’, an ideology that promotes domestic economic growth and opposes globalization, free trade, and immigration.   

Impact on Air and Rail Freight

Since 2016 the retreat from Globalism has had a significant impact on levels of air and rail freight traffic.  It has resulted in the Global economy growing at its slowest pace since the 2008 financial crisis (2.9% this year, the smallest annual rise since 2009) .

FedEx recently reduced its 2020 outlook pointing to trade tensions and the ‘weak’ global economy due to the absence of a trade deal with China.  The Dow Transportation Average which tracks 20 of the nation’s largest airlines, railroads and truckers (including FedEx) is down 8.8% over the past year.  The index of freight shipments maintained by Cass Information Systems Inc. has been falling every month this year with negative volume nine months in a row.  The loss of traffic points to a growing downside risk to the economic outlook.

The Shifting Economy

The U.S. expansion has put people back to work.  Economists agree the nation is at or close to full employment.  But the economy is now dominated by high skill high wage jobs, and low skill low wage jobs.  Middle wage jobs are gone.  It’s this loss of ‘middle American’ manufacturing jobs that is driving our Nation’s political polarization. 

Republican districts hold a growing share of agriculture, mining and low-skill manufacturing jobs while Democratic districts dominate the most productive parts of the country.  People have jobs, but they’re not good jobs. Even with our labor markets upended by global trade (and technology) our economic fundamentals remain nearly double that of other developed countries (Europe, Japan, or Britain). 

Acting to support continued growth the Fed lowered interest rates by a quarter of a percentage point on September 18th, its second cut since late July, and suggested it was prepared to move aggressively if the economy showed signs of weakening.  In Europe the ECB cut its key interest rate and put into place a package of monetary stimulus highlighted by bond purchases. Trade policy remains a question mark and freight traffic continues to be impacted by the lack of a trade deal with China.  Energy prices remain volatile as Iranian threats to Saudi Arabia’s oil production continue and shale oil production slows.

Partisan politics may make headlines and political theatre, but our economy is built on principles that encourage enterprise, diversity, individual rights, and fair elections.  For now, the economy remains resilient and confidence in the expansion continues. When thinking about transportation investment risk consider the range of possibilities. To be prepared, call RESIDCO.  

Precision Scheduled Railroading’s Various Effects

The S&P 500 posted its best first half in 22 years.  US Job openings outnumber the unemployed by widest gap ever.  The U.S. economy continues to expand (2.1% in the Second Quarter).  Yet U.S. Domestic rail freight volumes are down.  Chinese challenges to the Western Global Trading System certainly are one reason.  And, as Class Ones adopt Precision Scheduled Railroading (“PSR’), they are focused on point to point carload traffic to the exclusion of merchandise traffic; running longer trains with fewer locomotives, and lower employment.  PSR is generating excess equipment.  As these changes ripple through the system, Shippers, Equipment Lessors, and Railway Labor are dealing with the unexpected.  

Shippers are concerned with first and last mile issues, a lack of short haul efficiency, and the demanding loading and unloading behaviors being enforced with rising demurrage charges, less free time, a lack of fault allocation and lack of reciprocity.  Railway Labor is clearly against PSR implementation as a recent Capitol Hill hearing ‘The State of the Rail Workforce’ demonstrated. Chairman Peter DeFazio grilled Federal Railroad Administration administrator Ron Batory about PSR; in addition to job losses, Chairman DeFazio asked about increasing train sizes saying he has received reports of 15,000 foot freight trains passing through Oregon’s Willamette Valley.   

Further effects on rail business

The impact on rail equipment values and lease rates?  Locomotives are stored and cars online are down.  The Class Ones are clearly managing for yield.  With truckload pricing falling, intermodal rail is now more expensive than trucking in some secondary markets.  Yet even in the face of flat to declining volumes and modal competition the Class Ones are reporting record operating results.  “The company is handling the same volume as last year with fewer assets, fewer crew starts and less network congestion, improving customer service, operating metrics and cost.”  Will lower rail cost lead to lower rail rates?  Shippers are saying no, “Rates are up and service is down”.  

What’s the purpose of the Rail freight business?  Shareholders would say profits. Shippers would say competitively priced and frequent service.  Labor would say jobs. Equipment investors would say positive after tax cash flow. Short term, Shippers are dealing with less flexible service caused by PSR and its changing metrics.  Origin destination pairs are being cut and Shipper supply chains are being upset by both PSR and tariff and trade disagreements.  

Railroads have a monopoly on heavy freight.  It must move, and often only by rail.    Businesses exist only because of their ability to generate positive cash flow.  But positive cash flow and profits are the result of competitively delivered services and products.  Free trade is important but not if National security is threatened.  Investment requires confidence in the future. Will the Roads manage for both yield and growth?  Regardless, future rail traffic will be constrained by capital spending, productivity, labor pricing, and our tariff and trade negotiations.  What can we expect as Shippers react to PSR?  For answers to that question call RESIDCO

Total carloads were down 8.9% in March while carloads for the first quarter were down 3.1%.  Year-to-date coal is down 8.1%, grain down 5.2%, chemicals down 1.2%, and intermodal down 1.8%.  Excluding coal and grain U.S. carloads were down 2.8% in March 2019 (from March 2018). The U.S. Energy Information Administration (EIA) reported 12.9 gigawatts of coal-fired utility scale electricity generating capacity was retired in 2018 (Texas, Ohio, Florida, and Wisconsin).   Grain traffic has softened, but China imported 180.8 million bushels of soybeans in March, up 10.5% from their February totals.  Much of that grain was sourced from the U.S. and Brazil (China is the world’s No. 1 soybean importer).  

With softening traffic and with the Roads focused on improving network operations, equipment and locomotives are being taken out of service.  Fewer, longer trains are running in scheduled service.  Customer loads are spending less time in classification yards.  Less congestion improves on-time delivery and less equipment improves operating ratios and shareholder value.  If ‘economic uncertainties’ continue and if the Roads are successful in implementing ‘scheduled’ railroading, expect an overall reduced demand for equipment. Yet cars in storage have remained essentially unchanged from a year ago. There were 313,456 cars in storage this April 1 compared to 315,188 railcars in storage a year ago (approximately 19% of the total fleet).  

Why?  Shippers still demand equipment be available to respond to changing market conditions in their markets.  In order to ensure equipment is available for loads when needed Shippers will adjust by increasing investment in railcars.  Rail Portfolio Managers will assist by maintaining their focus on keeping existing fleets in service.  

With the global economy weakening and the Trump Administration and China locked in trade negotiations many analysts were concerned growth was stalling.  The Fed’s reaction was to leave interest rates alone as inflation is near their 2% goal. The Wall Street Journal forecasts the probability of a recession at 25% in the next 12 months, rising to 49% in 2020.  But the purchasing manager index doesn’t indicate any current signs of contraction (having risen to 55.3 in March from 54.2 in February).  Job growth rebounded last month after a February slowdown. Unemployment is historically low. While traffic has been affected by trade disputes, slower growth in Europe, and weaker consumer spending, most analysts predict continued moderate growth during 2019.  Economic uncertainties?  

A recession does not appear on the horizon and the U.S. economy remains resilient in its 10th year of expansion.  Softening traffic, stored equipment, improving network operations, Shipper demands, and the need to keep equipment in service will change how the Industry manages investment. Returns accrue to those with experience, diligence and integrity.

Successful portfolio management is a difficult thing to imitate.  For air and rail alternatives call RESIDCO.

Past Challenges

Before Hunter Harrison, the prevailing view was more locomotives, more railcars, and more crews allow for the movement of more volume. But because track and yard capacity is finite, adding more equipment creates congestion and slows the system. While it is counterintuitive, reducing fleet size enables a road to move more volume by running fewer (longer) trains, faster. ‘Scheduled’ service results in better asset utilization and higher profits.

For example, CSX’s ‘operating ratio’ (its operating cost as a share of revenue, the industry’s leading benchmark for efficient operations) dropped to 58.7%, a third-quarter record, while third-quarter profit increased 106%.

CSX’s Revolution

The results CSX is delivering are pushing the remaining U.S. Class Ones to consider adopting similar strategies as North American railroad executives face investor pressure. By rigorously scheduling service and eliminating bottlenecks, ‘Precision Scheduled Railroading (“PSR”)’ transports the same or more freight with less capital in the form of railcars, locomotives, and classification yards. Classification yards are choke points that slow traffic.

After dropping out of Memphis State to work as a dispatcher in a rail switch tower, he said: “It was then I learned that how you arrange schedules and manage assets are the key.” In his eight months at CSX, Hunter Harrison converted no fewer than 7 of CSX’s 12 hump yards into ‘flat-switching’ (by a locomotive on yard tracks) facilities resulting in faster deliveries from origin to destination.

Hunter Harrison’s legacy? Root out schedule inefficiencies, minimize asynchronous traffic flows, reduce cost, and create opportunities for timely ‘scheduled’ delivery. Focusing on efficient network operations results in maximum use of existing equipment and ultimately will change how the industry invests.

A Locomotive Industry Shift

Union Pacific is moving to follow the same playbook. It has idled 625 locomotives, with plans for idling another 150 by the end of this year while removing 6,000 cars from its network with plans to cut an additional 10,000 railcars over the near term. Compare PSR to airline network operations. Aircraft fly on schedules with minimum time on the ground. The efficient use of aircraft results in less investment and improved yields. ‘Scheduling’ operations allows matching of staffing, asset levels, and work sequences accurately. CSX results demonstrate this.

As Class Ones effectively implement PSR, network and terminal velocities will improve. Improving service will grow market share, take traffic from the highway, and deliver enhanced financial results for both the Class Ones and shippers, thus enticing new private investment in rail assets.

The Goal? Right-sizing capacity while implementing efficient asset management techniques. The results? Timely deliveries, improved returns on invested capital, and satisfied customers. Rail equipment knowledge creates opportunities that unlock portfolio values in this environment. Interested? Call RESIDCO.