The Impact of Natural Disasters

On the Gulf Coast, Hurricane Harvey forced the shutdown of refineries and disrupted the production of plastic resins and refined oil products. The Union Pacific and Burlington Northern have lifted embargos for shipments to, from, or passing through the Gulf region. They continue to evaluate affected areas as repairs complete on port and intermodal facilities, switching yards, track, bridges, and signal operations.

How Rail Equipment Traffic has been Affected

The latest weekly AAR traffic reports U.S. rail carload and intermodal volumes ‘tumbled’ in week 37 while year to date traffic remained up 4.1% and intermodal units up 3.4%. Since the shale revolution shifted crude production inland from the Gulf (there was little damage to fracking activities), there is no expectation of a shortage of crude. The Hurricanes will have traffic impacts on certain commodities. But pent-up demand from manufacturers in the affected areas and rebuilding efforts will boost rail traffic in the fourth quarter and into 2018. The will also impact the scrap markets will be felt in a similar manner, as scrap will come out of the damaged areas (light iron and shreddables first, then automobiles and heavier steel).

CSX and “Precision Railroading”

Whether it’s a natural disaster or another unseen event, disruption provides an opportunity to bring to market different value propositions. Disruption changes how we think, behave, and go about our day to day business. The Class Ones and shippers consistently strive to improve operational efficiency and maximize asset utilization. An example: CSX as it transitions to ‘precision railroading’.

Since Hunter Harrison disclosed he was leaving the Canadian Pacific with plans to join the CSX, its shares surged from $36.88 to $45.51, adding $7 Billion in value. He’s a unique talent having taken the Illinois Central, Canadian National, and Canadian Pacific from worst in class to hugely profitable businesses.

CSX’s Vision and Strategy

Harrison’s vision? Dismantle the ‘hub and spoke’ systems widely deployed to a ‘point to point’ system. This would eliminate yard stops, handling, and increase the amount of freight carried and delivered. At the same time it would reduce investment in locomotive power, cars and switching equipment[1].

The key metrics CSX monitors are train velocity, terminal dwell, and cars on line. Downtime and delays are to be avoided. He is pushing customers to shift dispatching cars from five days a week to every day. The approach intends to shrink delivery times by keeping the assets moving and minimizing idle time in rail yards. Cars move directly from their origin to their destination and deliver the same or greater amounts of freight with fewer cars and locomotives.

The goal of this strategy is clear. It’s an operations mindset. Harrison believes this back to basics focused approach will drive superior financial performance. Implementation has been rocky since it’s been incredibly disruptive to both employees and shippers. But the strategy seeks to deliver value to CSX shippers and shareholders by ensuring transportation assets respond to changing circumstances as opportunities for profitable growth. The result seeks to improve CSX profitability while reducing delivery times and shipper freight cost.

Assessing Your Rail Equipment Investment

Harrison senses operational efficiency and efficient asset utilization ultimately drive rail profitability. As you analyze your rail equipment investment be careful of projecting data into the future. Historical data is usually the most reliable, but that data will be an accurate guide only if the future resembles the past. Automating your analytics can lead to insights that formerly only highly experienced analysts could derive. You must overlay that analysis with intuition and skill to unearth where future values will appear.

Recognize disruption as an opportunity for growth. Competitiveness is doing what customers want. Staying competitive requires a willingness and ability to recognize patterns and to learn. If successful, the CSX example may provide a template to revive American manufacturing. Rail equipment investment dynamics may change. The future is not guaranteed. Work with experts who integrate finance, rail equipment expertise to optimize value particularly when disruption occurs. Work with RESIDCO.

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[1] Similar to Southwest Airline’s model which allows it to keep its equipment flying more hours per day than its rivals.

The first half of 2016 has seen its share of volatility. Globalization, central bank actions, the impact of the internet (speeding the flow of information and creating social networks), Presidential election politics, acts of global terror, and Brexit are all phenomena that have contributed. Historically, markets have not been as volatile.

Declining rail freight volumes continue to pressure North American Railroads[1]. July carloads declined 8.8%, led by coal at 17.5%[2] (U.S. coal production has dropped to its lowest level since 1981[3]). Crude by rail has declined 45% in 2016[4]. Class One railroads are storing more locomotives and railcars[5]. With less equipment on line increased train speeds have allowed the roads to more efficiently serve customers, further reducing equipment demand. Air travel is down due to terrorism and currency swings. Lower jet fuel pricing has improved margins and allowed air carriers to add capacity; the resulting competition has reduced revenue per available seat mile and increased pressure on air carrier yields.

Economic activity drives traffic, and demand for transportation influences equipment pricing at the margin. Transportation services cannot be ‘stored’. Unsold seats on a flight, unused air-cargo capacity, empty freight cars, and parked locomotives represent lost revenue. Are we at a bottom? The 34 nation Organization for Economic Cooperation and Development (‘OECD’) thinks so. The OECD expects U.S. growth, as measured by GDP, to slow to 1.8% in 2016, but to then accelerate in 2017 to 2.2%[6].

Political, policy, business, and investment leaders constantly grapple with the increasingly fickle cycles of consumer and business confidence. Is the world is in a ‘rut’ because of a chronic shortage of demand for goods and services and an extended period of low interest rates[7]? Short term thinking, uncertainty, over regulation, anxieties, and a lack of confidence in the future have impacted our economy’s structural growth rate and contributed to a deterioration in productivity. When economic freedom is suppressed, growth fades, and when growth fades it takes the American Dream with it. Our Presidential candidates? If elected, one has stated, “coal miners and coal companies will be put out of business[8]” as part of a clean energy agenda. In contrast, the other would reduce taxes and government regulation.

In this environment, agility, adaptability, and an open mind are essential tools. Asset allocation is critical and risk management is key. Volatility creates opportunities to buy equipment at discounted prices. Experience teaches staying the course proves its virtue in the long run. A long investment horizon diminishes the effects of volatility. Traffic may be down, but we expect it will stabilize through the rest of this year.

Choose wisely. Work with a firm that has a history of excellence, expertise and ethics. Call RESIDCO!

[1] Moody’s Investors Services, May 16, 2016.

[2] Association of American Railroads (‘AAR’) July, 2016 weekly U.S. rail traffic reports.

[3] Truewealth Publishing, July 21, 2016.

[4] August 3, 2016, U.S. Energy Information Administration, a division of the U.S. Department of Energy.

[5] Progressive Railroading, Rail News: Mechanical, Fleet Stats, July 2016.

[6] The Associated Press, June 17, 2016.

[7] Larry Summers, “Zero interest rates are a systemic inhibitor of economic activity.” Bloomberg Businessweek, May 12, 2016.

[8] May 2, 2016 Democratic presidential nominee, at a round table discussion with locals at the Williamson Health and Wellness Center in Williamson, W.V.