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Three Companies And What They Said About Precision Railroading In Their Earnings Calls


Three sides of the move to precision railroading (PSR) were on display last week during earnings season conference calls, and they helped to drive home how deeply the practice is embedding itself in the nation's railroads.

Within 48 hours, the industry could listen in on an earnings call from CSX Corporation (NASDAQ: CSX), the railroad whose admirable operating ratio (OR) has helped set off the adoption of PSR among other companies; an earnings call from Kansas City Southern (NYSE: KSU), which said on Friday it was going to adopt the "principles" of PSR; and the earnings call of J B Hunt Transport Services (NASDAQ: JBHT), which ironically is most identified with the single Class 1 railroad between Canada and the U.S. – BNSF, a unit of Berkshire Hathaway (NYSE: BRK-A) – that has not adopted PSR but which puts enough intermodal service on the other railroads to have the perspective of a shipper needing to do its own adoption to the new reality on the rails.  

Terrence Matthews, the executive vice president and head of intermodal for Hunt, said on his company's earnings call that he expects rationalizations of various lanes at the carriers adopting PSR will probably cost Hunt 50,000 to 70,000 loads on an annual basis. Those railroads "decided to get out because (the lanes don't) meet their expectations of whatever the rationale for that is," Matthews said, according to a transcript of the earnings call supplied by SeekingAlpha. It's forced Hunt to search a little harder for business, but Matthews was upbeat on those prospects. Bids the company has received so far on providing intermodal service, according to Matthews, have come in with high-single-digit rate increases, "and we will need to be able to grow some volume because we have some headwinds in the East with some of the rail rationalization that's going on with (precision railroading)."
That idea of looking to book higher prices and more business to offset getting rid of lanes as a result of PSR rationalizations was also discussed by CSX CEO Jim Foote. His perspective is that CSX needed to "reengineer" its intermodal business, and took 7 percent of the intermodal volume off the railroad. But the volume on the intermodal sector was up 2 percent – revenue was up 4 percent – "so the 2 percent plus 7 percent means recurring about 9 percent, OK. So I would say under the circumstances, pretty good," Foote said according to the transcript of the CSX call.

CSX is not done cutting in its intermodal division. Mark Wallace, a sales and marketing executive from CSX on the earnings call, said that on October 1, 2018 another 3 percent of the volume was cut from the system and at the start of this month, changes hitting about another 5 percent went into effect. Wallace also said no further cuts are anticipated this year.

With the intermodal service actually showing growth in volumes while cutting lanes, that fact sits in the middle of the question: does PSR just involve cutting costs and driving OR higher, or at what point is it used to grow a railroad's business? Foote was asked that by an analyst on the CSX call and said the inflection point would be when "all of a sudden you start to see above average growth for a railroad company that's adopted this, it's because the quality of the service becomes so much better than it historically was," he said. "Again, it's not like some people say, oh, all of a sudden you get to some point in time, June 22, 2020 and you go, oh, we are going to pivot from cost reduction to growth. It is an evolutionary process that as you continue to focus on getting your trains to run on time as efficiently as possible, it improves the quality of the service and that customers can put more, because we become more reliable, they will put more business on it."

Is the service getting better? J.B. Hunt's Matthews, on that company's call, was mixed.  He expressed some optimism: "Precision railroading by definition is this should be better on-time service, better on-time service means that intermodal should grow," he said. "And then, the quality of the revenue should also follow that as well."

But that's the theory. In the fourth quarter, Matthews said, "the service that we received from all railroads... was not what we had hoped and the velocity was obviously down which consumed boxes." But as the calendar flipped, Matthews said, "we see some of the best service we have seen in the last year-and-a-half, much better than last January and hopefully that would continue."

Shelley Simpson, chief commercial officer and executive vice president of J.B. Hunt, said she saw a railroad that fully adopts the principles of PSR as being an asset in moving freight off of a truck and onto the rails. The widely-discussed "principles" of PSR include many  fewer hub-and-spoke operations, which means some customers might lose their service if they are on a "spoke" that the company no longer considers worth the effort. The upside, theoretically, is that more point-to-point service and tighter adherence to a schedule means the customers that do get serviced get their freight on time. The upside to the railroad, theoretically, is a tighter cost structure and a higher operating ratio.

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If that occurs, Simpson said, the intermodal business could see "a change from what the truckload market will see overall,  and also if we think there is an opportunity this year for intermodal conversions to occur as the railroads do speed up and have more capacity, and they are more predictable... customers could be moving into that at maybe a higher price for intermodal but it would lower their overall transportation cost."

Kansas City Southern announced it was adopting PSR "principles" when it released its earnings early Friday. A few hours later, in a conference call with analysts, CEO Pat Ottensmeyer held off on many details about the company's implementation of PSR, saying, "We are very early in our thinking here."

But COO Jeff Songer was more detailed for the railroad that has trade with Mexico as its core activity. There is "low-hanging fruit" in the company's Mexico network, such as  standard PSR targets like train length "and I think that's where we are really kind of setting our sights." Songer also said Kansas City Southern already has been able to "rationalize" equipment out of its Mexican operations; a reduction in the amount of equipment in the network is another key goal of PSR.

Songer also said KCS had redesigned its intermodal and manifest product offering between Kansas City and St. Louis and cut eight train starts per week on that lane.

Earlier in the call, Ottensmeyer said Kansas City Southern had not yet identified a "total number" of locomotives to be reduced on the system as it adopts PSR, but the railroad has returned 25 leased units and is in the process of storing 20 additional locomotives.

KCS made another move in bringing in Sameh Fahmy. Songer said the relationship with Fahmy is a "consulting agreement" for an executive with 27 years of experience at Canadian National. Twelve of those years were served with Hunter Harrison, the late railroad executive who implemented PSR at Canadian National before moving on to CSX and putting it into place there.

Even as KCS was touting the move, Ottensmeyer said he didn't think the railroad was "coming from kind of the distance to the pack in terms of operating ratio and performance." (For the record, KCS's OR in the quarter was 63.1 percent, compared to a bit more than 60 percent for CSX.) He referred to a statement he said Harrison made once that KCS "run a pretty good railroad there. So I don't know what the magnitude of the change that we see is such that kind of as you refer to a culture shock (the basis of an analyst question) is necessary or appropriate."

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