How to read the Class I railroads’ second-quarter earnings reports and what questions to ask.
CSX Corp. (NASDAQ: CSX) on Tuesday kicks off the second-quarter 2019 financial reports of the major North American Class I railroads. Across North America, all the major railroad companies will publicly disclose financial results within the next 30 days.
Let’s discuss what those reports tell rail customers versus rail investors in North America.
Overall, let’s recognize that the intelligence about freight railroads’ financial results and the pattern of rail freight traffic movement results is relatively impressive in regard to both the rapid reporting as well as to accounting details. The rapid reporting and the depth of intelligence regarding Canadian, Mexican and U.S. railroad companies is frankly “world class” compared to the lack of details and the relatively slow timing of most government-owned railway organizations.
Why the public knows less about government rail performance than private investors remains a mystery.
This short piece gives readers who are newcomers to the rail freight sector a quick primer on what to expect, what might only lightly be discussed by the quarterly railroad companies’ reports and executives’ “open” Q&A interviews.
The quarterly sessions usually document results using PowerPoint slides as PDF readable files. Besides the slides and their embedded graphs, the railroads also make publicly available a report filed with the Securities and Exchange Commission. Access is easily available to anyone. You need not be a stockholder. Just log onto the railroad company’s website and go to the investors tab. You might have to register.
What you’ll see: Delivering an investor’s point of view and expectations is the rail company’s primary focus. Typically investors center on reading four subjects according to one Motley Fool journalist:
1. Lapping the previous quarter — and the previous year’s quarter — is perhaps the primary investor interest. Lapping will likely be a challenge in the second quarter of 2019 for railroads in the West, where weather has pounded both Union Pacific Corp. (NYSE:UNP) and BNSF (NYSE: BRK.A — BNSF is part of Berkshire Hathaway) operating performance this spring.
2. The railroad freight operating ratio (OR) achievement is No. 2. CSX leads off the railroads’ financial reporting — and will try to demonstrate an improvement over its first-quarter 2019 operating ratio of 59.5%. That might be a huge challenge for the Western carriers — but perhaps achieved by the two Canadian carriers, Canadian National Railway (NYSE: CNI) and its geographic competitor Canadian Pacific Railway (CP). Once the cold and snow ebbed, the Canadians haven’t faced U.S. Midwest-like flooding challenges.
What is the operating ratio really and why is it important? It’s a simple physics-like calculation of how much work as labeled by accountants was expense versus operating gross revenues. The math is total expenses divided by customer revenues paid in as rail operations earned gross income. Note that subsidies and grants are not allowed as revenues.
3. Railroad company pricing power is estimated. Is pricing power being maintained, increased or dwindling? That is a critical investor benchmark. To some, the OR seems to be an overbalance focus.
4. Traffic unit decline or increase is clearly one of the strategically watched company report card marks. Is traffic unit volume as ton miles (or tonne kilometers) increasing or not? It’s normally a percentage change focus.
What is overlooked? The freight mode volume share change is often discounted in a quarterly report to investors. Investors need to think about mode share change even if not reported by the railroads. Why? Because unquestionably railway mode decline is a troubling pattern. At some point a critical mass drop might become future investors’ main decision point. Time will tell.
Thinking as a railroad man (or woman), what drives them day to day during a quarter’s work? Six benchmarks stand out:
1. Revenue per carload and contribution per carload are internal keys managers focus on.
2. Since about 1992, railroads like Consolidated Rail Corp.(CONRAIL) focused on the OR. Back then, by about the sixth week of each quarter, CONRAIL managers could pretty well estimate the ending quarterly OR at about 90% or better accuracy. That is pretty good for pre-E. Hunter Harrison days. (Harrison began using precision scheduled railroading at railroads he ran and is credited with several turnarounds because of it.) However, the 1992-to-1996 objective was by 2019 standards an anemic 79% OR. Looking back, that was a poor performance given ORs in the low 60s today.
3. Operating measures like gross annual tons per track mile above 20 million was a primary goal. So too was average train length above at about 80 cars compared with more than 100 today.
4. Capital investment was often capped at about 80% of operating income as the 1990s-era board of directors indifference target.
5. Positive free cash flow was a target clearly reachable after the depressed Penn Central and Rock Island days.
6) And a targeted 9 to 11% return on invested capital was definitely seen important by managers 30 years ago.
Internally, the above measures are railroaders’ day-to-day focus today — but the target deliverable metrics are now at a much higher level.
What’s important from shippers’ points of view in the quarterly reports?
1. Consistent service performance is No. 1. Where? At the loaded car final delivery location (receiver dock). That may be their No. 1 benchmark. Which of the seven major Class I railroad companies is going to be the first competitor to report this ETA scheduled performance at about an excellent 88 to 92% final car delivery to receivers?
2. Customers care about train performance. How close to truck-like delivery timing can freight railroads achieve — and which railroad will be the first to show that as a quarterly achievement?
3. Continuous quality improvement and railcar tracking and tracing is another item shippers seek on a quarterly scorecard.
Conclusions: Quarterly reports will continue and will be primarily financially or accounting based.
Shippers will have to rely on periodic customer or business commodity forums for better intelligence about service quality. Until when? Until the first railway decides that ETA performance is a strategic quarterly reporting competitive advantage.
It’s important, therefore, for rail freight customers — and employees who are increasingly now compensated by incentives, stock options and 401k plans — to understand what’s actually in the investor reports.
How might employees and customers do that? The beginning step is to learn how to better read and translate what is in a financial report. One of the ways to do that is take a short one- to three-day course that covers accounting for non-accountants. Learn simple techniques for reading income statements. Expand that to understanding balance sheets and the uses of corporate cash.
Among the best old-time study aids is “How to Read a Financial Report” by Merrill Lynch. It’s just 30 pages.
Don’t just rely upon the rail company’s public relations translation. Beyond improving your skills, study the rail companies’ annual fact books or their sustainability reports. Subscribe to various independent rail market “watchers” like Roy Blanchard. Demand that your shipper associations push their conference speakers to challenge the investor reporting with more of the “user” perspectives about service.
Yes, read and think about the investor materials. Then push beyond for customer intelligence. Respectfully challenge the railroads to provide more.
Jim Blaze is a career railroad economist with an engineering background and a strategic analysis outlook. His career includes 21 years with Consolidated Rail Corp. (CONRAIL); 17 years with the rail engineering firm Zeta Tech Associates; seven years with the Illinois Department of Transportation; and two years studying what to do with the seven bankrupt and unrecognizable Northeast railroads at the federal agency USRA.