Time For a New North American Rail Strategy November 28, 2017 Transp sportation a and Logist stics s Adviso sors, s, LLC
Disclaimer Statement This report has been prepared by Transportation and Logistics Advisors (T&LA) for Stifel Capital Markets (Stifel). The report is based upon information obtained from sources deemed to be reliable. All findings, conclusions, and recommendations are based upon the information made available to us. Market analyses and projections represent T&LA’s judgment, based upon data sources cited, and are subject to the validity of the assumptions noted herein. For purposes of the analyses presented in this report, T&LA has relied upon, and considered accurate and complete, data obtained from the sources cited, but has not independently verified the accuracy and completeness that data. No representation or claim is made that the results projected will actually be achieved. It is expected that any and all recipients will conduct their own independent analysis. All estimates and projections contained in this report are based on data obtained from the sources cited and involve significant elements of subjective judgment and analysis, which may or may not be correct. Stifel has agreed that any report prepared by T&LA and any information, findings, conclusions or recommendations provided by T&LA or any of its representatives to Stifel in connection with its work are for the exclusive use of Stifel and that no third party may rely on our report or our work. The delivery of this and any report in connection therewith is not intended to confer rights to any other person or provide any other person (including affiliates, partners, advisors and of such person) with any direct or indirect benefits or permit any other person to be regarded as a third party beneficiary. 1 Transp sportation and L Logist stics A s Adviso sors, s, L LLC
Agenda • Rail Strategy Deregulation Though 2004 • Rail Strategy 2004 - 2014 • Recent Strategy Limitations • The Growth Opportunity 2 Transp sportation and L Logist stics A s Adviso sors, s, L LLC
After deregulation, railroad rates not only declined significantly, but declined faster than truck rates Real Change in Rail and Truck Rates • From 1990 to 2004 (1990 - 2004) both rail and truck inflation-adjusted rates declined Truck Rates – Rail rates decreased over 30% – Truck rates Rail Rates decreased less than 10% • Truck rate declines came to an end in 2002 and began to Sources: ACT Publications, Morgan Stanley; BLS; AAR 2014 presentation to the Transportation trend upward Research Board; TandLA analysis 3 Transp sportation and L Logist stics A s Adviso sors, s, L LLC
The result was volume, revenue and profitability growth, but below GDP growth, and railroads were not earning their cost of capital Annual US Railroad Industry Figures Indexed to 1990 Levels 2.00 CAGR 3.5% 1.50 2.7% 2.4% 1.00 0.50 Annual Nominal GDP Growth: 5.3% - 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Revenue Net Income Ton Miles Sources: AAR Annual Analysis of Class I Railroads; TandLA analysis and estimates 4 Transp sportation and L Logist stics A s Adviso sors, s, L LLC
Agenda • Rail Strategy Deregulation Though 2004 • Rail Strategy 2004 - 2014 • Recent Strategy Limitations • The Growth Opportunity 5 Transp sportation and L Logist stics A s Adviso sors, s, L LLC
Starting in the early 2000’s railroads changed strategy, focusing on improving Operating Ratio and earning cost of capital • Changed from declining rates to increasing rates – Closed price gap with truck and barge • Continued focus on productivity and driving down costs – Cut overhead – Changed train operations • Added distributed power • Larger/longer trains • Focused away from low density lines – Added more productive equipment • Newer technology railcars • More fuel efficient locomotives • Focused CapEx on infrastructure – Added capacity in growing areas – Levered Infastructure to facilitate smoother operations and lower operating costs 6 Transp sportation and L Logist stics A s Adviso sors, s, L LLC
The result was rate increases averaging 5% per year, after declining about 1% per year over the previous 20+ years Nominal US Railroad Revenue Per Ton-Mile (2004 - 2014) • Nominal revenue/ton mile $0.045 increased 5.1% per year on average from 2004 to 2014 $0.040 • From 1981 to 2004 nominal $0.035 revenue/ton mile $0.030 decreased about 1% per $0.025 year $0.020 $0.015 $0.010 $0.005 $- Sources: AAR Annual Analysis of Class I Railroads; AAR 2014 Overview of America’s Freight Railroads; TandLA analysis and estimates 7 Transp sportation and L Logist stics A s Adviso sors, s, L LLC
This strategy proved financially very successful, as railroad profitability increased about 400% from 2004 to 2014 US Railroad Net Income (2004 - 2014) • Rail industry net income $15 increased 17.5% per year on average from 2004 to 2014 $12 – From about $3 B to more than $14 B in a decade $9 • Even the Great Recession only created a one year $6 pause in net income growth $3 $- Sources: AAR Annual Analysis of Class I Railroads; TandLA analysis and estimates 8 Transp sportation and L Logist stics A s Adviso sors, s, L LLC
Along with net income, stock prices also grew significantly faster than the over-all market Indexed Stock Price Change • Between the start of 2005 (2005 - 2014) and end of 2014 the market 8 increased: 7 – Dow: Up ~65% – S&P500: Up ~70% 6 5 • Rail stocks performed 4 much better: 3 – UP: Up 690% – KCS: Up 530% 2 – CP: Up 420% 1 – CSX: Up 400% - – CN: Up 340% – NS: Up 190% CSX NS UP CNI KSU CP DJI Sources: Fidelity.com; TandLA analysis and estimates 9 Transp sportation and L Logist stics A s Adviso sors, s, L LLC
Agenda • Rail Strategy Deregulation Though 2004 • Rail Strategy 2004 - 2014 • Recent Strategy Limitations • The Growth Opportunity 10 Transp sportation and L Logist stics A s Adviso sors, s, L LLC
Following the Great Recession, volume initially rebounded, but never approached earlier levels. In 2015 the decline in carload volume resumed Monthly Rail Carloads (excluding Intermodal) • Rail carloads were relatively (thousands) flat from 2000 to 2008 • Rail carloads recovered from 1,500 2009 to 2014 1,350 − Total up 10% 1,200 − Non-coal up 30% 631 623 • However, the 2014 recovery 1,050 643 509 peak was well below 2006 496 588 517 453 589 900 362 levels 570 − 750 Total down 11% − Non-coal down 7% 600 − From 2014 to 2016 the decline 450 hastened 815 787 759 737 740 725 725 712 − 678 Total down 14% 649 300 584 − Coal down 29% 150 − Non-coal down 4.5% • Even the 2017** “recession - 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016* recovery” is leaving volumes All Other Commodities Coal down vs. 2015. 2017 YTD: − Up 5.5% from 2016 − Down 9% from 2015 *2016 is annualized based on actual January – November volume **All comparisons through first 12 weeks Sources: St. Louis Federal Reserve; Bureau of Transportation Statistics; AAR Commodity database; AAR weekly rail volume; 11 TandLA analysis and estimates Transp sportation and L Logist stics A s Adviso sors, s, L LLC
Since 2004, rail carload volume has under-performed, even excluding the impact of coal on rail – particularly since the Great Recession Indexed Volume Growth by Mode • Rail carload volumes 2004 Indexed to 100 roughly tracked truck in the 130 mid-2000’s and outperformed barge 120 – Driven by growth in coal – Non-coal was in slow 110 decline 100 • In the Great Recession, rail carload took the worst hit 90 and never recovered • Since 2014, the rail carload 80 decline has accelerated 70 – Decline is more than coal driven Rail Carloads* Truck Tonnage Water Tonnage Rail Carload* Ex. Coal *Excludes intermodal Sources: St. Louis Federal Reserve; Bureau of Transportation Statistics; AAR Commodity database; AAR weekly rail 12 volume; TandLA analysis and estimates Transp sportation and L Logist stics A s Adviso sors, s, L LLC
Rail carload growth (excluding intermodal) has significantly trailed US industrial production and US industrial production plus imports 25-Year Growth Trends (1990=100) 25-Yr • Rail carloads excluding CAGRs intermodal are down from 2.20 1990 levels 2.00 • Tons/carload is only a 2.7% partial explanation for the 1.80 period up to 2000 – but 1.60 much less so since 2000 1.6% – 1990 tons/carload*: 81 1.40 – 2000 tons/carload*: 87 1.20 – 2015 tons/carload*: 88 1.00 (0.2%) 0.80 1990 1995 2000 2005 2010 2015 Carloads Ex IML Industrial Production + Imports Industrial Production *Excluding intermodal 13 Sources: U.S. BEA; AAR Analysis of Class I Data 1986– 2015; IANA data; TandLA analysis and estimates Transp sportation and L Logist stics A s Adviso sors, s, L LLC
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