Railroad capacity issues

Trains Magazine General Discussion
1

There is another thread discussing Matthew Rose’s comments regarding capacity, investment, and tax credits.

Unfortunately it is strayed off the original path and is now a discussion of agricultural issues, while important, are not germaine to the topic.

So, I will restart this issue.

I find Rose’s comments interesting, in that he is looking for Federal help in increasing the capacity of the nation’s rail systems. I am not in disagreement with him that there could be a problem in the future. The problem is already manifesting itself in certain corridors and terminals.

What I find interesting is the choice of most systems use of their cash flow.

I have not done a complete survey of the publicly traded railroads, but as a shareholder of CN, I know that they use their cash flow to purchase stock. I checked this morning and found BNSF does the same. In fact, BNSF used $799,000,000 (that is 799 million dollars) in 2005 for stock purchases.

There are very sound reasons for companies to do this. In many ways it is superior to issuance of that cash as a dividend, although the tax issue has been leveled out somewhat with the classification of “qualified dividends” (taxed at a lower rate).

However, if there is a capacity issue; and if the rails are now beginning to earn their costs of capital; and there is significant growth in their industry…wouldnt that $799,000,000 be better invested in the physical plant of BNSF?

ed

2

Using the $799,000,000 to buy back stock wiil result in the stock rising more than investing in capacity. I am sure that the people who decide how that money is spent earn bonuses determined by the performance of the stock.
If BNSF is planning a merger, the other railroad becomes more affordable as BNSF’s stock rises. I have the feeling that BNSF, NS and CN are all watching KCS’s stock price and are ready to pounce if KCS stock has a dip.

3

nanaimo:

I agree with what you are saying. Since I posted, I discussed this issue with a BNSF official in the investors relations department. He did confirm the stock buyback was $799 million for 2005. He indicated their capex was $2.4 billion for 2005 and they are investing in certain “growth” segments of their franchise.

We did discuss the “tipping point” of more capex vs stock buyback. It is a fine line which needs to be balanced. Whether we like it or not, Wall Street must be considered…the investors do own the company. My question to him was “at what point does BNSF address the capacity issues with more investment in the plant rather than stock buybacks?” Particularly in light of Mr. Rose’s comments regarding capacity issues and tax credits.

It was a pretty good conversation. He admitted for the first time since Staggers BNSF has “pricing power” to raise rates. He indicated intermodal rates, as the contracts roll over with the steamship companies are rising.

The numbers seem to support that statement. 4Q 05 freight revenue per thousand ton miles for intermodal is up 17.3% over 4Q04.

ed

4

If BNSF invests that $799,000,000 in capacity, do they get to claim the whole amount as a business expense ?

I would be interested to see a gerenal breakdown for capacity projects that would show the percentage of the cost that goes to the various governments though taxes, permits, ect.
Perhaps 15% or 20% ?

5

I find the stock buy back plan to be more than a little disengenious on the part of the management at this aledged stage of a capacity problem. In this day and time many executives who have the position, and influence to direct spending, are recepients of stock bonus plans of one sort or another. Truly, it [stock buyback] does have the effect of boosting overall stock value, and thus is a financial benefit to the corporations, but it seems to do little to increasing speed or capacity over their system. Resolution of the capacity issues would be a much longer term benefit, but would do little in the short term to benefit management bonus packages. The increase in the overall value of the property would benefit from the capacity improvement, but again, does not create an immediate benefit to the stockholder.
Sam

6

.
A short and simple answer to why they didn’t invest the 799 million in the plant.
Logistics…
The plant improvements you see underway today were decided upon two or three years ago, and the necessary operation put in motion then.

It isn’t like Rose was sitting in his office last week, and decided to double track the “B” line, grabbed the phone, called the VP in charge of plant improvements, and told him “Hey, I want to double track the B line, I got the check in the mail to you…”

And you can’t run down to Auto Zone and pick this stuff up off the shelf.

“Yeah, I want ten million pandrol clips, 5 million steel ties, about thirty #6 frogs, and five hundred miles of CWR, please…hey, you guys take American Express?”

Yes, railroads do keep stockpiles of materials and crew ready to go, but only enough to handle “small” jobs, derailments, things like that.
No one would spend their budget on miles and miles of rail supplies only to stockpile it just in case the boss wants to double track a main or two next week.

BNSF is laying down two new sidings here on my railroad; both will hold 120 grain cars and locomotives.
If you go out and look at it, you could imagine that, from the start, it might take a month or two, I mean its what…a stack of steel ties, barrels of track clips, a few piles of rock and a bunch of guys with a grader, back hoe and some track machines?
Nothing to it, huh.
Wham, bam thank you Mame…

What you don’t see is the fact that, from the initial planning stage to the last spike, it took over a year to get all the sub contractors lined up, order the materials, and get the men and equipment staged, just for a few miles of track.

You are dealing with a system that can only respond in years…but the economy can alter in weeks, so the budgets for improvements in 2006 were locked in way back in 2003/04…contracts signed, materials ordered, personnel notified, machines st

7

Ed:

Great points. I think sometimes we think on the short term basis…lets get it done NOW!

When you come to think about it, CEO and Chairmen, if they are good, earn their money. When you must decide several years in advance what to do based on current situations and future projections and you have the responsiblity of the organization riding on your decisions…it is a big task.

Sam, I agree with you in this situation, so much compensation today is based on either options or restricted stock, which is tied to stock price. Is it asking a CEO too much to decide what to do with that $799 million? Will he or she be influenced by how it impacts compensation? I guess in one way it is good to have top management as owners of the corporation…it makes them look very closely at how to run the company. My problem is I dont think many of these people buy the stock, it is awarded to them thru the options/restricted stock.

At this point in time, if I were Mr. Rose, and I said what I said, the stock buyback plan would be trimmed back and cash would start to be accumulated. Now, that has risks…the ROE will fall, as it takes 2-3 years to plan the capex. Thus the cash will be a drain on the ROE. Also, large amounts of cash in the treasury makes the company very attractive for takeovers.

Nanaimo…regarding the investment of $799 million. If that is a capex, then it is depreciated over the life of the asset, with yearly depreciation expenses flowing thru. Lets just say they invested the entire $799 on capacity and it has an IRS stated depreciation rate of 25 years (I have no idea if this is correct or not). Then each year 1/25th or 4% of the $799 can be written off as depreciation. That is about $32million. If they were allowed to receive a tax credit of $799 million…THAT IS HUGE on the tax bill. That is simply $799 million of taxes they dont pay vs. the corporate tax rate * $32million.

My guess is that if the Feds would give so

8

When you say this, are you saying the railroad is buying back it’s own stock exclusively, or are they diversifying, as seperate investment strategy?

9

I understand what both Eds are saying, and I definitely have some idea of the work that has to be done before the first shovelfull of dirt is turned on a construction project. That said, I have a real problem with Mr. Rose asking for help from the public purse while spending that kind of money on a stock buyback program. Call me a dinosaur who is hopelessly out of touch, but first you help yourself and only when you have exhausted all your resources do you ask anyone else for help.

10

Very interesting discussion of long term investment vs. keeping Wall Street happy. If a CEO does not feed the anaylists hunger for short term quarter to quarter earnings improvements growth the railroad may get a new CEO. As an example, when NS and BNSF proactivly hired and trained T&E employees three years ago they took a lot of heat from Wall Street for not being focused on cost cutting.

On another issue has any one developed an estimate of how much capital it would take to get the railroads unplugged? I see numbers for the BNSF transcon, the NS between Hampton Roads and Ohio, Chicago, the UP from :LA to El Paso, etc. but I have not seen a total.

11

Tom Murray has a good website-
http://www.tmrail.com/pages/1/index.htm

12

No American Express, Mastercard…

Half a million sleepers…$50 Million
2 Million Pandrol clips…$2.1 Million
60 thousand tons of rail…$60 Million

The look on the stockholder’s faces when they look in the year end report… priceless…

And it takes longer now to build a railroad because the NIMBYs and environmentalists have their say, which can hold up things in the courts for years…

13

Perhaps our “corporate culture” has made things come to this. It seems every big company is trying to get some level of government involvement(freebies). Look at every compamy that plays one area against another to see who will give the most, to get a company to relocate tp their area. Why would we expect a railroad to be any different than say-Walmart?[}:)]

14

If railroads are going to go after significant amounts of government money they will need to cater to those “stakeholders” as they cater to Wall Street, shippers and employees. In turn governments will place new demands on railroads in return for government funding. Lets suppose a year from now CSXT was asking KY for money to build a new intermodal terminal somewere in the Cinncinati area and the legislator from Covington could stop the funding. I’ll bet Covington would get their bridges painted!

15

To amplify what others have said, New capacity in the form of new trackage is a capital item and so is subject to tax. All the components that make up the capacity can be depreciated except for land acquisition. All of the components have differing rates of depreciation, rail is fairly fast, subgrade and bridges fairly long. In any case the entire investment is taxed in the current year. All of the railroads have a strong financial incentive to NOT completely solve the capacity problem. If they lose pricing power they will lose return on investment. What they want is to achieve a balance where they do not miss out more on revenue by volume than they gain by price. No railroad is going to get it right, the most profitable railroad will be the one that comes closest to right. What Matt Rose is saying is that if the government wants the railroads to increase capacity faster they will have to give the railroads some incentive to do so. The method suggested is what Mr. Rose believes would be most palatable. It directly ties the money to the capacity expansion. The more they spend for expansion the more they save on their taxes. Some of the items have very long terms of depreciation and so can be thought of as lifetime investments ( i. e. they are sunken). Nobody currently working for the railroad will be working when the last bit of depreciation is taken. One further point is that as interest rates rise it pushes the point at which the investment in capacity will payoff, further into the future.

16

I think what Matt Rose fand other Class I execs fail to comprehend is that the government doesn’t necessarily want BNSF, UP, et al to increase capacity per se, but that the government just wants increased rail capacity to catch up with and then stay ahead of the economic demand, with or without the current Class I’s participation. I’d like to think that DOT and FRA folks are up to speed on why we have the current situation today (aka that half-assed legislation known as Staggers), and leaving the foxes in charge of the henhouse of capacity expansion will not produce the desired result of staying ahead of the demand curve.

What we need in the US are new players to water down the current rail oligarchy.

17

You mean like Stalin, Lenin, and Chairman Mao?

18

Stalin, Lenin, and Mao.

That’s either your law firm, or your deity.

Or both![}:)]

19

As I’ve opined elsewhere, FM seems to see railroad operations in isolation from the rest of the world, including the railroad’s own shareholders. As the earlier postings have noted, railroad executives have a play a balancing act between running the company efficiently and placating the shareholders (owners). The current Wall Street and shareholder culture also expects the price of the shares to rise, so an executive who merely runs the firm efficiently while the share price languishes runs a real risk of being shown the door. What happened to Ed Burkhardt at Wisconsin Central is a good example of this.

Since expanding capacity is a long-term project, it has to be done judiciously since continued economic growth is hardly a sure thing.

20

I would guess that we’re still waiting for someone to come up the money to invest in an alternate rail system?[:)]