Traffic growth on the rails is just that… A dog that won’t hunt… The current scenario concerning NS, and Ancora just proves that point thousands of times over…
The fact that over the last two decades, a hedge fund can launch a proxy battle scaring most of the C1’s into submission. Speaks volumes to the industry… The rails move liquid now… Money doesn’t require labor, physical plant, rolling stock, or pesky fuel with its cyclical price movement… The railroads main customer is the shareholder, and has been for sometime.
That is the cross that any business that deals with real products as opposed to financial products have to deal with in dealing with their stock holders.
Not every business can clear bushels of cash without producing real products or services.
IIRC, average-man investors (before the PennCentral debacle, anyway) used to buy major railroad stocks like PRR for their dividends, which were usually decent-sized and dependable. I don’t recall hearing of people buying such stocks hoping for a big increase in share prices in a few years.
The focus on share price may be misplaced, but that could be a consequence of today’s economic culture which doesn’t seem to care about dividends as much.
In the 12-13 years after the Great Recession when the Federal Reserve kept interest rates unusually low, the railroad companies almost across the board touted them returning more cash to shareholders than net income earned.
UP, for instance, in 2018 returned $10.5 billion and in 2019 returned $8.4 billion, both amounts over 100% of net income for the year.
They did so with dividends, but the vast majority was stock repurchases using issuances of long term debt.
Long term debt for most of the large railroads except for CN increased by several magnitudes over where it had been before the Great Recession.
All that debt will have to be rolled over eventually, likely at higher rates.
George Hilton maintained that one of the things that did in the interurbans was relying too much on debt financing versus equity financing. With the latter, cutting off dividends during a downturn will tick off the shareholders, but won’t bankrupt the company. With respect to railroads, using stock buybacks to go from equity financing to debt financing is a recipe for disaster - though most of the hedge funds would have laready taken the money and run.
For some of the investors involved, maybe. For the population more broadly, probably not. All large railroads are producing very healthy returns on invested capital and have been for some time - and they are not particularly large companies anymore. (Union Pacific is only the 56th-largest company in the S&P 500 by market cap.) If they get in trouble for financial games unrelated to their operations, someone will still take the company as a going concern. Similarly, if their operations weaken, a strong balance sheet probably won’t protect the operating people from having the push hard on the cost-savings pedal.
On a related note: regulations on financial transactions, like limiting stock buybacks, would be silly and probably unproductive. Regulations that change the operating cash flow are the ones that have the potential to weaken the industry and hurt people other than the shareholders and bondholders.
The biggest change is just the realization by Wall St. that share repurchases are a far more tax-efficient way to return profits to investors than dividends are. Smart people have known this for a while, but it took a while for the idea that repurchases are an equally valid use of profits to catch on with the public at large. (As your post suggests, even then the lesson hasn’t quite penetrated to the retail investor.)
Issuing debt to fund share buybacks is a little harder to defend, IMHO. If I thought the stock was undervalued relative to current interest rates, I could buy the stock on margin myself, thank you very much. I don’t need the board of directors to make that decision for me.
100% agree that share repurchases are more tax-efficient - rather pay capital gains tax rate than the individual income tax rate on dividends.
100% agree that share repurchases themselves are not the issue, but leveraging up to make share repurchases is an issue. Of course, the piper will be paid years later when the debt needs to be refinanced as higher interest payments will bite into future earnings.
it is one thing to borrow for capital needs where the cash is being put into a long-lived asset, and another thing to borrow for a one time “sugar high” returning over 100% of net income to shareholders each quarter as was done so prodigiously during the 2010s.
The past is history and the future is a mystery. We’ll see how it all shakes out during the latter half of the 2020s.
No argument from me on poorly thought regulations can do more harm than good. Perhaps the simplest way to discourage the equity to debt transfer is to disallow deducting interest payments on debt taken to buy back stocks, though that still may leave leveraged buy-outs as a loophole.
The real culprits aren’t the hedge funds, its the vast majority of passive shareholders who don’t vote their shares and don’t bother in the least to be informed. In such an environment those folks who do vote and participate have a disproportionate say in what happens. It would be no different if voter turnout in the next federal election is, say 5%… those 5% getting their way.
The “general setup” needs to be overhauled so that shareholders have more accountability and skin in the game. Currently the stock market is little more than a casino and people do little more than “betting and red” when they buy shares/ownership in a business. If red looks bad then sell and buy green tomorrow.
Ancora is a threat because they largely have the field to themselves…the vast majority of other shareholders have their heads in the sand (or somewhere else), which is why NS may very well be gutted with layoffs and service reductions in the near future. It’s sad, but what else can one expect when the vast majority of shareholders remain passive and silent? We hear about election apathy all the time, but the same sort of apathy is hard at work undermining the foundations of capitalism.
Yes, and even there, it is individual investors who own stock in those institutional investors. Most are just along for the ride. The fund managers know that, and this is why they tend to focus on the short term and why there’s so much focus on share price appreciation.
According to the Harvard Business Review, Pensions and Investments, Securities Industry and Financial Markets Association, etc., approximately 80% of the S&P 500 shares are owned by institutional investors, i.e., pension funds, mutual funds, etc. The same percentage, give or take 10%, probably applies to the total securities market.
The funds are manged by sophisticated financial managers that are supported by even more sophisticated financial analysts. The notion that they have a short term view of investing is not supported by the evidence.
They are always looking for maximum ROI every quarter - the company itself be damned. Crank up the computers and let them trade according to the algorithm they have been programmed with.
I am hoping that the institutional investors have a long term view, but it seems they go along with the activist investors and Harrison type takeovers at CN, CP, CSX, etc.