American Railroads: Decline and Renaissance in the Twentieth Century

Michigan State University, 2013

Dr. Robert E. Gallamore

Adjunct Faculty

MSU RMP

August 12, 2014

Railroad Metrics: Size, Efficiency, and Financial

Performance

Michigan State University, 2014- 2 -

Common Metrics for Evaluation of Railroads –(Continued Next Slide)

Size

Total Revenue

Ton-Miles

Car-Miles

Employees

Track Mileage

Total Enterprise Value

Profits

Market Share

Operating Efficiency

Operating Ratio = OpExp/OpRev

Productivity = T-m / Empl Hour or T-m / $ Labor Wage + Fringe Exp.

Density = T-m / Trk-m

Unit Cost = Total Exp/ T-m

Velocity = Trn-m / Trn Hour

Length of Haul = T-m / Ton

Fuel Efficiency = T-m / Gal.


Common Metrics for Evaluation of Railroads – (Concluded)

Financial Performance

Profit (Net Income)

NROI (Net from RR Ops)

Margin = (OpRev – OpExp) / OpRev

Revenue / Variable Expense Ratio

Debt / Equity Ratio

Free Cash Flow = (Profit + Depreciation) - CapEx

CAGR (Revenues) Compound Annual Average Growth Rate

Moody’s Bond Rating

Investment Performance

Return on Investment

Return on Equity

Return on Assets

Yield = Dividends / Share

Earnings /Share (EPS)

Price per share / EPS = P/E Ratio

Capital Expenditures % of Total Operating Revenue

Market Capitalization


Some Problems in Using These Metrics --

Measure

Profits

Operating Expense

Length of Haul

Market Share

AAGR (Revenues)

Capital Expenditures

Common Difficulties/Limitations

Treatment of Extraordinary Items e.g. Write-downs

Deferred Maintenance

LOH benefit is relative; longer is better if same traffic rates apply; mergers mess up LOH metric.

Difficulty of defining markets and measuring share

Correcting for inflation

Wall Street Fashions – Are they pro or con CapEx for this RR?


Martland’s Model Translates Profit to ROI to Re-InvestmentNotice How Market Forecasts Support Revenues, Operating Budgets Relate to Operating Expense, and Capital Budgets Fund Plant, Equipment, and Control Improvements

Source: Carl D. Martland, MIT

Market Forecasts

OE Budgets

CapitalBudgets

Revenue

Profit

Expenses Equipment Control Facilities

Investment

ROI

Signals

Positive TrainControl

Grade Xings


Types of Performance Measures, Data Sources & Uses by Managers – Carl D. Martland, MIT

Carload Commodity Stats


Class I Railroad Rankings – 2012 – Road Mileage


Class I Railroad Rankings – 2012 – Revenue Ton-Miles


Class I Railroad Rankings – 2012 – Number of Employees


Operating Ratio is Revenue Divided by Operating Expenses –Smaller is Better

(Traditionally, Below 80% was Good)


Union Pacific Exceeded $4 Billion NROI in 2012


UP and BNSF Both Topped $20 Billion in Operating Revenue in 2012


What a Great Industry We Have Today – The Best Freight Railroads in the World

2012 2011 % Inc.


A Few Trends to Watch Going Forward

Reinvestment

Policy

Productivity

Performance

Rising Logistics

Costs


1981=100

Productivity (Hours)

Gross Margin Density

Productivity ($ Exp.)

Velocity

Ave. Haul


Logistics Costs Will Rise

Fuel and congestion tolls will push up trucking rates.

Costs of government mandated security.

Insurance costs still increasing sharply.

Interest rates are at historic lows – may increase, making inventory holding less desirable – favoring premium transport solutions.

Expect more distant sourcing to lower labor costs – more international transportation.


Integral Train Networks for Productivity

Private freight railways survived last 20 years with

productivity growth.• De-regulation, substitution of capital for labor,

PRB coal • Now must find other means of salvation

Integral trains = next generation technology.• High asset use, on-time performance, network

optimization• Coal, intermodal unit trains are the first to use

electronically activated brakes Depending on how it is implemented, PTC has the

ability to increase railway productivity significantly.


Ongoing Need for Capital Investment

Because heavy traffic wears out plant and equipment For capacity expansion to handle volume growth To reconfigure network for shifting demand To meet government mandates

-- Positive Train Control

-- Locomotive emissions

-- Tank car safety, etc. Continuing quest for productivity and competitive market

position

One key message of American Railroads: New technology comes embedded in reinvestment


Coal Has Declined Sharply as a Share of US Energy Production – Large Impact on Rail Freight


19

78

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80

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0.00

0.50

1.00

1.50

2.00

2.50

IND

EX

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80

=1

.0

Index of constant dollar GDP 1980 = 1.0

Constant Dollar Gross Domestic Product

Class I Railroad Revenue Ton-Miles

Railway Revenue Ton-Miles (a Measure of Industry Volume) Track

U.S. Domestic Product – But at Only ¾ the Rate of Growth

Note Impact of the Great Recession


Railroads spend 17% of revenue on capital investments plus maintenance and depreciation.

And note railroads kept investing in infrastructure and equipment – and plant and rolling stock maintenance – right through the Great Recession.



1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

$0.0

$2.0

$4.0

$6.0

$8.0

$10.0

$12.0

Class I Capital Expenditures Rose to about $14 Billion Annually in

2012

Capital Expenditures ($ Billions)

Annual C

apit

al Expendit

ure

s (

Billions)


1999 2001 2003 2005 2007 2009 20110%

2%

4%

6%

8%

10%

12%

14%

16%

18%

STB Revenue Adequacy Findings - 2000-2010 – Follow the Dots

Industry Cost of Capital BNSFCSX GT-CNKCS NSSOO-CP UP

Co

st

of

Ca

pit

al

(In

du

str

y)

or

Re

turn

on

In

ve

stm

en

t (R

ail

roa

ds)


1999 2001 2003 2005 2007 2009 20110%

2%

4%

6%

8%

10%

12%

14%

16%

18%

STB Revenue Adequacy Findings - 2000-2010 – Follow the Dots

Industry Cost of Capital BNSFCSX GT-CNKCS NSSOO-CP UP

Co

st

of

Ca

pit

al

(In

du

str

y)

or

Re

turn

on

In

ve

stm

en

t (R

ail

roa

ds)


Return on Investment is Crucial

RO I

If ROI > cost of capital:

• Capital spending expands

• Stronger physical plant; more and better equipment.

• Faster, more reliable service

• Sustainability

If ROI < cost of capital:

• Lower capital spending

• Weaker physical plant, equipment

• Slower, less reliable service

• Disinvestment


Rail Freight – 3 R’s for Remaining Vital

Re-investmentMust earn returns greater than or equal

to the cost of capitalHuge capital requirements for

expansion and renewal Reliability improvement

On-time / on-plan: meet customer expectations

Use technology to improve performance Remain in the private sector

Not re-regulatedMust defeat “open access” proposals


THANK YOU FOR YOUR ATTENTION

Documents

American Railroads: Decline and Renaissance in the Twentieth Century