Rail Pins Hopes On Auto Manufacturing As US Carloads Sustain Record Decline

The Class I railroads are closely watching the restart of North American automotive production, hoping that the slow ramp up will not only grow auto volumes but also improve demand for supplies such as steel and plastics, according to executives at recent investor conferences.

However, a key unknown variable is whether consumer demand will lift volumes for automobiles and other goods, executives said.

"Our auto plants reopened this week with very limited production. The sustainability of that production is going to be highly dependent on consumer demand and consumer confidence to go out there and buy automobiles," said Norfolk Southern Corporation NSC Chief Marketing Officer Alan Shaw during Wolfe Research's virtual conference for investors on Wednesday, May 20.

Limited auto production resumed this week among major U.S. automakers, according to various news reports, and production in Mexico is expected to restart on June 1 although the government previously announced it would begin production in mid-May.

Shaw added that the slow ramp-up in auto production would also likely result in "puts and takes" for auto suppliers since some supplies, such as steel, are already at the plants. The auto industry's suppliers might not see demand recovery until auto production has been up and running for some time, according to Shaw. 

While CSX Corporation CSX view on the market remains relatively unchanged since its first-quarter earnings call in April, the reopening of the Big Three automakers might help the railroad get some clarity on merchandise volumes for the remainder of the second quarter and into the third quarter, according to Mark Wallace, CSX's executive vice president of sales and marketing. Wallace also noted during the Wolfe conference how products feeding into auto manufacturing, such as plastics and steel, could benefit from the reopening of the auto manufacturing plants. 

Meanwhile, Wallace's colleague at CSX, Chief Financial Officer Kevin Boone, said last week that CSX was starting to see some "very small car orders" coming through the auto manufacturing plants. But Boone also noted it would be a couple of weeks before any sizable volumes appeared.

"This will be a slow ramp-up, and they're focused on protecting their workforce as well," Boone said at the Bank of America Securities Transportation and Industrials conference on May 12. But "certainly going zero to something is helpful."

Although revenue ton miles for Canadian Pacific Railway Limited CP are "at the bottom" for the second quarter, with revenue and volumes ebbing and flowing for the rest of May, the return of automotive production should provide some uplift for the railway, said CP President and CEO Keith Creel at the Wolfe Research conference on May 20.

"We're experiencing unique growth in the sector given our partners," Creel said, noting that production would restart soon at Toyota, Honda and Chrysler, while shipments are expected to resume at CP's Vancouver automotive compound. Creel also said volumes would be "climbing out" in the third quarter, followed by "flattish" volumes in the fourth quarter and strength in the first quarter of 2021.

The standstill in North American automotive production contributed greatly to the decline in rail volumes, with North American traffic for motor vehicles and parts falling 36.4% year-to-date to 335,839 carloads, according to the Association of American Railroads (AAR). The data is for the week ending May 16.

On a weekly basis, North American carloads fell 87.9% to 3,467 carloads.

North American carloads of motor vehicles and parts tumbled between March and April. RTOMV RTOMV.CAN, RTOMV.MEX)

How the Class I railroads are cutting costs

To counter tumbling rail volumes, the Class I railroads are continuing to apply some of the cost-control measures that they mentioned during their first-quarter earnings calls last month, including cutting their budgets for capital investments to focus on essential projects or maintenance, putting employees on furlough and ceasing operations at smaller rail yards, and storing hundreds of locomotives and railcars until demand improves. Other costs are more variable, such as fuel expenses. 

Many of the railroads also said they have reserve boards consisting of furloughed employees who can return to work quickly should there be a sudden rebound in volumes. 

"It gets harder to offset the volume declines as they accelerate," CSX's Boone said. He also said the current environment has prompted CSX to evaluate all its costs. 

The cost-cutting measures in turn make it harder to provide any guidance on where a company's operating ratio might be for the year, according to Canadian National Railway Company CNI President and CEO JJ Ruest. There is usually a lag when responding to lower volumes through layoffs and parking rolling stock.

"The drop in revenue in April and May has been so drastic. It's hard to keep up with the cost reduction without any timeline," Ruest said at the Bank of American conference on May 12.

One structural change Union Pacific Corporation UNP is tackling is how it operates its manifest network, which consists of trains made up with a variety of commodities as compared to a single commodity, like a unit train for grain. The railroad is eyeing running longer trains and making capital investments to sidings to allow for longer trains at its facilities. Running longer trains not only reduces crew starts but it also involves utilizing fewer assets to move the same amount of carloads, which in turn affects UP's productivity, according to UP's Chief Financial Officer Jennifer Hamann.

"The thing we're very encouraged about is that when we think about that productivity number, it's not just coming from one category," Hamann said May 12 at the Bank of America investor conference.

Kansas City Southern KSU also said it might keep some of the operations changes made as a result of the pandemic, such as reducing train starts and lengthening trains. Both actions "cleansed" the network, enabling velocity to increase because there are fewer trains running on the network, said Sameh Fahmy, KCS executive vice president for precision scheduled railroading, at the May 12 conference.

"We're not going back to 100 train starts" when everything returns to normal, Fahmy said. "We found the trick; we know how to do it now" with smaller yards.

U.S. carloads witness largest weekly decline

U.S. weekly carloads experienced their largest percentage decline ever since AAR began collecting rail volume data in 1988.

U.S. weekly carloads fell 30.2% to 184,425 carloads. Year-to-date, U.S. carloads were down 13.6% to 4.3 million carloads.

"The 30.2% decline in total U.S. carloads last week was the biggest year-over-year weekly decline for total carloads since 1988, when our data began. Coal didn't help – last week was the fifth straight week in which coal carloads were down at least 40% from last year," said AAR Senior Vice President John T. Gray. "For many other key rail commodities, including chemicals, petroleum products, and crushed stone and sand, carloads last week were roughly the same as in the previous few weeks, while intermodal originations last week were the most in eight weeks." 

Meanwhile, U.S. intermodal volumes slipped 14% on a weekly basis to 231,700 intermodal containers and trailers, while year-to-date volumes fell 11.4% to 4.7 million intermodal units.

Total U.S. weekly traffic slipped 22% to 416,115 carloads and intermodal units, while year-to-date traffic was down 12.5% to nearly 9.1 million carloads and intermodal units.

U.S. rail volumes have been trending lower in recent months. RTOTC RTOIC.CLASSI, RTOIT.CLASSI)

Photo: Flickr/Jerry Huddleston