Railroads: The big get bigger
Consolidation of the rail industry continues even as service woes leave shippers wary.
By Peter Bradley -- Logistics Management, 7/1/1998
If the railroads had a theme song, it might be an old showtune from the 1930s that begins with the words, "The more we get together, the happier we will be."The past three years have seen the merger of the Burlington Northern and the Santa Fe, the Southern Pacific disappear into the Union Pacific, the recent approval of Norfolk Southern and CSX's plan to divvy up Conrail, and the pending merger of the Canadian National and the Illinois Central. And those represent only the latest wave in a series of railroad mergers that go back to the creation of Conrail out of the wreckage of several Northeastern lines, and even earlier.
The idea is that bigger is more efficient and more profitable. Maybe so. But bigger also means the railroads have more market clout and greater dominance over the regions they serve--with the possible though unproven exception of the Conrail division. CSX and Norfolk Southern assure shippers that will increase competition in the Northeast. And the Surface Transportation Board (STB) has imposed some conditions on the $10 billion deal to reassure shippers that they will have some protection. (The board's written decision will be issued this month.)
The division of Conrail dramatically changes the railroad business in the East. When CSX and Norfolk Southern finish carving up the 11,000-mile system, those two railroads will dominate the industry east of the Mississippi.
The railroads insist that the new system will mean greater competition, not only between the railroads themselves but between the railroads and motor carriers. Nonetheless, many so-called captive shippers worry that CSX and Norfolk Southern will attempt to recoup some of their investment in Conrail--they paid a premium price of $115 per share for the line--through rate increases. (Captive shippers are those, such as utilities moving coal, that must use rail service and have only a single provider.) CSX and Norfolk Southern executives insist that network efficiencies and the ability to attract new traffic by offering single-line service throughout the East will pay for the transaction. CSX, for instance, predicts the single-line continuous service in the Northeast will take more than a million truck loads off the highways.
Shippers aren't so sure and want some regulatory protection. The National Industrial Transportation League and other shipper groups have asked the STB to toughen regulation of the railroads' rates as part of the conditions imposed on the Conrail deal. After the STB vote, the Society of the Plastics Industry, a trade group opposed to the plan, issued a statement that said, "[W]e remain deeply concerned about the acquisition premium and the potential for higher rail rates as a result of this unprecedented and costly transaction."
Rates are not shippers' only concern. Given the service problems that have plagued Union Pacific since last fall, shippers want assurances that the Conrail transition will proceed in a way that will avoid service meltdowns in the East. Once again, CSX and Norfolk Southern have taken pains to promise a careful and deliberate process to protect against any such problems. John Snow, chairman, president, and chief executive of CSX Corp., told the Surface Transportation Board last month that his company would make extraordinary efforts to assure the Conrail division would be "safe, smooth, and seamless."
Rails Set Records
The Union Pacific's sorry performance in the year after completing its takeover of Southern Pacific hurt shippers severely. Congestion, particularly along the Gulf Coast, has cost shippers hundreds of millions of dollars as a result of plant shutdowns, lost orders, and rerouting shipments to truckers.
In some respects, the problems on the Union Pacific, which rippled throughout the national rail network, were as much a sign of good times as of bad for the railroads: Much of the congestion arose because shippers were tendering record numbers of car loadings and intermodal shipments.
The Association of American Railroads (AAR), which keeps statistics on a number of rail operating categories, reported that U.S. railroads set records for intermodal volume and for total freight ton-miles in 1997. Total carloadings reached 17.76 million, only 0.3 percent below the 1995 record. The strong traffic meant improved profitability for most railroads in the face of congestion and resulting delays and shortages of equipment and train crews.
Burlington Northern Santa Fe, for instance, reported record revenues, record operating income, and record earnings per share. It also achieved the best operating ratio in its history, 77.9 percent. (Operating ratio is the percentage of revenues used to operate the railroad.)
Even Union Pacific Corp., for all the woes experienced by its rail operations and a fourth-quarter loss of $152 million, had net income for the year of $432 million. Not that its executives crowed about that number, which was a 41.0-percent drop from 1996 figures. The combined Union Pacific and Southern Pacific railroads had revenues of $9.9 billion for the year compared to what would have been $$10.1 billion had they been joined in 1996. The results of the congestion showed up in UP's operating ratio of 87.4 percent, up from 83.5 percent in 1996. The railroad's woes continued in the first quarter, in which UP announced additional heavy losses.
Illinois Central Corp., which operates the 2,600-mile Illinois Central railroad and the 850-mile Chicago Central, as usual posted one of the better margins in the industry. The corporation reported net income of $150.2 million for the year, up from $136.6 million a year earlier, on revenues of $699.8 million. Its operating ratio of 62.3 represents a one-point rise from the previous year's figure of 61.3.
In the East, Norfolk Southern reported record operating revenues of $4.2 billion, record rail income of $1.2 billion, and its best-ever operating ratio, 71.3 percent. CSX Transportation, which operates in 20 Eastern states, had freight revenues of $4.9 billion and a best-ever operating ratio of 75.4 percent.
To the north, both the Canadian National and the Canadian Pacific had record income. CN's profits jumped by 30 percent to CN$403 million, while CP posted net profits of CN$203 million, a 23.0-percent increase. (See Figure 1 for more on the railroads' performance.)
Rails Reinvest
Shippers, too, will benefit from the industry's relatively strong financial performance. All of the major railroads are pouring billions of dollars into capital investment, buying locomotives and railcars, adding double track on key routes, investing in intermodal and other rail yards and in computer technology, and upgrading existing infrastructure.
Norfolk Southern, for instance, has a $903 million capital-expenditure program under way, much of it aimed at integrating its own operations with the Conrail operations. CSX invested $712 million in capital improvements in 1997, including $100 million for projects related to the Conrail integration. The beleaguered UP expects to spend $450 million this year on capital improvements related to the integration of UP and SP.
Another sign of the industry's success: It is hiring again after years of cutting hundreds of thousands of jobs. BNSF, for instance, says it will hire more than 2,800 people this year. CSX is adding 1,500 new train and engine employees.
Intermodal Growth
One of the brightest spots for the industry is rail intermodal shipments. (See Figure 2.) With record volumes derived from a combination of a healthy domestic economy and strong international shipments, that segment is the fastest-growing segment of the industry. Intermodal now accounts for more than 17.0 percent of all rail revenues, according to the AAR. That's second only to coal, which generates 22.0 percent.
Again, intermodal's success bred difficulties for the industry, with shortages of equipment creating headaches for shippers, particularly in the fourth quarter.
The strength of intermodal shipping has allowed intermodal marketing companies (IMCs) to thrive. Those companies, descendants of railway agents, act as intermediaries between shippers and the railroads. Total loads managed by the IMCs were up 18.7 percent for the year, according to the IMC Market Activity Report produced by the Intermodal Association of North America. Revenue for IMCs was up by 14.7 percent.
The IMCs have expanded their reach in recent years by offering highway truck services as well as rail intermodal service, and most of their growth has come from those new services. Highway truck loads managed by IMCs jumped by 34.8 percent for the year, following a 39.0-percent increase in 1996. By way of contrast, IMC-managed rail intermodal shipments grew by 5.9 percent. As a result, truck loads outnumbered intermodal loads for the first time.
Most Railroads Report Performance Gains
Freight revenue
[$Millions] Operating ratio
1997 1996 1997 1996
East
Conrail 1,8431 3,714 81.21 79.7
CSX 4,859 4,765 75.4 77.0
Illinois Central 700 658 62.3 61.3
Norfolk Southern 4,223 4,101 71.3 71.6
West
BNSF 8,413 8,141 77.9 78.5
Kansas City Southern 518 493 83.4 84.5
UP* 9,981 10,113 87.4 83.5
Canada
Canadian National CN$4,255 CN$3,886 81.5 84.7
Canadian Pacific CN$3,717 CN$3,559 81.4 83.4
Source: Company reports 1Conrail 1997 figures for first six months. Full-year figures not reported.
*pro forma basis, including Southern Pacific operations
Intermodal shipments
[Millions, Except Where Noted]
1997 1996 % change
Trailers 3.45 3.30 4.6
Containers 5.24 4.84 8.3
Total 8.70 8.14 6.8
Carloads originated
(millions) 17.76 17.61 0.8
Estimated ton-miles
(billions) 1,372.6 1,360.1 0.9
Source: Association of American Railroads
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