Is the Railroads Renaissance simply a thing of the past? NRC! - PowerPoint PPT Presentation

Is the Railroads’ “ Renaissance ” simply a thing of the past? NRC! Chicagoland abh consulting January 13, 201 6

21 st Century: the Railroad Renaissance • Rails have well beaten the market 2001-2014 • LTM – “Not So Much” (CP doing relatively well) • Earnings Power misunderstood: Rails beat Street estimates – in the Boom, in the great Recession, and the tepid recovery • Record margins & results despite the coal hit (and drought and lukewarm economy, etc….) • Rails are still re-gaining market share from the highway

Emerging Challenges to the Railroad Renaissance • Earnings & Ratings Reductions/Sentiment • Coal’s Decline (#1US Utility #2 NA Export) • CBR Volatility (XL; CRR, etc….) • Rail Service, Safety & Capacity Issues • Rereg Threats • Cyclical Traffic Weakness (metals, etc) • Management Changes • Management Reactions: Guidance, Capex

Silver Linings? • Service Recovery Trend (Capex Pays Off) • Restoration of the “Grand Bargain” • Reduced (N/T) Political Pressure • Productivity (& volume?)Inflection • Coal “stabilization” (Part Two)?? • 6/7 Report “wins” Q3/15;Pricing Power Remains • IM (etc) latent demand….Bi-Modal results • Industrial Buildout (SHIELD); Mexico,South • Revised MoW Capex (GTMs/Mix) frees CF/2016

Renaissance Discussion Points! • Can Rails Survive – or even thrive – in the NOW? • Or, can rails replace coal (ROI if not OR) with (domestic) intermodal (etc)? • What is the future of industrial/merchandise railroading? • What is the new standard for Capex? • Is M&A the answer?

Top 10 Thoughts on Possible CP-NS merger 1. Risk/Reward Ratio Unfavorable 2. Diplomacy (“Politesse”) Required 3. Shipper Support Required 4. NS Approval Important 5. STB/CTA (etc) Pro-cess Will Be Long & Drawn-Oot

Top Ten NS/CP Continued 6. NS’ “Problems” Mostly Not of its Own Making (COAL!) – yet value is in “fixing” NS! 7. NS is Advanced in Preparing for “Post- Coal” World 8.New RR World to be Very High Service Focus 9. CP-NS Could Stand alone (but would it?) 10. YET: Never Underestimate EHH (& Friends)

S HALE -R ELATED R AIL T RAFFIC G ROWTH H AS N OT M ADE U P F OR C OAL L OADINGS L OSS U.S. QUARTERLY CARLOADS ORIGINATED 1,800,000 STCC 14413 1,600,000 - Industrial 4 Qtr. Avg. 1,754,908 sand and gravel 1,400,000 (includes frac -288,724 sand) 1,200,000 4 Qtr. Avg. 1,466,184 STCC 131 - 1,000,000 NET LOSS OF ~120K Crude CARLOADS PER QUARTER Petroleum 800,000 and Natural Gas 600,000 +167,368 400,000 4 Qtr. Avg. 245,012 STCC 1121 - Bituminous 4 Qtr. Avg. 77,644 coal 200,000 0 Source: Surface Transportation Board www.plgconsulting.com Experience / Expertise / Excellence 9

Rail Renaissance Phase Two • Rails will exit transitional period (faith) • CBR to continue longer term – as volatile as Ag? • Domestic Intermodal will achieve investable returns – the big bet will pay off • Service Recovery – Politics, Productivity & Price • Market confusion – OR vs ROIC=opportunity (BNSF example) • Industrial revival – the real energy advantage (PLG&”SHIELD”); TPP (& NAFTA) • Risks: Service; Execution; Safety; Regulation • Risk: M&A??

Q4/2015 – Inflection Point? • Low expectations for rail (transport) quarterly earnings – CSX starts us off with a “win” • Coal stabilizing? Sigh…. • Productivity/service turnaround? • Management confidence/guidance? • Waiting on “Big Decisions” on Capex, “stranded assets” • The “ Renaissance ” thesis faces first real challenges this century

Future Growth Potential (Revised) Secular stories (in order)…. Specific 1. Intermodal – international and now domestic targeted sectors 2. Chemicals/re-industrialization? Near- sourcing/Mexico 3. Cyclical recovery – housing, autos 4. Grain & Food – the world’s breadbasket, (un) predictable? 5. Shale/oil/sand – problem and solution? 6. Other rail opportunities exist but in smaller scale: for ex: The manifest/carload “problem” - Unitization - Industrial Products/MSW - Perishables (12)

What Looks Good for 2016? • Not much….at least in H1(H2 Comps better) • What are the “givens” for oil, the $, crops? • Chemical growth building (see SHIELD data) • Autos coming off of a record • Wither Intermodal? • Low Expectations heading into “earnings”

The “Grand Bargain” • In return for higher prices (& ROI), rails spend, increase capacity & improve service (2005- 2012) – The unstated “Grand Bargain” • Rails gain pricing power (~2003) & F/S • Rails (re) Gain Market Share • Rails Spend Cash “Disproportionately” on Capex (~18-20% of revenues) • Promotes “ Virtuous Circle ” – all stakeholders benefit • Under challenge, perceived and real

Chicago • Once again, as in the “Roaring 20s” or ‘68, the nation looks at Chicago as dangerous • What is new about these traffic flows? • Should (could) this have been foreseen? • How can one match 30-50 year assets and incomplete demand forecasts? • What is being done about it? • CREATE? CTC)? The League of Extraordinary Gentlemen!! • M&A????

Four Kinds of Growth/Location • Cyclical (ex autos) • Secular (ex intermodal) • Episodic (Grain – 50 year drought then record 7 record); coal? • New – brand new – CBR • Where? Low-density “Northern Tier” + winter • Direction – some through Chicago • Remarkable adjustment to handle a brand new industry and play a major role in America’s “energy revolution”

2010-2020: New Energy world Shakes Up Freight Railroading • Coal drops 30% 2010-2015, more to come? • CBR from 4K cars (‘09) to 500K+ (2014) – Now What? • Gi-normous RR Capital Spend (over?) • Targeted Spend – Chemicals (SHIELD), fertilizers, steel, autos, Mexico • Can rails handle it?? And - Was it worth the angst?

S HALE E NERGY I MPACT ON R AIL T RAFFIC T O D ATE U.S. Class I Carloads Originated for Ind. Sand, Crude, and LPGs with U.S. Land Rigs 180,000 3,000 U.S. Land Rigs 160,000 U.S. Quarterly Carloads Originated for Industrial Sand (STCC 14413) 2,500 140,000 U.S. Quarterly Carloads Originated for Liquified Petroleum Gases (STCC 2912) Carloads Originated U.S. Quarterly Carloads Originated for Petroleum (STCC 131) U.S. Land Rigs 120,000 2,000 100,000 1,500 80,000 60,000 1,000 40,000 500 20,000 Source: Surface Transportation Board, Baker Hughes, September 2015 - 0 SHALE GAS & CHEMICALS: THE TRANSPORTATION IMPACT www.plgconsulting.com Experience / Expertise / Excellence 19

S HALE -R ELATED R AIL T RAFFIC G ROWTH H AS N OT M ADE U P F OR C OAL L OADINGS L OSS U.S. QUARTERLY CARLOADS ORIGINATED 1,800,000 STCC 14413 1,600,000 - Industrial 4 Qtr. Avg. 1,754,908 sand and gravel 1,400,000 (includes frac -288,724 sand) 1,200,000 4 Qtr. Avg. 1,466,184 STCC 131 - 1,000,000 NET LOSS OF ~120K Crude CARLOADS PER QUARTER Petroleum 800,000 and Natural Gas 600,000 +167,368 400,000 4 Qtr. Avg. 245,012 STCC 1121 - Bituminous 4 Qtr. Avg. 77,644 coal 200,000 0 Source: Surface Transportation Board www.plgconsulting.com Experience / Expertise / Excellence 20

Intermodal Growth Drivers Domestic and International • Globalization • Trade • Railroad Cost Advantages • Fuel prices • Carbon footprint • Share Recovery from Highway • Infrastructure deficit & taxes (public vs privately financed network!) • Truckload Issues; regulatory issues, driver issues

Modal Shift Projection Current Rail Intermodal Market % of Market Share Projected Market Shift Current Truck Market

Intermodal 2016+ • Return to Growth? • Pricing? • Factors: Oil Prices, Consumer Spend, Truck Capacity • Infrastructure Advantage • Panama Canal impacts? • Rail Service Improvements • Driver Shortages Re-emerge?

Re-industrialization? • Near-Sourcing: Mexico , C/A • Natural Gas effect round two: – CHEMICAL INDUSTRY (see PLG) – Fertilizers • Steel/Aluminum/Autos/White Goods etc. • Northeast, etc. back “in play”? • Subject of future research

S HALE S UPPLY C HAIN AND D OWNSTREAM I MPACTS Downstream Direct Inputs Wellhead Thermal Fuels Raw Materials Products Output All Manufacturing Generation Steel Gas Process Feedstocks Fertilizer (Ammonia) Proppants Home Heating Methanol (Propane) OCTG NGLs Other Fuels Chemicals and Feedstock (Ethane) Chemicals Polymers Byproduct (Condensate) Water Petroleum Products Cement Petrochemicals Crude Other Fuels Gasoline IMPACTS TO-DATE INCLUDE THE NEXT WAVE Dramatic reduction in crude imports, lower electricity costs, Manufacturing renaissance in the US based on lower gasoline prices, increased refined products exports abundant, low cost energy and feedstocks Significant rail impacts noted in red www.plgconsulting.com Experience / Expertise / Excellence 26