Rail executives downplay consolidation outlook

Canadian Pacific Railway CEO E. Hunter Harrison sees railroad consolidation as possible and a way to greatly improve service, but the majority of his Class I counterparts aren’t on board.

“And I will go ahead and say I have a very high regard and respect for the head of the CP, but this is just a place where I have a different opinion. I think that a major railroad merger is not a good idea,” NS Chairman and CEO Wick Moorman said on Oct. 22, according to a SeekingAlpha transcript.

During recent third-quarter earnings calls, the heads of Canadian National Railway, CSX Transportation, Kansas City Southern Railway, and Union Pacific Railroad also to varying degrees downplayed the prospects of Class I rail consolidation. Harrison on Oct. 21 said U.S. regulators could approve a merger between two major railroads, allowing the industry to improve deteriorated rail service to a degree that can’t be achieved through deployment of more equipment and train crews, and more infrastructure spending.

In an hour-and-half October 21 call with investors and media, Harrison sought to clarify reports that CP had sought to acquire CSX, saying CP discussed a potential merger but never made an offer. Harrison, a highly-respected railroader and former CN CEO, who has made CP far more profitable since taking the reins in 2012, admitted that some rail executives were opposed to consolidation. But he argued that there are signs that this view is losing ground. However the so-called “chinks in the armor” of the industry’s skepticism in consolidation weren’t apparent during other railroads’ earnings calls, though.

The merging of railroads has led to service issues, Moorman said. CSX CEO, President and Chairman Michael Ward raised a similar point with investors on Oct. 15, saying mergers could actually cause service to erode further.

The merger of Burlington Northern and Santa Fe in 1993 is one of the major examples of how the meshing of two railroads’ operations can cause shippers years of pain. The merger of Union Pacific and Southern Pacific in 1996 also caused service disruptions as the duo’s operations were melded.

Compared to earlier Class 1 rail consolidation, Moorman said there are fewer “significant synergies” to gain from the existing Class I railroads, as they have fewer overlapping routes, and redundant terminals and yards.

“You can save some money, yes, but it’s not necessarily the order of magnitude that it used to be,” he said.

Moorman said regulators aren’t open to major mergers, and new rules out of the U.S. Surface Transportation Board, the federal railroad regulatory agency,requiring mergers to instill more competition aren’t clear Those new rules might require the merging railroads to give up some of the very benefits they seek through a deal, he said.

The current rail service problems stemming from last winter’s weather would also be an obstacle to overcome. Current rail congestion would make it “very hard” for regulators and shippers to get behind a merger, KCS President and CEO David Starling said on Oct. 17. In its latest effort to pressure railroads to improve U.S. rail service, the STB on Oct. 8 ordered railroads to issue detailed weekly performance metrics for each major freight type, including intermodal.

U.S. rail service isn’t expected to see major improvement until early 2015, as steadily building freight growth is making it difficult for railroads to dig out of cargo backlogged during the harsh 2013-2014 winter. Another severe winter could set the recovery process back further, making it even harder for the major railroads to restore service to the levels seen in mid-2013.

Not only do the new STB rules make mergers trickier because they require more competition, not just maintaining current levels, a merger could spur other consolidations, UP CEO, President and Chairman John Koraleski said Oct. 23, according to SeekingAlpha. He said railroads’ improving the hand-off of freight to one another - which accounts for the majority of rail freight - was the way to tackle bottlenecks, not mergers.

CN CEO Claude Mongeau didn’t comment directly on the prospects of industry mergers, But he said say that the “best going-forward strategy” was having the existing major railroads continue to operate as they are. If there was a merger, Mongeau said it would likely be of a U.S. transcontinental nature where each of the U.S. Western railroads, UP and BNSF Railway, would merge with a U.S. Eastern railroad, CSX and NS. This is a scenario that Harrison has laid out to investors in past earnings calls. Harrison said such a model would improve services by creating interchange efficiencies and still keep the industry competition since shippers in each region would still have two choices.

BNSF Railway hasn’t made any public comments regarding potential industry consolidation. The privately-held company doesn’t host earnings calls for investors.

Source: Journal of Commerce