Trucks are hearing the distant rumblings of an approaching freight train that they would rather see derailed. Precision scheduled railroading (PSR) may finally be paying off for railroads. Operating ratios have improved, and two rail companies are considering the reintroduction of intermodal routes, which could be to the detriment of trucks.
Intermodal is the crux of feuding logistics
A decision is imminent among railroads on the reintroduction of intermodal routes that were dropped during PSR implementation. Intermodal shipping uses two modes of freight, such as truck and rail, to transport goods from shipper to consignee. A container is moved by truck to rail, then back to a truck to complete the process.
The PSR principle was created by the late Hunter Harrison who envisioned higher revenues using fewer railcars and engines. Canadian National Railway (CNI -0.64%) first implemented the system when Harrison was the CEO until 2009. The PSR system was successful, and CNI improved its operating ratios.
Harrison later implemented the system at Canadian Pacific Railway Limited (CP -0.65%) after he became the CEO in 2012. CSX also benefited from the PSR technique when, in 2017, Harrison was appointed as CSX's CEO. When U.S. coal volumes faced systemic decline, Class I railroads increasingly leaned on intermodal to fill the gap, which put them in direct competition with trucks. Trucks are often the preferred mode of transport for intermodal -- shorter distances of 500 miles or less -- because they are easier for point-to-point deliveries.
As the railroads transitioned to PSR, they streamlined by shedding some of their intermodal lanes that did not fit the PSR operating model. This had spillover effects. According to the Association of American Railroads, for the week ending August 3, total combined U.S. traffic for the first 31 weeks of 2019 was 16,054,912 carloads and intermodal units, a decrease of 3.5% compared to the previous year. What isn't clear is whether this decline was due to a general weakening of the economy or a result of the railroads shedding intermodal lanes.
Something was causing ripple effects across the wider rail network. Suspecting that shippers had moved to truckers such as J.B. Hunt Transport Services (JBHT -0.17%) or Schneider National (SNDR 0.17%), in August, CSX and Union Pacific were talking with shippers and logistics providers about whether to restore intermodal service to Philadelphia, Cincinnati, and Columbus, Ohio.
As the railroads and trucks go head to head on intermodal, the railroads seem sure of one thing: Any teething problems with PSR are finally abating.
Union Pacific's operating ratio for fourth-quarter 2018 was 61.6%, up 1.1 points compared to fourth-quarter 2017. Operating revenue totaled $22.8 billion compared to $21.2 billion in 2017. For CSX's fourth-quarter earnings 2018, the operating ratio was 60.3%, a fourth-quarter record. In 2017, the company had an operating ratio of 67.9%. CEO Jim Foote set a goal of a 60% annual operating ratio by 2020, something that Foote now expects CSX to achieve this year. With these results, the railroads can now transition to incremental capacity growth.
Opportunity after opportunity
According to Foote, growth may come at the expense of trucks once the advantages of PSR take effect and trip plan performance, or reliability, improves.
"CSX has customers that might have 50% to 60% of their business moving on CSX with the balance on trucks. It's possible that those customers are paying 15% more per mile for the reliability of truck service because they've been burned by the railroads so many times," said Foote.
The upcoming decision on whether to restore the intermodal services could go either way, and an announcement should come by the end of October. However, it seems that the railroads are leaning toward restoration.
A CSX executive also said that the company was looking at "opportunity after opportunity after opportunity" to improve earnings and cash flow growth. Indeed, in early August, CSX announced a new intermodal service and partnership with Canadian National Railway between greater Montreal and Southern Ontario and the CSX-served ports of Philadelphia, New York, New Jersey, and the New York City metropolitan area starting in October 2019.
Of course, whether shippers return to the railroads should lanes reopen will depend on the economics and the cheapest options. But as the railroads come to grips with PSR, they may find ways to undercut the trucks if there is a contraction in total shipping.
For investors, it seems likely that the railroads will ramp up their intermodal routes as the PSR transition solidifies. The truckers are hearing distant rumblings. Just when the trucks thought they could make gains in intermodal routes, the trains are fighting back!