The Rapidly Evolving Rail Opportunity

Transcription

1 The Rapidly Evolving Rail Opportunity Midwest Association of Rail Shippers Winter Meeting Wednesday January 23, 2013 Mark Davis Senior Analyst/Partner

2 Factors Impacting Rail Demand Evolving International/Domestic Sourcing Strategies Changing Energy Paradigm Part I: The Supplier Benefit Changing Energy Paradigm Part II: Secular Market Share Gains The Evolving Intermodal Opportunity Source: Cleveland Research Analysis

3 Evolving International/Domestic Sourcing Strategies Supply chains are global as companies develop resource networks that help them access raw materials and cheap labor Companies are also seeking to gain access to new markets and customers Competitive advantages in places like China have run their course much faster than expected $40 Trade Between United States and China ( ) $35 $30 U.S. Dollars (Billions) $25 $20 $15 $10 Source: Cleveland Research Analysis, U.S. Department of Commerce $5 $0 Jan-85 Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Exports Jan-98 Jan-99 Jan-00 Imports Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11

4 Evolving International/Domestic Sourcing Strategies The 2009 recession drove companies to implement supply chain management strategies that move beyond minimizing transportation expenses Control now resides at the senior management level and involves balance sheet/cash flow considerations Goal is to lean supply chains while still being responsive to customer buying patterns 1.60 Total Business Inventory to Sales Ratio ( YTD) Source: U.S. Department of Commerce

5 Evolving International/Domestic Sourcing Strategies Lean supply chains increase the velocity of distribution networks Shipment size getting smaller but shipment frequency is accelerating, inventory at rest is the enemy Driving modal substitution: Ocean Airfreight Ocean/LCL Ocean Truck/Rail Rate Index Inbound Airfreight Rates Asia to U.S. 40% 30% 20% 10% 0% -10% -20% Year-Over-Year Change Source: U.S. Department of Commerce Bureau of Labor Statistics

6 Evolving International/Domestic Sourcing Strategies Near sourcing will accelerate as companies relocate manufacturing operations from Asia to countries like Mexico (and even the U.S.) In the future, more raw materials and sub-components as well as finished products of all types will move by truck and rail vs. air and ocean Rails benefit from aggregate volume growth and more balanced ratio of imports to exports between the U.S. & Mexico (1.2:1) vs. U.S. & Asia (2:1) Trade in Dollars $500,000 $475,000 $450,000 $425,000 $400,000 $375,000 $350,000 $325,000 $300,000 $275,000 $250,000 $225,000 $200,000 $175,000 $150,000 $125,000 $100,000 $75,000 $50,000 $25,000 $0 U.S. Trade with Mexico (Imports and Exports - Millions of Dollars) Compound Annual Growth Rate 10.3% Imports Exports Source: U.S. Department of Commerce

7 Changing Energy Paradigm Part I

8 Changing Energy Paradigm Peak Oil: The point in time when the maximum rate of global petroleum extraction is reached, after which the rate of production enters terminal decline Currently, approximately 3x as much oil is consumed than discovered on a global basis Declining global production will drive oil prices higher on a secular basis as the supply of cheap oil is exhausted Energy companies aggressively exploring new sources of energy (natural gas, oil sands, CTL technology) validates the concept of Peak Cheap Oil Source: The Oil Drum

9 Changing Energy Paradigm Global oil prices are high today and the global economy is in a recession. Where would oil be if the global economy was growing? Alternatives are being explored, but the energy returned per unit of invested energy (EROIE) is much lower than traditional Middle East crude Oil and gas reserves in the U.S. are plentiful, but the cost to recover these energy sources is expensive given the geology of U.S. fields 100:1 Energy Return on Invested Energy (EROIE) by Fuel Source 90:1 80:1 70:1 60:1 50:1 40:1 30:1 20:1 10:1 0:1 Source: The Oil Drum

10 Changing Energy Paradigm The oil and gas boom in the U.S. offers railroads a tremendous opportunity to move support materials for drilling as well as extracted crude oil The opportunity is made all the more compelling given the challenge of extracting oil from tight oil formations like Bakken and Eagle Ford The number of barrels per day per well has not changed much in five years despite the fact that the number of wells has exploded Source: North Dakota Department of Mineral Resources

11 Changing Energy Paradigm The primary reason for flat overall production is that wells in places like Bakken and Eagle Ford have steep depletion curves Energy companies are running hard just to maintain production as more less productive wells are exploited because the best prospects were drilled first Growth in overall oil production will be driven by growth in the number of wells which is bullish for oil equipment and railroads that deliver this equipment Source: David Hughes of the Post Carbon Institute

12 Changing Energy Paradigm Changing pricing dynamics in energy markets over the past two years have resulted in shifting demand patterns The resulting price volatility within the oil and gas markets have had some negatively consequences for rail services Energy company are now making significant investments in energy transport infrastructure (rail depots, tank cars) which mitigates some risk 1,600 1,400 1,200 1, U.S. Rig Count ( ) Gas Oil Source: Baker Rig Count, CRC estimates

13 Changing Energy Paradigm Transportation of crude oil also represents a tremendous opportunity for railroads given growing output Rail transport offer more flexibility than pipelines especially when serving fast developing markets where production is hard to scale Movement by rail is more expensive, but rail can reach metropolitan markets where new pipelines are hard to establish and refineries pay the highest price Source: Association of American Railroads

14 Changing Energy Paradigm Part II

15 Changing Energy Paradigm Peak Cheap Oil is impacting transportation systems as rising energy costs not only cause supply chain disruptions but also demand destruction Companies starting to look at near-sourcing as competitive advantages in places like Asia (China) rapidly deteriorate due to inflation We believe the U.S. Government and transportation industry recognize these changes and are adapting to this new reality with new regulations Dollars Per Gallon $4.90 $4.60 $4.30 $4.00 $3.70 $3.40 $3.10 $2.80 $2.50 $2.20 $1.90 Weekly Retail On-Highway Diesel Prices 85% 80% 75% 70% 65% 60% 55% 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% -5% -10% -15% -20% -25% -30% -35% -40% -45% -50% -55% Year-Over-Year Source: U.S. Energy Information Agency

16 Changing Energy Paradigm U.S. Government is implementing several new regulations (CSA, HoS, EOBRs) that will impact trucking over the next several years Headline motive is safety; we believe long term energy concerns are the real driver as trucks consume ~90% of all diesel for transportation Carrier reactions to new regulations indicates a fundamental change in the transport markets Source: Department of Transportation

17 Changing Energy Paradigm Carrier behavior unlike anything seen since deregulation (1980) Large carriers have not chasing market share as capacity tightens Now focused more on dedicated runs and regional truckload services which is reducing the FTL average length of haul 950 Full Truckload (TL) Average Length of Haul ( ) Length of Haul in Miles Source: Cleveland Research Proprietary Trucking Database

18 Changing Energy Paradigm Ongoing evolution of the role of big carriers; no longer placing huge equipment orders with OEMs Fleets sizes remain relatively static (ex-replacement) after the 2009 recession due to driver shortage Tight credit and rising equipment costs making it difficult for owner-operators and small to mid-sized trucking companies to buy new equipment Carriers looking to partner with railroads to capture intermodal business 60,000 Class 8 Truck Net Orders 350% Class 8 Truck Builds 110% New Class 8 Truck Net Orders 50,000 40,000 30,000 20,000 10, % 300% 275% 250% 225% 200% 175% 150% 125% 100% 75% 50% 25% 0% -25% Year-Over-Year New Class 8 Truck Builds 37,000 32,000 27,000 22,000 17,000 12,000 90% 70% 50% 30% 10% -10% -30% -50% Year-Over-Year 0-50% -75% 7,000-70% Net Orders Y/Y Change Builds Y/Y Change Source: CRC analysis of ACT data

19 The Evolving Intermodal Opportunity

20 The Evolving Intermodal Opportunity Higher fuel costs and regulation causing trucks to cede traditional lanes; rails will fill the void serving lane segments as low as 550 miles Service and fit with shipper supply chains is the biggest inhibitor to intermodal adoption but the rails are addressing this issue through investment o o Corridor initiatives (Heartland, National Gateway, Sunset) allowing double-stack service Investments in intermodal terminal footprint Service offerings and performance will improve giving shippers a more cost effective and time-sensitive solution for their supply chains Addressable Market for Intermodal Rail Source: IANA, CRC Analysis

21 The Evolving Intermodal Opportunity Within the U.S. trucking market, we estimate there were approximately 525 million Class 8 truckload movements during We believe approximately 45.5 million loads are eligible for domestic intermodal conversion (includes multi-stop shipments) Railroads handled 14.1 million intermodal movements in 2011; approximately 6.6 million (47%) were domestic movements Implies intermodal currently accounts for approximately 14.5% market share of total U.S. truck volume. Regional: Impact from 1% of market share from trucks o Equates to approximately 180,000 incremental intermodal opportunities for rails or roughly 2.7% more loads than are currently moved National: Impact from 1% of market share from trucks o Equates to approximately 273,000 incremental intermodal opportunities for rails or roughly 4.2% more loads than are currently moved Bottom Line: Finding volume is less of an issue than onboarding this freight at the right price and meeting service performance expectations Class 8 Truck Load Analysis Class 8 Truck Population 2,252,401 Share by Trucks per Miles Avg. Length Loads per Loads per Segment Segment Year of Haul Truck / Year Segment Private 33% 743,292 65, ,255,998 For-Hire: Regional TL & O/O 20% 450, , ,610,442 For-Hire: National TL & O/O 12% 270, ,000 1, ,786,014 LTL & Package 10% 225,240 95, ,494,522 Local Delivery 25% 563,100 25, ,775,057 Total Loads per Year 524,922,031 Addressable For Hire Market 178,673,954 Addressable Tractor Trailer Loads 130,431,987 Subtract: Dedicated loads (3%) 126,519,027 TL Loads above 550 miles 45,546,850 For-Hire: Regional TL & O/O 18,218,740 For-Hire: National TL & O/O 27,328,110 Source: IANA data; CRC primary research

22 The Evolving Intermodal Opportunity West Coast ports have historically been the primary gateways through which Asian manufactured goods reached U.S. consumption markets West Coast ports dominate inbound trade but East Coast ports have been taking market share ever since the West Coast ports strike in Between 2000 and 2011, U.S. West Coast ports saw their combined market share fall (approximately 510bps), while U.S. East Coast and Gulf Coast ports increased their market share (approximately 290bps and 220bps respectively) as shippers took advantage of all-water services. We see East Coast ports gaining market share at the expense of the West Coast ports due to a number of factors o Port congestion, service delays, onerous user-fees, and risk of labor strife at the Ports of Los Angeles and Long Beach o Rising oil/fuel prices o Congestion at Midwestern rail yards (Chicago) which has introduced a new element of risk and uncertainty into supply chains. TOTAL CONTAINER VOLUME (TEUs) U.S. East Coast Container Volume 6,877,783 10,197,444 12,561,478 U.S. West Coast Container Volume 9,238,475 13,329,555 14,253,619 U.S. Gulf Coast Container Volume 1,118,242 1,617,500 2,559,969 TOTAL 17,234,500 25,144,499 29,375,066 East Coast Market Share 39.9% 40.6% 42.8% West Coast Market Share 53.6% 53.0% 48.5% Gulf Coast Market Share 6.5% 6.4% 8.7% 1% U.S. Port Market Share 172, , ,751 Source: Port and IANA data; CRC primary research

23 The Evolving Intermodal Opportunity How will the expansion of the Panama Canal impact the demand for intermodal? Currently, the Panama Canal is operating at close to capacity handling approximately 12 million TEUs annually. Completion of the expansion project in 2014 will double the canal s existing annual capacity (to 24 million TEUs) by accommodating containerships with Twenty-foot Equivalent Unit (TEU) capacities over 13,000. Shippers have increasingly used all-water service from Asia to East Coast ports to access the Midwest given that nearly 60% of the U.S. population resides east of the Mississippi River and accounts for roughly 60% of U.S. GDP. In a slow growth economic environment, shippers are using slower all-water service as free warehousing (inventory in motion) Source: CRC primary research

24 The Evolving Intermodal Opportunity Approximately 50% of import containers arriving at all U.S. ports are destined for inland markets At West Coast ports, approximately 62% of import container volumes move inland In the greater NY/NJ metro area, approximately 23% of containers move inland with most destined for local markets or hauled by truck due to close proximity to their final destinations (100 million people live within one day s drive of NY/NJ). Most other U.S. ports serve much smaller local populations than LA/LB or NY/NJ and therefore the proportion of inbound containers destined for inland population centers are commensurately higher. This is particularly true of the East Coast ports (Norfolk/Hampton Roads, Savannah, and Charleston) where 80-90% of inbound containers are destined for distant, inland locations therefore making them suitable for movement by intermodal rail. Source: Port and IANA data; CRC primary research

25 The Evolving Intermodal Opportunity We estimate there are 1.9 million TEUs that currently transit West Coast ports destined for the Midwest (3.4 million if containers destined for the northeast and southeast are included) could migrate to all-water service. If just 10% of this volume (or just over 340,000 TEUs) migrated, East Coast intermodal volumes would increase by 27%. WEST COAST INTERMODAL (TEUs, 2006) WEST COAST INTERMODAL (TEUs, 2011) Container Traffic by Lane Containers Container Traffic by Lane Containers DELTA '06-'11 Southern California (LA/LB) to: Southern California (LA/LB) to: Midwest 1,283,980 Midwest 1,337, % Market Share of Total WC Traffic 33.3% Market Share of Total WC Traffic 48.5% Northeast 345,253 Northeast 196, % Market Share of Total WC Traffic 9.0% Market Share of Total WC Traffic 7.1% South Central 907,946 South Central 760, % Market Share of Total WC Traffic 23.5% Market Share of Total WC Traffic 27.6% Southeast 604,960 Southeast 462, % Market Share of Total WC Traffic 15.7% Market Share of Total WC Traffic 16.8% TOTAL 3,142,139 TOTAL 2,757, % Northern California (Sea-Tac,Portland) to: Northern California (Sea-Tac,Portland) to: Midwest 560,869 Midwest 554, % Market Share of Total WC Traffic 14.5% Market Share of Total WC Traffic 16.5% Northeast 95,016 Northeast 29, % Market Share of Total WC Traffic 2.5% Market Share of Total WC Traffic 0.9% South Central 16,821 South Central 16, % Market Share of Total WC Traffic 0.4% Market Share of Total WC Traffic 0.5% Southeast 40,832 Southeast 14, % Market Share of Total WC Traffic 1.1% Market Share of Total WC Traffic 0.4% TOTAL 713,538 TOTAL 615, % TOTAL WEST COAST TRAFFIC 3,855,677 TOTAL WEST COAST TRAFFIC 3,372, % Source: Port and IANA data; CRC primary research EAST COAST INTERMODAL (2006) EAST COAST INTERMODAL (2011) Container Traffic by Lane Containers Container Traffic by Lane Containers DELTA '06-'11 Northeast (NY/NJ) to: Northeast (NY/NJ) to: Midwest 731,379 Midwest 821, % Market Share of Total EC Traffic 66.2% Market Share of Total EC Traffic 66.1% Southeast (FL, GA, NC) to: Southeast (FL, GA, NC) Midwest 195,043 Midwest 235, % Market Share of Total EC Traffic 17.7% Market Share of Total EC Traffic 18.9% South Central (Gulf Coast) to: South Central (Gulf Coast) to: Midwest 178,288 Midwest 185, % Market Share of Total EC Traffic 16.1% Market Share of Total EC Traffic 14.9% TOTAL EAST COAST TRAFFIC 1,104,710 TOTAL EAST COAST TRAFFIC 1,242, %

26 Disclosures Other Disclosures: I, Mark Davis, certify that the views expressed in the research report(s) accurately reflect my personal views about the subject security(s). Further I certify that no part of my compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in the research report(s). The analysts responsible for the preparation of this report have no ownership stake in this company. Cleveland Research Company provides no investment banking services of any type on this or any company. The information transmitted is intended only for the person or entity to which it is addressed. Any review, retransmission, dissemination or other use of, or taking of any action in reliance upon, this information by persons or entities other than the intended recipient is prohibited. If you received this in error, please contact the sender and delete the material from any computer. Member FINRA/SIPC

27 The Rapidly Evolving Rail Opportunity Midwest Association of Rail Shippers Winter Meeting Wednesday January 23, 2013 Mark Davis Senior Analyst/Partner