Watching Washington FRAnk n. wilneR
Regulatory rat holes worth watching
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or institutional investors with large holdings in railroads, actions by Congress and decisions of the Surface Transportation Board (STB) are—with all due respect—rat holes worth watching. Decisions made in Washington, D.C., that adversely affect railroads’ earnings growth, operating ratio, and return on investment can shut off access to capital for infrastructure renewal and expansion more abruptly than economic downturns, adverse changes in the commodity mix, liberalization of truck sizes and weights, and labor strife. This is why Wall Street analysts and their institutional investor clients keep a close eye on pending legislation that would reregulate railroads, and on STB decisions that could produce similar results. Some 80% of railroad stock shares are owned by institutional investors such as mutual, pension, and hedge funds, and hospital, museum, religious, and university endowments, says one of Wall Street’s most respected railroad financial analysts, William Greene, who is a managing director and senior transportation analyst at Morgan Stanley Research. While BNSF no longer is publicly traded, it is 100% owned by Berkshire Hathaway, which itself is owned primarily by institutional investors. A sell-off of railroad stocks does more than reduce share prices. It may signal concerns of rail bond buyers and other suppliers of short and long-term financing about the long-term health of the rail industry. The cost and access to this financing are important for rail network reinvestment. As railroad borrowing costs rise— because some lenders cease lending and others demand higher
interest rates—capital spending on infrastructure and equipment renewal declines along with service quality. What follows is a rail network in disrepair and reduced service quality, causing shippers of time-sensitive freight to flee to other modes. “It’s not immediate, but happens over time,” Greene says, explaining that the aim of shippers using re-regulation to impose lower freight rates may be short-sighted if it threatens the long-term financial health of the industry.
The outcome of an antitrust lawsuit over fuel surcharges is nothing compared to the long-term costs of re-regulation. Institutional investors are a savvy bunch and recall too vividly the lessons from the 1960s and 1970s, when pervasive economic regulation created a wave of railroad bankruptcies and massive deferred maintenance that slowed rail transportation to an unacceptable crawl. For this reason, railroads spend heavily to educate Congress on the draconian tribulations of railroads prior to passage of the Staggers Rail Act of 1980, which partially deregulated railroads and allowed them more flexibility to react swiftly to changing market forces. Re-regulation of railroads by Congress—or de facto re-regulation by the STB using its regulatory powers— would, says Greene, choke off the flow
of capital to railroads that are among the most capital intensive of all industries, investing at five times the rate of manufacturers to operate, maintain, and improve the nation’s rail infrastructure. “While some shippers may feel rail consolidation has reduced transportation options and raised rates, shipper efforts to lower freight rates could create negative long-term results for railroads, their customers, and the nation’s economy.” Greene says the most harmful outcome of a pending antitrust lawsuit against railroads over an alleged conspiracy to set fuel surcharges— which some predict, at worst, could cost the industry tens of billions of dollars—pales in comparison to the long-term costs of re-regulation. “The risk of losing the antitrust lawsuit is a unique one-off event, but doesn’t change the fundamental economics of the rail industry as would a rollback of Staggers Rail Act freedoms,” he says. “Re-regulation calls into question the industry’s future earnings growth, operating ratio, and return on investment—three metrics most watched by institutional investors,” Greene says. “The Staggers Rail Act is a wellthought-out Congressional success story. The industry is on the cusp of revenue adequacy, has vastly upgraded service quality, and has improved productivity and safety. Rail employment is rising, and average freight rates have trailed the rate of inflation.” “Unless railroads attempt a new round of mergers to create a duopoly, Congress should leave intact the framework the Staggers Rail Act created,” Greene says. “The Staggers Rail Act is a smashing success and re-regulation is a too great a risk to a sustainable national rail network.” August 2013 RAilwAy Age 15