Rail Renaissance: Returns, Capital

1
Rail Renaissance Returns, Capital Capacity

• AB HATCH abh18_at_mindspring.com
• The Transportation Conference
• Toronto September 2008

2
Railroads at historic tipping point

• The Railroad Renaissance is here will it last?
• Capacity issues across all modes
• Volume increasing right?
• Share, rates, service levels (yes) and returns
  increasing
• But pushback (shipper/regulator/union) also
  increasing!
• A secular, not a cyclical story right?
• Capacity and infrastructure and competitor -
  issues remain
• Fully reflected in the market? Or is this just
  another cyclical slowdown?
• NET/NET-
• The industry is poised to go up or down based
  on decisions made here now

3
Railroad PerformanceClass I Railroads
Index 1981 100
Productivity
Volume
Revenue
Price
Source Railroad Facts, AAR (Based on a
design by R. Gallamore)
4
Street influence on RRs and Why that affects
ALL stakeholders

• Battle for cash
• Managements reactions to pressures
• Investors, competitors, regulators, politicians,
  labor oh, yes, and customers
• Short term decisions/long term consequences
• Which bucket will they place their chips?

5
Show Me the Money

• Share Price is the Indicator over time!
• Cash (Flow) is King
• High ROIC High Stock Price
• And Vice Versa
• Key is the phrase through a cycle
• Old Model Disinvestment
• New Model TBD (But CP gives us a clue)

6
Simple Math

• Rates
• Returns
• Capital Expenditures
• Capacity
• Service
• ARE ALL CONNECTED!
• Virtuous Circle (03-07) or Disinvestment?

7
Sources of capital

• FCF booming at most carriers (capex vs. ROIC)
• Governments states, PAs, Feds, PPPs
• Governments Canada as contrast
• Traditional Street sources Banks
• Institutional investors
• Hedge funds
• Private Equity/Infrastructure Funds (still?)

8
New Sources of Capital Threat or Opportunity?

• Fortress-RailAmerica/FEC (etc)
• Infrastructure Funds (Toll Roads)
• Hedge Funds Activists (TCI)
• PPPs Heartland, Natl Gateway, CREATE
• Share repos
• C-1 Buyouts (DME)
• JVs Meridian, Patriot corridors

9
Threats to the Renaissance

• Cyclical vs. secular argument
• New Congress impacting labor shippers
• Mandated Reviews STB, Canada
• Rereg the MAD answer
• Execution service
• Execution merger
• Hedge funds?
• Liquidity?

10
Railroad Daily Stock PricesJanuary 2, 2008
through September 16, 2008
Index Jan 2, 2008 100
Sources Yahoo Finance (adjusted for dividends
and splits)
11
Railroad Daily Stock PricesSeptember 2, 2008
through September 16, 2008
Index Sept. 2, 2008 100
Source Yahoo Finance (adjusted for dividends
and splits)
12
SP 500 and RailroadsMonthly Data January 1980
April 2007
Index Jan. 1980 100
Sources MSN and CSI, Inc.
13
Railroad Return on EquityClass I Railroads
n.m.
n.m. not meaningful (negative value)
Source Railroad Facts, AAR
14
RR CoC vs. ROIC RR Stocks have done well but
they still trade at a discount to all stocks
Source Surface Transportation Board, 2007p
based on AAR filing and Railroad Schedule 250s
Note Cost of equity estimation method changed
by Board effective 2006.
15
Railroad Intermodal Revenue Growth Over 5 -
Long Live the New King!-
Coal Intermodal
Source Carload Waybill Statistics (includes
non-Class I railroads)
16
Intermodal is the Top Source of U.S. Freight
Rail Revenue
Intermodal and Coal as a of Revenue
Data for BNSF, CSX, KCS, NS, and UP Source
Railroad financial reports
17
U.S. Railroad Intermodal Traffic(millions)
Source Association of American Railroads
Weekly Railroad Traffic
18
U.S. Railroad Intermodal TrafficTrailers vs.
Containers (millions)
Source Association of American Railroads
Railroad Facts
19
Intermodal Growth DriversDomestic and
International

• Globalization
• Trade
• Railroad Cost Advantages
• Share Recovery From Highway
• Truckload Issues

20
Future Demand for Freight Transportation Will
Continue to Grow
Billions of Tons of Freight Transported in the
U.S.
p U.S. DOT projection
21
Intermodals Enduring Questions

• Lots of moving parts
• The improved ROIC of RR Intermodal 03-06 is the
  essence of the Railroad Renaissance
• Long term volume growth rate of 5-7
• Long term pricing growth rate 3-4
• True International drives the train
• Will True Domestic join the party?

22
Truckload Issues

• TL surplus perfect (ugh) storm in the short
  term
• Driver shortages permanent?
• Tight capacity a secular issue
• Q4/Q1 capacity and rates a temporary/cyclical
  issue (isnt it??)
• Transload increase to absorb some capacity?
• Stubbornly high fuel prices growing price gap
  to intermodal
• Insurance costs
• Traffic congestion
• Net better switch than fight?

23
Coal and Ag Bulk Comeback

• New growth mode?
• Emissions and environmental issues
• Oil prices and coal
• Politics and coal and grain/rereg
• Ethanol
• Exports
• Feed

24
What Are Railroads Doing to Increase Capacity?

• ? New operating plans
• ? Cooperative alliances
• Working with customers
• Technology
• Massive equipment and infrastructure investment
• Additional employees

25
Rail Employment is Up for the First Time in
Decades
Total Class I Employment Jan. 2001-Mar. 2008
Source Surface Transportation Board
26
Railroad Capital ExpendituresClass I Railroads
and so far 2008 looks to be a paradigm shift!
Billions
Source Railroad Facts, AAR
27
RRs and Investment

• Is growth affordable? Capex up 10 in 07?
• One rail cuts, 2 increase capex during 07
• What will 2008 look like? (long term growth v
  short term weakness)
• Is additional capacity necessary? Desirable?
• Can the intermodal model extend to carload?
• Wall Streets constrictive role (fighting the
  last war) is it changing?
• Is this disconnect between the Renaissance and
  the Street the opportunity of a lifetime?

28
Growth in Trains Per Day From 2005 to 2035 by
Primary Rail Corridor
29
Future Corridor Volumes Compared to Current
Corridor Capacity
2035 without improvements
30
Future Train Volumes Compared to Future Train
Capacity
2035 with improvements
31
Class I Railroad Capital Spending vs. Net Income
(Current Dollars)
Capital Spending
Net Income
Source Association of American Railroads
32
Tax Incentives to Leverage Capacity Expansion

• 25 tax credit for projects that expand rail
  capacity
• Expense other infrastructure capital expenditures
• Leverage private investment

33
Railroad Rates- the old story Class I Railroads,
Revenue Per Ton-Mile another (related) New
Paradigm
Cents
Constant Down 54 since 1980
Current Down 1 since 1980
Source Railroad Facts, AAR
34
Railroad Employee ProductivityClass I Railroads,
Ton-Miles Per Freight Service Employee
Millions
Source Railroad Facts, AAR
35
Rail Service Cycles

• Is the recent improvement in the metrics
  sustainable? Systemic?
• Is it a product of huge capex injection and IT?
• Or, is it merely a product of lower volumes/less
  stress on the network

36
Rail Regulatory Risk

• Biggest Uncertainty Entering 08
• Safety Bill
• Competition Bill (M-A-D)
• Cost of Capital Revision
• Mandated STB, CTA Reviews
• AAR/RAC/ASLRRA have great D but hard to score
  on defense

37
(No Transcript)