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Fall Forum ATLP/NITL 2007 Washington DC October 15, 2007 PowerPoint Presentation
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Fall Forum ATLP/NITL 2007 Washington DC October 15, 2007

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Fall Forum ATLP/NITL 2007 Washington DC October 15, 2007

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  1. Renaissance: Rails, Capital & Capacity Under ChallengeAnthony B. Hatch – abh consulting 155 W68th Street NYC 10023 (212) 595-0457 ABH18@mindspring.com:: Fall Forum ATLP/NITL 2007 Washington DC October 15, 2007

  2. Railroads at historic tipping point • Capacity issues across all modes • Volume increasing – right? • Share increasing • Rates increasing • Services levels (yes) increasing • Returns increasing • But pushback (shipper/regulator/union also increasing) • A secular, not a cyclical story • Capacity and infrastructure – and competitor - issues remain • Not fully reflected in the market? Or is this just another cyclical slowdown?

  3. Street influence on RRs – and Why that affects ALL stakeholders • Battle for cash • Management’s reactions to pressures • Investors, competitors, regulators, politicians, labor – oh, yes, and customers • Short term decisions/long term consequences

  4. 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)

  5. Spending $: Mgmt.’s #1 Decision • Capex for Maintenance – “base” • Capex for Capacity, Service & Growth • Dividends • Share Buybacks • M&A – Strategic • M&A – Non-strategic (conglomeracy) • How management allocates indicates confidence & direction and impacts all stakeholders

  6. Virtuous Circle 2004-07 • Better returns (half finally earn returns equal to the cost of capital) • Better stock prices • Better revenue prospects – up double digit ’04-06 • Equals more investment – capex up sharply • Equals more capacity, better service • …equals better returns and growth….

  7. Sources of capital • FCF – booming at most carriers (capex vs. ROIC) • Governments – states, PAs, Feds • 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) • Share repos – UNP, BNSF and especially CSX • C-1 Buyouts (CP)

  9. Threats to the Renaissance? • Cyclical vs. secular argument • New Congress –impacting labor & shippers • Rereg – the MAD answer • Execution: service • Execution: merger • Hedge fund investment reality – or the perception • Liquidity?

  10. Railroad Stock PricesJanuary 2001 – Mid-Year 2007 Index Jan 2001 = 100 Sources: MSN and CSI, Inc.

  11. S&P 500 and RailroadsMonthly Data January 1980 – April 2007 Index Jan. 1980 = 100 Sources: MSN and CSI, Inc.

  12. Even With Booming Traffic, Rail Earnings Are Substandard Median Return on Equity in 2005 (S&P 500 companies) *BNSF, CSX, NS, and UP Source: Business Week

  13. RR CoC vs. ROIC -stocks have done well but… they still trade at a discount to all stocks Cost of Capital Return on Investment Source: Surface Transportation Board

  14. Railroad Capital ExpendituresClass I Railroads Billions Source: Railroad Facts, AAR

  15. Food – 2.6% Transportation equipment – 2.8% Petroleum & coal products – 3.0% Wood products – 3.0% Fabricated metal products – 3.5% Average all manufacturing – 3.5% Chemicals – 4.4% Paper – 4.7% Nonmetallic mineral prod. – 5.4% Electric utilities – 11.6% Class I RRs – 17.8% Capital Expenditures as % of Revenue Source: Census Bureau, EEI, AAR

  16. Railroad PerformanceClass I Railroads Index 1981 = 100 Productivity Volume Revenue Price Source: Railroad Facts, AAR

  17. Intermodal Growth DriversDomestic and International • Globalization • Trade • Railroad Cost Advantages • Share Recovery From Highway • Truckload Issues

  18. RRs and Investment • Is growth affordable? Capex up 10% in ’07? • Can the intermodal model extend to carload? • Is additional capacity necessary? Desirable? • Wall Street’s constrictive role (“fighting the last war”) – changing? • Is this disconnect between the Renaissance and the Street the opportunity of a lifetime?

  19. Serious U.S. Transportation and Congestion Problems • High Cost of Highway Maintenance and Construction • Interdependence of Modes • $67 billion per Year Drag on Economy • Demand for Freight Transportation to Double by 2020

  20. Railroad Issues Fall 2007 • #1 is Economic/industrial status – recession? Perfect Landing? Etc? • Service metrics – recovery or a meltdown (again)? The key behind shipper/regulatory angst? • Trucking s/t surplus but – l/t troubles a secular issue • Capacity – coming shortage? Or “creative tension”? • Intermodal – new king of the hill • Coal and Grain: Comeback? Thanks to oil! • Ethanol – growth or Paying Peter… • Is Growth Affordable? (Who will pay?) • Alliances vs. Mergers? Big projects in Canada, Mexico and Wyoming • Labor – Coming shortage? • Safety and security – new risk? Who pays?

  21. Intermodal’s 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. 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

  23. Railroad Rates- the old story Class I Railroads, Revenue Per Ton-Mile Cents Constant $: Down 54% since 1980 Current $: Down 1% since 1980 Source: Railroad Facts, AAR

  24. Pricing - the new paradigm • Rates up 3% in ’04 – post-Staggers best • Up 11% in ’05 (Secular rate of 2-3%?) • Fuel surcharges similar to TL • Yet Price Gap to the highway widening, even in ’05 and ’06 YTD • Capacity (still) short across all freight modes, despite temporary surpluses • Rails moving toward tariff and spot markets Conclusion: Best Ever Rate Environment “The new Golden era” – cost of capital within sight; not there yet

  25. Railroad Employee ProductivityClass I Railroads, Ton-Miles Per Freight Service Employee Millions Source: Railroad Facts, AAR

  26. 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…

  27. Rail Regulatory Risk • CTA reform not a major issue; Canadian shipper/provincial/carrier cooperation at all time levels • STB reviewing a number of issues, with some expected minor shipper “wins”, as rates improve after years of subsidy • F/S covers 15-20% of revenues (less than 10% of CP) • Small shipper, cost of capital,paper barriers, other STB issues under review also BUT: • Labor a wild card • Potential new Revenue Adequacy rules not (at all) linked to reality • Haz-Mat/Security an emerging problem • AAR best lobby in DC – re-reg chances virtually zero, but too much time will be spent on DEFENSE • ITC chances reduced