RT09 was our biggest (record attendance!) and best yet – clearly showing the benefits of being lucky, in terms of timing (rereg, the perennial, as well as PTC, and strategy & capital in a changing world) as well as, well, pretty good, thanks to the hard work by Progressive Railroading and MillerTabak.  I left the busy sessions spread over a day and a half with reasons to keep the faith in the "railroad renaissance", helped by an outstanding presentation by Walmart on their future logistics plans that reinforces the opportunity for pure domestic intermodal that was echoed by rail planners.  The short lines are a scorching topic these days, and not just newly public again RailAmerica, but Watco and 3 S/L carriers that work with NS on the "Empire Link" showed that local entrepreneurship can reap growth.  Mexico looks like it can be a big winner in the "new normal", and KCS gave its best presentation yet on its opportunities there.  But to be fair, I was also confronted by more challenges to my world view than I had expected….perhaps that is what epitomized a great conference besides the quality of the fellowship: it made (and continues to make) me think. We also saw our first ever "standing –O" as Hunter Harrison gave valedictory-like address, demanding that we think, and saying that from challenges come the great opportunities for change.  Five of the many challenges are particularly worth noting:

1. Domestic Intermodal business is hard – the service levels are intense as is the competition.  The combination of better rail service (keeping the velocity gains from the recession into the recovery, for example), higher fuel prices, congested roads (someday again) and the increased attention to lower carbon footprints all create opportunity, but it wont be easy, as was pointed out by Jim McClellan and many others.
2. Rereg – the perennial issue, it seems, may indeed be coming to some conclusion many speakers and attendees thought (we heard from about every side on this issue, from rails to labor to regulators to shippers to legislators) but truth be told only the Senate Commerce Committee truly knows anything.  We may see something this month….There is huge potential downside of done wrong, balanced (word-du-jour) not by inclusion of replacement cost but by "cloud removal" and (a promised) access to future government funds.  The fear here (and elsewhere in the investment community) is that rails would compromise and agree to a less-than "balanced" legislation, perhaps in a split of western and eastern rail interests.  Why would they do that?
3. PTC is a much bigger topic of fear to rails than the Street realizes – in our "Wall Street" panel there was no (zero) mention of PTC, but to rail CEOs the possible $10 billion "unfunded mandate" is issue #1, or at least 1A….not long ago (’07) we held "Salons" discussing the virtues of PTC (capacity, velocity, labor needs, etc) and yet now the costs appear to well exceed those benefits in a changed world.  RT09 hosted several speakers, including the FRA Administrator, covering this re-emerging hot topic.  DC is the hot-button topic for rereg, PTC costs as well as
4. Climate Change looks more daunting than we had thought – new natural gas technologies, a concerted effort to attack coal (see, for example just yesterday the Times on coal scrubbers, "Cleansing the Air at the Expense of Waterways" http://www.nytimes.com/2009/10/13/us/13water.html?ref=todayspaper).  Huge utility coal inventories will hurt intermediate term coal results as well; meanwhile rail efforts to get compensation look challenged.  This is the other edge of the double edged "Green Sword" for rails – will domestic intermodal (& carload) gains compensate for coal declines?
5. Capex remains high and meaningful government help (partnerships) etc no guarantee – Even beyond the normal capital intensity (rails have averaged spending about 17 cents on the revenue dollar on capex) looms PTC as well as locomotive emissions controls (adding 25% to the cost of new plus higher maintenance costs sometime in the middle of the next decade) while tight (and getting tighter) governments funds will be spread around a lot of worthy causes.  As NS’ Deb Butler noted, there is unprecedented uncertainty out there.  Meanwhile, for suppliers – those not tied to track & signaling, anyway – the drought looks to be a long, long one.

And yet it moves – so said Galileo when his theory was questioned, and so say I….In the face of these challenges as well as the over-riding one (the pace and new directions of the economic recovery) I see en emerging rail story where the incremental margins in the recovery exceed those that have so far (positively) shocked in the recession.  That doesn’t make sense to some – the margins have held in the rail group in the face of the amazing economic/volume decline (almost 20%) because rails have increased the percentage of cost that is variable, which should mean incremental (not overall) margins actually decline in the recovery & growth phase – but that assumes a static condition.  And the rails, and their $8 billion in recent average annual (and more info-intensive) capex, are not static.  The test will be to hold off the DC threats while embracing the DC opportunities (railways as saviors), to hold or improve service metrics and system velocity (and thus asset turns) in the recovery.  If they do that productivity (and earnings) growth will be explosive, and market share opportunities in formerly medium and short lengths of haul, will be dramatic.  It is hard work, but the rewards, public and private, are out there for the taking.

Anthony B. Hatch