Class I railroads can continue business as usual and watch their earnings stagnate and profitability fall as their freight volume declines through 2030.
Or they can make meaningful service improvements, become easier for customers to deal with, and launch new intermodal services that capture freight from trucks. Adopting a successful growth strategy will boost revenue, increase profitability, and produce the returns that will raise railroad stock prices.
That’s the choice facing the railroads and their investors, according to an Oliver Wyman report released this week. Report authors Matthew Schabas and Adriene Bailey focused on three potential scenarios: business as usual, holding market share, and pursuit of volume growth.
“Recent research by Oliver Wyman on potential 2030 scenarios for North American Class I railroads shows that focusing on growth — backed by a cost-efficient and reliable operation — is the only strategy likely to lead to long-term value creation,” they wrote.
A growth strategy would increase rail operating income by up to $13 billion and improve the average operating ratio by 2.4 points.
Business as usual would lead to only a $1 billion increase in operating income, while operating ratios would deteriorate by 0.9 points as less traffic rolls over a rail network with high fixed costs.
The report says the industry’s focus on profit margins over volume growth has reached the end of the road.
“In a [business as usual] scenario, the railroads continue to do what many are doing now: cut costs, attempt to raise prices, and fail to materially improve service or the customer experience,” the report says. “The result will be continued market share loss to trucks; price-driven revenue growth will barely offset declining coal volumes. Ultimately, the railroads would become more like utilities: maximizing financial returns while shrinking back to regulated, rail-centric commodities and the network required to support these.”
It’s unlikely that railroads can continue to raise rates and reduce their operating ratios, Schabas and Bailey write.
“Management may believe they can improve on this, but attempting to increase prices further risks market share loss and regulatory action. To sustain today’s O.R. without coal will require deep cost cutting above and beyond prior efficiency improvements,” they write.
A winning strategy for railroads and their investors would lead to service improvements that – along with new shorter-haul intermodal service – ultimately could convert 6 million truckloads to rail.
“To grow volumes, railroads will need to deliver sustained service quality and a customer experience that is consistent and more competitive with truck. Today, shippers universally prefer truck because of its superior flexibility, reliability, and customer-centricity – and are willing to pay more for truck as a result,” Schabas and Bailey write. “Shippers we have spoken with and surveyed have repeatedly told us that they want to do more with rail because of its advantages, but that the product and experience simply are not meeting their supply chain needs.”
The report — titled “The Path to Long-Term Shareholder Value for Rail is Growth” — comes amid a proxy fight that will determine the fate of Norfolk Southern’s growth strategy.
Activist investor Ancora Holdings has been critical of the railroad’s service and resiliency strategy as well as Norfolk Southern’s lagging financial and operational performance. Ancora’s hand-picked management team would fully implement the low-cost Precision Scheduled Railroading operating model at NS while focusing on the most profitable traffic in pursuit of a 57% operating ratio target.
Shippers and rail labor unions have backed Norfolk Southern, and rail regulators have raised concerns about Ancora’s plans. But investors will ultimately decide the matter at the railroad’s May 9 annual shareholder meeting.
Bailey says the report’s financial predictions speak for themselves, and that the road to higher revenue and returns is growth.
“Railroads have to prove it’s possible by getting service and customer experience right,” she tells Trains. “Perhaps analysts are skeptical.”
If Wall Street analysts believe it’s impossible for railroads to grow, then perhaps extracting as much value from a shrinking traffic base makes sense, she says.
“But there are many experienced railroaders who will tell you it is absolutely possible with the commitment, support, and determination to run a scheduled, reliable railroad,” Bailey says.
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