(Reuters.com posted the following statement by Moody’s rating agency on February 5.)
NEW YORK — The ratings outlook for North American railroads is stable, Moody’s Investor’s Service says in its new annual outlook for the industry. There is a good chance, Moody’s says, that 2003 will pass without any downgrades among the investment-grade railroads.
“To some degree, the railroads anticipated the current economic downturn and have been weathering it relatively well,” says Moody’s Vice President/Senior Credit Officer Robert Jankowitz, lead author of the new report.
“In general, there is a recent record of improved free cash flow from operations, a well invested track infrastructure and operating system, very broad market access, and strong liquidity.” In all Moody’s rates 10 North American railroads, which have approximately $54 billion in rated debt outstanding. There are still some near-term risks to credit quality, however. Jankowitz says that the currently high service standards could falter once volumes pick up during a recovery. A double-dip recession, in turn, would hurt operating profits, particularly of those carriers with freight revenues that depend on consumer spending on hard goods. Companies especially at risk are those with high intermodal revenues, such as BNSF, big transporters of automotive finished goods and parts, such as UP, and movers of forest products and building materials, such as CN, whose businesses would decline should housing starts slow.
Jankowitz says that while debt-financed mergers have given the industry higher leverage than ever and cash flows are not what had been expected at this point in the merger integration, the railroads appear to be responding with more conservative financial policies. He cites Norfolk Southern and CSX as companies that have been willing to cut dividends in response to changing conditions. Longer term, rating stability or improvement will depend largely on the industry maintaining pricing discipline, says Jankowitz. At the moment, pricing discipline appears to be holding, but it remains to be seen whether this will continue once traffic begins to increase and customers begin to request price concessions in exchange for higher volumes. A second important ratings driver will be a carrier’s investment approach, says Jankowitz.
“The performance of individual carriers will, to a great extent, hinge on the degree to which a carrier has an investment approach that seeks a consistent return in excess of the cost of capital, while fully investing for safety and performance,” he says. Railways will remain one of the most capital intensive industries, and Moody’s anticipates annual expenditures for a Class I railroad averaging between 16% to 18% of revenue over the cycle. Moody’s also says that while another round of railway mergers is probable over the long run, this is unlikely in the next few years for two reasons. “First, there is no inclination among the industry leaders to merge – in fact, they profess an interest in just the opposite,” says Jankowitz. “Second, new merger rules, re-written by the Surface Transportation Board in 2001, are both somewhat vague and clearly untested.”