Can a legendary 72-year-old executive who’s revived three troubled railroads, and who was on the verge of retiring for a second time, add boxcars of profits at America’s third largest carrier?
On January 19, Hunter Harrison, the septuagenarian CEO of Canadian Pacific (CP), announced that he’ll depart in less than two weeks, months ahead of his scheduled retirement on June 30. Press accounts, including an article in the Wall Street Journal, reported that Harrison was teaming with activist investor Paul Hilal to seek the top job at CSX. CSX is the nation’s largest east coast railroad, and third-ranking nationwide behind two western carriers, Union Pacific (which Coins2Day profiled in this 2015 feature) and Berkshire Hathaway’s Burlington Northern.
Harrison apparently wants to steer CSX (CSX) so badly that he sacrificed $89 million in equity grants—money that he would have pocketed after June 30—in exchange for a release from non-compete restrictions that would have blocked him from running a rival.
Just two days earlier, investors had been fretting over the mildly disappointing fourth quarter earnings that CSX unveiled on January 17, sending its stock price 3% lower. But 48 hours later, the Harrison news propelled its shares from $37 to $45.50, or 23%, adding $3 billion in market cap and setting an all-time record. (CSX had retreated to around $43.50 by mid-afternoon on Inauguration Day.)
If indeed Harrison succeeds in winning the CEO job, it’s unclear that he can generate the same kind of epic improvements that he achieved during his turnaround triumphs at Illinois Central, Canadian National, and CP. Those railroads were all bloated underachievers, while CSX is rebounding strongly from a near-collapse in its staple coal business. And unlike the Canadian carriers, which carry freight gigantic distances through open prairies and frozen tundra, CSX operates short-haul routes that thread through congested urban corridors. “Harrison has been a revolutionary, but it’s a different challenge to achieve the kind of efficiencies he’s gotten before on CSX’s denser routes, especially when CSX’s efficiency is already improving,” says veteran railroad analyst Tony Hatch.
Pioneer of “Precision Railroading”
Harrison pioneered a groundbreaking strategy called “precision railroading.” “Traditionally, each railyard set their own schedules for the best use of their people and cars,” says Hatch. “But they didn’t work together, so their clashing schedules meant that the overall railroad was using too many employees and too much equipment.” Deploying precision railroading, Harrison imposed coordinated schedules that maximized the efficiency of the entire network. That meant running trains 7 days a week, 24 hours a day, to benefit from all-night runs when the routes were free of commuter trains.
To make the system run smoothy, Harrison also prodded customers to change their demands. Retailers and other clients wanted deliveries between 9 a.m. And 5 p.m. When their stores were open. But Harrison leaned on them to trade lower prices for late-night deliveries, explaining that lowering costs would benefit both themselves and the railroad carrying their clothes and computers. “The customers wanted the railroad to fit them, and Harrison convinced them they’d save money if the railroad set the schedule,” says Hatch. He was famous for his “Harrison camps,” offsites where instead of the usual golfing and speechmaking, the boss trained his lieutenants in the rigors of precision railroading.
The strategy worked brilliantly at Canadian Pacific. In 2012, Bill Ackman’s Pershing Capital installed Harrison as CEO following a bruising proxy fight. When he arrived, CP’s operating ratio, its costs as a share of revenues, stood at 81.3%. By deploying precision railroading to trim payrolls and rapidly “turn” cars so the a smaller fleet rode the rails far more hours each day, Harrison has lowered that figure to a best-in-class 58.6%. In five years, its stock has doubled to $150, adding $11 billion in market cap.
But Harrison harbors bigger ambitions. He’s attempted to create a trans-national colossus by seeking mergers with both Norfolk Southern and CSX. Both east coast carriers rebuffed CP. As a Pershing Square partner and CP board member, Hilal had strongly supported Harrison’s attempts at efficiency-through-consolidation. Last year, Hilal left Pershing to found activist hedge fund Mantle Ridge, which reportedly bought a stake in CSX.
It’s uncertain whether Hilal and Harrison will once again press for a merger between CP and CSX if their salvo succeeds. But it’s likely that they view CSX as ripe for big improvements in operations. Indeed, CSX’s operating ratio was an unimpressive 70.7% for 2016. Still, the railroad is showing remarkable resiliency given that its revenues from coal, its biggest single business, have dropped from $2.85 billion to $1.8 billion since 2014. To its great credit, CSX has succeeded in cutting expenses fast enough to post just an 8.5% fall in EPS in the past two years. Now, earnings are heading higher once again, propelled by strong growth in shipments of manufactured goods and surging coal exports that are on offsetting the continued fall in deliveries to US utilities.
CSX pledges to lower its operating ratio to 65% over the “long-term,” but declines to give a specific date. That kind of goal won’t satisfy Harrison. According to estimates by BMO Capital Markets, if CSX can lower its ratio to 60% by 2020, its stock will jump 40%, to $60. Those are the kind of stretch targets that would excite Harrison. “I think he’d be anxious to show that precision railroading works everywhere, not just for long-haul, but also in dense urban markets,” says Hatch.
The Harrison-Hilal adventure will be one of the most interesting spectacles of 2017. CSX’s CEO, Michael Ward, had planned hand the job to COO Oscar Munoz at the start of 2016, but Munoz departed to run United Continental. (For more about Munoz, read this recent profile.) It would be difficult for Ward and the board to rebuff a successor of Harrison’s reputation. But if Harrison and Hilal fail to secure the top job peacefully, stand by for a proxy battle at CSX’s annual meeting in February. Anyone who gives up $89 million to take a new job thinks it’s a hell of an opportunity.
