A Memphis native who got his start as a carman-oiler in 1963 found himself four decades later running Canadian National Railway, the largest freight railroad in Canada. Behind the Southern drawl was a mind geared for efficiency and a willingness to anger some shippers if that’s what it took to get trains running on time.
E. Hunter Harrison imposed on the railroad his same telltale fingerprints — a focus on tighter scheduling, asset utilization and operation efficiency — that he pressed on Illinois Central Railroad before CN acquired the smaller railroad in 1997. His guiding hand led CN in becoming the most profitable Class I railroad in North America, which it remains today.
Now an activist investor fed up with Canadian Pacific Railway being the least profitable in the Class I industry wants Harrison to leave his horses in Florida and pull a similar sleight of hand at CP. It’s looking increasingly likely shareholders at their annual meeting this week will support Pershing Square Capital Management by electing its slate of seven director nominees to the 16-member board. Whichever way they go, the outcome will determine crucial service and rates for intermodal shippers moving goods throughout North America.
Seventy-five percent of the shareholders who control slightly less than half of the company shares support replacing CP CEO Fred Green with Harrison, according to a study by Brendan Wood International, a financial services research firm. Most recently, a proxy advisory services firm castigated CP for “an enduring failure of board leadership” and endorsed the Pershing Square slate.
“Because the dissidents have demonstrated a compelling case that poor board oversight has allowed the company’s performance to drift further and further below both its peers and its potential over at least half a decade, it seems clear that change on the board is needed,” according to the Institutional Shareholder Services report.
Bringing on Harrison, CP argues, would jeopardize implementation of a multiyear plan to pull down operating ratio to 70 to 72 percent within three years. Railroad directors cite an analysis by railroad consultant Oliver Wyman that said the Pershing Square goal was unrealistic. CP had an operating ratio of 80.1 percent in the fourth quarter, compared with a ratio of 66.2 percent for CN in the same period.
While agreeing it needs to become more profitable, CP says direct comparisons to its larger Canadian rival are unfair. That’s because CP runs on more challenging terrain prone to harsher weather, and CN has a stronger presence in major industrial centers such as Ontario and Quebec. CP also argues CN gained an infrastructure edge by not being privatized until 1995.
Railroad management also has shot back that Pershing Square, which owns 14 percent of the railroad, hasn’t explained how it would drive the operating ratio to 65 percent by 2015 other than by bringing on Harrison. Pershing Square has been scant with details, but a survey of how Harrison manages, along with criticism leveled against CP by the hedge fund’s CEO William Ackman, provide a reasonable vision of what CP would look like under the former CN head.
First and foremost, Harrison would likely push for tighter scheduling, forcing shippers to arrange more of their shipments on the railroad’s watch, instead of at their convenience. Similar efforts implemented by Harrison at CN and Illinois Central raised the ire of some shippers, but he has proved again and again to be resistant to such complaints. The approach likely would bring better balance into the hubs and improve train density.
“Why should we run across the country 60 to 70 miles per hour, so that we can provide third- or fourth-morning service to a certain market, and get to the hub center and let (containers) sit in the hub center for seven days? We become a warehouse, not a transportation service. And if we don’t have a place to put the containers, they have to stay on railcars, and then people don’t have the cars for the reverse move,” Harrison told The Journal of Commerce in 2005.
The average dwell time for a CP carload in the first quarter fell 22.6 percent year-over-year to 16.4 hours, compared with an average time of 14.8 hours for CN carloads, according to a report from transportation consultant Stifel Nicolaus. Along with running longer trains, CP is running faster trains, with average train speed increasing 24.8 percent in the first quarter.
Despite the gains, Ackman argues changes aren’t coming soon enough, and Harrison is the ticket to bring a new level of efficiency to the company.
“Hunter believes in precision railroading,” said Larry Gross, senior consultant for freight transportation analyst FTR Associates. “Tradition is not a meaningful thing in his purview. He believes, ‘We are here to deliver a service, and we expect to be paid for it.’ ”
Despite the potential shakeup in scheduling, some shippers will welcome the promise of greater reliability. Others won’t, and threats of such schedule tightening might be why some of CP’s major shippers have rallied behind railroad management. Teck Resources, the railroad’s largest shipper; James Valley Grain, a U.S. Midwest shipper; and Mosaic, a potash shipper, have voiced support for Green and his team.
“As CP’s largest customer, we’ve been pleased with their dedication to ensuring that we get the rail service we need and their deep understanding of our current and long-term needs. That is why we recently increased the volume of business we allocate to CP, and, today, both companies are seeing growing economic returns,” said Don Lindsay, president and CEO of Teck Resources.
Harrison could look to cut less profitable lines and those that don’t fit into core operations, said Tom Finkbiner, senior chairman for the Intermodal Transportation Institute. The Dakota, Minnesota & Eastern Railroad is one potential segment Harrison might sell off.
“Simplicity. That’s how he operates. Paring down the network is what you do when you want to cut costs and run a tighter operation, ”Finkbiner said. “If you concentrate your tracks on major arteries, you bring your costs down.”
Pershing Square has pointed to the $1.5 billion acquisition of DM&E line in 2008 as a “blunder” illustrating board incompetence because the board spent up to 40 percent too much on the line. The 1,100-mile line runs through South Dakota, Minnesota, Iowa, Wyoming and Nebraska. CP has defended the acquisition by pointing out the line is well-placed to tap the Bakken crude oil boom and earlier this year opened a North Dakota hub initially capable of handling 35,000 barrels a day.
Pershing Square said improved reliability will bring back intermodal business CP lost to CN because of poor management. CP intermodal volume in the first quarter increased 3.3 percent year-over-year, an improvement from the 6.8 percent drop in 2011. The railroad quadrupled its earnings last quarter, which Ackman promptly dismissed as caused largely by more favorable weather in the first three months of 2012.
True or not, the railroad boosted revenue 18.3 percent to nearly $1.4 billion on an 8.3 percent volume increase. The “momentum CP has built” would be disrupted with Harrison at the reins, Chairman John Cleghorn wrote to investors on May 2. He said it appears Harrison and Pershing Square want to cut costs by nearly $700 million by 2015, equaling the cost of roughly half of the railroad work force or more than all the expenses tied to leases, depreciation and maintenance of the locomotive and railcar fleets.
“In short, Pershing Square is proposing to make drastic and unrealistic cuts to one of the smallest of the Class I railroads to achieve (operating ratio) targets at a rate no management team has ever delivered,” Cleghorn wrote.
Signaling a commitment to boost profitability, CP in January raised its capital spending plan to as much as $1.2 billion. Aside from running faster and heavier trains, the railroad also cites a spate of multiyear contract signings with major shippers as proof the multiyear plan is paying off. CP adds that cost control initiatives, aimed at boosting labor productivity, capacity and operating efficiency, will deliver operating income benefits of $180 million by 2014 and $235 million in 2016.
Ackman shrugs off the multiyear plan as a “rebranding” of previous initiatives, which also failed to boost profitability fast enough. Many shareholders appear to agree with him, considering the Brendan Wood report and the recent endorsement of the Ontario Teachers’ Pension Plan, the 16th-largest shareholder and one of Canada’s largest pension funds.
The extent of change shareholders will see, however, could fall short of promises made ahead of the proxy vote. The Children’s Investment Fund Management and 3G Capital Partners, two activist hedge funds, dropped their push to curb CSX Transportation capital spending after their elected directors realized it was key to boosting profitability. Still, whether it’s tighter scheduling, selling off lines or something else altogether, Harrison sees room for improvement. If elected, the push by the American CEO rock star to shake up the traditional Canadian railroad could be more exciting for shippers than the proxy war that came before.