Proposal to Extend Safety Deadline for US Freight Railroads Is Credit Positive

Proposal to Extend Safety Deadline for US Freight Railroads Is Credit Positive

Last Tuesday, a congressional committee proposed a five-year extension of the 2015 federal deadline for US freight railroads to install a multi-billion-dollar safety system called Positive Train Control (PTC) on some 60,000 miles of track. If the proposal passes, the extension would be credit positive because it would allow railroads to stretch out the capital spending requirements and give them more time to develop the complex technology.
The railroad industry estimates it will cost $5 billion to implement PTC, plus hundreds of millions a year thereafter for maintenance. Following industry lobbying, the US House Transportation and Infrastructure Committee tucked the PTC deadline extension into a sweeping transportation and energy infrastructure reform bill.

Although the railroads would benefit from an extension, it would carry some risks. Project costs would be subject to price inflation over the extended timeframe. Furthermore, there is the possibility of additional regulatory requirements or technological advances that could increase the scope, complexity and cost of implementation.

The cost to implement PTC will be borne mainly by the four largest US Class I railroads: Burlington Northern Santa Fe, LLC (railroad subsidiaries A2 stable), Union Pacific Corp. (railroad subsidiaries Baa1 positive), Norfolk Southern Corp. (railroad subsidiaries Baa1 stable), and CSX Corp. (railroad subsidiaries Baa3 positive), and each railroad’s share of the investment will be largely a function of the size of its network. In aggregate, we expect that railroads will have ample liquidity to absorb the project’s costs, even if they significantly exceed the $5 billion estimate. In total, the railroads generate about $4 billion in free cash flow on more than $60 billion in annual revenue. Their aggregate cash reserves ranged between $3 billion and $5 billion in 2011, even as they paid out around $10 billion for dividends and share repurchases.

A five-year extension of the deadline would increase the railroads’ flexibility in covering PTC costs. There would likely be a lesser call on capital between now and the original 2015 deadline, possibly freeing some capital for more-profitable network upkeep and growth initiatives. Nevertheless, if PTC costs were to spiral well beyond industry estimates, there could be a negative impact on their operations, pricing and financial position.
The effect on pricing is one of the main concerns. We expect that the railroads will attempt to pass through at least some of the PTC costs to customers. Chemicals shippers are the most likely to face such surcharges because the PTC mandate specifically targets tracks that carry passengers and “toxic by inhalation” materials, such as chlorine. Railroads would be levying these charges amid a trend towards shipper-friendly decisions at the Surface Transportation Board (STB), which rules on rate disputes. Chemicals shippers are preemptively arguing that railroads would reap benefits from PTC, including fuel savings and more efficient utilization of rail equipment and network capacity.