The operating ratio at every Class I railroad fell below 65% for the first time in 2019 as the industry average improved to an all-time low of 61.9%.
The increased profitability came as overall industry revenue was down 2.3% and four of the seven Class I systems reported lower revenue. This means the operating ratio improvement was due to the industry making productivity gains and cutting costs by more than the decline in revenue.
CSX Transportation, at 58.4%, won the operating ratio crown for the second year in a row and became the first U.S. railroad to post an operating ratio below 60%.
The operating ratio measures the percentage of revenue that’s consumed by operating expenses. The industry average operating ratio improved 3 points in the past five years and 9.7 points over the past decade, according to a Trains News Wire analysis.
Independent railroad analyst Anthony B. Hatch, who coined the term “Cult of the Operating Ratio” for Wall Street’s hyperfocus on the efficiency metric, says Precision Scheduled Railroading has made the industry far more productive.
The six railroads using the late E. Hunter Harrison’s Precision Scheduled Railroading operating model are moving tonnage in fewer but longer trains, meaning they don’t need as many crews, locomotives, and freight cars — or as many mechanical forces to maintain smaller equipment fleets.
Class I railroad employment in the U.S. reached record low levels in 2019 due to the combination of a traffic slump and PSR operational changes. Overall, Class I rail employment fell 11% last year, according to railroads’ regulatory filings with the U.S. Surface Transportation Board.
The continued decline of coal traffic, along with a freight recession tied to trade and political uncertainty, posed a “confidence check” in the industry last year, Hatch says. “And yet the railroads are in really good financial condition,” he says.
The lower operating ratios put railroads in a better position to make investments in technology in an effort to catch up to the trucking industry, Hatch says. And the increased profitability also means railroads should be able to make investments that can help make continued service improvements, he says.
But there is a danger in pushing operating ratios too low.
“We’re beginning to think that an operating ratio of 60 or slightly below might be optimal,” Hatch says.
Go much lower, Hatch says, and a railroad may become so efficient that it does not have capacity for growth and could wind up chasing away business — all while raising the risk of regulatory intervention from an increasingly active Surface Transportation Board.
Canadian Pacific’s operating ratio was 59.9% last year, and Union Pacific is on track to join the sub-60% operating ratio club this year. Its operating ratio was below 60% for the final nine months of 2019 and stood at 60.6% for the year. UP has a long-term operating ratio goal of 55%.
A better measure of a railroad’s financial success, Hatch contends, is return on invested capital, or ROIC. UP and Canadian National reported ROIC in the 15% range last year, while CP’s was nearly 17% while growing its intermodal business in Canada, Hatch notes.
Intermodal has a relatively low profit margin compared to carload and bulk freight — which can be a drag on the operating ratio. But it makes a positive contribution to ROIC, Hatch says.