News & Reviews News Wire How Wall Street holds railroads hostage: Analysis

How Wall Street holds railroads hostage: Analysis

By Bill Stephens | June 21, 2022

| Last updated on February 26, 2024

Focus on operating ratio inhibits volume growth, hurts service, and prevents share gain from highway

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Man climbing on front steps of orange locomotive
A BNSF crew member reboards his locomotive after providing protection at a pedestrian crossing during a maintenance-of-way project in Hinsdale, Ill., on Nov. 6, 2021. David Lassen

The U.S. Class I railroads’ recurring crew shortages, related bouts of service problems, and a lack of meaningful volume growth are intertwined. You can lay the blame for all three problems at just one place: Wall Street.

BNSF Railway, CSX Transportation, Norfolk Southern, and Union Pacific are in the midst of the mother of all crew shortages. The lack of crews has caused congestion, which in turn has slowed the network and sent operations into a downward spiral that requires even more crews.

So transit times are up. On-time performance is way down. Angry shippers are diverting loads to trucks. And frustrated regulators are demanding answers.

There’s no doubt that current crew shortages are exacerbated by pandemic-related changes in the labor market. It’s equally certain that the railroads’ operational changes and onerous attendance policies have prompted many longtime engineers and conductors to pull the pin, further thinning the crew ranks.

But we’ve seen this movie before. Over the past decade, service has suffered due to crew shortages three times each at BNSF and CSX, four times at UP, and five times at NS, according to a tally by Loop Capital Markets analyst Rick Paterson. “It cannot be all bad luck,” Paterson told the Surface Transportation Board during its rail service hearings in April.

He’s right. The culprit is a persistent failure to keep a sufficient cushion of crews on hand to ensure that a railroad can recover quickly from unexpected surges in traffic or extreme events like hurricanes, cold snaps, and wildfires. And the reason railroads don’t keep that capacity buffer? The Cult of the Operating Ratio, as analyst Anthony B. Hatch calls Wall Street’s hyperfocus on the key efficiency metric.

This short-term focus means railroads aim to keep costs at a bare minimum and reduce them every year — even if it jeopardizes service over the long term. Paterson notes that since gaining pricing power in 2004, railroads (except BNSF) have used a simple and wildly successful financial formula: Raise rates faster than costs and nevermind volume growth. This pushed Class I operating ratios from the 80s to the 50s and ushered in a Golden Era for railroad investors.

The party is over. Investors still push for lower operating ratios, but there’s not much juice left to squeeze. If your operating ratio is 80, a 1-point improvement will boost your bottom line by 7%. Now with an operating ratio in the 50s, a 1-point improvement nets just a 3% rise in income, Paterson says.

And this focus on reducing costs and raising rates has left railroads with a hangover. Since 2004 U.S. rail traffic has grown just 0.6%, even as industrial production has risen 13%, trucking tonnage is up 40%, and overall economic output has doubled.

The only way to boost earnings now is to gain volume by taking market share from trucks. Yet investors want railroads to maintain low operating ratios. This leaves railroads stuck between the proverbial rock and a hard place.

First, much of the traffic they could pursue comes with an operating ratio that’s higher than what’s currently moving on rails. So the new business would raise the operating ratio. Second, railroads need to provide consistent service for several years before shippers will trust rail enough to shift volume off the highway. This raises costs, too, because it means doing things like keeping more crews on hand.

Trains Columnist Bill Stephens

So a growth-minded railroad’s operating ratio would rise 3% to 5% before it could land enough new volume to move the earnings needle, Paterson says. And that spells trouble. Many investors are impatient and can’t wait years for real volume growth to materialize. In the interim, an activist investor might come in and demand management change – much like what happened at Canadian National last year.

There’s no clear way for railroads, Wall Street, or regulators to break the Cult of the Operating Ratio. So we’re likely to continue to see what Paterson calls a pattern of roller coaster service that rises and falls with crew levels.

Canadian Pacific, Canadian National, and Kansas City Southern escaped crew shortages, and their service has held up as traffic has come back from the pandemic lows that prompted all railroads to furlough crews. “You never take it all the way to the bone,” CP CEO Keith Creel told an investor conference last month. It’s a lesson, he says, that the other Class I’s have learned the hard way.

You can reach Bill Stephens at and follow him on LinkedIn and Twitter @bybillstephens

34 thoughts on “How Wall Street holds railroads hostage: Analysis

  1. First let’s stop calling stock (for the minute) owners investors. They (we?) are not. They are speculators. Now that the markets are on a downward swing and interest rates are moving upwards the chasing after counterproductive stock buybacks needs to cease. The money should be put into improving and increasing service for the longer haul. The wall street financialists have destroyed most American industry–there is a reason so much is messed up in the supply chain–and are of no benefit to society as a whole. But I know it will not change until there is a real crash of our house of cards.

  2. No one has mentioned greed, pure and simple. The cash generated by the O/R craze is going into share buybacks, which makes the institutional investors and upper management of the RR’s proportionately that much richer. That, and the fact that many of the lower level management bonuses are paid on cost savings, rather than business growth and customer satisfaction, so cut, cut, cut! Truly a death spiral.

  3. Everybody likes to blame the Wall St. “bogeyman” for problems that have nothing to do with the securities industry.
    CEOs and their immediate underlings compensation is usually tied to a number of corporate “goals” including the stock price. I can guess that this also applies to the RR industry.
    A lot more goes into a stock price than one metric such as the O/R.
    What other industry has an equivalent of the O/R?
    Securities firms rate stocks on cash flow, debt, p/e and more.
    A badly managed company (losing customers, union problems, threats from regulators) is run by inept managers, not Wall St.

    1. Yes, there is a book written by an economist (name escapes me) who said the US auto industry started failing when GM started tying bonuses to the stock price and less on sales. Ford and Chrysler soon followed.

      Companies run by inept people do fall down, but there are many examples of where shareholder activism undermined the executives ability to perform as they needed.

      Some point to Carl Icahn as the one who started the modern trend of buying 5% of a companies stock and then put pressure on the board to raise the dividends because the company was hoarding cash.

      Can it stifle innovation? Yes it can. Cell phone radio maker Qualcomm had stockpiled cash because they were about to come out with a new CPU that ran Microsoft Windows. They needed the cash to get the new CPU into a stable market condition. Broadcom saw all the cash stockpiled on their annual report and made a hostile offer for Qualcomm. Qualcomm had to use the cash to fend off Broadcom and cancelled the CPU project. Broadcom was going to use a bunch of debt to get Qualcomm and then use the cash to pay it off. Innovation stifled and Qualcomm learned a hard lesson. They wised up, acquired Nuvia and will try again.

  4. Hate to bring up not-so-ancient history, but having just attended the MRHA (Milwaukee Road Historical Asso.) convention this past weekend in Milwaukee (BTW a wonderful organization I encourage others to join, in part for the terrific quarterly publication edited by Mike Schaffer) an ongoing discussion was about the demise of the Milwaukee Rd. While there was talk of corruption, the over-riding consensus is that the Milwaukee neglected infrastructure investment in order to pay dividends and boost the stock price. We know how that worked out. A lesson to keep in mind.

    1. Lots of precedent. Most recent was Sears.

      Held hostage by pension funds who wanted no change in their dividend, Sears had to shed assets to keep the dividend afloat. (Sears Tower, Discover Card, DeanWitter Financial Services, Allstate Insurance) Then the leadership all left. (They saw the end was inevitable)

      New leadership merged with KMart to get access to their real estate so it could be sold and get some debt refinanced. Then they sold off their brands, Craftsman, Kenmore, DieHard etc.

      All that was left was real estate with alot of 40 year old buildings on them.

      Everytime the board was approached to cut the dividend so they could invest in a store refresh, they were denied. When they wanted to open a WalMart competitor (Sears GrandCentral) and asked to cut the dividend so they could finance it, nope.

      If the pension funds that held Sears stock had a little more long term view, Sears would still be around today. But it was all about the dividend, customers be damned.

  5. This just reinforces my increasing belief that nationalization is the only solution. A few years from now, the Class Is will be flooded with Conrail Blue.

  6. Argh! I’ve been screaming this message for years now!

    There are many ways to reduce operating costs other than trimming crew bases down to near zero safety stock.

    How about speeding things up (and I don’t mean max authorized speed) so that crews can get close to what over the road truckers do in a day.

    Warning! You might actually have to work at doing things differently and invest in the RR to make this happen.

    CEOs are also paid for having vision. A trained dog could raise stock price by cutting costs.

    What’s the vision RR CEOs? Going out of business sale?

    1. DON—– Best post ever.

      I wish the railroad CEO’s would read Don’s post (if they can read) but it wouldn’t do any good, their minds are made up.

      We’ve gone downhill from visionaries like Graham Claytor and John S. Reed, to EHH. Funny thing is, EHH is dead but he’s still running several railroads. About as well as when he was alive.

    2. Pay very close attention Mr. Landy. I worked for John Reed. I liked John Reed and I was at John Reed’s memorial service in April 2008 when the organist played our favorite song as the postlude. I also helped write Fred Frailey’s new history of the Santa Fe. Regrettably Mr. Reed was no visionary. He passed up the opportunity to have Missouri Pacific as a merger partner.

    3. He later said that was the worst mistake he ever made. But if they had merged MP management would have probably taken over the Santa Fe (like it did the UP, like Frisco people took over the BN, like Douglas Aircraft took over Boeing). I believe that not merging probably saved the Santa Fe and its service reputation. I think Krebs was a lot better manager than Davidson would have been.

  7. The company I worked for my entire working career at one time 12000 employees were managed by the old guard (founders family) they cared but never allowed the bankers to push them around. The management were always happy with stocks generally hovering around $25 to$30 CDN. The company was named the most sustainable company in Canada for many years.
    Employees ALWAYS came first, non unionized. Had a good profit sharing program that was decades old, actually formed the basis of a great pension fund.
    The investment community was always wondering why they could not get more and employees get less (profit sharing). I can remember at least one hostile take over by a corporate raider that eyeballed the money.

    So where I’m coming from is if indeed there were strong leaders in the railroad management they could satisfy both Wall Street and the employees. Long term vs short term but it doesn’t seem anyone of them have the nerve to stand up for the workers who actually make the company.

    It’s called sustainability.

  8. There is a way for regulators the break the “Cult of the Operating Ratio”, have the FRA or STB publish a rule that would enter the Federal Register that sets a minimum OR(Operating Ratio) at 65. There, end of story, no longer would there be a fight to be the first to reach 50, because you couldn’t go lower than 65. I’m pretty sure there’s a legal way to write it as well. Also, BNSF does not fall to this issue as they are 100% owned by Berkshire Hathaway and WS has no say in how BNSF is run, only BH would, and that’s not how Buffett and company work.

  9. I believe Krebs had to drastically slow his double tracking of the the “Transcon” on “orders” from Wall Street.

    1. Let’s pivot to UPRR Sunset Route. UP stopped or paused capacity improvements because there wasn’t as much traffic as before. Chicken and egg, whatever.

      Beat up on Wall Street all you want, I’m hardly an expert on the subject. If CEO compensation is tied to share price, that protocol takes care of itself when share prices go down — as is inevitable. In other words, when a major carrier goes bankrupt … which will happen if they continue to run themselves as they do now.

      Point the finger at Wall Street. Executive compensation is decided in the Board Room by the BOD. Blame the BOD.

    2. He didn’t have the money., He got a single bid for double-tracking the entire ATSF line which was much lower than the eventual cost but the railroad didn’t have the money to pay for it all at once. It would have had to borrow a huge amount of money which wasn’t feasible.

  10. May I get back to comment #1 by Mr. Marker? I have heard endless radio and TV worship of our sacred truckers and how the economy would halt without them and how, despite those crushing diesel fuel prices, they are trying their best to keep things going. Not one word either from a railroad advocate, or a railroader, employee or management, calling in or posting to say “Hey, what about us?”

    1. Because Mr. Pins if you’ve got it a truck brought it. J-I-T used to earn just-in-time Now it means just-in-truck.

      BTW, Rob Krebs had his bogeyman. His name is Warren Buffet.

  11. Part of the reason stuff isn’t getting fixed as fast as it ought to be gets back to the financialization drum I’ve been beating for the last couple of years. As Julian Brigden of MI2 Partners so pithily points out, “CEOs are literally paid to drive that equity price higher, not to make a bloody product. And the minute those prices start to wobble, they start saying people off.” Which may be one reason the Street started counting headcount reductions even before Covid hit.

  12. I strongly disagree with Bill’s basic premise – that Wall Street is to blame. It’s the company leadership that is to blame. The “Street” doesn’t decide what to cut and what to keep – the company leadership does. It’s leadership’s responsibility and obligation to inform and explain to investors what is happening to their company and to convey confidence that they know what they are doing. We have a generation of managers who don’t know the business or can’t lead the companies they work for. So they are easily scared by the investment firms. I can’t imagine a Rob Krebs, Stanley Crane, Robert Claytor, John Kenefick nor Hays Watkins being so intimidated. Those “old guys” made it through far worse times than we face now.

    1. I am not so sure about that. If a Flagler, Plant, Barringer, Gould came along and bought a large share of your stock and got themselves on your board, you say they would stand up to them? If Krebs had Elon Musk’s money, he probably would have bought out the hedge fund just to make a point, but he didn’t, so they probably would have just yelled at each other in the board room.

    2. Yes, exactly. Just as Buffett bought out BNSF. Institutional investors hold sway over any company they choose to. Yes, corporate officers’ first responsibility is to their shareholders, and that includes institutional investors. Individual investors long ago list any influence over corporations.

    3. The old guys worked in an era where Wall Street had a much more modest expectation on return than perhaps the current era.

      That said I like your thought. A very small group of leaders within a company make these decisions. Their compensation is highly tied to share price. They are making decisions in their own best interest, though they attempt to argue it is for the best interest of the entire company.

      Michael Ward was 59 during the TCI fight and must have wanted to continue to work. Hunter shows up in early 2017 when he was 67 and Ward caves. Was it because he was outflanked? Yeah. Did he also have his money? Oh yeah.

  13. Should be on the cover of your next issue with more in depth interviews with Hatch and other hedge managers (positive and negative). While Class 1 CFO’s would probably defer to go on the record, you could interview some former CFO’s who aren’t so bound by clauses. An interview with TCI would be a great way to provide some alternative views as they probably don’t see things the same way. Perhaps Bill Ackman would like to share his thoughts, he does like to speak to the press.

    This deserves more than a news wire column.

  14. Railroads are common carriers and in the public service. Profits are allowed, even expected, but they have a public purpose.

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