Renaissance: Rails, Capital & Capacity Under Challenge Anthony B. Hatch – abh consulting 155 W68th Street NYC (212) Fall Forum ATLP/NITL 2007 Washington DC October 15, 2007

Railroads at historic tipping point Capacity issues across all modes Capacity issues across all modes Volume increasing – right? Volume increasing – right? Share increasing Share increasing Rates increasing Rates increasing Services levels (yes) increasing Services levels (yes) increasing Returns increasing Returns increasing But pushback (shipper/regulator/union also increasing) But pushback (shipper/regulator/union also increasing) A secular, not a cyclical story A secular, not a cyclical story Capacity and infrastructure – and competitor - issues remain Capacity and infrastructure – and competitor - issues remain Not fully reflected in the market? Or is this just another cyclical slowdown? Not fully reflected in the market? Or is this just another cyclical slowdown?

Street influence on RRs – and Why that affects ALL stakeholders Battle for cash Battle for cash Management’s reactions to pressures Management’s reactions to pressures Investors, competitors, regulators, politicians, labor – oh, yes, and customers Investors, competitors, regulators, politicians, labor – oh, yes, and customers Short term decisions/long term consequences Short term decisions/long term consequences

Show Me the Money Share Price is the Indicator – over time! Share Price is the Indicator – over time! Cash (Flow) is King Cash (Flow) is King High ROIC = High Stock Price High ROIC = High Stock Price And Vice Versa And Vice Versa Key is the phrase “through a cycle” Key is the phrase “through a cycle” Old Model: Disinvestment Old Model: Disinvestment New Model: TBD (But CP gives us a clue) New Model: TBD (But CP gives us a clue)

Spending $: Mgmt.’s #1 Decision Capex for Maintenance – “base” Capex for Maintenance – “base” Capex for Capacity, Service & Growth Capex for Capacity, Service & Growth Dividends Dividends Share Buybacks Share Buybacks M&A – Strategic M&A – Strategic M&A – Non-strategic (conglomeracy) M&A – Non-strategic (conglomeracy) How management allocates indicates confidence & direction and impacts all stakeholders How management allocates indicates confidence & direction and impacts all stakeholders

Virtuous Circle Better returns (half finally earn returns equal to the cost of capital) Better returns (half finally earn returns equal to the cost of capital) Better stock prices Better stock prices Better revenue prospects – up double digit ’04-06 Better revenue prospects – up double digit ’04-06 Equals more investment – capex up sharply Equals more investment – capex up sharply Equals more capacity, better service Equals more capacity, better service …equals better returns and growth…. …equals better returns and growth….

Sources of capital FCF – booming at most carriers (capex vs. ROIC) FCF – booming at most carriers (capex vs. ROIC) Governments – states, PAs, Feds Governments – states, PAs, Feds Governments – Canada as contrast Governments – Canada as contrast Traditional Street sources & Banks Traditional Street sources & Banks Institutional investors Institutional investors Hedge funds Hedge funds Private Equity/Infrastructure Funds (still?) Private Equity/Infrastructure Funds (still?)

New Sources of Capital – Threat or Opportunity? Fortress-RailAmerica/FEC (etc) Fortress-RailAmerica/FEC (etc) Infrastructure Funds (Toll Roads) Infrastructure Funds (Toll Roads) Hedge Funds & “Activists” (TCI) Hedge Funds & “Activists” (TCI) Share repos – UNP, BNSF and especially CSX Share repos – UNP, BNSF and especially CSX C-1 Buyouts (CP) C-1 Buyouts (CP)

Threats to the Renaissance? Cyclical vs. secular argument Cyclical vs. secular argument New Congress –impacting labor & shippers New Congress –impacting labor & shippers Rereg – the MAD answer Rereg – the MAD answer Execution: service Execution: service Execution: merger Execution: merger Hedge fund investment reality – or the perception Hedge fund investment reality – or the perception Liquidity? Liquidity?

Railroad Stock Prices January 2001 – Mid-Year 2007 Index Jan 2001 = 100 Sources: MSN and CSI, Inc.

S&P 500 and Railroads Monthly Data January 1980 – April 2007 Index Jan = 100 Sources: MSN and CSI, Inc.

*BNSF, CSX, NS, and UP Source: Business Week Even With Booming Traffic, Rail Earnings Are Substandard Median Return on Equity in 2005 (S&P 500 companies)

RR CoC vs. ROIC -stocks have done well but… they still trade at a discount to all stocks Source: Surface Transportation Board Cost of Capital Return on Investment

Railroad Capital Expenditures Class I Railroads Billions Source: Railroad Facts, AAR

Capital Expenditures as % of Revenue Source: Census Bureau, EEI, AAR Food – 2.6% Transportation equipment – 2.8% Petroleum & coal products – 3.0% Wood products – 3.0% Average all manufacturing – 3.5% Chemicals – 4.4% Nonmetallic mineral prod. – 5.4% Paper – 4.7% Fabricated metal products – 3.5% Electric utilities – 11.6% Class I RRs – 17.8%

Railroad Performance Class I Railroads Index 1981 = 100 Source: Railroad Facts, AAR Productivity Volume Revenue Price

Intermodal Growth Drivers Domestic and International Globalization Globalization Trade Trade Railroad Cost Advantages Railroad Cost Advantages Share Recovery From Highway Share Recovery From Highway Truckload Issues Truckload Issues

RRs and Investment Is growth affordable? Capex up 10% in ’07? Is growth affordable? Capex up 10% in ’07? Can the intermodal model extend to carload? Can the intermodal model extend to carload? Is additional capacity necessary? Desirable? Is additional capacity necessary? Desirable? Wall Street’s constrictive role (“fighting the last war”) – changing? Wall Street’s constrictive role (“fighting the last war”) – changing? Is this disconnect between the Renaissance and the Street the opportunity of a lifetime? Is this disconnect between the Renaissance and the Street the opportunity of a lifetime?

Serious U.S. Transportation and Congestion Problems High Cost of Highway Maintenance and Construction High Cost of Highway Maintenance and Construction Interdependence of Modes Interdependence of Modes $67 billion per Year Drag on Economy $67 billion per Year Drag on Economy Demand for Freight Transportation to Double by 2020 Demand for Freight Transportation to Double by 2020

Railroad Issues Fall 2007 #1 is Economic/industrial status – recession? Perfect Landing? Etc? #1 is Economic/industrial status – recession? Perfect Landing? Etc? Service metrics – recovery or a meltdown (again)? The key behind shipper/regulatory angst? Service metrics – recovery or a meltdown (again)? The key behind shipper/regulatory angst? Trucking s/t surplus but – l/t troubles a secular issue Trucking s/t surplus but – l/t troubles a secular issue Capacity – coming shortage? Or “creative tension”? Capacity – coming shortage? Or “creative tension”? Intermodal – new king of the hill Intermodal – new king of the hill Coal and Grain: Comeback? Thanks to oil! Coal and Grain: Comeback? Thanks to oil! Ethanol – growth or Paying Peter… Ethanol – growth or Paying Peter… Is Growth Affordable? (Who will pay?) Is Growth Affordable? (Who will pay?) Alliances vs. Mergers? Big projects in Canada, Mexico and Wyoming Alliances vs. Mergers? Big projects in Canada, Mexico and Wyoming Labor – Coming shortage? Labor – Coming shortage? Safety and security – new risk? Who pays? Safety and security – new risk? Who pays?

Intermodal’s Enduring Questions Lots of moving parts Lots of moving parts The improved ROIC of RR Intermodal ’03- ’06 is the essence of the Railroad Renaissance The improved ROIC of RR Intermodal ’03- ’06 is the essence of the Railroad Renaissance Long term volume growth rate of 5-7% Long term volume growth rate of 5-7% Long term pricing growth rate 3-4% Long term pricing growth rate 3-4% True International drives the train True International drives the train Will “True” Domestic join the party? Will “True” Domestic join the party?

Coal and Ag – Bulk Comeback New growth mode? New growth mode? Emissions and environmental issues Emissions and environmental issues Oil prices and coal Oil prices and coal Politics and coal; and grain/rereg Politics and coal; and grain/rereg Ethanol Ethanol Exports Exports Feed Feed

Railroad Rates- the old story Class I Railroads, Revenue Per Ton-Mile Cents Source: Railroad Facts, AAR Current $: Down 1% since 1980 Constant $: Down 54% since 1980

Pricing - the new paradigm Rates up 3% in ’04 – post-Staggers best Rates up 3% in ’04 – post-Staggers best Up 11% in ’05 (Secular rate of 2-3%?) Up 11% in ’05 (Secular rate of 2-3%?) Fuel surcharges similar to TL Fuel surcharges similar to TL Yet Price Gap to the highway widening, even in ’05 and ’06 YTD Yet Price Gap to the highway widening, even in ’05 and ’06 YTD Capacity (still) short across all freight modes, despite temporary surpluses Capacity (still) short across all freight modes, despite temporary surpluses Rails moving toward tariff and spot markets Rails moving toward tariff and spot markets Conclusion: Best Ever Rate Environment “The new Golden era” – cost of capital within sight; not there yet

Railroad Employee Productivity Class I Railroads, Ton-Miles Per Freight Service Employee Source: Railroad Facts, AAR Millions

Rail Service Cycles Is the recent improvement in the metrics sustainable? Systemic? Is the recent improvement in the metrics sustainable? Systemic? Is it a product of huge capex injection and IT? Is it a product of huge capex injection and IT? Or, is it merely a product of lower volumes/less stress on the network… Or, is it merely a product of lower volumes/less stress on the network…

Rail Regulatory Risk CTA reform not a major issue; Canadian shipper/provincial/carrier cooperation at all time levels CTA reform not a major issue; Canadian shipper/provincial/carrier cooperation at all time levels STB reviewing a number of issues, with some expected minor shipper “wins”, as rates improve after years of subsidy STB reviewing a number of issues, with some expected minor shipper “wins”, as rates improve after years of subsidy F/S covers 15-20% of revenues (less than 10% of CP) F/S covers 15-20% of revenues (less than 10% of CP) Small shipper, cost of capital, paper barriers, other STB issues under review also BUT: Small shipper, cost of capital, paper barriers, other STB issues under review also BUT: Labor a wild card Labor a wild card Potential new Revenue Adequacy rules not (at all) linked to reality Potential new Revenue Adequacy rules not (at all) linked to reality Haz-Mat/Security an emerging problem Haz-Mat/Security an emerging problem AAR best lobby in DC – re-reg chances virtually zero, but too much time will be spent on DEFENSE AAR best lobby in DC – re-reg chances virtually zero, but too much time will be spent on DEFENSE ITC chances reduced ITC chances reduced