Are railroads hiding behing the "Growth Capital" moniker?

Implications: “growth capital” may really be the result of a railroad’s failure to actively manage their physical plant in a way the ensures capital investment  and disinvestment closely maps to changes in traffic volumes from year to year and from corridor to corridor.

Analysis: How much “Growth Capital” are railroads investing in?

When railroads buy new rails and ties, the vast majority, “Replacement”, goes to replace track that has worn out.  The remainder, “In Addition”, goes to new lines, new yards, etc.  Nominally, the “In Addition” portion is “Growth Capital”. 

However, at the same time railroads are deploying growth capital, they are also tearing up under-used tracks on light density corridors.  If a railroad has 10,000 miles of track, and it lays 1,000 miles of new track but tears up 2,000 miles of old, is the 1,000 miles of new really growth capital?  One may argue it is not – the railroad is effectively moving infrastructure from locations where it is not needed to locations where it is needed in response to changing traffic patterns.  

Investors are interested in understanding how much of a company’s current capital is “growth” versus replacement capital.  Presumably the “growth” capital will go away in future years, improving a company’s cash flow.  In addition, if a railroad builds infrastructure to the point that it is no longer capacity constrained, that railroad will lose much of its pricing power and lose the ability to use price as a yield management technique.  

There are four ways to characterize the amount of growth capital a railroad is spending:

1)    Assume the total change in track miles year over year is the total growth (as above) Growth = New Miles Track less Track sold, abandoned, removed

2)    Use each railroad’s reported amount of growth capital that they often give as guidance in their quarterly financial reports.  We have found these numbers are not reliable, as railroad numbers can vary wildly from year to year and employ fuzzy definitions of “growth” as to whether the growth has already occurred and they are reacting to it or if the growth is anticipated and they are getting ready for it. 

3)     Use annual figures reported to the STB for “ties laid in addition” and “rails laid in addition”.  These accounts are clearly defined but again do not seem to be well adhered to or enforced.  Presumably for each new mile of track a railroad is building, they will need to consume a given number of  ties and of rails.  However, with different weight of  rail, the mix of concrete and wood, and the mix of  relay components and new components, these numbers are difficult to reconcile.  We make the assumption that miles of new track is the greater of that implied by the miles of new rail laid in addition (divided by two rails per track) and the miles implied by the number of new ties laid in addition.

4)    Finally, growth capital at the highest level is simply the amount of additional capital required to support traffic growth.  If one assumes capital is proportional to gross ton miles, then one would expect that a 1% increase in GTM would require a 1% increase in capital, assuming track condition was at steady state replacement levels, and assuming no change in component lives, maintenance practices or track density.  This  is the definition of growth capital we prefer to use.    

We can isolate and quantify the major drivers of track capital spending.  Our hypothesis is that improvements in technology and maintenance practices, coupled with the economies of scale of increased GTM per track mile more than offset the need to increase capital spending due to traffic growth. 

Rather, what railroads and investors perceive as “growth capital” may simply be the symptom of a railroad’s failure to actively manage their physical plant in a way the ensures capital investment  and disinvestment closely maps to changes in traffic volumes; changes that occur from year to year and from corridor to corridor.