CP Rail’s Hunter Harrison finally sees the light

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Hunter Harrison aspired to build a North American railway that touched three coasts. In his ambitious quest to do it, he forgot to ask if anyone else supported the vision.

His oversight leaves a mark that will sting for some time. Canadian Pacific Railway Ltd.'s hostile bid for Norfolk Southern was to be a blockbuster – at $28-billion (U.S.), it was among the largest in Canada in the past decade. Advisers salivated over the fees.

Now that it's dead in the water, CP's CEO is left steering a company through a rough patch that plagues the whole industry. There just aren't as many commodities to haul any more.

Asked at a conference in March how he copes, Mr. Harrison cracked a pithy reply: "You pray every night."

He seemed to be only half-joking.

With the global economy showing slower growth, commodity demand has dropped, so customers are shipping less. A paradigm shift on the environment, and particularly the use of coal for power generation, has also hit railways. CP's profit is down 29 per cent in the last quarter from a year earlier, and its shares have tumbled 25 per cent from their peak.

Mr. Harrison's pursuit of Norfolk Southern was to help offset these headwinds by offering growth through consolidation. There's nothing the CEO can do about it now.

Of course, he already has plenty to be proud of, and will retire with another major victory. (He is widely expected to hand the reins to long-time deputy Keith Creel when his current contract expires in 2017.) The railway Mr. Harrison inherited in 2012 was deep in the doghouse with a cost structure that was the worst of the big ones.

Changing that hasn't been easy. Because he took power through an ugly proxy fight, insiders were largely suspicious of him. In his first three years, he fired almost 7,000 people. Another 1,000 will be out the door this year. The new CEO also rewrote the company's operating rules by lengthening trains and speeding them up. Anything to save money.

Last quarter, CP's operating ratio – a measure of its costs relative to revenue – fell slightly below 60 per cent, among the industry's best.

CP wasn't Mr. Harrison's first turnaround play, either, having embarked on similar revivals at Canadian National Railway and Illinois Central Railroad. Their rebounds were partly fuelled by industry consolidation – Mr. Harrison arrived at CN after it bought Illinois Central – so he had every reason to think acquisitions are crucial.

What he failed to see this time around is that the industry and its leaders have evolved. Which is largely why CSX Corp. rebuffed his overtures in 2014 and Norfolk Southern has now.

The so-called complacency of some rivals infuriates the hard-scrabble Mr. Harrison, who rants about their hypocrisy. The companies they run, he has said, are only as big and successful as they currently are because of consolidation.

He often leaves out that their acceptance of the current industry structure is the result of regulators, who have long suggested future mergers were highly likely to be blocked. One mega-deal would likely spawn a few more and that could severely hinder competition.

Mr. Harrison struggled to stomach this rationale. To his eyes, a merger would help remove bottlenecks in Chicago, where railways hand off cars to one another. And it would lower costs. Why build two bridges across the Mississippi when you can invest in one?

Maybe he fought so hard because he saw no other option.

"We think that fossil fuels are probably dead and it is going to take a long time to transition," he said at the March conference. "With all the issues related to environmental hurdles ... there is just not going to be any more investment in the Powder River basin or in U.S. thermal coal."

And a month earlier he acknowledged there was little more he could do on operating ratios. "We recognize and understand that the world is not built around operating ratios," he told another conference, adding that "at a point you can focus too much on the cost control aspect and it scares investors to death."

Even his ambitious merger would likely have done little to fix these problems. The roll-up game – where businesses continually acquire – has its limits. At some point you have to deal with the ugly truths.

Whether Mr. Harrison will see it this way is anyone's guess. But we do know he's more resigned now to his industry limitations, saying in interviews Monday that he won't be pursuing any more acquisitions. And with his contract's end date looming, it's possible the veteran railroader has done his last deal.

If he needs any help accepting this reality, he can find solace in his own words.

"We don't have to do this deal," he said in March. "I mean, look, Alberta beef is good, but we just got some gravy we thought was even better. ... [If] they don't want gravy on their steak, then fine."