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How GE beat Caterpillar with new locomotives

As rain pelted the windows at General Electric’s offices in Chicago, executives debated whether to build a low-emission locomotive. The deliberations went on for two days, and to keep the mood upbeat, anyone with a negative comment had to toss cash into a jar on the table.

Though predictions were for anemic demand, the team voted to press ahead and spend $200 million to develop the engine. The decision in April 2013 turned out to be pivotal, and not just for GE.

Caterpillar took industry forecasters at their word and may not have a model until 2017 that will meet U.S. pollution standards that kick in Jan. 1. GE’s will be ready next year.

That gives GE a lock on sales to U.S. railroads, the biggest buyers in a $2.5 billion North American market, at just the right time. Their fleet spending is taking off to meet a boom in consumer demand, surging crude oil shipments and the hangover of a record 2013 grain crop.

“The market happened to turn. We placed a strategic bet to be here should it turn, and it happened to turn,” said Russell Stokes, chief executive officer of GE’s transportation unit. “We’re clearly seeing indicators that it’s going to be a good 2015 for the railroads.”

The wager secures GE’s spot for at least a few years as the world’s largest locomotive maker, and it sets Caterpillar back in its goal of grabbing enough market share to be a closer No. 2.

As recently as four months ago, GE didn’t have a single order for the new model. Then Union Pacific and other carriers changed plans, faced with volumes causing gridlock on some tracks.

Now 1,000 orders have poured in, according to GE, which doesn’t identify buyers. That could bring $3 billion in revenue to the transportation unit over the next three years.

Strong orders for locomotives led General Electric to add a second shift this summer at the huge plant it opened last year in far north Fort Worth, just west of Texas Motor Speedway.

Last month, GE officials told reporters that the 1-million-square-foot Fort Worth plant was turning out 1.2 locomotives a day and employs about 500 workers.

Taken by surprise

The demand for the low-emission model surprised Caterpillar, which had figured the market for new engines would be “hardly any at all” in 2015 and 2016, Michael DeWalt, vice president for strategic services, said at a Citigroup conference Sept. 23. “Well, that situation changed around a little bit.”

Caterpillar, which acquired engine maker Electro-Motive Diesel four years ago, had scrapped the new-model program that was on the boards at EMD after concluding that railroads would hold off on purchases.

“We didn’t really like what we saw in terms of the end product with that engine,” Caterpillar CEO Doug Oberhelman told analysts on a July conference call. DeWalt said the company expects its low-emission model to be ready in 2017.

Freight locomotives use diesel engines to produce electricity for the motors that turn the wheels. Since 1998, manufacturers have been through periodic updates to meet anti-pollution rules — this is the fourth, called Tier 4.

The reductions in this upgrade will account for 70 percent of the cuts required by the government. Exhaust gases will be recirculated back into the engine, a process that requires an enhanced cooling system.

“They saved the toughest for last,” said Tina Donikowski, chief of GE’s global locomotive unit, who was at the Chicago meeting, an annual planning session for the transport business.

The executives around the table needed to make a thumbs-up-or-down decision on the Tier 4 model, which meant committing $200 million to development, Donikowski said. Waiting any longer would have made a rules-compliant engine in 2015 impossible.

“It was a move that took a good amount of discussion and courage,” she said. The money collected in the jar was donated to charity. GE declined to say how much the negative commentators threw in.

Carriers weren’t clamoring for a new locomotive when the GE team met 17 months ago. Union Pacific, for one, had expected to buy only 200 new engines this year and none in 2015, according to Chief Operating Officer Lance Fritz. Then the boom didn’t slow down. Freight carloads jumped 7.1 percent in the second quarter, the most since late 2010.

“With the volume growth we’ve seen this year, it’s just going to force us to get in the market” in 2015, Fritz said. “We’re in the best of worlds right now in terms of lots of demand and trying to figure out how to handle it effectively.”

Union Pacific, which added 29 locomotives to its 2014 order, is studying Tier 4 purchases and testing five of the new locomotives’ prototypes, Fritz said.

Fort Worth-based BNSF Railway, the largest railroad by revenue, is buying 500 Tier 3 models this year and hiring 6,000 workers as it tries to relieve the worst track congestion in the U.S. industry.

About half the locomotives are being built at GE’s factory in far north Fort Worth. Last month, it said it had already taken possession of 339.

EPA approval

At Connecticut-based GE, the transportation unit expects to sell 750 locomotives this year and is working with suppliers to increase output for 2015, Stokes said. It expects Tier 4 production to begin in the second half of next year. The machine’s design requires approval from the Environmental Protection Agency.

The GE unit’s revenue was up 54 percent in the five years that ended in 2013, reaching $5.89 billion. Caterpillar doesn’t break out results for its division but said in July that it has more than doubled locomotive sales since the acquisition of EMD, which had 2009 revenue of $1.8 billion.

With companywide sales of almost $56 billion last year, Peoria, Ill.-based Caterpillar, the largest maker of construction and mining machinery, can afford to forgo new-locomotive sales for two years, said Andy Kaplowitz, an analyst with Barclays.

“They’re willing to absorb the drop in ’15 and ’16,” Kaplowitz said. “It’s worth it to make sure the engine is done correctly.”

Tier 4 required a new motor design in what GE’s Donikowski called a “very, very intricate recipe.” The new six-axle locomotive will be 4 feet longer than Tier 3’s 68 feet. It will cost up to 20 percent more than engines on the market now, Donikowski said.

Those sell for about $2.5 million, according to railroad executives.

Caterpillar’s DeWalt said there’s no question that U.S. railroads “find themselves in a need for a bit more power” than most anyone in the industry had expected.

“They may end up buying more or at least want more than we thought they were going to need,” he said. “We’ll see how that plays out.”

This report includes material from the Star-Telegram archives.