The Railroad Week in Review:
Week Ending January 22, 2000

This underscores remarks made at a recent meeting of the Delaware Valley Regional Planning Corp's Goods Movement Committee in Philadelphia and in papers delivered at the Transportation research Board gathering in Washington. Consumers are demanding rapid access to everything, and that creates a shift in inventory management from raw material push to consumer pull. As a result transport vendors must perform to spec or be replaced by competitors who can. And part of that spec will be instant response to a transportation demand.

And so e-commerce is coming to transportation, too. RailMatch (WIR 1/8/2000) will be joined by a similar venture which lets shippers bid out transport needs on line. In Europe, The Economist (1/15/2000) reports two B2B venture capitalists are "in the process of creating a marketplace on the Internet for trading air freight capacity." Now why can't we trade rail freight capacity in the same way, once reliability issues are resolved?

Emons Transportation Group has put up a spiffy new website at www.emonstransportation.com. Check it out and you'll find it loads fast, is intuitive and easy to navigate, and is chock full of useful material. In addition to all the usual company information there are interactive features and links to business partners that should prove quite useful to customers and prospects alike. E-commerce features to enhance supply chain management are planned.

A feature not often found in small railroad presentations is a growth strategy statement. It is "to increase business with existing customers by offering better service, attracting new customers located off Emons' lines by offering rail/truck transloading and intermodal train service and engaging in industrial development activities to entice new customers to locate on Emons' rail lines." Regional rail carriers contemplating construction of a website (and all had better be) would do well to start here for ideas.

Union Pacific turned in a very respectable 95 cents per share for the quarter and $3.12 for the year, this in contract to street estimates going in of 88 cents and $3.03 respectively. This is clearly yet another instance of saying what you're going to do and then going about doing it. Recall that after my train trip over the Nebraska Triple Track (WIR9/4/1999) the operative word was "velocity" and improve velocity is exactly what they did.

As a result, service to shippers has improved markedly and they've been coming back in droves. So much so that UP has begun to be able to get back in the premium service business, meaning the ability to price on value rather than as a commodity. For both the year and the quarter revenues increased faster than carloads, and each of the six main commodity groups turned in more than a $billion in revenue.

More important, the free cash flow (FCF) picture has turned around completely. UP figures FCF as Cash Provided by Operations less Cash Used by Investing Activites. The FCF in 1999 was a positive $255 mm vs. a negative $1.3 bn in 1998, a $1.6 bn swing. A big driver was the 7% increase in operating revenues and 7% decrease in operating expenses. In other words, more money out for what they put in. And the bottom line is that UP can fund a lot more of its capex from internally generated funds, meaning less dependence on outside funding to keep the wheels turning.

The thread throughout the meeting was that, in the words of Dick Davidson, "UP will stay the course with unrelenting focus on growing out business high quality, reliable service to realize the tremendous potential of our franchise." Ten percent of that franchise is shortline business, or roughly a $billion in revenues. And, in side conversations with EVP Marketing & Sales Jack Koraleski and others I got the distinct impression the shortline focus for 2000 and beyond will be on revenue contribution more than on solving operating problems.

That's good news for the likes of publicly held shortlines like GNWR, RTEX, and RAIL, each of whom does substantial business with UP. Consider: the three commodity groups most important to most shortlines are agriculture, industrial products, and chemicals. These three account for $5 bn in revenues, and there's a lot of high-yield business in them. I have addressed these opportunities in detail in an addendum to this newsletter distributed to shortline readers. It is available to others on request.

Suffice to say UP did one helluva good job turning itself around in 1999. The street estimate for 2000 is now right at four bucks, up a third. Sounds like a nice train to be on. Got a ticket?

CSX, NS, CN and BNSF all come to town next week, and it'll be an interesting show. Last week we remarked on the NS outlook, so perhaps a few words on CSX are in order. To begin, the consensus 4Q99 eps is 20 cents and that brings the year in at $1.59 against FY98's $2.51, off 37%. Recall a month ago CSX warned us it would be a dismal quarter, so no surprises here.

What this means in terms of cash flow is net earnings of $347 mm of which $262 must be earmarked for dividends. If operating cash flow can bring in a $billion and there's an equal amount slated for capex in 2000, paying down the debt is going to be tight. The good news is that CSX still sees cost savings and revenue enhancement opportunities from the Conrail transaction. With the FY2000 consensus eps pegged at $2.74 the recent close of $32.25 is a reasonable 11.7 times that number. More important, that 2000 estimate is a 72% improvement on the 1999 consensus. The resulting PEG 2000 is a very low 0.16. The five-year growth rate is 13%, meaning this puppy ought to have some legs.

Rail Safety continues to be a key topic on Capitol Hill and last week NS reported that the just-released October 1999 FRA safety figures show "a dramatic safety improvements in the nation's railroads." NS came in with a 1.14 FRA reportable injury ratio (injuries per 200,000 man-hours), lowest among class 1 railroads, and now including the NS share of Conrail. Ironically, there is still congressional pressure to introduce even more rail safety bills even as highway and crossings accidents continue to climb. Sounds like the same bunch of Members who want whistle-blowing banned even though it's been proven that whistles not blown mean lives not saved.

Another shoe has dropped on BNSF+CN. Columnist Larry Kaufman reports in JOC that the Chemical Mfrs Assn has come out against it. At issue is the large number of captive shippers who pay significantly higher rail freight rates than do their non-captive competitors. A spokesman for the CMS is quoted as saying, "Chemical shippers pay $5 billion a year for rail transportation. [Yet] recent mergers have caused severe disruption in rail service and did nothing to improve competitiveness.''

Meanwhile, two influential congressmen, WASHINGTON - Two senior Congressmen, Bud Shuster (R-Pa.), Transportation and Infrastructure Committee chairman, and Jim Oberstar (D-Minn.), ranking member of the committee told the STB's Linda Morgan they approve of the Board's decision to consider "broader issues" in BNSF+CN. In particular these worthies praise the STB's stance on "downstream issues" (WIR 1/8/2000).

Shortline Extra

The UP goal is to grow the revenue base by "gross domestic product-plus," or something more than 3.5% a year. The fastest way to increase revenue without increasing cost is to get more for what you do, so it's logical for shortlines to focus on better-paying traffic. Like food products, STCC 20. Over the past few years UP's "stick-20" trade fell to a low of 187,000 cars in 1998 and bounced back six percent to 199,000 last year. A graph of this traffic may be seen at

http://www.rblanchard.com/corp/wk-rev/img/up_food.gif

In 1998 the average UP ag car garnered $1,600 in revenue. That includes a lot of "stick oh-one" like corn, so that number is on the low side, but let's use it anyway. What this tells me is there is shortline market for 20,000 carloads of food goods worth $32 mm to UP and $8 mm to shortlines at a standard 25% allowance. Grow it at another 6% in 2000 and it's worth another half-a-$mil.

CSX, like UP, has announced a specific growth goal for its merchandise traffic this year: up 3.5%. Not all carloads carry the same revenue number, and some will be above and some below. So there will be increasing emphasis on those rates above the line, and thus on customers and commodities (and shortlines) with the greatest opportunity to produce increased yields.

In my conversations with each of the class 1 railroad senior commercial officers it has become abundantly clear that the shortlines that produce the best returns on the costs of serving those shortlines will be looked on more favorably than ones with a lower return. The reason that GM is more valuable to UP than the Acme Widget Company applies as well to connecting shortlines.

The net per shortline operating cash flow is so important that small railroad owners absolutely must analyze which commodity O-D pairs will produce the best results for the connecting roads. One way to do that is to look for the best-yielding commodity groups for the class 1 in question and see what the shortline can add.

To do so is a relatively simple matter. First, look at the commodity carload and revenue breakouts in the class 1s' quarterly reports. In the case of UP, there are six groups: agricultural, automotive, chemicals, energy, industrial and intermodal. By zeroing in on those most likely to hit shortlines (see above) and then digging into specific five-digit STCC codes, you can then see how big a part your high-revenue commodity plays in the class 1 carload and revenue picture. See the STCC 20 example above, then see where you can bring an extra $million or two to the table.

The Blanchard Company, in cooperation with RailShare Inc., can assist in determining class 1 contributions and trends in five-digit STCC codes by railroad and year. Armed with your winners you can then approach your connecting class 1s with strategies to help them achieve their revenue goals for FY 2000. Drop me a note at roy@rblanchard.com to start mining for those winners.

--Roy Blanchard

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