The Railroad Week in Review:
Burlington Northern and Santa Fe had a particularly strong story to tell on Tuesday. (See slides at the www.bnsf.com "Investors" tab. It's a 5.8 gig PDF file, so be patient.) I think it was Frank Zappa who said, "The nice thing about money is it gives you options." If you're willing to define free cash flow as operating cash less capex, BNSF had options galore. The $636 mm FCF in 1999 for one thing allowed aggressive continuation of the share repurchase program. CFO Tom Hund said that BNSF "will stay in the market as long as prices are low." So far 27 mm of an authorized 60 mm shares have been bought at an average price of $31. That's a cool $840 mm worth.
What drove all this money? Four of the five commodity groups (agriculture, merchandise, intermodal, automotive) were up nicely while coal was off a mere one percent for the quarter. In the merchandise group, forest products and metals were the leaders, up 7% each. For the year, operating expenses rose 1.2% against 1.8% more revenue. Operating income is up for the fourth straight year in a row increasing at an average compound growth rate of 6.3% a year.
Contributing to this growth is continuing improvement in on-time operation. The 1999 Plan was for 89% OT Jan-Jun and 90% Jul-Dec. Targets were exceeded across the board except for Q1, missing the mark by 30 basis points. BNSF measures "on time" in terms of dock-to-dock performance, which is what customers watch most closely. Moreover, getting operational inefficiencies out of the system encourages more aggressive rates. That's what explains the slight decrease in freight revenue per thousand ton-miles to $18.59 from $19.05 full year over full year.
For the second half of the presentation Chairman Rob Krebs took the mike once again to show how BNSF exceeded pro forma projections in its merger filing. It's quite a display, and I won't waste your time with commentary here. The charts tell a powerful tale, and lead to Krebs' concluding slide addressing the proposed BNSF+CN. Essentially, he's saying, "We did it before; we can do it again and here's why."
Two weeks ago I opined that NS would finish the year with about a quarter of a $billion in net income (WIR 1/15/2000). Not quite. On Wednesday NS announced net income of $239 mm for the year. As it happened, 4Q99 was especially cruel to NS. Revenue was up a whopping 43%, only to be offset by a 71% operating expense increase. That drove the operating ratio to an unheard of (for NS) 90.7, up 15 points from last year's 75.7. If you'll go to the presentation charts under the "Investors" tab at www.nscorp.com, and start with Hank Wolf's remarks you'll get a sense of what happened.
Hank's third slide shows car hire and related expense was the biggest hit, followed by compensation. Together these two items accounted for $325 mm of the $556 mm operating expense increase over 1998. As Hank noted in the accompanying remarks, "A significant portion of the materials and rents increase, $49 mm, is related to Conrail congestion costs, principally higher equipment rents and alternative transportation costs to meet critical customer needs." As for compensation, he said, "An increase in employment of nearly 50 percent following commencement of operations over the new Northern Region and additional labor costs due to start-up congestion was the principal reason for the increase."
Now, having hung all this crepe, let's draw it back and see what's out there for FY 2000. To begin, Vice Chair and Chief Marketing Officer Ike Prilliman noted that in 4Q99 intermodal revenues doubled while general merchandise revenues rose 39 percent, bolstered by gains in metals and construction, up 83 percent; chemicals, up 45 percent; and automotive, up 32 percent. Coal revenues increased 25 percent, as utility coal, coke and iron ore business in Norfolk Southern's new Northern Region offset the decline in export coal revenues. The outlook is for FY 2000 to be more of the same.
In the Q&A following the formal presentation, CEO David Goode stressed that NS has "a chicken and egg" situation with respect to operating costs and service improvements. Essentially, as service improves, cost comes out, and as cost comes out service improves. The car hire and compensation numbers above demonstrate this fact of life particularly well. As for "returning to pre-merger service levels" (a NIT League theme, WIR 1/15/2000), Goode said, "We have the capacity to bring new business on, and we're positioned to offer better service than a separate Conrail and NS ever could have."
CSX numbers (full presentation visuals, audio, and "Quarterly Flash" are available at www.csx.com) were, as CEO John Snow said, "unhappy." You can read them for yourself and see that while revenues were up slightly, operating expenses were up slightly more and so operating income was down, thanks chiefly to extraordinary merger costs in 4Q99. So much for history. It's the FY2000 outlook that is most encouraging.
To use a marketing term, the Unique Selling Proposition of CSX going forward is an exciting shift to market pricing. And this will mean fewer long-term contracts and more short-term rates based on demand and capacity. Said Snow, "Where demand exceeds scarce resources we'll let the market tell us the proper value of these resources."
But that doesn't mean rates will be bumped willy-nilly. SVP Marketing John Sammon et al acknowledge that CSX can't charge premium rates for crummy service. Yet rising trucking costs combined with new local and interline opportunities will provide the right environment for premium pricing for premium services. Look for about 4.5% growth in merchandise (not coal or intermodal) this year. That's got to be particularly good news for shortlines as outlined in the separate Shortline Extra.
The best part is that the process has begun already. Results for both 4Q99 and FY99 show revenues increasing at a faster rate than carloads, with merchandise traffic up both in carloads and revenue. Most significant, CSX has set a timetable for achieving its goals, something the Philadelphia NIT League audience (WIR 1/15/2000) wished for most emphatically. Asked Thursday when the railroad would return to "normal operations," CSXT President Ron Conway said, "Well, first you have to define 'normal.' For us that's running to plan at target costs, velocities and dwell times. Look for it in the second quarter of 2000." How refreshing.
Canadian National, like BNSF, had as its focus what's been done right as a result of the recent IC merger and what can be done with the merger now before us. For the year CN netted $751 mm (all figures $US) on revenue of $5.2 bn, roughly that of NS. That net drove 1 $1.3 bn operating cash flow, which provided sufficient cash to cover the capex program and dividends with $273 mm for pocket change. That being said, CN has increased the dividend 17% and will buy back six percent of its outstanding common shares to the tune of about $400 mm at today's prices.
Revenues for the quarter and year saw double-digit gains in every commodity group. Operating expenses for the quarter were down double digits and flat for the year. No wonder the OR fell to a very respectable 70.7 for the quarter and 72.0 for the year. Going forward, CN is projecting 4% more revenue based on increased market share and a still lower operating ratio. What Hunter Harrison started on the IC with his killer focus on scheduling is paying off here in significant free cash flow generation.
And that, gentle reader, is how you get 20% appreciation in earnings per share, the kind of number you'd expect from a second-generation dot-com company. And it's the only way to make any significant money in this business.
Short Line Extra
This week's "Views & News" from the ASLRRA cites three CSX/shortline new business initiatives. It seems that they had been on the table for various lengths of time and now all they have become reality. It's clear that the Team at the Top has some new ideas about how to do things, and as those ideas make their way through the organization the changes will occur. I have that on good authority.
The message to shortlines is as we've said here before. Do the homework, make the proposal based on transportation economics, and follow through. The difference is that CSXT now has operations personnel at the same table with the commercial types to figure out how to create a price-service product that customers will embrace. However, as both Ron Conway and Gary Spiegel said, asset utilization is key. Shortlines have to do their part.
Another favorable factor noted by Sammon is that customers want transport vendors to solve ALL their movement needs. As a result CSX sees not only increased north-south traffic but also east-west. Think of PNW forest products to the southeast and Texas Gulf plastics to the Northeast. Sammon sees growth in boxcar traffic, chemicals, and especially metals contributing to the 4% target growth rate.
So if you want to do more business with CSXT, it is imperative you listen to the audio as you review the slides. The remarks themselves plus the speech nuances will provide an excellent sense of what CSX wants to achieve and how to achieve it. It's clear to me that the classic disconnect between operations and marketing is rapidly being replaced at CSXT by a commercial atmosphere geared to what the customer wants. That includes shortlines.
Last week's Shortline Extra touched a nerve as was expected (and hoped for). One shortline wrote to say that service deterioration during the past six months had driven a 15-car/week stick-20 customer into the arms of their friendly truckers. Our truck cost model estimates the truck freight bill is in the $7 mm per year range vs. a comparable rail freight bill of $4 mm. That tells us the rail rate is too high for the perceived value of the service provided and too low to keep the class 1 interested. It also tells us there's money on the table and a premium scheduled service could be a real moneymaker.
Another shortline owner writes, "Your example of food traffic is a classic case for us. We had a food warehouse on line that originated traffic on the UP. Sure, it paid better for us too. But we haven't had a car for them in two years and they have made it clear that with conventional service and equipment we shouldn't expect to see traffic ever again. The warehouse is on a branch line with very little traffic and now we are struggling to find whatever freight can be had at whatever rates it will take, to keep the line open."
Note that "conventional" service is the problem. It just ain't good enough. Both BNSF and CN are making gobs of money running scheduled dock-to-dock services. UP's remarkable turnaround is in part due to an unrelenting focus on velocity. Both the CP and its St. Lawrence & Hudson unit have proven the effectiveness of scheduled service. And now CSX and NS are zeroing in on dwell times and velocity, so the prognosis is good.
Do keep me posted on your successes and frustrations fitting your operations and opportunities in the context of what your connecting class 1s say they want to do.
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