THE BLANCHARD COMPANY

The Railroad Week in Review:
Week ending March 11, 2000


"We are committed to service guarantees."

So saith Rob Krebs and Paul Tellier at the close of this week's Ex Parte 582 hearings in DC. We're not going to devote space here to all the testimony, though based on my limited exposure to the press releases and prepared texts most of it was pretty objective. Rather it might be appropriate to offer a few lines on what's wrong with what my dear-departed friend E. M. Frimbo once called "our favorite patient," the railroad business.

The continuing thread through shipper forums, Wall Street analyst reports, and trackside reports is simply that service ain't what it ought to be. For example, shippers are paying $9,000 to truck a carload of canned fruit from Pennsylvania to California -- twice what the equivalent rail rate would be. What's wrong with this picture?

The $4,000 freight rate isnít big enough to get the railroad's attention and is too big for the perceived value of the service offered: random pickup, random transit time, random placement. But suppose, just suppose, the railroad said, "Gimme six big ones and I'll have it on your distant doorstep ten days after pulling or you get a grand back."

I posited that to a railroad sales person I know and the response was that the operating department would never allow it. He said that keeping operating costs down and minimizing train starts is the rule of thumb. As a result, said my friend, a scheduled railroad could never work. I beg to differ.

The only way to reverse the downward revenue trend is to start offering what customers want. As author Charles Decker (Winning with the P&G 99) notes in a 3/10/2000 WSJ Op Ed piece, "The fundamentals deeply ingrained in P&Gís culture are innovation, quality, and branding." Itís not too fantastic to think that these very fundamentals are behind the Krebs/Tellier call for scheduled trains and service guarantees. And it could be they will start our favorite patient on a road to full recovery. The alternative is not pleasant.

Bruce Flohr, founder and now retired chairman of RailTex, lamented at this week's Railroad Industry Financial Forum in NYC that "the best and the brightest are not flocking to the railroads." He noted that the ever-shrinking number of class 1 railroad customers has forced the RR supply industry to consolidate, move into non-traditional lines of business, and expand overseas. And if the railroads can't stanch the decline of revenues dollars and the brain drain, the supplier loss and shrinking capex programs will continue.

Flohr, a Board of Directors member at Harmon Industries, a leading supplier of signal, inspection, train control & communications products to the freight railroads and transit agencies, said his firm is doing all three. There is consolidation through restructuring, a move to more transit, and a move off shore. According to a recent company press release, "Even if North American freight railroad shipments continue at current depressed levels, savings captured through the restructuring combined with increases in revenues from the transit and international sectors, a substantial portion of which is in backlog, should lead to [improved] fiscal 2000 earnings."

The mergers of Motive Power Industries and Wabco, ABC Rail and NACO, and the consolidation of many smaller vendors under the Varlen umbrella have all been reported here. Yet rail supply industry continues to languish along with its railroad customers. For the past 12 months, Harmon and ABC-NACO stocks were off 25%, while Varlen itself nearly doubled before being acquired itself by privately held Amsted Industries in September. These issues will continue to underperform until we see improvement among their customers.

For the week, rail stocks continued in their non-performing ways even while the NASDAQ stocks hit new highs. CSX, CN, and NS didn't budge. The two western roads lost some points, UP off 10% and BNI about 3%. The PE picture, however, brightens somewhat looking forward. From Zacks:

Ticker

Recently

FY2000

PE 2000

FY2001

PE 2001

YTY Ch.

PEG 2000

RAIL

$ 7.13

$ 0.77

9.25

$ 1.18

6.04

53.2%

11.3

CSX

$ 22.69

$ 2.54

8.93

$ 3.39

6.69

33.5%

20.0

NSC

$ 13.06

$ 1.15

11.36

$ 1.59

8.22

38.3%

21.5

UNP

$ 36.38

$ 3.92

9.28

$ 4.73

7.69

20.7%

37.2

WCLX

$ 12.13

$ 1.50

8.08

$ 1.73

7.01

15.3%

45.7

CP

$ 18.81

$ 2.14

8.79

$ 2.47

7.62

15.4%

49.4

CNI

$ 23.75

$ 2.86

8.30

$ 3.23

7.35

12.9%

56.8

BNI

$ 19.44

$ 2.67

7.28

$ 2.97

6.54

11.2%

58.2

KSU

$ 83.75

$ 4.52

18.53

$ 5.47

15.31

21.0%

72.8

PWX

$ 7.13

$ 1.25

5.70

na

#VALUE!

#VALUE!

#VALUE!

 

Recall that a Price Earnings to Growth ratio (PEG) under 50 is a compelling argument to look further as a possible BUY, a PEG 50 to 100 is still strong, albeit less compelling as 100 is generally regarded as representing fair value. Any PEG above 150 is reason to start thinking of selling; get much above 200 and the thoughts of shorts might cross oneís mind. (Note: the high growth and hi-tech stocks have their own rules. CSCO, for example, even with a PEG 2000 of 1300.00 isnít something to short.)

That being said, we may have some bargains here. And when the forward estimates start a strong upward trend we might start climbing on board ourselves.

Recall that STB Chairman Linda Morgan laid out (WIR 2/19/2000) these "guiding principles" for this weekís hearings. First is the preservation of a rail system responsive to all users. Second, sustaining capital investment to insure uninterrupted service. Third, minimizing downstream effects of any mergers that do take place, and fourth, restoring financial stability which will enhance rail service and bring more freight, not less, to the rails.

Well, a rail system whose service standard is such that some customers pay twice the rail rate to use a truck because itís dependable isnít whatcha call responsive to all users. Second, falling revenues cannot sustain the cash flows needed to repair and replace the operating tools. Third, the downstream effects of the NS/CSX/Conrail merger on small northeastern railroads have been debilitating, and fourth, the falling market caps of the railroad companies car hardly be music to the lendersí ears. Testimony this week was not long on proof that the guiding principles have been met.

But industry-wide service thatís scheduled and guaranteed would go a long way. And maybe Ė just maybeóthe biggest fear is that if BNSF and CN do pull off their merger and control nearly half the class 1 track in the country, unscheduled railroads without service guarantees will not be able to compete for the high growth business. And so BNSF+CN becomes a very real threat. To the status quo.

--Roy Blanchard


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