The Railroad Week in Review:
Week ending July 29, 2000

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Networked markets can change suppliers overnight. Networked knowledge workers can change employers over lunch. Your own "downsizing initiatives" taught us to ask the question: "Loyalty? What's that?"

Smart markets will find suppliers who speak their own language. Cluetrain Clues 31, 32.

Canadian National rang up an 18% gain in net income on a 3% sales increase and operating expenses up less than a point. The operating ratio dropped to 68.6 and the net margin rose to a very healthy 17.3%, the highest in the business. Moreover, the free cash flow margin (FCF after property additions but before divs as a percent of sales) came in at 15.8% leaving $141 mm FCF after divs. What was truly amazing was seeing flat operating expenses against the specter of a whopping 46% increase in fuel costs. The 20% decrease in car hire and 16% less in casualty exposure helped drive a 7% gain in operating income.

Since I missed the presentation owing to another appointment, I've asked Tony Hatch if I could borrow his notes regarding the e-commerce segment of the presentation and he has graciously consented. He writes, "CN spent a fair amount of time discussing its e-commerce initiative on the procurement side with Ariba. The first goal is to improve its own business processes, and it remains unsure of industry initiatives without such internal preparation. [The second goal] will be new revenue service initiatives, mostly in intermodal and powered by i2's demand and supply chain planning software. The aim is [to create] web-enabled customer facing areas and to improve capacity planning and visibility."

Canadian Pacific posted quarterly results week before last. Because CP Rail (CPR) is part of a conglomerate it's not always easy to trace changes of one element in the context of the whole. But one does what one can. The press release said in part, "Operating income was $204 mm, an increase of $46 mm [with an] operating ratio of 77.4%, improved 3.6 percentage points. Operating expenses were up $29 mm, or 4%, to $700 million."

If you try to work it backwards to get sales, ops expense, the OR, and ops income YTY it doesn't work out to the numbers in the summary, and you can't get a railroad net income, either. Chalk one up for standardized reporting. Be that as it may, sales were up 9% for the quarter while expenses were up 4% vs 2.6% and 0.8% respectively for CN. Of course, CN sales were $1.3 bn to CPR's $0.9 bn, so the healthy gains are especially good to see.

Meanwhile, CP and CN announced a pair of joint initiatives aimed at increasing customer service while simultaneously improving equipment utilization. First is a 5-year agreement giving CN forest products carloads access to CP-served markets in NY, NJ and PA. Second is a 3-year agreement giving CP intermodal trains access to CN's double-stack cleared tunnel at Sarnia. Savings are a relatively modest $30 mm or so, however the access and efficiencies gained are going to be worth a lot more in capturing a bigger chunk of the freight now moving exclusively in trucks.

Sometimes you can tell as much about where a company is headed from the shape of the presentation as you can from its content. Burlington Northern & Santa Fe posted some nice numbers, all right, however the fact that 12 of 41 slides dealt with e-business was, to me at least, quite encouraging. If e-business is all about creating value in the experience of the customer, then BNSF has it covered with web-based marketing, service, and personalization. A complete tour of is highly recommended.

Getting back to the numbers, BNSF like CN was a story of moderate sales gains and high fuel costs adding points to the OR. Efficiencies drove FCF before dividends to $400 mm vs. $130 mm in 2Q99. The share repurchase program moved ahead to the tune of another 22K shares, bringing total count down 11% YTY. Freight revenues were up 2% largely due to double-digit gains in automotive and intermodal. Merchandise carloads were up 3% with metals leading the way.

It looks like the merchandise carload trade, especially consumer products, is in for significant increases as the BNSF e-commerce program unfolds. Scheduled service, trip plans which cover car moves from origin to destination and back, and getting on-time performance into the 90%+ range will sure help. Web-based customer services are accelerating the bid-offer-close-collect process and making it more accurate in the bargain. Equipment distribution, the bane of the carload business, has been vastly improved to the point where 70% of carload demand is received through the web and cycles time has been reduced 6% YTY.

But BNSF can't do it alone. With 40% of its loads moving off-line at some point, and with 20% of the total touching the eastern roads at some point, it's clear that everybody will have to be playing the same web game at some point. This includes the feeder railroads such as those operated by RailAmerica and Genesee & Wyoming. Right now, a car moving to the shortlines is not fully covered by the larger roads' e-commerce initiatives. The clever feeder road operator will have to take a more proactive role in making sure his offering is compatible with that of the connecting class 1.

The Story at NS and CSXT remains one of coming out from under the crushing burden of the Conrail merger. It's no secret that eastern rail system traffic is off from pre-split date. One study I've seen shows originated traffic in the top five commodity groups plus intermodal is down 200,000 carloads for the four quarters just ended vs the last four quarters of CR's existence. Total merchandise carloads quarter-to-quarter have shown virtually no improvement since the initial CR-induced jump in 3Q99.

CSX Corporate sales were off 16% YTY, largely due to the SeaLand sell off. Railroad and intermodal sales were up 19% YTY against a 24% increase in ops expenses thanks in large measure to a doubling in fuel costs. Total rail carloads were up only 10% YTY clearly showing the effects of the merger problems. Intermodal volumes however grew 50% thanks mainly to more international business.

But that's not all to the good. CSX Intermodal accounts for 15.8% of the Surface Transportation revenue, 16.1% of surface transportation expense, and only 12.7% of surface operating income. Look back at 2Q99, before the full effects of the merger hit CSX, and Intermodal's OR was 92.3 vs rail's 84.4. CSXT realizes carload is where the margins are, and presents an aggressive plan for improving revenues and running a more efficient railroad. STB performance targets are all at or near plan.

Norfolk Southern also saw a YTY jump in sales and the expenses starting with the 6/1/99 Split Date. On a trailing twelve-month basis, it's an encouraging story as revenues have increased 5% and operating expenses have pulled back by 4%. The OR has dropped to 82.4 from 90.3 in 3Q99, yet another indicator of progress. At the end of the day NS reported net income of $116 mm vs. $77 mm in 2Q99, a net margin of 7.4% -- still shy of the double-digit net margins generated by the NS of yore. But wait.

NS says it has recovered 87% of the traffic it lost to trucks during the worst of its merger-related service problems. Merchandise carloads including automotive are up 8% since 3Q99 even as coal and intermodal are relatively unchanged. The big mover in this category has been the metals and construction group, up 8% in the last quarter alone.

The outlook for coal tonnage is mixed, though some increases in steam and met coal are on the horizon. Intrermodal initiatives such as the BNSF run-through and the Mexican Triple Crown are expected to add value and volume in that market. Merchandise carloadings will most likely see only modest growth, depending largely on the direction of the economy and NS' ability to beat the trucks at their own game.

That's all we have space for this week, folks. I'll try to pick up with the UP and KSC earnings story next week along with earnings reports from WC and GNWR.


--Roy Blanchard

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