The Railroad Week in Review:
Week ending December 2, 2000

Short Line Extra

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If you're reading the right tea leaves, your shortline can improve revenues, operating ratio, and net income over the next 12 months. To be sure, it will require attention to detail, staying power, and sheer drive. First, look at what's out there.

On the surface, FY 2001 could be pretty good. Of the 12 railroad companies I follow, FY 2001 earnings estimates represent double digit earnings growth YTY for all but Florida East Coast (NYSE: FLA, off 35.7%) and Canadian Pacific (NYSE: CP, up 3.4%).

However, Street analysts are beginning to temper those projections already. Seven roads' estimates for FY 2001 have declined over the past 90 days and two have remained unchanged. The gainers were Canadian National (NYSE: CNI, up 11.9%), CP (up 7.7%), and Genesee & Wyoming (Nasdaq: GNWR, up 7.9%).

Barron's this week opines that "instead of the recent double-digit growth and the conventional wisdom's relatively cheery outlook that earnings will climb by 7%-7 1/2 % next year, actual gains may be no more than 4%-5%. A major depressant to earnings will be a sharp drop in GDP growth to 2 1/2 %-3%, from around 5%." This will cut across the very commodity lines so important to shortlines.

Automotive has been booming for the class 1s, as you've read in the earnings releases for 3Q00. Doesn't look like 2001 will be a repeat, though. The Wall Street Journal reports that "industry observers now forecast a decline next year, from an estimated 17.2 million units in 2000 to 16.5 million in 2001." Also slated for production declines are the steel, forest products, and chemical industries.

Agricultural products may go either way. A Midwest grain trader writes that the bio-tech awareness has tainted the perception of US grain quality to other countries, thanks in part to the Starlink corn episode. The S&P Industry Outlook suggests that commodity prices will move still lower driven by oversupply in the US.

Some offshore growers may be gaining market share at the expense of US producers. China came on very strong as a corn exporter in 2000, though school is still out as to whether that will be the case in 2001. Lastly, grain prices for delivery in late 2001 are significantly higher than for near-term delivery, and that can slow rail volumes. The result of all this uncertainty is that shortlines must manage car supply very nimbly.

Grain car supply can be enhanced by aggressive support of the various class 1 guaranteed equipment programs. Being able to sell the benefits to your customers and play by the rules (i.e. spot a specific set of cars at a specific location by a specific time and complete an audit trail) helps. Shortlines must be particularly careful about revenue requirements, however. Margins are thin, and the rails have to be sensitive to the fact that country elevators and area growers will kill for a penny a bushel.

Perhaps the best shortline scenario is to have a large consumer on line (Corn or Soy processor, Feed mill) to keep the traffic captive. Or to work with 2-3 shippers on the short line splitting a unit train, returning empties to the Class 1 as an assembled unit. This keeps the local elevators competitive and eliminates the switching for the Class 1. It's also possible to do something like this where the customer wants 50-car trains yet has track space for only 20 cars.

Automotive, metals, chemicals, forest products, and agricultural all fall into the "merchandise carload" category so key to shortline railroads. And since your class 1 connections typically gear their forward revenue estimates to GNP, what's down for them could be doubly hard on your bottom line. That is, unless you take steps to offset the class 1's declines with your increases.

Dave Garin, VP of Industrial Products for BNSF, spelled out the shortline advantages at the October shortline gathering in Fort Worth. Slide 40: "How Can Shortlines Help Us Attack the Truck Market?" Three ways, he says. Through your knowledge of what make local businesses tick, through your superior customer service standards, and through aggressive use of land and industrial development resources in your service area.

Now's the time to make sure your connecting class 1s know what you're doing and make sure your efforts are congruent with theirs. Many shortlines, especially the smaller ones in the 4,000 to 10,000 carloads per year range, fall short here. This is unfortunate, because the stakes are so high.

I'm particularly concerned about the properties on the lower end of that scale, especially if they average fewer than 100 carloads per year per route mile of track maintained. You've seen the numbers. It's $5,000 per mile per year to keep FRA class 2 track up to spec, so a 40-mile railroad costs $200,000 just for tie replacement and a little surfacing.

On a 4,000-car shortline car hire can be another $400,000 if you figure $100 per car for 5 days on line at $20 a day. (Getting cars back to the connection in four days saves $80,000, which ought to be a powerful incentive to improve turn times.) A train crew of two operating five days a week 52 weeks a year runs you $125,000. Fuel to operate just one locomotive 3000 hours a year at a buck-ten a gallon -- $33,000.

The 4,000 car shortline will have revenues around $1 mm. A target operating ratio of 80 yields an expense budget of $800,000. Yet, as we've seen above, a shortline of this size is there already -- without any locomotives or GS&A. With nowhere to cut expenses without limiting the ability to offer superior service, growing the revenue base is simply not optional. It's a matter of survival.

The good news is the class 1s genuinely want to do business with you precisely because of your superior customer service standards. But you gotta let them know you're out there and ready to step up to the plate.

Decide where you want to go today, get everybody on your team to buy in, and sell it to your class 1s. Then just do it.


--Roy Blanchard

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