THE BLANCHARD COMPANY

The Railroad Week in Review:
Week ending 12/17/00

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Mike Haverty will take the reins as Chairman of KCS effective January 1, 2001, succeeding Landon Rowland, who has resigned as Chairman but remains on the Board. Itís a good move for both. Haverty will retain his current titles of Chief Executive Officer and President while Rowland continues to serve as Chairman, President and Chief Executive Officer of Stilwell Financial.

Mike and I first met seven or eight years ago when he was Chief Operating Officer on the Santa Fe, before he became President. Itís entirely suiting he should move into the corner office now that KCS is returning to its railroad roots. The company will need a strong leader, surrounded as it is by powerhouses BNSF and UP.

Analysts have downgraded FY 2001 estimates from 89 cents three months ago to 78 cents. Others like Jim Valentine of MSDW take the position that KCS is really an asset play with a sum-of-the parts value around $12, though that number may be a ways away. One would hope that with Haverty at the throttle that day will come sooner, not later.

RailEstonia, a consortium that includes RailAmerica, CSX and Kinglsey Group, has been tapped by the Estonian railway privatization agency as the preferred bidder for a 66 percent stake in the state railway company, Eesti Raudtee. Kinglsey owns 90% of the consortium while CSX and RAIL each have 5% stakes. RAIL will be the railway operator and will not be required to commit any funding for this project.

Eesti Raudtee is a 200-kilometer (125 mile) railroad operating from the Russian border west to the Port of Tallinn and south to Valga in southern Estonia. Eesti Raudtee carries approximately 40 million tons of freight annually, with the largest commodity being oil and oil related products. Annual revenue is approximately US$70 million.

Word comes from Dallas that StatesRail CEO Pete Kleifgen has named Dan Lovelady VP and Chief Operating Office effective January 1. The promotion follows the retirement of Rick Cecil, who has served as president and chief operating officer since March 1999. Mr. Kleifgen assumes the responsibilities of president.

StatesRail owns and operates seven shortline freight railroads in the west and southern US plus a scenic railroad in Hawaii. It is one of the more substantial shortline holding companies under private ownership, handling a respectable 175,000 revenue carloads a year on its 1600-mile system. A visit to www.statesrail.com is highly recommended.

Federal Railroad Administrator Jolene M. Molitoris will leave office Dec. 31 to become president and chief executive of GeoFocus Inc., a provider of geographic information system and global positioning satellite wireless technology to the transportation industry. Molitoris became the first woman to lead the Federal Railroad Administration when she was named to the post in 1993. FRA Deputy Administrator Jack Wells will serve as acting federal railroad administrator.

Genesee & Wyoming (GNWR) says November 2000 carloads were off 5% in North America and up nearly a double in Australia. Coal was clearly the culprit in the former case as utilities in the Company's Illinois Region were completing a switch to Powder River Basin coal and generally increasing inventories in 1999. Australian results were largely driven by 8300 carloads of iron ore under the Dec 1999 contract with Broken Hill plus 2,358 more carloads of grain from the 1999/2000 harvest was being cleared from storage to make room for the 2000/2001 harvest.

GNWR stock continues to delight, closing the week at 30, up from 12 a year ago.

A friend in Melbourne, one whoís paid to look after such things, called Thursday to compare news and views of the international railroad scene. He was quite taken with the GNWR win for Westrail (WIR 11/4/2000), saying it really cements GNWRí presence in Southern AUS. Equal partner Wesfarmers Ltd. is a huge outfit with annual sales of AUS$1.5 bn, he says and it got a half interest in GNWRís Southern Australia Railroad to sweeten the deal. To review, the combined entity will be called Australian Rail Group (ARG) and will serve the western half of the Australian continent. It will be the nation's largest private rail operator with pro forma revenues of AUS$184 mm for the twelve month period ended June 30, 2000.

Meanwhile the battle over Wisconsin Central continues. Recall a month ago WCLX told New Zealandís Tranz Rail Holdings Ltd (TZR) its 24% stake was under review. At the same time it was announced that 14% interest holder Pacific Rail Ltd. was likewise considering a sale. There has been no further movement by either parties. My friend in Melbourne posits two possibilities: TZR could hang in with the WCLX stake in place. Or they could take up WCLX and Pacific on their mullings to sell and bring the whole operation under one roof. Which now holds is unclear.

In the UK the government has OKíd the use of 44-tonne lorries and reduced the vehicle excise duty for heavy trucks, which EWS says could cost it 20% of its existing traffic. Railtrack says in its "2000 Network Management Statement Summary" that "under the present regulatory system Railtrack has no incentive to increase rail freight traffic" (see following London Extra).

Be that as it may, Transport Minister Lord Macdonald talks about increasing rail freight 80% in ten years. Thatís good news for EWS. The bad is there are several existing and would-be rail freight operators ready to take bites from the EWS pie. Freightliner is the largest intermodal freight transport operator in the UK and wants to grow (with an OR in the mid 90s itís not doing all that well). Direct Rail services (DRS) is a sub of British Nuclear Fuels and specialized in transporting nuclear waste, though it would like to expand to other hazmat businesses.

Mendip Rail has been operating under the aegis of EWS though it has decided to apply for its own Safety Case. Rail Freight Group, formed by Julia Clarke, now Shadow Strategic Rail Authority (SSRA) Freight Director, has been turned over to Lord Berkeley to bring to fruition. GB Railfreight has won an 8-year contract to haul Railtrack maintenance materials principally in East Anglia, where its parent runs the Anglia Railways TOC. It has also won a grant for £1.01 mm for the "Minimodal" intermodal service development scheme from the SSRA.

Railtrack says rail freight grew 15% a year 1996-99 and now holds about 8% of the total UK freight market. Half of that is bulk, so the share of merchandise moves is smaller yet, however Railtrack suggests there are growth opportunities here. The total picture is thus much like what we see in the US. And thatís cause for some cautious optimism.

London Extra

The London newspapers would have you believe the whole UK rail system "in crisis." The October 17 Hatfield wreck on the GNER line attributed to a broken rail has caused the Railtrack, the owner of the UK rail infrastructure to put on more than 500 Temporary Speed Restrictions (TSR). As a result some trip times have lengthened to the point the Train Operating Companies (TOC) have had to annul trains for lack of equipment and crews. And the train-riding populace has, where there is an option, increasingly opted for the highways.

Farebox losses to the TOCs could run in the £millions. The deal between Railtrack and TOCs is such that trains delayed due to infrastructure failure mean compensation to passenger, and Railtrack pays. Thus Railtrack could be expected to pay the TOCs as much at £300 mm. The press corps has been having a field day with the aftermath of the accident, laying it all at the feet of Railtrack, even through there is some evidence from the Pueblo Testing Center that improperly maintained wheelsets on the TOCs' equipment may have been a contributing factor.

A second complaint against Railtrack is the number of "signals passed at danger," or SPADs, for short. This occurs when a driver comes up on a red signal but canít stop in time. The common thread between the broken rail and SPADs is the wayside signal system. Logically, a broken rail would break the track circuit and drop a red signal, which in turn would drop the preceding signal. In like manner, a signal "at danger" would drop the preceding indications, so the driver shouldnít be surprised.

To get beyond the media-hype and find out things are really supposed to work, on Monday I visited the Railtrack headquarters on Euston Square. Donal McCabe, Corporate Media Relations Manager, told me track circuits are much like those in the US, so itís not likely a wayside signal will suddenly go red in front of driver. Wayside signal indications are green, two yellows, yellow, and red, said McCabe. Passing a less-favorable indication causes a horn to sound in the cab and the driver has three seconds to acknowledge before the train goes into emergency.

There have been 595 SPADs in the past year, and itís not clear who should be responsible. It certainly seems to me that a driver passing two yellows, then a yellow, would be prepared to stop at the next signal. At any rate, says McCabe, Railtrack and the TOCs are embarked on a £360 mm program of wayside signal improvement and driver training expected to reduce SPAD risks by 70% by Dec 2002.

The number of broken rails had increased by about 50% by the mid-1990s, reaching a peak at 952 in the fiscal year ending Mar 30 1999. Even at that, the number of breaks resulting in derailment has averaged about two a year for the last decade, and they were Ė until Hatfield Ė minor. Total breaks are down about 4% YTY and the target is to reduce breaks to 1994 levels by the Dec 2002.

My next stop was at the Association of Train Operating Companies (ATOC). Media Relations Manager Jay Merritt was kind enough to tell me something of ATOCís purpose, its membersí goals and positions in the general scheme of things, and a bit of history to help frame the whole picture.

To begin, The 1993 rail privatization act split the old British Rail into 111 parts, however three distinct roles were carved out. Railroad infrastructure Ė track, signals, bridges, stations, etc. Ė would be owned by a national track authority, rolling stock would be owned by three leasing companies, and private operators would run the trains.

There are now 26 such train operating companies in a rapidly expanding market for rail passenger service. The TOCs in 1999 ran 18,500 separate trains over 30,000 miles of track, using 2,700 trainsets. The ATOC members ran their trains 92% on time calling at 2,500 stations, with growth projected at 5% a year through 2010. Achieving this target will require a 30% increase in track capacity, 6,000 new carriages (passenger cars) with 2,300 on order for delivery by 2002, and 900 new drivers trained in 18 months.

To do all this, said Merritt, each TOC must negotiate track space and access fees with Railtrack. Unfortunately, the model envisioned by the enabling legislation does not hold in todayís environment. Ten years ago, British Rail perceived rail revenues to be on an irreversible downward spiral and so they set fixed charges high and variable charges low, building in a potential conflict between the TOCs and Railtrack.

The TOCs need to maximize farebox intake so more trains is better. Yet Railtrack gets same fees from TOCs regardless of number of rains run and is penalized for late rains, so fewer trains is better. Happily, the whole scheme is begin renegotiated over the next year or so and early indications are this conflict will be resolved favorably for everybody, not the least the folks who pay the fares and ride the trains.

A potential conflict that I see is between equipment maintenance and safety. TOCs lease most of their equipment from three Rolling Stock Leasing Companies (ROSCOs). The length of the lease is a function of the expected franchise term, though some adjustments were made for older equipment with shorter useful life. ROSCOs are responsible for heavy maintenance and overhauls; TOCs either do the rest themselves or contract out to vendors or third parties.

The pressure is clearly on to max out revenue per vehicle as investor value depends entirely on the revenue-generating ability of the leased assets. How much TOCs are tempted to let something go is not known, but itís still a question.

Is the UK rail system really in crisis mode? I donít think so. Market forces point to greatly increased revenue potential over the next few years. The government is committed to a healthy rail passenger system. Clearly the opportunity exists for Railtrack, the TOCs, the ROSCOs, and the entire support network to do very well for their stakeholders. The present indicators are that the Office of the Rail Regulator and the Strategic Rail Authority are setting the stage for greater cooperation and more congruence of goals among the players.

Crisis implies broken beyond repair. The UK passenger rail system is as I see it slightly dented at worst and maybe in need of a tune-up. No need to trade a train ride on the Gatwick Express for a rent-a-car ride on the M23 quite yet.

--Roy Blanchard


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