THE BLANCHARD COMPANY

The Railroad Week in Review:
Week ending 12/23/00

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Markets do not want to talk to flacks and hucksters. They want to participate in the conversations going on behind the corporate firewall. Cluetrain Clue 62.

Norfolk Southern (NYSE: NSC) on Tuesday warned that earnings for 4Q00 will probably come in at 5 cents to a dime a share vs. the consensus estimate of 20 cents, citing higher fuel costs and a continuing softening of carloads. Split it and say 8 cents a share. That means a net income of $31 mm, assuming the 2% net margin from last quarter remains. Revenues should be about $1,454 mm which at a 90 operating ratio produces operating income of $135 mm.

Tack that on to the nine months results and get revenues of $6,044 mm, expenses $5,392 mm, operating income $632 mm, net income $198 mm or $0.52 a share on 383 mm shares. Current estimates (Zacks) ranged between 55 and 95 cents prior to this warning. By way of comparison NSC did 71 cents a share for all of 1999.

Some observers say there's a 50-50 chance NSC will reduce its dividend by some amount. It has to do with "earning the dividend." NSC pays 80 cents a share annual divs, 20 cents a quarter. So as long as they make 20 cents a quarter in net earnings, they're earning the dividend. Recall last Q NSC earned 14 cents before the timber sales, so they didn't "earn the div." This quarter they're now saying a nickel or a dime a share in earnings, missing "earning the div" by half or more.

Estimates for 2001 have been drifting steadily south from $1.53 in late Sep. This latest downgrade has already moved the number further down, approaching the dollar and small-change level in some houses. Meanwhile, NSC announced its 2001 capex program, $750 mm. Two thirds for track and infrastructure, one third going for 160 new six-axle locos.

NSC continues to be a tremendous cash generator, and the measure I prefer is changes in working capital (current assets less cash minus current liabilities less ST Debt). A negative number is a cash inflow; a positive is cash outflow. And while this may seem at first to be counterintuitive, thereís a reason it works.

Current assets represent investments in prepaid expenses and services sold but not yet paid for, i.e. future cash. Current assets represent money owed but not yet paid, essentially interest free loans. ST Debt Ė in the case of railroads almost always the current portion of LTD Ė carries interest fees and so is deducted from total current liabilities. Ergo the lower the net current assets and the higher the net current liabilities the less internal cash need to keep the doors open.

NSCís net working capital has dropped steadily from a plus $97 mm at the end of 4Q99 to a negative $841 mm as of 9/30/2000. This is also going to have a great effect on operating cash flow. Weíll get to that next week.

The railroad gods did not smile upon us in Pennsylvania this week as CSXT piled up a dozen cars of sulfuric acid in Phila and NS put 20 cars on the ground in Lewistown. The former took place north of Center City Philadelphia. At this point, the Schuylkill River, the East River Drive, and the railroad pass through a portion of Fairmount Park, and so itís a highly visible location.

The Philadelphia Inquirer said about 12,000 gallons of the stuff got away, and from my vantage point on the West River driver one could see where the acid had quite literally scorched the earth as it flowed down the railroad embankment. The accident occurred about 01:30 and by 04:30 the leakage had been contained. It appears very little actually got into the river, though the Drive will most likely remain closed until this afternoon. The good news is the Responsible Care program works and damage to people and property was slight. CSXT and its partners in this effort are to be congratulated.

There is less information available on the NS mishap, though son David was one of the 1000 people Amtrak had to bus around the incident. David was on the Three Rivers, scheduled to arrive in Phila at 16:52. The bus actually caught up with one of the Keystone Service trains in Harrisburg, putting passengers into 30th Street by 20:00, three hours off. Not bad.

Larry Kaufman writes in JOC that the STB misses the point in its argument that real rail rates adjusted for inflation have actually fallen since deregulation. Says he, "Prices are cut for two

reasons. One is competitive pressure that forces a business to make itself more efficient so that it can retain business and continue to make a profit. The other is the strategic decision that by cutting prices the enterprise may grow faster and total profit will increase."

There is yet another reason: prices are cut by marketing departments and sales reps who canít get the business any other way. Weíve been arguing here for years that the lowest price is no Unique Selling Proposition because as soon as A lowers the price competitor be can go still lower. Delivering sustainable competitive advantage in the eyes of the customer is the only way to capture premium rates, as demonstrated by the UP+CSXT Express Lane perishables service and the BNSF money-back guarantees on the I-5 corridor. Case closed.

Shortline West Michigan Railroad (WMI), a unit of Pioneer Railcorp (www.pioneer-railcorp.com) (Nasdaq: PRRR) has begun rail service to a new distribution center located in Paw Paw, Michigan. One of the customers at the new facility is Knouse Foods Cooperative headquartered in Peach Glen, PA, which itself is served by another shortline, the Gettysburg Railway (GBRR). WMI connects with CSXT and GBRR has links to both NSC and CSX.

By way of review, PRRR operates nearly 450 miles of track on 15 freight railroads in nine states. For the nine months ended 9/30/00, revenues were up 7% to $11.3 mm. Net income was $837K, up from $280K year-to-year. Results reflect increased freight and storage revenue and the absence of losses from the sale of a subsidiary.

The company has an operating ratio in the low 80s and a 13% net margin. Debt is three times equity, the current ratio is less than one and PRRR pays a 2.35% annual dividend. The stock trades in the under-two dollar range and has declined 23% over the trailing 12-month period, lagging the S&P by 11%.

NYSE Short Interest rose 6.32% with short selling reaching its fourth monthly high in a row. This is not surprising, given the questions about everything from the election to Christmas shopping. The NYSE rails were relatively unscathed, with KSU, NSC, and UNP actually posting double-digit declines in short interest, a ratio indicating the number of shares sold short but not yet covered or bought back. Thatíll make a Merrier Christmas for some, Iím sure.

--Roy Blanchard


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