The Blanchard Company

Marketing and Management Support
for Feeder Railroads

The Railroad Week in Review 1/4/97
featuring: The Battle for Conrail

Ready reference: homepages for Conrail | CSX | Norfolk Southern

This week we'll take a bit of a departure from our usual week in review and instead try to sort out some of the more significant 1996 developments and peer into the foggy mists of 1997. This Review and Outlook is truly a "work in progress." Remarks from the field are greatly encouraged.

Perhaps the best place to start is with the stock market. The Dow Industrials surpassed expectations again, turning in a second consecutive year of record-beating earnings, gaining some 26% for the year. This edged out the wider-focus S&P 500 which turned in a 20% increase and the Nasdaq which closed out the year up 23% The rails, using a simple market basket of an equal number of shares of each of the publicly traded rails, like the DJI rang up a 26%gain (without dividends). Again, the year's main price-drivers were improved earnings based on greater cost control. The question now is whether the rails can turn to building the revenue base. Ranked by class and returns:

Symbol 12/29/95 12/31/96 YTD chg. YTD Pct. Class
CNI.PP(1) $18.00 $30 $12.00 66.67% 1
CP $18.13 $26 1/2 $8.37 46.17% 1
CRR $70.00 $99 5/8 $29.63 42.32% 1
UNP (2) $44.50 $60 1/8 $15.63 35.11% 1
FLA $68.25 $87 3/8 $19.13 28.02% 1
IC $25.59 $32 $6.41 25.05% 1
NSC $78.39 $88 $9.61 12.26% 1
BNI $78.00 $86 3/8 $8.38 10.74% 1
KSU $45.75 $45 ($0.75) -1.64% 1
CSX $45.63 $42 1/4 ($3.38) -7.41% 1
WCLX $21.91 $39 5/8 $17.72 80.85% 2
PWRR $6.88 $7 7/8 $1.00 14.55% 2
DOCP $8.94 $10 $1.06 11.89% 2
EMON $1.88 $3 1/2 $1.63 86.67% 3
GNWR(3) $19.88 $34 3/4 $14.88 74.84% 3
RAIL $3.63 $4 7/8 $1.25 34.48% 3
RTEX $21.00 $25 1/4 $4.25 20.24% 3
PRRR (4) $4.00 $2 1/2 ($1.50) -37.50% 3

$580.34 $725.63 $149.07 25.69%

(1) From week ending 7/26
(2) Adjusted for UPR spin-off
(3) From IPO wk ending 7/19
(4) From 4/26 when listed thus

The observations which follow are my own, colored by what I see in the field, what I know about the managers and the franchises, and tidbits from trade sources. The remarks are provided only as a starting place for further investigation and in no way are to be construed as suggestions to buy or not buy.

The Canadians whomped everybody, even Conrail with its merger-driven gains. At Canadian National (NYSE: CNI) Paul Tellier and his merry band have blown the socks off the Street's expectations and ought to do well in 1997 as controls put in place in 1996 begin to take effect. Canadian Pacific (NYSE: CP) is still trying to figure out how to deal with too much railroad. Even with the Soo Line sale to Dennis Washington et al, and with the St. Lawrence & Hudson (SLH) regional subsidiary in the northeast, costs and revenues are still not in balance. Look for an OK 1997, that's all. It will be enough for CP to make the SLH behave.

Here in the lower 48 the big new is that Conrail (NYSE: CRR) is in play cozying up to formal rival CSX (NYSE: CSX) while former would-be buyer Norfolk Southern launches its own hostile bid. Regardless of the outcome, CRR is problematic as a long-term investment and whatever the outcome it will have a significant impact on each of its two suitors. The legal/shareholder battle is only Stage One; the endgame will largely be determined in Washington. Union Pacific (NYSE: UNP), selling off the resources, finally working the remains of the CNW into the system, and beginning to deal with the SP has moved ahead nicely. Further gains of this ilk will be hard won., however.

Florida East Coast (NYSE: FLA) is more a regional than class I. Owner St. Joe Paper wants to spin off the railroad, and Norfolk Southern (NYSE: NSC) has said it's interested, making this a speculative issue. Illinois Central (NYSE: IC) will capitalize on its new-found relationships with CNI and BNSF (NYSE: BNI) and turn in solid results. Norfolk ought to appreciate at the same rate or better -- depending how the Conrail game is played. BNSF continues to consolidate positions and ought to ring up better than average gains in 1997. KCS (NYSE: KSU) will remain a mutual fund company with a railroad as a sideline, and that railroad will be increasingly dominated by the likes of NSC, UNP, and BNI. CSX is up against a tougher, richer competitor in NSC for control of the Northeast. Returns could well remain below average regardless of outcome.

WCLX will consolidate its off-shore holdings and build further alliances on these shores. Ed Burkhardt and his team have shown they know how to make this money in this business and their class I collective experience shows they know the mistakes to avoid. The other two regionals, Delaware Otsego and Providence & Worcester (Nasdaq: DOCP and PWRR) have troubles of their own. DOCP is caught between its former benefactor CSX and former enemy CR trying to merge on the one hand and friendly connection CP Rail on the other. PWRR is caught in New England between privately held Springfield Terminal, RailTex, and Conrail all trying to make their own deals while PWRR tries to figure out what it brings to this crowded table. Neither will fare particularly well in this churning environment.

RailTex (Nasdaq: RTEX) got off to a slow start, however with the amount of borrowed money they're throwing at acquisitions I'm not sure 1997 will be the year of aggressive growth. Emons (Nasdaq: EMON) is still trying to gain a foothold in the line acquisition business; Pioneer and RailAmerica (Nasdaq: PRRR and RAIL) continue to buy up the marginal pieces, with the result that their carloads per mile per year will likely remain substandard. Perhaps the brightest light among the shortlines is Genesee & Wyoming (Nasdaq: GNWR). Since their midyear IPO the stock has nearly doubled and, depending how they play their cards in the Conrail merger game, could make out very well in 1997.

In short, the view from here is that 1997 will be a year of consolidation of the gains made in 1996 with a larger focus on growing the top line through more competitive service offerings. Growing the right revenues will yield more money per carload and again the rate of increase of earnings will exceed the rate of revenue increase. And finally, as the number of big railroads gets smaller, the smaller railroads will get bigger with increased market presence, economies of scale, and smarter management.

Best wishes for the New Year,

--Roy Blanchard

Ready reference: homepages for Conrail | CSX | Norfolk Southern

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