The Blanchard Company

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The Railroad Week in Review 1/25/97
featuring: The Battle for Conrail

Ready reference: homepages for Conrail | CSX | Norfolk Southern

This week began results week in NYC. I was able to cover the Burlington Northern Santa Fe and Illinois Central meetings and they were informative to say the least. The buzz at Conrail and CSX continues to be the merger and the Union Pacific results are the first posted since the Resources spin-off.

BNSF last week announced fourth quarter earnings Up 20% on revenues and carloads that didn't budge much from 4Q 1995 levels. Burlington Northern Santa Fe (NYSE: BNI) reported net income improved to $244 million, or $1.56 a share, from $203 million, or $1.32 a share, in the earlier year. Profit for the latest quarter matched analysts' forecasts. For the year BNI earned $889 million or $5.70 a share as expected. But those who are so inclined can read all the details on the BNSF website .

The real meat of the presentation had to do with what was billed as "BNSF's UP/SP Commercial Opportunity." Railroad readers should pay attention because what was said bears not only on BNI's future but also has implications for the Conrail merger. First, customers formerly accessed by Union Pacific (NYSE: UNP) and Southern Pacific are now served by BNI and UNP. Where UNP and SP was never much of a choice, now it's a different story and customers are happier. How many customers? Oh, about 600.

In a nutshell, BNI is taking major advantage of the STB-mandated trackage rights and line sales, adding 4,000 miles to the railroad, including the purchase of 335 miles in three line segments plus two yards. They started moving cars via haulage agreements immediately and are shifting to trackage rights as fast as traffic volumes will allow. BNI and UNP are negotiating proportional rates and other revenue sharing agreements on existing traffic, including half of what's on contract. BNI has added 17 new 2:1 shortline connections as well, and the same 2:1 benefits apply her as to the customers, above. And it all works because BNI's rights merely connect the dots. No new terminals are involved.

How much money's at stake? UP/SP collected $733 million for their services on the affected lines in 1994. This does not include revenues beyond UP/SP -- just what accrued to the serving railroad. BNI figures that in 1997 it has a shot at as much as $200 million, including what's already in the bag, what they've got a good shot at, and some long shots. Also note that the STB-mandated rights were possible because there were pre-existing yards at each end to support the carriers using the rights. Lacking same is one reason CP rights into Philadelphia and Northern NJ don't really work.

To conclude, BNI has set its sights on reducing the operating ratio a full two points to 76.4 and continuing to improve yield significantly even as revenues lump along in single digit increases. First Call consensus is for $6.89 in FY 1997, up 21%. Krebs says he can live with that. BTW, this outfit ranks first in the First Call class I railroad recommendation sweeps, garnering a 1.6 on a scale of 1 (buy NOW) to 5 (sell NOW).

Hunter Harrison, President and CEO of Illinois Central (NYSE: IC) opened Tuesday's analysts' conference saying he was disappointed with the meager revenue increases for the quarter and the year. Estimates were met, however, and the OR (operating ratio) dropped another point to 63.3. Carloads were 90% on time (OT in IC means within one hour for intermodal and two hours for merchandise. Not too shabby when some rails say it's on time when a car is +/- a DAY!!). On the labor front, only the BLE has yet to come to agreement, meaning they'll stick with the status quo and be left behind or they'll join their peers and share in the gains through profit sharing. In sum, he said, a game well played with mediocre cards dealt.

IC's play in the mergers is to remain a neutral carrier, thus insulating their customers from the liability of being captive to either BNSF or UP/SP. There is no real opposition to CR merger as long as the IC gateways are protected and that "meaningful competition" is preserved to eastern markets. That being said, Harrison volunteered that NS may be a better bet for opening new markets to IC given the "balanced rail competition" theme promoted by NS.

Revenues and net income for the quarter were $173.6 MM up 9% . For the year revenues were$657.5 MM, up a shade under 2% yet earnings were up a bit over 15%. Harrison says the 1997 budget targets 7.5% to 10% more revenue. It's doable, and puts them up another notch to the $billion revenue goal they've set.

In its quarterly press release Conrail reported some really astounding numbers. On gross sales that were virtually unchanged primary earnings were up a third; fully diluted only slightly less than that. Even more amazing, merger-related costs of $16 million ($10 million after taxes) are included in the fourth quarter 1996 operating expenses. Without these costs, net income for the quarter would have been $157 million ($1.99 and $1.82 per share, primary and fully diluted, respectively). How can all this be?

Revenue was essentially flat. The number two earnings driver, the operating ratio, improved (excluding unusual items). For the 1996 fourth quarter it hit 72.5 percent compared with 74.9 percent for the same period of 1995. The full year operating ratios, excluding unusual items, were 79.7 percent for 1996 and 79.9 percent for 1995. Looks like a good recovery from the weather-driven evils of Jan-Feb 96.

For the full year, traffic increased 2.1 percent in 1996. However if revenue was flat, it means they were making less money on each carload on average. Intermodal (where yields are least) increased 7.6 percent and Unit Train (more profitable) was unchanged. Automotive was off almost 2% and the Core Service Group (all of it carload, which really drives the operating ratio) declined 1.6 percent overall. Details? Metals increased 4.0 percent, Petrochemicals decreased 2.5 percent, Food & Agriculture Products decreased 2.8 percent, and Forest & Manufactured Products were down 5.3 percent.

LeVan, in a statement accompanying the results, notes the merger "has been a distraction." In the last quarter, a $16 million distraction at that. In real life terms, that's enough real money to completely re-tie more than 121 miles of railroad.

A Conrail conductor writes, "I know where the savings will come from. Most of the train service employees will lose their jobs, as will the rest of the CRR employees. As of 12:01 this morning Conrail ordered that all crews, yard and local freight to remove one crew member. Now there is only an engineer and conductor. They must be getting desperate for cash. Most of the employees...feel that our only chance is with the NSC." A fellow consultant up in New England writes, On the ESOP issue I am told by a former Conrail management type who took the buyout that the ESOP holders majority rules and that with many bitter ex types holding shares they have no loyalty toward...the CSX plan. They want to take their money and run. [The Philadelphia Inquirer noted that not all ESOPs voted for it Jan 17.]

The game is far from over. The STB weighed in last week saying they couldn't make or break a merger but they would have the final say on how the railroads wind up. And there were olive branch lettters swapped among Goode, LeVan and Snow. Could be the arbs will tire of the game and give the shareholder nod to Conrail/CSX while the STB says a pox on all your houses; go to your rooms and don't come out until you can be nice and give us an eastern system than works.

The Blanchard Company continues to advise NSC on certain aspects of the merger.

--Roy Blanchard

Ready reference: homepages for Conrail | CSX | Norfolk Southern

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