The Blanchard Company

Marketing and Management Support
for Feeder Railroads

The Railroad Week in Review 4/5/97

Ready reference: homepages for Conrail | CSX | Norfolk Southern

Conrail announced Thursday that it has decided to retain ownership and operation of freight service in six clusters of lines it had previously planned to sell to shortline or regional railroads. Among them are the Buffalo-Keating line originally slated to go to the Genesee & Wyoming's Buffalo & Pittsburgh unit, and the "Boston Cluster," nominally slated for RailTex. In addition, the Camden Cluster had been "put on hold" imdefinitely, thus derailing the expected Rail Development Corp transaction. Since these assets had been marked for sale, resources required for the continued operation and maintenance of the line have been diverted to other parts of the Conrail system. One can only hope the negative effects can be mitigated by an expedited process to convey the properties to their new owners, NS and CSX.

Canadian Pacific has now completed its sale of more than 1,100 miles former Milwaukee track between MSP and KC to Dennis Washington.The deal was worth a reported $250 MM. Washington also acquired in a separate transaction some 24 locomotives and a thousand cars. Operations start 4/5 and CP has acquired a one-third equity interest in the new company, which will be called "I&M Rail Link."

At the Norfolk Southern Shortline meeting this past week (a resounding success, by the way), some of us were chatting about recent changes in the industry. One I missed was the decision by RailAmerica to sell off its Steel City trucking operations and put more emphasis on expanding rail operations through its acquisition program. From the looks of things, its decision to dispose of its motor carrier operations should have a favorable impact going forward because operating margins of its short line rail business have most likely been significantly greater than those of Steel City Truck. Now if only they can get rid of that $2 MM good will albatross.

A friend at BNSF was lamenting his employer's low stock price the other day. At $74, it might just be a bargain. Read what reader Tim Ecklund has to say about the recent sell-off in class I rail stocks, and consider the impact on players like Mort Fuller and Walter Rich. Writes Ecklund, "I think the weakness in the Class 1 prices is simply a reaction or realization that the merger/consolidation activity in that sector. While the long term has great potential benefits, in the short-run is not as exciting as once thought.

"Typically the last 10-20% move up in a stock price during a long-term uptrend is fueled by the speculative or 'momentum' element that drives certain institutional/individual investors. Notice how this last surge upward in the Class 1s came as the merger activity reached its peak and the speculative/momentum element did its work." In this vein, corrections in the range of 15 to 30% off the tops are not unheard of, yet "if that 30% retracement holds, the stock will consolidate at lower levels. The spec element will have been worked out and a new a new uptrend can begin based upon more conservative expectations." If the 30% retracement level fails to hold, the stock will continue to fall until the spec money has at last been exhausted. That's why, with BNSF trading at less than 70% of "fair value," it begins to look attractive.

The shortline implication comes from the price-sales (PS) ratio. As prices fall, so does PS. Eklund again: "I get real nervous when I see rationalized Class 1 track being sold at two-plus times sales, especially when the acquiring SL/Regional is beholden to the Class 1 for everything." Two times sales infers a certain asset base which will allow the buyer to run and grow the business.

So why pay the premium where there is no asset base? Often the line being sold has been so de-marketed that no franchise remains, which is another hit against the asset base. The flip side of all this is the 2.8 times sales premium baked into the Conrail sale. There's a decent asset base and an excellent franchise, albeit one that is below market potential.

Reading the financial pages gives you an excellent feel for who's winning and why. Despite the moaning and groaning over the recent downturn, there are some S&P industry groups well ahead of the averages. Trucking, for example is up 35%, and rail/truck hybrid Hub Group (HUBG), the largest intermodal marketing company (IMC) in the business, rides along. Intermodal trafffic has increased at a rate of about 5% a year for the past five years and is expected to continue at that rate. Total market value as of Jan was $10 billion. IMCs have roughly 44%, and HUBGs share is 20% and growing at more than ten percent a year.

Hub opened its doors in 1971 as an intermodal freight consolidator and has since added truckload consolidation. We all know how little attention small shippers get from railroad marketing groups, and intermodal is no different. Enter HUBG and its strong relationships with railroad intermodal groups, a highly sophisticated customer service network, some 32 terminals in the US, a financial relationship with APL, and its aggressive pricing practices. The "mom and pop" shops and blown away as HUBG grows its business twice as fast as the industry average.

Wisconsin Central has been dropped two stars (avoid -- likely to be a below-average performer) by S&P. The anticipated earnings increases for 1997, the agency says, will be driven chiefly by the absence of the 1996 charges for a switching dispute and paying for that horrific derailment. It's S&P's opinion that the overseas acquisitions have bolstered earnings while the US core business has been uninspiring, yet these too will show less aggressive growth this year. Paper shipments, which account for a third of WC's traffic base, will continue to be depressed due to industry overcapacity and market resistance to price increases. Savings from consolidating operations Green Bay North and an easier winter will lower costs somewhat.

GATX now sports a five star (buy) recommendation from S&P. Leasing revenues, which account for nearly half the company's $1.4 billion annual revenue stream, have increased every year since 1993 at an average annual compound growth (ACG) rate of 15%. Financing activities, a quarter of the total have grown at an ACG of 23% since 1993. Earnings per have grown at an ACG of 19% over the same period. Shares are trading in the $49 range or 1.3 times book and 0.7 times sales.

ABC Rail expects third-quarter net income to be below analysts' estimates of 53 cents a share, but above its year-ago third-quarter loss of 30 cents a share. The company said that although orders were stronger than expected, a combination of factors hampered operations. Among the factors were several facility and process upgrades designed to streamline ABC Rail's manufacturing operations and reduce costs. First Call gives ABCR a rating of 2.0 with expected 1997 and 1998 earning up 47% and 30% over the prior year's results.

Next week perhaps we'll see a final system plan for un-merging Penn Central and completing the PRR-N&W and NYC-C&O mergers begun forty years ago.

--Roy Blanchard

Ready reference: homepages for Conrail | CSX | Norfolk Southern

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