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The Railroad Week in Review 9/27/97
featuring: The Breakup of Conrail

Ready reference: homepages for Conrail | CSX | Norfolk Southern

< In merger-related news, last week's meeting of the Intermodal Association of North America brought word that the industry will try again to match pricing with availability and demand. Volume is up almost 10% this fall even with equipment getting scarce. Norfolk's Tom Finkbiner said the rails' past record of erratic service makes it tough to get away with price hikes even in peak season. The alternative is for shippers who would like to buy capacity for the peak period to be prepared to pay for it the other 10 months of the year.

A corresponded in NJ, formerly a Conrail executive, notes, "Railroads have never made a successful effort to tie their prices to peaks in demand. They raised rates in the fall of 1994 to take advantage of record demand, but lost the business because shippers remembered the bad service that went with the rate increases. As soon as demand subsided, they switched business to truckers offering low rates and better service."

Meanwhile, Rip Wilson writes in the Journal of Commerce that there is great unrest in the area around Cleveland. Norfolk's plans to increase trains by a factor of four is particularly nettleseome. U.S. Rep. Dennis Kucinich, D-Ohio, maintains the transaction is "a real threat to the lives of my constituents. We are organizing substantial political and legal resources, not simply to stop the routing of the trains, but to block the merger itself." Norfolk spokesman Frank Brown counters that NS has "an internal task force that is reviewing the Cleveland traffic issue."

Norfolk Southern has named Roger M. Bennett to the new position of Director - Industrial Development with headquarters in Philadelphia. Bennett will lead Norfolk Southern's new Northeast Region Industrial Development office, responsible for New York, Pennsylvania, New Jersey, Delaware, Maryland and New England. He will report to Larry R. Collingwood, assistant vice president - Industrial Development in Atlanta, GA. NS also tapped Robert K. Atkinson for the new position of Regional Manager - Industrial Development Engineering in Philadelphia and will be responsible for Norfolk Southern's Industrial Development engineering efforts in the new Northeast Region.

Amid my weekly passel of press releases from the STB came news that Linda Morgan will not recuse herself from the Conrail proceedings as requested by a dozen union leaders. The unionists' claim was that Morgan had made public statements that compromised her ability to act impartially. The Board's strongly-worded response said the allegations were "absolutely false." Ms. Morgan continues, "My remarks did not specify what specific conditions might be used to achieve competitive balance in the east. The Board will define preservation of competition in the context of the record, the facts, the region, and the arguments that are made." As for the request she recuse herself, the message was, if you've got something to say, make a formal filing "so that the issues can be considered along with others pleadings filed in the case."

Amtrak took a major hit Monday. The Presidential Emergency Board (PEB) investigating the labor dispute between Amtrak provided no basis for a negotiated settlement. The main sticking point is the PEB's $250 mm idea that MW employees get the same pay package as those working for the class I freight roads. Said Amtrak President Tom Downs, "The Board's recommendations assume that by simply making Congress aware of the costs of a generous settlement, Congress will provide funding when in fact Congress is well aware of Amtrak's financial needs and has been insisting on reforms to allow for reduced costs."

Those who have not been vacationing in far Tibet know the KCS railroad is about to be spun off by the KCS Industries holding company so that the latter can focus on financial management. I've always kind of shunned KCS a "railroad investment" because from a revenue/earnings view it's more a financial company than anything else. Take the Jan-June 1997 results. Total Revenues were $490 mm of which the RR generated $274 mm, or 56%. However, the corporate net income for the period was $123 mm of which the rails contributed a mere $3.3 mm or 2.6%.

The stock closed Friday at $33.31. How much of that is railroad? Last week's Barron's pegged the Financial Asset management (FAM) arm at $30 a share, which would seem to indicate the railroad comes free at Friday's closing price. Running the numbers with the June 10-Q and the December 10-K gives us trailing 12-months rail revenues of $506.1 mm and operating income of $75.3 mm for an operating margin of 14.9%. Add back depreciation and amortization and we get a trailing 12-month EBITDA of $132.2 mm. Do the same with the consolidated statements for corporate revenues and EBITDA of $884.1 mm and $279.9 mm respectively. The railroad thus contributed 44.4% of the corporate cash flow.

There are 110 mm shares outstanding. It could be said 44.4% of the shares are rail shares and the balance are everything else and if this is so there are 48.8 mm rail shares. Trailing 12-month rail earnings then comes to $1.54 per share. At the moment First call says railroads are trading at 15.7 times 1997 earnings, so KCS could be worth as much as $24.17. Add this to Friday's close for a fair price of the whole enterprise of $57.48, meaning today's price represents a 42% discount, and if Barron's is right and the FAM is worth $30, then you could be getting the railroad for $3, one-eighth of the value.

However, before you all rush out, do recall that rails trade in the neighborhood of 1.5 times sales. Trailing 12-months revenues amount to $10.37 per prorated share. Apply the multiple and get $15.57. To be sure, you're still getting the railroad for three bucks, albeit one-fifth of the value. So either way this could be an interesting proposition. (BTW, there's a parallel discussion going on in America On Line's Motley Fool financial area in the Dividend Reinvestment folder. Non-AOLer's might check

In a related development, KCS has offered itself up as a solution to the UP/SP rail service problems being experienced by Texas Gulf customers (Week in Review, 8/30/97). First, UP/SP could divert traffic around Houston by giving more trackage rights to the Texas-Mexican Railway, in which KCS holds a 49% stake. Second, by shifting present Texas-Mexican Ry. trackage rights south of Houston to a less-congested route. Third, by removing existing restrictions that block Texas-Mexican Ry. from serving local customers in the Houston area and widening the switching authority of an existing local terminal railroad in Houston to give customers in the area new routing alternatives. In short, the STB could be asked to re-evaluate its original UP/SP position and give KCS permanent and broader local service access to Houston area customers.

Is there an echo in here?

--Roy Blanchard

Ready reference: homepages for Conrail | CSX | Norfolk Southern

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