The Railroad Week in Review:
Week Ending October 18, 1997

This past week about 500 shortline managers and vendor reps descended on Dallas for the annual American Short Line Association meeting. One of the highlights was a pair of back-to-back presentations by UP and BNSF on their respective views of railroading in the west. Naturally, UP's Charlie Eisley, VP for Strategic Planning, delved into the service problems. The basic cause, he said, was SP's lack of "surge capacity." When UP sought to fill in the gaps, it voided its own surge capability and the result is history.

Of interest to the group there assembled, Eisley noted that as part of the Service Recovery Plan (see Week in Review for 10/11/97) UP intends to reroute some traffic over its shortlines, run fewer locals, and even ask short line help in terminal switching. Surely this is a resource worth counting on. Eisley noted that UP's 160 short lines contribute about 15% of UP's annual railroad operating revenues which last year came to $7.7 billion for UP before adding the pro forma SP numbers.

Eisley's BNSF counterpart, Doug Babb, leaned heavily on that line's emphasis on "leveraging short line partnerships. A major thrust going forward will be on what Babb calls "electronic commerce," and that includes everything from EDI to email, literally joining the shortline and BNSF at the hip. So far more than 5,000 system miles have been turned over to short lines, although the process will essentially end in the next couple of years. And the successful bidders for what remains will have to embrace the strategic partnership going in or risk not being favorably considered for the acquisition. Extending the franchise is the operative term.

Another presenter of note was FRA's Jolene Molitoris. The UP/SP fracas weighs heavily on that august governmental body, and Molitoris made no bones about FRA's emphasis on safety going forward. Saying, "The American people don't differentiate between a UP locomotive and your [short line] locomotive," she went on to say FRA guidelines will be applied across the board. Moreover, what the FRA perceives as "intimidation and harassment" on the part of rail managers will not be tolerated. The FRA expects there to be a top-down emphasis on worker safety and is prepared to do whatever it takes to get it. Following her presentation, conversations with a number of shortline managers confirmed that the FRA has in fact been making good on its commitment to looking as closely at the Short Line as at the UP.

Elsewhere, the FRA is looking into the recent Amtrak-truck incident outside Savannah. One new requirement is for CSX to post an emergency toll-free number on all major railroad crossings listing the crossing identification number. It turns out that local police called the Jacksonville Operations Center when the low-boy truck got stuck yet the Amtrak train never got the stop order. Another aspect of the FRA initiative is, in the words of a press release, "to continue emphasis on the education of truckers on the issue of railroad crossing by providing the trucking community with educational and informational material on high risk crossings." Now to be really helpful the FRA could start supporting the railroads' efforts to close these particularly hazardous or redundant crossings.

While at the meeting I had a chance to talk with Barbara Wilson who is Managing Director of Bank of Boston's railroad finance group. In the context of the KCS split up, Barbara noted that her guidelines for valuing a line are pretty direct. The asking price shouldn't be over twice the annual revenues, for starts. Nor should the price exceed six times cash flow. (Short line accounting pro Jim Bowers supports this with a 5.7.) Lastly, says my Boston friend, if your cashflow plus taxes isn't at least 1.2 times your debt service, you're coming up short.

Applying these yardsticks to KCS - the railroad, twice sales gives you a $billion plus or minus. Six times cash flow comes to $740 million. Interest expense is about $40 MM and cash flow plus taxes is expected to be around $118 mm. Three-to-one is a decent number. So, with KCS total company stock still in the $33 range, and with the financial side still priced at $30, the 107 MM shares would seem to represent a $321 MM value on the railroad. Still looks low.

An area for railroad investing often overlooked is the vendor side. This is something I track monthly via a "market basket" of 14 companies from Ansaldo to Wabash National. Granted, not all the companies are 100% in the rail business (Timken, e.g.) however they have a substantial enough presence in the industry to be regarded, I think, as "railroad stocks." A portfolio of approximately $2,000 in each stock on January 1, total cost $27,730, would be worth $42,995 today. That's an increase of 61.3%.

Savvy investors who jumped on Johnstown Industries (Nasdaq: JAII) for $3.75 a ticket in January have tripled their money to $13.38. Powerhouse Motive Power Industries (Nasdaq: MOPO) more than doubled to $18.88 from $7.75. And Varlen (Nasdaq: VRLN), recent acquirer of Brenco and others, has more than doubled, now standing tall at $44.88 from a $20.50 start Jan 1. Other near-doubles include Westinghouse Air Brake (NYSE: WAB), Greenbrier (NYSE: GBX) and RoadRailer maker Wabash National (NYSE: WNC), all up 70% or more.

Also beating the averages were L B Foster (Nasdaq: FSTRA), Harmon (Nasdaq: HRMN), GATX (NYSE: GMT), and Trinity (NYSE: TRN), all up 30% ore more. ABC Rail (Nasdaq: ABCR), Timken (NYSE: TKR), and Ansaldo (Nasdaq: ASIGF) posted the only losses whereas Portec (NYSE: POR) was the only one to remain virtually unchanged, up a mere 4.6%.

Several of these companies had exhibits at the ASLRA session and I had the chance to talk some with the folks at each about their business and where they see it going. One of the most interesting was WAB. Here is a company that went through an LBO a few years ago, incurring a ton of debt to serve an industry conventional wisdom had long ago given up as D-E-A-D.

Yet a cursory glance o'er the articles shows a 17% three-year average compound gain in revenues and an 18% ACG in in earnings. First Call notes a 90-day rising trend in estimates for both FY 97 and FY 98, up 21% this year and 12% the next. With a 1997 PE of 18, it's trading at a three-point premium to the industry and a two-point discount to the sector. My big reservation has always has been the high debt and negative equity.

A phone conversation Friday with CFO Alvaro Garcia-Tunon yielded up more company strengths than weaknesses. First, the basics. WAB commercial paper is trading at more than par, meaning there's a lot of investor confidence in the financial strength of the firm. Cash flow is sufficient to cover the debt four times. And the product line is diverse enough to weather the cyclical nature of the American freight railroad scene.

The split between OEM and replacement parts is about 50/50 with a 15%-and-growing international business. In 1998 estimates are running 25% transit, 15% international, and 60% US freight roads. In transit, NYC alone represents about 40% of the market, so New York's order for 1,030 cars over three years bodes well. In freight, we've seen 40-60,000 new cars a year for the past five years, and WAB figures that pace will continue in 1998. The nice thing is, what you build today you repair tomorrow. And that's good for WAB shareholders.

--Roy Blanchard

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