The Railroad Week in Review:
Week Ending November 8, 1997

The Defense Department has decided not to use the nation's largest railroad to haul weapons and munitions shipments until it improves its operations. Union Pacific hauls more military goods than any other railroad. The military will use the railroad only if it can find no cheaper alternative that meets its security requirements. The San Antonio Express-News reported that a shipment of 63-ton M-1 Abrams tanks recently sat uninspected for four days on a railroad siding in Lafayette, La. The military order was issued last month and will be reviewed in January. It is the first time the military has taken such a step for a company's entire rail network, officials said.

Barron's today graphed UP's steady stock price decline for the last year on a 200-day moving average. The comment accompanying the graph? "Federal Regulators day the railroad's delays pose a 'transportation emergency in the west' and have it to temporarily open part of its Houston traffic to a line controlled by KCS."

Then there's the effect of UP's operational problems on distant customers'businesses. One affected firm is General Chemical Group in Hampton, NH on theformer B&M. Third quarter earnings were up due to greater volumes across business lines, however those gains were constrained by a shortage of soda ash originating on the UP. The company also notes, "despite the potential for continued problems with rail freight delays as well as higher natural gas prices, we remain positive about our earnings outlook for the year." I'm hopeful other railroads experiencing fallout from the UP follies will drop a note to to tell us what they see and what they're doing about it.

The whole STB schedule for the CR merger has been pushed back 45 days, according to press releases received this week. The delay is driven by the STB's desire to have the parties prepare a safety plan to insure against the kind of debacle being experienced in the west. The net effect of the schedule change will be to delay every step in the chain, beginning with the 12/15 due date for responses to the 10/21 filings being shifted to 1/30. The decision date thus becomes 23 July 1998.

At a recent meeting in DC Norfolk Southern EVP -Marketing Ike Prillaman said the players "could would wait months after getting regulatory approval before linking computer systems and adjusting their operating procedures. Doing nothing is a viable alternative. Day One will extend for a period of time until we are ready to go forward.'' With the process already delayed 45 days, one begins to wonder how long it will be until CSX and NS begin to see the positive effects of the merger in their respective earnings. As indicated below, there are indications that NS stock could be overpriced right now by some margin and that CSX is right about where it should be a year or more from now.

RailTex showed record carloadings, operating revenues and operating income. Loads were up 39% with revenues up 27% (which means yield takes a hit) and operating income was up 16%. For the nine months, loads were up a third producing 24% more revenue and 19% more operating income. Nine month loads were up a third producing 24% more operating revenue and a 24% operating income hike. Net income for nine months was off three cents to 74 cents a share from 77 cents, largely the result of interest expense on a $63.2 million acquisition and start-up loan in place since June 1996.

RTEX also noted that "same railroad" operating revenues increased 9% and 6% for the quarter and nine months respectively. Same railroad operating ratios dropped two and a half points for the quarter to 74% and 2.3 points to 74.2% for nine months. Meanwhile, RTEX stock continues to languish, though preliminary indications are there is significant long term room for growth. See elsewhere in this report for details.

Lose one, add one. I'm dropping Portec from my vendor market basket and adding Alcatel Alsthom. The former is selling its Railroad Products Group to Rail Products Acquisition Corp., whose principal stockholders Marshall T. Reynolds, a Huntington, W.Va. businessman. Portec's Railroad Products Group includes Railway Maintenance Products Division, Shipping Systems Division, Quebec's Portec, Ltd., and Portec (U.K.) Ltd. in North Wales. The transaction is subject to regulatory approval and is expected to be completed in the fourth quarter of 1997.

Alcatel is a Paris-based vendor trading on the NYSE as ALA. According to Morningstar, ALA "provides telecommunication equipment and transportation services, and generates power in more than 100 countries. Its Alcatel Telecom subsidiary produces network systems, satellites, and fiber-optic cables. Alcatel Alsthom holds a 50% stake in GEC Alsthom (Netherlands), which operates combined-cycle gas-turbine power plants, supplies railway equipment, and builds ships. It also provides contracting and consulting services. Alcatel Alsthom markets its products in France and worldwide. Sales outside of France account for about 77% of the company's total sales."

Railroad supplier Varlen Corporation has acquired one company in Germany and another in the Czech Republic to grow its international railroad products operations. While Varlen did not disclose the purchase price, it said both acquisitions were cash transactions that did not require additional debt. Both companies manufacture highly engineered, precision-forged railcar cushioning devices for corner buffers. As a result of these acquisitions, Varlen now will be the leading manufacturer of buffer springs used in European-type railcar energy absorption devices.

Back in the US, Varlen has acquired a line of portable laboratory and process petroleum analyzers from Boston Advanced Technologies, Inc. (B.A.T.). Varlen had been the exclusive worldwide distributor of B.A.T.'s Petro-Spec(R) brand under a strategic partnership. Varlen acquired the patents, technology, inventory, and assets needed to manufacture B.A.T.'s Petro-Spec(R) instrument product line and distribute it through Varlen's distribution and service network. For the record, Varlen's US product line includes Brenco bearings, Chrome Crankshaft, Prime locomotive accessories, and Keystone draft gear supply.

Amid all the talk about how overvalued stocks are, I thought I'd look at our favorite industry and see how we fared. I used easy and straight-forward analysis tools: the YPEG and the PEG. First, the YPEG. Generally used for bigger companies that will be around for a while and with steady earnings streams. It's the farthest out earnings estimate times the five year growth rate estimate. The product is a nominal "fair value" sometime in the future. The further below today's price the more room it has to grow. Six rails qualified with YPEGs less than current price. From best to worst: RAIL, RTEX, CP, GNWR, WCLX, BNI. For merger watchers, the CSX current stock price is 102% of the YPEG and NS stock is now a whopping 142% of its YPEG.

As a sanity check, I turned to the PEG. Though more helpful with smaller, more volatile companies, the PEG can be useful in comparing current prices. It is simply the current PE divided by the next year's growth rate. Here, when the PE equals the growth rate the stock is said to be fairly priced. Ideally, we're looking for PEGs of 0.5 or less. Get to One and you might think of selling; over 1.5 think of shorting it. Of our six YPEG winners, all but CP came in under 1.00. Best to worst: RAIL, RTEX, BNI, GNWR, WCLX. Of these, only RAIL and RTEX came under 0.5 with 0.28 and 0.47 respectively. These are starting places only, and should be used as indicators to begin one's own homework. Next week: the vendors.

Meanwhile, S&P's STARS ranking process gives UP one star (sell) based on "costs to integrate Southern Pacific." Five Stay (buy) recommendations go to Alcatel on valuation and restructuring, and CP on benefits of higher oil and gas prices.

--Roy Blanchard

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