The Railroad Week in Review:
Week Ending November 22, 1997

The week began with good news from Providence & Worcester. The third quarter results press release deals in terms of total income and earnings per share; I shall touch on some of the significant changes in operating revenues, operating income, and general health. To begin, operating revenues were up 13.8% quarter to quarter and 13.3% for the nine months, 1997 vs. 1998. This translates to a $720,000 revenue increase. Combine that with a $350,000 decrease in operating expenses and you begin to see improvement.

Over in the nine months column, revenue was up $1.9 mm and operating expenses were down 172,000. More important, earnings before interest and taxes were up 110% to $3.4 mm from 1.6 mm. Interest expense for the nine months was essentially flat year-to year, driving a double in interest coverage, to 3.27 from 1.54. Bottom line? Earnings per share jumped to $0.42 from $0.12 for the quarter and to $0.65 from $0.16 for nine months.

Tuesday brought quarterly results from Emons. Net income was up 26% for the fiscal first quarter on a 4.4% increase in revenues. More important from a management viewpoint was the 9.2% increase in freight revenues on a 4.7% decrease in carloads. In other words, yield increased markedly - more money, less work. Elsewhere, CEO Robert Grossman notes that net income was hit with a $108,000 special charge in connection with restructuring the bank debt.

Genesee & Wyoming (GNWR) reported quarterly results last week as well. For the period revenues increased $4.6 mm or 24% over last year's quarter to $23.6 mm. For the nine months, revenues hit $71.2 mm, up 30%. Per share earnings for the quarter were up 18.2%. Net income for both the quarter and the nine months was up as well, however a 59% increase in the number of shares outstanding caused the nine month eps to drop slightly to $1.18 from $1.25, just 5.8%. GNWR has issued a caveat for the next quarter, saying the UP problems will probably hurt the Louisiana, Oregon, and Illinois operations.

Union Pacific notes that earnings will be down this year due to the merger debacle, which is not surprising. The good news is that in the last three months 1998 estimates have declined only 12% against the 24% drop in 1997 estimates. UP closed Friday at $58.50 a share on estimated 1997 earnings of $2.92, yielding a 1997 PE of 20. Since UP earned $2.71 in 1996, the 1997 figure represents an earnings growth of just 8%. A stock trading at 20 times earnings on eight percent growth would appear to be vastly overpriced.

But wait. The 1998 estimate of $4.30 is 47% ahead of 1997's number. With UP trading at 20 times earnings today, the 1998 PEG becomes 20/48 or less than 0.5, which in my book is a buy signal.

But wait again. One could use a two-year estimate to even out the wide swings. UP shares earned $2.71 in 1996, are expected to earn $2.92 this year, and $4.30 the next. The farthest year's estimate represents a 50% improvement over the earliest number, an average compound growth rate of 22% (the square root of 1.5 - 1.22 - minus one). The more conservative PEG would thus be 20/22 or 0.91, indicating a 1998 fair price of $58.50/0.91 or $64.28. Buy at $58.50 today and get $64.50 in a year - is 10% growth enough?

As if UP didn't have enough problems, the Texas Railroad Commission said it may ask the STB to force the sale of some UP lines in Texas. The focus appears to be the Houston-Beaumont line plus much of the Houston-area trackage. The Commission's idea is for UP "to contribute" said track to the Port of Houston or "a new independent railroad authority." On Friday the scheme was formalized with a suggestion that the feds should force UP to transfer some 200 miles to BNSF and Tex-Mex. UP, for its part, is not thrilled, saying in its SEC filing that it is opposed to such a move which would "worsen the problem" and is "legally unjustified.'"

Business Week this week ran a piece noting "the UP mess is at least a billion-dollar-a-month problem for the country. That's manageable in a thriving $8 trillion economy. But consumers [may] eventually feel the pinch in the form of higher prices for everything from electric power to chicken. The congestion and shortages are raising broader concerns about the health of the nation's transportation infrastructure and its ability to support further economic expansion. Indeed, with more and more companies relying on just-in-time inventory systems, transportation blips hit the economy harder."

ABC Rail Products (ABCR) says the quarter just ended was a lot better than the same three months last year. According to the press release, revenues were up 21% and earnings were up a third, to 8 cents from six. If that's so, ABCR did twice what analysts expected, since the mean estimate was only four cents a week ago, and that was down from a dime three months ago. Moreover, current estimates for the Jan 1998 quarter stand at nine cents, down 71% from the Jan 1997 quarter's 31 cents. For the year ending July 1998, estimates call for $1.05 a share, up 156% from the prior year's 41 cents. Yet the July 1999 estimate shows only a five percent improvement over 1998. See why a two-year PEG is sometimes necessary to see what's really going on?

Varlen (VRLN) reported record sales, operating profit and earnings for its third quarter ended November 1, 1997. Highlights for the period include three acquisitions, the conversion of $69 million of subordinated debt, and the announcement of a 3-for-2 stock split. First Call estimates VRLN will earn $2.56 a share in the FY ending Jan 1998 and $2.90 the year following, representing growth rates of 25% and 13% respectively. Varlen currently trades at $43.25, 16.9 times 1998 estimates.

Trinity (TRN) was listed on the WSJ's monthly NYSE short interest page as the 26th largest decrease in short interest, down 67%. Recall that last week we identified TRN as perhaps the choice buy among car builders if one were looking in that direction.

This week's Industry Snapshot deals with non-class I railroads. Three made the cut based on the PEG and YPEG calculated as above: GNWR, RTEX, and WCLX. PEGs are less than one, and YPEGs show room to grow in the longer term. Picking one of the three is a tough call, however. All sport First Call recommendations between 1 and 2, which is a strong buy. RailTex has the most room to grow, however it also has the most debt. GNWR has stronger numbers than RTEX, but is a very new company. WCLX stock wins in three of the six snapshot categories-margin, ROE, and ROA, yet trades at six times sales, quite a premium in an industry where two times is considered on the pricey side.

WCLX has the least maneuvering room from current price to YPEG price, one of three secondary measures I use when the others are too close for comfort. The other two are PE and PS, and here RTEX wins with the lowest in each, 14.18 and 1.15 respectively. Then again, GNWR has a new president, Charlie Marshall, late of Conrail, and RTEX just lost a president, Henry Chidgey, off to Brazil. Like anything else, you pays your money and you makes your choice.

--Roy Blanchard

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