THE BLANCHARD COMPANY

The Railroad Week in Review:
Week Ending November 29, 1997


The Union Pacific problems continue to dominate the rail news, however the spillover from Asia's woes may have longer lasting effect than anything the UP has concocted. Wednesday's WSJ ran a thought-provoking page 2 story on how turmoil in the Pacific rim countries is beginning to impact the US. Nearly 60% of exports from the PNW go to Asia, as do half the exports from the southwest. South central and plains states each send a quarter of their exports to the far east, while regions east of Ole Miss average about a fifth of total exports to Asia.

Now take a look through a railroader's eyes. The roads with the greatest reliance on Pacific Rim trade will take the most heat, and that logically will fall on the UP and BNSF. Impacts on IC and KCS will be less, and eastern roads will fall someplace in the middle depending on their off-shore traffic flows, especially in intermodal. Shortlines and regionals, I think, will be hurt least in so far as they focus on raw materials and finished goods created and consumed in the contiguous 48 states and Canada. And as investors cast about looking to minimize far east exposure, the regional rails could look increasingly attractive.

Each year about this time RailTex sends out a gift package to its "friends" - customers, suppliers, etc. It's really a novel idea because the package contains about a dozen small items which are somehow related to one or more RailTex Properties. This year there are "Barnum's Animal Crackers" from Nabisco, linked to the Connecticut Southern's role in bringing the circus train to town. An oil-filled plastic paperweight relates the New Orleans Lower Coast Railroad to its customer Chevron and to Gordon terminal, a customer on Pittsburgh Industrial Railroad. All in all there are 14 items, and even the box itself is a "present," linked to two southeastern RTEX properties.

The marketing message in the box of goodies is simply that the RTEX roads make the effort to learn about their customers to relate what each does and for whom. And if you know your customers this well, it's that much simpler to translate customer logistical systems into carloads for the railroads. In my humble opinion, RTEX deserves to be trading at more than one and a smidge times sales (recall that RTEX was one of the three "industry Snapshot" winners last week), and this kind of customer attention will create the strategic partnerships that will drive revenues - and earnings - higher.

The caveat is that as RTEX seeks to grow through acquisitions as well as "same store" sales, the debt is being piled on. The S&P current STARS report notes, "Nine months '97 EPS down 3.9% as higher operating, interest costs offset 24% higher revenues." Here again, increasing same store revenues faster than costs is the best way to increase margins, increase yield, and increase ROE.

For the third quarter, RTEX reports record carloadings, operating revenues, and operating income Compared to the third quarter of 1996, carloadings increased by 39% and operating revenues increased by 27%a healthy increase, however more cars for proportionately less money means a decrease in yield. Be that as it may, operating income was up 16% for the quarter and earnings were up 26%. The 24% revenue increase for nine months came on 34% more carloads, another indicator margins may be shrinking. Operating income was up 10% however the net was off 4% causing a similar slip in EPS as noted above.

The decrease in net income is primarily the result of interest expense associated with the borrowing of $63.2 million to fund acquisitions and investments since June 1996 and expenses associated with the start-up of railroad properties acquired in 1997. "Same Railroad" operating revenues increased 9% and 6% for the quarter ended and the nine months ended September 30, 1997, respectively. The operating ratio for "Same Railroad" properties (excluding corporate expenses) improved to 74.0% in the quarter from 76.5% in the same quarter in 1996 and improved to 74.2% for the nine months ended September 30, 1997 from 76.5% for the nine months ended September 30, 1996.

Something I had missed about Genesee & Wyoming: S&P reports officer and directors hold about 2 million of the outstanding 4.8 mm shares, some 40%. This is good news if you feel that high insider ownership is good for the company, bad news if you feel that high institutional ownership and public float is better. The stock averaged 29,000 shares traded per day over the last month, so it's not like GNWR trades by appointment.

RailAmerica has sold its Gettysburg Railroad unit to Delaware Transportation Group (DTGI), which is under the control of John Marino. DGTI in turn will lease the railroad to a new Gettysburg Railway Company, Inc., for operation. Wayne August, Director of Investor Relations for RAIL, says that the sale "is part of our on-going process of evaluating and rationalizing our current holdings as we extend the scope of our rail acquisition program to larger properties."

The STB has accepted 15 "responsive applications" in the proposed CR merger proceeding. These are requests for conditions on the terms of the merger which will lessen perceived anticompetitive effects through trackage rights, new connections, elimination of paper barriers, etc. There were only three public companies listed: IC, WC, and RTEX through three of its properties. They are New England Central, Indiana Southern, and Indiana & Ohio. I have not seen the applications themselves, however in the prelims filed in August NEC was looking for rights over the former Boston & Albany and ISRR wanted some Indianapolis concerns addressed.

The Board also explained that several other pleadings styled as responsive applications would be treated instead as comments on, and/or requests for conditions with respect to, the CSX-NS-Conrail primary application. The Board took this action because the pleadings did not satisfy the requirements applicable to responsive applications under the Board's regulations at 49 CFR Part 1180. No further information as to the parties was given.

Two vendors that caught my eye while I was rummaging around in the S&P screens: Trinity and Varlen. It was encouraging to see that 2/3 of TRN revenues are from its transportation group, and even more encouraging to see the company gets four stars, "accumulate" on projected 58% earnings increase 1998-99. VRLN makes 82% of its revenue from transportation says S&P, though they don't break out rail/non-rail and neither does the company. VRLN gets no stars, with "FY 97 EPS down 7.3% despite 5.9% higher sales... 1st half FY 98 EPS down 3% despite 36% higher net sales, absence of gain on sale of a business."

Elsewhere in Vendorland, the Form 10-Q for Westinghouse Air Brake (WAB) has arrived. As reported here earlier, WAB is making strides to expand beyond domestic OEM and replacement brake systems. The 10-Q brings this home writ large. In September 1996 they acquired Vapor Group from Mark IV industries for Vapor's leadership in transit vehicle door controls. Stone Safety joined the fold in May 1997 with its line of transit air conditioning systems. And in July WAB bought the Italian firm of H. P. S.r.l., another transit door control maker.

These transactions were evidently priced as multiples of sales which exceeded the asset values of the target companies. As a result, nearly $33 mm has been added to "goodwill," which, as we all know from reading our Graham and Dodge, has to be counted as debt. The Sep 30 balance sheet now shows $370 mm in long term debt, less current portion of $23 mm, plus $64 mm in good will. Shareholder equity is a negative $88 mm. Trailing 12-month revenues through September were $526.2mm, for a PS ratio of 1.08 based on a recent price of $23. Suppliers I've checked trade slightly under one times earnings. WAB trades at 17 times earnings, certainly in the ball park for an industry that ranges from 14 to 30 times earnings, and is up 63% YTD.

Rail stocks through November were up a lousy 11%, thanks in part to single-digit increases in the majors and some serious losses in the minors. There were a pair of doubles, however, DOCP and KSU. The former is off the boards thanks to CSX and NS; the latter is spinning off the railroad soon, so there will be additional excitement there. CN continues to amaze, up 72%, while CP still can't get going, up a woeful 6.8%. Industry Snapshot winners WCLX, GNWR, and RTEX bring up the markers, down 24%, 24%, and 40% respectively. Vendors did a lot better with three doubles-plus (JAII, MOPO, VRLN) and a 38% gain YTD for the group. All increases but ABCR were in double digits and only TKR (of which roller bearings are a small part) was down, and 22% at that.

--Roy Blanchard


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