The Railroad Week in Review:
Week Ending January 24, 1998

Last week I wrote about the shortline operator who feared a class I might be shopping his carload business for their transload business. Ever the optimist, I put on my thinking cap in hopes of finding a way to turn this adversity into opportunity. One way is to look at it through the class I economic model. Let's say today the move gets $1,000 in freight charges of which $300 goes to the shortline. If the class I has an operating ratio of 70, then $210 goes to the class I cash drawer at the end of the day.

Now let's make the class I rate to the junction $1,000 and put $300 on top of that for the shortline. Now the class I takes $300 to the bottom line, or 43% more. Since we're talking about a transload near enough to the shortline customer to be competitive, we've got to assume the rate to the transload is the same as the rate to the junction, $1,000. BUT…out of that $1,000 the class I has to pay $1 a ton to transload and $100 a truckload, total $500 for a hundred-ton car. Net to the class I: $500, or $150 to the bottom line. Even if the class I passes the transload and trucking costs to the customer, and keeps its $1,000, the shipper pays a $200 premium over carload direct.

My question to my correspondent now must be, what are the economics relative to you and the class I so that your business is at risk? Even if the freight rate origin-to-transload is less than to the junction, the spread between the two options has to be enough to outweigh the value added by the shortline for delivering a carload at a time. I mean, 200 cars a year is 800 trucks a year, or 3+ trucks a day. What is the cost of enough pavement and admin personnel to track six truck arrivals and departures every day? $40,000 in labor and infrastructure? If so, that's $200 a carload and even at $1,300 we may be leaving something on the table, come to think of it. And therein lies opportunity.

Some of the hardest hit areas from the recent ice storms in Northern New York State are those communities that Conrail's Montreal Secondary serves. Well, the railroad saved the day with a special train. On 1/13 it left Syracuse late in the afternoon and arrived in Watertown at eight. It was interesting "mixed bag:" two NS coaches, three NYSW coaches, and six CR gons. Power was provided by a pair of U-boats, one each from CR and NYSW The coaches will be used as a camp train for volunteer relief works and the gondolas were loaded with much needed supplies. Merger-followers will recall CSX will get this line, and I'm told the new owners plan to make significant use of it.

Anybody want to buy a business car? Conrail #022 is ex-EL #833, and Car #11 is ex-EL Spirit of Youngstown, still pretty much original except for addition of HEP. Why do I ask? A bulletin from the CR Technical Society tells us the pair of E-8s and cars have gone to Altoona for wheel-truing and other work, however a firm has been hired to appraise the equipment and possibly handle its sale. If you're the gambling type, I wouldn't have money on NS or CSX keeping the set.

Want to buy a railroad? In small pieces? CSX has begun a direct stock investment plan called "CSXDirectInvest." With it investors can buy CSX common stock without paying a brokerage commission or other service charge. New CSX investors may enroll in the plan with a minimum initial investment of $500, plus a $10 enrollment fee. Existing CSX shareholders who participate in CSX's Dividend Reinvestment Program are automatically enrolled in CSXDirectInvest. All other current CSX shareholders may enroll in the plan without any minimum investment requirements or fees. For more info on dividend reinvestment plans (or DRIPs), see the DRP area at the Motley Fool,

Norfolk Southern's David Goode has been named 1997 Railroader of the Year by Railway Age, the world's oldest railroad trade publication. The award is widely regarded as the most prestigious in the industry. The citation reads: "For forging the agreement that strengthens rail transportation in the East and levels the playing field between eastern and western railroads." Goode led Norfolk Southern last year in reaching an agreement with CSX for joint acquisition of Conrail, with 58 percent going to NS and 42 percent to CSX. CSX had earlier attempted to buy all of Conrail. Goode told Railway Age that he viewed the award as "recognition of the entire Norfolk Southern Thoroughbred team, whose efforts made possible an extraordinary year."

The STB has issued an order requesting shipper groups to file information on the performance of the UP/SP and BNSF. In a previous order it required UP/SP and, to a lesser extent, BNSF, to file extensive reports demonstrating the levels of service they are providing. In this decision. The STB noted that those reports are intended to give the Board an overall picture of the extent of the service recovery. The more specific reports it has required for coal and agricultural movements have given it substantial insight into the levels of service being provided for those commodities.

However, the Board noted that, since its December 3, 1997, public hearing on this matter, it has not had input directly from shipper groups representing a broad spectrum of commodities as to the level of service that their members are currently receiving. Accordingly, the Board asked shipper groups to provide benchmark information from the shipper perspective. In particular, the Board requested reports covering the four-month period ending February 6, 1998, showing how performance in the period compares with that of the previous year's period.

Earnings week: BNSF reported adjusted fourth quarter 1997 net income of $274 million, or $1.74 per share on a diluted basis, an increase of 12 percent from fourth quarter 1996 net income of $244 million, or $1.57 per share. Including the effects of a $90 million pre-tax special merger-related charge, BNSF reported net income for the fourth quarter of 1997 of $217 million or $1.38 per common share. For the year, BNSF adjusted net income for the year ended December 31, 1997, was $942 million, or $6.00 per share, a 6 percent increase from 1996 net income of $889 million, or $5.74 per share. Revenues for the year were $8.4 billion, up 3 percent. Adjusted operating expenses of $6.6 billion for 1997 increased 3 percent. Adjusted operating income was $1.86 billion for 1997 compared with $1.75 billion for 1996. The adjusted operating ratio improved to 77.9 percent for 1997 compared with 78.5 percent a year earlier.

For me, the best part of these presentations is the Q&A following. In it, Krebs remarked that the continuing safety drive to decrease in FRA reportables and lost days has had a significant economic benefit: $12 mm in 1997, to be exact. SVP and COO Matt Rose, in his prepared remarks, said safety will get top billing among 1998's priorities along with service/velocity and expense control. That stands to reason. Safety incidents cost time, money, and get in the way of meeting service delivery commitments. BNSF's ratio of 1.66 reportables per 200,000 man-hours are second only to NS with 0.91 Jan-Nov 1997.

Fourth quarter earnings at CSX would have been flat with last year but for $40 mm net merger-related costs or 18 cents a share. The company earned $215 million, 98 cents per share. In the prior-year period, the company earned $253 million, $1.17 per share. On a pro forma basis assuming dilution, earnings for the 1997 quarter excluding the effects of the Conrail transaction would have been $254 million, $1.14 per share. For the year, operating income for 1997 totaled $1.58 billion, vs. $1.52 billion in 1996. Net earnings for the year were $799 million, $3.67 per share, compared with $855 million, $4.00 per share, in 1996 Excluding the effects of the Conrail acquisition, 1997 earnings would have been a record $896 million, $4.05 per share on a diluted basis.

Perhaps one of the best indicators of where the company is heading can be found in the capex tables for 1998. On the railroad, capex rises a third to $800 mm from $600 mm. Sea-Land and the ACL barge unit will see their capex cut nearly in half, to $247 mm from $400 mm. Operating income for both the water carriers was off in '97, with the barge lines taking the bigger hit. Sea-Land continues to ride out the Asia follies by dint of its alliance with Maersk; however, John Snow told us CSX is "reviewing its options" with respect to ACL.

Lastly, I had a chance to chat with Pete Carpenter before the session, and he said that, in regard to Conrail, CSX is committed to keeping CR people who know the railroad working the railroad they know. This was borne out later in the presentation when John Snow quipped, "We hope to avoid the unhappy results experienced in the west" in the context of CSX' plan to accelerate capital spending to accommodate CR when things finally fall into place.

Illinois Central reported 97Q4 net income of $46.7 million ($.75 per share) compared to fourth quarter 1996 net income of $40.0 million ($.65 per share), up 15.4%. Excluding the gains in both years for comparability, fourth quarter 1997 earnings of $43.0 million ($.69 per share) compared to fourth quarter 1996 earnings of $35.4 million ($.58 per share), up 19%, a better measure of what the railroad is truly doing. Fourth quarter 1997 operating expenses of $114.3 million resulted in an operating ratio of 60.7 percent, a 300 basis- point improvement.

For the full year 1997, IC netted $150.2 million ($2.42 per share) vs. 1996 full year of $136.6 million ($2.21 per share), up 9.5%. Excluding non- recurring gains in both years, it was $2.36 per share in 1997 vs. $2.14 per share in '96, up 103%. The 1997 operating ratio improved 1 percentage point to an industry-leading 62.3 percent. Recall Gruntal back on 1/12 raised its rating on Illinois Central railroad to buy from hold, setting a 12-month target price of $41 a share and fiscal 1998 earnings estimate at $2.70.

As expected, Union Pacific took a net loss. But it was $152 million, or $.62 per share, far larger than anybody expected, in the fourth quarter of 1997, reflecting the impact of severe congestion at its railroad subsidiary during the quarter, as well as the costs of its Service Recovery Plan. In total, the Corporation estimates that these congestion problems reduced net income by approximately $353 million, or $1.42 per share. Operating costs increased 12 percent, leading to an operating ratio of 102.5, compared with 81.6 in the fourth quarter of 1996. And this is the first railroad quarterly loss in decades.

For the year, Union Pacific Corporation reported net income of $432 million, or $1.74 per share. This compares with pro forma 1996 income of $664 million, or $2.71 per share, and reported 1996 income from continuing operations of $733 million, or $3.36 per share. In other words, UP shareholders earned half what they did in 1996. First Call is using the $2.71 figure for 1996 and calls for 1998 in the range of $4.00, down ten percent in the last 90 days. UP ended the week at $58 even, about where it was for its 52-week low in April. And even at 58 represents a PE of 14.25 on the 1998 estimate a slight discount to the industry 1998 PE of 15.1. (For an excellent write-up of the rails going forward, see Jim Valentine's "The inside Track - Final Stop 1997 for Salomon Smith Barney.")

Canadian National reported its second record year in a row. For the year, excluding special charges ($365 mm for labor, $16 mm for debt retirement in 1996), revenues were up nine percent to $4.4 billion while operating expenses grew at only five percent, generating a 320 basis-point improvement in operating ratio to 81.5. For the quarter, revenues were up eight percent to $1.1 billion against expenses up seven percent to $894 mm excluding the special charge. The quarterly OR improved by 50 basis points to 79.5.

What is particularly striking about the financials (see is the section on productivity. Route miles dropped by 11% (nearly 2,000 miles) to 15, 292 yet revenue per route mile was up by 22%. Average annual head count was down five percent and freight revenue per average number of employees was up 16%. Injuries dropped 24% to 1.6 injuries per 200,000 hours, on a par with BNSF here in the US. Revenue per route mile and per MGT miles were both up 24%.

The only sour note in all of this was the decline in average revenue per carload. It's the same phenomenon we're seeing in the US, and is unhealthy for the margin squeeze it causes. To be sure, there are bright spots. And one road's high is another road's low. Grain, for example. CN saw nine percent more revenue per car in 1997 yet BN saw its STCC 01 per car revenues drop by 6%. Where BNSF grew metals revenue per car 7% CN was flat. But still, system wide CN revenue per carload was even with 1996 while BNSF was down 1.2%. Even if you only count inflation, both are still behind by the spread of their per- car results and the inflation rate. To put that in perspective, a one-point spread on a $5 billion property is worth $50 mm.

--Roy Blanchard

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