The Railroad Week in Review:
Week Ending April 18, 1998

Canadian National, Illinois Central, and Kansas City Southern this week announced a 15-year marketing alliance. It's not a merger. Yet if KCS does at some point merge with another carrier, this agreement remains in effect. Wall Street wasn't particularly surprised, reports Frank Wilner in his "Rail Merger Intelligence" newsletter. He also notes the only part of the deal requiring STB approval is that which covers track-sharing arrangements.

Whereas KCS had picked up Gateway Western to access Chicago (albeit over UP), it can now get to town over IC, a more efficient route. At the other end, CN- IC gets new access in Dallas, Shreveport, and KC, not to mention Mexico via Beaumont and Laredo. And KCS gets to Gulfport, MS, for the first time.

According to the press release (available at "the companies will coordinate sales and marketing, operations, fleets and information systems, but not for traffic movements where any two of them provide the only direct service. Canadian National and Kansas City Southern will not acquire equity interests or financial holdings in each other."

Comparing stock price performance of CN and CP is an enlightening exercise. Readers who can access the WSJ On Line would do well to go to the Briefing Books section and bring up Canadian National's chart of the past 12 months' price performance and overlay a CP price curve. The comparison is astounding. The former has nearly doubled to the latter's 23% rise. YTD, Canadian National is up 39% compared to CP's six.

Yet a two-year price-earnings-growth calculation puts CN at 32% under-valued and CP at 12% over-priced. First Call says both can expect five-year growth in the 14% range. Bottom line: CN is still relatively cheap at 13+ times 1998 earnings and S&P thinks the IC link-up could well be accretive in 1999.

My personal sense is that the CN is the more aggressive and imaginative of the two. Paul Tellier has put together a management team that thinks as one and looks for the synergies, finding a big one in Hunter Harrison and his merry band. Yet CP has not helped its NAFTA options by exiting the KC market, has dithered with the St Lawrence & Hudson unit, and has fish other than railroads (steamships, hotels) to fry anyway (railroad revenues are about 40% of the total). It is clear where CN's focus lies and the stock performance shows it.

Illinois Central, another star performer - up 17.6% YTD, reported 1Q98 net income of $13.2 million ($.21 per share), including a pre-tax special charge of approximately $36.5 million for transaction fees and accelerated expenses resulting from the CN merger. Excluding the special charge, earnings would have been $40.0 million ($.64 per share) compared to first quarter 1997 net income of $33.9 million ($.55 per share), up 16%.

It's always a healthy sign when revenues increase faster than carloads, and IC has done it again. First quarter 1998 revenues of $181.6 million increased almost 6 percent compared to $172.1 million for first quarter 1997. Total freight carloads of 251,775 were down 2 percent, primarily reflecting weak demand for export grain and the loss last September of an intermodal move. (Now what is it we were saying about the Tellier-Harrison synergies?)

Merrill Lynch began coverage of Wisconsin Central this week with a "near term accumulate, long term buy" rating. Meanwhile, Standard & Poor's has given its triple-'B'-minus rating to WC's $150 million senior unsecured notes, issued under its $250 million shelf registration for debt securities. Says S&P, "The U.S. rail unit benefits from low cost and flexible operations, demonstrated by the 1997 operating ratio of 76.7%.

The company's risk profile is heightened somewhat by an acquisitive, but careful overseas growth strategy. The initial overseas investment in New Zealand-based Tranz Rail has performed well, returning all of WCLX's capital within three years. Further acquisitions are expected, particularly in Australia and longer-term possibly in Europe."

For an enlightening and thought-provoking read across a number of fronts, put the Harmon Industries 1997 Annual Report at the top of your list. To start, percent growth in key measures is presented in a column along side the years' results. Sales up 21%, net up 17%, etc. You also get a ten-year financial summary showing five- and ten-year average compound growth rates, a measure frequently used here and elsewhere to judge relative merits of investment choices. And the numbers here are very good.

It's oft been said that a good track record going back some years is an indication that the corporate culture that generates these results can keep doing it. Double-digit growth rates abound in this report for both long-term measures and forward estimates place HRMN in the 15% growth range. Harmon gets 70% of sales from the freight railroads where "the railroads' desires to fix operational responsibility on one supplier and to place orders with large suppliers played to Harmon's strengths in 1997."

A significant growth area is "asset management systems," to 26% of sales in 1997 from 10% in 1995. In dollars, it's a 110% change, from a shade over $14 mm to just under $30 mm. This is where Harmon manages purchasing, warehousing, assembly, and field delivery of signal systems. The annual correctly notes, "railroad mergers have increased market demand for services and products as the railroads' operating systems are consolidated."

Note also that key Harmon suppliers keep inventories on site at Harmon facilities, invoicing for materials as used. Says Harmon, "This gives our vendors a better understanding of our forecasting process and removes inertia from the order/delivery process." I can think of a shortline manager or two who could make points with manufacturing customers by suggesting something like this to encourage more boxcar loads.

RailAmerica's majority-owned Chilean railroad Empresa de Transporte Ferroviario S.A. (Ferronor) has commenced new rail service at the El Algarrobo mine operated by Compania Minera del Pacifico (CMP), a large Chilean mining company. Ferronor's contract with CMP, which began March 23, 1998, calls for the transportation of 2.1 million metric tons of iron ore over a five month period. The contract is expected to generate approximately $2.5 million of new revenue for Ferronor in 1998. Ferronor, a 1,400-mile railroad serving northern Chile, is majority-owned (55%) and operated by RailAmerica, with minority Chilean partner Andres Pirazzoli y Cia., Ltda.

An article in Wednesday's WSJ notes that St Joe paper is contemplating sale of its 96-mile Apalachicola Northern Railroad which operates between Port St. Joe and Chattahoochee. St Joe isn't saying whether there have been any firm offers, however estimates of the railroad's value run in low $30-35 mm range. My book says 45,000 cars a year of coal and forest products. Average per car revenue could well run about $250. One and a half times revenues yields $17-18 mm, so there has to be either a lot more than a railroad involved or revenue per car is closer to $450. Either way, it could be attractive to a RailTex or RailAmerica.

--Roy Blanchard

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