The Railroad Week in Review:
We're in the midst of "results week" on Wall Street. From the top, Burlington Northern Santa Fe posted 1Q98 net income of $233 mm or $1.47 per share, excluding a one-time gain on a pipeline partnership sale -- up 55% from net income of $150 mm or $0.96 per share in 1997. Coal, merchandise, and intermodal were the strong performers, up 14%, 8%, and 9% respectively while the operating ratio dropped to 79.3 from 83.7 a year ago. To put all this in perspective First Call says the consensus estimate for 2Q98 is up 15% and up 18% for the year ending 12/31/98.
CSX earnings were down for the quarter on operating income of $287 million, vs. $324 mm for the 1997 period. Earnings came to $91 mm, 41 cents per share on a diluted basis. In the prior-year period, the company earned $151 mm, 69 cents per share on a diluted basis. Excluding the effects of the Conrail transaction, earnings for the 1998 first quarter would have been $134 mm, 60 cents per share. John Snow told analysts "This was a tough quarter. Generally weak coal demand hurt railroad earnings, while dislocations in Asian economies adversely affected Sea-Land's cargo patterns."
John Snow held good on his word some time ago to review the role of the barge company in the CSX portfolio. Accordingly, American Commercial Lines (ACL) will be folded into to a joint venture with Vectura Group for $695 mm in cash and $155 mm of securities issued by the venture, giving CSX a 34% stake in the venture. As part of the transaction, National Marine, Inc., a wholly owned subsidiary of Vectura, will be combined with ACL to create a company with assets of approximately $1 billion.
At the KSCI meeting in NY Thursday many of the analysts who packed the room for the UP meeting earlier in the day were conspicuous by their absence. Not that I was surprised. The forum focus was largely on the financial asset management (FAM) side. Though KCS Railroad President Mike Haverty had a great story to tell, his piece was given relatively short shrift in the presentation. The parent company posted consolidated earnings of $46.2 mm (41 cents per diluted share) for the first quarter 1998, a 62% increase over $28.5 mm (26 cents per diluted share) in 1Q97.
Haverty's side generated 1Q98 earnings of $9.2 mm, more than tripling 1Q97's $3.0 mm. Exclusive of TFM's equity losses and interest expense earnings for the quarter were $15.0 mm. This 1998 earnings growth reflects revenue improvements coupled with effective cost control, primarily by the Kansas City Southern Railway. KCSI Chairman Landon Rowland thinks the railroad spin-off will occur in the third quarter, once the SEC has done its thing. That will be interesting.
Recall we've spent a fair amount of time on the eventual value of KCSR as a stand-alone. Here you have a company with $516 mm in revenues for 1997 carrying $806 mm in long term debt at year's end. Since we can't break out railroad equity from the holding company's, look at LTD in proportion to revenue: 1.56 times. In comparison, WC had $334 mm revenues and $260 mm in LTD at year's end, a debt/revenue ratio of 0.78, while NS now caries LTD equal to 1.74 times revenue. I think KSC, like NS, is banking on benefits from franchise expansion to carry the day.
Speaking of NS, they and KCS have opened a new joint intermodal facility in Port Arthur, Texas. According to a press release, "The new facility fills the void for intermodal services in the Port Arthur and Beaumont area and offers a competitive alternative to existing intermodal services in the Houston area. KCS began operating in the facility on March 31, providing intermodal service over major U.S. rail corridors through interchange points in Jackson, Shreveport, Kansas City, St. Louis and Minneapolis. NS operates the facility and uses KCS haulage over the Meridian, Miss., gateway to serve customers in the Southeast."
Norfolk Southern net income for the first quarter was a record $229 mm, boosted by a $98 mm after-tax gain, or $0.26 per share, on the sale of its North American Van Lines subsidiary. Diluted earnings per share were a record $0.61. Excluding Conrail-related items, net income would have been $279 mm, and diluted earnings per share would have been $0.74. Net income for the quarter excluding the one-time gain on the sale of North American was $131 mm, 2 percent higher than in 1997, and diluted earnings per share were $0.35, up 3 percent. Railway operating revenues of $1.07 billion, up 2 percent over the 1997 first quarter, set a record for the ninth consecutive quarter.
The automotive group led the revenue gains, up 12% partly as a result of the January launch of Norfolk Southern's mixing center operation with Ford Motor Co., and intermodal, up 10 percent over 1997. Metals and construction, and paper, clay and forest products posted 2 percent increases. Coal revenues were down 1 percent. First-quarter railway operating expenses were $815 mm, up 7 percent, however the OR took a three point hit rising to 76.5, compared with 73.1 for 1997.
Dick Davidson put the best spin he could on the $62 mm Union Pacific lost in the quarter, and I think he made a number of helpful points. To be sure, congestion continues, however carload inventories, trains held, and train speed have all improved. Not only has the embargo on traffic for Mexico been lifted, but so have been other limiters on cross-border moves. Railroad President Jerry Davis notes that the institution of directional running on the old MP and Cotton Belt lines have added further to the "fluidity" (their term, used many times) of the railroad. For details, go to www.uprr.com.
Washington Post columnist Don Phillips reports an interview with STB head Linda Morgan in which she had a few things to say about our favorite business. Most germane to readers of this letter, she said the STB will be looking for assurances that shortlines and regionals will be able to function. It appears there's some sentiments that the class 1s are placing "unreasonable requirements" on them." For their part, the class 1s have told the STB they will "continue the dialog to insure effective relationships between class 1 and shortline railroads."
The 1997 results from companies like Genesee & Wyoming (Nasdaq: GNWR) and RailTex (Nasdaq: RTEX) show a continued deterioration of per car revenue and yield per car. If allowances cannot be negotiated to reflect more closely the feeder lines' economic facts of life, there will be a shift from allowances to full participation in all rate-making. And since we all know the best way to grow the bottom line is to increase revenue faster than costs, there is bound to be a renewed interest here.
The STB has published a ruling on some of the thornier access issues under the formidable name of "Ex Parte 575." In it the STB charges the class 1s, shippers, and shortlines to come together and report on progress resolving the issues by specific dates. Of particular interest to shortlines is the focus on paper barriers, car supply, and lack of alternative routings. The overarching concern, however is that the STB take more of an advocacy role in resolving disputes and less of a rule-making approach to issues.
For an excellent commentary on the STB as the old ICC reincarnate, see Tom Donlan's end paper in this week's Barron's. The argument is that political pressures are prodding the agency to act in ways inimical to the health of the rail industry and thus to the very shippers the carriers serve. Which puts Linda Morgan herself in a tough spot. He notes, "Morgan's understanding of business and management is limited by a lack of experience. Before she was appointed to the ICC in 1994 Morgan was a staff counsel on the Senate Commerce Committee back when the Democrats controlled Congress. [She] has spent her entire career in Washington since graduation from Smith College. It's a life spent making up rules, not living under them, but in Washington, that passes for experience. It also leads to the making of more rules." Dolan concludes by noting that Morgan "is forced to act in ways that even she must know are futile at best and probably counterproductive."
For the ruling itself, go to the STB website, http://www.stb.dot.gov/.
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