The Railroad Week in Review:
Week Ending July 4, 1998

The talk regarding Kansas City Southern (NYSE: KSU) is now turning to split up value for the impending railroad spin-off from the financial services group. Gruntal has upped its rating to "strong buy" from "buy on valuation." Breakup values have escalated from $44 last spring to $54 last month to $74 now. KSU closed the week at $48.25 off a high of $49 but having picked up $4 in ten days with the options clustered around 50 and change. Has anything else changed? My bet is the railroad will fetch a premium given its Mex link. Conrail went for 2.7 times sales given NYC access. At 2X sales, a $billion divided by 107 mm shares is $9 a share, at 2.7 X you get almost $13. Another point of view was taken by this reader: "I would think that $70 a share is a little high if you look at the situation right now standing still. I think most analysts have the break-up pegged in the $60 range. However, two near-term positive factors could make a quick run to $70 not too inconceivable. First, KSU will probably have a positive earnings announcement. The railroad is continuing its turnaround and should meet if not exceed their 13.5 million net income of last quarter and as long as money continues pouring into 401Ks and the like, Janus, Berger and DST will not have any negative surprises. "Second, the long awaited split should happen some time in August. The financial side should see a quick positive run up as late-comers scramble to get on board. In the long term, the financial spin-off should do well. The interesting thing will be the RR side. It may drop some initially but should do all right long term. Look at the turn-around they've had in the last 3 years. Do you think that is just suddenly going to stop? Operating ratio has been under 80 for the last year and revenues are growing. Mexico and new alliance with the Canadian National (NYSE: CNI) should only strengthen that trend." Finally, Barron's this week presents a very positive outlook for KSU by Betsy Bramwell of Bramwell Capital. She suggests the railroad is valued in the $0 to $10 range, if you value DST at the same multiple as State Street Bank, and the Berger/Janus complex in the upper half of the fund family groups. She sees the railroad as well managed and holding a valuable north - south franchise. RailTex (Nasdaq: RTEX) made new lows this week on increasing volume. Genesee & Wyoming (Nasdaq: GNWR is) also getting back to its IPO price levels around $17. Some would consider RTEX and GNWR to be the "standard bearers of the regional universe." I'm not so sure. The business models are quite different: one is seldom contiguous, the other is usually contiguous, and neither is always contiguous. However both have strengths to be reckoned with. Chicago shortline observer and investor Tim Eklund notes, "The stock price is the collective filtered positive and negative perceptions of a company translated into an easy-to-understand format. So what does weakness in these leading short-line/regional railroad operators say about investors' perceptions of that segment of the marketplace? Some thoughts: "Prices for any decent piece of buyable railroad are getting out of hand. Friend of mine retired from Burlington Northern Santa Fe (NYSE: BNI) a few years back. His final assignment was running the line sales process for Santa Fe and some BN lines. He used benchmark price ranges of between 1.15 to 1.50 times current revenues (this was in 1994, 1995) as decent places to start in bidding, with allowances made for track conditions, Class 1 connections, and so forth. Today's benchmark prices are approaching 2.5x current sales as the entrance fee for getting in the door. To justify these prices, many best-case traffic scenarios have to be realized, or a contiguous extension envisioned. "While overall revenues have increased, the same-store sales revenues have not increased fast enough to justify high p/e ratios. With prices for new franchises growing rapidly, the impact of acquired revenues is not nearly as great because of the higher cost needed to acquire the revenue stream. I think the investment community is saying build your existing franchises instead of constantly buying new ones. "The economy is operating at near-capacity. Railroads are directly tied to the health of the economy, and in the past, were considered (as was the whole Transport Index), a leading economic indicator. Recent general weakness throughout the rail sector may presage economic slowdown 6-9 months out. " So while many believe RTEX to be a screaming table-pounding buy at these lows, I would wait until they get their management house in order. The recent closure of the Central Properties purchase did nothing to add value to the share price. From a technical perspective, any close below $13 would probably trigger new rounds of selling." Union Pacific (NYSE: UNP) has settled a lawsuit filed by DuPont. Details were not disclosed. Readers will recall DuPont claimed in its lawsuit that UNP's poor rail delivery performance had slowed production and jeopardized customer relations. It also increased per-ton lease costs for the company's fleet of 7,000 railcars. Elsewhere, UNP says the railroad is in settlement talks with Union Carbide and Dow. And car inventory rose for the seventh consecutive week to 333,500, up 2,000 from the prior week. Short takes: Canadian National has floated a US$925 mm debt offering in connection with its acquisition of Illinois Central (NYSE: IC)… CSX Corporation (NYSE: CSX) conveyed its ACL barge unit to a venture formed with Vectura Group, Inc. (Vectura) for $850 mm in cash and securities, retaining a 32% stake… MotivePower Industries (NYSE: MPO) has signed an agreement to sell its remaining investment in a non-core Argentina business for $9.2 mm in total consideration, which consists of $4.7 mm in cash and a secured note of $4.5 mm. MPO told Reuters on Thursday it is "comfortable" with First Call's consensus estimate of $1.39 per share. Rail industry stock prices for the first six months of the year have not as a whole been stellar performers. The Union Pacific follies have hurt UNP stock prices a lot more than they've helped BNI's performance. Norfolk Southern (NYSE: NSC) and CSX continue to be drug down by delays in polishing off the Conrail merger. Wisconsin Central (Nasdaq: WCLX) and GNWR are getting a double-whammy from UNP problems on the one hand and the Asian contagion on the other. RailTex is beset with what some see a management moratorium. CNI's meteoric rise is tapering off, and Canadian Pacific (NYSE: CP) can't seem to get above $30. How bad is it? A market basket of equal dollar amounts of the 14 railroad companies I follow has lost 6.13% YTD while the S&P 500 was up 18.14%. Top rail performer was oft-split KSU, which really isn't a railroad, up 51%, followed by CNI, up 12%. Normally robust BNI is up 8% and bride-elect IC is up 3%. Conrail merger players NSC and CSX are off by 3% and 16% respectively, and bottom honors (!!) go to UNP, off a third. Over in vendor land, it's a better story by 19 points, though still not market-beating, up 13%. The leaders as you'd expect were the low price stocks like car-builder Johnstown Industries (Nasdaq: JAII) up 90% and Netherlands- based signal supplier Ansaldo (Nasdaq: ASIGF) up 36% -- this company now owns the former Union Switch, for you old-timers. Other market-beaters were MPO, up 34%, and - my favorite - Harmon (Nasdaq: HRMN) up 22%. For the second half, I'd watch HRMN and MPO, followed by carbuilders Greenbrier (NYSE: GBX) and Trinity (TRN). HRMN has an excellent franchise among railroads of all sizes and transit systems while MPO is an incredibly creative company. GBX and TRN will capitalize on the strong new car market. Week in Review in review department. I've now been doing this for three years. Year One was as the railroad staffer for The Motley Fool (remember MF Rails?) and the last two years have been on my own to a growing list of railroad professionals. I need a break. So I'm taking off the month of July to read and reflect and will be back into the fray to resume this letter on August 1. You're a great audience; keep those e-mails coming and have a safe and enjoyable July.

--Roy Blanchard

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