The Railroad Week in Review:
The week before last the big snooze was the STB's written decision approving the CSX-NS partitioning of Conrail. It all happened pretty much as expected as I was returning from two glorious weeks in England (more on that later) so mot much comment is warranted. This week, however, was a different story, kicked off as it was by Danny Machalaba's rather news-less piece on the merger and then mid-week the actual earnings reports from the two contendahs.
First, Machalaba. It's pretty well known that the longer it takes to put the final merger together the more revenues lost and the more delay-related expense incurred. It's also a given that as NS and CSX combine services with Conrail there could well be fewer trains as connecting trains are melded into through trains, crew starts combined, and efficiencies of scale realized. Moreover, some smaller, less efficient intermodal ramps may be closed as they are displaced while the larger more efficient ramps become even more so.
The combined daily cost of $2 mm a day directly related to the holding action is also well known, and has been for a long time. At NS, David Goode has been saying for months this is a "work in progress," being put together a building block at a time, and he reiterated that theme at the Wednesday meeting in NYC. Two hours later he was closely echoed by John Snow of CSX. So the cost of the delay as the time to get to the final split date is non-news. The key bit of news is that both chief executives said the early spending on facilities and personnel ramp-ups in these early stages will make Conrail earnings accretive to their earnings that much sooner.
The only surprise was the news that NS plans to build two new freight yards - one in western Penna and one in eastern NY state, ostensibly to cut down congestion in the Shared Asset Areas, and possibly as a defense against any repeat of UP's Houston follies. I'm working on developing more detail on this aspect; stay tuned.
As for the earnings reports themselves, it was a mixed bag. Earnings for both lines were drug down with Conrail-related items, though NSC managed to turn in some respectable gains without them. CSX, on the other hand, caught the Asian Flu big time as its Sea Land unit was hit with an imbalance of traffic flows and other effects of the Pacific Rim melt-down.
At Norfolk, 2Q net income was $187 mm; diluted earnings per share were $0.48. Excluding Conrail-related items, net income would have been $224 mm, a 2Q record, up 12 %, and diluted earnings per share would have been $0.58. For the first half the net -- including a one-time after-tax gain of $98 mm on the sale of North American Van Lines -- was a record $416 mm ($503 mm excluding Conrail-related items). Diluted earnings per share were a record $1.09, up 30% ($1.32, up 32%, excluding Conrail-related items). Income from continuing operations was $319 mm, up 3%, and diluted earnings per share for the period were $0.83 ($1.06 excluding Conrail-related items).
Over at CSX 2Q earnings were $151 mm, 68 cents per share on a diluted basis, off 37% from 2Q97's earnings of $227 mm, $1.03 per share on a diluted basis. Costs related to the Conrail acquisition, along with weak coal exports, rail congestion across the country and container-shipping trade imbalances, contributed to the earnings decline. Excluding the effects of the Conrail acquisition, earnings for the 1998 second quarter would have been $187 million, 85 cents per share, vs. $245 million, $1.11 per share in the 1997 period, off 23%.
For the fist six months, CSX earned $242 mm, $1.09 per share on a diluted basis, off 37% from 1997's $378 mm, $1.72 per share on a diluted basis. Excluding the effects of the Conrail transaction, earnings for the first six months of 1998 would have been $321 mm, $1.45 per share, vs. $412 mm, $1.88 per share, off 23% from the 1997 period.
In Friday's Evening News my friends at The Motley Fool (www.fool.com) reported that Union Pacific Corp. (NYSE: UNP) "chugged ahead $1 3/4 to $42. This after announcing that the government has lifted an emergency service order that allowed other rail carriers to use the company's network to move goods in the Texas and Louisiana Gulf Coast region, signaling the end of the service crisis in that region." Now we have to see how the "other carriers," BNI and KSU react.
Overseas, the shares of RailTrack, owner of the tracks used by both freight and passenger trains in the UK, had a decent run-up last week. Wednesday's Financial Times (www.ft.com) reports that "Railtrack's regulation has to fit in with the government's strategy of boosting public transport. To encourage RailTrack to improve its network Rail Regulator John Swift has suggested linking some charges to growth in passengers. More revenue-sharing deals with train operators also look likely. While that would expose RailTrack to revenue risk, it could mean superior returns. All in all, the government's transport priorities provide a fair wind for RailTrack. The worry is that, if rail services do not improve, the mood music will change."
Elsewhere, FT reports that track problems have been behind about two-thirds of all train delays. As a result, Swift has "continued to put pressure on the company to improve its performance and said earlier this week that it would have to meet demanding targets under a revised track access charging regime due to take effect in April 2001." The company has responded by introducing a series of senior management performance bonuses based on the performance of using rail franchises. And since bonuses can be nearly half one's compensation, the effect ought to be significant and prompt.
I mention this because the English, Welsh & Scottish Railway unit of Wisconsin Central (Nasdaq: WCLX) is a big RailTrack customer. While in England last month I had to good fortune to spend very pleasant and informative afternoon with Randy Henke, chief commercial officer for EWS. Randy joined EWS three years ago after having begun his railroad career with the CNW in the mid-70s, however his knowledge of the British freight paradigm would make one think he'd been there all his life.
RailTrack not only provides the rails for EWS trains but also is a major EWS customer, accounting for nearly a fifth of total revenues. Sometimes, says Henke, there have been differences with RailTrack about managing capacity and repair programs, however there is a new sense of cooperation between the companies that is bound to pay off for both. Which can only be good news because, now that freight is no longer a step-child to British Rail's passenger focus, business on EWS is poised to boom.
The freight paradigm can be a little difficult for a Yank to comprehend initially, characterized as it is by short hauls, light axle loadings, and small trains where car cycle times can be measured in turns per day. It is this very environment that is key to the EWS plan to win back market share, and the customers are indeed streaming back. Henke is quick to note the EWS business development process is classic: deal first with your present customers, then go to your ex-customers, and finally approach totally new prospects.
As it is, building the traffic base from current customers and accommodating returning customers has so far dominated the picture. The challenge is now to find the "white space" (time table columns with no passenger trains in them) to run the trains and sufficient power and wagons (freight cars to you and me) to handle the demand. (For an excellent background write-up, see July 1998 Trains, "Britain's Rail Freight Revolution," www.trains.com).
From an investor's standpoint, the EWS component of WCLX seems all good news. The British government's transportation "white paper" published week before last finally acknowledges cars and trucks can't do it all. The above remarks concerning RailTrack are part of the story, and since EWS is both customer and vendor to RailTrack, both will benefit. Having spent several hours sitting still in traffic on the M-roads, I can personally say the government goal to get folks and goods off the roads and onto the rails is good news. I'm not selling my WCLX shares just yet.
P.S. If you're interested in ancient ruins, battle fields, and castle walls, go to www.rblanchard.com/middleham to see the first postings of our trip pictures. Laura has done a nifty job punching up the contrast of these cloudy- day shots using her Photo Shop tools. We'll be adding to the site regularly, and may even post some train pix.
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