The Railroad Week in Review:
Week Ending August 29, 1998

Rail stocks got hammered along with everybody else this week with some individuals achieving new lows. The view from here is that these lower prices have dropped multiples - Canadian National (NYSE: CNI) is now under 10 and Canadian Pacific (NYSE: CP) is down to 6, e.g. - creating potential buying opportunities. In deed, by noon Friday the blood bath seemed to be abating with six of the rails in positive territory and two with no change on the day.

As noted here last week, smaller properties like Wisconsin Central (Nasdaq: WCLX) and Genesee & Wyoming (Nasdaq: GNWR) are being tarred by the same brush brought out for the big roads. It's time to watch the fundamentals, beware excessive debt (EBITDA/interest less than than six), and see that revenues are growing faster than car counts.

There's good reason for the superb results turned in by the Burlington Northern Santa Fe (NYSE: BNI) reported in this space last week. The analysts' presentation given by SVP/Intermodal and Automotive Chuck Schultz is a graphic example of what one can do simply by following the essential rules of good customer service. (Those wishing to follow along will find the entire presentation in downloadable adobe format at The most remarkable part of the story is the number of customers whose business has doubled - or more - and the tools used to grow the business. These tools, I hasten to add, work in the carload business too.

Of particular note to those wishing to grow their own businesses is chart 25, Strengthening IMC, the last three bullets: simplify pricing, strengthen alliances with innovative agreements, and improve contribution through cost- cutting and better equipment utilization. Flip over to chart 28 and see how BNI brand recognition and being value-driven produced measurable results. Over on chart 31, you'll see how even more basics contributed. The chief thread is meeting the constituents' value-drivers. It's charts like these that spell investment value.

Responding to last week's BNI write-up, AVP Henry Lampe writes, "We are very proud of what we have done but have a way to go before our service is where we want it to be. Nice challenge though to essentially have more business than locomotive fleet can consistently deal with. We expect 3q and 4q deliveries to help a great deal." Recall fleet age, size, and optimization has been a continuing concern at BNI. This is good news.

Has Union Pacific (NYSE: UNP) turned the corner? Over the five quarters from June 1997 through June 1998 posted earnings per share have been $0.93, $0.91, ($0.11), ($0.25), and ($0.17). Estimates for the Sep and Dec quarters are $0.12 and $0.31 respectively, putting the estimated eps for 1998 at one penny. Yet the consensus recommendation has risen to 2.27 from a low of 2.5 in June. The 20-day moving average stands at $52 or so; this week's close of $41 7/16 represents a discount of 20%.

The turn-around will be tough going, to be sure. There are 247.3 mm shares outstanding, so the yearly net estimate is a mere $2.4 mm, which doesn't leave alotta cash for capital expenditures, let alone dividends. By comparison, arch-rival Burlington Northern Santa Fe (NYSE: BNI) is looking at earnings of $7.19 per share for a net of $1.1 billion which in turn buys lots of things.

The above bit of digging was triggered by an eye-opening presentation laid on the shortline gathering in Omaha last Monday. Bob Starzel, SVP-Corporate Relations for UNP, provided an illustration of what could happen to cash flow if revenues were cut as the inevitable result of the STB giving some of UP's franchise to other railroads in the Houston area. Of course, reduced revenues mean reduced cash flow for investment in capital projects in the very area - Houston - that needs 'em the most. The argument is, if you force divestiture to create short-term gains you harm a company's ability to make the long term investments to serve its customers and communities. Like Norfolk's David Goode has said, "We're not buying Conrail to sell it; we need every mile to pay for it." UNP is no different.

Starzel's words were not lost on his audience, and for the rest of the day and into the evening, hosts and visitors devoted the hours to finding joint opportunities and solutions. You see, the session was set up for a minimum of dais presentations in which UNP addressed the shortlines. Rather, each of the commodity groups had a table and a full dance card of pre-arranged appointments to talk specifics with the shortline managers.

At the same time there was a focus group going on in another room, so that spleens could be vented and constructive criticism be posted for all to see. Those results will be collated, assembled, stapled, and reviewed with an eye to creating the appropriate action plans. In a word, the unique aspect of this session was the focus on feedback. Which only makes sense with the shortlines representing revenues of some $1.5 bn to UNP. That's 15% of total revenues and requires absolutely zip in capex.

Monday night several dozen stalwarts boarded the UNP inspection train for a trip to St Louis, and there's nothing like a train ride to expose your strengths (and weaknesses). It also gives one a chance to chat with one's hosts and learn how the railroad works. Take traffic density. We learned that where the mains connecting Chicago and KS with the west coast and the PRB converge average density is more than 100 trains a day. So the parades of coal, automotive, grain, and merchandise trains we saw on the 10-hour trip were only part of the whole. It's mind-boggling to imagine hundred-car freights at commuter rush hour intervals.

Is UNP on the road to recovery? Judging by what we saw on the road and heard in the room, listening to lots of folks relating specific steps being taken toward recovery, seeing how the Customer Service Center in St Louis manages to handle 650,000 calls a month from 30,000 customers, and looking at the estimates, I'd say there's a chance. Today the rails as a group trade at 15.6 times 1998 earnings; apply that multiple to the present 1999 UNP estimate of $2.55 and you get right around $40. Make 1999e $3 at the industry multiple and you get a 20% return on today's $40 share price. In terms of the old PEG ratio, that's 15.6% multiple over 20% growth for a PEG of less than one. Now we're talking.

In support of the above, an analyst friend writes, "As for UNP, yes I think the stock has bottomed. The railroad is showing some operational improvements and is therefore starting to attract some investment interest. I think the stock price will continue to improve as long as the UP continues to show operational improvement. Is the company going to post a $4.00 EPS number any time soon? Probably not, but once investors begin to see the rail return to solid profitability they will start to look at the true earning power of the company. That earning power is big and investors will eventually use it to the stock. We've been telling long-term investors to buy the stock."

Man Bites Dog Department: RailTex (Nasdaq: RTEX) has sold Union Pacific its 105-mile North Kansas & Missouri Railroad between Upland Kansas and St Joseph MO. Where RTEX ran one train a day, UNP will run 15, mostly northbound empty coal trains bound for Wyoming. The move will free up capacity elsewhere and UNP is said to have plans for upgrading the line. Terms of the deal were not released.

In a related note, UNP has notified the STB that it has removed the 173-mile Tennessee Pass route in Colorado from abandonment status. In its letter to the STB, Union Pacific said it has "now determined that the entire Sage-Malta- Parkdale segment of the Tennessee Pass line should be retained in place while current capacity requirements are monitored rather than be abandoned." While the line will be kept intact, UP currently has no plans to run through trains over the line, which would require additional maintenance before operations could be resumed.

Short takes: Providence & Worcester (Amex: PWX) filed an SEC registration statement for a proposed public offering of 1,000,000 shares of its common stock...Merrill Lynch upgraded Kansas City Southern Industries (NYSE: KSU) to Near Term Accumulate from NT Neural; Merrill's LT Buy remains....The SeaLand unit of CSX (NYSE: CSX) and Maersk have proposed joint venture to acquire joint control of North Sea Terminal Bremerhaven...Morgan Stanley Dean Witter has begun coverage of Canadian Pacific (NYSE: CP) with a Neutral rating...RailAmerica (Nasdaq: RAIL) news) has authorized the repurchase of up to 1 million shares of its common stock on no particular schedule...Norfolk Southern (NYSE: NSC) and Florida East Coast (NYSE: FLA) are running one run- through train each way with Norfolk power, have opened a Ford mixing center in Titusville, and are building a NS Thoroughbred bulk transfer facility in Miami.

--Roy Blanchard

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