The Railroad Week in Review:
Week Ending September 19, 1998

How Being a Stock Watcher Puts Money in Your Railroad's Till A couple of weeks ago Barron's ran a feature article titled "Too Much Food?" The gist of the piece is that scientifically engineered crops can lower out-of pocket grain costs for processors while increasing farmers' dollar yield per acre. The rub for the rails comes in the form of a drive for smaller, more frequent, shorter haul deliveries spread out over longer times.

This could have long-term implications, especially in covered hopper fleet management. Recall that a number of shortlines have reported pressure from their connecting class 1s to buy equipment, especially the "286" jumbos. However, we already see some fall-off in yield per car. Burlington Northern Santa Fe (NYSE: BNSF) for example reported that carload revenues for corn and wheat were down 7% and 11% respectively in the first quarter and carload miles were off 31% and 27% respectively.

Yet if yield is down, why would a shortline buy cars to shore up the fleet? Gary Strausbaugh of Fostoria (OH) grain processor Mennel says the rails -- particularly those west of the Mississippi -- need to do a better job managing shipper -- and shortline -- fleets in terms of consistency and cycle times before they can ask anybody to add to the pot. It does appear Gary has a point as shortlines tell me their cars are being held out of yards while class 1 trains get priority.

Getting back to Barron's, Strausbaugh writes, "The goal of so-called bio-tech crops is to produce a raw material which provides a higher yield in processing and more desirable characteristics in the finished product. This is done by isolating or preserving the identity of a variety of grain. The seed companies such as Monsanto and Novartis are breeding soybeans and corn with higher oil contents. Wheat is gaining special characteristics which lend it to higher flour extraction rates and different flour profiles for special products.

"The challenge to the railroads will be to haul identity-preserved crops to forward mills which desire or need grain with certain characteristics. This will not necessarily lead to a higher volume of grain moving by rail but longer joint line hauls. On the longer moves the need is to reduce the cost per bushel and 286 equipment is a requirement. Conversely with the new emphasis on farmer owned processing plants with in a local growing area the majority of the grain will move by truck to processing.

"I see a niche for short lines with the ability to bring grain to local processors with shuttle trains to compete with trucks. Hauling processed higher value products to the population centers will be a better market for the class 1 railroads. The revenue is better than with raw material even if volume is a little lower. If the rails would put less emphasis on owning covered hopper cars and pushing the short lines to invest in equipment the private sector would do a better job. As a shipper and a lessor of covered hoppers I feel as if the railroads see me as a competitor with my equipment instead of a customer. The rails need to move equipment efficiently regardless of ownership."

A friend in the poultry business also feels there is a move away from long distance commodity shipping and toward locally grown crops to supply close-in feed mills. His firm has already expanded out of the Southeast into the Midwest where he can grow and process poultry products for consumer markets within 500-miles. No rail in, no rail out. Crops grown to order, delivered to order, and less waste in the bargain.

Sounds like a winning combination and a classic example of transportation economics driving markets. It's an interesting case of what goes around comes around. A hundred years ago cheap, efficient rail transportation for the first time expanded manufacturers' vendor options. Air freight, container ships, and trucks on interstates have continued the process. It would be nice to see the rails get some of what they started back again.

Now the feds are talking of forcing Union Pacific (NYSE:UNP) to divest some of its rail lines if service does not improve by the end of the year. Stories both in Reuters and JOC say the DOT allowed there was "some improvement" however was concerned that service would slow when grain season began. Naturally, UNP objects, calling on the STB to reject forced changes in the western rail network, noting that "Our operations on the Texas Gulf Coast are fluid and, in some cases, are better than they have been historically.'' Besides, how can UNP improve operations and cash flow if they're forced to give away the very store they need to sell the goods?

Meanwhile the JOC reports that J. B. Hunt (Nasdaq: JBHT) has predicted an earnings shortfall for 3Q98 in spite of an estimated 20% increase in revenue and a substantial improvement over 1997 third-quarter profit. Hunt blames a slowdown in rail service saying that and "related problems" could cut earnings a dime or more a share. The Motley Fool notes "Hunt was careful not to point fingers or name railroad names in its statement, but one has to wonder if the ongoing railroad traffic jam at UNP is at least partly to blame for the profit warning. Interestingly, Hunt's larger maintenance shops and truck terminals in Chicago and Lowell, Arkansas, just happen to coincide nicely with Union Pacific's Midwest and Southern-centric route map."

Emons Transportation Group (Nasdaq: EMON) reported record operating revenues of $17.45 mm for the fiscal year ended June 30, 1998, up 8.7%, and record pretax income of $1,488,000, up 27%. For FYQ498 operating revenues increased 19% to $5.0 mm, and income before taxes was up 66% to $632,000 from $380,000. EMON notes that shortline rail operations achieved record levels and it has completed "three small, but strategic rail line acquisitions." And just recently it reached an Agreement in Principle with CNI for a significant acquisition in Quebec.

Freight revenues, excluding intermodal, were up 18% for the year and 32% for the fourth quarter. Carloads increased 13.5% to 42,000 from 37,000 for the year, and increased 27% to 12,000 from 9,400 for the fourth quarter. Further, average revenues per carload increased 4.2% for the year and 3.9% for the fourth fiscal quarter due to the mix of carloads and rate increases. Excluding acquired operations, freight revenues increased 15% and carloads increased 10% for the year. That's the kind of yield improvement investors ought to cheer.

Short takes: RailTex (Nasdaq: RTEX) was upgraded by AG Edwards to Maintain from Reduce... Gruntal hiked Canadian National (NYSE: CNI) to Strong Buy from Buy... Trackwork specialist ABC Rail Products (Nasdaq: ABCR) jumped $2 1/8 Friday to $15 3/8 after the company announced its intention to purchase closely held NACO Inc... August rail traffic volumes were up 1.3% largely due to the end of the GM strike.

Thought-for-the Day Department. There are three reasons The Week in Review places so much emphasis on railroad industry stock analysis and financial reporting. The first is so railroad investors can see what to look for and how to measure their performance vis a vis the broader market. Second is so railroad managers can compare their own results with those of the public companies. Third - and less obvious - is to give railroad marketers the tools to delve into customers' financials to ferret out trends.

All too often the first indication of customer trouble is a fall-off in carloadings or an increase in demurrage billing as cars sit longer than usual. Yet following the 10-Ks and 10-Qs can help flag problem areas and give you a chance to take pre-emptive action before they smack you up-side the head. For example, a food processor traded on the NYSE -- and which lags the industry in many key measurements -- is going through a major restructuring, has a new Processes VP, is shedding certain product lines and is adding others, principally non-US.

The changes have been brewing for a year and have been duly reported in the SEC reports. The savvy railroad marketer who has this account should have seen the handwriting on the wall. As noted above in the grain processing article, there are changes afoot which can affect everything from fertilizer loading to grain car supply. The information is all there in an S&P stock or industry report, accessible from any number of sources.

It's a simple matter to set up phantom portfolios of customer stocks on AOL, Yahoo, or your own brokerage site. Set prices at the Jan 1 numbers, shares to amount to $1000 or so in each company, and track YTD changes. Some servers - Yahoo is particularly good at this - also flag daily news items by ticker so you can track why certain things are happening. Then the next time you visit the customer you can ask about the reorganization, increase/decrease in earnings, shifts in product line-up, etc. and talk in terms of what you can do to support the desired ends.

--Roy Blanchard

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