The Railroad Week in Review:
Week Ending October 24, 1998

The real story behind the earnings announced this week was YTD revenue changes more than actual quarterly or YTD earnings per share as freight revenue gains continued to lag carload gains. Union Pacific (NYSE: UNP) turned in a positive quarter with $38 mm left in the till on revenues of $2.4 billion, off 7% from last year's $2.6 billion. Operating expenses were down only 2% quarter-to quarter, fainlly dropping the OR below 100 to 91.6. The killer was interest expense: $189 mm or 93% of the $203 mm operating income vs. Q397 when interest payments of $156 mm were 37% of the $415 mm operating income.

Revenues YTD were off 9% at $7.1 billion vs. $7.8 billion. Of this, CEO Dick Davidson said most went to truck, some went to water, and BNSF got about $400 mm worth. The feeling is that the truck business will come back first and the others will take a little more time. All the railroad operations indicators improved as well over the quarter: recrew rate, car hire, car inventory, blocked sidings, train speed, and trains held. That said, UNP remains a victim of the same trend that plagues most railroads: declining revenue per car. Which would seem to say UNP must bring back quality service, set rates accordingly, and build back the cash flow needed to support and enhance the UNP's valuable franchise.

Burlington Northern Santa Fe (NYSE: BNI) freight revenues YTD came in at $6.7 billion vs. $6.2 billion a year ago, up 7%. Operating expenses YTD were up only 5%, leading to a 2.5 point improvement in the OR, coming in at a respectable 76.2. However, one must ask why, given the wounded state of UNP, revenues weren't up more. If 80% of the YTD revenue increase is former UNP business what would BNI had done against a healthy UNP? Still, with a pre-tax net of $1.3 billion YTD, BNI is left with a significant war chest to use for all kinds of competitive creativity.

RailTex (Nasdaq: RTEX) faced the yield problem in the quarter with 5% more revenues on 11% more cars and YTD with 7% more revenues 12% more carloads. Operating income YTD rose 11% to $19.5 mm. For the nine months the "same railroad" OR shed 110 basis points to end at 77.8. Long Term debt crept up 200 basis points as a percent of total capital December to September. Interest expense continues to eat up 43% of operating income.

The big news at CSX (NYSE: CSX) is a major realignment of CSXT (railroad) senior management responsibilities in this the 11th hour of its Conrail merger process. Aden Adams, one of the keenest and most creative commercial minds in the business, returns as SVP-Merchandise Sales & marketing after having retired three years ago. Adams protégé John Giles moves from VP-Marketing to VP-Planning and Performance Improvement, reporting to Paul Goodwin, CSX Chief Financial Officer. And Mike Ward moves from rail CFO to EVP -Coal and Merger Planning.

As expected, earnings for the quarter and YTD were less than one might have liked. Revenues were $2.4 bn for 3Q98 and $7.4 bn YTD, off from $2.6 bn and $7.9 bn respectively. Quarterly operating income decreased to $270 mm from $384 mm; the YTD decrease was to $884 mm from $1.1 bn. Net income was $187 mm for 3Q98, down from $206 mm a year ago; YTD net decreased to $429 mm from $584 last year. Per car revenues and carloadings were essentially flat. There is some good news, however, and that has to do with progress making needed infrastructure improvements to smooth the way for integration of the 42% of Conrail going to CSX.

Canadian National (NYSE: CNI) was awash in special credits and charges. Once, however, one waded through them to what the railroad was up to a couple of conclusions emerge. First, CN was not immune to the decreasing yield per carload experienced elsewhere. YTD revenue dipped 5% to $3.0 bn from $3.2 bn a year earlier. Carloads for the first nine months of 1998 were 1.8 bn, down 3% from the same period of 1997. Second, the big expense hits are getting harder and harder to find.

With revenues and carloads off and yields falling, CNI took a 3Q98 special charge of $590 mm for workforce reductions and booked an 11% operating expense cut. This latter is in response to a 9% fall-off in both revenue and carloads for the quarter. How many more times can CN boost earnings with massive expense reductions is open to question. However, recall merger partner IC has shown itself adept at boosting earnings by driving up per-car revenue yield. It should be interesting to see what magic Hunter Harrison et al can work on the yield curve in conjunction with CN's sharp pencils in the expense side.

To put workforce reductions in perspective, the Toronto Globe and Mail notes that 20 years ago the Canadian railroads employed more than 100,000. Ten years ago that number had fallen by 25% and nearly half of them were gone in another eight years. About half of those remaining (21,000) work for CNI, and that number will shrink again as the Canadians do what they can to match the productivity gains enjoyed by their peers in the United States.

Intermodal third party Hub Group (Nasdaq: HUBG) reported improved results for 3Q98 over 3Q97. Revenues were up 8.2% as Hub continues to gain share in the relatively flat intermodal market beset with service delays and no improvement in overall intermodal industry average transit times for the quarter. Yet HUBG reported "marked reductions in the transit times for the Union Pacific" at the end of the quarter. Sep was 22% better than Aug, though the quarter as a whole was only 2% better.

On Tuesday Norfolk Southern and the St Lawrence & Hudson (SLH) unit of Canadian Pacific teamed up to rededicate the "Bridge Route" through Central Pennsylvania, connecting the future NS hub at Harrisburg with the SLH at Scranton. The Sunbury-Scranton segment had initially been conveyed to the D&H when Conrail was formed more than 20 years ago, however the ravages of time and rail rationalization never let the line reach its full potential

Now, after a $12 mm rehab jointly funded by NS and CP the Sunbury line will be part of the joint route linking the Southeast and central Pennsylvania to upstate New York, New England and eastern Canada. Once operational, the Bridge Route, so-called because of the "bridge" it creates between the North and Southeast, will be the only direct, fully-cleared domestic double-stack route between eastern Canada and the Southeast. (The CSX "I-95 Corridor" is not cleared for double stack north of Virginia.)

Sometimes the granger roads just can't win. Last year a shortage of rail cars made farmers pile their grain on the ground. Now they're piling it on the ground because of depressed commodity prices. Corn is off two bits a bushel from a year ago in some places. Lower prices plus lower international demand due to the Asian Contagion don't provide much incentive to sell.

As a result, car fleets of UP, BNI, private car owners, and shortlines are looking for loads. Owners will need to keep the cars moving to keep per diem rates up and per-ton lease costs down regardless. It will be instructive to see if the economics of car ownership will cause carriers and owners to lower rates enough to make grain sales worth the effort.

Wisconsin Central (Nasdaq: WCLX) has reached a tentative contract agreement with the UTU for its conductors. It is anticipated that the ratification process will be completed by mid to late November. A company statement said "The wage movements are within the level expected and in line with earlier contract agreements reached by the company with the Association of Rail Unions on its Canadian affiliate, Algoma Central Railway Inc." WCLX and the BLE are still in talks.

Kansas City Southern (NYSE: KSU) took two steps back this week after saying it will postpone the rail spinoff. It's beginning to look like the IRS will not take the kinder view of the transaction, periling shareholder value still further. Results for YTD and 3Q98 are to be announced Monday with estimates hovering right around 48 cents for the quarter and $1.95 for the year. The company posted 38 cents and $1.30 a year ago, and it will be helpful to see the relative performance of the rail and financial management sides of the house.

--Roy Blanchard

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