The Railroad Week in Review:
Week Ending February 27, 1999

In announcement that must have caught many of us by surprise, New England's up-and-coming Providence and Worcester (Amex: PWX) revealed that after 16 years with the company Heidi Eddins, Vice President, Secretary and General Counsel has accepted the position of Senior Vice President, Secretary and General Counsel of Florida East Coast Industries (NYSE:FLA) effective March 15, 1999.

A consortium of which RailAmerica, Inc. (Nasdaq: RAIL) is a majority partner won the bidding for Australia's for V/Line Freight Corporation (V/Line Freight) with a purchase price of approximately US$103.7 million (A$163.1 million). V/Line Freight, the rail freight business of Australia's Victorian Government, provides services across southeastern Australia over 2,973 miles (4,756 km) of track. The transaction includes the purchase of 107 locomotives and over 2,800 rail cars, as well as a long-term lease of the V/Line Freight trackage.

In fiscal 1998, V/Line Freight, centered in and around Melbourne, generated revenues of approximately US$79 million (A$124 million) and moved over 8 million tons of freight. Commodities hauled include agricultural and grain products, minerals, forestry and petroleum products, as well as intermodal traffic. Do the arithmetic and the transaction comes to about 1.3 times sales. The consortium plans to invest approximately US$23 million (A$36 million) in the first two years to improve infrastructure, modernize or replace parts of V/Line Freight's locomotive fleet, as well as upgrade the Geelong grain loop to include standard gauge. The consortium also plans to increase key bulk traffic flows including paper and logs, sand, grain and fertilizer is expected to take over the running of V/Line Freight in late April or early May.

A reader and correspondent in Australia who follows these things closely adds, "Of the losing bidders, Australian Transport Network (comprising Wisconsin Central, Tranz Rail, Berkshire Partners and Faye Richwhite) has said that as one of the final two short-listed bidders, it had offered $A120 million for the business. However, industry sources have suggested that this figure does not include a provision for redundancy payments (thought to be approx $A40 million) that was required to be factored into all bids."

There is a second non-revenue-producing obligation - "a $25 million annual Community Service Obligation payment to maintain those tracks currently used by V/line Passenger to passenger operating standards. According to a previous Government press release, the 15-year lease option has been designed to protect the network and guarantee that all potential and existing operators including V/Line Passenger have access rights on fair terms."

"Another unsuccessful bidder, Mortimer B Fuller III, Chairman of Genesee & Wyoming (Nasdaq: GNWR), owners of Australia Southern Railroad, said in a US press release, 'Based on our success in South Australia and our analysis, our bid to bring V/Line into GWI Australia was aggressive. Although disappointed we are confident that our bid was as strong as we could justify to our shareholders.' There was no comment from a fourth bidder, US-based Railroad Development Corp. A dozen or so bids were received."

It is important to know who's bidding what for these offshore properties and to view the winners and losers in terms of their balance sheets. While it's true the shortline operators as a rule are growing revenues at a double-digit pace, one also has to look at the debt ratios and interest coverage. It's hard to fix track and buy power when a third of the operating cash flow goes to the banks in the form of interest payments.

Randy Resor picked up the pen (so to speak) to weigh in on the shipper's Y2K question from last week. He writes, "Having just last fall done some work on Y2K issues for railroads, I'm in a position to contribute some real information. Our work was done for an insurer who started out renewing policies with a Y2K exception clause (i.e. no coverage for Y2K problems). The insured railroads objected, so the insurer asked us to determine how bad the problem really was."

Resor found that first of all "most railroad field devices are so dumb and so old that they pre-date embedded processors (many aren't even electronic in any sense of the word). This is especially true on short lines." Second, writes Randy, "The devices with date/time functions use them almost exclusively for time-stamping status messages. In other words, the Y2K problem on a hotbox detector is likely to be only that it can't tell you what day and time the train went by that tripped the alarm. Inconvenient? Yes. Dangerous? No."

Thirdly, Resor reports " Signal systems are designed to be 'field vital'. The relay logic in the field will prevent conflicting routes from being established even if the central system goes haywire, and again, the field logic is so basic that it doesn't know about date and time. So even in the event of a complete failure of one of these state-of-the-art computerized dispatch centers, all that will happen is that signals will not clear."

"The bottom line," he concludes, is that "some potential for business disruption if railroads have to manually clear trains through interlockings or go back to keeping paper records when (if?) their dispatching systems fail. Potential for serious accidents? Insignificant. Don't buy your cabin in the mountains and start stacking up on canned food, water, and guns quite yet." Thanks, Randy.

By now most of the civilized world has probably checked the "Railroad Performance Measures" listed on all the rail websites and then some. The one that gets me is "Average Train Speed." The site definition says it is stated in MPH and "calculated by dividing train-miles by total hours operated." If this is the case, the figure is pretty meaningless as it includes drill freights, unit trains, mixed manifests, hotshot intertmodals, and all the cats and dogs. Tell a shipper your trains average 17 mph when the competition is blowing him off the road at eighty and he'll laugh you out of the office. Perhaps a different measure would be more meaningful.

Continuing the topic of shareholder value, the charts speak volumes. In all cases we're comparing 5-year split-adjusted stock price performance without dividends compared to the S&P 500. We also looked at the 200-day moving average for a sense of each company's stock price trend relative to itself. And we'll get to that next week.

Over five years the S&P-500 is up 150%, so an investor holding an index fund would have about 2 1/2 times his original money - about 14% ACG. Only Kansas City Southern (NYSE: KSU) beat that, however the railroad is but a reltively small part of that picture, so it's not really in the same league. Florida East Coast (NYSE: FLA) gained about 60% over the five years, but again, the railroad is not the whole story -- land management and forest products is.

The best an investor in "pure" railroad stocks could have gotten would be about half again the original money. Burlington Northern Santa Fe (NYSE: BNI) and Providence & Worcester (AMX: PWX) both grew about 40%. Then comes Canadian National (NYSE: CNI), up 29% since it went public in late 1996, Norfolk Southern (NYSE: NSC), up 25%. Canadian Pacific (NYSE: CP) eked out a 10% gain, CSX (NYSE: CSX) about 5%, and Union Pacific (NYSE: UNP) shareholders have seen the value of their holdings decline by some 10% over five years.

We're only talking stock price here. For total return, see the Wall Street Journal annual "Shareholder Scorecard" which it ran on Thursday. The paper notes, "Total return to shareholders includes changes in share prices and reinvestment of any dividends...Returns are also adjusted for stock splits, stock dividends, and recapitalizations." That being said, the railroad industry 5-year average return was 10.8%, driven by KSU's 13.5%. The others listed were BNI, +3.2%; NSC, -1.7%; UNP - 6.8%; and CSX, -8.2%

That does not necessarily mean, however, there is no money to be made investing in railroads. We've reported in this newsletter the things that companies big and small are doing right to build the revenue base and drive out costs. The traded shortlines in particular are growing revenues and income at a double-digit pace. And most everybody is trading at deeply discounted valuation ratios relative to the broader market. Next week we'll get into specifics.

--Roy Blanchard

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