The Railroad Week in Review:
One way to help earnings is to reduce the number of shares out. Westinghouse Air Brake Company (NYSE: WAB) (www.wabco_rail.com) has authorized a stock repurchase program of up to $10 million of the Company's common stock. The Company has approximately 25.7 million shares of common stock outstanding. Over the past year WAB has traded in the 17-30 range and for teh last few months has been at the low end.
In a press release provided by Moody's Investors Service it was reported that the outlook for Union Pacific has been changed to stable from negative. Says Moody's, "This change in outlook is based on the expectation of continued improvement in UP's cash flow and debt protection measurements as it improves customer service levels and regains revenues lost to other transport providers during its 1997-1998 period of operating difficulty.
"Such an improvement in operating performance should enable UP to rebuild its balance sheet and reduce the current high level of total debt over the next several years. However, the rail industry remains subject to the economic cycle and UP faces large capital expenditure needs. The ratings could come under renewed downward pressure if UP fails to make meaningful progress in generating an increasing level of cash flow or if anticipated debt reduction does not materialize." Fair enough.
CEO Robert Anestis of Florida East Coast (NYSE: FLA) has brought in another New Englander, Robert F. MacSwain as Executive Vice President for Special Projects. MacSwain's specialty is "bringing out the non-rail value associated with the assets of rail companies" and has worked with Guilford, Canadian National, and CSX. For the past two years MacSwain has been a consultant with FLA looking into longitudinal leases.
Recall Anestis himself is a Guilford alum and ran his own consulting firm in Westport CT from 1986 to his appointment to FLA last November. His specialty is in the realm of strategic and transactional planning, so it is only natural he would bring in MacSwain to work around the edges of the railroad and Heidi Eddins from Providence & Worcester to help with the legal side.
In the earnings announcement released the other day FLA did particularly well in real estate and telecommunications and saw the railroad's operating ratio at a respectable 77. Net income for the year was $43.6 mm with the Gran Central real estate arm bringing in 62% ($27.1 mm) and fiber optics another 9% ($4.1 mm), leaving the railroad at 29% of the pie ($12.4 mm). The corporation earned $1.20 a share vs. $1.11 last year, up 9%. Revenues were not broken out by segment in the release --I suspect they will be available later -- and came to $260.1 mm vs. $261.2 mm a year ago.
Providence & Worcester (Amex: PWX) also reported quarterly and year-end results last week. We will look at year-end only, and, like FLA, it is more a real estate story than a railroad one. Operating expenses consumed 88% of the $22.7 mm in operating revenue, leaving an operating income of $2.7 mm. That was off 28% from last year's $3.8 mm operating income even though revenues were actually up 3%. Higher operating expense was the culprit.
Real estate sales brought in $4.2 mm bumping pre-tax income to $6.4 mm vs. $3.0 mm last year. Net income after taxes and extraordinary item was $3.8 mm vs. $1.9 mm last year. Note that all the long term debt has gone away thanks to last spring's stock offer, however the number of diluted shares outstanding is now 50% more, 3.4 mm vs. 2.5 mm. My concern is that with many more shares and just so much real estate to sell off, future gains in earnings per share could be tough to come by. Now if they radically expanded the franchise…
On Thursday the Wall Street Journal ran a follow up on the Jordanian Rail situation in which Wisconsin Central is a player (see Week in Review for 12/5/98). The thread of the article is that Jordan, like many countries, "has staffed many state agencies with whomever needs a job." The railroad was no exception, and now there are 400 more souls on its payroll than needed to run the operation. The full flavor is summed up by this remark made by the railroad's planning officer: "The object of this company is not to make a profit. It's to give people a place to work." Workers are to say the least concerned about privatization. Says the union head," I can't control the people. It would be out of my hands [should the sale go ahead.]"
Last week we touched on yet another measure of relative shareholder value: past price performance. This time we dig a little deeper as we try to identify the companies most likely to perform well going forward. Doing so requires a look at the latest balance sheets and income statements to determine liquidity and trends. Liquidity is important because cash gives you options while debt (no debt is the best debt) drives up interest expense and limits investment for the future.
Momentum is a function of improving ratios - getting stronger every quarter and year bodes well for upcoming quarters and years. We also look for a declining number of diluted shares as growing earnings spread over fewer shares mean an accelerating rate of earnings per share. Finally, increasing receivables combined with growing inventories and declining payables are a sign of dwindling cash reserves as bills are paid faster than cash comes in.
Today's discussion centers on three stocks: Genesee & Wyoming (Nasdaq: GNWR), RailAmerica (Nasdaq: RAIL), and Wisconsin Central (Nasdaq: WCLX). Recall these were three bidders mentioned in the contest for the V/Freight transaction in Australia. RAIL has seen the best stock performance. And it was the winner in Australia. However, comparing full year 1997 with 1996 (1998 is due out March 16) we find share count increased 50% as revenues grew 85%. Receivables rose 84% as inventories went up 62%. Cash dropped 3%, raising a question as to unsold goods and collections. Lastly, cash decreased to 7% of LTD from 9%. Gross and net margins came in at 15% and 4% respectively. In short, liquidity diminished.
GNWR saw its gross margins (the complement of the operating ratio) decline to 13% from 18% however net margins held the line at 7%. Cash levels increased 26% even as LTD dropped 23%. Shares outstanding dropped 4%. Accounts receivable was up only 6% though sales were up 39%, which speaks well for cash management. In fact, cash management and cash/debt were the best of the three. And so liquidity actually improved.
WCLX saw sales fall 3% year over year while gross margins grew by more than 3 points to 27% and the net lost a point to 22%, still - though the most highly leveraged -- the strongest of the three by a comfortable margin. When points are assessed according to the Rule Breaker* plan WCLX leads with 30, then GNWR with 28, and RAIL with 14. I'm hopeful the full year 1998 results for RAIL will close the gap.
Getting back to Australia, the winning bid was $US 104 mm. That's more than a third of the debt WCLX had out as 12/31/98, slightly less than double what GNWR had out 12/31/98, and slightly more than double what RAIL had out 12/31/97. Even if RAIL picks up just a third of the deal, and its cash level doesn't change a whole lot, then it's looking at dropping the cash/debt ratio to less than 5%. WCLX bid about $US 77 mm. A third of that would put the cash/debt ratio down around one percent. If GNWR had won, again assuming one third to the shortline, cash would be at 18% of debt.
In sum, GNWR was the bidder most able to absorb the debt, WCLX the least. And RAIL, with debt already exceeding equity, may be challenged to take on the V/Rail load. It will be most helpful to see the 1998 year-end results week after next. Then we'll have a better handle on what's coming for the rail side of RAIL.
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