The Railroad Week in Review:
Week Ending July 31, 1999

Earnings Week continues, albeit at a somewhat slower pace. For 2Q99 RailTex (Nasdaq: RTEX) posted a 15% increase in revenue on a 13% increase in carloads. Operating expenses were up just 13% producing a 24% hike in operating income. Net income rose to $3.5 mm from $2.4 mm a year ago, a 33% increase. RTEX notes that all this good news is primarily the result of revenue growth and operating ratio improvements at the Company's “Same Railroad” properties.

Digging a little deeper into the results we have to strip out extraordinary items for both the 1998 and 1999 quarters - a line sale in ’99 and an accounting change in ’98. Even after that, operating revenues were up 13%, operating income was up 18% and the net was up only 24% to $3.1 mm. Shares outstanding remained essentially the same while LTD including current portion dropped a commendable 7%. Recall last week we made some favorable comment about the multiples sported by RTEX these days, concluding that if LTD dropped appreciably in 2Q99 that might make RTEX evern more attractive.

Norfolk Southern (NYSE: NSC) was in town last week to present the quarterly results and though the numbers were down, most of the assembled analysts felt that David Goode and company presented a very strong story. On a personal level it was most gratifying to hear him say both privately and publicly that the shortlines really came through for NS, working through the startup hiccups with yard work and line sharing. Reading between the lines I’d say that those who were a help have positioned themselves very nicely for future growth with NS.

As everybody expected the bottom line numbers were down as the operating ratio jumped ten points to 83 from last year’s 73 with operating expenses up 27% against an 11% gain in revenues. But NSC is still pumping quarterly revenues at the $billion plus level through the system as total carloads increased 11% with no change in average revenue per car. SVP-Ops Steve Tobias reports that cars on line stand now at 237,000, down from a peak of 241,000 for the week ending 6/11, and well on the way to the 8/31 goal of 233,000 cars. By 7/23 terminal dwell time had dropped to 27.4 hours against an 8/31 goal of 30 hours.

As Tobias explained over coffee before his presentation, a rail system is like a funnel in that the only way to increase volume through the small end is to increase the velocity of material passing through the funnel. And how fast you can push cars through a rail system funnel is a function of five things: line capacity, yard capacity, locomotives, cars, and crews. That explains why NS is adding power and crews, is creating new run-through trains (Macon GA to Wisconsin Central, e.g.), and has spent $29 mm on “alternative transportation” to meet what CFO Hank Wolf described as “the critical service needs of our customers.” Some $15 mm was consumed running special trains and shorter trains and burning a lot of overtime.

The Kansas City Southern (NYSE: KSU) breakup is in the news again. The plan is to form a new company called Stillwell Financial by combining the assets of Janus, Berger, Nelson Money Managers, and KSU's 1/3 stake in the DST Systems mutual fund processing operation.

An article in Barron's this week says the Janus wing of the house isn't so sure it likes "Stillwell" and could scuttle the deal. The issue has to do with executive compensation and revolves around a "phantom stock" clause which if implemented could halve the unit's earnings. Sources close to the transaction say KSU and Janus will likely reach a settlement, however the total potential impact is not yet known. The fourth quarter still looks like a good bet for the split. The rail side will probably fetch something in the ten dollars a share range with the financial end getting around $40-$45. KSU is now priced in that range.

For what it's worth, one of the value stock screens we use has picked up KSU again. The screen takes all of the stocks ranked Timeliness 1, 2, or 3 by the Value Line Investment Survey and then filters for four attributes. They are (1) Total Return (26 week) is greater than 20%; (2) EPS Growth 1-Year is greater than 20%; (3) % EPS Change from Last Quarter is greater than 20%; and (4) Estimated % EPS Change for the Fiscal Year is greater than 29%. Think KSU will keep up that pace as a pure rail play?

Finally, while we’re still on Earnings Week, my good friend and critic Dick Russack, who toils as VP Corporate Affairs at BNSF, was quick to note that last week I mistakenly reported their 2Q99 operating ratio as 86. Wrong. It was a respectable 76.2 compared with 76.0 for 2Q98. A fair cop. My Rule Maker spreadsheet shows operating margins 23.8% and 24.0% respectively. I just can't subtract.

Another contributor to these sheets is Randy Resor of Zeta Tech (ZT) fame who writes regarding RR technology, “You note that each one mph improvement in average velocity is worth $40 mm in equipment utilization. Well, ten years ago we identified a potential 30% improvement in end-to-end trip time as one of the benefits of the Advanced Railroad Electronics System (ARES): GPS location, on-board computers, and digital data link. The roads walked away from ARES, but that 30% translates into about 5-mph improvement for an 18-mph system average velocity, or $200 million.

“Some additional background: ZT was part of a team that assembled the so-called business case for ARES. Largest benefits (by far) were in equipment utilization and improved velocity (which of course is related to equipment utilization and also to line capacity). Estimated cost for the system was $350 million; after-tax estimated ROI was about 30%. The railroad walked away from an investment mainly because no one believed the size of the benefits. To wit, they doubted an information system (which is what ARES really was) could deliver that kind of improvement.

“As a postscript, CSX is now equipping all its locomotives with GPS receivers and digital radio, having determined in a test that this can improve utilization by about 10%. That’s a de facto reduction of about 250 locos in required fleet size, or an avoided capital investment of about $400 million at current prices. That will buy lots of computers.” It will also do a lot for the rail industry’s velocity needs. Thanks, Randy.

Reports that take exception to the official line continue to come in from the field. A major shipper in upstate NY writes, “Both NS and CSXT have shown improvement in the last two weeks. For this period it has been unusual to find more than one or two cars holding at any one spot in excess of 24-48 hours. Previous bad spots for us were Selkirk and Syracuse on CSXT and Chattanooga on NS. Both have cleared up and appear to be processing cars at an appropriate rate. My Friday morning snapshot indicates slow spots are Stanley Yard in Toledo on CSXT 80+ hours dwell time, Conway and Bellevue on NS with 70+ hours and Oak Island (Shared Asset Area) at 50+ hours.

“One thing making life difficult now, particularly with CSXT, is the lack of a consistent route to a destination. CSX continues to ‘explore’ the myriad routing possibilities on seemingly every release of cars we send out. While I understand their desire to keep the railroad fluid, it makes it difficult to manage both our rail fleet and inventories at customer locations when the transit time keeps bouncing around so much. I am hopeful that they will soon find the ‘best way’ and stick with it!”

A Pennsylvania shortline reports, “NS is not doing a whole lot better [than before]. We are still having trouble with EDI of outbound cars, in that they don't seem to be receiving the information. They often call several days after we tender cars to them requesting billing information which was transmitted at the time of interchange. They've also lost and misrouted cars -- one wandered all over their system for nearly a month before being returned to the origin still loaded! CSXT, on the other hand, seems to have a much better handle on how to get cars to us. Although they are occasionally a few days late due to congestion -- cars from NS at Hagerstown jamming up the yard -- they are at least consistent.”

Looks like the toothpaste tube analogy still holds after all.

--Roy Blanchard

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