The Railroad Week in Review:
August 14, 1999

Continuing our investor thread, two investment houses have upgraded ABC-NACO (Nasdaq: ABCR) to strong buy. Both Norfolk Southern (NYSE: NSC) and CSX Corporation (NYSE: CSX) are featured as strong buys in recent advisories from Gruntal. Yet Zack's gives only ABCR a buy rating. How can this be?

One must look at the number of brokers involved in each rating and where each places the issue. Six houses, four of which say strong buy, two of which say hold, follow ABCR. CSX has a dozen houses following and four give the stock a buy or strong buy. NSC likewise is followed by a dozen houses with two strong buy rankings and the rest hold. In terms of sheer numbers, there as many strong buy votes for CSX as for ABCR, however the larger total number of analysts pulls the average rating down.

Then look at the consensus earnings projections. Partly because of the recent ABC Rail merger with NACO analysts see earnings for 2000 nearly three times the 1999 estimate. CSX earnings for 2000 vs. 1999 are expected to be up by 47% and NSC up by nearly 60%. Yet Gruntal sees CSX earnings up 53% after allowing for the SeaLand sale and NSC up 76%. In each of these cases, sudden bumps can be smoothed out by taking a two-year average change from 1998 through 2000.

Then there's the volume issue. Stock charts on the web include volume indicators as well as price moves. If you look at one-day or five-day hourly trading activity, firms like ABCR often go hours with no trades. Same goes, incidentally, for small cap rails like Genesee & Wyoming (Nasdaq: GNWR) or RailTex (Nasdaq: RTEX). It's tough to get any appreciable movement when there are only 15 out of a possible 25 volume bars in a week of trading and most of them are under 10,000 shares a trade. RTEX was somewhat more active, however there were only three periods with more than 10,000 shares traded.

Back to CSX and NSC. If you read the Gruntal reports (available at the arguments for these growth rates are quite convincing, especially if you happened to attend or listen in on the earning presentations in NYC earlier this month. So if you take the Gruntal estimates, get a year 2000 PE, and divide by the 12-month anticipated growth rate, you come away with some rather intriguing PEG ratios.

Combine that with your own knowledge of the industry -- that CSX and NSC are taking some hits now but will both emerge a lot stronger - and you may have a convincing investment argument. Check some ratios with the Rule Maker spreadsheet available at and pick the one that fits your objectives. You make the rules.

Class 1 rail stocks finished the week generally below there they started, with CP faring better than the other five: no change. That in the face of an S&P gain of about 2 percentage points for the week. If it's any consolation, though, the rails generally finished the week on an uptick. I've been following CSX and NS daily thanks in part to the Gruntal report, and the curves are instructive. Norfolk troughed midweek and came back with the rest of the market on Thursday and Friday. CSX took a slight dip Wednesday, closing up on the day, and turned opposite to the market midday Thursday then tanking nearly four percentage points by Friday's close. Will CSX fall farther? Has NSC turned the corner? We'll see on Monday.

It's safe to say both CSX and NSC have some growth ahead, though it's hard to say how long prices will remain at the current levels. Buying shares through a Direct Investment Program (Drip, for short) may be the prudent move. Both rails offer Drips, and details are on the websites. Please note that although you can buy starter shares direct from CSX, you must already hold shares in NSC to participate. These shares cannot be held in an IRA or in a "street name." You have to hold the certificates yourself. And if you have no NSC shares, you have to pay a broker to get some. Pity.

Providence & Worcester (AMX: PWX) reported 2Q99 results the other day. Operating revenues were off 7%; operating expenses were off less than 2% pushing the OR to 91.5 from 2Q98's 86.7. In its press release PWX maintains "the decrease in income from operations is entirely attributable to the decrease in operating revenues" with about half the hit "attributable to the Conrail split-up." The firm says that some of it may be made up in subsequent quarters however "most of it represents shipments that were diverted to truck and thereby permanently lost."

Net income dropped nearly 80% as PWX posted $2.4 mm from the sales of easements, property, and licenses in 2Q98. Also, diluted shares outstanding grew by 23% to 4.4 mm, further whacking eps. Recall last week we reported GNWR increased eps on small changes in operating income and expense and an 18% increase in diluted shares.

NY analyst Scott Flower has just released some pretty powerful studies on class 1 railroad profitability. He has been kind enough to share his studies with me, and there are some clear messages for shortlines in his work. One has to do with yield management; the other has to do with return on invested capital (ROIC). With respect to the former, he delves into the different business models used by each of the six major North American carriers. The shortline message here is finding ways to support the appropriate class 1 model. My September Railway Age column develops this further.

With respect to ROIC, Scott writes, " Capital allocation discipline is an important factor in the success of the stocks." The application in the shortline model is not so much in stock performance since so few properties are stock-based, but it is essential to track for any railroad owner or operator simply due to the fact that this is a capital intensive business. There is always a need for additional rolling stock and infrastructure improvements, and funding same is of vital importance. Returns will not only affect what a property pays for a loan but also whether the money is available at all. We will look at some illustrative shortline ROIC numbers next week.

Newswise, this was a pretty quiet week. It should be noted however that the second quarter 10k's for most of the rails are now available at Edgar OnLine, Since it was a dull week, we took the time to update The Blanchard Company website, The "Merger!" button has been replaced by a "Services" button that will take you to a summary of what we've been up to of late. The number of hits from "Vendors" paragraph alone has been most gratifying.

Follow-up department: A number of shortline readers got a note from me last week asking about locomotive maintenance "best practices." If you got the note and have not responded, please do. If you did not get the note and would like to participate, drop me an e-mail. Specifically I'm looking for shortline operators with multiple properties and fleets of a dozen or more units.

--Roy Blanchard

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