The Railroad Week in Review:
A page C-1 article in Monday's WSJ suggests tech stocks' days may be numbered and a return to the cyclicals may be in the wings. Richard Unruh of the Philadelphia's Delaware Investments, an asset-management group, thinks the "excesses in the stock market" are attributable to technology and are at an all-time high.
PaineWebber's Edward Kerschner says the challenge is now to identify tech stocks of the future. And big companies that have shown an ability to adapt will be the winners. Upstarts will be bought out or fall by the wayside. Want proof? Look how the People Express innovation was gobbled up by the major airline's sudden focus on cheap flights and peanuts. What's more, other commentators have suggested much of the capital investment in the dot-net companies will turn out to be "as misplaced as the British investments in railroads in the 1840s." We all know the outcome when the good Dr. Beeching and his axe came along more than 100 years later.
Anyway, Kerschner and Unruh think "a recovering world economy will create a huge earnings gains for companies that make things like copper, paper, and chemicals and that those stocks are the place to be for two or three years to come." Also in Monday's In Box was a flyer from Argus Research suggesting purchases in the basic materials and industrial groups. Household names like Heinz (NYSE: HNZ), ALCOA (NYSE: AA), Caterpillar (NYSE: CAT) and Westvaco (NYSE: W) -- all good rail customers -- are mentioned along with Union Pacific (NYSE: UNP) and CSX (NYSE: CSX). Could this be a trend?
And speaking of UNP, Wednesday's WSJ carried a Page One byline from Dan Machalaba on the subject of Dick Davidson and the turn-around of his company. Machalaba pulls no punches, as regular readers of his material know very well, and this is a pretty positive piece. The gist of the article is that under Davidson's guidance Uncle Pete has indeed become more customer-focused and decentralized as it pushes decision-making into the field where the folks on the scene can make the decisions. Wall Street seems to agree, too. UNP stock closed Friday at $51.06, up 13.% YTD vs. 6.0% for my market basket of 14 railroad stocks. I remain long in this one, having bought in 11 months ago at $45 and have kept pace with the S&P ever since.
Next week I'll have a chance to see first hand what's been working on the railroad between Omaha and Denver. The annual UNP shortline gathering is slated for this weekend in Omaha and a number of us will go tooling off across the heartland on the office train on Tuesday. Highlights of the trip will be a look at the new triple track 70-mph raceway between Gibbon and North Platte as well as the North Platte Yard. Regarding the former, the UP website www.uprr.com) informs us, "Completed after four years and costing $327 million, the new triple track route runs 108 miles across Nebraska and is designed to handle today's volumes, which average 140 trains per day. It links UNP operations along the West Coast with vital rail hubs in Chicago and Kansas City as well as Mississippi River gateways to Eastern markets and Gulf Coast ports." Expect a full report here next week.
The Norfolk Southern (NYSE: NSC) shortline shortfall (WIR 8/21) is beginning add up to some significant numbers. To get an order of magnitude, consider that the 230 shortlines connecting with NSC will contribute something on the order of $750 mm in annual revenue for the newly expanded property. That's about $3.35 mm apiece. Consider also that at least 100 of these shortlines are in Pennsylvania and contiguous states. If so then these small railroads will contribute on average $335 mm in revenues to NS every year.
The slow start, with Norfolk's northeastern shortlines off about 20% in carloads, means that at this rate NSC will be out $65mm on an annualized basis. Put in an even more immediate vein, NSC runs at a net margin of about 17%, so $65 mm lost revenue means $11 mm in net earnings, or 3 cents a share. Stock watchers should note that after beginning to recover from its low last week NSC share prices headed south again Thursday erasing the week's gains.
RailAmerica (Nasdaq: RAIL) reported results for 2Q99 a few weeks ago and I simply blew it not reporting promptly on same. The faxed release from Boca Raton tells us the firm "achieved record carloadings, revenues, operating income, net income and earnings per share in the quarter." To be sure, revenue more than doubled to $41 mm, and that included $6 mm for the North American railroads (but not RaiLink), $22 mm of offshore railroads, and $13 mm for the truck trailer manufacturing unit.
In the process RAIL has taken on more debt, about $13 mm worth 2Q99 over 2Q98, bringing the total load to $84.8 mm including the current portion. Interest paid in the quarter was $3.2 mm, roughly half the total operating income. A year ago operating income covered interest 2.6 times. On the positive side, debt is now 1.55 times equity, down from twice equity a year ago.
This week GNWR's 3-month price line remained well above both the S&P 500 and its own 50- and 200-day moving averages. Longer term, the one-year chart shows the price line above both the moving averages which themselves are beginning to head north. The fundamentals are strong, and prices seem to have firmed. As a result, GNWR will be added to my real-money portfolio some time this week.
Motive Power (NYSE: MPO) continues to do what it does best regardless of the Westinghouse question. The Boise Locomotive subsidiary has been awarded a $5 mm contract to remanufacture seven SD40-3 locomotives for Transtar, Inc.'s Bessemer and Lake Erie railroad in Greenville, Pa. The work will begin immediately at the company's facility in Boise, Idaho, with delivery scheduled for the fourth quarter of 1999 and first quarter of 2000. Recall Transtar operates the former US Steel roads, and that family includes such household names as the EJ&E, Birmingham & Southern, and the DM&IR. About 200 locomotive units toil on these lines, so a good job here could undoubtedly result in more work for MPO.
Last week we promised more numbers on both MPO and its putative merger partner, Westinghouse Air Brake (NYSE: WAB) which has postponed indefinitely its shareholder meeting on the subject. On Monday MPO had its meeting anyway and the shareholders said YES. At least some analysts are taking this as a positive sign for MPO, saying the recent sell-off was "overdone." It's clear the two companies are going in opposite directions on the merger, and that'll probably kill the deal, at least in its present form. The consensus among the eight analysts following the stock calls for $1.32 a share this year and $1.60 next, a gain of 25%. With the stock in the $12 range you get a PE of 7.5 and a PEG of 0.3, definitely in the BUY range. It was up 8% on Thursday and held on Friday.
The Rule Maker spreadsheet for 2Q99 tells us quarter-to-quarter revenue grew at a rate of 11.5%, expenses were up just 5.7%, and the net grew at a 17% rate. Gross margins remained at a healthy 28.1% vs. 24.1% a year ago, and net margins increased 40 basis points to 9.3%. Still not the double digits we like, however the direction is north and that's good. For its part, WAB labors under a debt load of nearly half a $billion and still carries a negative shareholder equity balance, thanks to the June 1995 IPO, the share repurchase program, and establishment of an ESOP.
For the quarter just ended revenues and net income were both up 13% YTY. The operating margin came in at a respectable 32.6% while the net remains in the 7% range. According to the press release, "Interest expense in the second quarter of 1999 was $8.8 million compared to $7.5 million in the year earlier quarter. This increase reflects the incremental borrowing costs associated with the fourth quarter 1998 acquisitions of Rockwell Railroad Electronics and the Comet Industries Service Centers." Which tells us WAB remains in the acquisition mode, regardless of the high degree of leverage. In fact, a note to the 12/31/98 Form 10-K says, "The Company will remain leveraged to a significant extent and its debt service obligations will continue to be substantial." Seeing $470K in LTD against annual sales less than half that is a red flag for this investor at least.
Back to MPO. Based on the 12/31/98 balance sheet, my only quibble would be the doubling of debt to 66% of equity from 26% the prior year. Operating margins are 11 times interest, one of the highest coverage rates in the industry. As a result of these findings, plus what's been written here recently, we will be adding MPO to our real-money portfolio at some point next week.
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