The Railroad Week in Review:
Washington-Watcher and fellow Railway Age Columnist Frank Wilner writes that The BLE, UTU, and BMWE have been enjoying some successes on regional lines and are turning their sights toward the class III lines. Unions have won elections at Wisconsin Central (Nasdaq: WCLX), Florida East Coast (NYSE: FLA), and privately held Montana Rail Link and its sister company, I&M Rail Link. On the other side of the ledger the BMWE lost an election on the Dakota Minnesota & Eastern (DME).
Having worked with both union and nonunion shortlines I can see pros and cons either way. However, Wilner points out that union-sponsored training programs may add still engineers that could save shortline managers doubly. First, the sheer expense of training and keeping the records that goes with the exercise. Second, it could ease the pressure to retain engineers trained at shortline expense.
Last week it was noted here that both shortline holding company Genesee & Wyoming (Nasdaq: GNWR) and locomotive supplier MotivePower Industries (NYSE: MPO) were on my BUY list. They still are, however I'm not quite satisfied the enterprise values are where they need to be. Recall a recent discourse on Return on Invested Capital (ROIC) wherein companies were scored on how many dollars they earned for every dollar of invested capital. That's good, but what do you do when revenues and profits are in a slump?
There is a measure which indicates how good the company is at adding value to the invested capital (IC), and it has nothing to do with earnings per share but rather with how much the IC has grown over the past period of time. Companies that are worth more than the IC base have added value to the firm. Those whose capital base is greater than the present market value -- it could be argued -- have actually taken value out of that capital base.
For ROIC we used the asset side of the balance sheet. In this case, we're using equity plus LTD including current portion for the capitalized value of the firm and shares times price for the market value of the firm. Using this relationship it becomes possible to compare market value added (MVA) of companies with widely different financial postures.
Take Union Pacific (NYSE: UNP) and GNWR. The former lost money last year and so showed negatives in every income-based ratio. UNP is the more highly leveraged with $3.97 in assets for every $1.00 in equity; GNWR is leveraged 2.91 to one. The asset base of UNP is $14.7 billion, for GNWR $140 mm. Yet the Omaha crowd's MVA is a negative $6.11 per share vs. a negative $13.66 per share for the smaller road.
The next step is to see how MVA changes period to period. What we have above is a snapshot of the value of all the capital committed to each company at the end of 1998 as measured by today's market price per share. A snapshot of results for 2Q99 vs. 2Q99 might give us a better picture of the current dynamics. Look for that next week.
Perhaps in the interim some of the multiple road shortline holding companies would find it useful to look at their own MVA pictures. Since non-listed companies can't very well get a market value on a share price, a price/sales multiple of about 1.5 times sales gives a good market value proxy. I'd appreciate an e-mail from any that do the exercise. Confidentiality is assured, of course.
The operative word at Union Pacific these days is VELOCITY. Everything presented at the shortline meeting itself and everything we saw on the Omaha-Denver inspection trip carried that message. Clearly, the focus is on the most efficient use of the available capital. As Woody Sutton, AVP Service Design said, every one-MPH gained in average train speed gives back 250 locomotive units.
The question becomes where to get that one-MPH. One option is to add track, and the $320 mm triple track project between Gibbon and North Platte NE is the number one example. For another, John Rebensdorf, VP-Network & Service Planning, admonished the shortlines to think of ways they could accelerate the process as each develops its Interline Service Agreement (ISA).
The ISA is a critical element to making the shortline-UP relationship more fluid and thus more profitable for each. Three shortline concerns dominate: car hire administration, preparedness for 286,000 lb. cars, and rate increases. With respect to car hire, it would be ideal if all car hire relief agreements could go away and each shortline adjust its per car allowance to accommodate an average amount of car hire per car based on per diem rates and dwell times. Across the board this would have the benefit of lowering UP's car hire exposure (rents in financial statement lingo) and would increase car velocity as shortlines strive to turn cars in fewer than the number of car-days built into the allowance.
I'm not sure how big the 286 issue really is. Not all shortlines are running unit trains of the heavier cars, some will probably see none at all, and others will have the odd heavy car now and again. Obviously, T&S (track and structure) needs will vary as the anticipated exposure to the heavier cars varies. For that reason it is essential each shortline review its T&S needs with respect to its 286 exposure and set its own capital budget accordingly. How much is enough? Union Pacific's own engineering department is one source; another will be the ASLRRA program that Frank Turner is spearheading.
Rate increases have to be approached on a case-by-case basis. If the class 1 is taking a 2% increase in lumber tariff rates, then the shortline ought to share in that increase. If a grain tariff is up for renewal, the shortline ought to be involved in the rate negotiation. Like car hire and the 286 question, however, the shortline at the rate table has to sell its own program and show the class 1 the rate increase is deserved, and not some constitutional right.
In short, the ISA is a process document showing the rules of interchange. It will remain in place even as personnel change - a new terminal supervisor can step in, open the book, and see how each shortline relationship works. Shortlines are encouraged to present it right, make the business case, and be prepared to go to work. Opportunities abound to increase velocities by reducing car cycle times, changing interchange times and places, increasing locomotive and crew productivity, and filling the track space available. There ought to be a few points off the operating ratio in there for everybody.
Spending a few days with Union Pacific's senior operating team shed some very important light on what's happening back east. At last year's UP shortline meeting the mood was on the glum side but with an air of what I called at the time "cautious optimism." This year the mood was decidedly upbeat, and the culture change that WSJ's Danny Machalaba so accurately described in his 8/25 by-line is clearly a major force behind that change in attitude. One can sense a similarity between the UP's morale a year ago and that of the eastern roads today. So there is no doubt in my military mind the winds of culture change are blowing strongly in the east right now.
One result of the culture shift has been the intense and singular focus on velocity. So much so that the very day we were on the road to Denver from Omaha UP's track forces replaced, tied, tamped and surfaced nearly two miles of rail. It was open for business when we returned the next day. Hustle was evident among those running the trains and dispatching them. UP has a four-block signal system, which gives you a flashing yellow a block ahead of a steady yellow approach. As Rebensdorf showed when he took the right-hand seat from North Platte to Cheyenne, by moderating train speed ever so slightly a flashing yellow will jump to green before you get to it.
Such is common operating practice out here where hundred-car trains operate on subway train frequency in signal blocks only a mile and a half long. This saves fuel and brake shoes, keeps the railroad moving faster, increases revenue ton-miles per locomotive unit, and makes shippers (and investors) smile. I'm not selling my UP stock just yet.
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