The Railroad Week in Review:
September 11, 1999

Jill Evans at JP Morgan has upgraded Union Pacific (NYSE: UNP) to a BUY from MKT PERF. The consensus estimate for 1999 is $2.97 and $3.95 for 2000, up 33%. The estimate range is between $4.15 and $3.50 with 12 analysts reporting. UNP closed Thursday at $55.25 for a PE of 14 on the 2000 estimate. The PEG is thus 0.42, clearly a buy indicator. Readers know I've been long UNP for some time and hope to remain so. Thanks, Jill. (DLJ upgraded to BUY on Friday, adding another vote to the BUY column.)

Tuesday saw the final act in the acquisition of the Toledo, Peoria & Western (TPW) by RailAmerica (Nasdaq: RAIL). It will acquire all the outstanding stock of TP&W from CSX (NYSE: CSX), Norfolk Southern (NYSER: NSC), Delaware Otsego Corporation and other shareholders. This transaction, which represents RailAmerica's largest rail acquisition in the United States, had a purchase price of approximately $18 million, subject to certain purchase price adjustments. TPW's 1998 sales were in excess of $13 mm and it handles some 59,000 carloads of freight.

TPW is attractive because it is a well-maintained east-west rail corridor that by-passes the congested Chicago area, running Eastern Iowa to central Indiana serving more than 50 agricultural and manufacturing shippers and connecting with all the class 1 roads plus six regional carriers. In a press release RAIL said it will "implement significant marketing initiatives and service improvements to provide more competitive and timely rail service for its many customers.''

The STB sort of dodged the bullet on a case brought before it by Riverdale, NJ, site of a New York, Susquehanna & Western (NYSW) bulk transload facility. In this proceeding, Riverdale asked the STB to determine the extent to which the facility is covered by the federal preemption provisions. The STB came back to say it "relied largely on judicial precedent interpreting the statute and the Congressional intent behind it" because the facility itself is not subject to STB regulatory review.

The Board said precedent is that federal railroad laws preempt local permitting processes because they could interfere with interstate commerce. In the present case the STB said "a court would likely find local [regs] to be preempted." However, the decision goes on to note that "local jurisdictions can, through inspections, enforce in a non-discriminatory manner electrical and building codes, or fire and plumbing regulations, so long as they do not require permits as a prerequisite to the construction or improvement of railroad facilities." The Board has opened a declaratory order and welcomes public comment before it issues a final decision.

Canadian Pacific (NYSE: CP) issued a press release last week saying congestion on NS and CSX continues to cascade back into their system. "[Former D&H] yards in Buffalo, Binghamton, Selkirk and Saratoga remain at or near capacity. The congestion in our North Eastern network is still impacting our service delivery capabilities with both NS and CSX, and [thus] traffic moving on the CPR north east network." CP had hoped to have most delays gone three weeks ago, but so far no luck. Customers can expect delays of two to four days for the next month.

Norfolk Southern will spend $13 mm to rebuild part of the former Conrail Bison Yard in Buffalo. There will be five tracks to support local operations and five for through trains and interline moves with a target completion date of 12/1/99. It can't come any too soon as the Southern Tier (former Erie main) line and the former PRR Harrisburg line have been particularly hard hit by Buffalo congestion. Customers and shortlines have to be thinking of that line from Hamlet, Act 1, Scene 1: "For this relief much thanks."

Meanwhile, NSC stock continues to drift south. The charts will show it hit $36 a ticket at the beginning of June. It closed Thursday at $26.25, a drop of 27.8 percent in three months. At this rate, you will be able to get NSC stock for free in another five or six months. The Zacks consensus for FY 1999 has dropped to $1.10 from $1.72, 36%, in 90 days; the FY 2000 consensus is back to $1.89, exactly where it was 90 days ago. The overall ranking has dropped to 2.8 from 2.54, closer to Hold than "Moderate Buy."

Norfolk's arch competitor CSX reports growing pains of its own and hopes to save $75 mm a year cutting its non-agreement workforce by some 800 souls starting next month. They will take a pre-tax charge of $55 mm to $75 mm in the fourth quarter due to the costs of early retirement and severance pay, the company said. Interestingly, a "significant portion" of the program's expenses will come from the company pension plan, which is CSX says is over-funded. I seem to recall one of the per-merger concerns was that the CSX plan was UNDERfunded while the CR plan was indeed overfunded. For what it's worth CSX stock is off just 10% since June 1.

The Conrail affair continues to generate concerns. A regular contributor, who runs an e-mail forum himself, notes two "Hot Topics" in particular. The first is whether the CSX & NS railroads service problems concentrated mainly in the shared asset area or are service problems happening all over. The second is whether Chicago terminal area delays are growing or abating. I'll post responses here next week.

Last week's feedback includes this e-mail from a former Conrail trainman now on NS: "The west end is running much better than the east end. The number of trains parked around of Conway has been awful. Yard dwell at Conway has been about double what it was during Conrail and the number of delayed trains is more than last May." A rail-watcher in Upstate NY says during the week of August 30 CSX was fairly fluid west of Buffalo on the old NYC main however he reports the parallel NS line had all sidings between Buffalo and Erie full and trains waiting for hours, sometimes overnight, before moving on.

Now we all know NS doesn't end at Buffalo and what goes in from the west has to come out to the east and vice versa. We also know that Conrail "rationalized" large pieces of the former Erie main west of New York State. The track is still there, however under several separate owners. Finally, we know UP is having success with "directional running" through Arkansas using the former MP and SP lines and bought an old MKT line from RailTex (Nasdaq: RTEX) to do the same thing in southeast Nebraska. Now, class, what does that suggest? Hands, please, and don't all answer at once.

The response to last week's MVA challenge has been at once surprising and gratifying. Surprising for the number of responses, and gratifying for their frankness. I heard from both listed shortlines and closely-held properties. The math ran perfectly parallel, however the privately held companies, with shares in the thousands, not millions, had much larger per-share MVAs.

To be sure, MVA, as with any metric, can have hidden traps. A regular contributor writes, "I think that there is a dangerous circularity in mixing balance sheet numbers with market value CHANGES to develop measures of investment quality. The problem is that the mixture looks better as stock price increases and worse as it falls. The overpriced look good; the underpriced look poor."

The reader has a very good point and something I've puzzled about too: share price and market value. I think that you have to look at MVA as one piece of a puzzle. Continuing with the Genesee & Wyoming (Nasdaq: GNWR) example, it closed today (Wednesday) at $14.45, a mere 6.2 times the 2000 earnings estimate. If GNWR capitalization is indeed $140 mm and there are 5 mm shares, then the market capitalization is $28 a share. As long as the stock remains below that it could be argued value has been lost.

The good news is that $28 a share is just 12 times the 2000 estimate, which Zacks pegs at $2.35. The rail industry multiple is now about 15, which means GNWR should be worth at least $35.25 by the end of 2000, more if you believe earnings will grow at the predicted 25% per year rate. Like I said a few weeks ago, a PEG ratio of 0.24 (6/25) is a strong BUY. I placed my order today.

I will not be buying MotivePower Industries (NYSE: MPO). The Westinghouse (NYSE: WAB) deal is a mistake and the stock price nose dive tells me the market agrees.

--Roy Blanchard

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