The Railroad Week in Review:
September 25, 1999

The Fat Lady has yet to sing for Kansas City Southern (NYSE: KSU). Turns out the Janus fund managers are unhappy about being spun-off under a name -- Stillwell -- bearing no relation to the stellar brand they've built, and they resent having to take the under-performing Berger and Nelson along for the ride. Consider: Janus at $170 bn, Berger $4 bn, Nelson $680 mm. They do have a point.

So what's to become of the whole business? Perhaps Jon Friedman summed it up best, writing in CBS Market Watch: "As the parent, KSU can simply do whatever it wants. As a subsidiary, Janus appears to have no legal recourse to stop the IPO, unless its managers threatened to bolt to rival companies or form a new firm -- KSU's worst nightmare."

Jim Cramer professes in his newsletter that the fact that the transports are falling doesn't really seem to bother anybody. Conventional wisdom, as most stock watchers know, is that a fall in the transports presages a fall in the industrials. Cramer thinks it may not be so anymore. He says airline performance is too closely tied to fuel costs and ease of entry into and exit from trucking keeps rates -- and profits -- down.

He saves his best shot for the rails, saying The Big Four "have done so much consolidating that they can't get the trains to run on time. Reliability matters; share goes to the most reliable. These companies have all become borderline unreliable. I don't invest in them, and I don't think they matter as much as they used to." Get that last: they [may not] matter as much as they used to.

Which fits with a previous thread here suggesting you can only exit so many lines of business before you become marginal. Exited thus far: premium carload, UPS by default, perishables, light-loading consumer goods, and so on. Reason exited: inability to meet customer service requirements within the cost parameters. Fortunately, there still remain a handful of rail service providers who have put the customer requirements first. Unfortunately, the rail system is a network of providers and failure of one brings everybody down. And until that's fixed, the rails won't matter as much as they used to.

Recently there was a thread here about how per-ton lease costs go up and down with velocity. A regular reader writes, "Our Company has run some comparisons of car cost changes pre-split vs. post via specific origin/destination pairs. The results, while not a complete surprise, do graphically illustrate a "hidden cost" of the Conrail breakup. As info, I ran the data using complete round trips prior to the split and then from June 1 through August 15 (the latest I could get an adequate number of round trips with which to judge).

"First the good news, I assumed that CSXT would, at best, be the same as Conrail had been. Surprisingly they were better in all but two cases. Improvement ran from a low of 2.2% reduction in per ton car costs ($.15 per ton) to a high of a 50% reduction (over $4.62 per ton)! The two [where we missed] had increased by 1% ($.09/ton) and 33% ($1.17/ton). All in all, a pretty fine showing for CSXT and a validation of the merger/split.

"On the other foot, NS was downright disastrous, particularly on lanes running through the Buffalo or Pittsburgh areas. On one of our products, increases in car cost ran from 3% ($.37/ton) to 15% ($1.66/ton). On another, the numbers were even more substantial in terms of dollars (very high value equipment). Increased car costs ran from 4% ($.38/ton) to 57% higher (over $7.00/ton).

"Fortunately, we have not had to lease additional equipment to cover the longer transit times, however neither have we been able to optimize our utilization and reduce fleet size." And he's not the only one. I had lunch with a major private fleet operator the other day and he had hoped to reduce his fleet by 8% post-merger. It hasn't come to pass.

Scott Flower, recently moved to Solomon Smith Barney from his previous post at Paine Webber, has initiated SSB coverage of several railroads. Scott lists Burlington Northern Santa Fe (NYSE: BNI) as a Buy in anticipation of a rise to about $37 and CSX (NYSE: CSX) as Neutral until its portion of CR stabilizes. Canadian National (NYSE: CNI) is seen as a Buy on "attractive valuation" while Norfolk Southern (NYSE: NSC) is Neutral with current estimates already including upside potential. Union Pacific (NYSE: UNP) is rated Neutral on a ho-hum risk/reward sentiment with Wisconsin Central (Nasdaq: WCLX) called Outperform based on present low price and good potential for appreciation.

A couple of weeks ago (WIR 9/4/99) carried comment on the culture shift that has taken effect at Union Pacific. Here in the East, the difference in corporate cultures between arch rivals CSX and NSC is becoming clearer to the community at large. The Philadelphia Inquirer's Henry Holcomb (who has covered this merger from the very beginning) writes, "The crisis is, among other things, highlighting the sharply contrasting management styles of the two railroads, setting the stage for years of debate in the nation's business schools.

"Norfolk Southern has long set industry benchmarks with its fabled central controls," while "CSX is now largely run by ex-Conrailers, including [the new CSXT president] Ronald J. Conway. Conway is rapidly implementing a program, developed at Conrail, that gives local managers wide latitude and financial incentives to think like an entrepreneur." Henry has a point. Having seen the Local Area Management (LAM) concept at work at Conrail, I can point to some truly terrific results. Case in point: what Industrial Trainmaster David Arnovitz accomplished in the Allentown area, growing the carload business base by leaps and bounds bringing in such name brands as Coca Cola and Kellog's.

If I may be permitted some war stories, the LAM system is the antithesis of what we saw in Viet Nam, where the local commander's hands were pretty well tied by the military bureaucracy. Another former Viet Nam field commander and I were chatting about this Friday and he said, "One of two things must happen to get an outmoded structure out of the way. The leadership must either smack somebody upside the head and drive change down through the ranks or the organization will achieve catastrophic failure and correct itself as the price of staying in the game." In Viet Nam we had neither, and that's partly why it ended as it did. Fast forward to today, I'd say CSX is an example of the first option and UP the second.

Tuesday's Wall Street Journal reported trucker J.B. Hunt Transport (Nasdaq: JBH) unloaded 1 1/16 to 12 15/16 after warning its 3Q98 earnings will be off due to "rail-service outages, delays and problems associated with recent railroad-company acquisitions." That's one helluva way to nurture a new partnership, guys. Can Schneider be far behind? We already know what's happened at UPS.

Two weeks ago we mused about NS using the former Erie main as an escape route around Buffalo with some directional running a la UP. Since then I've done a little more homework on the subject and what looks great on the surface ain't necessarily so. According to my trusty June 1954 Official Guide the Erie route between Hornell and Cleveland is about 300 miles. Nickel Plate to Buffalo and Southern Tier to Hornell is 270 miles, so distance saving is moot. Recall N&W ended at Buffalo because most of the business going there either terminated or went to the Canadians. What was left was split between NYC and Erie routes. So through traffic was a not a big issue. Nor is it today.

Then there's infrastructure. Spies in the field tell me the old Erie is mostly a single main with jointed rail and too many grade crossings. The track is mostly class 2 or worse, so any saving of time is clearly out. What it really boils down to is where NS can invest to get needed velocity. Obviously, it's in fixing the Buffalo Gateway and thus the Frontier and other expansions. Moral of the story: what looks good on a map may not look at good when you're trying to speed up your railroad. (Reread UP's Woody Sutton, WIR 9/4/99, for proof.)

--Roy Blanchard

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