The Railroad Week in Review:
Week Ending October 23, 1999

Florida East Coast Industries (NYSE: FLA), parent of the Florida East Coast Railway (FEC), has posted its results for 3Q99. Net income was $8.6 mm ($0.24 per share), compared to $13.0 mm ($0.36 per share) in 3Q98, which included a gain of $3.1 million on a land sale. Other factors impacting 3Q99 include increased depreciation resulting from the aggressive property development program at Gran Central Corporation, FLA's commercial property subsidiary, and costs related to FEC Telecom, Inc.

New initiatives are paying off for the rail side with operating profit up by 11% in the quarter and year to date. The operating ratio is now below 73% with further improvement expected. The Big Event for the quarter was an agreement with Network Plus (NASDAQ: NPLS) for long term access to the FLA fiber optics loop linking Jacksonville, West Palm Beach, Ft.Lauderdale, Miami, Ft. Myers, Tampa/Clearwater and Orlando. The Network Plus transaction is the first dark fiber sale. Proceeds are dependent on the ultimate length of the network acquired, and are expected to be in the $5 mm to $11 mm range.

Union Pacific Corporation (NYSE: UNP) had a strong rebound in year-over-year operating performance. Income from continuing operations totaled $218 mm, $.86 per diluted share, in the 3Q99 vs. $34 million, $.14 per diluted share, a year ago. The Street consensus was more like 81 cents, so this was really quite good. These results included one-time after-tax merger implementation expenses of a nickel a share in 1999 vs. three cents last year.

Commodity revenues were up 10 % to a record $2.5 billion for the quarter, with gains in all six of the major business groups. Increased revenues combined with productivity improvements to reduce the third quarter operating ratio (OR) by 11.0 percentage points to 80.6 percent. So says the press release.

However, the real fun begins at Log on, click the "analyst meeting" gylph and go to the slides if you do nothing else. The first slide of note is Earnings per Share quarter-to-quarter. Talk about continuous improvement! Then flip to Commodity Revenue: under $2.3 mm a year ago to $2.5 mm, up 9%. Continuous improvement also shows up on the OR, dropping to 80.5 from 91.6, a 12% improvement.

Other significant improvements include customer satisfaction, revenue growth by commodity (don't sell the 4% gain in chemicals short as UNP has the dominant market share with more than 800,000 carloads a year), and "velocity vs. cost of quality." This last is most telling because it says as speed goes the unit cost of keeping customers happy and the railroad fluid goes down. And that's reflected in the OR and ultimately eps. See how neatly it all fits? Would that all my friends in the shortline industry took this systems approach.

Norfolk Southern (NYSE: NSC) has identified some of the specific steps it's taking to speed up the railroad and get rid of some of the choke-points. Most are already "works in progress," however knowing exactly what they are and how far they are long toward completion provides rail users a certain degree of comfort. The projects include additional double-tracking and improved signaling on the "Penn Route" through Pennsylvania, capacity enhancements on the core routes from Bellevue to Columbus and the Toledo area, an Atlanta bypass, and the Rutherford (PA) intermodal terminal outside Harrisburg.

The Rutherford work is scheduled for completion in second quarter 2000 and will help relieve congestion along the Penn Route. The previously announced work in Buffalo is about done and these improvements will help improve service for Buffalo, western New York and the Southern Tier. The view from here is that NSC will continue to evaluate its expanded rail system and will fund those projects that make the railroad work better. The Year 2000 capex program remains in the $1 billion range.

Canadian National (NYSE: CNI) logged in with results for 3Q99. Net income was $199 mm, 73 cents a share, up 42%, excluding a $590 million special charge for workforce reductions. Including this special charge, CNI reported a net loss of $205 mm ($1.06 a share). Note that results for the period and the nine months reflect the consolidation of Illinois Central financial statements. CNI took control of IC on July 1, 1999, and has consolidated IC financial statements retroactive to Jan. 1, 1999, to give investors a full picture of the Company's year-to-date results. The operating ratio was 71.0 for the latest quarter, down from 73.6 a year ago, excluding the special charge.

The shortline railroad world continues to discuss and evaluate the RailAmerica (Nasdaq: RAIL) purchase of RailTex (Nasdaq: RTEX). For the week, neither stock moved much, though RAIL dropped into a trading range of $7 .50 to $7.87 from $8.60 at the open on Monday and trading volumes have been about half normal. At week's end the blended value of a RTEX share had dropped to $18.69, a 6.6% discount from the previously announced $20 post-sale target value for RTEX shares.

For its part RTEX went from a high of $17.50 a week ago to close this week at 16.66. This presents an interesting conundrum. At Friday's closing price RTEX trades at 11 times the FY 2000 consensus estimate of $1.51. As an industry railroads are going four about 14 times earnings. Shortlines, though currently depressed along with the rest of the rails, are small cap companies and usually trade 100 or more basis points ahead of the class 1s, so multiples of 15 to 16 are not unheard of.

RTEX at 15 times FY 2000 earnings yields a share price in excess of $22, almost 18% more than the blended value above. The RTEX portfolio of US shortlines has some real gems. The South Carolina Central, the Indiana Southern, the Indiana & Ohio, the New England Central, and the Central Oregon & Pacific for example run far ahead of the 100 carloads per mile per year minimum rule of thumb for shortline success.

This may be a good fit for RAIL, fattening an otherwise thin domestic rail portfolio, and adding some management depth, but will RTEX shareholders ever see the $20? And why did RTEX sell in the first place? In short order RAIL bought Canada's RailLink, the Australia's V/Freight rail network, and the Toledo Peoria & Western, all leveraged transactions. What's next? We're watching. (NOTE: I said last week the new RAIL D/E ratio would be 2:1. Wrong. It's more like 3:1.)

Shortline readers who attended the ASLRRA Annual Meeting in NYC last month will recall the Wall Street Story as presented by independent analyst Tony Hatch. No stranger to shortline audiences, Tony laid out the pre- and post-Staggers environments that led to the present Big Four class 1 situation. He then shared some thoughts on where things are going from here and what the shortlines can do to shape the future landscape. Later this week the Tony's Text will be available at

Earnings Week continues this week with Burlington Northern Santa Fe (NYSE: BNI) on Tues, NSC on Wed, and CSX (NYSE: CSX) and Kansas City Southern (NYSE: KSU) Thurs. I've heard talk of a dime a share for NSC and of course the KSU/Janus intrigue continues. The CSX consensus stands at 40 cents, down 44% from 3Q98 as Conway and Company continue to fold their part of their past employer into the sprawling network of their current employer. I'll have to pass on the BNI meeting owing to prior commitments, however I'll make the other three, live and in color.

--Roy Blanchard

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