The Railroad Week in Review:
Week Ending October 30, 1999

Earnings Week Round Two was off to a great start with an upbeat article on Union Pacific (NYSE: UNP) in Barron's. Investors (says the writer) have grown wary of railroads for a number of reasons. Among them are interest rates, the state of the economy, service wobbles in the Northeast, phases of the moon, whatever. But regarding UNP, "The bulls say that with last year's massive tie-ups far behind it, the railroad is poised to reap the double-digit earnings growth from cost savings, capacity improvements and market share growth it originally hoped to get from the Southern Pacific merger." I have to agree.

UNP shares closed the week at $55.75, off 17% from the 52-week high of $67.00, which it hit last May. However that's still up 23.7% for the year. Donaldson, Lufkin & Jenrette analyst Jim Higgins told Barron's that "with the big increases in capacity spending from the merger now slowing significantly, much of any revenue pickup should fall to the bottom line." The Street consensus is for $4.00 a share in 2000 and there are rumblings of $5.00 or more in 2001. Assign a reasonable multiple of 15 times earnings and you have some very nice numbers indeed.

On Tuesday Burlington Northern Santa Fe (NYSE: BNI) reported a 2.5% increase in net income to $325 mm on revenues of $2.3 bn, up 2.3%. Shareholders made out better, however as diluted eps rose 6% to $0.70 thanks to the share buyback program that reduced the share count by 3% from 3Q98. Operating income was up 2.8% to $631 even though the operating ratio improved only 10 basis points to 73.2 (which is itself not too shabby for an organization this size).

In a press release accompanying the results BNI cites increases in agricultural, automotive and intermodal as particularly strong. The company has "substantially completed" the elimination 1,400 positions, continues on the path of a capex budget reduced to $1.9 bn, and "anticipates generating free cash flow for the first time since the 1995 merger."

RailTex (Nasdaq: RTEX) Tuesday afternoon did a conference call which I was able to play back on the Internet later in the evening. Ron Rittenmeyer held forth mainly on the quarterly results, having answered most of the merger questions in the recent conference call with Gary Marino. It's easy to see that RTEX has been busily getting ready for the merger. Revenues up 9% (same store 10%), net income up 11.6%, interest expense down 12.8%, LT Debt down 18% to $122 mm, a mere pittance in the general scheme of things. In context, this brings the debt/capital ratio to 44.6%, not outrageous in this business.

And now for something completely different, let's turn our attention to Norfolk Southern (NYSE: NSC). The Street estimate for 3Q99 going into Wednesday's meeting was a dime a share. So when David Goode announced a nickel a share it was a bit of a shock. What happened was simply this: revenues were up a healthy 43% only to be eaten up by a 71% hike in operating expenses. Operating income was literally cut in half. (At this point I heartily recommend logging on to and following along with the presenters remarks' - provided verbatim - and accompanying graphics.)

CFO Hank Wolf's Slide Six tells the story, showing how reduced velocity caused by system congestion dragged in $149 mm in "unusual items" exacerbated by "revenue opportunity losses" of $73 mm - total hit $222 mm or $0.58 a share. Which is actually an improvement on last quarter, when the combined merger effects for the singular month of June were two bits a share. The 58 cents is roughly double the June figure yet we're talking three months.

Flip over to Tim Dwyer's remarks for slide 2, Diversions. Says Dwyer, "Congestion has impacted our velocity and resulted in traffic diversions primarily to other transportation modes, and in many cases Norfolk Southern actually assisted the customer in arranging the necessary alternative service to protect the customer's requirements." That's truly a tough bullet to bite, however there is proof of improvement, and that's provided by John Samuels.

His slides 3 and 4 tell a big chunk of the story, first in leveling out the inventory over time, and second showing how swings in car inventory week-to-week are narrowing. We've remarked here in the past that the difficulty with a transaction like this is that as your fix something a A, it pops up again at B. What Samuels' slide 4 shows is how swings are slowing. The flat line is the desired outcome. The same thing can be said for slide 5, Terminal Dwell Time.

To be sure, a nickel a share is a major disappointment. The Street consensus for 4Q99 has now drifted down to $0.26 and for the year $0.87. At a nominal multiple of 15 times earnings that's only $13.05 a ticket. Even the '00 consensus of $1.69 lags 1998's earnings of $1.74 a share, maybe worth $25 a share. The view from here is that NSC must aggressively grow revenues and simultaneously shed every penny of expense that doesn't make the RR run faster.

CSX reported $123 mm, 58 cents a share, up from $78 mm, 37 cents a share in 3Q98. The Zacks consensus was 44 cents, but then the Zacks 3Q98 figure was 56 cents. Trouble is, I can't find either the 37 cents or the 56 cents in the meeting handouts. And that's the trouble with special charges and credits. For the non-financial investor it is sometimes difficult to follow the trail that leads to the ultimate numbers.

That being said, Week in Review is about railroads, so let's look there. Combining CSX Transportation (CSXT, or just "T") and CSXI quarterly operating revenues increased to $1.8 bn from $1.4 bn YTY, up 29%. Operating expenses were up 38% and so operating income declined to $213 mm from $238 mm, down 11%. The OR rose to 88.0 from 82.6 a year ago. So much for the numbers. What's behind them?

Like NSC, the CSX story is one of diminished velocity and increased congestion with the added excitement of Hurricane Floyd, which essentially shut down 1,000 miles of CSX main from Florida to Boston. Last quarter CSXT President Ron Conway laid out his three phase program for integrating CSX and its part of Conrail: Get Ready, Put 'em together, and Build the new business base. This hurricane happened in the midst of phase 2, driving up cars on line and terminal dwell time and killing velocity.

But as everybody know in this business stuff happens, and if it's not hurricanes it's blizzards, floods, or fires. The ticket, says Conway, is to shape every ops plan so that it can respond to events and reduce recovery time. To that end he looks to fellow ex-Conrailers John Sammon (Commercial) and Gary Spiegel (Ops) to control how far velocity drops and how long it stays dropped. And the key to that is simplification.

CSXT will go from 15 service lanes to five to eliminate delays in pass-offs and regional shifts in operating control. The result will be a simpler operating system, with less opportunity for delay. Conway is taking a page from the shortline playbook: get the decisions close to the customer. In that regard, John Sammons was able to talk about the CSXT e-commerce game plan. In a word, the goal is to get the rate-making logic onto laptops so the sales rep can give a customer a rate right on the spot. Or let customers log on to and get their own rates.

That kind of speed and convenience is something this industry sorely needs to compete with the truckers. We're just too slow and at times downright too difficult to do business with. Much of the single car merchandise business for everything from toys to timber is highly truck competitive and is most often lost over service and convenience. E-railroading will at least speed up pricing. Now if only we could figure out how to get more than a dozen loads a year in a boxcar…

--Roy Blanchard

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