The Railroad Week in Review:
Week Ending December 18, 1999

A blurb in one of the stock advisory columns notes that investors are bypassing the usual year-end value plays in favor of the go-go tech stocks. The argument is made the Dogs of the Dow are just that - dogs - and there's faster better money to be made elsewhere. With companies like Microsoft (Nasdaq: MSFT), Cisco (Nasdaq: CSCO) and Oracle (Nasdaq: ORCL) on a tear who can blame them?

The thought occurs there may be high-dividend discounted rail stocks suitable for value plays. Since the DOD looks for high dividend yield against low current price, some railroad dividend yields are getting attractive. Returns since Jan 1999 including dividends have been decidedly doggy with ranges from a plus 16.88% (Canadian Pacific, NYSE: CP) to minus 26.87% (Norfolk Southern, NYSE: NSC).

But look what happens to dividend yields at the current price levels: UNP, 4.13%; NSC, 3.58%; CSX, 3.43%. Not as good as a money market maybe, but with all three looking at significant profit rebounds on the year '00, the results could be worthwhile.

Kudos are in order for RailAmerica (Nasdaq: RAIL). The Boca Raton (FL) firm was named one of Fortune magazine's "Top 100 Fastest-Growing Companies." Featured companies were US-based, have been in operation for at least three years, and had market caps of at least $50 mm. RAIL was Number 20 among all and the only railroad in the Top 100 List. Congrats, all.

The STB announced a decision to conduct a three-year study of Buffalo, New York-area rail rates and switching fees. The study will begin with a review of Buffalo-area rail rates and switching fees during the first six months following the June 1, 1999 integration of Conrail into CSX and NS. The first full-year review will be conducted in the summer of 2000.

CSX and NS must provide by 1/14/2000 information that shows whether they are complying with all the switching conditions imposed by the Board in the Buffalo area. They will also provide input so the STB can determine the trend in rates for rail movements into and out of the Buffalo area. Customer comments regarding class 1 compliance with the STB's mandates are due 2/24. CSX and NS replies to comments are due by 2/29.

English Welsh & Scottish Railway (EWS) has tapped Philip Mengel as chief executive, effective January 3. He joins EWS from Ibstock, the international building products company, where he was group chief executive. He joined the Ibstock Group in 1990 as CEO of Glen-Gery Corporation, Ibstock's USA subsidiary. He is a graduate of Princeton University and is a non-executive director of The Economist Newspaper Group.

Providence and Worcester Railroad Company (AMEX: PWX ) says that it has reached agreement with Bestfoods (formerly CPC International, Inc.) with respect to payment of PWX's 10% share in the recovery obtained by Bestfoods from its insurance carrier for remediation expenses. Under the terms of the agreement, PWX will receive from Bestfoods final payment in the amount of $947,088.00. This payment is in addition to an interim payment of $1 mm that Bestfoods made to PWX in July 1998.

Burlington Northern Santa Fe (NYSE: BNI) has extended the current BNSF share repurchase program, adding 30 mm shares to the 30 mm shares authorized in July 1998. BNSF has completed more than 90 percent of the initial 30-mm share repurchase program.

Since the start of the program BNI shares have been trading in the $30-$35 range with a few forays up and down from that. The 200-day moving average has been steady at $32 or so. From that we can conclude the first 30 mm shares cost about $900 mm and unless something drastic happens the second 30 mm about the same, meaning $1.8 bn spent buying back shares.

BNI's capital program in 1998 was $2.1 bn; the 1999 program thru Sep was $1.4 bn vs. $1.6 bn for nine months in 1998. BNI spent $153 mm on its own shares in 1998 and has plunked another $561 mm down Jan-Sep 1999. Operating cash flow was $2.2 bn in 1998 and $1.7 bn three quarters into 1999.

An institutional investor in NY and regular WIR contributor writes, "Another note of caution. Service improvements in a capital-intensive business ultimately require railroads like CSX to put their money where their mouth is. Problem is, truckers have GE Capital's balance sheet to back them. CSX's balance sheet (and the other major rails) can't match it.

"Stressed balance sheets are the result of either losing economics (not the case here), or financial stupidity. Huge interest expenses need to be, and ultimately will be, eliminated. The path from here to there should be interesting. Hopefully it will not be too late for our railroads, because ways of doing business and acceptable business practices most often favor reliability, user-friendliness, and custom, if costs are acceptable. Europe works with minimal freight railroads, Japan works with none. It would be sad if our railroads continued to wane due to sheer managerial incompetence."

In that regard, reviewing regional and shortline railroad cash flow statements can be quite revealing. And one doesn't need to restrict one's inquiry to public companies, either. For example, we know the average revenue per car on the class 1 roads is about $1000 and shortline allowances run 25% as a rule. Small RR carloads are available in the very helpful American Shortline and Regional Railroad Guide by Ed Lewis. His 5th Edition is available in most bookstores.

By this measure a $1 mm (sales) small railroad will have to handle 4,000 revenue carloads and to keep its operating ratio (OR) below 80 can budget no more than $800,000 a year operating expenses all in. We also know that to be profitable the road has to average 100 loads per mile of track per year. So our 4,000-car example can't be more than 40 miles long.

On the cost side, our 4,000 car example pays about $625,000 a year in crew starts, routine track maintenance, fuel, car hire, and administrative. That's before any equipment ownership costs, derailments, depreciation or purchased services. Which doesn't leave much for interest, taxes, or capital programs.

Shortline operators and investors would be well served to take an operating expense breakout like the one on page 29 of the 10-K for RailTex (Nasdaq: RTEX) as of 12/31/98 and plug in one's own numbers. The comparison could be enlightening.

It's a fact of economic life in the railroad business that the fastest way to increase profitability is to increase revenues. The trick is in knowing which revenues to increase. Norfolk Southern recently pointed out to one of its shortlines that much of its business was marginal at best and the partnership could be significantly enhanced if the shortline commodity mix could be upgraded.

As it happened, the biggest customer by car count wasn't necessarily the most profitable after car hire and track, never mind cost of service. The exercise also showed the best places to start looking for increased revenues. Targeted first were those industries using cars with no car hire on the shortest line segments.

The shortline probably would not have run these numbers had not NSC said something. It's well they did because shortlines and regionals handle a more than 10% of Norfolk's pro forma post-merger annual revenue of $7 billion. The Big Railroads know all too well that enhanced shareholder results are driven by improved operating margins. And making sure Small Railroads are counting end-of-the-day dollars in the till -- not just carloads - can be worth a bundle. To be continued.

--Roy Blanchard

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