The Railroad Week in Review:
Week ending March 18, 2000

This possibly apocryphal remark crossed my desk this week. It was attributed to a form letter to customers complaining of poor service and distributed by a class 1 railroad. The source was reliable, and the class 1 itself has been contacted for comment. Public affairs directed the inquiry to marketing and there it stands. Contrast that to Rob Krebs' remark leading off last week's Review: "We are committed to service guarantees."

It's no news any more that the STB put the kibosh on any more mergers for another 15 months. Both CSX and UP issued statements saying how delighted they are whereas BNSF and CN are crying "foul." Far be it from me to take sides, however the path is now clear for the prospective bride and groom to make good on their promises of scheduled operations and service guarantees.

The NIT League and CMA issued statements of surprise, saying essentially the issue is about preserving competition, not mergers per se. JP Morgan's Jill Evans said she doubts the parties will put everything on hold but will go forward with some sort of alliance falling short of out-an-out merger. That's reasonable.

BNSF says that over the past four years it has invested roughly $9.5 billion to improve its network, locomotive and car fleet, and to build and expand terminals and intermodal facilities. As a result, BNSF can tout improved service, better on-time performance, and better response to customer needs. The moratorium will give BNSF and CN the opportunity to show what more can be done to delight rail users and to increase their number. Then maybe - just maybe - the rest of the class 1s will catch on.

RailAmerica issued its 4Q99 and FY99 financials this week. I think the big news is the commitment to shed the Kalyn-Siebert manufacturing unit and some "non-core" railroad properties. Although specifics were not provided in the conference call, a look at the map will give the astute observer a pretty good idea of what might go on the block. As we've said before, the number of extant individual shortline properties will positively shrink in the next few years. It's good to see RAIL starting the process.

It's also important to note the 1999 North American acquisitions - even before RTEX -- will do a lot to add heft to the portfolio. On an annualized basis, the former RaiLink operation in Canada adds about 250,000 carloads, TP&W ought to pull in another 55,000 units, and the E&N on Vancouver Island should bring 8,000 revenue carloads.

The FY 2000 EBITDA is estimated to be something in the $125 mm range, which will give more free cash flow to work down the debt levels, now (without RTEX) at 2/3 total capitalization. Combining the strong international story with a North American rail market hungry for decent service at reasonable rates, the opportunities for the new, improved RailAmerica are significant.

Remarks about guaranteed scheduled service in last week's Review received mostly favorable reviews, including a longish treatise on service design from a former Conrail employee who was in the thick of it for nearly a quarter of a century. He's given me leave to quote him and writes, "I've found it maddening that railroads can't plan and execute an operating plan better than they do. I don't believe it's a lack of ability so much as it's a lack of vision. I haven't heard a single railroad executive say a word about what they think the industry ought to be doing and what it ought to look like 10, 20, 50 years from now.

"The idea of guaranteed service and running a scheduled railroad is not new. The idea is that running the railroad according to the plan would improve service and allow marketing to grow the traffic. But why doesn't the traffic grow? One is reason is the customer's impression of the service must change. Late trains, missed connections, shortages of locomotives and crews and equipment failures have as great an impact on service as running all the trains in the plan.

"One of the lessons learned from Conrail's LAM projects was that the customer's impression of service drove their overall opinion of service quality more than the actual improvement. While the LAM teams were operating, customer service satisfaction surveys showed Conrail moving from near the bottom to near the top. I believe survey results improved dramatically because customers were actually being PAID ATTENTION TO; it may have been the first time anybody ever asked them if there was anything we could do to improve service for them.

"Up until the recent round of mergers, railroad service design was usually done by "old heads" who had the whole train service plan memorized. The use of data and planning tools to identify, analyze and speed the design cycle of service design changes was generally poorly understood and ineffectively utilized. Consequently, there now exists a major disconnect between the "techies" and the "railroaders" with each side not understanding the other.

So, is a scheduled railroad and guaranteed service an impossible dream? Certainly not. It should be possible to develop a scheduled, nationwide network of guaranteed service trains to deliver premium service at a premium price. Like the intermodal network, "productivity" in terms of ton-miles per crew, locomotive hour, et. al. might be viewed as poor, but the revenue-generating productivity would look very good. Like the intermodal network, the premium service network would have to be simple with few hand-offs, block swaps, re-handlings, etc.

"If railroads are going to survive in the long term, they will have to find ways to do things better, cheaper AND faster. Imagine carload service at truckload speed and reliability yet with "railroad" prices, say a 14-18 hour schedule from NJ to Chicago. When was the last time a railroad tried to CREATE a market niche? All they do is grouse when Amtrak tries tacking freight on the end of passenger trains. It took vision to do the cost cutting and restructuring to get the industry where it is today. It's going to take some strong leadership and vision to get the industry to where it needs to be in the future. Because pretty soon nobody is going to want what to buy what we're selling today." Strong stuff, that. And it needs to be said.

One of the reasons given for the merger moratorium is to get rail stock prices back in the ring. Class 1 rail stocks rode higher for the week along with the rest of the Dow "old economy" stocks, with the rise occurring Wed-Fri. Whether this is because investors think rails are value stocks about to make their move remains to be seen. A look at FY2000 and FY2001 earnings estimates may yield some clues.

Over the past 90 days FY2000 estimates for BNI and UNP remained flat, CNI up a tad, with NSC and CSX continuing their downward drift. Looking at FY 2001 we see upward trends over the last 90 days for BNI, CNI, and UNP. The eastern roads do not follow.

Small railroad prices saw no price appreciation for the week. WCLX and GNWR held their own while RAIL lost a point over Thurs and Fri. The message here could be that as small cap companies they lost some favor along with the rest of the small caps while the world rediscovered the DJIA. Forward estimates show modest growth YTY but are essentially unchanged over the last 90 days.

Speaking of clues, readers are commended to check out www.cluetrain.com to have their brain cells jangled just a bit. The argument is that "Thanks to the web, markets are becoming better informed, smarter, and more demanding of qualities missing from most business organizations." There are many shoes that fit our industry; why not try a few on and drop me a note for next week's Review? (Hint: see Clues 8 and 9.)

--Roy Blanchard

© 1995-2000, The Blanchard Company, 2041 Christian Street, Philadelphia PA 19146-1338, 215-985-1110 (voice) 215-985-1446 (fax). All rights reserved.