The Railroad Week in Review:
Week ending April 29, 2000

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The Internet is enabling conversations among human beings that were simply not possible in the era of mass media. Hyperlinks subvert hierarchy. (Cluetrain clues 6, 7)

John Snow's opening remarks for Monday's quarterly results conference were brief and to the point. "Management's charge," he said, "is to accelerate the process of change at CSXT. There is nothing 'broken' as such, and what's needed is an intense focus on fine tuning the network." As the STB charts showed, so much emphasis had been placed on the Conrail end of the railroad that train velocity and yard dwell times in the southern regions fell behind, and as a result system carloads on line hit new highs.

What Snow wants to achieve now is a "better blend of CSXT and Conrail talent top-down, taking advantage of the institutional knowledge of both groups." The crux of the matter is that holding trains to maximize cars per crew-start may work in the north where there are multiple tracks and routes, but not necessarily in the south where there are fewer multiple track lines and fewer routing options. Thus we can anticipate more scheduled operations system-wide and thus better operating results going forward.

Turning to the numbers, rail and intermodal revenues were up 23% while ocean shipping was down 68%, the upside being CR and the downside being SeaLand, driving total revenues down 16%. Against this operating expenses drew back only 13% creating a 35% drop in operating income. The operating ratio increased to 91.6%, up 2.6 points YTY and the net margin shrank to a mere 1.4% from 3.0% YTY.

For the rest of the year CSXT anticipates continuing strong demand for merchandise (carload), intermodal and automotive business with coal remaining at present levels. There will likely be selected price increases where service can be improved and the truck-competitive environment allows, which is about what we saw with UP last week. Going forward, the CSX picture will brighten considerably if they can improve network fluidity, deliver on customer service commitments, manage the incremental traffic opportunities, and improve the all-important OR.

Most of us who've been watching the various merger activities have made reference to "Railroading 101" at one point or another. Rule Number One in that basic course is "If You Can't Measure It You can't Fix It." Judging from the STB Performance numbers it's quite possible CSXT's locomotive utilization rates are too low and recrew rates are too high.

Two measures CSXT may wish to include in the July presentation are locomotive Mean Time Between Failures (MBTF) and recrew rates. BNSF uses the former most effectively, and with a little math it can be shown how MBTF affects available fleet size. See http://www.bnsf.com/investors/assets/pdf/2000_apr.pdf.

Similarly, UP shows how the recrew rate has been cut YTY on page 3 of the 1999 Annual Report or http://www.up.com/investor/99annual/facts.shtml. It's not much of a leap from the recrew rate to train velocity, yard dwell times and yard inventories. One thing I wish all the railroads would do is to link productivity measures like these to the STB Performance measures. Then we'd have a sense quarter-to-quarter of what's being done to make customers' shipments move more promptly and dependably.

BNSF reported 2.5% more revenue, 1.5% more expense, 3% more net income, and 10% better earnings per share. See what tight expense control and an aggressive share-buyback program will do? Better yet, free cash flow after dividends improved to a mere negative $7 mm from a negative $226 mm a year ago. Turning to the presentation (www.bnsf.com/investors/assets/pdf/2000_apr.pdf) note that the OR went down 80 basis points even with a 30% increase in fuel prices. The percent on time increased to 91.0% vs. 88.7% a year ago, an all-time record, showing once again a scheduled RR works better than an ad hoc operation. Revenues in every commodity but coal were up, repeating the pattern we saw at UP, with auto in the lead. Offsetting higher fuel prices car hire and materiel costs were down, the former again reflective of the benefits of scheduling. It's the old trade-off: how much more do you spend in car hire by holding trains to meet a cars-per-crew-start target?

Having a scheduled plan in place lets BNSF focus on improving service offerings for carload customers. With a plan to measure against, they will be able to point to achieving specific improvement objectives, thereby adding more value to the transportation package. Recall Tom Peter's Rule which states quality is defined by the customer relative to the competition.

Like CSX, Norfolk Southern didn't exactly have a quarter to write home about. "First-quarter net income, excluding the effects of a one-time workforce reduction charge, was $14 mm compared with net income of $112 mm for the first quarter of last year. Taking into account the effects of the charge, which amounted to $101 mm pre-tax ($62 mm after-tax) first-quarter reported results were a net loss of $48 mm." Operating revenues were up 45% however railroad expenses were up 85%, largely driven by sharply higher fuel prices and the continuing expense of the Conrail integration.

The real story is in the cash flow statement. Add back the $62 mm net charge for the buyouts and operating revenue becomes a positive $14 mm from a negative $48 mm. Operating cash flow is now $355 mm, exactly what UP had. Norfolk, however, really pinched its net capex pennies down to a modest $126 mm so that even after laying out $77 mm in dividends there remained $151 mm in free cash flow and a FCF margin of 15.3%, a point better even than the usual NS net margin of 14%.

Sometimes you have to go behind published numbers to get the real story. In a recent commentary on railroad earnings trends, I wrote, "Another of the STB's Ex Parte 582 concerns was falling rail profitability. Go back to 1995, if you will, and take that as your base year for comparison. How do the rails do when comparing average annual compound growth (ACG) for the following four years? Not surprisingly, the small roads did the best...RailAmerica (Nasdaq: RAIL) posted a 12.3% gain..."

Wrong. Today this e-mail from RAIL: "Check out the attached file on RailAmerica's EPS growth over the last 4 years. Growth average vastly different than what you had in last week's WIR. Can you let me know if your source is different?" Their spreadsheet, complete with the excel RATE function, shows that for four years the ACG was 111.5% based on steady improvements starting at $0.04 and rising to $0.77 per share. My source was a table showing five-year earnings ACG without the individual years and the lesson is double-check everything. My apologies for weakening a very strong earnings story.

At Thursday evening's NY Railroad Club gathering Federal Railroad Administrator Jolene Molitoris had a few thing to say about the present, past and future of our industry. She recounted the safety progress made, the shortline benefits, the community efforts to do more with their rail lines. And then she told the darker part of the tale.

Molitoris, like the STB's Morgan, is concerned that inconsistent service and loss of market value could do lasting harm to the industry. She told the assembled dinner crowd that railroaders in the 21st century are going to have to climb out of their chimneys and listen carefully across disciplines and constituencies. Could it be she's telling us that companies and communities, like markets, are conversations? Recall, gentle reader, Clue Train Thesis No. One.

--Roy Blanchard

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