The Railroad Week in Review:
Week ending May 13, 2000

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When I ran my FY 1999 BNI numbers for the quarter a strict arithmetical calculation gave me an operating ratio of 75.8. Dick Russack, VP Public Affiars at BNSF, quickly pointed out they reported an OR of 75.4, 40 basis point better. “Where could it be?” I asked.

Dick, never at a loss for words, responded, “Earnings for year ended December 31, 1999 were reduced by $0.01 to exclude second quarter special items. They consisted of adjustments for reorganization costs and environmental expenses and were partially offset by a credit for the reversal of liabilities associated with the consolidation of certain clerical work forces. Also, a third quarter gain in connection with prior period line sales that was partially offset by costs related to those line sales." See why I like Free Cash Flow margins? Thanks, Dick.

Speaking of FCF, Jack Hellman of GNWR weighed in with some observations regarding their 1999 results. He writes, “"In order to analyze our capital expenditures, you must be careful to subtract government grants (broken out under "cash flows from financing activities"). These grants are "free money" for projects that we would not initiate unless someone else was paying for them (or part of them).

“Also, exclude cash generated by sale-leaseback transactions from the free cash flow analysis since these are not recurring sources of cash from operations. Likewise exclude new acquisitions from the analysis of free cash flow. The free cash flow impact of an acquisition can only be measured in the first complete year following the transaction (i.e., the acquisition's annual operating cash flow less its annual maintenance capex). The cash used for an acquisition reflects the debt and equity capital that we put to work in order to generate free cash flow, but should not be part of the calculation itself.” That being said, here is the revised cash flow calculation:

Now the FCF margin is more than three times the net margin for 1998 and twice the net for 1999, even with the Mexican acquisition. No wonder the stock price is climbing.

The trouble with earnings estimates is you never know what’s in ‘em. RailAmerica reported a record $0.23 a share for 1Q00 exclusive of one-time charges associated with the RailTex transaction and exclusive of results from Kalyn-Siebert, which moved to “discontinued operations” in 4Q99. The street consensus (all two of the analysts following) was $0.19, though including the RTEX charges and so forth the net-net was a loss of two cents a share. So did RAIL meet, fail to meet, or exceed expectations?

I’d say they exceeded expectations. It’s hard to make meaningful comparisons with 1Q99 because the RAIL landscape has been so dramatically altered. They added RTEX and TP&W. They have already clocked $6.5 mm of the $11 mm synergies expected from the RTEX combo. The have commitments on five of the ten non-core shortlines slated for sale, have 90 locomotives and “several hundred” cars on the block, and have already turned away two offers for K-S as too light.

CEO Gary Marino told conference call listeners that they will close on all the railroad sales and K-S by the end of June and the $100 mm or so in anticipated proceeds will go to knock down the current $370 mm in LTD. On the other hand, the RTEX transaction increased share count 62% to 16.5 mm shares vs 1Q99, and with the stock price now half what it was a year ago market cap isn’t doing all that well. Going forward, RAIL will remain an aggressive player in Australia, what with there being still two transactions to be finalized. As for the “open access” being discussed in AUS, Marino says he’s not too worried because most of what he has is broad gauge and not open to everybody anyway.

Major investment houses appear to be now looking beyond technology to firms that will fare well in an environment of rising interest rates and slowing economic growth. Earnings and cash flow still count, goes the current mantra. Among rails, NS had the strongest cash flow story for 1Q00 followed by BNSF, so it is doubly encouraging to read of their joint program for non-stop transcontinental intermodal trains starting May 21. In a slowing economy manufacturing margins get pinched, so more efficient transport is especially welcome.

The service will provide shippers fifth-morning availability for both westbound and eastbound freight moving between southern California and Atlanta. When the new service begins, NS plans to add at least 1,300 53-foot containers to the total number of containers it sponsors for use in the North American Container System (NACS). NACS is a doublestack container network comprised of ten North American intermodal rail networks (BNSF, CN, CSX, I & M Rail Link, Iowa Interstate Railroad, KCS, NS, Texas-Mexican Railway, Transportacion Ferroviaria Mexicana and Wisconsin Central). The beauty of NACS is its dedicated fleet of nearly 11,000 free-running 48- and 53-foot intermodal containers that can be interchanged among participating rail networks. Now that’s proper equipment utilization.

Kansas City Southern made the Wall Street Journal Pros vs. Dartboard List for the next six months. New contestant John Meara, president of Argent Capital Management in St. Louis, notes that the play here is Janus, 82% owned by the KCS Industries holding company, and “the premier brand name in money management, with tremendous growth.” The stock closed at $70 1/8 on Friday, off $2 for the week.

According to the article in Monday’s paper, Meara says, “The stock has a significantly lower price-to-earnings ratio [29.65 Friday] than other money managers. The price reflects concern about the Janus exposure to tech stocks as well as uncertainty about Kansas City Southern's proposed spinoff of its financial-services business, including Janus. However uncertainty can provide opportunity. There's tremendous upside potential.”

Over the next few days we’ll take another look at the KCS railroad, this time in comparison with FEC and WCTC (the North American side of WCLX), and see if we can figure out what it’s worth by itself. Readers’ thoughts on the subject would be most welcome.

--Roy Blanchard

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