The Railroad Week in Review:
Week ending May 27, 2000

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There are no secrets. A networked market knows more than companies do about their own products. And whether the news is good or bad, they tell everyone. (Cluetrain Clue Number 12)

Last week I wrote, “E-commerce will transform the railroad industry over the next decade” and asked for comment. You would have thought on a hot topic like this they’d be burning up the wires. Wrong. I got ONE note: “The motor carriers are getting business via a huge selection of web sites devoted to one-stop shopping for freight movements. The number of shippers relying on this method of matching freight to carriers is growing exponentially. It’s been stated that from less than one percent two years ago, by 2003 25% of all freight transactions will be via the web.

"The point here is that the rail industry is at least two years behind the curve. The 'Steelroads.net' program is an excellent effort, but individual railroads are not as far along. The shipper is already experiencing that procurement can be easy on the net. We are having trouble just making it available.”

To which I say, untless the rails can fix the service issues there won't be any market, web-based pricing or not. Service complaints continue, and until the carriers can do better at what one might call "Railroading 101" the competition will walk off with the marbles. E-commerce will just accelerate the process. E-commerce is fast; it is sexy. But without consistent, reliable service to back it up, ain't nobody gonna play.

The very next day The Four Amigos (UP, NS, CSX, CP) issued a release saying they have each invested in Arzoon, a privately-held company that has developed Internet technology to provide one-stop transportation management services across all modes and borders. Alliances among railroads are the key to providing customers with quality service, including flawless interchange of freight traffic --the goal of every company in the rail industry. The purpose of our partnership's investment is to achieve seamless service.

Just who and what is Arzoon? According to the press release, the firm was founded in September last year and has “developed a communications platform that assists in procuring, executing and tracking freight movements using Internet.” Of these three, you can already do two of them on each railroad’s own site. Procurement will be the breakthrough largely because it will eliminate the need to build rate quotes by getting revenue requirements separately from each carrier. We’ll see how far it gets.

Wisconsin Central held its first-ever analysts’ conference in Chicago last week. Monday morning we were treated to presentations from WCTC (North America). EWS (the UK) and TranzRail (New Zealand). After lunch there were breakout sessions so each of us could chat with each group’s senior managers, and on Tuesday we got an up-close look at the railroad with a train ride to Green Bay from WC’s Schiller Park terminal near O’Hare. To be sure we were paying attention, AVP-Corporate Affairs Ann Thoma had prepared a quiz on WCLX facts and figures. The prize was a trip for two on the scenic Algoma Central and the winner was Carole Neely of Brown Brothers Harriman.

The format couldn’t have been better. CEO Tom Power set the tone saying, “We start with the customer, fit costs to the customer service need, use service quality to build the business base with current customers and leverage the reputation won to find new ones.” The biggest revenue growth opportunity in 2000 is to have NS and CSX return to pre-split transit times. WCTC lost an estimated $5 mm in revenues to truck in the last two 1999 quarters thanks to service problems in the east. Moreover, untold new business was lost simply because of customers’ generally lousy perception of eastbound rail service. Added WCTC President Reilly McCarren, the longer the service delays continue the more business will be lost and at an accelerating rate.

On EWS, newly tapped (Jan 2000) CEO Philip Mengel sees his challenge as a cultural one, starting with 50 years of government patronage with all its ills and molding it into a customer-oriented team spirit. The enigma about EWS is it has a 90 share of the rail freight market in the UK but rails have only a 10-share of the total freight market. Customer expectations regarding punctuality run very high, so scheduling must be very tight, trains very short (11-30 cars) and distances short (less than 70 miles average).

Because dependability is so critical, EWS is acquiring 280 new locomotives to replace an aging fleet at a rate of about 1.6 old units retired for every new unit put in service. The downside of this rapid deployment is a huge lease bubble. EWS earned £6.2 mm all-in for 1Q00 vs. £8.9 mm a year ago. Put back costs related to the new power and the operating profit triples to £20 mm vs. £16.6 mm and the adjusted OR drops to 84.9 vs. 86.8 YTY. After the formal presentation Mengel told me that part of the prior periods' performance problems stemmed from resource allocation of everything from locomotives to drivers (engineers). A lot of that is clearly on the mend and we ought to see some of the benefit in 2Q00.

The RailTrack issue is a conundrum. In 1Q00 access charges represented 27% of total operating costs and EWS didn't think it was getting its money's worth. Still the £35 mm RailTrack got for its services clearly wasn't enough for them. Trouble is the mix. EWS pays £90 mm a year in fixed charges plus about two pounds six per million ton-miles, or £140 mm a year. Mengel says, and rightly so, the formula should be more variable than fixed and constructed in such a way both parties can come out where they need to be. A new contract is still a year away, so there's some room to negotiate.

TranzRail (TRZ) in New Zealand has a brand new management team, too, and they are putting TRZ through a soup-to-nuts strategic review. The outlook is encouraging as the economy of the entire region is improving, freight volumes are up, and practice of reducing rates to win business is being nipped in the bud. Headcounts are being reduced, fuel prices are coming down, and purchasing practices are being standardized and centralized with the help of SAP control. The five-year profit trend is up, averaging 5.5% ACG. My only concern is that each year since 1995 a good year is followed by a not-so-good year. As it happens, 1999 was a good year. Can the New broom sweep clean enough to sweep away this trend?

Australia is an interesting situation as GNWR and RAIL dominate the mainland with the WC-owned Australian Transport Network (ATN) on Tasmania. Relative sizes in tonnes (000): Australia Southern (GNWR) 5,400; Freight Australia (RAIL) 6,900; ATN (WC) 3,500. WC comes to the mainland in June 2000 with “ATN Access.” This will begin with one train in Southern New South Wales and Victoria under a 10-year contract with AWB, Australia's "single desk" wheat exporter. Operating on 900 KM of standard gauge track, Access will have 4 rebuilt 3000 EMD locos, 44 grain wagons, and 8 employees. Regarding further expansion, the WC team has done their homework on Westrail et al and it seems they have decided when to hold and when to fold.

Westrail is a 5,400 KM two-gauge and dual-gauge network producing $A250mm in revenue ($A1.75 = $US1.00) with 82% of that coming from mining activities, so it’s not a small operation. National Rail is even bigger, $A417 in revenue and 8,800 miles of standard gauge track, losing $A32 mm before taxes last year. Either one of these will be serious money to a prospective buyer. The question is who has the resources and who is willing to take on a railroad that lives largely on low-rated commodities or one that’s losing money.

We've written elsewhere that some of the rails, notably UP and NS, are beginning to come out of their recent slumps. For my own account, UP is the first to come up roses crossing the 200-day average and with a rising estimate trend, so it’s on my shopping list for next week with a December target of $80. NS is looking better, with estimates for the next two quarters holding their own and leveling out for this year and next. I had thought NS would cross its 200-day average at $20 but it’s since pulled back. Let’s see what happens on the next bump up.

WCLX is next on my list, just as soon as the earnings estimate trend flattens out. The reasoning here is that the new brooms will indeed sweep clean. Seeing the WCTC in action was the clincher for me. This is a company that has a customer focus, is investing in track and power to increase velocity, and has a motivated workforce. I’ve visited the EWS twice and all it lacked was the sort of nudge it will get from Mengel. As for TRZ and ATN, the focus is there as well.

Some who attended the meeting have downgraded WCLX to Market Perform from Buy. EWS concerns, fuel costs, and eastern links have been cited. I think EWS will get lots better, eastern connections are cleaning up their acts, and fuel costs are anybody’s guess. Besides, EWS is but 14% of income and TRZ 10%, the balance coming from WCTC, an impressive property that looks good for the long term. At a PE of only nine it’s a bargain.

--Roy Blanchard

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