The Railroad Week in Review:
Week ending August 5, 2000

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Cluetrain Reprieve: Many senior managers sense the need for radical changes to save their companies. But they're choosing to wait. After all, why act now if you can retire before this whole thing plays out? It's like Woody Allen said: "I'm not afraid to die. I just don't want to be there when it happens."

Union Pacific finished the quarter with earnings of $244 mm or 96 cents per diluted share, up 26% thanks to solid revenue growth and continued service improvement. That's against net income of $194 million, or $.77 per diluted share, in the second quarter of 1999. The Railroad's commodity revenue increased 5% to a record $2.6 billion. The Automotive, Intermodal and Industrial Products business groups continued strong with each showing double-digit revenue gains.

As we've said time and again, growing revenue is the surest way to reduce the OR. Case in point: UP increased revenue 7% and expenses only 5% producing a 2.5 percentage point reduction in the operating ratio to 80.5 percent, a quarterly best for the merged company. This improvement was accomplished despite a 50 percent increase in fuel prices year over year.

At the beginning of the year Chief Commercial Officer Jack Koraleski told me he expected to grow revenues at the GNP growth rate "plus." Exactly what "plus" was he left to his listeners, and now we know. Commodity revenues hit $2.6 bn in 2Q00, 4.9% above 2Q99 - not too shabby. A second goal is to get the OR below 80. UP got to within half a point and without the doubled fuel costs would have made it. What this tells me is that UP knew what it would take to get its post-merger house in order and has set about to do so. With a vengeance.

The long awaited split and un-split of KCS happened July 12. The split was the Stilwell spin-off of the financial asset management group comprising such brands as the Janus and Berger mutual fund families. KCS holders got two shares of Stilwell for each KSU. The un-split the same day and every two shares of remaining KSU stock was converted into one share of the new KCS.

Following the spin-off KCS has its wholly owned KCS+Gateway Western network plus Grupo TFM and Mexrail. KCSI reported 2Q00 income from continuing operations of $8.8 mm against $5.2 mm in 2Q99. Revenues dropped 3% to 144 mm from $149 mm YTY due mainly to lower combined KCSR and Gateway Western sales. Weaknesses in the chemical and agricultural/minerals sectors were partially offset by growth in the paper and forest products, automotive and intermodal businesses. Along with increased yields in most lines of business. The combined KCSR/Gateway Western operating ratio for second quarter 2000 was 84.9% compared to 84.5% in the same 1999 period.

Equity earnings from Grupo TFM increased $8 mm YTY reflecting primarily continued revenue improvements at Grupo TFM. Revenues and operating income increased 17% and 34%, respectively, resulting in an operating ratio of 67.7% versus 71.9% in second quarter 1999. Second quarter 2000 interest expense increased 26% from the prior year quarter due to higher interest rates and amortization of debt issuance costs associated with the January 2000 debt re-capitalization.

Genesee & Wyoming (GNWR) held its first ever conference call on Tuesday. Revenues were $52.4 mm, up 22.7% from $42.7 mm YTY. Operating income was $7.8 mm up 36.4% over 2Q99. Net income for the second quarter of 2000 was $3.8 mm excluding the after-tax effect of a $1.5 million non-cash charge from the depreciation of the Mexican peso. This compares with net income of $2.7 mm for 2Q99.

Operating results were driven by strong growth in North American railroad revenues which increased 36.8% to $39.8 mm QTQ. Of this $10.7 million increase in revenue, 77.0% was from the Company's Mexican subsidiary, which commenced operations in September 1999, and 23.0% was from internal growth at United States and Canadian properties. Revenues in Australia declined from $10.6 million in the second quarter of 1999 to $10.1million in the second quarter of 2000.

The operating ratio improved to 85.1% in the second quarter of 2000 from 86.6% in the 1999 quarter, a trend that is noteworthy given the high level of diesel fuel prices in 2000. The operating ratio for the contract switching group was 93% and for the NA rail 84%. Also in the US, CEO Mort Fuller noted that the New York/Pennsylvania Region has seen steady operational improvements as shipments begin to stabilize in the aftermath of the Conrail break-up.

Lastly, GNWR continues its efforts to grow its Australian franchise via a partnership with an unnamed party to operate the West Rail system. Indicative bids are due later this month after which a short list will be announced with final bids due in October. The winner will be named in Nov with closure expected in Dec. GNWR will incur in 4Q00 a $US1 mm charge for legal fees associated with this transaction.

Wisconsin Central presentations are always a delight. Tom Power's wrap on Wedesday's session: "There are new initiatives and new energies; excitement abounds. Don't miss the train." In other words, there's so much going on here that if Wall Street doesn't buy the shares, we will and the share buyback program will continue.

Net income for 2Q00 was $15.7 mm on $93 mm revenues plus $4.5 mm equity income from affiliates and excluding special items. A year ago the net was $18.8 mm on $91 mm sales with $2.7 mm from affiliates. Earnings per share for both years was $0.32, with 2Q00 up a penny from estimates. Special items included a write-off of obsolete equipment, expensing of project development costs previously capitalized, and a redundancy provision.

North American operating income was $24.2 mm vs. $25.1 mm YTY. Operating revenues of $93.0 mm set a quarterly record, up more than 2% YTY. Gains in most revenue categories, notably paper, were partially offset by declines in movements of metallic ore, primarily due to customer adjustments of inventory levels and special, short-term movements last year that did not recur this year. Operating expenses came to $68.8 mm including a 32% hike in fuel costs for an OR of 73.9 Vs 72.3 YTY. Again this quarter revenues were hit by service problems in the east.

Excluding special items EWS contributed $3.5 mm for the quarter, nearly doubling the $1.8 mm recorded in 2Q00. Revenues improved 8% with increases in most revenue categories, notably coal and infrastructure. Expenses were up 7 percent, primarily due to increased equipment lease expense and a 46 % increase in fuel expense. Tranz Rail (TRZ) brought home $807,000 Vs $577,000 a year ago.

Coming soon will be the West Rail bid (see GNWR above). Other offshore interests include Jordan (already won), Poland (an office there) and South Africa. Power also alluded to others "too numerous to mention." In North America, paper business continues to be a winner as major producers consolidate and increase rail orientation. With 75% of the carload trade on contract, a steady revenue stream is assured.

According to the WSJ, new research on the value of Business-to-Business web activity says customers can save the equivalent of 5% of sales by putting supply chains on the web. Three active, profitable players in this sandbox are Oracle, iTwo Technologies, and Siebel. Oracle, the biggest and the obvious Gorilla in the field, has, as reported in Barron's, set its sights on the two interlopers "hoping to blunt their challenge."

Oracle is already active in railroads, having just introduced a sophisticated web-based MOW record-keeping system in Austria. Procurement king iTwo is mentioned in the same breath as Manugistics, the prime BNSF customer relationship management (CRM) supplier. Siebel is up six-fold YTD in the CRM arena, so it's the clear leader here. No wonder Oracle is watching, and railroad managers should be too. The fun is just beginning, sports fans, so stick around. (BTW, I have positions in all three.)

--Roy Blanchard

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