The Railroad Week in Review:
Week ending October 28, 2000

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There are two conversations going on. One inside the company. One with the market. In most cases, neither conversation is going very well. Almost invariably, the cause of failure can be traced to obsolete notions of command and control. Cluetrain Clues 52, 53

Canadian Pacific kicked off Earnings Week on Monday. The railroad posted operating income up 6% on 4% more revenue, in spite of a 7% hike in fuel prices. This was a recurring theme: how dollar-a-gallon diesel fuel has added points to the OR, and the impact on profits. The related theme is this is a fact of life, and hit hits the competition just as bad or worse, and that now’s the time to get service in order so as to earn the inevitable rate increases. Other than that, the CP Rail story presented here last week remains intact. Let’s watch.

BNSF opened the festivities Tuesday with some sobering news: revenues down a point, ops expense up a point, OR up 2 points mostly thanks to fuel. On the revenue side, Agriculture took the big hit, off 15%, negating strong intermodal gains. Coal was off as well, though just 2%, while auto was up 8% thanks mainly to more vehicle shipments. CEO Rob Krebs maintains that minimal revenue growth and higher fuel costs will not change the income picture soon

On the commercial front, the e-commerce portal FreightWise launched its beta to rave reviews and will go live any day now. This is part and parcel of the BNSF effort to know their customers better and get active in supply chain management, not just buying market share back from the other guy. Taking a page from the highly successful grain car management program, “LOGS” - Loading Origin Guarantees” -- have been introduced for lumber shippers resulting in better turn times and use rates.

We’ve already talked about the I-5 Corridor premium service, and the Ice Cold Express RoadRailer is now reaching as far east as Montreal. It’s all about franchise expansion according to Marketing EVP Chuck Schultz. And a big part of that is making the RR easier to do business with, especially for the “second tier” players who’ve never done business with the railroad before.

Canadian National followed BNSF with an OR that broke 70, never mind higher fuel prices. Said Hunter Harrison, with normal fuel consumption running 5.7% of revenues the OR would have been 67.2 so every $13 mm in added fuel expense cost a point. Even at that QTQ revenues up 5%, operating income up 14%, and net income up 30%. Dot-coms, step aside.

Starting with the premise that the best prospect for new business is the truck customer, CN has been delivering carload traffic 92% on time dock-to dock, and 50% of that is off the highway. New product offerings include three cooperative ventures with BNSF: corn from Iowa to eastern Canada bypassing Chicago, the Ice Cold Express (above) and RoadRailer service expended to Chicago from Toronto and Montreal. Is it worth while?

For 2001, CN sees growth in the merchandise carload business winning market share from new service offerings, continued expense containment and better asset utilization, double-digit EPS appreciation, and significant free cash flow. If you want to add a railroad to your IRA, this could be the one.

CSX , with somewhat less robust results, remains a Work in Progress. Looking solely at the railroad (“surface transportation”) side, CSXT, like its neighbors, was not left unscathed by the severe increase in fuel costs. However, unlike its neighbors, “Tee” was unable to offset fuel with savings elsewhere and as a result the after-fuel OR increased to 89.4 from 88.0. Revenue was no help, rising a scant 85 BP in the period YTY.

Breaking out product lines intermodal was flat while the rest of the rail industry saw significant increases. Its OR went up 30 BP to 90.6 while the OR for the railroad alone rose to 89.1 from 85.7. A positive sign is that carload changes in merchandise commodities were smaller than revenue changes, indicating some upward rate momentum.

The operating metrics are all pointing in the right direction. Cars on line down, train speeds up, dwell times down, on-time departures up. As a result, one would expect to see lower crew costs, lower car hire, better loco productivity. One would also expect to see improved volumes as customer satisfaction levels improve. And everybody knows the biggest driver of lower operating ratios is strong revenue growth.

The NS story is, I think, better than the numbers would have you believe at first. Recall the viewpoint here is as much or more about how the railroad is behaving as it is an investment advisory. That being said, the Income Statement will have you believe there was 1% more revenue and 4% less operating expense. That includes a fuel bill that was 8% of revenue where 5% is the norm. Absent the fuel price increase, operating expense would have been down 7% and the OR 83.2 rather than the reported 86.1.

Drilling down deeper, coal loadings for 3Q00 are off 2% YTY, however on an annualized basis NS could do 177 mm tons this year, up 12% from 158 mm in 1999. The lows seem to have been hit in 1997,8 with 134 mm each year. Utility coal (two thirds of the NS tonnage) may be stronger in 4Q00. Export coal could increase in 4Q00 as a result of shortages in Australia and South Africa. And the softening demand for steel may further impact met coal.

On the intermodal side of the house, it’s clear NS is getting back to a scheduled RR with a big push to getting the trains out of yards on time. As a result, the IM on-time rate is 74% vs. 39% a year ago, and of all the IM trains launched this quarter a third of ‘em were on time all the time. Merchandise traffic including auto accounted for $869 mm in revenue vs. $648 in IM plus coal. Automotive is the strong story here, up $17 mm, again driven by schedule service designed to meet specific customer requirements.

Agriculture is the No. 2 story with NS currently running 19 export trains compared to only 8 last year. Chemicals including plastics were unchanged YTY. Paper took a hit down 3%, as mergers, consolidations, inventory reductions, and plant closings continue so the future remains cloudy. NS is not ready to do an I-5 Corridor type premium service, but it won’t be long. Fuel prices won’t go down any time soon and surcharges won’t do. More permanent changes are needed in the rate structure and the key to higher rates is better service through scheduled operations.

--Roy Blanchard

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