The Blanchard Company

Christmas Week was quiet on the merger front. In an extensive interview with retiring UP Chairman Drew Lewis, Philadelphia Inquirer reporter Andrew Cassel quotes Lewis thus: "For the Conrail merger to go through, it has to be pro-competitive -- giving the maximum service to the customers on their system. And that means that Conrail has got to permit CSX and Norfolk Southern to figure out how customers are best served by their two railroads. It doesn't necessarily mean breaking up Conrail, but you have to open it up to get it approved [ by federal regulators. ] . I would suggest that that's probably going to end up with CSX and NS somehow rationalizing . . . Conrail."

Apropos of jobs, UP's Drew Lewis noted that Union Pacific HQ may be in Bethlehem PA with about a hundred folks, but the real action is in Omaha. "The guts of the railroad is where the people are: the engineers, the logistics people, the traffic controllers. Where the corporate headquarters is really makes no difference." And to top it off, Philly Congressman and local power figure Vince Fumo is still fuming about the 900 jobs lost at CR this year, according to the Phila Daily News on Thursday. In another twist, Conrail Director David Lewis, Chairman of Detroit's Lewis, White & Clay law firm, abstained from voting on the two year lock-out while still fully supporting the proposed transaction.

In the course of my work tracking the rails, I also check in on the trucking industry from time to time to see what's hot there. Here are three posts regarding a small, aggressive, and successful trucking company, Heartland Express (HTLD), recently listed by Forbes as one of the 200 best small companies (see www.forbes.com).

Reader One writes that Heartland is a non-union company that operates in the eastern half of US and specializes in short to medium haul with a single type of trailer ... a very uncomplicated business model that allows them to operate with an industry-leading low operating ratio in the low 80's and throw off tons of cash. To which Reader Two added that HTLD has latched onto "just-in-time" inventory management as the core of its business model. Manufacturers don't want to tie their capital up in inventory and warehouses, so they are converting to just-in-time inventory management. They keep only a few days of supplies on hand and arrange with suppliers to deliver more supplies "just in time."

Most truckers compete on price, yet the cost savings from just-in-time inventory management are so great, that manufacturers are willing to pay premium prices to carriers providing the delivery reliability needed to make just-in-time inventory management work. HTLD has targeted this market and charges a premium price for premium service. HTLD's uniform fleet of late-model tractors, uniform sized trailers, high trailer to tractor ratio, satellite communication system and attention to pleasing their customers is custom- designed for the just-in-time inventory management customer. Recently priced at $26, HTLD has no debt, $81 Million in cash on its balance sheet, EPS up by 21.15% for the first 9 months of its FY and its operating ratio was 83.2% last quarter.

Here's where I put in my two cents. The previous post, I wrote, has it exactly right about Just In Time. It's why the rails are losing share in the time-sensitive market. And there's another reason quality truckload carriers are doing well: transportation buyers are using fewer carriers.

In a recent trucking industry report Corina Bergschneider of the George Baum group in KC noted that "in the dry van industry shippers are decreasing the numbers of motor carriers in their core carrier groups. One shipper decreased its number of carriers from 200 to 15 before reducing the group to just eight." So the supplier (carrier) who can add value in terms of a quality on-time service that is part of the logistical process can charge a premium price and win share. The rails are told continually, clean up your act and deliver a reliable product and we'll even pay more. So rates are not the drivers everybody seems to think they are.

Bergschneider also reports " Information is replacing inventory as JIT inventory management evolves into just in the nick of time inventory management. More and more this means that trucking companies must provide real-time status reports on freight movements." From this she goes into per-truck spending on satellite-based communication systems, running $3,000 to $11,000 over the last five years for companies like Werner (WERN), Frozen Food (FFEX),and Aasche Transpiration (ASHE). With respect to HTLD, Bergschneider says, "We believe their high mix of owner-operators coupled with its access to a well-educated workforce continues to its above-average profitability."

Lastly, on the subject of JIT, Bergschnieder notes "Manufacturing inventory-to-sales ratios have dropped to a range of 1.45-1.50 from historical peaks of 1.70 and troughs of 1.55. This shift required carriers to meet exacting shipping schedules." No wonder the ones who can spend on commo to keep in touch, do. And they that do can charge more as long as they deliver the goods on time every time without fail. In other words, if I can help you do your job cheaper, let me share in the savings. It's not an outlandish request.

To get some sense of how the readership views the Conrail situation, I posed this question on the investors' electronic bulletin board I host: Let's for the sake of argument say that when CSX and Conrail hold the "opt out" vote in three weeks those who wish to opt out of the Penna takeover law prevail. This prevents CSX from acquiring the 20.1% of Conrail needed to effectively take control. Let's also say that NS is not successful in convincing Judge VanArtsdalen to bar the two-year no-talk provision CR's board has agreed to. What happens to Conrail shippers, employees, and stock?

A Conrail break-up seems to be gathering steam as a consensus scenario. One reader likened a potential Conrail break-up to what happened to the old Rock Island. As he tells it (Dick Robey, correct us if we're wrong), it appeared the net asset value was worth far more than the most optimistic going concern value. The pieces were sold off and although many of the routes were inferior, in a competitive sense they were extremely valuable to other railroads and most are still in operation today by such carriers as CSX, UP, and Iowa Interstate. Although the CR situation isn't exactly the same, it's certainly possible that the sum of the parts may be worth more to various railroads than the whole would be to one railroad.

Another regular wrote that the STB is already getting pressure to provide open access, and politically-based hearings are taking place on the entire rail merger scene, so it could be neither CSX or NS will get Conrail. As a result, pieces of Conrail will be sold off to more than CSX and Conrail. Every shortline east of the Miss will be looking to pick the carcass clean. To which another reader added the observation that each of the major players (CSX, NS, BNSF, UP) has a shopping list for which pieces of CR they'd like to own. For UP, I'd say St. Louis to Detroit via Indianapolis would be a keeper. For BNSF, the Chicago Line to Selkirk and down to NYC would be a keeper.

So, as I said to the BNSF shortline group last week, the rails of all stripes, large and small, now have an unequaled chance to manage the change around them. Miss this chance and they'll be managed by the changes around them. Our assignment, as students' of the passing scene? Watch for who does what and when and put your money on those who step up to the plate to manage the change.

--Roy Blanchard