The Blanchard Company--Week in Review 8/21/99

The Railroad Week in Review:
August 21, 1999

ABC-NACO (Nasdaq: ABCR) has been a topic of discussion here for a while. Debt has been mentioned as a cause for concern. To show just how much an impact a ton of debt can have on performance, take a look at the stock evaluator at quicken.com. This is a tool that assigns an intrinsic value based on net present value (NPV) of an estimated earnings stream less current LTD. Here's how it works, according to Quicken:

"If we assume initial [annual] earnings of $7,400,000 grow at a rate of 11.45%, and we discount those future earnings at a rate of 17.00%, we arrive at a net present value for the company's next 10 years of earnings of $57,196,924. To account for potential earnings beyond the 10th year, we estimate a growth rate of 11.00%, a discount rate of 15.00%, and we arrive at a continuing value of $126,821,776. To complete the calculation we add these two figures together, subtract the long-term debt for ABCR ($221,400,000), and divide by the outstanding shares (18,356,000) to get a per share intrinsic value of $0.00." The debt is greater than the discounted forward earnings thus the intrinsic value is zero.

Motive Power (NYSE: MPO), on the other hand, shows an intrinsic value of $247.67 against a current price of $17.50. The forward earnings NPV is $5.9 billion; LTD is $133.5 mm. Divide the difference by 27 mm outstanding shares for that $247 figure. On the railroad side the shortlines appear as a group to be the most undervalued using the Quicken model. Here again, debt plays a major role in determining intrinsic value.

Genesee & Wyoming (Nasdaq: GNWR), with $66 mm in LTD (including current portion) is worth $177.20 a share, ten times today's price. RailAmerica (Nasdaq: RAIL), with less robust current earnings and a larger debt load fares less well with intrinsic value of $4.10 against today's share price of more than twice that. RailTex (Nasdaq: RTEX) falls in the middle: Intrinsic $105.92 against current $15.19, a factor of seven.

The pending merger with Westinghouse (NYSE: WAB) just got more so. In a terse release on Friday WAB said due to "market volatility" in its stock and that of MPO the shareholder meeting set for 8/23 to consider the merger has been postponed. No new date has been set. Market volatility? I'll say. For the past two weeks both stocks had been humming along keeping pace with the S&P 500 until Wednesday. Then both tanked to a point 20% below the index, and stayed there till Friday afternoon. At that point MPO dropped to 30% below the average while WAB regained to a point ten points below the S&P. Interestingly both moves occurred at about 3PM.

It was at about that hour when a press release from MPO said "Shareholders will still vote Aug 23 on the proposed merger with WAB" and that it "regretted WAB's decision. Evidently MPO offered to postpone the 8/23 meeting a couple of days but WAB said no thanks. Looks like the market says YAY to Westinghouse and BOO to MotivePower. Interesting. We'll look at some relative values next week.

Last week I wrote, "The Return on Invested Capital (ROIC) application is essential to track for any railroad owner or operator simply due to the fact that this is a capital intensive business." And this holds true whether the target firm is privately held or traded on the open market. First, there are two ways to identify "invested capital." The easy way is to sum equity and LTD. However, this misses some fine points like Good Will, a non-cash asset that really nobody can use. It, plus money in the till but not paid -- accounts payable, deferred compensation and taxes, e.g. -- represent financial, not operating, capital. These items do not, in short, represent capital purposely invested in the enterprise by its owners.

To get at ROIC, plus ROE, ROA, and measures like share price multiples of cash flow, a spreadsheet comprised of entries on the Income Statement, the Balance Sheet, and Statement Cash Flows is most useful. Mine compares 19 ratios, and since GNWR was beginning to look like it had superior investment potential (see above and WIR 8/14) I ran the numbers against RAIL, RTEX, and Providence & Worcester (AMX: PWX). GNWR had the best ratios in 11 categories, PWX got seven, RTEX one.

By way of comparison, how to the class 1 rails compare? Burlington Northern Santa Fe (NYSE: BNI) was the clear winner garnering 10 hits vs. 5 for CSX (NYSE: CSX), 3 for Norfolk Southern (NYSE: NS) and just one for Union Pacific (NYSE: UNP). BNI wins the return ratios sweeps, garnering 15% on equity, 8% on invested capital, and 5% on assets. But is this enough?

Consider the cost of capital is essentially what investors expect of a railroad, and the industry multiple of 15 is a fair mirror of that. Here's the rub: BNI plops down $2 bn in capex -- 24% of revenues, 97% of EBITDA -- and gets 8%? The challenge now becomes using that $2 bn in capex to generate enough new revenues to push the net toward that 15% growth rate.

The merger grinds on. Despite rosy reports in the press releases, a number of shortlines in Pennsylvania and contiguous states tell me they are off as much as 20% for the last two months compared with 1998, and all of it is attributable to merger follies. Where is the traffic going, if not to the shortlines? Over the road, either long haul origin to destination, or short haul as shippers seek to avoid interchanges and use class 1 transloads for everything from plastics to lumber. What's wrong with this picture? Several things.

Recall the rallying cry of this merger was to take trucks off the roads, greater competition, and lowered shipping costs. We've got more trucks, not less. Transloads add about $1,000 per car in shipping costs, increasing manufacturing costs where the rails' cry was to reduce them. And lastly, rather than kicking cars off line to shortlines for disposition, the class 1s add to their own local costs and congestion as these cars remain on line.

We continue to get the so-called anecdotal items relative to the current service situation on Norfolk Southern. Everybody knows Buffalo is a problem. A regular contributor to these pages writes, "We were advised yesterday by CSXT customer service that they have in excess of 150 cars being held in Buffalo awaiting interchange to the NS. We were told that NS will not (cannot?) accept them."

My correspondent continues, "This second item is courtesy of my mother in Lewistown, PA. Apparently there was an article in the local paper about people who live adjacent to the NS tracks (former PRR mainline) complaining about locomotives idling through the night for night after night. This would be, of course, from trains parked on NS' "fluid" main line."

This fits with other complaints from shippers and shortlines alike that cars coming via NS/Buffalo and CSX to NS for delivery are routinely being misrouted or held. For example, there are signs cars in Oak Island for NS points in NJ are shipped back to Conway (which may contribute to the Lewisburg parade). It would be a help if anybody with further developments on this thread would write.

The other shoe has finally dropped - sorta - on the Kansas City Southern (NYSE: KSU) split. On Tuesday the company announced it is ready to proceed with the 4Q99 "Stillwell" split, even though Janus does not want to be included. The argument remains that Janus fears Stillwell could make the wrong buys and thus hurt shareholder value. Then on Thursday the Stillwell plan was filed with the SEC even though Janus does account for most of KSU's earnings. Some analysts downgraded the equity which closed Friday at $49 5/8, down about 10% for the week.

--Roy Blanchard

Tell Us What You Think!
The goal of this site is to help short line managers, railroad investors, and students of the industry find the tools necessary in their respective areas of interest. The beauty of this medium lies in its ability to educate and inform as it communicates. Send comments to roy@rblanchard.com