The importance of being Earnest - Financial Edge - railroad purchasing and debt - Industry Overview - Column

Railway Age, Jan, 2003 by Anthony Kruglinski

Those of our readers who have done some cross-country air travel in the last few months may be familiar with a British film called "The Importance of being Earnest." The title is a play on words. The literal reading is one way to interpret the title. Another reading relates to a principal character named--what else?--Earnest.

Dry humorists, the Brits.

There would be no humor--dry or otherwise--if the movie's title was a label for the current lockjaw situation that faces the North American rail equipment industry and its principal customers--the Class I railroads, equipment lessors, and the industries they serve, Earnest they are not when it comes to purchasing new railcars and locomotives. The dearth of new equipment orders has created a depression in the equipment manufacturing and component supply industries.

This is not the first time this has happened, and probably won't be the last. So what's the big issue? Nobody owes anyone a living, right?

True. But this absence of significant new orders for cars and locomotives is occurring despite the convergence of a variety of logical reasons to place those very same orders. These include aggressive price cutting by new car builders and--it would appear--a significant desire to hold the line on technology driven price increases in the locomotive industry (the equivalent of massive retail discounting on Christmas goods in October). Most important, this depression in new building is also occurring at a time when interest rates are at historic lows.

Economic woes, traffic uncertainty, and a significant surplus of many car types contribute to the caution that buyers are exhibiting. This equipment acquisition strategy of having no acquisitions is dead wrong.

If you are a Class I railroad, albeit with significant concerns about your own business levels and profits (and stock price), you know what it is costing you to keep your existing rolling stock in proper operating condition. These operating maintenance dollars are just as real as the dollars you are worrying about receiving from your shippers. You also know that in most kinds of service, a new car or locomotive will be largely free of major repairs for five years or more. That's why--whether you purchase them yourself or support their purchase by lessors--you seek a reasonable mix of new and used equipment.

Why now when you can acquire new equipment under long term financing arrangements of nearly unprecedented value, have you dropped out of the market? Aren't low, long-term mortgage rates propping up the housing industry despite the same economic dislocations that you face?

There is at least one significant answer as to why reinvestment in cars and locomotives in this otherwise "purchaser friendly" situation has not occurred. And to get it, you need only to chat up a Class I CFO or treasurer. Many Class I's are fearful of the negative reaction that they will get from analysts and rating agencies if they load up on additional debt, no matter how cheap it is, And it really doesn't make much difference if the financing is off-balance-sheet lease financing. Credit appraisers will generally load long-term equipment lease obligations into the same hopper as debt.

Granted, that is an issue. A big one. But I cannot understand--especially when it is now common for railroads and lessors to have regular meetings with analysts and rating agencies--why someone has not made this point: Despite the obvious issues of further leveraging a company's equity, in this low-cost debt market it just makes sense to do something!

I know some analysts and rating agency types. Despite having been burned for some overly optimistic calls in the past, the ones I know remain cogent, concerned people. They are paid to take short-, medium-, and long-term views, Railcars and locomotives are longterm investments.

Analysts and their kith and kin are out there with the rest of us buying houses with 30-year mortgages at a time when the economy is softening. They have figured it out for themselves: Some things you just need to find a way to do.

Most of us expect to need housing for the next 20 or 30 years. And unless someone plans on pulling up a lot of track, the railroad industry will need long-lived capital equipment. What's so difficult about figuring out a way to buy it and finance it when things are cheap?

Tony Kruglinski welcomes comments and controversy via E-mail at: tkruglinski@railfin.com