The financial outlook for railroads - Burton Strauss - 1991 Rail Finance Review and Desk Book - interview

Railway Age, Dec, 1990 by Anthony D. Kruglinski

RA: What does the marketplace think of railroads today?

Strauss: We are entering a period of the greatest concern for financial performance for the railroad industry since the 1981-82 recession (almost a depression for the railroads, which saw revenue ton-miles decline 12.3%). We believe the marketplace has already anticipated much of the worst that can occur, with the 19% decline in the Dow Jones Railroad Index since July 31 just before Saddam Hussein's move into Kuwait. At that time a number of individual railroad stocks were selling at or near all-time highs. These same shares have declined anywhere from 12% to 34% in the ensuing three months.

RA: Are investor fears justified?

Strauss: We believe there are a number of concerns that may be overdone by investors. For instance, we entered a new era for the industry that arrived almost simultaneously with the creation of today's major systems. The mergers that formed these mega-rails took place between 1978 and 1981, almost in conjunction with the deregulation of the industry in 1980. The third major occurrence of the period was the onset of a major business slowdown that followed the period of exceptionally high interest rates. The latter had an adverse effect on rail wages, with the labor settlement of 1979 causing contract wages to rise 12% during 1982's rail recession/depression.

The interesting fact about 1982 was that the railroad industry was able to reduce expenses in line with the traffic decline. In 1982 while ton-miles fell 12.3%, train miles dropped 15.4%, fuel consumption fell 16.6%, and employment was off 13.2%. Except for the wage cost decline of only 5.4%, caused by the excessive contract settlement, we believe operating income would have dropped only 16% instead of the 45.5% actually recorded. In 1983, with a traffic recovery of 3.8%, operating income soared 148%, resulting in record industry profit levels.

RA: What about today?

Strauss: After 1982, industry depreciation, following 1983's rate revisions, peaked at $3 billion by 1988 and declined in 1989 to $2.2 billion. Also affecting the bottom line positively is the stable level of fixed charges, which were $ 1.1 billion in 1982 and $ 1.1 billion last year. The fixed cost portion of rail expenses indicates to us that a modest recession, which we currently expect to last through the first half of 1991, should not Create a major drop in industry profitability if operating costs can be reduced in line with traffic as in 1982.

Adding to our positive feeling of the rails' likelihood of holding their earnings is the nature of rail traffic today. The industry has been largely relegated to handling a heavy concentration of bulk commodities. Some of these sources of traffic are less likely to follow the economic cycle. Commodities such as, coal, grain, and food products account for about 22%, 8% and 7%, respectively, of total industry revenues and are not directly related to the general economy. In fact, coal in 1991 should gain from increasing European demand for steam-generation coal to replace higher-cost oil sources. Grain, which has had a slowdown in export demand, could be strong in 1991 following this year's large harvest and the possibility that renewed buying could emerge from Russia in 199 1. Other important revenue sources such as chemicals - 13% of revenues, lumber and wood products - 5%, and transportation equipment - 11%, have more cyclicality and may be down during the recession. However, with the expected start of the economic recovery by midyear, it is possible that 1991 traffic will not be significantly lower than the current year's.

RA: What are the odds of the cost cutting helping out?

Strauss: With the industry in good physical condition, it is possible that equipment and road work can be deferred. Combining this deferral with employment reduction in the operating, clerical and maintenance areas, we believe the industry will show surprisingly effective efforts to reduce expenses when traffic slows. A number of carriers have already announced furloughs, and we expect more to be forthcoming as the seasonally slow volume period begins in the near future.

RA: Where are the negatives?

Strauss: Well, issues that must be considered for the near term include fuel cost increases, pending legislation for greater truck lengths and weights, and settlements of rail-labor negotiations. The rails are unable to fully pass on the rapid rise in fuel costs due to their large amount of contractual business. We believe that the industry has learned a lesson - upon renegotiation of existing contracts, future agreements will provide for recovery of costs that are not under the control of the management.

The threat from increased truck sizes, if passed, could hurt the rails' efforts to recover high-value manufactured freight from truckload operators. Earlier attempts utilizing piggyback vans and single containers proved less than successful, with profit margins minuscule if even existing. The doublestack mode presumably is producing real profits, but a major change in truck lengths could quickly reduce the rails' operating cost benefits, which may be utilized to offset perceived service disadvantages.