Traders think railroads are on right track

VIEW FROM WALL STREET

April 28, 1991|By Thomas Easton | Thomas Easton,New York Bureau of The Sun

NEW YORK — New York--The chief executives of the three major railroads rolling through Baltimore dropped by New York during the past two weeks and gave similar reports on current conditions: The economy is still derailed.

Railroads are in a good position to monitor business conditions since they tend to carry the bulk commodities that feed the factories that ultimately feed society. Their role at the beginning of the economic food chain is why some of the oldest theories of stock market timing are premised on movement in the Dow Jones transportation index (once entirely comprised of rail stocks) being subsequently replicated by the better-known industrial index.

Recently, there's been less cooking going on. Traffic everywhere is down. On the East Coast, where the Consolidated Rail Corp., CSX Corp. and Norfolk Southern Corp. dominate, it has plunged.

"Charitably, it could be called a difficult operating environment," CSX Chief Executive John Snow said.

By perhaps the crudest measure, car loadings excluding intermodal containers, Conrail's business is down 12.5 percent, CSX's 10.5 percent and Norfolk Southern's 8.5 percent, said Susan Chapman, a securities analyst with Forbes, Walsh, Kelly & Co. in New York.

Not surprisingly, that took a toll on all three's quarterly earnings. But Wall Street looked at the poor results and decided the industry, if not the economy, is on track. As one rail executive after another told his gloomy tale, the share price of his company hit new records.

Mr. Snow suggested the second half of the year may see a rebound, but his optimism was not universally shared. Conrail's outlook was expressed in two words: "no relief." Because of a route structure that stretches between East Coast cities and the Midwest manufacturers, Conrail has been particularly good at picking up embryonic trends. In 1989, a decline in its shipments presaged the official figures that certified a recession.

That made its current results all the more disheartening. During the January through March quarter, every one of Conrail's major business categories registered lower traffic levels than a year ago, from automotive to metals to forest products to grains to fertilizer -- in short, every stage of the economic food chain short of actual consumption, from the most basic staples to building products to refined sophisticated manufactured luxuries.

Why then the rebound in rail stocks? Analysts point to two reasons. First, investors seem, for the moment at least, to be devoid of despair. "There's a sense that the economy has to turn around and the rails will be a beneficiary," said Ms. Chapman. Secondly, the railroad industry itself appears to be in the midst of profound internal change. Traditionally, the heavy fixed structure of railroads has meant any shift in revenue has an exagerated impact on the bottom line. But recently, railroads have demonstrated an ability to pare costs in line with sales. In 1990, the 11 publicly traded railroads cut expenses almost dollar for dollar with declining revenues, according to data compiled by Media General.

"We're learning what we have to do to get through this recession, and we are going to be able to continue to do it when the recession is over," H. William Brown, Conrail's senior vice president for finance, said.

The most evident cause for the sharp cost reductions has been a dramatic decline in employment. The payroll of the largest railroads -- those with about $100 million or more in revenue -- has declined from 458,000 to 216,000. Conrail, because of its extensive reorganization from the bankrupt Penn Central, has undergone the greatest contraction, from more than 70,000 workers to less than 28,000. But the others have also trimmed to an extent that would be considered remarkable in almost any other industry. CSX has cut about half of its railroad employees and Norfolk & Southern about one-third.

A report released last week by Salomon Brothers suggests that between 1983 and 1989, the eight largest publicly traded railroads cut the amount of revenues absorbed by direct labor costs by 15 percent to 20 percent. Whether the industry can continue to drive down labor costs and find further expense cuts, however, is uncertain. "Over the next 10 years we won't see as much as during the past 10," Ms. Chapman said. "I think the shrinkage has about run its course."

A one-day strike by rail workers the week before last underscored a stiff round of negotiations between rail companies and employees, and a recommended settlement by a presidential advisory board would provide the companies with significant, but limited, gains. "We did not get a fun

damental breakthrough," Mr. Snow said.

And the traffic losses may not be over, making any decline in productivity growth particularly painful. Gary Yablon, an analyst with Wertheim Schroder, said that the contraction in traffic was twice as severe during the last recession and that history could ++ repeat. "Just because it's bad now," Mr. Yablon said, "doesn't mean it can't get worse."

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