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Some Shortline Railroad Finance Basics

AAR Annual Meeting of the Railroad Treasury/Finance Division

Naples, Florida

11/6/2007

Roy Blanchard, The Railroad Week in Review

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“There is a need to work more closely with short lines in the light of growing regulatory and legislative pressures now facing the industry.”

-- Mark Schmidt, BNSF, 3Q07 Short Line Newsletter

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Short Lines and Class Is (FY 2006)

Class I SL Rev Units Class I RU Pct SL

BNSF 1,417,000 10,637,000 13.3%

CN 640,600 4,824,000 13.3%

CP 277,000 2,618,000 10.6%

CSX 926,900 7,358,000 12.6%

KCS 171,100 1,921,000 8.9%

NS 1,018,000 7,901,000 12.9%

UP 1,400,000 9,852,000 14.2%

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The Shortline Railroad Universe:

• More than 500 shortline (regional and local) names, 43,000 route miles, 12 mm cars per year (cpy)*

• 32 S&Ts (BRC et al), steel roads (EJ&E) have 2600 route miles, 5.2 mm cpy

• NS has most (253), CP fewest (61)• Top 20 SL ops companies (ex steel, S&T) - 174 roads, 27,000

miles, > 4 mm cpy• Top 5 Commodities 2007 thru Q3: 16% forest products

(lumber, panels, paper and related), 14% chemicals, 11% grain, 12% coal, 9% metals and related

*More accurately, revenue units (I’ll explain)

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Leading North American Short Line Operators

Operator RRS Miles of Line Cars per Year Cars/yr/mile

RailAmerica 43 8000 1,140,000 143

Genesee & Wyoming 43 3027 1,021,000 337

Washington Group 2 723 285,000 394

DM&E 2 2,300 227,000 99

OmniTrax 17 2,600 200,800 77

Watco 16 3600 275,000e 76

Anacostia & Pacific 4 594 137,000 231

Quebec Railway 7 1643 83,000 51

Ohio Central 7 516 71,000e 138

Rio Grande Pacific 3 484 57,000 118

Totals 145 23,487 3,496,800 149

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How Short Lines Earn Their Money

• Revenue per carload, mostly from Class I divisions, allowances or fees; some ancillary fees (demurrage et al), property leases, short-haul intra-line moves.

• Class I pays short lines out of revenue per EITF99-19; can discourage short line participation if market manager performance is measured on total revenue.

• Common short line compensation schemes: ISS, handling fee, Jct Settlement, switch fees; the folly of car-hire reclaim.

• How fuel surcharge revenue is shared varies widely.

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Shortline Economics

• Class I average FY 2006 revenue per merchandise load was US$1996.

• Shortline pro forma allowance still US$250-$300 per revenue load, does not go up with Class I RPU increases

• Double-digit Class I volume YTD 2007 decreases in low-rated commodities (forest products, aggregates, waste) hit allowance-based short lines the hardest

• Proposed regulatory and legislative limits to rate increases will hurt ISS short lines the most

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Short Line 3Q07 YTD Commodity Trends Commodity Class I delta SL delta PP spread

Grain -2.6% .09% 2.51

Coal -0.8% -1.4% (0.63)

Lumber, Wood -19.4% -17.3% 2.06

Pulp, Paper -6.6% -8.7% (2.05)

Chemicals 4.5% 7.7% 3.25

Metals -9.2% -7.4% 1.78

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Class I vs. Short Line Expense Comparisons

BNSF RailAmerica (1)

($millions) 2005 Pct of Rev 2005 Pct of Rev

Revenues $ 12,987   $ 424  

Expenses        

Comp & benefits $ 3,515 27.1% $ 131 30.9%

Purchased Services $ 1,714 13.2% $ 33 7.8%

Depreciation $ 1,075 8.3% $ 31 7.3%

Equipment Rents $ 886 6.8% $ 51 12.0%

Fuel $ 1,959 15.1% $ 47 11.1%

Materials, other $ 916 7.1% $ 80 18.9%

Total Ops Exp $ 10,065 77.5% $ 373 88.0%

Ops Income $ 2,922 22.5% $ 51 12.0%

Operating Ratio 77.5   88.0  

Note (1) FY 2005 was the last FY 10-K for RRAGWR not used because it reports consolidated results w Australia

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Measuring Short Line Results

• Rules of thumb: Rule of 100, $5,000 per mile per year for track maintenance to meet FRA Class 2 specs, fuel burn 8-10 gallons per revenue unit per year

• Resources consumed per revenue unit (Watco): man-hours, car hire, fuel burn, switching hours, etc.

• EBITDA vs. Operating ratio: No tax advantage to capitalizing major expenditures, below-the-line items have little meaning for core values; puts focus on cash-generating capabilities of property.

• EBITDA margin 40% - 50% for well-run short line; CP estimates DM&E will be at 40% for CY 2007

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Shortline Growth

• Most roads started as Class I branch lines

• Staggers Act encouraged spin-offs; effects of new STB ruling?

• Lines transferred at low cost on assumption that short line would continue to feed Class I core exclusively

• Some short lines “bought their freedom” (A&M/BNI)

• Recent short line transactions have been leases (BNI), Joint Ventures (NSC)

• Until recently SL pct volume growth > Class Is; Masking Class I losses?

• A bright spot: BNI short line units up 8% through 3q07

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Short Line Realities

• Better than Class Is for gathering and distribution, small-customer service, local infrastructure funding

• Free up scarce Class I resources (locos esp) for core ops

• 60% of short lines may not meet minimum economic thresholds; exceptions are single-purpose lines w hi vols

• The most successful understand and complement Class I financial, commercial and operating goals

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Shortline Consolidation

• Bethlehem Steel roads to Lehigh Valley Rail Mgt., Georgia Pacific to GWR, Alcoa to RailAmerica

• Consolidation among shortlines: RailNet to OmniTrax, Savage; Rail Management Group, Maryland Midland to GWR

• Second-tier moves – Caney Fork & Western to Cundiff Group

• Class Is wary of buyers over-paying

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The Capacity Question

• AASHTO: Predicts 70% growth in freight volume by 2020. • National Freight Infrastructure Capacity and Investment

Study: Rails need to invest $135 bn in capacity over the next 30 years to meet demand.

• The AAR: HR 2116, S 1125: the Rail Freight Infrastructure Act of 2007, provides for 25% tax credit for new railroad capacity in both infrastructure and locomotives. See also www.aar.org/itc/itc.asp .

• Public-Private Partnerships

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Short Line Capacity

• ASLRRA: Current federal tax credit program offsets up to 50% of the amount invested in new or rebuilt track.

• Railroad Rehabilitation and Improvement Financing (RRIF) Loans – Administered by FRA. Direct loans or loan guarantees for the acquisition, development, improvement or rehabilitation of existing or new intermodal or rail equipment facilities. 

• State and local rail infrastructure funding varies by state, some more generous than others.

• Save Our Service (SOS) rail customer coalition lobbying for the tax credit extension

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Closing thoughts: Possible Implications for Short Lines in a Re-regulated Railroad Environment

• Cost of Capital: Rate ceilings, low-rated commodities most, shortline concentration.

• Small Rate Cases: Risks of customer filing to remove commodity from exempt list.

• HR 2125: “Railroad competition and Improvement” Act does none of the above; nobody calls it “re-regulation.”

• Paper Barriers: Class Is holding off; “buying your freedom.”• Competitive Access: A bad deal all around. A fable.

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Thanks

For your kind attention. Now for the fun part…

It’s Q&A time!