By John D. Boyd

Bridge News

KANSAS CITY (B)--The stocks of North American rail freight companies could soon break out of their long decline, stock analysts say, once the U.S. regulatory Surface Transportation Board follows up on recent hearings on rail mergers with some statement of how it will proceed from here. Analysts say that could come as soon.

The STB's hearings began in Washington March 7 and concluded March 10, and STB Chair Linda Morgan had signaled that she gave the industry and its customers guidance on how that regulatory board would treat merger requests.

That guidance could affect virtually every major business in the U.S. Railroads serve not only bulk shippers and customers of such commodities as coal, grain and metal ores, but also a vast array of manufacturers and retailers who depend on railroads to haul truck containers and trailers full of products over long distances.

And while trucks compete for business against trains, any significant slowdown in rail service can throw enough extra freight onto highways that it strains the already hard-pressed trucking industry.

Analysts pose differing scenarios for what the STB might do, but agree that the stock impact from the agency's extraordinary rail-merger hearings will depend on whether--and how--the agency offers some form of moratorium on mergers.

Charts of the stocks' performance tell a broad tale of investor wariness for almost all major rail companies--whether they are struggling through post-merger congestion like the eastern-U.S. lines or are performing effectively like the big western-U.S. and Canadian lines. One after another, their charts look as if the railroads have tumbled off a mountainside.

Among railroad-owning companies, only Kansas City Southern Industries has enjoyed a strong run-up in its stock price. But that is widely seen as a play on the hot Janus mutual funds that are part of KCSI holdings, rather than its Kansas City Southern railroad unit that operates in the central U.S.

Although many traditional types of businesses are suffering similar stock declines, rail stocks are bogged down by something more than the broader market's resistance to "old economy" companies in favor of the "new economy" high-technology firms that are building go-go Internet businesses.

Ever since Canada's largest rail line, Canadian National, and the second-largest U.S. railroad, Burlington Northern Santa Fe, announced in December that they would merge pending STB regulatory approval, the entire industry has been under an "ugly, gray cloud" of merger uncertainty, said ING Barings analyst Douglas Rockel.

The fears are that this could touch off another fast-moving

wave of big rail mergers as rivals to the CN-BNSF team seek partners to stay competitive, and in the melee rail service could suffer or freight rate s could rise for the growing number of freight shippers who would be captive to a single massive carrier.

And investors worry with good reason, Rockel added. Even though some mergers have gone smoothly in recent years, others were followed by long periods of faltering rail service that pushed up costs and lost customers.

Investors in rail stocks, Rockel notes, have "seen missed estimates (for performance), lowered dividends, less-than-expected earnings and higher-than-expected congestion costs."

He believes investors would be mostly relieved if the STB imposed a moratorium on large rail mergers, which is just the route many rail customers are urging the STB to take so that everyone can have more time to adjust to the mergers that took place in the late 1990s.

Michael Lloyd, analyst for Merrill Lynch, said the STB wants to avoid a rush to the endgame--a new wave of rail mergers that very quickly results in just two combined rail systems competing across the entire North American continent.

To prevent that, Lloyd told Bridge News, "it's very clear that they (the STB) are going to come out with new merger standards" that railroads would have to meet before the agency would consider their merger proposals.

that would allow them to go ahead and combine while putting off merger candidates that cannot show they are ready. "The problem is in the follow-on mergers," Lloyd said, "not this merger."

Top executives of other major railroads have made it plain that they could not afford to ignore a CN-BNSF merger, and would soon be looking to match it. BNSF competes in the western and central U.S. against the largest U.S. line, Union Pacific, which suffered an historic 1997-98 service meltdown after it absorbed ailing Southern Pacific.

CN is already a force in the U.S. It recently acquired the smooth-running Illinois Central, giving it a prime north-south route in the U.S. that basically parallels the Mississippi River corridor. And it has a marketing alliance with Kansas City Southern.

and Midwest.

Smaller Kansas City Southern would have to be absorbed as well. It would not expect its alliance with CN to survive a BNSF-CN merger and would be forced to negotiate a merger. It runs mainly from the central U.S. to the Gulf of Mexico, but has links to Chicago, owns a cross-border connecting line into Mexico and is a part owner in the largest Mexican rail concession.

The analysts think the STB will try to find a way to stop all that from quickly unfolding. The issues are how soon the STB acts, how that affects each of the players and their stocks, and how the companies respond.

"We will have to wait a couple of weeks" to determine the impact on rail stocks, said Merrill Lynch's Lloyd. He said the STB would certainly signal its intentions on rail-merger procedures by the end of March and perhaps before.

And even if the agency allows the big pending merger to go forward while blocking others for now, Lloyd said the STB would not need to stretch out its review process beyond the time it normally takes to consider a merger. That has averaged a year or less in recent cases.

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