Updated 4:17 p.m. ET, Mon May 14, 2001

JoC ONLINE

Railroad stock prices are near their highs for the last 52 weeks. Considering that rail traffic generally is running below levels of a year ago, what does the market know that the rest of us don't?

For one thing, the market knows that despite the run-up in rail stocks so far this year, with one exception, they still are way below the prices at which they were selling in May 1999. So, if you're a short term investor who got in last year you've had a pretty good run. But if you're a long term investor who got in more than two years ago, you're still looking for a profit.

Talk to securities analysts and to veteran railroad watchers and you find two related themes: Service quality is the way to improving earnings.

After years of the stumbling and bumbling of inconsistent service, reliability is improved at just about every carrier. That relieves the railroads of the need to sell by price. Despite the economic slowdown that has hit railroads along with the rest of the manufacturing economy, carriers have been successful at increasing rates this year.

Paul M. Teller, Canadian National president and chief executive, likes to talk of his railroad's improved quality of revenue. That means CN doesn't have to discount to keep or gain traffic.

Rate increases go a long way to cushion softness in traffic. Norfolk Southern, for example, realized a 4% gain, year-over-year, in carload yield despite a decline in volume. Its first quarter earnings quadrupled those of first quarter 2000, when the railroad still was tying to recover from the service disruptions that followed the June 1, 1999, assumption of 58% of Conrail operations.

David Goode, NS chairman, president and chief executive sounded like CN's Tellier when he recently told analysts: "We're now beginning to see fair pricing for our service, which is clearly improving. It's a value pricing proposition."

Railroads are being aided by continued strong coal shipments. Even though coal is a lower priced commodity, it is crucial for the capital intensive railroads that rely on base-load traffic to provide the revenue need to cover their high fixed costs.

Coal shipments are likely to remain strong throughout the year. Earlier, the gain was an easy comparison to 2000 when utilities were working down bloated inventories accumulated in anticipation of possible Y2K computer problems and a mild winter of 1999-2000. Volume now is being aided by normal weather patters and low coal inventories.

Toss in the fact that railroads moved vigorously and quickly to cut operating expenses as soon as traffic began to soften late in 2000 and you have the makings of improving profit margins even though overall volume is nothing to write home about.

Railroads also appear to be capturing some traffic from the trucking industry, which softens the effects of the economic slowdown. One reason for that may be that rail rates generally are lower than truck rates but shippers who could opted to use trucks because of the inconsistency of rail service. With service consistency, railroads can compete on the margin where price is more important than service.

Service quality improvements couldn't come at a better time. Their costs are under less pressure than are those of competing truckers. Truckers face a continuing shortage of drivers, which causes them either to turn down available business or to shift some of their traffic to rail intermodal service.

High fuel prices are hitting truckers considerably harder than railroads. While railroads can hedge and lock in future prices for delivery to their system fuel points, the truckers must buy their diesel fuel at the retail pump.

There also is a theory that railroad price/earnings multiples tend to expand later in recessions or economic slowdowns. Having already taken costs out of their systems, according to this theory, they will carry more of each dollar of revenue to the bottom line as traffic increases resume.