Industry Trends (from Progressive Railroading/June 2008)

North American railroads’ rolling stock purchases might be down, but at least one financial services law firm seems pleased with the number of recent orders. Last month, Chapman and Cutler L.L.P. announced it has advised on transactions worth more than $3.5 billion so far in 2007-08.

Last year, the firm — which represents Class Is in lease and pass-through financings of locomotives, rail cars and intermodal facilities — helped clients in 26 separate leveraged lease financings involving more than $1.7 billion worth of locomotives and equipment, including coal, grain, box and refrigerated cars, and intermodal containers.

Economic factors are well aligned in rail’s favor, such as strong growth in coal volume, agricultural exports and international trade, Chapman and Cutler said.

Making the revenue adequacy grade

Last month, the Surface Transportation Board reported that three of the seven Class Is were “revenue adequate” in 2006: BNSF Railway Co., Norfolk Southern Corp. and Canadian Pacific Railway subsidiary the Soo Line Railroad Co.

The STB determined the large roads’ rate of return on net investment (ROI) as follows: BNSF, 11.43 percent; CSX Transportation, 8.15 percent; Grand Trunk Corp. Consolidated (including all Canadian National Railway Co. U.S. affiliates), 9.47 percent; Kansas City Southern Railway Co., 9.31 percent; NS, 14.36 percent; Soo Line, 11.6 percent; and Union Pacific Railroad, 8.21 percent.

The STB considers a railroad to be revenue adequate if it achieves an ROI equal to the current cost of capital (i.e., the cost of borrowing). Congress directed the board to conduct revenue adequacy determinations on an annual basis.

Earlier this year, the STB ruled it would begin using a multi-stage discounted cash flow (DCF) model to complement a capital asset pricing model when determining the cost-of-equity component of the rail industry’s cost of capital. Since 1982, the board had employed a single-stage DCF method to determine the cost of equity, but the multi-stage DCF is more “theoretically sound,” the STB believes.