When If Ever a Profit?

One night last week the members of the New York Railroad Club sat down to their 67th annual dinner in Manhattan's Hotel Commodore. For topflight railroad executives it was a relatively cheery meal. They were still chortling because freight carloadings rose 30% between Sept. 9 and Oct. 21 --the largest increase over the shortest period in U. S. history. Phrases like "this augurs well" cropped up in more than one of the evening's speeches. But to thoughtful men among them, the carloading boom was an ugly fact to face. For it demonstrated that their huge industry cannot make a respectable profit even when business is booming.

Of the 139 Class I roads,* about one-third (including 20 in bankruptcy) are unable to meet their fixed charges on bonds and preferred stock. Another third is little better off. Only eight Class I roads have bonds outstanding which are gilt-edged enough to be marked with Moody's Aaa (Pennsylvania, Norfolk & Western, Chesapeake & Ohio, Union Pacific, Wheeling & Lake Erie, Virginian, Detroit & Toledo Shore Line, Richmond Fredericksburg & Potomac).

Complaints. Railroad men have many a complaint against the economic conspiracy which has ruined their business. One big complaint is against the tremendous rise in taxes and wages which they have to pay. In 1916 taxes took 4.4% of gross operating revenues. By 1938 the tax percentage had gone up to 9.5%, $340,781,954. Wages took 28.3% of gross revenues in 1916. But in 1938 employes got close to 50% of the roads' $3,565,000,000 gross.

Other industries have borne similar loads of taxes and wages but few have had to face such entrenched unions as the railroad brotherhoods, which resolutely resist the march of technological progress. Even when improvements sped up schedules the brotherhoods prevented any savings and successfully insisted on "featherbedding" which means paying crews on a mileage basis. They draw eight hours pay for 100 miles on a freight, 150 miles on a passenger train. Many "featherbed" crews now draw eight hours pay for runs of less than four hours.

Meanwhile barge competition heavily subsidized by the Government undercuts railroad rates on many inland waterways. Trucks--which until recently did not have the handicap of being under Government regulation--meanwhile cut into freight traffic, and pipelines took a flood of oil (1938's total: 1,158,000,000 bbls.) that railroads would have liked to have in their tank cars. At the same time automobiles and motorbuses cut passenger traffic particularly on short runs, and finally airplanes arrived to cut long distance Pullman travel.

Capitalization. Railroad spokesmen like to insist that the railroad industry is not overcapitalized. They point out that the stock and bonds in the public's hands are only $17,987,962,640 as against property investment of $26,055,536,805. This statement does not take account of the fact that $5,867,000,000 of rail securities are held by other railroads, notably Pennsylvania, Chesapeake & Ohio, Union Pacific. Nor does it account for the fact that the figure of $26 billion includes many an asset that has not been adequately depreciated. ICC permits equipment in many cases to be depreciated as though its efficient life runs over 30 years, in other cases as though it were immortal. Fact is that rail equipment is in large part old and high cost, and the managements admittedly owe the properties many hundreds of millions of dollars of back maintenance.

Most unarguable fact about rail capitalization is that in the last good year--1937 --Class I U. S. railroads had $3,186 per mile (miles operated: 238,539) of road left, after operating expenses, with which to pay their interest bill of $2,769 a mile, leaving a meagre $417 per mile for preferred and common stockholders. In short, 87% of operating revenue was required for fixed charges in an excellent year. This contrasted with an average of $4,694 a mile available for charges in the ten years 1925-35, $1,821 a mile earned for stock (39% of operating revenue for fixed charges). In 1938, a bad year, fixed interest charges remained around $2,700 a mile, earnings available for interest dropped to $2,177 a mile. Result: preferred & common stockholders were $527 a mile under water. As capitalized on earnings, a conservative value of U. S. railroads today is certainly far below $26 billion.

Reorganization. The 20 bankrupt Class I railroads of the U. S. are:

Akron, Canton & Youngstown

Central of New Jersey

Chicago & Eastern Illinois

Chicago & North Western

Chicago Great Western

Chicago, Indianapolis & Louisville

Chicago, Milwaukee, St. Paul & Pacific

Chicago, Rock Island & Pacific

Denver & Rio Grande Western

Duluth, South Shore & Atlantic

Erie

Minneapolis, St. Paul & Sault Ste Marie

Missouri Pacific

New Haven

New York, Ontario & Western

New York, Susquehanna & Western

Frisco (St. Louis-San Francisco)

St. Louis Southwestern (Cotton Belt)

Spokane International

Western Pacific

Book value of their securities is roughly $5,000,000,000. Delaying their reorganization into new, solvent corporations is the fact that preferred & common stockholders don't want to take their licking. They may be induced to throw in the sponge by the Supreme Court's recent (unanimous) decision in the Los Angeles Lumber case (TIME, Nov. 20) that, where stock is under water in reorganizations, it must be wiped out. Universally admitted is the fact that railroad mileage, revenue, equipment have shrunk substantially in the last ten years. Reasonable enough, therefore, is the contention that capitalization must be slashed proportionately. Unanswerable is the moral to be drawn from the drastic reorganization in the nineties of roads like the Santa Fe and the Union Pacific which have done well ever since. The same moral is reinforced by the case of the Milwaukee which came out of bankruptcy in 1927 with a higher capitalization than it went broke on, which was bankrupt again in 1935.

Rail reorganization, new style, is typified by the case of the Chicago & Eastern Illinois. The Interstate Commerce Commission recently approved the reorganization plan of the C. & E. I., and it needs only formal Federal Court approval to go into effect. C. & E. I.'s common stockholders are wiped out completely by this, the first reorganization plan to be completed under 776. Under reorganization the road's fixed charges have been cut from $2,274,000 to $657,000. Under reefed capital sail C. & E. I. bad a good chance to operate at a profit. For that it can thank its smart president Charles Thomas O'Neal, who pulled up the road's operating socks and combed its hair while its financial paunch was being reduced.

To get reorganization plans for these roads into the same shape as the plan of the C. & E. I., honest, scholarly, hardworking Chairman Joseph Bartlett Eastman and his colleagues of the Interstate Commerce Commission have many a busy year ahead. For a railroad reorganization is not a job to be whipped up in six months or a year. The roads now working under 776 have been years in working down to their plight, will be years working out of it again. For in beating down capitalization to a point where a road can make money, many divergent interests must be brought into agreement.

Consolidation. Exempt from strictures placed by investors on most railroads are a handful of blue chips: chiefly Pennsylvania, Union Pacific,, Norfolk & Western. Chesapeake & Ohio, Virginian--whose bonds sell for around 100, whose common is almost always on a paying basis. Of these top-notchers, the last three have the steady and lucrative business of moving bituminous coal from the famed Pocahontas fields. These roads have fat to live on during lean years. During the last bull market they went shopping for weak feeder lines into other territories, tried to expand their operations, ride the bull market into consolidation.

When the 1929 crack came, C. & O. was deep into the Erie and C. & E. I. (both now in bankruptcy) plus the weak Nickel Plate and Pere Marquette. The Pennsylvania had the New Haven, the Lehigh Valley, the Wabash.

There are several obstacles to consolidation on the basis of sober values.

> To rail labor, Congressionally represented by shrewd Senator Burt Wheeler, is conceded Washington's No. 1 lobby. Notorious is its ability to send bills crashing through in the last few days of a session; formidable is its veto of any bill to reduce the number of rail jobs available for its dues-paying members.

> Rail management, mostly flabby and bureaucratic, generally opposes any move to cut the number of management jobs.

> U. S. public opinion refuses to accept railroads as monopolies although, perversely, it approves having the Interstate Commerce Commission regulate them as such.

> Consolidations are also impractical because the big roads cannot agree among themselves on which of the little roads they will absorb. ICC, in its Consolidation Plan in 1929, compromised by agreeing to the creation of as many as 21 systems. Plans less influenced by political prudence advocate something more like nine systems; the most drastic one provides for just three systems.

Rates: Governed by no general rules, shrouded in metaphysical complexity are U. S. freight rates. No rhyme or reason explains why iron products move from Chicago to Los Angeles more cheaply than from Denver, which is roughly half the distance. There are countless parallel cases. High rates on less-than-carload freight originally invited the trucks into the business, which they are handling at lower rates than the roads can meet.

High freight rates on oil practically subsidized the pipelines.

An overdue rate row is being kicked up by husky moose-hunting Luther Mason Walter, operating trustee of Chicago Great Western, one of the chronically anemic roads in the great midwestern bankruptcy belt. Mr. Walter's complaint: the Midwestern roads are not getting their fair share of charges on transcontinental hauls, get a lean, unprofitable cut while the roads at the eastern and western ends take the big slices.

General is the agreement that more realistic capitalization, plus economies of consolidation, equipment modernization, would make important rate reductions possible & profitable.

Management: No more eloquent commentary on the alertness, competitive mindedness of U. S. rail management exists than the story of how they were caught asleep at the switch by the hard-hitting, aggressive, new transport men who came into bus & airline management, cutting deeply into the railroad's passenger business (which is roughly 15% of their total).

In 1916 U. S. railroads carried more than a billion passengers. Last year they carried less than half a billion. Much of the loss went into trips made by U. S. citizens in their own automobiles. But a big piece was lost to U. S. bus lines and a big reason for the loss was the failure of the railroads to provide up-to-date accommodations for day coach passengers soon enough or to charge competitive fares. In the 1938 recession eastern roads actually upped fares. Bus lines quickly placed orders for new equipment.

Meanwhile the airlines began to drain the cream of the Pullman business from the 2,000 U. S. Pullman cars. Today, the number of airline travelers between New York and Chicago is almost equal to the total combined average carried by the Twentieth Century and the Broadway Limited. And airline passenger mileage is about equal to 9.5% of the railroad's Pullman passenger mileage. Few years ago the railroads suddenly came to life, tried to head off the bus and airline business. On U. S. roads went fancy day coach trains. Pullman accommodations were improved. Schedules were speeded up. as they could have been long ago. But it was too late. The bright young men of the bus and airline business had too much of a jump on the conservative old men in the railroad game.

Renaissance. Dreary is the prospect, shocking the record of U. S. railroading by the norms of successful capitalist operation established by such corporate pace setters as General Motors, Chrysler, Ford, Bethlehem, National and Inland Steels, General Electric, Du Pont, Monsanto Chemical, Union Carbide. Stagnant is the condition of U. S. communities and heavy industries which throve on purchases by U. S. railroads. Strictly boycotted by ambitious capital and ambitious youth is the U. S.'s former No. 1 industry. Meanwhile, basic units of the nation's transportation system--like bonds of the Rock Island--go begging for two to 15-c- on the dollar.

A classic example of the practice--neglect your property before bankruptcy, rebuild it (during bankruptcy) out of unpaid interest--is Baltimore & Ohio, which reduced maintenance over 25% in 1938 in order to make as good a showing as possible. U. S. capitalists with idle money to invest remain more impressed by the B. & O. rule than stray examples of new methods like the Great Western and the Southern.

Yet the eventual transformation of rail management is not beyond hope. In the bankruptcy-ridden Middle West, C.&E. I. President O'Neal, like Chicago Great Western Trustee Walter have demonstrated what smart management can do with even marginal roads. President Scandrett of the over-capitalized, wretched Milwaukee has built up his property, won kudos from Moody's for paring maintenance much less than other roads when the 1938 recession cut revenues. Southern Railroad's Ernest E. Norris recently set a precedent by buying new equipment, making money on it and retiring some debt.

But for the most part U. S. railroading's renaissance waits for the day when railroads cease to regard officers under 55 as babes-in-arms.

*Roads with annual operating revenue over $1,000,000.

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