Financial Model & Business Planning for Armenian Railways

Prepared for:

The World Bank

29 November 2000

Prepared by:

HARRAL·WINNER·THOMPSON·SHARP·LAWRENCE, INC.

HARRAL·WINNER·THOMPSON·SHARP·LAWRENCE, INC.HWTSL/ARC 27-Nov-00 2

Financial Model

HWTSL has developed a Railway Financial Model for Armenian Railways.

• The model contains three interrelated Excel workbooks, one for each of the three CJSC of Armenian Railways

– Can be used together or individually

– ARC can change forecasting assumptions

Charges based on gtk train-

km

Model of Transportation

CJSC - Income Stmt - Balance Sheet - Cash Flow

Model of Infrastructure

CJSC - Income Stmt - Balance Sheet - Cash Flow

Model of Rollingstock

CJSC - Income Stmt - Balance Sheet - Cash Flow

Charges based on

use of rolling stock

gtk

tkm, train-km

tonnes

tkm, train-km

HARRAL·WINNER·THOMPSON·SHARP·LAWRENCE, INC.HWTSL/ARC 27-Nov-00 3

Financial Model

The model for the Transportation CJSC forecasts railways traffic demand. This is used in all three models. It also forecasts and financial results for Transportation.

• Two traffic forecasts

– Base case

– Open borders

• Incorporates methodology for charging for Infrastructure and Rollingstock recommended by Victor Alalouf

• Produces pro forma financial statements for the Transportation CJSC

• Generates measures of activity that measure “demand” for Infrastructure and Rollingstock

Revenue collection period,

bad debt

pkm, passenger train-km, tkm, tonnes

TransportDemand

Freight Rev

Revenue

Pass Rev

asset values operating expenses

depreciation

OperatingExpenses

Assets

Payment to Rollingstock

Payment to Infrastructure

Wagon Hire

Stations & Yards Income Statement

Cash

Balance

FinancialStatements

Auxiliary & Other

HARRAL·WINNER·THOMPSON·SHARP·LAWRENCE, INC.HWTSL/ARC 27-Nov-00 4

Financial Model

The model for the Rollingstock CJSC forecasts pro forma financial statements based on demand for service from Transportation CJSC.

• Demand for Rollingstock services come from Transportation CJSC

– Train-km

– Tonnes

– Tonne-km

• Asset requirements & operating expenses are calculated based on these demands & estimates of Rollingstock productivity/input prices

Auxiliary loans & Other

Income Statement

Cash

Balance

FinancialStatements

Revenue collection

period,bad debt

Model of Transportation

CJSCRevenue

train-km, tonnes,tonne-km

asset values operating expenses

depreciation

OperatingExpenses

Assets

Diesel locomotives

Electric trains

Wagons

Electric locomotives

Coaches

HARRAL·WINNER·THOMPSON·SHARP·LAWRENCE, INC.HWTSL/ARC 27-Nov-00 5

Financial Model

The model for the Infrastructure CJSC is similar to the model for Rollingstock.

• Demand for Infrastructure services come from Transportation CJSC

– Train-km

– Tonne-km

• Asset requirements & operating expenses are calculated based on these demands & estimates of Infrastructure productivity/input prices

Revenue collection

period,bad debt

Model of Transportation

CJSCRevenuetrain-km,

tonne-km

Auxiliary loans & Other

Income Statement

Cash

Balance

FinancialStatements

asset values operating expenses

depreciation

OperatingExpenses

Assets

Signaling & Communications

Electrification & Power Supply

Management

Track

HARRAL·WINNER·THOMPSON·SHARP·LAWRENCE, INC.HWTSL/ARC 27-Nov-00 6

Traffic & Revenue Forecast

HWTSL forecasts modest traffic growth in the base case, with some additional traffic if borders are opened.

• Economic growth is expected to add modestly to rail traffic volumes, both passenger and freight.

• Opening of borders is expected to stimulate the economy of Armenia and generate additional rail freight traffic (~25% by 2005)

• Opening of borders is not expected to result in an order of magnitude change in rail traffic

– Trading patterns of the former Soviet Union have changed dramatically in the last 10 years

– Armenia’s has limited heavy industry that might generate rail traffic

– Transit routes through Armenia face stiff competition from road and rail

Revenue Comparison: Base Case vs. Open Borders Case

0

2,000

4,000

6,000

8,000

10,000

2000 2001 2002 2003 2004 2005

Year

AM

D (

000,

000)

Base Open Borders

Freight Traffic Comparison: Base Case vs. Open Borders Case

0

100

200

300

400

500

600

2000 2001 2002 2003 2004 2005

Year

tkm

(00

0,00

0)

Base Open Borders

Passenger Traffic Comparison: Base Case vs. Open Borders Case

010,000

20,00030,00040,00050,000

60,00070,000

2000 2001 2002 2003 2004 2005

Year

Pass

enge

r-km

(00

0)

Base Open Borders

HARRAL·WINNER·THOMPSON·SHARP·LAWRENCE, INC.HWTSL/ARC 27-Nov-00 7

Railway Freight Prices

0.00 0.02 0.04 0.06 0.08 0.10 0.12

Ireland

Denmark

New Zealand

United Kingdom

Japan

Netherlands

Austria

Brazil

France

Italy

Hungary

Israel

Portugal

Sweden

Slovakia

USA/FEC

Armenia

Czech Republic

South Africa

Poland

Czechoslovakia

Bulgaria

Canada

USA:D&RG

Turkey

Russia

Chile

China

Kazakhstan ('00)

Belarus

Former Soviet Union

Mongolia

US$/TKM

Traffic & Revenue Forecast

Armenian Railways freight prices are moderate relative to other countries..

• Freight rates are forecast to increase with inflation

• However, freight rates are not forecast to increase in real terms because most freight hauls are short distance

– Trucks are competitive for most movements

• Armenian transport law restricts the railways ability to price transport according to market demands

– Currently, all freight traffic is charged the same tariff level on a drams-per-tonne-kilometer basis

– This restricts growth in some traffic that may be best suited for rail traffic but where trucking prices are lower

– And limits growth in other traffic that may be generated with lower tariffs

– Further, some tariffs could be raised, generating increased operating revenue, without significant impact on the Armenian economy.

HARRAL·WINNER·THOMPSON·SHARP·LAWRENCE, INC.HWTSL/ARC 27-Nov-00 8

Cost Per Passenger Kilometer

0.00 0.05 0.10 0.15 0.20 0.25 0.30 0.35

Belarus

Armenia

Former Soviet Union

Bulgaria

Kazakhstan (99)

Czechoslovakia

China

Russia

Slovakia

Turkey

Mongolia

Indonesia

Czech Republic

South Africa

Poland

Chile

Hungary

Portugal

Brazil

Israel

Australia

Austria

Italy

France

Netherlands

Denmark

Canada

Sweden

United Kingdom

Japan

USA

Ireland

US$

Traffic Forecast

Armenian Railways passenger fares are very low relative to other countries.

• Armenian Railways passenger rates are some of the lowest in the world

• Passenger rates are forecast to increase with inflation

• However, passenger rates are not forecast to increase in real terms

– Armenian passengers are thought to be very price sensitive

– Government is expected to continue to constrain passenger pricing

HARRAL·WINNER·THOMPSON·SHARP·LAWRENCE, INC.HWTSL/ARC 27-Nov-00 9

Financial Results

With recommended charging mechanisms for Infrastructure and Rollingstock, the Transportation CJCS will make losses unless cost reduction measures are undertaken. Even with cost reduction, Transportation is forecast to make losses until 2005.

• Cost reduction strategies for transportation operations include:

– Review operating plan to eliminate stations (passenger and freight) where possible, simplify operations and close all but essential marshalling facilities.

– Implement computer systems for revenue waybilling, transportation operations management, eliminating or reducing station staffing at remaining stations.

– Improved management of foreign wagons on-line (through improved operating plan, reduced marshalling, improved operations management from computer systems).

– Work with Infrastructure and Rolling stock companies to eliminate unnecessary station trackage, reduce energy consumption.

– Reduce lightly used services, consolidate driver/assistant on-duty points and rosters.

HARRAL·WINNER·THOMPSON·SHARP·LAWRENCE, INC.HWTSL/ARC 27-Nov-00 10

Financial Results

Allocation of expenses between passenger and freight shows that passenger revenue covers only a small fraction of its cost and is heavily subsidized by freight. Cost saving measures have little impact on the profitability of passenger, but do improve the profitability of freight.

• Passenger cost reduction opportunities include:

– Elimination of any unnecessary services (investigate service substitution, monitor daily usage levels to identify lowest services and days).

– Elimination of any unnecessary station facilities, downgrade lightly used manned stations to unmanned, reduce station staff.

– Accelerate electric train rebuilds to eliminate locomotive hauled train services, reduce train sizes where possible.

• For all services and railway organizations, implement zero-based budgeting, eliminate excess staffing and facilities where possible.

HARRAL·WINNER·THOMPSON·SHARP·LAWRENCE, INC.HWTSL/ARC 27-Nov-00 11

Financial Results

Operating revenues of the Infrastructure CJSC are forecast to cover operating cost and generate some cash for investment.

• Infrastructure cost reduction opportunities include:

– Improved rail-life management practices (rail lubrication, improved rolling stock bogie lubrication, rail transposition on curves).

– Use of improved materials (larger sleeper plates on timber sleepers, greater supply of concrete sleepers, improved rail fastening system on concrete sleepers).

– Investigate use of radio or satellite train control systems, especially with new communications capability) and elimination of manned stations.

– Review electrification systems to implement power-off and other electrical energy conservation measures

HARRAL·WINNER·THOMPSON·SHARP·LAWRENCE, INC.HWTSL/ARC 27-Nov-00 12

Financial Results

Operating revenues of the Rollingstock CJSC are forecast to cover operating cost and generate some cash for investment.

• Rollingstock cost reduction opportunities include:

– Improved management of excess assets (to eliminate excess by sale, scrap or leasing).

– Specialize workshops, one for electric locomotives, one for electric trains, one for wagons and carriages, rationalize and close others.

– Standardize on one electric locomotive (either VL8 or VL10), overhaul those required, store some, eliminate the rest (see excess assets).

– Review working methods to reduce energy consumption as much as possible.

– Improve lubrication of bogies, investigate locomotive wheel lubrication, purchase new wheels to reduce wheel and rail wear.

HARRAL·WINNER·THOMPSON·SHARP·LAWRENCE, INC.HWTSL/ARC 27-Nov-00 13

Financial Results

Armenian Railways have several options for improving financial results.

• Armenian Railways strategy of working down its overhang of excess assets is appropriate for a railway with greatly reduced traffic. Some investment will, however, be required to maintain service.

• Increasing revenue & traffic

– Traffic growth will improve Armenian Railways financial results. However, Armenian Railways should not expect to “grow out” of its financial constraints, even if borders are opened.

– Little scope for raising the overall level of freight tariffs appears to exist.

– Little scope appears to exist for raising the level of passenger fares. Given the extremely low level of fares, government should subsidize passenger service or allow Armenian Railways to reduce the services provided.

• Reducing costs

– Develop new operating plan to reduce fuel consumption, unnecessary shunting and operating movements as much as possible. Also identify excess facilities, stations and buildings no longer needed for rail services (by any of the railway companies).

– Close excess facilities, eliminate electricity, heating, other utility services.

– Conduct energy efficiency program, to identify losses of electrical energy and diesel fuel, improve operating practices.

– Identify excess rolling stock assets, segregate and scrap unusable assets, form company or group to lease, rent or dispose of excess rolling stock assets that are still useable, leaving a margin for Armenian Railway use in the future.

– Try to use only one electric locomotive type, storing or leasing the other. Maintain parts and repair facilities in good order for that type.