Financial Model & Business Planning for Armenian Railways

1. Prepared for: The World Bank 29 November 2000 Prepared by: HARRAL·WINNER·THOMPSON·SHARP·LAWRENCE, INC. Financial Model & Business Planning for Armenian Railways

2. Financial ModelHWTSL has developed a Railway Financial Model for Armenian Railways. Model of Transportation CJSC - Income Stmt - Balance Sheet - Cash Flow Charges based on gtk train-km • 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 tkm, train-km Charges based on use of rolling stock Model of Infrastructure CJSC - Income Stmt - Balance Sheet - Cash Flow tkm, train-km tonnes Model of Rollingstock CJSC - Income Stmt - Balance Sheet - Cash Flow gtk

3. 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 Transport Demand Revenue Revenue collection period, bad debt Freight Rev Pass Rev pkm, passenger train-km, tkm, tonnes Assets Operating Expenses Stations & Yards Payment to Rollingstock Payment to Infrastructure Wagon Hire Financial Statements Income Statement Balance asset values operating expenses Cash depreciation Auxiliary & Other Financial ModelThe model for the Transportation CJSC forecasts railways traffic demand. This is used in all three models. It also forecasts and financial results for Transportation.

4. 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 Model of Transportation CJSC Revenue collection period, bad debt Revenue train-km, tonnes, tonne-km Assets Operating Expenses Electric locomotives Diesel locomotives Electric trains Wagons Financial Statements Coaches Income Statement Balance asset values operating expenses Cash depreciation Auxiliary loans & Other Financial ModelThe model for the Rollingstock CJSC forecasts pro forma financial statements based on demand for service from Transportation CJSC.

5. 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 Model of Transportation CJSC Revenue collection period, bad debt Revenue train-km, tonne-km Assets Operating Expenses Track Signaling & Communications Electrification & Power Supply Financial Statements Management Income Statement Balance asset values operating expenses Cash depreciation Auxiliary loans & Other Financial ModelThe model for the Infrastructure CJSC is similar to the model for Rollingstock.

6. 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 Traffic & Revenue ForecastHWTSL forecasts modest traffic growth in the base case, with some additional traffic if borders are opened.

7. 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. Railway Freight Prices 0.00 0.02 0.04 0.06 0.08 0.10 0.12 Ireland Denmark US$/TKM 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 Traffic & Revenue ForecastArmenian Railways freight prices are moderate relative to other countries..

8. 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 Traffic ForecastArmenian Railways passenger fares are very low relative to other countries. Cost Per Passenger Kilometer Ireland USA Japan United Kingdom Sweden Canada Denmark Netherlands France Italy Austria Australia Israel Brazil Portugal Hungary Chile Poland South Africa Czech Republic Indonesia Mongolia Turkey Slovakia Russia China Czechoslovakia Kazakhstan (99) Bulgaria Former Soviet Union Armenia Belarus 0.00 0.05 0.10 0.15 0.20 0.25 0.30 0.35 US$

9. 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. Financial ResultsWith 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.

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.

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

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

13. Financial ResultsArmenian 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.