A Closer Look at Norfolk Southern

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Norfolk Southern Corp (NYSE: NSC) should have had a bad year. But instead, the company has delivered surprises four out of the last five quarters, reported its best year ever, set a record for revenues and earnings per share, plus received the International Finance Review “Deal of the Century Award.” Not too shabby for a company that saw revenues decline 25% just three years ago.

NSC reported both good and weak second quarter earnings in July. Earnings per share beat analysts' expectations by 4.6%, and outdid the year previous earnings by 15.9%. But operating revenue fell short with a paltry 0.3% increase from the year previous. Overall operating income increased 6.7% for the year. Operating ratio (a key metric for the transportation sector) improved 2% to a record high of 67.5%.

The company was profitable despite a steep decline in coal shipments. The company's coal revenues decreased 15.5% year over year. Despite facing a steep decline in coal shipments, this class 1 freight railroad operator has maintained profitability thanks to strong operating efficiency and cost control measures.

Norfolk Southern continues to please investors with its reliable dividend (120 consecutive quarters!). In August the company raised its dividend to 2.72%, up from its five year average of 2.4%. NSC continues to look to the future with a $2.4 billion investment this year on capital improvements, including new track, signal systems and trains.

The company attributes some of its success to its CFO, Jim Squires, who recently won the Virginia CFO Award for publicly traded companies. “His oversight allowed Norfolk Southern to control expenses, even while adding critical resources, such as engineering and conductors, handling increased traffic volume and managing higher diesel fuel costs,” says Wick Moorman, the company’s chairman, president and CEO.

The future has bright spots and dark spots for the Norfolk, Virginia based company. The company has done well thanks in part to a renewed demand for rail transportation. But due to a recent sharp decline in metallurgical coal prices, analysts downgraded the company from “buy” to “hold.” Metallurgical coal is used to make the iron and steel used in construction, automotive and household-products industries. Coal prices dropped due to a warmer than usual spring and winter, reducing demand for coal from utilities. At the same time there was a natural gas surplus and renewed interest in natural gas. The lack of demand for coal has caused a drop in prices. From a railway perspective, a lack of demand for coal means a lack of demand for the transportation of coal.

Almost all railroad companies, including competitors Union Pacific (NYSE: UNP) and CSX Corp (NYSE: CSX) are faced with the same problem. They need a cold winter to bring back demand for coal. Coal, coke, and ore are 31% of NSC revenues. Second quarter coal revenues for Union Pacific were down 9%. Coal and coke make up approximately 20% of its revenue. CSX saw a 14% decline in coal revenue in the same time period.

But the railroad industry is benefiting from the recovering housing industry. The increased demand for construction materials, including lumber, wood, gravel, metal, etc., has meant an increase in revenue for the railroads as well. But with a potential “fiscal cliff” facing the United States, housing will likely be the first industry to feel the pinch. With the potential combination of decreased coal and housing, railroads will be significantly impacted.

But Norfolk Southern is prepared. The company has award-winning management, has outperformed the S&P 500 over the past 25 years, and overall things look good. The factors that could hurt the company are the same factors that could hurt many companies across many industries. However, the railroads may burden the impact sooner than later.


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