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Investment Overview for Norfolk Southern (NYSE:NSC)
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Below are the key drivers of Norfolk Southern's value that present opportunities for upside or downside to the current Trefis price estimate:
- Norfolk Southern's EBITDA margin: We currently forecast Norfolk Southern's EBITDA margin to increase from 39.1% in 2012 to 40.3% by the end of the Trefis forecast period, primarily driven by robust growth opportunities in export coal and intermodal freight.
The coal freight services business is a highly profitable segment of Norfolk Southern, due to its highly efficient unit train configurations and longer-than-average lengths of haul which helps commands high yields. The intermodal segment, although less profitable than the coal freight segment, carries high incremental margins as the incremental costs of increasing train lengths are low.
The recent double-stack initiatives further provides an upside to margins.
Productivity improvements partly depend on volume growth and the expected margin gains are easier to reach should we see healthy volume growth over the next few years.
There could be a downside of approximately 7% to the Trefis price estimate if the volume growth is below expectations due to lower than expected economic growth and the EBITDA margin declines to 38% by the end of the Trefis forecast period.
Coal Freight
- Revenue per Carload of Coal Freight:
We currently forecast the coal freight revenue per carload to increase substantially, reaching $2.3 thousand by the end of the Trefis forecast period from $2.04 thousand in 2012.
There could be a downside of nearly 5% to the Trefis price estimate if the revenue per carload of coal freight decreases to $1.9 thousand by the end of the Trefis forecast period.
Intermodal Freight
- Revenue per Intermodal Unit:
We currently forecast the revenue per intermodal unit to increase substantially, reaching $805 by the end of the Trefis forecast period from $667 in 2012 because of tighter truckload capacity thereby causing truck-to-rail conversions. This is in addition to the ongoing corridor projects, which improve capacity, service, reliability and efficiency thereby providing operating leverage.
If the revenue per thousand revenue ton-miles for intermodal freight increases marginally reaching $700 by the end of the Trefis forecast, then there could be a downside of around 4% to the Trefis price estimate.
For additional details, select a driver above or select a division from the interactive Trefis split for Norfolk Southern at the top of the page.
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Norfolk Southern Corporation is the leading railroad network in the Eastern United States, engaged primarily in the rail transportation of raw materials, intermediate products, and finished goods. Goods are primarily transported in the Southeast, East, and Midwest US and via interchange services with rail carriers, to and from the rest of the United States. Norfolk Southern also transports overseas freight through several Atlantic and Gulf Coast ports.
Its principal subsidiary, Norfolk Southern Railway Company
is wholly owned. NSC also has a joint ownership along with CSX of the Consolidated Rail Corporation. Norfolk Southern's route map covers most of the eastern United States, east of the Mississippi River, the District of Columbia and the Canadian provinces of Ontario and Quebec, covering nearly 22 states. Norfolk Southern's primary competitor is CSX Corporation which covers much of the same territory.
The company operates on 20,141 miles of track out of which 15,493 is owned outright and the remainder is pursuant to trackage rights or leases. Norfolk Southern offers the most extensive intermodal network in the eastern half of the United States..
Norfolk Southern’s business mix includes coal, intermodal and general merchandise which is composed of six major commodity groupings: automotive; chemicals; metals and construction; agriculture; consumer products and government; as well as paper, clay and forest products. Although the company's primary role is transporting freight, its non-carrier subsidiaries engage principally in the acquisition, leasing, and management of coal, oil, gas and minerals; the development of commercial real estate; telecommunications; and the leasing or sale of rail property and equipment.
Norfolk Southern's earnings depend upon the volume of freight contracts it sells and the price of those contracts while its expenses primarily consist of labor, fuel costs, utilities costs and track maintenance. The largest of Norfolk Southern's customers include steamship lines, vehicle manufacturers, agricultural companies, utilities, intermodal companies and chemical manufacturers.
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We believe the Coal Freight and Intermodal Freight divisions are the most valuable divisions and contribute nearly half of the Norfolk Southern's total value. The key factors responsible for this are:
Large volumes of coal freight
Coal, petroleum coke and iron ore is Norfolk Southern’s largest commodity group and accounts for the highest share of Norfolk Southern's total freight volume, representing nearly 37% of total carloads (excluding intermodal units)in 2012.
- The coal demand in domestic electricity production had been subdued in 2012 and Q1 2013 as natural gas was favored by many utility companies on account of its environmental friendly properties and cheaper price. However, we expect overall coal volume to grow in the future as natural gas prices should inevitably increase to more normalized levels. The recent increase in natural gas prices in 2013 and decline in coal inventory levels at utilities support our outlook that coal volumes could recover in the future.
- Given Norfolk Southern's exposure to export terminals, the company is well positioned to see strong growth in export coal volumes. We expect the export coal volume to increase substantially due to solid long term global demand (particularly in Asia)
High incremental margin of Intermodal Freight
The Intermodal Freight business has a strong earnings outlook due to relatively higher incremental margins and firm pricing. With tight truckload capacity, rising fuel costs, an improving economy and the ongoing corridor projects, which improve capacity as well as increased service, reliability and efficiency will help drive intermodal freight rates higher.
The intermodal segment, although less profitable than coal freight, carries high incremental margins as train lengths are extended, because the additional costs associated with adding containers and trailers to existing trains is low. The recent double-stack initiatives further provides an upside to margins.
Given a strong intermodal growth outlook, Norfolk Southern's EBITDA margin in expected to improve substantially, reaching 40.3% by the end of the Trefis forecast period.
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Increasing freight demands and productivity with growing economy
Volumes in the freight industry are highly correlated to macroeconomic conditions. Volumes fall during economic slowdown, leading to a decline in railroad freight revenues. The ongoing recovery in the U.S. economy and recent rebound in the housing market in 2013 bode favorably for railroads.
Continued pricing improvements
The pricing power of railroads, with longstanding exemptions from regulation, has been a key factor in Norfolk Southern's success. Railroads have steadily increased rates during the past 10 years primarily through contract renewals and repricing. The company still has some contracts that are outstanding, which should result in healthy price increases. Most rails claim to target long-run 4% to 5% annual price increases, or greater than railroad cost inflation.
Trefis Forecast Rationale for US Rail Intermodal Units
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${forecast} consists of the number of intermodal units shipped by railroads in the United States.
Intermodal units are used to determine the intermodal volume that is shipped by a transportation company. Each intermodal container or trailer, not less than 10,000 pounds from one consignor to one consignee, is counted as one intermodal unit.
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${forecast} slumped significantly during the economic slowdown. In 2009, total units decreased to 9.9 million, 19.6% below 2005 levels, due to reduced freight demand as a result of the global economic slowdown. As economic conditions began to improve, there was a recovery of 14% in 2010 with the total units reaching 11.3 million. In 2011 and 2012, it further increased to 11.9 million and 12.3 million, respectively.
We expect healthy growth in intermodal units going forward, eventually reaching 15.1 million by the end of the Trefis forecast period.
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Trefis considered the following factors for its forecast.
Supporting Factors
- Railroads gaining market share from truck carriers
- U.S. railroads are faced with stiff competition from the trucking industry. Rising fuel prices, a shortage of long-haul drivers and highway congestion is expected to hamper the trucking industry, allowing railroads to gain market share.
- Given the Eastern region's greater exposure to highway congestion issues and relatively shorter length of hauls, the eastern railroads are particularly well-positioned to take market share. Accordingly NSC should be well-positioned to capture more market share than its Western competitors.
- Ongoing corridor projects
- The Eastern railroads' ongoing and recent infrastructure upgrades improve service, reliability, efficiency and capacity by adding double stack containers. This is expected to drive incremental volumes.
- The railroads' increased investments in infrastructure and the double-stack initiatives should materially enhance capacity and improve volumes.
- The Panama Canal expansion project provides long term growth potential
- The expansion of the Panama Canal, proposed by the Panama Canal Authority (ACP), is aimed to double the capacity of the Panama Canal by 2015 by allowing more and larger ships through. We believe the eastern rails will benefit from the expansion of the Panama Canal in the long run.
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How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
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