Norfolk Southern Q2 Earnings Will Be A Mixed Bag

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Norfolk Southern

Norfolk Southern (NYSE:NSC) will release its quarterly results for Q2 on July 24. The results could be severely impacted as two of its top three divisions – coal freight, agricultural & consumer products freight – are likely to show weak performance. For the quarter, we expect to see a decline in coal freight volumes as well as a fall in agricultural freight due to reduced grain volumes. This could be partly offset by the growth in intermodal freight and automotive commodities freight during the quarter. The automotive sector benefited heavily from a 24.6% y-o-y growth in motor vehicle & parts freight; intermodal freight continued its steady growth in Q2 with a healthy 4% growth compared to Q2 2011; and coal volumes dipped by a staggering 11.7%, as per the data reported by Association of American Railroads. [1]

We expect mixed results for Norfolk Southern this quarter. Below are a few emerging trends that may impact the company’s earnings and valuation.

We have a $76 Trefis price estimate for Norfolk Southern, nearly 5% above the current market price.

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See our complete analysis for Norfolk Southern here

Intermodal and automotive freight to drive growth

Overall, U.S. freight rail carloads have been declining quarter over quarter while intermodal freight has gradually grabbed more  freight share at the expense of U.S. rail traffic. During Q1, total carloads declined 3.2% whereas intermodal volumes increased by 4%.

This transition in U.S. freight traffic from railroad to intermodal is going to have a significant impact on NSC’s Q2 earnings and value as NSC derives nearly 20% of its stock value from the Intermodal freight division, by our analysis. Hence it’s imperative for NSC to invest heavily in intermodal facilities.

Of the estimated $2.4 billion capital budget for 2012, NSC is expected to invest $322 million in intermodal terminals and equipment to add capacity to the intermodal network. This includes $128 million investment in Crescent Corridor program, which consists of infrastructure projects for a high-capacity intermodal route. The corridor will span 11 states from New Jersey to Louisiana and offer a tremendous opportunity in intermodal volume growth for NSC. Norfolk Southern (NYSE:NSC) directly competes in the east coast with CSX Corp (NYSE:CSX), and we expect it to report sound revenue growth in intermodal freight in Q2.

Automotive goods had phenomenal growth during the quarter, which will drive revenues for the automotive freight division.

Agriculture and coal could hurt

Agricultural freight is likely to be affected adversely, particularly by a fall in grain carloads. On the other hand, coal demand declined significantly due to low natural gas prices that led power producers to increasingly switch from coal-fired to gas-fired plants. Coal carloads reduced by 11.7% while grain carload declined by 13.2% during the quarter.

On the contrary, the overall consumption pattern improved across the nation as evidenced by a marked improvement in housing starts during the quarter. Housing pattern has a spillover effect on other sectors mainly because it drives growth for other goods such as furniture, appliances and petrochemical products. Consumer goods could partially offset declines in agricultural freight and support the results for agricultural and consumer products freight division; but, overall, we expect these two divisions (agriculture and coal) to hurt NSC the most in Q2.

Long-term prospects intact

The U.S. GDP and freight rail traffic have traditionally demonstrated a  close correlation as 70% of the U.S. GDP is driven by personal spending, which drives volumes of consumer goods. For Q1 2012, we saw U.S. GDP grow by only 1.9%, but performance for the rest of the year could pick up.

In terms of specific trends, we expect domestic coal demand to increase gradually as gas prices increase and the attractiveness of coal revives. Nevertheless, if domestic coal demand remains subdued, exports along the east coast will drive volumes. While NSC may have mixed earnings this quarter, the long-term prospects for the company are intact. In the long run , NSC should look beyond coal freight, which contributes nearly 30% value to NSC’s stock.

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Notes:
  1. AAR Rail Time Indicators Report, aar.org []