Norfolk Southern’s Managment Must Lay Out Strategic Initiatives

Norfolk Southern (NYSE:NSC) is set to release its third quarter earnings on Tuesday, October 23 after the market close. The company saw a steep decline in its stock in mid-September, falling almost 10% when it announced that its Q3 earnings per share would decrease around 25% year-over-year. ^[1]  The lower guidance occurred primarily due to declines in volume in the company’s coal and merchandise businesses and a decline in revenues from fuel surcharges. All in all, the company expects that its revenues will be approximately $120 million lower when compared with 3Q 2011, a decline of around 5%.

Since we know what to expect during this earnings announcement on the financial front, we’ll be keeping a close eye on the earnings call to get insights about management’s strategies going forward. We’ll be looking for how NSC plans to tackle the decline in certain segments of its business and whether or not it plans to cut costs in subsequent quarters.

Click here to see our complete analysis of NSC here

Q2 Recap

During the second quarter, Norfolk Southern posted revenues of approximately $3 billion. Income from operations grew approximately 7% to around $930 billion. Earnings were helped by a year-over-year increase in operating ratio, which declined by 2% to 67.5%.

Coal Might Continue to Have Short Term Issues

According to our estimates, coal freight is the biggest contributor to NSC’s value, making up approximately 26% of the $66 Trefis price estimate for the stock. NSC took a hit in this business during the third quarter as coal export volume was down due to lower Chinese demand. ^[2]

During the earnings call, we will be closely watching for information about what the company plans to do to tackle the decline in coal volumes. In our opinion, a possible strategy could be to move to a different mix of freight, but that would also require a transitional period which could affect Q4 earnings. The fact that global economic growth is expected to be muted over the next few quarters concerns us because NSC’s coal freight volumes and prices are likely to take take a hit. We really need to see some proactive strategies from NSC management to have the confidence that this slowdown in coal freight won’t affect NSC’s top-line for an extended period.

NSC’s Management Must Cut Costs

A reason why NSC warned investors of lower earnings during the third quarter was because the company was not quick to cut fixed costs. This is evident by the fact that a 5% decline in revenues is expected to decrease EPS by around 25%. If compared with the figures reported by competitor CSX Corporation (NYSE:CSX), NSC’s decline in earnings show a lack of proactive action by management:  CSX reported an earnings decline of 3% on revenue declines of 2%.

During this earnings announcement, we expect NSC’s operating ratio to be much higher than the 67.5% it posted in Q2. Therefore, we will be watching the company’s earnings call for management’s strategy on how it plans to cut costs over the next couple of quarters, since this will be imperative in growing or maintaining its bottom line.

We currently have a $66 price estimate for Trefis which is approximately the same as the current market price.

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1. 8-K, SEC [↩]
2. Fires flicker on demand for US coal, Financial Times [↩]