Norfolk Southern (NYSE:NSC) is the leading railroad network in the Eastern United States engaged in the rail transportation of raw materials, intermediate products and finished goods. In 2012, its revenues stood at $11 billion with an operating margin of 28%. Owing to challenging conditions in the coal market, the company’s top line faced continuous pressure during 2012. Unlike other railroads such as Union Pacific (NYSE:UNP), the company was unable to offset volume decline with price rises. Its profitability also declined during 2012, due to a higher railway operating ratio.
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Going forward, we feel challenging conditions in the coal market will continue to impact its volume and revenue per unit in the coming future. In addition, the expansion in its operating ratio will affect its bottom line in 2013.
Norfolk Southern’s revenue recorded an annual decline of 4% and 7% in Q4 2012 and Q3 2012, respectively. Weakness in the coal business was the main factor responsible for this decline as revenues from its coal business dropped by around 22% in the last two quarters. Lower volume and a declining average revenue per unit have both contributed to this lower revenue.
Norfolk Southern’s volume declined by 1% annually in the last two quarters. While coal shipments were lower by around 14% in the period, a 5% rise in intermodal shipments curbed some of the decline in overall volume. We expect challenging conditions in the coal market to weigh on Norfolk Southern’s overall volume in 2013.
Decreasing Average Revenue Per Unit
Norfolk Southern’s revenue per unit fell by 5% and 3% annually in Q3 2012 and Q4 2012, respectively. We feel this RPU decline is especially troubling as other railroads such as Union Pacific were able to offset volume declines with price rises. If the company is not able to reverse this trend in the future, we feel NSC’s revenues will further decline in the coming quarters.
Norfolk Southern’s bottom line was hit harder than its top line in the recent period. Its net income dropped by 14% and 27% annually in Q4 2012 and Q3 2012, respectively. An increase in the railway operating ratio has contributed to this decline in profitability. Its railway operating ratio grew from 71.4% in Q4 2011 to 73.4% in Q4 2012. While the company announced cost-cutting initiatives in the latest earnings call, we will have to wait and see how this will impact its profitability in the coming quarters.
Weakness in Coal Market To Persist
Coal shipments account for around 26% of Norfolk Southern’s revenue and contribute for around a quarter of its value. Owing to reduced demand by domestic utilities as well as lower export demand, the company saw a decline in coal shipments throughout 2012.
Coal for utilities comprised for 65% of the coal that Norfolk Southern shipped in 2012. However, the demand for coal by utilities has decreased as they are increasingly shifting to cheaper natural gas for producing electricity. Utility coal tonnage fell by 17% in 2012, and we feel that if natural gas prices continue to remain low, then NSC’s coal freight business will remain constrained in the coming future.
Coal exports which account for 18% of the coal transported by Norfolk Southern recorded a marginal decline in 2012. Going forward, we feel coal exports will continue to stay under pressure due to uncertainty in the global economy. We currently forecast U.S. carloads of coal to decrease to around 6.40 million in 2013, but if this figure declines further to 5.5 million, it would represent 5% downside to our price estimate.
We currently have a $64 price estimate for Norfolk Southern, which is approximately 13% below the current market price.