Norfolk Southern’s Volume Growth Will Drive Results

Norfolk Southern (NYSE:NSC) is among the leading railroad networks in the eastern United States. It is scheduled to report its Q1 2013 results on April 23. The company achieved 4% improvement in overall volumes during the first nine weeks ending on March 2, 2013, which is encouraging considering the fact that other railroads including CSX Corporation and Union Pacific saw overall decrease in volumes during a similar period.

While the volume growth looks encouraging, we will keep a close track on pricing gains and profitability this quarter as they are important for earnings growth. Norfolk Southern recorded a higher operating ratio as compared to its peers in Q4 2012, and we think the company must focus on productivity initiatives to achieve growth in its bottom line.

See our complete analysis of Norfolk Southern here

Recap Of Q4 2012 Results

In Q4 2012, Norfolk Southern’s railway operating revenue declined by 4% on account of 1% drop in volumes, coupled with 3% decrease in revenue per unit (RPU). A steep decline in coal shipments was partially offset by higher demand in intermodal, chemicals, auto and housing sectors.

Profitability Will Be Keenly Tracked In Q1 2013

Norfolk Southern’s railway operating ratio increased by 200 basis points annually in Q4 2012, to reach 73.4%. The increase in operating ratio represents a discouraging trend since other railroads such as Union Pacific and CSX Corporation achieved a better operating ratio of 67.1% and 72.1% respectively, in Q4 2012.

We believe Norfolk Southern must continue to focus on productivity initiatives through network right-sizing, higher velocity, and improvements in technology, engineering, and processes. The company aims to achieve more than $100 million in expense savings in 2013, and we will keep a track of the company’s success against this strategic initiative in the future. ^[1]

Increase In Quarter-to-date Volumes Shows An Encouraging Trend

During the first nine weeks ending on March 2, 2013, Norfolk Southern’s overall volumes were up by 4% annually. The increase in NSC’s volumes was underscored by growth in chemicals and intermodal businesses, whose volumes rose by 11% and 10% respectively, during the period. However, both the coal and the metal (and construction) market saw 5% decline in volumes.

Chemicals And Intermodal Business Could Keep Growing Throughout 2013

We expect continued growth in chemicals and intermodal businesses throughout 2013. The shipments of chemicals are seeing high demand on account of rising crude oil production in North America, which continues to surpass current pipeline capacity. Moreover, the shale gas boom is driving the U.S. chemicals sector, which is resulting in higher shipments of industrial chemicals and plastics.

Fueled by truck to rail conversions and the company’s investments in its Crescent Corridor program, we expect intermodal business to be a key growth driver for Norfolk Southern in the future. We think both domestic and international intermodal business could grow for the company in 2013.

Coal Market Could See A Recovery In The Future

The coal market, which represents a major headwind for Norfolk Southern, could see a recovery in the future with rise in natural gas prices. Natural gas prices have been increasing in the recent past and were recorded at around $4 (per million BTU) at the end of March 2013. The continuation of this trend could lead utilities to switch to coal for producing electricity, and this could reverse the decline in coal volumes in the future. ^[2]

Growth In Auto Business Could Remain Slow in 2013

Norfolk Southern’s auto volumes, which grew by double digits in the prior year, could see lower growth this year, on account of difficult y-o-y comparisons. It rose by a mere 1% during the first nine weeks of 2013, and we expect slow growth throughout 2013.

Our $64 price estimate for Norfolk Southern, is approximately 15% below the current market price.

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1. Norfolk Southern Management Discusses Q4 2012 Results – Earnings Call Transcript, Seeking Alpha, January 22, 2013 [↩]
2. Natural Gas Spot and Futures Prices (NYMEX), U.S Energy Information Administration, April 3, 2013 [↩]