Norfolk Southern (NYSE:NSC), one of the leading railroad networks in the eastern United States, posted net income of $450 million in Q1 2013, which represented a 10% y-o-y increase. A sale of land (a non-operating item) contributed $60 million to net income in Q1. However, railway operating revenue declined by 2% annually to $2.7 billion in Q1 2013 mainly on account of a 5% drop in average revenue per unit even as the overall volume was up by 3% annually.
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Weakness in the coal business dragged down overall revenue for Norfolk Southern. Its coal revenue decreased by 17% annually in Q1 2013, which was partially offset by 9% and 2% revenue growth in intermodal and general merchandise businesses respectively. The company’s railway operating ratio rose from 73.3% in Q1 2012 to 74.8% in Q1 2013.
We think these results indicate a mixed outlook. While the overall volume increase represents an encouraging trend, the declines in revenue and operating margins are troubling. Though the coal market is expected to stay challenging in the near term, we think that its outlook could improve in the future with a rise in natural gas prices and a decrease in coal inventory levels at utilities. We believe pricing gains will be the key for Norfolk Southern to achieve revenue growth going foward.
Performance of Norfolk Southern’s Different Segments In Q1 2013
|% Contribution in Overall Revenue (2012)||Revenue Growth (annual)||Volume Growth (annual)||
Revenue Per Unit Growth (annual)
|Metals and Construction||
|General Merchandise (Total)||
Coal Market Presented The Biggest Headwind To Growth
Norfolk Southern’s coal business showed a significant decline in the first quarter on account of weakness in utility, domestic metallurgical and industrial coal volumes. Utility demand continued to be weak due to competition from natural gas and higher coal inventory levels at utilities. The impact was higher on longer-haul Southern utility volumes, which declined by 16%, as compared to shorter-haul Northern utility volumes, which were down by only 3%.
Export coal volumes, which grew by 21% annually in the first quarter, partially offset the decline in other coal markets. However, with the pricing environment remaining weak for export metallurgical coal, its lower pricing affected the overall revenue per unit within the coal segment.
Norfolk Southern expects challenges in the coal market to continue in the near future on account of competition from natural gas and soft overall demand for electricity generation. However, the recent surge in natural gas prices, which crossed $4 (per million BTU) in March, could lead to some recovery in utility coal demand. With respect to export coal volumes, the company expects growth in this market to be slower in the future.
Intermodal Business Proved To Be A Key Growth Driver
The intermodal business showed strong gains on account of 7% and 13% rise in domestic and international intermodal volumes respectively. Continued truck-to-rail conversions and increased capacity due to the Crescent Corridor program contributed to the increase in domestic volumes. Norfolk Southern expects both its domestic and international intermodal businesses to grow during 2013, however, the pace of growth in the international intermodal business is expected to slow down in the future.
Mixed Performance In The Merchandise Business
While the chemicals and automotive segments witnessed revenue growth, other markets suffered a decline in revenue. Norfolk Southern’s chemicals volumes showed strong growth on account of increased shipments of crude oil and other petroleum products. Automotive revenues increased mainly on account of a 5% rise in revenue per unit as the volume growth was lower at 2%.
Metals and construction volume declined by 6% annually on account of lower domestic raw steel production as well as reduced shipments of frac sand and highway construction materials. The bankruptcy of RG Steel also impacted volumes negatively. Agricultural volumes witnessed a drop on account of lower shipments of corn and ethanol, which were partially offset by higher fertilizer and soybean shipments.
Norfolk Southern has a positive outlook for chemicals, automotive and housing-related materials during the rest of 2013. While the agricultural and metal and construction markets are expected to stay challenging in the near term, the company forecasts the outlook for these markets to improve in the second half of 2013. 
We are in the process of updating our $63.57 price estimate for Norfolk Southern’s stock.Notes:
- Norfolk Southern Management Discusses Q1 2013 Results – Earnings Call Transcript, Seeking Alpha, April 23, 2013 [↩]