Norfolk Southern’s Coal Business Could Dampen Its Quarterly Results

Norfolk Southern (NYSE:NSC), one of the leading railroad networks in the eastern U.S., is scheduled to report its Q3 2013 results on October 23. While the overall volume outlook is positive, we expect the company to face challenges on the revenue per unit (RPU) side. The overall volume will be driven by growth in chemicals, automotive, intermodal and housing-related shipments. However, challenges such as lower volumes of export coal and longer-haul Southern utility coal could lead to a decline in the overall RPU in Q3.

We expect the company to also face profitability pressure in the third quarter, due to changes in product mix carried by the company. NSC’s railway operating ratio rose to 70.2% in Q2 2013 as compared to 67.5% in Q2 2012, and we will closely monitor this metric in the earnings results.

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Recap Of Q2 2013 Results

NSC’s operating revenue declined by 3% annually in Q2 2013 to $2.8 billion, due to 5% fall in average RPU, which was partially offset by 2% increase in overall volumes. Headwinds in the coal market were mainly responsible for the decline in the overall RPU as coal RPU fell by 14% in Q2. The overall volumes rose owing to strength across the intermodal, chemicals, automotive, and housing markets.

Coal Market Headwinds To Persist In The Third Quarter

We expect the coal market to present both volume and RPU related challenges for NSC in the third quarter. Low coal volumes will be caused by reduced demand for electricity generation, high inventory stockpiles in the Southern utilities, as well as subdued demand for U.S. thermal and metallurgical coals in the international market. Further, pricing challenges in the export coal market coupled with lower volumes of longer-haul Southern utility coal will put pressure on coal RPU during the quarter.

Intermodal Segment Will Continue To Grow

We expect NSC to show growth in the intermodal segment in Q3 owing to continued highway-to-rail conversions along with the company’s initiatives to expand its capacity in this segment. The international intermodal segment could also show increased volumes due to increased business with existing customers.

Chemicals, Automotive And Housing-Related Shipments Could Boost Revenue Growth In The Merchandise Segment

We expect the results in the merchandise segment to be led by gains in the chemicals, automotive and housing-related shipments.

• NSC’s chemicals and petroleum products shipments is expected to post growth owing to expansion in the U.S. oil and gas industry, as well as increase in crude oil by rail shipments.
• Automotive shipments are also forecast to increase substantially due to growth in North American light vehicular production.
• Increased construction activity combined with the housing recovery being seen in the U.S. is expected to boost shipments of products such as crushed stone, sand, gravel, stone, clay, etc. Housing starts grew by 19% annually in August 2013 and this trend is expected to continue in the future. ^[1]
• We think the agricultural grain shipments will continue to bear the impact of the last year’s drought in the third quarter. The outlook in the agricultural market is expected to improve in the fourth quarter with increase in the crop output.

Our $74.30 price estimate for Norfolk Southern, represents nearly 5% downside to the current market price.

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