Norfolk Southern (NYSE:NSC), one of the leading railroad networks in the eastern U.S., posted promising results in Q3 2013, which caused about 7% increase in its stock price on October 24. Its diluted earnings per share grew by 23% in Q3, which outpaced performance at other railroads including Union Pacific and CSX Corporation. The railway operating revenue rose by 5% to $2.8 billion, owing to 4% rise in volumes and 1% increase in average revenue per unit (RPU). Solid performance across the merchandise and intermodal markets helped the company offset challenges in the coal business.
Norfolk Southern’s railway operating ratio increased by 300 basis points annually to 69.9%, due to productivity improvements. This was achieved through factors such as higher network velocity, improved technology, as well as better asset and resource utilization. Total crew starts dropped by 3%, while the overall volume rose by 4%, indicating increased efficiency. We are encouraged by this profitability improvement as it came on the top of negative changes in product mix carried by the company.
We believe the company could see overall revenue and volume growth in the fourth quarter. While coal market headwinds will persist, this will be offset by continued growth in the merchandise and intermodal markets.
Coal Market Presented Headwinds
NSC’s coal revenue fell by 9% in Q3 2013, on account of 2% and 6% drop in volume and RPU respectively. Competition from natural gas, high inventory levels at Southern utilities, decreased demand for electricity generation as well as soft demand for U.S. export coal led to lower volumes. The RPU fell owing to pricing challenges in the export coal market and negative mix in volumes. We expect this market to stay challenging in the fourth quarter due to soft demand across the utility and export coal markets.
Intermodal Segment Is Positioned As A Long Term Growth Driver For NSC
NSC’s intermodal volumes grew by 5% during the third quarter. Combined with 2% RPU growth, it resulted in a 7% rise in intermodal revenue. Domestic intermodal volume increased by 7% due to continued truck-to-rail conversions. And the international intermodal volumes rose by 2% owing to organic growth with existing customers.  We believe this segment will continue to see growth in the future, as the company is taking several measures to enhance its capacity and improve its service levels in the intermodal segment.
Merchandise Segment Showed Growth, Outlook Continues To Be Positive
NSC’s merchandise segment showed 11% revenue growth, due to 6% increase in volume and 4% rise in RPU. This was fueled by growth across the chemicals, automotive, metal and construction markets, which was partially offset by challenges in the agricultural market.
- Shipments of metals and construction products rose by 9% during the quarter, driven by increased transportation of aggregates, sand, gravel and other construction material. We expect the positive outlook to continue in this market during the rest of the year. 
- NSC’s chemicals volumes rose by 14%, due to higher shipments of crude oil, plastics, natural gas liquids and other chemicals. This segment will continue to see strong growth in the fourth quarter due to increased crude by rail transportation. 
- NSC’s automotive volumes grew by 9%, helped by new business and higher vehicular production at plants served by the company. The North American vehicle production is estimated to rise by 6% in Q4, and this will benefit NSC’s volumes during the quarter. 
- Volumes of paper, clay, and forest products rose by 4% due to an increase in lumber and pulpboard shipments. This was driven by the recovery in the housing and consumer product markets, which helped offset a 13% drop in graphic paper shipments. 
- NSC’s agricultural volumes dropped by 3%, due to the continued impact from last year’s drought, which affected corn and soybean shipments. This market is expected to recover in the fourth quarter with the improvement in agricultural output this year.
We are in the process of revising our $74.30 price estimate for Norfolk Southern.Notes:
- Norfolk Southern Management Discusses Q3 2013 Results – Earnings Call Transcript, Seeking Alpha, October 23, 2013 [↩] [↩] [↩] [↩]
- Norfolk Southern Management Discusses Q3 2013 Results – Earnings Call Transcript, Seeking Alpha, October 23, 2013 [↩]