Norfolk Southern’s Top Line Shows Strong Increase Despite Sluggish Revenue Per Unit

After a poor performance in the first quarter 2014, Norfolk Southern (NYSE:NSC) posted a strong comeback with its second quarter results. Its revenue increased 8.6% year-on-year on the back of 7.9% growth in volume. ^[1] The high revenue growth helped Norfolk Southern drastically improve its operating ratio (operating expense expressed as a percentage of revenues) from 75.2% in the first quarter to 66.5% in this quarter.

Revenue per unit grew a very weak 0.7% primarily due to stagnant intermodal revenue per unit. The 4.5% increase in coal revenue per unit came as a pleasant surprise in this quarter given the weak export coal shipments.

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Coal offsets weak intermodal revenue per unit

In the previous quarter, coal revenue per unit declined 2.4% due to weak export coal shipments. However, in the second quarter, coal revenue per unit increased 4.5% despite declines in export coal. ^[1] Growth in utility coal tonnage, driven by replenishment of coal stocks at utilities and the rising price of natural gas, and industrial coal tonnage more than offset the decline in export coal leading to growth in coal revenue per unit. It also helped offset the stagnant revenue per unit in intermodal segment.

Norfolk Southern’s intermodal revenue per unit remained stagnant primarily due to the rise in intermodal shipments. In the second quarter, international intermodal volume grew 16% due to the increase in container traffic at U.S. ports. ^[2] In order to avoid any risk arising out of the ongoing negotiations between the West Coast longshore labor and marine terminal operators, retailers increased their holiday season imports leading to five–year high container volumes at ports. ^[3] Norfolk Southern’s overall intermodal volume benefited from this move, growing 10.8%. Since international intermodal shipments command lower revenue per unit, an increase in these shipments tempered revenue per unit growth despite positive pricing and higher fuel surcharge.

Intermodal revenue per unit should see some improvement in the coming quarters driven by an increase in domestic intermodal rates. Norfolk Southern increased the rates for its transcontinental service on June 1^st and will be increasing rates of its Equipment Management Program service effective from September 1^st. ^[2] We expect coal revenue per unit to continue to increase driven by high demand for utility coal. However, weak export coal shipments will continue to present headwinds.

Norfolk Southern’s Operating Ratio reaches record level despite volume surge

Norfolk Southern’s 3.7% year-on-year improvement in operating ratio comes at a time when the railroad was trying to cope with the after effects of the severe winter weather conditions and manage the 8.5% surge in weekly carload volume during the second quarter. ^[1] Though the railroad’s service metrics are still not back to last year’s levels, it has managed its network exceptionally well compared to its closest competitor, CSX Corporation (NYSE:CSX), whose operating ratio improved only 20 basis points in the second quarter.

Norfolk Southern’s service metrics were low primarily because they had not anticipated the surge in volume. They were understaffed by 900 employees, which led to increase in employee overtime, high terminal dwell times and low trains speed. In order to manage the high volume, Norfolk Southern had to deploy additional locomotives, which because of their of old age required considerable repair and maintenance. Fuel costs also increased due to the high volume.

In the coming quarters, volume related increase in operating expense will continue to remain elevated. ^[2] However, Norfolk Southern will be working towards improving its service metrics by adding more employees.

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1. Norfolk Southern Second Quarter 2014 Financial Review, July 23 2014, www.nscorp.com [↩] [↩] [↩]
2. Norfolk Southern’s (NSC) CEO Wick Moorman on Q2 2014 Results – Earnings Call Transcript, July 23 2014, www.seekingalpha.com [↩] [↩] [↩]
3. Retailers Step Up Holiday Imports In Case Of A West Coast Port Strike, June 9 2014, www.forbes.com [↩]