Norfolk Southern Earnings: Intermodal And General Merchandise Growth Offsets Coal Weakness

Norfolk Southern (NYSE:NSC), one of the leading railroads in the eastern U.S., reported its third quarter 2014 results on October 22. Its revenue increased 7% year-on-year, to reach $3.02 billion, driven by volume growth across all commodities except for coal, which continues to suffer due to the weak export coal environment for the U.S. ^[1] Norfolk Southern’s operating ratio (operating expense expressed as a percentage of revenues) improved significantly, 2.4% year-on-year, to reach 67%, driving a 16% increase in net profits. Norfolk Southern’s diluted earnings per share increased 17%, to reach $1.79.

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Volume growth drives Norfolk Southern’s revenue

In the third quarter, Norfolk Southern’s overall volume increased 7.7% driven by double digit growth at its Intermodal and General Merchandise segment. ^[1] Its intermodal segment grew 10% driven by increased conversion of truckloads from highway to rail. The trucking capacity in the U.S. has been declining due to the dearth of truck drivers and the Hours-of-Service regulation (Click here to read our article). Shippers have therefore been forced to move their shipments via rail. Additionally, the lower cost and time-efficient services provided railroads make intermodal services provided by railroads such as Norfolk Southern, a lucrative shipping option. According to Norfolk Southern’s management, there is a price differential of 12-15% between intermodal prices and truckload prices. ^[2] We believe that the continued tightening in trucking capacity will continue to drive growth in Norfolk Southern’s Intermodal segment in the future.

Norfolk Southern’s General Merchandise shipments which comprises of chemicals, agricultural products, metals and construction materials, automotives, paper, clay and forest products, grew 10% driven by strong growth in their respective end or source markets.

• Last year’s strong corn and soybean harvest helped drive Norfolk Southern’s agricultural shipments. Corn production grew 30% in the last year pushing down prices. This encouraged an increase in ethanol production, which also contributed to the increase in agricultural shipments. ^[3] Corn production is expected to increase 4% year-on-year in 2014, to 14.5 billion bushels and soybean production is expected to increase 17% year-on-year, to 3.93 billion bushels. ^[4] This should help continue to drive growth in Norfolk Southern’s agricultural volumes through 2014 and 2015.
• Crude oil production in the U.S has been increasing consistently since 2011, thanks to horizontal drilling techniques. ^[5] Shipments of frac sand, used for drilling, have also increased as a consequence of higher crude oil production. The U.S EIA forecasts crude oil production to increase to 8.54 million barrels per day in 2014 and 9.50 million barrels per day in 2015, compared to 7.44 million barrels per day in 2013. ^[6] Norfolk Southern should continue to benefit from the growth in crude oil production.
• Housing starts have been fluctuating a lot in 2014. After a strong 1.117 million in July, housing starts declined to 956,000 in August. ^[7] However, these numbers were up 24% and 8% year-on year in July and August respectively, indicating a continued upward trend. Housing starts increased 18% year-on-year in September. Building permits have also been up year-on-year. These trends are driving the forecast for a 7.7% increase in housing starts in 2014. Housing starts for 2015 are expected to increase 24%. An increase in housing activity should continue to drive Norfolk Southern’s housing and construction shipments. ^[8]

Contract loss and weak export demand tempers Norfolk Southern’s coal shipments

As we had pointed out in our previous article, Norfolk Southern’s 2.2% decline in coal shipments was the result of a loss of contract for one of the northern utilities in the first quarter of 2014 and the weak demand for U.S. coal in the global markets. ^[1] Declining global prices of thermal and metallurgical coal, due to high exports from Australian coal suppliers and low demand from China, have created a challenging environment for U.S. coal. Recent reports put global prices for thermal and metallurgical coal at their 5 year lows. ^{[9] [10]} U.S. coal suppliers are unable to compete at such low prices, which leads to lower coal carloads for Norfolk Southern. Decline in export coal shipments also impacted Norfolk Southern’s coal revenue per unit, which was flat during the third quarter.

With the recent announcement of China imposing tariffs on imported coal, the low price environment is expected to continue. ^[11] This should continue to put pressure on U.S. coal, which will further impact Norfolk Southern’s export coal volumes and revenue per unit.

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1. Norfolk Southern’s Third Quarter 2014 Financial Review, October 22, 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. Crop Production 2013, www.usda.gov [↩]
4. Crop Production,October 10, 2014, www.usda.gov [↩]
5. US Crude Oil Production Historical Data, www.ycharts.com [↩]
6. U.S. EIA Short Term Energy Outlook, October 7, 2014, www.eia.gov [↩]
7. US Housing Starts Historical Data, www.ycharts.com [↩]
8. NAHB Housing and Interest Rate Forecast, September 16, 2014, www.nahb.org [↩]
9. THERMAL COAL-Prices remain weak as Australian exports surge, October 7, 2014, www.reuters.com [↩]
10. Metallurgical Coal at 6-Year Low as Chinese Demand Slows, September 25, 2014, www.businessweek.com [↩]
11. China’s Coal Tariff Prolongs the Pain, October 10, 2014, onlinw.wsj.com [↩]