Norfolk Southern Earnings Preview: Coal Weakness Should Be Offset By Merchandise, Intermodal

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Norfolk Southern (NYSE:NSC) is scheduled to report its fourth quarter and annual results on January 26. As indicated by its carloading data for the quarter through the week ended January 3, 2015, we believe that Norfolk Southern’s fourth quarter revenues will likely rise on strong growth in its intermodal and merchandise volumes. However, the decline in coal carloads will likely temper growth.

In the previous quarter, the railroad’s revenue increased 7% year-on-year to reach $3.02 billion, driven by volume growth across all commodities except for coal, which continued 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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General Merchandise Volumes To Grow

According to its carloading report, Norfolk Southern’s fourth quarter petroleum products carloads are up 34%. [2] This is due to the increase in crude oil production in the U.S. The U.S Energy Information Administration estimates crude oil production to have increased to 8.6 million barrels per day in 2014, compared to 7.4 million barrels per day in 2013. [3] Norfolk Southern’s Chemicals segment, which includes petroleum products, should benefit from the growth in crude oil production.

Though housing starts have fluctuated a lot in 2014, they remained 8.2% higher for the year to date ending November 2014. [4] [5] Additionally, construction spending in the U.S was up 6.4% year-on-year over the same period. [6] Norfolk Southern’s construction related shipments, which includes lumber, gravel, crushed stone, and sand, benefited from the growth in housing and construction activity and saw double digit growth in 2014. [2] This should help drive Norfolk Southern’s revenue generated from construction and forest products in the fourth quarter.

Intermodal Will Likely Grow On Tightening Trucking Capacity

According to its carloading report, Norfolk Southern’s intermodal carloads in 2014 are up 7%, which should help drive revenue growth. [2] In the first half of 2014, intermodal volumes grew as shippers imported their holiday season merchandise earlier than usual due to concerns regarding the possible disruptions that could have been caused by the ongoing labor contract negotiations between ILWU and PMA. However, base level growth in Norfolk Southern’s intermodal volumes has primarily come from the tightening trucking capacity in the U.S.

The Hours-of-Service safety regulation for commercial vehicle drivers added pressure on the trucking industry, which was already suffering from a dearth of truck drivers and declining fleet sizes. Because of this limited trucking capacity, shippers began to move their merchandise by rail rather than trucks. Comparatively lower costs also made railroads a more attractive option.

Export Coal Will Likely Present Headwinds

The price of coal in the global markets has dropped sharply due to high exports from Australian coal suppliers and low demand from China. U.S. coal suppliers have had to lower their prices in order to remain competitive or have stopped exporting. Because of this, Norfolk Southern’s export coal tonnage declined 17% in the first nine months of 2014. The same trends will likely continue to put pressure on Norfolk Southern’s export coal volumes in the fourth quarter.

Apart from the weak export coal environment, Norfolk Southern will also face pressure on the domestic front. Throughout 2014, Norfolk has faced troubles with its domestic coal shipments due to a contract loss.

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Notes:
  1. Norfolk Southern’s Third Quarter 2014 Financial Review, October 22, 2014, www.nscorp.com []
  2. Norfolk Southern’s Week 53 2014 Carloadings Report, www.nscorp.com [] [] []
  3. EIA Short Term Energy Outlook – Oil, December 9, 2014, www.eia.gov []
  4. New Residential Construction, December 16, 2014, www.census.gov []
  5. NAHB Housing and Interest Rate Forecast, January 5, 2015, www.nahb.org []
  6. US Construction Spending Chart, www.ycharts.com []