Norfolk Southern Earnings: Coal Declines Lead To Flat Revenues

Norfolk Southern (NYSE:NSC) announced its fourth quarter and annual results on Monday, January 26. The railroad reported flat revenues as gains in its Intermodal and General Merchandise segments were offset by the decline in the Coal segment. Though it marginally exceeded analyst expectations, Norfolk Southern’s earnings per share was also flat at $1.64. ^[1]

For the full year, Norfolk Southern’s revenue grew 3%, to reach $11.6 billion, tempered by the decline in its Coal segment. The brightest spot in Norfolk Southern’s full year results was its operating ratio, which declined 180 basis points year-on-year to reach 69.2%, the company’s first ever sub-70s level. This helped drive an increase of 6% in its full year earnings per share.

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Coal Declines On Weak Utilities, Exports

Norfolk Southern’s coal volumes declined 6% in the quarter due to weak demand from utilities and international coal markets. The contract loss, which Norfolk Southern suffered earlier in the year, continued to plague its coal volumes to utilities, the tonnage for which declined 5% in the fourth quarter. However, this contract loss should not have any negative impact in the future as the comparison cycle ended January 1.

Weak service levels also had a negative impact on Norfolk Southern’s utility coal volumes. For the quarter, Norfolk Southern’s composite service performance declined to 62.8%, compared to 82.4% in the fourth quarter of 2013. ^[2] In order to improve upon its service levels, Norfolk Southern increased hiring and purchase of locomotives. These efforts had helped service levels improve gradually over the quarter and should continue to bolster service levels in 2015 as well. The coal volumes lost during the fourth quarter due to service issues are likely to be recovered in the first quarter of 2015.

Norfolk Southern’s coal volumes were also tempered by the continued weakness in global coal prices. Strong competition, low demand from China and a weak Australian dollar have made it difficult for U.S. coal to compete in the global market. Because of this, Norfolk Southern’s export coal tonnage declined 24% in the fourth quarter. ^[1]

Norfolk Southern will likely face headwinds from export coal in 2015 as well, since the low price environment is expected to persist. Additionally, the threat of utilities shifting to low price natural gas may hamper domestic coal demand. Natural gas for February delivery fell 3.5% to $2.881 per million British thermal units on the New York Mercantile Exchange on Monday. Mild winter and summer weather will also play a role in low demand for coal.

Revenue Per Unit Declines On Weak Export Coal

In the fourth quarter, Norfolk Southern’s average revenue per unit (ARPU) declined 4% primarily due to an unfavorable mix in its Coal and Intermodal segments. Coal ARPU declined 10% as a result of an unfavorable mix due to low export coal volumes, which generate higher ARPU. ^[1]

Norfolk Southern’s international intermodal volumes grew 10% in the fourth quarter, primarily due to a contract gain, new service lanes and disruptions at the West Coast related to labor contract negotiations. ^[3] Since international intermodal volumes carry lower ARPUs, a higher volume of such shipments led to a 1% decline in Intermodal ARPU.

Low fuel surcharge, due to the decline in WTI and on-highway diesel prices in the U.S, also contributed to the decline in overall ARPU. In the fourth quarter, fuel surcharge declined $45 million as a result of 13% decline in WTI price. ^[2]

Going forward, we expect to see Norfolk Southern’s overall ARPU continue to suffer from the low fuel price environment. Around 85% of the railroad’s revenue base yields fuel surcharge revenue, with an even split between WTI and on-highway diesel-based programs. ^[2] More than two-thirds of the contracts tied to the WTI have a trigger price of $64 per barrel. These contracts will likely not yield any fuel surcharge in 2015 since crude oil prices have already fallen way below the trigger price. Light, sweet crude listed on the New York Mercantile Exchange for March delivery fell to $45.15 a barrel on Monday. The remaining WTI and on-highway diesel based contracts are likely to generate lower revenues. Norfolk Southern generated $1.3 billion in fuel surcharge revenue in 2014.

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1. Norfolk Southern’s Fourth Quarter 2014 Financial Review, January 26, 2015, www.nscorp.com [↩] [↩] [↩]
2. Norfolk Southern’s Fourth Quarter 2014 Slides, January 26, 2015, www.nscorp.com [↩] [↩] [↩]
3. Norfolk Southern (SO) Earnings Report: Q4 2014 Conference Call Transcript, January 26, 2015, www.thestreet.com [↩]