Why Norfolk Southern’s ARPU Could Continue To Decline

Norfolk Southern’s (NYSE:NSC) average revenue per unit (ARPU) declined 1% in 2014 and 4% in the fourth quarter, tempering its revenue growth. ^[1] Weak coal exports, declining oil prices and unfavorable intermodal mix were responsible for the decline in Norfolk Southern’s ARPU. Here is why we believe that these trends are likely to persist in the short term.

See our complete analysis of Norfolk Southern here

Export Coal Weakness To Pressure Coal ARPU

The prices of metallurgical and thermal coal in the global markets have dropped sharply due to high exports from Australian coal suppliers and low demand from China. U.S. coal suppliers have either had to lower their prices in order to remain competitive or have stopped exporting. Because of this, Norfolk Southern’s export coal tonnage declined 19% in 2014. ^[1] Due to lower volumes of export coal, which generate higher ARPU, coal ARPU declined 2% in 2014.

The price of metallurgical coal is likely to decline to its six year low in the second quarter of the year as Australian coal producers have agreed to sell met coal at $109.5 per metric ton to Japanese steel mills in the second quarter, compared to $117 in the first quarter. ^[2] This will likely keep U.S. met coal producers at bay. Thermal coal traded at around $51 in the beginning of March, significantly lower than the $60 cost of production in the Central Appalachian, where Norfolk Southern’s thermal coal carloads originate. ^[3] Together, these trends will continue to suppress Norfolk Southern’s export coal volumes, leading to lower coal ARPU.

International Intermodal Volumes Could Remain High

Norfolk Southern’s international intermodal volumes grew 10% in the fourth quarter, primarily due to a disruptions at the West Coast related to labor contract negotiations, which led many shippers to move their shipments to the East Coast. ^[3] A contract gain also contributed to the volume growth.

Though the labor contract negotiations have ended, shipments continue to move in and out of the East Coast due to the backlog at the West Coast. This should continue to drive Norfolk Southern’s international intermodal volumes in the short term. Since international intermodal volumes carry lower ARPUs, a higher volume of such shipments should lead to decline in intermodal ARPU, as was seen in the fourth quarter, where intermodal ARPU declined 1% due to the higher mix of international intermodal volumes.

Norfolk Southern’s intermodal ARPU could benefit from the pricing power that the railroad industry has gained as a result of tightening trucking capacity. However, this could be offset by the decline in fuel surcharge revenues.

Fuel Surcharge Revenue Will Continue To Decline

Norfolk Southern’s fuel surcharge revenue declined $45 million in the fourth quarter as a result of 13% decline in the price of WTI crude, contributing to the decline in overall ARPU. ^[4] 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. ^[4] 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 WTI fell to $42.2 per barrel on March 18, way below the trigger price. 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 and expects to generate only about half of that in 2015. ^[5]

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1. Norfolk Southern’s Fourth Quarter 2014 Financial Review, January 26, 2015, www.nscorp.com [↩] [↩]
2. Met Coal Tumbles to New Six-Year Low Amid Slumping Demand, March 17, 2015, www.bloomberg.com [↩]
3. Norfolk Southern Corp’s (NSC) CEO Wick Moorman on Q4 2014 Results – Earnings Call Transcript, January 26, 2015, www.seekingalpha.com [↩] [↩]
4. ref:1 [↩] [↩]
5. Norfolk Southern at J.P. Morgan Aviation, Transportation and Industrials Conference, March 4, 2015, www.nscorp.com [↩]