Norfolk Southern Earnings Preview: Earnings To Take A Hit Due To Fuel Prices

Norfolk Southern (NYSE:NSC) is set to announce its first quarter 2015 results on Wednesday, April 29. The company has provided its expectations for the quarter in a bid to prepare the market for a disappointment. Plagued by declining coal volumes and fuel surcharge revenues, the railroad expects to report a 5% year-on-year decline in revenues, to reach $2.6 billion. ^[1] Though Norfolk Southern’s operating expenses will likely decline due to a lower fuel bill, the decline will not be commensurate with the revenue loss, leading to a decline in net profits. The railroad expects its first quarter earnings per share to fall 15% year-on-year, to $1.00.

In the fourth quarter, Norfolk Southern reported flat revenues as gains in its Intermodal and General Merchandise segments were offset by the decline in the Coal segment. The railroad’s average revenue per unit (ARPU) declined 4% primarily due to an unfavorable mix in its Coal and Intermodal segments. Though it marginally exceeded analyst expectations, Norfolk Southern’s earnings per share were also flat at $1.64. ^[2]

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Revenue Per Unit To Decline On Low Fuel Price

One of the primary reasons why Norfolk Southern is likely to report a decline in its top line is the loss of fuel surcharge revenues, which will impact revenue per unit across all of its segments.

Around 85% of the railroad’s revenue base yields fuel surcharge revenue, with an even split between WTI and on-highway diesel-based programs. ^[3] 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 May delivery traded at around $56 a barrel on Thursday. 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.

The declining fuel prices should ultimately lead to a net positive benefit for Norfolk Southern. This is because fuel surcharge is based on two-month lagged values of the reference rate, while fuel expenses are based on spot prices. Since fuel prices have declined continuously, spot prices are lower than prices two months back, which should lead to lower fuel expenses than fuel surcharge revenues.

The benefit of a decline in fuel expense will likely be partially offset by the operational expenses related to weather related disruptions, service-recovery costs and labor costs.

Weak Coal Carloads

U.S. railroads have been suffering from weak metallurgical and thermal coal prices in the global market. Coal prices have slumped due to high exports from Australian coal suppliers and low demand from China. The strong U.S. dollar has also presented headwinds. U.S. coal suppliers have either had to lower their prices in order to remain competitive or have stopped exporting. This has led to steep declines in railroads’ export coal carloads.

On the domestic front, the demand for coal at electric utilities has declined. For the month of January, coal consumption at electric utilities declined 15% year-on-year, leading to a 16% rise in coal stock piles. ^{[4] [5]} The spot price for natural gas at Henry Hub has remained close to $3 per million btu in the past few months, a level at which utilities start to shift from coal to natural gas. This is also evident from the rise in natural gas consumption at electric utilities, which grew 6% year-on-year in January. ^[6]

Norfolk Southern’s coal carloads, which accounted for 20.5% of its revenues in 2014, have been suffering due to these trends. Its coal carloads have declined 10% in the quarter to date ending March 28. ((Norfolk Southern Carloading Report, www.nscorp.com))

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1. Norfolk Southern expects to report earnings of $1.00 per share, 15% below 2014, April 13, www.nscorp.com [↩]
2. Norfolk Southern’s Fourth Quarter 2014 Financial Review, January 26, 2015, www.nscorp.com [↩]
3. Norfolk Southern’s Fourth Quarter 2014 Slides, January 26, 2015, www.nscorp.com [↩]
4. Table 2.1.A. Coal: Consumption for Electricity Generation, March 27, 2015, www.eia.gov [↩]
5. Electric Power Sector Coal Stocks: January 2015, March 27, 2015, www.eia.gov [↩]
6. Table 2.4.A. Natural Gas: Consumption for Electricity Generation, March 27, 2015, www.eia.gov [↩]