Norfolk Southern’s Earnings Decline On Coal Volumes, Fuel

Norfolk Southern (NYSE:NSC) announced its first quarter 2015 results on Wednesday, April 29. A few days ahead of its earnings, the railroad had provided its expectations for the quarter in a bid to prepare the market for a disappointment. Despite this, its stock fell 1.14% through the day. Plagued by declining coal volumes and fuel surcharge revenues, the railroad reported a 5% year-on-year decline in revenues, just under $2.6 billion. ^[1]

Norfolk Southern’s operating expenses declined 3% due to a lower fuel bill. However, its operating ratio increased 120 basis points, to 76.4%, as the decline in operating expenses was not commensurate with the revenue loss. This also led to a decline in net profits, which reduced earnings per diluted share by 15% year-on-year, to $1.00.

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Low Fuel Prices Eat Into Top Line

Norfolk Southern reported a decline in its top line primarily due to the loss of $132 million in fuel surcharge revenues as a result of the steep decline in oil prices. ^[1] This also reduced the railroad’s revenue per unit, which declined 7%. In the first quarter, the average price of the U.S. on-highway diesel fuel and WTI declined 26% and 51% year-on-year, respectively. ^{[2] [3]} However, the declining fuel prices led to a net positive benefit for Norfolk Southern as its fuel bill declined $168 million. This is because fuel surcharge is based on two month lagged values of highway diesel prices or WTI, while fuel expenses are based on spot prices. Since fuel prices have declined continuously, spot prices are lower than prices two months back, leading to lower fuel expenses than fuel surcharge revenues.

Going forward, we expect Norfolk Southern’s revenue per unit to 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 crude oil prices have already fallen way below the trigger price. Light, sweet crude listed on the New York Mercantile Exchange for June delivery traded at around $59 a barrel on Wednesday. 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.

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. Additionally, 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. Norfolk Southern’s coal carloads, which accounted for 20.5% of its revenues in 2014, have also been suffering due to these trends. Its coal volumes declined 7.4% in the first quarter and the weakness is likely to persist in the short term. ^[1]

The price of metallurgical coal is likely to decline to a six year low in the second quarter of the year as Australian coal producers have agreed to sell met coal at around $109.50 per metric ton to Japanese steel mills in the second quarter, compared to $117 in the first quarter. ^[5] This will likely keep U.S. met coal producers at bay. Thermal coal traded at around $54 in the beginning of April, significantly lower than the cost of production at many U.S. mines, which is likely to lead to a decline in Norfolk Southern’s thermal coal shipments.

On the domestic front, the demand for coal at electric utilities seems to be declining, which should have an impact on Norfolk Southern’s domestic coal shipments. For the month of February, coal consumption at electric utilities declined 11.1% year-on-year, leading to a 25% rise in coal stock piles. ^{[6] [7]} The spot price for natural gas at Henry Hub has remained lower than $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 23.9% year-on-year in February. ^[8]

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1. Norfolk Southern’s First Quarter 2015 Financial Review, April 29, 2015 www.nscorp.com [↩] [↩] [↩]
2. U.S. On-Highway Diesel Fuel Prices (dollars per gallon), www.eia.gov [↩]
3. Cushing, OK WTI Spot Price FOB, (dollar per barrel), www.eia.gov [↩]
4. Norfolk Southern’s Fourth Quarter 2014 Slides, January 26, 2015, www.nscorp.com [↩]
5. Met Coal Tumbles to New Six-Year Low Amid Slumping Demand, March 17, 2015, www.bloomberg.com [↩]
6. Table 2.1.A. Coal: Consumption for Electricity Generation, April 27, 2015, www.eia.gov [↩]
7. Electric Power Sector Coal Stocks: January 2015, March 27, 2015, www.eia.gov [↩]
8. Table 2.4.A. Natural Gas: Consumption for Electricity Generation, April 27, 2015, www.eia.gov [↩]