Norfolk Southern Earnings: Coal And Fuel Woes Will Likely Continue

Norfolk Southern (NYSE:NSC) announced its second quarter 2015 results on Monday, July 27. ^[1] The railroad operator reported an 11% decline in revenue to $2.7 billion, as its coal volume and fuel surcharge revenue took a dive. The low revenues also brought down earnings per shares, which declined 21%, to reach $1.41, offsetting the favorable impact of heavy declines in its fuel expenses. ^[2] We anticipate that the situation might worsen over the second half of the year as natural gas and fuel prices remain low. In addition, any fuel lag benefit that Norfolk Southern has been enjoying will likely disappear or turn negative.

Click here to see our complete analysis of Norfolk Southern.

Net Fuel Impact Likely To Turn Negative

Norfolk Southern reported a decline in its top line primarily due to the loss of $239 million in fuel surcharge revenues as a result of the steep decline in oil prices. ^[3] The average price of the U.S. on-highway diesel fuel declined 28% year-on-year and WTI declined 44% year-on-year in the second quarter. ^[4] ((Cushing, OK WTI Spot Price FOB, (dollar per barrel), www.eia.gov)) This also reduced the railroad’s revenue per unit, which declined 9%. However, declining fuel prices helped reduce Norfolk Southern’s fuel bill by $168 million. This is because fuel surcharge is based on two-month lagged values of U.S. on-highway diesel prices or West Texas Intermediate (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. ^[5] 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 September delivery traded at around $47 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.

Additionally, lower fuel surcharge revenues will likely lead to a net negative fuel impact as the U.S. Energy Information Administration (EIA) expects that the price of U.S. on-highway diesel will increase over the second half of the year. ^[6] Iran’s crude oil exports are unlikely to have an impact on oil prices this year, since increasing its oil output will take more than a year. ^[7] Therefore, there is very little chance crude oil prices going down any further. This could negatively impact Norfolk Southern over the next couple of quarters, as fuel spot prices will likely be higher, leading to higher fuel bills and comparatively lower fuel surcharge revenue. As a result, the railroad operator might see a drop in earnings and increase in its operating ratio. However, since the fuel price would still be lower than what it was in 2014, the impact may not be major.

Coal Demand To Remain Suppressed

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. Also, many electric utilities have shifted to natural gas for power generation due to its lower price. 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 21.3% in the second quarter and the weakness is likely to persist in the second half of the year. ^[2]

Metallurgical coal are likely to go down further as a result of new contracts for the third quarter, which have been priced at $93 per ton. ^[8] Thermal coal is also trading at lows of $50 per ton, compared to its peak of $338.75 per ton in 2011. According to Citi, the low price environment will likely persist. ^[9] This should keep the pressure on U.S. metallurgical and thermal coal producers and temper exports, which will likely lead to a decline in Norfolk Southern’s export coal volumes in the future, as well as its coal revenue per carload.

Going forward, domestic coal demand will also likely remain low as electric utilities are currently well stocked with coal. According to the EIA, electric utilities’ coal stock piles in April were 30% higher than the previous year. ^[10] The EIA expects the average price of Natural Gas to be around $2.97 per million btu in 2015, which is low enough for utilities to stay away from coal. ^[11]

View Interactive Institutional Research (Powered by Trefis):

Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap
More Trefis Research

1. Norfolk Southern reports second-quarter 2015 results, July 27, 2015, Norfolk Southern News Release [↩]
2. Norfolk Southern’s Q2 2015 Financial Review, July 27, 2015, Norfolk Southern Quarterly Financial Reviews [↩] [↩]
3. Norfolk Southern’s Q2 2015 Presentation, July 27, 2015, Norfolk Southern’s Presentations [↩]
4. U.S. On-Highway Diesel Fuel Prices (dollars per gallon), www.eia.gov [↩]
5. Norfolk Southern’s Fourth Quarter 2014 Slides, January 26, 2015, www.nscorp.com [↩]
6. Diesel Fuel Retail Incl Taxes U.S. Average, July 7, 2015, EIA’s Short Term Energy Outlook Report [↩]
7. Iranian Oil Exports Won’t Flood The World’s Crude Markets Anytime Soon, Energy Experts Say, July 14, 2015, International Business Times [↩]
8. Met Coal Hits Lowest Price in a Decade, June 17, 2015, Wall Street Journal [↩]
9. Coal headwinds tipped to drive down prices, May 28, 2015, The Sydney Morning Herald [↩]
10. Stocks of Coal: Electric Power Sector – April 2015, June 25, 2015, www.eia.gov [↩]
11. Natural Gas Henry Hub Spot Price, July 7, 2015, EIA’s Short Term Energy Outlook Report [↩]