Norfolk Southern’s Q3 Earnings Preview: Weak Shipments To Negatively Impact Results

Norfolk Southern (NYSE:NSC) will announce its third quarter results and conduct a conference call with analysts on Wednesday, October 28. ^[1] We expect weak shipment volumes, especially coal shipments, to negatively impact the company’s revenues and profitability. According to Norfolk Southern’s carloading report for the third quarter ending September 26, the company’s shipment carloads, including intermodal shipments, declined roughly 4% year-over-year, with coal carloads declining around 17%. ^[2] Besides weaker shipment volumes, lower fuel surcharge revenues, as a result of the decline in oil prices over the past twelve months, will negatively impact the company’s top line. However, lower fuel expenses will partially offset the impact of lower fuel surcharge revenues on the company’s profits. In this article, we will take a look at what to expect from Norfolk Southern’s Q3 results.

Declining Coal Shipments

Weak demand for both thermal and metallurgical coal has negatively impacted the company’s coal shipments. A combination of an adverse regulatory environment and weak natural gas prices has weakened the demand for thermal coal, which is used in electricity generation. As a part of the Federal Government’s ongoing efforts to reduce carbon dioxide emissions, new environmental regulations target a 32% reduction in power plant carbon dioxide emissions below 2005 levels by 2030. ^[3] Since coal has a much higher emissions intensity as compared to natural gas, the current regulatory environment is favorable for increasing adoption of natural gas as the preferred fuel for electricity generation. In addition to the adverse regulatory environment, low natural gas prices are accelerating the pace of adoption of natural gas as the preferred fuel for electricity generation, and consequently, lowering demand for thermal coal.

Oversupplied global markets and weak demand conditions both in North America and globally have negatively impacted the demand for metallurgical coal, which is used as an input in steelmaking. As per World Steel Association (WSA) estimates, steel demand in North America is expected to decline by 0.9% in 2015, whereas global steel demand is expected to grow by a sluggish 0.5%. ^[4] Weak demand for met coal has negatively impacted Norfolk Southern’s met coal shipments.

Lower Fuel Prices Will Impact Revenues

WTI Crude Oil Prices, Source: Y Charts

The decline in crude oil prices and consequently, highway diesel prices, over the last twelve months, will adversely affect Norfolk Southern’s fuel surcharge revenues. The company’s fuel surcharge revenues are based on two month lagged values of either West Texas Intermediate (WTI) Crude Oil Prices or U.S. On-Highway Diesel prices. U.S. On-Highway Diesel prices for the period ranging from May to July, which would impact Norfolk Southern’s Q3 results, declined roughly 27% year-over-year. ^[5] Similarly, WTI crude oil prices for the same period stood about 50% lower on a year-over-year basis. However, the impact of lower fuel surcharge revenues on the company’s bottom line will be partially offset by lower fuel expenses, which will also decline due to the drop in fuel prices.

In the last quarter, Norfolk Southern reported an operating ratio (operating expenses as a percentage of revenues) of 70, which was 350 basis points worse off than in the corresponding period of last year. ^[6] It would be interesting to note to what extent the company is able to offset the impact of the decline in shipments and fuel prices on its operating ratio through improvements in productivity in Q3. With Norfolk’s shipments, particularly coal shipments, unlikely to improve significantly in the near term, improving the productivity of its operations will be essential to maintaining profitability. We would like to know the management’s views on this in the earnings conference call.

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1. Norfolk Southern to hold third-quarter 2015 earnings conference call Oct. 28, Norfolk Southern News Release [↩]
2. Norfolk Southern’s Week 38 2015 Carloading Report, Norfolk Southern Website [↩]
3. Obama’s New Climate-Change Regulations to Alter, Challenge Industry, Wall Street Journal [↩]
4. Short Range Demand Outlook 2015-2016, World Steel Association [↩]
5. U.S. On-Highway Diesel Fuel Prices (dollars per gallon), EIA [↩]
6. Norfolk Southern’s Q2 2015 Earnings News Release, Union Pacific Website [↩]