Norfolk Southern’s Q3 Earnings Review: Weak Shipment Volumes And Fuel Prices Negatively Impact Results

Norfolk Southern (NYSE:NSC) announced its third quarter results and conducted a conference call with analysts on Wednesday, October 28. ^[1] As expected, the company’s results were negatively impacted by weaker shipment volumes, particularly coal shipments, as well as lower fuel surcharge revenues. Norfolk Southern’s overall revenue stood at $2.7 billion in Q3 2015, around 10% lower on a year-over-year basis. ^[2] Net income (excluding restructuring charges that impacted net income by $23 million) stood at $475 million, around 14% lower year-over-year, with lower fuel expenses offsetting some of the impact of lower fuel surcharge revenues and shipments on earnings. ^[2] The main takeaway from the the earnings conference call was the company management’s acknowledgement that Norfolk Southern faces the prospect of weak shipment volumes in the near term. The company has taken steps in response to the prevailing business environment.

Declining Coal Shipments

Norfolk Southern reported a 17% decline in coal shipment carloads in Q3. ^[3] Thermal coal, which constitutes the bulk of the company’s coal shipments, is characterized by weakness in demand. A combination of an adverse regulatory environment and weak natural gas prices has weakened the demand for thermal coal by power plants. With the Federal Government cracking down on carbon dioxide emissions, new environmental regulations target a 32% reduction in power plant carbon dioxide emissions below 2005 levels by 2030. ^[4] Coal and natural gas based thermal power plants account for roughly equal proportions of electricity generation in the U.S. However, coal based power plants account for a much higher proportion of power plant carbon dioxide emissions in the U.S., as indicated by the figure shown below. Since coal has a much higher emissions intensity as compared to natural gas, the prevailing regulatory environment is certainly favorable for increasing adoption of natural gas as the preferred fuel for electricity generation. Moreover, weak natural gas prices are accelerating the pace of adoption of natural gas as the preferred fuel for electricity generation by thermal power plants, and consequently, lowering the demand for thermal coal.

Power Plant Carbon Dioxide Emissions, Source: EIA

Norfolk’s shipments of metallurgical coal, which is a key input in steelmaking, have also weakened considerably. Weak demand conditions for steel in the U.S. and oversupplied global markets have negatively impacted the demand for steel in domestic and export markets, respectively. 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%. ^[5] Weak demand conditions have negatively impacted Norfolk Southern’s met coal shipments.

Operating Expenses

Norfolk Southern reported a 7% year-over-year decrease in operating expenses to $1.9 billion in Q3 2015, with the decline in fuel expenses offsetting increases in other operating expenses. ^[6] Fuel expenses have declined largely due to the sharp decline in crude oil prices over the past year and a corresponding reduction in fuel prices. The decline in fuel prices partially offset the impact of the decline in revenue on Norfolk Southern’s operating ratio (operating expenses as a percentage of operating revenues), with the company reporting an operating ratio of 69.7 in Q3 2015, around 270 basis points worse off than in the corresponding period of last year. ^[2]

With Norfolk Southern’s shipment volumes and fuel surcharge revenues expected to remain under pressure due to weakness in demand for coal and weak fuel prices respectively, the company management has taken measures to more closely align the company’s operations with the prevailing business environment. The company has put 300 miles of coal transportation lines out of service over the course of the last 18 months in response to weak demand conditions. ^[6] Though this is just a start, with top line growth expected to be subdued in the near term, the company management did acknowledge the need for productivity improvements to maintain profitability. ^[1] These measures will stand the company in good stead in the prevailing business environment.

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1. Norfolk Southern’s Q3 2015 Earnings Call Transcript, Seeking Alpha [↩] [↩]
2. Norfolk Southern’s Q3 2015 Earnings Release, SEC [↩] [↩] [↩]
3. Norfolk Southern to hold third-quarter 2015 earnings conference call Oct. 28, Norfolk Southern News Release [↩]
4. Obama’s New Climate-Change Regulations to Alter, Challenge Industry, Wall Street Journal [↩]
5. Short Range Demand Outlook 2015-2016, World Steel Association [↩]
6. Norfolk Southern’s Q3 2015 Earnings Presentation, Norfolk Southern Website [↩] [↩]