Norfolk Southern’s Q4 2015 Earnings Review: Top Line Headwinds Adversely Impact Results

Norfolk Southern (NYSE:NSC) announced its fourth quarter results and conducted a conference call with analysts on January 27. ^[1] As expected, a decline in shipment volumes, particularly coal shipments, and lower fuel surcharge revenues, negatively impacted the company’s Q4 results. Norfolk Southern’s railway operating revenues declined 12% year-over-year to $2.5 billion. ^[2] Net income (excluding restructuring charges that impacted net income by $31 million) stood at $392 million, around 23% lower year-over-year, with a decline in 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 emphasis on cost reduction and efficiency improvement going forward, given that top line headwinds are expected to persist in 2016, as well.

Declining Coal Shipments

Norfolk Southern reported a 19% year-over-year decline in coal shipment carloads in Q4 2015. ^[3] Lower demand for both thermal (which is used in electricity generation) and metallurgical coal (which is used in steelmaking) drove down the company’s coal shipments. A combination of an unfavorable regulatory environment and weak natural gas prices have weakened the demand for thermal coal by power plants. As a part of the federal government’s crackdown on carbon dioxide emissions, new regulations envision a 32% reduction in power plant carbon dioxide emissions below 2005 levels by 2030. ^[4] Since coal based power plants have a much higher emissions intensity as compared to natural gas based ones, the regulatory environment supports a greater proportion of natural gas based electricity generation in the U.S. going forward. Moreover, soft natural gas prices are expediting the shift towards natural gas as the preferred fuel for electricity generation. The share of coal in U.S. electricity generation stood at 32% in Q4 2015, down from 37% in the corresponding period of 2014. ^[5] The decline in demand for thermal coal translated into a 16% year-over-year decline in Norfolk Southern’s Q4 2015 thermal coal shipments. ^[6]

Besides weaker shipments of thermal coal, oversupplied global markets, weak steel prices, and a strong U.S. Dollar have weakened the demand for metallurgical coal in both domestic and international markets. As a result, Norfolk Southern’s shipments of metallurgical coal for export and domestic markets declined 31% and 14% year-over-year, respectively, in Q4 2015. ^[6]

Lower Operating Expenses

WTI Crude Oil Prices, Source: Y Charts

Norfolk Southern reported a 5% year-over-year decrease in operating expenses to $1.9 billion in Q4 2015, with the decline in fuel expenses accounting for the most significant component of the decline in 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, with lower shipment volumes also contributing to the decline in fuel expenses. Despite lower fuel expenses, the net impact of lower fuel surcharge revenues and fuel expenses was an $89 million reduction in the company’s operating income. ^[6] As a result, Norfolk Southern’s operating ratio (operating expenses as a percentage of operating revenues) declined to 74.5% in Q4 2015, as compared to 69% in the corresponding period last year. ^[2] Though restructuring charges accounted for a 200 basis point deterioration in the operating ratio, the decline in expenses was insufficient to counter the impact of top line headwinds on results. ^[2]

As a result of subdued commodity prices, Norfolk Southern’s shipments of coal, frac sand, and steel are likely to remain under pressure in 2016. In addition, fuel surcharge revenues will also remain under pressure if oil prices do not recover significantly. In response to these challenges, the company has embarked on a cost reduction and productivity enhancement program under which it is targeting $130 million worth of productivity savings in 2016, rising to $650 million worth of annual productivity savings by 2020. ^[1] The company is targeting a sub-65% operating ratio by 2020. ^[1] Though achieving a sub-65% operating ratio by 2020 is a tall order, a focus on cost reduction and efficiency improvement will certainly stand the company in good stead, given that top line headwinds will continue to impact its results in 2016.

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1. Norfolk Southern’s Q4 2015 Earnings Call Transcript, Seeking Alpha [↩] [↩] [↩]
2. Norfolk Southern’s Q4 2015 Earnings Release, SEC [↩] [↩] [↩] [↩]
3. Norfolk Southern’s Week 52 2015 Carloading Report, Norfolk Southern Website [↩]
4. Obama’s New Climate-Change Regulations to Alter, Challenge Industry, Wall Street Journal [↩]
5. Union Pacific Corporation Q4 2015 Earnings Call Transcript, Seeking Alpha [↩]
6. Norfolk Southern’s Q4 2015 Earnings Presentation, Norfolk Southern Website [↩] [↩] [↩] [↩]