Three Ways Norfolk Southern Can Cash In On The Shale Gas Boom

Norfolk Southern (NYSE:NSC) is suffering heavily from the decreased use of coal in the U.S. as it derives nearly 30% value from the coal freight business, which is its most valuable division, according to our analysis. The company can, however, benefit from the shale gas boom which has caused the coal demand to wane. And this is possible through three ways: fuel cost savings, fracking sand transport, and fertilizers transport.

We have a $76 Trefis price estimate for Norfolk Southern, nearly 5% above the current market price.

See our complete analysis for Norfolk Southern here

1) Fuel cost savings

Norfolk primarily uses diesel and other petroleum products to run its transport system, and its fuel expenses run up to 20% of its total incurred expenses. However, there is a possibility that Norfolk might switch from diesel-based locomotives to gas-based locomotives in the future. Chesapeake Energy (NYSE:CHK), one of the largest gas producers in the U.S., has collaborated with General Electric (NYSE:GE) to popularize the use of gas in locomotives. It is not yet ascertained that a gas-driven locomotive will be cheaper; however, existing diesel engines can be retrofitted to run on a blend of natural gas and diesel. ^[1]

Natural gas is a cheaper commodity than diesel and would help Norfolk save millions of dollars. Norfolk could also reduce freight charges, keeping reasonable profits aside to gain market share from its primary competitor CSX Corp (NYSE:CSX). Hence, by adopting gas-based locomotives, Norfolk could expand its margins as well as gain more freight volume at the expense of its competitors.

2) Higher freight from fracking sand

Natural gas is extracted from shale formations using various fracking techniques that require loads of frack sand, chemicals and metal pipes. These materials are reflected under the metals and construction commodities freight business, which contributes nearly 11% to the company value by our analysis. The Utica shale in Ohio, which falls in the territory of Norfolk’s operation, is gearing up for increased fracking activity in the next few years. Hence, we believe the demand for fracking materials will increase, going forward, which will lead to higher freight volumes for Norfolk.

3) Higher agricultural and consumer freight

Natural gas is a primary raw material in the Haber process used for fertilizer production, and it forms the largest expense for any fertilizer company. The fall in gas prices has benefited the fertilizer companies immensely with higher profit margins. Hence, it is likely that these companies will increase utilization of their plants and produce more fertilizers to enhance their profits.

Alternatively, in April 2012, Dow chemical (NYSE:DOW) announced that it will build an ethylene cracker, which is used in the process of petrochemical production. Some other companies are also planning to set up plants to increase their petrochemical production. We believe the fertilizer and petrochemical production will increase in the future, leading to increased freight volumes in Norfolk’s agricultural and consumer freight division.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. How To Profit From The Shale Gas Boom, seekingalpha.com, June 28, 2012 [↩]