What To Expect From Norfolk Southern’s Coal Freight Business In The Near Term?

Norfolk Southern’s (NYSE:NSC) coal freight business accounts for over 15% of the company’s value, according to our estimates. The business is dependent on macro trends in the coal industry, primarily the coal as well as natural gas pricing. In the recent quarters, the company has seen a decline in utility and domestic coal shipments, while export coal has seen strong gains, led by a rise in global benchmark coal prices. Natural gas prices have seen a strong up move over the last couple of months, and this could bode well for coal demand in the near term. We expect higher shipments and pricing gains to drive a mid-single digit growth in coal freight revenues for Norfolk Southern in 2018 and 2019. We have created an interactive dashboard analysis ~ How Is The Coal Freight Business Trending For Norfolk Southern~ highlighting the company’s coal freight segment. You can adjust revenue and margin drivers for 2018 and 2019. Below we discuss our expectations and forecasts for the coal freight business.

Expect Coal Freight Revenues To Grow In Mid-Single Digits Led By Both Volume And Pricing Gains

Norfolk Southern’s coal freight revenues grew in high teens to $1.7 billion in 2017. We forecast them to grow in mid-single digits in 2018 and 2019. In terms of volume, we forecast low single digit growth in the near term, as an expected decline in utility and domestic coal shipment will be offset by strong export volume growth. In fact, utility coal tonnage was down 7% while export tonnage was up 13% in the nine month period ending September 2018. This resulted in 2% decline in overall coal tonnage for Norfolk Southern during the same period. The decline in utility coal tonnage can partly be attributed to the trends in natural gas prices. The benchmark Henry Hub natural gas price was at $3 levels by the end of Q3 2018, more or less similar to what it was in the prior year. The general trend in recent years has been that attractive natural gas prices resulting in lower dependency on coal as an energy source. Note that the U.S. coal consumption in particular has been falling, and as per the latest EIA estimates of 652 million short tons (mst) coal consumption in 2019 will mark the year with the lowest coal consumption over the last 40 years.

However, since September 2018, natural gas prices have seen a sharp move upward with the Henry Hub natural gas price moving over 50% to $4.69 by early December. This can be attributed to concerns over supply shortages in the near term. Coal prices have also inched higher with NYMEX coal futures moving up 10% during the same period. Over the last week or so oil prices have stabilized with Brent trading around $60 levels, and this has pushed natural gas price down. While this volatility could continue in the near term, global benchmark coal prices are expected to remain strong. Coal prices could inch higher in the long run as well, given the introduction of tough environmental protection laws in several countries, which will make it difficult to develop new mines, thereby limiting the supply. With coal prices remaining higher, the U.S. coal exports could continue to see strong growth, thereby aiding the export volume for railroad companies. Also, the overall U.S. coal exports stood at 87 mst for the nine month period ending September 2018, as compared to 69 mst, during the prior year period.

Despite strong trends in export, there are certain concerns looming over the U.S. coal exports given the trade tensions. China has already imposed a 25% tariff on imports of U.S. coal in August, as part of its retaliation against tariffs on its exports implemented by the U.S. While Netherlands, Japan, and India currently remain the top buyers of U.S. coal, continued war over tariffs could slow the export growth for Norfolk Southern in the near term. Looking at the margins, we forecast Norfolk Southern’s EBITDA margins to grow by 150 basis points to around 47% by 2019. This can be attributed to higher average revenue per carload, which will likely see mid-single digit growth in the near term, aided by higher fuel surcharges. Also, the company’s effort to bring down its operating ratio will further aid the margin expansion. While a strong decline in crude oil prices over the last two months could impact the near term revenues for the company, they will likely trend higher for the full year.

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