Could COVID-19 Drag Norfolk Southern’s Stock To $110?

by Trefis Team
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Despite around a 22% decline in Norfolk Southern’s (NYSE: NSC) stock since the beginning of the year, at the current price of around $150, we believe that Norfolk Southern’s stock could see a significant downside. Why is that? Even though Norfolk Southern’s stock is up 8% since the end of 2017, this move has largely been driven by expansion in the P/E multiple, which surged 96% over this period. We believe that given the current crisis, and its impact on Norfolk Southern’s business, this will likely result in lower revenues and earnings for 2020, and the P/E multiple could see a 20% contraction. Our dashboard, ‘Norfolk Southern Downside: How Low Can Norfolk Southern Stock Go?‘ provides the key numbers behind our thinking, and we explain more below.

A significant contributor to Norfolk Southern’s stock price move over the last two years has been the expansion of its P/E multiple, which on a trailing basis, grew from about 7.4x at the end of 2017 to over 18.7x at the end of 2019, based on GAAP earnings. Norfolk Southern’s P/E multiple plunged to 7.4x in 2017 from 17.9x in 2016, due to tax benefits of $2.3 billion, vs. tax expense of $914 million in 2016, amid the changes to the U.S. tax laws. As such, GAAP EPS swelled in 2017, resulting in a lower P/E multiple.

So what’s the likely trigger and timing to this downside?

The current coronavirus crisis will likely have a significant impact on Norfolk Southern’s business, due to an overall decline in manufacturing, and lower consumer demand amid lockdown. Moreover, the oil price war led by Saudi Arabia has resulted in more than a 70% plunge in benchmark oil prices, with WTI down from $56 toward the beginning of February to $15 levels currently (as of April 22). Lower oil prices will likely impact the U.S. oil production, thereby impacting transportation of oil and related products. Lower oil prices led to around a 20% decline in benchmark natural gas prices as well, which will directly impact the demand for coal, one of the key business segments of Norfolk Southern. Given that several countries are on lockdown, the exports are also expected to take a hit as well. We believe Norfolk Southern’s Q1 results next week will confirm the hit to its revenue. It is also likely to accompany a lower Q2 as-well-as full-year 2020 guidance.

Specifically, we believe the full-year revenue expectations formed by the market at the time of Q1 results may be closer to $10.2 billion, about 4% lower than its 2017 revenue of $10.6 billion, and 10% lower than the 2019 revenue of $11.3 billion. The market isn’t going to stomach this well, and Norfolk Southern’s P/E multiple is likely to shrink by about 20% from 18.7x in 2019 to 15.0x in 2020.

Norfolk Southern’s earnings margin can also shrink to about 19%, from the 24% seen in 2019, as lower volume and lower fuel prices will impact the overall pricing, which includes fuel surcharge revenue for Norfolk Southern. This would mean a double whammy of 28% lower earnings, and 20% lower P/E multiple, translating into Norfolk Southern’s price drop of over 25%, to about $110 or lower.

Will such a drop be justified? Absolutely not. However, investors who are first out the door in a panic selling situation take a smaller hit to their portfolio. The actual recovery and its timing hinge on the broader containment of the coronavirus spread. Our dashboard forecasting US COVID-19 cases with cross-country comparisons analyzes expected recovery time-frames and possible spread of the virus.

We do believe these trends are likely to reverse over the next few quarters, and as the coronavirus crisis is tamed during late Q2 or early Q3, higher revenue and earnings expectations will replace the dire scenarios that are easily imagined during difficult times.

Further, our dashboard -28% Coronavirus crash vs. 4 Historic crashes builds a complete macro picture and complements our analyses of the coronavirus outbreak’s impact on a diverse set of companies, including Union Pacific and Adobe. The complete set of coronavirus impact and timing analyses is available here.

See all Trefis Price Estimates and Download Trefis Data here

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