After A Massive 60% Rise Since March Lows, Has Norfolk Southern Stock Run Its Course?

Norfolk Southern (NYSE: NSC), one of the largest railroad companies in the eastern United States, has seen its stock rally an oversize 62% from sub $120 levels on Mar 23 (the recent bottom made by the markets) to over $190 currently. This significantly outperformed the broader markets, which grew 44% over the same period. This can partly be attributed to the company’s announcement of leadership and organizational changes, aimed at increasing cost savings and operational efficiency. Norfolk Southern stock also remains up by about 38% from levels seen in early 2018, a little over 2 years ago. While the company has seen steady revenue and earnings growth over the recent years, its P/E multiple has also remained fairly stable. We believe the stock is unlikely to see any significant upside from the current levels, given the recent rally in the stock, and the potential impact of a Covid-19 led recession on the company’s business.  Our dashboard, ‘What Factors Drove 38% Change In Norfolk Southern Stock Between 2017 And Now?‘, has the underlying numbers.

The Stock Price Growth Was Supported By Strong Fundamentals Over The Recent Years

Norfolk Southern revenue grew 7% from $10.6 billion in 2017 to $11.3 billion in 2019, primarily due to strong growth in its Intermodal business. The company’s net income grew a strong 42% from $1.9 billion to $2.7 billion, led by net margin expansion of roughly 600 bps from 18% to 24% over the same period. The margin growth can be attributed to the company’s focus on improving its operations efficiency, which resulted in a decline in its largest expense item, Compensation & Benefits, both in dollar terms ($3.0 Bil to $2.7 Bil) as well as when looked at as a percentage of revenue (28% to 24%). The Compensation & Benefits expense was largely impacted by a reduction of 2,523 employees between 2017 and 2019. Higher revenues coupled with improved margins meant Norfolk Southern’s EPS grew 55% over the same period to $10.25, with an 8.5% decline in number of shares outstanding, led by share repurchases. Despite the strong earnings growth, the company’s P/E Multiple declined slightly from 21x to 19x, and it remains at 19x trailing earnings currently.

Why The Stock Could Underperform?

The global spread of the Covid-19 virus is expected to have a significant impact on the global economy, which is expected to go into recession. This will translate into lower consumer demand and an overall decline in industrial output, thereby impacting the shipments for railroad companies, such as Norfolk Southern. Additionally, oil prices at sub $40 levels over the recent months has led to lower production in the U.S., and it is now estimated to average 11.7 Mil barrels per day, reflecting a decline of 0.5 Mil barrels per day vs 2019. This will impact railroad companies, as shipments related to frac sand, chemicals, as well as other oil related products will likely decline. Moreover, the benchmark natural gas prices have also been trending lower over the recent months, translating into lower demand for coal, and in turn, likely impacting the volume being transported.

These are extraordinary times for businesses and the question really is, despite the expected headwinds and after the recent rally of 60%, is Norfolk Southern stock a good buy? We don’t think so. The company’s P/E Multiple is yet to see a meaningful decline from the current 19x levels, which still remain 22% higher than the levels of 15x seen in 2018. We believe that the stock could remain rangebound around the current levels in the near term. Firstly, the coronavirus pandemic led recession clouds the company’s outlook. Secondly, going by our Norfolk Southern Valuation, with an EPS estimate of $9.00 and P/E Multiple of 20x in 2020, it translates into a price of $180, which is roughly 6% below the current market price.

Looking for more insights on the transportation sector? Look at our analyses on – Union Pacific’s Revenues And Stock Price Change Mismatch and UPS vs. UNP: Does The Stock Price Movement Make Sense?

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