Norfolk Southern Stock Has Run Out Of Steam

NSC: Norfolk Southern logo
Norfolk Southern

After an 82% rise since the March 23 lows of this year, at the current price of around $217 per share we believe Norfolk Southern’s stock (NYSE: NSC) has reached its near-term potential. NSC stock has rallied from $119 to $217 off the recent bottom compared to the S&P which moved 54%, with the resumption of economic activities as lockdowns are gradually lifted. NSC stock is also up roughly 60% from levels seen in early 2018, two years ago.

NSC stock is 4% above the levels it was at before the drop in February due to the coronavirus outbreak becoming a pandemic. This seems to make it fully valued as, in reality, demand and revenues will likely be lower than last year.

Some of the rise of the last 2 years is justified by the roughly 7.1% growth seen in Norfolk Southern’s revenues from 2017 to 2019. While the company’s Net Margins on a GAAP basis contracted from 51.2% to 24.1%, margins were higher in 2017 due to one-time tax adjustments related to changes in the tax law. On an adjusted basis, Norfolk Southern’s margins actually improved from 18.2% to 24.1%.

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With the steady revenue and earnings growth over recent years, Norfolk Southern’s P/E multiple has also expanded. We believe the stock is vulnerable to downside risk after the recent rally and the potential weakness from a recession driven by the Covid outbreak. Our dashboard – What Factors Drove 59% Change in Norfolk Southern Stock between 2017 and now? – has the underlying numbers.

Norfolk Southern’s P/E multiple changed from 7x in 2017 to 18x in 2019. While the company’s P/E is now 21x, there is a downside risk when the current P/E is compared to levels seen in the past years. P/E of 15x at the end of 2018 and 18x as recently as late 2019.

So what’s the likely trigger and timing for downside?

The global spread of Covid-19 has meant restrictions on movement, resulting in lower demand for power, and in turn, lower demand for coal. While the electricity consumption is expected to decline 2% in the US in 2020, the coal production is estimated to plunge 26% [1]. Norfolk Southern’s coal freight revenue plunged 55% to $209 million in Q2 2020 and it is down 44% to $507 million for the first half of 2020. Other than coal, the company’s merchandise freight revenue was down 26% due to a massive 63% drop in automotive freight, impacted by the lockdowns imposed during the period. We currently forecast a 14% decline in total sales for 2020. Norfolk Southern’s earnings will likely see a similar decline.
The actual recovery and its timing hinge on the broader containment of the coronavirus spread. Our dashboard Trends In U.S. Covid-19 Cases provides an overview of how the pandemic has been spreading in the U.S. and contrasts with trends in Brazil and Russia. Following the Fed stimulus — which set a floor on fear — the market has been willing to “look through” the current weak period and take a longer-term view. With investors focusing their attention on 2021 results, the valuations become important in finding value. Though market sentiment can be fickle, and evidence of an uptick in new cases could spook investors once again. At the current price of $215, NSC stock is trading at 25x the 2020 earnings estimate of $8.70 per share, and 20x the 2021 earnings estimate of $10.70, compared to levels of 15x and 18x seen in 2018 and 2019 respectively, making the stock vulnerable to downside risk.
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  1. Short Term Energy Outlook, EIA []