After a rise of over 2x from its March 2020 lows, at the current price of $253 per share, Norfolk Southern stock (NYSE: NSC), one of the largest railroad companies in the Eastern United States, appears to be fully valued. NSC stock has rallied from $118 to $253 off the March 2020 bottom compared to the S&P which moved 76%. NSC stock has outperformed the market due to better than expected quarterly results, and a rebound in transportation demand, especially Intermodal business, which accounts for roughly 28% of the company’s total top line. Also, the stock is up 22% in the last one year despite revenue falling 13% y-o-y over the last four quarters. While the gradual opening up of the economy is expected to lead to higher demand for railroads, the stock appears to be richly valued when compared to its historical levels, making it vulnerable to downside risk. Our dashboard Buy Or Fear Norfolk Southern Stock provides the key numbers behind our thinking.
NSC stock is also up 69% from the levels of $150 seen toward the end of 2018. Most of the stock price growth since 2018 can be attributed to the expansion of the company’s P/E multiple. Looking at fundamentals, total revenues declined from $11.5 billion in 2018 to $9.8 billion in 2020, primarily due to the impact of Covid-19 on overall railroad demand, and a continued decline in coal transportation, as pricing for natural gas remains more favorable. Furthermore, a 270 bps decline of net income margin due to increased costs during the pandemic, and an 8% drop in total shares outstanding, due to share repurchases, has meant that the company’s EPS declined 18% to $7.88 in 2020, compared to $9.58 in 2018.
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Despite the company posting a decline in revenue and profits, the P/E multiple expanded from less than 15x in 2018 to over 30x in 2020. The P/E multiple is currently at 32x, which we believe is high and compares with levels of around 15x seen in 2017 and 2018.
The coronavirus crisis induced lockdown affected industrial activity and hit railroad demand. Additionally, a weakness in the oil & gas sector has weighed on the oil related shipments. Coal freight also has continued to slide down, with lower power consumption during the pandemic, as well as favorable natural gas prices weighing on the overall demand for coal. Now with the economy gradually opening up, Norfolk Southern’s business is also seeing an increase in demand. While the company reported a 4% drop in its top line in Q4 2020, revenues were up 3% sequentially.
Norfolk Southern will likely continue to see increased railroad demand in the near term. Any further 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. Currently, investors seem to be buoyed by Norfolk Southern’s positive revenue and earnings outlook based on the expected recovery in the economic activity, and that appears to be priced in the current stock price of $253. Even if we were to look at the forward earnings estimate of $11.31 for Norfolk Southern in 2021, at the current price of $253, it is trading at a 22x P/E multiple, which is higher than the levels of around 15x seen in 2017 and 2018, making the stock appear vulnerable to downside risk.
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