We believe that there are several transportation stocks that are currently better valued than Norfolk Southern (NYSE: NSC). Norfolk Southern’s current market cap-to-operating income ratio of 22x is much higher than levels of under 15x for U.S. Xpress Enterprises (USX), Werner Enterprises (WERN), Canadian Pacific Railway (CP) and 17x for Heartland Express (HTLD).
Does this gap in valuation between Norfolk Southern and its peers make sense? We don’t think so, especially if we look at the fundamentals of these companies. More specifically, we arrive at our conclusion by looking at historical trends in revenues, operating income, and market cap-to-operating income ratio for these companies. Our dashboard Better Bet Than Norfolk Southern Stock: Pay Less To Get More From USX, WERN, CP, HTLD has more details – parts of which are summarized below.
1. Revenue Growth
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Norfolk Southern’s revenue declined at an average rate of 2.1% over the last three years, as compared to revenue growth of 4.2% for U.S. Xpress as well as that for Werner, 5.7% growth for Canadian Pacific Railway, and 2.1% growth for Heartland Express. Even if we look at the revenue growth over the last twelve month period, Norfolk Southern’s decline of 13% is much worse than 11% growth for Heartland Express, 2.0% growth for U.S. Xpress, and 3.7% and 1.1% decline for Werner and Canadian Pacific, respectively.
- While Norfolk Southern’s business has been impacted by the Covid-19 pandemic in 2020, even otherwise, the company’s energy freight, especially coal freight, has been on a decline over the last few years. This is due to macro factors impacting the demand of coal, as well as fluctuation in oil & gas prices impacting the overall merchandise freight business. Now that multiple countries have initiated vaccination programs, the transportation demand is expected to rise, with a growth in overall economic activity, boding well for Norfolk Southern in the near term.
- U.S. Xpress is one of the largest truckload carriers in the Eastern United States, and it has seen a modest increase in volume as well as pricing over the recent quarters. The company has been focused on moving to Variant, a digitally recruited, dispatched, and managed asset-based fleet that uses artificial intelligence. It has already shown 20% improvement in utilization. The company expects to have 1,500 tractors under Variant by the end of 2021, as compared to 700 currently. This is important, as it is expected to improve the company’s margins going forward.
- Werner has seen a 3.7% decline in revenues in 2020, primarily due to the impact of the pandemic on its business, especially in Q2. That said, the company has also seen a growth in pricing while there has been a slight decline in total fleet. Werner is also building an integrated platform that will connect drivers, brokerage partners, and customers. The company has an in-house product called Edge, while it has also partnered with Mastery Logistics Systems for a cloud-based transportation management system. The new technology will help Werner improve its utilization, and in turn, margins.
- Canadian Pacific, a large railroad company, reported a 1% decline in revenues in 2020, as growth in grains and fertilizers was more than offset by a decline in metals, minerals, and consumer products shipments. The company, in-line with other railroad companies, has been focused on reducing its operating ratio, which declined to 57.1% in 2020 from 59.9% in 2019, despite a challenging environment due to the pandemic. Earlier this week, Canadian Pacific Railway announced its plans to acquire Kansas City Southern in a deal valued at $29 billion, including Kansas’ debt of $3.8 billion. This is a positive development for Canadian Pacific, given that the company expects synergies of $780 million, and the merger to be EPS accretive from the first year itself. Furthermore, both the companies have an existing interchange in Kansas city, implying lower integration costs. Also, Canadian Pacific will become the first railroad to connect Mexico, the U.S., and Canada, implying better market reach.
- Heartland Express is one of the leading trucking companies in the short-to-medium haul truckload market in the U.S. The company has seen its revenue expand in 2020, primarily due to the impact of the Millis Transfer acquisition in August 2019. The company expects driver shortages to continue in 2021, adversely impacting its overall costs. In fact, Heartland’s operating ratio is much higher at 85.5% compared to 69.3% for Norfolk Southern.
2. Operating Income Growth
The three-year average operating income growth for Norfolk Southern stands at -3.9%, much lower than 70% for U.S. Xpress, 19% for Werner, 11% for Canadian Pacific, and 15% for Heartland Express. Better revenue growth for the latter four led to higher operating income for these companies. Looking at the last twelve month period, Norfolk Southern’s 25% drop in operating income compares with 119%, 1%, and 5% gains for U.S. Xpress, Werner, and Canadian Pacific, respectively, while Heartland Express saw a decline of 18%.
The Net of It All
Although Norfolk Southern’s revenue base is much larger than U.S. Xpress, Werner, Canadian Pacific, and Heartland Express, each of these companies has seen higher growth in revenues and operating income than Norfolk Southern in the last twelve months as well as the last three years. Yet, they appear to be significantly cheaper than Norfolk Southern. Despite better profit and revenue growth, these companies have a comparatively lower market cap-to-operating income ratio.
Norfolk Southern’s comparatively persistent underperformance in revenue and operating income growth to some of its peers reinforces our conclusion that the stock is expensive compared to its peers, and we think this gap in valuation will eventually narrow over time to favor the group of comparatively less expensive names. As such, we believe that U.S. Xpress, Werner, and Canadian Pacific, are currently better buying opportunities compared to Norfolk Southern.
While NSC stock looks comparatively expensive, 2020 has created many pricing discontinuities which can offer attractive trading opportunities. For example, you’ll be surprised how counter-intuitive the stock valuation is for Canadian Pacific Railway vs. D.R. Horton.