Morningstar | Norfolk Southern Continues on Its Margin Improvement Track
Norfolk Southern delivers reliable returns, and it typically produced the highest margins among U.S. railroads since the rail renaissance began in 2004. By outearning its cost of capital for several years, it joined the rarefied company of Canadian National. However, Norfolk's operating ratio degraded to 75.4% in 2009 and was stuck between 69% and 73% from 2010 to 2015. This pales in comparison with progress made by Union Pacific and Canadian Pacific, which lack Norfolk's exposure to Appalachian coal. However, in 2018 the firm looked back on track, reaching a record 65.4% OR.A railroad's competitive advantage is inseparable from its track location. Norfolk hauls coal directly from Illinois and Appalachian mines; it also transfers Powder River Basin coal eastward from Western rails. The market's legitimate concern about coal demand destruction from cheap natural gas and lower exports has weighed heavily on Norfolk's shares during recent year. However, coal runs in unit trains hauling exclusively coal (often using customers' cars) so we think the rail will be able to adjust its train and crew starts to match demand, but the decline of high-margin export coal loads is indeed a stiff earnings headwind.Norfolk Southern has increased intermodal volume impressively during the past decade, such that this is the highest-volume segment (55% of 2018 carloads versus just 13% for coal), and intermodal revenue surpassed coal in 2014. In 2018, intermodal produced 25% of revenue and coal, 16%. Recent capacity and speed improvement capital projects have focused on enhancing Norfolk's intermodal franchise and increasing locomotive efficiency.Norfolk Southern is voicing renewed committment to pricing discipline to raise rates in accord with the value it provides, applying fuel surcharges, and (long run) increasing profitability through better operations. We anticipate Norfolk will be able to improve margins as it makes even more efficient use of fuel and labor, though reduced high-margin export coal in 2019 will likely present a challenge.Norfolk Southern is a holding company. Through its subsidiaries, the company is engaged in the rail transportation of raw materials, intermediate products, and finished goods primarily in the Southeast, East, and Midwest and, via interchange with rail carriers, to and from the rest of the United States. The company also transports overseas freight through several Atlantic and Gulf Coast ports. The company provides intermodal network in the eastern half of the United States. The company's railroad operates in several states and the District of Columbia. The company's system reaches manufacturing plants, electric generating facilities, mines, distribution centers, transload facilities, and other businesses in its service area.
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