EUR 850.00 For Business Accounts Only

Morningstar | Norfolk Southern Reaches Records Aplenty, Adaptation of Some Precision Scheduled Railroading

Norfolk Southern achieved record third-quarter operating income, net income, EPS, and operating ratio, resulting in record year-to-date performance in these same metrics. The Eastern rail grew revenue 10%, EBIT 14%, net income 39%, and EPS 44% over the prior-year period. While it was a third-quarter record for NS, the firm’s record 65.4% OR still pales compared with most peers. We maintain our wide moat rating and expect to increase our fair value estimate slightly as we update rate expectations.

As good as results are, what investors should glean from this quarter is management’s mentioning it will adapt precision scheduled railroading, or PSR, principles and has hired operations employees with PSR experience. While the firm also expressed openness to all schools of best practice, NS follows Union Pacific in recognizing what the market wants; namely, to embrace the principles Hunter Harrison employed to turn four railroads from zero to hero.

NS is still pulling some key levers for margin improvement. Train length, crew productivity (ton-miles per crew start), and fuel efficiency all reached records for the third quarter. Healthy demand doesn’t hurt. The 5% consolidated carload growth includes 11% year-over-year improvement in chemicals and 8% in intermodal. We expect rails to handle low- and mid-single-digit carload growth well.

We already project 100 basis points of OR improvement over each of the next four years. Employee count is a major lever here, and headcount this quarter was 320 lower (about 1%) than in the prior-year period. That said, when a railroad adopts PSR, we expect employee reduction to be more of the order of magnitude of 25%, but we note NS started some rightsizing a couple years ago. CEO Jim Squires indicated confidence in his current C-suite, suggesting he is not open to hiring executives with PSR experience. Too bad, because we think such hires would boost investor confidence at Norfolk (as they would at Union Pacific as well).

We consider coal and intermodal to be the most material commodities at Norfolk Southern, and though total coal is down 4% in the period and 2% for the year to date, export coal increased 5% and 13% for the third quarter and year. We don’t believe export coal demand will persist at this attractive level, but instead will cycle back down for some years. Because we believe export coal is a high-margin business, the core operating ratio excluding lucrative coal may need more work than what the current quarter OR (benefiting from this strong export coal business) might reflect.

Norfolk Southern grew its intermodal revenue a steep 20% on 8% stronger volumes and a really impressive 12% higher revenue per unit. The strong economy and constrained trucking capacity favor intermodal growth.