Despite the gloomy economic outlook and dampened coal demand,
Norfolk Southern Corp.
's (
NSC
) second quarter earnings were driven by strong operating
performance and cost-control measures. Quarterly earnings surpassed
the Zacks Consensus Estimate and also improved from the year-ago
level.
We believe accelerated investments in new projects, coupled with
business expansion, will likely result in strong growth. Further,
the company remains committed to enhancing shareholders' value in
the form of dividend payments and share buybacks, and looks to
further improve service offerings.
However, several headwinds such as the downturn in coal and crop
markets will likely limit the potential upside over the near term.
In addition, tightened railroad regulation and competitive pressure
from other leading railroads such as
Union Pacific Corporation
(
UNP
) and
CSX Corp.
(
CSX
) also remain significant headwinds for the company's growth.
Consequently, we maintain our cautious stance on the company with a
long-term Neutral recommendation.
We believe Norfolk Southern is poised to benefit from strong
pricing momentum on the back of growing market demand and shortage
in truckload transportation. We expect the company's pricing
improvements together with productivity gains to offset the current
rail inflation. It is also expected to lead to continued margin
improvement and earnings growth this year and beyond.
We believe the company will gain from its superior service and
network capabilities, infrastructural investments, and accelerated
growth in Intermodal and Merchandize segments, aided by strong
freight pricing.
Norfolk Southern initiated adequate cost-control measures that
bode well for growth targets. As a result, Norfolk Southern is
replacing its older and less fuel-efficient locomotives with new
machinery. We expect the new fuel-efficient locomotives to reduce
average fleet age and result in lower maintenance expenses, driving
further cost improvement. Further, lower fuel prices are also
expected to enhance margins.
We remain highly optimistic on the company's growth across most
segments. In particular, the company's Merchandize and Intermodal
recorded significant revenue growth that offset lackluster
performance of the Coal segment. Merchandize mainly benefited from
automotive, which will continue to bode well on higher North
American light vehicle production, along with business wins from
Volkswagen and other manufacturers.
Steel shipments are also on the rise, with increased demand from
Russia and Eastern Europe. New business wins in fracturing sand,
mainly from Marcellus and Utica shale regions and products related
to natural gas drilling will remain key growth drivers.
Additionally, higher shipments of crude oil and waste products
such as ethanol will continue to drive growth for the segment.
Further, Intermodal will continue to gain from highway conversions.
International intermodal business is also expected to remain strong
on capacity additions after completion of key intermodal terminal
projects.
However, the near-term growth of Norfolk Southern is expected to
be tempered by its aggressive outlook on accelerated crew capacity,
increasing locomotive and freight car material expenses, and
compensation benefit expenses.
Despite its consistent focus on reducing its operating ratio,
the company plans to ramp up hiring for business growth. Although
this is a significant strategic move for long-term gains, it is
likely to remain detrimental to improving margins in the near term.
Moreover, the current market conditions in utility coal remain
unfavorable for the company in the near term.
Given the low prices of natural gas and declining electricity
generation, utility coal revenues will remain headwinds for the
company this year. In addition, the U.S. grain market also looks
suppressed due to the drought in the U.S. Mid-West.
Going forward, the company also estimates subdued performance to
affect its earnings for the third quarter of 2012. Recently the
company provided its third quarter 2012 outlook, with earnings per
share projected in the range $1.18 to $1.25. The company expects
poor coal shipments and lower fuel surcharge to have an adverse
impact on the company's growth. The projections remain
significantly below $1.59 per share earned in the third quarter of
2011.
For the short-term (1-3 months) the stock has a Zacks #3 Rank
(Hold).
CSX CORP (CSX): Free Stock Analysis Report
NORFOLK SOUTHRN (NSC): Free Stock Analysis
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