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Norfolk Southern Corp. Launch: $84 Trefis Price Estimate

Posted
7/8/2011 3:07:00 PM
By: Trefis
Referenced Stocks:CSX;UNP

Norfolk Southern Corporation (NYSE:NSC) is the leading Class-1 railroad in the Eastern U.S. and transports raw materials, intermediate products and finished goods. The company offers the most extensive intermodal network in the eastern half of the United States and operates on over 20,000 miles of track, out of which 15,500 miles are owned outright and the remainder is pursuant to trackage rights or leases. Its network  serves major population centers in 22 states east of the Mississippi River, the District of Columbia and the Canadian provinces of Ontario and Quebec. Goods are primarily transported in the Southeast, East, and Midwest U.S. and via interchange services with rail carriers to and from the rest of the United States. Norfolk Southern competes with CSX Corporation ( CSX ), which covers much of the same territory, as well as with other railroads like Union Pacific ( UNP ) Burlington Northern (owned by Berkshire Hathaway (NYSE:BRK.A)).

We recently launched coverage activity on Norfolk Southern Corporation with a $84 price estimate for the company's stock, which is around 10% ahead of the market price.

Launch of Coverage on Norfolk Southern Corporation; $84 price estimate

We have broken down our analysis of Norfolk Southern Corporation into 7 main divisions:

  1. Coal Freight
  2. Intermodal Freight
  3. Chemicals Freight
  4. Agricultural & Consumer Products Freight
  5. Metals & Construction Commodities Freight
  6. Automotive Freight
  7. Clay and Forest Products Freight

North American Railroads at a Glance

Railroads are an important segment of freight transportation industry in the United States. They serve many of the fastest growing U.S. population centers and provide Americans with a fuel-efficient, environmentally responsible and safe mode of freight transportation. They move everything - coal and lumber, automobiles and scrap iron, grains and vegetables, chemicals and oils, transporting 42% of United States' freight (measured in ton-miles) - more than any other mode of transportation. With numerous consolidations and acquisitions, U.S. railroads are monopolistic in nature and carry high barriers to entry for new entrants.

Freight demand is extremely impacted by the economy. The slowdown of 2008-09 had a considerable drag in volume levels, leading to a record decline in the railroad freight revenues. Strong demand recovery characterized 2010 railroading, but we think there's room for more growth, especially for coal and intermodal freight. The total 2010 carloads plus the intermodal units are still below 2008 levels so the railroads have further opportunity for volume growth.

The recent margin and productivity trends have exceeded market expectations and the railroads have set records even during the recession. The margin improvements are primarily attributable to the railroad's continued repricing above rail inflation, volume growth and the productivity gains with normalizing costs. Expanding train lengths is the key to rail profitability and the railroads have a potential to leverage the recovering volumes.

Export Coal and Intermodal Outlook presents an upside

Coal freight service of Norfolk Southern consists of transportation of coal and petroleum coke and accounts for the highest share of Norfolk Southern total freight volume, representing 41% of total carloads (excluding intermodal units) in 2010. Export coal freight is a very profitable segment of Norfolk Southern due to its highly efficient unit train configurations and longer than average lengths of haul.

Given the tight truckload capacity, improving global coal demand and Norfolk Southern's high exposure to export volumes, the export coal is expected to grow at a relatively higher rate than other segments, thereby providing some operating leverage. In 2010, Norfolk Southern's coal volumes recovered sharply helping the company increase its market share by 1.2%. But the coal volumes are still below pre-recession levels leaving enough room for growth.

The intermodal volume recovered rapidly driving strong margin improvements. The segment carries high incremental margins as train lengths are extended because the additional costs associated with adding containers to existing trains are low. The intermodal freight segment of Norfolk Southern has a stiff competition with several truck carriers due to the eastern railroads' relatively shorter length of hauls. Rising fuel prices, a shortage of long-haul drivers and highway congestion is expected to hamper the trucking industry, thereby encouraging railroads to gain market share. The increasing truck rates also deliver a pricing flexibility to Norfolk Southern.

See our full analysis of Norfolk Southern.