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Norfolk Southern's Coal Business Could Drag On Results

By: Trefis
Posted: 7/22/2013 4:08:00 PM
Referenced Stocks: CSX;NSC;UNP

Quick Take

Norfolk Southern ( NSC ), one of the leading railroad networks in the eastern United States, is scheduled to report its Q2 2013 results on July 23, 2013. The company reported an annual revenue decline in the previous quarter, mainly on account of lower average revenue per unit as the overall volumes grew during the period.

Norfolk Southern's volume outlook for the second quarter is mixed as its overall volume showed 2% annual growth during the first 10 weeks of Q2 2013 (ending on June 8). However, this was lower compared to 3% annual growth seen in Q1 2013. In Q2 2013, we expect increased volumes in the chemicals, automotive and intermodal segments; however, these gains will be partially offset by challenges in the coal, agricultural, and metal and construction markets.

We believe Norfolk Southern's average RPU will remain under pressure in Q2, mainly on account of challenges in the coal market. The negative mix in price caused by higher proportion of shorter haul Northern utility volumes and export thermal coal could impact overall RPU during the quarter. Weakness in the export coal market on account of lower international prices of coal could further impact RPU. We will closely track profitability and efficiency gains during the quarter as these will be critical for NSC's EPS growth in 2013.

See our complete analysis of Norfolk Southern here

Recap of Q1 2013 results

Norfolk Southern posted railway operating revenue of $2.7 billion in Q1 2013, which marked an annual decline of 2%. The revenue decline was caused by 5% decrease in average revenue per unit as the overall volume rose by 3% annually. Weakness in the coal business, which showed 17% revenue decline during the quarter was primarily responsible for this performance.

Norfolk Southern's operating ratio increased to 74.8% in Q1 2013 from 73.3% in Q1 2012. However, its net income rose by 10% annually in Q1 2013 to $450 million. The strong growth in net income was partially caused by sale of land, which added $60 million to net income in Q1.

The company targets more than $100 million in expense savings in 2013, and we will keep a track of the company's progress against this goal in the quarterly results.

Coal, Agricultural and Metal (and Construction) segments are expected to present headwinds to NSC in the second quarter

Norfolk Southern's coal volumes declined by 4% during the first 10 weeks of Q2 2013, and hence we expect the coal volume outlook to be weak in the second quarter. The outlook for coal revenue per unit (RPU) is also negative for Q2 on account of increased proportion of shorter-haul Northern utility volumes and export thermal coal (as compared to export met coal) in the overall volume, which contributes lower RPU. We expect challenging conditions in the coal market to persist in 2013 for NSC, owing to competition from natural gas for electricity generation and negative mix in price.

NSC's agricultural volumes are expected to post a decline in Q2 2013 due to the carryover from last year's drought, which has affected soybean, corn and feed shipments. However, this market could post a recovery in the second half of 2013, driven by easier y-o-y comparisons and better agricultural output.

Owing to factors such as RG steel bankruptcy, decline in domestic steel production and challenges in the highway construction market, we believe NSC's metal and construction volumes could show a decline in Q2 2013. However, we could see a slight recovery in this segment in the second half of 2013.

Chemicals, Automotive and Intermodal segments will drive volume growth in Q2 2013

NSC's chemicals volumes grew at a strong rate of 15% during the first 10 weeks of Q2 2013. Increased shipments of crude oil by rail on account of insufficient pipeline infrastructure is supporting the high demand in this segment. In addition, the shipments of chemicals and plastics are also rising due to growth in the U.S. chemicals sector. We expect this segment to post high growth throughout 2013.

NSC's automotive shipments are expected to grow at a healthy rate in Q2 2013, driven by auto sector growth in the U.S. Increased vehicular production in North America owing to factors, such as economic recovery and high vehicular age is contributing to growth in this sector. We expect high demand in this segment throughout 2013; however, difficult y-o-y comparisons could affect the growth rate in the future.

The intermodal segment represents a long-term growth driver for Norfolk Southern due to significant truck to rail conversion opportunity and rising U.S. international trade. We expect strong growth in both domestic and international intermodal volumes in Q2 2013.

Our $76 price estimate for Norfolk Southern's stock , is broadly in line with the current market price.

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