Wednesday, July 27, 2016

For NS, a record-low operating ratio

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Norfolk Southern Chairman, President and CEO Jim Squires Norfolk Southern Chairman, President and CEO Jim Squires

Like most of its peers, Norfolk Southern’s second-quarter 2016 volume, revenues and income were down compared to the same period last year, but the railroad managed lower its operating ratio to below 70% and expects to sustain that for the remainder of the year.

NS’s second-quarter operating ratio was 68.6%, a 140 basis point improvement compared with 70.0% in the second quarter of last year. For the first six months of 2016, the OR was 69.4%, a first-half record. Net quarterly income was $405 million, compared with $433 million during the same period of 2015. Diluted earnings per share were $1.36, 4% lower than 2015’s $1.41 diluted EPS.

Railway operating revenues were $2.5 billion, down 10% compared with second-quarter 2015, due to reduced volumes and lower fuel surcharge revenues. Overall volume declined 7% to 1.8 million units for the quarter. Railway operating expenses declined 11% to $1.7 billion, primarily due to cost reduction initiatives as well as lower fuel costs. Income from railway operations was $770 million, 5% lower compared with second-quarter 2015. NS’s composite service metric improved 13% in the quarter and 18% for the first six months of 2016, compared with the same periods last year.

Merchandise revenues were $1.6 billion, 3% lower than the same period last year. Volume declined 3%, largely due to fewer chemicals shipments resulting from continued low oil prices. The five merchandise commodity groups reported the following year-over-year revenue results: Chemicals—$426 million, down 6%; Agriculture—$383 million, up 1%; Metals/Construction—$334 million, down 3%; Automotive—$248 million, down 2%; Paper/Forest—$186 million, down 5%

Intermodal revenues were $538 million, 15% lower compared with second-quarter 2015. Volume declined 5% primarily due to the restructuring of the company’s Triple Crown Services subsidiary.

Coal revenues were $339 million, 25% lower compared with second-quarter 2015. High stockpiles, limited coal burn due to mild winter weather, and sustained low natural gas prices combined to decrease volume by 24%, NS noted.

“Our second-quarter results reflect our unwavering focus on cost-control, steadfast commitment to customer service and significant improvements in network performance,” said Chairman, President and CEO Jim Squires. “We are on track to achieve productivity savings of at least $200 million for 2016, and our record first-half operating ratio of 69.4% gives us confidence we’ll achieve a full-year operating ratio below 70%. Through the continued execution of our strategic plan, we remain confident in our ability to drive superior shareholder value through excellent customer service that positions us for future revenue growth, combined with network efficiency and asset utilization.”

“We are encouraged by NS’s pricing discipline, which could get some help from positive signs in the trucking market,” said Cowen and Company Managing Director and Railway Age Wall Street Contributing Editor Jason Seidl. “While second-half 2016 margins are likely to be worse than what we had initially modeled, the full-year OR should still come in below 70%, and the company’s longer-term target of a sub-65 OR by 2020 remains intact.”

“NS reported 2Q16 EPS of $1.36, 5% below last year but above our and consensus estimates of $1.28 and $1.35, respectively,” Siedl noted. “Operating income declined 5% to $770 million, but was also ahead of our and street expectations of $722 million and $756 million, respectively. Revenue fell 10% to $2.45 billion and was just shy of our and consensus estimates. The OR was 68.6%, 140 basis points better than last year, 210 basis points better than our assumption, and 80 basis points better than the implied consensus forecast. The improvement occurred as operating expenses declined 11% to revenue’s 10% decline. Additionally, pricing was in excess of rail inflation and up year-over-year and sequentially. While soft trucking rates continue to negatively affect NS’s truck-competitive businesses, the company noted that it has seen a sequential rise in spot truckload rates, which is consistent with the takeaways from our July 13 private trucker call if sustainable, this could boost NS’s pricing further going forward.” (Download Right Turn Ahead for Trucking? - Private Trucker & 3PL Call Takeaways at the link below.)

NS “is on pace for at least $200 million in productivity savings during 2016” and “still expects to achieve $650 million in annual savings and a sub-65 OR by 2020,” Siedl said. “While second-half 2016 looks like it will be a minor setback to our and consensus margin expectations, we see this as a hiccup and not a long-term concern. Indeed, the slight OR deterioration now expected for the third quarter is largely attributable to a $30 million headwind for incentive compensation, which should occur again in the fourth quarter, since last year’s third and fourth quarters included reversals of accruals. The rate of decline in the Materials expense should also moderate somewhat. Longer term, if management can keep posting results close to first-half 2016, it may have many people believing that the $650 million in annual cost savings will happen sooner than 2020. We think management’s guidance for a sub-70% OR in 2016 should still be easily achievable. We are forecasting a 69% OR. In addition to the headcount reductions, shuttering of Triple Crown Services and division mergers, NS is in the process of rationalizing, in one way or another, 1,600 miles worth of track, which is about 8% of the company's network.”

Siedl said Cowen is “modestly lowering” its 2016 EPS estimate for Norfolk Southern to $5.70 from $5.80, while maintaining its 2017 EPS estimate of $6.60, as “we do not see a significant change to long-term outlook. Our price target remains unchanged at $99, based on the same 15x multiple and our 2017 EPS estimate. We remain constructive on NS shares and encouraged by the company’s pricing discipline and operational improvements.”




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