Thursday, May 05, 2016

Jason Seidl: NS valuation “remains too cheap”

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Jason Seidl: NS valuation “remains too cheap” Norfolk Southern

“We would still be buyers of Norfolk Southern stock,” Cowen and Company Managing Director and Railway Age Wall Street Contributing Editor Jason Seidl wrote in Reiterate Outperform—Just the Tip of the Iceberg, on May 5, 2016.

“CP’s attempt at an acquisition kicked NS’s cost-cutting initiatives into high gear,” said Seidl. “NS has been streamlining operations and adjusting to not only a soft freight environment, but also toward a structurally better OR (operating ratio) longer term. Management is no longer distracted by the CP bid and has plenty of room for improvement. Valuation remains too cheap, in our opinion.”

“NS’s show of such solid operating leverage in 1Q16 surprised us and nearly everyone we’ve spoken with since the release,” noted Seidl. “Despite revenue falling 6% year-over-year, the company grew operating profit by 19% and EPS by 29%. EPS was much stronger than we expected. Share repurchases, a lack of weather-related costs, more efficient handling of freight cars, 12% fewer locomotives and nearly 2,000 fewer employees were key reasons for the big earnings beat. For those reasons and some others, we think NS is poised to outperform the market and its peer group in the face of a challenging volume environment.

“NS has increased its near-term productivity expectations. The company is now on pace for an additional $70 million of savings, or $200 million in total during 2016. That’s up 54% from prior guidance of $130 million. NS still expects to achieve $650 million in annual savings and a sub-65% OR by 2020. If management can keep posting results like 1Q16, 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 be easily achievable given its start. We are forecasting a 67.9%. In addition to the headcount reductions, shuttering of Triple Crown 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.

“NS was one of the only companies for which we raised our EPS forecasts during 1Q16 earnings season. We expect Norfolk Southern to post 15% EPS growth in 2016. We expect the railroad with the next closest 2016 EPS growth to be CN at 4%, a significant gap from NS. However, NS trades two turns below the Class I average on both 2016 and 2017 PE bases. The stock is also trading one turn below its peers on both 2016 and 2017 EV/EBITDA as well. We think the discounts are unwarranted and assign a 15x 2017 EPS multiple, in-line with the Class I average to arrive at our price target of $101.”

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