Wednesday, October 26, 2016

NS 3Q: Record-low OR

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Norfolk Southern on Oct. 26 reported third-quarter 2016 results with a record low operating ratio, which improved to 67.5%, reflecting a 10% reduction in operating expenses coupled with a 7% decline in operating revenues.

Net income was $460 million, 2% higher compared with $452 million during the same period of 2015. Diluted earnings per share were $1.55, 4% higher compared with $1.49 per diluted share earned in the third quarter last year.

“Our continued focus on efficiency and asset utilization, balanced with our commitment to customer service, drove an operating ratio of 67.5% for the quarter and a record 68.7% for the first nine months, setting us well on the way to achieving productivity savings of about $250 million and an operating ratio below 70% for the year -- even in the face of economic headwinds,” said Chairman, President and CEO James A. Squires. “As we move forward, we are well positioned for growth opportunities longer term and confident in our ability to drive shareholder value.”

NS highlighted these third-quarter stats:

• Railway operating revenues were $2.5 billion, down 7% compared with third-quarter 2015, due to reduced volumes and lower fuel surcharge revenues. Overall volume declined 4% to 1.9 million units for the quarter.

• General merchandise revenues were $1.6 billion, 4% lower than the same period last year. Volume declined 4%, due to fewer crude oil, vehicles, pulpboard, and feed market shipments. The five merchandise commodity groups reported the following year-over-year revenue results:

• Chemicals: $408 million, down 10%

• Agriculture: $380 million, flat

• Metals/Construction: $337 million, up 2%

• Automotive: $236 million, down 4%

• Paper/Forest: $191 million, down 6%

Intermodal revenues were $575 million, 7% lower compared with third-quarter 2015. Volume declined one percent due to lower Triple Crown Services volume, a result of last year’s restructuring. Domestic volume, excluding Triple Crown Services, and International volume were up 8% and one percent, respectively. Coal revenues were $397 million, 18% lower compared with the same quarter last year. Above-normal stockpiles and low natural gas prices combined to decrease volume by 15%.

Railway operating expenses declined 10% to $1.7 billion, primarily due to targeted expense reduction initiatives, reduced fuel expenses, the absence of last year’s restructuring costs, and gains from the disposition of operating property. These decreases were partially offset by higher incentive compensation expense related to improved operating results:

•  Income from railway operations was $820 million, flat compared with third-quarter 2015.

• The composite service metric, which measures train performance, terminal operations, and operating plan adherence, improved 8% in the quarter, and 14% for the first nine months, compared with the same periods last year.

• The railway operating ratio, or operating expenses as a percentage of revenue, was 67.5%, a 220 basis point improvement compared with 69.7% in the third quarter of last year.

“Still riding this horse”

Despite NS’s solid third quarter performance, its stock closed at $90.03 (NYSE), down 3.47% from the prior-day close. “We view Norfolk Southern’s results favorably and believe the negative reaction is unwarranted,” said Cowen and Company Managing Director and Railway Age Wall Street Contributing Editor Jason Seidl. “The company appears to be tracking ahead of schedule on both its productivity and short line outsourcing initiatives. It should achieve a sub-70 OR in 4Q, even excluding operating property sales. The longer-term target of a sub-65 OR by 2020 remains intact.”

“NS reported 3Q16 EPS of $1.55, 4% above last year and ahead of our and the consensus estimate of $1.45,” Seidl noted. “A favorable impact from the sale of operating properties and an unfavorable impact from the sale of non-operating properties largely offset each other. Operating income was largely unchanged y/y at $820 million, but excluding the operating property sales it would have been down modestly y/y, largely in line with consensus, and above our estimate. Revenue declined 7% to $2.5 billion, in line with our and street projections. The operating ratio was 67.5%, 220 bps (basis points) better than last year, 210 bps better than our assumption, and 190 bps better than the implied consensus forecast. Excluding the property sale, the OR would have been 68.6%, still a y/y improvement and better than our and consensus assumptions.

“The improvement occurred as the company continued to manage costs effectively, improve productivity (we would not be surprised if NS exceeds its goal of $250 million in productivity savings this year; the goal was $200 million as of last quarter), and target inflation plus pricing. This last task is becoming a bit more challenging in a continued sluggish freight environment and loose trucking capacity. That said, while Union Pacific’s pricing appears to have dipped below rail inflation, in good part due to competitive pressure from BNSF, we believe the competitive dynamic is a little different in the east, where NS and CSX, both more badly hurt by coal declines over the past several years, may have little appetite for price wars. Normal winter weather and a tightening in truckload capacity from the approach of ELDs (electronic logging devices) could aide NS’s pricing efforts.

“NS still expects to achieve $650 million in annual savings and a sub-65 OR by 2020. If management can keep posting results close to what we have seen YTD it may have some 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 very achievable. We are forecasting a 69% OR. 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 1,500 miles worth of track, which is about 8% of the company's network. We are fine-tuning our 2016 and 2017 EPS estimates to $5.60 and $6.50, from $5.65 and $6.60, respectively.”





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