Wednesday, January 27, 2016

NS: New strategic plan follows a challenging year

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NS Chairman, President and CEO Jim Squires NS Chairman, President and CEO Jim Squires

Though Norfolk Southern’s fourth-quarter and 2015 financial results aren’t all that different from those of most other Class I railroads, NS has  been particularly compelled to develop an aggressive strategic plan because it is fending off a hostile takeover attempt.

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Speculation that Canadian Pacific and its largest shareholder, activist hedge fund king Bill Ackman, will abandon pursuit of NS hasn’t deterred NS from undertaking what it’s calling “a strategic plan to streamline operations and drive profitability and growth.” NS says its plan, details of which were announced on Jan. 27, 2016 concurrent with its financial report, “includes cost reductions across the organization and improved operational efficiencies” that are expected to “achieve annual productivity savings of more than $650 million by 2020, with approximately $130 million to be realized in 2016.” NS added that with these initiatives, it’s “confident in its ability to achieve an operating ratio below 65% by 2020.”

First, the financials: NS’s fourth-quarter 2015 net income was $361 million, or $1.20 per diluted share, compared with $511 million, or $1.64 per diluted share, in fourth-quarter 2014. For full-year 2015, net income was $1.6 billion, or $5.10 per diluted share, compared with $2.0 billion, or $6.39 per diluted share, in 2014. These results included expenses related to restructuring of its Triple Crown Services subsidiary and closing its Roanoke, Va., office, which together reduced fourth-quarter net income by $31 million, or $0.10 per diluted share, and lowered 2015 net income by $58 million, or $0.19 per diluted share.

Compared to the prior-year period, railway operating revenues declined 12% to $2.5 billion. Traffic volume declined 6%, a result of lower coal volumes and the effects of low commodity prices. Average revenue per unit decreased 6% as the effects of higher rates were more than offset by a $226 million, or 73%, decline in fuel surcharge revenues. General merchandise revenues were $1.5 billion, 9% lower. Volume declined 4%, as a 9% gain in automotive traffic was more than offset by decreases in the other four commodity groups. Intermodal revenues declined to $563 million, 13% below fourth-quarter 2014. The Triple Crown restructuring and fewer domestic shipments combined to reduce traffic volume by 5%. Coal revenues were $433 million, 20% lower. A weak global export market, record high temperatures in the East, and low natural gas prices combined to decrease coal volume by 18%.

NS’s quarterly railway operating expenses decreased $103 million, or 5%, to $1.9 billion compared with same period of 2014, notwithstanding $49 million of expenses related to the Triple Crown restructuring and Roanoke office closure. Income from railway operations was $642 million, 28% lower. The operating ratio was 74.5%, compared with 69% during the same quarter in 2014. Triple Crown restructuring and Roanoke office closure expenses added 2.0 percentage points to the operating ratio.

For full-year 2015, NS’s railway operating revenues were $10.5 billion, 10% lower than 2014, reflecting an $852 million, or 64%, reduction in fuel surcharge revenues. Traffic volume was down 3%, driven by a sharp decline in coal. General merchandise revenues declined 6% to $6.3 billion, while traffic volume was about even compared with the prior year. Intermodal revenues totaled $2.4 billion, 6% lower, though volume was up slightly. Coal revenues were $1.8 billion, down 23%, due to a 16% decline in traffic volume

. 2015 railway operating expenses were $7.6 billion, a $422 million, or 5%, decline, compared with 2014, despite $93 million of additional expenses related to the Triple Crown restructuring and Roanoke office closure. Income from railway operations was $2.9 billion, 19% lower. The 2015 operating ratio was 72.6%, compared with 69.2% the prior year. The Triple Crown restructuring and Roanoke office closure costs added 0.9 percentage points to the operating ratio.

In 2016, Norfolk Southern plans to invest $2.1 billion “to maintain the safety of its rail network, enhance service, improve operational efficiency, and support growth opportunities.”

NEW STRATEGIC PLAN

“Our fourth-quarter results reflect current challenges in domestic and global markets,” said Chairman, President and CEO Jim Squires. “We are implementing a plan to reduce costs and enhance profitable growth. This plan will enable us to achieve significant annual expense savings beginning in 2016 without compromising our ability to capitalize on volume and revenue growth opportunities. We are making progress despite a challenging operating environment, including successfully restoring our rail service to previous high levels, realigning resources, and completing strategic capacity investments to improve efficiency and productivity. Through these actions, we are positioning Norfolk Southern for improved performance and value creation in 2016 and beyond. We are confident in our ability to deliver superior shareholder value through our strategic plan, which is built on exceptional customer service, growth through pricing and new business, cost reduction and control, and increasing returns on capital. With this plan, we expect to improve consistency, reliability and availability, resulting in a faster, lower cost, and more profitable railroad.”

NS’s projected expense reductions and “disciplined cost control initiatives” are in the categories of compensation and benefits, purchased services and rents, materials, and fuel. NS said it expects to achieve annual productivity savings of more than $650 million per year by 2020, growing from an initial $130 million in 2016. NS has begun implementing the plan and expects associated net benefits to begin appearing in financial results beginning in the first half of 2016.

The strategic plan, which was announced on Dec. 4, 2015, “is the result of a six-month comprehensive evaluation of the our business model, including customer service, network performance efficiency measures and revenue growth,” said Squires, who led the evaluation with the assistance of the board of directors and management team. “As a result of these measures, we expect to achieve an operating ratio below 70 in 2016 with additional improvements driving OR to less than 65 by 2020, with double-digit annual EPS growth, increased return on investment and higher return of capital.”

NS said the plan is “a balance of revenue growth through pricing and volume, and resource optimization through a variety of expense reduction and cost control initiatives”:

Compensation and Benefits: Service and efficiency improvements, consolidation, and network rationalization will enable Norfolk Southern to reduce headcount in 2016 and beyond, building on initiatives begun in 2015 to “right-size” the workforce. This improved productivity is expected to result in $420 million in annual expense savings by 2020. NS expects to reduce headcount by 2,000 employees by 2020; decrease overtime by 50% from 2015 levels; reduce employee levels in areas affected by lower coal traffic and by the “rightsizing” of its coal infrastructure; consolidate operating regions from three to two; halt or reduce operations in several hump or secondary yards in 2016, reducing manpower needs and locomotive fleet requirements and consolidating traffic on fewer, larger trains; and dispose of or downgrade 1,500 miles of secondary lines by 2020, including 1,000 miles in 2016, as traffic is rerouted onto higher-density lines and some parts of the system are more economically operated in collaboration with short line rail carriers.

Purchased Services and Rents: Projected efficiency improvements and network rationalization should enable NS to realize annual savings of $70 million by 2020 by reducing the size of the car fleet and associated costs and reducing payments to third parties. NS expects to reduce equipment rental and lease costs, along with maintenance expenses for that equipment; reduce the use of third-party switching terminals by leveraging the recently completed expansion of Moorman Yard in Bellevue, Ohio; and reduce trackage and haulage payments.

Materials: Projected efficiency improvements should enable Norfolk Southern to reduce expenses by $80 million per year by 2020. NS expects to decrease locomotive maintenance expenses by reducing active fleet size by 300 units in 2016 and another 100 units by 2020 through improved velocity, line, yard, and local-switching-network rationalizations; reduce overhaul and maintenance expenses and improve locomotive reliability by replacing older, less-reliable units; and conserve capital while enhancing the efficiency and reliability of the locomotive fleet by continuing its 6-axle rebuild strategy, which includes DC to AC conversions.

In addition, projected fuel efficiency initiatives should allow NS to reduce fuel consumption by $80 million per year by 2020. NS expects to maximize fuel efficiency through implementation of energy management technology and reduce fuel consumption as a result of fewer units in the fleet, removal of the oldest, least efficient units, and higher system velocity.

“Our new leadership team has already taken significant steps to improve financial and operational performance,” Squires said. “Specifically, we are focused on delivering high levels of superior service to build a more profitable franchise based on price and volume growth, implementing efficiency measures, and increasing returns, while simultaneously maintaining our commitment to returning substantial capital to shareholders through share repurchases and dividends. While our fourth-quarter results do not yet reflect the initiatives under way, we believe we have the right strategic plan to streamline operations, accelerate growth, and enhance value for shareholders. The plan leverages our core competencies in customer service and reliability, while also improving network efficiency and consolidating operations. Importantly, through disciplined cost control, we believe we can achieve the productivity savings outlined in this plan, and even more.”

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