Jason Seidl: NS, and the race to maximize shareholder value

Norfolk Southern shareholders “continue to find themselves in the enviable position of having two Class I management teams competing to maximize shareholder value,” says Cowen and Company Managing Director and Railway Age Wall Street Contributing Editor Jason Seidl.

“While NS management has been working on improving operations since well before Canadian Pacific’s [takeover] bid, the Eastern carrier has shifted its efforts into higher gear, rolling out a fairly detailed plan to achieve a sub-70% OR (operating ratio) in 2016 and a sub-65% OR in 2020,” notes Seidl. “The plan bakes in somewhat modest volume growth of 2.5% from 2015 to 2020 while emphasizing disciplined pricing action to achieve increases in excess of rail inflation, even during volume declines. It also aims for annual cost savings of $660 million by 2020 via initiatives ranging from rightsizing the workforce to improving locomotive productivity and train speed. We believe these long-term goals are achievable with the help of a recovery in carloadings, but for 2016 we have modeled for an OR just above 70% due to our view that the current challenges in industrial markets will persist in the foreseeable future.”

“NS reported solid results partly aided by a lower-than-expected tax rate,” says Seidl. “We remain constructive on the stock as the battle to win shareholders’ hearts unfolds between management and CP, with the Eastern carrier rolling out a plan to achieve its long-term OR target, an effort intended to not only improve results but also to repel CP’s advances. If CP continues to pursue NS despite what appears to us as widespread opposition from shippers and railroads and skepticism by regulators, the stock may outperform in the near term, but if CP throws in the towel, there could be a near-term pullback as we believe the shares still reflect a modest merger-speculation premium. Indeed, since shortly before the early-November reports of CP’s bid, NS shares are down just 12%, relative to the Class I average of a 17% decline.”

NS’s adjusted EPS of $1.30 was aided by a more favorable tax rate than Cowen expected, contributing $0.11 per share relative to Cowen’s estimate. “We were forecasting $1.24, slightly above consensus’ $1.23,” says Seidl. “Revenue of $2.52 billion was in line with our forecast, but below the $2.56 billion consensus forecast. Adjusted EBIT of $691 million exceeded our $646 million forecast by 7.0%, but fell 3.5% short of consensus’ $716 million expectations. As a result, the adjusted OR of 72.5% was 190 basis points better than our 74.4% forecast but 40 basis points worse than consensus’ 72.1%.”