NS 3Q20: Intermodal, PSR ‘Key Drivers Going Forward’

Written by Marybeth Luczak, Executive Editor
“With the resilience of our railroad, strong customer relationships and the hard work of our team, including new Chief Operating Officer and PSR veteran Cindy Sanborn, we are confident in our ability to achieve our goal of a 60% operating ratio with more to come,” NS Chairman, President and CEO James A. Squires said.

“With the resilience of our railroad, strong customer relationships and the hard work of our team, including new Chief Operating Officer and PSR veteran Cindy Sanborn, we are confident in our ability to achieve our goal of a 60% operating ratio with more to come,” NS Chairman, President and CEO James A. Squires said.

Norfolk Southern Corp. reported third-quarter financial results that reflected the pandemic’s impact, similar to the other five publicly traded Class I’s, but emphasized how Precision Scheduled Railroading has “significantly enhanced” operational and financial performance since its launch.

Cowen and Company analysts noted that PSR as well as intermodal growth will be the “key drivers going forward” for NS (see their insight below).

NS reported net income of $569 million, diluted earnings per share of $2.22, and an operating ratio of 66.5%. These results, the railroad said, include a previously announced $99 million non-cash impairment charge related to an equity-method investment.

Other third-quarter highlights:

  • Excluding the effects of the impairment charge, adjusted third-quarter net income was $643 million, adjusted diluted earnings per share were $2.51, and the adjusted operating ratio was 62.5%, which reflects a 240 basis-point improvement compared with third-quarter 2019.
  • Railway operating revenues of $2.5 billion fell 12% compared with third-quarter 2019, driven by a 7% decline in total volume and 5% decline in revenue per unit.
  • Railway operating expenses were $1.7 billion, including the impairment charge. Excluding the charge, adjusted operating expenses fell $278 million, or 15%, compared with third-quarter 2019, “driven by lower compensation and benefits, fuel, purchased services, materials, and the absence of last year’s $32 million receivable write-off.”
  • Income from railway operations was $840 million and the operating ratio was 66.5%. Excluding the impairment charge, adjusted income from railway operations was $939 million, while the adjusted operating ratio improved to 62.5% versus the third-quarter record of 64.9% set in 2019.
NS Chairman, President and CEO James A. Squires

“Given the impact of the COVID-19 pandemic on our industry and the broader economy, we quickly executed a plan to align our assets and resources with demand and generate sustainable margin improvement,” NS Chairman, President and CEO James A. Squires said. “In addition to maintaining outstanding service levels with fewer resources and reduced headcount, we successfully idled our fifth hump [yard] in the past five quarters, helping Norfolk Southern achieve record productivity. With the resilience of our railroad, strong customer relationships and the hard work of our team, including new Chief Operating Officer and PSR veteran Cindy Sanborn, we are confident in our ability to achieve our goal of a 60% operating ratio with more to come, while delivering enhanced free cash flow and further value creation for Norfolk Southern shareholders.”

The NS website provides more details.

The Cowen Insight

Cowen and Company Managing Director and Railway Age Wall Street Contributing Editor Jason Seidl

NS “achieved an earnings beat and OR improvement as a decline in operating expenses outpaced a revenue decline,” said Cowen and Company analysts Jason Seidl (Managing Director and Railway Age Wall Street Contributing Editor), Matt Elkott and Adam Kramer. “Inventory replenishment, tight TL capacity, and service improvement should spur intermodal growth, while at the same time the company continues to optimize its network as part of PSR. We remain constructive and raise our PT to $224 from $221.”

The analysts’ key takeaways:

  • “NSC [NS] delivered adjusted 3Q20 EPS of $2.51, handily beating our and consensus estimates of $2.37 and $2.38, respectively. Adjusted operating income declined ~9% y/y to $939MM, slightly above the company’s pre-announcement on October 7, just shy of our $941MM estimate but above consensus of $838MM. Revenue declined 12% to $2.5Bn (in line with the aforementioned pre-announcement and in line with our and Street estimates) on a 7% drop in volume and a 5% decrease in RPU. Meanwhile, operating expenses decreased 15%. As a result, the adjusted operating ratio (OR) improved ~130bps y/y to 62.5% and was in line with our estimate but 400bps better than consensus of 66.5%. The big OR beat to consensus is likely due to some analysts not adjusting their estimates following the October 7 pre-announcement.
  • “The company continued its PSR implementation with the curtailment of a hump yard in Pennsylvania in September. Another curtailment is under way at a yard in Georgia, after which NSC will have curtailed operations at 6 humps in the past 18 months, leaving the carrier with 4 high-volume yards. The company should also be able to continue to improve its train velocity, which should be key to accommodating incremental volumes without significant additions of resources. Additionally, this will lower NSC’s capital requirements going forward. Management noted that it has line of sight to a 60% OR during 2021 through a combination of cost reductions and revenue growth. We are modeling for a 6% volume increase next year and a 61% annual OR, a ~340bps improvement.
  • “NSC’s merchandise and intermodal volumes should benefit from a number of dynamics in the balance of the year and into next. These include record TL capacity tightness and a prolonged inventory replenishment cycle following COVID-19 shutdowns earlier this year. Additionally, the intermodal service improvements NSC has made over the last few years should continue to facilitate conversion from the highway.
  • “We are fine-tuning our 2020 and 2021 EPS estimates to $9.16 and $11.40, from $9.02 and $11.35, respectively. We are also introducing our 2022 EPS estimate of $12.80. This new estimate calls for NSC to finally get its OR below 60%. Our price target rises $3 to $224 as we move to valuing the shares based on our 2022 EPS estimate (previously 2021) while discounting our multiple to 17.5x, from 19.5x.”
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