“Short-term pressure,” in the words of President and CEO Jim Squires, contributed to Norfolk Southern on July 27, 2015 posting second-quarter 2015 financials with significant declines in net income, operating revenues and earnings per share, and an operating ratio that rose 350 basis points.
Net income for the quarter was $433 million, 23% lower compared with the $562 million record results from the same period of 2014. Diluted EPS was $1.41, 21% lower than the $1.79 per diluted share earned in the second quarter last year. Railway operating revenues were $2.7 billion, 11% lower compared with second-quarter 2014, “a result of lower fuel surcharges and coal volumes,” NS said. Total volume decreased 2%, or about 46,000 units. Railway operating income was $814 million, 20% lower than second-quarter 2014. Railway operating expenses declined 6% to $1.9 billion, “primarily due to lower fuel costs.” The operating ratio was 70.0%, compared with 66.5% in the prior-year period.
Nose-diving coal traffic appears to be the prime culprit in NS’s second-quarter performance. Coal revenues were $453 million, 33% lower compared with the second quarter of 2014. Volume was down 21%, driven by declines of 23% in domestic utility and 38% in export. NS said coal revenues “were affected by continuing low natural gas prices and declining fuel surcharges,” and the losses in coal greatly offset relatively small gains in intermodal and merchandise traffic.
General merchandise volume grew by 1%, with strong growth in chemicals offsetting declines in steel. Automotive and paper volume increased with higher vehicle production and strength in pulpboard and lumber. Despite the volume gain, general merchandise revenues were $1.6 billion, 5% lower than the same period last year, “reflecting lower fuel surcharges,” NS said. The railroad’s five general merchandise commodity groups reported mostly lower revenue results on a year-over-year basis: chemicals, $454 million, about even with 2014; agriculture, $ 379 million, down 2%; metals/construction, $344 million, down 16%; automotive, $254 million, down 6%; and paper/forest products, $196 million, down 2%.
Intermodal revenues were $633 million, 3% lower compared with second-quarter 2014, “as lower fuel surcharges more than offset volume gains,” NS said. Higher shipments in international business drove overall volume growth of 2% in the quarter, compared with the prior-year period.
“NS reported largely in-line results and indicated that coal may have reached bottom while intermodal and merchandise could help the company inch closer to volume growth,” said Cowen and Company Managing Director and Railway Age Wall Street Contributing Editor Jason Seidl. We remain constructive on the shares but note that significant near term upside may be limited, as difficult comparisons continue in 3Q15 and overall freight demand remains sluggish.”
“NS reported second-quarter 2015 EPS of $1.41, but excluding a $5 million nonrecurring item, EPS from continuing operations came in at $1.43, compared to our and consensus estimates of $1.37 and $1.42, respectively,” Seidl noted. “This represented a 20% decline from the same period last year. Reported operating income was $814 million, but excluding the aforementioned item, operating income declined 20% year over year to $819 million, compared to our and consensus estimates of $789 million and $827 million, respectively. Revenue decreased 11% to $2.71 billion, compared to our and consensus estimates of $2.73 billion and $2.78 billion, respectively. The reported operating ratio was 70%, but excluding the aforementioned item, the OR deteriorated 330 basis points year over year to 69.8%, but was 130 basis points better than our assumption and 50 basis points better than the implied consensus OR.
“While sharp year over year coal traffic declines should continue in second-half 2015, the commodity may be stabilizing sequentially, with NS projecting 3 million tons of export coal and 20 million tons of utility coal per quarter for the remainder of the year. Utility stockpiles are about 20 days above normal levels on average in the company's served regions, but we believe most natural gas switching has occurred, and unless temperatures are unseasonably mild for an extended period of time, further significant downside in the commodity is limited. However, due to continued tough comps in third-quarter 2015 and still sluggish freight demand, we are still modeling a second-half 2015 traffic decline even though management appeared hopeful that traffic could grow. The company has taken steps to ramp down resources, albeit not to the same extent as some other carriers. NS has taken 50 locomotives out of service and aims for that number to rise to 200, but no timeline was provided. The company may furlough employees in select spots, but total headcount should rise by 400 in the second half, consistent with the company’s plans at the end of last year. NS achieved solid core pricing in excess of rail inflation in the second quarter and indicated that it will remain disciplined, the CEO commenting that the company will ‘lean into pricing.’
“We are lowering our 2015 and 2016 EPS estimates to $5.35 and $6.20, from $5.40 and $6.25, respectively. Our price target drops slightly from $97 to $96, based on our new 2016 EPS estimate and the same 15.5x multiple. NS remains a good investment for long-term investors, in our opinion. The shares currently trade at a roughly 11% discount to the Class I group average of 15.1x, which is slightly above the historical discount and could pique some investors' interest. That said, we believe share price upside may be limited in the near term by current coal volumes.”
NS shares opened on July 27 on the New York Stock Exchange at $82.32, a 52-week low, and as of mid-morning were trading at $83.35. NS's 52-week high was $117.64.