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From The Survey: Norfolk Southern
Norfolk Southern (NSC) is a Virginia-based railroad operator that has been in existence in its current form since 1982. The company operates on 20,000 miles of track in the Midwest, Southeast, and East. The railroad hauls everything from coal, crude oil, automobile, and various finished goods in the retail sector. Additionally, the company partners with its rail peers, truckers, and logistic firms to transport goods across the country.
The transportation of coal is a big business for most railroads. In particular, Norfolk Southern is highly levered to the commodity, with coal accounting for 26% of its total revenue in 2012. Unfortunately, the coal market has been struggling over the past year, due to weak electricity demand, competition from natural gas, and tougher regulations. Additionally, softer demand from Europe and China have hurt volumes. What’s more, the company lost 5% of its total coal revenue when RG Steel filed for bankruptcy in May of last year.
We believe the double-digit declines in coal volumes are probably over for the industry. Norfolk Southern may take a little longer to recover than other operators, given its exposure to southern utilities, the export markets, and the loss of RG Steel. That said, the latest EIA report highlighted that coal should begin to gain market share in the utility power markets to more historic norms by 2014.
The company has a substantial intermodal business, accounting for 20% of its total revenue. We expect intermodal growth will continue to outpace GDP growth, driven by a housing recovery and increased global trade. Additionally, the growth in domestic intermodal transportation and truck-to-rail conversions should boost volumes. Manufacturers will continue to relocate to North America, due to lower transportation expenses and more competitive labor costs. We believe Norfolk Southern’s significant intermodal investments over the past few years ought to help capture this new business in the coming years.
In fact, Norfolk Southern’s Crescent Corridor project offers a nice opportunity to capitalize on the aforementioned trends. The endeavor is a series of infrastructure projects and rail improvements spanning from New Jersey to Louisiana, which management believes will boost capacity 20% to 25% at full capacity. We think intermodal will be a long-term focus for the company, given the tougher operating environment in the coal market.
The last category the company reports under is General Merchandise. The segment is composed of five business lines, including chemicals, agriculture, automotive, metals and construction materials, and paper products. The agriculture unit has been under pressure over the last couple of quarters, largely due to last summer’s drought in the Midwest. However, volumes are set to rebound next year, driven by more robust planting and the prospect of a better harvest.
We believe the chemicals and automotive divisions will be stronger contributors to share-net growth going forward. The crude-by- rail trend and transportation of other petroleum products will likely remain quite strong, given the increased crude oil production in North America. Additionally, distribution bottlenecks in Bakken and Canada and the relative flexibility a railroad offers oil operators, should create a number of opportunities for Norfolk Southern.
An improvement in the U.S. economy and housing recovery should help drive solid volume gains and better pricing in the automotive unit. Over the last few years, the company has benefited from the recovery in automobile manufacturers in the United States and Mexico. Favorable financing conditions for cars and increased demand for light trucks ought to sustain the volume gains we foresee in the coming years.
Competition and Market Share
The company’s primary competition along the east coast is CSX (CSX). CSX operates along the same track and provides a good comparison when analyzing the company’s outlook. Norfolk Southern competes with various trucking and shipping companies, as well. As previously mentioned, the company is highly levered to the coal with an 18% market share. We believe the company will begin to gain share in the automotive and intermodal markets, given past investments upgrading their networks. Currently, Norfolk Southern retains a 20% and 18% share of these industries, respectively.
The stock has rebounded since its poor showing in 2012. Indeed, the issue trailed the industry and the broader market averages, largely due to the weakness in its utility coal business. The shares continue to trade at a discount to those of its peers, owing to its exposure to coal. Consequently, we believe the stock’s current quotation offers a favorable entry point for longer-term investors. We also think these shares are more than suitable for the dividend-oriented accounts, as the current yield (2.8%) CHK tops its peers and the Value Line median. All told, we believe Norfolk Southern is a worthwhile selection for most diversified portfolios.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.