Why Norfolk Southern Corp. Shares Jumped Higher Today

Facing a dismal outlook for coal loads, one of the nation's leading railroads keeps chugging along.

Jan 22, 2014 at 6:00PM

After the East Coast railroad CSX (NYSE:CSX) left investors stranded by the station last week, Norfolk Southern (NYSE:NSC) lifted their spirits by steamrolling through the fourth quarter of 2013.

CSX was able to stave off steep drops in coal traffic, but the market reacted negatively nonetheless, sending shares down 6.8% last Thursday. On the flip side, Norfolk Southern jumped 4% by this afternoon on the back of record-setting profits that topped analysts' estimates. The Norfolk-based railroad carrier provided a few reasons for investors to celebrate, including steady growth, streamlined operations, and an improving environment for 2014.

Norfolk Southern Wikimedia Commons Railfan Jack

Photo credit: Wikimedia Commons/Railfan Jack.

What's fueling growth?
Norfolk Southern drove revenue higher by 7% for the fourth quarter as merchandise and intermodal shipments outweighed a 2% decline in coal. Fortunately for Norfolk, coal's taken a back seat to the other two categories, contributing only 22% of fourth-quarter revenue. Meanwhile, merchandise shipments make up 56% of Norfolk's revenue and posted 12% quarter-over-quarter growth. A strong uptick in chemicals, automotive, agricultural, and construction products have fueled this category in recent years.

Most importantly, the bottom line swelled in the fourth quarter as income from railway operations increased 23%. As noted by Norfolk in its earnings presentation, "Revenue growth far exceeded the increase in expenses." Despite a 7% increase in railway operating revenue, operating expenses budged only 2% higher during the quarter. This one-two punch pushed net income in that period up by 24%. For comparison, Norfolk's peer CSX felt the impact of a weak coal market more severely and reported a 2.9% fourth-quarter decline in earnings.

How's the engine running?
If expenses are moderating at Norfolk, it's due to a well-tuned operation. While compensation and fuel expenses increased year over year, they were nearly offset by decreases in purchased services, rents, and materials. Overall, operating expenses ticked only 2% higher despite 4% volume growth for the year.

Never one to brag, Norfolk's management team also pointed out that the railroad's operating ratio -- a measure of operational efficiency -- decreased 5% from 73.4 to 69.4 quarter over quarter. Meanwhile, CSX reported an increasing ratio, from 70.6 in 2012 to 71.1 in 2013.

Facing a crossroads, rail operators seem to be taking divergent routes. The Class 1 carriers are prospering from growth in intermodal and merchandise, but only those that can truly weather the storm in coal markets are flourishing.

What's ahead on the tracks?
Norfolk predicts gains in intermodal and merchandise volumes to continue in 2014. Between the oil, automotive, construction, and metals industries, more than a few businesses are in need of long-haul shipments on the backs of the railroad. Expect coal markets, however, to remain depressed. This commodity just can't catch a break during an era of plentiful natural gas reserves and increasing environmental concerns.

Conversely, the future looks bright for railroad infrastructure investment. Norfolk's CEO commented on the company's intention to open its pocketbook to upgrade tracks: "In 2014, we plan to invest $2.2 billion, a 12 percent increase over 2013, to maintain safe railway operations, purchase locomotives and freight cars, and support growth and productivity initiatives." Of this outlay, about 24% of the $2.2 billion is considered a "growth/productivity investment" for Norfolk.

Foolish takeaway
So far, CSX and Norfolk have provided a mixed bag for rail investors. The near-term outlook for coal shipments appears dismal, both domestically and in export markets. Long considered the "backbone of the railroads," coal is facing secular decline that will no doubt hamper growth.

Still, this is old news, and Norfolk proves that a nimble railroad can still thrive. For the nation's largest public railroad, Union Pacific (NYSE:UNP), that's reassuring news. Union Pacific continues to chug along, bolstered by a surging oil and gas sector. The West Coast carrier has beat analysts' earnings estimates for four straight quarters and reports tomorrow.

Meanwhile, Kansas City Southern (NYSE:KSU) will reveal whether coal-dependency is a cause for concern when it reports on Friday. I wouldn't bet on it. Coal accounted for less than 15% of revenue through the first nine months of 2013, a period in which Kansas City Southern topped analysts' earnings estimates for three straight quarters.

While analysts have cast a cloud over CSX's future since its earnings call, Norfolk Southern appears to be hitting on all cylinders. The outlook for railroads in 2014 might be a promising one for investors after all.

The next rail boom
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Isaac Pino, CPA has no position in any stocks mentioned. The Motley Fool owns shares of CSX. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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