It wasn't that long ago that it was hard to get excited about Norfolk Southern (NYSE:NSC) as an investment in the railroad industry. It was consistently a laggard in the all-important operating metric, operating ratio, and most of its peers made for much more compelling investments. After this most recent quarter, though, we may have to rethink that narrative as the company is now posting operating metrics on par with its larger peers.

Let's take a look at Norfolk Southern's most recent earnings results and see what's in the sauce of these rather remarkable earnings results lately. 

Rail yard at night.

Image source: Getty Images.

By the numbers

Metric Q2 2018 Q1 2018 Q2 2017
Revenue $2.90 billion $2.72 billion $2.64 billion
Operating income $1.03 billion $835 million $872 million
Net income $710 million $552 million $487 million
Diluted EPS $2.50 $1.93 $1.71

DATA SOURCE: NORFOLK SOUTHERN EARNINGS RELEASE. EPS = EARNINGS PER SHARE.

This was perhaps the closest thing to a perfect quarter you will see for Norfolk Southern as it blew past expectations and delivered on every measurable metric for the business. The company set quarterly records up and down the income statement and reported its best-ever operating ratio of 64.8%. In fact, it wasn't that long ago that Norfolk Southern had an operating ratio above 70% and one of the real laggards in the business when it came to efficiency. This result even looks good compared to some of the larger Western and Canadian rail operators that don't have to maneuver the more densely populated eastern half of the U.S., which typically means slower train speeds. 

Both intermodal and merchandise traffic performed quite well this past quarter as on both volume and revenue. Considering the 6% increase in volume compared to the prior year, one might even think that the company wasn't struggling with capacity constraints. What's more, management was able to pass along higher shipping fees. Revenue per unit in its intermodal segment was up 11%, which is a testament to the amount of freight moving around the U.S. 

NSC revenue by business segment for Q2 2017, Q1 2018, and Q2 2018. Shows big year-over-year increase for merchandise and intermodal.

Data source: Norfolk Southern earnings release. Chart by author.

These much stronger revenue numbers and the benefits of the lower corporate tax rate meant that Norfolk Southern generated gobs of cash this past quarter, most of which has been returned to shareholders. In the first half of the year, management repurchased $700 million worth of its own stock. 

What management had to say

On the conference call, CEO James Squires highlighted the improvements in operating ratio and how he thinks the company can improve on that even more.

As we handled near record volumes, we continue our focus on deploying resources to improve service and remain committed to improving network performance for our customers.

Two-and-a-half years ago, we laid out our five-year operating plan and highlighted a number of aggressive yet achievable goals. Since then, we have consistently delivered record financial results. And today, we are more confident than ever that we will hit our targeted OR [operating ratio] of less than 65% by 2020.

Importantly, based on the significant momentum under way and the dedication of our team, we are on track to achieve that target ahead of schedule. As we've said before, given our operations and seasonality, we do not expect OR improvements to occur in a straight line. However, we have already significantly reduced OR and remain on track to achieve another year of year-over-year OR improvement for 2018.

NSC Chart

NSC data by YCharts.

Chugging along at full speed

If you are a Norfolk Southern shareholder, there isn't much else you can ask for in an earnings report. Even with fuel prices on the rise, management running its network at one of the most efficient rates it has ever achieved. It's a great time to do that, too, because intermodal traffic will likely remain strong as the trucking market remains incredibly tight. According to Bloomberg, long-distance trucking rates in June were up 9.4% compared to the prior year and are at multiyear highs. Those kinds of cost increases are going to lead to more intermodal containers moving on rail, which bodes incredibly well for Norfolk Southern for the rest of the year.

The question investors need to start asking is: How much better things can get from here? This was the very best quarter in the company's history in terms of efficiency, fuel prices are on the rise, and pricing inflation can't go on at these rates forever. Can we really expect Norfolk Southern's management to wring out more efficiency from its network as they say they can? Or will it start to incur costs from reaching the upper limits of its capacity as we have seen with other railroads this year?

I don't see the company making a whole lot more improvements in terms of operational efficiency, but high demand in the short term should enable Norfolk Southern to keep charging a premium to move goods and return gobs of cash to shareholders. That, in and of itself, can make a decent value proposition.

Tyler Crowe has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.