Source: Norfolk Southern.

The railroad industry has been reasonably strong lately, and Norfolk Southern Corp. (NSC 9.87%) weighed in with impressive earnings a few days ago that included record levels of revenue and net income for the company's third quarter. Yet in some ways, Norfolk Southern's management team was dissatisfied with the railroad's performance, as they saw several ways in which the company fell short of its goals. To find out more about what insiders want to do to make things better, let's take a closer look at five things that Norfolk Southern's management team highlighted in its most recent conference call and assess their potential impact on the railroad going forward.

I have very high regard and respect for the head of [Canadian Pacific], but this is just a place where I have a different opinion. I think that a major railroad merger is not a good idea.
-- CEO Wick Moorman

The revelation that Canadian Pacific (CP -1.06%) had looked at a possible acquisition of CSX (CSX 8.41%) took some attention away from railroads' earnings reports, as different analysts assessed the pros and cons of consolidation in the industry. But Moorman cited three reasons that merger activity would be a bad idea. First, he notes that historically, structuring a merger is hard and produces substantial problems in providing high-quality service after the deal is done. Second, there aren't that many overlapping routes left in the industry, making synergies harder to realize. And finally, regulators aren't terribly supportive of mergers among railroads, with requirements that combinations be pro-competitive, posing a huge potential obstacle to any deal.

None of this means that consolidation won't occur. But if Canadian Pacific were thinking about responding to CSX's rebuff by going after Norfolk Southern, then it's likely to find an even more disappointing reception from Moorman and his team.


Source: Norfolk Southern

[W]hile our financial results were very strong ... we continue to be challenged by demand in excess of our forecast for the year. This was particularly significant in terms of our crew base, which was sized for lower volumes.
--Moorman

With most businesses, it's hard to have too much activity at any given time, as growth is generally seen as good. But in the railroad business, limited resources of personnel and equipment can lead to situations in which too much demand from customers makes it impossible for a railroad to deliver high-quality service. That's what happened to Norfolk Southern during the quarter, as average velocities fell and lag times in getting goods where they needed to go climbed.

Norfolk Southern is working to get more qualified personnel among its ranks. But Moorman has said that a seven- to nine-month process will be necessary before it can fully hire and qualify new employees, and that will continue to weigh on Norfolk Southern's growth prospects in the near future.

[O]ur first priority is capital expenditures to grow the company. ... Our second is dividends. We have a very strong dividend track record, and we'll continue to have a strong dividend policy. And then, share repurchases.
-- Moorman

Capital allocation has been a hot-button issue throughout the stock market, as more companies find themselves with excess cash flow and aren't sure how best to deploy their financial resources. Dividend yields have crept up in recent years, and stock buyback activity across the market has seen large increases as more companies see their own shares as the best investment for their money.

Yet Norfolk Southern realizes that it still has profitable opportunities to invest in its own business, and so far, that remains the railroad's top priority. As Moorman noted, Norfolk Southern continually looks at its capital allocation decisions to make sure they're still strong, but the stock's yield above 2% makes its overall strategy look sound.

We see continued opportunity ahead to generate solid growth across most of our business units. The exception is coal.
-- CMO Don Seale

Macroeconomic factors appear to be in Norfolk Southern's favor in most respects. Seale sees tighter capacity and rising trucking costs helping its intermodal segment, while the energy boom continues to drive shipments of chemicals. Strength in the auto industry should lift steel and metals shipments, while record harvests could send demand for agricultural shipments through the roof. Housing's ongoing recovery should lead to customers seeking more lumber, aggregates, and construction materials.


Coal has been an important railroad revenue source for decades. Source: Wikimedia Commons.

Yet coal could have problems ahead. Mild summer weather reduced the need for coal for electricity generation, and global oversupply and low prices have crushed the coal export market. Norfolk Southern doesn't believe that coal will do well in the near future, with currency impacts also taking their toll on the segment. Coal isn't as huge an influence on the entire company as it used to be, but it's still important enough to have a big impact if things go wrong.

[T]he problems we're experiencing are not unique to Norfolk Southern. ... Certainly the Chicago Gateway has been congested and erratic over the past number of months, but all the carriers are trying to address that.
-- Moorman

Chicago is a key area for railroads because it's a major hub between different rail networks. Recently, high traffic and substantial delays have made many experts question the ability of the railroad industry to handle the situation effectively. That's part of what's driving Canadian Pacific and its interest in CSX.

Nevertheless, like CSX, Norfolk Southern apparently believes that further investment in improvements at the company level can lead to better transportation efficiency for everyone. That could prove to be too optimistic, but for now, it's the direction that Norfolk Southern will go in for the foreseeable future.