Once given up as a dying industry, railroads have roared back to life over the past decade, and Norfolk Southern (NYSE:NSC) has been one of the biggest beneficiaries of the boom in rail transport. With the railroad stock hitting new record highs earlier this month, investors are excited about Norfolk Southern's ability to keep growing. Moreover, Norfolk Southern has not only taken advantage of favorable industry conditions, but also has taken affirmative steps toward opening new opportunities with its railroad network. Let's take a closer look at some of the reasons that investors remain positive about Norfolk Southern's future prospects and how its stock could keep soaring to new heights.
1. Lower fuel costs should fall directly to Norfolk Southern's bottom line.
One major element of a railroad's expenses is how much it spends on fuel. In the third quarter alone, Norfolk Southern spent $387 million to power its locomotives, making up almost 20% of the company's overall operating expenses and representing about 13% of its total revenue. With prices of oil falling and distilled products following suit, Norfolk Southern could see its fuel expenses drop considerably both in this quarter and for the foreseeable future, and that could boost earnings at a critical time for the company.
Admittedly, lower fuel costs also have second-order effects that aren't as favorable to Norfolk Southern. Indeed, one of the drivers of the renaissance of railroads generally has been the high cost of fuel, as steep energy prices have made trucking and other alternatives to rail transport more costly on a relative basis. Nevertheless, with customers having seen the value of using railroads, Norfolk Southern isn't likely to face a massive reversal of demand unless energy prices fall further and for a more extended period of time.
2. Takeover speculation could send Norfolk Southern even higher.
Earlier this fall, railroad company Canadian Pacific (NYSE:CP) discussed the possibility of merging with Norfolk Southern rival CSX (NASDAQ:CSX) in a move intended to bolster efficiency and help Canadian Pacific compete more effectively with its own archrival in the Canadian railroad market. Even though CSX ended the talks and has indicated that further consolidation is not likely, Canadian Pacific CEO Hunter Harrison has remained optimistic about the possibility of a merger.
Earlier this month, activist investor Bill Ackman strongly hinted at the possibility that Canadian Pacific might approach one of CSX's competitors with a merger proposition. Norfolk Southern is the obvious choice, with complementary route systems and strong similarities to what CSX has to offer. It's far from clear whether a proposed merger of this magnitude would gain regulatory approval, but even the prospect could help send Norfolk Southern shares to new highs.
3. Norfolk Southern is seeking its own strategic combinations.
One reason for skepticism about a large-scale merger with Canadian Pacific is that Norfolk Southern just announced a smaller transaction of its own that points toward a different type of relationship. Earlier this week, Norfolk Southern said it would spend $217 million to acquire more than 280 miles of track between upstate New York and central Pennsylvania from the Delaware & Hudson Railway, which is a subsidiary of Canadian Pacific. Norfolk Southern CEO Wick Moorman noted that "Aligning the D&H track with Norfolk Southern's 22-state network allows us to connect businesses in central Pennsylvania, upstate New York and New England with domestic and international markets."
At the same time, Norfolk Southern stressed that the scale of the transaction should actually enhance competitive markets in the region rather than restraining them. "Absent this transaction and its efficiencies," said Norfolk Southern strategic planning Vice President John Friedmann, "we are concerned that rail service along much of New York's Southern Tier would be threatened with losing a crucial link to New England." The deal still must receive regulatory approval, but by addressing Canadian Pacific's desire to divest some of its noncore assets, Norfolk Southern stands to gain from its completion if approved.
Norfolk Southern has a lot going for it, and recent conditions have become even more favorable for the company. If it can move forward with new initiatives to make the most of its opportunity, Norfolk Southern could keep enjoying new record stock highs.