5 Things Norfolk Southern's Management Expects in 2015

Source: Norfolk Southern.

Railroad stocks have been strong for years, but in its most recent quarterly report, Norfolk Southern (NSC -3.60%) put in a sluggish performance, as revenue slipped slightly and earnings per share were essentially flat. After the report, Norfolk Southern's top management assessed the quarter, pointing out some of the key areas they saw during the fourth quarter and how they plan to move forward in 2015. To see what company leaders expect the railroad to achieve this year, let's take a closer look at the Norfolk Southern conference call, with five choice comments you need to know about.

I think that if you look at the positives, the first is we are clearly in an economy that continues to expand. ... [T]hat is going to drive some segments of our business that are very profitable for us and where we can continue to make volume and margin headway.
-- CEO Wick Moorman

One of the biggest concerns among some investors is that Norfolk Southern won't be able to sustain the improvement it has seen in areas like profit margins and rising volume. Although some of the headwinds holding back the railroad are common to the entire industry, Norfolk Southern's geographical focus leaves it more exposed than rivals like Union Pacific to the difficulties in the coal industry.

Norfolk Southern CEO Wick Moorman. Source: Norfolk Southern.

Nevertheless, Norfolk's CEO is comfortable that the economic strength we've seen in the U.S. lately will strengthen the railroad's overall business. Moorman doesn't expect a lightning-fast turnaround, but he does believe that 2015 will be a good year for Norfolk Southern.

More than two-thirds of the WTI-based surcharge revenue programs contained trigger prices above the current WTI price per barrel. At these expected prices, these contracts will yield zero fuel surcharges in 2015. The remaining WTI-based contracts, as well as the on-highway diesel-based contracts, are expected to generate fuel surcharge revenue, but at a substantially lower rate than in 2014.
-- Chief Marketing Officer Don Seale

For years, Norfolk Southern and other railroads have passed on some of their operating costs from rising energy prices to their customers in the form of fuel surcharges. In some industries, such as the airlines, businesses were under no obligation to discontinue these surcharges regardless of whether energy prices rose further or declined sharply. For Norfolk Southern, though, fuel surcharges tended to be tied directly to domestic crude prices, and that will have a huge adverse effect on the railroad going forward.

Obviously, as CFO Marta Stewart pointed out later in the call, Norfolk Southern will also have lower fuel costs to offset the loss of surcharge revenue. Nevertheless, the railroad won't see as much benefit from falling energy prices as it would if it didn't have to pass on some of its savings to customers.

Source: Norfolk Southern.

While network velocity for the full fourth quarter declined, our velocity and overall operation improved in December.
-- COO Mark Manion

High traffic levels have been a boon for Norfolk Southern, but they've also brought with them sluggish performance metrics. Average speeds for trains have fallen, on-time records have declined dramatically, and the length of delay time that trains spend at terminals has increased as a result. Yet as Manion points out, Norfolk Southern has put new resources to work to try to lessen these problems and increase efficiency without putting safety at risk. With December looking better than the fourth quarter as a whole, Norfolk Southern hopefully can continue the upward trend and keep improving.

[F]uel expense decreased by $56 million, or 14%. For the quarter, our average price per gallon was $2.52, a 17% decline. On the consumption side, gallons used rose just 3%.
-- CFO Marta Stewart

Fuel costs are a key component of Norfolk Southern's operations, and the plunge in energy prices promises to have a considerable impact in pushing fuel-related expenses downward. Stewart pointed out that the railroad uses about 125 million gallons of diesel fuel every quarter, and so reductions of around $0.50 per gallon during the past year equate to as much as $250 million in yearly savings. Combined with other favorable factors like a drop in compensation and benefits costs, Norfolk Southern has the potential to improve its cost structure dramatically in 2015, although some expected increases in costs will eat into some of the anticipated savings.

Quite frankly, neither we nor anyone else we know of understand exactly how this will all play out. ... At the end of the day, our strategy remains the same: do our very best to operate an efficient, high-velocity railroad. -- Moorman

Source: Norfolk Southern.

Norfolk Southern is going through a lot, with its operational hurdles posing challenges for the railroad even as the wild card of energy prices has been offsetting impacts on its business. Moorman doesn't know whether low oil will help on the expense side more than it hurt because of lost fuel surcharges and the potential decline of shipping of energy-related products like crude and fracking materials. Moreover, with oil and gas prices low, coal becomes less attractive, and so that segment could see more pain.

Nevertheless, in his words, Moorman believes that "Norfolk Southern has the best team in the business," and he remains confident that the railroad will regain its past operational success while still treating customers and shareholders well. As long as the company keeps making progress on that front, investors should feel comfortable holding onto their Norfolk Southern stock.