After a long run of success, railroad stocks have given back much of their gains in 2015, and Norfolk Southern (NSC -1.65%) in particular has had to struggle under the stress of a weak coal market and its impact on overall shipping volume. Yet even though Norfolk Southern's second-quarter results were disappointing enough to send the stock to levels not seen since 2013, CEO Jim Squires and his management team still have high hopes for the railroad's long-term future. Let's look more closely at what Norfolk Southern executives said about the company's performance and what lies ahead on down the tracks for the railroad giant.
"These are challenging conditions, but there's some good news as our business mix undergoes a significant change. ... We are confident in our long-term strategy and our prospects for growth and strong financials." --CEO Jim Squires
Overall, Norfolk Southern highlighted the drop in coal volumes and the big decline in revenue from fuel surcharges as the primary causes for a decrease in earnings from 2014's record levels. Yet Squires was still able to point to some successes for the railroad, as intermodal volume hit a new record level and as Norfolk Southern overcame tough conditions in the steel industry to boost its overall merchandise volumes during the second quarter. As long as the overall U.S. economy continues to see strength in consumer spending, housing markets, and strong manufacturing activity levels, Norfolk Southern should remain poised to capitalize on those favorable areas.
"Within the energy arena, we benefit from the movement of crude oil to the East Coast refinery complex as well as increased natural gas drilling within the Marcellus/Utica region, driving inputs of sand and pipe and outputs of natural gas liquids. While reduced commodity prices have tempered 2015 growth, this will continue as a significant market for us. Similarly, our coal franchise, which has been affected by lower market prices this year, will remain an important part of our business." --Chief Marketing Officer Alan Shaw
There's no question that a huge part of Norfolk Southern's success in recent years has come from the energy boom, and so the recent declines in prices have definitely hurt the railroad badly. The company foresees that coal volumes will remain subdued, as low natural-gas prices make it more cost-effective for utilities to use the cleaner-burning fuel, and even exports of coal have dropped substantially. Yet what Norfolk Southern is noticing is that cheap energy has helped the U.S. manufacturing industry in its level of competitiveness, and a pickup in goods produced here and shipped abroad could help make up for any declines in shipping energy-related materials and products.
"We're very encouraged that our resources are coming in balance with our business volume, and our operating metrics are trending favorably." --COO Mark Manion
Norfolk Southern has taken advantage of the tough conditions to clamp down on some of the operational challenges it has faced lately. COO Mark Manion noted that service levels have risen, with train speeds reaching their highest levels in more than a year. The length of time that trains are spending in terminals waiting for further movement has also dropped, with a streak of low dwell times having matched its performance from mid-2014. Manion said that Norfolk Southern has more work to do, but getting more crews on board and improving locomotive efficiency has paid off with solid results.
"Nearly three-quarters of the revenue decline was due to lower fuel revenue. ... Fuel expense decreased by $153 million or 38%, [as] a lower average price accounted for most of the decline." --CFO Marta Stewart
Most railroad analysts had expected that declining fuel costs would be a boon to profitability. Yet as Norfolk Southern has found, the impact on revenue from fuel surcharges has been even larger than the benefits from lower fuel costs. In the second quarter, fuel-surcharge revenue dropped almost $240 million, compared to just a $153 million drop in actual fuel costs. In other words, Norfolk Southern had turned high fuel costs into a profit center, and the elimination of the conditions that allowed those high surcharges to continue has hurt profitability more than many expected. Stewart pointed out that the railroad is making efforts to reduce costs in other areas, but the fuel arena still plays a key role in Norfolk Southern's overall profitability.
"The first thing we're going to do is grow the top line. ... Secondly, we are going to push on return on capital by prioritizing capital spending around revenue growth. ... Third, services is the key to all of this." --Squires
Norfolk Southern's overall strategy involves working through the tough parts of the current business environment while emphasizing the positive elements that remain. As the railroad boosts its efficiency numbers, conserves cash by focusing its capital spending efforts where they're most needed, and keeps working at capturing more business from the strong manufacturing and intermodal areas, Norfolk Southern has the ability to bounce back from its recent difficulties and become stronger than ever.