S&P 500: +24.23 (+3.21%)
Norfolk Southern Corporation (NSC) *contact for tearsheet*
Norfolk Southern provides rail transportation service in the eastern U.S. Operating over 21,000 miles of road, Norfolk hauls shipments of coal (24 percent of revenues), intermodal traffic (20 percent), plus a diverse mix of automobile, agriculture, metals, chemical, and forest products (each 9 percent to 12 percent).
Coal is Norfolk’s most profitable segment, but their intermodal business is the fastest growing segment longer term. The company is committing a significant amount of capital to the intermodal franchise to position themselves to capture growth from freight moving away from highway transportation and to the railroads.
The case for this longer term trend is that fuel prices are not expected to remain at current low levels, highway congestion is getting worse and large shippers are trying to reduce their carbon footprint – railroads account for about 40 percent of the overall freight ton miles moved, but only consume 8 percent of the associated fuel.
Because coal demand represents one-fourth of Norfolk’s revenues, environmental regulation discouraging utilities from using coal is an obvious risk. Norfolk also has a significant automobile franchise, which is subject to the cyclical automobile market.
One of the biggest criticisms of railroads is their lower profitability. Despite the best pricing in decades, returns on invested capital (ROIC) are still fairly close to its cost of capital. This is largely due to high capital expenditures, which represent roughly 13 percent of Norfolk’s revenues annually. Profitability among railroad companies is also hurt by unionized employees. Even so, Norfolk stands out by generating around $1 billion in free cash flow annually, or 10 percent of revenue, making them on of the most profitable rails in North America.
The U.S. rail industry has an oligopoly-like structure – over 80 percent of revenues generated by the four largest railroads – meaning Norfolk enjoys overwhelming barriers to entry. Another positive is management’s commitment to returning value to shareholders via share repurchases and increasing dividend payments.
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Peter Lazaroff, Junior Analyst
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