Norfolk Southern Earnings: Anemic Volumes and Cost Inefficiencies Persist, but Trends Likely Bottomed

Eastern Class-I railroad Norfolk Southern’s NSC third-quarter revenue declined 11% year over year primarily due to lower fuel surcharges, persistent intermodal weakness, easing storage income, and soft energy end markets for merchandise volumes. Revenue missed our forecast slightly on greater-than-anticipated intermodal yield pressure. We suspect core carload pricing remains positive.

Total yield fell 9% year over year (lower storage income and fuel), while consolidated volume was down 2%, led by sluggish intermodal trends. Domestic intermodal activity (down 8%) and rates are facing minimal retailer restocking and excess capacity in the competing truckload sector. Carload volumes (excluding intermodal) declined 4%, including lower chemicals (especially energy-related shipments) and soft utility end markets for coal, partly offset by automotive restocking activity; albeit recent UAW strikes may become a headwind.

Excluding East Palestine, or EP, environmental remediation costs/accruals, Norfolk’s adjusted operating ratio (expenses/revenue) deteriorated to 69.1%, from 59.8% a year ago—worse than our forecast and worse than other rails. OR deterioration stems from lower volumes (including EP-related business losses), painful wage and benefit inflation, lingering network inefficiencies (including an IT outage), investments targeting productivity gains, and fuel surcharge lag.

Uncertainty is elevated, especially since Norfolk is underperforming its peers, but we look for OR improvement to return in 2024, assuming intermodal recovers modestly and with help from pricing gains as Norfolk pushes through the impact of wage hikes to shippers. Aggressive productivity initiatives and the absence of EP-related disruption should help.

We will be tempering our 2023 margin forecasts but only expect to reduce our DCF-derived $229 per share fair value estimate by less than 2%. The shares are undervalued, in our view, offering an attractive entry point for long-term-minded investors.