Norfolk Southern Holds Up Better Than Investors Feared

Image: Norfolk Southern.

The railroad industry has struggled to adjust to changing conditions in the industries it serves, and Norfolk Southern has been particularly exposed to weakness in the coal industry and its impact on its overall business. After rival CSX reported somewhat encouraging results earlier in the month, Norfolk Southern investors came into Wednesday's third-quarter financial report hoping to see signs of potentially better performance down the road even as they expected substantial declines in revenue and income. Norfolk Southern's results showed the continued pressure on the railroad industry, but the company managed to cushion the blow compared to the even more pessimistic views that many of its investors had. Let's look more closely at Norfolk Southern's latest results and what shareholders should take from them.

The (somewhat less) gloomy perspective on Norfolk SouthernNorfolk Southern's third-quarter results looked pretty bad, even if they weren't as bad as they could have been. Revenue posted a 10% decline to $2.71 billion, just barely surpassing the consensus forecast among investors for the top line. Net income fell a more precipitous 19% to $452 million, but the resulting earnings of $1.49 per share were nevertheless $0.08 higher than most of those following the stock had expected.

As we've seen in previous quarters, Norfolk Southern's weakness was more pronounced in its commodity-related segments. Coal revenues fell 23%, with low natural gas prices and weak global export demand for coal leading to a 16% drop in shipment volumes. The metals and construction segment also saw a huge revenue decline of 20%, reflecting poor pricing conditions in commodity markets and economic weakness in the infrastructure and construction industries. The key chemicals segment saw revenue fall by 8%, and intermodal, automotive, and paper-forest revenue also declined, leaving the agriculture segment as the only growing part of Norfolk Southern's business.

Lower fuel costs continued to offset the decline in revenue, with Norfolk Southern saving $166 million compared to the year-ago quarter. Yet once again, the negative impact on fuel surcharges to the top line more than offset those savings, and even with keeping compensation and benefits expenses in check, total operating costs couldn't fall enough to counteract falling revenues. Norfolk's operating ratio rose to 69.7%, up 2.7 percentage points from a year ago and showing the impact of stubbornly high operating costs.

CEO James Squires was pragmatic about Norfolk Southern's results. In his eyes, the declines "reflect commodities markets that continue to soften, as well as costs associated with restructuring initiatives to strengthen our company going forward." Squires believes that the best course is to look forward and expect conditions to improve in the future.

What's next for Norfolk Southern?Unfortunately, that future could take a while to play out favorably. Squires said that the current quarter could hold many of the same challenges for Norfolk Southern, arguing that "these pressures will linger in the fourth quarter, while traffic volume to date continues to lag last year['s levels]." The CEO is hopeful that by 2016, a stable economy will set Norfolk Southern up for better performance.

The key to Norfolk Southern's long-term prospects appears to be finding ways to move beyond its traditional emphasis on coal. For CSX, which has had to deal with many of the same concerns in its reliance on the coal industry, revenue from coal has steadily shrunk over time, making its future influence on CSX's results gradually less important. Nevertheless, both CSX and Norfolk Southern can't afford to give up on coal entirely, at least in the short term. With few positive prospects for the coal industry right now, it'll be tough for the railroads to gain speed in that part of their respective businesses.

Investors were generally pleased with the way Norfolk Southern managed to soften the blow to its sales and earnings, sending shares higher following the announcement. For that bounce to last, Norfolk Southern will have to keep finding ways to grow, even if it means looking beyond its traditional areas of strength and pioneering the way into other lucrative opportunities in the future.

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Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends CSX. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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