Norfolk Southern Corporation — Q2 2023 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2023. Norfolk Southern operates a freight railroad across 22 states and the District of Columbia. Figures are in U.S. dollars; financial statement amounts are in millions unless noted.
Financial performance
| Metric | Q2 2023 | Q2 2022 | First six months 2023 | First six months 2022 |
|---|---|---|---|---|
| Railway operating revenue | $2,980 | $3,250 | $6,112 | $6,165 |
| Income from railway operations | $576 | $1,271 | $1,287 | $2,356 |
| Net income | $356 | $819 | $822 | $1,522 |
| Diluted EPS | $1.56 | $3.45 | $3.60 | $6.37 |
| Railway operating ratio | 80.7% | 60.9% | 78.9% | 61.8% |
Revenue fell 8% in Q2 and 1% year to date. GAAP operating income declined 55% in Q2 and 45% for the first six months; net income declined 57% and 46%, respectively. The operating ratio is operating expenses as a percentage of revenue, so a higher ratio indicates weaker operating performance.
The East Palestine derailment contributed $416 million of Q2 and $803 million of first-half expense. Excluding those costs, the company reported non-GAAP Q2 operating income of $992 million, net income of $673 million, diluted EPS of $2.95 and operating ratio of 66.7%. First-half adjusted figures were $2.090 billion, $1.432 billion, $6.27 and 65.8%, respectively. Compared with 2022, adjusted Q2 EPS fell 14% and adjusted first-half EPS fell 2%. These company-presented non-GAAP measures exclude Incident expenses and are not substitutes for GAAP results.
Q2 revenue weakness was concentrated in intermodal, down 23%, while merchandise declined 1% and coal declined 4%. Total units fell 6%; average revenue per unit decreased 3%, reflecting lower fuel surcharge revenue. First-half revenue was nearly flat as merchandise and coal gains mostly offset intermodal weakness. Q2 expenses also reflected higher compensation, purchased services, depreciation and materials costs; lower fuel expense partly offset those increases. The effective tax rate was 23.1% for Q2 and 22.1% for the first half.
Cash flow, debt and liquidity
- First-half operating cash flow was $1.846 billion, versus $2.011 billion a year earlier. Property additions were $948 million; investing cash outflow was $741 million.
- Financing cash outflow was $1.005 billion, including $615 million of dividends, $303 million of share repurchases, $724 million of borrowings and $802 million of debt repayments. Cash rose $100 million from year-end to $556 million.
- At June 30, total debt was approximately $15.1 billion, comprising $14.594 billion long-term debt, $405 million current maturities and $130 million short-term debt. The debt-to-total-capitalization ratio was 54.5%, compared with 54.4% at year-end. The company issued $500 million of 4.45% senior notes due 2033 in February.
- Current assets were $2.031 billion and current liabilities $2.986 billion, implying negative working capital of $955 million. The company said cash on hand and expected operating cash flow should cover ongoing obligations, with borrowing capacity and the ability to reduce shareholder distributions providing additional flexibility.
- The $400 million receivables securitization facility expires in May 2024; $130 million was drawn and $270 million remained available. An $800 million credit facility expiring in March 2025 was undrawn. Available borrowing against corporate-owned life insurance policies was $530 million.
Outlook, material risks and contingencies
- Management expects revenue for the remainder of 2023 to decline versus 2022, citing lower fuel prices, declining storage service charges and softening coal pricing. 2023 property additions are expected to be approximately $2.2 billion. The filing provides no specific earnings or EPS guidance.
- The February 3, 2023 East Palestine derailment and February 6 controlled vent-and-burn response remain the principal contingent exposure. First-half Incident expense of $803 million included $581 million for environmental obligations, $105 million for Incident lawsuits and $117 million for legal fees, community support and other response costs. Cash expenditures were $287 million. No insurance or third-party recoveries had been accrued.
- Environmental cleanup, government oversight, civil litigation, shareholder litigation, and federal and state investigations continue. The company said the final outcome and reasonably possible range of loss cannot be estimated with certainty. Potential future costs, penalties or settlements may exceed accrued amounts; certain healthcare-fund costs and some fines or penalties were not accrued because they were not considered probable or reasonably estimable.
- The NTSB investigation remains ongoing; its preliminary report identified a wheel bearing in the final stage of overheating before the derailment. The FRA investigation also continues. The company expected an NTSB final report in 2024 and an FRA safety-assessment report in early August 2023.
- A proposed purchase of approximately 337 miles of Cincinnati Southern Railway is expected to cost $1.6–$1.7 billion. Closing depends, among other conditions, on voter approval in November 2023 and Surface Transportation Board approval; if approved, closing was expected no earlier than March 15, 2024.
- About 80% of railroad employees are covered by collective bargaining agreements. The latest national bargaining round concluded in December 2022; neither party can compel mandatory bargaining on new proposals before November 1, 2024. Management also cited service challenges, softer demand, inflation, higher service-related costs and increased headcount.
Most important facts for investors to verify
- Whether East Palestine cleanup, litigation, regulatory actions and potential penalties produce material additional costs beyond the $803 million accrued, and whether any insurance or third-party recovery becomes probable.
- Whether service performance and demand improve, particularly in intermodal, and how lower fuel prices and storage charges affect the forecast revenue decline.
- Whether operating costs, including compensation, service expenses and headcount, can be managed while maintaining safe and reliable operations.
- Whether operating cash flow, debt levels and available liquidity remain adequate alongside planned capital spending and the potential $1.6–$1.7 billion rail-line purchase.
- Whether the Cincinnati Southern Railway transaction receives voter and regulatory approvals and proceeds on the anticipated timetable.