Norfolk Southern Corporation — Q3 2018 Form 10-Q
Business context and period: Norfolk Southern operates a major eastern U.S. freight rail network. This unaudited filing covers the quarter and first nine months ended September 30, 2018, compared with the corresponding 2017 periods.
Financial results
| Metric | Q3 2018 | Q3 2017 | First 9 months 2018 | First 9 months 2017 |
|---|---|---|---|---|
| Railway operating revenue | $2.947 billion | $2.670 billion | $8.562 billion | $7.882 billion |
| Income from railway operations | $1.020 billion | $895 million | $2.881 billion | $2.524 billion |
| Net income | $702 million | $506 million | $1.964 billion | $1.436 billion |
| Diluted EPS | $2.52 | $1.75 | $6.95 | $4.93 |
| Operating ratio | 65.4% | 66.5% | 66.4% | 68.0% |
| Operating cash flow | Not presented separately for the quarter | $2.884 billion | $2.465 billion |
Margins and costs: Q3 railway operating expenses were $1.927 billion, up 9% year over year, while revenue rose 10%. The operating ratio improved 1.1 percentage points to a reported record-low 65.4%. Higher fuel prices, volume-related costs, and slower network velocity raised expenses; lower compensation costs partly offset these increases.
Cash, investment, and debt: Nine-month property additions were $1.326 billion; operating cash flow less property additions was approximately $1.558 billion. Cash and cash equivalents were $729 million at September 30. Current liabilities exceeded current assets by $332 million. Long-term debt was $10.635 billion and current maturities were $500 million; total debt including current maturities was $11.135 billion. The total-debt-to-total-capitalization ratio rose to 41.8% from 37.5% at year-end 2017. The company reported no borrowings under its $750 million credit facility or $400 million receivables securitization program. Cash flow statements include $88 million of restricted cash held as collateral.
Material changes and operating trends
- Q3 revenue increased 10%, operating income 14%, net income 39%, and diluted EPS 44%. For the first nine months, the respective increases were 9%, 14%, 37%, and 41%.
- Freight volumes rose 5% in both periods. Intermodal revenue grew 20% in Q3 and year to date, supported by 8% unit growth and higher revenue per unit. Merchandise revenue rose 9% in Q3; coal revenue rose 3% despite a 4% decline in coal tonnage.
- Fuel expense increased 38% in Q3 and 35% year to date, primarily from higher locomotive fuel prices. Purchased services and rents rose 19% and 12%, respectively, with equipment rents affected by slower network velocity and added resources.
- The effective tax rate fell to 22.7% for Q3 and 22.6% year to date, from 36.8% and 35.7%, respectively, primarily reflecting federal tax reform and, year to date, certain retroactively enacted tax credits.
- Nine-month share repurchases totaled 12.8 million shares at a cost of $2.1 billion, compared with 6.0 million shares and $712 million in 2017. The company issued $1.5 billion of senior notes in Q3 and $500 million in Q1; financing cash flows also included $750 million of debt repayments.
Outlook, risks, and contingencies
- Management expected Q4 merchandise and intermodal revenues to exceed the prior year, citing pricing, fuel surcharges, and volume growth. Coal revenue was also expected to rise, driven by export and utility volumes and pricing/mix. These are segment outlook statements; the filing gives no consolidated earnings or EPS guidance.
- Management said cash on hand and operating cash flow were expected to be sufficient for ongoing obligations. It also expected about half of the Q3 increase in equipment-rent costs not to recur in Q4.
- Key operating pressures include fuel-price volatility and reduced network velocity. Coal utility volumes remained weak, while regulatory, safety, environmental, and climate-related developments could affect costs, operations, or demand. Positive train control implementation deadlines and related costs were identified as risks.
- Environmental liabilities were $59 million at quarter-end. The company stated known matters were not expected to have a material adverse effect, while noting that latent contamination and changing cleanup requirements could create additional exposure.
- Railroad injury, occupational, third-party, and other litigation claims involve estimation uncertainty. The filing described fuel-surcharge antitrust litigation whose class certification had been denied, subject to appeal; management considered the allegations without merit and did not expect a material effect.
- Operating lease accounting changes were scheduled for adoption in 2019; the company cited $660 million of undiscounted operating lease obligations disclosed in its latest 10-K and did not anticipate a material impact on results of operations.
Important facts for investors to verify
- Whether freight growth and Q4 segment revenue expectations materialized, particularly in intermodal, merchandise, and coal.
- How fuel costs and network velocity affect expenses, service levels, equipment rents, and the operating ratio.
- The effect of substantial repurchases and new debt issuance on leverage, liquidity, and future cash available for capital investment and dividends.
- Developments in environmental, casualty, regulatory, PTC, and fuel-surcharge litigation exposures.
- Implementation effects of the new lease standard and the company’s actual lease liabilities upon adoption.