Norfolk Southern Corporation — Q2 2017 Form 10-Q
Business context and period. Norfolk Southern operates a railroad network of approximately 19,500 miles across 22 states and the District of Columbia. This unaudited filing covers the quarter and six months ended June 30, 2017; comparisons are with the same 2016 periods unless stated otherwise. Amounts below are in millions of dollars except per-share data.
Financial results and liquidity
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Railway operating revenue | $2,637 | $2,454 | $5,212 | $4,874 |
| Income from railway operations | $888 | $770 | $1,661 | $1,493 |
| Net income | $497 | $405 | $930 | $792 |
| Diluted EPS | $1.71 | $1.36 | $3.18 | $2.65 |
| Operating ratio | 66.3% | 68.6% | 68.1% | 69.4% |
| Operating cash flow | Not stated by quarter | Not stated by quarter | $1,576 | $1,432 |
Q2 revenue, operating income, net income, and diluted EPS rose 7%, 15%, 23%, and 26%, respectively. For the first six months, the increases were 7%, 11%, 17%, and 20%. Management attributed the improvement to higher revenue and disciplined cost control; traffic volume increased 6% in both comparisons. The Q2 operating ratio of 66.3% was a company record, as was first-half diluted EPS.
At June 30, cash was $642 (down from $956 at year-end); current assets were $1,936 and current liabilities $2,343, a working-capital deficit of $407. Management said cash on hand and expected operating cash flow should cover ongoing obligations. Long-term debt was $9,273, current maturities were $600, and the balance sheet showed no short-term debt; the company separately reported $100 outstanding under its receivables securitization facility, classified as long-term debt. The debt-to-total-capitalization ratio was 43.8%, versus 45.1% at year-end. The $750 credit facility was undrawn and available.
First-half investing cash outflow was $824, including $883 of property additions. Financing cash outflow was $1,066, including $354 of dividends, $402 of share repurchases, and $650 of debt repayments, partly offset by $298 of net borrowing proceeds. Cash declined $314 in the period.
Business drivers and changes
- Coal revenue grew 32% in Q2 and 26% in the first half, led by stronger export and utility shipments. Coal volume rose 27% and 24%, respectively.
- Intermodal revenue increased 10% in both periods, supported by volume growth and higher fuel surcharges. Merchandise revenue grew 1% in Q2 and 2% year to date; merchandise volume was broadly flat.
- Operating expenses rose 4% in Q2 and 5% year to date. First-half fuel expense increased 25%, reflecting higher locomotive fuel prices, partly offset by improved fuel efficiency. Compensation and benefits increased 4% year to date; average rail headcount was down about 800 in Q2.
- Other income, net, increased $28 in Q2 and $36 year to date, reflecting higher corporate-owned life insurance returns, more income from coal-mining properties, and the absence of prior-year advisory fees.
Outlook, risks, and unusual items
Management expected merchandise revenue to increase during the rest of 2017, with slightly lower volumes than in the second half of 2016; intermodal revenue to rise on pricing, fuel surcharges, and volume; and coal revenue to increase, mainly on export volumes and pricing. It anticipated a full-year effective tax rate of about 37%, and approximately $1.0 billion of share repurchases during 2017. Illinois tax legislation enacted July 6 was expected to add about $13 of deferred tax expense in Q3. Employment levels were expected to remain fairly steady for the balance of the year.
Q2 included issuance of $300 of 3.15% senior notes due 2027. Environmental liabilities were $65 at June 30, covering 131 known locations and projects; management considered recorded probable costs adequate but noted environmental exposures can change. Railroad injury, occupational, third-party, and other claims involve estimation uncertainty. The fuel-surcharge antitrust class actions remain pending; the company disputes the allegations and did not expect a material effect. A customer rate-reasonableness matter remained decided in the company’s favor but was subject to appeal. National labor negotiations were ongoing for much of the union workforce.
The company was evaluating upcoming accounting standards, including revenue recognition (effective 2018), leases (2019), and credit losses (2020); it did not expect revenue recognition or credit-loss adoption to materially affect the financial statements. Forward-looking projections are subject to the risks described in the company’s 2016 Form 10-K and subsequent filings.
Important facts for investors to verify
- Whether coal export and utility demand, which drove a significant share of growth, persists through the rest of 2017.
- Whether fuel prices, wage and benefit inflation, and casualty-claim costs offset revenue growth and operating-ratio gains.
- Execution of the stated $1.0 billion 2017 repurchase plan alongside capital spending, dividends, and debt obligations.
- Progress and potential cost implications of labor negotiations, pending litigation, and environmental remediation.
- The Q3 tax impact of Illinois legislation and the full-year effective tax rate versus management’s approximately 37% expectation.