Norfolk Southern Corporation — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. Norfolk Southern operates a major eastern U.S. rail network, serving merchandise, intermodal, and coal markets.
Financial performance
| Metric | Q2 2016 | Q2 2015 | First six months 2016 | First six months 2015 |
|---|---|---|---|---|
| Railway operating revenue | $2.454 billion | $2.713 billion | $4.874 billion | $5.280 billion |
| Railway operating expenses | $1.684 billion | $1.899 billion | $3.381 billion | $3.860 billion |
| Income from railway operations | $770 million | $814 million | $1.493 billion | $1.420 billion |
| Net income | $405 million | $433 million | $792 million | $743 million |
| Diluted EPS | $1.36 | $1.41 | $2.65 | $2.41 |
| Operating ratio | 68.6% | 70.0% | 69.4% | 73.1% |
Q2 revenue fell 10% and net income fell 6%; first-half revenue declined 8% while net income increased 7%. The first-half operating ratio was described as a record. The filing attributes revenue pressure mainly to weaker volumes—especially coal—and lower average revenue per unit, including reduced fuel surcharges. Q2 total units declined 7%; coal revenue fell 25% and intermodal revenue fell 15%. Expense reductions, led by lower fuel costs and cost-control measures, partly offset revenue declines.
Cash flow and liquidity: First-half operating cash flow was $1.432 billion, versus $1.501 billion a year earlier. Investing used $912 million, including $932 million of property additions; financing used $755 million. Cash declined by $235 million to $866 million. Working capital was $132 million at June 30, compared with $281 million at year-end 2015.
Debt and capital: Debt totaled $10.099 billion on a carrying-value basis, including current maturities; short-term debt was zero. The company issued $600 million of 2.9% senior notes due 2026. Its debt-to-total-capitalization ratio was 45.1%, versus 45.3% at year-end. The renewed $750 million revolving credit facility had no borrowings; $100 million was outstanding under the accounts-receivable securitization program. Management said cash and operating cash flow should be sufficient for ongoing obligations.
First-half dividends were $350 million and share repurchases were $400 million for 5.0 million shares, below the prior-year $765 million repurchase total. Planned 2016 property additions were approximately $1.9 billion.
Outlook and management commentary
Management said it remained focused on productivity and service, citing strong network fluidity and near all-time-best service levels. It expected about $200 million of productivity savings and an operating ratio below 70% for 2016. It projected a full-year effective tax rate of about 37%.
For the remainder of 2016, management expected merchandise revenue to increase year over year, intermodal revenue to be flat, and coal revenue to be lower. It expected lower fuel-surcharge revenue than in 2015 if fuel prices remained at then-current levels, though the decline was expected to be less severe than in the first half. Management also expected headcount to remain relatively flat, incentive compensation to be about $30 million higher per quarter than the prior-year comparison, and materials expense to remain about $15 million per quarter more favorable year over year. These expectations depend on current volume projections.
Risks, contingencies, and unusual items
- Demand and pricing: Continued coal-market weakness, low natural-gas prices, high utility coal stockpiles, subdued export demand, and lower fuel surcharges weighed on results. Management warned coal revenues would remain lower year over year.
- Legal matters: A chemical customer’s rate complaint remained decided in Norfolk Southern’s favor but subject to appeal. Fuel-surcharge antitrust class actions remained pending; the company said it intended to defend them and did not expect a material effect. The company also disclosed an environmental notice concerning soil runoff at a facility; potential penalties could exceed $100,000, which it did not expect to be material.
- Environmental and casualty exposure: Environmental liabilities were $66 million at June 30, 2016. The company noted that environmental, personal-injury, and other claims are subject to estimation uncertainty and could require additional accruals.
- Labor: National bargaining with several union coalitions was ongoing; more than 80% of railroad employees were covered by collective bargaining agreements.
- Accounting and other items: A change in the method used to estimate pension and postretirement service and interest costs reduced those costs by $7 million in Q2 and $13 million in the first half. The company also adopted share-based payment accounting guidance, recognizing a $6 million tax benefit in the first half. Depreciation rose as the capital base expanded.
Key facts for investors to verify
- Whether coal and intermodal volumes stabilize, and whether merchandise growth offsets continued weakness in coal.
- Whether management achieves the approximately $200 million productivity target and sub-70% full-year operating ratio.
- How fuel prices and surcharge mechanisms affect revenue per unit and fuel expense in the second half.
- Whether the $1.9 billion capital-additions plan and planned liquidity remain consistent with cash generation, debt maturities, and shareholder returns.
- Developments in the Sunbelt rate case, fuel-surcharge litigation, environmental matters, and labor negotiations.