Norfolk Southern Corporation — Q3 2016 Form 10-Q
Business context and period. Norfolk Southern operates a freight railroad across 22 states and the District of Columbia. This unaudited filing covers the quarter and nine months ended September 30, 2016, with comparisons to 2015.
Financial performance and condition
| Metric | Q3 2016 | Q3 2015 | First nine months 2016 | First nine months 2015 |
|---|---|---|---|---|
| Operating revenue | $2.524 billion | $2.713 billion | $7.398 billion | $7.993 billion |
| Operating expenses | $1.704 billion | $1.891 billion | $5.085 billion | $5.751 billion |
| Income from railway operations | $820 million | $822 million | $2.313 billion | $2.242 billion |
| Operating ratio | 67.5% | 69.7% | 68.7% | 72.0% |
| Net income | $460 million | $452 million | $1.252 billion | $1.195 billion |
| Diluted EPS | $1.55 | $1.49 | $4.21 | $3.90 |
| Cash from operations | Not presented quarterly | $2.312 billion | $2.208 billion |
Q3 operating margin, calculated as income from railway operations divided by revenue, was approximately 32.5%, versus 30.3% a year earlier; the corresponding nine-month margins were approximately 31.3% and 28.1%. Dividends were $0.59 per share for Q3 and $1.77 per share for the nine-month period, unchanged from 2015.
At September 30, 2016, cash was $984 million and working capital was $85 million, versus $1.101 billion and $281 million, respectively, at year-end 2015. Total debt, including current maturities, was $10.105 billion; the debt-to-total-capitalization ratio was 44.9%, down from 45.3% at year-end. The company reported $550 million of current maturities of long-term debt and no short-term debt. Management said cash on hand and operating cash flow should cover ongoing obligations.
Nine-month investing cash outflow was $1.330 billion, including $1.304 billion of property additions. Financing cash outflow was $1.099 billion, including $523 million of dividends and $603 million of share repurchases. Cash declined $117 million to $984 million during the period. Operating cash flow less property additions was approximately $1.008 billion, compared with $431 million in 2015; this is a simple calculation, not a company-defined free-cash-flow measure.
Material changes versus prior period
- Revenue declined 7% in both Q3 and the first nine months. The filing attributes the decline to lower volumes—particularly energy-related traffic and the Triple Crown Services restructuring—and lower average revenue per unit, mainly from reduced fuel surcharges.
- Coal revenue fell 18% in Q3 and 22% year to date, with coal volumes down 15% and 20%, respectively. Intermodal revenue fell 7% and 11%; merchandise revenue fell 4% and 2%.
- Expenses fell 10% in Q3 and 12% year to date, reflecting cost controls, lower fuel costs, and, in the comparison with 2015, the absence of $37 million of Triple Crown restructuring and Roanoke office closure costs. Nine-month fuel expense declined 32%.
- Net income increased 2% in Q3 and 5% year to date despite lower revenue. Lower expenses and lower effective tax rates contributed; reduced share count also supported per-share results.
- Nine-month repurchases were 7.2 million shares for $603 million, compared with 10.3 million shares for $997 million in 2015. The company issued $600 million of 2.9% senior notes due 2026.
Outlook, commentary, and risks
- Management said it remained on track to achieve approximately $250 million in productivity savings and an operating ratio below 70% for 2016. It described service levels as near all-time best and network fluidity as strong.
- For the remainder of 2016, management expected merchandise revenue to be relatively flat, intermodal revenue to increase, and coal revenue to decline versus 2015. It expected fuel surcharge revenue to remain lower than 2015, though by less than in the first nine months, if fuel prices persisted. The expected full-year effective tax rate was approximately 36%.
- Coal demand remained exposed to utility stockpiles, mild weather, low natural-gas prices, weak export markets, and depressed commodity prices. Other cited pressures included demand weakness in several merchandise markets and competition in transportation.
- Environmental liabilities were $64 million at quarter-end. The company stated known matters were not expected to have a material adverse effect, while noting environmental exposures and claims can change as facts and cleanup costs evolve. The Sunbelt rate case remained decided in Norfolk Southern’s favor but was subject to appeal. The company also disclosed fuel-surcharge antitrust class actions and an environmental notice of violation in Tennessee; it did not expect these matters to have a material effect.
- National labor negotiations were ongoing for multiple union coalitions. More than 80% of railroad employees were covered by collective bargaining agreements.
- Management adopted accounting updates affecting share-based compensation tax treatment and deferred-tax balance-sheet classification. The filing reports a $12 million nine-month tax benefit from the share-based compensation update.
Key facts for investors to verify
- Whether management achieved its 2016 productivity-savings and sub-70% operating-ratio objectives.
- Whether coal, intermodal, and merchandise volumes and revenues followed the stated remainder-of-year outlook.
- How sustainable the expense reductions are, including the effects of fuel prices, headcount, service levels, and prior-year unusual costs and property-sale gains.
- Debt maturities, borrowing needs, liquidity, and the pace of repurchases and capital spending.
- Developments in labor negotiations, the Sunbelt appeal, fuel-surcharge litigation, environmental matters, and casualty claims.