Norfolk Southern's Operations Derailed, Analyst Downgrades To Sell

Railroad operator Norfolk Southern Corp. NSC seems to be floundering on the operational front, if views from Loop Capital Markets is anything to go by.

The Analyst

Loop Capital Markets analyst Rick Paterson downgraded Norfolk Southern from Hold to Sell and lowered his price target from $133 to $120.

The Thesis

Train speeds, thus far in the fourth quarter, have been down 11.3 percent year-over-year, and the time taken to process cars through yards has been 6.7 percent more, Paterson said in a note. The analyst thinks this will begin to show up in the financials, in the form of higher labor overtime expense, care hire and equipment rents, higher purchased services and weaker fuel efficiency.

The company's operation is breaking under the strain of year-to-date volume growth of 4.7 percent, Paterson said, giving reasons for the weak operational metrics. Meanwhile, the company blamed the predicament on recent hurricanes and some higher-than-normal disruptive track maintenance work.

The weakness of operations leaves the company vulnerable to any potential unforeseen developments. Loop Capital sees the upcoming winter and the continuing operational restructure at CSX Corporation CSX, which has been pushing incremental volumes onto Norfolk Southern's network as risks.

"The point here is that the risks are asymmetric—in an attempt to squeeze out a few more basis points in operating margin, management is risking a much greater reaction on the downside, and one that would take at least 12 months to remedy and may put its target of a 65% operating ratio by 2020 out of reach," Paterson said.

As such, the firm lowered its 2018 earnings per share estimate from $7.07 to $6.75 and its 2019 estimate from $7.80 to $7.50.

The Price Action

Norfolk Southern stock is up 20 percent in the year-to-date period, trading north of $126 per share.

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