After A Strong Quarter, Norfolk Southern Management Asked: Why Aren't You More Like CSX?

The strong earnings report issued last week by CSX Corporation CSX is reverberating through the quarterly release of class 1 railroad earnings, which is now at an end.

Last week, CSX reported an operating ratio of 58.6 percent. Wednesday, in its own second quarter earnings report, Norfolk Southern Corp. NSC reported a record quarterly operating ratio of 64.6 percent, improved from 66.9 percent a year earlier. It was the 10th consecutive quarter in which Norfolk Southern recorded an improved operating ratio.  

That difference with CSX was in a quarter in which Norfolk Southern had record income from operations (up 18 percent from 2Q 2017), record net income (up 43 percent from a year earlier) and record earnings per share (up 46 percent from a year ago.). Michael Wheeler, the company's COO, said NS volumes were a near record quarterly total and were a record for the second quarter. Average train length was a record as was crew productivity. "We handled 6 percent more volume with just a 1 percent increase in crew," he said.

But on the earnings call with analysts, the questions about the OR and its comparison against CSX, (and to a lesser degree, Canadian National, which also came in at less than 60 percent) and what it meant, kept coming steadily. Similar questions were directed at the management of Union Pacific Corporation UNP whose earnings and less attractive OR were released last week one day after the CSX earnings.

One analyst was blunt, asking CEO James Squires why NS can't put up numbers like CSX. Similar questions were answered by Squires with an indirect suggestion that there is a balance between seeking short-term profits at the expenses of long-term service, though Squires would not take the bait and criticize any railroad directly.

Questions were also posed to Squires whether NS needed to adopt more of the features of precision railroading, a practice developed primarily by the late CSX CEO Hunter Harrison, who died unexpectedly late last year. Harrison had honed his approach previously at Canadian Pacific and Canadian National. Precision railroading involves several steps, but generally is associated with lesser staffing, fewer hump yards and other operational changes.

"We are always open to best practices driving for shareholder value, and I am very confident we are on the right track," Squires said. "We will pursue a balanced plan and we'll produce great results for our shareholders." A version of that statement was issued by Squires several times during the call

NS is adding personnel (though headcount is down year-on-year); CSX is cutting staff. That was the focus of another question to Squires. "We are an asset and resource-intensive business," Squires said. "We are making sure we have the right level of people. We also have to make the investments in order to grow. We are going to keep people on the staff needed to generate the growth."

Another analyst asked whether there was "a case to restructure a little quicker, to take the service hit but be generating the same growth rate at a much better OR."

Squires said there are operational changes being made at NS. For example, the centralization of dispatchers, which has occurred at other railroads but not NS so far, is being undertaken at Norfolk, Squires said, with all dispatchers to be centralized in Atlanta. And while the company reopened a hump yard in Chattanooga, it has closed hump yards in recent years, he said.

But in an industry whose service levels began plummeting about a year ago, Squires said the customer needs to be the primary area of attention. "We are very focused on getting customer service back to where it needs to be," he said. Adding head count now is part of that, Squires added.

Despite the questioning of the Norfolk Southern management, investors appeared to focus more on the strong earnings report. At approximately 12:30 p.m., Norfolk Southern stock was up about 1 percent to $162.15, though most transportation stocks recovered after Wednesday's severe selloff even as broader market indices were mostly lower.  

Norfolk Southern does not give pricing guidance, and does not disclose the rate of agreed-upon price increases. But Alan Shaw, the company's chief marketing officer, said there had been a strong performance by the Norfolk Southern intermodal division, driven in part by the truck market. "We felt like the tight truck market would lead to an improvement in pricing well into 2019, and that is what we are seeing now," Shaw said. The NS intermodal division had a 20 percent increase in revenue, an 8 percent increase in volume (both to record levels) and a 6 percent increase in revenue per unit adjusted for fuel.  

Michael Wheeler, the Norfolk Southern COO, said intermodal pricing "remains strong, but it did flatten out relative to the first quarter."

Shaw said Norfolk Southern's intermodal franchise is "the best in the east. We've made investments in this over time, and that is bearing fruit for us, and that is why we are able to deliver 20 percent growth in each quarter this year." The company is in a position to "leverage the tight truck market into 20 percent growth."

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