Seeking Alpha
Long only, value, long-term horizon, research analyst
Profile| Send Message|
( followers)  

Norfolk Southern Corporation (NYSE:NSC) is a railroad company operating in the Eastern United States. Norfolk Southern ships coal, intermodal freight, and automobile, metal, chemical, and forest products. Its main source of revenue comes from its shipment of coal, comprising approximately a quarter of all revenues. Thus, Norfolk Southern is highly exposed to the cyclical demand for coal. However, it has seen substantial growth in shipments of other products, most notably intermodal freight. Here a few basic statistics to give you a better understanding of the company and its stock price:

  • Market capitalization: $24 billion
  • Current stock price: $76.17
  • 52-week high: $81.00
  • 52-week low: $56.05
  • 5-Yr Forward EPS CAGR: 12.5%
  • 2012 EPS: $5.42


(Click to enlarge)

Growth

NSC's earnings have grown steadily since taking a major hit during the 2008 financial crisis. Since 2009, they have grown at an average rate of 24%, and analysts expect earnings to reach $6.38 by 2014. Both revenues and earnings declined in 2012, due to losses from less coal demand, but these figures should increase over time as automobile and intermodal shipments more than make up for the losses in coal shipments.

In terms of NSC's growth, the most important takeaway are the dividends. Its current dividend yield is 2.63% with dividends at $1.94 per share in 2012. NSC is known in the railroad industry for increasing its dividends per share every year. Analysts expect this trend to continue, and I believe that this is a major differentiatior among its competition.

2010 2011 2012 2013E 2014E
EPS $ 3.99 $ 5.65 $ 5.42 $ 5.73 $ 6.38
EPS growth 44.57% 41.6% -4.07% 5.72% 11.34%
Revenue $ 9.5B $ 11.1B $ 11.0B $11.2B $11.9B
Dividends per share $ 1.40 $ 1.66 $ 1.94 $ 2.04 $ 2.19
Dividend growth 2.94% 18.57% 16.87% 5.15% 7.35%

As you can see, earnings, revenues, and dividends, are all expected to increase through 2014, as NSC improves operations, maintains high margins, and generates sufficient free cash flows. It is very important for CEO Wick Moorman to increase dividends for its shareholders every year and to maintain a target payout ratio of 33%.

Valuation

NSC is a cheap stock relative to its peers. In my comparable company analysis, I have compared NSC to Union Pacific Corporation (NYSE:UNP), CSX Corporation (NYSE:CSX), and to the industry averages.

Market Cap P/E Ratio ROE Dividend Yield
NSC $ 24.19B 14.36 17.92% 2.56%
UNP $ 73.64B 18.52 20.76% 1.64%
CSX $ 25.88B 13.86 20.98% 2.23%
Industry Avg. $ 18.36B 19.61 14.03% 1.49%

Based on its price relative to earnings, NSC looks cheap among its competitors. Unlike most other railroad companies, however, NSC commits to a substantially higher dividend yield, and it will continue to make that commitment into the future. Investors seeking income should take this into consideration.

With analysts projecting earnings to reach $6.38 in 2014, NSC could trade for $125, given the current industry average P/E. This would be a very optimistic case, but I expect NSC to increase in price significantly over the long term.

Risks

NSC's primary risk is its exposure to coal. It relies heavily on coal shipments in order to generate solid earnings. Cheaper natural gas alternatives may cause coal demand to decrease over the next few years, so NSC may have to rely more on intermodal, chemical, and metal shipments. Analysts expect these shipments to increase, but nothing can be certain. International demand for coal has also softened. In addition, the railroad industry is very capital intensive because railroads must purchase and maintain their roads. NSC's return on invested capital tends to be slightly above its cost of capital.

Conclusion

NSC is buy for the long term investor. Coal demand is certainly a reasonable cause for concern, but NSC is the best in its industry at cost efficiency and operations. In addition, NSC has nearly zero risk of losing market share to new entrants. Building and earnings the rights to build railroads are extremely difficult. Therefore, the current market leaders are likely to stay there for a long time. NSC will continue to increase its dividends, earnings are expected to increase, and the stock is cheap relative to its competitors.

Source: Why I Like Norfolk Southern Corporation