Norfolk Southern: Post Earnings Weakness Is A Buying Opportunity

Aug. 5.14 | About: Norfolk Southern (NSC)

Summary

Norfolk Southern shares dipped despite record results, citing the effects of a limit in transportation speeds.

Norfolk Southern management believes the transport department will not impose a restriction which is detrimental to the railroad industry.

Norfolk Southern is seeing good growth in the end-market, driven by coal, automotive, and housing.

An impressive valuation makes Norfolk Southern a buy on the dip.

Railroader Norfolk Southern (NYSE:NSC) has done decently this year, appreciating almost 11% so far. However, despite delivering record second-quarter results on July 23, Norfolk shares have dropped more than 5%.

A concern

Norfolk is worried about the cut in train speeds, which could be a big setback for the company and the industry as a whole. It is reported that the U.S. Department of Transportation is planning to curtail the crude train speed to 25 miles to 30 miles per hour. According to CEO Charles Moorman, "We have compelling evidence that any significant speed restriction would be in fact disruptive to the point of almost shutting down the North American rail network."

This is a grave statement, and it is no surprise that it has sparked fear among investors. However, any move detrimental to the railroad industry will disturb a number of industries, including automotive, housing, coal etc. As such, Norfolk expects that it would be able to convince the authorities that 40 mph to 45 mph speeds are safe and will not disrupt other rail traffic.

If Norfolk and other railroaders manage to convince the Department of Transportation regarding the ill-effects of a slower speed, then the company should be able to sustain its terrific run going forward.

Automotive and housing will propel future growth

Going forward, the company remains focused and is optimistic about its prospects. According to management, "The utility coal shipments are expected to be up throughout the rest of the year, as gas prices remain elevated and stock piles are replenished."

Other segments will also remain strong. There is strong opportunity in the automotive market, which is growing at a terrific rate. As reported by Edmunds.com:

"The auto industry will enjoy another year of growth in 2014 with new car sales topping 16 million for the first time since 2007. Edmunds.com forecasts sales of 16.4 million light vehicles in 2014, an increase of nearly 6 percent over the 15.5 million expected in 2013. Many of the same sales drivers from 2013 will remain in play and support car sales momentum. The release of pent-up demand from buyers who deferred sales during the recession will continue as the increasingly aged fleet drives more consumers back to the new car market. Sales will also benefit from an expected 300,000 additional lease returners compared to 2013, who will lease or buy a new vehicle when their current leases terminate."

This means that more cars will need to be transported via railroad, and increase the addressable opportunity for the likes of Norfolk.

Moreover, recent housing data indicates that construction is still strong. As Reuters reports:

"Economists had forecast new home sales rising to a pace of only 440,000 units last month. Compared to May of last year, sales were up 16.9 percent, indicating some momentum in the new homes market.

Higher mortgage rates and a surge in prices amid a dearth of properties available for sale have weighed on the housing market since the middle of 2013.

But as mortgage rates level off and house price appreciation slows, signs of life are emerging.

A report on Monday showed sales of previously owned homes, the largest segment of the housing market, recorded their largest increase in more than 3-1/2 years in May."

As a result, Norfolk can expect an increase in shipments of construction materials going forward.

Strong performance despite headwinds

Norfolk Southern saw a significant increase in its revenue (8.6%) and profits (21%) in the previous quarter. The stock buyback program adopted by the company fueled its earnings. The company's performance is encouraging, considering the fact that it had faced challenges in the recent past. For instance, it was under pressure from Environmental Protection Agency (EPA), which had restricted coal burning, according to Wall St. Cheat Sheet.

But, since then, Norfolk's coal shipments have improved, along with gains in other segments such as metal and construction. Although there have been various headwinds along the way, such as lower prices of natural gas that led to a drop in coal shipments, Norfolk has bounced back strongly. Moreover, the frigid winter during the first three months also dampened coal shipping volume, which led to an increase in its expenses. But things are getting better as Norfolk is diversifying into other sectors such as automotive and industrial to mitigate the weakness in coal.

As such, it wasn't surprising that Norfolk reported growth in its total shipments during the quarter, led by metals and construction, intermodal, coal, crude oil, natural gas liquids, and housing-related commodities. The merchandise market was the lead performer with a 13% increase. The rise in coal revenue was also overwhelming, marking the first quarterly revenue increase in coal since 2011.

Another concern

However, this was offset by the declining export market on account of strong competition in thermal supply in Europe. Along with this, Norfolk also cites some other reasons behind the declining export market. This includes weak seaborne pricing of metallurgical coal, strong Australian competition, and oversupply in the steel market, which led to the closure of two plants in Canada. Despite these issues, Norfolk has done well and is on track to get better.

Conclusion

Norfolk has a trailing P/E of 17.51, better than the industry P/E of 21.92. Its forward P/E looks even better at 13.87, indicating toward earnings growth in the future. Considering the rebound in coal shipments and growth in other areas, along with a cheap valuation, more upside in Norfolk shares cannot be ruled out, making the stock a good buy on the dip.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.