Norfolk Southern Corporation (NYSE:NSC) is scheduled to release its first quarter earnings after the bell tomorrow. Norfolk Southern is the third major freight railroad company to report following CSX Corp (NASDAQ:CSX) and Union Pacific (NYSE:UNP) last week. If the others are any indication, the quarter will be marked by many successes, but the glaring yellow flag is the expectation that coal demand remains weak through the second quarter.
When valuing freight railroad companies, I tend to watch three things: volumes, pricing, and operating ratio. During the first quarter, the US economy saw some strong signs of a recovery, but volume growth has been rather sluggish after being strong last year. The rails are considered economic bellwethers, and we are seeing some of that weakness come through in the latest round of economic data. For CSX, volumes increased 0.6% year over year while UNP saw volumes gain 1.3% compared to the first quarter of 2010. I am expecting volume gains of approximately 1.0% for the quarter for NSC, stemming mostly from Chemical shipments and MetCon shipments.
Pricing (revenue per unit) growth is the second key metric I monitor. Revenue per unit (RPU) increased a strong 10.6% for Norfolk Southern during the fourth quarter of 2011. CSX saw its pricing power slip slightly during the first quarter, gaining 4.9% year over year (after gaining 9.5% in the fourth quarter of 2011), while UNP saw total RPU growth of 12.1% (compared to growth of 12.9% during the fourth quarter of 2011). NSC has seen its RPU growth be much more volatile and erratic compared to the other railroads, but I am expecting a high single digit growth rate as intermodal, agriculture, and MetCon will help to offset pricing weakness in coal.
Operating ratio, which is computed as the total expenses as a percentage of revenue, monitors how well the company is controlling costs. As has been the norm for the industry over the past several years, only fuel costs increased as a cost of revenue during the fourth quarter for NSC. Fuel costs are going to continue to rise as a percentage of revenue as a result of higher fuel costs, despite the fact that these companies become more fuel-efficient. Interestingly enough, the rails become a more attractive mode of transportation relative to the highways (via trucks) as fuel costs increase. So yes, fuel costs go higher, but there is also an incremental increase in volumes as fuel prices rise. Eventually, the railroad industry will run into capacity issues (we last saw them back in 2006 and 2007), however the industry has been spending billions of dollars per year to expand its capacity, and despite the rebound in volumes, the industry is still far from at its max capacity.
CSX had a mixed quarter at best, especially with the prospects for coal during the quarter (click here for my reaction to CSX's earnings), while UNP delivered another strong quarter. I like NSC's chances to beat the Street's estimates on both the top and bottom lines. The Street is expecting NSC to report earnings of $1.12 per share on revenue of $2.75 billion. A slight negative is that estimates have been declining for the past 90 days, falling from $1.22 per share. The Street is also modeling for only approximately a 5% increase in revenues. That is a little on small side for my expectations. My models have called for earnings of $1.14 per share on revenue of $2.80 billion.
Disclosure: I am long CSX.