Norfolk Southern a Sell Based Solely on Valuation

Ockham Research has turned negative on Norfolk Southern Corporation (NSC) largely on price concerns. At near $73 per share, NSC is well above glide slope and up 44% for 2008. Indeed, it has been one of the lone bright spots for the transports as most other stocks in this sector have had a rough year.

The perception that, in a highly inflationary fuel environment, railroads offer a more efficient means to transport goods than competitors has certainly boosted the stock’s performance relative to air freight and ground competitors. Also, fuel surcharges have enabled NSC to pass its added fuel costs on to customers. Thus, the stock has turned in a heady performance for the year-to-date.

However, as a value shop, Ockham is now quite concerned about NSC’s lofty valuation, not the underlying strength of the company. With two major rail customer’s businesses suffering enormously (construction and autos), we find it likely that domestic rail transportation will enter a period of weakness, much like other components of the economy. Some of this weakness will be offset by strong demand in agriculture, possibly coal as well as certain parts of the manufacturing sector (benefiting from a weak dollar) but we doubt that this strength alone will offset the headwinds generated by a sluggish economy.

It is also possible that lower fuel costs going forward will benefit the company. However, fuel surcharges have already enabled NSC to pass much of this inflation on to end users and a drop in fuel costs may not present as much of a boost as one would expect.

Ockham’s Sell on NSC is solely based on valuation. The stock’s historic price-to-cash flow range is 6.8 – 10.43x and it currently trades at 11.11x. Its historic price-to-sales range is 1.36 – 2.06x and it currently trades at 2.55x. Based on these metrics, at $73 a share, NSC is fully valued and then some. Again, this in no way represents a negative view on the company, but rather a concern regarding the stock’s current over-valuation. There are other opportunities in the transport sector that offer more compelling entry point for patient, value-oriented investors.

Comments

[railtruck:]

My opinion-NS is one of the best managed railroads in history, (look at the meaningful numbers) so I will hold for very possible future split and continued growth

2008 Aug 01 11:14 AM

[User 236160:]

I agree with Railtruck. Ockham Research has been the only Co. to make negative comments. All other research has only good things to say about NSC & other railroads.

2008 Aug 01 02:06 PM

[User 183867:]

I agree with Railtruck. Ockham Research has been the only Co. to make negative comments. All other research has only good things to say about NSC & other railroads.

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Which is almost reason enough to sell.

2008 Aug 03 12:02 AM