PSR 20 Transformation Will Unlock Operational Efficiencies And Cost Savings

Key Takeaways

• Norfolk Southern's PSR 2.0 transformation and cost reduction initiatives are boosting efficiencies and enhancing net margins and earnings.
  
• Strategic focus on customer confidence and industrial development growth is bolstering market share and supporting long-term revenue growth.
  
• Norfolk Southern faces potential revenue and margin pressure from storm restoration costs, lower coal prices, trade policy uncertainty, limited insurance recovery, and competitive pricing challenges.

Catalysts

Engages in the rail transportation of raw materials, intermediate products, and finished goods in the United States.

• Norfolk Southern's implementation of its PSR 2.0 transformation is unlocking network value, streamlining operations, and driving efficiencies that are expected to improve the company's operating ratio and reduce expenses, positively impacting net margins and earnings.
  
• The commitment to $150 million in productivity and cost reduction initiatives over three years is being propelled by better labor productivity and fuel efficiency, which are anticipated to sustain EPS growth even if revenue growth slows.
  
• The company's focus on increasing customer confidence through consistent service improvements is leading to meaningful market share gains, particularly in merchandise and intermodal segments, which could bolster future revenue growth.
  
• Strategic plans to capitalize on industrial development activity, particularly in sectors like steel and food production, along with the potential for highway-to-rail conversions, are expected to provide new demand drivers for volume growth, supporting long-term revenue enhancement.
  
• The company's resilience and efficient recovery following weather disruptions, alongside ongoing operational improvements, position Norfolk Southern to effectively manage costs and potentially improve earnings during periods of economic uncertainty.

Norfolk Southern Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Norfolk Southern's revenue will grow by 4.0% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 27.4% today to 24.5% in 3 years time.
• Analysts expect earnings to remain at the same level they are now, that being $3.3 billion (with an earnings per share of $15.55). However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as $3.0 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 21.8x on those 2028 earnings, up from 14.9x today. This future PE is lower than the current PE for the US Transportation industry at 23.5x.
• Analysts expect the number of shares outstanding to decline by 0.21% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.02%, as per the Simply Wall St company report.

Norfolk Southern Future Earnings Per Share Growth

Risks

• Norfolk Southern's operating expenses were impacted by $35 million in storm restoration costs, which could adversely affect net margins and the operating ratio if such events occur more frequently.
  
• The company faces potential headwinds from lower export coal pricing, which could impact revenues due to declining coal prices affecting RPU less fuel.
  
• Tariffs and evolving trade policies present uncertainty, particularly in auto and intermodal markets, potentially impacting revenue consistency.
  
• Insurance recovery from past incidents may not sustain financial outcomes beyond a temporary benefit, thus affecting net income stability in subsequent periods.
  
• Norfolk Southern's ability to pass on increased costs through higher prices remains challenging in certain markets, particularly for intermodal services facing flat truck pricing, potentially impacting profit margins amidst rising operational costs.

Valuation

• The analysts have a consensus price target of $257.88 for Norfolk Southern based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $290.0, and the most bearish reporting a price target of just $174.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $13.6 billion, earnings will come to $3.3 billion, and it would be trading on a PE ratio of 21.8x, assuming you use a discount rate of 8.0%.
• Given the current share price of $218.63, the analyst price target of $257.88 is 15.2% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.