Tactical Efficiency Moves And Smart Investments Set To Revitalize Railroad Operations

Key Takeaways

• Accelerating productivity and cost control measures are enhancing operational efficiency, leading to improved margins and lower expenses.
  
• Strategic investments in infrastructure and technology support growth in service-sensitive markets, potentially increasing market share and revenue.
  
• Challenges including market weakness, contractual wage increases, unexpected costs, and competition may strain revenue, operational costs, and net income.

Catalysts

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

• Accelerating productivity initiatives and cost control measures are enhancing operational efficiency, likely leading to improved net margins and lower operating expenses.
  
• Focused efforts on improving key operational metrics, such as train velocity and locomotive reliability, suggest a decrease in overall maintenance and fuel costs, contributing to better net income.
  
• Initiatives in fuel procurement and optimization are expected to reduce fuel expenses, positively impacting net margins.
  
• Strategic capital investments in infrastructure and technology to support efficient operations and growth in service-sensitive markets, indicating potential revenue growth from increased market share.
  
• Implementation of the NS intermodal reservation system aims to streamline operations and reduce costs associated with rents and handling, likely enhancing earnings through better asset utilization and cost savings.

Assumptions

• Analysts are assuming Norfolk Southern's revenue will grow by 4.9% annually over the next 3 years.
• Analysts assume that profit margins will increase from 14.8% today to 25.8% in 3 years time.
• Analysts expect earnings to reach $3.6 billion (and earnings per share of $16.89) by about August 2027, up from $1.8 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $3.6 billion in earnings, and the most bearish expecting $3.2 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 20.2x on those 2027 earnings, down from 30.3x today. This future PE is lower than the current PE for the US Transportation industry at 26.7x.
• Analysts expect the number of shares outstanding to decline by 0.4% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 7.13%, as per the Simply Wall St company report.

Risks

• Persistent market weakness and unfavorable mix within business lines could negatively impact volume growth and result in lower revenue per unit (RPU), potentially affecting overall revenues.
  
• The industry's next contractual wage increase, effective July 1, 2024, could lead to a $25 million increase in compensation and benefits, stressing operational costs and potentially affecting net margins.
  
• Adverse mix headwinds, notably in intermodal segments with lower rates for merchandise commodities like aggregates and finished vehicles, might suppress RPU improvement efforts and impact earnings.
  
• The soft macroeconomic environment and high interest rates could constrain new industrial activity, potentially limiting growth in the merchandise segment and adversely affecting revenue growth.
  
• Increased competition and potential operational challenges associated with venturing into new markets or expanding service offerings (e.g., through Mexico for the Southeast market) could lead to execution risks and additional costs, potentially impacting net income and operational ratios.

Valuation

• The analysts have a consensus price target of $265.23 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 $292.0, and the most bearish reporting a price target of just $175.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $13.9 billion, earnings will come to $3.6 billion, and it would be trading on a PE ratio of 20.2x, assuming you use a discount rate of 7.1%.
  
• Given the current share price of $239.68, the analyst's price target of $265.23 is 9.6% 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.