Norfolk Southern

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Norfolk Southern Corporation is a major freight railroad operator in the eastern U.S., transporting a diverse range of goods and materials.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: Norfolk Southern (NSC) is primarily engaged in rail transportation of raw materials, intermediate products, and finished goods. It operates approximately 19,100 route miles in 22 states and the District of Columbia in the eastern United States. The company’s network spans from the Southeast to the Midwest, with key corridors for various freight types.

  • Revenue Distribution:
    • Merchandise: A diverse category including agriculture, forest, and consumer products, making up a significant portion of NSC’s revenues.
    • Intermodal: Transporting containers and trailers, moving both domestic and international goods
    • Coal: Shipments of coal, mostly utility and metallurgical coal, represent another substantial revenue source.
  • Industry Trends:
  • The railroad industry is a capital-intensive and highly regulated sector.
  • There is a trend of increased competition among railroads, as well as increased pricing power from a concentrated base of large-volume customers, such as big-box retailers, as the volume of goods being transported decreases. * There are increased pressures from other forms of transportation, specifically trucking, which will have an impact on overall volumes and pricing.
  • The shift to new technologies, including automation, has created a need for significant capital investments

  • Customers are increasingly sophisticated and need sophisticated real time planning and execution. * This is increasing the importance of reliable, scheduled transportation.

  • Competitive Landscape:
    • NSC is one of the leading players, alongside CSX and Union Pacific. They’re all large and somewhat similar in the business they do.
    • Competition is affected by factors such as route density, capacity, operational excellence, service offerings, pricing, labor costs, and the network itself.
    • A key aspect of competition is the ability to provide reliable, cost-effective transportation solutions.
    • High barriers to entry, due to high infrastructure costs, make a new entrant very unlikely.
  • Differentiation:
    • Extensive rail network across the eastern U.S. allows it to transport products in high demand in several industries with reliable transportation, and high-customer service focus.
    • It’s a very capital intensive business, requiring huge upfront costs to maintain the business.
    • It has high switching costs for customers who need a reliable and consistent solution.

Financial Analysis:

  • Income Statement:
    • In 2023, Railway operating revenues increased by 8%, although Railway operating expenses also increased by 11%, driven by rising wage and fuel costs. Operating income declined by 19%.

    • Diluted earnings per share were $7.11, significantly down from $12.16 last year, which the management attributes mainly to the Eastern Ohio Incident.

    • In the Third Quarter of 2024, railway operating revenues were down 3%, operating expenses were also down by 4%, and net income was down by 7%.
  • They’re seeing reduced pricing in Merchandise and increased volume in Intermodal.

  • Fuel expenses are seeing a price decline, but a volume increase.

  • Balance Sheet:
    • As of September 30, 2024, Norfolk Southern had total assets of $43.3 billion and total liabilities of $30.5 billion, resulting in $12.8 billion in stockholders’ equity.
    • A cash and cash equivalent of $1.3 billion shows that the company has good liquidity.
    • Long-term debt is $17 billion which is very important.
    • The net debt position is around $16 billion.
  • Cash Flow:
    • In the first nine months of 2023, cash from operations was $2.6 billion, while investments decreased cash flow by $2.8 billion and finance activities decreased cash flow by 0.6 billion
    • In 2023, they have a capital-intensive business and spent $2.3B on property additions.
    • The company has been doing share buybacks, however, there has been negative Free Cash Flow. They’re currently financing the business with debt.

Recent Concerns/Controversies:

  • The Eastern Ohio Incident caused considerable operating expenses, liability issues, and a decline in their results for the recent quarters.
  • Management mentioned several times that they have focused on the region and are committed to the community for long-term improvement.
  • In 2024 Q3 results, there has been a decline in revenue and earnings and the management attributed it to a lower freight demand.

Moat Assessment: 3 / 5

  • Barriers to Entry: Railroads possess natural monopolies because of the large upfront capital investment. Once a network has been created, it is exceedingly difficult for any competitor to replicate. It is a capital-intensive business, and it requires regulatory approval and permits, making new entry by competitors very difficult.
  • Network Effect: There is a strong network effect in their services. The more customers use them, the more routes the railroad will want to invest in, making their network more attractive.
  • Switching Costs: Some switching costs are present, as customers must deal with their current operations and move them to a different transportation service. However, given the option to switch to trucks or other methods, switching costs are likely not as high as in other moat sources.
  • Intangible Assets: The brand provides a little benefit, and they have some regulatory licenses and permits that are hard to duplicate for others, but, overall, the moat isn’t as strong as it is based on scale and efficiency.
  • Cost Advantages: Through network density, and long existing relationships with customers, the company is able to reduce expenses compared to a theoretical startup that has to build everything from the beginning. This advantage however is limited to certain regions. Based on these, I am giving the business a moat rating of 3/5.

Legitimate risks that could harm the moat and the business resilience:

  • Increased Competition: Increased competition in the transportation sector could threaten pricing power and market share.
  • Regulatory Changes: Government regulations regarding environmental protection, safety and operations can directly affect profitability and increase costs.
  • External Factors: Recessions, wars, or trade disputes could harm the financial performance and outlook of the company.
  • High Fixed Costs: High fixed costs mean that a sudden reduction in volumes can severely affect profitability, and they need to maintain operational expenses whether they have lower or higher volume.
  • Dependence on Commoditized Transportation: A railroad is a transportation method, which makes it difficult to separate its value proposition from competitors, and it’s hard to differentiate their service.

Understandability: 2 / 5

  • While the core concept of a railway business is straightforward, with trucks transporting goods, many of the intricacies and factors are hard to understand and follow.
    • This makes it more difficult for regular investors to analyze the company for long term investment.
  • The valuation is difficult, as discounted cash flow valuations are tough, and there’s an abundance of factors to account for when analyzing the business.
  • Also, with acquisitions, and restructuring, it becomes more difficult to understand the company’s accounting reports.

Balance Sheet Health: 4 / 5

  • The balance sheet is strong, but not at all without risks.
    • It has a good cash balance, but a large debt portion in liabilities, and it continues to acquire debt to fund operations.
  • However, in comparison with other Railroad companies, its metrics are strong.
  • The recent incident in Eastern Ohio has a potential impact on the company’s finances and it will be interesting to follow how it develops. However, management is working with regulatory authorities and insurance companies to offset some costs.

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