Last night Norfolk Southern Corp. (NYSE:NSC) unexpectedly released guidance for the third quarter, indicating earnings are likely to come in roughly 25% below Street expectations.
Soft demand is not a new theme in transports recently, but the magnitude of the earnings decline will undoubtedly have many investors asking questions about the sustainability of railroad earnings.
Credit Suisse said the statement was alarming and puzzling. They note:
Alarming 3Q Shortfall: NSC announced after the market close on Wednesday that it expects 3Q12 EPS in a range of $1.18 to $1.25 – the midpoint of which is ~26% below both our initial estimate and the current consensus of $1.64, and down ~24% from 3Q11.
CitiGroup research notes the implications for the competitors of Norfolk Southern Corp. (NYSE:NSC).
Initial Read-Across Negative for CSX, Continue to Favor UNP — While fuel headwinds and volume weakness are clearly a headwind for the entire rail group, we believe that CSX is the most likely to be susceptible to negative headwinds from rising fuel prices as, similar to NS, coal weakness has softened overall yields, which leaves less ability to offset volume declines and fuel lag EBIT headwinds. In addition, volumes are down 0.8% quarter-to-date. While Union Pacific faces fuel headwinds, we believe that it is more insulated than NS and CSX, primarily given that its pricing is still likely to remain positive year-over-year, aided by legacy contracts, and its volumes are slightly positive. We continue to favor Union Pacific over the Eastern rails primarily based on its better pricing position, more favorable end market exposure, and potential to better leverage productivity gains.
It will be interesting to see how Burlington North Santa Fe does this quarter. The large rail-road company is held by Warren Buffett’s Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B)
Following the Q3 2012 earnings pre announcement on September 19, 2012, NSC presented at an investor conference on September 20, 2012 and offered comments that we think confirmed our concern that the yr/yr decline in earnings (exfuel) is due to negative mix issues. We see an 11-16% yr/yr decline in earnings excluding the effects of fuel surcharge timing and against a modest 2% yr/yr decline in carloads.
• In Q3 2012 lower margin intermodal business is modestly offsetting volume declines in higher margin coal and
• Within the coal franchise NSC continues to see lower demand for export met coal, which has been supplemented with what
we think is lower margin thermal export coal. Domestic coal remains lackluster but a hot summer helped modestly.
• The sequential decline in merchandise traffic (expected to be down 5% qtr/qtr) is also negatively impacting profitability.
• We heard no mention of any onetime items in the Q3 2012 lower guidance.
Norfolk Southern Corp. (NYSE:NSC) received downgrades from several sell-side analysts including, BMO, Goldman Sachs Group, Inc. (NYSE:GS), among others.
Norfolk Southern Corp. (NYSE:NSC) is currently trading at $66.16, down 9%. Union Pacific Corporation (NYSE:UNP) is down 4.5% and CSX Corporation (NYSE:CSX) is down 5.2%.
Disclosure: The author is long Berkshire Hathaway. No other positions in any companies mentioned