Norfolk Southern Corp. (NS), fresh from beating back an acquisition attempt by Canadian Pacific Railway (CP), yesterday reported first-quarter results well above Wall Street's expectations, an indication its five-year plan to improve operating efficiencies is gaining traction despite persistent weakness in volumes and revenues.
Perhaps the most striking improvement for NS was in the all-important operating ratio, which is a company's operating expenses as a percentage of its revenue. NS posted a first-quarter operating ratio of 70.1 percent, a reduction of more than 6 percentage points from the same period in 2015. That was a record for the quarter, and much better than analysts' most optimistic projections. Norfolk Southern's operating ratio has lagged that of its rail peers for years and was used by CP executives as ammunition to convince investors and shareholders that NS was an inefficient operation that in the right hands could be turned around.
On April 11, Calgary-based CP said it would abandon its six-month quest to acquire NS for US$28 billion. The deal would have created North America's first end-to-end transcontinental rail network.
In releasing its results, NS' management reaffirmed its plan to hit a 65-percent operating ratio by achieving $650 million in annualized productivity savings by 2020. The railroad's first-quarter revenue fell 6 percent year-over-year on a 3-percent drop in volumes and a 3-percent decline in per-unit revenue. Backing out the impact of declining fuel-surcharge revenue, revenue per unit rose 1 percent year-over-year.
Analysts were uniform both in their praise and in their surprise over the performance. "It's real, and it's spectacular," wrote Scott Group, analyst for Wolfe Research LLC, in a note today, paraphrasing a line made famous in the 1990s sitcom Seinfeld. However, they noted that NS' performance was driven by better-than-expected progress in cost cuts and efficiency improvements, not by stellar top-line growth. The macroeconomic environment for rails remains difficult—especially in the carload sector, as coal demand continues to weaken due to competition from cleaner-burning natural gas and the surge in shale oil and gas exploration recedes, meaning fewer energy-related loads for the rails.
Intermodal, which for the most part has held its own, has also been affected by dramatically lower diesel fuel prices that make truck traffic more cost-competitive with rail.
John G. Larkin, lead transport analyst for the investment firm Stifel, acknowledged in a note that NS "has made great operating strides." He cautioned, however, that all rails face tough challenges in managing through the tough operating environment.