NS 4Q23 Concludes ‘Challenging, Transformational’ Year (Updated, TD Cowen Insight)

"Norfolk Southern enters 2024 with positive momentum and a focus on driving further productivity gains and operational discipline through aggressive cost management," said NS President and CEO Alan H. Shaw.

For Norfolk Southern (NS), fourth-quarter 2023 railway operating revenue was $3.1 billion, down 5%, or $164 million, compared with fourth-quarter 2022, marking the end of a “challenging, yet transformational year” for NS, the Class I reported Jan. 26.

Among other fourth-quarter results:

• Income from railway operations was $808 million inclusive of a $150 million charge associated with the Eastern Ohio Incident, a 32% decline compared to $1.2 billion in fourth-quarter 2022.
• Adjusting for the Eastern Ohio Incident, income from railway operations was $958 million, down $223 million, or 19%, compared to fourth-quarter 2022.
• Diluted earnings per share were $2.32, a decline of 32% compared to fourth-quarter 2022.
• Adjusting for the Eastern Ohio Incident, diluted earnings per share were $2.83, down $0.59, or 17%, compared to fourth-quarter 2022.

2023 Results

NS’s railway operating revenues were $12.2 billion in 2023, down 5%, or $589 million, compared with 2022. Among other full-year results:

• Railway operating expenses were $9.3 billion inclusive of a $1.1 billion charge associated with the East Palestine accident, an increase of 17% compared to 2022.
• Adjusting for East Palestine, railway operating expenses were $8.2 billion, up 3% compared to 2022, “driven by higher compensation and benefits, inflation, and ongoing network congestion.” 
• Income from railway operations was $2.9 billion inclusive of the $1.1 billion charge associated with East Palestine, down 41% year-over-year.
• Adjusting for East Palestine, income from railway operations was $4.0 billion, down 18% compared to the prior year.
• Diluted earnings per share were $8.02 inclusive of the $1.1 billion charge associated with East Palestine, down 42% compared with 2022. 
• Adjusting for East Palestine, diluted earnings per share were $11.74, down 15%. 

“The fourth quarter marked the end of a challenging, yet transformational year for Norfolk Southern,” said NS President and CEO Alan H. Shaw. “I’m proud that the team responded with unwavering dedication while continuing to advance our strategy that strikes the necessary balance between service, productivity and growth. We invested in our people, enhanced our service performance and made a safe railroad even safer. Norfolk Southern enters 2024 with positive momentum and a focus on driving further productivity gains and operational discipline through aggressive cost management. We see growth on the horizon, and we are confident in our ability to deliver industry-competitive margins over time.”

In its Jan. 26 earnings call, NS also announced that, to cut costs, it will be eliminating some management and staff positions. The Class I railroad is offering voluntary severance packages to eligible non-agreement employees, estimated to be 300. “Importantly, we are streamlining our cost structure and eliminating inefficiencies,” Shaw said. “We’ll take actions this year to reduce costs in other areas. This includes a program to reduce management headcount by roughly 7% to help offset increases in critical operating areas.”

TD Cowen Insight: “Obstacles Abound as NS Plays Catchup to Peers”

By Wall Street Contributing Editor Jason Seidl

Norfolk Southern faced a tough 2023 with a major derailment and tech outages that hit margins. A gradual recovery is anticipated over the coming three years as NSC plays catchup with Class I peers. NSC has invested heavily in improving safety and staffing for long-term growth and service metrics continue to improve. A 4Q beat was more than offset by 2024 outlook that came in well below our forecast and a three-year margin forecast that was disappointing. While the U.S. Class I rails struggle to find the next growth lever for top-line growth, NSC’s cost structure should continue to notably underperform its peer group for this year. We downgrade NSC to Market Perform and place our PT at $236.

NSC’s Cost Structure Proving Sticky:  NSC ended 2023 with an OR of 67.4%, more than 500bps above its two U.S. Class I competitors. While the company faced an uphill battle following last February’s derailment ($650MM derailment related outlays) and two technology outages in 2H23, the margin outlook for 2024 suggested little improvement off easy comparisons. A slow start to the year due to weather should continue to challenge OR in 1Q24 (along with normal seasonality) and improve sequentially from there, lapping easy comparisons beginning in the second quarter.

Three-Year Outlook Leaves Most Wanting More: Management also gave a three-year outlook for 100-150bps of OR improvement annually. This would place NSC’s guidance materially below its peer group for 2025 (we don’t have 2026 estimates published) if it just hits the bottom of that range. In fact, if the company just hit the high end every year for the next three years, NSC’s OR would still be below where its East Coast peer was in 2023. We do not view new financial guidance as closing the gap with competitors as management suggested, given both other Class I’s are expected to see margin improvement off a much lower (better) 2023 base.

2024 Revenue Outlook Represents 2% Growth From 2018 Levels: We believe it is concerning that 4Q24 OR underperformed despite greater network volumes with 2.9% y/y carload growth. Management pointed to muted volume outlook in 2024, which we see as a negative sign for margins in the year. The volume outlook calls for modest growth with some strength in autos, steel and intermodal. Management acknowledged broader macro uncertainty (like some others have thus far in transport earnings season) in producing tepid outlook. Like the other Class I’s, 1Q24 carloads are expected to be impacted materially by harsh weather. NSC also expects persistent pressure on intermodal and coal pricing but continued strength in merchandise. Top-line growth guidance of ~3% in 2024 is below our estimate and represents only 2% growth from 2018 levels.

Capital Allocation Going Forward:  Investors stand to lose accretion from share repurchases in the near-term as NSC has temporarily suspended its buyback program (we note that UNP suspended its buyback for 1Q24 as well) with cash flow being diverted to debt servicing arising out of the $1.6B Cincinnati Southern Railroad acquisition (while the deal closes in March, NSC raised debt in November 2023). Management guided to a $210MM per quarter interest expense and capex except CSR flat at ~$2.3B. Management highlighted that these below-the-line items should suppress y/y bottom line growth vs. 2023, and we estimate a large $0.60 drag on 2024 EPS relative to our prior forecast.