Rail Carriers Gain from Improved Traffic and Higher Freight Rates

The latest report by the Association of American Railroads, released on November 3, shows continued improvements in rail traffic in October 2011 with the highest weekly carload average of any month since October 2008. Carloads increased 1.7% and intermodal volume was up 3.6% compared to October 2010. ^[1] The rise in volume, along with the better pricing that most transportation companies reported in Q3, should translate into strong revenues going forward. Last week, Norfolk Southern Corporation (NYSE:NSC) reported third quarter net income of $554 million, up 24% from last year. Competitors CSX Corporation (NYSE:CSX) and Union Pacific Corporation (NYSE:UNP) also saw double-digit growth in revenue and earnings.

We have updated our price estimate for Norfolk Southern to $91 to incorporate Q3 earnings and reflect higher revenue per unit and volumes. Our estimate is nearly 25% above the current market price.

See our full analysis of Norfolk Southern here

Autos and coal drive volume growth…

The increase in rail traffic was primarily driven by gains in motor vehicles and coal, up 11.1% and 1.1% respectively, more than offsetting declines in agricultural commodities. Norfolk, which is the biggest carrier of autos and vehicle parts, will gain with from pent-up demand for automotive. Moreover, some encouraging economic reports of late could provide some momentum for the transportation industry, as volume growth is largely dependent on economic expansion.

… but possible re-regulation of the industry will challenge revenue growth

Even though volumes increased only slightly, revenues and earnings of freight carriers showed double-digit increases due to higher revenues per unit. According to Norfolk, “approximately 82% or $353 million of the revenue gain in the quarter was driven by higher revenue per unit, including pricing gains and increased fuel surcharge revenue.” ^[2]

However, the efforts of the Senate Commerce Committee to reform federal rail policy could have adverse effects on the rail industry if changes are made to the discretionary pricing policies allowed under the Staggers Rail Act. Committee head Sen. John D. Rockefeller insists that reforms are required as high pricing is affecting customer budgets.

Our $91 price estimate for Norfolk does not take into account the potential impact on RPU from regulatory changes, but should substantial reform take place we may revisit our RPU estimates.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. AAR Reports Gains in October Rail Traffic, AAR Press Release [↩]
2. NSC – Q3 2011 Norfolk Southern Corp Earnings Conference Call Transcript, Norfolk Southern website [↩]