Norfolk Southern’s Intermodal Yield Likely To Improve With Favorable Intermodal Mix And Price Increase

Norfolk Southern’s (NYSE:NSC) second quarter 2014 earnings received a significant boost from growth in intermodal volume. Intermodal revenue increased 10.5% year-on-year, to reach $650 million, on the back of 10.8% growth in volume. ^[1] The increase in international intermodal volume was primarily the result of heavy traffic at U.S. ports due to the labor contract negotiations between International Longshore and Warehouse Union (ILWU) and Pacific Maritime Association (PMA). We expect international intermodal volume growth to moderate during the second half of the year.

Norfolk Southern’s intermodal yield has been a key factor limiting growth in intermodal revenue. From 2011 to 2013, Norfolk Southern’s intermodal revenue grew 12%, driven by an 11% increase in shipment volumes, however, revenue per unit was relatively stagnant. Intermodal revenue per unit remained stagnant in the first half of 2014 as well.  We believe that given the recent price increase announcements of intermodal services and expected moderation in international intermodal volume, intermodal revenue per unit may increase during the second half of the year.

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Fearing disruptions due to labor contract negotiations, shippers expedited holiday season imports

Norfolk Southern’s international intermodal volume increased 16% due to worried retailers expediting their third and fourth quarter shipments into the second quarter. Retailers were concerned about possible disruptions that could have been caused by the ongoing labor contract negotiations between ILWU and PMA, which led them to import their holiday season merchandise earlier than usual. Because of this move, container traffic at U.S. ports reached an all-time high during the second quarter of 2014. ^[2]

Norfolk Southern’s second quarter results benefitted from the increase in container traffic at U.S. ports. However, we believe that this will also be the reason behind moderate growth in international intermodal volume during the second half of the year. Shippers have already imported some of their third and fourth quarter merchandise, which means they will have fewer shipments in the second half of the year. Though this may slow down international intermodal volume growth, we believe that tightening trucking capacity will help drive up domestic intermodal volumes, leading to continued increase in overall intermodal shipments.

Favorable intermodal mix and price increases will help increase revenue per unit

Moderation in growth of international intermodal volume may prove to be beneficial for Norfolk Southern since it will lead to a better product mix, which will have a positive impact on revenue per unit. Norfolk Southern’s international intermodal revenue per unit is around 33% lower than that of its domestic intermodal shipments. ^[3] Therefore, lower international intermodal shipments will help bring up the intermodal revenue per unit.

Additionally, intermodal revenue per unit should see some improvement in the coming quarters driven by an increase in domestic intermodal rates. The tightening tucking capacity has created a favorable pricing environment, because of which, Norfolk Southern has been able to increase rates of its domestic intermodal services. Norfolk Southern increased the rates for its transcontinental service on June 1, and will be increasing rates of its Equipment Management Program service effective from September 1. These services represent 17% of Norfolk Southern’s domestic intermodal business. With no sign of an increase in trucking capacity, we expect the favorable pricing environment to sustain for a long time. However, competitive pricing pressures, primarily from CSX (NYSE:CSX), may limit price increases.

For the remaining 83% of Norfolk Southern’s domestic intermodal service, price increases during the second half of the year will be dependent on escalators included in contracts. Escalators trigger price increases based on the Rail Cost Adjustment Factor, which measures the rate of inflation in railroad inputs such as labor and fuel. Re-pricing of these contracts will have to wait till 2015 since contracts are priced on an annual basis.

Norfolk Southern has additional capacity to manage intermodal volume growth

In order to capitalize on the tightening trucking capacity and increase price, Norfolk Southern needs to be able to manage additional intermodal carloads. Given its significant investment in adding terminals and corridors, we believe that Norfolk Southern has the capacity to handle an increase in intermodal volume. Norfolk Southern successfully managed double-digit growth at its Crescent, Heartland and Meridian corridors in the second quarter.

Proper management of its double-stack operations and efficient utilization of resources also enable Norfolk Southern to manage high intermodal volume without having to add trains or increase train length. For example, the additional 95,000 intermodal units during the second quarter 2014 were handled by using the right intermodal boxes on the rights cars instead of adding trains. ^[3] Norfolk Southern’s intermodal trains are generally 6,000 feet long, however, it can easily manage 10,000 feet long trains as well. This indicates sufficient additional capacity to manage an increase in intermodal volumes.

We believe with an increase in revenue per unit and volume, the intermodal business will continue to drive Norfolk Southern’s earnings in 2014 and beyond.

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1. Norfolk Southern Second Quarter 2014 Financial Review, July 23 2014, www.nscorp.com [↩]
2. Retailers Step Up Holiday Imports In Case Of A West Coast Port Strike, June 9 2014, www.forbes.com [↩]
3. Norfolk Southern’s (NSC) CEO Wick Moorman on Q2 2014 Results – Earnings Call Transcript, July 23 2014, www.seekingalpha.com [↩] [↩]