Freight News:
Norfolk Southern says higher costs will pay off in long term
Norfolk Southern defended the rationale behind its elevated costs to investors during its third-quarter 2023 earnings call Wednesday morning, saying the higher costs reflect investments that will result in greater long-term yields, including improved service and greater market share.
Some Wall Street analysts on the call questioned whether NS (NYSE: NSC) could do more to cut costs and improve its margins, particularly as its competitors have been reporting better margins.
NS’ third-quarter operating ratio, a metric that investors sometimes use to gauge the financial health of a company, was 74.6%, compared to 62% in the third quarter of 2022. A lower OR implies improved financial health.
The third-quarter OR accounts for a $163 million charge for site remediation efforts following the Feb. 3 derailment of an NS train in East Palestine, Ohio. That incident included the derailment and subsequent venting of rail cars carrying vinyl chloride. Excluding that charge, NS’ OR would have been 69.1%.
But NS President and CEO Alan Shaw defended his company’s strategy on tackling costs.
“We’re committed to industry-competitive margins. We’ve said that from the get-go. We’ve also said that returns follow the investment. We’re invested over the long term. We’re not going to chase short-term OR targets,” Shaw said.
NS had forewarned during its investor day last December that during times of an economic trough, the railroad’s margins could “get a little worse as we invest in the long term,” Shaw said Wednesday. “But as you evaluate this through an economic cycle, this is the better way forward for Norfolk Southern to invest in long-term growth, deliver top-tier growth [and] industry-competitive margins and drive long-term shareholder value.”
Shaw said last December that while a market downturn might result in higher operating costs associated with a slower network, the option of furloughing employees can cost the railroad much more in the long term. That is because when freight rail demand bounces back, the railroad can’t meet that demand and therefore loses that service to trucking, he said. Service disruptions could also arise because there are not enough crews to run the trains.
On Wednesday, Shaw said NS is “not happy with our cost structure right now, [but] as we drive operational discipline into our network, as we refresh our operations team, as we drive a high degree of plan compliance, it allows us to continue to iterate the plan for productivity and service.”
NS CFO Mark George divided the railroad’s costs into two categories: one reflecting short-term costs and the other reflecting expenses that NS hopes will improve the resiliency of the rail network long term.
The first category includes costs associated with two technology-related service disruptions that occurred in the third quarter, as well as labor costs that should “unwind over the next couple of quarters” as new train and engine employees make their contributions at critical locations on NS’ network and help improve network fluidity, said George, who added that these labor efforts should also help reduce reliance on overtime.
Meanwhile, the structural expenses “are really around developing and building resiliency,” with some of those costs related to the quality-of-life initiatives in NS’ labor agreements, as well as to investments in locomotives, George said, pointing out that these expenses could moderate heading into 2024, although NS will provide more guidance when the railroad reports fourth-quarter 2023 earnings in January.
Shaw alluded to NS’ improving service metrics in the third quarter. Among them, terminal dwell fell 10% to 23.2 hours year-over-year (y/y), while train velocity increased by 7.3% to 20.5 miles per hour.
“With respect to the resiliency costs, some of that has to do with predictable work schedules. Some of that has to do with the historic wage increase that the rail industry and labor came to agreement on last year. Some of it has to do with investing in additional resources,” Shaw said. “As a result of that, what you’re seeing is third-quarter service that is better year over year and better sequentially. Our safety figures improved in the third quarter. … Our volumes [and weekly carloadings in] the last four weeks are at levels that we haven’t seen [since] the second quarter of last year. So we’re making progress. We’re doing exactly what we said we were going to do. This is the better way for Norfolk Southern to drive long-term shareholder value.”
By improving service through these investments, NS will “have greater opportunity to eliminate the service recovery costs, we’ll have greater opportunity to drive productivity throughout our organization as we standardize our operating practices, we’ll have greater opportunities to generate more volume, and we’ll have greater opportunity to generate more price reflecting the value of the products that we sell,” Shaw said. “All of those things will contribute to improvements in our margins and [create] industry-competitive margins, and I think we’re going to see improvement in that next year.”
NS Chief Operating Officer Paul Duncan also pointed to continued efforts to minimize car dwell and maximize network velocity, which should result in improved fuel efficiency, particularly as more tonnage goes onto the network.
“Disciplined terminal execution … starts with strict adherence to the operating plan to ensure trains are arriving on plan to balance terminal flows and both our merchandise yards and intermodal facilities,” Duncan said in prepared remarks. “We’re minimizing dwell by switching cars within six hours of arrival.”
NS’ Q3 financial results
NS’ third-quarter net income plunged by 50% in large part because of the $163 million charge resulting from the Feb. 3 train derailment in East Palestine.
Net income was $478 million, or $2.10 per diluted share, for the third quarter of 2023, compared with net income of $958 million, or $4.10 per diluted share, for the third quarter of 2022.
In addition to the $163 million charge, the third-quarter 2023 amount includes initial insurance recovery of $25 million. The primary driver of those charges was site remediation efforts, NS told FreightWaves.
George said during the earnings call that of the over $900 million in NS’ anticipated expenses and cleanup costs so far that are related to the East Palestine derailment, half of that has already been paid in the first, second and third quarters. The remaining $450 million could be spent in the fourth quarter and in 2024.
“The situation remains fluid and we will continue working through these issues for many quarters to come. We expect that there will be additional costs that have not yet been incurred related to future settlements, fines and penalties, as well as legal fees,” George said.
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