Norfolk Southern is set to announce its second quarter 2015 results on Monday, July 27. The railroad operator is likely to report a decline in revenues and earnings as weak coal carloads impact the top line. According to
In the first quarter, Norfolk Southern reported a 5% year-on-year decline in revenues, just under $2.6 billion. Norfolk Southern's operating expenses declined 3% due to a lower fuel bill. However, its operating ratio increased 120 basis points, to 76.4%, as the decline in operating expenses was not commensurate with the revenue loss. This also led to a decline in net profits, which reduced earnings per diluted share by 15% year-on-year, to $1.00.
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Weak Coal Carloads
The demand for coal at U.S. electric utilities has declined through the first half of 2015, as the spot price for natural gas remained lower than $3 per million btu, a level at which utilities generally start moving away from coal. This is also evident from the rise in natural gas consumption at electric utilities, which grew 25% year-on-year in April, while coal consumption declined 11% year-on-year, leading to a 30% rise in coal stock piles.
On the export front, U.S. coal has been suffering from weak metallurgical and thermal coal prices in the global market. Coal prices have slumped due to high exports from Australian coal suppliers and low demand from China. The strong U.S. dollar has also presented headwinds. U.S. coal suppliers have either had to lower their prices in order to remain competitive or have stopped exporting. This has led to steep declines in railroads' export coal carloads.
These trends have led to a decline in Norfolk Southern's coal carloads. According to its carload report for the quarter to date ending June 27, coal carloads declined 21.4% year-on-year. Not only will the decline in carloads impact the railroad operator's top line but also its coal revenue per unit, primarily due to a lower mix of export coal.
Low Fuel Prices To Eat Into Top Line
One of the reasons why Norfolk Southern is likely to report a decline in its top line is the loss of fuel surcharge revenues as a result of the sharp decline in fuel prices.
In the first quarter, Norfolk Southern's fuel surcharge revenue declined $132 million, which drove down its revenue per unit by 7%. However, the declining fuel prices led to a net positive benefit for Norfolk Southern as its fuel bill declined $168 million. This is because fuel surcharge is based on two month lagged values of highway diesel prices or WTI, while fuel expenses are based on spot prices. Since fuel prices have declined continuously, spot prices are lower than prices two months back, leading to lower fuel expenses than fuel surcharge revenues.
Presently, the price of U.S. on-highway diesel fuel has been fluctuating around its lows, as crude oil prices have showed some upwards momentum. In the second week of April, the average price of U.S. on-highway diesel fuel declined to a low of $2.75. However, it climbed to $2.91 by the fourth week of May. Thereafter, the U.S. on-highway diesel fuel price has continued to gradually decline, ending the fourth week of June with an average price of $2.84.
This situation does not bode well for Norfolk Southern, since fuel expenses are likely to be in line with fuel surcharge revenues, despite the two month lag. As a result, Norfolk Southern might witness a net negative impact from the fluctuations in fuel price in the second quarter, which would impact its operating ratio. Operational expenses such as service-recovery costs, labor costs and those related to relocation of Norfolk Southern's Roanoke office will also present headwinds.
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