Big Day for the Black Horse: NSC's Q4 and Investor Day Preview

February 8, 2019

Greetings;

Big Day for the Black Horse:  Norfolk Southern ‘s Q4/18 was above Street expectations, by a little or a lot depending on how you look at it, but it was essentially an after-thought ahead of Monday’s(2/11) critical Investor Day Conference in their soon-to-be HQ city of Atlanta.  NSC closes the door on the major rail reporting (7 for 7); look for imminent write-up on GWR (8-fo-8) and then my Q4/18 Review/2019 Preview after the Berkshire Hathaway/BNSF report which the WSJ says will be on (or about) March 1.

Mixed Expectations for the Conference:  I have high hopes; many remain Missourians about Monday.  I have been calling this long-awaited event “critical” and even “the most important event in their history – and I stand by it.  The financial community knew that NSC would benefit, even at the end of a bidding war, from the Conrail split (the questions were mostly around “when” and “how much”).  This event, set to explain their new operating plan and financial guidance – and their commitment to PSR – will face widespread skepticism and, stock-price notwithstanding (remember the age-old rail investment strategy of betting on the under-performers), a rather surly audience. Most of the Street never knew NS as the “Thoroughbred of Transportation”, the swaggering best-in-class carrier with the best OR (eventually settling for the best OR in the USA) and a safety record so good that the industry retired the Harriman Award that NS won year in, year out.  In fact, to hear NS, as with UP before them, negatively compared to CSX is, to the hearing of anyone with experience, a sign that the world’s turned upside down.  And, in fact, the (rail)world has….

 

What’s happened to NSC?

  • The rest of the rails have caught up and surpassed NS in terms of the OR (never mind that it is one ratio, not the only one) and most (all?) have done so by undertaking PSR

  • Hunter Harrison’s success at CSX erased the concept that PSR worked only in Canada, or only in simple systems, or….UP’s embrace and early success also drove the final nail in that coffin

  • Hunter Harrison (and Jim Foote’s subsequent) success at CSX also meant that NS’ direct rival would be PSR – a lower OR, more productive rival

  • It was UP that won the game of Big Buck Hunter, nabbing ex-CN Jim ($8B) Vena as their new COO; NS’s prize in the “find me a Canadian!” sweepstakes is/was unknown to the investment community

  • NS service and service reputation have been slowly but steadily diminishing (recent result suggest a turnaround may be in hand); Q4/18 provided mixed results (higher casualty claims, etc and a FY 12% decline in velocity although the Q4 decline was “only” 6%.  Dwell, where the initial (clean sheeting) efforts are concentrated, improved by 3% in the quarter but increased by 9% for the year).

  • NSC over a period of years has chosen to reveal less and less qualitative information, an IR strategy that was spectacularly ill-timed:

o   This will be NSC’s first Investor Conference since 2014!  By comparison, Canadian National (the PHR example of the end goal of PSR transformation) will hold an investor conference in June, almost exactly two years after its’ last one

o   Although the last (“Flexible & Dynamic”) Operating Plan was touted as a success, it was never explained – and NSC’s service metrics have been declining for about two years….

o   It is the only railway to not publish 2018FY ROIC – which I was hoping to use as a defense of its big domestic intermodal franchise (which I believe to be OR dilutive but ROIC contributory)

o   NS has rigorously stayed “on message”, so while it travels the “Analyst Conference Circuit”, it rarely reveals much if anything - leaving the tenor of the questions (CSX comparisons, etc) as the most interesting component, rather then the answers….

o   This has led to a severe disconnect between the financial community and management, as evidenced by the differences in interpreting the Q4/18 OR by the former (inflated by RE gains by some 200bps) and the latter (sticking with the published number, a sign of the former Plan’s success; the financial community does not consider the former Plan to be successful!)

o   NSC’s new Plan (using the unfortunate phrase “informed by tenets of PSR”, interpreted by the most cynical as, well, let’s say a sign of little commitment) hasn’t been well-explained – yet – beyond “clean sheeting” descriptions

What can NSC do?  Plenty – we need to remember, that if only a few of us see the Thoroughbred potential, this aint any ol’ nag, neither; NSC has consistently delivered good, consensus-beating financial results.  It’s just that others (CSX) have done better, faster (and threaten to change the rules of the game unless NSC adapts).  But there is a lot they can do, and they have set the stage to do it (In My Humble Opinion):

  • Strive for increased transparency in order to restore credibility (show how they got into their service rut, and how they will get out of it)

  • Set strong Targets/Goals (this is what I have heard most consistently from investors – in their cases mostly OR Targets that approximate CSX; in mine ROIC targets that are consistently industry-leading….

  • Be bold!  Investors fear incrementalism - Even as UP is daily making a better and better case for a/their “measured approach”

  • Provide detail on the New Operating Plan and reliable – and repeatable – metrics

  • Listen as well as speak – the disconnect as reflected in the Q4 Q&A is real

  • Correct misconceptions – that same Q4 Q&A revealed analysts who mistook yield for price; the biggest is of course that OR is the only measurement of quality (rather than ROIC, etc)

  • Defend some unpopular decisions – will they join the ranks and severely cut Capex?  Sure, PSR leads to a bug initial reduction in buffer stock (NS has already parked or returned a total of 400 locos, for example) – but the Post-Hunter Railroads (PHR) up North in fact unite growth, strong capex – yielding a 15%+ ROIC

  • Discuss technology – NSC seized some rail/tech high ground at Railtrends 2017, leading the industry fight on getting regulatory standards to better understand the post-PTC world and its potential (note – labor “Section 6”notices go out this November); in addition, the joint NS-shortline visibility imitative with a forest products customer was one of the, to me, eye-opening initiatives of last year….

  • Be open and inclusive with shippers – so far publicly so good 9although one shipper told me that their new NS pricing options (commit to capacity for a 20% increase in rates at a locked in volume commitment or subject themselves to capacity risk at a 6% increase – came without any service improvement guarantees.  And remember, the shipper trade associations have their complaint letters already written, waiting only for the dating….

Risks:

  • Regulatory – the PSR process is already being watched like a hawk by the STB (and by the new Congress) due in part to misremembering Hunter Harrison’s legacy and also a nice turd-in-the-punchbowl left by CSX as they exited their rather violent restructuring….

  • Regulatory/Common Carrier Obligations (thank you Matt Rose) – in the past, when a railway undertook the PSR restructuring, the other regional competitor was not – and had capacity to accept  some shed (“de-marketed”) business – think N when Hunter went to CP – or NS when Hunter went to CSX.  Now, if

  • Activist Intervention – Unlikely (again, NSC had a 65.4% OR FY’18 – not 75.4%) but….Investors are more empowered to act, with possible unintended consequences - there may no longer be a Hunter Harrison (and CP’s Keith Creel is – happily – locked up till 2022) but there are plenty of firms that fancy themselves a Pershing Square or Mantle Ridge

  • Market Share – Highway – NS built out the best intermodal franchise in the east (at an high “Corridor” buildout cost), and with premium partner JB Hunt (and others) is on the attack in the mid/short haul arena, the hardest but richest prize of all.  I don’t thin the folks in Conway want to see their boxes linked to a coal train….e need to understand the new intermodal interchange routing protocols initiated with the UP in December – demarketing?  Or re-marketing?  Will PSR end the truck-conversion dream?  (Note – CP and especially CN intermodal – PHR – are doing just fine, merci beaucoup).

  • Market Share – Rail – CSX is notably better than before, and, it seems than NS (at least in metric times and in manifest).  If CSX’ metrics (velocity, etc) continue to improve, and NS continues to decline(or even stagnate), what happens to regional rail share?  Or Industrial Development (historically an NS strength)?

How long?  Not Long!  In the spirit of Atlanta, I reference the great MLK’s speech to say that the hour of understanding is almost upon us.  And make no mistake - this is a Big Day for the Black Horse.  If they (IMHO) adapt (to a pattern of increased transparency) and adopt (to PSR and improvement) there is no reason that they cannot aspire to recapture their long held title of the Beast of the (South) East. 

NSC has picked a city with a rich rail history to move to….BTW, whilst in the ATL, I plan to check out the new exhibit at the Atlanta History Center om “Railroads & the Making of Atlanta” (http://www.atlantahistorycenter.com/explore/exhibitions/texas-locomotive ) featuring a series of rail-inspired Meet the Past museum theatre characters that will premiere with the opening of Locomotion: Railroads and the Making of Atlanta. Performed on weekends, these include Pullman porter James Stewart, Southern Railway chairman W. Graham Claytor Jr. (who also ran Amtrak and is the brother of first Norfolk Southern CEO/Chairman Robert Claytor), and pioneering woman switch tender and brakeman Gertie Stewart…. Later re-enactors might include Tom Finkbiner to explain intermodal and Jim McClellan to explain….well, everything.

Anthony B. Hatch 
abh consulting
http://www.abhatchconsulting.com