Reflections on NSC’s Q2/19

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Greetings;

Reflections on NSC’s Q2/19; what quarterly results mean (or should mean) – and some real questions for the future….

  • Jim Squires (NSC CEO) “And in terms of the pace of our improvement as have said in 2019 at least 100bps over 2019 (in OR) and (a) 60 (% OR) by 2021” /from the NSC Q2/19 Earnings Call transcript….
  • “PSR is a growth enabler” /Squires, at the AARS, Norfolk VA 7/23/2019

So Norfolk Southern missed Q2/19 earnings by a couple of cents (maybe 1%), and the stock drops 5%+ last week….EPS was up 8%, the OR dropped 100bps (on target – we’ll get to that below) to 63.6%. Volumes were industry-level lousy (-4%) – but unlike their peers, they see bright skies just ahead (H2/19). To be fair, auto production looks solid. Some impact was the unexpectedly sharp 16% drop in margin export coal tons (interestingly utility coal tons were up 3%). Service and operating metrics, to the extent they were shared, were improved, even well-improved (velocity by 19% and terminal dwell, the beneficiary of the “Clean-sheeting” process, by 37%). But – the Top-21 PSR rollout began on day one of the third quarter! In effect, judging NSC on the pre-T21 rollout numbers is like reviewing the naval parade in the English Channel on July 5th, 1944 – without finding out how D-Day actually went! And the answer, as far as early reports on NSC’s T-Day, is so far, so really, really good.

T21 is “flawless so far - Slide 12 of the NSC Q2/19 presentation is by far the most significant for the intermediate/long term – as of the first week of July, for merchandise (the PSR sweet spot, recall) and automotive, train starts are down 10%+, “circuity” down 20%+, train miles -15%. The rollout of T21 (including intermodal, which will it seems – and should be – left alone, with ‘some opportunities”, perhaps, on the international side) begins next year as they plow through six months of phase one. But this piece of good news did lead to some questions, some on the Q&A and some that occurred to me; unfortunately NSC remained to stolidly “on message” – see the quote above - that they missed the chance to engage in a better, more illuminating dialogue; one example is on continued strong pricing opportunities in the face of the volumes, truck capacity, etc (just saying it’s so doesn’t make it so, even if I too believe that it is so). And for that matter, on pricing, CMO Alan Shaw noted that pricing, the “Yield-Up” strategy, the emerging “capacity dividend” and the improving product to sell all are working in harmony – but his statement that “within our Merchandise network we have had seven consecutive quarters of improving YOY pricing increases” leads me to ask – only seven?

Among the questions:

  • If NSC is already running more efficiently, to the tune of its 100bps OR improvement (its target for 2019 as announced in the Investor Conference) – why won’t 6 months of the so-far “flawless’ T21 rollout lead to even more productivity gains, thereby raising the (admittedly) short term target? Part of the answer is that the cost (heads, yards, etc) take out will follow the operating improvements, part of the shipper-collaborative (and politically savvy) and more nuanced transformation that fits NSC’s style (and anyone following CSX 2017-18 given the STB’s acute interest). As Squires has pointed out (below) – for railway transformation, there is an advantage for being the second-mover! But is that all of the reason? Why is the above-target headcount reduction not showing up very dramatically on the bottom line (heads down 5% but compensation costs down 2% in Q2)? I mean, it had better be so – it is the lead growth engine (as it has been this century and was highlighted as such on Investor day).

  • Intermodal – why was domestic down so much – 10%?? It had grown in 33 of the last 40 quarters. Similar to CSX – but they are going through the second round of de-marketing (which, come to think of it, should lead to opportunity!).

    • Are they de-marketing? (I think not)

    • And what really gives NSC such confidence that we have passed an inflection point, given recent economic headlines about tariffs, consumers, etc?

    • And I am surprised by both the Q and the A regarding international IM which grew 7% in Q2/19 – “is it just sort of an East Coast (port) share win versus the west coast” event?”/”….we’ve got great alignment with the steamship lines that are adding capacity to the East Coast”. So I ask:

      • Was there much port share shift in Q2/19? I don’t think so….

      • And, more importantly, isn’t share shift to East Coast ports a negative for eastern rails, given the high percentage that goes off the ship to the highway (compared to LA/LB, BC, etc)and the shorter LOH of what volume is retained?

  • More on the disclosure - The KPIs listed (slide 10) were a repeat of the Investor Conference without hard numbers, and were indexed to 2018 – which is useful, of course, but was a baaaaad year (the cause for the T21/PSR shift, in fact) so comparisons – with “hard metrics” to 2015, say, would also be useful! And – avoid pre-programmed robotic phrases – this isn’t a political debate but an ongoing process….

  • Meanwhile, CEO Squires was fantastic at the AARS Conference the day before the earnings release – strenuously arguing for the customer/growth aspects of PSR (“it has to be”), defending the need to “invest for growth (and technology)” as a key differentiator (to the tune of 16-18% of revenues). THAT is the engaged, enthusiastic Thoroughbred leader we need to hear more from!

  • If the remainder of the T21 rollout and reduction program continues as the first month has, then Q2/19’s slight disappointment will be far away in the rearview mirror….

Now on to GWR (even they ignore us) and BNSF/Berkshire (ditto)….Word is that GWR has already, pre-deal, disposed of its 51% stake in GWA (Australia). After those “reports” will be the Q2/19 Review. Meanwhile, I am off to Big Sky country with a major rail car leasing company and plenty of rail shippers to discuss PSR with….and a write-up of the excellent American Association of Railway Association meeting last week….

 

Anthony B. Hatch
abh consulting
www.abhatchconsulting.com
abh18@mindspring.com

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