Norfolk Southern Earnings: Intermodal Under Pressure, but East Palestine Derailment Charges in Line

Eastern Class I railroad Norfolk Southern’s NSC first-quarter top line grew 7% year over year—not far off our expectations. While slowing, growth came from core pricing gains and higher fuel surcharges, and total yield expanded 7.5% (yield rose 15% last quarter). Total volume, which was roughly flat, was mostly in line with our forecast as merchandise activity came in ahead but intermodal underperformed.

In terms of the volume trends, intermodal is facing retail-sector inventory destocking and loose capacity in the competing truckload sector. This largely offset surprisingly strong merchandise volume gains of 5%, including growth in autos (recovering vehicle production), grain, aggregates, and metals and minerals (infrastructure strength). We expected a weaker merchandise showing given otherwise sluggish U.S. industrial production. Coal volumes also expanded nicely on strong export activity. The East Palestine derailment disruption (single track, reduced speeds) tempered carloadings in the quarter, but it had more of an impact later in the quarter and thus far into the second quarter.

Excluding East Palestine incident/response costs and accruals, Norfolk’s adjusted operating ratio (expenses/revenue), or OR, deteriorated 220 basis points year over year to 64.9%—worse than our forecast. Relative to first-quarter 2022, lower profitability primarily stems from significant wage inflation from the new union agreement (secured in December) and derailment-related inefficiencies such as recrew costs. Management did not provide OR guidance but noted that network headwinds should diminish by June as East Palestine track replacement efforts wrap up.

Overall, our DCF-derived $240 per share fair value estimate may come down slightly (less than 3%) due to reducing our near-term OR forecasts. That said, thus far, estimated derailment outflows/liabilities aren’t deviating materially from what we’ve already baked into our model. The shares are modestly undervalued.