Norfolk Southern Grapples With East Palestine Derailment; No Change to Fair Value Estimate

In early February, one of Norfolk Southern’s NSC trains carrying hazardous chemicals derailed and spilled some of its contents in the town of East Palestine, Ohio, causing an evacuation of the area. The National Transportation Safety Board suspects the incident was caused by an overheated wheel bearing. The situation is still developing, but based on comments from the Environmental Protection Agency, we suspect Norfolk will be liable for the cost of cleanup, which is already well underway, though its severity remains uncertain. It also sounds like lawsuits will be a factor.

The good news is that there were no reported fatalities or injuries, and as of Feb. 16, Norfolk noted that testing by it and government agencies suggests the town’s outdoor and indoor air quality and drinking water are safe.

Visibility is quite limited, but we speculate that Norfolk will incur charges in the first quarter (we wouldn’t be surprised to see $50 million-$100 million). That said, at first glance (from the 10-K), it looks like Norfolk is self-insured for up to $75 million, with coverage above that up to roughly $800 million, which should mitigate a meaningful amount of financial risk. Generally speaking, the present value of liability-related outflows would need to approach $1 billion to materially move our discounted cash flow-derived fair value estimate, ignoring future costly regulatory changes that affect the business model. Regulatory changes aren’t a foregone conclusion but certainly a risk—consider positive train control.

We maintain our $246 DCF-derived fair value estimate, though we suspect the market price will see variability in the weeks ahead depending on headline news. The shares are trading in fairly valued territory relative to our longer-term revenue, margin, and free cash flow growth forecasts.