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Why Norfolk Southern’s 3Q17 Operating Margins Took the High Track

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Dec. 4 2020, Updated 3:52 p.m. ET

NSC’s operating margin in 3Q17

In 3Q17, Norfolk Southern’s (NSC) operating margin expanded 160 basis points to 34.1%, up from 32.5% in 3Q16. NSC’s revenues rose 5.8%, while its operating expenses grew 3.2% YoY (year-over-year) to nearly $1.8 billion.

Notably, Norfolk Southern has been able to improve its operating margins on a YoY basis for the past seven quarters.

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3Q17 operating expenses—breakup

In 3Q17, Norfolk Southern’s employee compensation expenses were $755.0 million, up 9.3%, from $691.0 million in the same quarter last year. Higher incentive compensation and a rise in premiums on union medical plans drove the growth in compensation expenses, but these were offset by $26.0 million in savings due to a low comparable employee base.

Purchased services and rent expenses fell 2.3% to $377.0 million, down from $386.0 million in 3Q16. Lower equipment rent of $6.0 million due to reduced automotive traffic as well as better equipment utilization led the fall in purchased services expenses.

Fuel expenses totaled $198.0 million, up 9.4% from $181.0 million in 3Q16. Higher fuel prices led the rise in fuel expenses in 3Q17. Norfolk Southern noted that the average price per gallon for locomotive fuel was $1.70 in 3Q17, compared with $1.51 in 3Q16.

Most notable was the $9.0 million gain on the sale of land, which also acted in favor of reducing NSC’s overall operating expenses in 3Q17.

Management insights

Norfolk Southern expects a flat or slightly higher employment level in 2018 compared with 2017. With the reduction in its locomotive fleet and services, the company anticipates lower locomotive repair costs in 2017.

Cost reduction actions should mean $150.0 million in productivity gains for NSC for fiscal 2017. In the long term, NSC aims to achieve an operating margin of more than 35%, as outlined in its strategic plan for 2020.

Peer 3Q17 operating margins

The focus on cost-cutting has shifted to better pricing for the US Class I railroads. In 2016, railroads were concentrating on cost related actions. In 2018, they’ll likely focus on actions associated with top-line growth. Below are the 3Q17 operating margins of peers compared with their operating margins in 3Q16:

  • CSX (CSX): 32%, up from 31% in 3Q16
  • Canadian National Railway (CNI): 45.3%, down from 46.7% in 3Q16
  • Canadian Pacific Railway (CP): 43.3%, up from 42.3% in 3Q16
  • Kansas City Southern (UNP): 35.6%, up from 33.1% in 3Q16

Notably, the First Trust Industrials/Producer Durables AlphaDEX Fund ETF (FXR) holds ~21% in major US airlines and trucking companies.

In the next part, we’ll discuss Norfolk Southern’s quarterly dividend.

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