October 13, 2012

Quarterly Stock Pick

NYSE: NSC

By: Justen Leicht

Business Overview

• Norfolk Southern Corporation is a leading North American transportation provider.

• Its Norfolk Southern Railway subsidiary operates approximately 21,000 route miles in 22 states and the District of Columbia, serves every major container port in the eastern U.S., and provides efficient connections to other rail carriers.

• The railroad is a major transporter of domestic and export coal in the eastern half of the country with its major sources of minerals located in Pennsylvania, Indiana, West Virginia, Virginia, Kentucky and Tennessee. The coal is delivered primarily to steel mills and power plants.

More Business Overview

• The company is also a major transporter of auto parts and completed vehicles.

• It operates intermodal container and TOFC (trailer on flat car) trains, some in conjunction with other railroads.

• In 2011, its principal operating revenue sources were:– Coal, coke and iron ore = 31%– Intermodal = 19%– Agriculture, fertilizer and consumer products = 13%– Chemicals 12%– Metals and construction = 11%– Automotive = 7%– Paper, clay and forest products = 7%

Railway System Map

History

• Norfolk Southern was created from predecessor railroads which date back to the early portion of the 19th century.

• The three main branches of the current corporate family tree were: Norfolk and Western (formed in 1881), Southern Railway Company (formed in 1894), and Conrail (formed in 1976).

• Norfolk southern was created in 1982 from the merger of the Norfolk and Western Railway and the Southern Railway Company.

• In 1997, Norfolk Southern acquired 58% of Conrail’s assests in a joint application with CSX (major competitor) for authority to purchase, divide and operate the assests of Conrail.

Main Railway Competitors

• CSX Corporation• Kansas City Southern• Union Pacific Corporation• Genesee & Wyoming• Canadian National Railway• Canadian Pacific• Burlington Northern• And others

The Numbers

• Current Price = $67.28– 52 Wk Range: $62.82 - $78.50

• P/E = 11.39 ( Industry P/E = 16.22, Sector P/E = 22.07)

• Forward P/E = 10.96• Mkt cap = 21.50B• Div/yield = 0.50/3.01• Shares outstanding = 319.52• Beta = 1.05• EPS = 5.83

Over the Past 5 Years

Mid-Year Financial Highlights

• Profit margin = 17.34%• Operating margin = 30.03%• Revenue = 11.35B• Revenue per share = 34.22• Operating cash flow = 3.19B• Total Debt = 8.13B

2011 Financial Highlights

• Operating revenue = $11,172M• Net income = $1.916M• Total assets = $28.538M• Total debt = $7.540M• Debt to capitalization ratio = 43.2%• Year-end stock price = $72.86• Dividends per share = $1.66• Price/earnings ratio = 13.4

Concerns About Coal

• Coal freight is currently one of NSC’s biggest businesses.

• Unfortunately, coal export volume was down from last quarter and year over year as lower Chinese demand has played a huge factor in denting worldwide coal demand.

• This is especially important since lower coal demand has caused a decrease in coal prices.

• As prices decrease, NSC will likely make price concessions for its coal freight business, or risk losing these ventures all together.

On the Bright Side of Coal

• The stimulus packages announced by the Chinese government, the European Central Bank and the Federal Reserve are likely to increase the economic activity around the world.

• As a result, it can be reasonably expected that these actions will buoy the coal markets over the long term, keeping NSC’s coal freight revenues in line with estimates.

So Why Norfolk Southern

• Earnings per share will be roughly $1.20 this quarter. Way below analyst estimates. As a result, the stock has decreased significantly. But...

• The stock has a one year target price of $81 with the stock currently trading close to its 52-week low.

• NSC has a beta of 1.05 and a market cap of more than $20B.

• NSC has an attractive P/E of 11 as compared to the industry average of 16 and an EPS of $5.83.

• In addition, the stock offers a healthy dividend yield of 3% and annual dividends of $2/share.

My Recommendation

• I believe the long term business prospects of NSC are strong and the current drop in price to be temporary.

• In fact, I believe the current dip in price gives us an opportunity to take a position in NSC at discounted price.

• With that said, I suggest NSC as a long term investment with potential to generate steady returns.