Stock Watch
Norfolk Southern: Building Steam
Railroads such as this Virginia-based operator have the potential for both volume growth and price increases.
November 18, 2005
With all the business they can handle plus the ability to raise their rates, railroads are on track for higher earnings. Their stocks have been building steam, too. But it may not be too late for investors to get on board.
Norfolk Southern (NSC), which operates in the East and Midwest, is one way to participate in the rebirth of railroads as a growth industry (so is Burlington Northern Santa Fe.) Morgan Stanley analyst James Valentine considers the Virginia-based Norfolk to be one of the highest-quality U.S. operators, looking at its strong cash flows and margins.
Coal has been a boon for the railroad industry as environmental regulations have forced many East Coast power plants to rely on cleaner-burning coal shipped from Wyoming. Norfolk counts on coal for a higher percentage of its revenues than do any of its U.S. counterparts. Together with its intermodal transport business, coal has been driving Norfolk's growth over the past couple of years, Valentine says in an October research note.
On Thursday, Credit Suisse First Boston analyst Jason Seidl outlined results from a survey the firm recently conducted among railroad customers. He says that, according to survey responses, railroads' potential pricing power looks better than he anticipated, and coal and intermodal volumes appear "poised for a strong 2006." Although many customers are considering switching to cheaper modes of transport, Seidl doesn't consider that to be a significant threat because "neither truck nor barge capacity is sufficient enough to make a considerable impact."
He rates the railroad sector "overweight."
Valentine also notes that Norfolk in particular has been investing in improving its service, which should "lead to a higher sustainable growth rate and operating margins" over the long term.
There are risks to Norfolk's stock, however. For example, Valentine says that any slowing in the industrial economy is likely to hurt Norfolk's volume growth.
Norfolk shares have gained some 90% since January 2004, including a nearly 3% jump on Friday. But the stock still sells for about 14 times the consensus 2006 estimate of $3.09 per share.
--Lisa Dixon and David Landis
