Norfolk Southern (NYSE: NSC) expects some of the cost cuts it made in response to the pandemic-induced rail volume decline to be permanent, its executives said during the eastern U.S. railroad’s first-quarter 2020 earnings call today.
The railroad has removed excess locomotives and reduced crew starts, with expectations to cut crew starts even further, executives said. Norfolk Southern (NS) is also examining which terminals and rail yards to close, including outlying smaller yards that “we can continue to live without,” according to NS Chief Operating Officer Mike Wheeler.
These operational changes, while hastened by the COVID-19 pandemic, are also part of NS’ broader efforts to implement TOP21, NS’ version of precision scheduled railroading (PSR), an operating model that seeks to streamline operations and cut costs.
“We’re pressing the TOP21 accelerator right now,” the railroad’s CEO Jim Squires said.
Another operational change has been to “blend” trains so that a train carries various commodities instead of a single commodity. NS has “blended” its general merchandise and bulk trains into its intermodal trains, and it is starting to blend its premium trains.
“We’re to the point now where a train is a train…and a [commodity] can ride on the train that gives it the right service requirements it needs,” Wheeler said. NS Chief Marketing Officer Alan Shaw added that the blended trains give NS “a broader product offering” by enabling shippers new access to existing lanes.
To accommodate anticipated future demand once rail volumes rebound, NS executives said the railroad will have capacity through its longer trains and at its terminals. NS would deploy these measures first before it would start considering increasing train starts again. During phase 3 of its plan to implement TOP21, NS’ rail volumes have fallen 11% while train crew starts declined by 19% in the first quarter compared with the same period in 2019.
An increase in train starts would “depend on how traffic comes back,” but “we’ve got awhile” before NS will consider increasing train starts, Wheeler said.
The decision to divest of around 700 locomotives was also part of NS’ plan to deploy PSR, since keeping the locomotives only adds to maintenance and storage costs. NS is seeking a target fleet size of around 3,200 locomotives, of which 420 locomotives would be inactive or for use in conditions where capacity needs surge. This is in contrast to over 3,900 active and inactive locomotives at the end of December 2019.
“It’s healthier to get the surplus [through] upfront and move them out as quickly as possible,” than to parse out the divestment over time, according to NS Chief Financial Officer Mark George.
NS also decided to trim its capital expenditures (capex) budget for 2020 by about 25% to $1.5 billion, compared with $2 billion for 2019, as part of wider company efforts to run a leaner operation. The capex budget reduction occurred “across the board,” with cuts in budgets for maintenance, information technology and terminals, among other avenues.
“We really got together as a team and reiterated what we could do to reduce capital spend and get to a low level,” George said, adding that NS sensed that there would “be volume pressure” in 2020. “From here, I would hope we would be able to maintain capex at a moderate pace.”
Despite taking back its financial guidance for the year, including expectations for its annual operating ratio (OR), NS is still maintaining its OR guidance of 60% for 2021. OR, which is a company’s operating expenses as a percentage of its revenue, has been used as an indicator to gauge the financial health of a company. A lower OR percentage can imply improved financial health. NS’ OR for 2019 was 64.7%
NS acknowledged that one of its biggest competitors right now is the spot trucking market, but the railroad said that it is “maintaining a long-term view” and pricing to the value of the product and the franchise. Market conditions are similar to what NS experienced in 2009 and 2010 during the Great Recession, according to Alan Shaw, NS chief marketing officer.
NS will continue to collaborate with supply chain and channel partners and look for new lanes to sell capacity, all while doing so at a lower cost structure, Shaw said.
First-quarter financial results
The costs associated with NS’ actions to divest a portion of its locomotive fleet resulted in lower net profits for the company in the first quarter.
First-quarter net income was $381 million, or $1.47/diluted share, compared with $677 million, or $2.51/diluted share, in the first quarter of 2019. The 2020 first-quarter results take into account a $385 million non-cash locomotive rationalization charge related to the ongoing disposition and marketing of excess locomotives, NS said. NS attributed its decision to divest a portion of its locomotive fleet to its deployment of PSR.
Without the $385 million charge, NS’ first-quarter net income on a non-GAAP (generally accepted accounting principles) basis was $669 million, or $2.58/diluted share.
| Norfolk Southern | 2020 Value | 2019 Value | Y/Y Gross Change | Y/Y % Change |
| Freight revenue (in millions) | $2,625.0 | $2,840.0 | ($215.0) | -7.6% |
| Carloads incl intermodal (000s) | 1,688 | 1,906 | -217.80 | -11.4% |
| Revenue per carload | $1,556 | $1,490 | $66.0 | 4.4% |
| Intermodal shipments | 955 | 1,071 | -115.90 | -10.8% |
| Intermodal revenue per carload | $685 | $671 | $14.0 | 2.1% |
| Gross ton miles (in billions) | 84.9 | 94.5 | -9.60 | -10.2% |
| Revenue tonmile (in billions) | $44 | $49 | ($5.5) | -11.2% |
| Employee counts (average) | 21232 | 26,257 | -5,025.00 | -19.1% |
| Train velocity (mph) | 23.8 | 21.7 | 2.10 | 9.7% |
| Dwell time (hours) | 18.6 | 22.2 | -3.60 | -16.2% |
| OR% | 78.4% | 66.0% | 12.40% | 18.8% |
| EPS | $1.47 | $2.51 | ($1.0) | -41.4% |
For more first-quarter financial results, go here.
