Norfolk Southern Earnings Call Insights: Yield Deterioration and Liquidated Damages

Norfolk Southern Corporation (NYSE:NSC) recently reported its third quarter earnings and discussed the following topics in its earnings conference call.

Yield Deterioration

Justin Yagerman – Deutsche Bank: Wanted to dig in a bit on this coal pricing, obviously down 11% you said that it was materially weighted towards the export side. So, curious how export broke down from a volume standpoint thermal versus med and then if you could talk a little bit mix and how length of haul may have influenced some of the yield deterioration in the quarter that will be helpful?

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Donald W. Seale – EVP and Chief Marketing Officer: Justin, this is Don. Good afternoon. With respect to export first 75% of our export tons in the quarter were metallurgical coal, 25% steam and I would add for the year (detailing) was 79% net and 21% steam. That market as we indicated in the remarks continues to be challenged with respect to world pricing. We have seen Australian coal to Asia recently tick up a little bit from 160 to 170 per ton. So, little bit of encouragement there with the world market improving with respect to settlement in China. On the mix and length of haul we did have an increase in the quarter of Illinois basin coal going to the river for content Louisiana for export over the port of New Orleans that is shorter haul business. It’s good business for us but it does generate a lower RPU. Also as I’ve pointed out our Lamberts Point tonnage was up 10% – carloads were up 10% and our Baltimore traffic was up 8% and our Baltimore exports carry a lower revenue per unit than our longer haul Lamberts Point export. I hope that covers the question.

Justin Yagerman – Deutsche Bank: Switching to OpEx a little bit. I wanted to dig in – you called out crude by rail has one of the opportunities as you’re looking this year. It looks like PBF has a contract with you guys that should be increasing this year and wanted to also get a sense, how that pipeline looks as you look out at 2013, by our calculations, it looked like just that ramp alone, is like a 30% bump to your current run rate, so curious as you pick up these different contracts, how exacted you are about this opportunity as we look out over the next several months.

Charles W. Moorman – Chairman, President and CEO: We see a material opportunity in crude oil and I will confirm that we have executed a contract with PBF for its Delaware City, Delaware Refinery, we’re very pleased to have that and we see some significant opportunities for growth in 2013, on top of the base that we built in 2012.

Justin Yagerman – Deutsche Bank: Any color on those crude by rail carloads from a yield standpoint compared to the rest of your chemical line?

Charles W. Moorman – Chairman, President and CEO: I can’t get into the particulars because these are contract based rates, but I will tell you that those are revenue per unit train moves that are appealing to us.

Liquidated Damages

William Greene – Morgan Stanley: Don, in the quarter did you have any revenue from take-or-pays or liquidated damages in the coal contracts and if so, how much was that?

Donald W. Seale – EVP and Chief Marketing Officer: We had one entry on an ongoing contract shortfall in volume and, Jake, I think it was in the range of $9 million.

William Greene – Morgan Stanley: That would be in the coal revenue line or is it in another…?

Donald W. Seale – EVP and Chief Marketing Officer: In the coal.

William Greene – Morgan Stanley: So, not too big at this point…

Charles W. Moorman – Chairman, President and CEO: It’s a long-term ongoing accrual on that build, not just quarterly accrual.

William Greene – Morgan Stanley: Then, as you think about what occurred here in 2012, should we expect that, that will be a driver to sort of coal yields in 2013?

Charles W. Moorman – Chairman, President and CEO: Not a driver, no.

William Greene – Morgan Stanley: Then, when you look at sort of the long-term here and we look at kind of what happens with the coal and I realize Norfolk Southern has a large and very profitable coal franchise. So if coal levels today are kind of steady from here, is it the sort of thing where you can get back to industry leading margins like you had at one point or do we need coal to come back in a much bigger way given the mix effect it has on the overall business?

Donald W. Seale – EVP and Chief Marketing Officer: I’ll segment that question into two parts. As you know, our utility franchise is about 70% of our coal volume and utility business, we were off about 20 million tons of coal for the full year, about 5 million tons in the quarter. We estimate that gas competition for the year was about 50% of that shortfall, and then it cascades down into demand that was weaker due to weather, plant maintenance, a couple of small plant closures. So, for utility business to rebound in terms of its volume and to help us grow that business back, we need electricity demand to pick back up, we need industrial load demand for electricity to improve and we need gas prices to move up into the – above the $3.50 to $4 range. PRB coal dispatches at $3, but Central App does not even Northern App coal is pressed. So we need to see natural gas prices move up above $3.50 to $4. So, that addresses utility and it’s all about demand and it’s about gas competition. On the export side of our business, we need a couple of things to happen; one, the world economy needs to improve. In China you probably saw a record December which helped us in our December as far as export metallurgical and some steam coal, but Western Europe were 50% of our export coal is destined, continues to be very anemic with respect to its economic recovery. So, those are the kind of things we need to see before we will see export coal pricing. And see the delivered price of coal improve in the world where U.S. coals are more competitive. As you know year before last metallurgical coal prices hit $330 per metric ton in the world market that gave plenty of room for U.S. coals to compete, with it dropping to $160 now at $170 on the latest settlement. There’s a lot less room for supply chain pricing and the coal price and still be competitive in the market.

William Greene – Morgan Stanley: Sorry Don, I don’t want to put words in your mouth, but just for clarification. So, in terms of the ability to kind of get back to industry-leading margins, I suppose all of this we started to say, what we got underway here can help get us there but it doesn’t get all the way what we really need or some of the things that you listed here to push us back?

Donald W. Seale – EVP and Chief Marketing Officer: We certainly need those in addition to the things we are doing from an operational efficiency perspective. For coal, we need the pricing to improve and the market to improve to allow for that.

A Closer Look: Norfolk Southern Earnings Cheat Sheet>>