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Norfolk Southern (NSC) Strong on Dividends Despite Cost Woes

Norfolk Southern’s NSC efforts to reward its shareholders through dividends and buybacks are encouraging. However, high fuel costs are concerning as the same is limiting bottom-line growth.

Factors Favoring NSC

We are impressed with Norfolk Southern's efforts to reward its shareholders through dividends and buybacks. In January 2022, NSC’s board announced a 14% increase in its quarterly dividend payout, taking the total to $1.24 per share. This was the third dividend hike approval in a year’s time.

A strong free cash flow generating ability supports NSC's shareholder-friendly activities. In 2021, Norfolk Southern generated a free cash flow of $2,785 million, up 30% year over year. In first-half 2022, free cash flow was $1,174 million.

Driven by strong freight demand, revenues are likely to have been impressive in third-quarter 2022. Owing to upbeat revenues, operating ratio (operating expenses as a percentage of revenues) is likely to have improved year over year in the September quarter.

Key Risks

Fuel expenses represent a key input cost for any transportation player, and Norfolk Southern is no exception. The current scenario of increasing fuel costs does not bode well as far as bottom-line growth is concerned. At NSC, fuel costs surged 94% year over year in first-half 2022, inducing a 17% rise in operating costs.

Norfolk Southern is also being hurt by headwinds like supply-chain disruptions and slower network velocity. Due to these headwinds, overall volumes declined 3% year over year in the June quarter. Volumes contracted in first-quarter 2022 as well.

High Fuel Costs a Bane for Other Railroads Too

Thanks to the northward movement in oil price (up 48% in first-half 2022) induced by the Russia-Ukraine war, fuel expenses are on the rise, hurting bottom-line growth of not only Norfolk Southern but other railroads like Union Pacific Corporation UNP and CSX Corporation CSX as well.

At Union Pacific, fuel expenses escalated 82% in first-half 2022, causing a 20% jump in operating costs. The increase in operating costs affected the key efficiency metric of operating ratio (operating expenses as a % of revenues) to the tune of 130 basis points in the June quarter.

Fuel costs are likely to be high in the September quarter as well. Results will be out on Oct 20. High capital expenditures may also be a downside as far as Union Pacific’s bottom line is concerned in the third quarter.

At CSX, operating expenses increased 41% year over year in first-half 2022, mainly due to the 102% rise in fuel expenses. The increase in fuel costs was due to the steep rise in highway diesel fuel prices and the addition of non-locomotive fuel used for trucking. Costs are likely to be high in the September quarter too. Detailed results will be out on Oct 20.

Like UNP, capital expenditures are high at CSX. In 2021, CSX’s capital expenditures were $1.79 billion, higher than $1.63 billion in 2020.  For 2022, CSX expects capital expenditures to increase to approximately $2 billion. High capex may also hurt CSX’s free cash flow-generating ability.

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