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Norfolk Southern Corporation (NSC - Analyst Report) recently provided its third quarter 2012 outlook, with earnings per share projected in the range $1.18 to $1.25. The company expects poor coal shipments and lower fuel surcharge to have an adverse impact on the company’s growth. The projections remain significantly below $1.59 per share earned in the third quarter of 2011.

The company expects poor shipments of coal and merchandise products to offset higher revenue performance of Intermodal segment. Consequently, they expect this impact to lower revenues by approximately $120 million from the third quarter 2011 level. Last year, the company registered an 18% revenue growth to $2.9 billion in the third quarter.

Further, fuel surcharge revenues would also remain a drag on revenues resulting in a reduction of $80 million. In the third quarter 2011, fuel surcharge revenues included a favorable lag impact of $52 while in the third quarter of this year, it is anticipated to have an unfavorable lag impact ranging within $25 and $30 million.

Over the past years, railroads have significantly benefited from the demand for U.S coal in the emerging market. However, coal volumes registered a setback compared to the second half of 2011 due to lower coal production in the U.S. Consequently, the U.S. Energy Information Administration (EIA) released a lower coal production outlook for 2012. EIA projects coal production to decline 6.1% in 2012 on lower domestic consumption. Domestic coal demand, of which utility coal accounts for approximately 93%, is witnessing persistent declines. Lower natural gas prices implied that gas is largely substituting the demand for utility coal. Additionally, higher stockpile levels have resulted in lower utility coal demand.

According to the latest report from EIA, coal consumption by coal fired power plants is expected to total 829 million short tons (MMst) in 2012, representing the lowest amount in 20 years. In terms of export coal, the outlook is not encouraging given the economic concerns in China and higher stockpile levels and increased exports from Indonesia and a recovery in the Australian mines. EIA expects coal exports to decline approximately 16% by 2013. 

Further, in the Merchandize segment, grain shipments are also expected to be affected in the near term. Global food grain production remains impacted by dry weather in Eastern Europe, lower grain production from major grain exporting countries such as Russia and Kazakhstan, and a poor monsoon in India. According to data from the U.S. Department of Agriculture (USDA), grain shipments through rail until June 2012 were down approximately 43,000 carloads year over year.

Additionally, higher prices of U.S. grain also limited exports to the global market. The strength in the U.S. dollar and the economic slowdown due to the European debt crisis are also adversely affecting the U.S. agriculture and commodities markets.

However, we believe Norfolk Southern is poised to benefit from strong pricing momentum on the back of growing market demand and shortage in truckload transportation. We expect the company’s pricing improvements together with productivity gains to offset the current rail inflation.

Further, we remain encouraged about the company’s cost-control measures. Norfolk Southern is replacing its older and less fuel-efficient locomotives with new machinery. We expect the new fuel-efficient locomotives to reduce average fleet age and result in lower maintenance expenses, driving further cost improvement and providing competitive edge over peers like CSX Corp. (CSX - Analyst Report). Further, lower fuel prices are also expected to enhance margins. Norfolk Southern remains keen on its hiring strategy and expect to recruit 500 employees this year in approximately eight states to improve service capabilities throughout its network and support demand growth.

We are currently maintaining our long-term Neutral recommendation on the stock. For the short term (1–3 months), the stock retains a Zacks # 3 Rank (Hold rating)

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