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Congestion hits NS profits
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October 27, 1999: 5:48 p.m. ET
Integration of Conrail leads to sharp increases in revenue, expenses
By Staff Writer Chris Isidore
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NEW YORK (CNNfn) - Norfolk Southern Corp. posted sharply reduced profits Wednesday, although company officials and some analysts believe the worst of the railroad's merger problems may be behind it.
Norfolk Southern and CSX Corp., which reports earnings Thursday, purchased Conrail together last year and split the Northeastern and Midwest railroad between them as of June 1. The operational problems that followed included congestion on tracks, trains delayed in terminals and loss of business to other modes of transportation.
While some analysts believe Norfolk Southern is close to back to normal, others believe it will be another six months before its customers and investors can relax. There wasn't even agreement Wednesday whether Norfolk Southern met analysts estimates, because of debate whether a $31 million after-tax non-cash charge the railroad took in the quarter should be considered a special charge.
Norfolk Southern (NSC) posted income of $19 million, or 5 cents a share, diluted, if the charge is included in results. The charge -- which covered payment with Norfolk Southern stock to unionized employees' retirement accounts in return for them deferring vacation during periods of the summer -- cost 8 cents a share, diluted, against income.
Most of the analysts surveyed by First Call believe the charge should be counted against the bottom line. And the consensus estimate had been 10 cents a share, meaning Norfolk missed the mark by 5 cents rather than exceeding it by 3 cents.
In the year ago period it made $151 million, or 42 cents a share diluted, from continuing operations.
"Our efforts to smooth operations and relieve congestion continue to weigh heavily on our operating expenses, but these expenses are investments that will benefit our customers and our shareholders in the long run," said David Goode, Norfolk Southern's chairman, president and chief executive.
Revenue gains brings congestion
Revenue soared 43 percent to $1.5 billion in the period from $1.05 billion a year ago, as a result of adding Conrail tracks and customers to the system. Until June 1, Conrail continued to operate as a separate railroad without any addition to the revenue number of either Norfolk Southern or CSX.
But while the new operation brought greater revenue, it also brought massive congestion problems and costs. The railroad said it spent an extra $116 million in the period dealing with that congestion, including the work incentive plan, which cost $49 million on a pre-tax basis.
The ratio of operating expenses to revenue, a key measure of a railroad's financial performance, worsened significantly to 90.3 percent from 84.4 percent a year ago. But the without the integration costs and problems, the ratio would have improved to 78.4 percent.
How close is improvement?
The consensus estimate for the Norfolk Southern in the fourth quarter is 25 cents a share, down from 42 cents a year ago. But even some of the analysts aren't comfortable in their estimates right now, and most analysts have a "hold" recommendation on both Norfolk Southern and CSX.
"The uncertainty here is how quickly these improvements flow through to earnings," said James Higgins of Donaldson, Lufkin & Jenrette Securities, who has a fourth quarter estimate of 20 cents a share, on the low end of the range. "Everyone's shooting in the dark, to be honest, including Norfolk."
But Michael Lloyd, analyst at Merrill Lynch, believes that recent operating numbers suggest that Norfolk Southern could be back to historically strong profit margins as early as this quarter.
"I was told by Steve Tobias, the chief operating officer, that one day recently they had no trains being held between Philadelphia and Chicago. That's the first time that's happened since June 1," Lloyd said. "The only thing we have to worry about right now is weather. If the snow doesn't come early, this thing could be humming in few weeks."
Problems, but not gridlock
After a year of assurances from CSX and Norfolk Southern that they were more prepared for the Conrail integration than Union Pacific Corp. (UNP) had been for its purchase of Southern Pacific in 1997, both railroads have been plagued by a unexpected problems. Lloyd gives Norfolk Southern a grade of "D" for the integration effort, but he and Higgins both agree it is far better than the UP-SP merger.
"It is not gridlock. We had gridlock on UP-SP," said Lloyd. "Do we have congestion? Yes. Have we had service problems? Yes. It's going to get a little worse over next couple of weeks while traffic peaks. But it's not nearly as bad as UP."
CSX helped by shipping gains
CSX is expected Thursday to post improved income of 44 cents a share, compared to 37 cents a year ago. The gain is due to improved rates in its Sea-Land Service ocean shipping subsidiary over year-ago results. Income from rail operations is expected to drop about 25 percent, according to Higgins. CSX has agreed to sell most of its maritime operations by the end the year.
Both Higgins and Lloyd think CSX has had more service problems recently than NS due to the merger. It also was more affected by Hurricane Floyd, which increased costs for both eastern railroads.
"I would say up until the recent few weeks, it looked like CSX might be doing a better job, now the shoe may be on the other foot," Lloyd said. "I'd be more worried about CSX going forward than Norfolk Southern."
For the year to date, Norfolk Southern made $208 million, or 55 cents a share diluted, from continuing operations, including the recent charge, compared to $470 million, or $1.23 a share on the same basis, a year ago. The year ago period also included a $104 million gain, worth 28 cents a share diluted, for the sale of North American Van Lines in the first quarter of 1998.
Revenue for the nine months rose 16.6 percent to $3.7 billion from $3.2 billion, with much of that gain again being due to the addition of Conrail business after June 1.
Norfolk Southern's stock closed Wednesday up 1, or 4.5 percent, to 23. CSX's stock closed up 1/2 at 37-3/16.
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