Norfolk Southern Corp (NSC)

13 Aug 2013 22:47

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No matter how old we get there is always a kid in all of us and I am no exception. As a kid I was fascinated with model trains and when a childhood fascination collides with another favorite hobby (investing) I just cannot help myself.

Norfolk Southern (symbol NSC) is a railroad company operating on the East Coast. For the last 12 years they have been increasing their dividend payout at a significant pace and with a current yield of 2.84% one cannot help but take notice.

Dividend Growth Rates
1-Yr 3-Yr 5-Yr 10-Yr
16.9% 12.6% 15.1% 22.3%

The kid in me cannot stop being giddy as what is better than big trains and rising dividends. But the adult in me has to step in and ruin the fun. Looking at some basic numbers NSC meets most of my screening criteria for a DG stock:

Dividend Growth Rate Debt/Equity Ratio
Criteria NSC Criteria NSC
>= 7.2% 16.9% < 1 .83
Dividend Yield Payout Ratio
Criteria NSC Criteria NSC
> 3% 2.84% < 70% 38%

Though dividend was slightly lower than my criteria the growth rate was more than enough to compensate. The big question left was if the dividend growth rate was sustainable and for how long which required a deeper dive.

Earnings from 2011 to 2012 actually decreased by 1% sending the first warning signal something might be amiss. After further research the decline was attributable to a decrease in demand for coal which makes up 26% of NSC revenue which was -16.7%. NSC revenue is classified into three main revenue streams:
2012 Revenue M$ 2011 Revenue M$
Coal 2879 3458
General Merchandise 5920 5584
Intermodal 2241 2130

Luckily increased revenue from General Merchandise & Intermodal helped offset some of the loss for 2012. Looking at the first six months of 2013 NSC saw another 17% decline in coal revenue and is on pace to see annual revenues decrease by an additional 2% (pushing the payout ratio up from 38 to 39%).

During 2012 & 2013 NSC has been investing in intermodal deliveries as an alternative and have yielded a 6% increase in 2012 and is on pace for a 7% increase for 2013.

Unfortunately, competitor CSX, which operates in the same area, also has revenue based on a similar structure and allocation as NSC so CSX has also seen steady declines in coal revenue. Like NSC they are also pursuing growth in intermodal business.

Assuming coal demand levels off by the end of 2013 and natural gas remains affordable then revenue growth will primarily come from general merchandise and intermodal shipping. Add to the issue that NSC and CSX are pursuing growth in the same intermodal business that minimizes overall future growth to approximately to 4-5% annually.

With a payout ratio of only 38% and combining it with a 4-5% EPS growth rate, dividend growth could continue at a 10% pace annually for the next 9 years before it hits my limit of a 70% payout. Considering how well NSC manages its financials it does question if they would increase dividends at that rate or hold at a certain payout ratio. Last month NSC announced a 4% dividend increase (well below its average) so my inclination is that they will hold at a payout ratio of 50% or lower.

As much as I would love to buy into a railroad for diversification, and to satisfy the kid in me, I believe now is the wrong time to buy NSC. For now keep watching and see how management reacts to revenue and dividend growth.

Note: I do not own this stock at time of this writing.

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