Norfolk Southern (NSC) is a railway company operating about 21,000 miles of track in 22 eastern and southern states. The company hauls freight including coal, agriculture products, consumer products, metals and intermodal freight. NSC has shown their commitment to paying yearly increasing dividends to their shareholders as they have increased their dividend for 11 years in a row.
Dividend Growth and Current Yield
Norfolk Southern currently pays a dividend of $0.50 per quarter for a $2.00 annual dividend. At the close of market on Monday December 10, 2012 NSC’s price per share was $62.08. This gives the stock a current dividend yield of 3.23% (2/62.08). Typically I look for a dividend yield of at least 2.5% so I would be satisfied with this dividend yield from NSC.
In 2002 Norfolk Southern’s annual dividend amount was $0.26 per share. The dividend trend has been up each year as it now pays $2.00 annually per share. This gives NSC a 10 year annual compound dividend growth rate of 22.63% which is a pretty good growth rate. More recently the annual dividend growth rate was 18.58% for 2010 to 2011 and 20.49% from 2011 to 2012. This is a good rate of dividend growth for shareholders to enjoy. Norfolk Southern has shown a commitment to it’s shareholders with their long history of increasing dividends. As long as they continue to increase their dividend at a faster rate than inflation, shareholders should be happy.
Earnings Per Share Growth
NSC had a 2001 earnings per share (EPS) of $0.94 and a 2011 EPS of $5.27. Over the 10 years their earnings per share have been consistently climbing upward at a strong rate. NSC has had a 10 year EPS growth rate of 18.81% which is a great growth rate. More recently NSC’s annual EPS growth rate was 44.93% from 2009 to 2010 and 31.75% from 2010 to 2011. NSC has had such high growth rates recently because of their strong recovery from the 2008 recession when their earnings took a big hit. Over the past 10 years, the 2008 recession was the only down year for EPS. NSC has done a very good job of growing their EPS over the years. For 2012, Norfolk Southern has an estimated EPS from Value Line of $5.30. This is about even with 2011 earnings. The reason for lack of growth this past year is a decline in the coal market which is a large part of NSC’s freight. NSC stock price is down about 15.5% this year due to the coal market decline. The big question to answer is what will happen to revenues from coal freight going forward.
Net Income Growth
Net income has shown the same pattern as EPS from 2002 through 2011. Net Income was 460,000,000 in 2002 and grew to 1,853,000,000 in 2011. This gives NSC a compound annual net income growth rate of 16.74%. More recently NSC had a net income growth rate of 23.87% from 2010 to 2011 and decline expected for 2012. While net income has grown well over the past 9 years, analysts are expecting a decline in the near term due to the decrease in coal freight.
Sales have been growing for Norfolk Southern over the past 9 years in a consistent uptrend as well. The compound annual growth rate of sales revenues was 6.63%. Sales growth is considerably lower than net profits and EPS growth. This shows me that NSC has done a good job lowering expenses to increase profits but in the future growth will most likely slow down. With a share repurchase program they can continue to grow EPS even with little growth in revenues or net income.
Generally I like to see a decreasing trend or at least a consistent balance in the number of outstanding shares of the company. Since 2005, NSC’s outstanding share count has been decreasing every single year. With less shares outstanding, the value of each share still available increases. When a company decreases the number of shares available it means the shares I own will have rights to a greater portion of the companies profits.
Return on Equity Trend
When evaluating a company I look for return on equity to be consistently above 12%. Norfolk Southern has had a fluctuating return on equity percentage but it has been consistently above 10% since 2003. Maintaining a consistent return on equity shows me that management is doing a good job with shareholders investment.
Current ratio measures a companies ability to meet short term obligations. Norfolk Southern has a 2011 FYE current ratio of 1.03. This means that current assets will be able to cover 103% of current liability obligations. I generally want to see this number be above 1, therefore NSC passes this test.
Net Profit to Long Term Debt
This number tells me how many years worth of profits it will take to pay off the current long term debt of the company. I like looking at this metric because it gives me an idea of whether the company has taken on too much debt or not. Generally I look for this number to be less then 5 meaning if the company used all their earnings over the next 5 years they could wipe out all debt. For NSC this net profit to long term debt ratio stands at about 4.55 for 2012. This means Norfolk Southern would be able to pay off all long term debt with about 4 and half years worth of profits.
Dividend Payout Ratio
The dividend payout ratio measures the dividend per share compared to the earnings per share. How much of a companies earnings per share are they paying out to shareholders in the form of a dividend. The past few years NSC has maintained a dividend payout ratio around 30%. This tells me that NSC is paying out around 30% of profits to shareholders and keeping 70% of profits to grow the company and increase shareholder value through share repurchases. I like this payout ratio because it is fairly low and I don’t believe NSC should have any trouble maintaining dividend growth in the future even with the near term headwinds due to coal market decline.
The P/E ratio is a metric I look at to determine if a companies current stock price is too high or within reason. With the most recent closing market price of $62.08 and most recent EPS of $5.27, NSC has a current P/E right around 8.5. Typically the market P/E average is right around 14 so compared to the market in whole I might determine NSC to be slightly under valued. However, since NSC is facing declining profits due to lack of coal freight demand I believe the market is valuing them lower. Depending on how I believe the coal market will affect NSC over the long term, this could be considered a good entry point for a long term investment.
Looking at WMT’s past P/E ratios of the last few years it looks like they have ranged from a high of 20 to a low of 10. The current P/E of 8.5 is under this range. This could be a chance to get in at a great valuation. Based on the companies performance, I believe the current valuation to be fair depending on your opinion of how coal will do going forward.
NSC had EPS of $5.27 in 2011. The past earnings per share growth rate has been roughly around 19% but we calculated a slower growth rate in sales. Therefore I am going to use a more conservative EPS growth rate of 8% over the next 10 years to figure out what 2021 EPS might look like. This gives me an estimated EPS of $11.38 for NSC in 2021.
If NSC is trading at reasonable P/E ratio of 14 in 2021 then it will have a market price of $159.32/share (11.38*14). This will give me an estimated annual growth rate for Norfolk Southern of 9.88% over the next 10 years. If you would be happy with an 9.88% return over the next 10 years as well as collecting increasing dividends along the way then NSC may be a good investment for you. This is a very rough exercise based on growth estimates that may not come to reality. Actual returns in NSC will vary depending on how well the company increases their earnings and how the market values NSC in the future.
Based on the above analysis I believe Norfolk Southern to be a good buy at current levels. The future performance of Norfolk Southern really depends on what will happen with the coal market in the long term. Currently there is less demand for coal because many electric companies are switching to the use of natural gas to produce electricity due to its lower cost compared to coal. The future of coal demand is the big question mark for an investment in NSC in my opinion. Rail transport still has many benefits over trucking transport because of the lower costs. Therefore, demand for transport of other freight besides coal should remain to be strong in the future. I think the market has priced in the decline of coal freight and currently you would be getting a good by at current price levels for NSC. While I believe the road may be rocky for NSC in the short term, long term prospects still seem high.
I wanted to do this analysis because I am considering initiating a position in NSC. The only worry I have with this company is the decline in coal demand and freight. Do you have any thoughts on NSC or the long term demand for coal? Feel free to share your advice in the comments below.
Disclosure: I do not currently own NSC but will possibly make a purchase in the next couple
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