Analysts press Norfolk Southern about keeping pace with CSX

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Norfolk Southern CEO James Squires
Norfolk Southern
NORFOLK, Va. — There’s more than one way to run a railroad.

That sums up Norfolk Southern’s response to Wall Street analysts’ questions on why it has not closed a widening operating ratio gap with its Eastern rival, CSX Transportation.

NS CEO Jim Squires on Wednesday took his turn in the same hot seat that Union Pacific CEO Lance Fritz found himself in last week, with both chief executives facing questions about why their railroads couldn’t move as fast as CSX to cut costs and boost profitability.

Like UP, NS reported record quarterly financial results. But its operating ratio did not keep pace with the progress at CSX under its shift to Precision Scheduled Railroading, the operating model of the late CEO E. Hunter Harrison.

CSX posted a record 58.6-percent operating ratio for the second quarter. NS’s operating ratio was a record, too, but at 64.6 percent it was 6 points higher than CSX’s and ranked last among the publicly traded Class I railroads.

Squires said he was confident that NS would meet its 2020 sub-65 operating ratio goal ahead of schedule, although he declined to provide a date.

Some Wall Street analysts were unimpressed.

Deutsche Bank analyst Amit Mehrotra asked whether there was any reason NS should have a different return profile than CSX.

Squires said NS recognizes boosting profitability is important, and consistent improvement in the operating ratio is part of its plan that balances growth and productivity gains.

“We’re going to continue to push on operating ratio,” Squires says. “When we get to the current goal of sub-65 we certainly won’t stop there.”

But is it fair to say that NS has more of a growth focus than CSX?

“I will say this. This is a terrific environment in which to grow. And we have been executing on growth by sending that growth to the bottom line,” Squires said, pointing to the railroad’s improvements in operating income.

The railroad business is cyclical, Squires adds.

“You better jump on that growth opportunity when you have it,” Squires says.

Norfolk Southern’s traffic was up 6 percent for the quarter, compared to CSX’s gain of 2 percent — which ranked the lowest among the big six systems.

RBC Capital Markets analyst Walter Spracklin asked if NS saw the need to make disruptive operational changes like CSX did last year in order to quickly reduce structural costs and then pursue more profitable growth.

Squires said NS closely watches industry developments and will adopt best practices. It’s about to restructure its operating regions and divisions, will consolidate dispatching in Atlanta by the end of the year, and is simplifying its local operating plan by collaborating with customers, Squires notes.

But is anything more dramatic than that, such as significantly reducing the number of hump yards as CSX did last year, seen as too risky?

“A classification network that can provide good local service is one of the keys to growth in the merchandise network,” Squires says. “We have rationalized our yard network and will continue to look at that. But it is important to maintain adequate classification capacity. We closed a couple of hump yards, and we brought one back recently.”

Wolfe Research analyst Scott Group noted that historically NS has been more profitable than CSX. Does that mean NS has a better network than CSX?

“I like our network a lot, Scott,” Squires says. “I think we have an outstanding network with a lot of potential for both efficiency and growth. … I’ll take our network any day.”

Bank of America Merrill Lynch analyst Ken Hoexter asked where NS saw opportunities to improve — and whether it needed to hire operations people with Precision Scheduled Railroading experience in order to reduce the number of employees the way CSX has.

CSX had 22,942 employees at the end of the second quarter, which was down 11 percent from a year ago, while NS had 26,535, a decrease of 2 percent.

“I’m very, very confident in our operations team and their ability to drive productivity while maintaining a foundation for growth. We’re in great shape with the team,” Squires responded.

A railroad’s cost structure comes down to people and assets, Squires says, and NS remains focused on both as it looks to balance cost cuts with growth, service, and safety.

Susquehanna Financial Group analyst Bascome Majors asked whether CSX’s financial turnaround was driving short-term profits at the expense of long-term growth. Will NS shareholders be better served by its current strategy or a more aggressive approach like CSX?

“We believe in our plan, and our plan is a balance of efficiency and growth, as I’ve said several times this morning. That really is the right formula in our view,” Squires says. “You do need to make the investments for growth. You do need to have a certain level of resources available, particularly in times that are conducive to growth, like these times. So while we are definitely focused on productivity going forward, right now is the time to make sure you have the workforce in place to handle the business so that you can grow when that’s possible. So I think our plan will be the right plan for our shareholders in the future.”
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