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Investment idea - Norfolk Southern

Norfolk Southern provides rail transportation services. The company transports raw materials, intermediate products, and finished goods primarily in the Southeast, East, and Midwest and, via interchange with rail carriers, to and from the rest of the United States.

Norfolk Southern’s 3Q13 financial performance was very solid. Net income jumped 20% y-o-y to $482 mn, or $1.53/share, which was well above the average estimate of $1.39/share from 26 analysts surveyed by Bloomberg. Strong results were driven by better than expected revenue that increased 4.9% y-o-y on 4% volume growth and 0.8% total carload yield growth. The company also demonstrated a significant improvement in operating efficiency. Despite volume growth, train & engine overtime costs fell 11% y-o-y, carloads per locomotive increased 7%, and fuel efficiency improved 2%. Headcount decreased 2.9% y-o-y in 3Q, Gross Ton Miles (GTMs) per employee (a measure of employee productivity) increased 7.7% and carloads per employee rose 7.2%. As a result, 3Q operating ratio improved 2.9 p.p. y-o-y to 69.9%, which was better than consensus estimate.

Despite a significant growth YTD, Norfolk Southern’s shares, in our view, still represent an interesting investment idea betting on the continuing economic recovery in the US that should result in higher industrial and intermodal rail volumes. At the same time good headcount control and cost side performance should improve margins and contribute to the future positive surprises in EPS growth. Medium term target price for the company’s stock is $95.