NS works to move past $803M hit from Ohio derailment

July 27, 2023

Like the other Class I railroads reporting earnings this month, Norfolk Southern is looking to cut costs and increase productivity in the second half of 2023 to match anticipated market demand. But unlike the other railroads, NS is also contending with bringing both operating costs and rail service back to normal following the Feb. 3 train derailment in East Palestine, Ohio.

Thirty-eight rail cars had derailed that Feburay evening and a fire ensued, damaging an additional 12 cars. No fatalities or injuries were reported, although there was a 1-mile evacuation zone due to the release of hazardous materials. Days after the derailment, NS and officials had decided to vent and burn the tank cars carrying vinyl chloride because of concerns that one of the cars could pose an explosion hazard.

NS estimated that the derailment cost the railroad $416 million in the second quarter, with environmental cleanup activities driving much of that cost. Factoring in derailment-related costs from the first quarter, the derailment could cost NS upwards of $803 million.

“The single biggest lever we’ve got right now is to absorb volume growth into our current cost structure,” CFO Mark George told investors during NS’ (NYSE: NSC) earnings call Thursday morning to discuss second-quarter 2023 results. “That is really going to provide a bit of peeling out from where we are today. And then I think at the same time … [NS is] working hard on productivity initiatives because … we’ve been growing a lot of costs and resources to accelerate the network.”

Regarding the derailment, George noted that the railroad’s 2023 financial results so far don’t reflect potential recoveries from third parties nor any payments coming from insurance coverage. He said NS has started to pursue financial recovery from third parties and it will begin filing insurance claims in the third quarter.

NS has been steadily working toward restoring train velocity, dwell and service across its network, as well as getting performance levels back to normal levels in the Midwest and Northeast, according to Paul Duncan, NS chief operating officer, who said to help out with that, the railroad has restored its double-track mainline service through East Palestine.

Now that performance levels are normalizing, NS hopes to work toward the goals it announced last December during its investor day. Those goals include bringing more reliability, productivity and resiliency into the network.

“As the service product has stabilized, it gives us the opportunity to continue to iterate our plan and drive productivity and efficiencies into the base plan,” NS President and CEO Alan Shaw said during the earnings call. “So, it’s not just the elimination of the service recovery cost, we’re going to make the base plan better. And that’s exactly what we’re doing now, and that’s the structure that Paul has built into his organization.”

When looking at head count for the second half of 2023, NS, like other Class I railroads, plans to slow down hiring efforts, focus on areas where there is still need for staffing and look to attrition to match resources with demand.

“We are now at a point at which the training pipeline has crested and will begin to taper down over the back half of the year,” Duncan said. “We are committed to maintaining an appropriately sized workforce to drive reliability and long-term resilience as part of our strategy.”

In terms of the outlook for different segments for the remainder of this year, NS sees opportunities in metals, construction and automotive volumes but continued weakness in chemicals, according to Ed Elkins, NS’ chief marketing officer. International intermodal volumes may continue to grow amid an anticipated rebound in import volumes, but domestic intermodal “will be dependent on the U.S. consumer, retail inventory levels and the truck market.”

NS has adjusted its full-year revenue outlook to account for lower revenues in the first half of 2023, Shaw said.

“We entered the year expecting to achieve revenues comparable to 2022. The first-half revenue shortfalls require us to modify our full-year outlook. We now anticipate revenue to be down at least 3% in 2023, implying some modest volume improvements in the back half,” Shaw said. “We’re also expecting modestly higher capital expenditures for the year as we accelerate investments in safety, service, productivity and growth.”

Q2 2023 earnings results

NS reported second-quarter net income of $356 million, or $1.56 per diluted share, compared with net income of $819 million, or $3.45 per diluted share, for the second quarter of 2022.

Revenues were down 8% year over year (y/y) to $2.98 billion for the second quarter, with revenue from NS’ intermodal segment falling 23% to $745 million. A 1% increase in international intermodal volume wasn’t enough to offset a 14% decrease in domestic intermodal volumes.

Meanwhile, operating expenses were $2.4 billion for the second quarter, compared with $1.98 billion y/y. Expenses included the $416 million charge associated with the railroad’s ongoing response to the train derailment in East Palestine.

Adjusting for the eastern Ohio incident charge, NS’ adjusted income from railway operations would be $992 million, while adjusted diluted earnings per share would be $2.95. This constitutes declines of 22% and 14%, respectively, from the second quarter of 2022, NS said Thursday.

If NS takes out the costs related to service disruptions, lost revenue and the $416 million in expense costs related to East Palestine, the railroad calculates its adjusted operating ratio would have been 66.7%, according to George, compared with the reported 80.7% for the second quarter. Investors sometimes use OR to determine the financial health of a company, with a lower OR implying improved health.

OR for the second quarter of 2022 was 60.9%.

“Our financial results were challenged this quarter as we noted in May that they would be. They reflect the decisive actions we have taken to advance our strategy and keep our promises in East Palestine. With every step forward, we are doing exactly what we said we would do when we announced our strategy last December [during NS’ investor day]. We are investing in the long-term success of our company,” Shaw said in prepared remarks on the earnings call. “With our strategy as our road map, we made significant progress in the second quarter, building the foundation for long-term value creation.”

Train-the-trainer program

In a separate announcement Wednesday, NS said it and the International Association of Sheet Metal, Air, Rail and Transportation Workers – Transportation Division (SMART-TD) would be working on several initiatives to enhance the trainee program for conductors as well as increase compensation for conductors helping out with the training.

“Ensuring that every conductor trainee receives proper training is the foundation of running a safe railroad,” Jeremy Ferguson, president of SMART-TD, said in a news release. “These changes will deliver even greater quality and consistency for the Norfolk Southern conductor training program and ensure that every trainee will have a positive and comprehensive experience focused on safely performing their important work.”

The initiatives include developing a train-the-trainer program, creating a standardized process to monitor and report progress and instituting a bilateral rating system to allow trainers and trainees to rate each other.

NS is also increasing the pay for conductors who provide instruction to trainees and those conductors to decide to step away from work full-time and offer support and instruction as “craft mentors.”

Said Shaw: “We have an obligation to make sure our newest employees — our conductor trainees — have the skills and knowledge to get the job done as safely as possible. We committed to partnering with our unions on safety, and our ongoing work with SMART-TD is another step in fulfilling that promise and investing in the future of our people.”

The partnership comes as the Federal Railroad Administration placed a deadline on NS to have its conductor trainee certification program meet federal standards, according to news reports and SMART-TD.

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