Company Description: Norfolk Southern Corp. operates 20,000 route miles serving 22 eastern states, the District of Columbia and Ontario, Canada.
Fair Value: In calculating fair value, I consider the NPV MMA Differential Fair Value along with these four calculations of fair value (see page 2 of the linked PDF for a detailed description):
1. Avg. High Yield Price
2. 20-Year DCF Price
3. Avg. P/E Price
4. Graham Number
NSC is trading at a discount to only 3.) above. The stock is trading at a 8.3% discount to its calculated fair value of $72.37. NSC earned a Star in this section since it is trading at a fair value.
Dividend Analytical Data: In this section there are three possible Stars and three key metrics (see page 2 of the linked PDF for a detailed description):
1. Free Cash Flow Payout
2. Debt To Total Capital
3. Key Metrics
4. Dividend Growth Rate
5. Years of Div. Growth
6. Rolling 4-yr Div. > 15%
NSC earned three Stars in this section for 1.), 2.) and 3.) above. A Star was earned since the Free Cash Flow payout ratio was less than 60% and there were no negative Free Cash Flows over the last 10 years. The stock earned a Star as a result of its most recent Debt to Total Capital being less than 45%. NSC earned a Star for having an acceptable score in at least two of the four Key Metrics measured. Rolling four-year Div. > 15% means that dividends grew on average in excess of 15% for each consecutive four-year period over the last 10 years (2001 to 2004, 2002 to 2005, 2003 to 2006, etc.). I consider this a key metric since dividends will double every five years if they grow by 15%. The company has paid a cash dividend to shareholders every year since 1901 and has increased its dividend payments for 11 consecutive years.
Dividend Income vs. MMA: Why would you assume the equity risk and invest in a dividend stock if you could earn a better return in a much less risky money market account (MMA) or Treasury bond? This section compares the earning ability of this stock with a high yield MMA. Two items are considered in this section (see page 2 of the linked PDF for a detailed description):
1. NPV MMA Diff.
2. Years to > MMA
NSC earned a Star in this section for its NPV MMA Diff. of the $6,970. This amount is in excess of the $2,400 target I look for in a stock that has increased dividends as long as NSC has. If NSC grows its dividend at 15.0% per year, it will take one year to equal a MMA yielding an estimated 20-year average rate of 3.1%. NSC earned a check for the Key Metric 'Years to >MMA' since its one year is less than the five-year target.
Memberships and Peers: NSC is a member of the S&P 500 and a member of the Broad Dividend Achievers™ Index. The company's peer group includes: CSX Corp. (NYSE:CSX) with a 2.2% yield, Canadian National Railway Company (NYSE:CNI) with a 1.9% yield and Union Pacific Corporation (NYSE:UNP) with a 2.2% yield.
Conclusion: NSC earned one Star in the Fair Value section, earned three Stars in the Dividend Analytical Data section and earned one Star in the Dividend Income vs. MMA section for a total of five Stars. This quantitatively ranks NSC as a 5-Star Very Strong stock.
Using my D4L-PreScreen.xls model, I determined the share price would need to increase to $100.80 before NSC's NPV MMA Differential decreased to the $2,400 minimum that I look for in a stock with 11 years of consecutive dividend increases. At that price the stock would yield 1.8%.
Resetting the D4L-PreScreen.xls model and solving for the dividend growth rate needed to generate the target $2,400 NPV MMA Differential, the calculated rate is 11.3%. This dividend growth rate is well below the 15.0% used in this analysis, thus providing a margin of safety. NSC has a risk rating of 1.50 which classifies it as a Low risk stock.
As a cyclical stock, NSC is exposed to the ups and downs of economic cycles. In addition, the company has to deal with regulations, labor unions and significant capital requirements. However, NSC is one of the best-run railroads in North America generating one of the top operating ratios in the industry.
Management continues to invest in its network by improving capacity on heavily trafficked routes. As the economy recovers and truck capacity diminishes, NSC is well-positioned to to pick up the excess demand.
With only moderate debt and strong free cash flows (six of the last seven years FCF was over $1 billion), the company should continue to grow its dividend for many years to come. I recently initiated a position in NSC and will look to add to it while the stock is trading below my calculated fair value price of $72.37, and as my allocation allows.
Disclaimer: Material presented here is for informational purposes only. The above quantitative stock analysis, including the Star rating, is mechanically calculated and is based on historical information. The analysis assumes the stock will perform in the future as it has in the past. This is generally never true. Before buying or selling any stock you should do your own research and reach your own conclusion. See my Disclaimer for more information.
Full Disclosure: At the time of this writing, I was long in NSC (0.9% of my Dividend Growth Portfolio), and long in CNI. See a list of all my dividend growth holdings here.
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