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The Stock Advisors
The Stock Advisors
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Ride the rails with Norfolk Southern (NSC)

December 21, 2009 | About:

"If, as I anticipate, we do see increasing consumer spending in the first quarter, one industry that stands to benefit immediately is the railways," says Tom Slee.

The contributing analyst with Internet Wealth Builder explains, "I like the outlook for Norfolk Southern (NYSE:NSC), a major freight railroad operating on the U.S. eastern seaboard with lines into Ontario. It should do well next year."

"With roots back to 1827, the modern Norfolk Southern was formed in 1982 through a merger of Norfolk and Western Railway and the Southern Railway Company.

"Based in Norfolk, Virginia, the company operates 21,500 route miles in 22 eastern states as well as the District of Columbia and Ontario.

"The bulk of Norfolk's revenues still come from the transportation of coal, coke, and iron ore, although intermodal traffic is now a growing factor. In 2008, revenues totaled $10.6 billion (all dollar amounts are in U.S. currency) and generated a profit of $1.7 billion.

"Incidentally, it's interesting to note that Warren Buffett owns 1.9 million shares of Norfolk and has agreed to sell them before closing his purchase of Burlington Northern.

"The consensus opinion on Wall Street at the moment is that U.S. railroads are going to have a lackluster 2010 but then hit their stride once more. Analysts believe that single-digit rate increases will stick during the coming year but that volumes may actually decline.

"I think that they are being too cautious. Given even a small uptick in consumer spending, car loadings should increase, especially on the intermodal side. As a matter of fact, weekly railroad volumes have been rising since May. At the same time, fuel surcharges will offset rising fuel costs.

"As far as Norfolk is concerned, its 2010 book of business has already been priced and should provide gains above the rate of inflation. Moreover, prospects for the company's major business markets are improving.

"We could see NSC booking a 5% increase in car-loadings next year. Meanwhile the company's operating margins are improving. NSC's operating ratio (the percentage of revenues needed to operate the system) is a respectable 72.8%.

"This feeling of momentum was reflected in the company's third-quarter results. Earnings came at 81cents a share, down from $1.37 in 2008 but above the expected 78 cents.

"Revenues of $2.1 billion were sharply lower than $2.9 billion the year before. They were, however, up from $1.9 billion the previous quarter.

"Management continued to tighten its controls and operating expenses were reduced 25%. There was a net cash flow from operations of $600 million.

"Looking ahead, higher oil prices have led to further consolidation in the trucking industry where there has been cut-throat competition for the reduced intermodal business. This will allow Norfolk to increase market share as the recovery continues.

"Demand for coal, which represents 30% of the company's revenues, is improving as the devastated steel industry starts to show signs of life. The World Steel Association expects steel consumption to grow about 9% in 2010 to the levels achieved in 2006. That will boost coal shipments.

"It all points to earnings of $2.75 a share in 2009 and as much as $4 a share next year. Overall, we rate Norfolk Southern a a 'Buy' wiith a target price of $60 per share."

The Stock Advisors


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