DEFA14A: Norfolk Southern Aims for Sub-60% Operating Ratio Amidst Proxy Battle

Norfolk Southern's CEO and COO discuss the company's strategy to improve efficiency and achieve industry-competitive margins, despite challenges and a proxy contest.

Summary

• Norfolk Southern is focused on improving its operating ratio (OR) to a sub-60% level in the next 3-4 years.
• The company aims to achieve this through productivity improvements, particularly in the merchandise network, and revenue growth.
• A key component of the strategy is PSR 2.0, which focuses on providing a reliable service product to attract volume and price.
• The company acknowledges challenges from the East Palestine incident and a weak truck market impacting domestic intermodal pricing.
• Norfolk Southern reported first-quarter earnings in line with expectations and anticipates a 400-500 basis point improvement in OR in the second half of the year.
• The company has brought in John Orr as COO, a veteran with PSR experience, to drive operational improvements.
• Norfolk Southern is committed to safety and has seen a 38% decline in its mainline accident rate.
• The company is addressing terminal performance, reducing dwell times, and improving velocity to enhance efficiency.
• Norfolk Southern is facing a proxy contest, with the other side proposing its own COO candidate and criticizing the company's governance decisions.

Sentiment

Score: 7

Explanation: The sentiment is moderately positive. While there are challenges and a proxy battle, management expresses confidence in their strategy and ability to improve performance. The focus on safety and operational improvements is also a positive sign.

Positives

• The company is targeting a sub-60% operating ratio (OR) within the next 3-4 years, driven primarily by productivity gains in the merchandise network.
• Norfolk Southern expects a 400-500 basis point improvement in OR in the second half of the year.
• The mainline accident rate declined by 38% and is amongst the lowest in the industry.
• Merchandise velocity is improving, with a 10% increase in recent weeks.
• Terminal dwell times are decreasing, leading to better fuel efficiency and reduced locomotive usage, with 75 locomotives moved into stored serviceable readiness.
• The company has reached a $600 million settlement related to the East Palestine incident to address financial exposure and remove tail risk.
• The company is seeing improvements in on-time performance at major terminals, increasing from 30% to almost 90%.

Negatives

• The company had a 70 OR in Q1.
• Norfolk Southern's results in the third and fourth quarter of last year were not what management was looking for.
• The company estimates it missed $175 million to $200 million of high-margin merchandise revenue in the second quarter of last year due to a slow network.
• Revenue per unit (RPU) was worse than expected in the beginning of the quarter due to mix headwinds.
• Domestic intermodal pricing is pressured by the truck market.
• Purchased services are up 20% in 2 years and are at a higher percentage of revenue than when the OR was 80.

Risks

• The company faces risks related to the ongoing proxy contest and potential changes in leadership.
• A weak truck market continues to pressure domestic intermodal pricing.
• The company is exposed to fluctuations in export MET prices.
• The company is exposed to potential service disruptions and network inefficiencies.
• The company is exposed to potential service disruptions and network inefficiencies.
• The company is exposed to potential service disruptions and network inefficiencies.

Future Outlook

Norfolk Southern is confident in its ability to improve its operating ratio and achieve industry-competitive margins through productivity improvements and revenue growth. The company expects a 400-500 basis point improvement in OR in the second half of the year and a sub-60% OR in the next 3-4 years.

Management Comments

• 'We're going to deliver 400 to 500 basis point improvement in OR in second half of this year and a sub-60 OR in the next 3 to 4 years,' stated Alan Shaw, President and CEO.
• John Orr, COO, emphasized the importance of 'accountability, clarity and purpose' in driving operational improvements.
• Alan Shaw noted that 'a faster railroad...is a less expensive railroad.'

Industry Context

The discussion highlights the broader industry trend of railroads ceding market share to trucks due to service issues. Norfolk Southern's strategy aims to reverse this trend by improving service and competing more effectively with trucks. The company also references the PSR model, a common approach in the rail industry focused on efficiency and cost reduction.

Comparison to Industry Standards

• The document references Canadian National (CN) under Claude Mongeau, which achieved a mid-50s operating ratio and the highest revenue growth in the industry, as an example of what Norfolk Southern is aiming to achieve.
• The document mentions other Class 1 railroads such as CSX, UP, and BNSF, highlighting the competitive landscape and the importance of interline connections.
• The document references Keith Creel and Pat Ottensmeyer, former CEOs of other railroads, who recommended John Orr, suggesting his reputation and experience are highly valued in the industry.

Management Changes

Legal Proceedings

• The company reached a $600 million settlement related to the East Palestine incident.

Stakeholder Impact

• Shareholders are impacted by the company's financial performance and the outcome of the proxy contest.
• Employees are impacted by changes in operations and the company's commitment to safety.
• Customers are impacted by the company's service levels and pricing.
• The community of East Palestine is impacted by the settlement and the company's ongoing efforts to address the aftermath of the incident.

Next Steps

• The company will continue to focus on improving its merchandise network and driving productivity.
• Norfolk Southern will continue to pursue insurance recoveries related to the East Palestine incident.
• The company will engage with shareholders and proxy advisory firms regarding the upcoming vote at the 2024 Annual Meeting.

Key Dates

Keywords

operating ratio, PSR 2.0, productivity, merchandise network, intermodal, East Palestine, proxy contest, safety, velocity, terminal dwell, revenue growth, margins, Norfolk Southern