Norfolk Southern (NSC) Ratings Affirmed by Moody's; Outlook Remains Stable
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Moody's Investors Service ("Moody's") affirmed the Baa1 senior unsecured rating of Norfolk Southern Corporation (NYSE: NSC). In a related action, Moody's upgraded the rating of senior unsecured debt issued by Norfolk Southern Railway Company, the principal railroad operating subsidiary, to A3 from Baa1. The ratings outlook is stable.
RATINGS RATIONALE
Norfolk Southern is one of two major freight railroads in the eastern U.S., which makes the company an integral part of the nation's transportation infrastructure. The company has a fairly balanced freight mix and has demonstrated its ability to adapt its cost base swiftly to fluctuations in freight demand. Debt levels are elevated, yet manageable, compared to expected earnings and cash flows. Although a secular decline in U.S. coal production continues to pose a risk, revenues from coal shipments represent currently a more manageable proportion of Norfolk Southern's total revenues, after having declined to approximately 15% in the first nine months of 2016, from more than 30% in 2011.
Moody's expects Norfolk Southern to increase its operating margin to more than 32% in 2017, from an expected 31.4% in 2016. In conjunction with an expected increase in revenues of approximately 3%, this would ease debt/EBITDA to 2.5 times in 2017, from 2.6 times at the end of 2016, assuming Norfolk Southern maintains its current pace of share repurchases of $800 million per annum. Metrics are calculated on a Moody's adjusted basis, including adjustments in relation to pension obligations, operating leases and unamortized debt discounts.
Moody's considers Norfolk Southern's liquidity to be good. Cash flows from operations amply exceed requisite investments in infrastructure, equipment and technology, which Moody's expects to remain at just above 20% of revenues. Moody's anticipates free cash flow to improve further towards $600 million in 2017, after free cash flow turned negative in 2015.
The A3 ratings of the 9.75% debentures due 2020 and the 7.875% notes due 2043 take into account that debt issued by Norfolk Southern Railway Company, the principal railway operating subsidiary, is structurally senior to debt issued by Norfolk Southern Corporation, the entity that has issued the vast majority of the company's outstanding debt.
The stable ratings outlook is predicated on Moody's expectation that freight demand is stabilizing and that Norfolk Southern will continue its trajectory of margin enhancement through price increases, productivity measures and asset rationalizations. The outlook also incorporates Moody's expectation that the company manages the amount of share repurchases such that debt/EBITDA decreases to 2.5 times or less.
The ratings could be upgraded if Norfolk Southern demonstrates a sustained improvement in (adjusted) operating margins to around 35%. Debt/EBITDA maintained at 2 times or less, FFO/debt of at least 35.0% and EBITA/average assets of at least 12.5% would also be supportive of higher ratings.
The ratings could be downgraded if Moody's expects freight demand and pricing to weaken such that revenues would decline considerably, or operating margins to decrease below 30% for some time due to the company's inability to attain pricing in excess of rail cost inflation or due to operational inefficiencies. The ratings could also be downgraded in the absence of steady progress in decreasing debt/EBITDA to 2.5 times or less, increasing FFO/debt to at least 30% and increasing EBITA/average assets to 10% or more.
The following summarizes today's rating actions:
Affirmations:
..Issuer: Norfolk Southern Corporation
.... Issuer Rating, Affirmed Baa1
....Senior Unsecured Shelf, Affirmed (P)Baa1
....Senior Unsecured Regular Bond/Debenture, Affirmed Baa1
Upgrades:
..Issuer: Norfolk Southern Railway Company
....Senior Unsecured Regular Bond/Debenture, Upgraded to A3 from Baa1
Outlook Actions:
..Issuer: Norfolk Southern Corporation
....Outlook, Remains Stable
..Issuer: Norfolk Southern Railway Company
....Outlook, Remains Stable
The principal methodology used in these ratings was Global Surface Transportation and Logistics Companies published in April 2013. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.
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