Norfolk Southern

Norfolk Southern’s second-quarter top line surged 11% year over year on a solid intermodal rebound, stronger merchandise carload activity, and higher fuel surcharges. Consolidated adjusted margin worsened due mostly to fuel noise.

Why it matters: Carloads (excluding intermodal) rose 2% as coal increased on better export demand, and as merchandise shipments rose 2% on new business wins, especially for chemicals. Improving US industrial production probably lifted a few end markets as well. Intermodal volumes jumped 5% on good Class I service over the past few years (save for slight recent deterioration), along with tightening capacity and rapidly rising rates (including fuel) across the competing truckload industry. Rising TL rates materially boost intermodal's value proposition. Norfolk has executed well over the past year in terms of underlying network-productivity gains, but its adjusted operating ratio (expenses/revenue; lower is better) worsened to 65.5% on the mathematical impact of rapidly rising fuel costs and surcharges, coupled with wage inflation.

The bottom line: We are raising our fair value estimate for wide-moat Norfolk to $340 per share, from $313, due in part to a higher Union Pacific offer price, which varies with UP's share price. It also reflects a higher stand-alone fair value for Norfolk, as we raised our medium-term revenue growth assumptions. Our fair value estimate reflects a probability-weighted average of Union Pacific's acquisition offer for Norfolk and the chance the Surface Transportation Board won't approve a merger. Uncertainty is high, but we're assuming a roughly 60% chance of deal approval. If the deal fails to receive regulatory approval, our fair value estimate will revert to reflecting Norfolk's stand-alone prospects (DCF-derived $252 per share, all else equal).

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Following second-quarter results, we are raising our fair value estimate for wide-moat Norfolk to $340 per share, from $313, due in part to a higher Union Pacific offer price, which varies with UP's share price. It also reflects a higher stand-alone fair value for Norfolk (to $252), as we raised our medium-term revenue growth assumptions on robust intermodal activity.

Our fair value estimate uses a probability-weighted average reflecting Union Pacific's acquisition offer for Norfolk and the chance the STB won't approve a deal. Uncertainty is elevated, but we are assuming roughly a 60% chance of deal approval. If the tie-up fails to receive regulatory approval, our fair value estimate would revert to reflecting Norfolk's stand-alone prospects.

Several cross-currents were at play in 2024, translating into flat revenue. Total yield fell 5% on lower benchmark coal prices, mix, and domestic intermodal pricing pressure from depressed trucking rates. Still, core pricing on the merchandise business remained positive. Total traffic grew 5% on an international intermodal rebound and new business development. On the other hand, industrial end markets remained sluggish, and coal fell on low natural gas prices. Despite wage inflation and hurricane-related disruption, Norfolk's adjusted OR improved 160 basis points to 65.8% in 2024 as the firm regained its cost footing following the East Palestine derailment in 2023.

Revenue was up slightly in 2025 (0.5%) on higher carloads, as intermodal activity declined and all-in yield was flat. Carloads grew 2% on an easy comparison with the 2024 hurricane disruption, higher domestic coal volume, higher autos (an uptick in manufacturer production), and benefits from infrastructure investment in the US Southeast. On the other hand, because of tariffs, industrial end markets remained sluggish. Intermodal volume fell 1% on tough comps linked to the import pull-forward (ahead of tariffs), which receded in the second half. Additionally, Norfolk lost market share as CSX dialed up its competitive response to the proposed Union Pacific-Norfolk merger. On the pricing front, total yield was flat due to depressed benchmark coal pricing and intermodal rate pressure (low truckload rates), though core merchandise pricing gains remained positive.

Norfolk's adjusted OR improved to 65% (from 65.8%) in 2025, but that was due to elevated gains on the sale of land. Otherwise, despite continued productivity improvement, margins faced pressure from a jump in claims costs, weak benchmark coal pricing, and lower domestic intermodal rates.

For 2026, assuming tariffs or an oil shock don't spark an economic pullback, we expect the US industrial sector to see modest improvement for carloads (along with new business development tailwinds) and truck-to-rail conversions to remain strong for intermodal. We also expect improvement in intermodal contract pricing as rates recover in the competing truckload sector. Overall, we model 6% revenue growth in 2026, driven by spiking fuel surcharges, higher volume (especially intermodal and chemicals), and incremental core pricing gains. We look for 4% revenue growth in 2027, reflecting modest industrial end market improvement, benefits from new business wins, and stable intermodal demand.

We expect adjusted OR deterioration to 66.1% in 2026 due to unusually high land sale gains in 2025, coupled with wage inflation and fuel-related headwinds, partly offset by continued productivity progress and revenue growth. That said, we look for OR improvement to 64.4% in 2027 and 62.8% in 2028, thanks to fuel-related noise subsidies and continued efficiency efforts and revenue growth.

In our view, each of the North American Class I railroads we cover, including Norfolk Southern, enjoys a wide economic moat rooted in cost advantages and efficient scale. Core pricing and margin resilience during past freight recessions and in the face of substantial coal volume losses over the past decade-plus are a testament to their robust competitive positioning. With near certainty, we expect the rails to continue turning their two core moat sources into economic profit for the next 10 years and, more likely than not, for the next 20 years.

Cost advantage is a key factor in Norfolk's wide moat. While barges, ocean liners, aircraft, and trucks also haul freight, railroads are by far the low-cost option where no waterway connects the origin and destination, especially for freight with low value-per-unit weight (bulk commodities). Along those lines, railroads enjoy roughly quadruple the fuel efficiency of trucking (per ton-mile of freight), and through greater railcar capacity and train length, rails make more effective use of locomotive assets and manpower despite the need for train yard personnel. Rails can also carry significantly more freight at once. We estimate railroads enjoy a 10%-30% discount to trucking on similar lanes (on average). Marine shipping by barge is less costly than rail for certain bulk commodity shippers that are located near the inland waterways offering access to the desired destination. However, customers in a position to ship via barge already do so, thus removing any threats barging could pose to current railroad volume. Even for intermodal container freight, which consists largely of consumer-related products, rail has historically been cheaper than its key competitor, truckload shipping, on average over the cycle, thanks to the rails’ aforementioned fuel efficiency and more economical use of labor.

Furthermore, route density plays a role in rails’ cost advantage relative to a would-be new railroad entrant in a given corridor. We don’t expect any new mainlines to be built, but the incumbent Class I providers would enjoy vastly lower unit and marginal costs than an upstart, given immense network/lane density—the existing six North American Class I railroads have thousands of customers across myriad end markets and geographies that drive significant freight volume across their networks.

In addition to cost advantage, the Class I railroads benefit from efficient scale. Would-be rational competitors have little incentive to enter because massive upfront infrastructure costs and the potential for creating excess capacity amid limited demand would preclude economic profit and destroy value. The network of tracks and assets that US Class I railroads have in place is essentially impossible to replicate. Norfolk Southern's system spans like a spiderweb across the densely populated Eastern US, capturing about half of the region's rail volume. Would-be entrants are fended off by the steep barrier to entry posed by the need to obtain contiguous rights-of-way on which to lay continuously welded steel rail spanning a significant portion of North America. Railroads occasionally build new spurs or restore abandoned lines, but we anticipate no new mainlines will be built, given the massive barriers to entry.

Efficient scale followed industry consolidation, escalated by the 1980 Staggers Rail Act, which permitted extensive rail line sales, abandonment, and combination while allowing for private contracts and rate setting based on market demand. In 1980, more than 40 Class I rails operated across North America. Today, there are only six. (By definition, a Class I rail generates at least $1.1 billion of annual revenue.) Consequently, a single railroad often serves an end-of-the-line shipper, only two railroads operate in most regions, and the rails have been able to reinvest while becoming quite profitable. In fact, we suspect that, barring government intervention, the rational number of competitors on the continent would be two, via additional consolidation. This is because in most regions, customers already have only two capable providers that service the market effectively and efficiently.

As shippers continue to optimize/diversify their transportation options, railroads are a ready solution, and Norfolk Southern's intermodal franchise is targeting additional share gains from over-the-road trucking on shorter-haul lanes in the east. Thanks in part to previous service investment and its partnerships with intermodal marketing leaders J.B. Hunt and Hub Group (which originate most domestic intermodal freight from shippers), we think Norfolk Southern's intermodal division is poised to expand over the long run, despite near-term headwinds from depressed rates in the competing truckload sector.

Intermodal shipping should enjoy favorable long-term trends, including secular constraints on truckload capacity expansion and shippers' efforts to minimize transportation costs through mode conversions (truck to rail).

Pressure from an activist investor has prompted Norfolk's management to reinvigorate its precision scheduled railroading focus and commit to reducing the margin gap relative to peers.

The East Palestine derailment created a major profitability setback in 2023, but the firm made good OR progress over the past few years and incremental productivity gains should persist.

Union contract wage and benefit inflation will remain a partial margin headwind over the near term.

The STB oversees railroads' pricing, so there will always be an underlying risk of reregulation in terms of a policy shift to a more heavy-handed approach.

Domestic utility coal volume will probably see near-term headwinds from lower relative natural gas prices and elevated inventories.