Deals

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Norfolk Southern was right: It didn't need Bill Ackman's help.

It's been about a year since the $27 billion railroad found itself on the receiving end of Canadian Pacific's takeover advances, with the then-Ackman-backed carrier arguing that its CEO Hunter Harrison would do a better job turning around the business than his counterpart at Norfolk Southern, Jim Squires.

The pursuit ultimately failed amid opposition from the Justice Department and major customers like FedEx, and Ackman later sold his Canadian Pacific stake and resigned from the board. But Norfolk Southern has still been on the hook with investors to show that it can deliver on its own the kind of cost cuts and higher valuation that Ackman and Canadian Pacific were promising. So far, it's doing a decent job.

Holding Its Own
Norfolk Southern has slightly outperformed Canadian Pacific since the latter formally walked away from its takeover pursuit.
Source: Bloomberg

Norfolk Southern on Wednesday said that its operating ratio (a measure of efficiency in which a lower number is better) improved to 67.5 percent in the third quarter. Train speeds were up, the hours they spent dwelling at stops were down -- both good signs. The company also increased its estimate for cost cuts this year to $250 million, compared with an already-boosted call for $200 million of savings in April. And earnings were better than analysts had expected.

The caveat to all of this good news is that Norfolk Southern's profit beat -- its fifth in a row -- wasn't quite as strong as it looked. The third quarter included significant one-time gains for divestitures, which added about 6 cents to the company's earnings-per-share, Royal Bank of Canada analyst Walter Spracklin wrote in a report on Wednesday. Without that benefit and a boost from a favorable tax rate, the results were essentially in line with estimates.

That didn't do much to make investors excited, especially considering Norfolk Southern shares had already surged about 15 percent in the year leading up to the results as the S&P 500 Railroads Index remained virtually unchanged. Hence why Norfolk Southern shares fell as much as 3.1 percent on Wednesday.

Holding the Applause
Norfolk Southern beat analysts' earnings estimates, but the showing wasn't as strong as it looked at first blush.
Source: Bloomberg
Intraday times are displayed in ET.

But let's not sell Norfolk Southern's accomplishments short. Even if you back out the divestiture benefit, the company's operating ratio still would have stacked up well relative to Spracklin's estimates for the quarter and it remains on track to deliver a reading of less than 70 percent this year -- exactly as it promised last December when Ackman and Canadian Pacific were circling. It will be only the second time in the past decade that Norfolk Southern has been able to reach that threshold.

Getting There
Norfolk Southern is on track to meet its goal of improving its operating ratio to below 70 percent in 2016.
Source: Bloomberg

Norfolk Southern still has its challenges. Like its peers, the company is still grappling with the slump in commodity carloads --particularly coal, which has lost its appeal in the face of cheaper natural gas. It's also not immune to competition from truck drivers, which have used lower diesel prices and excess capacity to steal cargo away from the railroads. But at least in terms of what Norfolk Southern can control, its management team is doing what it needs to do.

Aside from Wednesday's performance, investors appear to be giving it some credit for that. Norfolk Southern shares have traded at an average of about $94 over the last month. There was much consternation about how investors should actually value Canadian Pacific's (increasingly complicated) takeover bid. But based on one approach, that offer today would be worth about $98. So there's a ways to go, but for now, things at Norfolk Southern appear to be on track.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. This does not account for the contingent value right included in Canadian Pacific's latest offer, which may or may not be worthless. The company bid $32.86 a share in cash and 0.451 of a share in the combined company. According to Canadian Pacific, that values Norfolk Southern at $125 to $140 a share based on the future earnings potential of the merged railroads. Norfolk Southern said the actual value was more like $92, based on Canadian Pacific's stock price at the the time it was announced. 

To contact the author of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net