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Avoid Norfolk Southern Shares — More Room to Fall

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Recently, Canadian Pacific dropped its bid for Norfolk Southern, removing one of the last hopes that investors had for a rebound in this struggling railroad stock.

Norfolk Southern has seen its rail volumes decline substantially due to the collapse in energy prices that have shocked the markets over the past several quarters. Although energy prices have rebounded recently, railroad stocks like Norfolk Southern continue to see reduced volumes.

Rail stocks, like Norfolk Southern, have significant exposure to the coal industry. There already have been a wave of bankruptcy filings in the coal sector, and this seems likely to continue. Peabody Energy, considered to be one of the strongest and most diversified coal companies, has seen its stock price collapse and recently filed for bankruptcy; this shows that coal industry might be on its last legs. If more bankruptcies occur, Norfolk Southern’s coal business could perform even worse than already reduced expectations, driving down shares further.

Another concern for railroad companies, US economy may slow down as the pace of job gains slows. This could result in slower future growth for NSC versus growth experienced since the Great Recession.

Given these negative headwinds, one would expect NSC to trade at a lower valuation that its average historical PE ratio. As the below chart displays, NSC is currently trading right around its average historical valuation. Hence, we at Ideal Asset Management would avoid NSC right now.

NSC PE Ratio (TTM) Chart

NSC PE Ratio (TTM) data by YCharts

In the long run, railroad stocks will thrive again. Railroad companies can transport goods more efficiently over long distances, using less fuel than other modes of transportation. This cost advantage ensures that the rails will always be a necessity in moving goods across the country. But for the time being, the headwinds facing the industry are quite stiff, and the shares currently trade at a valuation level that does not reflect these headwinds. If the shares fall 25-30% from these levels, it may present a strong buy-low opportunity, but for now it may be best to avoid Norfolk Southern.

 

Disclosure:

All of the ideas expressed in this article are the opinions of Ideal Asset Management LLC

Before trading on any of the information in this article, consider consulting your financial advisor to make it suits your financial goals

Ideal Asset Management does not own shares of NSC for its clients

All investments carry the risk of loss

 

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