Is Norfolk Southern Corp. (NYSE: NSC) A Buy At This Enterprise Multiple?

in VALUATION MULTIPLES by

Norfolk Southern Corp. (NYSE: NSC) trades at a Sales Multiple of 4.2x, which is higher than the Industrials sector median of 1.5x. While this makes NSC appear like a stock to avoid or sell if you own it, you might change your mind after gaining a better understanding of the assumptions behind the EV / Sales ratio. In this article, I will break down what a Sales Multiple is, how to interpret it and what to watch out for.


Understanding Valuation Multiples and EV / Sales

A multiples valuation, also known as a comparable companies analysis, determines the value of a subject company by benchmarking the subject’s financial performance against similar public companies (peer group). We can infer if a company is undervalued or overvalued relative to its peers by comparing metrics like growth, profit margin, and valuation multiples.

An Sales Multiple, also known as Enterprise Value-to-Sales Multiple (EV / Sales), measures the dollars in Enterprise Value for each dollar of revenue. To determine if a company is expensive, it’s far more useful to compare EV / Sales multiples than the absolute stock price. Furthermore, its key benefit over the P/E multiple is that it’s capital structure-neutral, and, therefore, better at comparing companies with different levels of debt. The general formula behind a Sales Multiples valuation model is the following:

Enterprise Value = Revenue x Selected Multiple

A sales multiple is not meant to be viewed in isolation and is only useful when comparing it to other similar companies. Since it is expected that similar companies have similar EV / Sales ratios, we can come to some conclusions about the stock if the ratios are different. I compare Norfolk Southern’s sales multiple to those of Canadian National Railway Company (NYSE: CNI), Union Pacific Corporation (NYSE: UNP), Canadian Pacific Railway Limited (NYSE: CP) and Kansas City Southern (NYSE: KSU) in the chart below.

NSC Sales Multiple vs Peers Chartsource: finbox.io Benchmarks: Sales Multiples

Since Norfolk Southern’s sales multiple of 4.2x is lower than the median of its peers (5.8x), it means that investors are paying less than they should for each dollar of NSC’s revenue. As such, our analysis shows that NSC represents an undervalued stock. In fact, finbox.io’s Sales Multiples Model calculates a fair value of $181.96 per share which implies 33.3% upside.

NSC EV / Sales Valuation Calculation

Note that the selected multiple of 5.5x in the analysis above was determined by averaging Norfolk Southern’s current sales multiple with its peer group.


Understanding the EV / Sales Ratio’s Limitations

Before jumping to the conclusion that Norfolk Southern should be added to your portfolio, it is important to understand that our conclusion rests on two important assumptions.

(1) the selected peer group actually contains companies that truly are similar to Norfolk Southern, and

(2) the selected peer group stocks are being fairly valued by the market.

If the first assumption is not accurate, the difference in sales multiples could be due to a variety of factors. For example, if you accidentally compare Norfolk Southern with higher growth companies, then its sales multiple would naturally be lower than its peers since investors reward high growth stocks with a higher price. In addition, revenue multiples are highly correlated with profit margins so differences in EBITDA margin often explain differences in valuation.

NSC revenue Growth and Margins vs Peers Tablesource: sales multiples model

Now if the second assumption does not hold true, Norfolk Southern’s lower multiple may be because firms in our peer group are being overvalued by the market.


What This Means For Investors

As a shareholder, you may have already conducted fundamental analysis on the stock so its current undervaluation could signal a potential buying opportunity to increase your position in NSC. However, keep in mind the limitations of a sales multiples valuation when making an investment decision. There are a variety of other fundamental factors that I have not taken into consideration in this article. If you have not done so already, I highly recommend that you complete your research on Norfolk Southern by taking a look at the following:

Valuation Metrics: what is Norfolk Southern’s free cash flow yield and how does it compare to its publicly traded peers? This metric measures the amount of free cash flow for each dollar of equity (market capitalization). Analyze the free cash flow yield here.

Risk Metrics: what is Norfolk Southern’s cash ratio which is used to assess a company’s short-term liquidity. View the company’s cash ratio here.

Efficiency Metrics: return on equity is used to measure the return that a firm generates on the book value of common equity. View Norfolk Southern’s return on equity here.


Author: Andy Pai

Expertise: financial modeling, mergers & acquisitions

Andy is also a founder at finbox.io, where he’s focused on building tools that make it faster and easier for investors to do investment research. Andy’s background is in investment banking where he led the analysis on over 50 board advisory engagements involving mergers and acquisitions, fairness opinions and solvency opinions. Some of his board advisory highlights:

  • Sears Holdings Corp.’s $620 mm spin-off via rights offering of Sears Outlet, Hometown Stores and Sears Hardware Stores.
  • Cerberus Capital Management’s $3.3 bn acquisition of SUPERVALU Inc.’s New Albertsons, Inc. assets.

Andy can be reached at andy@finbox.io.

As of this writing, I did not hold a position in any of the aforementioned securities and this is not a buy or sell recommendation on any security mentioned.

Expertise: financial modeling, mergers & acquisitions. Andy is also a founder at finbox.io, where he’s focused on building tools that make it faster and easier for investors to do investment research. Andy’s background is in investment banking where he led the analysis on over 50 board advisory engagements involving mergers and acquisitions, fairness opinions and solvency opinions. Some of his board advisory highlights: - Sears Holdings Corp.’s $620 mm spin-off via rights offering of Sears Outlet, Hometown Stores and Sears Hardware Stores. - Cerberus Capital Management’s $3.3 bn acquisition of SUPERVALU Inc.’s New Albertsons, Inc. assets. Andy can be reached at andy@finbox.io or at +1 (516) 778-6257.

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