While the proxy battle between Norfolk Southern (NSC) and TCI Fund Management continues to grab headlines, a quiet revolution is brewing within the company's merchandise network. This under-the-radar shift, barely mentioned in their recent Q1 2024 earnings call, has the potential to be a game-changer, driving the kind of explosive margin improvement that even the most bullish analysts haven't dared to predict.

Most analysts, understandably focused on the ongoing proxy battle and the aftermath of the East Palestine derailment, seem to have missed the significance of what John Orr, Norfolk Southern's newly appointed Chief Operating Officer, has quietly set in motion. Orr, a seasoned PSR veteran with a track record of transformative operational improvements, has laser-focused his attention on the often-overlooked merchandise network, which accounts for a whopping two-thirds of Norfolk Southern's train starts and operating costs.

While the company's successful implementation of PSR principles in their intermodal network has driven impressive service improvements and volume growth, the potential for similar gains in merchandise is far more significant. This is where Orr's deep PSR expertise comes into play. He's not simply trimming around the edges; he's systematically dismantling ingrained inefficiencies and streamlining operations, all while maintaining the company's commitment to safe and reliable service.

The numbers tell a compelling story. In just his first 30 days, Orr has already removed 200 locomotives from the active fleet, with plans to sideline a total of 500 units over the next six months. This dramatic reduction in active locomotives, coupled with an 8% improvement in terminal dwell and a 22% reduction in recrews, signals a dramatic shift in operational efficiency.

Orr's strategy is centered on achieving a high degree of plan compliance, reducing variability and complexity in the merchandise network. This focus on plan compliance is already yielding significant cost savings, as evidenced by the unwinding of service-related costs in March, a trend expected to accelerate in Q2.

Here's where the real potential for an earnings explosion lies. Orr has laid out near-term targets that are both challenging and achievable, including a 20% improvement in terminal dwell, an 8% increase in car miles, and a 4% reduction in train starts. Achieving these targets alone would result in substantial cost savings, but Orr is also eyeing a longer-term glide path to a sub-60% operating ratio within the next three to four years.

This ambitious target, while met with skepticism by some analysts, is well within reach given the magnitude of cost-reduction opportunities identified by Orr. He's already flagged potential savings from reduced rents and materials, streamlined fleet composition, discretionary capital expenditure reductions, terminal consolidation, and operational efficiencies.

The key to Orr's strategy is the commitment to a balanced approach, ensuring that operational efficiency and service excellence go hand in hand. This focus on a balanced approach, coupled with Orr's deep PSR expertise, sets the stage for the kind of transformative margin improvement that has eluded Norfolk Southern for years.

While the proxy battle and the East Palestine aftermath continue to dominate headlines, investors would be wise to pay close attention to the quiet revolution taking place in Norfolk Southern's merchandise network. This under-the-radar shift, spearheaded by a seasoned PSR veteran, has the potential to unlock a treasure trove of cost savings, driving the kind of earnings explosion that would make even the most skeptical analysts reconsider their positions.

Projected Operating Ratio Improvement

The chart below shows the projected operating ratio (OR) improvement for Norfolk Southern over the next few years, based on John Orr's statements during the Q1 2024 earnings call. Note that actual results may vary.

"Key Takeaways: John Orr, Norfolk Southern's new COO, is driving significant operational efficiencies in the merchandise network. Key metrics like terminal dwell, car miles, and recrews are showing substantial improvement. Orr's plan aims for a 400-500 basis point OR improvement in the second half of 2024 and a sub-60% OR in the next 3-4 years. Significant cost savings are expected from reduced rents and materials, streamlined fleet composition, and terminal consolidation. Orr's balanced approach prioritizes both operational efficiency and service excellence."

"Fun Fact: Did you know that Norfolk Southern operates the largest coal export terminal in North America? Located in Norfolk, Virginia, the Lambert's Point terminal handles over 40 million tons of coal annually, fueling power plants and industrial facilities around the globe."