Is the CP+NS combination worth $3.48 a share?

There is a lot of talk about operating ratios when it comes to Canadian Pacific’s proposal to acquire Norfolk Southern. CP’s Hunter Harrison, the master of operating ratio at Canadian National and now CP, says he can shave a full nine percentage points off NS’s operating ratio of just over 69 percent.

What does that mean in real numbers? Now, I’m no math guy. That’s why I went into journalism. Words are my friends. Numbers, not so much. But I still figured that we should have an idea about how much money we’re talking about, right?

So, working with Associate Editor Steve Sweeney, we carefully figured out that Harrison is proposing to trim NS’s operating ratio by a grand total of $1 billion. To break it down, right now NS rakes in $11.6 billion and has operating expenses of a little over $8 billion. Assuming the revenue stays the same but the costs drop to $6.9 billion, he’d come up with an operating ratio of 60 percent. That’s about $119.5 million per percentage point or about $1 billion total. That’s a lot of money.

What does that mean to an individual share of NS stock? If you divide the cash among NS’s 308 million outstanding shares it is about $3.48 a share. Of course, nobody owns just one share of stock. There are 29,575 shareholders, so on average, the deal is worth about $36,348. The more shares you own, of course, the more money you stand to make.

The question is, can you keep revenues steady — or better yet, grow them — while you cut costs? It does seem to be possible. CP says that while it was cutting operating costs, the operating ratio dropped 13 percent from 77 in 2012 to 64 in 2014. Meanwhile, revenues jumped from $5.6 billion to $6.6 billion.

Can the same be done on an eastern carrier like NS? I suspect so, and sooner than later. My guess is that we’ll see NS’s operating ratio drop quickly in 2016 as the company works to whittle down its expenses and works hard to grab more carload and intermodal traffic. Without that boost in revenue, there’s just that much more to cut to achieve the same results.