Tickers in this Article: CSX, NSC, UNP, ACI
Although rail stocks have come a bit off their highs, particularly the eastern operators, Wall Street still remains pretty bullish on the prospects of rail continuing to take share from trucking. With that, an in-line quarter for CSX (NYSE:CSX) isn't likely to change the story much in either direction. Improvements in the coal business next year, a continued housing recovery, and ongoing growth in the intermodal business should all lead to better volume and operating profits, but the stock's valuation indicates that Wall Street is already counting on that happening.

Second Quarter Results Come In On Target
While there were some line by line deviations relative to estimates, CSX came in basically as expected for the second quarter, which will likely give investors a bit more confidence about the upcoming earnings from other railroads like Norfolk Southern (NYSE:NSC), Union Pacific (NYSE:UNP), and Kansas City Southern (NYSE: KSU).

SEE: A Primer On The Railroad Sector

Revenue rose 2% this quarter, as growth was nearly evenly balanced between carload (volume) and yield (price) growth. Carloads rose 1% as merchandise volumes improved 3%, auto improved 2%, intermodal improved 4%, and coal/iron ore volume declined 6%. Pricing was a little more consistent, as merchandise yields improved 1%, auto rose 3%, coal was up slightly, and intermodal improved 2%. All told, this was very much as expected as chemicals and fertilizer traffic was a little higher, but a few other categories were slightly softer than expected.

Profitability was likewise more or less as expected. Reported operating income rose 2%, though ex-items it was down less than 1%. Either way, the operating ratio was still below 70 and still better than the first quarter, though the adjusted number was slightly worse than the year-ago level. EBITDA was up 1% from last year and CSX saw a slight improvement in fuel costs relative to the year-ago quarter.

Coal Still Uncertain
Coal is a major part of the volume for every Class I railroad and still a major talking point in the industry. Between the rail traffic numbers, the utility stockpile data, and the comments from coal companies like Arch Coal (NYSE:ACI) and Peabody (NYSE:BTU), I would be cautiously optimistic that U.S. utility coal demand is on the way back.

That would certainly help explain part of the 9% increase in domestic utility volume this quarter for this quarter. It's also worth noting that the exceptional heat in the Northeast right now could help demand, as utility stockpiles were already relatively low (at least compared to the levels of recent years). Likewise, it's worth noting that CSX has shifted its coal exposure away from the Appalachian region such that Illinois Basin and Powder River Basin coal is about 50% of the mix.

SEE: A Clear Look At EBITDA

Export coal volumes are still a big unknown and a big deal to both CSX and Norfolk Southern at roughly one-third and one-quarter of coal volumes, respectively. A recovery in the steel industry would certainly help met coal demand, but I don't know how likely that is for 2014. I do believe, though, that thermal volumes could turn around if/when the economy in Europe improves.

The Bottom Line
I understand the bull story for the railroads and intermodal companies like J.B. Hunt (Nasdaq: JBHT). My only real issue with it is the extent to which the magnitude of the truck-to-rail shift is already reflected in the prices of the stocks.

SEE: Intermodal Growth Continues To Push J.B. Hunt Higher

If CSX gets a 7x multiple to forward EBITDA (above the long-term average), the fair value for the shares is about $24. A multiple of 7x or 7.5x (which would lead to a $26.50 target price) would normally be pretty good for a railroad, but investors have been willing to go higher to factor in the growth and profit potential of drivers like crude over rail, intermodal, and the housing recovery. That's fair enough, I suppose, but I won't pay more than 7.5x for a stock in a cyclical, economically-sensitive, derived demand industry with high capex needs, so I won't be buying CSX shares for my own account any time soon.

comments powered by Disqus

Trading Center