It's no understatement to say that the earnings warning from Norfolk Southern (NYSE:NSC) spooked investors in the rail sector and focused a great deal more attention on fellow East Coast operator CSX (NYSE:CSX). And yet, a company that still carries historical baggage from below-peer operating performance managed to deliver a satisfactory quarter. Although this rail company is still vulnerable to weakness in coal volume, it may not be a bad pick for investors who want to make a leveraged play on a better economy.
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Results Weren't Great, but Could Have Been a Lot Worse
Coal remains the elephant in the room for eastern rail operators, as volumes continue to fall significantly. That said, while CSX's revenue was a bit light this quarter, the company delivered a solid bottom line result on better expense control.
Revenue fell a little more than 2% this quarter on balanced declines in both carload volume and yields. Intermodal revenue was up nearly 10% (on an 8% volume improvement), but this is still less than 15% of the total.
Despite the volume and yield headwinds, CSX continues to strip out costs. Operating income was down 3% and the railroad saw its operating ratio worsen by 10 basis points to 70.5%.
SEE:Understanding The Income Statement
ABC - All About Coal
Even with double-digit declines, coal is still 20% of total carload volume and one-third of non-intermodal volumes. So whatever happens to coal has a major influence on CSX ... and right now coal is weak indeed. Coal volume plunged another 16% this quarter, pricing fell and export volumes dropped 25% from the second quarter (though they were still up strongly from last year).
Unfortunately, management didn't have a lot of great things to say about the near-term coal outlook. Although the company's contract positions on coal are okay, it doesn't seem like higher natural gas prices are doing much to help utility demand. What's more, export coal demand is predictably unpredictable and can't really be counted on as a reliable positive driver.
On the other hand, current conditions for nearly 60% of the company's volume can be described as "positive," with good outlooks for intermodal, chemicals, forest products and fertilizers. While companies such as J.B. Hunt (Nasdaq:JBHT) and Hub Group (Nasdaq:HUBG) are more leveraged to intermodal trends, it's still an important profit-improver for CSX. It's also worth noting that, outside of coal, yields were up nearly 4%.
Can CSX Hit Ambitious Expense Targets?
While CSX's operating ratio worsened a bit and stands above 70% (Union Pacific (NYSE:UNP) just reported an operating ratio nearly four points better), management remains confident with its long-term 65% goal.
That's a challenging goal, but the company is making progress. Cost-per-employee fell 3% from last year's third quarter, while fuel consumption fell 4% (against a 1% carload volume decline). What's more, service metrics such as on-time performance continue to improve.
SEE: Earning Forecasts: A Primer
The Bottom Line
I do believe in the long-term potential of intermodal as a profit center for railroads, and I likewise believe that rail companies such as CSX are in a good position to not only benefit from an ongoing improvement in the U.S. economy, but also to take more share from trucking companies like YRC Worldwide (Nasdaq:YRCW) and Werner (Nasdaq:WERN).
Although both expectations and CSX's stock price have come down in the last quarter, the shares are at a somewhat equivocal price-value point. Assigning a basically average multiple to 2013 EBITDA suggests a fair value of about $24.50, with a confidence interval of about $2 above and below. That doesn't scream "buy" to me, but it is close enough to make it worth watching, and I can understand if investors look at these recent declines as an opportunity to reload ahead of better economic data.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.
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