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.

Discount Brokers Comparison: Your one-stop shop for finding the perfect broker for your investments.

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.

Related Articles
  1. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  2. Markets

    PEG Ratio Nails Down Value Stocks

    Learn how this simple calculation can help you determine a stock's earnings potential.
  3. Investing Basics

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  4. Investing

    What’s the Difference Between Duration & Maturity?

    We look at the meaning of two terms that often get confused, duration and maturity, to set the record straight.
  5. Economics

    Is Wall Street Living in Denial?

    Will remaining calm and staying long present significant risks to your investment health?
  6. Stock Analysis

    When Will Dick's Sporting Goods Bounce Back? (DKS)

    Is DKS a bargain here?
  7. Investing News

    How AT&T Evolved into a Mobile Phone Giant

    A third of Americans use an AT&T mobile phone. How did it evolve from a state-sponsored monopoly, though antitrust and a technological revolution?
  8. Stock Analysis

    Home Depot: Can its Shares Continue Climbing?

    Home Depot has outperformed the market by a wide margin in the last 12 months. Is this sustainable?
  9. Stock Analysis

    Yelp: Can it Regain its Losses in 2016? (YELP)

    Yelp investors have had reason to be happy recently. Will the good spirits last?
  10. Stock Analysis

    Is Walmart's Rally Sustainable? (WMT)

    Walmart is enjoying a short-term rally. Is it sustainable? Is Amazon still a better bet?
  1. What does low working capital say about a company's financial prospects?

    When a company has low working capital, it can mean one of two things. In most cases, low working capital means the business ... Read Full Answer >>
  2. Do nonprofit organizations have working capital?

    Nonprofit organizations continuously face debate over how much money they bring in that is kept in reserve. These financial ... Read Full Answer >>
  3. Can a company's working capital turnover ratio be negative?

    A company's working capital turnover ratio can be negative when a company's current liabilities exceed its current assets. ... Read Full Answer >>
  4. Does working capital measure liquidity?

    Working capital is a commonly used metric, not only for a company’s liquidity but also for its operational efficiency and ... Read Full Answer >>
  5. How do I read and analyze an income statement?

    The income statement, also known as the profit and loss (P&L) statement, is the financial statement that depicts the ... Read Full Answer >>
  6. Can working capital be too high?

    A company's working capital ratio can be too high in the sense that an excessively high ratio is generally considered an ... Read Full Answer >>

You May Also Like

Trading Center