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Investment Overview for CSX Corporation (NYSE:CSX)
Below are the key drivers of CSX's value that present opportunities for upside or downside to the current Trefis price estimate:
- CSX's EBITDA margin: We currently forecast CSX's EBITDA margin to increase from 38.7% in 2014 to 44% by the end of the Trefis forecast period, primarily driven by productivity initiatives being undertaken by the company. CSX plans to achieve operating ratio in the high-60′s by 2015 and mid-60′s over the long term by undertaking productivity and efficiency initiatives.
Growth in chemicals, automotive and intermodal segment is supporting revenue growth for railroads. The intermodal segment, although less profitable than coal freight, carries high incremental margins as train lengths are extended. This is because the additional costs associated with adding containers and trailers to existing trains is low, particularly in comparison to the revenue potential. The recent double-stack initiatives further provide upside to margins.
There could be a downside of nearly 10% to the Trefis price estimate if the volume growth is below expectations due to lower-than-expected economic growth and the EBITDA margin only improves marginally to 40% at the end of Trefis forecast.
- U.S. Rail Carloads of Coal: We currently forecast U.S. Rail Carloads of Coal to increase from 7.3 million in 2014 to 8.1 million by the end of the Trefis forecast period, as we expect an eventual recovery in domestic coal demand and solid export coal demand.
There could be a downside of more than 8% to the Trefis price estimate if U.S. Rail Carloads of Coal decrease to 7 million by the end of the Trefis forecast period. This could happen if a large number of utilities shift to natural gas (instead of coal)and in the event of lower than expected economic growth.
CSX is the leading railroad in the Eastern U.S., engaged primarily in freight transportation in the Southeast, East, and Midwest regions of the U.S. CSX also transports overseas freight through Atlantic and Gulf Coast ports in addition to providing freight to the Western U.S. through interchange with other railroads.
CSX’s rail network of more than 20k route miles serves many large population centers in 23 states east of the Mississippi River in addition to Washington DC, Ontario and Quebec. CSX's primary competitor is Norfolk Southern, which covers much of the same territory.
We have broken up our analysis of CSX into six major business segments: Coal Freight; Industrial Freight (which includes chemicals); Agricultural Freight; Intermodal Freight (freight which can be switched from train to another mode of transport like ships); Housing and Construction Freight; and Other Services which include revenue from railroads that the company does not directly operate, revenue for customer volume commitments not met and other items.
CSX's customers include steamship lines, vehicle manufacturers, agricultural companies, utilities, intermodal companies and chemical manufacturers.
We believe the Industrial Freight and Intermodal divisions are the most valuable divisions and contribute around half of CSX's total value. The key factors responsible for this are:
Tightening trucking capacity
Declining fleet sizes and a lack of truck drivers have significantly tempered the freight transport capacity of the trucking industry. The Hours-of-Service safety regulation for commercial vehicle drivers has also put pressure on trucking capacity by limiting the number of working hours for truck drivers. The tight trucking capacity will lead to high volumes of freight shifting to railroads. As the demand for railroads’ services increase, so will their pricing power.
Growth in the U.S. economy
The U.S. has seen healthy growth in the past few years, driven by growth in sectors such as automotive, industrials and housing. The growth in crude oil and natural gas production have also had a major role to play. CSX has benefited from this growth through an increase in carloads for its Industrials, Housing & Construction and Automotive segments. The IMF forecasts the U.S. output to grow 3.1% in 2015 and 2016, compared to 2.4% in 2014, which indicates that the growth in these sectors is likely to persist. (Link) This should help drive CSX carloads in the coming years.
Growing demand for railroad services
The railroad industry has been booming in the past few years as a result of economic recovery. The tight trucking capacity has further increased the demand. As a result, the railroad industry expects to see continued growth in its carloads over the next few years.
Consistent pricing improvements
The pricing power of railroads with the long standing exemptions from regulation has been a key issue in the success of railroads. In the present time, railroads have a significant upper hand in terms of pricing. The growing U.S. economy and tight trucking capacity have given railroads enough leverage to increase prices. Railroads have steadily improved rates during the past 10 years primarily through contracts renewals and repricing. Most rails claim to follow railroad cost inflation plus pricing.
Weak coal market
Coal segment volumes were down in 2013, owing to increased competition from natural gas, high inventory levels and reduced demand for overall electricity generation. These trends had reversed in 2014 as a result of a spike in natural gas prices and extreme weather conditions. However, in 2015, things are going back to how they were 2 years back. Natural gas prices have plummeted and the weather conditions are mild. As a result, utilities have shifted to natural gas for power generation, leading to a pile up of coal inventory. Export demand continues to remain weak, with thermal and metallurgical coal prices falling to six year lows.
Declining fuel prices
The falling fuel prices have acted as a double-edged sword for the railroad industry. On the one hand it has reduced the fuel surcharge that railroads add to their prices, thereby eating into their top line, while on the other, it has reduced fuel expenses, leading to improved operating income.
Labor contract negotiations at the West Coast
Earlier in the year, disputes between the ILWU and PMA regarding labor contract negotiations had led to disruptions in operations at the West Coast. Though negotiations have ended, there is now a significant backlog at the West Coast, which would take a few months to clear out and for operations to return to normal. This should impact the railroad industry.
How Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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