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Investment Overview for CSX Corporation (NYSE:CSX)
WHAT HAS CHANGED?
Two important factors have impacted the business prospects of railroad companies such as CSX over the past few quarters -- weak fuel prices and weak coal shipments. Whereas weak fuel prices have helped prop up CSX's profitability, declining coal shipments are a point of concern for all rail companies, including CSX.
- Weak fuel prices have impacted operations
- Crude oil prices have weakened considerably over the course of the last twelve months, as a result of a global supply glut. This has negatively impacted the fuel surcharge revenues for CSX, which are tied to diesel fuel prices. However, low fuel prices have also helped reduce operating costs for CSX, adding to the effect of other company initiatives to enhance operating efficiency. As a result, the company's operating ratio (operating expenses as a % of revenue) improved 180 basis points year-over-year in 2015.
- Declining coal shipments
- A combination of an adverse regulatory environment and weak natural gas prices has undermined the demand for coal. As a part of the federal government's crackdown on carbon dioxide emissions, it is targeting a 32% reduction in power plant carbon dioxide emissions from 2005 levels by 2030. Since coal based thermal power plants have a higher emissions intensity as compared to natural gas based thermal power plants, the prevailing regulatory environment favors natural gas, instead of coal, as the preferred fuel for electricity generation. In addition, weak natural gas prices have accelerated the shift towards natural gas as the preferred fuel for electricity generation. These developments have lowered the demand for coal, which has negatively impacted CSX's coal shipments, which declined 16% in 2015.
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 an operating ratio in the mid-60′s over the long term by undertaking productivity improvement initiatives.
Growth in chemicals, automotive, and intermodal segment is supporting revenue growth for railroads. The intermodal segment 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 an upside of roughly 5% to the Trefis price estimate if margin growth as a result of productivity improvement is above expectations and margins improve to 46% by the end of the Trefis forecast period as opposed to 44% in our base case forecast.
- U.S. Rail Carloads of Coal: We currently forecast U.S. Rail Carloads of Coal to decrease from 7.3 million in 2014 to 6.1 million by the end of the Trefis forecast period, as we expect a continuous decline in demand for thermal coal.
The decline in demand for thermal coal could be sharper than expected, particularly if gas prices remain subdued. If U.S. rail carloads of coal decline to 4 million tons by the end of our forecast period, as opposed to 6 million in the base case, it would imply a 6% downside to our price estimate.
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 20,000 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 inadequate availability 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 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 2.6% in 2016 and 2017, following on from 2.5% in 2015, which indicates that the growth in these sectors is likely to persist. (Link) This should help drive CSX carloads in the coming years.
Weak coal market
CSX's coal shipments declined 16% in 2015, as the demand for thermal coal fell sharply. A combination of an adverse regulatory environment and weak natural gas prices has undermined the demand for coal, with utilities shifting towards natural gas as their preferred fuel for electricity generation. Besides the decline in demand for thermal coal, the demand for metallurgical coal, which is used in steel production, has also weakened considerably. Oversupplied global markets, plummeting steel prices and a strong U.S. Dollar have weakened met coal shipments, most of which are meant for export markets.
Decline in fuel prices
The decline in fuel prices has been a double-edged sword for the railroad industry. On 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, which has helped offset the impact of lower fuel surcharge revenues on profits. The decline in fuel surcharge revenues has resulted in a decline in average revenue per carload across shipments of various commodities despite core pricing gains in the case of certain commodity shipments.
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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