Weak Export Coal Market Will Impact CSX’s Earnings

CSX Corporation (NYSE:CSX), a leading railroad company in the eastern U.S., is scheduled to report its Q2 2013 results on July 16, 2013. Its net income grew 2% annually in Q1 2013, primarily due to improvement in operating ratio, as the revenue was flat as compared to the previous year.

In Q2, CSX will face several headwinds in the export coal market on account of difficult y-o-y comparisons and lower volumes due to weak international coal prices. In addition, the weak demand in this sector could also impact coal revenue per unit (RPU). The overall volumes in the second quarter will be driven by high demand in the intermodal and chemicals businesses. In addition, a slight recovery is being seen in the housing and construction as well as agricultural markets, which is expected to positively impact volumes during the quarter.

We will closely track CSX’s operating ratio in Q2 as certain expense related challenges are expected to play out starting from the second quarter. The company forecasts EPS in 2013 to be flat to slightly down compared to the prior year.

See our complete analysis of CSX here

Recap of Q1 2013 Results

CSX posted revenue of around $3 billion in Q1 2013, which was in line with the previous year. Revenue growth in the intermodal and merchandise businesses was offset by weakness in the coal business. However, the company’s net earnings rose by 2% annually to $459 million during the quarter. Its operating ratio declined from 71.1% in Q1 2012 to 70.4% in Q1 2013, and helped the company achieve this earnings growth.

CSX targets operating ratio in the high-60’s by 2015 and expects efficiency gains of over $150 million in 2013. This is another item to watch in this release. We expect certain challenges on the expense side during the rest of 2013, on account of difficult y-o-y comparisons and higher incentive compensation charges.

While some recovery is expected in the domestic coal market, export coal market will present headwinds

During the first nine weeks of Q2 2013, CSX’s domestic coal volumes saw 3% annual growth as compared to 14% decline in the first quarter. The company is seeing higher shipments from coal basins, such as the Powder River Basin and Illinois Basin due to increase in natural gas prices. Easier y-o-y comparisons will also positively impact domestic coal volumes growth in Q2 2013. While some recovery is being seen in the domestic coal market, CSX still estimates domestic coal volumes to fall by 5%-10% annually in 2013.

The export coal market will present challenges to CSX during the rest of 2013. CSX’s export coal volumes fell by 16% during the first nine weeks of Q2 2013, after dropping by 3% in the first quarter. Difficult y-o-y comparisons and a decline in coal exports due to weaker coal prices in the international market have contributed to this change. CSX forecasts export coal volumes to drop by 16% annually in 2013.

Growth in the intermodal and chemicals businesses represent growth drivers for CSX

The intermodal segment presents huge growth opportunities for CSX on account of a 9 million truckload domestic truck to rail conversion opportunity in the eastern region and rising U.S. international trade. ^[1] CSX aims to tap high demand in this segment by expanding and opening new terminals to add capacity.

CSX’s intermodal volumes rose by 2% during the first nine weeks of Q2 2013, on account of 4% increase in domestic business, coupled with 1% growth in the international business. We estimate CSX’s intermodal volumes to rise by 3%-5% annually over our forecast horizon.

CSX is seeing high demand in the chemicals business on account of growing shipments of crude oil, liquefied petroleum gas (LPG) and frac sand. We expect the strong demand to continue in this business throughout 2013, driven by rising crude oil transportation by rail. In addition, the shale gas boom being witnessed in North America is also driving shipments of plastics and chemicals.

Housing and construction sector, and agricultural market are seeing some recovery

CSX’s volumes in the housing and construction segment saw 2% growth during the first nine weeks of Q2 2013, as compared to 1% decline in Q1 2013. The ongoing housing recovery in the U.S. is fueling shipments of aggregates (which includes crushed stone, sand and gravel). We expect the housing recovery to be a demand driver for this segment throughout 2013.

Supported by higher shipments of phosphates and fertilizers, CSX’s agricultural volumes posted 1% annual growth during the first nine weeks of Q2 2013, compared to 5% decline in the previous quarter. We expect this segment to grow at a higher rate in the second half of 2013, owing to easier y-o-y comparisons and a normal crop output.

Our $23.10 price estimate for CSX represents around 5% downside to the current market price.

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1. CSX Corporation’s CFO Presents at Deutsche Bank Global Industrials and Basic Materials Conference (Transcript), Seeking Alpha, June 12, 2013 [↩]