CSX Posts Earnings Growth Despite Weak Coal Revenues

CSX Corporation (NYSE:CSX), a leading railroad company in the eastern U.S., posted net earnings growth of 2% annually in Q3 2013. Its revenue rose by 4% to around $3 billion on a 3% and 1% rise in volume and revenue per unit (RPU), respectively. Strong growth in the merchandise and intermodal businesses helped the company offset the significant decline in the coal business.

The operating ratio stood at 71.5% in Q3, which was 100 basis points higher compared to the prior year. The ratio was impacted by factors such as higher incentive compensation, inflation, volume-related expenses and cycling of prior year’s real estate gains. CSX targets to achieve an operating ratio in the high-60’s by 2015 and mid-60’s in the long term. It is focusing on aspects such as safety, service, efficiency and above-inflation pricing to achieve this goal.

CSX forecasts stable to favorable market conditions for 79% of its overall volumes in the fourth quarter. In an encouraging sign, the company now expects earnings per share (EPS) in 2013 to be slightly higher compared to the prior year. Previously, it expected 2013 EPS to be in line with the previous year. Moreover, it continues to forecast 10%-15% CAGR increase in its EPS over 2014 to 2015. While we believe these goals are achievable, the headwinds in the coal market could present challenges to the company in meeting these targets.

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Intermodal Business Showed Significant Growth

CSX’s intermodal revenue rose by 8% in Q3, driven by 6% growth in volume coupled with a 2% increase in RPU. Domestic intermodal volumes grew by 9% due to increased business with existing customers as well as continued truck-to-rail conversions. International volumes rose by 3% owing to new business with existing customers as well as new service offerings. ^[1]

We expect the intermodal business to be a long-term growth driver for CSX, thanks to the massive highway-to-rail conversion opportunity present in the market coupled with the company’s investments to increase its capacity in this area.

Heavy Decline In The Coal Business Impacted Overall Results

CSX’s coal revenue fell by 9% in Q3 2013 due to a decline in both domestic and export coal businesses. CSX’s domestic coal business showed a 7% volume decline due to reduced demand for electricity and high inventory stockpiles in the Southern utilities. CSX’s export coal volume fell by 10% due to lower demand for U.S. thermal and metallurgical coal in international markets. Moreover, the RPU declined by 2% in the coal business due to pricing pressure in the export coal market. ((CSX CEO Discusses Q3 2013 Results – Earnings Call Transcript, Seeking Alpha, October 16, 2013))

In the fourth quarter, CSX’s export coal business is forecast to grow marginally primarily on weak y-o-y comparisons. However, pricing in this segment will continue to be impacted by lower demand for U.S. coal in the international markets. Finally, CSX’s domestic coal business will continue its decline in the fourth quarter because of competition from natural gas and high inventory stockpiles.

Strong Growth In Chemicals, Automotive And Housing & Construction Boosted Merchandise Revenue

Merchandise revenue increased by 7% in Q3 2013 due to a 5% rise in volume and 2% growth in RPU. Strong growth in this segment was buttressed by strength in the chemicals, automotive, metals, and housing and construction markets.

• CSX’s chemical revenue expanded by 11% owing to increased shipments of crude oil, frac sand and liquefied petroleum gas. We expect the strong growth in this segment to continue due to expansion in the U.S. oil and gas industry.
• Metal revenue rose by 6% due to growth in domestic steel production and modal conversions. A favorable outlook is expected in this business in the fourth quarter due to the same drivers.
• The automotive business showed 6% revenue growth, primarily on a 5% increase in RPU as volume growth was slower at 1%. While the North American light vehicle production rose annually during the quarter, the volume growth was impacted by competitive losses. The company expects a neutral outlook in this business in the fourth quarter as the overall growth in the industry will be offset by competitive losses.
• A slight decline in agricultural shipments was seen during the third quarter due to the continued impact from last year’s drought. Ethanol shipments were impacted by reduced demand for gasoline and lower production levels. Agricultural products shipments are expected to show solid growth in the fourth quarter with an increase in corn output.
• CSX’s housing and construction segment saw significant growth in Q3 on account of a recovery in the housing market and increased construction activity. This business is expected to see a mixed performance in the fourth quarter as minerals shipments will be impacted by difficult y-o-y comparisons. However, shipments of forest products could continue to rise with a recovery in housing and construction activity.

We are in the process of updating our $25.59 price estimate for CSX’s stock.

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1. CSX CEO Discusses Q3 2013 Results – Earnings Call Transcript, Seeking Alpha, October 16, 2013 [↩]