CSX Corporation (NYSE:CSX), a leading railroad company operating in eastern U.S., announced that its operating ratio for the fourth quarter of 2013 grew by 140 basis points year on year to 73.2%.  Also, its full year operating ratio increased by 50 basis points to 71.1%. Operating ratio is an important measure of efficiency in the railroad industry and impacts the bottom line profitability. It is the railroad’s operating expenses expressed as a percentage of its revenue. A higher percentage indicates lower efficiency in managing expenses. The increase in CSX’s operating ratio is a matter of concern since it represents a step backward from the company’s aim to achieve operating ratio in the high 60′s by 2015.
For the fourth quarter 2013, CSX’s operating expenses grew 7% year on year to reach $2.2 billion.  The increase in labor & fringe expenses, depreciation, materials, supplies and other expenses was partially offset by the decline in fuel, equipment and rent expenses. The growth in operating expenses outpaced growth in revenue which led to an increase in the fourth quarter operating ratio.
In this article we look at the factors that impacted CSX’s operating ratio and its outlook in 2014.
Labor & Fringe Expenses
CSX’s labor and fringe expenses, which accounted for 36% of the total operating expenses in the fourth quarter, consist of employee compensation and benefit programs. Factors such as inflation, employee headcount, wage rates, incentives, healthcare and pension costs impact this category.
Labor and fringe expenses increased 7% in the fourth quarter due to higher incentives, training expenses and inflation.  In addition, the higher volume in agricultural shipments led to an increase in crew members, driving up expenses.
In the first quarter of 2014, CSX expects employee levels to remain stagnant.  Inflation-related costs are expected to grow. However, there would be no incentive compensation to increase costs.
Material, Supplies and Other Costs
CSX’s material and supplies expenses relate to materials and services contracted to maintain infrastructure and equipment. These expenses accounted for 28% of the total operating expenses in the fourth quarter of 2013. Other costs involve casualty claims, train accidents, property and sales taxes. Material and supplies expenses are highly volume dependent.
CSX’s material and supplies expenses grew 17% in the fourth quarter due to higher volumes and inflation.  Also, a gain on real estate sale that occurred in the fourth quarter of the previous year helped bringing down material and supplies expense, thereby having an unfavorable impact on this quarter’s expense.
Material, supplies and other costs will continue to be impacted by the real estate sale gains through the first half of 2014.  Additionally, inflation and volume related increase in expenses will present headwinds.
Fuel expenses, which include diesel for locomotives as well as non-locomotive fuel, are driven by market price of diesel fuel and locomotive consumption. Fuel accounted for 18% of the overall operating expenses in the fourth quarter of 2013. Fuel expenses declined in the fourth quarter due to lower fuel prices but were slightly offset by the higher consumption, driven by an increase in volume of shipments. The average cost of fuel declined 7% whereas average consumption increased 3.6%.
The U.S Energy Information Administration forecasts diesel price to fall in 2014.  Depending on CSX’s efficiency in fuel consumption, an increase in volume of shipments may offset declines in fuel prices.
Depreciation and Equipment & Other Rents
Depreciation and equipment & other rents accounted for 12.6% and 4.2%, respectively, of the total operating expense in the fourth quarter of 2013. Depreciation relates to realizing the cost of capital assets such as locomotives, railcars and tracks over their useful lives and is impacted by ongoing capital expenditures. Depreciation expense increased 4% in the fourth quarter due to a larger asset base. Equipment & other rents include rent and leases paid for use of freights cars and locomotives owned by other railroads or companies. These expenses declined 2% in the fourth quarter due to better asset utilization.
In 2014, CSX intends to invest $2.3 billion in 2014 towards capital expenditure.  A majority of this expenditure will be towards maintenance of infrastructure and the rest on locomotives and freight cars. We expect depreciation expense to increase in 2014 due to a larger asset base. However, equipment & other rents may decline.Notes: