Harsh Winter Weather May Impact CSX’s Earnings

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CSX (NYSE:CSX), a leading railroad in the eastern U.S., is set to release its first quarter 2014 results on April 16. Its first quarter earnings may be suppressed due to higher operating costs incurred during the harsh winter weather this season. CSX believes that the volume and revenue impact of the harsh weather can be recovered over the coming quarters. However, growth in earnings per share for the full year will be somewhat moderate compared to the company’s earlier guidance of 10-15%. [1]

Domestic coal shipments, which have been a declining throughout 2012 and 2013 due to a shift towards cheaper natural gas and overhanging coal inventories, may see a turnaround this quarter. Additionally, chemicals, intermodal, agriculture and automobile shipments will continue to drive growth in volumes. However, export coal shipments and construction material shipments will be low.

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Revisiting Fourth Quarter 2013

CSX’s revenue grew 5% in the fourth quarter of 2013 to reach $3 billion. This was mainly driven by growth in revenue and volumes of intermodal and merchandise shipments. [2] However, the company’s net earnings for the quarter declined 5%, resulting in a decrease of 2 cents in earnings per share. This was due to the favorable impact that an after-tax real estate gain had in the fourth quarter of 2012. CSX’s operating ratio, which is its operating expenses expressed as a percentage of revenues, increased by 1.4% compared to the previous year’s fourth quarter, to reach 73.2%. [2]

Operational Costs Will Rise Due To The Harsh Weather

In order to facilitate smooth functioning of the railroad and timely delivery of shipments during the harsh winter, CSX has had to increase crew and locomotives employed. Increase in crew combined with a 50% increase in overtime will heavily impact labor and fringe expense, which accounts for around a third of CSX’s operational costs.

In the previous quarter equipment & other rental expense declined 2% and the average cost of fuel declined 7%.  However, due to the increase in locomotive count in the first quarter 2014, equipment & other rental expense and fuel expense are expected to increase. [1] Increases in operational costs will heavily impact CSX’s operating ratio for the quarter. Despite the impact of higher costs in the first quarter, CSX believes that it will still be on track to achieving its target operating ratio of high-60’s by 2015.

Domestic Coal Shipments May Turnaround Whereas Export Coal May Present Headwinds

Domestic and export coal shipments remained depressed in the fourth quarter of 2013. However, domestic coal shipments are expected to improve in the first quarter 2014 due to increased price of natural gas and easier comparison to last year’s heavily depressed volumes. In the first nine weeks of the first quarter, CSX’s domestic coal shipments grew 1% year over year. [1] Lately, natural gas prices have risen due to increasing demand and the harsh winter weather this season. This has partially eroded the price advantage that natural gas had over coal. If natural gas price stays above $3.50, around 50% of CSX’s domestic coal business will remain profitable. This includes coal sourced from the Powder River Basin and the Illinois Basin.

Export coal shipments will continue to present headwinds for CSX. In the first nine weeks of the first quarter, export coal shipments declined 16% due to competition from Australian coal which has impacted the global export share of U.S. coal. Also, coal demand from Europe, the largest regional importer of U.S. coal, has been low due to the continuing weakness in its economy.

Merchandise And Intermodal Businesss Will Continue To Grow

CSX’s merchandise and intermodal businesses have helped in offsetting declines in its coal business throughout 2013.  Looking at the trends, we believe that they will continue to drive growth in 2014 as well. Merchandise business includes shipments of construction material, agricultural products and food grains, paper, automotives, and chemical shipments. In the previous quarter, merchandise shipments grew 7% driven by strong growth in its end markets. During the first nine weeks of the first quarter, almost all merchandise shipments have performed well, however partially impacted by the winter weather. Shipments for construction material like crushed stone, sand gravel have been depressed due to the harsh winter weather which had a severe impact on the housing construction industry where housing starts declined from 1 million units in Dec 2013 to 0.9 million units in February 2014. [3] CSX’s construction material shipments declined 2% year over year in the first nine weeks of the first quarter 2014. [1] We expect to see  moderate growth of mid-single digits in the merchandise shipments and volume in the first quarter.

Intermodal business is a long term growth driver for CSX. However, during the first nine weeks of the first quarter, intermodal shipments grew moderately by 2% due to the negative impact of the harsh weather. Revenue from the segment will be heavily impacted by the low growth in volume in the first quarter.

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Notes:
  1. Fredrik Eliasson Addresses J.P. Morgan Aviation, Transportation and Industrials Conference, March 12 2014, www.csx.com [] [] [] []
  2. CSX Fourth Quarter 2013 Financial Report, January 15, 2013 [] []
  3. Housing Starts Data, www.census.gov []