CSX May Miss Its Target Of Achieving A High 60’s Operating Ratio By 2015

CSX Corporation’s (NYSE:CSX) first quarter 2014 operating expenses increased $190 million due to high costs associated with weather disruptions and inflationary pressure on input costs. This led to a 5.2% increase in the company’s operating ratio, which reached 75.5%. ^[1] Operating ratio is the railroad’s operating expenses expressed as a percentage of its revenue. A lower percentage indicates higher efficiency in managing expenses. During the first quarter earning’s meet, the company’s management showed apprehension regarding meeting its target for a high 60’s operating ratio by 2015 due to the huge increase in expenses. ^[2] CSX’s management believes that its operating expenses may remain high in the coming quarter. Combined with the declining revenue per unit, we believe it may be a difficult task for CSX to achieve its target operating ratio. In this article, we look at the factors affecting CSX’s operating ratio and their outlook.

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Increased Operating Costs And Low Revenue Per Unit Contributed To Higher Operating Ratio

In order to facilitate smooth functioning of the railroad and timely delivery of shipments during the harsh winter, CSX had increased crew and locomotives employed. Around 75% of the $47 million increase in CSX’s labor and fringe expenses can be attributed to an increase in crew combined with a 50% increase in overtime due to the weather conditions. ^[1] Weather disruptions and recognition of sale of a rail corridor in the previous year drove up material, supplies and other costs.

Fuel expenses increased $2 million dollars due to a 4.8% increase in consumption driven by the cold weather. However, this was considerably offset by a decline in the average price per gallon, which decreased 5% compared to the first quarter of the previous year. Equipment rent was up 6% to $101 million due to the weather’s impact on the network and higher locomotive lease expense as active fleet was increased to minimize service disruption.

Low revenue per unit indirectly added to the pressure on CSX’s operating ratio since it negatively impacted overall revenues. In the first quarter, CSX’s revenue per unit declined 1% due to an unfavorable mix in its intermodal and coal segments. Door-to-door domestic intermodal shipments, which command high revenue per unit, declined due to the severe weather during the winter.

Low export coal pricing led to an unfavorable impact on coal revenue per unit which declined 8%. ^[3] Export coal prices have been low in order to keep U.S. coal competitive in the global markets. Domestic coal demand grew only in the northern utilities, which commands low revenue per unit for coal due to its short haul. Demand from southern utilities continued to suffer from the coal inventory overhang.

Outlook For Expenses And Volume Mix

The impact of the higher operating expenses in the first quarter is expected to spill over into the second quarter since the company is yet to recover from the effects of the weather disruption. CSX’s performance metrics such a terminal dwell and network velocity still remain below the previous year’s quarter-to-date numbers. ^[4] Inflationary pressures on input costs will also contribute to the increase in expenses. However, company’s management believes that the increase in operating expenses will be moderate and expects to see some improvement in the second half of the year. ^[2]

CSX’s coal volume mix is not expected to become favorable any time soon due to the uncertainty around the export and domestic coal market. If export coal prices remain low and demand for coal from southern utilities does not recuperate, coal revenue per unit may remain suppressed. This will present significant headwinds in improvement of CSX’s operating ratio. CSX may get help from growth in its intermodal and general merchandise shipments, however, past trends suggest that growth in these segments has been offset by declines in coal revenue per unit.

Overall, it seems unlikely that we will see any major improvements in CSX’s operating ratio in 2014 that would suggest that the company may be able to achieve its target. Any improvements in 2015 will be highly dependent on growth in revenue per unit across CSX’s segments. The high operating ratio will be a matter of concern over the coming quarters since it directly impacts profitability of the company.

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1. CSX First Quarter 2014 Financial Report, April 15 2014, www.csx.com [↩] [↩]
2. CSX’s CEO Discusses Q1 2014 Results – Earnings Call Transcript, April 16 2014, www.seekingalpha.com [↩] [↩]
3. CSX First Quarter 2014 Financial Report , April 15 2014, www.csx.com [↩]
4. CSX Transportation Weekly Performance Report, www.railroadpm.org [↩]