Strong Intermodal and Merchandise Growth Drives CSX’s Earnings

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CSX Corporation (NYSE:CSX) recently announced its second quarter 2014 earnings reporting strong growth in revenue and volume. Revenue grew 6.5% year-on-year to reach $3.2 billion on the back of a strong performance in merchandise and intermodal segments which was partially offset by a decline in coal revenue. [1] Overall revenue per unit declined 1% due to an unfavorable mix in the coal segment. CSX’s earnings per share improved 4% driven by a 2% increase in net profits.

CSX’s management reiterated its modest earnings per share growth expectations, compared to an earlier guidance of 10-15%, due to the poor performance in the first quarter. The management also announced an increase in its capital expenditure for the year by $100 million, bringing the total to $2.4 billion. The increased amount will be used to enhance infrastructure and add freight cars.

See our complete analysis of CSX here

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Growth in production of petroleum products and feed grains and increase in construction activity boosted Merchandise shipments

CSX’s merchandise revenue grew 11% and volume was up 8.3% on account of increase in agricultural, chemical and housing and construction related shipments. [1]

  • Last year’s strong corn and soybean harvest helped drive agricultural shipments. Corn production grew 30% in the last year pushing down prices. This encouraged an increase in ethanol production, which also contributed to the increase in agricultural shipments. [2] 
  • Continued growth in crude oil, liquid petroleum gas and frac sand contributed to the increase in industrial shipments.
  • Housing and construction activity recommenced in the second quarter after being hampered by the harsh weather during the first quarter driving growth in housing and construction related shipments. Carryover from the first quarter also contributed to the growth.

Increasing demand for intermodal services and port labor issues drive growth in intermodal shipments

Intermodal demand has been rising given its cost, capacity and time advantage over trucks. Because of this, CSX and other railroads have experienced continued growth in intermodal shipments. In the second quarter, CSX’s intermodal shipments were also impacted by an increase in international shipments as a consequence of contract negotiations between the West Coast longshore labor and marine terminal operators. [3] In order to avoid any risk arising out of the ongoing talks, retailers increased shipments of holiday merchandise coming into the U.S. leading to high traffic at U.S. ports.

Low coal prices in global markets present headwinds for U.S. coal leading to a decline in CSX’s coal revenue

Low prices for thermal and metallurgical coal in the global market have created a challenging environment for U.S coal leading to a decrease in coal exports. [4] [5] This has significantly impacted CSX’s export coal shipments, the volume of which decreased 10% year-on-year in the second quarter. [1] Decline in export coal volume also had a negative impact on coal revenue per unit. Increase in domestic coal shipments, driven by renewed demand from utilities, was not enough to counter the decline in revenue caused by export coal. The rise in price of natural gas and low coal inventory at north and south utilities have rejuvenated the demand for coal thereby boosting domestic coal shipments.

Operating ratio improves sequentially however it still remains a concern

Though not as bad as the operating ratio in the first quarter, CSX’s second quarter operating ratio (operating expenses are expressed as a percentage of revenues) increased 20 basis points to reach 69.3% due to the after effects of a harsh winter weather. [1] Its operating ratio increased 5.2% to reach 75.5% in the first quarter. [6] Performance improvement related costs, high fuel consumption, increase in labor overtime, high volume-related costs and inflation drove up operating expenses by 7% in the second quarter.

It will be important for CSX to maintain its operating ratio at the current level in the coming quarters if it wants to tie-out its 2014 operating ratio with 2013. However, if we look at the trend in the past three years, CSX’s operating ratio has always dipped in the second quarter and then increased in the following quarters. If the same trend continues in 2014, then it is likely that CSX’s operating ratio will be higher than its 2013 operating ratio of 71.1%.

Outlook for the third quarter

CSX’s third quarter results will be driven by the same trends that impacted its second quarter. Growth in production of grains, crude oil, liquid petroleum gas, automobiles and increase in demand for coal at utilities and intermodal services will continue to drive CSX’s earnings. However, export coal shipments will present headwinds since the low price environment is expected to continue with no indications of a reversal in the near future. CSX’s operating ratio will also be a point of concern and we shall be following its movement closely.

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Notes:
  1. CSX Q2 2014 Financial Report, www.csx.com [] [] [] []
  2. Crop Production, www.usda.gov []
  3. Retailers Step Up Holiday Imports In Case Of A West Coast Port Strike, June 9 2014, www.forbes.com []
  4. Metallurgical Coal to Stay Cheap for Years, Moody’s Says, July 11 2014, www.bloomberg.com []
  5. Report: Thermal coal price forecasts too pessimistic, June 11 2014, www.mining.com []
  6. CSX Q1 2014 Financial Report, www.csx.com []