CSX Earnings Preview: Strong Domestic Volumes Likely To Offset Weak International Shipments

CSX Corporation (NYSE: CSX), a leading railroad in the eastern U.S., will be reporting its third quarter earnings on October 15. Similar to its previous quarter, CSX’s third quarter revenues will be driven by growth in shipments of commodities such as grains, crude, petroleum products, automobiles, domestic coal and intermodal. However, weak export coal shipments could present headwinds for the railroad’s revenue per package. We will be closely monitoring CSX’s international intermodal shipments to see if there has been any impact due to the expedited shipments witnessed in the previous quarter. A notable metric to keep an eye on will be CSX’s operating ratio (operating expenses are expressed as a percentage of revenues), which had increased considerably in the first quarter, followed by a marginal increase in the second quarter. A high operating ratio is not favorable for the railroad’s bottom line.

Revisiting second quarter 2014

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

Export coal shipments could depress revenue per unit; Domestic demand likely to drive volumes

Declining prices of thermal and metallurgical coal, due to high exports from Australian coal suppliers and low demand from China, have created a challenging environment for U.S. coal. Recent reports put thermal and metallurgical coal prices at their 5 year lows. ^{[2] [3]} U.S. coal suppliers have to significantly decrease their costs and reduce prices in order to compete with the global price, leading to lower revenues for railroads such as CSX. The lower shipments and revenues have a negative impact on CSX’s coal shipments and revenue per package.

In the previous quarter, CSX export coal shipments declined 10% and its coal revenue per unit declined 9%. The decline in revenue per unit was also the result of an unfavorable mix of domestic coal services. With export coal shipments 11% lower during the third quarter through week ending August 29, 2014, ^[4] we expect to see a similar impact on revenue per unit as in the previous quarter.

However, coal volumes are expected to remain up, driven by stable domestic demand from utilities. In August 2014, the coal tonnage available at north and south utilities were down 5.4% and 35.4% year-on-year respectively. ^[4] This was enough to last only for 65 and 74 days at the north and south utilities respectively, in line with the historic average, which would have encouraged utilities to replenish their inventory. Additionally, high natural gas prices will have supported the demand for coal. During the three months ended September 30, 2014, natural gas price averaged around $4.00 per million btu. At this price, coal from the Powder River Basin and Illinois Basin are profitable, which account for 50% of CSX’s coal shipments. ^[5]

International Intermodal Shipments could slow down

Expedited holiday season shipments during the second quarter may have had a negative impact on international intermodal shipments in the third quarter. Shippers had imported their holiday season merchandise earlier than usual due to concerns regarding the possible disruptions that could have been caused by the ongoing labor contract negotiations between ILWU and PMA. These expedited shipments led to 6% growth in CSX’s international intermodal volume in the second quarter.

Since shippers have already imported some of their third and fourth quarter merchandise, they will have fewer shipments later in the year, leading to a slowdown in international intermodal volume growth. CSX expects its international intermodal volumes to grow low single digits due to the impact of the high volume in the second quarter. ^[6]

However, growing domestic demand for intermodal services could considerably boost CSX’s intermodal volumes. Tightening trucking capacity is likely to drive volumes from the highway to rails. CSX believes that there is a 9 million truck load opportunity ^[4] in the eastern U.S. and it is well positioned to cater to the growing demand due its investments in expanding its intermodal capacity.

Deteriorating operating ratio needs to be put in check

CSX’s operating ratio increased 5.2%, to reach 75.5%, in the first quarter due to the impact of the harsh winter weather. ^[7] The spillover of costs into the second quarter led to a 20 basis points increase in the operating ratio, to reach 69.3%. ^[1] 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%, which could temper its earnings per share.

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1. CSX Q2 2014 Financial Report, www.csx.com [↩] [↩]
2. THERMAL COAL-Prices remain weak as Australian exports surge, October 7, 2014, www.reuters.com [↩]
3. Metallurgical Coal at 6-Year Low as Chinese Demand Slows, September 25, 2014, www.businessweek.com [↩]
4. Fredrik Eliasson Addresses UBS Best of Americas Conference, September 11, 2014, www.www.csx.com [↩] [↩] [↩]
5. Henry Hub Natural Gas Spot Price, www.eia.gov [↩]
6. CSX’s (CSX) CEO Michael Ward on Q2 2014 Results – Earnings Call Transcript, July 16, 2014, www.seekingalpha.com [↩]
7. CSX Q1 2014 Financial Report, www.csx.com [↩]