CSX Earnings: Volumes Up But Revenue Per Unit Remains Sluggish

CSX Corporation (NYSE: CSX), a leading railroad in the eastern U.S., reported its third quarter earnings on October 15. The company’s revenue grew 7.9%, to reach $3.2 billion, on strong volume growth across all commodities. ^[1] However, revenue per unit remained sluggish due to export coal headwinds and an unfavorable domestic coal mix. CSX’s net profits improved 11.8% on account of an improvement in its operating ratio (operating expenses expressed as a percentage of revenue). An increase in net profits and lower share count helped boost earnings per share for the quarter by 13.3%, to reach $0.51.

See our complete analysis of CSX here

Merchandise volumes up, driven by a strong agricultural harvest, growth in production of petroleum products and an increase in construction activity

CSX’s merchandise revenue grew 12.1% and volume was up 8.8% on account of an increase in agricultural, crude oil and housing and construction related shipments. ^[1]

• Last year’s strong corn and soybean harvest helped drive CSX’s 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] Corn production is expected to increase 4% year-on-year in 2014, to 14.5 billion bushels and soybean production is expected to increase 17% year-on-year, to 3.93 billion bushels. ^[3] This should help continue to drive growth in CSX’s agricultural volumes through 2014 and 2015.
• Crude oil production in the U.S has been increasing consistently since 2011, thanks to horizontal drilling techniques. ^[4] Shipments of frac sand, used for drilling, have also increased as a consequence of higher crude oil production. The U.S EIA forecasts crude oil production to increase to 8.54 million barrels per day in 2014 and 9.50 million barrels per day in 2015, compared to 7.44 million barrels per day in 2013. ^[5] CSX should continue to benefit from the growth in crude oil production.

• Housing starts have been fluctuating a lot in 2014. After a strong 1.117 million in July, housing starts declined to 956,000 in August. ^[6] However, these numbers were up 24% and 8% year-on year in July and August respectively, indicating a continued upward trend. Building permits have also been up year-on-year. These trends are driving the forecast for a 7.7% increase in housing starts in 2014. Housing starts for 2015 are expected to increase 24%. An increase in housing activity should continue to drive CSX’s housing and construction shipments. ^[7] 

Revenue per unit sluggish due to export coal headwinds

In line with our expectations, CSX’s revenue per unit grew at a sluggish pace of 0.8%. ^[1] This was primarily due to the impact of weak export coal prices and unfavorable domestic coal services mix. Prices for coal in global markets have dropped sharply due to high exports from Australian coal suppliers and low demand from China. U.S. coal suppliers have had to lower their prices in order to remain competitive or have stopped exporting. For CSX, this has resulted in a significant negative impact on revenue per unit generated from shipments of export coal. Export coal tonnage declined 13% in the third quarter, which led to a 6% decline in coal revenue per unit. Domestic coal tonnage was up 14% due to high demand at northern and southern utilities driven by high natural gas prices. A competitive gain had also contributed to the increase in domestic coal volume. This competitive gain likely refers to the contract loss that Norfolk Southern mentioned in its first quarter earnings release.

With a recent announcement of China imposing tariffs on imported coal, the low price environment is expected to continue. ^[8] This should continue to put pressure on U.S. coal, which will further impact CSX’s export coal volumes and revenue per unit.

Operating ratio improves but still remains a concern

CSX’s third quarter operating ratio improved 2.2%, to reach 69.7%, due to the higher growth in revenue compared to operating expenses. ^[1] Overall operating expenses increased 4.6%, with only fuel expenses moving in a favorable direction. Fuel expenses declined $14 million due to higher fuel surcharge as a result of the two month lag effect over the U.S. on-highway diesel prices. Since U.S. on-highway diesel price has been declining steadily from $4.00 in March to $3.79 in September, ^[9] the two month lag resulted in higher fuel surcharges.

All other expenses such as Labor & Fringe, Materials, Supplies & Others, Depreciation, and Equipment and Other Rents increased due to volume increase and inflation. These expenses are expected to increase in the coming quarters due to the same factors. CSX’s Labor & Fringe expenses will be higher in the coming quarters since it has started managing its locomotive maintenance force in-house. However, this will be offset by a corresponding decrease in Materials, Supplies & Others expense.

Despite improvements in operating ratio this quarter, CSX’s operating ratio for nine-months ended September 26, 2014 is still 100 basis points higher than the previous year’s operating ratio for the same period. In order to tie-out with last year’s operating ratio, CSX needs to aim for an operating ratio of 70.2% in the fourth quarter, which seems unlikely given the expected increase in volume for the fourth quarter and the sluggish pace of CSX’s revenue per unit.

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1. CSX’s Q3 2014 Financial Report, www.csx.com [↩] [↩] [↩] [↩]
2. Crop Production 2013, www.usda.gov [↩]
3. Crop Production,October 10, 2014, www.usda.gov [↩]
4. US Crude Oil Production Historical Data, www.ycharts.com [↩]
5. U.S. EIA Short Term Energy Outlook, October 7, 2014, www.eia.gov [↩]
6. US Housing Starts Historical Data, www.ycharts.com [↩]
7. NAHB Housing and Interest Rate Forecast, September 16, 2014, www.nahb.org [↩]
8. China’s Coal Tariff Prolongs the Pain, October 10, 2014, onlinw.wsj.com [↩]
9. U.S. No 2 Diesel Retail Prices, www.eia.gov [↩]