CSX Could See Growth Despite Coal Weakness

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At the JPMorgan Aviation, Transportation and Industrials Conference, CSX Corporation (NYSE: CSX) announced that it expects a 5% decline in its domestic coal volumes and some moderation in growth of crude oil carloads, which should have a negative impact on its top line. [1] Export coal will also present headwinds. However, we believe that there are several factors that are likely to more than offset the negative impact of coal and crude oil.

See our complete analysis of CSX here

Intermodal Will Likely Grow On Tightening Trucking Capacity

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Intermodal volumes have been an important driving factor for CSX in the past few years, cushioning the decline in coal carloads in 2012 and 2013. We believe that base level growth in intermodal volumes will primarily come from the tightening trucking capacity in the U.S.

The Hours-of-Service safety regulation for commercial vehicle drivers added pressure on the trucking industry, which was already suffering from a dearth of truck drivers and declining fleet sizes. Because of this limited trucking capacity, shippers began to move their merchandise by rail rather than trucks. Comparatively lower costs also made railroads a more attractive option. CSX’s intermodal service benefited from the highway-to-rail conversion of shipments and has been growing at a strong pace in the past few years.

According to its carloading report for the week ending February 28, CSX’s year to date intermodal carloads are up 1.3%. [2] The moderate growth is primarily due to the impact of the bad weather. However, once this weather improves, intermodal volumes should see strong growth as pent up carloads are cleared out.

Merchandise Volumes To Grow

Last year’s strong corn and soybean harvest helped drive CSX’s agricultural volume up by 4% in 2014. Corn output is expected to decline 4% this year, but it would still be the third highest ever. [3] The strong corn output in 2014 and 2015 should help continue to drive growth in CSX’s agricultural volumes this year. Also, low corn prices, driven by the high production, should encourage an increase in ethanol output, which will also contribute to an increase in CSX’s agricultural volumes.

Housing starts and building permits had a strong 2014, driving CSX’s housing and construction related volumes up by 5%. We expect to see continued growth in the segment in 2015 as well, given the National Association of Home Builders’ forecast of a 16% increase in housing starts in 2015, compared to an 8% increase in 2014. [4]

Though the U.S Energy Information Administration (EIA) forecasts daily crude oil production to increase 8% in 2015, CSX’s crude oil volumes could face headwinds due to the declining price. [5] However, this is unlikely to have a significant impact on the top line since crude oil accounts for 2% of CSX’s chemicals volumes. Additionally, growth in production of petrochemicals in the U.S. should more than offset the impact of any moderation in crude oil volumes.

Robust Increase In Pricing Expected

On its fourth quarter earnings call, CSX announced that it expects to see a robust increase in its pricing of contracts for 2015. [6] In 2014, pricing took a hit due to weak export coal volumes. However, the company believes that the current environment is conducive for pricing growth.

The primary reason why CSX expects to see solid growth in its pricing is due to the leverage it has gained as a result of the tightening trucking capacity. The tight trucking capacity has led to high volumes of freight shifting to railroads. As the demand for railroads’ services increase, so will their pricing power. Additionally, railroads command a significant cost advantage over trucks. To give some perspective, CSX’s domestic intermodal volumes are priced 10-15% below truck rates. [7] This difference allows for significant leg room to increase prices while maintaining a cost advantage.

Growth in consumers’ disposable income, as a result of the decline in the cost of fuel, should also help drive railroads’ pricing power. With the higher disposable income, consumers are more likely to increase their spending. Since many consumer goods are transported across the U.S. by rail, the increase in purchase of such products may result in the rise of demand for rail services, thereby increasing pricing power for railroads such as CSX.

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Notes:
  1. Fredrik Eliasson addresses the J.P. Morgan Aviation, Transportation and Industrials Conference, March 4, 2015, www.csx.com []
  2. CSX’s 2015 Week 8 Carloadings Report, www.csx.com []
  3. Grains and Oilseeds Outlook, February 20, 2015, www.usda.gov []
  4. NAHB Housing and Interest Rate Forecast, February 2015, www.nahb.org []
  5. U.S. EIA Short Term Energy Outlook, www.eia.gov []
  6. CSX’s (CSX) CEO Michael Ward on Q4 2014 Results – Earnings Call Transcript, January 14, 2015, www.seekingalpha.com []
  7. CSX’s (CSX) CEO Clarence Gooden on Q3 2014 Results – Earnings Call Transcript, October 15, 2014, www.seekingalpha.com []