CSX Earnings Preview: Pricing Increase Could Offset Sluggish Volumes

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CSX Corporation (NYSE: CSX) will be reporting its first quarter earnings results on April 14, after market close. Its carload report for the quarter to date ending March 28, paints a weak picture with overall carload traffic remaining stagnant. CSX’s coal carloads have declined due to weak export prices and domestic demand. Carloads of industrial commodities such as chemicals, petroleum products, metals and automobiles, and intermodal carload were sluggish due to the bad weather. The railroad’s revenue will be majorly reliant on its pricing, which is expected to show robust growth this year. Its operating ratio (operating expenses expressed as a percentage of revenue) is likely to have benefited from the pricing increase, as well as a decline in fuel prices.

In the fourth quarter, CSX’s revenue grew 5% driven by broad-based volume growth but unaided by revenue per unit. [1] Its net income increased 15% driven by solid improvements in its operating ratio (operating expenses expressed as a percentage of revenue). Earnings per share increased 17% in the fourth quarter, benefiting from a lower share count.

See our complete analysis of CSX here

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Weak Coal Carloads

U.S. railroads have been suffering from weak metallurgical and thermal coal prices in the global market. Coal prices have slumped due to high exports from Australian coal suppliers and low demand from China. The strong U.S. dollar has also presented headwinds. U.S. coal suppliers have either had to lower their prices in order to remain competitive or have stopped exporting. This has led to steep declines in railroads’ export coal carloads.

On the domestic front, the demand for coal at electric utilities has declined. For the month of January, coal consumption at electric utilities declined 15% year-on-year, leading to a 16% rise in coal stock piles. [2] [3] The spot price for natural gas at Henry Hub has remained close to $3 per million btu in the past few months, a level at which utilities start to shift from coal to natural gas. This is also evident from the rise in natural gas consumption at electric utilities, which grew 6% year-on-year in January. [4]

CSX’s coal carloads, which accounted for 22.5% of its revenues in 2014, have been suffering due to these trends. Its coal carloads have declined 5% in the quarter to date ending March 28. [5]

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 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 in demand for rail services, thereby increasing pricing power for railroads such as CSX.

Operating Ratio Could Improve On Low Fuel Expenses

CSX’s fourth quarter operating ratio improved 140 basis points, to reach 71.8%, compared to 73.2% in the previous year’s fourth quarter as fuel expenses declined $47 million due to the declining fuel prices. [1] However, the decline in fuel prices took a toll on fuel surcharge revenue, which declined 3% in the fourth quarter.

In the first quarter, we expect to see a repeat of the past quarter’s trends that helped improve CSX’s operating ratio. The average price of the U.S. on-highway diesel fuel declined 26% year-on-year in the first quarter, which should have helped reduce CSX’s fuel bills. [8] However, its fuel surcharge will likely have taken a hit. This may have been offset by the increase in pricing we mentioned earlier.

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Notes:
  1. CSX’s Q4 2014 Financial Report, www.csx.com [] []
  2. Table 2.1.A. Coal: Consumption for Electricity Generation, March 27, 2015, www.eia.gov []
  3. Electric Power Sector Coal Stocks: January 2015, March 27, 2015, www.eia.gov []
  4. Table 2.4.A. Natural Gas: Consumption for Electricity Generation, March 27, 2015, www.eia.gov []
  5. CSX’s 2015 Week 12 Carloading Report, www.csx.com []
  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 []
  8. U.S. On-Highway Diesel Fuel Prices (dollars per gallon), www.eia.gov []