CSX Earnings: Low Fuel Prices Drive Earnings, But For How Long?

CSX’s (NYSE:CSX) stock jumped 3.4% during after-hours trading on Tuesday, as the company reported better than expected earnings. Given the weakness across most commodity carloads, the market was expecting earnings of $0.53 per share, flat when compared to the previous year. However, low fuel prices and efficiency initiatives drove a significant reduction in the railroad operator’s expenses, leading to a healthier bottom line of $0.56 per share. ^[1] As expected, lower fuel surcharge revenues and weak coal volumes hurt CSX’s top line, which declined 6%, to just cross $3.0 billion, partially benefiting from the increase in pricing. Going forward, we expect the same trends to continue to impact the railroad operator’s revenue. However, it seems that the net impact of fuel will be negative through the second half of the year. Coupled with steeper declines in coal volumes, this could turn out to be a weak year for CSX.

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Low Fuel Price Reduces Operating Expense

Crude oil prices have declined significantly over the past year, leading to a sharp drop in fuel prices. The average price of the U.S. on-highway diesel fuel declined 28% year-on-year in the second quarter. ^[2] This led to a $153 million, or 37%, decline in CSX’s fuel expense. The lower fuel bill helped reduce CSX’s operating expenses, which declined by $200 million, leading to a 250 basis point improvement in the railroad operator’s operating ratio (operating expenses expressed as a percentage of revenues).

While the lower fuel prices reduced CSX’s fuel bill, it also brought down its fuel surcharge revenue. For the second quarter, the railroad operator reported a $183 million decline in fuel surcharge revenues as a result of the drop in fuel prices. This more than offset the favorable impact of a 3.5% increase in CSX’s same store sales pricing.

Through the first quarter, CSX had been enjoying a net positive fuel lag impact due to falling fuel prices. This is because fuel surcharge is based on two month lagged values of U.S. on-highway diesel prices, while fuel expenses are based on spot prices. Since fuel prices were declining continuously, spot prices were lower than prices two months back, leading to lower fuel expenses than fuel surcharge revenues and resulting in a net positive benefit. However, this appears to have changed in the second quarter.

The price of U.S. on-highway diesel fuel had been fluctuating around its lows in the first half of the year, as crude oil prices showed some upwards momentum. In the first week of February, the average price of U.S. on-highway diesel fuel declined to $2.83. It climbed to $2.94 by the second week of March. In the second week of April, the average price of U.S. on-highway diesel fuel declined to a low of $2.75. ^[2] However, it climbed to $2.91 by the fourth week of May. Thereafter, the U.S. on-highway diesel fuel price continued to gradually decline, ending the fourth week of June with an average price of $2.84. Since fuel prices had been fluctuating around the same level over the past couple of months, spot prices were relatively in line with prices two months before. This led to a slightly negative fuel lag impact for CSX in the second quarter.

The U.S. Energy Information Administration (EIA) expects that the price of U.S. on-highway diesel will increase over the second half of the year. ^[3] This could negatively impact CSX over the next couple of quarters, as diesel spot prices will likely be higher, leading to higher fuel bills and comparatively lower fuel surcharge revenue. As a result, the railroad operator might see a drop in earnings and increase in its operating ratio. However, since the fuel price would still be lower than what it was in 2014, the impact may not be major.

Coal Declines Could Become Heavier

CSX reported an 11% decline in coal volume for the second quarter as a result of weak domestic and export demand. ^[1] The domestic demand for coal has been severely tempered as a result of electric utilities moving to natural gas for power generation because of its lower price. This is also evident from the rise in natural gas consumption at electric utilities, which grew 25% year-on-year in April, ^[4] while coal consumption declined 11% year-on-year, ^[5]

Going forward, domestic coal demand will likely remain low as electric utilities are currently well stocked with coal. According to the EIA, electric utilities’ coal stock piles in April were 30% higher than the previous year. ^[6] CSX expects a 10% decline in its annual coal volumes, compared to its previous forecast of a 5% decline, as a result of the high stock piles and competitive natural gas prices.

CSX’s export coal volumes 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, resulting in a decline of export coal volumes for CSX. For the second quarter, CSX’s export coal tonnage fell 18%. ^[1]

Metallurgical coal was trading at around $111.50 per ton by the end of May. ^[7] However, prices are likely to go down further as a result of new contracts for the third quarter, which have been priced at $93 per ton. ^[8] Thermal coal is also trading at lows of $50 per ton, compared to its peak of $338.75 per ton in 2011. According to Citi, the low price environment will likely persist. ^[7] This should keep the pressure on U.S. metallurgical and thermal coal producers and temper exports, which will likely lead to a decline in CSX’s export coal volumes in the future, as well as its coal revenue per carload.

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1. CSX’s Q2 2015 Financial Report, CSX’s Website [↩] [↩] [↩]
2. U.S. On-Highway Diesel Fuel Prices (dollars per gallon), www.eia.gov [↩] [↩]
3. Diesel Fuel Retail Incl Taxes U.S. Average, July 7, 2015, EIA’s Short Term Energy Outlook Report [↩]
4. Table 2.4.A. Natural Gas: Consumption for Electricity Generation, June 25, 2015, www.eia.gov [↩]
5. Table 2.1.A. Coal: Consumption for Electricity Generation, June 25, 2015, www.eia.gov [↩]
6. Stocks of Coal: Electric Power Sector – April 2015, June 25, 2015, www.eia.gov [↩]
7. Coal headwinds tipped to drive down prices, May 28, 2015, The Sydney Morning Herald [↩] [↩]
8. Met Coal Hits Lowest Price in a Decade, June 17, 2015, Wall Street Journal [↩]