CSX’s Q3 Earnings Review: Lower Operating Expenses Offset Impact Of Lower Shipments And Fuel Surcharge Revenues

CSX Corporation (NYSE:CSX) released its third quarter earnings results on October 13 and conducted a conference call with analysts the next day. ^[1] Lower fuel expenses and the company’s initiatives to improve operating efficiency helped offset the impact of lower fuel surcharge revenues and lower shipments on the company’s bottom line. CSX’s net income stood at $507 million in Q3 2015, which matched the figure of $509 million reported in the corresponding period last year, despite a 9% year-over-year decline in revenues in Q3 2015. ^[1] Lower fuel surcharge revenues and shipment volumes offset the gains in core pricing to lower CSX’s quarterly revenues to $2.94 billion. ^[1] The key takeaway from the earnings conference call was the management’s commitment towards controlling expenses in a challenging business environment.

Lower Operating Expenses

Decline In Brent Crude Oil Prices Over Last Twelve Months, Source: Y Charts

CSX’s operating expenses declined around 11% year-over-year to $2.01 billion, primarily due to a $170 million, or 43%, year-over-year decline in fuel expenses. ^[1] The reduction in fuel expenses is primarily due to the decline in oil prices over the course of the last twelve months, which resulted in a roughly 31% year-over-year decline in highway diesel prices in Q3. ^[2] Highway diesel prices are the reference prices for calculating CSX’s fuel expenses. In addition to the decline in fuel prices, improvements in operating efficiency and lower shipment volumes also helped lower expenses. Productivity improvements helped reduce expenses by $42 million, whereas lower volumes reduced costs by $70 million. ^[3]

Lower Shipments and Fuel Surcharge Revenues

CSX’s revenues were negatively impacted by a decline in fuel surcharge revenues and lower shipments. CSX’s fuel surcharge revenues are tied to two month lagged values of highway diesel prices. Lower fuel surcharge revenues negatively impacted the company’s top line by $175 million. ^[3] In addition, the decline in shipments negatively impacted CSX’s revenues to the tune of $75 million. ^[3] Shipment volumes were 3% lower year-over-year in Q3, primarily due to an 18% decline in coal shipments. ^[1]

Weak demand for both thermal coal, which is used in electricity generation, and metallurgical coal, which is used in steelmaking, translated into a decline in CSX’s coal shipments. An adverse regulatory environment and weak natural gas prices have lowered the demand for thermal coal. The prevailing regulatory environment is extremely unfavorable for coal based power plants. As a part of the federal government’s crackdown on carbon dioxide emissions, new regulations target a 32% reduction in power plant carbon dioxide emissions from 2005 levels by 2030. ^[4] Since coal based power plants have a much higher emissions intensity as compared to natural gas based ones, the regulatory environment clearly supports a greater proportion of natural gas based power generation going forward. In addition to the adverse regulatory environment, weak natural gas prices have accelerated the pace of adoption of natural gas as the preferred fuel for electricity generation.  Natural gas prices are expected to average less than $3 per million British Thermal Units (MMBtu) in 2015, which is a level that favors increasing adoption of natural gas as the preferred fuel for electricity generation, undermining the demand for thermal coal. ^[5] Not only has weak demand negatively impacted CSX’s coal shipments in Q3, but the adverse regulatory environment is likely to lead to a decline in the demand for thermal coal, as well as the company’s shipments of the commodity, over the long term.

Besides weak thermal coal shipments, oversupplied global markets, weak steel prices, and a strong U.S. Dollar have negatively impacted CSX’s metallurgical coal shipments. Most of CSX’s met coal shipments are exported. Oversupplied global markets are likely to limit the upside for the company’s met coal shipments in the near term.

Increasing Operating Efficiency

Mindful of the fact that the prevailing business conditions characterized by weak coal shipments and lower fuel surcharge revenues could continue for some time, the company management stressed the goal of improving operating efficiency to maintain profitability, during the conference call. The company is striving towards a mid-60s operating ratio (operating expenses as a percentage of operating revenues) in the long term. ^[3] CSX’s operating ratio stood at 69.1% in the first nine months of 2015, as compared to 71.4% in the corresponding period last year. ^[1] While there is still a long way to go for CSX to achieve its stated target, more efficient operations would give the company the flexibility to deal with a variety of business environments.

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1. CSX Corporation’s Q3 2015 Earnings Release, SEC [↩] [↩] [↩] [↩] [↩] [↩]
2. U.S. On-Highway Diesel Fuel Prices (dollars per gallon), EIA [↩]
3. CSX Corporation’s Q3 2015 Earnings Call Transcript, Seeking Alpha [↩] [↩] [↩] [↩]
4. Obama’s New Climate-Change Regulations to Alter, Challenge Industry, Wall Street Journal [↩]
5. Short Term Energy Outlook, EIA [↩]