CSX Corporation (NYSE:CSX) is the leading Class-1 railroad in the Eastern United States and transports raw materials, intermediate products and finished goods. The company operates on 21,000 route miles of rail network, which serves major population centers in 23 states east of the Mississippi River, the District of Columbia and the Canadian provinces of Ontario and Quebec. CSX also transports overseas freight through several Atlantic and Gulf Coast ports. CSX competes with Norfolk Southern Corporation (NYSE:NSC), which covers much of the same territory, as other as with other railroads like Union Pacific (NYSE:UNP) Burlington Northern (owned by Berkshire Hathaway (NYSE:BRK.A)).
We recently launched coverage activity on CSX Corporation with a $32 price estimate for the company’s stock, which is around 16% ahead of the market price.
Launch of Coverage on CSX Corporation; $32 Price Estimate
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We have broken down our analysis of CSX Corporation into 6 main divisions:
- Coal Freight
- Industrial Freight
- Agricultural Freight
- Intermodal Freight
- Housing & Construction Commodities Freight
- Other services
North American Railroads at a Glance
Railroads are an important segment of freight transportation industry in the United States. They serve many of the fastest growing population centers and provide a fuel-efficient, environmentally responsible and safe mode of freight transportation. They move everything – coal and lumber, automobiles and scrap iron, grains and vegetables, chemicals and oils, transporting 42% of United States’ freight (measured in ton-miles) – more than any other mode of transportation. With numerous consolidations and acquisitions, U.S. railroads are monopolistic in nature and carry high barriers to entry for new entrants.
Freight demand is extremely impacted by the economy. The slowdown of 2008-09 had a considerable drag in volume levels, leading to a record decline in the railroad freight revenues. Strong demand recovery characterized 2010 railroading, but we think there’s room for more growth, especially for coal and intermodal freight. The total 2010 carloads plus the intermodal units are still below 2008 levels so the railroads have further opportunity for volume growth.
The recent margin and productivity trends have exceeded market expectations and the railroads have set records even during the recession. The margin improvements are primarily attributable to the railroad’s continued repricing above rail inflation, volume growth and the productivity gains with normalizing costs. Expanding train lengths is the key to rail profitability and the railroads have a potential to leverage the recovering volumes.
Export Coal and Intermodal Outlook Presents Upside
Coal freight service of CSX consists of transportation of coal and petroleum coke and accounts for the highest share of CSX total freight volume, representing 38% of total carloads (excluding intermodal units) in 2010. Export coal freight is a very profitable segment of CSX due to its highly efficient unit train configurations and longer than average lengths of haul. Given the tight truckload capacity, improving global coal demand and CSX’s high exposure to export volumes, the export coal is expected to grow at a relatively higher rate than other segments, thereby providing an operating leverage. Coal volume recovery has been relatively slow in 2010 and the coal volumes are still below pre-recession levels, leaving enough room for growth.
The intermodal volume recovered rapidly driving strong margin improvements. The segment carries high incremental margins as train lengths are extended because the additional costs associated with adding containers to existing trains are low. The intermodal freight segment of CSX has a stiff competition with several truck carriers due to the eastern railroads’ relatively shorter length of hauls. Rising fuel prices, a shortage of long-haul drivers and highway congestion is expected to hamper the trucking industry, thereby encouraging railroads to gain market share. The increasing truck rates also deliver pricing flexibility to CSX.