VALUATION HIGHLIGHTS

1. Merchandise Freight constitutes 58% of the Trefis price estimate for CSX Corporation's stock.
2. Intermodal Freight constitutes 18% of the Trefis price estimate for CSX Corporation's stock.
3. Coal Freight constitutes 14% of the Trefis price estimate for CSX Corporation's stock.

WHAT HAS CHANGED?

1. Impact of Coronavirus On CSX Corporation's Stock

CSX stock lost more than 35% – dropping from $26 (price adjusted post stock split) at the beginning of 2020 to below $17 in late March 2020 – then spiked over 2x to around $35 now (through Apr 28, 2022). That means it is now roughly 35% above the pre-Covid levels.

Why? While the Covid-19 outbreak and associated lockdowns resulted in an uncertain outlook for the broader markets, the multi-billion-dollar Fed stimulus announced in late March 2020 helped the markets stage a strong recovery. Q1 2021 marked the beginning of the vaccination programs by various governments, resulting in the global economic rebound, which bode well for CSX's transportation business.

Overall, 2020 marked a year of sales and earnings decline for railroad companies. The coronavirus crisis had a significant impact on transportation demand in 2020, due to an overall decline in manufacturing, lower consumer demand, lower oil prices impacting production and transportation of oil and related products, as well as lower natural gas prices resulting in lower demand for coal. Given the tensions between the U.S. and China on trade, the exports were also hit.

2. Q1 2022 Performance

CSX has been focused on reducing its operating ratio over the last few years. Despite the challenges during the pandemic, CSX reported a low figure of 58.8% in 2020, just 40 bps higher compared to the 58.4% in 2019. In 2021, the company's operating ratio stood at 55.3%. However, in Q1 2022, the figure rose to 62.4% (vs. 60.9% in the prior-year quarter) due to inflationary pressure.

The company's top line expanded a good 21% y-o-y to $3.4 billion, driven by growth in all segments. Coal freight revenues were up 39%, intermodal up 13%, and merchandise freight revenues were up 6% during the quarter. Looking at the bottom line, EPS grew 26% (y-o-y) to $0.39.

3. Trends In Coal Shipments

With the increased use of cleaner sources of energy such as natural gas, the demand for coal has dropped drastically over the last few years. Consequently, coal shipments have witnessed a sharp decline over the last five years. However, if there is any sharp movement in natural gas prices, it would result in higher coal demand. In 2018, utility coal shipments remained sluggish, while the coal export saw a strong uptrend, given the overall coal prices and demand in international markets. Exports weakened in 2019, and with natural gas prices falling sharply in 2020, coal demand has also declined. That said, 2021 figures were high due to favorable comparisons, given the very low volume shipped in 2020, as well as due to nearly a 2x rise in natural gas prices over the last year or so, sending the coal demand higher.

4. Greater Infrastructure Spending Plans To Boost Prospects of Railroads

The US government has promised a $1 trillion overhaul of domestic infrastructure, with an emphasis on transportation infrastructure, including railways. Improvements in transportation infrastructure, as well as a boost to economic growth from the pro-business policies of the federal government, should boost the shipments of railroad companies such as CSX.

POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICE

Below are the key drivers of CSX's value that present opportunities for upside or downside to the current Trefis price estimate:

• CSX's Total Carloads of Coal: We currently forecast CSX's Total Carloads of Coal to rise marginally from 0.71 million in 2021 to 0.80 million by the end of the Trefis forecast period, as we expect the upside for natural gas prices to remain limited in the coming years.
  However, potential steps pertaining to loosening environmental regulation on coal production by the U.S. government could significantly boost coal production in the country. If CSX's Total Carloads of Coal rise to 1.1 million tons by the end of our forecast period, as opposed to 0.80 million in the base case, it would result in a 5% upside to our price estimate.

• CSX's EBITDA margin: We currently forecast CSX's EBITDA margin to rise marginally to 58%, compared to levels of 57% in 2021, primarily driven by productivity initiatives being undertaken by the company. CSX has achieved an operating ratio of less than 56% in 2021, by undertaking productivity improvement initiatives. There could be a downside of roughly 10% to the Trefis price estimate if the growth is below expectations, and margins were to hover around 50% by the end of the Trefis forecast period, as opposed to 58% in our base case forecast.

BUSINESS SUMMARY

CSX is the leading railroad in the Eastern U.S., engaged primarily in freight transportation in the Southeast, East, and Midwest regions of the U.S. CSX also transports overseas freight through Atlantic and Gulf Coast ports in addition to providing freight to the Western U.S. through interchange with other railroads.

CSX’s rail network of more than 36,000 route miles serves many large population centers in 23 states east of the Mississippi River in addition to Washington DC, Ontario, and Quebec. CSX's primary competitor is Norfolk Southern, which covers much of the same territory.

We have broken up our analysis of CSX into four major business segments: Coal Freight; Merchandise Freight (which includes chemicals, automotive, agriculture, and others), Intermodal Freight (freight which can be switched from train to another mode of transport like ships), and Trucking & Others, which include revenue from trucking business and railroads that the company does not directly operate, revenue for customer volume commitments not met, and other items.

CSX's customers include steamship lines, vehicle manufacturers, agricultural companies, utilities, intermodal companies, and chemical manufacturers.

SOURCES OF VALUE

We believe the Merchandise Freight is the most valuable division, and it contributes around 65% of CSX's total value. The key factors responsible for this are:

Tightening Trucking Capacity

Declining fleet sizes and inadequate availability of truck drivers have significantly tempered the freight transport capacity of the trucking industry. The Hours-of-Service safety regulation for commercial vehicle drivers has put pressure on trucking capacity by limiting the number of working hours for truck drivers. The tight trucking capacity will lead to high volumes of freight shifting to railroads. As the demand for railroads’ services increases, so will their pricing power.

Growth In The U.S. economy

The U.S. has seen healthy growth in the past before the pandemic, driven by growth in sectors such as automotive, industrials, and housing. CSX has benefited from this growth through an increase in carloads for its Industrials, Housing & Construction, and Automotive segments.

However, given the Covid-19 pandemic in 2020, economic growth has taken a severe hit. Now that a significant portion of the U.S. population is fully vaccinated for Covid-19, the economic growth is picking up pace. After nearly a 10% GDP growth in 2021, the U.S. economy is expected to grow by another 3% in 2022. This will bode well for CSX's business.

KEY TRENDS

Trends In Coal Market

CSX's coal shipments rose in 2017, as a result of rising demand for the commodity from utilities. An increase in natural gas prices in 2017 boosted the share of coal in U.S. electricity generation. Coal benefited from higher exports in 2018. However, coal shipments remained sluggish in 2019 and 2020. Natural gas prices remained high for the better part of 2021, and this resulted in an increase in demand for coal. In the medium to long run, favorable policy support from the U.S. government could boost shipments from the recent lows.